Edgar Filing: Community Bankers Trust Corp

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

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

For the quarterly period ended March 31, 2018

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

For the transition period from to

Commission File Number: 001-32590

COMMUNITY BANKERS TRUST CORPORATION

(Exact name of registrant as specified in its charter)

Virginia	20-2652949
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

9954 Mayland Drive, Suite 2100
Richmond, Virginia	23233
(Address of principal executive offices)	(Zip Code)

(804) 934-9999 (Registrant’s telephone number, including area code)

n/a (Former name, former address and former fiscal year, if changed since last report)

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

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 the definitions of “large accelerated filer”, “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer	¨		Accelerated filer	þ

Non-accelerated filer	¨	(Do not check if a smaller reporting company)	Smaller reporting company	¨

			Emerging growth company	¨

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

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

At March 31, 2018, there were 22,084,193 shares of the Company’s common stock outstanding.

COMMUNITY BANKERS TRUST CORPORATION

TABLE OF CONTENTS

FORM 10-Q

March 31, 2018

PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Unaudited Consolidated Balance Sheets	3
Unaudited Consolidated Statements of Income	4
Unaudited Consolidated Statements of Comprehensive Income	5
Unaudited Consolidated Statements of Changes in Shareholders’ Equity	6
Unaudited Consolidated Statements of Cash Flows	7
Notes to Unaudited Consolidated Financial Statements	8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3. Quantitative and Qualitative Disclosures About Market Risk	40
Item 4. Controls and Procedures	41
PART II — OTHER INFORMATION
Item 1. Legal Proceedings	41
Item 1A. Risk Factors	42
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	42
Item 3. Defaults upon Senior Securities	42
Item 4. Mine Safety Disclosures	42
Item 5. Other Information	42
Item 6. Exhibits	42
SIGNATURES	43

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

COMMUNITY BANKERS TRUST CORPORATION

UNAUDITED CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2018 AND DECEMBER 31, 2017

(dollars in thousands, except per share data)

	March 31, 2018			December 31, 2017 *
ASSETS
Cash and due from banks	$	12,013		$	14,642
Interest bearing bank deposits		9,141			7,316
Federal funds sold		152			—
Total cash and cash equivalents		21,306			21,958

Securities available for sale, at fair value		202,165			204,834
Securities held to maturity, at cost (fair value of $44,578 and $46,888, respectively)		44,534			46,146
Equity securities, restricted, at cost		9,356			9,295
Total securities		256,055			260,275

Loans		964,311			942,018
Purchased credit impaired (PCI) loans		42,215			44,333
Total loans		1,006,526			986,351
Allowance for loan losses (loans of $8,968 and $8,969, respectively; PCI loans of $200 and $200, respectively)		(9,168	)		(9,169	)
Net loans		997,358			977,182

Bank premises and equipment, net		29,761			30,198
Bank premises and equipment held for sale		525			—
Other real estate owned		3,166			2,791
Bank owned life insurance		28,282			28,099
Other assets		16,779			15,687
Total assets	$	1,353,232		$	1,336,190

LIABILITIES
Deposits:
Noninterest bearing	$	150,037		$	153,028
Interest bearing		946,283			942,736
Total deposits		1,096,320			1,095,764

Federal funds purchased		20,000			4,849
Federal Home Loan Bank borrowings		101,061			101,429
Trust preferred capital notes		4,124			4,124
Other liabilities		6,683			6,021
Total liabilities		1,228,188			1,212,187

SHAREHOLDERS’ EQUITY
Common stock (200,000,000 shares authorized, $0.01 par value; 22,084,193 and 22,072,523 shares issued and outstanding, respectively)		221			221
Additional paid in capital		147,935			147,671
Retained deficit		(21,338	)		(23,932	)
Accumulated other comprehensive (loss) income		(1,774	)		43
Total shareholders’ equity		125,044			124,003
Total liabilities and shareholders’ equity	$	1,353,232		$	1,336,190

* Derived from audited financial statements

See accompanying notes to unaudited consolidated financial statements

COMMUNITY BANKERS TRUST CORPORATION

UNAUDITED CONSOLIDATED STATEMENTS OF INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2018 AND 2017

(dollars and shares in thousands, except per share data)

	Three months ended
	March 31, 2018		March 31, 2017
Interest and dividend income
Interest and fees on loans	$	10,876	$	9,597
Interest and fees on PCI loans		1,398		1,479
Interest on deposits in other banks		40		26
Interest and dividends on securities
Taxable		1,186		1,249
Nontaxable		579		597
Total interest and dividend income		14,079		12,948
Interest expense
Interest on deposits		2,143		1,779
Interest on borrowed funds		469		302
Total interest expense		2,612		2,081
Net interest income		11,467		10,867
Provision for loan losses		—		—
Net interest income after provision for loan losses		11,467		10,867
Noninterest income
Service charges and fees		581		525
Gain on securities transactions, net		30		95
Income on bank owned life insurance		232		234
Mortgage loan income		111		33
Other		128		148
Total noninterest income		1,082		1,035
Noninterest expense
Salaries and employee benefits		5,898		4,682
Occupancy expenses		812		732
Equipment expenses		314		284
FDIC assessment		206		201
Data processing fees		486		488
Amortization of intangibles		—		477
Other real estate expense, net		50		27
Other operating expenses		1,649		1,442
Total noninterest expense		9,415		8,333
Income before income taxes		3,134		3,569
Income tax expense		540		1,076
Net income	$	2,594	$	2,493
Net income per share — basic	$	0.12	$	0.11
Net income per share — diluted	$	0.12	$	0.11
Weighted average number of shares outstanding
Basic		22,076		21,962
Diluted		22,521		22,433

See accompanying notes to unaudited consolidated financial statements

COMMUNITY BANKERS TRUST CORPORATION

UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2018 AND 2017

(dollars in thousands)

	Three months ended
	March 31, 2018			March 31, 2017
Net income	$	2,594		$	2,493

Other comprehensive (loss) income:
Unrealized (loss) gain on investment securities:
Change in unrealized (loss) gain in investment securities		(2,488	)		770
Tax related to unrealized loss (gain) in investment securities		548			(262	)
Reclassification adjustment for gain in securities sold		(30	)		(95	)
Tax related to realized gain in securities sold		7			32
Cash flow hedge:
Change in unrealized gain in cash flow hedge		186			82
Tax related to cash flow hedge		(40	)		(28	)
Total other comprehensive (loss) income		(1,817	)		499
Total comprehensive income	$	777		$	2,992

See accompanying notes to unaudited consolidated financial statements

COMMUNITY BANKERS TRUST CORPORATION

UNAUDITED CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2018 AND 2017

(dollars and shares in thousands)

										Accumulated
					Additional					Other
	Common Stock				Paid in		Retained			Comprehensive
	Shares		Amount		Capital		Deficit			(Loss) Income			Total

Balance January 1, 2017		21,960	$	220	$	146,667	$	(31,128	)	$	(1,223	)	$	114,536
Issuance of common stock		11		—		39		—			—			39
Exercise and issuance of employee stock options		—		—		146		—			—			146
Net income		—		—		—		2,493			—			2,493
Other comprehensive income		—		—		—		—			499			499
Balance March 31, 2017		21,971	$	220	$	146,852	$	(28,635	)	$	(724	)	$	117,713
Balance January 1, 2018		22,073	$	221	$	147,671	$	(23,932	)	$	43		$	124,003
Issuance of common stock		4		—		39		—			—			39
Exercise and issuance of employee stock options		7		—		225		—			—			225
Net income		—		—		—		2,594			—			2,594
Other comprehensive loss		—		—		—		—			(1,817	)		(1,817	)
Balance March 31, 2018		22,084	$	221	$	147,935	$	(21,338	)	$	(1,774	)	$	125,044

See accompanying notes to unaudited consolidated financial statements

COMMUNITY BANKERS TRUST CORPORATION

UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2018 AND 2017

(dollars in thousands)

	March 31, 2018			March 31, 2017
Operating activities:
Net income	$	2,594		$	2,493
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and intangibles amortization		459			877
Stock-based compensation expense		234			185
Tax benefit of exercised stock options		(10	)		—
Amortization of purchased loan premium		54			45
Amortization of security premiums and accretion of discounts, net		443			359
Net gain on sale of securities		(30	)		(95	)
Net gain on sale and valuation of other real estate owned		—			(14	)
Originations of mortgages held for sale		(872	)		—
Proceeds from sales of mortgages held for sale		872			—
Increase in bank owned life insurance investment		(184	)		(192	)
Changes in assets and liabilities:
Increase in other assets		(182	)		(226	)
Increase in accrued expenses and other liabilities		673			1,000
Net cash provided by operating activities		4,051			4,432

Investing activities:
Proceeds from sales/calls/maturities/paydowns of available for sale securities		9,363			23,816
Proceeds from calls/maturities/paydowns of held to maturity securities		1,584			89
Proceeds from sales of restricted equity securities		17			813
Purchase of available for sale securities		(9,596	)		(20,981	)
Purchase of restricted equity securities		(78	)		(700	)
Proceeds from sale of other real estate owned		21			872
Net increase in loans		(20,708	)		(13,832	)
Principal recoveries of loans previously charged off		83			105
Purchase of premises and equipment, net		(548	)		(631	)
Purchase of small business investment company fund investment		(210	)		—
Net cash used in investing activities		(20,072	)		(10,449	)

Financing activities:
Net increase in deposits		556			15,378
Net increase (decrease) in federal funds purchased		15,151			(4,714	)
Net increase in short-term Federal Home Loan Bank borrowings		5,000			—
Payments on long-term Federal Home Loan Bank borrowings		(5,368	)		(195	)
Proceeds from issuance of common stock		30			—
Payments on long-term debt		—			(1,670	)
Net cash provided by financing activities		15,369			8,799

Net (decrease) increase in cash and cash equivalents		(652	)		2,782

Cash and cash equivalents:
Beginning of the period		21,958			21,072
End of the period	$	21,306		$	23,854

Supplemental disclosures of cash flow information:
Interest paid	$	2,638		$	2,141
Transfers of loans to other real estate owned		396			—
Transfers of building premises and equipment to held for sale		525			—

See accompanying notes to unaudited consolidated financial statements

COMMUNITY BANKERS TRUST CORPORATION

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Banking Activities and Significant Accounting Policies

Organization

Community Bankers Trust Corporation (the “Company”) is headquartered in Richmond, Virginia and is the holding company for Essex Bank (the “Bank”), a Virginia state bank with 26 full-service offices in Virginia and Maryland. The Bank also operates one loan production office in Virginia.

The Bank engages in a general commercial banking business and provides a wide range of financial services primarily to individuals and small businesses, including individual and commercial demand and time deposit accounts, commercial and industrial loans, consumer and small business loans, real estate and mortgage loans, investment services, on-line and mobile banking products, and safe deposit box facilities.

Financial Statements

The consolidated statements presented include accounts of the Company and the Bank, its wholly-owned subsidiary. All material intercompany balances and transactions have been eliminated. The statements should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The accounting and reporting policies of the Company conform to U.S. generally accepted accounting principles (GAAP) and to the general practices within the banking industry. The interim financial statements have not been audited; however, in the opinion of management, all adjustments, consisting of normal accruals, were made that are necessary to present fairly the balance sheet of the Company as of March 31, 2018, the statements of income and comprehensive income for the three months ended March 31, 2018, and the statements of changes in shareholders’ equity and cash flows for the three months ended March 31, 2018. Results for the three month period ended March 31, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018.

The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when either earning income, recognizing an expense, recovering an asset or relieving a liability. The Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that the Company uses. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the Company’s transactions would be the same, the timing of events that would impact its transactions could change.

In preparing these financial statements, the Company has evaluated subsequent events and transactions for potential recognition or disclosure through the date the financial statements were issued.

Certain reclassifications have been made to prior period balances to conform to the current year presentations. Such reclassifications had no impact on net income or shareholder’s equity.

