LIMESTONE BANCORP, INC. - FORM 10-Q

Attached files

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EX-32.2 - EXHIBIT 32.2 - LIMESTONE BANCORP, INC.	ex_126594.htm
EX-32.1 - EXHIBIT 32.1 - LIMESTONE BANCORP, INC.	ex_126593.htm
EX-31.2 - EXHIBIT 31.2 - LIMESTONE BANCORP, INC.	ex_126592.htm
EX-31.1 - EXHIBIT 31.1 - LIMESTONE BANCORP, INC.	ex_126591.htm

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the Quarterly Period Ended September 30, 2018

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

For the transition period from to

Commission file number: 001-33033

LIMESTONE BANCORP, INC.

(Exact name of registrant as specified in its charter)


Kentucky		61-1142247
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

2500 Eastpoint Parkway, Louisville, Kentucky		40223
(Address of principal executive offices)		(Zip Code)

(502) 499-4800

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

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

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

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☐(Do not check if a smaller reporting company)	Smaller reporting company ☒
	Emerging growth company ☐

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

6,236,590 Common Shares and 1,220,000 Non-Voting Common Shares, no par value, were outstanding at October 31, 2018.

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INDEX

		Page
PART I –	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS	3
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	33
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	48
ITEM 4.	CONTROLS AND PROCEDURES	48

PART II –	OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	49
ITEM 1A.	RISK FACTORS	49
ITEM 2.	UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS	49
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	49
ITEM 4.	MINE SAFETY DISCLOSURES	49
ITEM 5.	OTHER INFORMATION	49
ITEM 6.	EXHIBITS	49

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Limestone Bancorp, Inc. and subsidiary, Limestone Bank, Inc. are submitted:

Unaudited Consolidated Balance Sheets for September 30, 2018 and December 31, 2017

Unaudited Consolidated Statements of Income for the three and nine months ended September 30, 2018 and 2017

Unaudited Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2018 and 2017

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2018

Unaudited Consolidated Statements of Cash Flows for the nine months ended September 30, 2018 and 2017

Notes to Unaudited Consolidated Financial Statements

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LIMESTONE BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

	September 30, 2018			December 31, 2017
Assets
Cash and due from banks	$	5,770		$	8,137
Interest bearing deposits in banks		31,761			25,966
Cash and cash equivalents		37,531			34,103
Securities available for sale		184,870			152,720
Loans held for sale		—			70
Loans, net of allowance of $8,634 and $8,202, respectively		748,417			703,913
Premises and equipment, net		17,027			16,789
Other real estate owned		3,750			4,409
Federal Home Loan Bank stock		7,233			7,323
Bank owned life insurance		15,551			15,229
Deferred taxes, net		30,230			31,313
Accrued interest receivable and other assets		5,882			4,932
Total assets	$	1,050,491		$	970,801

Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing	$	135,561		$	137,386
Interest bearing		738,465			709,638
Total deposits		874,026			847,024
Federal Home Loan Bank advances		51,591			11,797
Accrued interest payable and other liabilities		5,662			6,057
Subordinated capital note		—			2,250
Junior subordinated debentures		21,000			21,000
Senior debt		10,000			10,000
Total liabilities		962,279			898,128
Commitments and contingent liabilities (Note 13)		—			—
Stockholders’ equity
Preferred stock, no par
Series E - none and 6,198 issued and outstanding, respectively; Liquidation preference of $6.2 million		—			1,644
Series F - none and 4,304 issued and outstanding, respectively; Liquidation preference of $4.3 million		—			1,127
Total preferred stockholders’ equity		—			2,771
Common stock, no par, 39,000,000 shares authorized, 6,236,590 and 6,039,864 voting, and 1,220,000 and 220,000 non-voting issued and outstanding, respectively		140,639			125,729
Additional paid-in capital		24,097			24,497
Retained deficit		(68,641	)		(75,108	)
Accumulated other comprehensive loss		(7,883	)		(5,216	)
Total common stockholders’ equity		88,212			69,902
Total stockholders' equity		88,212			72,673
Total liabilities and stockholders’ equity	$	1,050,491		$	970,801

See accompanying notes to unaudited consolidated financial statements.

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LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Income

(dollars in thousands, except per share data)

	Three Months Ended September 30,					Nine Months Ended September 30,
	2018			2017		2018			2017
Interest income
Loans, including fees	$	9,539		$	8,021	$	27,423		$	23,493
Taxable securities		1,245			1,088		3,386			3,370
Tax exempt securities		95			143		287			432
Federal funds sold and other		241			194		624			510
		11,120			9,446		31,720			27,805
Interest expense
Deposits		2,130			1,324		5,123			3,877
Federal Home Loan Bank advances		233			13		605			64
Senior debt		98			97		292			97
Junior subordinated debentures		247			193		694			553
Subordinated capital note		—			32		39			98
		2,708			1,659		6,753			4,689
Net interest income		8,412			7,787		24,967			23,116
Provision (negative) provision for loan losses		(350	)		—		(500	)		—
Net interest income after provision for loan losses		8,762			7,787		25,467			23,116

Non-interest income
Service charges on deposit accounts		608			568		1,767			1,617
Bank card interchange fees		411			387		1,258			1,118
Income from bank owned life insurance		100			103		337			309
Net gain (loss) on sales and calls of investment securities		—			—		(6	)		(5	)
Other		390			266		751			723
		1,509			1,324		4,107			3,762
Non-interest expense
Salaries and employee benefits		3,893			3,683		11,566			11,433
Occupancy and equipment		896			836		2,671			2,501
Professional fees		186			232		613			776
Marketing expense		259			364		867			880
FDIC Insurance		118			356		439			1,055
Data processing expense		281			321		912			931
State franchise and deposit tax		282			225		846			675
Deposit account related expense		213			222		653			646
Other real estate owned expense		271			111		590			92
Litigation and loan collection expense		61			78		162			121
Other		770			889		2,485			2,585
		7,230			7,317		21,804			21,695
Income before income taxes		3,041			1,794		7,770			5,183
Income tax expense		604			—		1,416			—
Net income		2,437			1,794		6,354			5,183
Basic and diluted income per common share	$	0.33		$	0.29	$	0.90		$	0.83

See accompanying notes to unaudited consolidated financial statements.

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LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Net income	$	2,437		$	1,794		$	6,354		$	5,183
Other comprehensive income (loss):
Unrealized gain (loss) on securities:
Unrealized gain (loss) arising during the period		(1,006	)		(280	)		(3,234	)		1,783
Amortization during the period of net unrealized loss transferred to held to maturity		—			32			—			98
Net unrealized gain (loss) recognized in comprehensive income		(1,006	)		(248	)		(3,234	)		1,881
Tax effect		211			—			680			—
Other comprehensive income (loss)		(795	)		(248	)		(2,554	)		1,881

Comprehensive income	$	1,642		$	1,546		$	3,800		$	7,064

See accompanying notes to unaudited consolidated financial statements.

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LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Nine Months Ended September 30, 2018

(Dollar amounts in thousands except share and per share data)

	Shares												Amount
	Preferred						Common						Preferred						Common
	Series E			Series F			Common		Non-Voting Common		Total Common		Series E			Series F			Common and Non-Voting Common		Additional Paid-In Capital			Retained Deficit			Accumulated Other Comprehensive Income (Loss)			Total

Balances, January 1, 2018		6,198			4,304			6,039,864		220,000		6,259,864	$	1,644		$	1,127		$	125,729	$	24,497		$	(75,108	)	$	(5,216	)	$	72,673
Issuance of unvested stock		—			—			46,726		—		46,726		—			—			—		—			—			—			—
Issuance of stock		—			—			150,000		1,000,000		1,150,000		—			—			14,910		—			—			—			14,910
Redemption and retirement of preferred shares		(6,198	)		(4,304	)		—		—		—		(1,644	)		(1,127	)		—		(734	)		—			—			(3,505	)
Stock-based compensation expense		—			—			—		—		—		—			—			—		334			—			—			334
Net income		—			—			—		—		—		—			—			—		—			6,354			—			6,354
Reclassification of disproportionate tax effect
due to change in federal tax rate		—			—			—		—		—		—			—			—		—			113			(113	)		—
Net change in accumulated other		—			—			—		—		—		—			—			—		—			—			(2,554	)		(2,554	)
comprehensive income, net of taxes
Balances, September 30, 2018		—			—			6,236,590		1,220,000		7,456,590	$	—		$	—		$	140,639	$	24,097		$	(68,641	)	$	(7,883	)	$	88,212

See accompanying notes to unaudited consolidated financial statements.

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LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Nine Months Ended September 30, 2018 and 2017

(dollars in thousands)

	2018			2017
Cash flows from operating activities
Net income	$	6,354		$	5,183
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		739			896
Provision (negative provision) for loan losses		(500	)		—
Net amortization on securities		669			931
Stock-based compensation expense		334			271
Deferred taxes, net		1,762			—
Net gain on sales of loans held for sale		(1	)		(39	)
Origination of loans for sale		—			(2,179	)
Proceeds from sales of loans held for sale		71			2,218
Net gain on sales of other real estate owned		(72	)		(75	)
Net write-down of other real estate owned		585			98
Net (gain) loss on sale of premises and equipment		(46	)		—
Net realized loss on sales and calls of investment securities		6			5
Earnings on bank owned life insurance, net of premium expense		(322	)		(293	)
Net change in accrued interest receivable and other assets		(950	)		1,929
Net change in accrued interest payable and other liabilities		(395	)		(10,183	)
Net cash from operating activities		8,234			(1,238	)

Cash flows from investing activities
Purchases of available for sale securities		(58,965	)		(15,340	)
Proceeds from sales and calls of available for sale securities		6,054			2,000
Proceeds from maturities and prepayments of available for sale securities		16,852			17,480
Proceeds from calls of held to maturity securities		—			47
Proceeds from maturities of held to maturity securities		—			145
Proceeds from redemptions of Federal Home Loan Bank stock		90			—
Proceeds from sale of other real estate owned		876			738
Net change in loans		(44,823	)		(43,590	)
Proceeds from sale of premises and equipment		141			328
Purchases of premises and equipment		(982	)		(153	)
Net cash from investing activities		(80,757	)		(38,345	)

Cash flows from financing activities
Net change in deposits		27,002			16,922
Payments of Federal Home Loan Bank advances		(85,206	)		(30,611	)
Advances from Federal Home Loan Bank		125,000			25,000
Payments of subordinated capital note		(2,250	)		(675	)
Proceeds from senior debt		—			10,000
Proceeds from issuance of common stock		14,910			—
Redemption of preferred stock		(3,505	)		—
Net cash from financing activities		75,951			20,636
Net change in cash and cash equivalents		3,428			(18,947	)
Beginning cash and cash equivalents		34,103			66,316
Ending cash and cash equivalents	$	37,531		$	47,369

Supplemental cash flow information:
Interest paid	$	7,631		$	4,140
Supplemental non-cash disclosure:
Transfer from loans to other real estate	$	730		$	270

See accompanying notes to unaudited consolidated financial statements.

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LIMESTONE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Limestone Bancorp, Inc. (Company) and its subsidiary, Limestone Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income or stockholders’ equity.

New Accounting Standards – In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASC 606”). The ASU provides guidance on revenue recognition for entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of non-financial assets. 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 majority of the Company’s revenues come from interest income and other sources, including loans and securities that are outside the scope of ASC 606. The Company’s services that fall within the scope of ASC 606 are presented in non-interest income and are recognized as revenue as the Company satisfies its obligation to the customer. Services within the scope of ASC 606 include service charges on deposit accounts, bank card interchange income, and the sale of OREO. Additional disclosures are required to provide quantitative and qualitative information regarding the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The new guidance became effective for the Company on January 1, 2018. The impact of adopting this new guidance did not have a material impact on the consolidated financial statements, but did result in additional disclosures, which have been incorporated into “Note 14 – Revenue from Contracts with Customers.”

In January 2016, the FASB issued an update ASU No. 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in this update impact public business entities as follows: 1) Require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. 2) Simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value. 3) Eliminate the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet. 4) Require entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. 5) Require an entity to present separately in other comprehensive income the portion of the total change in fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. 6) Require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements. 7) Clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. The amendments in this update became effective for the Company on January 1, 2018. The impact of adopting the new guidance did not have a material impact on the consolidated financial statements, but did require additional disclosures. The additional disclosures have been incorporated into “Note 8 – Fair Value Measurements.”

