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(Mark One)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
☒☒
☐☐
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 201 7
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
OR
Commission file number: 001-33033
PORTER BANCORP, INC.
(Exact name of registrant as specified in its charter)
Kentucky
(State or other jurisdiction of
incorporation or organization)
61-1142247
(I.R.S. Employer Identification No.)
2500 Eastpoint Parkway, Louisville, Kentucky
(Address of principal executive offices)
40223
(Zip Code)
Registrant ’s telephone number, including area code: (502) 499-4800
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Common Stock, no par value
Name of each exchange on which registered
N asdaq Capital Market
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer (as defined in Rule 405 of the Securities Act). Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of
registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company , or an emerging
growth company. See definition of “accelerated filer,” “large accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of
the Exchange Act. (Check one):
Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer ☐ Smaller reporting company ☒ Emerging growth company ☐
If an emerging growth company, i ndicate 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 pursuant to Section 13(a) of the Exchange Act. Yes ☐ No ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The aggregate market value of the voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold as of
the close of business on June 30, 2017, was $22,183,313 based upon the last sales price reported for such date on the Nasdaq Capital Market.
6 ,039,864 Common Shares and 220,000 Non-Voting Common Shares were outstanding as of February 28, 2018.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant ’s Proxy Statement for the Annual Meeting of Shareholders to be held May 23, 2018 are incorporated by reference into Part III of this
Form 10-K.
TABLE OF CONTENTS
Table of Contents
PART I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
Item 2. Properties
Item 3. Legal Proceedings
Item 4. Mine Safety Disclosures
PART II
Item 5. Market for Registrant ’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management ’s Discussion and Analysis of Financial Condition and Results of Operation
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
PART III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions, and Director Independence
Item 14. Principal Accounting Fees and Services
PART IV
Item 15. Exhibits and Financial Statement Schedules
Index to Exhibits
Signatures
Page No.
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Preliminary Note Concerning Forward-Looking Statements
PART I
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 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 beyond our control. Factors that could
contribute to differences in our results include, but are not limited to deterioration in the financial condition of borrowers resulting in significant increases in loan
losses and provisions for those losses; changes in the interest rate environment, which may reduce our margins or impact the value of securities, loans, deposits and
other financial instruments; changes in loan underwriting, credit review or loss reserve policies associated with economic conditions, examination conclusions, or
regulatory developments; general economic or business conditions, either nationally, regionally or locally in the communities we serve, may be worse than
expected, resulting in, among other things, a deterioration in credit quality or a reduced demand for credit; the results of regulatory examinations; any matter that
would cause us to conclude that there was impairment of any asset, including intangible assets; the continued service of key management personnel; our ability to
attract, motivate and retain qualified employees; factors that increase the competitive pressure among depository and other financial institutions, including product
and pricing pressures; the ability of our competitors with greater financial resources to develop and introduce products and services that enable them to compete
more successfully than us; inability to comply with regulatory capital requirements and to secure any required regulatory approvals for capital actions; legislative
or regulatory developments, including changes in laws concerning taxes, banking, securities, insurance and other aspects of the financial services industry; and
fiscal and governmental policies of the United States federal government.
Other risks are detailed in Item 1A. “Risk Factors” of this Form 10-K all of which are difficult to predict and many of which are beyond our control.
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. We have made our assumptions and bases in good faith and believe they are reasonable. We caution you 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. We do not intend to update these statements unless applicable laws require us to do so.
Item 1.
Business Overview
As used in this report, references to “ the Company,” “we,” “our,” “us,” and similar terms refer to the consolidated entity consisting of Porter Bancorp, Inc. and its
wholly-owned subsidiary. The “Bank” refers to Porter Bancorp, Inc.’s bank subsidiary, Limestone Bank, Inc.
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 PBIB. We operate the Bank, our wholly owned subsidiary and the fifteenth largest bank domiciled in the Commonwealth of Kentucky based on total assets
(formerly known as PBI Bank). We operate banking offices in twelve counties in Kentucky. Our markets include metropolitan Louisville in Jefferson County and
the surrounding counties of Henry and Bullitt. We serve south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson,
Barren, Warren, Ohio, and Daviess Counties. We also have 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 December 31, 2017, we had total assets of $970.8 million, total loans of $712.1 million, total deposits of
$847.0 million and stockholders’ equity of $72.7 million.
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Our Markets
We operate in markets that include the four largest cities in Kentucky – Louisville, Lexington, Bowling Green and Owensboro – and in other communities along
the I-65, Western Kentucky Parkway, and Natcher Parkway corridors.
■ Louisville/Jefferson, Bullitt and Henry Counties : Our headquarters are in Louisville, the largest city in Kentucky. We also have banking offices in
Bullitt County, south of Louisville, and Henry County, east of Louisville. Our banking offices in these counties also serve the contiguous counties of
Spencer, Shelby and Oldham to the east and northeast of Louisville. The area’s major employers are diversified across many industries and include
the air hub for United Parcel Service (“UPS”), two Ford assembly plants, GE Appliances and Lighting, Humana, Norton Healthcare, Brown-Forman,
YUM! Brands, Papa John’s Pizza, and Texas Roadhouse.
■ Lexington/Fayette County : Lexington, located in Fayette County, is the second largest city in Kentucky. Lexington is the financial, educational,
retail, healthcare and cultural hub for Central and Eastern Kentucky. It is known worldwide for its horse farms and Keeneland Race Track, and
proudly boasts of itself as “The Horse Capital of the World”. It is also the home of the University of Kentucky and Transylvania University. The
area’s major employers include Toyota, Lexmark, IBM Global Services and Valvoline.
■
Southern Kentucky : This market includes Bowling Green, the third largest city in Kentucky, located about 60 miles north of Nashville, Tennessee.
Bowling Green, located in Warren County, is the home of Western Kentucky University and is the economic hub of the area. This market also
includes communities in the contiguous Barren County, including the city of Glasgow. Major employers in Barren and Warren Counties include
GM’s Corvette plant, automotive supply chain manufacturers, and R.R. Donnelley’s regional printing facility.
■ Owensboro/Daviess County : Owensboro, located on the banks of the Ohio River, is Kentucky’s fourth largest city. The city is called a festival city,
with over 20 annual community celebrations that attract visitors from around the world, including its world famous Bar-B-Q Festival which attracts
over 80,000 visitors. It is an industrial, medical, retail and cultural hub for Western Kentucky and the area employers include Owensboro Medical
System, US Bank Home Mortgage, Titan Contracting and Specialty Food Group.
■
South Central Kentucky: South of the Louisville metropolitan area, we have banking offices in Butler, Edmonson, Green, Hart, and Ohio Counties.
This region includes stable community markets comprised primarily of agricultural and service-based businesses. Each of our banking offices in
these markets has a stable customer and core deposit base.
Our Products and Services
We meet our customers ’ banking needs with a broad range of financial products and services. Our lending services include real estate, commercial, mortgage,
agriculture, and consumer loans to those in our communities and to small to medium-sized businesses, the owners and employees of those businesses, as well as
other executives and professionals. We complement our lending operations with an array of retail and commercial deposit products. In addition, we offer our
customers drive-through banking facilities, automatic teller machines, night depository, personalized checks, credit cards, debit cards, internet banking, mobile
banking, treasury management services, remote deposit services, electronic funds transfers through ACH services, domestic and foreign wire transfers, cash
management, and vault services, along with loan and deposit sweep accounts.
Employees
At December 31, 2017, the Company had 217 full-time equivalent employees. Our employees are not subject to a collective bargaining agreement, and
management considers the Company’s relationship with employees to be good.
Competition
The banking business is highly competitive, and we experience competition from many other financial institutions. Competition among financial institutions is
based upon interest rates offered on deposit accounts, interest rates charged on loans, other credit and service charges relating to loans, the quality and scope of the
services offered, the convenience of banking facilities and, in the case of loans to commercial borrowers, relative lending limits. We compete with commercial
banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money
market funds and other mutual funds, as well as super-regional, national and international financial institutions that operate offices within our market area and
beyond.
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Supervision and Regulation
Written Agreement. On September 21, 2011, we entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of St. Louis. The
Company made formal commitments in the Written Agreement to use its financial and management resources to serve as a source of strength for the Bank and to
assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends without prior written approval, to pay no interest or principal
on subordinated debentures or trust preferred securities without written approval, and to submit an acceptable plan to maintain sufficient capital.
Bank and Holding Company Laws , Rules and Regulations. The following is a summary description of the relevant laws, rules and regulations governing banks
and bank holding companies. The descriptions of, and references to, the statutes and regulations below are brief summaries and do not purport to be complete. The
descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.
The Dodd-Frank Act. On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank Act”) was signed into law. The
Dodd-Frank Act imposed new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions.
The Dodd-Frank Act represents a comprehensive overhaul of the financial services industry within the United States. There are a number of reform provisions that
significantly impact the ways in which banks and bank holding companies, including the Company and the Bank, do business. For example, regulations issued
under the Dodd-Frank Act changed the assessment base for federal deposit insurance premiums by modifying the assessment base calculation to be based on a
depository institution’s consolidated assets less tangible capital instead of deposits, and permanently increased the standard maximum amount of deposit insurance
per customer to $250,000. The Dodd-Frank Act also imposed more stringent capital requirements on bank holding companies by, among other things, imposing
leverage ratios on bank holding companies and prohibiting new trust preferred security issuances from counting as Tier I capital. The Dodd-Frank Act also
repealed the federal prohibition on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction
and other accounts. The Dodd-Frank Act codified and expanded the Federal Reserve’s source of strength doctrine, which requires that all bank holding companies
serve as a source of financial strength for its subsidiary banks. Other provisions of the Dodd-Frank Act include, but are not limited to: (i) the creation of a financial
consumer protection agency that is empowered to promulgate new consumer protection regulations and revise existing regulations in many areas of consumer
protection; (ii) enhanced regulation of financial markets, including derivatives and securitization markets; (iii) reform related to the regulation of credit rating
agencies; (iv) the elimination of certain trading activities by banks; and (v) new disclosure and other requirements relating to executive compensation and
corporate governance.
Many provisions of the Dodd-Frank Act require interpretation and rule -making by federal agencies. The Company monitors all relevant sections of the Dodd-
Frank Act to ensure continued compliance with laws and regulations, which results in greater compliance costs and higher fees paid to regulators. Future
implementation of the Dodd-Frank Act may result in restrictions on the Company’s operations.
Porter Bancorp . The Company is registered as a bank holding company under the Bank Holding Company Act of 1956, as amended, and is subject to supervision
and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As such, we must file with the Federal Reserve Board
annual and quarterly reports and other information regarding our business operations and the business operations of our subsidiaries. We are also subject to
examination by the Federal Reserve Board and to operational guidelines established by the Federal Reserve Board. We are subject to the Bank Holding Company
Act and other federal laws on the types of activities in which we may engage, and to other supervisory requirements, including regulatory enforcement actions for
violations of laws and regulations.
Acquisitions.
A bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, ownership or control of more than 5%
of the voting stock or all or substantially all of the assets of a bank, merging or consolidating with any other bank holding company and before engaging, or
acquiring a company that is not a bank and is engaged in certain non-banking activities. Federal law also prohibits a person or group of persons from acquiring
“control” of a bank holding company without notifying the Federal Reserve Board in advance, and then may only do so if the Federal Reserve Board does not
object to the proposed transaction. The Federal Reserve Board has established a rebuttable presumptive standard that the acquisition of 10% or more of the voting
stock of a bank holding company would constitute an acquisition of control of the bank holding company. In addition, approval of the Federal Reserve Board is
required before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of a bank holding company’s voting securities,
or otherwise obtaining control or a “controlling influence” over a bank holding company.
Permissible
Activities
.
A bank holding company is generally permitted under the Bank Holding Company Act to engage in or acquire direct or indirect control of
more than 5% of the voting shares of any bank, bank holding company or company engaged in any activity that the Federal Reserve Board determines to be so
closely related to banking as to be a proper incident to the business of banking.
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Under current federal law, a bank holding company may elect to become a financial holding company, which enables the holding company to conduct activities
that are “financial in nature ,” incidental to financial activity, or complementary to financial activity that do not pose a substantial risk to the safety and soundness
of depository institutions or the financial system generally. Activities that are “financial in nature” include securities underwriting, dealing and market making in
securities; sponsoring mutual funds and investment companies; insurance underwriting and agency; merchant banking activities; and activities that the Federal
Reserve Board has determined to be closely related to banking. No regulatory approval is required for a financial holding company to acquire a company, other
than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the
Federal Reserve Board. We have not filed an election to become a financial holding company.
Capital
Adequacy
Requirements
.
Both the Company and the Bank are required to comply with capital adequacy guidelines. Guidelines are established by the
Federal Reserve Board for the Company and the FDIC for the Bank. Both the Federal Reserve Board and the FDIC have substantially similar risk based and
leverage ratio guidelines for banking organizations, which are intended to ensure that banking organizations have adequate capital related to the risk levels of assets
and off-balance sheet instruments. The capital adequacy guidelines are minimum supervisory ratios generally applicable to banking organizations that meet certain
specified criteria, assuming they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions
well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the
minimum ratios when circumstances warrant. Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible
assets.
In July 2013, the Federal Reserve Board and the FDIC approved final rules that substantially amended the regulatory risk-based capital rules applicable to the
Company and Bank. The final rules implement the regulatory capital reforms of the Basel Committee on Banking Supervision reflected in “Basel III: A Global
Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”) and changes required by the Dodd-Frank Act. The final rules implementing
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 the capital ratios.
The Basel III minimum capital level requirements applicable to bank holding companies and banks subject to the rules are a common equity Tier 1 capital ratio of
4.5%, a Tier 1 risk-based capital ratio of 6%, a total risk-based capital ratio of 8%, and a Tier 1 leverage ratio of 4% for all institutions. 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 area 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 phase-in of the capital conservation buffer requirement began in January 2016 at 0.625% of risk-weighted assets and increases each year until fully
implemented in January 2019. 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.
Under these new rules, Tier 1 capital generally consist s of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the
form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and
other specified intangible assets and other regulatory deductions. Tier 2 capital may consist of subordinated debt, certain hybrid capital instruments, qualifying
preferred stock and a limited amount of the allowance for loan losses. Proceeds of trust preferred securities are excluded from Tier 1 capital unless issued before
2010 by an institution with less than $15 billion of assets. Total capital is the sum of Tier 1 and Tier 2 capital.
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Prompt
Corrective
Action.
Pursuant to the Federal Deposit Insurance Act (“FDIA”), the FDIC must take prompt corrective action to resolve the problems of
undercapitalized institutions. FDIC regulations define the levels at which an insured institution would be considered “well capitalized,” “adequately capitalized,”
“undercapitalized,” “significantly undercapitalized” and “critically undercapitalized”. A bank is “undercapitalized” if it fails to meet any one of the ratios required
to be adequately capitalized. A depository institution may be deemed to be in a capitalization category that is lower than is indicated by its actual capital position if
it receives an unsatisfactory examination rating. The degree of regulatory scrutiny increases and the permissible activities of a bank decrease, as the bank moves
downward through the capital categories. Depending on a bank’s level of capital, the FDIC’s corrective powers include:
•
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•
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requiring a capital restoration plan;
placing limits on asset growth and restriction on activities;
requiring the bank to issue additional voting or other capital stock or to be acquired;
placing restrictions on transactions with affiliates;
restricting the interest rate the bank may pay on deposits;
ordering a new election of the bank’s board of directors;
requiring that certain senior executive officers or directors be dismissed;
prohibiting the bank from accepting deposits from correspondent banks;
requiring the bank to divest certain subsidiaries;
prohibiting the payment of principal or interest on subordinated debt; and
ultimately, appointing a receiver for the bank.
If an institution is required to submit a capital restoration plan, the institution ’s holding company must guarantee the subsidiary’s compliance with the capital
restoration plan up to a certain specified amount. Any such guarantee from a depository institution’s holding company is entitled to a priority of payment in
bankruptcy. The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it
became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations
where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company
controlling such an institution can be required to obtain prior Federal Reserve Board approval of proposed dividends, or might be required to consent to a
consolidation or to divest the troubled institution or other affiliates.
Dividends.
Under Federal Reserve Board policy, bank holding companies should pay cash dividends on common stock only out of income available over the past
year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank
holding companies should not declare a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking
subsidiaries.
The Company is a legal entity separate and distinct from the Bank. Historically, the majority of the Company’s revenue has been from dividends paid to it by the
Bank. The Bank is subject to laws and regulations that limit the amount of dividends it can pay. If, in the opinion of a federal regulatory agency, an institution
under its jurisdiction is engaged in or is about to engage in an unsafe or unsound practice, the agency may require, after notice and hearing, that the institution
cease such practice. The federal banking agencies have indicated that paying dividends that deplete an institution’s capital base to an inadequate level would be an
unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act (“FDICIA”), an insured institution may not pay any
dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the Federal Reserve and the FDIC have issued policy
statements providing that bank holding companies and banks should generally pay dividends only out of current operating earnings. A bank holding company may
still declare and pay a dividend if it does not have current operating earnings if the bank holding company expects profits for the entire year and the bank holding
company obtains the prior consent of the Federal Reserve.
Under Kentucky law, dividends by Kentucky banks may be paid only from current or retained net profits. The KDFI must approve the declaration of dividends if
the total dividends to be declared by a bank for any calendar year would exceed the bank’s total net profits for such year combined with its retained net profits for
the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. Additionally, retained earnings must be
positive. We are also subject to the Kentucky Business Corporation Act, which generally prohibits dividends to the extent they result in the insolvency of the
corporation from a balance sheet perspective or in the corporation becoming unable to pay its debts as they come due. The Bank did not pay any dividends in 2017
or 2016 and cannot currently pay any dividends without prior regulatory approval.
With respect to the payment of dividends, Porter Bancorp’s issued and outstanding Series E and Series F Preferred Shares rank senior to its common shares and
non-voting common shares.
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Source
of
Financial
Strength
.
Under Federal Reserve policy, a bank holding company is expected to act as a source of financial strength to, and to commit
resources to support, its bank subsidiaries. This support may be required at times when, absent such a policy, the bank holding company may not be inclined to
provide it. In addition, any capital loans by the bank holding company to its bank subsidiaries are subordinate in right of payment to deposits and to certain other
indebtedness of the bank subsidiary. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank
regulatory agency to maintain the capital of subsidiary banks will be assumed by the bankruptcy trustee and entitled to a priority of payment. The Federal
Reserve’s “Source of Financial Strength” policy was codified in the Dodd-Frank Act.
Limestone Bank. The Bank, a Kentucky chartered commercial bank, is subject to regular bank examinations and other supervision and regulation by both the
FDIC and the KDFI. Kentucky’s banking statutes contain a “super-parity” provision that permits a well-rated Kentucky banking corporation to engage in any
banking activity which could be engaged in by a national bank operating in Kentucky; a state bank, a thrift or savings bank operating in any other state; or a federal
chartered thrift or federal savings association meeting the qualified thrift lender test and operating in any state could engage, provided the Kentucky bank first
obtains a legal opinion specifying the statutory or regulatory provisions that permit the activity.
Capital
Requirements
.
Please see capital adequacy requirements discussion above.
Deposit
Insurance
Assessments.
The deposits of the Bank are insured by the Deposit Insurance Fund (“DIF”) of the FDIC up to the limits set forth under applicable
law and are subject to the deposit insurance premium assessments of the DIF. The FDIC imposes a risk-based deposit premium assessment system, which was
amended pursuant to the Federal Deposit Insurance Reform Act of 2005 (the “Reform Act”). Under this system, as amended, the assessment rates for an insured
depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one
of four risk categories determined by reference to its capital levels and supervisory ratings. The assessment rate schedule can change from time to time, at the
discretion of the FDIC, subject to certain limits.
The Dodd-Frank Act impose d additional assessments and costs with respect to deposits. Under the Dodd-Frank Act, the FDIC imposes deposit insurance
assessments based on total assets rather than total deposits. Pursuant to the Dodd-Frank Act, the FDIC revised the deposit insurance assessment system and
implemented a revised assessment rate process with the goal of differentiating insured depository institutions who pose greater risk to the DIF.
Safety
and
Soundness
Standards.
The FDIA requires the federal bank regulatory agencies to prescribe standards, by regulations or guidelines, relating to internal
controls, information systems and internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset quality, earnings,
stock valuation and compensation, fees and benefits, and such other operational and managerial standards as the agencies deem appropriate. Guidelines adopted by
the federal bank regulatory agencies establish general standards relating to these matters. In general, the guidelines require, among other things, appropriate
systems and practices to identify and manage the risk and exposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and
unsound practice and describe compensation as excessive when the amounts paid are unreasonable or disproportionate to the services performed by an executive
officer, employee, director or principal shareholder. In addition, the agencies adopted regulations that authorize, but do not require, an agency to order an
institution that has been given notice by an agency that it is not satisfying any of such safety and soundness standards to submit a compliance plan. If, after being
so notified, an institution fails to submit an acceptable compliance plan or fails in any material respect to implement an acceptable compliance plan, the agency
must issue an order directing action to correct the deficiency and may issue an order directing other actions of the types to which an undercapitalized institution is
subject under the “prompt corrective action” provisions of FDIA. See “Prompt Corrective Actions” above. If an institution fails to comply with such an order, the
agency may seek to enforce such order in judicial proceedings and to impose civil money penalties.
Branching.
Kentucky law permits Kentucky chartered banks to establish a banking office in any county in Kentucky. A Kentucky bank may also establish a
banking office outside of Kentucky. Well capitalized Kentucky banks that have been in operation at least three years and satisfy certain criteria relating to, among
other things, their composite and management ratings, may establish a banking office in Kentucky without the approval of the KDFI upon notice to the KDFI and
any other state bank with its main office located in the county where the new banking office will be located. Otherwise, branching requires the approval of the
KDFI, which must ascertain and determine that the public convenience and advantage will be served and promoted and that there is reasonable probability of the
successful operation of the banking office. The transaction must also be approved by the FDIC, which considers a number of factors, including financial history,
capital adequacy, earnings prospects, character of management, needs of the community and consistency with corporate powers.
Section 613 of the Dodd -Frank Act effectively eliminated the interstate branching restrictions set forth in the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994. Banks located in any state may now de novo branch in any other state, including Kentucky. Such unlimited branching power may increase
competition within the markets in which the Company and the Bank operate.
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Insider
Credit
Transactions
.
The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to as
“insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured depository institutions and their subsidiaries. These restrictions include
limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and
their related interests, which may not exceed the institution’s total unimpaired capital and surplus.
Consumer
Protection
Laws.
The Bank is subject to federal consumer protection statues and regulations promulgated under those laws, including, but not limited to,
the:
Truth-In-Lending Act and Regulation Z, governing disclosures of credit terms to consumer borrowers;
●
● Home Mortgage Disclosure Act and Regulation C, requiring financial institutions to provide certain information about home mortgage and refinanced
loans;
● Real Estate Settlement Procedures Act (“RESPA”), requiring lenders to provide borrowers with disclosures regarding the nature and cost of real estate
●
●
settlements and prohibiting certain abusive practices;
Secure and Fair Enforcement for Mortgage Licensing Act (“S.A.F.E. Act”), requiring residential loan originators who are employees of financial
institutions to meet registration requirements;
Fair Credit Reporting Act and Regulation V, governing the provision of consumer information to credit reporting agencies and the use of consumer
information;
Equal Credit Opportunity Act and Regulation B, prohibiting discrimination on the basis of race, religion or other prohibited factors in the extension of
credit;
Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
●
●
Truth in Savings Act, which requires disclosure of deposit terms to consumers;
● Regulation CC, which relates to the availability of deposit funds to consumers;
● Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for
●
●
complying with administrative subpoenas of financial records;
Electronic Funds Transfer Act, governing automatic deposits to and withdrawals from deposit accounts and customers ’ rights and liabilities arising from
the use of automated teller machines and other electronic banking services;
● Automated Overdraft Payment Regulations and Regulation E, requir ing financial institutions to provide customer notices, monitor overdraft payment
programs, and prohibiting financial institutions from charging consumer fees for paying overdrafts on automated teller machine and one time debit card
transactions unless a consumer consents, or opts in to the service for those types of transactions.
The Dodd-Frank Act created the Consumer Financial Protection Bureau, which is granted broad rulemaking, supervisory and enforcement powers under various
federal consumer financial protection laws. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10 billion
or more in assets. Smaller institutions are subject to rules promulgated by the CFPB, but continue to be examined and supervised by federal banking regulators for
consumer compliance purposes. The CFPB has authority to prevent unfair, deceptive or abusive acts or practices in connection with the offering of consumer
financial products. The Dodd-Frank Act authorizes the CFPB to establish certain minimum standards for the origination of residential mortgages including a
determination of the borrower’s ability to repay. In addition, the Dodd-Frank Act allows borrowers to raise certain defenses to foreclosure if they receive any loan
other than a “qualified mortgage” as defined by the CFPB.
The Dodd-Frank Act also permits states to adopt consumer protection laws and standards that are more stringent than those adopted at the federal level and, in
certain circumstances, permits state attorneys general to enforce compliance with both the state and federal laws an d regulations. Federal preemption of state
consumer protection law requirements, traditionally an attribute of the federal savings association charter, has also been modified by the Dodd-Frank Act and now
requires a case-by-case determination of preemption by the Office of the Comptroller of the Currency (“OCC”) and eliminates preemption for subsidiaries of a
bank. Depending on the implementation of this revised federal preemption standard, the operations of the Bank could become subject to additional compliance
burdens in the states in which it operates.
Loans
to
One
Borrower.
Under current limits, loans and extensions of credit outstanding at one time to a single borrower and not fully secured generally may not
exceed 20% of an institution ’s unimpaired capital and unimpaired surplus. Loans and extensions of credit fully secured by collateral may represent an additional
10% of unimpaired capital and unimpaired surplus.
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Volcker
Rule
. On December 10, 2013, the final Volcker Rule under the Dodd-Frank Act was approved and implemented by the Federal Reserve Board, the FDIC,
the Securities and Exchange Commission (“SEC”), and the Commodity Futures Trading Commission. The Volcker Rule attempts to reduce risk and banking
system instability by restricting U.S. banks from investing in or engaging in proprietary trading and speculation and imposing a strict framework to justify
exemptions for underwriting, market-making and hedging activities. U.S. banks are restricted from investing in funds with collateral comprised of less than 100%
loans that are not registered with the SEC and from engaging in hedging activities that do not hedge a specific identified risk. The Volcker Rule does not have a
significant effect on the Bank’s operations.
Privacy.
Federal law currently contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its
customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’
nonpublic personal financial information. These provisions also provide that, except for certain limited exceptions, an institution may not provide such personal
information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the
opportunity to opt out of such disclosure. Federal law makes it a criminal offense, except in limited circumstances, to obtain or attempt to obtain customer
information of a financial nature by fraudulent or deceptive means.
Community
Reinvestment
Act.
The Community Reinvestment Act (“CRA”) requires the FDIC to assess our record in meeting the credit needs of the communities
we serve, including low- and moderate-income neighborhoods and persons. The FDIC’s assessment of our record is made available to the public. The assessment
also is part of the Federal Reserve Board’s consideration of applications to acquire, merge or consolidate with another banking institution or its holding company,
to establish a new banking office or to relocate an office.
Bank
Secrecy
Act.
The Bank Secrecy Act of 1970 (“BSA”) was enacted to deter money laundering, establish regulatory reporting standards for currency
transactions and improve detection and investigation of criminal, tax and other regulatory violations. BSA and subsequent laws and regulations require us to take
steps to prevent the use of the Bank in the flow of illegal or illicit money, including, without limitation, ensuring effective management oversight, establishing
sound policies and procedures, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive internal
audit of BSA compliance activities. In recent years, federal regulators have increased the attention paid to compliance with the provisions of BSA and related laws,
with particular attention paid to “Know Your Customer” practices. Banks have been encouraged by regulators to enhance their identification procedures prior to
accepting new customers in order to deter criminal elements from using the banking system to move and hide illegal and illicit activities.
USA
Patriot
Act.
The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-
dealers and certain other financial institutions. The Patriot Act requires financial institutions to implement policies and procedures to combat money laundering and
the financing of terrorism. This includes standards for verifying customer identification at account opening, as well as rules to promote cooperation among
financial institutions, regulators and law enforcement entities in identifying parties that may be involved in terrorism or money laundering. It grants the Secretary
of the Treasury broad authority to establish regulations and to impose requirements and restrictions on the operations of financial institutions. In addition, the
Patriot Act requires the federal bank regulatory agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing
bank mergers and bank holding company acquisitions.
Effect on Economic Environment. The policies of regulatory authorities, including the monetary policy of the Federal Reserve Board, have a significant effect on
the operating results of bank holding companies and bank subsidiaries. Among the means available to the Federal Reserve Board to affect the money supply are
open market operations in U.S. government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against
member bank deposits. These means are used in varying combinations to influence overall growth and distribution of bank loans, investments and deposits. Their
use may affect interest rates charged on loans or paid for deposits.
Federal Reserve Board monetary policies have materially affected the operating results of commercial banks in the past and are expected to continue to do so in the
future. The nature of future monetary policies and the effect of such policies on our business and earnings and those of our subsidiaries cannot be predicted.
Legislative and Regulatory Initiatives . From time to time various laws, regulations and governmental programs affecting financial institutions and the financial
industry are introduced in Congress or otherwise promulgated by regulatory agencies. Such measures may change the environment in which the Company and its
subsidiaries operate in substantial and unpredictable ways. The nature and extent of future legislative, regulatory or other changes affecting financial institutions
are unpredictable at this time. Future legislation, policies and the effects thereof might have a significant influence on overall growth and distribution of loans,
investments and deposits. They also may affect interest rates charged on loans or paid on time and savings deposits. New legislation and policies have had a
significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.
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Available Information
The Company files periodic reports with the SEC including its annual report on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K
and proxy statements. The public may read and copy any materials filed with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC
20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an internet
site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at http://www.sec.gov .
Our SEC reports are accessible at no cost on our web site at http://www. limestonebank .com , under the Investors Relations section of the About Us tab, once they
have been electronically filed with the SEC. A shareholder may also request a copy of our Annual Report on Form 10-K free of charge upon written request to:
Chief Financial Officer, Porter Bancorp, Inc., 2500 Eastpoint Parkway, Louisville, Kentucky 40223.
Item 1A. Risk Factors
An investment in the Company’s common stock involves a number of risks. Realization of any of the risks described below could have a material adverse effect on
the Company’s business, financial condition, results of operations, cash flow and/or future prospects.
The Company is subject to a Written A greement with the Federal Reserve that restrict s the conduct of the Company’s operations and may have a
material adverse effect on its business.