Note 2. Securities

Amortized costs and fair values of securities available for sale and held to maturity at March 31, 2018 and December 31, 2017 were as follows (dollars in thousands):

	March 31, 2018
			Gross Unrealized
	Amortized Cost		Gains		Losses			Fair Value
Securities Available for Sale
U.S. Treasury issue and other U.S. Gov’t agencies	$	37,978	$	149	$	(526	)	$	37,601
U.S. Gov’t sponsored agencies		9,168		81		(22	)		9,227
State, county and municipal		123,949		1,079		(1,454	)		123,574
Corporate and other bonds		7,702		164		(52	)		7,814
Mortgage backed – U.S. Gov’t agencies		5,456		20		(204	)		5,272
Mortgage backed – U.S. Gov’t sponsored agencies		19,207		26		(556	)		18,677
Total Securities Available for Sale	$	203,460	$	1,519	$	(2,814	)	$	202,165

Securities Held to Maturity
U.S. Treasury issue and other U.S. Gov’t agencies	$	10,000	$	—	$	(255	)	$	9,745
State, county and municipal		34,111		415		(121	)		34,405
Mortgage backed – U.S. Gov’t agencies		423		5		—			428
Total Securities Held to Maturity	$	44,534	$	420	$	(376	)	$	44,578

	December 31, 2017
			Gross Unrealized
	Amortized Cost		Gains		Losses			Fair Value
Securities Available for Sale
U.S. Treasury issue and other U.S. Gov’t agencies	$	40,473	$	165	$	(382	)	$	40,256
U.S. Gov’t sponsored agencies		9,247		55		(24	)		9,278
State, county and municipal		124,032		2,324		(596	)		125,760
Corporate and other bonds		7,323		173		(36	)		7,460
Mortgage backed – U.S. Gov’t agencies		5,551		37		(146	)		5,442
Mortgage backed – U.S. Gov’t sponsored agencies		16,985		26		(373	)		16,638
Total Securities Available for Sale	$	203,611	$	2,780	$	(1,557	)	$	204,834

Securities Held to Maturity
U.S. Treasury issue and other U.S. Gov’t agencies	$	10,000	$	—	$	(155	)	$	9,845
State, county and municipal		35,678		922		(33	)		36,567
Mortgage backed – U.S. Gov’t agencies		468		8		—			476
Total Securities Held to Maturity	$	46,146	$	930	$	(188	)	$	46,888

The amortized cost and fair value of securities at March 31, 2018 by final contractual maturity are shown below. Expected maturities may differ from final contractual maturities because issuers may have the right to call or prepay obligations without any penalties.

	Held to Maturity				Available for Sale
(dollars in thousands)	Amortized Cost		Fair Value		Amortized Cost		Fair Value
Due in one year or less	$	13,662	$	13,426	$	5,321	$	5,292
Due after one year through five years		13,737		13,808		89,246		89,466
Due after five years through ten years		12,529		12,692		101,615		100,099
Due after ten years		4,606		4,652		7,278		7,308
Total securities	$	44,534	$	44,578	$	203,460	$	202,165

Proceeds from sales of securities available for sale were $7.0 million and $22.3 million during the three months ended March 31, 2018 and 2017, respectively. Gains and losses on the sale of securities are determined using the specific identification method. Gross realized gains and losses on sales of securities available for sale during the three months ended March 31, 2018 and 2017 were as follows (dollars in thousands):

	Three months ended
	March 31, 2018			March 31, 2017
Gross realized gains	$	42		$	130
Gross realized losses		(12	)		(35	)
Net securities gains	$	30		$	95

In estimating other than temporary impairment (OTTI) losses, management considers the length of time and the extent to which the fair value has been less than cost, the financial condition and short-term prospects for the issuer, and the intent and ability of management to hold its investment for a period of time to allow a recovery in fair value. There were no investments held that had OTTI losses for the three months ended March 31, 2018 and 2017.

The fair value and gross unrealized losses for securities, segregated by the length of time that individual securities have been in a continuous gross unrealized loss position, at March 31, 2018 and December 31, 2017 were as follows (dollars in thousands):

	March 31, 2018
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Securities Available for Sale
U.S. Treasury issue and other U.S. Gov’t agencies	$	7,555	$	(70	)	$	16,619	$	(456	)	$	24,174	$	(526	)
U.S. Gov’t sponsored agencies		-		-			2,969		(22	)		2,969		(22	)
State, county and municipal		42,017		(815	)		10,481		(639	)		52,498		(1,454	)
Corporate and other bonds		481		(16	)		2,681		(36	)		3,162		(52	)
Mortgage backed – U.S. Gov’t agencies		1,670		(42	)		1,836		(162	)		3,506		(204	)
Mortgage backed – U.S. Gov’t sponsored agencies		7,865		(238	)		7,790		(318	)		15,655		(556	)
Total	$	59,588	$	(1,181	)	$	42,376	$	(1,633	)	$	101,964	$	(2,814	)

Securities Held to Maturity
U.S. Treasury issue and other U.S. Gov’t agencies	$	-	$	-		$	9,745	$	(255	)	$	9,745	$	(255	)
State, county and municipal		6,118		(89	)		1,245		(32	)		7,363		(121	)
Total	$	6,118	$	(89	)	$	10,990	$	(287	)	$	17,108	$	(376	)

	December 31, 2017
	Less than 12 Months					12 Months or More					Total
	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
Securities Available for Sale
U.S. Treasury issue and other U.S. Gov’t agencies	$	5,097	$	(36	)	$	19,443	$	(346	)	$	24,540	$	(382	)
U.S. Gov’t sponsored agencies		497		(3	)		5,040		(21	)		5,537		(24	)
State, county and municipal		20,740		(188	)		9,569		(408	)		30,309		(596	)
Corporate and other bonds		-		-			2,772		(36	)		2,772		(36	)
Mortgage backed – U.S. Gov’t agencies		1,722		(25	)		1,876		(121	)		3,598		(146	)
Mortgage backed – U.S. Gov’t sponsored agencies		6,525		(111	)		7,985		(262	)		14,510		(373	)
Total	$	34,581	$	(363	)	$	46,685	$	(1,194	)	$	81,266	$	(1,557	)

Securities Held to Maturity
U.S. Treasury issue and other U.S. Gov’t agencies	$	-	$	-		$	9,845	$	(155	)	$	9,845	$	(155	)
State, county and municipal		1,485		(14	)		1,262		(19	)		2,747		(33	)
Total	$	1,485	$	(14	)	$	11,107	$	(174	)	$	12,592	$	(188	)

The unrealized losses (impairments) in the investment portfolio at March 31, 2018 and December 31, 2017 are generally a result of market fluctuations of interest rates that occur daily. The unrealized losses are from 176 securities at March 31, 2018. Of those, 169 are investment grade, have U.S. government agency guarantees, or are backed by the full faith and credit of local municipalities throughout the United States. Five investment grade asset-backed securities comprised of student loan pools included in corporate obligations and two corporate bonds make up the remaining securities with unrealized losses at March 31, 2018. The Company considers the reason for impairment, length of impairment, and ability and intent to hold until the full value is recovered in determining if the impairment is temporary in nature. Based on this analysis, the Company has determined these impairments to be temporary in nature. The Company does not intend to sell, and it is more likely than not that the Company will not be required to sell, these securities until they recover in value or reach maturity.

Market prices are affected by conditions beyond the control of the Company. Investment decisions are made by the management group of the Company and reflect the overall liquidity and strategic asset/liability objectives of the Company. Management analyzes the securities portfolio frequently and manages the portfolio to provide an overall positive impact to the Company’s income statement and balance sheet.

Securities with amortized costs of $68.6 million and $71.7 million at March 31, 2018 and December 31, 2017, respectively, were pledged to secure public deposits as required or permitted by law. Securities with amortized costs of $7.0 million and $7.0 million at March 31, 2018 and December 31, 2017, respectively, were pledged to secure lines of credit at the Federal Reserve discount window. At each of March 31, 2018 and December 31, 2017, there were no securities purchased from a single issuer, other than U.S. Treasury issue and other U.S. Government agencies that comprised more than 10% of the consolidated shareholders’ equity.

Note 3. Loans and Related Allowance for Loan Losses

The Company’s loans, net of deferred fees and costs, at March 31, 2018 and December 31, 2017 were comprised of the following (dollars in thousands):

	March 31, 2018					December 31, 2017
	Amount		% of Loans			Amount		% of Loans
Mortgage loans on real estate:
Residential 1-4 family	$	222,717		23.10	%	$	227,542		24.16	%
Commercial		371,494		38.52			366,331		38.89
Construction and land development		109,534		11.36			107,814		11.44
Second mortgages		7,689		0.80			8,410		0.89
Multifamily		59,920		6.21			59,024		6.27
Agriculture		7,424		0.77			7,483		0.79
Total real estate loans		778,778		80.76			776,604		82.44
Commercial loans		170,445		17.67			159,024		16.88
Consumer installment loans		13,878		1.44			5,169		0.55
All other loans		1,210		0.13			1,221		0.13
Total loans	$	964,311		100.00	%	$	942,018		100.00	%

The Company held $17.7 million and $18.0 million in balances of loans guaranteed by the United States Department of Agriculture (USDA), which are included in various categories in the table above, at March 31, 2018 and December 31, 2017, respectively. As these loans are 100% guaranteed by the USDA, no loan loss allowance is required. These loan balances included a purchase premium of $785,000 and $824,000 at March 31, 2018 and December 31, 2017, respectively. The purchase premium is amortized as an adjustment of the related loan yield on a straight line basis, which is substantially equivalent to the results obtained using the effective interest method.

At March 31, 2018 and December 31, 2017, the Company’s allowance for credit losses was comprised of the following: (i) a specific valuation component calculated in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 310, Receivables, (ii) a general valuation component calculated in accordance with FASB ASC 450, Contingencies, based on historical loan loss experience, current economic conditions and other qualitative risk factors, and (iii) an unallocated component to cover uncertainties that could affect management’s estimate of probable losses. Management identified loans subject to impairment in accordance with ASC 310.

The following table summarizes information related to impaired loans as of March 31, 2018 (dollars in thousands):

							Three months ended
	March 31, 2018						March 31, 2018
	Recorded Investment ⁽¹⁾		Unpaid Principal Balance ⁽²⁾		Related Allowance		Average Investment		Interest Recognized
With no related allowance recorded:
Mortgage loans on real estate:
Residential 1-4 family	$	1,873	$	2,235	$	—	$	1,888	$	7
Commercial		3,825		4,467		—		3,844		37
Construction and land development		417		417		—		208		—
Agriculture		—		—		—		—		—
Total real estate loans		6,115		7,119		—		5,940		44
Commercial loans		978		978		—		1,043		—
Subtotal impaired loans with no valuation allowance		7,093		8,097		—		6,983		44
With an allowance recorded:
Mortgage loans on real estate:
Residential 1-4 family		2,253		2,688		296		2,234		19
Commercial		518		955		64		525		2
Construction and land development		5,137		6,401		694		4,707		—
Agriculture		67		71		8		68		—
Total real estate loans		7,975		10,115		1,062		7,534		21
Commercial loans		250		251		31		287		1
Consumer installment loans		4		4		—		5		—
Subtotal impaired loans with a valuation allowance		8,229		10,370		1,093		7,826		22
Total:
Mortgage loans on real estate:
Residential 1-4 family		4,126		4,923		296		4,122		26
Commercial		4,343		5,422		64		4,369		39
Construction and land development		5,554		6,818		694		4,915		—
Agriculture		67		71		8		68		—
Total real estate loans		14,090		17,234		1,062		13,474		65
Commercial loans		1,228		1,229		31		1,330		1
Consumer installment loans		4		4		—		5		—
Total impaired loans	$	15,322	$	18,467	$	1,093	$	14,809	$	66

(1)

The amount of the investment in a loan, which is not net of a valuation allowance, but which does reflect any direct write-down of the investment