In February 2016, the FASB issued an update ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting in largely unchanged. The amendments in this update become effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. Based on the Company’s current lease agreements, the impact of adopting the new guidance on the consolidated financial statements will not have a material impact on the consolidated financial statements.

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In June 2016, the FASB issued ASU No. 2016-13, –Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. Under the CECL model, certain financial assets that are carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The change could materially affect how the allowance for loan losses is determined. The standard is effective for public companies for fiscal years beginning after December 15, 2019. Management has formed a cross functional committee that has overseen the enhancement of existing technology required to source and model data for the purpose of meeting this standard. The committee has selected a vendor to assist in generating loan level cash flows and disclosures. The impact of CECL model implementation is being evaluated, but it is expected that a one-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance. The magnitude of any adjustment or the overall impact of the new standard on financial condition or results of operation cannot yet be determined.

In March 2017, the FASB issued ASU No. 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization of Purchased Callable Debt Securities. The final standard will shorten the amortization period for premiums on callable debt securities by requiring that premiums be amortized to the first (or earliest) call date instead of as an adjustment to the yield over the contractual life. The standard is effective for public companies for fiscal years beginning after December 15, 2018. Adoption of this new guidance will not have a material impact on the consolidated financial statements.

In February 2018, the FASB issued ASU No. 2018-02, –Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects From Other Comprehensive Income. The final standard allows institutions to elect to reclassify the stranded tax effects from AOCI to retained earnings, limited to amounts in AOCI that are affected by the tax reform law. This includes remeasuring deferred tax assets and liabilities related to items presented in AOCI at the newly enacted tax rate and on other income tax effects of items remaining in AOCI. The standard is effective for public companies for fiscal years beginning after December 15, 2018, and interim periods during 2018. Early adoption is permitted. The Company adopted the standard on January 1, 2018 and adoption did not have a material impact on the consolidated financial statements as it resulted in a $113,000 entry between AOCI and retained deficit.

Note 2 – Securities

Securities are classified as available for sale (AFS). AFS securities may be sold if needed for liquidity, asset liability management, or other reasons. AFS securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax.

The amortized cost and fair value of securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
September 30, 2018
Available for sale
U.S. Government and federal agency	$	23,762	$	—	$	(1,112	)	$	22,650
Agency mortgage-backed: residential		88,526		79		(2,793	)		85,812
Collateralized loan obligations		34,908		4		(36	)		34,876
State and municipal		32,835		194		(381	)		32,648
Corporate bonds		8,877		32		(25	)		8,884
Total available for sale	$	188,908	$	309	$	(4,347	)	$	184,870

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December 31, 2017	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Government and federal agency	$	22,105	$	2	$	(483	)	$	21,624
Agency mortgage-backed: residential		65,935		117		(1,087	)		64,965
Collateralized loan obligations		25,343		182		(20	)		25,505
State and municipal		33,303		508		(101	)		33,710
Corporate bonds		6,838		78		—			6,916
Total available for sale	$	153,524	$	887	$	(1,691	)	$	152,720

Sales and calls of securities were as follows:

	Three Months Ended September 30,				Nine Months Ended September 30,
	2018		2017		2018		2017
	(in thousands)				(in thousands)
Proceeds	$	—	$	2,000	$	6,054	$	2,047
Gross gains		—		—		—		—
Gross losses		—		—		6		5

The amortized cost and fair value of our debt securities are shown by contractual maturity. Expected maturities may differ from actual maturities when borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are shown separately.

	September 30, 2018
	Amortized Cost		Fair Value
	(in thousands)
Maturity
Available for sale
Within one year	$	25,700	$	25,720
One to five years		55,798		54,962
Five to ten years		15,877		15,370
Beyond ten years		3,007		3,006
Agency mortgage-backed: residential		88,526		85,812
Total	$	188,908	$	184,870

Securities pledged at September 30, 2018 and December 31, 2017 had carrying values of approximately $55.7 million and $76.8 million, respectively, and were pledged to secure public deposits.

At September 30, 2018 and December 31, 2017, the Bank held securities issued by the Commonwealth of Kentucky or Kentucky municipalities having a book value of $15.2 million and $15.4 million, respectively. At September 30, 2018 and December 31, 2017, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

The Company evaluates securities for other-than-temporary impairment on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. As of September 30, 2018, management does not believe any securities in the portfolio with unrealized losses should be classified as other than temporarily impaired.

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Securities with unrealized losses at September 30, 2018 and December 31, 2017, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
	(in thousands)
September 30, 2018
Available for sale
U.S. Government and federal agency	$	7,191	$	(206	)	$	15,459	$	(906	)	$	22,650	$	(1,112	)
Agency mortgage-backed: residential		50,542		(1,172	)		27,602		(1,621	)		78,144		(2,793	)
Collateralized loan obligations		25,808		(36	)		—		—			25,808		(36	)
State and municipal		18,591		(381	)		—		—			18,591		(381	)
Corporate bonds		1,975		(25	)		—		—			1,975		(25	)
Total temporarily impaired	$	104,107	$	(1,820	)	$	43,061	$	(2,527	)	$	147,168	$	(4,347	)


December 31, 2017
Available for sale
U.S. Government and federal agency	$	5,788	$	(97	)	$	14,121	$	(386	)	$	19,909	$	(483	)
Agency mortgage-backed: residential		21,104		(172	)		27,158		(915	)		48,262		(1,087	)
Collateralized loan obligations		6,038		(20	)		—		—			6,038		(20	)
State and municipal		7,492		(101	)		—		—			7,492		(101	)
Total temporarily impaired	$	40,422	$	(390	)	$	41,279	$	(1,301	)	$	81,701	$	(1,691	)

Note 3 – Loans

Loans net of unearned income, deferred loan origination costs, and net premiums on acquired loans by class were as follows:

	September 30,			December 31,
	2018			2017
	(in thousands)
Commercial	$	125,699		$	113,771
Commercial Real Estate:
Construction		83,368			57,342
Farmland		83,917			88,320
Nonfarm nonresidential		163,346			156,724
Residential Real Estate:
Multi-family		46,144			56,588
1-4 Family		173,674			179,222
Consumer		40,242			18,439
Agriculture		40,144			41,154
Other		517			555
Subtotal		757,051			712,115
Less: Allowance for loan losses		(8,634	)		(8,202	)
Loans, net	$	748,417		$	703,913

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The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended September 30, 2018 and 2017:

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture		Other			Total
	(in thousands)
September 30, 2018:
Beginning balance	$	1,133		$	4,234		$	2,778		$	66		$	367	$	2		$	8,580
Provision (negative provision)		65			(48	)		(393	)		21			5		–			(350	)
Loans charged off		(50	)		–			(78	)		(15	)		–		–			(143	)
Recoveries		10			295			231			9			2		–			547
Ending balance	$	1,158		$	4,481		$	2,538		$	81		$	374	$	2		$	8,634


September 30, 2017:
Beginning balance	$	956		$	4,223		$	3,317		$	53		$	335	$	1		$	8,885
Provision (negative provision)		(41	)		206			(147	)		(31	)		15		(2	)		–
Loans charged off		(5	)		–			(57	)		(5	)		–		–			(67	)
Recoveries		3			9			103			25			16		3			159
Ending balance	$	913		$	4,438		$	3,216		$	42		$	366	$	2		$	8,977

The following table presents the activity in the allowance for loan losses by portfolio segment for the nine months ended September 30, 2018 and 2017:

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture			Other			Total
	(in thousands)
September 30, 2018:
Beginning balance	$	892		$	4,032		$	2,900		$	64		$	313		$	1		$	8,202
Provision (negative provision)		61			(68	)		(557	)		7			60			(3	)		(500	)
Loans charged off		(50	)		(198	)		(166	)		(49	)		(12	)		(8	)		(483	)
Recoveries		255			715			361			59			13			12			1,415
Ending balance	$	1,158		$	4,481		$	2,538		$	81		$	374		$	2		$	8,634


September 30, 2017:
Beginning balance	$	475		$	4,894		$	3,426		$	8		$	162		$	2		$	8,967
Provision (negative provision)		399			(791	)		134			(5	)		274			(11	)		–
Loans charged off		(5	)		(58	)		(512	)		(30	)		(95	)		–			(700	)
Recoveries		44			393			168			69			25			11			710
Ending balance	$	913		$	4,438		$	3,216		$	42		$	366		$	2		$	8,977

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The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of September 30, 2018:

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	–	$	46	$	190	$	–	$	–	$	–	$	236
Collectively evaluated for impairment		1,158		4,435		2,348		81		374		2		8,398
Total ending allowance balance	$	1,158	$	4,481	$	2,538	$	81	$	374	$	2	$	8,634

Loans:
Loans individually evaluated for impairment	$	56	$	1,377	$	2,371	$	–	$	–	$	–	$	3,804
Loans collectively evaluated for impairment		125,643		329,254		217,447		40,242		40,144		517		753,247
Total ending loans balance	$	125,699	$	330,631	$	219,818	$	40,242	$	40,144	$	517	$	757,051

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of December 31, 2017:

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	13	$	–	$	206	$	–	$	–	$	–	$	219
Collectively evaluated for impairment		879		4,032		2,694		64		313		1		7,983
Total ending allowance balance	$	892	$	4,032	$	2,900	$	64	$	313	$	1	$	8,202


Loans:
Loans individually evaluated for impairment	$	587	$	2,635	$	3,950	$	1	$	–	$	–	$	7,173
Loans collectively evaluated for impairment		113,184		299,751		231,860		18,438		41,154		555		704,942
Total ending loans balance	$	113,771	$	302,386	$	235,810	$	18,439	$	41,154	$	555	$	712,115

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Impaired Loans

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

The following tables present information related to loans individually evaluated for impairment by class of loans as of September 30, 2018 and December 31, 2017 and for the nine months ended September 30, 2018 and 2017:

	As of September 30, 2018						Three Months Ended September 30, 2018				Nine Months Ended September 30, 2018
	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	122	$	56	$	—	$	33	$	—	$	143	$	1
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		2,753		952		—		974		27		1,423		308
Nonfarm nonresidential		714		255		—		259		11		343		19
Residential real estate:
Multi-family		—		—		—		—		—		—		—
1-4 Family		2,761		1,619		—		1,591		116		2,048		151
Consumer		8		—		—		—		—		1		—
Agriculture		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—
Subtotal		6,358		2,882		—		2,857		154		3,958		479
With An Allowance Recorded:
Commercial		—		—		—		50		—		75		4
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		170		170		46		171		—		86		—
Nonfarm nonresidential		—		—		—		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—		—		—		—
1-4 Family		752		752		190		1,102		—		1,208		32
Consumer		—		—		—		—		—		—		—
Agriculture		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—
Subtotal		922		922		236		1,323		—		1,369		36
Total	$	7,280	$	3,804	$	236	$	4,180	$	154	$	5,327	$	515

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	As of December 31, 2017						Three Months Ended September 30, 2017				Nine Months Ended September 30, 2017
	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	703	$	487	$	—	$	499	$	—	$	497	$	—
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		3,687		2,059		—		2,336		—		2,800		209
Nonfarm nonresidential		1,047		576		—		311		1		752		53
Residential real estate:
Multi-family		—		—		—		—		—		1,025		—
1-4 Family		4,293		2,787		—		2,879		22		2,909		50
Consumer		9		1		—		—		2		2		2
Agriculture		—		—		—		60		1		30		1
Other		—		—		—		—		—		—		—
Subtotal		9,739		5,910		—		6,085		26		8,015		315
With An Allowance Recorded:
Commercial		100		100		13		100		1		100		5
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		—		—		—		—		—		294		—
Nonfarm nonresidential		—		—		—		294		5		298		14
Residential real estate:
Multi-family		—		—		—		—		—		—		—
1-4 Family		1,163		1,163		206		1,412		17		1,465		51
Consumer		—		—		—		—		—		—		—
Agriculture		—		—		—		—		—		30		—
Other		—		—		—		—		—		—		—
Subtotal		1,263		1,263		219		1,806		23		2,187		70
Total	$	11,002	$	7,173	$	219	$	7,891	$	49	$	10,202	$	385

Cash basis income recognized for the three and nine months ended September 30, 2018 was $93,000 and $410,000, respectively, compared to $24,000 and $309,000 for the three and nine months ended September 30, 2017, respectively.