In a Written Agreement with the Federal Reserve Bank of St. Louis, the Company made formal commitments in the agreement to use its financial and management
resources to serve as a source of strength for the Bank and to assist the Bank in addressing weaknesses identified by the FDIC and the KDFI, to pay no dividends
without prior written approval, to pay no interest or principal on subordinated debentures or trust preferred securities without written approval, and to submit an
acceptable plan to maintain sufficient capital.
Bank regulatory agencies can exercise discretion when an institution does not meet minimum regulatory capital levels and the other terms of a consent order. The
agencies may initiate changes in management, issue mandatory directives, impose monetary penalties or refrain from formal sanctions, depending on individual
circumstances. Any action taken by regulatory agencies could damage our reputation and have a material adverse effect on the Company’s business.
As a bank holding company , we depend on dividends and distributions paid to us by our banking subsidiary .
The Company is a legal entity separate and distinct from the Bank and our other subsidiaries. Our principal source of cash flow, from which we would fund any
dividends paid to our shareholders, has historically been dividends the Company receives from the Bank. Regulations of the FDIC and the KDFI govern the ability
of the Bank to pay dividends and other distributions to the Company, and regulations of the Federal Reserve govern our ability to pay dividends or make other
distributions to shareholders. Since the Bank is unlikely to be in a position to pay dividends to the Company without prior regulatory approval until retained
earnings are positive, cash inflows for the Company are limited to common stock or debt issuances. See the “Item 1. Business” “Item 5. Market for Registrant’s
Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities – Dividends.”
We are currently precluded from paying any dividends .
Our agreement with the holders of our trust preferred securities provides that we cannot pay dividends until we pay all deferred distributions in full and resume
paying quarterly distributions. We have also agreed with the Federal Reserve to obtain its written consent prior to declaring or paying any future dividends. In
addition, the dividend preferences of our Series E and Series F Preferred Shares entitle our preferred shareholders to receive an annual, noncumulative 2% dividend
before we can pay a dividend on our non-voting common shares and voting common shares.
Interest on junior subordinated debt is in deferral .
At December 31, 201 7, we had an aggregate obligation of $22.2 million relating to the principal and accrued unpaid interest on our four issues of junior
subordinated debentures, which has resulted in a deferral of distributions on our trust preferred securities. Although we are permitted to defer payments on these
securities for up to five years (and we commenced doing so in 2016), the deferred interest payments continue to accrue until paid in full. Our deferral period
expires after the second quarter of 2021.
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The Company ’s senior debt is secured by the Bank’s common stock and contains financial covenants that must be maintained to avoid default.
T he Company’s senior secured loan agreement is 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 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 December 31, 2017.
W e are defendants in various legal proceedings.
The Company and the Bank are involved in judicial proceedings and regulatory investigations concerning matters arisin g from our business activities. Although
we believe we have a meritorious defense in all significant litigation pending against us, we cannot predict the ultimate outcome. Litigation is subject to inherent
uncertainties and unfavorable rulings could occur. We record contingent liabilities resulting from claims against us when a loss is assessed to be probable and the
amount of the loss is reasonably estimable. 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. Accruals are not made in cases where liability is not probable or the amount cannot be reasonably
estimated. We provide disclosure of matters where we believe liability is reasonably possible and which may be material to our consolidated financial statements.
If we do not prevail, the ultimate outcome of litigation matters could have a material adverse effect on our financial condition, results of operations, or cash flows.
For more information about ongoing legal proceedings, see the Notes to Consolidated Financial Statements.
In the past, the Bank served as trustee for employee stock ownership plans (“ESOPs ”) which engaged in transactions that are under review by the U. S.
Department of Labor (“DOL”) , subjecting us to certain legal risks .
From 2007 until the first quarter of 2013, the Bank served as trustee for certain ESOPs that purchased the stock of companies from prior owners in purchase
transactions. Stock purchase transactions by ESOPs are subject to regular and routine reviews by the DOL for compliance with ERISA. Failure to fulfill fiduciary
duties under ERISA with respect to any such plan would subject the Bank to certain financial risks such as claims for damages as well as fines and penalties
assessable under ERISA. The Bank was a defendant in legal proceedings initiated by the DOL with respect to two stock purchase transactions by ESOPs for which
the Bank served as trustee. Both matters were settled. A ruling in any future litigation that the Bank failed to fulfill its fiduciary duties under ERISA with respect to
an ESOP, including stock purchases by the ESOP, could subject the Bank to claims for damages as well as fines and penalties assessable under ERISA.
Investigations into and heightened scrutiny of our operations could result in additional costs and damage our reputation.
In October 2014, the Department of Justice (“DOJ”) initiated an investigation concerning possible violations of federal laws, including, among other things,
possible violations related to false bank entries, bank fraud and securities fraud. The investigation concerns allegations that Bank personnel engaged in practices
intended to delay or avoid disclosure of the Bank’s asset quality at the time of and following the United States Treasury’s purchase of preferred shares from the
Company in November 2008. The Bank has cooperated with all requests for information from the DOJ. At this time, the DOJ has not indicated whether it intends
to pursue any action in the matter. Heightened scrutiny of the operations of the Company and the Bank by federal officials may subject us to governmental or
regulatory inquiries, investigations, actions, penalties and fines, which could adversely affect our reputation and result in costs to us in excess of current reserves
and management’s estimate of the aggregate range of possible loss for such matters.
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Our business may be adversely affected by conditions in the financial markets and by economic conditions generally.
W eakness in business and economic conditions generally or specifically in our markets may have one or more of the following adverse effects on our business:
● A decrease in the demand for loans and other products and services we offer;
● A decrease in the value of collateral securing our loans; and
● An increase in the number of customers who become delinquent, file for protection under bankruptcy laws or default on their loans.
Adverse conditions in the general business environment have had an adverse effect on our business in the past. Although the general business environment has
improved, we cannot predict how long such improvement can be sustained. In addition, the improvement of certain economic indicators, such as real estate asset
values, rents, and unemployment, may vary between geographic markets and may continue to lag behind improvement in the overall economy. These economic
indicators typically affect the real estate and financial services industries, in which we have a significant number of customers, more significantly than other
economic sectors. Furthermore, we have a substantial lending business that depends upon the ability of borrowers to make debt service payments on loans. Should
economic conditions worsen, our business, financial condition or results of operations could be adversely affected.
A large percentage of our loans are collateralized by real estate, and prolonged weakness in the real estate market may result in losses and adversely
affect our profitability.
Approximat ely 73.7% of our loan portfolio as of December 31, 2017, was comprised of commercial and residential loans collateralized by real estate. Adverse
economic conditions could decrease demand for real estate and depress real estate values in our markets. Persistent weakness in the real estate market could
significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. The real estate collateral in each case provides an alternate
source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If real estate values decline, it will
become more likely that we would be required to increase our allowance for loan losses. If during a period of depressed real estate values, we were required to
liquidate the collateral securing a loan to satisfy the debt or to increase our allowance for loan losses, it could materially reduce our profitability and adversely
affect our financial condition.
We offer real estate construction and development loans, which carry a higher degree of risk than other real estate loans . Weakness in the residential
construction and commercial development real estate markets has in the past increased the non-performing assets in our loan portfolio and our provision
for loan loss expense. These impacts have had, and could have in the future , a material adverse effect on capital, financial condition and results of
operations.
Approximately 8.1% of our loan portfolio as of December 31, 2017 consisted of real estate construction and development loans, up from 5.7% at December 31,
2016 and 5.4% at December 31, 2015. These loans generally carry a higher degree of risk than long-term financing of existing properties because repayment
depends on the ultimate completion of the project and permanent financing or sale of the property. If the Bank is forced to foreclose on a project prior to its
completion, it may not be able to recover the entire unpaid portion of the loan or it may be required to fund additional money to complete the project, or hold the
property for an indeterminate period of time. Any of these outcomes may result in losses and adversely affect profitability and financial condition.
R esidential construction and commercial development real estate activity in our markets were affected by the challenging economic conditions that followed the
financial crisis of 2008. Weakness in these sectors could lead to valuation adjustments to the loan portfolios and real estate owned. A weak real estate market could
reduce demand for residential housing, which, in turn, could adversely affect real estate development and construction activities. Consequently, the longer
challenging economic conditions persist, the more likely they are to adversely affect the ability of residential real estate development borrowers to repay loans and
the value of property used as collateral for such loans.
Our decisions regarding credit risk may not be accurate, and our allowance for loan losses may not be sufficient to cover actual losses, which could
adversely affect our business, financial condition and results of operations.
The Bank maintains an allowance for loan losses at a level we believe is adequate to absorb probable incurred losses in the loan portfolio based on historical loan
loss experience, economic and environmental factors, specific problem loans, value of underlying collateral and other relevant factors. If our assessment of these
factors is ultimately inaccurate, the allowance may not be sufficient to cover actual future loan losses, which would adversely affect operating results.
Management’s estimates are subjective, and their accuracy depends on the outcome of future events. Changes in economic, operating, and other conditions that are
generally beyond our control could cause actual loan losses to increase significantly. In addition, bank regulatory agencies, as an integral part of their supervisory
functions, periodically review the adequacy of our allowance for loan losses. Regulatory agencies may require an increase in provision for loan losses or to
recognize additional loan charge-offs when their judgment differed from ours. Any of these events could have a material negative impact on our operating results.
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Our levels of classified loans and non-performing assets may increase in the foreseeable future if economic conditions cause borrowers to default. Further, the
value of the collateral underlying a given loan, and the realizable value of such collateral in a foreclosure sale, may decline, making it less likely to realize a full
recovery if a borrower defaults on a loan. Any additional increases in the level of our non-performing assets, loan charge-offs or provision for loan losses, or our
inability to realize the estimated net value of underlying collateral in the event of a loan default, could negatively affect our business, financial condition, results of
operations and the trading price of our securities.
If we experience greater credit losses than anticipated, our operating results would be adversely affected.
As a lender, the Bank is exposed to the risk that borrowers will be unable to repay their loans according to their terms and that any collateral securing the payment
of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on our
operating results. Our credit risk with respect to our real estate and construction loan portfolio will relate principally to the creditworthiness of borrowers and the
value of the real estate serving as security for the repayment of loans. Our credit risk with respect to our commercial and consumer loan portfolio will relate
principally to the general creditworthiness of businesses and individuals within our local markets.
We make various assumptions and judgments about the collectability of our loan portfolio and provide an allowance for estimated loss losses based on a number of
factors. We believe that our allowance for loan losses is adequate. However, if our assumptions or judgments are wrong, our allowance for loan losses may not be
sufficient to cover our actual loan losses. We may have to increase our allowance in the future at the request of one of our primary banking regulators, to adjust for
changing conditions and assumptions, or as a result of any deterioration in the quality of our loan portfolio. The actual amount of future provisions for loan losses
cannot be determined at this time and may vary from the amounts of past provisions.
We continue to hold and from time to time acquire OREO properties, which could increase operating expenses and result in future losses to the
Company.
During recent years, the Bank has acquired and disposed of a significant amount of real estate as a result of foreclosure or by deed in lieu of foreclosure that is
listed on our balance sheet as other real estate owned (“OREO”). An increase in our OREO portfolio increases the expenses incurred to manage and dispose of
these properties, which sometimes includes funding construction required to facilitate sale.
Properties in our OREO portfolio are recorded at fair value, which represents the estimated sales price of the properties on the date acquired less estimated selling
costs. Generally, in determining “fair value” an orderly disposition of the property is assumed, except where a different disposition strategy is expected. Significant
judgment is required in estimating the fair value of OREO, and the period of time within which such estimates can be considered current may change during
periods of market volatility. Any decreases in market prices of real estate in our market areas may lead to additional OREO write downs, with a corresponding
expense in our statement of operations. We evaluate OREO property values periodically and write down the carrying value of the properties if and when the results
of our analysis require it.
In response to market conditions and other economic factors, we may utilize alternative sale strategies other than orderly disposition as part of our OREO
disposition strategy, such as auctions or bulk sales. In this event, as a result of the significant judgments required in estimating fair value and the variables involved
in different methods of disposition, the net proceeds realized from such sales transactions could differ significantly from appraisals, comparable sales, and other
estimates used to determine the fair value of our OREO properties. In addition, our disposition of OREO through alternative sales strategies could impact the fair
value of comparable OREO properties remaining in our portfolio.
Our profitability depends significantly on local economic conditions.
M ost of our business activities are conducted in central Kentucky and most of our credit exposure is in that region. We are at risk from adverse economic or
business developments affecting this area, including declining regional and local business and employment activity, a downturn in real estate values and
agricultural activities and natural disasters. To the extent the central Kentucky economy weakens, delinquency rates, foreclosures, bankruptcies and losses in our
loan portfolio will likely increase. Moreover, the value of real estate or other collateral that secures our loans could be adversely affected by the economic
downturn or a localized natural disaster. Events that adversely affect business activity and real estate values in central Kentucky have had and may continue to have
a negative impact on our business, financial condition, results of operations and future prospects.
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Our small to medium-sized business portfolio may have fewer resources to weather a downturn in the economy.
Our portfolio includes loans to small and medium-sized businesses and other commercial enterprises. Small and medium-sized businesses frequently have smaller
market shares than their competitors, may be more vulnerable to economic downturns, often need additional capital to expand or compete and may experience
variations in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small or medium-sized business often
depends on the management talents and efforts of one or two persons or a small group of persons. The death, disability or resignation of one or more of these
persons could have a material adverse impact on the business and its ability to repay our loan. A continued economic downturn may have a more pronounced
negative impact on our target market, causing us to incur substantial credit losses that could materially harm our operating results.
Our profitability is vulnerable to fluctuations in interest rates.
Changes in interest rates could harm our financial condition or results of operations. Our results of operations depend substantially on net interest income, the
difference between interest earned on interest-earning assets (such as investments and loans) and interest paid on interest-bearing liabilities (such as deposits and
borrowings). Interest rates are highly sensitive to many factors, including governmental monetary policies and domestic or international economic or political
conditions. Factors beyond our control, such as inflation, recession, unemployment and money supply may also affect interest rates. If, as a result of decreasing
interest rates, our interest-earning assets mature or reprice more quickly than our interest-bearing liabilities in a given period, our net interest income may decrease.
Likewise, our net interest income may decrease if interest-bearing liabilities mature or reprice more quickly than interest-earning assets in a given period as a result
of increasing interest rates.
Fixed-rate loans increase our exposure to interest rate risk in a rising rate environment because interest -bearing liabilities may be subject to repricing before assets
become subject to repricing. Fixed rate investment securities are subject to fair value declines as interest rates rise. Adjustable-rate loans decrease the risk
associated with changes in interest rates but involve other risks, such as the inability of borrowers to make higher payments in an increasing interest rate
environment. At the same time, for secured loans, the marketability of the underlying collateral may be adversely affected by higher interest rates. In a declining
interest rate environment, there may be an increase in prepayments on loans as the borrowers refinance their loans at lower interest rates, which could reduce net
interest income and harm our results of operations.
If we cannot obtain adequate funding, we may not be able to meet the cash flow requirements of our depositors and borrowers, or meet the operating
cash needs of the Company.
Our liquidity policies and limits are established by the Board of Directors of the Bank, with operating limits managed and monitored by the Asset Liability
Committee (“ALCO”), based upon analyses of the ratio of loans to deposits and the percentage of assets funded with non-core or wholesale funding. The ALCO
regularly monitors the overall liquidity position of the Bank and the Company to ensure that various alternative strategies exist to meet unanticipated events that
could affect liquidity. Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost. If our liquidity policies and strategies do not work as
well as intended, we may be unable to make loans and repay deposit liabilities as they become due or are demanded by customers. The ALCO follows established
board approved policies and monitors guidelines to diversify our wholesale funding sources to avoid concentrations in any one-market source. Wholesale funding
sources include Federal funds purchased, securities sold under repurchase agreements, and Federal Home Loan Bank (“FHLB”) advances that are collateralized
with mortgage-related assets.
We maintain a portfolio of securities that can be used as a secondary source of liquidity. There are other available sources of liquidity, including additional
collateralized borrowings such as FHLB advances, the issuance of debt securities, and the issuance of preferred or common shares in public or private transactions.
If we are unable to access any of these funding sources when needed, we might not be able to meet the needs of our customers, which could adversely impact our
financial condition, our results of operations, cash flows, and our level of regulatory-qualifying capital.
We may not be able to realize the value of our tax losses and deductions.
Due to historic losses, we have a net operating loss carry-forward of $25.6 million, credit carry-forwards of $900,000, and other net deferred tax assets of $4.8
million. In order to realize the benefit of these tax losses, credits and deductions, we will need to generate substantial taxable income in future periods. Our
deferred tax assets are calculated using a federal corporate tax rate of 21%. Changes in tax laws and rates may affect our deferred tax assets in the future. If lower
federal corporate tax rates are enacted, our net deferred tax assets would be reduced commensurate with the rate reduction. Additionally, s hould the Company
need to raise additional capital by issuing new common shares or securities convertible into common shares, then depending on the number of common share
equivalents issued, it could trigger a “change in control,” as defined by Section 382 of the Internal Revenue Code. Such an event could negatively impact or limit
the ability to utilize our net operating loss carry-forwards, credit loss carry-forwards, and other net deferred tax assets.
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We may sell capital stock in the future to raise additional capital or for additional liquidity at the holding company . Future sales or other dilution of our
equity may adversely affect the market price of our common shares .
Our issuance of additional common shares or securities convertible into common shares would dilute the ownership interest of our existing common shareholders.
The market price of our common shares could decline as a result of such an offering as well as other sales of a large block of shares of our common shares or
similar securities in the market after such an offering, or the perception that such sales could occur. Our common shares have traded from time-to-time at a price
below our book value per share. A sale of common shares at or below our book value would be dilutive to current shareholders. The sale of shares at a price below
market value could negatively impact the market price of our common shares.
Higher FDIC deposit insurance premiums and assessments could significantly increase our non-interest expense.
Our deposits are insured by the FDIC up to legal limits and, accordingly, we are subject to FDIC deposit insurance premiums and assessments. FDIC assessments
for deposit insurance are based on the average total consolidated assets of the insured institution during the assessment period, less the average tangible equity of
the institution during the assessment period. Any increase in assessment rates may adversely affect our business, financial condition or results of operations.
We face strong competition from other financial institutions and financial service companies, which could adversely affect our results of operations and
financial condition.
We compete with other financial institutions in attracting deposits and making loans. Our competition in attracting deposits comes principally from other
commercial banks, credit unions, savings and loan associations, securities brokerage firms, insurance companies, money market funds, and other mutual funds. Our
competition in making loans comes principally from other commercial banks, credit unions, savings and loan associations, mortgage banking firms, and consumer
finance companies. In addition, competition for business in the Louisville and Lexington metropolitan areas has grown in recent years as changes in banking law
have allowed banks to enter those markets by establishing new branches.
Competition in the banking industry may also limit our ability to attract and retain banking clients. We maintain smaller staffs of associates and have fewer
financial and other resources than larger institutions with which we compete. Financial institutions that have far greater resources and greater efficiencies than we
do may have several marketplace advantages resulting from their ability to:
offer higher interest rates on deposits and lower interest rates on loans than we can;
●
●
offer a broader range of services than we do;
● maintain more branch locations than we do; and
● mount extensive promotional and advertising campaigns.
In addition, banks and other financial institutions with larger capitalization and other financial intermediaries may not be subject to the same regulatory restrictions
as we are and may have larger lending limits than we do. Some of our current commercial banking clients may seek alternative banking sources as they develop
needs for credit facilities larger than we can accommodate. If we are unable to attract and retain customers, we may not be able to maintain growth and our results
of operations and financial condition may otherwise be negatively impacted.
We depend on our senior management team, and the unexpected loss of one or more of our senior executives could impair our relationship with
customers and adversely affect our business and financial results.
Our future success significantly depends on the continued services and performance of our key management personnel. Our future performance will depend on our
ability to motivate and retain these and other key officers. The Dodd-Frank Act, and the policies of bank regulatory agencies have placed restrictions on executive
compensation practices. Such restrictions and standards may further impact our ability to compete for talent with other businesses that are not subject to the same
limitations as we are. The loss of the services of members of senior management or other key officers or our inability to attract additional qualified personnel as
needed could materially harm our business.
Our reported financial results depend on management ’s selection of accounting methods and certain assumptions and estimates.
A ccounting policies and assumptions are fundamental to the reported financial condition and results of operations. Management must exercise judgment in
selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s
judgment of the most appropriate manner in which to report our financial condition and results. In some cases, management must select the accounting policy or
method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in reporting materially different results
than would have been reported under a different alternative.
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Certain accounting policies are critical to presenting our reported financial condition and results. They require management to make difficult, subjective or
complex judgments about matters that are uncertain. Materially different amounts could be reported under different conditions or using different assumptions or
estimates. These critical accounting policies include the valuation of securities, allowance for loan losses, valuation of OREO, valuation of stock based
compensation, valuation of net deferred income tax asset, assessing and estimating contingencies, and revenue recognition. Because of the uncertainty of estimates
involved in these matters, we may be required, among other things, to significantly increase the allowance for credit losses, sustain credit losses that are
significantly higher than the reserve provided, recognize significant impairment on OREO, or permanently impair deferred tax assets.
While management continually monitors and improves our system of internal controls, data processing systems, and corporate wide processes and
procedures, we may suffer losses from operational risk in the future.
Management maintains internal operational controls , and we have invested in technology to help us process large volumes of transactions. However, we may not
be able to continue processing at the same or higher levels of transactions. If our systems of internal controls should fail to work as expected, if our systems were to
be used in an unauthorized manner, or if employees were to subvert the system of internal controls, significant losses could occur.
We process large volumes of transactions on a daily basis and are exposed to numerous types of operation al risk, which could cause us to incur substantial losses.
Operational risk resulting from inadequate or failed internal processes, people, and systems includes the risk of fraud by employees or persons outside of our
company, the execution of unauthorized transactions by employees, errors relating to transaction processing and systems, and breaches of the internal control
system and compliance requirements. This risk of loss also includes potential legal actions that could arise as a result of the operational deficiency or as a result of
noncompliance with applicable regulatory standards.
We establish and maintain systems of internal operational controls that provide management with timely and accurate information about our level of operational
risk. While not foolproof, these systems have been designed to manage operational risk at appropriate, cost effective levels. We have also established procedures
that are designed to ensure that policies relating to conduct, ethics and business practices are followed. Nevertheless, we experience loss from operational risk from
time to time, including the effects of operational errors, and these losses may be substantial.
Our information systems may experience an interruption or security breach.
Failure in or breach of our operational or security systems or infrastructure, or those of our third party vendors and other service providers, including as a result of
cyber attacks, could disrupt our businesses, result in the disclosure or misuse of confidential or proprietary information, damage our reputation, increase our costs
and cause losses. As a financial institution, we depend on our ability to process, record and monitor a large number of customer transactions on a continuous basis.
As customer, public and regulatory expectations regarding operational and information security have increased, our operational systems and infrastructure must
continue to be safeguarded and monitored for potential failures, disruptions , and breakdowns. Our business, financial, accounting, data processing systems or other
operating systems and facilities may stop operating properly or become disabled or damaged as a result of a number of factors including events that are wholly or
partially beyond our control. For example, there could be sudden increases in customer transaction volume, electrical or telecommunications outages, natural
disasters such as earthquakes, tornadoes, and hurricanes; disease pandemics, events arising from local or larger scale political or social matters, including terrorist
acts, and, as described below, cyber attacks. Although we have business continuity plans and other safeguards in place, our business operations may be adversely
affected by significant and widespread disruption to our physical infrastructure or operating systems that support our businesses and customers.
Information security risks for financial institutions have generally increased in recent years in part because of the proliferation of new technologies, the use of the
Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers,
terrorists, activists, and other external parties. As noted above, our operations rely on the secure processing, transmission and storage of confidential information in
our computer systems and networks. In addition, to access our products and services, our customers may use personal smartphones, tablet PC’s, and other mobile
devices that are beyond our control systems. Although we believe we have appropriate information security procedures and controls, our technologies, systems,
networks, and our customers’ devices may become the target of cyber attacks or information security breaches. These events could result in the unauthorized
release, gathering, monitoring, misuse, loss or destruction of our customers’ confidential, proprietary and other information or that of our customers, or otherwise
disrupt the business operations of ourselves, our customers or other third parties.
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Third parties with which we do business or that facilitate our business activities, could also be sources of operational and information security risk to us, including
from breakdowns or failures of their own systems or capacity constraints. Although to date we have not experienced any material losses relating to cyber attacks or
other information security breaches, we can give no assurance that we will not suffer such losses in the future. Our risk and exposure to these matters remains
heightened because of, among other things, the evolving nature of these threats and the prevalence of Internet and mobile banking. As cyber threats continue to
evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate
any information security vulnerabilities. Disruptions or failures in the physical infrastructure or operating systems that support our businesses and customers, or
cyber attacks or security breaches of the networks, systems or devices that our customers use to access our products and services could result in customer attrition,
regulatory fines, penalties or intervention, reputational damage, reimbursement or other compensation costs, and/or additional compliance costs, any of which
could materially adversely affect our business, results of operations or financial condition.
We operate in a highly regulated environment and, as a result, are subject to extensive regulation and supervision that could adversely affect financial
performance and ability to implement growth and operating strategies.
We are subject to examination, supervision and comprehensive regulation by federal and state regulatory agencies, as described under “Item 1 – Business-
Supervision and Regulation.” Regulatory oversight of banks is primarily intended to protect depositors, the federal deposit insurance funds, and the banking system
as a whole, and not our shareholders. Compliance with these regulations is costly and may make it more difficult to operate profitably.
Federal and state banking laws and regulations govern numerous matters including the payment of dividends, the acquisition of other banks, and the establishment
of new banking offices. We must also meet specific regulatory capital requirements. Our failure to comply with these laws, regulations, and policies or to maintain
required capital could affect our ability to pay dividends on common shares, our ability to grow through the development of new offices, make acquisitions, and
remain independent. These limitations may prevent us from successfully implementing our growth and operating strategies.
In addition, the laws and regulations applicable to banks could change at any time, which could significantly impact our business and profitability. For example,
new legislation or regulation could limit the manner in which we may conduct our business, including our ability to attract deposits and make loans. Events that
may not have a direct impact on us, such as the bankruptcy or insolvency of a prominent U.S. corporation, can cause legislators and banking regulators and other
agencies such as the Consumer Financial Protection Bureau, the SEC, the Public Company Accounting Oversight Board and various taxing authorities to respond
by adopting and or proposing substantive revisions to laws, regulations, rules, standards, policies, and interpretations. The nature, extent, and timing of the
adoption of significant new laws and regulations, or changes in or repeal of existing laws and regulations may have a material impact on our business and results of
operations. Changes in regulation may cause us to devote substantial additional financial resources and management time to compliance, which may negatively
affect our operating results.
Changes in banking laws could have a material adverse effect on us.
We are subject to changes in federal and state laws as well as changes in banking and credit regulations, and governmental economic and monetary policies. We
cannot predict whether any of these changes could adversely and materially affect us. The current regulatory environment for financial institutions entails
significant potential increases in compliance requirements and associated costs. Federal and state banking regulators also possess broad powers to take supervisory
actions as they deem appropriate. These supervisory actions may result in higher capital requirements, higher insurance premiums and limitations on our activities
that could have a material adverse effect on our business and profitability.
Recent legislation regarding the financial services industry may have a significant adverse effect on operations.
Enacted in July 2010, the Dodd-Frank Act has had a significant impact the U.S. financial system, including among other things:
●
●
●
●
new requirements on banking, derivative and investment activities, including the repeal of the prohibition on the payment of interest on business demand
accounts, and debit card interchange fee requirements ;
the creation of the Consumer Financial Protection Bureau with supervisory authority, including the power to conduct examinations and take enforcement
actions with respect to financial institutions with assets of $10 billion or more and implement regulations that will affect all financial institutions;
provisions affecting corporate governance and executive compensation of all companies subject to the reporting requirements of the Securities and
Exchange Act of 1934, as amended; and
a provision requiring bank regulators to set minimum capital levels for bank holding companies that are as strong as those required for their insured
depository subsidiaries, subject to a grandfather clause for holding companies with less than $15 billion in assets as of December 31, 2009.
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Some provisions in the Dodd-Frank Act remain subject to regulatory rule-making, implementation, and interpretation, the effects of which are not yet known. As a
result, it is difficult to gauge the ultimate impact of certain provisions of the Dodd-Frank Act because the implementation of many concepts is left to regulatory
agencies. For example, the CFPB is given the power to adopt new regulations to protect consumers and is given control over existing consumer protection
regulations adopted by federal banking regulators. The CFPB has already adopted a number of regulations but it is not known at this time when additional rules
will be finalized and implemented.
The provisions of the Dodd-Frank Act and any rules adopted to implement those provisions , as well as any additional legislative or regulatory changes may impact
the profitability of our business activities and costs of operations, require that we change certain of our business practices, materially affect our business model or
affect retention of key personnel, require us to raise additional regulatory capital, including additional Tier 1 capital, and could expose us to additional costs
(including increased compliance costs). These and other changes may also require us to invest significant management attention and resources to make any
necessary changes and may adversely affect our ability to conduct our business as previously conducted or our results of operations or financial condition.
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Item 1B.
Unresolved Staff Comments
Not applicable.
Item 2.
Properties
The Bank operates 15 banking offices in Kentucky. The following table shows the location, square footage and ownership of each property. We believe that each
of these locations is adequately insured. Support operations are located in our main office in Louisville and in Glasgow.
Markets
Louisville/Jefferson, Bullitt and Henry Counties
Main Office: 2500 Eastpoint Parkway, Louisville
Eminence Office: 646 Elm Street, Eminence
Hillview Office: 6890 North Preston Highway, Hillview
Pleasureville Office: 5440 Castle Highway, Pleasureville
Conestoga Office: 155 Conestoga Parkway, Shepherdsville
Lexington/Fayette County
Lexington Office: 2424 Harrodsburg Road, Suite 100, Lexington
South Central Kentucky
Brownsville Office: 113 East Main Cross Street, Brownsville
Greensburg Office: 202 North Main Street, Greensburg
Horse Cave Office: 2 01 East Main Street, Horse Cave
Morgantown Office: 112 West G.L. Smith Street, Morgantown
Munfordville Office: 949 South Dixie Highway, Munfordville
Beaver Dam Office: 1300 North Main Street, Beaver Dam
Owensboro/Davie s s County
Owensboro Office: 1819 Frederica Street, Owensboro
Southern Kentucky
Campbell Lane Office: 751 Campbell Lane, Bowling Green
Glasgow Office: 1006 West Main Street, Glasgow
Other Properties
Office Building: 701 Columbia Avenue, Glasgow
Square Footage
Owned/Leased
30,000
1,500
3,500
10,000
3,900
Owned
Owned
Owned
Owned
Owned
8,500
Leased
8,500
11,000
5,000
7,500
9,000
3,200
Owned
Owned
Owned
Owned
Owned
Owned
3,000
Owned
7,500
12,000
Owned
Owned
19,000
Owned
Legal Proceedings
Item 3.