(2)

The contractual amount due, which reflects paydowns applied in accordance with loan documents, but which does not reflect any direct write-downs or valuation allowances

The following table summarizes information related to impaired loans as of December 31, 2017 and the three months ended March 31, 2017 (dollars in thousands):

							Three months ended
	December 31, 2017						March 31, 2017
	Recorded Investment ⁽¹⁾		Unpaid Principal Balance ⁽²⁾		Related Allowance		Average Investment		Interest Recognized
With no related allowance recorded:
Mortgage loans on real estate:
Residential 1-4 family	$	1,901	$	2,246	$	—	$	1,947	$	7
Commercial		3,862		4,477		—		5,363		38
Construction and land development		—		—		—		—		—
Agriculture		—		—		—		—		—
Total real estate loans		5,763		6,723		—		7,310		45
Commercial loans		1,108		1,108		—		600		—
Consumer installment loans		—		—		—		—		—
Subtotal impaired loans with no valuation allowance		6,871		7,831		—		7,910		45
With an allowance recorded:
Mortgage loans on real estate:
Residential 1-4 family		2,216		2,640		290		2,478		12
Commercial		533		958		65		506		2
Construction and land development		4,277		5,537		556		4,900		—
Agriculture		68		71		8		—		—
Total real estate loans		7,094		9,206		919		7,884		14
Commercial loans		325		446		39		168		1
Consumer installment loans		7		7		1		162		—
Subtotal impaired loans with a valuation allowance		7,426		9,659		959		8,214		15
Total:
Mortgage loans on real estate:
Residential 1-4 family		4,117		4,886		290		4,425		19
Commercial		4,395		5,435		65		5,869		40
Construction and land development		4,277		5,537		556		4,900		—
Agriculture		68		71		8		—		—
Total real estate loans		12,857		15,929		919		15,194		59
Commercial loans		1,433		1,554		39		768		1
Consumer installment loans		7		7		1		162		—
Total impaired loans	$	14,297	$	17,490	$	959	$	16,124	$	60

(1)

The amount of the investment in a loan, which is not net of a valuation allowance, but which does reflect any direct write-down of the investment

(2)

The contractual amount due, which reflects paydowns applied in accordance with loan documents, but which does not reflect any direct write-downs or valuation allowances

Troubled debt restructures still accruing interest are loans that management expects to ultimately collect all principal and interest due, but not under the terms of the original contract. A reconciliation of impaired loans to nonaccrual loans at March 31, 2018 and December 31, 2017, is set forth in the table below (dollars in thousands):

	March 31, 2018		December 31, 2017
Nonaccruals	$	10,090	$	9,026
Trouble debt restructure and still accruing		5,232		5,271
Total impaired	$	15,322	$	14,297

Interest income on nonaccrual loans, if recognized, is recorded using the cash basis method of accounting. There was an insignificant amount of cash basis income recognized during the three months ended March 31, 2018 and 2017. For the three months ended March 31, 2018 and 2017, estimated interest income of $160,000 and $163,000, respectively, would have been recorded if all such loans had been accruing interest according to their original contractual terms.

There were no loans greater than 90 days past due and still accruing interest at March 31, 2018 and December 31, 2017. The following tables present an age analysis of past due status of loans by category as of March 31, 2018 and December 31, 2017 (dollars in thousands):

	March 31, 2018
	30-89 Days Past Due		Nonaccrual		Total Past Due		Current		Total Loans Receivable
Mortgage loans on real estate:
Residential 1-4 family	$	1,075	$	1,985	$	3,060	$	219,657	$	222,717
Commercial		1,611		1,466		3,077		368,417		371,494
Construction and land development		62		5,554		5,616		103,918		109,534
Second mortgages		—		—		—		7,689		7,689
Multifamily		—		—		—		59,920		59,920
Agriculture		19		67		86		7,338		7,424
Total real estate loans		2,767		9,072		11,839		766,939		778,778
Commercial loans		98		1,014		1,112		169,333		170,445
Consumer installment loans		9		4		13		13,865		13,878
All other loans		—		—		—		1,210		1,210
Total loans	$	2,874	$	10,090	$	12,964	$	951,347	$	964,311

	December 31, 2017
	30-89 Days Past Due		Nonaccrual		Total Past Due		Current		Total Loans Receivable
Mortgage loans on real estate:
Residential 1-4 family	$	1,056	$	1,962	$	3,018	$	224,524	$	227,542
Commercial		104		1,498		1,602		364,729		366,331
Construction and land development		—		4,277		4,277		103,537		107,814
Second mortgages		—		—		—		8,410		8,410
Multifamily		—		—		—		59,024		59,024
Agriculture		19		68		87		7,396		7,483
Total real estate loans		1,179		7,805		8,984		767,620		776,604
Commercial loans		48		1,214		1,262		157,762		159,024
Consumer installment loans		12		7		19		5,150		5,169
All other loans		—		—		—		1,221		1,221
Total loans	$	1,239	$	9,026	$	10,265	$	931,753	$	942,018

Activity in the allowance for loan losses on loans by segment for the three months ended March 31, 2018 and 2017 is presented in the following tables (dollars in thousands):

	December 31, 2017		Provision Allocation			Charge-offs			Recoveries		March 31, 2018
Mortgage loans on real estate:
Residential 1-4 family	$	3,466	$	(366	)	$	—		$	15	$	3,115
Commercial		2,423		184			—			13		2,620
Construction and land development		1,247		364			—			1		1,612
Second mortgages		24		9			—			1		34
Multifamily		496		(298	)		—			—		198
Agriculture		14		19			—			—		33
Total real estate loans		7,670		(88	)		—			30		7,612
Commercial loans		1,139		(152	)		(39	)		14		962
Consumer installment loans		110		8			(45	)		39		112
All other loans		3		7			—			—		10
Unallocated		47		225			—			—		272
Total loans	$	8,969	$	—		$	(84	)	$	83	$	8,968

	December 31, 2016		Provision Allocation			Charge-offs			Recoveries		March 31, 2017
Mortgage loans on real estate:
Residential 1-4 family	$	2,769	$	62		$	(26	)	$	18	$	2,823
Commercial		1,952		(183	)		—			7		1,776
Construction and land development		2,195		(635	)		(14	)		1		1,547
Second mortgages		72		(69	)		—			47		50
Multifamily		260		(67	)		—			—		193
Agriculture		15		17			—			—		32
Total real estate loans		7,263		(875	)		(40	)		73		6,421
Commercial loans		602		712			—			2		1,316
Consumer installment loans		135		13			(45	)		30		133
All other loans		7		8			—			—		15
Unallocated		1,486		142			—			—		1,628
Total loans	$	9,493	$	—		$	(85	)	$	105	$	9,513

The following tables present information on the loans evaluated for impairment in the allowance for loan losses as of March 31, 2018 and December 31, 2017 (dollars in thousands):

	March 31, 2018
	Allowance for Loan Losses						Recorded Investment in Loans
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total
Mortgage loans on real estate:
Residential 1-4 family	$	296	$	2,819	$	3,115	$	4,126	$	218,591	$	222,717
Commercial		64		2,556		2,620		4,343		367,151		371,494
Construction and land development		694		918		1,612		5,554		103,980		109,534
Second mortgages		—		34		34		—		7,689		7,689
Multifamily		—		198		198		—		59,920		59,920
Agriculture		8		25		33		67		7,357		7,424
Total real estate loans		1,062		6,550		7,612		14,090		764,688		778,778
Commercial loans		31		931		962		1,228		169,217		170,445
Consumer installment loans		—		112		112		4		13,874		13,878
All other loans		—		10		10		—		1,210		1,210
Unallocated		—		272		272		—		—		—
Total loans	$	1,093	$	7,875	$	8,968	$	15,322	$	948,989	$	964,311

	December 31, 2017
	Allowance for Loan Losses						Recorded Investment in Loans
	Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total		Individually Evaluated for Impairment		Collectively Evaluated for Impairment		Total
Mortgage loans on real estate:
Residential 1-4 family	$	290	$	3,176	$	3,466	$	4,117	$	223,425	$	227,542
Commercial		65		2,358		2,423		4,396		361,935		366,331
Construction and land development		556		691		1,247		4,276		103,538		107,814
Second mortgages		—		24		24		—		8,410		8,410
Multifamily		—		496		496		—		59,024		59,024
Agriculture		8		6		14		68		7,415		7,483
Total real estate loans		919		6,751		7,670		12,857		763,747		776,604
Commercial loans		39		1,100		1,139		1,433		157,591		159,024
Consumer installment loans		1		109		110		7		5,162		5,169
All other loans		—		3		3		—		1,221		1,221
Unallocated		—		47		47		—		—		—
Total loans	$	959	$	8,010	$	8,969	$	14,297	$	927,721	$	942,018

Loans are monitored for credit quality on a recurring basis. These credit quality indicators are defined as follows:

Pass - A pass loan is not adversely classified, as it does not display any of the characteristics for adverse classification. This category includes purchased loans that are 100% guaranteed by U.S. Government agencies of $17.7 million and $18.0 million at March 31, 2018 and December 31, 2017, respectively.

Special Mention - A special mention loan has potential weaknesses that deserve management’s close attention. If left uncorrected, such potential weaknesses may result in deterioration of the repayment prospects or collateral position at some future date. Special mention loans are not adversely classified and do not warrant adverse classification.

Substandard - A substandard loan is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified as substandard generally have a well defined weakness, or weaknesses, that jeopardize the liquidation of the debt. These loans are characterized by the distinct possibility of loss if the deficiencies are not corrected.

Doubtful - A doubtful loan has all the weaknesses inherent in a loan classified as substandard with the added characteristics that the weaknesses make collection or liquidation in full, highly questionable and improbable, on the basis of currently existing facts, conditions, and values. The possibility of loss is extremely high.

The following tables present the composition of loans by credit quality indicator at March 31, 2018 and December 31, 2017 (dollars in thousands):

	March 31, 2018
	Pass		Special Mention		Substandard		Doubtful		Total
Mortgage loans on real estate:
Residential 1-4 family	$	217,935	$	2,753	$	2,029	$	—	$	222,717
Commercial		354,462		14,073		2,959		—		371,494
Construction and land development		103,810		170		5,554		—		109,534
Second mortgages		7,474		215		—		—		7,689
Multifamily		57,357		—		2,563		—		59,920
Agriculture		6,952		386		86		—		7,424
Total real estate loans		747,990		17,597		13,191		—		778,778
Commercial loans		167,659		1,738		1,048		—		170,445
Consumer installment loans		13,683		191		4		—		13,878
All other loans		1,210		—		—		—		1,210
Total loans	$	930,542	$	19,526	$	14,243	$	—	$	964,311

	December 31, 2017
	Pass		Special Mention		Substandard		Doubtful		Total
Mortgage loans on real estate:
Residential 1-4 family	$	222,026	$	3,442	$	2,074	$	—	$	227,542
Commercial		355,188		8,145		2,998		—		366,331
Construction and land development		103,356		182		4,276		—		107,814
Second mortgages		8,187		223		—		—		8,410
Multifamily		56,452		—		2,572		—		59,024
Agriculture		7,010		385		88		—		7,483
Total real estate loans		752,219		12,377		12,008		—		776,604
Commercial loans		156,604		1,171		1,249		—		159,024
Consumer installment loans		5,137		25		7		—		5,169
All other loans		1,221		—		—		—		1,221
Total loans	$	915,181	$	13,573	$	13,264	$	—	$	942,018

In accordance with FASB Accounting Standards Update (ASU) 2011-02, Receivables (Topic 310): A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring, the Company assesses all loan modifications to determine whether they are considered troubled debt restructurings (TDRs) under the guidance. The Company had 23 and 17 loans that met the definition of a TDR at March 31, 2018 and 2017, respectively.

The Company had no loan modifications considered to be TDRs during the three months ended March 31, 2018 and 2017.