Troubled Debt Restructuring

A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of September 30, 2018 and December 31, 2017:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
September 30, 2018
Commercial Real Estate:
Farmland
Principal deferral		—		700		700
Nonfarm nonresidential
Rate reduction		186		—		186
Residential Real Estate:
1-4 Family
Rate reduction		724		—		724
Total TDRs	$	910	$	700	$	1,610

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	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
December 31, 2017
Commercial
Rate reduction	$	—	$	33	$	33
Principal deferral		—		434		434
Commercial Real Estate:
Farmland
Principal deferral		—		1,362		1,362
Nonfarm nonresidential
Rate reduction		483		—		483
Residential Real Estate:
1-4 Family
Rate reduction		734		—		734
Total TDRs	$	1,217	$	1,829	$	3,046

At September 30, 2018 and December 31, 2017, 57% and 40%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated $162,000 and $122,000 in reserves to borrowers whose loan terms have been modified in TDRs as of September 30, 2018, and December 31, 2017, respectively. The Company has committed to lend no additional amounts as of September 30, 2018 and December 31, 2017 to borrowers with outstanding loans classified as TDRs.

Management periodically reviews renewals and modifications of previously identified TDRs, for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan subsequent to the date of the renewal/modification. In this instance, the TDR was originally considered a restructuring in a prior year as a result of a modification with an interest rate that was not commensurate with the risk of the underlying loan. Additionally, TDR classification can be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

No TDR loan modifications occurred during the three or nine months ended September 30, 2018 or September 30, 2017. During the first nine months of 2018 and 2017, no TDRs defaulted on their restructured loan within the twelve-month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

Non-performing Loans

Non-performing loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of September 30, 2018, and December 31, 2017:

	Nonaccrual				Loans Past Due 90 Days And Over Still Accruing
	September 30, 2018		December 31, 2017		September 30, 2018		December 31, 2017
	(in thousands)

Commercial	$	56	$	487	$	—	$	—
Commercial Real Estate:
Construction		—		—		—		—
Farmland		1,122		2,059		—		—
Nonfarm nonresidential		69		93		—		—
Residential Real Estate:
Multi-family		—		—		—		—
1-4 Family		1,445		2,817		—		—
Consumer		—		1		—		—
Agriculture		—		—		—		1
Other		—		—		—		—
Total	$	2,692	$	5,457	$	—	$	1

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The following table presents the aging of the recorded investment in past due loans as of September 30, 2018 and December 31, 2017:

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual
	(in thousands)
September 30, 2018
Commercial	$	—	$	—	$	—	$	56	$	56
Commercial Real Estate:
Construction		—		—		—		—		—
Farmland		369		372		—		1,122		1,863
Nonfarm nonresidential		128		—		—		69		197
Residential Real Estate:
Multi-family		—		—		—		—		—
1-4 Family		808		147		—		1,445		2,400
Consumer		43		8		—		—		51
Agriculture		144		402		—		—		546
Other		—		—		—		—		—
Total	$	1,492	$	929	$	—	$	2,692	$	5,113

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual

	(in thousands)
December 31, 2017
Commercial	$	—	$	—	$	—	$	487	$	487
Commercial Real Estate:
Construction		—		—		—		—		—
Farmland		593		—		—		2,059		2,652
Nonfarm nonresidential		—		—		—		93		93
Residential Real Estate:
Multi-family		—		—		—		—		—
1-4 Family		850		126		—		2,817		3,793
Consumer		30		45		—		1		76
Agriculture		5		—		1		—		6
Other		—		—		—		—		—
Total	$	1,478	$	171	$	1	$	5,457	$	7,107

Credit Quality Indicators

Management categorizes all loans into risk categories at origination based upon original underwriting. Thereafter, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed through internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through the credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

Watch – Loans classified as watch are those loans which have or may experience a potentially adverse development which necessitates increased monitoring.

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that the Bank will sustain some losses if the deficiencies are not corrected.

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Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of September 30, 2018, and December 31, 2017, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

	Pass		Watch		Special Mention		Substandard		Doubtful		Total
	(in thousands)
September 30, 2018
Commercial	$	125,392	$	180	$	—	$	127	$	—	$	125,699
Commercial Real Estate:
Construction		83,368		—		—		—		—		83,368
Farmland		77,827		2,796		—		3,294		—		83,917
Nonfarm nonresidential		160,671		2,017		—		658		—		163,346
Residential Real Estate:
Multi-family		40,992		5,152		—		—		—		46,144
1-4 Family		167,620		1,965		114		3,975		—		173,674
Consumer		39,890		23		—		329		—		40,242
Agriculture		39,916		181		—		47		—		40,144
Other		517		—		—		—		—		517
Total	$	736,193	$	12,314	$	114	$	8,430	$	—	$	757,051

	Pass		Watch		Special Mention		Substandard		Doubtful		Total

	(in thousands)
December 31, 2017
Commercial	$	112,978	$	84	$	—	$	709	$	—	$	113,771
Commercial Real Estate:
Construction		57,342		—		—		—		—		57,342
Farmland		76,563		7,607		—		4,150		—		88,320
Nonfarm nonresidential		152,004		2,906		—		1,814		—		156,724
Residential Real Estate:
Multi-family		47,121		9,467		—		—		—		56,588
1-4 Family		169,774		3,535		164		5,749		—		179,222
Consumer		18,042		306		—		91		—		18,439
Agriculture		38,654		1,810		—		690		—		41,154
Other		555		—		—		—		—		555
Total	$	673,033	$	25,715	$	164	$	13,203	$	—	$	712,115

Note 4 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.

Fair value of OREO is determined on an individual property basis. When foreclosed properties are acquired, management obtains a new appraisal of the subject property or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Updated appraisals are typically obtained within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a marketing price is lowered below the appraised amount.

The following table presents the major categories of OREO at the period-ends indicated:

	September 30, 2018		December 31, 2017
	(in thousands)
Commercial Real Estate:
Construction, land development, and other land	$	3,750	$	4,335
Farmland		—		74
	$	3,750	$	4,409

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Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $813,000 and $616,000 at September 30, 2018 and December 31, 2017, respectively.

Activity relating to OREO during the nine months ended September 30, 2018 and 2017 is as follows:

	For the Nine Months Ended September 30,
	2018			2017
	(in thousands)
OREO Activity
OREO as of January 1	$	4,409		$	6,821
Real estate acquired		730			270
Valuation adjustment write-downs		(585	)		(98	)
Net gain on sales		72			75
Proceeds from sales of properties		(876	)		(738	)
OREO as of September 30	$	3,750		$	6,330

Expenses related to other real estate owned include:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
	(in thousands)						(in thousands)
Net gain on sales	$	(22	)	$	(10	)	$	(72	)	$	(75	)
Valuation adjustment write-downs		260			98			585			98
Operating expense		33			23			77			69
Total	$	271		$	111		$	590		$	92

Note 5 – Deposits

The following table details deposits by category:

	September 30, 2018		December 31, 2017
	(in thousands)
Non-interest bearing	$	135,561	$	137,386
Interest checking		87,407		99,383
Money market		159,499		151,388
Savings		34,320		34,632
Certificates of deposit		457,239		424,235
Total	$	874,026	$	847,024

Time deposits of $250,000 or more were $29.2 million and $31.7 million at September 30, 2018 and December 31, 2017, respectively.

Scheduled maturities of total time deposits at September 30, 2018 for each of the next five years are as follows (in thousands):

Year 1	$	233,009
Year 2		200,558
Year 3		6,832
Year 4		6,714
Year 5		10,126
	$	457,239

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Note 6 – Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

	September 30,		December 31,
	2018		2017
	(in thousands)

Short term advances (fixed rates 2.18% to 2.29%) maturing October 2018	$	50,000	$	10,000
Long term advances (fixed rates 0.00% to 5.24%) maturing April 2020 to August 2033		1,591		1,797
Total advances from the Federal Home Loan Bank	$	51,591	$	11,797

FHLB advances had a weighted-average rate of 2.24% at September 30, 2018 and 1.48% at December 31, 2017. Each advance is payable per terms on agreement, with a prepayment penalty. No prepayment penalties were incurred during 2018 or 2017. The advances were collateralized by approximately $127.4 million and $130.9 million of first mortgage loans, under a blanket lien arrangement at September 30, 2018 and December 31, 2017, respectively. At September 30, 2018, our additional borrowing capacity with the FHLB was $41.1 million.

Scheduled principal payments on FHLB advances during the next five years and thereafter (in thousands):

	Advances
Year 1	$	50,174
Year 2		476
Year 3		728
Year 4		100
Year 5		77
Thereafter		36
	$	51,591

Note 7 – Senior Debt

The Company has a $10.0 million senior secured loan agreement with a commercial bank. The loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty. The lender retained a portion of the proceeds in escrow to service quarterly interest payments. At September 30, 2018, the escrow account had a balance of $514,000.

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $750,000 through June 30, 2018, and not less than $2,500,000 thereafter, (ii) the Company must maintain a total risk based capital ratio at least equal to 9% of risk-weighted assets to June 30, 2018, and 10% thereafter, (iii) the Bank must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets to June 30, 2018, and 11% thereafter, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of September 30, 2018.

Note 8 – Fair Values Measurement

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Various valuation techniques are used to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

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In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, the fair value hierarchy is classified on the lowest level of input that is significant to the fair value measurement. The following methods and significant assumptions are used to estimate fair value.

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Management routinely apply an internal discount to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined (1) to have a thin trading market or (2) to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

Management also apply discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. Discounts ranging from 10% to 33% have been utilized in our impairment evaluations when applicable.

Impaired loans are evaluated quarterly for additional impairment. Management obtains updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and the assessment of deterioration of real estate values in the market in which the property is located. The first stage of management’s assessment involves management’s inspection of the property in question. Management also engages in conversations with local real estate professionals, investors, and market participants to determine the likely marketing time and value range for the property. The second stage involves an assessment of current trends in the regional market. After thorough consideration of these factors, management will either internally evaluate fair value or order a new appraisal.

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less estimated cost to sell. Quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, management consults with staff from the Bank’s special assets group as well as external realtors and appraisers. Based on these consultations, management determines asking prices for OREO properties being marketed for sale. If the internally evaluated fair value or asking price is below the recorded investment in the property, appropriate write-downs are taken.

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For larger dollar commercial real estate properties, management obtains a new appraisal of the subject property or has staff in the special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management generally obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. When an asking price is lowered below the most recent appraised value, appropriate write-downs are taken.

Financial assets measured at fair value on a recurring basis at September 30, 2018 and December 31, 2017 are summarized below:

			Fair Value Measurements at September 30, 2018 Using
			(in thousands)
			Quoted Prices In				Significant
			Active Markets for		Significant Other		Unobservable
	Carrying		Identical Assets		Observable Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
Available for sale securities
U.S. Government and federal agency	$	22,650	$	—	$	22,650	$	—
Agency mortgage-backed: residential		85,812		—		85,812		—
Collateralized loan obligations		34,876		—		34,876		—
State and municipal		32,648		—		32,648		—
Corporate bonds		8,884		—		8,884		—
Total	$	184,870	$	—	$	184,870	$	—

			Fair Value Measurements at December 31, 2017 Using
			(in thousands)
Description	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government and federal agency	$	21,624	$	—	$	21,624	$	—
Agency mortgage-backed: residential		64,965		—		64,965		—
Collateralized loan obligations		25,505		—		25,505		—
State and municipal		33,710		—		33,710		—
Corporate bonds		6,916		—		6,916		—
Total	$	152,720	$	—	$	152,720	$	—

There were no transfers between Level 1 and Level 2 during 2018 or 2017.