We are defendants in various legal proceedings. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur. See Note 16, “Off Balance
Sheet Risks, Commitments, and Contingent Liabilities” in the Notes to our consolidated financial statements for detail regarding ongoing legal proceedings and
other matters.
Item 4.
Mine Safety Disclosure
Not applicable .
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PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market Information
Our common shares are traded on the Nasdaq Capital Market under the ticker symbol “PBIB”. The following table presents the high and low market closing prices
per share for our common shares reported on the Nasdaq Capital Market for the periods indicated. The per share prices shown in the table have been adjusted for
the 1-for-5 reverse stock split of our common shares that took effect on December 16, 2016.
Quarter Ended
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
Quarter Ended
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
$
High
$
201 7
Low
201 6
Low
Market Value
15.45 $
11.81
10.49
12.75
Market Value
12.90 $
8.55
11.25
7.10
11.42 $
9.98
8.73
9.14
8.05 $
7.70
5.95
5.45
Dividend
Dividend
0.00
0.00
0.00
0.00
0.00
0.00
0.00
0.00
As of January 31, 2018, we had approximately 1,664 shareholders, including 470 shareholders of record and approximately 1,194 beneficial owners whose shares
are held in “ street” name by securities broker-dealers or other nominees.
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Dividends
As a bank holding company, our ability to declare and pay dividends depends on various federal regulatory considerations, including the guidelines of the Federal
Reserve regarding capital adequacy and dividends.
Our principal source of revenue with which to pay dividends on our common shares are dividends the Bank may declare and pay out of funds legally available for
payment of dividends. Currently, the Bank must obtain the prior written consent of its primary regulators prior to declaring or paying any dividends until retained
earnings are positive. A Kentucky chartered bank may declare a dividend of an amount of the bank’s net profits as the board deems appropriate. The approval of
the KDFI is required if the total of all dividends declared by a bank in any calendar year exceeds the total of its net profits for that year combined with its retained
net profits for the preceding two years, less any required transfers to surplus or a fund for the retirement of preferred stock or debt. Under our Written Agreement,
the prior approval of the Federal Reserve Bank of St. Louis is also required for the payment of any Bank dividends.
Effective with the third quarter of 2016, the Company resumed deferring interest payments on the junior subordinated notes underlying our trust preferred
securities. Deferring interest payments on the junior subordinated notes resulted in the deferral of distributions on our trust preferred securities. If we defer interest
payments on our trust preferred securities for 20 consecutive quarters, we must pay all deferred interest or we will be in default. Our deferral period expires after
the second quarter of 2021.
We will not be able to pay cash dividends on our common shares until we have paid all deferred distributions on our trust preferred securities. Deferred
distributions on trust preferred securities are cumulative, and distributions accrue and compound on each subsequent payment date. If we become subject to any
liquidation, dissolution or winding up of affairs, holders of the trust preferred securities and then holders of our preferred shares will be entitled to receive the
liquidation amounts to which they are entitled including the amount of any accrued and unpaid distributions and dividends, before any distribution can be made to
the holders of common shares or preferred shares. Series E and Series F Preferred Shares have priority over our common shares and non-voting common shares
with respect to any payment of dividends.
Purchase of Equity Securities by Issuer
During the fourth quarter of 2017, the Company did not repurchase any of its common shares, which is its only registered class of equity securities.
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Table of Contents
Item 6.
Selected Financial Data
The following table summarizes our selected historical consolidated financial data from 2013 to 2017. You should read this information in conjunction with Item 7.
“Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Item 8. “Financial Statements and Supplementary Data.”
Selected Consolidated Financial Data
(Dollars in thousands except per share data)
201 7
As of and for the Years Ended December 31,
20 1 4
20 1 5
201 6
20 1 3
Income Statement Data:
Interest income
Interest expense
Net interest income
Provision (negative provision) for loan losses
Non-interest income
Non-interest expense
Income (l oss) before income taxes
Income tax expense (benefit)
Net income (loss)
Less:
Dividends and accretion on preferred stock
Effect of exchange of preferred stock for common stock
Earnings (loss) allocated to participating securities
Net income (loss) attributable to common
Common Share Data: (1)
Basic earnings (loss) per common share
Diluted earnings (loss) per common share
Cash dividends declared per common share
Book value per common share ( 2)
Tangible book value per common share ( 2)
Balance Sheet Data (at period end):
Total assets
Debt obligations:
FHLB advances
Junior subordinated debentures
Subordinated capital note
Senior debt
Average Balance Data:
Average assets
Average loans
Average deposits
Average FHLB advances
Average junior subordinated debentures
Average subordinated capital note
Average senior debt
Average stockholders ’ equity
$
$
$
37,522 $
6,405
31,117
(800)
4,855
30,218
6,554
(31,899)
38,453
—
—
967
37,486 $
6.15 $
6.15
—
11.17
11.17
35,602 $
5,981
29,621
(2,450)
4,764
39,567
(2,732)
21
(2,753)
—
—
(88)
(2,665) $
(0.46) $
(0.46)
—
4.81
4.79
36,574 $
7,023
29,551
(4,500)
7,695
44,959
(3,213)
—
(3,213)
—
—
(336)
(2,877) $
(0.62) $
(0.62)
—
5.43
5.33
39,513 $
9,795
29,718
7,100
4,079
39,435
(12,738)
(1,583)
(11,155)
2,362
(36,104)
3,159
19,428 $
7.94 $
7.94
—
8.37
8.05
43,228
11,143
32,085
700
5,919
38,890
(1,586)
—
(1,586)
2,079
—
(267)
(3,398)
(1.44)
(1.44)
—
(0.92)
(1.46)
$
970,801 $
945,177 $
948,722 $
1,017,989 $
1,076,121
11,797
21,000
2,250
10,000
22,458
21,000
3,150
—
3,081
21,000
4,050
—
15,752
25,000
4,950
—
4,492
25,000
5,850
—
$
947,961 $
667,474
864,278
9,184
21,000
2,805
5,068
37,851
929,140 $
621,275
852,717
2,967
21,000
3,708
—
39,423
984,419 $
635,948
907,785
3,473
23,981
4,608
—
33,083
1,049,232 $
662,442
961,671
4,473
25,000
5,508
—
33,881
1,098,400
788,176
1,004,052
4,990
25,000
6,404
—
42,631
(1) On December 16, 2016, the Company completed a 1-for-5 reverse stock split of its issued and outstanding common and non-voting common shares. As a
result of the reverse stock split, all share and per share data has been adjus ted in the accompanying tables. Preferred shares were not impacted by the 1-for-5
reverse stock split.
(2) After shareholder approval on February 25, 2015, our two series of mandatorily convertible preferred shares converted into a total of 810,720 common
shares and 1,291,600 non-voting common shares.
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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
Management ’s discussion and analysis of financial condition and results of operations analyzes the consolidated financial condition and results of operations of
Porter Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, Limestone Bank, Inc. (the “Bank”). The Bank completed a name change from PBI Bank to
Limestone Bank on February 20, 2018. The Company is a Louisville, Kentucky-based bank holding company that operates banking offices of the Bank in twelve
Kentucky counties. Our markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. We serve south central
Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. We also have 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.
Historically, we have focused on commercial and commercial real estate lending, both in markets where we have banking offices and other growing markets in our
region. Commercial, commercial real estate and real estate construction loans accounted for 58.4% of our total loan portfolio as of December 31, 2017, and 55.6%
as of December 31, 2016. Commercial lending generally produces higher yields than residential lending, but involves greater risk and requires more rigorous
underwriting standards and credit quality monitoring.
The following discussion should be read in conjunction with our consolidated financial statements and accompanying notes and other schedules presented
elsewhere in the report.
Overview
For the year ended December 31, 2017, the Company reported net income of $38.5 million compared with net loss of $2.8 million for the year ended
December 31, 2016 and a net loss of $3.2 million for the year ended December 31, 2015. After allocating earnings to participating securities, net income
attributable to common shareholders was $37.5 million for the year ended December 31, 2017, compared with net loss attributable to common shareholders of $2.7
million for the year ended December 31, 2016, and a net loss attributable to common shareholders of $2.9 million for the year ended December 31, 2015. Basic and
diluted income per common share were $6.15 for the year ended December 31, 2017, compared with net loss per common share of ($0.46) for 2016, and net loss
per common share of ($0.62) for 2015.
The following significant items are of note for the year ended December 31, 2017:
●
●
●
The Company has had a full valuation allowance against its net deferred tax asset since 2011. The ability to utilize the net deferred tax asset depends upon
generating sufficient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance depends upon
the evaluation of both positive and negative evidence regarding the likelihood of achieving sufficient future taxable income levels. 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. As a result of the conclusion to reverse the valuation allowance, the Company
recorded an income tax benefit of $54.0 million for the year ended December 31, 2017. On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was
signed into law. Among other significant changes to the tax code, the new law lowered the federal corporate tax rate from 35% to 21% beginning in 2018.
As a result, the Company revalued its net deferred tax asset at the new 21% rate. Due to this revaluation, the Company recorded a $20.3 million charge to
income tax expense for the year ended December 31, 2017. The combination of the reversal of the valuation allowance and the change in federal
corporate tax rates, as well as income tax expense for the year, resulted in an income tax benefit of $31.9 million for the year ended December 31, 2017.
The Bank is no longer subject to a consent order with the Federal Deposit Insurance Corporation and Kentucky Department of Financial Institutions. We
were notified that the Bank ’s prior consent order was terminated, effective October 31, 2017.
Loan growth outpaced paydowns during the period. Average loans receivable increased approximately $ 46.2 million or 7.4% to $667.5 million for the
year ended December 31, 2017, compared with $621.3 million for the year ended December 31, 2016. This resulted in an increase in interest revenue
volume of approximately $2.2 million, which was offset by rate decreases of $895,000 for the year ended December 31, 2017, compared with the year
ended December 31, 2016.
● Net interest margin increased six basis points to 3.48% for the year ended 2017 compared with 3.42% in the year ended December 31, 2016. The increase
in margin between periods was primarily due to an increase in the rate of interest earned on interest earning assets from 4.11% in 2016 to 4.18% in 2017.
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● N egative provision for loan losses expense was $800,000 in 2017, compared to a negative provision for loan losses expense of $2.5 million for 2016,
because of declining historical loss rates, improvements in loan quality, and management’s assessment of risk in the loan portfolio. Net loan recoveries
were $35,000 for 2017, compared to net loan charge-offs of $624,000 for 2016 and $2.8 million for 2015. In the following paragraphs, we discuss the
improving trends in non-performing loans, past due loans, and loan risk categories during the period, factors that led to the negative provision expense.
● Non-performing loans decreased $3.8 million to $5.5 million at December 31, 2017, compared with $9.2 million at December 31, 2016. The decrease in
non-performing loans was due to $5.0 million in paydowns, $665,000 in charge-offs, $199,000 in loans returned to accrual status, and $270,000 in
transfers to OREO, offset by $2.3 million in loans placed on non-accrual.
●
Loans past due 30-59 days decreased from $ 2.3 million at December 31, 2016 to $1.5 million at December 31, 2017, and loans past due 60-89 days
decreased from $315,000 at December 31, 2016 to $171,000 at December 31, 2017. Loans past due 90 days or more totaled $1,000 at December 31, 2017,
compared to no loans past due 90 days or more at December 31, 2016. Total loans past due and nonaccrual loans decreased to $7.1 million at December
31, 2017 from $11.8 million at December 31, 2016.
● All loan risk categories (other than pass loans) have dec reased since December 31, 2016. Pass loans represent 94.5% of the portfolio at December 31,
2017, compared to 91.7% at December 31, 2016 and 83.6% at December 31, 2015. During 2017, the pass category increased approximately $86.6
million, the watch category declined approximately $4.7 million, the special mention category declined approximately $333,000, and the substandard
category declined approximately $8.7 million. The $8.7 million decrease in loans classified as substandard was driven by $6.8 million in principal
payments received, $270,000 in migration to OREO, $4.6 million in loans upgraded from substandard, and $790,000 in charge-offs, offset by $3.7 million
in loans moved to substandard during 2017.
●
Foreclosed properties were $ 4.4 million at December 31, 2017, compared with $6.8 million at December 31, 2016. During the year ended December 31,
2017, the Company acquired $270,000 and sold $793,000 of OREO. We incurred OREO losses totaling $2.0 million during the year ended December 31,
2017, reflecting fair value write-downs for updated appraisals, changes in marketing strategies, and reductions in listing prices for certain properties,
offset by $74,000 in net gain on sales of OREO.
● N on-performing assets decreased to $9.9 million or 1.02% of total assets at December 31, 2017, compared with $16.0 million or 1.70% of total assets at
December 31, 2016. In addition, accruing troubled debt restructurings declined to $1.2 million at December 31, 2017 from $5.4 million at December 31,
2016.
● Non-interest income increased by $ 91,000 in 2017 to $4.9 million compared with $4.8 million for the year ended December 31, 2016. This increase was
primarily attributable to a $295,000 increase in service charges on deposit accounts, a $123,000 increase in bank card interchange fees, and a $72,000
increase in net gain on sale of securities partially offset by no OREO income during 2017, compared to $456,000 during 2016.
● Non-interest expense for the year ended December 31, 2017 of $30.2 million represented a 23.6% decrease from $39.6 million for 2016. The decrease in
non-interest expense was attributable primarily to a decrease in litigation and loan collection expense, which decreased $8.6 million. Litigation expense
was negatively impacted in 2016 by a ruling from the Kentucky Court of Appeals against the Bank that approximated $8.0 million. Non-interest expense
also benefited from a $590,000 decrease in professional fees, a $418,000 decrease in salaries and employee benefits, and a $248,000 decrease in FDIC
insurance.
● Deposits decreased $2.9 million or 0.3% to $847.0 million at December 31, 2017 compared with $849.9 million at December 31, 2016. Certificate of
deposit balances decreased $20.4 million during 2017 to $424.2 million at December 31, 2017, from $444.6 million at December 31, 2016. Non-interest
bearing demand deposits increased $13.0 million or 10.4% during 2017 to $137.4 million compared with $124.4 million at December 31, 2016. Money
market accounts increased $8.9 million or 6.2% during 2017 to $151.4 million compared with $142.5 million at December 31, 2016.
23
Table of Contents
● On June 30, 2017, the Company entered into 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 Company contributed $9.0 million of the
borrowing proceeds to the Bank as common equity Tier 1 capital. The remaining $1.0 million of the borrowing proceeds was retained by the lender in
escrow to service quarterly interest payments. At December 31, 2017, the escrow account had a balance of $806,000.
These items are discussed in further detail throughout this Item 7.
Application of Critical Accounting Policies
The Company ’s accounting and reporting policies comply with GAAP and conform to general practices within the banking industry. We believe that the following
significant accounting policies may involve a higher degree of management assumptions and judgments that could result in materially different amounts to be
reported if conditions or underlying circumstances were to change.
Allowance for Loan Losses – The Bank maintains an allowance for loan losses believed to be sufficient to absorb probable incurred credit losses existing in the
loan portfolio. The Board of Directors evaluates the adequacy of the allowance for loan losses on a quarterly basis. We evaluate the adequacy of the allowance
using, among other things, historical loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to
repay, estimated value of the underlying collateral and current economic conditions and trends. The allowance may be allocated for specific loans or loan
categories, but the entire allowance is available for any loan. The allowance consists of specific and general components. The specific component relates to loans
that are individually evaluated and measured for impairment. The general component is based on historical loss experience adjusted for qualitative environmental
factors. We develop allowance estimates based on actual loss experience adjusted for current economic conditions and trends. Allowance estimates are a prudent
measurement of the risk in the loan portfolio applied to individual loans based on loan type. If the mix and amount of future charge-off percentages differ
significantly from the assumptions used by management in making its determination, we may be required to materially increase our allowance for loan losses and
provision for loan losses, which could adversely affect our results.
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. OREO is recorded at its fair market value less estimated cost to sell. Any write-down of the property at the time of acquisition is charged to the
allowance for loan losses. Costs incurred in order to perfect the lien prior to foreclosure may be capitalized if the fair value less the cost to sell exceeds the balance
of the loan at the time of transfer to OREO. Examples of eligible costs to be capitalized are payments of delinquent property taxes to clear tax liens or payments to
contractors and subcontractors to clear mechanics’ liens. Fair value of OREO is determined on an individual property basis. To determine the fair value of OREO
for smaller dollar single family homes, we consult with staff from the Bank’s special assets group as well as external realtors and appraisers. If the internally
evaluated market price is below our underlying investment in the property, appropriate write-downs are taken. For larger dollar residential and commercial real
estate properties, we obtain a new appraisal of the subject property or have staff from our special assets group evaluate the latest in-file appraisal in connection
with the transfer to OREO. We typically obtain 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
appraised amount.
Stock-based Compensation – Compensation cost is recognized for restricted stock awards issued to employees, based on the fair value of these awards at the date
of grant. The market price of the Company’s common shares at the date of grant is used for restricted stock awards. Compensation cost is recognized over the
required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the
requisite service period for the entire award.
Valuation of Deferred Tax Asset – We evaluate deferred tax assets for impairment on a quarterly basis. We established a 100% deferred tax valuation allowance
in December 2011 based upon the analysis of our past performance and our expected future performance. The Company’s ability to utilize the net deferred tax
asset depends upon generating suffient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance
depends upon the evaluation of both positive and negative evidence regarding the likelihood of achieving future taxable income levels. In 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.
24
Table of Contents
Contingencies – We are defendants in various legal proceedings. We record contingent liabilities resulting from claims against us when a loss is assessed to be
probable and the amount of the loss is reasonably estimable. 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.
Results of Operations
The following table summarizes components of income and expense and the change in those components for 2017 compared with 2016:
For the
Years Ended December 31,
Gross interest income
Gross interest expense
Net interest income
Provision (negative provision) for loan losses
Non-interest income
Gains on sale of securities, net
Non-interest expense
Net income (loss) before taxes
Income tax expense (benefit)
Net income (loss)
Earnings (l osses) attributable to participating securities
Net income (loss) attributable to common shareholders
NM: Not Meaningful
$
201 7
37,522 $
6,405
31,117
(800)
4,567
288
30,218
6,554
(31,899)
38,453
967
37,486
Change from Prior Period
Percent
Amount
201 6
(dollars in thousands)
35,602 $
5,981
29,621
(2,450)
4,548
216
39,567
(2,732)
21
(2,753)
(88)
(2,665)
1,920
424
1,496
1,650
19
72
(9,349)
9,286
(31,920)
41,206
1,055
40,151
5.4%
7.1
5.1
67.3
0.4
33.3
(23.6)
339.9
NM
NM
NM
NM
Net income of $38.5 million for the year ended December 31, 2017 increased by $41.2 million from a net loss of $2.8 million for 2016. During the period,
improving trends in non-performing loans, past due loans, and loan risk categories continued. In addition, net income for 2017 was impacted by the reversal of the
Company’s deferred tax asset valuation allowance and the change in federal corporate tax rates in connection with the enactment of the Tax Cuts and Jobs Act of
2017. The net result of these two items, as well as income tax expense for the year, was an income tax benefit of $31.9 million for 2017. A negative provision for
loan losses expense of $800,000 was recorded during 2017, compared to $2.5 million negative provision for loan losses expense for 2016. Non-interest income
increased $19,000 during 2017. There was an increase of $295,000 in service charges on deposit accounts, $123,000 in bank card interchange fees, and $62,000 in
other non-interest income which was offset by no OREO income during 2017, compared to $456,000 during 2016. Non-interest expense decreased $9.3 million
during 2017 due primarily to a decrease in litigation and loan collection expense of $8.6 million as 2016 was negatively impacted by a ruling from the Kentucky
Court of Appeals against the Bank that approximated $8.0 million. After consideration of earnings attributable to participating securities, net income attributable to
common shareholders was $37.5 million for the year ended December 31, 2017, as compared to net loss attributable to common shareholders of $2.7 million for
2016.
25
Table of Contents
The following table summarizes components of income and expense and the change in those components for 2016 compared with 2015:
For the
Years Ended December 31,
Gross interest income
Gross interest expense
Net interest income
Provision (negative provision) for loan losses
Non-interest income
Gains on sale of securities, net
Non-interest expense
Net loss before taxes
Income tax expense
Net loss
Earnings (losses) attributable to participating securities
Net loss attributable to common shareholders
$
201 6
35,602 $
5,981
29,621
(2,450)
4,548
216
39,567
(2,732)
21
(2,753)
(88)
(2,665)
Change from Prior Period
Percent
Amount
201 5
(dollars in thousands)
36,574 $
7,023
29,551
(4,500)
5,929
1,766
44,959
(3,213)
—
(3,213)
(336)
(2,877)
(972)
(1,042)
70
(2,050)
(1,381)
(1,550)
(5,392)
481
21
(460)
248
(212)
(2.7)%
(14.8)
0.2
(45.6)
(23.3)
(87.8)
(12.0)
15.0
100.0
(14.3)
(73.8)
(7.4)
Net loss of $2.8 million for the year ended December 31, 2016 decreased by $460,000 from a net loss of $3.2 million for 2015. A negative provision for loan
losses expense of $2.5 million was recorded for 2016 due to improvements in loan quality and management’s assessment of risk within the portfolio as compared
to $4.5 million negative provision for loan losses expense for 2015. Non-interest income decreased $2.9 million during 2016 due primarily to a decrease in OREO
rental income of $890,000 driven by the sale of income producing properties and a $1.6 million decrease in gains on the sale of securities compared to 2015. Non-
interest expense decreased $5.4 million during 2016. OREO expense decreased by $10.8 million, but was offset by a $7.7 million increase in litigation and loan
collection expense primarily resulting from the adverse Kentucky Court of Appeals ruling. After consideration of losses attributable to participating securities, net
loss attributable to common shareholders was $2.7 million for the year ended December 31, 2016, as compared to net loss attributable to common shareholders of
$2.9 million for 2015.
Net Interest In come – Net interest income was $31.1 million for the year ended December 31, 2017, an increase of $1.5 million, or 5.1%, compared with $29.6
million for the same period in 2016. Net interest spread and margin were 3.35% and 3.48%, respectively, for 2017, compared with 3.32% and 3.42%, respectively,
for 2016. Average nonaccrual loans were $7.1 million and $11.4 million in 2017 and 2016, respectively.
A verage interest-earning assets were $904.1 million for 2017, compared with $875.3 million for 2016, a 3.3% increase, primarily attributable to higher average
loans and investment securities, partially offset by a decrease in interest bearing deposits with financial institutions. Average loans were $667.5 million for 2017,
compared with $621.3 million for 2016, a 7.4% increase. Average investment securities were $193.1 million for 2017, compared with $183.7 million for 2016, a
5.1% increase. Average interest bearing deposits with financial institutions and fed funds sold were $36.2 million in 2017, compared with $62.9 million in 2016, a
42.4% decrease. Total interest income increased 5.4% to $37.5 million for 2017, compared with $35.6 million for 2016.
A verage interest-bearing liabilities increased by 1.7% to $773.2 million for 2017, compared with $760.7 million for 2016. Our total interest expense increased by
7.1% to $6.4 million for 2017, compared with $6.0 million during 2016, due primarily to the completion of a $10.0 million senior debt transaction during 2017 as
well as an increase in FHLB advances outstanding during 2017. Average volume of certificates of deposit decreased 2.9% to $452.4 million for 2017, compared
with $466.0 million for 2016. The average interest rate paid on certificates of deposit increased to 0.93% for 2017, compared with 0.88% for 2016. Average
volume of interest checking and money market deposit accounts increased 6.2% to $247.3 million for 2017, compared with $232.7 million for 2016. The average
interest rate paid on interest checking and money market deposit accounts decreased to 0.38% for 2017, compared with 0.40% for 2016.
N et interest income was $29.6 million for the year ended December 31, 2016, an increase of $70,000, or 0.2%, compared with $29.6 million for the same period in
2015. Net interest spread and margin were 3.32% and 3.42%, respectively, for 2016, compared with 3.18% and 3.27%, respectively, for 2015. Average nonaccrual
loans were $11.4 million and $29.0 million in 2016 and 2015, respectively.
A verage interest-earning assets were $875.3 million for 2016, compared with $917.5 million for 2015, a 4.6% decrease, primarily attributable to lower average
loans, investment securities and interest bearing deposits with financial institutions. Average loans were $621.3 million for 2016, compared with $635.9 million for
2015, a 2.3% decrease. Average investment securities were $183.7 million for 2016, compared with $194.1 million for 2015, a 5.3% decrease. Average interest
bearing deposits with financial institutions were $62.3 million in 2016, compared with $78.9 million in 2015, a 21.0% decrease. Our total interest income
decreased 2.7% to $35.6 million for 2016, compared with $36.6 million for 2015.
26
Table of Contents
A verage interest-bearing liabilities decreased by 8.0% to $760.7 million for 2016, compared with $826.9 million for 2015. Total interest expense decreased by
14.8% to $6.0 million for 2016, compared with $7.0 million during 2015, due primarily to lower interest rates paid on and lower volume of certificates of deposit.
Average volume of certificates of deposit decreased 16.4% to $466.0 million for 2016, compared with $557.4 million for 2015. The average interest rate paid on
certificates of deposit decreased to 0.88% for 2016, compared with 0.96% for 2015, as the result of continued re-pricing of certificates of deposit at maturity to
lower interest rates. The average volume of interest checking and money market deposit accounts increased 15.7% to $232.7 million for 2016, compared with
$201.2 million for 2015. The average interest rate paid on interest checking and money market deposit accounts increased to 0.40% for 2016, compared with
0.38% for 2015.
27
Table of Contents
Average Balance Sheets
The following table sets forth the average daily balances, the interest earned or paid on such amounts, and the weighted average yield on interest-earning assets and
weighted average cost of interest-bearing liabilities for the periods indicated. Dividing income or expense by the average daily balance of assets or liabilities,
respectively, derives such yields and costs for the periods presented.
Average
Balance
201 7
Interest
Earned/Paid
For the Years Ended December 31,
Average
Yield/Cost
Average
Balance
(dollars in thousands)
201 6
Interest
Earned/Paid
Average
Yield/Cost
ASSETS
Interest-earning assets:
Loans receivables (1)(2)
Real estate
Commercial
Consumer
Agriculture
Other
$
U.S. Treasury and agencies
Mortgage-backed securities
Collateralized loan obligations
State and political subdivision securities
(non-taxable) (3)
State and political subdivision securities
(taxable)
Corporate bonds
FHLB stock
Federal funds sold
Interest-bearing deposits in other
financial institutions
Total interest-earning assets
Less: Allowance for loan losses
Non-interest-earning assets
Total assets
$
LIABILITIES AND STOCKHOLDERS ’
EQUITY
Interest-bearing liabilities
Certificates of deposit and other time
509,133 $
107,188
10,790
39,839
524
31,440
94,451
20,242
19,617
23,689
3,651
7,323
960
35,222
904,069
(8,961)
52,853
947,961
24,544
4,403
843
2,047
29
694
2,240
541
571
757
167
366
10
4.82% $
4.11
7.81
5.14
5.53
2.21
2.37
2.67
4.48
3.20
4.57
5.00
1.04
310
37,522
0.88
4.18%
$
493,068 $
81,110
9,818
36,811
468
34,049
101,249
802
21,041
23,921
2,656
7,323
639
62,307
875,262
(10,719)
64,597
929,140
24,486
3,471
826
1,733
21
757
2,240
28
620
768
93
293
3
263
35,602
deposits
$
452,443 $
4,191
0.93% $
466,007 $
4,111
Interest checking and money market
deposits
Savings accounts
FHLB advances
Junior subordinated debentures
Senior debt
Total interest-bearing liabilities
Non-interest-bearing liabilities
Non-interest-bearing deposits
Other liabilities
Total liabilities
Stockholders ’ equity
Total liabilities and stockholders ’ equity $
247,261
35,486
9,184
23,805
5,068
773,247
129,088
7,775
910,110
37,851
947,961
940
59
120
901
194
6,405
921
61
70
818
—
5,981
0.38
0.17
1.31
3.78
3.83
0.83%
$
232,717
34,257
2,967
24,708
—
760,656
119,736
9,325
889,717
39,423
929,140
Net interest income
Net interest spread
Net interest margin
Ratio of average interest-earning assets to
average interest-bearing liabilities
$
31,117
$
29,621
3.35%
3.48%
116.92%
(1)
Includes loan fees in both interest income and the calculation of yield on loans.
4.97%
4.28
8.41
4.71
4.49
2.22
2.21
3.49
4.53
3.21
3.50
4.00
0.47
0.42
4.11%
0.88%
0.40
0.18
2.36
3.31
—
0.79%
3.32%
3.42%
115.07%
(2) Calculations include non-accruing loans of $7.1 million and $11.4 million in average loan amounts outstanding.
(3)
Taxable equivalent yields are calculated assuming a 35% federal income tax rate.
28
Table of Contents
ASSETS
Interest-earning assets:
Loans receivables (1)(2)
Real estate
Commercial
Consumer
Agriculture
Other
$
U.S. Treasury and agencies
Mortgage-backed securities
Collateralized loan obligations
State and political subdivision securities
(non-taxable) (3)
State and political subdivision securities
(taxable)
Corporate bonds
FHLB stock
Other debt securities
Federal funds sold
Interest-bearing deposits in other
financial institutions
Total interest-earning assets
Less: Allowance for loan losses
Non-interest-earning assets
Total assets
$
Average
Balance
201 6
Interest
Earned/Paid
For the Years Ended December 31,
Average
Yield/Cost
Average
Balance
(dollars in thousands)
201 5
Interest
Earned/Paid
Average
Yield/Cost
493,068 $
81,110
9,818
36,811
468
34,049
101,249
802
21,041
23,921
2,656
7,323
—
639
62,307
875,262
(10,719)
64,597
929,140
24,486
3,471
826
1,733
21
757
2,240
28
620
768
93
293
—
3
4.97% $
4.28
8.41
4.71
4.49
2.22
2.21
3.49
4.53
3.21
3.50
4.00
—
0.47
263
35,602
0.42
4.11%
$
516,605 $
78,993
10,432
29,395
523
31,269
107,277
—
25,354
24,059
6,116
7,323
544
752
78,904
917,546
(17,154)
84,027
984,419
25,423
3,475
856
1,470
27
684
2,420
—
764
774
155
293
43
1
189
36,574
4.92%
4.40
8.21
5.00
5.16
2.19
2.26
—
4.64
3.22
2.53
4.00
7.90
0.13
0.24
4.03%
LIABILITIES AND STOCKHOLDERS ’
EQUITY
Interest-bearing liabilities
Certificates of deposit and other time
deposits
Interest checking and money market
deposits
Savings accounts
Federal funds purchased and repurchase
agreements
FHLB advances
Junior subordinated debentures
Total interest-bearing liabilities
Non-interest-bearing liabilities
Non-interest-bearing deposits
Other liabilities
Total liabilities
Stockholders ’ equity
Total liabilities and stockholders ’ equity $
Net interest income
Net interest spread
Net interest margin
Ratio of average interest-earning assets to
average interest-bearing liabilities
$
466,007 $
4,111
0.88% $
557,441 $
5,329
0.96%
921
61
—
70
818
5,981
232,717
34,257
—
2,967
24,708
760,656
119,736
9,325
889,717
39,423
929,140
0.40
0.18
—
2.36
3.31
0.79%
$
201,164
35,604
587
3,473
28,589
826,858
113,576
10,902
951,336
33,083
984,419
756
75
1
95
767
7,023
0.38
0.21
0.17
2.74
2.68
0.85%
$
29,621
$
29,551
3.32%
3.42%
115.07%
3.18%
3.27%
110.97%
Includes loan fees in both interest income and the calculation of yield on loans.
