NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

United Bancshares, Inc. (the “Corporation”) was incorporated in 1985 in the state of Ohio as a single-bank holding company for The Union Bank Company (the “Bank”).  The Bank formed a wholly-owned subsidiary, UBC Investments, Inc. (“UBC”) to hold and manage its securities portfolio.  The operations of UBC are located in Wilmington,  Delaware.  The Bank has also formed a wholly-owned subsidiary, UBC Property, Inc. to hold and manage certain property that is acquired in lieu of foreclosure.

 

The Corporation, through its wholly-owned subsidiary, the Bank, operates in one industry segment, the commercial banking industry.  The Bank, organized in 1904 as an Ohio-chartered bank, is headquartered in Columbus Grove, Ohio, with branch offices in Bowling Green, Delaware, Delphos, Findlay, Gibsonburg, Kalida, Leipsic, Lima, Marion, Ottawa, and Pemberville Ohio. 

 

The primary source of revenue of the Corporation is providing loans to customers primarily located in Northwestern and West Central Ohio.  Such customers are predominately small and middle-market businesses and individuals.

 

Significant accounting policies followed by the Corporation are presented below.

 

Use of Estimates in Preparing Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during each reporting period.  Actual results could differ from those estimates.  The estimates most susceptible to significant change in the near term include the determination of the allowance for loan losses, valuation of servicing assets and goodwill, and fair value of securities and other financial instruments.    

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of the Corporation and its wholly-owned subsidiary, the Bank, and its wholly-owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.

 

Cash and Cash Equivalents

 

For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash on hand, amounts due from banks, and federal funds sold which mature overnight or within four days.

 

Restrictions on Cash

 

The Corporation was required to maintain cash on hand or on deposit with the Federal Reserve Bank in the amount of $2,623,000 and $657,000 at December 31, 2014 and 2013, respectively, to meet regulatory reserve and clearing requirements.

 

 

Securities, Federal Home Loan Bank Stock and Certificates of Deposits

 

The Corporation has designated all securities as available-for-sale.  Such securities are recorded at fair value, with unrealized gains and losses, net of applicable income taxes, excluded from income and reported as accumulated other comprehensive income (loss).

 

The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity.  Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities.  Declines in fair value of securities below their cost that are deemed to be other-than-temporary are reflected in income as realized losses.  In estimating other-than-temporary impairment losses, management considers (1) the intent to sell the securities and the more likely than not requirement that the Corporation will be required to sell the securities prior to recovery, (2) the length of time and the extent to which the fair value has been less than cost, and (3) the financial condition and near-term prospects of the issuer.  Gains and losses on the sale of securities are recorded on the trade date, using the specific identification method, and are included in non-interest income.

 

Investment in Federal Home Loan Bank of Cincinnati stock is classified as a restricted security, carried at cost, and evaluated for impairment.

 

Investment in certificates of deposit are carried at cost and evaluated for impairment annually or when circumstances change that may have a significant effect on fair value.

 

Loans Held for Sale

 

Loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate.  Estimated fair value is determined based on quoted market prices in the secondary market.  Any net unrealized losses are recognized through a valuation allowance by charges to income.  The Corporation had no unrealized losses at December 31, 2014 and 2013.

 

Loans

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are generally stated at its outstanding principal amount adjusted for charge-offs and the allowance for loan losses.  Interest is accrued as earned based upon the daily outstanding principal balance.  Loan origination fees and certain direct obligation costs are capitalized and recognized as an adjustment of the yield of the related loan.

 

The accrual of interest on mortgage and commercial loans is generally discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection.  Personal loans are typically charged-off no later than when they become 150 days past due.  Past due status is based on contractual terms of the loan.  In all cases, loans are placed on non-accrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.

 

Loans, Continued

 

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

 

Allowance for Loan Losses

 

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

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions.  This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.  Due to potential changes in conditions, it is at least reasonably possible that changes in estimates will occur in the near term and that such changes could be material to the amounts reported in the Corporation’s consolidated financial statements.