A loan is considered to be in default if it is 90 days or more past due. There were no TDRs that had been restructured during the previous 12 months that resulted in default during either of the three months ended March 31, 2018 and 2017.

In the determination of the allowance for loan losses, management considers TDRs and subsequent defaults in these restructures by reviewing for impairment in accordance with FASB ASC 310-10-35, Receivables, Subsequent Measurement.

At March 31, 2018, the Company had 1-4 family mortgages in the amount of $137.1 million pledged to the Federal Home Loan Bank with a lendable collateral value of $110.3 million.

Note 4. PCI Loans and Related Allowance for Loan Losses

On January 30, 2009, the Company entered into a Purchase and Assumption Agreement with the Federal Deposit Insurance Corporation (FDIC) to assume all of the deposits and certain other liabilities and acquire substantially all assets of Suburban Federal Savings Bank (SFSB). The Company is applying the provisions of FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, to all loans acquired in the SFSB transaction (the “PCI loans”). Of the total $198.3 million in loans acquired, $49.1 million met the criteria of FASB ASC 310-30. These loans, consisting mainly of construction loans, were deemed impaired at the acquisition date. The remaining $149.1 million of loans acquired, comprised mainly of residential 1-4 family, were analogized to meet the criteria of FASB ASC 310-30. Analysis of this portfolio revealed that SFSB utilized weak underwriting and documentation standards, which led the Company to believe that significant losses were probable given the economic environment at the time.

As of March 31, 2018 and December 31, 2017, the outstanding contractual balance of the PCI loans was $68.2 million and $71.0 million, respectively. The carrying amount, by loan type, as of these dates is as follows (dollars in thousands):

	March 31, 2018					December 31, 2017
	Amount		% of PCI Loans			Amount		% of PCI Loans
Mortgage loans on real estate:
Residential 1-4 family	$	37,980		89.97	%	$	39,805		89.79	%
Commercial		503		1.19			547		1.23
Construction and land development		1,526		3.61			1,588		3.58
Second mortgages		1,953		4.63			2,136		4.82
Multifamily		253		0.60			257		0.58
Total real estate loans		42,215		100.00			44,333		100.00
Total PCI loans	$	42,215		100.00	%	$	44,333		100.00	%

There was no activity in the allowance for loan losses on PCI loans for the three months ended March 31, 2018 and 2017.

The following table presents information on the PCI loans collectively evaluated for impairment in the allowance for loan losses at March 31, 2018 and December 31, 2017 (dollars in thousands):

	March 31, 2018				December 31, 2017
	Allowance for loan losses		Recorded investment in loans		Allowance for loan losses		Recorded investment in loans
Mortgage loans on real estate:
Residential 1-4 family	$	200	$	37,980	$	200	$	39,805
Commercial		—		503		—		547
Construction and land development		—		1,526		—		1,588
Second mortgages		—		1,953		—		2,136
Multifamily		—		253		—		257
Total real estate loans		200		42,215		200		44,333
Total PCI loans	$	200	$	42,215	$	200	$	44,333

The change in the accretable yield balance for the three months ended March 31, 2018 and the year ended December 31, 2017, is as follows (dollars in thousands):

Balance, January 1, 2017	$	48,355
Accretion		(5,729	)
Reclassification from nonaccretable difference		1,500
Balance, December 31, 2017	$	44,126
Accretion		(1,397	)
Reclassification to nonaccretable difference		(113	)
Balance, March 31, 2018	$	42,616

The PCI loans were not classified as nonperforming assets as of March 31, 2018, as the loans are accounted for on a pooled basis, and interest income, through accretion of the difference between the carrying amount of the loans and the expected cash flows, is being recognized on all PCI loans.

Note 5. Other Real Estate Owned

The following table presents the balances of other real estate owned at March 31, 2018 and December 31, 2017 (dollars in thousands):

	March 31, 2018		December 31, 2017

Residential 1-4 family	$	882	$	486
Commercial		15		15
Construction and land development		2,269		2,290
Total other real estate owned	$	3,166	$	2,791

At March 31, 2018, the Company had $417,000 in residential 1-4 family loans and PCI loans that were in the process of foreclosure.

Note 6. Deposits

The following table provides interest bearing deposit information, by type, at March 31, 2018 and December 31, 2017 (dollars in thousands):

	March 31, 2018		December 31, 2017

NOW	$	154,236	$	157,037
MMDA		148,404		143,363
Savings		93,724		93,980
Time deposits less than or equal to $250,000		435,481		437,810
Time deposits over $250,000		114,438		110,546
Total interest bearing deposits	$	946,283	$	942,736

Note 7. Accumulated Other Comprehensive (Loss) Income

The following tables present activity net of tax in accumulated other comprehensive (loss) income (AOCI) for the three months ended March 31, 2018 and 2017 (dollars in thousands):

	Three months ended March 31, 2018
	Unrealized Gain (Loss) on Securities			Defined Benefit Pension Plan			Gain (Loss) on Cash Flow Hedge		Total Other Comprehensive (Loss) Income

Beginning balance	$	954		$	(1,048	)	$	137	$	43
Other comprehensive (loss) income before reclassifications		(1,940	)		-			146		(1,794	)
Amounts reclassified from AOCI		(23	)		-			-		(23	)
Net current period other comprehensive (loss) income		(1,963	)		-			146		(1,817	)
Ending balance	$	(1,009	)	$	(1,048	)	$	283	$	(1,774	)

	Three months ended March 31, 2017
	Unrealized Gain (Loss) on Securities			Defined Benefit Pension Plan			Gain (Loss) on Cash Flow Hedge			Total Other Comprehensive (Loss) Income

Beginning balance	$	(410	)	$	(767	)	$	(46	)	$	(1,223	)
Other comprehensive (loss) income before reclassifications		508			-			54			562
Amounts reclassified from AOCI		(63	)		-			-			(63	)
Net current period other comprehensive (loss) income		445			-			54			499
Ending balance	$	35		$	(767	)	$	8		$	(724	)

The following table presents the effects of reclassifications out of AOCI on line items of consolidated income for the three months ended March 31, 2018 and 2017 (dollars in thousands):

Details about AOCI Components	Amount Reclassified from AOCI						Affected Line Item in the Unaudited Consolidated Statement of Income
	Three months ended
	March 31, 2018			March 31, 2017
Securities available for sale:
Unrealized gains on securities available for sale	$	(30	)	$	(95	)	Gain on securities transactions, net
Related tax expense		7			32		Income tax expense
	$	(23	)	$	(63	)	Net of tax

Note 8. Fair Values of Assets and Liabilities

FASB ASC 820, Fair Value Measurements and Disclosures, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs and also establishes a fair value hierarchy that prioritizes the valuation inputs into three broad levels. The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

• Level 1—Valuation is based upon quoted prices for identical instruments traded in active markets.

• Level 2—Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

• Level 3—Valuation is determined using model-based techniques with significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of third party pricing services, option pricing models, discounted cash flow models and similar techniques.

FASB ASC 825, Financial Instruments, allows an entity the irrevocable option to elect fair value for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company has not made any material FASB ASC 825 elections as of March 31, 2018.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

The Company utilizes fair value measurements to record adjustments to certain assets to determine fair value disclosures. Securities available for sale and loans held for sale are recorded at fair value on a recurring basis. The tables below present the recorded amount of assets and liabilities measured at fair value on a recurring basis (dollars in thousands):

	March 31, 2018
	Total		Level 1		Level 2		Level 3
Investment securities available for sale
U.S. Treasury issue and other U.S. Gov’t agencies	$	37,601	$	-	$	37,601	$	-
U.S. Gov’t sponsored agencies		9,227		-		9,227		-
State, county and municipal		123,574		1,468		122,106		-
Corporate and other bonds		7,814		-		7,814		-
Mortgage backed – U.S. Gov’t agencies		5,272		-		5,272		-
Mortgage backed – U.S. Gov’t sponsored agencies		18,677		1,046		17,631		-
Total investment securities available for sale		202,165		2,514		199,651		-
Cash flow hedge		363		-		363		-
Total assets at fair value	$	202,528	$	2,514	$	200,014	$	-
Total liabilities at fair value	$	-	$	-	$	-	$	-

	December 31, 2017
	Total		Level 1		Level 2		Level 3
Investment securities available for sale
U.S. Treasury issue and other U.S. Gov’t agencies	$	40,256	$	-	$	40,256	$	-
U.S. Gov’t sponsored agencies		9,278		-		9,278		-
State, county and municipal		125,760		332		125,428		-
Corporate and other bonds		7,460		-		7,460		-
Mortgage backed – U.S. Gov’t agencies		5,442		-		5,442		-
Mortgage backed – U.S. Gov’t sponsored agencies		16,638		-		16,638		-
Total investment securities available for sale		204,834		332		204,502		-
Cash flow hedge		177		-		177		-
Total assets at fair value	$	205,011	$	332	$	204,679	$	-
Total liabilities at fair value	$	-	$	-	$	-	$	-

Investment securities available for sale

Investment securities available for sale are recorded at fair value each reporting period. Fair value measurement is based upon quoted prices, if available (Level 1). Quoted prices are available within the same month as the settlement date of the related security transaction. As a result, investment securities held at December 31, 2017 priced as Level 1 that were still held at March 31, 2018 were priced as Level 2 securities. If quoted prices are not available, fair values are measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions (Level 2).

The Company utilizes a third party vendor to provide fair value data for purposes of determining the fair value of its available for sale securities portfolio. The third party vendor uses a reputable pricing company for security market data. The third party vendor has controls in place for month-to-month market checks and zero pricing, and a Statement on Standards for Attestation Engagements No. 16 report is obtained from the third party vendor on an annual basis. The Company makes no adjustments to the pricing service data received for its securities available for sale.

Cash flow hedge

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

The Company is also required to measure and recognize certain other financial assets at fair value on a nonrecurring basis on the consolidated balance sheet. The following tables present assets measured at fair value on a nonrecurring basis as of March 31, 2018 and December 31, 2017 (dollars in thousands):

	March 31, 2018
	Total		Level 1		Level 2		Level 3
Impaired loans	$	8,983	$	—	$	1,716	$	7,267
Bank premises and equipment held for sale		525		—		—		525
Other real estate owned		3,166		—		1,183		1,983
Total assets at fair value	$	12,674	$	—	$	2,899	$	9,775
Total liabilities at fair value	$	—	$	—	$	—	$	—

	December 31, 2017
	Total		Level 1		Level 2		Level 3
Impaired loans	$	7,915	$	—	$	1,306	$	6,609
Other real estate owned		2,791		—		1,203		1,588
Total assets at fair value	$	10,706	$	—	$	2,509	$	8,197
Total liabilities at fair value	$	—	$	—	$	—	$	—

Impaired loans

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures the impairment in accordance with FASB ASC 310, Receivables. The fair value of impaired loans is estimated using one of several methods, including collateral value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceeds the recorded investments in such loans. At March 31, 2018 and December 31, 2017, a majority of total impaired loans were evaluated based on the fair value of the collateral. The Company frequently obtains appraisals prepared by external professional appraisers for classified loans greater than $250,000 when the most recent appraisal is greater than 18 months old and/or deemed to be invalid. The Company may also utilize internally prepared estimates that generally result from current market data and actual sales data related to the Company’s collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan within Level 2.

The Company may also identify collateral deterioration based on current market sales data, including price and absorption, as well as input from real estate sales professionals and developers, county or city tax assessments, market data and on-site inspections by Company personnel. When management determines that the fair value of the collateral is further impaired below the appraised value, due to such things as absorption rates and market conditions, and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. In instances where an appraisal received subsequent to an internally prepared estimate reflects a higher collateral value, management does not revise the carrying amount. Impaired loans can also be evaluated for impairment using the present value of expected future cash flows discounted at the loan’s effective interest rate. The measurement of impaired loans using future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest is not a fair value measurement and is therefore excluded from fair value disclosure requirements. Reviews of classified loans are performed by management on a quarterly basis.