(1)
(2) Calculations include non-accruing loans of $11.4 million and $29.0 million in average loan amounts outstanding.
(3)
Taxable equivalent yields are calculated assuming a 35% federal income tax rate.
29
Table of Contents
Rate/Volume Analysis
The table below sets forth 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.
Year Ended December 31, 201 7 vs. 201 6
Increase (decrease)
due to change in
Year Ended December 31, 201 6 vs. 20 1 5
Increase (decrease)
due to change in
Rate
Volume
Net
Change
(in thousands)
Rate
Volume
Net
Change
(895) $
(5)
155
(9)
(9)
33
73
—
4
2,224 $
(58)
(155)
522
(51)
41
—
—
3
1,329 $
(63)
—
513
(60)
74
73
—
7
196
(149)
47
7 $
11
(46)
—
(13)
126
—
—
2
102
(721) $
62
(134)
28
(137)
(188)
—
(43)
—
(28)
(457)
2,377
1,920
189
(1,161)
(714)
73
(180)
28
(150)
(62)
—
(43)
2
74
(972)
(390)
(828)
(1,218)
202
(122)
(37)
(4)
—
(42)
114
—
56
2
—
92
(31)
194
80
19
(2)
—
50
83
194
233
(690) $
191
2,186 $
424
1,496 $
42
(11)
—
(12)
164
—
(207)
396 $
123
(3)
(1)
(13)
(113)
—
(835)
(326) $
$
Interest-earning assets:
Loan receivables
U.S. Treasury and agencies
Mortgage-backed securities
Collateralized loan obligations
State and political subdivision securities
Corporate bonds
FHLB stock
Other debt securities
Federal funds sold
Interest-bearing deposits in other
financial institutions
Total increase (decrease) in interest
income
Interest-bearing liabilities:
Certificates of deposit and other time
deposits
Interest checking and money market
accounts
Savings accounts
Federal funds purchased and repurchase
agreements
FHLB advances
Junior subordinated debentures
Senior debt
Total increase (decrease) in interest
expense
Increase (decrease) in net interest income $
Non- i nterest Income – The following table presents for the periods indicated the major categories of non-interest income:
Service charges on deposit accounts
Bank card interchange fees
Income from bank owned life insurance
Net g ain on sales and calls of securities
Other real estate owned rental income
Gain on extinguishment of junior subordinated debt
Other
Total non-interest income
201 7
For the Years Ended
December 31,
201 6
(in thousands)
20 1 5
$
$
2,253 $
972
412
288
—
—
930
4,855 $
1,958 $
849
417
216
456
—
868
4,764 $
Non-int erest income increased by $91,000 in 2017 to $4.9 million compared with $4.8 million for the year ended December 31, 2016. This increase was primarily
attributable to a $295,000 increase in service charges on deposit accounts, a $123,000 increase in bank card interchange fees, and a $72,000 increase in net gain on
sale of securities partially offset by no OREO income during 2017, compared to $456,000 during 2016.
30
165
(14)
(1)
(25)
51
—
(1,042)
70
1,851
839
295
1,766
1,346
883
715
7,695
Table of Contents
Non-interest income decreased by $2.9 million in 2016 to $4.8 million compared with $7.7 million for the year ended December 31, 2015 driven primarily by a
decline in gains on the sales of securities from $1.8 million in 2015 to $216,000 in 2016, as well as a decrease in OREO rental income of $890,000 between the
two periods as a result of income producing properties being sold. Non-interest income for 2015 was also positively impacted by an $883,000 gain on
extinguishment of junior subordinated debt.
Non-interest Expense – The following table presents the major categories of non-interest expense:
Salary and employee benefits
Occupancy and equipment
FDIC insurance
Data processing expense
Marketing expense
State franchise and deposit tax
Professional fees
Communications
Insurance expense
Postage and delivery
Litigation and loan collection expense
Other real estate owned expense
Other
Total non-interest expense
201 7
For the Years Ended
December 31,
201 6
(in thousands)
20 1 5
15,090 $
3,420
1,412
1,256
1,098
956
978
722
540
395
179
1,973
2,199
30,218 $
15,508 $
3,517
1,660
1,185
973
965
1,568
706
565
359
8,805
1,541
2,215
39,567 $
15,857
3,449
2,212
1,128
560
1,120
2,885
663
589
400
1,141
12,302
2,653
44,959
$
$
Non-interest expense for the year ended December 31, 2017 of $30.2 million represented a 23.6% decrease from $39.6 million for 2016. The decrease in non-
interest expense was attributable primarily to a decrease in litigation and loan collection expense, which decreased $8.6 million. Litigation expense was negatively
impacted in 2016 by a ruling from the Kentucky Court of Appeals against the Bank that approximated $8.0 million . Non-interest expense also benefited from a
$590,000 decrease in professional fees, a $418,000 decrease in salaries and employee benefits, and a $248,000 decrease in FDIC insurance. As shown below,
expenses related to OREO trended higher due to higher valuation adjustment writedowns during 2017 compared to 2016.
Net gain on sales
Provision to allowance for declining market values
Operating expense
Total
201 7
201 6
(in thousands)
(74) $
1,963
84
1,973 $
(222)
1,180
583
1,541
$
$
During the year ended December 31, 201 7, fair value write-downs of $2.0 million were recorded compared with $1.2 million for the year ended December 31,
2016. The 2017 write-downs reflect declines in the fair value due to updated appraisals, changes in marketing strategies, and reductions in listing prices for certain
properties. We were successful in selling OREO totaling $793,000 and $12.7 million during 2017 and 2016, respectively.
31
Table of Contents
Non-interest
Expense
Comparison
–
201
6
to
201
5
Non-interest expense for the year e nded December 31, 2016 of $39.6 million represented a 12.0% decrease from $45.0 million for 2015. The decrease in non-
interest expense was attributable primarily to decreases in OREO expenses and professional fees, offset by increases in litigation and loan collection expense as a
result of the Kentucky Court of Appeals ruling against the Bank . As shown below, expenses related to OREO trended lower as the size of the portfolio
significantly declined.
Net (gain) loss on sales
Provision to allowance for declining market values
Operating expense
Total
201 6
201 5
(in thousands)
(222) $
1,180
583
1,541 $
74
9,855
2,373
12,302
$
$
During the year ended December 31, 201 6, fair value write-downs of $1.2 million were recorded compared with $9.9 million for the year ended December 31,
2015. The write-downs reflect declines in the fair value and include reductions in listing prices for certain properties, updated appraisals, and sales of certain
properties through auctions. We were successful in selling OREO totaling $12.7 million and $22.6 million during 2016 and 2015, respectively.
Income Tax Expense and Benefit – Effective tax rates differ from the federal statutory rate of 35% applied to income (loss) before income taxes due to the
following:
Federal statutory rate times financial statement income (loss)
Effect of:
V aluation allowance
Tax-exempt income
Non -taxable life insurance income
Restricted stock vesting
Change in federal statutory rate
Other, net
Total
201 7
201 6
(in thousands)
20 15
$
2,294 $
(956) $
(1,125)
(54,049)
(196)
(144)
(121)
20,274
43
(31,899) $
1,238
(211)
(146)
—
—
96
21 $
$
717
(264)
(103)
—
—
775
—
The Company has had a full valuation allowance against its net deferred tax asset since 2011. The Company ’s ability to utilize the net deferred tax asset depends
upon generating sufficient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance depends upon the
evaluation of both positive and negative evidence regarding the likelihood of achieving sufficient future taxable income levels. 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. As a result of the conclusion to reverse the valuation allowance, the Company recorded an income tax benefit of
$54.0 million for the year ended December 31, 2017.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law. Among other significant changes to the tax code, the new law lowered the federal
corporate tax rate from 35% to 21% beginning in 2018. As a result, the Company revalued its net deferred tax asset at the new 21% rate. Due to this revaluation,
the Company recorded a $20.3 million charge to income tax expense for the year ended December 31, 2017.
The combination of the reversal of the valuation allowance and the change in federal corporate tax rates , as well as income tax expense for the year, resulted in an
income tax benefit of $31.9 million for the year ended December 31, 2017.
See Note 1 2, “Income Taxes”, for additional discussion of our income taxes.
I ncome tax expense of $21,000 was recorded for 2016, with no income tax expense or benefit recorded for 2015. Our deferred tax valuation allowance increased
to $54.0 million at December 31, 2016. Our statutory federal tax rate was 35% in both 2016 and 2015. The effective tax rate for 2016 and 2015 is not meaningful
due to the reduction of income tax benefit as the result of the deferred tax valuation allowance.
32
Table of Contents
Analysis of Financial Condition
Total assets at December 31, 2017 were $970.8 million compared with $945.2 million at December 31, 2016, an increase of $25.6 million or 2.7%. This increase
was primarily attributable to an increase in net loans of $73.6 million as well as the restoration of a net deferred tax asset of $31.3 million. These increases were
partially offset by a decrease in investment securities of $41.9 million as well as a $30.9 million decrease in interest bearing deposits in banks.
Total as sets at December 31, 2016 were $945.2 million compared with $948.7 million at December 31, 2015, a decrease of $3.5 million or 0.4%. This decrease
was primarily attributable to a decrease in cash and cash equivalents of $27.0 million which funded the redemption of deposits of $28.1 million. There was also a
decrease in OREO of $12.4 million offset by an increase in net loans of $23.6 million, an increase in available for sale securities of $7.8 million, and an increase in
FHLB advances of $19.4 million.
Reversal of Deferred Tax Asset Valuation Allowance and Change in Federal Tax Rate – The Company had a full valuation allowance against its net deferred
tax asset since 2011. The Company’s ability to utilize the net deferred tax asset depends upon generating sufficient future levels of taxable income. The
determination to restore a deferred tax asset and eliminate a valuation allowance depends upon the evaluation of both positive and negative evidence regarding the
likelihood of achieving sufficient future taxable income levels. 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.
As a result of the conclusion to reverse the valuation allowance and the reduction of the federal tax rate from 35% to 21%, the Company has a net deferred tax
asset of $31.3 million at December 31, 2017.
Loans Receivable – Loans receivable increased $72.9 million, or 11.4%, during the year ended December 31, 2017, to $712.1 million. Our commercial,
commercial real estate and real estate construction portfolios increased by an aggregate of $61.0 million, or 17.2%, during 2017 and comprised 58.4% of the total
loan portfolio at December 31, 2017.
Loans receivable increased $20.6 million, or 3.3%, during the year ended December 31, 2016, to $639.2 million. Our commercial, commercial real estate and real
estate construction portfolios increased by an aggregate of $18.8 million, or 5.6%, during 2016 and comprised 55.6% of the total loan portfolio at December 31,
2016.
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.
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total loans
As of December 31,
201 7
201 6
Amount
Percent
Amount
Percent
(dollars in thousands)
$
113,771
15.98% $
97,761
15.29%
57,342
88,320
156,724
56,588
179,222
18,439
41,154
555
712,115
8.05
12.40
22.01
7.94
25.17
2.59
5.78
0.08
100.00% $
36,330
71,507
149,546
48,197
188,092
9,818
37,508
477
639,236
5.68
11.19
23.39
7.54
29.42
1.54
5.87
0.08
100.00%
$
33
Table of Contents
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total loans
20 1 5
As of December 31,
20 1 4
201 3
Amount
Percent
Amount
Percent
Amount
Percent
(dollars in thousands)
$
86,176
13.93% $
60,936
9.75% $
52,878
7.45%
33,154
76,412
140,570
44,131
201,478
10,010
26,316
419
618,666
5.36
12.35
22.72
7.13
32.57
1.62
4.25
0.07
100.00% $
33,173
77,419
175,452
41,891
197,278
11,347
26,966
537
624,999
5.31
12.39
28.07
6.70
31.56
1.82
4.31
0.09
100.00% $
43,326
71,189
232,026
46,858
228,505
14,365
19,199
980
709,326
6.11
10.04
32.71
6.61
32.21
2.03
2.71
0.13
100.00%
$
L ending activities are subject to a variety of lending limits imposed by state and federal law. The Bank’s secured legal lending limit to a single borrower or
guarantor was approximately $31.4 million at December 31, 2017.
At December 31, 2017, we had 12 loan relationships each with aggregate extensions of credit in excess of $10.0 million, all of which were classified as pass by the
Bank’s internal loan review process. In 2016, we had four loan relationships each with aggregate extensions of credit in excess of $10.0 million.
As of December 31, 2017, we had $46.2 million of loan participations purchased from, and $19.1 million of loan participations sold to, other banks. As of
December 31, 2016, we had $33.4 million of loan participations purchased from, and $26.0 million of loan participations sold to, other banks.
34
Table of Contents
Loan Maturity Schedule – The following table sets forth at December 31, 2017, the dollar amount of loans, net of deferred loan fees, maturing in the loan
portfolio based on their contractual terms to maturity:
Loans with fixed rates:
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total fixed rate loans
Loans with floating rates:
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total floating rate loans
Maturing
Within
One Year
As of December 31, 201 7
Maturing
1 through
5 Years
Maturing
Over 5
Years
(dollars in thousands)
Total
Loans
$
4,509 $
25,481 $
4,707 $
34,697
5,602
5,273
14,801
5,038
14,028
1,172
3,143
90
53,656 $
17,765
16,985
77,138
28,337
27,730
5,951
5,582
316
205,285 $
10,177
21,075
22,287
15,449
58,034
1,275
779
59
133,842 $
33,544
43,333
114,226
48,824
99,792
8,398
9,504
465
392,783
10,169 $
45,673 $
23,232 $
79,074
9,790
1,127
1,598
208
1,885
10,013
22,087
—
56,877 $
13,976
5,665
7,170
4,956
5,096
—
9,349
—
91,885 $
32
38,195
33,730
2,600
72,449
28
214
90
170,570 $
23,798
44,987
42,498
7,764
79,430
10,041
31,650
90
319,332
$
$
$
Loan Portfolio by Risk Category –
The following table presents a summary of the loan portfolio at the dates indicated, by risk category.
Pass
Watch
Special Mention
Substandard
Doubtful
Total
201 7
201 6
As of December 31,
201 5
(in thousands)
201 4
20 1 3
$
673,033 $
25,715
164
13,203
—
586,430 $
30,431
497
21,878
—
517,484 $
63,363
1,395
36,424
—
461,126 $
68,200
4,189
91,484
—
369,529
144,316
5,865
189,616
—
$
712,115 $
639,236 $
618,666 $
624,999 $
709,326
L oans receivable increased $72.9 million, or 11.4%, during the year ended December 31, 2017. All loan risk categories have decreased since December 31, 2016,
with the exception of pass graded loans. The pass category increased approximately $86.6 million, the watch category declined approximately $4.7 million, the
special mention category declined approximately $333,000, and the substandard category declined approximately $8.7 million.
35
Table of Contents
Loan Delinquency –
The following table presents a summary of loan delinquencies at the dates indicated.
Past Due Loans:
30-59 Days
60-89 Days
90 Days and Over
Total Loans Past Due 30-90+ Days
Nonaccrual Loans
Total Past Due and Nonaccrual Loans
201 7
201 6
As of December 31,
201 5
(in thousands)
201 4
20 1 3
$
$
1,478 $
171
1
1,650
5,457
7,107 $
2,302 $
315
—
2,617
3,133 $
241
—
3,374
3,960 $
980
151
5,091
9,216
11,833 $
14,087
17,461 $
47,175
52,266 $
10,696
775
232
11,703
101,767
113,470
L oans past due 30-59 days decreased from $2.3 million at December 31, 2016 to $1.5 million at December 31, 2017, and loans past due 60-89 days decreased
from $315,000 at December 31, 2016 to $171,000 at December 31, 2017. This represents a $968,000 decrease in loans past due 30-89 days. We considered this
trend in delinquency levels during the evaluation of qualitative trends in the portfolio when establishing the general component of the allowance for loan losses.
N onaccrual loans decreased $3.8 million from December 31, 2016 to December 31, 2017. The $3.8 million decrease in nonaccrual loans was primarily driven by
$5.0 million in paydowns, $665,000 in charge-offs, $270,000 in transfers to OREO, and $199,000 in loans returned to accrual status, offset by $2.3 million in loans
placed on non-accrual. The $5.5 million in nonaccrual loans at December 31, 2017, and $9.2 million at December 31, 2016, were generally secured by farmland,
other commercial real estate, and other residential real estate loans. Management believes it has established adequate loan loss reserves for these credits.
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. Loans, including
impaired loans, are placed on nonaccrual status when they become past due 90 days or more as to principal or interest, unless they are adequately secured and in
the process of collection. Loans are considered impaired if full principal or interest payments are not anticipated in accordance with the contractual loan terms.
Impaired loans are carried at the present value of expected future cash flows discounted at the loan’s effective interest rate or at the fair value of the collateral less
cost to sell if the loan is collateral dependent. Loans are reviewed on a regular basis and normal collection procedures are implemented when a borrower fails to
make a required payment on a loan. If the delinquency on a mortgage loan exceeds 120 days and is not cured through normal collection procedures or an
acceptable arrangement is not agreed to with the borrower, we institute measures to remedy the default, including commencing a foreclosure action. Consumer
loans generally are charged off when a loan is deemed uncollectible and often before any available collateral has been disposed. Commercial business and real
estate loan delinquencies are handled on an individual basis with the advice of legal counsel.
Interest income on loans is recognized on the accrual basis excep t for those loans placed on nonaccrual status. The accrual of interest on impaired loans is
discontinued when management believes, after consideration of economic and business conditions and collection efforts, that the borrowers’ financial condition is
such that collection of interest is doubtful, which typically occurs after the loan becomes 90 days delinquent. When interest accrual is discontinued, existing
accrued interest is reversed and interest income is subsequently recognized only to the extent cash payments are received on well-secured loans.
Real estate acquired as a result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until such time as it is sold. New and used
automobile s and other motor vehicles acquired as a result of foreclosure are classified as repossessed assets until they are sold. When such property is acquired 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.
Subsequent gains and losses are included in non-interest expense.
36
Table of Contents
T he following table sets forth information with respect to non-performing assets as of the dates indicated:
201 7
201 6
As of December 31,
201 5
20 1 4
20 1 3
Past due 90 days or more still on accrual
Loans on non accrual status
Total non-performing loans
Real estate acquired through foreclosure
Other repossessed assets
Total non-performing assets
Non-performing loans to total loans
Non-performing assets to total assets
Allowance for non-performing loans
Allowance for non-performing loans to non-performing loans
$
$
$
1
5,457
5,458
4,409
—
9,867
$
$
0.77%
1.02%
108
$
1.98%
(dollars in thousands)
$
$
—
9,216
9,216
6,821
—
16,037
—
14,087
14,087
19,214
—
33,301
$
$
1.44%
1.70%
241
$
2.62%
2.28%
3.51%
295
$
2.09%
151
47,175
47,326
46,197
—
93,523
$
$
7.57%
9.19%
$
2.65%
1,253
232
101,767
101,999
30,892
—
132,891
14.38%
12.35%
2,285
2.24%
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, we review 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.
L oan 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 we 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 intiated.
We consider 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, we 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, we do 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 period ically 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, we place the loan on nonaccrual status and seek 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.
37
Table of Contents
At December 31, 201 7, we had six restructured loans totaling $3.0 million with borrowers who experienced deterioration in financial condition compared with
nine restructured loans totaling $8.7 million at December 31, 2016. In general, these loans were granted interest rate reductions to provide cash flow relief to
borrowers experiencing cash flow difficulties. At December 31, 2017, two loans totaling approximately $1.8 million had been granted principal payment deferrals
until maturity. 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. Restructured loans also included
$467,000 of commercial loans at December 31, 2017. At December 31, 2017, $1.2 million of TDRs were performing according to their modified terms.
There were no modifications granted during 2017 or 2016 that resulted in loans being identified as TDRs. During the twelve months ended December 31, 2017,
TDRs were reduced as a result of $1.6 million in payments. In addition, the TDR classification was removed from two loans that met the requirements discussed
above in 2017. These loans totaled $4.1 million at December 31, 2016, and are no longer evaluated individually for impairment.
The following table sets forth information with respect to TDRs, non-performing loans, real estate acquired through foreclosure, and other repossessed assets.
201 7
201 6
As of December 31,
201 5
(dollars in thousands)
201 4
20 1 3
Total non-performing loans
TDRs on accrual
Total non-performing loans and TDRs on accrual
Real estate acquired through foreclosure
Other repossessed assets
Total non-performing assets and TDRs on accrual
$
$
$
5,458
1,217
6,675
4,409
—
11,084
$
$
$
9,216
5,350
14,566
6,821
—
21,387
$
$
$
14,087
17,440
31,527
19,214
—
50,741
$
$
$
47,326
21,985
69,311
46,197
—
115,508
$
$
$
101,999
44,346
146,345
30,892
—
177,237
Total non-performing loans and TDRs on accrual to total loans
Total non-performing assets and TDRs on accrual to total assets
0.94%
1.14%
2.28%
2.26%
5.10%
5.35%
11.09%
11.35%
20.63%
16.47%
See Footnote 3, “Loans”, to the financial statements for additional disclosure related to troubled debt restructuring.
Interest income that would have been earned on non-performing loans was $465,000, $738,000, and $1.7 million for the years ended December 31, 2017, 2016,
and 2015, respectively. Interest income recognized on accruing non-performing loans was $135,000, $445,000, and $710,000 for the years ended December 31,
2017, 2016, and 2015, respectively.
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 e stimated 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. Prior to June 2017, the look-back period
for historical losses was 12 quarters, weighted 40% for the most recent eight quarters and 20% for the previous four quarter period. Effective June 30, 2017, the
Company extended the look-back period to 16 quarters on a prospective basis, weighted 40% for the most recent four quarters, then declining one tenth for each of
the remaining annual periods. Management determined the four-year look-back period was appropriate as the four-year period more appropriately correlates to the
period in which the current portfolio was underwritten and originated. 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.
38
Table of Contents
The following table sets forth an analysis of loan loss experience as of and for the periods indicated:
Balances at beginning of period
$
8,967
$
12,041
$
19,364
$
28,124
$
56,680
201 7
201 6
As of December 31,
20 1 5
(dollars in thousands)
20 1 4
20 1 3
Loans charged-off:
Real estate
Commercial
Consumer
Agriculture
Total charge-offs
Recoveries:
Real estate
Commercial
Consumer
Agriculture
Total recoveries
Net charge-offs (recoveries)
Provision (negative provision) for loan losses
Balance at end of period
Allowance for loan losses to period-end loans
Net charge-offs (recoveries) to average loans
Allowance for loan losses to non-performing loans
Allowance for loan losses for loans individually evaluated for
impairment
Loans individually evaluated for impairment
Allowance for loan losses to loans individually evaluated for
impairment
Allowance for loan losses for loans collectively evaluated for
impairment
Loans collectively evaluated for impairment
Allowance for loan losses to loans collectively evaluated for
impairment
$
$
$
750
5
51
95
901
714
59
130
33
936
(35)
(800)
8,202
$
1.15%
(0.01%)
150.27%
2,157
276
178
18
2,629
1,189
334
368
114
2,005
624
(2,450)
$
8,967
1.40%
0.10%
97.30%
5,050
696
268
118
6,132
2,338
723
240
8
3,309
2,823
(4,500)
$
12,041
1.95%
0.44%
85.48%
17,943
1,099
354
30
19,426
2,726
614
213
13
3,566
15,860
7,100
19,364
$
28,879
2,828
773
128
32,608
1,622
1,212
266
252
3,352
29,256
700
28,124
3.10%
2.39%
40.92%
3.96%
3.71%
27.57%
$
219
7,173
$
399
15,131
$
428
31,776
$
752
71,993
3,471
149,883
3.05%
2.64%
1.35%
1.04%
2.32%
7,983
704,942
$
8,568
624,105
$
11,613
586,890
$
18,612
553,006
$
24,653
559,443
1.13%
1.37%
1.98%
3.37%
4.41%
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 December 31, 2017, decreased to 1.15% from 1.40% at
December 31, 2016. 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, improved charge-off levels, and
improved past due trends. The allowance for loan losses to non-performing loans was 150.27% at December 31, 2017, compared with 97.30% at December 31,
2016. Net recoveries in 2017 totaled $35,000.
39
Table of Contents
The following table sets forth the net charge-offs (recoveries) for the periods indicated:
Commercial
Commercial Real Estate
Residential Real Estate
Consumer
Agriculture
Other
Total net charge-offs (recoveries)
Year Ended
December 31 ,
201 7
Year Ended
December 31,
201 6
(in thousands)
Year Ended
December 31,
201 5
$
$
(54) $
(361)
397
(64)
62
(15)
(35) $
(58) $
(339)
1,307
(200)
(96)
10
624 $
(27)
1,225
1,487
37
110
(9)
2,823
A general reserve is maintained for each loan type in the loan portfolio. In determining the amount of the general reserve portion of the allowance for loan losses,
management considers factors such as our historical loan loss experience, the growth, composition and diversification of our loan portfolio, current delinquency
levels, loan quality grades, the results of recent regulatory examinations and general economic conditions. Based on these factors, we apply estimated percentages
to the various categories of loans, not including any loan that has a specific allowance allocated to it, based on our historical experience, portfolio trends and
economic and industry trends. This information is used by management to set the general reserve portion of the allowance for loan losses at a level it deems
prudent.
Generally, all loans identified as impaired are reviewed on a quarterly basis in order to determine whether a specific allowance is required. A loan is considered
impaired when , based on current information, it is probable that we will not receive all amounts due in accordance with the contractual terms of the loan
agreement. Once a loan has been identified as impaired, management measures impairment in accordance with ASC 310-10, “Impairment
of
a
Loan
.
”
When
management’s measured value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve
or charged-off if the loan is deemed collateral dependent. These specific reserves are determined on an individual loan basis based on management’s current
evaluation of our loss exposure for each credit given the payment status, financial condition of the borrower and value of any underlying collateral. Loans for
which specific reserves have been provided are excluded from the general reserve calculations described below. Changes in specific reserves from period to period
are the result of changes in the circumstances of individual loans such as charge-offs, pay-offs, changes in collateral values or other factors.
The allowance for loan losses represents management ’s estimate of the amount necessary to provide for probable losses in the loan portfolio in the normal course
of business. Due to the uncertainty of risks in the loan portfolio, management’s judgment of the amount of the allowance necessary to absorb loan losses is
approximate. The allowance for loan losses is also subject to regulatory examinations and may be adjusted in response to a determination by the regulatory
agencies as to its adequacy in comparison with peer institutions.
We make specific allowances for each impaired loan based on its type and risk classification as discussed above. At year-end 2017, the allowance for loan losses to
total non-performing loans increased to 150.27% from 97.30% at year-end 2016. It is important to look more closely at this ratio as a significant portion of
impaired loans are collateral dependent and have been charged down to the estimated fair value of the underlying collateral less cost to sell. Please see the next
table for comparison and disclosure of recorded investment less allocated allowance relative to the unpaid principal balance. Impaired loans have been assessed for
collectability which considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure
that the allowance for loan losses is adequate to absorb probable incurred losses.
40
Table of Contents
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 December 31, 201 7 and 2016.
Unpaid principal balance
Prior charge-offs
Recorded investment
Allocated allowance
December 31 , 201 7
December 31, 201 6
Commercial
Real Estate
Residential
Real Estate
Commercial
Real Estate
Residential
Real Estate
$
$
4,734
(2,099)
(in thousands)
5,456
$
(1,506)
2,635
—
3,950
(206)
10,985
$
(5,131)
5,854
(35)
10,439
(1,818)
8,621
(350)
Recorded investment, less allocated allowance
$
2,635
$
3,744
$
5,819
$
8,271
Recorded investment, less allocated allowance / Unpaid principal balance
55.66%
68.62%
52.97%
79.23%
Based on prior charge-offs, the current recorded investments 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 balances of those loans. The recorded investment net of the allocated allowance was 55.66%
and 68.62% of the unpaid principal balance in the commercial real estate and residential real estate segments, respectively, at December 31, 2017.
T he following table illustrates recent trends in loans collectively evaluated for impairment and the related allowance for loan losses by portfolio segment:
Commercial
Commercial real estate
Residential real estate
Consumer
Agriculture
Other
Total
December 31, 201 7
December 31, 201 6
Loans
Allowance
% to Total
Loans
Allowance
% to Total
$
$
113,184 $
299,751
231,860
18,438
41,154
555
704,942 $
879
4,032
2,694
64
313
1
7,983
(dollars in thousands)
0.78% $
1.35
1.16
0.35
0.76
0.18
1.13% $
97,166 $
251,529
227,668
9,817
37,448
477
624,105 $
462
4,859
3,076
8
161
2
8,568
0.48%
1.93
1.35
0.08
0.43
0.42
1.37%
The allowance for those loan losses related to loans collectively evaluated for impairment trended downward from 1.37% at December 31, 2016 to 1.13% at
December 31, 2017 as a result of declining historical charge-off levels and improving trends in loan category risk ratings. The residential real estate segment
constitutes approximately 32.9% of total loans collectively evaluated for impairment. The related allowance for the residential real estate segment trended
downward from 1.35% at December 31, 2016 to 1.16% at December 31, 2017 as net charge-offs declined from approximately $1.3 million in 2016 to $397,000 in
2017. The commercial real estate segment constitutes approximately 42.5% of total loans collectively evaluated for impairment. The related allowance for the
commercial real estate segment trended downward from 1.93% at December 31, 2016 to 1.35% at December 31, 2017. This is consistent with the decline in
historical rates and improvement in loan quality within the commercial real estate segment. The overall decrease in the allowance also reflects improving historical
loss experience, qualitative factors, improvement in risk grade classification metrics, improved charge-off levels, improved past due trends, and the negative
provision.