 

The allowance consists of specific, general and unallocated components.  The specific component relates to impaired loans when the discounted cash flows, collateral value, or observable market price of the impaired loan is lower than the carrying value of that loan.  The general component covers classified loans (substandard or special mention) without specific reserves, as well as non-classified loans, and is based on historical loss experience adjusted for qualitative factors.  An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

 

A loan is considered impaired when, based on current information and events, it is probable that the Corporation will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement.  Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired.  Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.  Impairment is measured individually for commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

 

Allowance for Loan Losses, Continued

 

Under certain circumstances, the Corporation will provide borrowers relief through loan restructurings.  A restructuring of debt constitutes a troubled debt restructuring (TDR) if the Corporation, for economic or legal reasons related to the borrower’s financial difficulties, grants a concession to the borrower that it would not otherwise consider.  Restructured loans typically present an elevated level of credit risk as the borrowers are not able to perform according to the original contractual terms.  Loans that are reported as TDRs are considered impaired and measured for impairment as described above.  TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal or interest due, or acceptance of other assets in full or partial satisfaction of the debt.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment.  Accordingly, the Corporation does not separately identify individual consumer and residential loans for impairment disclosures.

 

Acquired Loans

 

Purchased loans acquired in a business combination are segregated into three types: pass rated loans with no discount attributable to credit quality, non-impaired loans with a discount attributable at least in part to credit quality and impaired loans with evidence of significant credit deterioration.

 

 

In accordance with ASC 310-30, for both purchased non-impaired loans and purchased impaired loans, the difference between contractually required payments at acquisition and the cash flows expected to be collected is referred to as the non-accretable difference. This amount is not recognized as a yield adjustment or as a loss accrual or a valuation allowance. Further, any excess of cash flows expected at acquisition over the estimated fair value is referred to as the accretable yield and is recognized into interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.

 

Increases in expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over its remaining estimated life. Decreases in expected cash flows are recognized immediately as impairment. If the Corporation does not have the information necessary to reasonably estimate cash flows to be expected, it may use the cost recovery method or cash basis method of income recognition. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition (meaning the present value of all cash flows expected at acquisition that ultimately are not to be received).

 

Other Real Estate Owned

 

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the lower of cost or fair value, less estimated cost to sell, at the date of foreclosure, establishing a new cost basis with loan balances in excess of fair value charged to the allowance for loan losses.  Subsequent to foreclosure, valuations are periodically performed and the assets are carried at the lower of carrying amount or fair value less cost to sell.  Revenue and expenses from operations and subsequent valuation adjustments are included in other operating expenses.    

 

Loan Sales and Servicing

 

Certain mortgage loans are sold with mortgage servicing rights retained or released by the Corporation.  The value of mortgage loans sold with servicing rights retained is reduced by the cost allocated to the associated mortgage servicing rights.  Gains or losses on sales of mortgage loans are recognized based on the difference between the selling price and the carrying value of the related mortgage loans sold.  The Corporation generally estimates fair value for servicing rights based on the present value of future expected cash flows, using management’s best estimates of the key assumptions – credit losses, prepayment speeds, servicing costs, earnings rate, and discount rates commensurate with the risks involved.

 

Capitalized servicing rights are reported at fair value and changes in fair value are reported in net income for the period the change occurs.

 

Servicing fee income is recorded for servicing loans, based on a contractual percentage of the outstanding principal, and is reported as other operating income.  Amortization of mortgage servicing rights is charged against loan servicing fee income.

 

Premises and Equipment

 

Premises and equipment is stated at cost, less accumulated depreciation.  Upon the sale or disposition of the assets, the difference between the depreciated cost and proceeds is charged or credited to income.  Depreciation is determined based on the estimated useful lives of the individual assets (typically 20 to 40 years for buildings and 3 to 10 years for equipment) and is computed primarily using the straight-line method.

 

Premises and equipment is reviewed for impairment when events indicate the carrying amount may not be recoverable from future undiscounted cash flows.  If impaired, premises and equipment is recorded at fair value and any corresponding write-downs are charged against current year earnings.