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Financial assets measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurements at September 30, 2018 Using
			(in thousands)
Description		Carrying Value	Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans:
Commercial	$	—	$	—	$	—	$	—
Commercial real estate:
Construction		—		—		—		—
Farmland		124		—		—		124
Nonfarm nonresidential		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		562		—		—		562
Consumer		—		—		—		—
Agriculture		—		—		—		—
Other		—		—		—		—
Other real estate owned:
Commercial real estate:
Construction		3,750		—		—		3,750
Farmland		—		—		—		—
Nonfarm nonresidential		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		—		—		—		—

			Fair Value Measurements at December 31, 2017 Using
			(in thousands)
Description		Carrying Value	Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans:
Commercial	$	87	$	—	$	—	$	87
Commercial real estate:
Construction		—		—		—		—
Farmland		—		—		—		—
Nonfarm nonresidential		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		957		—		—		957
Consumer		—		—		—		—
Agriculture		—		—		—		—
Other		—		—		—		—
Other real estate owned, net:
Commercial real estate:
Construction		4,335		—		—		4,335
Farmland		74		—		—		74
Nonfarm nonresidential		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		—		—		—		—

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $922,000 at September 30, 2018 with a valuation allowance of $236,000, resulting in no additional provision for loan losses for the three months ended September 30, 2018 and an additional provision for loan losses of $18,000 for the nine months ended September 30, 2018. Impaired loans had a carrying amount of $1.7 million at September 30, 2017 with a valuation allowance of $399,000, resulting in additional provision for loan losses of $171,000 and $29,000, respectively, for the three and nine months ended September 30, 2017. At December 31, 2017, impaired loans had a carrying amount of $1.3 million, with a valuation allowance of $219,000.

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OREO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $3.8 million as of September 30, 2018, compared with $6.3 million at September 30, 2017 and $4.4 million at December 31, 2017. Write-downs of $260,000 and $585,000 were recorded on OREO for the three and nine months ended September 30, 2018, compared to write-downs of $98,000 for the three and nine months ended September 30, 2017, respectively.

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at September 30, 2018:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(in thousands)

Impaired loans – Residential real estate	$	562	Sales comparison approach	Adjustment for differences between the comparable sales		0%	-	26%	(9%)

Other real estate owned – Commercial real estate	$	3,750	Sales comparison approach	Adjustment for differences between the comparable sales		0%	-	35%	(18%)

			Income approach	Discount or capitalization rate			25%		(25%)

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2017:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(in thousands)

Impaired loans – Residential real estate	$	957	Sales comparison approach	Adjustment for differences between the comparable sales		0%	-	26%	(9%)

Other real estate owned – Commercial real estate	$	4,409	Sales comparison approach	Adjustment for differences between the comparable sales		0%	-	35%	(18%)

			Income approach	Discount or capitalization rate			25%		(25%)

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

			Fair Value Measurements at September 30, 2018 Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	37,531	$	5,770	$	31,761	$	—	$	37,531
Securities available for sale		184,870		—		184,870		—		184,870
Federal Home Loan Bank stock		7,233		N/A		N/A		N/A		N/A
Loans, net		748,417		—		—		733,877		733,877
Accrued interest receivable		3,707		—		1,119		2,588		3,707
Financial liabilities
Deposits	$	874,026	$	135,561	$	737,570	$	—	$	873,131
Federal Home Loan Bank advances		51,591		—		51,549		—		51,549
Junior subordinated debentures		21,000		—		—		16,344		16,344
Senior debt		10,000		—		—		9,908		9,908
Accrued interest payable		597		—		544		53		597

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			Fair Value Measurements at December 31, 2017 Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	34,103	$	8,137	$	25,966	$	—	$	34,103
Securities available for sale		152,720		—		152,720		—		152,720
Federal Home Loan Bank stock		7,323		N/A		N/A		N/A		N/A
Loans held for sale		70		—		70		—		70
Loans, net		703,913		—		—		703,263		703,263
Accrued interest receivable		3,136		—		925		2,211		3,136
Financial liabilities
Deposits	$	847,024	$	137,386	$	693,320	$	—	$	830,706
Federal Home Loan Bank advances		11,797		—		11,799		—		11,799
Subordinated capital notes		2,250		—		—		2,246		2,246
Junior subordinated debentures		21,000		—		—		19,090		19,090
Senior Debt		10,000		—		—		10,000		10,000
Accrued interest payable		1,475		—		357		1,118		1,475

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as either Level 1 or Level 2. Noninterest bearing deposits are Level 1 whereas interest bearing due from bank accounts and fed funds sold are Level 2.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(c) Loans, Net

At September 30, 2018, fair values of loans, excluding loans held for sale, are determined using an estimated exit price. Contractual cash flow estimates are projected using a loan’s balance, interest rate, repricing characteristics, maturity and payment amounts. Loans are grouped into homogenous pools for valuation purposes based on type and credit risk metrics. Contractual cash flows are adjusted for potential prepayment estimates, as well as potential defaults over the expected life of each pool. A discount rate is determined based upon current financial conditions and the nature of the cash flow forecast. The resulting exit price for the portfolio is a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously.

At December 31, 2017, fair values of loans, excluding loans held for sale, was estimated as follows: For variable rate loans that reprice frequently and with no significant change in credit risk, fair values were based on carrying values resulting in a Level 3 classification. Fair values for other loans were estimated using discounted cash flow analyses, using interest rates being offered for loans with similar terms to borrowers of similar credit quality resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans did not necessarily represent an exit price.

(d) Loans Held for Sale

The fair value of loans held for sale is estimated based upon binding contracts and quotes from third party investors resulting in a Level 2 classification.

(e) Deposits

The fair values for non-interest bearing non-maturity deposits are, by definition, equal to the amount payable on demand at the reporting date resulting in a Level 1 classification. The carrying amounts of interest bearing non-maturity deposits approximate their fair values at the reporting date resulting in a Level 2 classification. Fair values for interest bearing time deposits are estimated using discounted cash flow calculations that utilize the contract rate of the deposits discounted at current market rates for like maturities resulting in a Level 2 classification.

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(f) Other Borrowings

At September 30, 2018, fair values of FHLB advances are determined using an estimated exit price. Contractual cash flow estimates are projected for each advance utilizing contractual interest rates, repricing characteristics, maturities and payment amounts. Contractual cash flows are adjusted for potential prepayment estimates. A discount rate is determined based upon current market conditions and the nature of the cash flow forecast. The resulting exit price for FHLB advances is a Level 2 classification. At December 31, 2017, the fair values of FHLB advances were estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Level 2 classification.

At September 30, 2018, fair values of junior subordinated debentures and senior debt are determined using an estimated exit price. Contractual cash flow estimates are projected for each instrument utilizing contractual interest rates, repricing characteristics, maturities and payment amounts. Contractual cash flows are adjusted for potential prepayment estimates and credit risk. A discount rate is determined based upon current market conditions and the nature of the cash flow forecast. The resulting exit price is a Level 3 classification. At December 31, 2017, the fair values of subordinated capital notes, junior subordinated debentures, and senior debt were estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 3 classification.

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification based on the level of the asset or liability with which the accrual is associated.

Note 9 – Income Taxes

Deferred tax assets and liabilities were due to the following as of:

	September 30,		December 31,
	2018		2017
	(in thousands)
Deferred tax assets:
Net operating loss carry-forward	$	24,079	$	25,645
Allowance for loan losses		1,813		1,723
OREO write-down		2,555		2,432
Alternative minimum tax credit carry-forward		346		692
Net assets from acquisitions		307		358
Net unrealized loss on securities		848		169
New market tax credit carry-forward		208		208
Nonaccrual loan interest		234		271
Accrued expenses		204		172
Deferred compensation		269		277
Other		241		241
		31,104		32,188

Deferred tax liabilities:
FHLB stock dividends		557		557
Fixed assets		77		68
Deferred loan costs		141		152
Other		99		98
		874		875
Net deferred tax asset	$	30,230	$	31,313

At September 30, 2018, the Company had net operating loss carryforwards (“NOLs”) of $114.7 million, which will begin to expire in 2031. As of September 30, 2018, a total of $346,000 in alternative minimum tax credit carry-forward was reclassified to other assets as it is currently refundable for the 2018 tax year.

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the three or nine months ended September 30, 2018 or September 30, 2017 related to unrecognized tax benefits.

Under Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's voting and non-voting common shares increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.

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In 2015, the Company took two measures to preserve the value of its NOLs. First, the Company adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights plan was extended in May 2018 to expire upon the earlier of (i) June 30, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

On September 23, 2015, the Company’s shareholders approved an amendment to its articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions were extended in May 2018 by shareholder vote and will expire on the earlier of (i) May 23, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2015.

Note 10 – Stock Plans and Stock Based Compensation

Shares available for issuance under the 2018 Omnibus Equity Compensation Plan (“2018 Plan”) total 328,274. Shares issued to employees under the plan vest annually on the anniversary date of the grant over three years.

Shares issued annually to non-employee directors have a fair market value of $25,000 and vest on December 31 in the year of grant.

The fair value of the 2018 unvested shares issued was $654,000, or $13.99 per weighted-average share. The Company recorded $171,000 and $334,000 of stock-based compensation to salaries and employee benefits for the three and nine months ended September 30, 2018, respectively, and $129,000 and $271,000 for the three and nine months ended September 30, 2017, respectively. Management expects substantially all of the unvested shares outstanding at the end of the period to vest according to the vesting schedule. A deferred tax benefit of $36,000 and $70,000 was recognized related to this expense during the three and nine months ended September 30, 2018, respectively, and no deferred tax benefit during the three and nine months ended September 30, 2017.

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:

	Nine Months Ended					Twelve Months Ended
	September 30, 2018					December 31, 2017
				Weighted					Weighted
				Average					Average
				Grant					Grant
	Shares			Price		Shares			Price
Outstanding, beginning		142,334		$	5.67		179,513		$	4.89
Granted		46,726			13.99		37,865			9.64
Vested		(66,164	)		5.39		(73,728	)		5.75
Forfeited		—			—		(1,316	)		9.35
Outstanding, ending		122,896		$	8.98		142,334		$	5.67

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Unrecognized stock based compensation expense related to unvested shares for the remainder of 2018 and beyond is estimated as follows (in thousands):

October 2018 – December 2018	$	190
2019		259
2020		185
2021		67

Note 11 – Earnings per Share

The factors used in the basic and diluted earnings per share computations follow:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2018		2017		2018		2017
	(in thousands, except share and per share data)

Net income	$	2,437	$	1,794	$	6,354	$	5,183
Less:
Earnings allocated to unvested shares		40		45		105		133
Net income available to common shareholders, basic and diluted	$	2,397	$	1,749	$	6,249	$	5,050

Basic
Weighted average common shares including unvested common shares outstanding		7,455,316		6,259,864		7,059,472		6,245,418
Less:
Weighted average unvested common shares		122,097		157,412		117,060		160,825
Weighted average common shares outstanding		7,333,219		6,102,452		6,942,412		6,084,593
Basic income per common share	$	0.33	$	0.29	$	0.90	$	0.83

Diluted
Add: Dilutive effects of assumed exercises of common stock warrants		—		—		—		—
Weighted average common shares and potential common shares		7,333,219		6,102,452		6,942,412		6,084,593
Diluted income per common share	$	0.33	$	0.29	$	0.90	$	0.83

The Company had no outstanding stock options at September 30, 2018 or 2017. A warrant for the purchase of 66,113 shares of the Company’s common stock at an exercise price of $79.41 was outstanding at September 30, 2018 and 2017, but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. The warrant is exercisable at the holder’s option through November 21, 2018.

Note 12 – Regulatory Capital Matters

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can result in regulatory action.