A significant portion of the portfolio is comprised of loans secured by real estate. A decline in the value of the real estate serving as collateral for loans may impact
our ability to collect those loans. In general, we obtain updated appraisals on property securing our loans when circumstances are warranted such as at the time of
renewal or when market conditions have significantly changed. We use qualified licensed appraisers approved by our Board of Directors. These appraisers possess
prerequisite certifications and knowledge of the local and regional marketplace.
Based on its assessment of the loan portfolio, management presents a quarterly review of the allowance for loan losses to the Bank’s Board of Directors, indicating
any change in the allowance for loan losses since the last review and any recommendations as to adjustments in the allowance for loan losses.
41
Table of Contents
This assessment is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events
change. The allowance for loan losses has decreased as a percentage of loans outstanding to 1. 15% at December 31, 2017 from 1.40% at December 31, 2016. This
decline is the result of growth in the portfolio driven by new loans underwritten with lower loss expectations, improving historical loss experience, improvement in
risk grade classification metrics, improved charge-off levels, and improved past due trends. The level of the allowance is based on estimates, and losses may
ultimately vary from these estimates.
The Bank follows a loan grading program designed to evaluate the credit risk in the loan portfolio. Through this loan grading process, an internally classified watch
list is maintained which helps management assess the overall quality of the loan portfolio and the adequacy of the allowance for loan losses. Loans categorized as
watch list loans show warning elements where the present status exhibits one or more deficiencies that require attention in the short-term or where pertinent ratios
of the loan account have weakened to a point where more frequent monitoring is warranted. These loans do not have all of the characteristics of a classified loan
(substandard or doubtful) but show weakened elements as compared with those of a satisfactory credit. These loans are reviewed to assist in assessing the adequacy
of the allowance for loan losses.
In establishing the appropriate risk rating for specific assets, management considers, among other factors, the borrower’s ability to repay, the borrower’s repayment
history, the current delinquency status, the estimated value of the underlying collateral, and the capacity and willingness of a guarantor to satisfy the obligation. As
a result of this process, loans are categorized as special mention, substandard or doubtful.
Loans classified as “special mention” do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies that warrant
special attention and which corrective action, such as accelerated collection practices, may remedy.
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 that may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct
possibility that we will sustain some losses if the deficiencies are not corrected.
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.
Specific reserves may be carried for accruing TDRs in compl iance with restructured terms. Once a loan is deemed impaired or uncollectible as contractually
agreed (other than performing TDRs), the loan is charged-off either partially or in-full against the allowance for loan losses, based upon the expected future cash
flows discounted at the loan’s effective interest rate, or the fair value of collateral less estimated cost to sell with respect to collateral-based loans if collateral
dependent.
As of December 31, 2017, $13.2 million of loans were classified as substandard, $164,000 classified as special mention and no loans classified as doubtful or loss.
This compares with $21.9 million of loans classified as substandard, $497,000 classified as special mention and no loans classified as doubtful or loss as of
December 31, 2016. The $8.7 million decrease in loans classified as substandard was primarily driven by $6.8 million in principal payments received, $270,000 in
migration to OREO, $4.6 million in loans upgraded from substandard, and $790,000 in charge-offs, offset by $3.7 million in loans moved to substandard during
2017. Substandard loans are primarily concentrated in the residential real estate portfolio. As of December 31, 2017, $418,000 of the allowance for loan losses was
allocated to substandard loans. This compares to allocations of $600,000 in the allowance for loan losses related to substandard loans at December 31, 2016.
42
Table of Contents
The following table depicts management’s allocation of the allowance for loan losses by loan type. Allowance funding and allocation is based on management’s
current evaluation of risk in each category, economic conditions, past loss experience, loan volume, past due history and other factors. Since these factors and
management’s assumptions are subject to change, the allocation is not necessarily predictive of future portfolio performance. The allocation is made for analytical
purposes and is not necessarily indicative of the categories in which future losses may occur. The total allowance is available to absorb losses from any segment of
loans.
As of December 31,
201 7
201 6
Percent of
Loans to
Total
Loans
Amount of
Allowance
Percent of
Loans to
Total
Loans
(dollars in thousands)
Amount of
Allowance
$
892
15.98% $
475
15.29%
301
449
3,282
627
2,273
64
313
1
8,202
8.05
12.40
22.01
7.94
25.17
2.59
5.78
0.08
100.0% $
470
288
4,136
610
2,816
8
162
2
8,967
5.68
11.19
23.39
7.54
29.42
1.54
5.87
0.08
100.0%
$
20 1 5
Percent of
Loans to
Total
Loans
Amount of
Allowance
As of December 31,
20 1 4
Amount of
Allowance
Percent of
Loans to
Total
Loans
(dollars in thousands)
20 1 3
Percent of
Loans to
Total
Loans
Amount of
Allowance
$
818
13.93% $
2,046
9.75% $
3,221
7.45%
424
364
6,205
422
3,562
122
122
2
12,041
5.36
12.35
22.72
7.13
32.57
1.62
4.25
0.07
100.0% $
739
1,094
9,098
886
4,901
274
319
7
19,364
5.31
12.39
28.07
6.70
31.56
1.82
4.31
0.09
100.0% $
2,149
1,623
12,642
1,449
6,313
416
305
6
28,124
6.11
10.04
32.71
6.61
32.21
2.03
2.71
0.13
100.00%
$
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
Provision
for
Loan
Losses
–
A negative provision for loan losses of $800,000 was recorded for the year ended December 31, 2017, compared with a negative
provision for loan losses of $2.5 million for 2016 and a negative provision for loan losses of $4.5 million for 2015. The negative provision in 2017 was driven by
declining historical loss rates, improvements in loan quality, and management’s assessment of risk within the portfolio. The total allowance for loan losses was
$8.2 million, or 1.15% of total loans, at December 31, 2017, compared with $9.0 million, or 1.40% of total loans, at December 31, 2016, and $12.0 million, or
1.95% of total loans, at December 31, 2015. The decreased allowance is consistent with the overall trends within the portfolio. Substandard loans decreased by
$8.7 million or 39.7% during 2017, net recoveries were $35,000 for 2017 compared to net charge-offs of $624,000 in 2016 and $2.8 million in 2015, and
nonaccrual loans decreased by $3.8 million or 40.8% during 2017. Charge-offs for 2017 were concentrated in the loans secured by the residential real estate
category of the portfolio. These net charge-offs consisted of $397,000 of residential real estate loans. We consider the size and volume of our portfolio as well as
the credit quality of our 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.
43
Table of Contents
Foreclosed
Properties
– Foreclosed properties at December 31, 2017 were $4.4 million compared with $6.8 million at December 31, 2016. See Note 5, “Other
Real Estate Owned”, to the financial statements. During 2017, we acquired $270,000 of OREO properties and sold properties totaling approximately $793,000. We
value foreclosed properties at fair value less estimated cost to sell when acquired and expect to liquidate these properties to recover our investment in the due
course of business.
OREO is recorded at fair market value less estimated cost t o 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. We typically obtain 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.
The following table presents the major categories of OREO at the year-ends indicated:
Commercial Real Estate:
Construction, land development, and other land
Farmland
Nonfarm nonresidential
Residential Real Estate:
1-4 Family
N et activity relating to other real estate owned during the years indicated is as follows:
OREO Activity
OREO as of January 1
Real estate acquired
Valuation adjustment write-downs
Net gain (loss) on sale
Proceeds from sale of properties
OREO as of December 31
201 7
201 6
(in thousands)
201 5
4,335 $
74
—
—
4,409 $
6,571 $
—
—
250
6,821 $
201 7
201 6
(in thousands)
201 5
6,821 $
270
(1,963)
74
(793)
4,409 $
19,214 $
1,273
(1,180)
222
(12,708)
6,821 $
12,344
—
6,746
124
19,214
46,197
5,513
(9,855)
(74)
(22,567)
19,214
$
$
$
$
Net gain on sales, write-downs, and operating expenses for OREO totaled $2.0 million for the year ended December 31, 2017, compared with $1.5 million in 2016
and $12.3 million in 2015.
During the year ended December 31, 201 7, fair value write-downs of $2.0 million were recorded compared with $1.2 million for 2016 and $9.9 million for 2015.
The write-downs recorded in each year reflect fair value write-downs due to updated appraisals, changes in marketing strategies, and reductions in listing prices for
certain properties. OREO sales totaled $793,000, $12.7 million, and $22.6 million during 2017, 2016, and 2015, respectively. We expect to resolve certain
nonaccrual loans through the acquisition and sale of the underlying real estate collateral.
Investment Securities – The securities portfolio serves as a source of liquidity and earnings and contributes to the management of interest rate risk. Investments
are made in various types of liquid assets, including short-term United States Treasury obligations and securities of various federal agencies, obligations of states
and political subdivisions, corporate bonds, collateralized loan obligations, certificates of deposit at insured savings and loans and banks, bankers’ acceptances and
federal funds. The investment policy also authorizes investment in mutual funds and stocks whose assets conform to the investments that we are authorized to
make directly. The investment portfolio decreased by $41.9 million, or 21.5%, to $152.7 million at December 31, 2017, compared with $194.6 million at
December 31, 2016 as the Bank sold selected securities to manage liquidity and interest rate risk.
44
Table of Contents
The following table sets forth the carrying value of our securities portfolio at the dates indicated.
December 31, 201 7
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Amortized
Cost
Fair
Value
Amortized
Cost
(dollars in thousands)
December 31, 201 6
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair
Value
Securities available for sale
U.S. Government and
federal agencies
Agency mortgage-backed:
residential
Collateralized loan
obligations
State and municipal
Corporate bonds
Total available for
$
22,105 $
2 $
(483) $
21,624 $
34,757 $
50 $
(708) $
34,099
65,935
117
(1,087)
64,965
103,390
455
(1,492)
102,353
25,343
33,303
6,838
182
508
78
(20)
(101)
—
25,505
33,710
6,916
11,203
2,028
3,069
—
25
24
—
(8)
(3)
11,203
2,045
3,090
sale
$
153,524 $
887 $
(1,691) $
152,720 $
154,447 $
554 $
(2,211) $
152,790
Amortized
Cost
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Fair
Value
Amortized
Cost
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Fair
Value
Securities held to maturity
$
State and municipal
Total held to
maturity
$
— $
— $
— $
— $
— $
— $
— $
41,818 $
1,272 $
(18) $
43,072
— $
41,818 $
1,272 $
(18) $
43,072
In 2013, the Bank transferred a portion of its tax-free municipal and taxable municipal bond portfolios from available for sale (AFS) to held to maturity (HTM). At
that time, the transfer occurred at fair value with the unrealized loss of $1.3 million remaining in other comprehensive income. That unrealized loss has
subsequently been amortized on the level yield method out of other comprehensive income with an offsetting entry reducing interest income as a yield adjustment
through earnings. No gain or loss was recorded at the time of transfer in 2013. Given the Bank’s current balance sheet composition, interest rate risk profile, the
current tax environment, and the Bank’s strategic plan, management reassessed the classification of the held to maturity securities and, effective December 1, 2017,
transferred $41.4 million of tax-free municipals and taxable municipals from HTM to AFS. As a result, the $702,000 in remaining unamortized loss from the 2013
transfer was reclassified through a book value adjustment of these securities. At December 31, 2017, these securities were carried at fair value with unrealized
holding gains and losses reported in other comprehensive income, net of tax, with the remaining securities classified as AFS.
The following table sets forth the contractual maturities, fair values and weighted-average yields for our available for sale securities held at December 31, 2017:
Due Within
One Year
Amount Yield
After One Year
But Within
Five Years
Amount Yield
After Five Years
But Within
Ten Years
Amount Yield
After Ten Years
Amount Yield
Total
Amount Yield
Available for sale
U.S. Government and federal
agencies
$
—
—% $
—
—% $
5,788
2.19% $ 15,836
2.18% $ 21,624
2.18%
Agency mortgage-backed:
residential
Collateralized loan
obligations
State and municipal
Corporate bonds
Total available for sale $
—
—
2,956
2.64
9,415
2.31
52,594
2.46
64,965
2.45
—
145
—
145
—
2.10
—
—
19,612
—
2.10% $ 22,568
—
3.31
—
10,631
11,539
3,160
3.22% $ 40,533
14,874
0.28
2,414
3.27
4.54
3,756
2.20% $ 89,474
25,505
2.59
33,710
5.19
5.11
6,916
2.61% $ 152,720
1.63
3.42
4.86
2.59%
Average yields in the table above were calculated on a tax equivalent basis using a federal income tax rate of 3 5%. Mortgage-backed securities are securities that
have been developed by pooling a number of real estate mortgages. These securities are issued by federal agencies such as Ginnie Mae, Fannie Mae and Freddie
Mac, as well as non-agency company issuers. These securities are deemed to have high credit ratings, and minimum regular monthly cash flows of principal and
interest. Cash flows from agency backed mortgage-backed securities are guaranteed by the issuing agencies.
Unlike U.S. Treasury and U.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from
regular principal and interest payments and principal prepayments throughout the lives of the securities. Mortgage-backed securities that are purchased at a
premium will generally return decreasing net yields as interest rates drop because home owners tend to refinance their mortgages. Thus, the premium paid must be
amortized over a shorter period. Therefore, those securities purchased at a discount will obtain higher net yields in a decreasing interest rate environment. As
interest rates rise, the opposite will generally be true. During a period of increasing interest rates, fixed rate mortgage-backed securities do not tend to experience
heavy prepayments of principal and consequently, average life will not be shortened. If interest rates begin to fall, prepayments will generally increase. Non-
agency issuer mortgage-backed securities do not carry a government guarantee. We limit our purchases of these securities to bank qualified issues with high credit
ratings. We regularly monitor the performance and credit ratings of these securities and evaluate these securities, as we do all of our securities, for other-than-
temporary impairment on a quarterly basis. At December 31, 2017, 81.0% of the agency mortgage-backed securities we held had contractual final maturities of
more than ten years with a weighted average life of 23.9 years.
45
Table of Contents
Deposits – We attract both short-term and long-term deposits from the general public by offering a wide range of deposit accounts and interest rates. In recent
years, we have been required by market conditions to rely increasingly on short to mid-term certificate accounts and other deposit alternatives, which are more
responsive to market interest rates.
We primarily rely on our banking office network to attract and retain deposits in our local markets and have in the past leveraged the online channel to attract out-
of-market deposits. Market interest rates and rates on deposit products offered by competing financial institutions can significantly affect our ability to attract and
retain deposits. During 2017, total deposits decreased $2.9 million compared with 2016. During 2016, total deposits decreased $28.1 million compared with 2015.
The decrease in deposits for 2017 and 2016 was primarily in higher cost certificates of deposit balances.
To evaluate our funding needs in light of deposit trends resulting from continually changing conditions, we evaluate simulated performance reports that forecast
changes in margins along with other pertinent economic data. We continue to offer attractively priced deposit products along our product line to allow us to retain
deposit customers and reduce interest rate risk during various rising and falling interest rate cycles.
We offer savings accounts, interest checking accounts, money market accounts and fixed rate certificates with varying maturities. The flow of deposits is
influenced significantly by general economic conditions, changes in interest rates and competition. Management adjusts interest rates, maturity terms, service fees
and withdrawal penalties on the Bank’s deposit products periodically. The variety of deposit products allows the Bank to compete more effectively in obtaining
funds and to respond with more flexibility to the flow of funds away from depository institutions into outside investment alternatives. However, the ability to
attract and maintain deposits and the cost of these funds have been, and will continue to be, significantly affected by market conditions.
The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:
201 7
Average
Balance
Average
Rate
For the Years Ended December 31,
201 6
Average
Balance
Average
Rate
(dollars in thousands)
20 1 5
Average
Balance
Average
Rate
$
$
129,088
101,980
145,281
35,486
452,443
864,278
$
0.13%
0.55
0.17
0.93
$
0.60%
119,736
96,294
136,423
34,257
466,007
852,717
$
0.13%
0.58
0.18
0.88
$
0.60%
113,576
88,814
112,350
35,604
557,441
907,785
0.13%
0.57
0.21
0.96
0.68%
Demand
Interest Checking
Money Market
Savings
Certificates of Deposit
Total Deposits
Weighted Average Rate
The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:
Certificates of Deposit
Less than $ 250,000
$ 250,000 or more
Total
201 7
Average
Balance
Average
Rate
For the Years Ended December 31,
201 6
Average
Balance
Average
Rate
(dollars in thousands)
20 1 5
Average
Balance
Average
Rate
$
$
419,816
32,627
452,443
1.01% $
0.92
0.93% $
46
437,955
28,052
466,007
0.88% $
0.97
0.88% $
524,279
33,162
557,441
0.95%
1.12
0.96%
Table of Contents
The following table shows at December 31, 2017 the amount of our time deposits of $250,000 or more by time remaining until maturity:
Maturity Period
(in thousands)
Three months or less
Three months through six months
Six months through twelve months
Over twelve months
Total
$
$
5,276
1,995
3,497
20,963
31,731
The Bank maintains competitive pricing on its deposit products, which we believe allows it to retain a substantial percentage of our customers when their time
deposits mature.
Borrowing – Deposits are the primary source of funds for lending and investment activities and for general business purposes. We can also use advances
(borrowings) from the FHLB of Cincinnati to supplement the pool of lendable funds, meet deposit withdrawal requirements and manage the terms of liabilities.
Advances from the FHLB are secured by the Bank’s stock in the FHLB, and substantially all of its first mortgage residential loans. At December 31, 2017, the
Bank had $11.8 million in advances outstanding from the FHLB and the capacity to increase borrowings by an additional $79.0 million. The FHLB of Cincinnati
functions as a central reserve bank providing credit for savings banks and other member financial institutions. As a member, the Bank is required to own capital
stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of our home mortgages and other assets (principally, securities
that are obligations of, or guaranteed by, the United States) provided that it meets certain standards related to creditworthiness.
The following table sets forth information about our FHLB advances as of and for the periods indicated:
Average balance outstanding
Maximum amount outstanding at any month-end during the period
End of period balance
Weighted average interest rate:
At end of period
During the period
201 7
December 31,
201 6
(dollars in thousands)
2,967
$
22,458
22,458
$
9,184
26,830
11,797
$
20 1 5
1.48%
1.31%
0.85%
2.34%
3,473
8,705
3,081
2.65%
2.73%
Subordinated Capital Note – At December 31, 2017, the Bank had a subordinated capital note outstanding in the principal amount of $2.3 million. The note is
unsecured, bears interest at three-month LIBOR plus 300 basis points adjusting quarterly, and qualifies as Tier 2 capital until five years before the note matures on
July 1, 2020. Beginning on July 1, 2015, one-fifth of the principal amount of the subordinated note was excluded from Tier 2 capital each year until fully excluded
during the year before maturity. At December 31, 2017, a total of $1.7 million of the outstanding balance was included in Tier 2 capital. The note requires quarterly
principal payments of $225,000 plus interest. At December 31, 2017, the interest rate on this note was 4.34%.
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Junior Subordinated Debentures – At December 31, 2017, the Company had four issues of junior subordinated debentures outstanding totaling $21.0 million as
shown in the table below.
Description
Porter Statutory Trust II
Porter Statutory Trust III
Porter Statutory Trust IV
Ascencia Statutory Trust I
Liquidation
Amount
Trust
Preferred
Securities
(dollars in thousands)
Issuance Date
Junior
Subordinated
Debt and
Investment
in Trust
Maturity Date
Interest Rate ( 1 )
$
$
5,000
3,000
10,000
3,000
21,000
2/13/2004
4/15/2004
12/14/2006
2/13/2004
3-month LIBOR + 2.85% $
3-month LIBOR + 2.79%
3-month LIBOR + 1.67%
3-month LIBOR + 2.85%
$
5,155
3,093
10,433
3,093
21,774
2/13/2034
4/15/2034
3/1/2037
2/13/2034
(1) As of December 31, 201 7, the 3-month LIBOR was 1.69%.
The trust preferred securities are subject to mandatory redemption, in whole or in part, upon repayment of the subordinated debentures at maturity or their earlier
redemption at the liquidation preference. The subordinated debentures are redeemable before the maturity date at our option at their principal amount plus accrued
interest.
On April 15, 2016, the Company completed the private placement of 580,000 common shares and 220,000 non-voting common shares to accredited investors
resulting in total proceeds of $5.0 million. The investors in the private placement directed a portion of the purchase price to pay all deferred interest payments on
junior subordinated debentures, bringing interest payments current through the second quarter of 2016.
The Company has the option to defer interest payments on the subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. Since
the third quarter of 2016, we have been deferring interest payments on the junior subordinated debentures held by our trust subsidiaries, requiring the trust
subsidiaries to defer distributions on the trust preferred securities held by investors. Deferred distributions on the $21.0 million of trust preferred securities
outstanding totaled $1.2 million as of December 31, 2017. The deferral period expires after the second quarter of 2021, at which time we will be required to pay all
accrued interest or be in default. A deferral period may begin at the Company’s discression so long as interest payments are current. We are prohibited from paying
cash dividends on our preferred and common shares until such time as we have paid all deferred distributions on our trust preferred securities. So long as the
Written Agreement remains in effect, we will be required to obtain the approval of the Federal Reserve Bank of St. Louis before making any interest payments on
the subordinated debentures.
T he Federal Reserve Board rules allow trust preferred securities to be included in Tier 1 capital, subject to quantitative and qualitative limits. Currently, no more
than 25% of our Tier 1 capital can consist of trust preferred securities and qualifying perpetual preferred stock. To the extent the amount of our trust preferred
securities exceeds the 25% limit, the excess would be includable in Tier 2 capital. As of December 31, 2017, the Company’s trust preferred securities totaled 22%
of its Tier 1 capital and 40% of its Tier 2 capital.
Each of the trusts issuing the trust preferred securities holds junior subordinated debentures issued with a n original maturity of 30 years. In the last five years
before the junior subordinated debentures mature, the associated trust preferred securities are excluded from Tier 1 capital and included in Tier 2 capital. In
addition, the trust preferred securities during this five-year period are amortized out of Tier 2 capital by one-fifth each year and excluded from Tier 2 capital
completely during the year before maturity.
Senior Debt – On June 30, 2017, the Company entered into 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.
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Table of Contents
The Company contributed $9.0 million of the borrowing proceeds to the Bank as common equity Tier 1 capital. The remaining $1.0 million of the borrowing
proceeds were retained by the lender in escrow to service quarterly interest payments. At December 31, 2017, the escrow account had a balance of $806,000.
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 December 31, 2017.
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 we meet our
cash flow needs at a reasonable cost. We maintain 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 our 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 mortgage-backed securities, customer deposit inflows, and other wholesale funding.
The Bank also borrows from the FHLB to supplement funding requirements. At December 31, 2017, the unused borrowing capacity with the FHLB was $79.0
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. However, the availability of these lines could be affected by our financial
position.
Historically, we have also utilized brokered and wholesale deposits to supplement our funding strategy. At December 31, 2017, we had no brokered deposits.
The Company uses cash on hand to service senior debt 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 December 31, 2017, cash on hand totaled $2.0 million, of which, $806,000 is held in
escrow by the Company’s senior debt holder to service interest payments.
Capital
Stockholders ’ equity increased $39.9 million to $72.7 million at December 31, 2017, compared with $32.7 million at December 31, 2016. The increase was due
primarily to current year net income $38.5 million .
The Company had a full valuation allowance against its net deferred tax asset since 2011. 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. On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law. Among other significant changes to the tax code, the new law lowered
the federal corporate tax rate from 35% to 21% beginning in 2018. As a result, the Company revalued its net deferred tax asset at the new 21% rate. The
combination of the reversal of the valuation allowance and the change in federal corporate tax rates, as well as income tax expense for the year, resulted in an
income tax benefit of $31.9 million for the year ended December 31, 2017.
On June 30, 2017, the Company entered into 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. A total of $9.0 million of loan proceeds was injected to the Bank as common equity Tier 1
capital.
On December 16, 2016, the Company completed a 1-for-5 reverse stock split of its issued and outstanding common and non-voting common shares. The reverse
stock split was intended to increase the trading price per share of the common shares, with the objective to make the common shares a more attractive and cost
effective investment and enhance liquidity for shareholders. All share and per share data in this annual report has been adjusted to reflect the reverse stock split.
Preferred shares were not affected by the 1-for-5 reverse stock split.
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Table of Contents
On April 15, 2016, the Company completed the private placement of 580,000 common shares and 220,000 non-voting common shares to accredited investors,
raising total proceeds of $5.0 million. The investors in the private placement directed a portion of purchase price to pay all deferred interest payments on our junior
subordinated debentures, bringing interest payments current through the second quarter of 2016. The remaining proceeds were retained for general corporate
purposes and to support the Bank.
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 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 phase-in of
the capital conservation buffer requirement began in January 2016 at 0.625% of risk-weighted assets and increases each year until fully implemented in
January 2019. 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.
T he following table shows the ratios of Tier 1 capital, common equity Tier 1, and total capital to risk-adjusted assets and the leverage ratios (excluding the capital
conservation buffer) for the Bank at December 31, 2017:
Tier 1 capital
Common equity Tier 1 capital
Total risk-based capital
Tier 1 leverage ratio
Regulatory
Minimums
Well-Capitalized
Minimums
Limestone
Bank
6.0%
4.5
8.0
4.0
8.0%
6.5
10.0
5.0
10.35%
10.35
11.61
8.70
Failure to meet minimum capital requirements could result in additional discretionary actions by regulators that, if taken, could have a materially adverse effect on
our financial condition.
Off Balance Sheet Arrangements
In the normal course of business, we enter into various transactions, which, in accordance with GAAP, are not included in our consolidated balance sheets. We
enter into these transactions to meet the financing needs of our customers. These transactions include commitments to extend credit and standby letters of credit,
which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.
The commitments associated with outstanding standby letters of credit and commitments to extend credit as of December 31, 2017 are summarized below. Since
commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect our actual future
cash funding requirements:
Commitments to extend credit
Standby letters of credit
Total
One year
or less
More than 1
year but less
than 3 years
3 years or
more but less
than 5 years
(dollars in thousands)
5 years
or more
Total
$
$
37,862 $
2,588
40,450 $
36,699 $
—
36,699 $
19,542 $
1
19,543 $
33,419 $
—
33,419 $
127,522
2,589
130,111
Standby Letters of Credit – Standby letters of credit are written conditional commitments we issue to guarantee the performance of a borrower to a third party. If
the borrower does not perform in accordance with the terms of the agreement with the third party, we may be required to fund the commitment. The maximum
potential amount of future payments we could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, we
would be entitled to seek recovery from the borrower. Our policies generally require that standby letter of credit arrangements be underwritten in a manner
consistent with a loan of similar characteristics.
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Table of Contents
Commitments to Extend Credit – We enter into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at
specified rates and for specific purposes. Substantially all of our commitments to extend credit are contingent upon borrowers maintaining specific credit standards
at the time of loan funding. We minimize our exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.
Risk Participation Agreements – In connection with the purchase of loan participations, the Bank has entered into risk participation agreements, which had
notional amounts totaling $19.8 million at December 31, 2017 and $14.6 million at December 31, 2016.
Contractual Obligations
The following table summarizes our contractual obligations and other commitments to make future payments as of December 31, 2017:
Time deposits
FHLB borrowing (1)
Subordinated capital note
Junior subordinated debentures
Senior debt
Total
One year
or less
More than 1
year but less
than 3 years
3 years or
more but less
than 5 years
(dollars in thousands)
$
$
204,018 $
10,200
900
—
—
215,118 $
205,986 $
665
1,350
—
500
208,501 $
14,231 $
836
—
—
2,000
17,067 $
5 years or
more
Total
— $
96
—
21,000
7,500
28,596 $
424,235
11,797
2,250
21,000
10,000
469,282
( 1) Fixed rate borrowings with rates ranging from 0% to 5.24%, and maturities ranging from 2018 through 2033, averaging 1.48%.
Impact of Inflation and Changing Prices
The financial statements and related data presented herein have been prepared in accordance with U.S. generally accepted accounting principles, which require the
measurement of financial position and operating results in historical dollars without considering changes in the relative purchasing power of money over time due
to inflation.
We have an asset and liability structure that is essentially monetary in nature. As a result, interest rates have a more significant impact on performance than the
effects of general levels of inflation. Periods of high inflation are often accompanied by relatively higher interest rates, and periods of low inflation are
accompanied by relatively lower interest rates. As market interest rates rise or fall in relation to the rates earned on loans and investments, the value of these assets
decreases or increases respectively.
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Table of Contents
Item 7A.
Quantitative and Qualitative Disclosures About Market Risk
To minimize the volatility of net interest income and exposure to economic loss that may result from fluctuating interest rates, we manage our exposure to adverse
changes in interest rates through asset and liability management activities within guidelines established by our Asset Liability Committee (“ALCO”). The ALCO,
which is comprised of senior officers, has the responsibility for approving and ensuring compliance with asset/liability management policies. Interest rate risk is
the exposure to adverse changes in the net interest income as a result of market fluctuations in interest rates. The ALCO, on an ongoing basis, monitors interest rate
and liquidity risk in order to implement appropriate funding and balance sheet strategies. Management considers interest rate risk to be our most significant market
risk.
The Company utilizes an earnings simulation model to analyze net interest income sensitivity. It then evaluates potential changes in market interest rates and their
subsequent effects on net interest income. The model projects the effect of instantaneous movements in interest rates of both 100 and 200 basis points that are
sustained for one year. Assumptions based on the historical behavior of our deposit rates and balances in relation to changes in interest rates are also incorporated
into the model. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the
impact of fluctuations in market interest rates on net interest income. Actual results may differ from the model’s simulated results due to timing, magnitude and
frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
Given an ins tantaneous 100 basis point increase in interest rates, the base net interest income would increase by an estimated 0.9% at December 31, 2017
compared with an decrease of 2.5% at December 31, 2016. The following table indicates the estimated impact on net interest income under various interest rate
scenarios for the year ended December 31, 2017, as calculated using the static shock model approach:
+ 200 basis points
+ 100 basis points
- 100 basis points
- 200 basis points
Change in Future
Net Interest Income
Dollar Change
Percentage Change
(dollars in thousands)
$
545
271
(1,061)
(2,384)
1.7%
0.9
(3.3)
(7.5)
I mplementation of strategies to mitigate the risk of changing interest rates in the future, could lessen our forecasted “base case” net interest income in the event of
no interest rate changes. Interest sensitivity at any point in time will be affected by a number of factors. These factors include the mix of interest sensitive assets
and liabilities as well as their relative pricing schedules. It is also influenced by market interest rates, deposit growth, loan growth, deposit decay rates and asset
prepayment speed assumptions.