 

Off-Balance Sheet Credit Related Financial Instruments

 

In the ordinary course of business, the Corporation has entered into commitments to extend credit, including commitments under commercial letters of credit, and standby letters of credit.  Such financial instruments are recorded when they are funded.  The Corporation maintains a separate allowance for off-balance sheet commitments.  Management estimates anticipated losses using historical data and utilization assumptions.  The allowance for off-balance sheet commitments is included in other liabilities.

 

Goodwill and Core Deposit Intangible Assets

Goodwill arising from branch acquisitions is not amortized, but is subject to an annual impairment test to determine if an impairment loss has occurred.  Significant judgment is applied when goodwill is assessed for impairment.  This judgment includes developing cash flow projections, selecting appropriate discount rates, identifying relevant market comparables, incorporating general economic and market conditions, and selecting an appropriate control premium.  At December 31, 2014, the Corporation believes the Bank does not have any indicators of potential impairment based on the estimated fair value of this reporting unit. 

 

The core deposit intangible asset resulting from the Findlay branch acquisition was determined to have a definite life and is being amortized on a straight-line basis over seven years through March 2017.  Future amortization of the core deposit intangible asset is $40,857 annually for years 2015 through 2016 and $10,215 in 2017.  The core deposit intangible asset resulting from The Ohio State Bank acquisition was also determined to have a definite life and is being amortized on a straight-line basis over ten years through October 2024.  Future amortization of the core deposit intangible asset is $96,470 annually for years 2015 through 2023 and $80,388 in 2024.

 

Supplemental Retirement Benefits

Annual provisions are made for the estimated liability for accumulated supplemental retirement benefits under agreements with certain officers and directors.  These provisions are determined based on the terms of the agreements, as well as certain assumptions, including estimated service periods and discount rates.

 

Advertising Costs

All advertising costs are expensed as incurred. 

 

Income Taxes

Deferred income taxes are provided on temporary differences between financial statement and income tax reporting.  Temporary differences are differences between the amounts of assets and liabilities reported for financial statement purposes and its tax bases.  Deferred tax assets are recognized for temporary differences that will be deductible in future years’ tax returns and for operating loss and tax credit carryforwards.  Deferred tax assets are reduced by a valuation allowance if it is deemed more likely than not that some or all of the deferred tax assets will not be realized.  Deferred tax liabilities are recognized for temporary differences that will be taxable in future years’ tax returns.

 

Income Taxes, Continued

 

Benefits from tax positions taken or expected to be taken in a tax return are not recognized if the likelihood that the tax position would be sustained upon examination by a taxing authority is considered to be 50% or less.  The Corporation has adopted the policy of classifying any interest and penalties resulting from the filing of its income tax returns in the provision for income taxes.

 

The Corporation is not currently subject to state or local income taxes.

 

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered.  Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Corporation, (2) 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 (3) the Corporation does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

 

The transfer of a participating interest in an entire financial asset must also meet the definition of a participating interest.  A participating interest in a financial asset has all of the following characteristics:  (1) from the date of transfer, it must represent a proportionate (pro rata) ownership interest in the financial asset, (2) from the date of transfer, all cash flows received, except any cash flows allocated as any compensation for servicing or other services performed, must be divided proportionately among participating interest holders in the amount equal to their share ownership, (3) the rights of each participating interest holder must have the same priority, (4) no party has the right to pledge or exchange the entire financial asset unless all participating interest holders agree to do so.

 

Comprehensive Income

 

Recognized revenue, expenses, gains and losses are included in net income.  Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the consolidated balance sheet, such items, along with net income, are components of comprehensive income.

 

Per Share Data

 

Basic net income per share is computed based on the weighted average number of shares of common stock outstanding during each year.  Diluted net income per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued. 

 

The weighted average number of shares used for the years ended December 31, 2014, 2013 and 2012:

 

 

Dividends per share are based on the number of shares outstanding at the declaration date.