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company and Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule through January 1, 2019. The final rules allowed banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The capital conservation buffer for 2018 is 1.875% and 1.25% for 2017. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

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The following tables show the ratios (excluding capital conservation buffer) and amounts of common equity Tier 1, Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios for the Company and the Bank at the dates indicated (dollars in thousands):

	Actual					Minimum Requirement for Capital Adequacy Purposes					Minimum Requirement to be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of September 30, 2018:
Total risk-based capital (to risk-weighted assets)
Consolidated	$	100,936		12.07	%	$	66,910		8.00	%		N/A		N/A
Bank		105,243		12.60			66,836		8.00		$	83,545		10.00	%
Tier 1 capital (to risk-weighted assets)
Consolidated		90,555		10.83			50,183		6.00			N/A		N/A
Bank		96,609		11.56			50,127		6.00			66,836		8.00
Total common equity Tier 1 risk-based capital (to risk-weighted assets)
Consolidated		77,013		9.21			37,637		4.50			N/A		N/A
Bank		96,609		11.56			37,595		4.50			54,304		6.50
Tier 1 capital (to average assets)
Consolidated		90,555		8.91			40,638		4.00			N/A		N/A
Bank		96,609		9.51			40,622		4.00			50,778		5.00

	Actual					Minimum Requirement for Capital Adequacy Purposes					Minimum Requirement to be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2017:
Total risk-based capital (to risk- weighted assets)
Consolidated	$	83,072		10.55	%	$	63,014		8.00	%		N/A		N/A
Bank		91,305		11.61			62,938		8.00		$	78,672		10.00	%
Tier 1 capital (to risk-weighted assets)
Consolidated		66,487		8.44			47,260		6.00			N/A		N/A
Bank		81,393		10.35			47,203		6.00			62,938		8.00
Total common equity Tier 1 risk- based capital (to risk-weighted assets)
Consolidated		54,535		6.92			35,445		4.50			N/A		N/A
Bank		81,393		10.35			35,403		4.50			51,137		6.50
Tier 1 capital (to average assets)
Consolidated		66,487		7.11			37,392		4.00			N/A		N/A
Bank		81,393		8.70			37,421		4.00			46,777		5.00

N/A: Not applicable. Regulatory framework does not define well capitalized for holding companies.

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. In addition, a bank must have positive retained earnings.

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Note 13 – Off Balance Sheet Risks, Commitments, and Contingent Liabilities

The Company, in the normal course of business, is party to financial instruments with off balance sheet risk. The financial instruments include commitments to extend credit and standby letters of credit. The contract or notional amounts of these instruments reflect the potential future obligations of the Company pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with the Company’s credit policies. Collateral from the client may be required based on the Company’s credit evaluation of the client and may include business assets of commercial clients, as well as personal property and real estate of individual clients or guarantors.

An approved but unfunded loan commitment represents a potential credit risk and a liquidity risk, since the Company’s client(s) may demand immediate cash that would require funding. In addition, unfunded loan commitments represent interest rate risk as market interest rates may rise above the rate committed to the Company’s client. Since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. Commitments to make loans are generally made for periods of one year or less.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Company does not deem this risk to be material. No liability is currently established for standby letters of credit.

The following table presents the contractual amounts of financial instruments with off-balance sheet risk for each period ended:

	September 30, 2018				December 31, 2017
	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
	(in thousands)
Commitments to make loans	$	6,609	$	11,436	$	27,349	$	31,412
Unused lines of credit		5,505		63,887		11,034		57,727
Standby letters of credit		542		1,749		2,216		373

Commitments to make loans are generally made for periods of one year or less.

In connection with the purchase of loan participations, the Bank is party to risk participation agreements, which had notional amounts totaling $26.6 million at September 30, 2018 and $19.8 million at December 31, 2017. The risk participation agreements are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The derivatives are recorded on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income. The fair value of the derivative instruments incorporates a consideration of credit risk in accordance with ASC 820, resulting in some volatility in earnings each period. At September 30, 2018 and December 31, 2017, the fair value of the risk participation agreements were $26.6 million and $19.8 million, respectively.

The Company is subject to claims and lawsuits that arise primarily in the ordinary course of business. Litigation is subject to inherent uncertainties and unfavorable rulings could occur. The Company records contingent liabilities resulting from claims against it when a loss is assessed to be probable and the amount of the loss is reasonably estimable. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably estimated. Assessing probability of loss and estimating probable losses requires analysis of multiple factors, including in some cases judgments about the potential actions of third party claimants and courts. Recorded contingent liabilities are based on the best information available and actual losses in any future period are inherently uncertain. Based upon current knowledge and after consultation with counsel, the Company believes pending legal proceedings or claims should not have a material impact on its financial position or results of operations. However, in light of the uncertainties involved in such proceedings, the outcome of a particular matter may be material to the financial position or results of operations for a particular reporting period in the future.

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Note 14 – Revenue from Contracts with Customers

The Company adopted ASC 606 using the full retrospective method. The adoption of ASC 606 for in-scope revenue streams did not result in a cumulative effect adjustment. Bank card interchange income and expenses were previously reported net in non-interest income. The income statement impact of adopting ASC 606 resulted in a reclassification adjustment of $142,000 and $405,000 related to the three and nine months ended September 30, 2017, respectively, between bank card interchange income and deposit account related expense in order to report debit card interchange income gross and provide a comparable disclosure for 2018 and 2017 results. This reclassification adjustment had no impact on previously reported net income for the three or nine months ended September 30, 2017.

All of the Company’s revenue from customers in the scope of ASC 606 is recognized within non-interest income. A description of the Company’s revenue streams accounted for under ASC 606 follows:

Service Charges on Deposit Accounts: The Company earns fees from its deposit customers for transaction-based, account maintenance, and overdraft services. Transaction-based fees, which include services such as ATM use fees, stop payment charges, statement rendering, and ACH fees, are recognized at the time the transaction is executed as that is the point in time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges are withdrawn from the customer’s account balance.

Bank Card Interchange Income: The Company earns interchange fees from bank cardholder transactions conducted through the Shazam payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Prior to adopting ASC 606, the Company reported bank card interchange fees net of expenses. Under ASC 606, bank card interchange fees are reported gross.

Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assess whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. The Company did not finance any OREO sale during 2018 or 2017. Gains and losses on sales of OREO are netted with OREO expense and reported in non-interest expense.

Other Non-interest Income: Other non-interest income includes revenue from several sources that are within the scope of ASC 606, including title insurance commissions, income from secondary market loan sales, and other transaction-based revenue that is individually immaterial. Other non-interest income included approximately $301,000 and $546,000 of revenue for the three and nine months ended September 30, 2018, respectively, within the scope of ASC 606. Other non-interest income included approximately $195,000 and $531,000 of revenue for the three and nine months ended September 30, 2017, respectively, within the scope of ASC 606. The remaining other non-interest income for the three and nine months is excluded from the scope of ASC 606.

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

This item analyzes the Company’s financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Preliminary Note Concerning Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of management’s control. Factors that could contribute to differences in results include, but are not limited to the following:

●

Changes in fiscal, monetary, regulatory and tax policies;

●

Changes in political and economic conditions;

•

The magnitude and frequency of changes to the Federal Funds Target Rate implemented by the Federal Open Market Committee of the Federal Reserve Bank;

•

Long-term and short-term interest rate fluctuations as well as the overall steepness of the yield curve;

•

Competitive product and pricing pressures;

•

Equity and fixed income market fluctuations;

•

Client bankruptcies and loan defaults;

•

Inflation;

•

Recession;

•

Natural disasters impacting Company operations;

•

Future acquisitions;

•

Integrations of acquired businesses;

•

Changes in technology and regulations or the interpretation and enforcement thereof;

●

Changes in accounting standards;

●

Changes to the Company’s overall internal control environment;

●

Success in gaining regulatory approvals when required;

●

Information security breaches or cyber security attacks involving either the Company or one of the Company’s third-party service providers; and

●

Other risks and uncertainties reported from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”), including Part 1 Item 1A “Risk Factors” of the Company’s December 31, 2017 Annual Report on Form 10-K for the year ended December 31, 2017.

Overview

The Company is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol LMST. The Company operates Limestone Bank (the Bank), our wholly owned subsidiary and the eleventh largest bank domiciled in the Commonwealth of Kentucky based on total assets. The Bank operates banking offices in twelve counties in Kentucky. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. The Bank serves south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. The Bank also has an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of September 30, 2018, the Company had total assets of $1.05 billion, total loans of $757.1 million, total deposits of $874.0 million and stockholders’ equity of $88.2 million.

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The Company reported net income of $2.4 million and $6.4 million for the three and nine months ended September 30, 2018, compared with net income of $1.8 million and $5.2 million for the same periods of 2017.

Highlights for the nine months ended September 30, 2018 are as follows:

●

Loan growth outpaced paydowns during the period. Average loans receivable increased approximately $77.9 million or 11.8% to $735.9 million for the nine months ended September 30, 2018, compared with $658.0 million for the first nine months of 2017. This resulted in an increase in interest revenue volume of approximately $2.9 million for the nine months September 30, 2018 compared with the nine months of 2017.

●

Deposits were $874.0 million at September 30, 2018, compared with $847.0 million at December 31, 2017. Certificate of deposit balances increased $33.0 million during the first nine months of 2018 to $457.2 million at September 30, 2018, from $424.2 million at December 31, 2017. Interest checking accounts decreased $12.0 million and money market accounts increased $8.1 million during the first nine months of 2018 compared with December 31, 2017.

●

Net interest margin increased eight basis points to 3.55% in the first nine months of 2018 compared with 3.47% in the first nine months of 2017. The cost of interest bearing liabilities increased from 0.81% in the first nine months of 2017 to 1.14% in the first nine months of 2018 as a result of increases in short-term interest rates during 2017 and 2018.

●

Improving trends in asset quality continued. The Company recorded negative provision for loan losses expense of $500,000 during the first nine months of 2018, compared to no provision for loan losses expense for the first nine months of 2017. The negative provision was attributable to net loan recoveries, declining historical loss rates, improvements in asset quality, and management’s assessment of risk in the loan portfolio. Net loan recoveries were $932,000 for the first nine months of 2018, compared to net loan recoveries of $10,000 for the first nine months of 2017.

●

Nonaccrual loans decreased $2.8 million to $2.7 million at September 30, 2018, compared with $5.5 million at December 31, 2017. The decrease in nonaccrual loans was primarily due to $2.5 million in paydowns and $730,000 in loans moved to OREO, which were partially offset by $777,000 in loans placed on nonaccrual.

●

Loans past due 30-59 days remained unchanged at $1.5 million at September 30, 2018 compared to December 31, 2017, and loans past due 60-89 days increased from $171,000 at December 31, 2017 to $929,000 at September 30, 2018. Total loans past due and nonaccrual loans decreased to $5.1 million at September 30, 2018, from $7.1 million at December 31, 2017.

●

Foreclosed properties were $3.8 million at September 30, 2018, compared with $4.4 million at December 31, 2017, and $6.3 million at September 30, 2017. During the first nine months of 2018, the Company acquired $730,000 and sold $876,000 of OREO. Operating expenses, fair value write downs, and a net gain on sales totaled $590,000 for the first nine months of 2018 compared to $92,000 for the first nine months of 2017.

●

The ratio of non-performing assets to total assets decreased to 0.70% at September 30, 2018, compared with 1.14% at December 31, 2017, and 1.38% at September 30, 2017.

Application of Critical Accounting Policies

Management continually reviews accounting policies and financial information disclosures. The Company’s more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2017. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first nine months of 2018, there were no material changes in the critical accounting policies and assumptions.

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Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended September 30, 2018, compared with the same period of 2017:

	For the Three Months					Change from
	Ended September 30,					Prior Period
	2018			2017		Amount			Percent
	(dollars in thousands)

Gross interest income	$	11,120		$	9,446	$	1,674			17.7	%
Gross interest expense		2,708			1,659		1,049			63.2
Net interest income		8,412			7,787		625			8.0
Provision (negative provision) for loan losses		(350	)		—		(350	)		100.0
Non-interest income		1,509			1,324		185			14.0
Non-interest expense		7,230			7,317		(87	)		(1.2	)
Net income before taxes		3,041			1,794		1,247			69.5
Income tax expense		604			—		604			100.0
Net income		2,437			1,794		643			35.8

Net income for the three months ended September 30, 2018 totaled $2.4 million, compared with $1.8 million for the comparable period of 2017. Net interest income increased $625,000 from the 2017 third quarter as a result of an increase in earning assets and an improvement in net interest margin. Net interest margin increased one basis point to 3.45% in the third quarter of 2018 compared with 3.44% in the third quarter of 2017. The increase in margin between periods was due in part to an increase in the yield of interest earning assets from 4.16% in the third quarter of 2017 to 4.56% in the third quarter of 2018. Average earning assets increased from $907.7 million for the third quarter of 2017 to $968.9 for the third quarter of 2018. Non-interest income increased by $185,000 to $1.5 million from $1.3 million in the third quarter of 2017 due to increases in service charges on deposit accounts as well as the sale of the Bank’s fully amortized secondary market residential mortgage servicing rights portfolio during the third quarter of 2018, which resulted in a one-time gain of approximately $150,000. The gain on sale is included in other non-interest income. The Bank no longer sells residential mortgages on a servicing retained basis to the secondary market. Non-interest expense decreased from $7.3 million in the third quarter of 2017 to $7.2 million in the third quarter of 2018 primarily due to decreased FDIC insurance expense of $238,000 attributable to the Bank’s improved risk profile, a $105,000 decrease in marketing expenses, and a decrease in other non-interest expense of $119,000, which were partially offset by a $210,000 increase in salaries and employee benefits and an increase in OREO expenses of $160,000 primarily attributable to fair value write-downs arising from lower marketing prices.