Bank premises and equipment held for sale

The fair value of bank premises and equipment held for sale was determined using the adjusted appraisal methodology described in the other real estate owned (OREO) asset section below.

Other real estate owned

OREO assets are adjusted to fair value less estimated disposal costs upon transfer of the related loans to OREO property, establishing a new cost basis. Subsequent to the transfer, valuations are periodically performed by management and the assets are carried at the lower of carrying value or fair value less estimated disposal costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset within Level 2. When an appraised value is not available or management determines that the fair value of the collateral is further impaired below the appraised value due to such things as absorption rates and market conditions, the Company records the foreclosed asset within Level 3 of the fair value hierarchy.

Fair Value of Financial Instruments

FASB ASC 825, Financial Instruments, requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring or nonrecurring basis. FASB ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The following reflects the fair value of financial instruments, whether or not recognized on the consolidated balance sheet, at fair value measures by level of valuation assumptions used for those assets. These tables exclude financial instruments for which the carrying value approximates fair value (dollars in thousands):

	March 31, 2018
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Securities held to maturity	$	44,534	$	44,578	$	—	$	44,578	$	—
Loans, net of allowance		955,343		961,245		—				961,245
PCI loans, net of allowance		42,015		46,345		—		—		46,345

Financial liabilities:
Interest bearing deposits		946,283		945,267		—		945,267		—
Borrowings		105,185		104,859		—		104,859		—

	December 31, 2017
	Carrying Value		Estimated Fair Value		Level 1		Level 2		Level 3
Financial assets:
Securities held to maturity	$	46,146	$	46,888	$	—	$	46,888	$	—
Loans, net of allowance		933,049		933,938		—		927,329		6,609
PCI loans, net of allowance		44,133		48,655		—		—		48,655

Financial liabilities:
Interest bearing deposits		942,736		943,037		—		943,037		—
Borrowings		105,553		105,363		—		105,363		—

Note 9. Earnings Per Common Share

Basic earnings per common share (EPS) is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common shares outstanding during the period, including the effect of all potentially dilutive common shares outstanding attributable to stock instruments. The following table presents basic and diluted EPS for the three months ended March 31, 2018 and 2017 (dollars and shares in thousands, except per share data):

	Net Income (Loss) (Numerator)		Weighted Average Common Shares (Denominator)		Per Common Share Amount
For the three months ended March 31, 2018
Basic EPS	$	2,594		22,076	$	0.12
Effect of dilutive stock awards		—		445		—
Diluted EPS	$	2,594		22,521	$	0.12

For the three months ended March 31, 2017
Basic EPS	$	2,493		21,962	$	0.11
Effect of dilutive stock awards		—		471		—
Diluted EPS	$	2,493		22,433	$	0.11

Antidilutive common shares issuable under awards or options of 279,000 were excluded from the computation of diluted earnings per common share for the three months ended March 31, 2018. There were no antidilutive exclusions from the computation of diluted earnings per common share for the three months ended March 31, 2017.

Note 10. Employee Benefit Plan

The Company adopted the Bank of Essex noncontributory, defined benefit pension plan for all full-time pre-merger Bank of Essex employees over 21 years of age. Benefits are generally based upon years of service and the employees’ compensation. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.

The Company has frozen the plan benefits for all the defined benefit plan participants effective December 31, 2010.

The following table provides the components of net periodic benefit cost for the plan for the three months ended March 31, 2018 and 2017 (dollars in thousands):

	Three months ended
	March 31, 2018			March 31, 2017
Interest cost	$	39		$	39
Expected return on plan assets		(59	)		(70	)
Amortization of prior service cost		1			1
Recognized net actuarial loss		15			12
Net periodic benefit cost	$	(4	)	$	(18	)

Note 11. Cash Flow Hedge

On November 7, 2014, the Company entered into an interest rate swap with a total notional amount of $30 million. The Company designated the swap as a cash flow hedge intended to protect against the variability in the expected future cash flows on the designated variable rate borrowings. The swap hedges the interest rate risk, wherein the Company will receive an interest rate based on the three month LIBOR from the counterparty and pays an interest rate of 1.69% to the same counterparty calculated on the notional amount for a term of five years. The Company intends to sequentially issue a series of three month fixed rate debt as part of a planned roll-over of short term debt for five years. The forecasted funding will be provided through one of the following wholesale funding sources: a new FHLB advance, a new repurchase agreement, or a pool of brokered CDs, based on whichever market offers the most advantageous pricing at the time that pricing is first initially determined for the effective date of the swap and each reset period thereafter. Each quarter when the Company rolls over the three month debt, it will decide at that time which funding source to use for that quarterly period.

The swap was entered into with a counterparty that met the Company’s credit standards, and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant. The Company had $0 and $390,000 of cash pledged as collateral for the periods ended March 31, 2018 and December 31, 2017, respectively.

Amounts receivable or payable are recognized as accrued under the terms of the agreements. In accordance with FASB ASC 815, Derivatives and Hedging, the Company has designated the swap as a cash flow hedge, with the effective portions of the derivatives’ unrealized gains or losses recorded as a component of other comprehensive income. The ineffective portions of the unrealized gains or losses, if any, would be recorded in other operating expense. The Company has assessed the effectiveness of each hedging relationship by comparing the changes in cash flows on the designated hedged item. The Company’s cash flow hedge was deemed to be effective for the three months ended March 31, 2018 and 2017. The fair value of the Company’s cash flow hedge was an unrealized gain of $363,000 and $177,000 at March 31, 2018 and December 31, 2017, respectively, and was recorded in other assets. The gain was recorded as a component of other comprehensive income net of associated tax effects.

Note 12. Revenue Recognition

On January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), and all subsequent ASUs that modified Topic 606. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain noninterest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to noninterest revenue streams such as deposit related fees, interchange fees, merchant income, and brokerage fees and commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Noninterest revenue streams in-scope of Topic 606 are discussed below.

Service charges on deposit accounts

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

Interchange fees

The Company earns interchange and ATM fees from debit/credit cardholder transactions conducted through the Visa and ATM payment networks. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Because the Company acts as an agent and does not control the services rendered to the customers, related costs are netted against the fee income. These costs were included in other operating expenses prior to the adoption of Topic 606.

Brokerage fees and commissions

Brokerage fees and commissions consist of other recurring revenue streams such as commissions from sales of mutual funds and other investments to its customers by a third-party service provider and investment advisor fees. The Company receives commissions from the third-party service provider on a monthly basis based upon customer activity for the month. The investment advisor fees are charged to the customer’s account in advance on the first month of the quarter, and the revenue is recognized over the following three-month period.

The following table presents noninterest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three months ended March 31, 2018 and 2017 (dollars in thousands):

	Three months ended
	March 31, 2018		March 31, 2017
Noninterest income
In-scope of Topic 606:
Service charges on deposit accounts	$	391	$	370
Interchange fees		190		155
Brokerage fees and commissions		61		80
Noninterest income (in-scope of Topic 606)		642		605
Noninterest income (out-of-scope of Topic 606)		440		430
Total noninterest income	$	1,082	$	1,035

Note 13. Branch Closing

The Company will close its Prince Street branch located in Tappahanock, Virginia as of the close of business June 29, 2018. From a historical perspective, when the Company opened its Dillard branch, also in Tappahannock, the Company’s intention was to consolidate the Prince Street branch into the newer Dillard branch, which was built as a larger and modern banking facility. The Company is now following through with its intention.

The Prince Street branch building is being marketed for sale. The book value of $525,000 reflects the lower of cost or fair market value at March 31, 2018.

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

The following discussion and analysis of the financial condition at March 31, 2018 and results of operations of Community Bankers Trust Corporation (the “Company”) for the three months ended March 31, 2018 should be read in conjunction with the Company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in this report and in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

OVERVIEW

The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest earning assets outstanding during the period and the interest rates earned thereon. The Company’s cost of funds is a function of the average amount of interest bearing deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on nonaccrual loans and the amount of additions to the allowance for loan losses. Additionally, the Bank earns noninterest income from service charges on deposit accounts and other fee or commission-based services and products. Other sources of noninterest income can include gains or losses on securities transactions, mortgage loan income and income from bank owned life insurance (BOLI) policies. The Company’s income is offset by noninterest expense, which consists of salaries and employee benefits, occupancy and equipment costs, professional fees, transactions involving bank-owned property, the amortization of intangible assets and other operational expenses. The provision for loan losses and income taxes may materially affect net income.

CAUTION ABOUT FORWARD-LOOKING STATEMENTS

The Company makes certain forward-looking statements in this report that are subject to risks and uncertainties. These forward-looking statements include statements regarding our profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, future strategy, and financial and other goals. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.

These forward-looking statements are subject to significant uncertainties because they are based upon or are affected by factors, including, without limitation, the effects of and changes in the following:

the quality or composition of the Company’s loan or investment portfolios, including collateral values and the repayment abilities of borrowers and issuers;

assumptions that underlie the Company’s allowance for loan losses;

general economic and market conditions, either nationally or in the Company’s market areas;

the interest rate environment;

competitive pressures among banks and financial institutions or from companies outside the banking industry;

real estate values;

the demand for deposit, loan, and investment products and other financial services;

the demand, development and acceptance of new products and services;

the performance of vendors or other parties with which the Company does business;

time and costs associated with de novo branching, acquisitions, dispositions and similar transactions;

the realization of gains and expense savings from acquisitions, dispositions and similar transactions;

assumptions and estimates that underlie the accounting for purchased credit impaired loans;

consumer profiles and spending and savings habits;

levels of fraud in the banking industry;

the level of attempted cyber attacks in the banking industry;

the securities and credit markets;

costs associated with the integration of banking and other internal operations;

the soundness of other financial institutions with which the Company does business;

inflation;

technology; and

legislative and regulatory requirements.

These factors and additional risks and uncertainties are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017 and other reports filed from time to time by the Company with the Securities and Exchange Commission.

Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

CRITICAL ACCOUNTING POLICIES

The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States (GAAP). The financial information contained within the statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained when either earning income, recognizing an expense, recovering an asset or relieving a liability. For example, the Company uses historical loss factors as one factor in determining the inherent loss that may be present in its loan portfolio. Actual losses could differ significantly from the historical factors that the Company uses. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of the Company’s transactions would be the same, the timing of events that would impact its transactions could change.

The following is a summary of the Company’s critical accounting policies that are highly dependent on estimates, assumptions and judgments.

Allowance for Loan Losses on Loans

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

The allowance is an amount that management believes is appropriate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio, based on an evaluation of the collectability of existing loans and prior loss experience. This evaluation also takes into consideration such factors as changes in the nature and volume of the loan portfolio, overall portfolio quality, review of specific problem loans, and current economic conditions that may affect the borrower’s ability to pay. This evaluation does not include the effects of expected losses on specific loans or groups of loans that are related to future events or expected changes in economic conditions. The evaluation also considers the following risk characteristics of each loan portfolio:

Residential 1-4 family mortgage loans include HELOCs and single family investment properties secured by first liens. The carry risks associated with owner-occupied and investment properties are the continued credit-worthiness of the borrower, changes in the value of the collateral, successful property maintenance and collection of rents due from tenants. The Company manages these risks by using specific underwriting policies and procedures and by avoiding concentrations in geographic regions.

Commercial real estate loans, including owner occupied and non-owner occupied mortgages, carry risks associated with the successful operations of the principal business operated on the property securing the loan or the successful operation of the real estate project securing the loan. General market conditions and economic activity may impact the performance of these loans. In addition to using specific underwriting policies and procedures for these types of loans, the Company manages risk by avoiding concentrations to any one business or industry, and by diversifying the lending to various lines of businesses, such as retail, office, office warehouse, industrial and hotel.