 

Rate Lock Commitments

 

Loan commitments related to the origination or acquisition of mortgage loans that will be held for sale are accounted for as derivative instruments.  The Corporation enters into commitments to originate loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments).  Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives.  Accordingly, such commitments, along with any related fees received from potential borrowers, are to be recorded at fair value as derivative assets or liabilities, with changes in fair value recorded in the net gain or loss on sale of mortgage loans.  Fair value is based on fees currently charged to enter into similar agreements, and for fixed-rate commitments also considers the difference between current levels of interest rates and the committed rates.  At December 31, 2014 and 2013, derivative assets and liabilities relating to rate lock commitments were not material to the consolidated financial statements.

 

Fair Values of Financial Instruments

 

Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully discussed in Note 18.  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. 

Subsequent Events

 

Management evaluated subsequent events through the date the consolidated financial statements were issued.  Events or transactions occurring after December 31, 2014, but prior to when the consolidated financial statements were issued, that provided additional evidence about conditions that existed at December 31, 2014, have been recognized in the financial statements for the year ended December 31, 2014.  Events or transactions that provided evidence about conditions that did not exist at December 31, 2014 but arose before the financial statements were issued, have not been recognized in the consolidated financial statements for the year ended December 31, 2014.

 

On January 22, 2015, United Bancshares, Inc. issued a release announcing that its Board of Directors approved a cash dividend of $0.09 per common share payable March 16, 2015 to shareholders of record at the close of business on February 27, 2015.

 

Reclassifications

 

Certain reclassifications of prior period amounts have been made to conform to the current presentation

NOTE 2 - NEW ACCOUNTING PRONOUNCEMENTS

 

In July 2013, the FASB issued ASU 2013-11, Income Taxes, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.  The FASB issued ASU 2013-11 to eliminate the diversity in the presentation of unrecognized tax benefits in those instances.  The amendments in this update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013.  The Corporation has determined the provisions for ASU 2013-11 did not have a material impact on the financial statements.

 

In January 2014, the FASB issued ASU 2014-04, Receivables – Troubled Debt Restructurings by Creditors.  The FASB issued ASU 2014-04 to reduce diversity by clarifying when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real property recognized.  The amendments in this update are effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2014.  The Corporation has determined the provisions for ASU 2014-04 will not have a material impact on future financial statements. 

 

In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures, amending ASC topic 860.  The FASB issued ASU 2014-11 to change the accounting for repurchase-to-maturity transactions and linked repurchase financials to secure borrowing accounting, which is consistent with the accounting for other repurchase agreements.  The amendments also require two new disclosures.  The first disclosure requires an entity to disclose information on transfers accounted for as sales in transactions that are economically similar to repurchase agreements.  The second disclosure provides increased transparency about the types of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings.  The amendments in this update are effective for the first interim or annual period beginning after December 15, 2014, and the Corporation has determined the provisions for ASU 2014-11 will not have a material impact on future financial statements

 

In August 2014, the FASB issued ASU 2014-14, Receivables – Troubled Debt Restructurings by Creditors.  The FASB issued ASU 2014-14 to reduce the diversity of how creditors classify government-guaranteed mortgage loans, including FHA or VA guaranteed loans, upon foreclosure.  The amendments in this update require that a mortgage loan be derecognized and that a separate other receivable be recognized upon foreclosure if the following conditions are met:  1) The loan has a government guarantee that is not separable from the loan before foreclosure.; 2) At the time of foreclosure, the creditor has the intent to convey the real estate property to the guarantor and make a claim on the guarantee, and the creditor has the ability to recover under that claim.; and 3)  At the time of foreclosure, any amount of the claim that is determined on the basis of the fair value of the real estate is fixed.  The amendments in this update are effective for annual periods, and interim periods within those periods, beginning after December 15, 2014.  The Corporation has determined the provisions for ASU 2014-04 will not have a material impact on future financial statements. 