Income tax expense was $604,000 for the three months ended September 30, 2018 compared to no tax expense for the comparable period of 2017. The Company previously had a full valuation allowance against its net deferred tax asset and therefore, the effective tax rate was 0% for the three months ended September 30, 2017.

The following table summarizes components of income and expense and the change in those components for the nine months ended September 30, 2018, compared with the same period of 2017:

	For the Nine Months					Change from
	Ended September 30,					Prior Period
	2018			2017		Amount			Percent
	(dollars in thousands)

Gross interest income	$	31,720		$	27,805	$	3,915			14.1	%
Gross interest expense		6,753			4,689		2,064			44.0
Net interest income		24,967			23,116		1,851			8.0
Provision (negative provision) for loan losses		(500	)		—		(500	)		100.0
Non-interest income		4,107			3,762		345			9.2
Non-interest expense		21,804			21,695		109			0.5
Net income before taxes		7,770			5,183		2,587			49.9
Income tax expense		1,416			—		1,416			100.0
Net income		6,354			5,183		1,171			22.6

Net income for the nine months ended September 30, 2018 totaled $6.4 million, compared with net income of $5.2 million for the comparable period of 2017. Net interest income increased $1.9 million from the first nine months of 2017 as a result of an increase in earning assets and an improvement in net interest margin. Net interest margin increased eight basis points to 3.55% in the first nine months of 2018 compared with 3.47% in the first nine months of 2017. The increase in margin between periods was due to an increase in the yield on earning assets from 4.17% for the first nine months of 2017 to 4.51% for the first nine months of 2018, partially offset by an increase in the cost of interest bearing liabilities from 0.81% for the first nine months of 2017 to 1.14% for the first nine months of 2018. Average earning assets increased from $899.9 million for the first nine months of 2017 to $942.7 million for the first nine months of 2018. Non-interest income increased by $345,000 to $4.1 million from $3.8 million in the first nine months of 2017 primarily due to an increase in service charges on deposit accounts of $150,000, an increase in bank card interchange fees of $140,000, and a $150,000 one-time gain on sale of the fully amortized secondary market residential mortgage servicing portfolio. The one-time gain was partially offset by a reduction in title insurance commissions and secondary market income as compared to 2017. Non-interest expense increased to $21.8 million in the first nine months of 2018 compared with $21.7 million for the first nine months of 2017. FDIC insurance expense decreased $616,000 due to improvements in the Bank’s risk profile. This savings was partially offset by increases in salaries and employee benefits, state franchise taxes, and OREO expenses.

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Income tax expense was $1.4 million for the nine months ended September 30, 2018 compared to no tax expense for the comparable period of 2017. The Company previously had a full valuation allowance against its net deferred tax asset and therefore, the effective tax rate was 0% for the nine months ended September 30, 2017.

Net Interest Income – Net interest income was $8.4 million for the three months ended September 30, 2018, an increase of $625,000, or 8.0%, compared with $7.8 million for the same period in 2017. Net interest spread and margin were 3.24% and 3.45%, respectively, for the third quarter of 2018, compared with 3.31% and 3.44%, respectively, for the third quarter of 2017. Net average non-accrual loans were $3.0 million and $6.2 million for the third quarters of 2018 and 2017, respectively.

Average loans receivable increased approximately $78.9 million for the third quarter of 2018 compared with the third quarter of 2017. This resulted in an increase in interest revenue of approximately $984,000 attributable to volume and an increase of $534,000 attributable to increasing interest rates for the quarter ended September 30, 2018, compared with the third quarter of 2017. Interest foregone on non-accrual loans totaled $59,000 for the third quarter of 2018, compared with $105,000 for the third quarter of 2017.

Net interest margin increased one basis point from our margin of 3.44% in the prior year third quarter to 3.45% for the third quarter of 2018. The yield on earning assets increased 40 basis point and rates paid on interest-bearing liabilities increased 47 basis points from the third quarter of 2017. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2017 and 2018.

Net interest income was $25.0 million for the nine months ended September 30, 2018, an increase of $1.9, or 8.0%, compared with $23.1 million for the same period in 2017. Net interest spread and margin were 3.37% and 3.55%, respectively, for the first nine months of 2018, compared with 3.36% and 3.47%, respectively, for the first nine months of 2017. Net average non-accrual loans were $4.0 million and $7.5 million for the first nine months of 2018 and 2017, respectively.

Average loans receivable increased approximately $77.9 million for the nine months ended September 30, 2018 compared with the first nine months of 2017. This resulted in an increase in interest revenue of approximately $2.9 million attributable to volume and an increase of $1.1 million attributable to increasing interest rates for the nine months ended September 30, 2018 compared with the prior year period. Interest foregone on non-accrual loans totaled $220,000 for the nine months ended September 30, 2018, compared with $368,000 for the nine months ended September 30, 2017.

Net interest margin increased eight basis points to 3.55% for the first nine months of 2018 from our margin of 3.47% in the first nine months of 2017. The yield on earning assets increased 34 basis points for the first nine months of 2018 from the first nine months of 2017, compared with an increase of 33 basis points in rates paid on interest-bearing liabilities. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2017 and 2018.

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Average Balance Sheets

The following table presents the average balance sheets for the three month periods ended September 30, 2018 and 2017, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Three Months Ended September 30,
	2018								2017
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	748,444		$	9,539		5.06	%	$	669,592		$	8,021		4.75	%
Securities
Taxable		167,280			1,245		2.95			174,776			1,088		2.47
Tax-exempt (3)		14,147			95		3.37			19,547			143		4.47
FHLB stock		7,243			110		6.03			7,323			95		5.15
Federal funds sold and other		31,762			131		1.64			36,485			99		1.08
Total interest-earning assets		968,876			11,120		4.56	%		907,723			9,446		4.16	%
Less: Allowance for loan losses		(8,742	)							(8,964	)
Non-interest earning assets		77,502								52,928
Total assets	$	1,037,636							$	951,687

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	450,125		$	1,671		1.47	%	$	451,948		$	1,059		0.93	%
NOW and money market deposits		251,020			445		0.70			253,699			250		0.39
Savings accounts		34,778			14		0.16			35,904			15		0.17
FHLB advances		43,995			233		2.10			2,350			13		2.19
Junior subordinated debentures		20,999			247		4.67			23,696			225		3.77
Senior debt		10,000			98		3.89			10,000			97		3.85
Total interest-bearing liabilities		810,917			2,708		1.32	%		777,597			1,659		0.85	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		133,784								129,072
Other liabilities		5,449								5,859
Total liabilities		950,150								912,528
Stockholders’ equity		87,486								39,159
Total liabilities and stockholders’ equity	$	1,037,636							$	951,687

Net interest income				$	8,412							$	7,787

Net interest spread							3.24	%							3.31	%
Net interest margin							3.45	%							3.44	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans averaging $3.0 million and $6.2 million, respectively, in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a federal income tax rate of 21% and 35% for 2018 and 2017, respectively.

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The following table presents the average balance sheets for the nine month periods ended September 30, 2018 and 2017, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Nine Months Ended September 30,
	2018								2017
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	735,874		$	27,423		4.98	%	$	657,980		$	23,493		4.77	%
Securities
Taxable		157,537			3,386		2.87			175,838			3,370		2.56
Tax-exempt (3)		14,184			287		3.42			19,805			432		4.49
FHLB stock		7,296			320		5.86			7,323			264		4.82
Federal funds sold and other		27,857			304		1.46			38,913			246		0.85
Total interest-earning assets		942,748			31,720		4.51	%		899,859			27,805		4.17	%
Less: Allowance for loan losses		(8,655	)							(8,950	)
Non-interest earning assets		78,769								52,904
Total assets	$	1,012,862							$	943,813

LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	433,933		$	4,041		1.25	%	$	458,732		$	3,149		0.92	%
NOW and money market deposits		246,271			1,040		0.56			244,521			683		0.37
Savings accounts		35,221			42		0.16			35,650			45		0.17
FHLB advances		43,035			605		1.88			6,594			64		1.30
Junior subordinated debentures		22,057			733		4.44			23,920			651		3.64
Senior debt		10,000			292		3.90			3,407			97		3.81
Total interest-bearing liabilities		790,517			6,753		1.14	%		772,824			4,689		0.81	%

Non-interest-bearing liabilities:
Non-interest-bearing deposits		133,756								125,932
Other liabilities		5,406								8,401
Total liabilities		929,679								907,157
Stockholders’ equity		83,183								36,656
Total liabilities and stockholders’ equity	$	1,012,862							$	943,813

Net interest income				$	24,967							$	23,116

Net interest spread							3.37	%							3.36	%

Net interest margin							3.55	%							3.47	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.

(2)	Calculations include non-accruing loans averaging $4.0 million and $7.5 million, respectively, in average loan amounts outstanding.

(3)	Taxable equivalent yields are calculated assuming a federal income tax rate of 21% and 35% for 2018 and 2017, respectively.

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Rate/Volume Analysis

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

	Three Months Ended September 30, 2018 vs. 2017									Nine Months Ended September 30, 2018 vs. 2017
	Increase (decrease) due to change in									Increase (decrease) due to change in
	Rate			Volume			Net Change			Rate			Volume			Net Change
	(in thousands)
Interest-earning assets:
Loan receivables	$	534		$	984		$	1,518		$	1,060		$	2,870		$	3,930
Securities		195			(86	)		109			362			(491	)		(129	)
FHLB stock		16			(1	)		15			57			(1	)		56
Federal funds sold and other		46			(14	)		32			142			(84	)		58
Total increase (decrease) in interest income		791			883			1,674			1,621			2,294			3,915

Interest-bearing liabilities:
Certificates of deposit and other time deposits		616			(4	)		612			1,070			(178	)		892
NOW and money market accounts		198			(3	)		195			352			5			357
Savings accounts		(1	)		—			(1	)		(2	)		(1	)		(3	)
FHLB advances		(1	)		221			220			41			500			541
Junior subordinated debentures		50			(28	)		22			136			(54	)		82
Senior debt		1			—			1			2			193			195
Total increase (decrease) in interest expense		863			186			1,049			1,599			465			2,064
Increase (decrease) in net interest income	$	(72	)	$	697		$	625		$	22		$	1,829		$	1,851

Non-Interest Income – The following table presents the major categories of non-interest income for the three and nine months ended September 30, 2018 and 2017:

	For the Three Months				For the Nine Months
	Ended September 30,				Ended September 30,
	2018		2017		2018			2017
	(dollars in thousands)

Service charges on deposit accounts	$	608	$	568	$	1,767		$	1,617
Bank card interchange fees		411		387		1,258			1,118
Income from bank owned life insurance		100		103		337			309
Net gain (loss) on sales and calls of securities		—		—		(6	)		(5	)
Other		390		266		751			723
Total non-interest income	$	1,509	$	1,324	$	4,107		$	3,762

Non-interest income for the third quarter of 2018 increased by $185,000, or 14.0%, compared with the third quarter of 2017. The increase in non-interest income was due to increases in service charges on deposit accounts as well as the sale of the Bank’s fully amortized secondary market residential mortgage servicing rights portfolio, which resulted in a one-time gain of approximately $150,000. The gain on sale is included in other non-interest income. The Bank no longer sells residential mortgage loans on a servicing retained basis to the secondary market. For the nine months, ended September 30, 2018, non-interest income increased by $345,000, or 9.2% to $4.1 million compared with $3.8 million for the same period of 2017. The increase in non-interest income between the nine-month comparative periods was primarily due to a $150,000 increase in service charges on deposit accounts, a $140,000 increase in bank card interchange fees, and the $150,000 one-time gain on sale of the fully amortized servicing rights portfolio. The gain on sale of the servicing rights portfolio was offset by decreases in title insurance commissions and secondary market increases as compared to 2017.