The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at December 31, 2017, which we anticipate,
based upon certain assumptions, to reprice or mature in each of the future time periods shown. The projected repricing of assets and liabilities anticipates
prepayments and scheduled rate adjustments, as well as contractual maturities under an interest rate unchanged scenario within the selected time intervals. While
we believe such assumptions are reasonable, we cannot provide assurance that assumed repricing rates will approximate actual future activity.
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Table of Contents
Assets:
Federal funds sold and short-term investments $
Investment securities
FHLB stock
Loans held for sale
Loans, net of allowance
Fixed and other assets
$
$
Total assets
Liabilities and Stockholders ’ Equity
Interest-bearing checking, savings, and money
market accounts
Certificates of deposit
Borrowed funds
Other liabilities
Stockholders ’ equity
Total liabilities and stockholders ’
equity
Period gap
Cumulative gap
Volume Subject to Repricing Within
0 – 90
Days
91 – 181
Days
182 – 36 5
Days
1 – 5
Years
Over 5
Years
(dollars in thousands)
Non-
Interest
Sensitive
Total
$
$
$
25,966
46,712
7,323
70
272,599
—
352,670
285,403
74,560
43,274
—
—
$
$
$
—
2,726
—
—
48,677
—
51,403
—
52,197
208
—
—
$
$
$
—
7,649
—
—
84,009
—
91,658
—
76,126
233
—
—
$
$
$
—
58,131
—
—
260,961
—
319,092
—
221,184
1,187
—
—
$
$
$
—
37,056
—
—
45,869
—
82,925
—
168
145
—
—
— $
516
—
—
(8,202)
80,739
73,053 $
25,966
152,790
7,323
70
703,913
80,739
970,801
— $
—
—
143,443
72,673
285,403
424,235
45,047
143,443
72,673
$
$
$
403,237
(50,567)
(50,567)
$
$
$
52,405
(1,002)
(51,569)
$
$
$
76,359
15,299
(36,270)
$
$
$
222,371
96,721
60,451
$
$
$
313
82,612
143,063
$
216,116 $
970,801
Period gap to total assets
Cumulative gap to total assets
Cumulative interest-earning assets to
cumulative interest-bearing liabilities
(5.21)%
(5.21)%
(0.10) %
(5.31) %
1.58%
(3.74)%
9.96%
6.23%
8.51%
14.74%
87.46%
88.68%
93.18%
108.01%
118.96%
The one-year cumulative gap position as of December 31, 2017 was negative $36.3 million or 3.7% of total assets. This is a one-day position that is continually
changing and is not necessarily indicative of the Company’s position at any other time. Any gap analysis has inherent shortcomings because certain assets and
liabilities may not move proportionally as interest rates change.
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Table of Contents
Item 8.
Financial Statements and Supplementary Data
The following consolidated financial statements and reports are included in this section:
Report of Independent Registered Public Accounting Fir m
Consolidated Balance Sheets as of December 31, 2017 and 2016
Consolidated Statements of Operations for the Years Ended December 31, 2017, 2016, and 2015
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016, and 2015
Consolidated Statements of Change in Stockholders ’ Equity for the Years Ended December 31, 2017, 2016, and 2015
Consolidated Statement s of Cash Flows for the Years Ended December 31, 2017, 2016, and 2015
Notes to Consolidated Financial Statements
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Table of Contents
Crowe Horwath LLP
Independent Member Crowe Horwath International
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Shareholders and the Board of Directors of Porter Bancorp, Inc.
Louisville, Kentucky
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Porter Bancorp, Inc. (the "Company" ) as of December 31, 2017 and 2016, the related
consolidated statements of operations, comprehensive income (loss), changes in stockholders’ equity, and cash flows for each of the three years in the period ended
December 31, 2017, and the related notes (collectively referred to as the "financial statements"). In our opinion, the financial statements present fairly, in all
material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three
years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements
based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are
required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the
Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were
we engaged to perform, an audit of its internal control over financial reporting in accordance with the standards of the PCAOB. As part of our audits we are
required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the
Company's internal control over financial reporting. Accordingly, we express no such opinion in accordance with the standards of the PCAOB.
Our audits included performing procedures to assess the ris ks of material misstatement of the financial statements, whether due to error or fraud, and performing
procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial
statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall
presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
We have served as the Company's auditor since 1998.
Louisville, Kentucky
February 28, 2018
/s/ Crowe Horwath, LLP
55
Table of Contents
PORTER BANCORP, INC.
CONSOLIDATED BALANCE SHEETS
December 31,
(Dollar amounts in thousands except share data)
201 7
201 6
Assets
Cash and due from banks
Interest bearing deposits in banks
Cash and cash equivalents
Securities available for sale
Securities held to maturity (fair value of $0 and $43,072, respectively)
Loans held for sale
Loans, net of allowance of $8, 202 and $8,967, respectively
Premises and equipment , net
Other real estate owned
Federal Home Loan Bank stock
Bank owned life insurance
Deferred taxes, net
Accrued interest receivable and other assets
Total assets
Liabilities and Stockholders ’ Equity
Deposits
Non-interest bearing
Interest bearing
Total deposits
Federal Home Loan Bank advances
Accrued interest payable and other liabilities
Subordinated capital note
Junior subordinated debentures
Senior d ebt
Total liabilities
Commitments and contingent liabilities (Note 16)
Stockholders ’ equity
Preferred stock, no par
Series E - 6,198 issued and outstanding; Liquidation preference of $6.2 million
Series F - 4,304 issued and outstanding; Liquidation preference of $4.3 million
Total preferred stockholders ’ equity
Common stock, no par, 39,000,000 shares authorized, 6,039,864 and 4,632,933 voting, and 220,000 and
1,591,600 non-voting shares issued and outstanding, respectively
Additional paid-in capital
Retained deficit
Accumu lated other comprehensive loss
Total common stockholders ’ equity
Total stockholders' equity
Total liabilities and stockholders ’ equity
See accompanying notes.
56
$
$
$
$
8,137 $
25,966
34,103
152,720
—
70
703,913
16,789
4,409
7,323
15,229
31,313
4,932
970,801 $
137,386 $
709,638
847,024
11,797
6,057
2,250
21,000
10,000
898,128
—
1,644
1,127
2,771
125,729
24,497
(75,108)
(5,216)
69,902
72,673
970,801 $
9,449
56,867
66,316
152,790
41,818
—
630,269
17,848
6,821
7,323
14,838
—
7,154
945,177
124,395
725,530
849,925
22,458
15,911
3,150
21,000
—
912,444
—
1,644
1,127
2,771
125,729
24,097
(113,561)
(6,303)
29,962
32,733
945,177
Table of Contents
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF OPER A TIONS
Years Ended December 31,
(Dollar amounts in thousands except per share data)
201 7
201 6
20 1 5
Interest income
Loans, including fees
Taxable securities
Tax exempt securities
Federal funds sold and other
Interest expense
Deposits
Federal Home Loan Bank advances
Senior d ebt
Junior subordinated debentures
Subordinated capital note
Federal funds purchased and other
Net interest income
N egative provision for loan losses
Net interest income after negative provision for loan losses
Non-interest income
Service charges on deposit accounts
Bank card interchange fees
Income from bank owned life insurance
Other real estate owned rental income
Net gain on sales of securities
Gain on extinguishment of junior subordinated debt
Other
Non-interest expense
Salaries and employee benefits
Occupancy and equipment
FDIC insurance
Data processing expense
Marketing expense
State franchise and deposit tax
Professional fees
Communications
Insurance expense
Postage and delivery
Litigation and l oan collection expense
Other real estate owned expense
Other
Income (l oss) before income taxes
Income tax expense (benefit)
Net income (loss)
Less:
Earnings (loss) allocated to participating securities
Net income (loss) attributable to common shareholders
Basic and diluted income (loss) per common share
$
$
$
See accompanying notes.
57
31,866 $
4,399
571
686
37,522
5,190
120
194
753
148
—
6,405
31,117
(800)
31,917
2,253
972
412
—
288
—
930
4,855
15,090
3,420
1,412
1,256
1,098
956
978
722
540
395
179
1,973
2,199
30,218
6,554
(31,899)
38,453
967
37,486 $
6.15 $
30,537 $
3,886
620
559
35,602
5,093
70
—
671
147
—
5,981
29,621
(2,450)
32,071
1,958
849
417
456
216
—
868
4,764
15,508
3,517
1,660
1,185
973
965
1,568
706
565
359
8,805
1,541
2,215
39,567
(2,732)
21
(2,753)
(88)
(2,665) $
(0.46) $
31,251
4,076
764
483
36,574
6,160
95
—
606
161
1
7,023
29,551
(4,500)
34,051
1,851
839
295
1,346
1,766
883
715
7,695
15,857
3,449
2,212
1,128
560
1,120
2,885
663
589
400
1,141
12,302
2,653
44,959
(3,213)
—
(3,213)
(336)
(2,877)
(0.62)
Table of Contents
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME ( LOSS )
Years Ended December 31,
(in thousands)
Net income (loss)
Other comprehensive income (loss):
Unrealized gain (loss) on securities:
Unrealized gain (loss) arising during the period
Transfer of investment securities from held to maturity to available for sale
Amortization during the period of net unrealized loss transferred to held to maturity
Reclassification of adjustment for gains included in net income
Net unrealized gain/(loss) recognized in comprehensive income
Tax effect
Other comprehensive income (loss)
Comprehensive income (loss)
201 7
201 6
201 5
$
38,453 $
(2,753) $
(3,213)
1,141
702
119
(288)
1,674
(587)
1,087
(1,917)
—
129
(216)
(2,004)
—
(2,004)
$
39,540 $
(4,757) $
(490)
—
129
(1,766)
(2,127)
—
(2,127)
(5,340)
See accompanying notes.
58
Table of Contents
Balances, December
31, 201 4
Issuance of unvested
stock
Terminated s tock
Forfeited unvested
stock
Stock-based
compensation
expense
Net loss
Net change in
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS ’ EQUITY
Years Ended December 31,
(Dollar amounts in thousands except share and per share data)
Shares
Preferred
Preferred
Common
Amount
Voting
and
Non-
voting
Series
Common Series B Series D
E
Series
F
Series
Series
Common
B
D
S eries
E
S eries
F
Additional
Paid-In
Capital
Retained
Earnings
(Deficit)
Accumulated
Other
Compre-
hensive
Income
(Loss)
Total
2,978,103 40,536 64,580 6,198 4,304 $ 113,238 $ 2,229 $ 3,552 $ 1,644 $ 1,127 $
21,442 $ (107,595) $
(2,172) $ 33,465
183,148
(107,696)
—
—
— —
— —
—
—
—
—
—
—
—
—
— —
— —
(6,368)
—
— —
—
—
—
—
— —
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
— —
— —
—
—
—
—
—
—
—
—
— —
— —
445
—
—
(3,213)
—
—
445
(3,213)
accumulated
other comprehensive
income, net of taxes
—
—
— —
—
—
—
—
— —
—
240,000
—
— —
—
1,680
—
—
— —
1,767
—
—
(2,127)
(2,127)
—
3,447
Debt to equity
exchange
Conversion of
preferred stock to
common and non-
voting common
stock
Balances, December
31, 201 5
Issuance of unvested
stock
Forfeited unvested
stock
Reverse stock split
round ing shares
Stock-based
compensation
expense
Net loss
Net change in
accumulated
other comprehensive
income, net of taxes
Issuance of stock
Balances, December
31, 2016
Issuance of unvested
stock
Forfeited unvested
stock
Reverse stock split
round ing shares
Stock-based
compensation
expense
Net income
Net change in
accumulated
other comprehensive
income, net of taxes
Balances, December
2,102,320 (40,536) (64,580) —
—
5,781 (2,229) (3,552)
— —
—
—
—
—
5,389,507
—
— 6,198 4,304 $ 120,699 $ — $ — $ 1,644 $ 1,127 $
23,654 $ (110,808) $
(4,299) $ 32,017
35,465
—
— —
—
—
—
—
— —
(1,972)
—
— —
—
—
—
—
— —
—
—
—
—
1,533
—
— —
—
—
—
—
— —
—
—
—
—
—
—
—
—
—
—
—
—
— —
— —
—
—
—
—
—
—
—
—
— —
— —
443
—
—
(2,753)
—
—
443
(2,753)
—
800,000
—
—
— —
— —
—
—
—
5,030
—
—
—
—
— —
— —
—
—
—
—
(2,004)
—
(2,004)
5,030
6,224,533
—
— 6,198 4,304 $ 125,729 $ — $ — $ 1,644 $ 1,127 $
24,097 $ (113,561) $
(6,303) $ 32,733
37,865
—
— —
—
—
—
—
— —
(1,316)
—
— —
—
—
—
—
— —
—
—
—
—
(1,218)
—
— —
—
—
—
—
— —
—
—
—
—
—
—
—
—
—
—
—
—
— —
— —
—
—
—
—
—
—
—
—
— —
— —
400
—
—
38,453
—
400
— 38,453
—
—
— —
—
—
—
—
— —
—
—
1,087
1,087
31, 2017
6,259,864
—
— 6,198 4,304 $ 125,729 $ — $ — $ 1,644 $ 1,127 $
24,497 $ (75,108) $
See accompanying notes.
59
(5,216) $ 72,673
Table of Contents
PORTER BANCORP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(in thousands)
Cash flows from operating activities
Net income (loss)
Adjustments to reconcile net income (loss) to net cash from operating activities
$
38,453 $
(2,753) $
201 7
201 6
201 5
Depreciation and amortization
Negative provision for loan losses
Net amortization on securities
Stock-based compensation expense
Deferred taxes, net
Gain on extinguishment of junior subordinated debt
Net (gain) loss on sales of loans held for sale
Loans originated for sale
Proceeds from sales of loans held for sale
Net (gain) loss on sales of other real estate owned
Net write-down of other real estate owned
Net realized (gain) loss on sales and calls of investment securities
Net (gain) loss on sale of premises and equipment
Increase in cash surrender value of owned life insurance, net of premium
expense
Net change in accrued interest receivable and other assets
Net change in accrued interest payable and other liabilities
Net cash from operating activities
Cash flows from investing activities
Purchases of available for sale securities
Sales and calls of available for sale securities
Maturities and prepayments of available for sale securities
Proceeds from c alls of held to maturity securities
Proceeds from maturities of held to maturity securities
Proceeds from sales of loans not originated for sale
Proceeds from sale of other real estate owned
Loan originations and payments, net
Proceeds from sale of premises and equipment
Purchases of premises and equipment
Purchase of bank owned life insurance
Net cash from investing activities
Cash flows from financing activities
Net change in deposits
Net change in repurchase agreements
Repayment of Federal Home Loan Bank advances
Advances from Federal Home Loan Bank
Repayment of subordinated capital note
Proceeds from senior debt
Issuance of common stock
Net cash from financing activities
Net change in cash and cash equivalents
Beginning cash and cash equivalents
Ending cash and cash equivalents
Supplemental cash flow information:
Interest paid
Income taxes paid (refunded)
Supplemental non-cash disclosure:
Proceeds from common stock issuance directed by investors to pay junior
subordinated debt interest
$
$
$
Transfer from loans to other real estate
Financed sales of other real estate owned
Effect of junior subordinated debt to equity exchange
Transfer from held to maturity to available for sale securities
AOCI component of transfer from held to maturity to available for sale , net of tax
1,239
(800)
1,246
400
(31,899)
—
(46)
(2,859)
2,835
(74)
1,963
(288)
3
(391)
2,079
(9,854)
2,007
(21,112)
41,686
21,838
47
145
—
793
(73,202)
331
(284)
—
(29,758)
(2,901)
—
(55,661)
45,000
(900)
10,000
—
(4,462)
(32,213)
66,316
34,103 $
5,665 $
—
—
270 $
—
—
41,380
456
1,725
(2,450)
1,297
443
—
—
(86)
(5,145)
5,417
(222)
1,180
(216)
(1)
(397)
(814)
8,133
6,111
(41,827)
8,311
22,876
—
—
12,438
(22,368)
268
(464)
(5,000)
(25,766)
(28,072)
—
(623)
20,000
(900)
—
2,231
(7,364)
(27,019)
93,335
66,316 $
5,253 $
21
2,799
1,273 $
270
—
—
—
(3,213)
1,711
(4,500)
1,434
445
—
(883)
204
(6,652)
6,548
74
9,855
(1,766)
—
(274)
810
267
4,060
(21,828)
45,012
21,084
—
8,640
22,567
(2,239)
—
(385)
—
72,851
(48,844)
(1,341)
(17,671)
5,000
(900)
—
—
(63,756)
13,155
80,180
93,335
7,076
—
—
5,513
—
4,330
—
—
See accompanying notes.
60
Table of Contents
PORTER BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 201 7 , 201 6 and 201 5
NOTE 1 – SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations and Principles of Consolidation – The consolidated financial statements include Porter Bancorp, Inc. (Company) and its subsidiary, PBI
Bank (Bank). The Bank completed a name change to Limestone Bank on February 20, 2018. The Company owns a 100% interest in the Bank.
The Company provides financial services through its offices in Central and South Central Kentucky, Lexington and Louisville. Its primary deposit products are
checking, savings, and term certificate accounts, and its primary lending products are residential mortgage, commercial, agricultural, and real estate loans.
Substantially all loans are collateralized by specific items of collateral including business assets and real estate. Commercial loans are expected to be repaid from
cash flow from operations of businesses. There are no significant concentrations of loans to any one industry or customer. However, borrowers’ ability to repay
their loans is dependent on the real estate and general economic conditions in the area. Other financial instruments which potentially represent concentrations of
credit risk include deposit accounts in other financial institutions, federal funds sold, municipal securities, collateralized loan obligations, corporate securities, and
bank owned life insurance.
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.
Cash and Cash Equivalents – For the purpose of presentation in the statements of cash flows, the Company considers all cash and amounts due from depository
institutions as well as interest bearing deposits in banks that mature within one year and are carried at cost to be cash equivalents. The Bank is required to maintain
average reserve balances with the Federal Reserve Bank of St. Louis.
Securities – Debt securities are classified as held to maturity and carried at amortized cost when management has the intent and ability to hold them to maturity.
Debt securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized
holding gains and losses reported in other comprehensive income.
Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method anticipating
prepayments on mortgage backed securities. Gains and losses on sales are recorded on the trade date and determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market
conditi ons warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the
financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to
sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the
entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned
criteria, the amount of impairment is split into 1 ) OTTI related to credit loss, which is recognized in the income statement and 2 ) OTTI related to other factors,
which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be
collected and the amortized cost basis.
Loans Held for Sale – Loans held for sale include residential mortgage loans originated for sale into the secondary market and are carried at the lower of
aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and
charged to earnings.
Mortgage loans held for sale are generally sold with servicing rights released. If sold with servicing retained, the carrying value of mortgage loans sold is reduced
by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying
value of the related loan sold.
Mortgage banking derivatives used in the ordinary course of business consist of mandatory forward sales contracts and rate lock loan commitments. Forward
contracts represent future commitments to deliver loans at a specified price and date and are used to manage interest rate risk on loan commitments and mortgage
loans held for sale. Rate lock commitments represent commitments to fund loans at a specific rate. These derivatives involve underlying items, such as interest
rates, and are designed to transfer risk. Substantially all of these instruments expire within 60 days from the date of issuance. Notional amounts are amounts on
which calculations and payments are based, but which do not represent credit exposure, as credit exposure is limited to the amounts required to be received or paid.
Commitments to deliver loans and rate lock loan commitments were insignificant at year end.
61
Table of Contents
Loans – Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance
outstanding, net of deferred loan fees and costs, and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees,
net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. The recorded
investment in loans includes the outstanding principal balance and unamortized deferred origination costs and fees.
Interest income recognition on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the loan is well collateralized and
in process of collection. Consumer loans are typically charged off no later than 90 days past due. Past due status is based on the contractual terms of the loan. In all
cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is not expected.
All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the
cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts
contractually due are brought current and future payments are reasonably assured.
Allowance for Loan Losses – The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the
allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.
Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower
situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire
allowance is available for any loan that, in our judgment, should be charged off.
The allowance consists of s pecific and general components. The specific component relates to loans that are individually classified as impaired. A loan is deemed
impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial
difficulties, are considered troubled debt restructurings and treated as impaired.
Factors considered in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments
when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. The significance of payment delays
and payment shortfalls is determined on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including
the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan ’s
existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as
consumer and residential real estate loans, are collectively evaluated for impairment and are not separately identified for impairment disclosures. Troubled debt
restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective
rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported at the fair value of the collateral. For troubled
debt restructurings that subsequently default, the amount of reserve is determined in accordance with the accounting policy for the allowance for loan losses.
The general component covers non -impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is
determined by portfolio segment and is based on actual loss history experienced over the most recent four years with weighting towards the most recent periods.
This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include
consideration of the following: changes in lending policies, procedures, and practices; effects of any change in risk selection and underwriting standards; national
and local economic trends and conditions; industry conditions; trends in volume and terms of loans; experience, ability and depth of lending management and other
relevant staff; levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; and effects of changes in credit
concentrations.
62
Table of Contents
A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine its allowance for loan losses.
Management identified the following portfolio segments: commercial, commercial real estate, residential real estate, consumer, agricultural, and other.
● Commercial loans are made to businesses and depend on the strength of the industries, related borrowers, and cash flow from the businesses. Commercial
loans are advances for equipment purchases, or to provide working capital, or to meet other financing needs of business enterprises. These loans may be
secured by accounts receivable, inventory, equipment or other business assets. Financial information is obtained from the borrowers to evaluate their
ability to repay the loans.
● Commercial real estate loans are affected by the local commercial real estate market and the local economy. Commercial real estate loans include loans
on commercial properties occupied by borrowers and/or tenants. Construction and development loans are a component of this segment. These loans are
generally secured by land under development or homes and commercial buildings under construction. Appraisals are obtained to support the loan amount.
Financial information is obtained from the borrowers and/or the individual project to evaluate cash flows sufficiency to service the debt.
● Residential real estate loans are affected by the local residential real estate market, local economy, and, for variable rate mortgages, movement in indices
tied to these loans. For owner occupied residential loans , the borrowers’ repayment ability is evaluated through a review of credit scores and debt to
income ratios. For non-owner occupied residential loans, such as rental real estate, financial information is obtained from the borrowers and/or the
individual project to evaluate cash flows sufficiency to service the debt. Appraisals are obtained to support the loan amount.
● Consumer loans depend on local economies. Consumer loans are generally secured by consumer assets, but may be unsecured. Management evaluates the
borrowers’ repayment ability through a review of credit scores and an evaluation of debt to income ratios.
● Agriculture loans depend on the industries tied to these loans and are generally secured by livestock, crops, and/or equipment, but may be unsecured.
Management evaluates the borrowers’ repayment ability through financial and business performance review.
● Other loans include loans to municipalities, loans secured by stock, and overdrafts. For municipal loans , management evaluates the borrowers’ revenue
streams as well as ability to repay form general funds. For loans secured by stock, management evaluates the market value of the stock securing the loan
in relation to the loan amount. Overdrafts are funded based on pre-established criteria related to the deposit account relationship.
Management analyzes key relevant risk characteristics for each portfolio segment having determined that loans in each segment possess similar general risk
characteristics that are analyzed in connection with loan underwriting processes and procedures. In determining the allocated allowance, the weighted average loss
rates over the most recent four years are used with weighting towards the most recent periods. Commercial real estate qualitative adjustment considerations include
trends in the markets for underlying collateral values, risks related to tenant rents, and economic factors such as decreased sales demand, elevated inventory levels,
and declining collateral values. Residential real estate loan considerations include macro economic factors such as unemployment rates, trends in vacancy rates,
and home value trends. The commercial and agricultural portfolio qualitative adjustments are related to economic and portfolio performance trends. The
agricultural, consumer and other portfolios are less significant in terms of size and risk is assessed based on the smaller dollar size of these loans and the more
geographical areas where the collateral is located.
Transfers of Financial Assets – Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over
transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that
constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the
transferred assets through an agreement to repurchase them before their maturity.
Other Real Estate Owned (“OREO”) – Assets acquired through or instead of loan foreclosure are initially recorded at fair value less estimated costs to sell when
acquired, establishing a new cost basis. These assets are subsequently accounted for at the lower of cost or fair value, less estimated costs to sell. If fair value
declines subsequent to foreclosure, a write-down is recorded through expense. Costs after acquisition are expensed.
Premises and Equipment – Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Buildings and related components
are depreciated using the straight-line method with useful lives generally ranging from 5 to 40 years. Furniture, fixtures and equipment are depreciated using the
straight-line or accelerated method with useful lives generally ranging from 2 to 10 years.
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Federal Home Loan Bank (FHLB) Stock – The Bank is a member of the FHLB system. Members are required to own a certain amount of stock based on the
level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically
evaluated for impairment. Because this stock is viewed as long term investment, impairment is based on ultimate recovery of par value. Both cash and stock
dividends are reported as income.
Intangible Assets – Intangible assets with definite useful lives are included with other assets and amortized over their estimated useful lives to their estimated
residual values, if any. Other intangible assets consist of core deposit intangible assets arising from whole bank and branch acquisitions. They are initially
measured at fair value and then are amortized on an accelerated or straight-line basis over their estimated useful lives, which range from 7 to 10 years.
Bank Owned Life Insurance – The Bank has purchased life insurance policies on certain key executives. Company owned life insurance is recorded at the
amount that can be realized under the insurance contract at the balance sheet date, which is the cash surrender value adjusted for other charges or other amounts
due that are probable at settlement.
Long-Term Assets – Premises and equipment, other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying
amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value through a charge to earnings.
Benefit Plans – Employee 401 (k) and profit sharing plan expense is the amount of matching contributions. Deferred compensation and supplemental retirement
plan expense allocates the benefits over years of service.
Stock-Based Compensation – Compensation cost is recognized for unvested stock awards issued to employees, based on the fair value of these awards at the date
of grant. The market price of the Corporation’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the
required service period, generally defined as the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the
requisite service period for the entire award.
Income Taxes – Income tax expense is the total of the current year income tax due or refundable and the change in deferred tax assets and liabilities. Deferred tax
assets and liabilities are the expected future tax amounts for the temporary differences between carrying amounts and tax bases of assets and liabilities, computed
using enacted tax rates. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.
A tax position is recognized as a benefit only if it is "more likely than not" that the tax position would be sustained in a tax examination, with a tax exami nation
being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being realized on examination. For tax
positions not meeting the "more likely than not" test, no tax benefit is recorded. The Company recognizes interest and/or penalties related to income tax matters in
income tax expense.
Loan Commitments and Related Financial Instruments – Financial instruments include off-balance sheet credit instruments, such as commitments to make
loans and commercial letters of credit, issued to meet customer-financing needs. The face amount for these items represents the exposure to loss, before
considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.
Comprehensive Income ( Loss ) – Comprehensive loss consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss)
includes unrealized gains and losses on securities available for sale, which are also recognized as a separate component of equity.
Earnings (Loss) Per Common Share – Basic earnings (loss) per common share are net income (loss) attributable to common shareholders divided by the
weighted average number of common shares outstanding during the period. Diluted earnings (loss) per common share include the dilutive effect, if any, of
additional potential common shares issuable under stock options and warrants. Earnings (loss) and dividends per share are restated for all stock splits and dividends
through the date of issue of the financial statements.
Earnings (Loss) Allocated to Participating Securities – The Company has issued and outstanding unvested common shares to employees and directors through
the stock incentive plan. Earnings (loss) are allocated to these participating securities based on their percentage of total issued and outstanding shares.
Loss Contingencies – Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the
likelihood of loss is probable and an amount or range of loss can be reasonably estimated.
Dividend Restriction s – Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the Company or by the
Company to shareholders.
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Fair Value of Financial Instruments – Fair values of financial instruments are estimated using relevant market information and other assumptions. Fair value
estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of
broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.
D erivative I nstruments – Derivative Instruments are carried at fair value and reflect the estimated amounts that would have been received to terminate these
contracts at the reporting date based upon pricing or valuation models applied to current market information.
As part of the asset/liability management program, the Company utilize s, from time to time, risk participation agreements to reduce its sensitivity to changing
interest rates. These are derivative instruments, which are recorded as assets or liabilities in the consolidated balance sheets at fair value. Changes in the fair values
of derivatives are reported in the consolidated statements of operations or other comprehensive income (“OCI”) depending on the use of the derivative and whether
the instrument qualifies for hedge accounting. The key criterion for the hedge accounting is that the hedged relationship must be highly effective in achieving
offsetting changes in those cash flows that are attributable to the hedged risk, both at inception of the hedge and on an ongoing basis.
Derivatives that qualify for the hedge accounting treatment are designated as either: a hedge of the fair value of the recognized asset or liability or of an
unrecognized commitment (a fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized
asset or liability (a cash flow hedge). To date, the Company has not entered into a cash flow hedge. For cash flow hedges, changes in the fair values of the
derivative instruments are reported in OCI to the extent the hedge is effective. The gains and losses on derivative instruments that are reported in OCI are reflected
in the consolidated statements of income in the periods in which the results of operations are impacted by the variability of the cash flows of the hedged item.
Generally, net interest income is increased or decreased by amounts receivable or payable with respect to the derivatives, which qualify for hedge accounting. At
inception of the hedge, a Company must establish the method it uses for assessing the effectiveness of the hedging derivative and the measurement approach for
determining the ineffective aspect of the hedge. The ineffective portion of the hedge, if any, is recognized currently in the consolidated statements of operations
and time value expiration of the hedge when measuring ineffectiveness is excluded.
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.
Adoption of New Accounting Standards – In August 2015, FASB issued ASU 2015 - 14, Revenue from Contracts with Customers (Topic 606 ). This ASU is an
update to ASU 2014 - 09, and delays the effective date of ASU 2014 - 09. 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 nonfinancial 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. 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 is effective for annual reporting periods, and
interim reporting periods within those annual periods, beginning after December 15, 2017. The Company’s revenue is comprised of net interest income on
financial assets and liabilities, which is explicitly excluded from the scope of this guidance, and non-interest income. Based on the evaluation of the Company’s
non-interest income revenue streams, adoption of this new guidance will not have a material impact on the consolidated financial statements. Changes to the
related disclosures are still being finalized.
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 become effective for annual periods and interim periods within those annual periods beginning after December 15, 2017. The impact of
adopting the new guidance did not have a material impact on the consolidated financial statements, but will require additional disclosures. The Company currently
does not have any equity investments.
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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. The impact of adopting the new guidance on the consolidated
financial statements will not have a material impact.
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 is currently gathering loan level data, and assessing our data and system needs. 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. The Company is currently evaluating the impact of adopting the new guidance 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 will adopt the standard in the first quarter of
2018 and adoption will not have a material impact on the consolidated financial statements.