 

In November 2014, the FASB issued ASU 2014-17, Business Combinations – Pushdown Accounting.  The FASB issued ASU 2014-17 to provide guidance on whether and at what threshold an acquired entity that is a business or nonprofit activity can apply pushdown accounting in its separate financial statements.  The amendments in this update provide an acquired entity with an option to apply pushdown accounting in its separate financial statements upon occurrence of an event in which an acquirer obtains control of the acquired entity.  The amendments in this update were effective on November 18, 2014.  The Corporation has determined the provisions for ASU 2014-17 did not have a material impact on the financial statements.

NOTE 3 – ACQUISITION

 

On July 1, 2014, the Corporation, Ohio State Bancshares, Inc. (“OSB”) and Rbancshares, Inc. (“Rbancshares”) entered into a Stock Purchase Agreement (the “Purchase Agreement”) pursuant to which the Corporation purchased from OSB all of the issued and outstanding shares of The Ohio State Bank (“The Ohio State Bank”), an Ohio banking corporation and wholly-owned subsidiary of OSB (the “Acquisition”). Immediately following the acquisition, The Ohio State Bank was merged into the Bank.  The Ohio State Bank operated three full-service branches with a main office and one other facility in Marion, Ohio and one branch in Delaware, Ohio.  These offices became branches of the Bank after the acquisition.  The transaction was completed in November, 2014 with assets acquired and deposits assumed being recorded at their estimated fair values as follows:

 

 

Consideration paid for the transaction was $1,197,237, which included the repayment of debt of $1,190,856 that was owed by The Ohio State Bank.  Cash acquired at closing is presented above net of the repayment of debt that occurred at closing.  Acquisition-related costs of approximately $935,000 are included in other non-interest operating expenses in the accompanying 2014 consolidated statements of income.  This acquisition is intended to expand the geographical footprint of the Corporation, which will help grow the balance sheet and future earnings.

 

Cash proceeds from the acquisition were used to repay the Federal Home Loan Bank borrowings that were assumed in the acquisition.

 

Goodwill of $1,517,420 arising from the acquisition consists largely of synergies and the cost savings expected to result from the combining of operations and is not expected to be deductible for income tax purposes.

NOTE 4 – SECURITIES

 

The amortized cost and fair value of securities as of December 31, 2014 and 2013 are as follows:

 

A summary of unrealized gains and losses on securities at December 31, 2014 and 2013 follows:

 

 

The amortized cost and fair value of securities at December 31, 2014, by contractual maturity, are shown below.  Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

Securities with a carrying value of approximately $20,168,000 at December 31, 2014 and $34,271,000 at December 31, 2013 were pledged to secure public deposits and for other purposes as required or permitted by law.

 

The following table presents gross unrealized losses and fair value of debt securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at December 31, 2014 and 2013:

 

 

 

 

 

There were 100 securities in an unrealized loss position at December 31, 2014, 75 of which were in a continuous unrealized loss position for 12 months or more.  Management has considered industry analyst reports, whether downgrades by bond rating agencies have occurred, sector credit reports, issuer’s financial condition and prospects, the Corporation’s ability and intent to hold securities to maturity, and volatility in the bond market, in concluding that the unrealized losses as of December 31, 2014 were primarily the result of customary and expected fluctuations in the bond market.  As a result, all security impairments as of December 31, 2014 are considered to be temporary.

 

Gross realized gains from sale of securities, including securities calls, amounted to $412,812 in 2014, $134,848 in 2013, and $293,226 in 2012, with the income tax provision applicable to such gains amounting to $140,356 in 2014, $45,848 in 2013, and $99,697 in 2012.  Gross realized losses from sale of securities amounted to $13,052 in 2014, $671 in 2013, and $25,713 in 2012 with related income tax effect of $4,438 in 2014, $228 in 2013, and $8,742 in 2012.

NOTE 5 - LOANS

 

Loans at December 31, 2014 and 2013 consist of the following:

 

 

Fixed rate loans approximated $65,287,000 at December 31, 2014 and $48,206,000 at December 31, 2013.  Certain commercial and agricultural loans are secured by real estate.