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Non-interest Expense – The following table presents the major categories of non-interest expense for the three and nine months ended September 30, 2018 and 2017:

	For the Three Months				For the Nine Months
	Ended September 30,				Ended September 30,
	2018		2017		2018		2017
	(dollars in thousands)

Salary and employee benefits	$	3,893	$	3,683	$	11,566	$	11,433
Occupancy and equipment		896		836		2,671		2,501
Professional fees		186		232		613		776
Marketing expense		259		364		867		880
FDIC insurance		118		356		439		1,055
Data processing expense		281		321		912		931
State franchise and deposit tax		282		225		846		675
Deposit account related expenses		213		222		653		646
Other real estate owned expense		271		111		590		92
Litigation and loan collection expense		61		78		162		121
Other		770		889		2,485		2,585
Total non-interest expense	$	7,230	$	7,317	$	21,804	$	21,695

Non-interest expense for the third quarter ended September 30, 2018 decreased $87,000, or 1.2%, compared with the third quarter of 2017. This decrease was primarily due to a decrease in FDIC insurance expense of $238,000 and a $119,000 decrease in other non-interest expense, which was partially offset by a $210,000 increase in salaries and employee benefits and an increase in OREO expenses of $160,000 primarily attributable to fair value write-downs arising from lower marketing prices. For the nine months ended September 30, 2018, non-interest expense increased $109,000, or 0.5% to $21.8 million compared with $21.7 million for the first nine months of 2017. The increase in non-interest expense for the nine months ended September 30, 2018 was primarily attributable to increased OREO expenses of $498,000, due to to fair value write-downs arising from lower marketing prices, as well as an increase in state franchise and deposit tax expense of $171,000, which was partially offset by a $616,000 decrease in FDIC insurance expense due to improvements in the Bank’s risk profile.

Income Tax Expense – Effective tax rates differ from the federal statutory rate of 21% for 2018 and 35% for 2017 applied to income before income taxes due to the following:

	For the Three Months						For the Nine Months
	Ended September 30,						Ended September 30,
	2018			2017			2018			2017
	(dollars in thousands)

Federal statutory rate times financial statement income	$	639		$	628		$	1,632		$	1,814
Effect of:
Valuation allowance		—			(551	)		—			(1,488	)
Tax-exempt income		(20	)		(50	)		(60	)		(147	)
Non-taxable life insurance income		(13	)		(36	)		(63	)		(108	)
Restricted stock vesting		—			—			(116	)		(98	)
Other, net		(2	)		9			23			27
Total	$	604		$	—		$	1,416		$	—

The Company previously had a full valuation allowance against its net deferred tax asset and therefore, the effective tax rate was 0% for the nine months ended September 30, 2017. During the fourth quarter of 2017, management concluded it was more-likely-than-not the asset would be utilized to reduce future taxes payable related to the future taxable income of the Company, and as such, reversed the valuation allowance and recorded an income tax benefit.

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Analysis of Financial Condition

Total assets increased $79.7 million, or 8.2%, to $1.05 billion at September 30, 2018, from $970.8 million at December 31, 2017. This increase was primarily attributable to an increase in net loans of $44.5 million and an increase in securities available for sale of $32.2 million.

Loans Receivable – Loans receivable increased $44.9 million, or 6.3%, during the nine months ended September 30, 2018 to $757.1 million as loan growth outpaced paydowns. Our commercial and commercial real estate portfolios increased by an aggregate of $40.2 million, or 9.7% during the first nine months of 2018 and comprised 60.3% of the loan portfolio at September 30, 2018.

Loan Portfolio Composition – The following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio and other than the categories noted, there is no concentration of loans in any industry exceeding 10% of total loans.

	As of September 30,					As of December 31,
	2018					2017
	Amount		Percent			Amount		Percent
			(dollars in thousands)

Commercial	$	125,699		16.60	%	$	113,771		15.98	%
Commercial Real Estate
Construction		83,368		11.01			57,342		8.05
Farmland		83,917		11.08			88,320		12.40
Nonfarm nonresidential		163,346		21.58			156,724		22.01
Residential Real Estate
Multi-family		46,144		6.10			56,588		7.94
1-4 Family		173,674		22.94			179,222		25.17
Consumer		40,242		5.32			18,439		2.59
Agriculture		40,144		5.30			41,154		5.78
Other		517		0.07			555		0.08
Total loans	$	757,051		100.00	%	$	712,115		100.00	%

Loan Portfolio by Risk Category – The following table presents a summary of the loan portfolio at the dates indicated, by risk category.

	September 30, 2018					December 31, 2017
	Loans		% to Total			Loans		% to Total
	(dollars in thousands)

Pass	$	736,193		97.2	%	$	673,033		94.5	%
Watch		12,314		1.6			25,715		3.6
Special Mention		114		0.1			164		0.0
Substandard		8,430		1.1			13,203		1.9
Doubtful		—		—			—		—
Total	$	757,051		100.0	%	$	712,115		100.0	%

Loans receivable increased $44.9 million, or 6.3%, during the nine months ended September 30, 2018. Since December 31, 2017, the pass category increased approximately $63.2 million, the watch category decreased approximately $13.4 million, the special mention category decreased approximately $50,000, and the substandard category declined approximately $4.8 million. The $4.8 million decrease in loans classified as substandard was primarily driven by $10.0 million in principal payments received, $730,000 in loans moved to OREO, $394,000 in charge-offs, and $77,000 in loans upgraded from substandard, offset by $6.5 million in loans moved to substandard during the first nine months of 2018.

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Loan Delinquency – The following table presents a summary of loan delinquencies at the dates indicated.

	September 30, 2018		December 31, 2017
Past Due Loans:	(in thousands)
30-59 Days	$	1,492	$	1,478
60-89 Days		929		171
90 Days and Over		—		1
Total Loans Past Due 30-90+ Days		2,421		1,650

Nonaccrual Loans		2,692		5,457
Total Past Due and Nonaccrual Loans	$	5,113	$	7,107

During the nine months ended September 30, 2018, nonaccrual loans decreased by $2.8 million to $2.7 million. This decrease was due primarily to $2.5 million in pay downs, $730,000 in loans foreclosed and transferred to OREO, and $265,000 in charge-offs, offset by $777,000 in loans placed on nonaccrual status. During the nine months ended September 30, 2018, loans past due 30-59 days remained unchanged at $1.5 million compared to December 31, 2017. Loans past due 60-89 days increased from $171,000 at December 31, 2017 to $929,000 at September 30, 2018. This represents a $772,000 increase from December 31, 2017 to September 30, 2018, in loans past due 30-89 days. This trend in delinquency levels is considered during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

Troubled Debt Restructuring - A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession to a borrower who is experiencing financial difficulty. The Bank’s TDRs typically involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

The Bank does not have a formal loan modification program. If a borrower is unable to make contractual payments, management reviews the particular circumstances of that borrower’s situation and determine whether or not to negotiate a revised payment stream. The goal when restructuring a credit is to afford the borrower a reasonable period of time to remedy the issue causing cash flow constraints so that they may return to performing status over time.

Loan modifications have taken the form of a reduction in interest rate and/or curtailment of scheduled principal payments for a short-term period, usually three to six months, but in some cases until maturity of the loan. In some circumstances management may restructure real estate secured loans in a bifurcated fashion whereby there is a fully amortizing “A” loan at a market interest rate and an interest-only “B” loan at a reduced interest rate. The majority of restructured loans are collateral secured loans. If a borrower fails to perform under the modified terms, the loan(s) are placed on nonaccrual status and collection actions are initiated.

Management considers any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan to be a troubled debt restructuring. Specifically, management consider a concession involving a modification of the loan terms, such as (i) a reduction of the stated interest rate, (ii) a reduction or deferral of principal, or (iii) a reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be troubled debt restructurings. When a modification of terms is made for a competitive reason, management does not consider it to be a troubled debt restructuring. A primary example of a competitive modification would be an interest rate reduction for a performing customer’s loan to a market rate as the result of a market decline in rates.

Management periodically reviews renewals and modifications of previously identified TDRs for which there was no principal forgiveness, to consider if it is appropriate to remove the TDR classification. If the borrower is no longer experiencing financial difficulty and the renewal/modification did not contain a concessionary interest rate or other concessionary terms, management considers the potential removal of the TDR classification. If deemed appropriate based upon current underwriting, the TDR classification is removed as the borrower has complied with the terms of the loan at the date of renewal/modification and there was a reasonable expectation that the borrower would continue to comply with the terms of the loan after the date of the renewal/modification. Additionally, the TDR classification may be removed in circumstances in which the Company performs a non-concessionary re-modification of the loan at terms that were considered to be at market for loans with comparable risk. Management expects the borrower will continue to perform under the re-modified terms based on the borrower’s past history of performance.

If the borrower fails to perform, management places the loan on nonaccrual status and seeks to liquidate the underlying collateral. The nonaccrual policy for restructured loans is identical to the nonaccrual policy for all loans. The policy calls for a loan to be reported as nonaccrual if it is maintained on a cash basis because of deterioration in the financial condition of the borrower, payment in full of principal and interest is not expected, or principal or interest is past due 90 days or more unless the assets are both well secured and in the process of collection. Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loan losses. Upon determination that a loan is collateral dependent, the loan is charged down to the fair value of collateral less estimated costs to sell.

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At September 30, 2018, the Bank had three restructured loans totaling $1.6 million with borrowers who experienced deterioration in financial condition compared with six loans totaling $3.0 million at December 31, 2017. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. At September 30, 2018, one loan totaling approximately $700,000 had been granted principal payment deferrals until maturity. That loan is on nonaccrual status. There were no concessions made to forgive principal relative to these loans, although we have recorded partial charge-offs for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential or commercial real estate properties, or farmland. At September 30, 2018, $910,000 of TDRs were performing according to their modified terms.

There were no modifications granted during the first nine months of 2018 or during all of 2017 that resulted in loans being identified as TDRs. During the nine months ended September 30, 2018, TDRs were reduced as a result of $774,000 in payments and $500,000 due to a transfer of a loan to OREO. See “Note 3 - Loans,” of the notes to the financial statements for additional disclosure related to troubled debt restructuring.

Non-Performing Assets – Non-performing assets consist of certain restructured loans for which interest rate or other terms have been renegotiated, loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. The following table sets forth information with respect to non-performing assets as of September 30, 2018 and December 31, 2017.

	September 30, 2018			December 31, 2017
	(dollars in thousands)

Loans on nonaccrual status	$	2,692		$	5,457
Troubled debt restructurings on accrual		910			1,217
Loans past due 90 days or more still on accrual		—			1
Total non-performing loans		3,602			6,675
Real estate acquired through foreclosure		3,750			4,409
Other repossessed assets		—			—
Total non-performing assets	$	7,352		$	11,084

Non-performing loans to total loans		0.48	%		0.94	%
Non-performing assets to total assets		0.70	%		1.14	%
Allowance for non-performing loans	$	123		$	108
Allowance for non-performing loans to non-performing loans		3.41	%		1.62	%

Nonperforming loans at September 30, 2018, were $3.6 million, or 0.48% of total loans, compared with $6.7 million, or 0.94% of total loans at December 31, 2017, and $7.0 million, or 1.02% of total loans at September 30, 2017.