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N OTE 2 – SECURITIES
Securities are classified into available for sale (AFS) and held to maturity (HTM) categories. AFS securities are those that 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. HTM securities are those that the Bank has the intent and ability to hold to maturity and are reported at amortized cost.
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:
December 31, 201 7
Available for sale
U.S. Government and federal agency
Agency mortgage-backed: residential
Collateralized loan obligations
State and municipal
Corporate bonds
Total available for sale
December 31, 201 6
Available for sale
U.S. Government and federal agency
Agency mortgage-backed: residential
Collateralized loan obligations
State and municipal
Corporate bonds
Total available for sale
Held to maturity
State and municipal
Total held to maturity
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(in thousands)
Fair Value
$
$
$
$
$
$
22,105 $
65,935
25,343
33,303
6,838
153,524 $
2 $
117
182
508
78
887 $
(483) $
(1,087)
(20)
(101)
—
(1,691) $
21,624
64,965
25,505
33,710
6,916
152,720
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
(in thousands)
Fair Value
34,757 $
103,390
11,203
2,028
3,069
154,447 $
50 $
455
—
25
24
554 $
(708) $
(1,492)
—
(8)
(3)
(2,211) $
34,099
102,353
11,203
2,045
3,090
152,790
Amortized
Cost
Gross
Unrecognized
Gains
Gross
Unrecognized
Losses
Fair Value
41,818 $
41,818 $
1,272 $
1,272 $
(18) $
(18) $
43,072
43,072
In 2013, the Bank transferred a portion of its tax-free municipal and taxable municipal bond portfolios from AFS to HTM. At that time, the transfer occurred at fair
value with the unrealized loss of $1.3 million remaining in other comprehensive income. That unrealized loss has subsequently been amortized on the level yield
method out of other comprehensive income with an offsetting entry reducing interest income as a yield adjustment through earnings. No gain or loss was recorded
at the time of transfer in 2013. Given the Bank’s current balance sheet composition, interest rate risk profile, the current tax environment, and the Bank’s strategic
plan, management reassessed the classification of the held to maturity securities and, effective December 1, 2017, transferred $41.4 million of tax-free municipals
and taxable municipals from HTM to AFS. As a result, the $702,000 in remaining unamortized loss from the 2013 transfer was reclassified through a book value
adjustment of these securities. At December 31, 2017, these securities were carried at fair value with unrealized holding gains and losses reported in other
comprehensive income, net of tax, with the remaining securities classified as AFS.
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Sales and calls of securities were as follows:
Proceeds
Gross gains
Gross losses
201 7
201 6
(in thousands)
201 5
$
41,733 $
449
161
8,311 $
245
29
45,012
1,902
136
T he tax provision related to net gains and losses realized on sales was $101,000, $76,000, and $618,000, respectively.
T he 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.
Maturity
Available for sale
Within one year
One to five years
Five to ten years
Agency mortgage-backed: residential
Total
December 31, 201 7
Amortized
Cost
Fair
Value
(in thousands)
$
$
14,648 $
40,197
32,744
65,935
153,524 $
14,682
40,675
32,398
64,965
152,720
Securities pledged at year-end 2017 and 2016 had carrying values of approximately $76.8 million and $61.2 million, respectively, and were pledged to secure
public deposits.
At December 31, 2017 and 2016, the Bank held securities issued by the Commonwealth of Kentucky or Kentucky municipalities having a book value of $15.4
million and $16.4 million, respectively. At year-end 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 at least 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 December 31, 2017, management does not believe any securities in the portfolio
with unrealized losses should be classified as other than temporarily impaired.
Securities with unrealized losses at December 31, 2017 and December 31, 2016, aggregated by investment category and length of time the individual securities
have been in a continuous unrealized loss position, are as follows:
Description of Securities
201 7
Available for sale
Less than 12 Months
12 Months or More
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
(in thousands)
U.S. Government and federal agency
Agency mortgage-backed: residential
State and municipal
Collateralized loan obligations
Total temporarily impaired
$
$
5,788 $
21,104
7,492
6,038
40,422 $
14,121 $
27,158
—
—
41,279 $
(386) $
(915)
—
—
(1,301) $
19,909 $
48,262
7,492
6,038
81,701 $
(483)
(1,087)
(101)
(20)
(1,691)
(97) $
(172)
(101)
(20)
(390) $
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Description of Securities
201 6
Available for sale
U.S. Government and federal agency
Agency mortgage-backed: residential
State and municipal
Corporate bonds
Total temporarily impaired
Held to maturity
State and municipal
Total
N OTE 3 – LOANS
Less than 12 Months
Fair
Value
Unrealized
Loss
12 Months or More
Total
Fair
Value
Unrealized
Loss
Fair
Value
Unrealized
Loss
(in thousands)
$
$
$
27,738 $
63,460
465
—
91,663 $
(708) $
(1,449)
(8)
—
(2,165) $
— $
2,745
—
1,566
4,311 $
1,540
1,540 $
(18)
(18) $
—
— $
— $
(43)
—
(3)
(46) $
—
— $
27,738 $
66,205
465
1,566
95,974 $
1,540
1,540 $
(708)
(1,492)
(8)
(3)
(2,211)
(18)
(18)
Loans net of unearned income, deferred loan origination costs, and net premiums on acquired loans by class were as follows:
201 7
201 6
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
Less: Allowance for loan losses
Loans, net
$
(in thousands)
113,771 $
57,342
88,320
156,724
56,588
179,222
18,439
41,154
555
712,115
(8,202)
703,913 $
$
69
97,761
36,330
71,507
149,546
48,197
188,092
9,818
37,508
477
639,236
(8,967)
630,269
Table of Contents
The following table presents the activity in the allowance for loan losses by portfolio segment for the year ended December 31, 2017, 2016, and 2015:
Commercial
Commercial
Real Estate
Residential
Real Estate Consumer
(in thousands)
Agriculture
Other
Total
Dec ember 3 1 , 201 7 :
Beginning balance
Provision (n egative provision)
Loans charged off
Recoveries
Ending balance
$
$
Dec ember 3 1 , 201 6 :
Beginning balance
Provision (negative p rovision)
Loans charged off
Recoveries
Ending balance
Dec ember 3 1 , 201 5 :
Beginning balance
Provision (negative provision)
Loans charged off
Recoveries
Ending balance
$
$
$
$
475 $
363
(5)
59
892 $
4,894 $
(1,223)
(58)
419
4,032 $
3,426 $
(129)
(692)
295
2,900 $
818 $
(401)
(276)
334
475 $
6,993 $
(2,438)
(505)
844
4,894 $
3,984 $
749
(1,652)
345
3,426 $
2,046 $
(1,255)
(696)
723
818 $
10,931 $
(2,713)
(2,879)
1,654
6,993 $
5,787 $
(316)
(2,171)
684
3,984 $
8 $
(8)
(51)
115
64 $
122 $
(314)
(99)
299
8 $
274 $
(115)
(221)
184
122 $
162 $
213
(95 )
33
313 $
2 $
(16)
–
15
1 $
8,967
(800)
(901)
936
8,202
122 $
(56)
(18 )
114
162 $
319 $
(87)
(118 )
8
122 $
2 $
10
(79)
69
2 $
7 $
(14)
(47)
56
2 $
12,041
(2,450)
(2,629)
2,005
8,967
19,364
(4,500)
(6,132)
3,309
12,041
T he 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
Collectively evaluated for
impairment
Total ending allowance balance $
$
Loans:
Loans individually evaluated for
impairment
Loans collectively evaluated for
impairment
Total ending loans balance
$
$
13 $
– $
206 $
879
892 $
4,032
4,032 $
2,694
2,900 $
– $
64
64 $
– $
313
313 $
– $
1
1 $
219
7,983
8,202
587 $
2,635 $
3,950 $
1 $
– $
– $
7,173
113,184
113,771 $
299,751
302,386 $
231,860
235,810 $
18,438
18,439 $
41,154
41,154 $
555
555 $
704,942
712,115
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T he 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, 2016:
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
Collectively evaluated for
impairment
Total ending allowance balance $
$
Loans:
Loans individually evaluated for
impairment
Loans collectively evaluated for
impairment
Total ending loans balance
$
$
Im paired Loans
13 $
35 $
350 $
462
475 $
4,859
4,894 $
3,076
3,426 $
– $
8
8 $
1 $
161
162 $
– $
2
2 $
399
8,568
8,967
595 $
5,854 $
8,621 $
1 $
60 $
– $
15,131
97,166
97,761 $
251,529
257,383 $
227,668
236,289 $
9,817
9,818 $
37,448
37,508 $
477
477 $
624,105
639,236
I mpaired 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 had been provided.
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2017:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
(in thousands)
Average
Recorded
Investment
Interest
Income
Cash
Basis
Income
Recognized
Recognized
With No Related Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
With An Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
Total
$
703 $
487 $
— $
495 $
7 $
—
3,687
1,047
—
4,293
9
—
—
9,739
—
2,059
576
—
2,787
1
—
—
5,910
100
100
—
—
—
—
1,163
—
—
—
1,263
11,002 $
$
—
—
—
—
1,163
—
—
—
1,263
7,173 $
71
—
—
—
—
—
—
—
—
—
13
—
—
—
—
206
—
—
—
219
219 $
—
2,651
716
820
2,884
2
24
—
7,592
100
—
235
238
—
1,404
—
24
—
2,001
9,593 $
—
210
59
—
143
2
1
—
422
7
—
—
14
—
68
—
—
—
89
511 $
7
—
210
47
—
143
2
1
—
410
—
—
—
—
—
—
—
—
—
—
410
Table of Contents
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 201 6:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
(in thousands)
Average
Recorded
Investment
Interest
Income
Cash
Basis
Income
Recognized
Recognized
With No Related Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
With An Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
Total
$
707 $
495 $
— $
758 $
39 $
—
5,566
4,502
4,100
4,663
41
—
—
19,579
100
—
614
303
—
1,676
—
78
—
2,771
22,350 $
—
3,742
1,219
4,100
2,910
1
—
—
12,467
100
—
590
303
—
1,611
—
60
—
2,664
15,131 $
72
$
—
—
—
—
—
—
—
—
—
13
—
5
30
—
350
—
1
—
399
399 $
156
4,188
4,699
2,608
5,509
7
73
—
17,998
20
—
358
398
2,506
1,659
—
39
—
4,980
22,978 $
9
94
310
287
162
8
28
—
937
6
—
—
23
101
111
—
—
—
241
1,178 $
39
—
95
189
1
94
8
28
—
454
—
—
—
—
—
—
—
—
—
—
454
Table of Contents
The following table presents information related to loans individually evaluated for impairment by class of loan as of and for the year ended December 31, 2015:
Unpaid
Principal
Balance
Recorded
Investment
Allowance
For Loan
Losses
Allocated
(in thousands)
Average
Recorded
Investment
Interest
Income
Cash
Basis
Income
Recognized
Recognized
With No Related Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
With An Allowance Recorded:
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Subtotal
Total
$
1,558 $
1,112 $
— $
1,526 $
5 $
278
6,004
11,256
32
14,066
118
260
—
33,572
—
—
—
574
4,195
1,690
—
—
—
6,459
40,031 $
262
4,263
7,829
32
11,756
20
152
—
25,426
—
—
—
465
4,195
1,690
—
—
—
6,350
31,776 $
73
$
—
—
—
—
—
—
—
—
—
—
—
—
43
57
328
—
—
—
428
428 $
1,993
4,497
16,073
35
13,584
23
206
49
37,986
13
—
63
4,591
4,229
1,705
8
—
—
10,609
48,595 $
14
114
263
—
456
—
—
5
857
—
—
—
25
204
89
—
—
—
318
1,175 $
5
1
114
9
—
99
—
—
5
233
—
—
—
—
—
—
—
—
—
—
233
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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 December 31, 2017 and 2016:
December 31, 201 7
Commercial
Rate reduction
Principal deferral
Commercial Real Estate:
Farmland
Principal deferral
Nonfarm nonresidential
Rate reduction
Residential Real Estate:
1-4 Family
Rate reduction
Total TDRs
December 31, 201 6
Commercial
Rate reduction
Principal deferral
Commercial Real Estate:
Farmland
Principal deferral
Nonfarm nonresidential
Rate reduction
Principal deferral
Residential Real Estate:
Multi-family
Rate reduction
1-4 Family
Rate reduction
Total TDRs
TDRs
Performing to
Modified Terms
TDRs Not
Performing to
Modified Terms
(in thousands)
Total
TDRs
$
$
$
$
— $
—
—
483
734
1,217 $
— $
—
—
507
—
4,100
743
5,350 $
33 $
434
1,362
—
—
1,829 $
33 $
434
2,300
—
607
—
—
3,374 $
33
434
1,362
483
734
3,046
33
434
2,300
507
607
4,100
743
8,724
At December 31, 2017 and 2016, 40% and 61%, respectively, of the Company’s TDRs were performing according to their modified terms. The Company allocated
$122,000 and $197,000 as of December 31, 2017 and 2016, respectively, in reserves to customers whose loan terms have been modified in TDRs. The Company
has committed to lend no additional amounts to customers as of December 31, 2017 or 2016 with outstanding loans that are classified as TDRs.
Managemen t 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. During 2017, the TDR classification was removed from two loans that met the requirements
as discussed above. These loans totaled $4.1 million at December 31, 2016. These loans are no longer evaluated individually for impairment.
74
Table of Contents
No TDR loan modifications occurred during the twelve months ended December 31, 2017 or 2016. During the year ended December, 31 2017 and 2016, 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
December 31, 2017 and 2016:
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
Nonaccrual
Loans Past
Due 90 Days
And Over Still
Accruing
201 7
201 6
201 7
201 6
(in thousands)
$
487 $
495 $
—
2,059
93
—
2,817
1
—
—
5,457 $
—
4,332
1,016
—
3,312
1
60
—
9,216 $
$
— $
—
—
—
—
—
1
—
—
1 $
—
—
—
—
—
—
—
—
—
—
T he following table presents the aging of the recorded investment in past due loans by class as of December 31, 2017 and 2016:
December 31 , 201 7
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
30 – 59
Days
Past Due
60 – 89
Days
Past Due
90 Days
And Over
Past Due
Nonaccrual
Total
Past Due
And
Nonaccrual
$
— $
—
593
—
—
850
30
5
—
1,478 $
75
$
— $
—
—
—
—
126
45
—
—
171 $
(in thousands)
— $
487 $
—
—
—
—
—
—
1
—
1 $
—
2,059
93
—
2,817
1
—
—
5,457 $
487
—
2,652
93
—
3,793
76
6
—
7,107
Table of Contents
December 31, 201 6
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
Credit Quality Indicators
30 – 59
Days
Past Due
60 – 89
Days
Past Due
90 Days
And Over
Past Due
Nonaccrual
Total
Past Due
And
Nonaccrual
(in thousands)
$
— $
—
626
—
—
1,454
19
203
—
2,302 $
$
— $
—
—
59
—
256
—
—
—
315 $
— $
495 $
—
—
—
—
—
—
—
—
— $
—
4,332
1,016
—
3,312
1
60
—
9,216 $
495
—
4,958
1,075
—
5,022
20
263
—
11,833
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
possibility of some losses if the deficiencies are not corrected.
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.
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Table of Contents
Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated l oans. As of December
31, 2017 and 2016, 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)
$
112,978 $
84 $
— $
709 $
— $
113,771
57,342
76,563
152,004
47,121
169,774
18,042
38,654
555
673,033 $
—
7,607
2,906
9,467
3,535
306
1,810
—
25,715 $
$
—
—
—
—
164
—
—
—
164 $
—
4,150
1,814
—
5,749
91
690
—
13,203 $
—
—
—
—
—
—
—
—
— $
57,342
88,320
156,724
56,588
179,222
18,439
41,154
555
712,115
Pass
Watch
Special
Mention
Substandard
Doubtful
Total
(in thousands)
$
96,402 $
294 $
— $
1,065 $
— $
97,761
35,823
63,323
142,222
38,281
173,565
9,397
26,940
477
586,430 $
507
1,521
5,217
6,080
6,909
348
9,555
—
30,431 $
$
—
—
445
—
52
—
—
—
497 $
—
6,663
1,662
3,836
7,566
73
1,013
—
21,878 $
—
—
—
—
—
—
—
—
— $
36,330
71,507
149,546
48,197
188,092
9,818
37,508
477
639,236
December 31, 201 7
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
December 31, 201 6
Commercial
Commercial Real Estate:
Construction
Farmland
Nonfarm nonresidential
Residential Real Estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Total
N OTE 4 – PREMISES AND EQUIPMENT
Year-end premises and equipment were as follows:
Land and buildings
Furniture and equipment
Accumulated depreciation
Depreciation expense was $955,000, $1.1 million and $1.0 million for 2017, 2016 and 2015, respectively.
77
201 7
201 6
(in thousands)
23,124 $
10,151
33,275
(16,486)
16,789 $
23,515
10,050
33,565
(15,717)
17,848
$
$
Table of Contents
N OTE 5 – 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 listing price is lowered below the appraised amount.
The following table presents the major categories of OREO at the period-ends indicated:
Commercial Real Estate:
Construction, land development, and other land
Farmland
Residential Real Estate:
1-4 Family
201 7
201 6
(in thousands)
$
$
4,335 $
74
—
4,409 $
6,571
—
250
6,821
Residential loans secured by 1 - 4 family residential properties in the process of foreclosure totale d $616,000 and $932,000 at December 31, 2017 and December
31, 2016, respectively.
A ctivity relating to OREO owned during the years indicated is as follows:
OREO Activity
OREO as of January 1
Real estate acquired
Valuation adjustment write-downs
Net gain (loss) on sale
Proceeds from sale of properties
OREO as of December 31
201 7
201 6
(in thousands)
20 1 5
$
$
6,821 $
270
(1,963)
74
(793)
4,409 $
19,214 $
1,273
(1,180)
222
(12,708)
6,821 $
46,197
5,513
(9,855)
(74)
(22,567)
19,214
There was no OREO rental income for the year ended December 31, 2017, compared to $456,000, and $1.3 million for the years ended December 31, 2016, and
2015, respectively.
Expenses related to OREO owned include:
Net (gain) loss on sales
Valuation adjustment write-downs
Operating expense
Total
201 7
201 6
(in thousands)
20 1 5
(74) $
1,963
84
1,973 $
(222) $
1,180
583
1,541 $
74
9,855
2,373
12,302
$
$
78
Table of Contents
N OTE 6 – DEPOSITS
The following table details deposits by category:
Non-interest bearing
Interest checking
Money market
Savings
Certificates of deposit
Total
December 31,
201 7
December 31,
201 6
(in thousands)
$
$
137,386 $
99,383
151,388
34,632
424,235
847,024 $
124,395
103,876
142,497
34,518
444,639
849,925
Time deposits of $ 250,000 or more were approximately $31.7 million and $29.1 million at year-end 2017 and 2016, respectively.
Scheduled maturities of total time deposits for each of the next five years are as follows (in thousands):
201 8
201 9
20 20
202 1
20 22
Total
204,018
178,479
27,507
5,316
8,915
424,235
$
$
NOTE 7 – ADVANCES FROM FEDERAL HOME LOAN BANK
At year-end, advances from the Federal Home Loan Bank were as follows:
A dvances with fixed rates from 0.00% to 5.24% and maturities ranging from 2018 through 2033, averaging
1.48% for 2017 and 0.85% for 2016
$
11,797 $
22,458
Each advance is payable per terms on agreement, with a prepayment penalty. No prepayment penalties were incurred during 2017 or 2016. The advances were
collateralized by approximately $130.9 million and $124.2 million of first mortgage loans, under a blanket lien arrangement at year-end 2017 and 2016,
respectively. At December 31, 2017, our additional borrowing capacity with the FHLB was $79.0 million.
Scheduled principal payments during the next five years and thereafter (in thousands):
201 7
201 6
(in thousands)
2018
2019
2020
2021
202 2
Thereafter
Advances
10,200
180
485
728
108
96
11,797
$
$
At year-end 2017, the Company had a $5.0 million federal funds line of credit available on an unsecured basis from a correspondent institution.
NOTE 8 – SUBORDINATED CAPITAL NOTE
T he outstanding principal amount of the Bank’s subordinated capital note totaled $2.3 million at December 31, 2017. The note is unsecured, bears interest at the
BBA three -month LIBOR floating rate plus 300 basis points, and qualifies as Tier 2 capital until five years before maturity on July 1, 2020. During the final five -
year period to maturity, one - fifth of principal amount of the subordinated note is excluded from Tier 2 capital each year and until fully excluded from Tier 2
capital during the year before maturity. Principal payments of $225,000 plus interest are due quarterly. Scheduled principal payments of $900,000 per year are due
each of the next two years with $450,000 due thereafter. The interest rate was 4.34% and 3.85% at December 31, 2017 and 2016, respectively.
79
Table of Contents
N OTE 9 – JUNIOR SUBORDINATED DEBENTURES
The junior subordinated debentures are redeemable at par prior to maturity at the option of the Company as defined within the trust indenture. The Company has
the option to defer interest payments on the junior subordinated debentures from time to time for a period not to exceed 20 consecutive quarters. A deferral period
may begin at the Company’s discression so long as interest payments are current. The Company is prohibited from paying dividends on its preferred and common
shares when interest payments are in deferral.
On April 15, 2016, the Company completed the private placement of 580,000 common shares and 220,000 non-voting common shares to accredited investors
resulting in total proceeds of $5.0 million. The investors in the private placement directed a portion of purchase price to pay all deferred interest payments on
junior subordinated debentures, bringing our interest payments current through the second quarter of 2016.
On June 29, 2016, the Company notified the trustees of its election to again defer interest payments effective with the third quarter 2016 payment. The deferral
period ends after the second quarter of 2021. After 20 consecutive quarters, the Company must pay all deferred distributions to avoid default. Dividends accrued
and unpaid on our junior subordinated debentures totaled $1.2 million at December 31, 2017.
A sum mary of the junior subordinated debentures is as follows:
Description
Porter Statutory Trust II
Porter Statutory Trust III
Porter Statutory Trust IV
As cencia Statutory Trust I
Issuance
Date
2 /13/2004
4 /15/2004
12 /14/2006
2 /13/2004
Interest Rate (1)
3-month LIBOR + 2.85% $
3-month LIBOR + 2.79%
3-month LIBOR + 1.67%
3-month LIBOR + 2.85%
$
Junior
Subordinated
Debt Owed
To Trust
5,000,000
3,000,000
10,000,000
3,000,000
21,000,000
Maturity
Date (2)
2 /13/2034
4 /15/2034
3 /01/2037
2 /13/2034
( 1 ) As of December 31, 2017, the 3 -month LIBOR was 1.69%.
( 2 ) The debentures are callable at our option at their principal amount plus accrued interest.
On September 30, 2015, the Company completed a common equity for debt exchange with holders of $4.0 million of the capital securities (the “Trust Securities”)
of Porter Statutory Trust IV, a trust subsidiary of the Company. Accrued and unpaid interest on the Trust Securities totaled of approximately $330,000. In
exchange for the $4.3 million debt and interest liability, the Company issued 160,000 common shares and 80,000 non-voting common shares, for a total of 240,000
shares. In the transaction, a wholly owned subsidiary of the Company received a one - third portion of the Trust Securities directly from an unrelated third party in
exchange for the issuance of 80,000 common shares resulting in an $883,000 gain on extinguishment of debt. The $883,000 gain was determined based upon the
difference in the $560,000 fair value of the common shares issued and the $1.4 million book value of the debt securities and accrued interest thereon tendered to
the Company by the unrelated third party on the date of closing. The fair value of the shares issued to the unrelated third party was computed by multiplying the
80,000 shares issued by $7.00 per share, which was the NASDAQ closing price of the Company’s common stock on September 30, 2015. The subsidiary also
received two -thirds of the Trust Securities having a book value of $2.9 million from related parties in exchange for the issuance of 80,000 common shares and
80,000 non-voting common shares. In accordance with ASC 470 - 50 - 40 - 2 and SEC Guidance 405 - 20 - 40 - 1.J, the debt and interest liability exchanged with
related parties was treated as a capital transaction.
N OTE 1 0 – S ENIOR D EBT
On June 30, 2017, the Company entered into 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 Company contributed $9.0 million of the borrowing proceeds to the Bank as common equity Tier 1 capital. The remaining $1.0 million of the borrowing
proceeds were retained by the lender in escrow to service quarterly interest payments. At December 31, 2017, the escrow account had a balance of $806,000.
80
Table of Contents
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 December 31, 2017.
NOTE 1 1 – OTHER BENEFIT PLANS
401 ( k ) Plan – The Company 401 (k) Savings Plan allows employees to contribute up to the annual limits as determined by the Internal Revenue Service, which
is matched equal to 50% of the first 4% of compensation contributed. The Company, at its discretion, may make an additional contribution. Total contributions
made by the Company to the plan totaled approximately $200,000, $189,000 and $160,000 in 2017, 2016 and 2015, respectively.
Supplemental Executive Retirement Plan – The Company has a supplemental executive retirement plan covering certain executive officers. Under the plan, the
Company pays each participant, or their beneficiary, a specific defined benefit amount over 10 years, beginning with the individual’s retirement or early
termination of service for reasons other than cause. A liability is accrued for the obligation under these plans. The expense incurred for the plan was $121,000,
$121,000 and $121,000 for the years ended December 31, 2017, 2016 and 2015, respectively. The related liability was $1.3 million at December 31, 2017 and
2016 and is included in other liabilities on the balance sheets.
The Company purchased life insurance on the participants of the plan. The cash surrender value of all insurance policies was $15.2 million and $14.8 million at
December 31, 2017 and 2016, respectively. Income earned from the cash surrender value of life insurance totaled $412,000, $417,000 and $295,000 for the years
ended December 31, 2017, 2016, and 2015, respectively. The income is recorded as other non-interest income.
NOTE 1 2 – INCOME TAXES
The Company has had a full valuation allowance against its net deferred tax asset since 2011. The Company ’s ability to utilize the net deferred tax asset depends
upon generating sufficient future levels of taxable income. The determination to restore a deferred tax asset and eliminate a valuation allowance depends upon the
evaluation of both positive and negative evidence regarding the likelihood of achieving sufficient future taxable income levels. 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. The positive evidence that outweighed the negative evidence evaluated by management in arriving at the conclusion
to remove the valuation allowance included, but was not limited to, the following:
●
●
●
●
●
positive cumulative pre-tax earnings over the prior three -year period ended December 31, 2017
growth in net interest income, stable non-interest income trends, and lower non-interest expense trends
improvement in asset quality which increases management ’s ability to forecast future taxable income and achieve forecasted results
the Company ’s net operating loss (“NOLs”) carryforwards do not begin to expire until 2032, and
the Bank ’s Consent Order was terminated in the fourth quarter of 2017
As a result of the conclusion to reverse the valuation allowance, the Company recorded an income tax benefit of $54.0 million for the year ended December 31,
2017.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 was signed into law. Among other significant changes to the tax code, the new law lowered the federal
corporate tax rate from 35% to 21% beginning in 2018. As a result, the Company revalued its net deferred tax asset at the new 21% rate. Due to this revaluation,
the Company recorded a $20.3 million charge to income tax expense for the year ended December 31, 2017.
The combination of the reversal of the valuation allowance and the change in federal corporate tax rates , as well as income tax expense for the year, resulted in an
income tax benefit of $31.9 million for the year ended December 31, 2017.
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Income tax expense (benefit) was as follows:
Current
Deferred
Net operating loss
Change in federal statutory rate
Change in valuation allowance
201 7
201 6
(in thousands)
20 1 5
$
$
— $
2,523
(647)
20,274
(54,049)
(31,899) $
21 $
2,771
(4,009)
—
1,238
21 $
Effective tax rates differ from federal statutory rate of 35% applied to income (loss) before income taxes due to the following:
201 7
201 6
(in thousands)
—
5,258
(5,975)
—
717
—
20 1 5
Federal statutory rate times financial statement income (loss)
Effect of:
$
2,294 $
(956) $
(1,125)
V aluation allowance
Tax-exempt income
Non -taxable life insurance income
Restricted stock vesting
Change in federal statutory rate
Other, net
Total
(54,049)
(196)
(144)
(121)
20,274
43
(31,899) $
1,238
(211)
(146)
—
—
96
21 $
$
717
(264)
(103)
—
—
775
—
Year-end deferred tax assets and liabil ities were due to the following:
Deferred tax assets:
Net operating loss carry-forward
Allowance for loan losses
O REO write-down
Alternative minimum tax credit carry-forward
Net assets from acquisitions
Net unrealized loss on securities
New market tax credit carry-forward
Nonaccrual loan interest
Accrued expenses
Deferred compensation
Other
Deferred tax liabilities:
FHLB stock dividends
Fixed assets
Deferred loan costs
Other
Net deferred tax assets before valuation allowance
Valuation allowance
Net deferred tax asset
201 7
201 6
(in thousands)
25,645 $
1,723
2,432
692
358
169
208
271
172
277
241
32,188
557
68
152
98
875
31,313
—
31,313 $
42,094
3,139
3,366
692
674
867
208
481
3,860
465
360
56,206
928
89
274
866
2,157
54,049
(54,049)
—
$
$
At December 31, 2017, the Company had net operating loss carryforwards ("NOLs") of $122.1 million, which will begin to expire in 2031.
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 2017 or 2016
related to unrecognized tax benefits.
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U nder 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.
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
will expire upon the earlier of (i) June 29, 2018, ( 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 will expire on the earlier of (i) September 23, 2018, ( 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 incom e tax in the Commonwealth of Kentucky. The
Company is no longer subject to examination by taxing authorities for years before 2014.
NOTE 1 3 – RELATED PARTY TRANSACTIONS
Loans to principal officers, directors, significant shareholders, and their affiliates in 201 7 were as follows (in thousands):
Beginning balance
New loans
Repayments
Ending balance
$
$
—
9,400
—
9,400
Depo sits from principal officers, directors, significant shareholders, and their affiliates at year-end 2017 and 2016 were $401,000 and $321,000, respectively.
Hogan Development Company assists the Bank in onboarding, managin g, and selling the Bank’s OREO. Hogan Development Company is owned by W. Glenn
Hogan, a director. The agreement with Hogan Development Company is periodically reviewed and evaluated by the Audit Committee. The Bank paid real estate
management fees of $20,000 and $56,000 and real estate sales and leasing commissions of $6,000 and $478,000 to Hogan Development Company in 2017 and
2016, respectively.
On April 15, 2016, the Company completed the private placement of 580,000 common shares and 220,000 non-voting common shares to accredited investors
resulting in total proceeds of $5.0 million. The investors in the private placement directed a portion of purchase price to pay all deferred interest payments on
junior subordinated debentures, bringing our interest payments current through the second quarter of 2016. The investors included three directors of the Company,
including President and CEO John T. Taylor, who purchased common shares on the same terms and conditions as the other investors.