 

Most of the Corporation’s lending activities are with customers located in Northwestern and West Central Ohio.  As of December 31, 2014 and 2013, the Corporation’s loans from borrowers in the agriculture industry represent the single largest industry and amounted to $39,781,326 and $38,343,403, respectively.  Agriculture loans are generally secured by property and equipment.  Repayment is primarily expected from cash flow generated through the harvest and sale of crops or milk production for dairy products.  Agriculture customers are subject to various risks and uncertainties which can adversely impact the cash flow generated from their operations, including weather conditions; milk production; health and stability of livestock; costs of key operating items such as fertilizer, fuel, seed, or animal feed; and market prices for crops, milk, and livestock.  Credit evaluation of agricultural lending is based on an evaluation of cash flow coverage of principal and interest payments and the adequacy of collateral received.

 

The Corporation originates 1-4 family real estate and consumer loans utilizing credit reports to supplement the underwriting process. The Corporation’s underwriting standards for 1-4 family loans are generally in accordance with the Federal Home Loan Mortgage Corporation (FHLMC) manual underwriting guidelines.  Properties securing 1-4 family real estate loans are appraised by fee appraisers, which is independent of the loan origination function and has been approved by the Board of Directors and the Loan Policy Committee.  The loan-to-value ratios normally do not exceed 80% without credit enhancements such as mortgage insurance.  The Corporation will lend up to 100% of the lesser of the appraised value or purchase price for conventional 1-4 family real estate loans, provided private mortgage insurance is obtained. The underwriting standards for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of their ability to meet existing obligations and payments on the proposed loan.  To monitor and manage loan risk, policies and procedures are developed and modified, as needed by management. This activity, coupled with smaller loan amounts that are spread across many individual borrowers, minimizes risk. Additionally, market conditions are reviewed by management on a regular basis.  The Corporation’s 1-4 family real estate loans are secured primarily by properties located in its primary market area.

 

Commercial and agricultural real estate loans are subject to underwriting standards and processes similar to commercial and agricultural operating loans, in addition to those unique to real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial and agricultural real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan.  Loan to value is generally 75% of the cost or appraised value of the assets.  Appraisals on properties securing these loans are performed by fee appraisers approved by the Board of Directors.  Because payments on commercial and agricultural real estate loans are often dependent on the successful operation or management of the properties, repayment of such loans may be subject to adverse conditions in the real estate market or the economy.  Management monitors and evaluates commercial and agricultural real estate loans based on collateral and risk rating criteria. The Corporation may require guarantees on these loans.  The Corporation’s commercial and agricultural real estate loans are secured primarily by properties located in its primary market area.

 

Commercial and agricultural operating loans are underwritten based on the Corporation’s examination of current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed.  This underwriting includes the evaluation of cash flows of the borrower, underlying collateral, if applicable and the borrower’s ability to manage its business activities. The cash flows of borrowers and the collateral securing these loans may fluctuate in value after the initial evaluation. A first priority lien on the general assets of the business normally secures these types of loans. Loan to value limits vary and are dependent upon the nature and type of the underlying collateral and the financial strength of the borrower. Crop and/or hail insurance may be required for agricultural borrowers.  Loans are generally guaranteed by the principal(s). The Corporation’s commercial and agricultural operating lending is primarily in its primary market area.

 

The Corporation maintains an internal audit department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management and the audit committee. The internal audit process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Corporation’s policies and procedures.

 

 

 

The following tables present the activity in the allowance for loan losses by portfolio segment for the years ended December 31, 2014, 2013 and 2012:

 

 

 

 

 

 

 

 

The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on impairment method as of December 31, 2014 and 2013:

 

 

 

 

 

 

The following is a summary of the activity in the allowance for loan losses of impaired loans, which is a part of the Corporation’s overall allowance for loan losses for the years ended December 31, 2014, 2013, and 2012:

 

 

 

No additional funds are committed to be advanced in connection with impaired loans.