Allowance for Loan Losses – The allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

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An analysis of changes in the allowance for loan losses and selected ratios for the three and nine month periods ended September 30, 2018 and 2017, and for the year ended December 31, 2017 follows:

	Three Months Ended September 30,						Nine Months Ended September 30,						Year Ended December 31,
	2018			2017			2018			2017			2017
	(in thousands)
Balance at beginning of period	$	8,580		$	8,885		$	8,202		$	8,967		$	8,967

Loans charged-off:
Real estate		78			57			364			570			750
Commercial		50			5			50			5			5
Consumer		15			5			49			30			51
Agriculture		—			—			12			95			95
Other		—			—			8			—			—
Total charge-offs		143			67			483			700			901

Recoveries
Real estate		526			112			1,076			561			714
Commercial		10			3			255			44			59
Consumer		9			25			59			69			115
Agriculture		2			16			13			25			33
Other		—			3			12			11			15
Total recoveries		547			159			1,415			710			936
Net charge-offs (recoveries)		(404	)		(92	)		(932	)		(10	)		(35	)
Provision (negative provision) for loan losses		(350	)		—			(500	)		—			(800	)
Balance at end of period	$	8,634		$	8,977		$	8,634		$	8,977		$	8,202

Allowance for loan losses to period-end loans		1.14	%		1.32	%		1.14	%		1.32	%		1.15	%
Net charge-offs (recoveries) to average loans		(0.21	%)		(0.05	%)		(0.17	%)		0.00	%		(0.01	%)
Allowance for loan losses to non-performing loans		239.70	%		128.33	%		239.70	%		128.33	%		122.88	%

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is comprised of general reserves and specific reserves. The loan loss reserve, as a percentage of total loans at September 30, 2018, decreased to 1.14% compared to 1.15% at December 31, 2017 and 1.32% at September 30, 2017. The change in loan loss reserve as a percentage of total loans between periods is attributable to growth in the portfolio driven by new loans underwritten with lower loss expectations, improving historical loss experience, improvement in risk grade classification metrics, and improved charge-off levels. The allowance for loan losses to non-performing loans was 239.70% at September 30, 2018, compared with 122.88% at December 31, 2017, and 128.33% at September 30, 2017. Net recoveries in the first nine months of 2018 totaled $932,000 compared to net loan recoveries of $10,000 in the first nine months of 2017.

The majority of nonperforming loans are secured by real estate collateral, and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of principal. Management has assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses. The allowance for non-performing loans to non-performing loans was 3.41% at September 30, 2018 compared with 1.98% at December 31, 2017, and 4.99% at September 30, 2017. The increase in this ratio from December 31, 2017 to September 30, 2018 was primarily attributable to the improving non-performing loan trends during the period.

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The following table presents the unpaid principal balance, recorded investment and allocated allowance related to loans individually evaluated for impairment in the commercial real estate and residential real estate portfolios as of September 30, 2018 and December 31, 2017.

	September 30, 2018						December 31, 2017
	Commercial Real Estate			Residential Real Estate			Commercial Real Estate			Residential Real Estate
	(in thousands)
Unpaid principal balance	$	3,637		$	3,513		$	4,734		$	5,456
Prior charge-offs		(2,260	)		(1,142	)		(2,099	)		(1,506	)

Recorded investment		1,377			2,371			2,635			3,950
Allocated allowance		(46	)		(190	)		—			(206	)

Recorded investment, less allocated allowance	$	1,331		$	2,181		$	2,635		$	3,744

Recorded investment, less allocated allowance/ Unpaid principal balance		36.60	%		62.08	%		55.66	%		68.62	%

Based on prior charge-offs, the current recorded investment in loans individually evaluated for impairment in the commercial real estate and residential real estate segments of the portfolio are significantly below the unpaid principal balance for these loans. The recorded investment net of the allocated allowance was 36.60% and 62.08% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at September 30, 2018.

Provision for Loan Losses – A negative provision for loan losses of $350,000 was recorded for the third quarter and total negative provision for loan losses for the first nine months of 2018 totaled $500,000. No provision was recorded for the same periods in 2017. This was a result of declining historical loss rates, net recoveries for the three and nine-month periods, improvements in asset quality, changes in the composition of the portfolio, and management’s assessment of risk within the portfolio. Asset quality improvement is evidenced by, among other things, improvements in loan risk category migration. The pass category increased approximately $63.2 million, the watch category decreased approximately $13.4 million, the special mention category decreased approximately $50,000, and the substandard category declined approximately $4.8 million. Net recoveries were $932,000 for the nine months ended September 30, 2018, compared with net recoveries of $10,000 for the nine months ended September 30, 2017. Management considers the size and volume of our portfolio as well as the credit quality of the loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

Foreclosed Properties – Foreclosed properties at September 30, 2018 were $3.8 million compared with $6.3 million at September 30, 2017 and $4.4 million at December 31, 2017. See Note 4 – “Other Real Estate Owned,” to the financial statements. During the first nine months of 2018, the Bank acquired $730,000 of OREO properties and sold properties totaling approximately $876,000. Management values foreclosed properties at fair value less estimated costs to sell when acquired and expects to liquidate these properties to recover our investment in the due course of business.

OREO is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. When foreclosed properties are acquired, management obtains a new appraisal or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management typically obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraisal amount.

Net gain (loss) on sales, write-downs, and operating expenses for OREO totaled $590,000 for the nine months ended September 30, 2018, compared to $92,000 for the nine months ended September 30, 2017. During the nine months ended September 30, 2018, fair value write-downs of $585,000 were recorded to reflect declines in fair value driven by reductions in marketing prices compared with $98,000 in write-downs for the nine months ended September 30, 2017.

Liabilities – Total liabilities at September 30, 2018 were $962.3 million compared with $898.1 million at December 31, 2017, an increase of $64.2 million, or 7.1%. This increase was primarily attributable to an increase in FHLB advances of $39.8 million and an increase in total interest bearing deposits of $28.8 million, offset by a decrease in junior subordinated debentures of $2.3.

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Deposits are our primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

	For the Nine Months					For the Year
	Ended September 30,					Ended December 31,
	2018					2017
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
	(dollars in thousands)
Demand	$	133,756				$	129,088
Interest checking		90,980		0.13	%		101,980		0.13	%
Money market		155,291		0.82			145,281		0.55
Savings		35,221		0.16			35,486		0.17
Certificates of deposit		433,933		1.25			452,443		0.93
Total deposits	$	849,181		0.81	%	$	864,278		0.60	%

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

	For the Nine Months					For the Year
	Ended September 30,					Ended December 31,
	2018					2017
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
	(dollars in thousands)
Less than $250,000	$	405,154		1.23	%	$	419,816		0.92	%
$250,000 or more		28,779		1.39	%		32,627		1.01	%
Total	$	433,933		1.25	%	$	452,443		0.93	%

The following table shows at September 30, 2018 the amount of our time deposits of $250,000 or more by time remaining until maturity (in thousands):

Maturity Period

Three months or less	$	2,391
Three months through six months		5,055
Six months through twelve months		6,357
Over twelve months		15,364
Total	$	29,167

Liquidity

Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that cash flow needs are met at a reasonable cost. Management maintains an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. The Asset Liability Committee regularly monitors and reviews the liquidity position.

Funds are available to the Bank from a number of sources, including the sale of securities in the available for sale investment portfolio, principal pay-downs on loans and investment securities, customer deposit inflows, and other wholesale funding.

The Bank also borrows from the FHLB to supplement funding requirements. At September 30, 2018, the Bank had an unused borrowing capacity with the FHLB of $41.1 million. Advances are collateralized by first mortgage residential loans and borrowing capacity is based on the underlying book value of eligible pledged loans.

The Bank also has available on an unsecured basis federal funds borrowing lines from a correspondent bank totaling $5.0 million. Management believes the sources of liquidity are adequate to meet expected cash needs for the foreseeable future. Historically, the Bank has also utilized brokered deposits to supplement it’s funding strategy. At September 30, 2018, the Bank had no brokered deposits.

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The Company uses cash on hand to service senior debt, service junior subordinated debentures, and to provide for operating cash flow needs. The Company also may issue common equity, preferred equity and debt to support cash flow needs and liquidity requirements. At September 30, 2018, cash on hand totaled $5.8 million, of which, $514,000 is held in escrow by the Company’s senior debt holder to service interest payments.

Capital

Stockholders’ equity increased $15.5 million to $88.2 million at September 30, 2018, compared with $72.7 million at December 31, 2017 primarily due to the $14.9 million issuance of common stock completed during the first quarter of 2018, as well as current year net income of $6.4 million, offset by the $3.5 million repurchase of the Company’s series E and F preferred shares and the other comprehensive loss for the first nine months of 2018 of $2.6 million.

The Company completed a private placement of common stock on March 30, 2018. In the transaction, the Company issued 150,000 common shares and 1.0 million non-voting common shares to Patriot Financial Partners III, L.P. at $13.00 per share resulting in net proceeds of $14.9 million of which $5.0 million was contributed as capital to the Bank. The balance of the proceeds were for general corporate purposes and to support the growth of the Bank.

On June 26, 2018, the Company completed the purchase and retirement of all of its issued and outstanding Series E and Series F Non-Voting Perpetual Preferred Shares for an aggregate price of $3.5 million paid in cash. The Series E and Series F Shares had an aggregate liquidation preference of $10.5 million.

The following table shows the ratios of Tier 1 capital, common equity Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios (excluding the capital conservation buffer) for the Bank at the dates indicated:

	Regulatory Minimums			Well-Capitalized Minimums			September 30, 2018			December 31, 2017

Tier 1 Capital		6.0	%		8.0	%		11.56	%		10.35	%
Common equity Tier 1 capital		4.5			6.5			11.56			10.35
Total risk-based capital		8.0			10.0			12.60			11.61
Tier 1 leverage ratio		4.0			5.0			9.51			8.70

Failure to meet minimum capital requirements could result in discretionary actions by regulators that, if taken, could have a materially adverse effect on our financial condition.

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. Once the capital conservation buffer is fully phased in, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total capital to total risk-weighted assets (“total risk-based capital ratio”) of 10.5%. The capital conservation buffer for 2018 is 1.875% and 1.25% for 2017. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Given an instantaneous 100 basis point increase in interest rates, the base net interest income would increase by an estimated 1.4% at September 30, 2018 compared with an increase of 0.9% at December 31, 2017. Given a 200 basis point increase in interest rates, base net interest income would increase by an estimated 2.7% at September 30, 2018, compared with an increase of 1.7% at December 31, 2017.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following September 30, 2018, as calculated using the static shock model approach:

	Change in Future Net Interest Income
	Dollar Change			Percentage Change
	(dollars in thousands)
+ 200 basis points	$	896			2.65	%
+ 100 basis points		462			1.37
- 100 basis points		(835	)		(2.47	)
- 200 basis points		(785	)		(2.32	)

Item 4. Controls and Procedures

As of the end of the quarterly period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

The Company and Bank are subject to claims and lawsuits that arise primarily in the ordinary course of business. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur. See Note 13, “Off Balance Sheet Risks, Commitments, and Contingent Liabilities” to the consolidated financial statements for additional detail regarding involvement in legal proceedings.

Item 1A. Risk Factors

Refer to the detailed cautionary statements and discussion of risks that affect the Company and its business in “Item 1A – Risk Factors” of the Annual Report on Form 10-K, for the year ended December 31, 2017. There have been no material changes from the risk factors previously discussed in those reports.

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

Not applicable.

Item 3. Default Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable

Item 6. Exhibits

(a) Exhibits

The following exhibits are filed or furnished as part of this report:

Exhibit Number	Description of Exhibit

3.1	Amended and Restated Articles of Incorporation of the Company, incorporated by reference to Exhibit 3.1 of the Quarterly Report on Form 10-Q filed August 2, 2018.

3.2	Amended and Restated Bylaws of the Company dated June 18, 2018, incorporated by reference to Exhibit 3.2 of the Current Report on Form 8-K dated June 18, 2018.

4.1	Tax Benefits Preservation Plan, dated as of June 25, 2015, between the Company and American Stock Transfer Company, as Rights Agent. Exhibit 3.1 to Form 8-K filed June 29, 2015 is incorporated by reference.

4.2	Amendment No. 1 to the Tax Benefits Preservation Plan, dated August 4, 2015. Exhibit 4.2 to the Quarterly Report on Form 10-Q filed August 5, 2015 is incorporated by reference.

4.3	Amendment No. 2 to the Tax Benefits Preservation Plan dated May 23, 2018, incorporated by reference to Exhibit 4 of the Current Report on Form 8-K dated May 23, 2018.

31.1	Certification of Principal Executive Officer, pursuant to Rule 13a - 14(a).

31.2	Certification of Principal Financial Officer, pursuant to Rule 13a - 14(a).

32.1	Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101	The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended September 30, 2018, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

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SIGNATURES

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

	LIMESTONE BANCORP, INC.
	(Registrant)

November 2, 2018	By:	/s/ John T. Taylor
		John T. Taylor
		Chief Executive Officer

November 2, 2018	By:	/s/ Phillip W. Barnhouse
		Phillip W. Barnhouse
		Chief Financial Officer

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LIMESTONE BANCORP, INC. Reports