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NOTE 1 4 – PREFERRED STOCK
The Company has issued and outstanding 6,198 Series E preferred shares and 4,304 Series F preferred shares, both of which series are not convertible into
common shares, have a liquidation preference of $1,000 per share, and are entitled to a 2% noncumulative annual dividend if and when declared. Series E and
Series F preferred shares rank senior to, and have liquidation and dividend preferences over, the common shares and non-voting common shares.
NOTE 1 5 – CAPITAL REQUIREMENTS AND RESTRICTIONS ON RETAINED EARNINGS
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 2017 is 1.25% and 0.625% for 2016. 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.
The Bank is no longer subject to a consent order with the Federal Deposit Insurance Corporation and Kentucky Department of Financial Institutions. The Bank ’s
prior consent order was terminated effective October 31, 2017.
On September 21, 2011, the Company entered into a Written Agreement with the Federal Reserve Bank of St. Louis. Pursuant to the Agreement, management
made formal commitments to use the Company’s financial and management resources to serve as a source of strength for the Bank and to assist the Bank in
addressing weaknesses identified by the FDIC and the KDFI (which has since been terminated), to pay no dividends without prior written approval, to pay no
interest or principal on subordinated debentures or trust preferred securities without prior written approval, and to submit an acceptable plan to maintain sufficient
capital.
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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 Porter Bancorp, Inc. 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 December 31, 2017:
Total risk-based capital (to risk-weighted
assets)
Consolidated
Bank
$
83,072
91,305
10.55% $
11.61
63,014
62,938
8.00%
$
8.00
N/A
78,672
N/A
10.00%
Total common equity Tier 1 risk- based
capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to average assets)
Consolidated
Bank
54,535
81,393
66,487
81,393
66,487
81,393
6.92
10.35
8.44
10.35
7.11
8.70
35,445
35,403
47,260
47,203
37,392
37,421
4.50
4.50
6.00
6.00
4.00
4.00
N/A
51,137
N/A
62,938
N/A
46,777
N/A
6.50
N/A
8.00
N/A
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, 2016:
Total risk-based capital (to risk-weighted
assets)
Consolidated
Bank
$
71,109
68,773
10.21% $
9.88
55,714
55,663
8.00%
$
8.00
N/A
69,579
N/A
10.00%
Total common equity Tier 1 risk- based
capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to average assets)
Consolidated
Bank
36,199
57,642
48,713
57,642
48,713
57,642
5.20
8.28
6.99
8.28
5.27
6.24
31,339
31,311
41,786
41,747
36,975
36,949
4.50
4.50
6.00
6.00
4.00
4.00
N/A
45,226
N/A
55,663
N/A
46,186
N/A
6.50
N/A
8.00
N/A
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 1 6 – 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 year
ended:
Commitments to make loans
Unused lines of credit
Standby letters of credit
Commitments to make loans are generally made for periods of one year or less.
201 7
201 6
Fixed
Rate
Variable
Rate
Fixed
Rate
Variable
Rate
$
27,349 $
11,034
2,216
(in thousands)
31,412 $
57,727
373
19,445 $
7,935
582
18,347
51,407
360
I n connection with the purchase of loan participations, the Bank entered into risk participation agreements, which had notional amounts totaling $19.8 million at
December 31, 2017 and $14.6 million at December 31, 2016.
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 .
On October 17, 2014, the United States Department of Justice (the “DOJ”) notified the Bank that it was the subject of an investigation into possible violations of
federal laws, including, among other things, possible violations related to false bank entries, bank fraud and securities fraud. The investigation concerns allegations
that Bank personnel engaged in practices intended to delay or avoid disclosure of the Bank ’s asset quality at the time of and following the United States Treasury’s
purchase of preferred shares from the Company in November 2008. The Bank has cooperated with all requests for information from DOJ. At this time, the DOJ
has not indicated whether it intends to pursue any action in this matter.
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NOTE 1 7 – FAIR VALUES
F air 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.
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.
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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 quarter ly 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 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.
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.
Management routinely applies an internal discount to the value of appraisals used in the fair value evaluation of OREO. 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.
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Table of Contents
Financial assets measured at fair value on a recurring basis are summarized below:
Description
Available for sale securities
U.S. Government and federal agency
Agency mortgage-backed : residential
Collateralized loan obligations
State and municipal
Corporate bonds
Total
Description
Available for sale securities
U.S. Government and federal agency
Agency mortgage-backed : residential
Collateralized loan obligations
State and municipal
Corporate bonds
Total
$
$
$
$
There were no transfers between Level 1 and Level 2 during 2017 or 2016.
Fair Value Measurements at December 31, 201 7 Using
(in thousands)
Significant Other
Observable
Inputs
(Level 2)
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
21,624 $
64,965
25,505
33,710
6,916
152,720 $
— $
—
—
—
—
— $
21,624 $
64,965
25,505
33,710
6,916
152,720 $
Fair Value Measurements at December 31, 201 6 Using
(in thousands)
Significant Other
Observable
Inputs
(Level 2)
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
— $
—
—
—
—
— $
34,099 $
102,353
11,203
2,045
3,090
152,790 $
34,099 $
102,353
11,203
2,045
3,090
152,790 $
89
—
—
—
—
—
—
—
—
—
—
—
—
Table of Contents
Financial assets measured at fair value on a non-recurring basis are summarized below:
Description
Impaired lo ans :
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Other real estate owned, net :
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Description
Impaired loans:
Commercial
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Consumer
Agriculture
Other
Other real estate owned, net :
Commercial real estate:
Construction
Farmland
Nonfarm nonresidential
Residential real estate:
Multi-family
1-4 Family
Fair Value Measurements at December 31, 201 7 Using
(in thousands)
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
$
87 $
—
—
—
—
957
—
—
—
4,335
74
—
—
—
— $
— $
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
87
—
—
—
—
957
—
—
—
4,335
74
—
—
—
Fair Value Measurements at December 31, 201 6 Using
(in thousands)
Quoted Prices In
Active Markets for
Identical Assets
(Level 1)
Significant Other
Observable Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Carrying
Value
$
87 $
—
585
—
—
1,261
—
59
—
6,571
—
—
—
250
— $
— $
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
87
—
585
—
—
1,261
—
59
—
6,571
—
—
—
250
Impaired loans , which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1.3 million, with
a valuation allowance of $219,000, at December 31, 2017, resulting in no additional provision for loan losses for the year ended December 31, 2017. At December
31, 2016, impaired loans had a carrying amount of $2.4 million, with a valuation allowance of $370,000, at December 31, 2016, resulting in no additional
provision for loan losses for the year ended December 31, 2016.
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Table of Contents
O REO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $4.4 million as of December 31, 2017, compared
with $6.8 million at December 31, 2016. Write-downs of $2.0 million and $1.2 million were recorded on OREO for the years ended December 31, 2017 and 2016,
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 December 31, 201 7:
Fair Value
(in thousands)
Valuation
Technique(s)
Unobservable Input(s)
Range (Weighted
Average)
Impaired loans – Residential real estate
$
957
Sales comparison approach
Adjustment for differences between
0% - 26% (9%)
the comparable sales
Other real estate owned – Commercial
$
4,409
Sales comparison approach
Adjustment for differences between
0% - 35% (18%)
real estate
the comparable sales
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, 201 6:
Fair Value
(in thousands)
Valuation
Technique(s)
Unobservable Input(s)
Range (Weighted
Average)
Impaired loans – Residential real estate
$
1,261
Sales comparison approach
Adjustment for differences between
0% - 22% (9%)
the comparable sales
Other real estate owned – Commercial
$
6,571
Sales comparison approach
Adjustment for differences between
0% - 20% (9%)
real estate
the comparable sales
Income approach
Discount or capitalization rate
18% - 20% (19%)
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Table of Contents
C arrying amount and estimated fair values of financial instruments were as follows at year-end 2017:
Financial assets
Cash and cash equivalents
Securities available for sale
Federal Home Loan Bank stock
Loans held for sale
Loans, net
Accrued interest receivable
Financial liabilities
Deposits
Federal Home Loan Bank advances
Subordinated capital notes
Junior subordinated debentures
Senior debt
Accrued interest payable
Carrying
Amount
Fair Value Measurements at December 31, 201 7 Using
Level 1
Level 2
(in thousands)
Level 3
Total
$
$
34,103 $
152,720
7,323
70
703,913
3,136
847,024 $
11,797
2,250
21,000
10,000
1,475
29,898 $
—
N/A
—
—
—
137,386 $
—
—
—
—
—
4,205 $
152,720
N/A
70
—
925
693,320 $
11,799
—
—
—
357
— $
—
N/A
—
703,263
2,211
— $
—
2,246
19,090
10,000
1,118
34,103
152,720
N/A
70
703,263
3,136
830,706
11,799
2,246
19,090
10,000
1,475
C arrying amount and estimated fair values of financial instruments were as follows at year-end 2016:
Financial assets
Cash and cash equivalents
Securities available for sale
Securities held to maturity
Federal Home Loan Bank stock
Loans, net
Accrued interest receivable
Financial liabilities
Deposits
Federal Home Loan Bank advances
Subordinated capital notes
Junior subordinated debentures
Accrued interest payable
Carrying
Amount
Fair Value Measurements at December 31, 201 6 Using
Level 1
Level 2
(in thousands)
Level 3
Total
$
$
66,316 $
152,790
41,818
7,323
630,269
3,137
849,925 $
22,458
3,150
21,000
734
31,091 $
—
—
N/A
—
—
124,395 $
—
—
—
—
35,225 $
152,790
43,072
N/A
—
1,203
712,458 $
22,475
—
—
369
— $
—
—
N/A
632,528
1,934
— $
—
3,091
13,263
365
66,316
152,790
43,072
N/A
632,528
3,137
836,853
22,475
3,091
13,263
734
The methods and assumptions used to estimate fair value 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
Fair values of loans, excluding loans held for sale, are estimated as follows: For variable rate loans that reprice frequently and with no significant change in
credit risk, fair values are based on carrying values resulting in a Level 3 classification. Fair values for other loans are estimated using discounted cash flow
analyses, using interest rates currently 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 do not necessarily
represent an exit price.
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Table of Contents
(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 dis closed for non-interest bearing 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 variable rate interest bearing deposits approximate their fair values at the reporting date resulting in a Level 2
classification. Fair values for fixed rate interest bearing deposits are estimated using a discounted cash flows calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.
(
f ) Other Borrowings
The fair values of FHLB advances are estimated using discounted cash flow analyses based on the current borrowing rates resulting in a Lev el 2
classification.
The fair values of subordinated capital notes , junior subordinated debentures, and senior debt are 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.
N OTE 1 8 – STOCK PLANS AND STOCK BASED COMPENSATION
S hares available for issuance under the 2016 Omnibus Equity Compensation Plan ( “2016 Plan”) total 25,000. Shares issued to employees under the plan vest
annually on the anniversary date of the grant generally over three to four years.
The Company also maintains the Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan ( “2006 Director Plan”) pursua nt to which
2,834 shares remain available for issuance as annual awards of restricted stock to the Company’s non-employee directors. 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 t he 2017 unvested shares issued was $365,000, or $9.64 per weighted-average share. The Company recorded $400,000 and $443,000 of stock-
based compensation during 2017 and 2016, respectively, to salaries and employee benefits. 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 $140,000 was recognized in 2017 related to this expense,
whereas no deferred tax benefit was recognized in 2016.
The following table summarizes unvested share activity as of and for the periods indicated for the Stock Incentive Plan:
Twelve Months Ended
December 31 , 201 7
Twelve Months Ended
December 31, 201 6
Weighted
Average
Grant
Price
Shares
Weighted
Average
Grant
Price
Shares
Outstanding, beginning
Granted
Vested
Forfeited
Outstanding, ending
179,513 $
37,865
(73,728)
(1,316)
142,334 $
4.89
9.64
5.75
9.35
5.67
184,482 $
35,465
(38,462)
(1,972)
179,513 $
Unrecognized stock based compensation expense related to unvested shares for 2018 and beyond is estimated as follows (in thousands):
201 8
201 9
20 20
20 21 & thereafter
$
93
4.81
9.10
8.32
6.16
4.89
258
99
25
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N OTE 19 – EARNINGS (LOSS) PER SHARE
The factors used in the basic and diluted earnings per share computation follow:
201 7
201 6
(in thousands, except share and per share data)
201 5
Net income (loss)
Less:
Earnings (l osses) allocated to unvested shares
Earnings (l osses) allocated to participating preferred shares
Net income (loss) attributable to common shareholders, basic and diluted
Basic
Weighted average common shares including unvested common shares and
participating preferred shares outstanding
Less:
Weighted average unvested common shares
Weighted average Series B Preferred Shares
Weighted average Series D Preferred Shares
Weighted average common shares outstanding
Basic income (loss) per common share
Diluted
Add: Dilutive effects of assumed exercises of common stock warrants
Weighted average common shares and potential common shares
Diluted income (loss) per common share
$
$
$
$
38,453 $
(2,753) $
967
—
37,486 $
(88)
—
(2,665) $
(3,213)
(122)
(214)
(2,877)
6,249,059
5,980,945
5,191,944
157,127
—
—
6,091,932
6.15 $
192,232
—
—
5,788,713
(0.46) $
—
6,091,932
6.15 $
—
5,788,713
(0.46) $
197,355
133,269
212,318
4,649,002
(0.62)
—
4,649,002
(0.62)
The Company had no outstanding stock options at December 31, 2017, 2016 or 2015. 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 December 31, 2017, 2016 and 2015, 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 2 0 – PARENT COMPANY ONLY CONDENSED FINANCIAL INFORMATION
Condensed financial information of Porter Bancorp Inc. is presented as follows:
CONDENSED BALANCE SHEETS
December 31,
ASSETS
Cash and cash equivalents (1)
Investment in banking subsidiary
Investment in and advances to other subsidiaries
Deferred taxes , net
Other assets
Total assets
LIABILITIES AND SHAREHOLDERS ’ EQUITY
Debt
Accrued expenses and other liabilities
Shareholders ’ equity
Total liabilities and shareholders ’ equity
201 7
201 6
(in thousands)
$
$
$
$
2,045 $
99,651
776
2,497
711
105,680 $
31,775 $
1,232
72,673
105,680 $
2,048
51,528
776
—
645
54,997
21,775
489
32,733
54,997
( 1 ) $806,000 is held in escrow by the senior note lender to be used exclusively for interest payments on senior debt.
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Table of Contents
CONDENSED STATEMENTS OF OPERATIONS
Years ended December 31,
Interest income
Dividends from subsidiaries
Other income
Interest expense
Other expense
Income (loss) before income tax and undistributed subsidiary income
Income tax expense (benefit)
Equity in undistributed subsidiary income (loss)
Net income ( loss )
CONDENSED STATEMENTS OF CASH FLOWS
Years ended December 31,
Cash flows from operating activities
Net income (loss)
Adjustments:
Equity in undistributed subsidiary (income) loss
Deferred taxes , net
Gain on sale of assets
Change in other assets
Change in other liabilities
Other
Net cash (used in) operating activities
Cash flows from investing activities
Investments in subsidiaries
Sales of securities
Net cash (used in) from investing activities
Cash flows from financing activities
Proceeds from issuance of common stock
Proceeds from senior debt
Net cash (used in) financing activities
Net change in cash and cash equivalents
Beginning cash and cash equivalents
Ending cash and cash equivalents
201 7
201 6
(in thousands)
201 5
$
$
4 $
26
—
(973)
(1,137)
(2,080)
(2,497)
38,036
38,453 $
5 $
23
17
(694)
(1,240)
(1,889)
21
(843)
(2,753) $
46
20
102
(647)
(1,457)
(1,936)
—
(1,277)
(3,213)
201 7
201 6
(in thousands)
20 1 5
$
38,453 $
(2,753) $
(3,213)
(38,036)
(2,497)
—
743
(128)
462
(1,003)
(9,000)
—
(9,000)
—
10,000
10,000
(3)
2,048
2,045 $
843
—
—
(95)
358
978
(669)
(500)
—
(500)
2,231
—
2,231
1,062
986
2,048 $
1,277
—
(70)
(40)
634
481
(931)
—
642
642
—
—
—
(289)
1,275
986
$
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Table of Contents
NOTE 2 1 – QUARTERLY FINANCIAL DATA (UNAUDITED)
Interest
Income
Net Interest
Income
Provision
For
Net
Income
(Loss)
(in thousands, except per share data)
OREO
Expense
Loan Losses
Earnings (Loss)
Per Common Share
Basic (1)
Diluted (1)
201 7
First quarter
Second quarter
Third quarter
Fourth quarter
201 6
First quarter
Second quarter
Third quarter
Fourth quarter
$
$
9,225 $
9,134
9,446
9,717
9,185 $
8,705
8,931
8,781
7,741 $
7,588
7,787
8,001
7,651 $
7,196
7,458
7,316
— $
—
—
(800)
(550) $
(600)
(750)
(550)
(16) $
(3)
111
1,881
1,680 $
1,709
1,794
33,270 (2)
668 $
294
322
257
1,480 $
1,012
1,393
(6,638) (3)
0.27 $
0.27
0.29
5.31
0.27 $
0.17
0.22
(1.07)
0.27
0.27
0.29
5.31
0.27
0.17
0.22
(1.07)
( 1 )The sum of the quarterly net income (loss) per share (basic and diluted) differs from the annual net income (loss) per share (basic and diluted) because of
the differences in the weighted average number of common shares outstanding and the common shares used in the quarterly and annual computations as
well as differences in rounding.
( 2 )Net income for the fourth quarter of 2017 was impacted by the reversal of the Company ’s deferred tax asset valuation allowance and the change in
federal corporate tax rates in connection with the enectment of the Tax Cuts and Jobs Act of 2017. The net result of these two items, as well as tax
expense for the year, was an income tax benefit of $31.9 million.
( 3 )The $6.6 million loss for the fourth quarter of 2016 was due to the $8.0 million in litigation expenses accrued as a result of the Kentucky Court of Appeals
ruling against the Bank.
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Table of Contents
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None
Item 9A.
Controls and Procedures
Disclosure Controls and Procedures
Management is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the
Securities Exchange Act of 1934. Our management, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial
Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of December 31, 2017. Based on that evaluation,
management believes that our disclosure controls and procedures were effective to collect, process, and disclose the information required to be disclosed in the
reports filed with the SEC within the required time periods as of the end of the period covered by this report.
There was no change in the internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to
materially affect, the Company’s internal control over financial reporting.
Management ’s Report on Internal Control Over Financial Reporting
The management of Porter Bancorp, Inc. is responsible for establishing and maintaining adequate internal co ntrol over financial reporting. Internal control over
financial reporting is defined in Rule 13a-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of; the
principal executive and principal financial officers and effected by the board of directors, management and other personnel, to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted
accounting principles and includes those policies and procedures that:
Pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets;
Provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally
accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and
directors; and
Provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a
material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or
procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial rep orting as of December 31, 2017. In making this assessment, management used the
criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in the 2013 Internal Control-Integrated Framework.
Based on that assessment, management believes that, as of December 31, 2017, our internal control over financial reporting is effective based on those criteria.
This annual report does not include an attestation report of our registered public accounting firm regarding internal con trols over financial reporting.
Management’s report was not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that
permit us to provide only management’s report in this annual report.
/s/ John T. Taylor
John T. Taylor
President and Chief Executive Officer
/s/ Phillip W. Barnhouse
Phillip W. Barnhouse
Chief Financial Officer
Item 9B. Other Information
None
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Table of Contents
Item 10. Directors , Executive Officers and Corporate Governance .
PART III
The Company has adopted a code of ethics applicable to the Chief Executive Officer and the senior financial officers, which is posted on the Bank’s website at
http://www.limestonebank.com under the Investors Relations section of the About Us tab . If we amend or waive any of the provisions of the Code of Ethics
applicable to our Chief Executive Officer or senior financial officers, we intend to disclose the amendment or waiver on our website. We will provide to any person
without charge, upon request, a copy of this Code of Ethics. You can request a copy by contacting Porter Bancorp, Inc., Chief Financial Officer, 2500 Eastpoint
Parkway, Louisville, Kentucky, 40223, (telephone) 502-499-4800.
Additional information required by this Item 10 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30,
2018, which includes the required information. The required information contained in our proxy statement is incorporated herein by reference.
Item 11. Executive Compensation.
The information required by this Item 11 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,
which includes the required information. The required information contained in our proxy statement is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The information required by this Item 12 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,
which includes the required information. The required information contained in our proxy statement is incorporated herein by reference.
Item 13. Certain Relationships and Related Transactions , and Director Independence .
The information required by this Item 13 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,
which includes the required information. The required information contained in our proxy statement is incorporated herein by reference.
Item 14. Principal Accounting Fees and Services.
The information required by this Item 14 is omitted because we are filing a definitive proxy statement pursuant to Regulation 14A on or before April 30, 2018,
which includes the required information. The required information contained in our proxy statement is incorporated herein by reference.
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Table of Contents
Item 15.
Exhibits and Financial Statement Schedules
(a) 1. The following financial statements are included in this Form 10-K:
PART IV
Consolidated Balance Sheets as of December 31, 2017 and 2016
Consolidated Statements of Operations for the Years Ended December 31, 2017, 2016, and 2015
Consolidated Statements of Comprehensive Income (Loss) for the Years Ended December 31, 2017, 2016, and 2015
Consolidated Statements of Change in Stockholders ’ Equity for the Years Ended December 31, 2017, 2016, and 2015
Consolidated Statements of Cash Flows for the Years Ended December 31, 2017, 2016, and 2015
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
(a) 2. List of Financial Statement Schedules
Financial statement schedules are omitted because the information is not applicable.
(a) 3. List of Exhibits
The Exhibit Index of this report is incorporated by reference. The compensatory plans or arrangement required to be filed as exhibits to this Form 10-K
pursuant to Item 15(c) are noted with an asterisk in the Exhibit Index.
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Table of Contents
Exhibit No. (1) Description
3.1
Amended and Restated Articles of Incorporation, dated March 25, 2016. Exhibit 3.1 to Form 8-K filed May 26, 2016 is incorporated by
EXHIBIT INDEX
reference.
3.2
3.3
4.1
10.1
10.2
10.3
Amendment to Articles of Incorporation, dated December 6, 2016, effecting reverse stock split. Exhibit 3.1 to Form 8-K filed December 21,
2016 is incorporated by reference.
Amended and Restated Bylaws of Porter Bancorp, Inc. Exhibit 3.1 to Form 8-K filed May 22, 2013 is hereby incorporated by reference.
Warrant to purchase up to 299,829 shares. Exhibit 4.1 to Form 8-K filed November 24, 2008 is incorporated by reference.
Loan Agreement between Porter Bancorp, Inc. and First Merchants Bank dated June 30, 2017. Exhibit 1.1 to Form 8-K filed July 5, 2017 is
incorporated by reference.
Promissory Note between Porter Bancorp, Inc. and First Merchants Bank dated June 30, 2017. Exhibit 1.2 to Form 8-K filed July 5, 2017 is
incorporated by reference.
Pledge Agreement between Porter Bancorp, Inc. and First Merchants Bank dated June 30, 2017. Exhibit 1.3 to Form 8-K filed July 5, 2017 is
incorporated by reference.
10.4+
Porter Bancorp, Inc. 2016 Omnibus Equity Compensation Plan. Appendix A to Schedule 14A proxy statement (DEF 14A) filed April 25, 2016
is incorporated by reference.
10.5+
Form of Porter Bancorp, Inc. Restricted Stock Award Agreement. Exhibit 10.3 to 8-K filed June 22, 2016 is incorporated by reference.
10.6+
10.7+
10.8+
10.9+
Porter Bancorp, Inc. 2006 Non-Employee Directors Stock Ownership Incentive Plan, as amended and restated as of March 26, 2014. Exhibit
10.1 to Form S-8 Registration Statement (Reg. No. 333-202746) filed March 13, 2015 is incorporated by reference.
Non-Employee Director Stock Incentive Program. Exhibit 10.1 to Form 8-K filed June 22, 2016 is incorporated by reference.
Porter Bancorp, Inc. 2017 Incentive Compensation Bonus Plan. Exhibit 10.1 to Form 10-Q filed May 4, 2017 is incorporated by reference.
Form of Ascencia Bank (now Limestone Bank) Supplemental Executive Retirement Plan. Exhibit 10.5 to Form S-1 Registration Statement (Reg.
No. 333-133198) filed April 11, 2006 is incorporated by reference.
10.10+
Form of Amendment to Supplemental Executive Retirement Plan. Exhibit 10.7 to Form 10-K filed March 26, 2009 is incorporated by
reference.
10.11+
Employment Agreement with John T. Taylor. Exhibit 10.1 to Form 8-K filed September 27, 2016 is incorporated by reference.
10.12+
Employment Agreement with John R. Davis. Exhibit 10.2 to Form 8-K filed September 27, 2016 is incorporated by reference.
10.13+
Employment Agreement with Joseph C. Seiler. Exhibit 10.3 to Form 8-K filed September 27, 2016 is incorporated by reference.
10.14+
Employment Agreement with Phillip W. Barnhouse. Exhibit 10.4 to Form 8-K filed September 27, 2016 is incorporated by reference.
21.1
23.1
31.1
31.2
32.1
List of Subsidiaries of Porter Bancorp, Inc.
Consent of Crowe Horwath LLP, Independent Registered Public Accounting Firm.
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14 or 15d-14.
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14 or 15d-14.
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and 18 U.S.C. Section 1350.
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Table of Contents
Exhibit No. (1) Description
32.2
101
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(b) or 15d-14(b) and U.S.C. Section 1350.
The following financial statements from the Company ’s Annual Report on Form 10-K for the year ended December 31, 2017, formatted in
XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations, (iii) Consolidated Statements of Comprehensive Income,
(iv) Consolidated Statements of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated
Financial Statements.
+
(1)
Management contract or compensatory plan or arrangement.
The Company has other long-term debt agreements that meet the exclusion set forth in Section 601(b)(4)(iii)(A) of Regulation S-K. The Company hereby
agrees to furnish a copy of such agreements to the Securities and Exchange Commission upon request.
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Table of Contents
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
February 28 , 2018
PORTER BANCORP, INC.
By:
/s/ John T. Taylor
John T. Taylor
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in
the capacities indicated.
/s/ John T. Taylor
John T. Taylor
/s/ Phillip W. Barnhouse
Phillip W. Barnhouse
/ s/ W. Glenn Hogan
W. Glenn Hogan
/s/ Michael T. Levy
Michael T. Levy
/s/ Bradford T. Ray
Bradford T. Ray
/s/ W. Kirk Wycoff
W. Kirk Wycoff
/s/ James M. Parsons
James M. Parsons
/s/ Dr. Edmond J. Seifried
Dr. Edmond J. Seifried
Chief Executive Officer
February 28, 2018
Chief Financial Officer
February 28 , 2018
Director
Director
Director
Director
Director
Director
102
February 28 , 2018
February 28 , 2018
February 28 , 2018
February 28 , 2018
February 28 , 2018
February 28 , 2018
SUBSIDIARIES OF PORTER BANCORP, INC.
Exhibit 21.1
Direct Subsidiary
Limestone Bank, Inc.
As cencia Statutory Trust I
Porter Statutory Trust II
Porter Statutory Trust III
Porter Statutory Trust IV
PBIB Corporation, Inc.
Jurisdiction of Organization
Does Business As
Kentucky
Connecticut
Connecticut
Connecticut
Connecticut
Kentucky
Limestone Bank, Inc.
As cencia Statutory Trust I
Porter Statutory Trust II
Porter Statutory Trust III
Porter Statutory Trust IV
PBIB Corporation, Inc.
Indirect Subsidiary
PBI Title Services, LLC
Jurisdiction of Organization
Kentucky
Does Business As
Parent Entity
PBI Title Services, LLC
Limestone Bank, Inc.
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Exhibit 23.1
We consent to the incorporation by referenc e in Registration Statement Nos. 333-188988; 333-189005; 333-202746 and 333-202749 on Form S-8 of Porter
Bancorp, Inc. of our report dated February 28, 2018 with respect to the consolidated financial statements of Porter Bancorp, Inc., which report appears in this
Annual Report on Form 10-K of Porter Bancorp, Inc. for the year ended December 31, 2017.
Louisville, Kentucky
February 28 , 2018
/s/ Crowe Horwath LLP
Exhibit 31.1
PORTER BANCORP, INC .
RULE 13A-14(A) CERTIFICATION OF CHIEF EXECUTIVE OFFICER
I, John T. Taylor, Chief Executive Officer of Porter Bancorp, Inc. (the “Company”), certify that:
1. I have reviewed this Annual Report on Form 10-K of the Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant ’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's
auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely
to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over
financial reporting.
Dated: February 28, 2018
/s/ John T. Taylor
John T. Taylor
Chief Executive Officer
Exhibit 31.2
PORTER BANCORP, INC .
RULE 13A-14(A) CERTIFICATION OF CHIEF FINANCIAL OFFICER
I, Phillip W. Barnhouse, Chief Financial Officer of Porter Bancorp, Inc. (the “Company”), certify that:
1. I have reviewed this Annual Report on Form 10-K of the Company;
2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements
made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial
condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
4. The registrant ’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act
Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and
have:
(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure
that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during
the period in which this report is being prepared;
(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision,
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles;
(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of
the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal
quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's
internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's
auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):
(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely
to adversely affect the registrant's ability to record, process, summarize and report financial information; and
(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over
financial reporting.
Dated : February 28, 2018
/s/ Phillip W. Barnhouse
Phillip W. Barnhouse
Chief Financial Officer
SECTION 906 CERTIFICATION
Exhibit 32.1
In connection with the Annual Report on Form 10-K of Porter Bancorp, Inc. (the “Company”) for the annual period ended December 31, 2017, as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I, John T. Taylor, Chief Executive Officer of the Company, do hereby certify, in
accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1)
The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and
(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: February 28, 2018
PORTER BANCORP, INC.
By:/s/ John T. Taylor
John T. Taylor
Chief Executive Officer
SECTION 906 CERTIFICATION
Exhibit 32.2
In connection with the Annual Report on Form 10-K of Porter Bancorp, Inc. (the “Company”) for the annual period ended December 31, 2017, as filed with
the Securities and Exchange Commission on the date hereof (the “Report”), I, Phillip W. Barnhouse, Chief Financial Officer of the Company, do hereby certify, in
accordance with 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1)
The Report fully complies with the requirements of Section 13(a) or 15(d), as applicable, of the Securities Exchange Act of 1934, as amended; and
(2)
The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.
Dated: February 28, 2018
PORTER BANCORP, INC.
By:/s/ Phillip W. Barnhouse
Phillip W. Barnhouse
Chief Financial Officer