Construction and land development loans are generally made to commercial and residential builders/developers for specific construction projects, as well as to consumer borrowers. These carry more risk than real estate term loans due to the dynamics of construction projects, changes in interest rates, the long-term financing market and state and local government regulations. The Company manages risk by using specific underwriting policies and procedures for these types of loans and by avoiding concentrations to any one business or industry and by diversifying lending to various lines of businesses, in various geographic regions and in various sales or rental price points.

Second mortgages on residential 1-4 family loans carry risk associated with the continued credit-worthiness of the borrower, changes in value of the collateral and a higher risk of loss in the event the collateral is liquidated due to the inferior lien position. The Company manages risk by using specific underwriting policies and procedures.

Multifamily loans carry risks associated with the successful operation of the property, general real estate market conditions and economic activity. In addition to using specific underwriting policies and procedures, the Company manages risk by avoiding concentrations to geographic regions and by diversifying the lending to various unit mixes, tenant profiles and rental rates.

Agriculture loans carry risks associated with the successful operation of the business, changes in value of non-real estate collateral that may depreciate over time and inventory that may be affected by weather, biological, price, labor, regulatory and economic factors. The Company manages risks by using specific underwriting policies and procedures, as well as avoiding concentrations to individual borrowers and by diversifying lending to various agricultural lines of business (i.e., crops, cattle, dairy, etc.).

Commercial loans carry risks associated with the successful operation of the business, changes in value of non-real estate collateral that may depreciate over time, accounts receivable whose collectability may change and inventory values that may be subject to various risks including obsolescence. General market conditions and economic activity may also impact the performance of these loans. In addition to using specific underwriting policies and procedures for these types of loans, the Company manages risk by diversifying the lending to various industries and avoids geographic concentrations.

Consumer installment loans carry risks associated with the continued credit-worthiness of the borrower and the value of rapidly depreciating assets or lack thereof. These types of loans are more likely than real estate loans to be quickly and adversely affected by job loss, divorce, illness or personal bankruptcy. The Company manages risk by using specific underwriting policies and procedures for these types of loans.

All other loans generally support the obligations of state and political subdivisions in the U.S. and are not a material source of business for the Company. The loans carry risks associated with the continued credit-worthiness of the obligations and economic activity. The Company manages risk by using specific underwriting policies and procedures for these types of loans.

While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses, and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

The allowance consists of specific, general and unallocated components. For loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. The unallocated component covers uncertainties that could affect management’s estimate of probable losses.

A loan is considered impaired when, based on current information and events, it is probable that the Company 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 by either the present value of the 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.

Large groups of smaller balance homogeneous loans are evaluated for impairment as a pool. Accordingly, the Company does not separately analyze these individual loans for impairment disclosures.

Accounting for Certain Loans Acquired in a Transfer

FASB ASC 310, Receivables, requires acquired loans to be recorded at fair value and prohibits carrying over valuation allowances in the initial accounting for acquired impaired loans. Loans carried at fair value, mortgage loans held for sale, and loans to borrowers in good standing under revolving credit arrangements are excluded from the scope of FASB ASC 310, which limits the yield that may be accreted to the excess of the undiscounted expected cash flows over the investor’s initial investment in the loan. The excess of the contractual cash flows over expected cash flows may not be recognized as an adjustment of yield. Subsequent increases in cash flows to be collected are recognized prospectively through an adjustment of the loan’s yield over its remaining life. Decreases in expected cash flows are recognized as impairments through the allowance for loan losses.

The Company’s acquired loans from the Suburban Federal Savings Bank (SFSB) transaction (the “PCI loans”), subject to FASB ASC Topic 805, Business Combinations, were recorded at fair value and no separate valuation allowance was recorded at the date of acquisition. FASB ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, applies to loans acquired in a transfer with evidence of deterioration of credit quality for which it is probable, at acquisition, that the investor will be unable to collect all contractually required payments receivable. The Company is applying the provisions of FASB ASC 310-30 to all loans acquired in the SFSB transaction. The Company has grouped loans together based on common risk characteristics including product type, delinquency status and loan documentation requirements among others.

The PCI loans are subject to the credit review standards described above for loans. If and when credit deterioration occurs subsequent to the date that the loans were acquired, a provision for loan loss for PCI loans will be charged to earnings for the full amount.

The Company has made an estimate of the total cash flows it expects to collect from each pool of loans, which includes undiscounted expected principal and interest. The excess of that amount over the fair value of the pool is referred to as accretable yield. Accretable yield is recognized as interest income on a constant yield basis over the life of the pool. The Company also determines each pool’s contractual principal and contractual interest payments. The excess of that amount over the total cash flows that it expects to collect from the pool is referred to as nonaccretable difference, which is not accreted into income. Judgmental prepayment assumptions are applied to both contractually required payments and cash flows expected to be collected at acquisition. Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected. Subsequent decreases in cash flows expected to be collected over the life of the pool are recognized as an impairment in the current period through the allowance for loan losses. Subsequent increases in expected or actual cash flows are first used to reverse any existing valuation allowance for that loan or pool. Any remaining increase in cash flows expected to be collected is recognized as an adjustment to the accretable yield with the amount of periodic accretion adjusted over the remaining life of the pool.

Other Real Estate Owned

Real estate acquired through, or in lieu of, loan foreclosure is held for sale and is initially recorded at the fair value at the date of foreclosure net of estimated disposal costs, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the carrying amount or the fair value less costs to sell. Revenues and expenses from operations and changes in the valuation allowance are included in other operating expenses. Costs to bring a property to salable condition are capitalized up to the fair value of the property while costs to maintain a property in salable condition are expensed as incurred.

Income Taxes

Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.

Positions taken in the Company’s tax returns may be subject to challenge by the taxing authorities upon examination. Uncertain tax positions are initially recognized in the consolidated financial statements when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50 percent likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. The Company provides for interest and, in some cases, penalties on tax positions that may be challenged by the taxing authorities. Interest expense is recognized beginning in the first period that such interest would begin accruing. Penalties are recognized in the period that the Company claims the position in the tax return. Interest and penalties on income tax uncertainties are classified within income tax expense in the consolidated statement of income. The Company had no interest or penalties during the three months ended March 31, 2018 and 2017. Under FASB ASC 740, Income Taxes, a valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. In management’s opinion, based on a three year taxable income projection, tax strategies that would result in potential securities gains and the effects of off-setting deferred tax liabilities, it is more likely than not that the deferred tax assets are realizable; therefore, no allowance is required.

The Company and its subsidiaries are subject to U. S. federal income tax as well as Virginia and Maryland state income tax. All years from 2014 through 2017 are open to examination by the respective tax authorities.

RESULTS OF OPERATIONS

Overview

Net income was $2.6 million for the first quarter of 2018, compared with net income of $2.5 million in the first quarter of 2017. Earnings per common share, basic and fully diluted, were $0.12 per share and $0.11 per share for the three months ended March 31, 2018 and 2017, respectively.

The increase of $101,000, or 4.1%, in net income, for the first quarter of 2018 compared with the first quarter of 2017 was primarily the result of a $1.1 million increase in interest income and a reduction of $536,000 in income tax expense. Offsetting these increases was an increase of $531,000 in interest expense and an increase of $1.1 million in noninterest expenses, including an increase of $703,000 in group benefit costs.

Net Interest Income

The Company’s operating results depend primarily on its net interest income, which is the difference between interest income on interest-earning assets, including securities and loans, and interest expense incurred on interest bearing liabilities, including deposits and other borrowed funds. Net interest income is affected by changes in the amount and mix of interest earning assets and interest bearing liabilities, referred to as a “volume change.” It is also affected by changes in yields earned on interest earning assets and rates paid on interest bearing deposits and other borrowed funds, referred to as a “rate change.”

Net interest income increased $600,000, or 5.5%, from the first quarter of 2017 to the first quarter of 2018. Net interest income was $11.5 million in the first quarter of 2018 compared with $10.9 million for the same period in 2017. Interest income increased $1.1 million, or 8.7%, over this time period. The increase in interest income was generated by an increase of $86.7 million, or 7.4%, in the level of earning assets. The yield on earning assets decreased from 4.61% in the first quarter of 2017 to 4.60% in the first quarter of 2018. The average balance of loans, excluding PCI loans, increased $104.2 million, or 12.4%, from $839.2 million in the first quarter of 2017 to $943.4 million in the first quarter of 2018. Interest income on securities was $1.8 million in each of the first quarter of 2018 and first quarter of 2017. On a tax-equivalent basis, the yield on investment securities was 2.98% in the first quarter of 2018, based on a 21% tax rate, and 3.22% in the first quarter of 2017, based on a 34% tax rate.

Interest on PCI loans was $1.4 million in the first quarter of 2018 compared with $1.5 million in the first quarter of 2017. The average balance of the PCI portfolio declined $7.4 million during the year-over-year comparison period.

Interest expense increased $531,000, or 25.5%, when comparing the first quarter of 2017 and the first quarter of 2018. Interest expense on deposits increased $364,000, or 20.5%, as the average balance of interest bearing deposits increased $41.3 million, or 4.6%. The increase in deposit cost was driven by an increase in NOW and MMDA average balances, which increased a combined $62.5 million year-over-year. Likewise, the cost of these balances increased $189,000, from 0.24% to 0.45%, over the same time frame. Higher cost time deposit balances declined over the comparison period by $22.4 million; however, expense on this category increased by $176,000, resulting in an increase in cost from 1.11% to 1.29%. FHLB and other borrowings increased, on average, $15.6 million year-over-year, and there was an increase in the rate paid, from 1.33% in the first quarter of 2017 to 1.74% in the first quarter of 2018. This resulted in an increase in the expense of $162,000, to $458,000 in the first quarter of 2018. The average balance of FHLB and other borrowings was $105.5 million in the first quarter of 2018. Overall, the Bank’s cost of interest bearing liabilities increased 15 basis points, from 0.85% in the first quarter of 2017 to 1.00% in the first quarter of 2018.

The tax-equivalent net interest margin decreased 12 basis points, from 3.88% in the first quarter of 2017 to 3.76% in the first quarter of 2018. Likewise, the interest spread decreased from 3.76% to 3.60% over the same time period. The decrease in the margin was precipitated by the increase in the cost of interest bearing liabilities without a corresponding increase in the yield on earning assets and the decrease in the tax benefit derived from tax exempt securities resulting from the decrease in the Company’s corporate federal tax rate.

The following table sets forth, for each category of interest-earning assets and interest bearing liabilities, the average amounts outstanding, the interest earned or paid on such amounts, and the average rate earned or paid for the three months ended March 31, 2018 and 2017. The table also sets forth the average rate paid on total interest bearing liabilities, and the net interest margin on average total interest earning assets for the same periods. Except as indicated in the footnotes, no tax equivalent adjustments were made and all average balances are daily average balances. Any nonaccruing loans have been included in the tables, as loans carrying a zero yield.

NET INTEREST MARGIN ANALYSIS

AVERAGE BALANCE SHEETS

(Dollars in thousands)

	Three months ended March 31, 2018								Three months ended March 31, 2017
						Average								Average
	Average			Interest		Rates			Average			Interest		Rates
	Balance			Income/		Earned/			Balance			Income/		Earned/
	Sheet			Expense		Paid			Sheet			Expense		Paid
ASSETS:
Loans, including fees	$	943,398		$	10,876		4.68	%	$	839,167		$	9,597		4.64	%
PCI loans, including fees		43,331			1,398		12.91			50,777			1,479		11.65
Total loans		986,729			12,274		5.05			889,944			11,076		5.05
Interest bearing bank balances		9,060			40		1.80			9,134			26		1.13
Federal funds sold		58			-		1.55			49			-		0.88
Securities (taxable)		176,563			1,186		2.69			183,247			1,249		2.73
Securities (tax exempt)⁽¹⁾		81,342			733		3.60			84,726			905		4.27
Total earning assets		1,253,752			14,233		4.60			1,167,100			13,256		4.61
Allowance for loan losses		(9,177	)							(9,722	)
Non-earning assets		88,610								88,613
Total assets	$	1,333,185							$	1,245,991

LIABILITIES AND SHAREHOLDERS' EQUITY

Demand - interest bearing	$	301,313			331		0.45		$	238,829			142		0.24
Savings		93,107			60		0.26			91,936			61		0.27
Time deposits		551,987			1,752		1.29			574,344			1,576		1.11
Total interest bearing deposits		946,407			2,143		0.92			905,109			1,779		0.80
Short-term borrowings		2,343			11		1.95			2,104			6		1.08
FHLB and other borrowings		105,532			458		1.74			89,975			296		1.33
Total interest bearing liabilities		1,054,282			2,612		1.00			997,188			2,081		0.85
Noninterest bearing deposits		148,371								126,827
Other liabilities		5,542								5,414
Total liabilities		1,208,195								1,129,429
Shareholders' equity		124,990								116,562

Total liabilities and shareholders' equity	$	1,333,185							$	1,245,991
Net interest earnings				$	11,621							$	11,175
Interest spread							3.60	%							3.76	%
Net interest margin							3.76	%							3.88	%

Tax equivalent adjustment:
Securities				$	155							$	308

(1)

Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 21% for 2018 and 34% for 2017.