 

The average balance of impaired loans (excluding loans acquired with deteriorated credit quality) approximated $3,851,000,  $9,761,000, and $17,188,000, during 2014, 2013, and 2012, respectively.  There was approximately $197,000,  $203,000, and $214,000 in interest income recognized by the Corporation on impaired loans on an accrual or cash basis during 2014, 2013, and 2012, respectively.

 

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2014 and 2013:

 

 

The following table presents the recorded investment in nonaccrual loans, loans past due over 90 days still on accrual and troubled debt restructurings by class of loans as of December 31, 2014 and 2013:

 

 

The nonaccrual balances in the table above include troubled debt restructurings that have been classified as nonaccrual.

 

The following table presents the aging of the recorded investment in past due loans as of December 31, 2014 and 2013 by class of loans:

 

 

 

 

 

Credit Quality Indicators:

 

The Corporation 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, among other factors.  The Corporation analyzes loans individually by classifying the loans as to the credit risk.  This analysis generally includes loans with an outstanding balance greater than $250,000 and non-homogenous loans, such as commercial and commercial real estate loans.  This analysis is performed on a quarterly basis.  The Corporation uses the following definitions for risk ratings:

 

 

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.  Loans listed as not rated are generally either less than $250,000 or are included in groups of homogenous loans. As of December 31, 2014 and 2013, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

 

 

 

 

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan losses.  For residential 1 – 4 family and consumer loan classes that are not rated, the Corporation also evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity.  Generally, consumer and residential 1-4 family loans not rated that are 90 days past due or are classified as nonaccrual and collectively evaluated for impairment, are considered nonperforming.  The following table presents the recorded investment in residential 1 – 4 family and consumer loans that are not risk rated, based on payment activity as of December 31, 2014 and 2013:

 

 

Modifications:

 

The Corporation’s loan portfolio also includes certain loans that have been modified in a TDR, where economic concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties.  These concessions typically result from the Corporation’s loss mitigation activities and could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.  All TDRs are also classified as impaired loans.

 

When the Corporation modifies a loan, management evaluates any possible concession based on the present value of expected future cash flows, discounted at the contractual interest rate of the original loan agreement, except when the sole (remaining) source of repayment for the loan is the operation or liquidation of the collateral.  In these cases, management uses the current fair value of the collateral, less selling costs, instead of discounted cash flows.  If management determines that the value of the modified loan is less than the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount), an impairment is recognized through a specific reserve in the allowance or a direct write down of the loan balance if collection is not expected.

 

The following table includes the recorded investment and number of modifications for TDR loans during the year ended December 31, 2014 and December 31, 2013

 

In 2014, the concession granted which resulted in the TDR was the Bank agreed to extend an interest only period to the borrower.  In 2013, one borrower was given a below-market interest rate, and the other was granted an interest only period.  In 2013, there was no allowance allocated due to the difference between the recorded investment and present value of future cash flows not being significant.

 

The following is additional information with respect to loans acquired with The Ohio State Bank acquisition:

 

 

 

There was not a significant change in the amount of accretable yield at the beginning and end of the period since the date of the acquisition and end of the period were so close.

 

As a result of The Ohio State Bank acquisition, the Corporation has loans, for which there was at acquisition, evidence of deterioration of credit quality since origination and for which it was probable at acquisition, that all contractually required payments would not be collected.  The carrying amount of those loans as of November 14, 2014 and December 31, 2014 was $958,744 and $870,037, respectively.

 

No provision for loan losses was recognized during the year ended December 31, 2014 related to the acquired loans as there was no significant change to the valuation of loans acquired from November 14, 2014 to December 31, 2014.

 

Certain directors and executive officers, including their immediate families and companies in which they are principal owners, are loan customers of the Corporation.  Such loans are made in the ordinary course of business in accordance with the normal lending policies of the Corporation, including the interest rate charged and collateralization.  Such loans amounted to $34,391,  $45,480, and $989,194 at December 31, 2014, 2013, and 2012, respectively.  The following is a summary of activity during 2014, 2013, and 2012 for such loans:

 

 

Additions and repayments include loan renewals, as well as net borrowings and repayments under revolving lines-of-credit.