Provision for Loan Losses

Management actively monitors the Company’s asset quality and provides specific loss provisions when necessary. Provisions for loan losses are charged to income to bring the total allowance for loan losses to a level deemed appropriate by management of the Company based on such factors as historical credit loss experience, industry diversification of the commercial loan portfolio, the amount of nonperforming loans and related collateral, the volume growth and composition of the loan portfolio, current economic conditions that may affect the borrower’s ability to pay and the value of collateral, the evaluation of the loan portfolio through the internal loan review function and other relevant factors. See Allowance for Loan Losses on Loans in the Critical Accounting Policies section above for further discussion.

Loans are charged-off against the allowance for loan losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for loan losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the initial determinations.

Management also actively monitors its PCI loan portfolio for impairment and necessary loan loss provisions. Provisions for these loans may be necessary due to a change in expected cash flows or an increase in expected losses within a pool of loans.

There was no provision for loan losses on the loan portfolio, excluding PCI loans, during either of the first quarter of 2018 or the first quarter of 2017. The absence of a provision in the first quarter of 2018 was the direct result of nominal charge-offs and stable asset quality. There was no provision for loan losses on the PCI loan portfolio during the first quarter of 2018 or the first quarter of 2017. Additional discussion of loan quality is presented below.

There were net charge-offs of $1,000 in the first quarter of 2018, compared with net recoveries of $20,000 in the first quarter of 2017. Total charge-offs were $84,000 for the first quarter of 2018 compared with $85,000 in the first quarter of 2017. Recoveries of previously charged-off loans were $83,000 for the first quarter of 2018 compared with $105,000 in the first quarter of 2017.

Noninterest Income

Noninterest income increased $47,000, or 4.5%, from $1.0 million in the first quarter of 2017 to $1.1 million in the first quarter of 2018. Mortgage loan income increased $78,000, or 236.4%, from $33,000 in the first quarter of 2017 to $111,000 in the first quarter of 2018. The increase in mortgage loan income reflects continued momentum from a shift that began in the fourth quarter of 2016 to a less expensive platform program. Service charges and fees increased $56,000, or 10.7%, and were $581,000 in the first quarter of 2018 compared with $525,000 in the first quarter of 2017. Gains on securities transactions declined $65,000 over this time frame and were $30,000 in the first quarter of 2018 versus $95,000 in the first quarter of 2017. There has been less activity in the securities portfolio in 2018 as the Company maintains the level of securities to total assets near a target close to the 18.9% reflected at March 31, 2018. Other noninterest income decreased from $148,000 in the first quarter of 2017 to $128,000 in the first quarter of 2018. Within other noninterest income, brokerage fees and commissions declined by $18,000 year-over-year.

Noninterest Expense

Noninterest expenses increased $1.1 million, or 13.0%, when comparing the first quarter of 2018 to the same period in 2017. The increase year-over-year was largely attributable to abnormally higher than usual group benefit costs, which increased by $703,000 in the first quarter of 2018 over the same period in 2017. Salaries and employee benefits increased $1.2 million, or 26.0%, from $4.7 million in the first quarter of 2017 to $5.9 million in the first quarter of 2018. Other operating expenses increased $207,000, or 14.4%, and were $1.6 million in the first quarter of 2018 compared with $1.4 million for the same period in 2017. Occupancy expenses increased $80,000 year-over-year and were $812,000 in the first quarter of 2018 compared with $732,000 in the first quarter of 2017. Since the beginning of 2017, the Bank has opened three full service banking facilities, one office in West Broad Marketplace in the Short Pump area of Richmond and two offices in Lynchburg. These openings also resulted in an increase year-over-year in equipment expenses, which increased $30,000, from $284,000 to $314,000. Other real estate expenses, net, of $50,000 in the first quarter of 2018 represented a year-over-year increase of $23,000. FDIC assessment was $206,000 in the first quarter of 2018 compared with $201,000 for the same period in 2017. Data processing fees of $486,000 in the first quarter of 2018 compared with $488,000 for the same period in 2017. Offsetting these increases was a decline of $477,000 in amortization of intangibles, which expired during 2017 and was $0 in the first quarter of 2018.

Income Taxes

Income tax expense was $540,000 for the three months ended March 31, 2018, compared with income tax expense of $1.1 million for the first quarter of 2017. The effective tax rate for the first quarter of 2018 was 17.2% versus 30.1% for the first quarter of 2017. The decrease in the Company’s effective tax rate resulted principally from the decrease in its applicable federal corporate tax rate from 34% to 21% as a result of the Tax Cuts and Jobs Act.

FINANCIAL CONDITION

General

Total assets increased $17.0 million, or 1.3%, to $1.353 billion at March 31, 2018 when compared to December 31, 2017. Total loans, excluding PCI loans, were $964.3 million at March 31, 2018, increasing $22.3 million, or 2.4%, from year end 2017. Total PCI loans were $42.2 million at March 31, 2018 versus $44.3 million at December 31, 2017.

During the first quarter of 2018, commercial loans grew $11.4 million, or 7.2%, and were $170.4 million at March 31, 2018. Consumer installment loans grew $8.7 million and were $13.9 million at March 31, 2018. On March 30, 2018, the Company purchased an in-market, high quality consumer auto loan pool totaling $9.0 million. The addition of these loans will bring an increase in diversification to the portfolio. Commercial mortgage loans on real estate grew by $5.2 million, or 1.4%, and were $371.5 million at March 31, 2018. Residential 1-4 family loans declined $4.8 million, or 2.1%, during the first quarter of 2018 and were $222.7 million at March 31, 2018.

The Company’s securities portfolio, excluding restricted equity securities, declined $4.3 million since year end 2017 to total $246.7 million at March 31, 2018. Net gains of $30,000 were recognized during the first quarter of 2018 through sales and call activity, and net gains of $95,000 were recognized during the first quarter of 2017. The Company actively manages the portfolio to improve its liquidity and maximize the return within the desired risk profile.

The Company is required to account for the effect of market changes in the value of securities available-for-sale (AFS) under FASB ASC 320, Investments – Debt and Equity Securities. The market value of the AFS portfolio was $202.2 million at March 31, 2018 and $204.8 million at December 31, 2017. At March 31, 2018, the Company had a net unrealized loss on the AFS portfolio of $1.3 million compared with a net unrealized gain of $1.2 million at December 31, 2017. Municipal securities comprised 61.1% of the total AFS portfolio at March 31, 2018. These securities exhibit more price volatility in a changing interest rate environment because of their longer weighted average life, as compared to other categories contained within the rest of the portfolio.

The Company had cash and cash equivalents of $21.3 million and $22.0 million at March 31, 2018 and December 31, 2017, respectively. There were federal funds purchased of $20.0 million and federal funds sold of $152,000 at March 31, 2018 compared with federal funds purchased of $4.8 million at December 31, 2017. The increase in federal funds purchased at March 31, 2018 was used to fund loan growth in the first quarter of 2018 and is anticipated to be short-term in nature. Interest bearing bank balances were $9.1 million at March 31, 2018 compared with $7.3 million at December 31, 2017.

Interest bearing deposits at March 31, 2018 were $946.3 million, an increase of $3.5 million from December 31, 2017. Money market balances grew $5.0 million since December 31, 2017. NOW accounts declined $2.8 million during the first quarter of 2018. Time deposits over $250,000 increased $3.9 million during the first quarter of 2018. Driving the changes were brokered deposits, which increased $2.4 million during the first quarter of 2018. The increase in money market and NOW account balances has allowed the Company to replace wholesale funding with core retail deposits. Time deposits less than or equal to $250,000 declined $2.3 million during the first quarter of 2018.

FHLB advances were $101.1 million at March 31, 2018, compared with $101.4 million at December 31, 2017.

Shareholders’ equity was $125.0 million at March 31, 2018 and $124.0 million at December 31, 2017. Shareholder’s equity to assets was 9.2% at March 31, 2018 and 9.3% at December 31, 2017. Total shareholders’ equity increased through retained earnings from net income but was negatively impacted by the rise in interest rates, which impacted accumulated other comprehensive (loss) income due to the effect on the fair value of available-for-sale securities.

Asset Quality – excluding PCI loans

The allowance for loan losses represents management’s estimate of the amount appropriate to provide for probable losses inherent in the loan portfolio.

Loan quality is continually monitored, and the Company’s management has established an allowance for loan losses that it believes is appropriate for the risks inherent in the loan portfolio. Among other factors, management considers the Company’s historical loss experience, the size and composition of the loan portfolio, the value and appropriateness of collateral and guarantors, nonperforming loans and current and anticipated economic conditions. There are additional risks of future loan losses, which cannot be precisely quantified nor attributed to particular loans or classes of loans. Because those risks include general economic trends, as well as conditions affecting individual borrowers, the allowance for loan losses is an estimate. The allowance is also subject to regulatory examinations and determination as to appropriateness, which may take into account such factors as the methodology used to calculate the allowance and size of the allowance in comparison to peer companies identified by regulatory agencies. See Allowance for Loan Losses on Loans in the Critical Accounting Policies section above for further discussion.

The Company maintains a list of loans that have potential weaknesses and thus may need special attention. This loan list is used to monitor such loans and is used in the determination of the appropriateness of the allowance for loan losses. Nonperforming assets totaled $13.3 million at March 31, 2018 and net charge-offs were $1,000 for the three months ended March 31, 2018. This compares with nonperforming assets of $11.8 million and net charge-offs of $1.1 million at and for the year ended December 31, 2017.

Nonperforming loans were $10.1 million at March 31, 2018, a $1.1 million increase from $9.0 million at December 31, 2017. The $1.1 million increase in nonperforming loans since December 31, 2017 was the net result of $1.4 million in additions to nonperforming loans and $293,000 in reductions. The increase related mainly to two residential 1-4 family construction relationships comprised of four loans totaling $1.3 million. With respect to the reductions in nonperforming loans, $249,000 were payments to existing credits and $44,000 were charge-offs.

The allowance for loan losses, excluding PCI, equaled 88.88% of nonaccrual loans at March 31, 2018 compared with 99.37% at December 31, 2017. The ratio of nonperforming assets to loans and OREO increased. The ratio was 1.37% at March 31, 2018 versus 1.25% at December 31, 2017.

In accordance with GAAP, an individual loan is impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts due in accordance with contractual terms of the loan agreement. The Company considers all troubled debt restructures and nonaccrual loans to be impaired loans. In addition, the Company reviews all substandard and doubtful loans that are not on nonaccrual status, as well as loans with other risk characteristics, pursuant to and specifically for compliance with the accounting definition of impairment as described above. These impaired loans have been determined through analysis, appraisals, or other methods used by management.

See Note 3 to the Company’s financial statements for information related to the allowance for loan losses. At March 31, 2018 and December 31, 2017, total impaired loans, excluding PCI loans, equaled $15.3 million and $14.3 million, respectively.

The following table sets forth selected asset quality data, excluding PCI loans, and ratios for the dates indicated (dollars in thousands):

	March 31, 2018			December 31, 2017
Nonaccrual loans	$	10,090		$	9,026
Loans past due 90 days and accruing interest		—			—
Total nonperforming loans		10,090			9,026
OREO		3,166			2,791
Total nonperforming assets	$	13,256		$	11,817

Accruing troubled debt restructure loans	$	5,232		$	5,271

Balances
Specific reserve on impaired loans		1,093			959
General reserve related to unimpaired loans		7,875			8,010
Total allowance for loan losses		8,968			8,969
Average loans during the year, net of unearned income		943,398			870,258

Impaired loans		15,322			14,297
Non-impaired loans		948,989			927,721
Total loans, net of unearned income		964,311			942,018

Ratios
Allowance for loan losses to loans		0.93	%		0.95	%
Allowance for loan losses to nonaccrual loans		88.88			99.37
General reserve to non-impaired loans		0.83			0.86
Nonaccrual loans to loans		1.05			0.96
Nonperforming assets to loans and OREO		1.37			1.25
Net charge-offs to average loans		—			0.12

The Company grants troubled debt restructures (TDR) and other various loan workouts whereby an existing loan may be restructured into multiple new loans. At March 31, 2018, the Company had 23 loans that met the definition of a TDR, which are loans that for reasons related to the debtor’s financial difficulties have been restructured on terms and conditions that would otherwise not be offered or granted. Six of these loans were restructured using multiple new loans. The aggregated outstanding principal of all TDR loans at March 31, 2018 was $6.2 million, of which $947,000 were classified as nonaccrual.

The primary benefit of the restructured multiple loan workout strategy is to maximize the potential return by restructuring the loan into a “good loan” (the A loan) and a “bad loan” (the B loan). The impact on interest is positive because the Bank is collecting interest on the A loan rather than potentially not collecting interest on the entire original loan structure. The A loan is underwritten pursuant to the Bank’s standard requirements and graded accordingly. The B loan is classified as either “doubtful” or “loss”. An impairment analysis is performed on the B loan and, based on its results, all or a portion of the B loan is charged-off or a specific loan loss reserve is established.

The Company does not modify its nonaccrual policies in this arrangement, and the A loan and the B loan stand on their own terms. At inception, this structure meets the definition of a TDR. If the loan is on nonaccrual at the time of restructure, the A loan is held on nonaccrual until six consecutive payments have been received, at which time it may be put back on an accrual status. The B loan is placed on nonaccrual. Under the terms of each loan, the borrower’s payment is contractually due.

A further breakout of nonaccrual loans, excluding PCI loans, at March 31, 2018 and December 31, 2017 is below (dollars in thousands):

	March 31, 2018		December 31, 2017
Mortgage loans on real estate:
Residential 1-4 family	$	1,985	$	1,962
Commercial		1,466		1,498
Construction and land development		5,554		4,277
Agriculture		67		68
Total real estate loans		9,072		7,805
Commercial loans		1,014		1,214
Consumer installment loans		4		7
Total loans	$	10,090	$	9,026

At March 31, 2018, the Company had eight construction and land development credit relationships in nonaccrual status. The borrowers for all of these relationships are residential land developers. All of the relationships are secured by the real estate to be developed and are in the Company’s central Virginia market. The total amount of the credit exposure outstanding at March 31, 2018 was $5.6 million. These loans have either been charged-down or sufficiently reserved against to equal the current expected realizable value.

The total amount of the allowance for loan losses attributed to all eight relationships was $694,000 at March 31, 2018, or 12. 5% of the total credit exposure outstanding. The Company establishes its reserves as described above in Allowance for Loan Losses on Loans in the Critical Accounting Policies section. In conjunction with the impairment analysis the Company performs as part of its allowance methodology, the Company ordered appraisals for all loans with balances in excess of $250,000 unless there existed an appraisal that was not older than 18 months and/or deemed to be invalid. The Company uses a ratio analysis for balances less than $250,000. The Company maintains detailed analysis and other information for its allowance methodology, both for internal purposes and for review by its regulators.

Asset Quality – PCI loans

Loans accounted for under FASB ASC 310-30 are generally considered accruing and performing loans as the loans accrete interest income over the estimated life of the loan. Accordingly, acquired impaired loans that are contractually past due are still considered to be accruing and performing loans.

The Company makes an estimate of the total cash flows that it expects to collect from a pool of PCI loans, which include undiscounted expected principal and interest. Over the life of the loan or pool, the Company continues to estimate cash flows expected to be collected. Subsequent decreases in cash flows expected to be collected over the life of the pool are recognized as impairment in the current period through the allowance for loan losses. Subsequent increases in expected cash flows are first used to reverse any existing valuation allowance for that loan or pool. Any remaining increase in cash flows expected to be collected is recognized as an adjustment to the yield over the remaining life of the pool.

Capital Requirements

The determination of capital adequacy depends upon a number of factors, such as asset quality, liquidity, earnings, growth trends and economic conditions. The Company seeks to maintain a strong capital base exceeding regulatory minimums for well capitalized institutions to support its growth and expansion plans, provide stability to current operations and promote public confidence in the Company.

Under the final rule on Enhanced Regulatory Capital Standards, commonly referred to as Basel III which became effective January 1, 2015, the federal banking regulators have defined four tests for assessing the capital strength and adequacy of banks, based on three definitions of capital. “Common equity tier 1 capital” is defined as common equity, retained earnings, and accumulated other comprehensive income (AOCI), less certain intangibles. “Tier 1 capital” is defined as common equity tier 1 capital plus qualifying perpetual preferred stock, tier 1 minority interests, and grandfathered trust preferred securities. “Tier 2 capital” is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock, non-tier 1 minority interests and a limited amount of the loan loss allowance. “Total capital” is defined as tier 1 capital plus tier 2 capital. Four risk-based capital ratios are computed using the above capital definitions, total assets and risk-weighted assets, and the ratios are measured against regulatory minimums to ascertain adequacy. All assets and off-balance sheet risk items are grouped into categories according to degree of risk and assigned a risk-weighting and the resulting total is risk-weighted assets. “Common equity tier 1 capital ratio” is common equity tier 1 capital divided by risk-weighted assets. “Tier 1 risk-based capital ratio” is tier 1 capital divided by risk-weighted assets. “Total risk-based capital ratio” is total capital divided by risk-weighted assets. The leverage ratio is tier 1 capital divided by total average assets.

The Company’s ratio of total risk-based capital was 12.6% at March 31, 2018 compared with 12.7% at December 31, 2017. The tier 1 risk-based capital ratio was 11.8% at March 31, 2018 and 11.9% at December 31, 2017. The Company’s tier 1 leverage ratio was 9.8% at March 31, 2018 and 9.7% at December 31, 2017. All capital ratios exceed regulatory minimums to be considered well capitalized. BASEL III introduced the common equity tier 1 capital ratio, which was 11.4% at March 31, 2018 and 11.5% at December 31, 2017.

Under Basel III, a capital conservation buffer of 2.5% above the minimum risk-based capital thresholds was established. Dividend and executive compensation restrictions begin if the Company does not maintain the full amount of the buffer. The capital conservation buffer will be phased in between January 1, 2016 and January 1, 2019. At March 31, 2018, the Company had a capital conservation buffer of 4.6%, well above the 2018 required buffer of 1.875%.

Liquidity

Liquidity represents the Company’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest bearing deposits with banks, federal funds sold and certain investment securities. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

The Company’s results of operations are significantly affected by its ability to manage effectively the interest rate sensitivity and maturity of its interest earning assets and interest bearing liabilities. A summary of the Company’s liquid assets at March 31, 2018 and December 31, 2017 was as follows (dollars in thousands):

	March 31, 2018			December 31, 2017
Cash and due from banks	$	12,013		$	14,642
Interest bearing bank deposits		9,141			7,316
Federal funds sold		152			—
Available for sale securities, at fair value, unpledged		167,103			168,221
Total liquid assets	$	188,409		$	190,179

Deposits and other liabilities	$	1,228,188		$	1,212,187
Ratio of liquid assets to deposits and other liabilities		15.34	%		15.69	%

Off-Balance Sheet Arrangements and Contractual Obligations

A summary of the contract amount of the Company’s exposure to off-balance sheet and balance sheet risk as of March 31, 2018 and December 31, 2017, is as follows (dollars in thousands):

	March 31, 2018		December 31, 2017
Commitments with off-balance sheet risk:
Commitments to extend credit	$	171,080	$	163,686
Standby letters of credit		6,792		6,532
Total commitments with off-balance sheet risks	$	177,872	$	170,218

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.

Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may be drawn upon only to the total extent to which the Company is committed.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to clients. The Company holds certificates of deposit, deposit accounts, and real estate as collateral supporting those commitments for which collateral is deemed necessary.

The fair value of the Company’s cash flow hedge was an unrealized gain of $363,000 and $177,000 at March 31, 2018 and December 31, 2017, respectively, which was recorded in other assets. The Company’s cash flow hedge is deemed to be effective. Therefore, the gain was recorded as a component of other comprehensive (loss) income recorded in the Company’s Consolidated Statements of Comprehensive Income.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate risk. The ongoing monitoring and management of interest rate risk is an important component of the Company’s asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Committee (ALCO) of the Bank. In this capacity, ALCO develops guidelines and strategies that govern the Company’s asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.

Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, affecting net interest income, the primary component of the Company’s earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over various periods, it also employs additional tools to monitor potential longer-term interest rate risk.

The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s balance sheet. The simulation model is prepared and results are analyzed at least quarterly. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given a 400 basis point upward shift and a 400 basis point downward shift in interest rates. The downward shift of 300 or 400 basis points is included in the analysis, although less meaningful in the current rate environment, because all results are monitored regardless of likelihood. A parallel shift in rates over a 12-month period is assumed.

The following table represents the change to net interest income given interest rate shocks up and down 100, 200, 300 and 400 basis points at March 31, 2018 (dollars in thousands):

	March 31, 2018
	%			$
Change in Yield curve
+400 bp		2.1			954
+300 bp		1.8			841
+200 bp		1.4			624
+100 bp		0.6			273
most likely		—			—
-100 bp		(0.8	)		(358	)
-200 bp		(3.3	)		(1,525	)
-300 bp		(4.7	)		(2,155	)
-400 bp		(4.8	)		(2,174	)

At March 31, 2018, the Company’s interest rate risk model indicated that, in a rising rate environment of 400 basis points over a 12 month period, net interest income could increase by 2.1%. For the same time period, the interest rate risk model indicated that in a declining rate environment of 400 basis points, net interest income could decrease by 4.8%. While these percentages are subjective based upon assumptions used within the model, management believes the balance sheet is appropriately balanced with acceptable risk to changes in interest rates.

The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels such as yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cash flows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change.

Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in response to, or in anticipation of, changes in interest rates.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this Form 10-Q, the Company’s management, with the participation of the Company’s chief executive officer and chief financial officer (the “Certifying Officers”), conducted evaluations of the Company’s disclosure controls and procedures. As defined under Section 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the term “disclosure controls and procedures” means controls and other procedures of an issuer that are designed to ensure that information required to be disclosed by the issuer in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the rules and forms of the Securities and Exchange Commission. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by an issuer in the reports that it files or submits under the Exchange Act is accumulated and communicated to the issuer’s management, including the Certifying Officers, to allow timely decisions regarding required disclosures.

Based on this evaluation, the Certifying Officers have concluded that the Company’s disclosure controls and procedures were effective to ensure that material information is recorded, processed, summarized and reported by management of the Company on a timely basis in order to comply with the Company’s disclosure obligations under the Exchange Act and the rules and regulations promulgated under it.

Internal Control over Financial Reporting

The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The Company’s internal control over financial reporting is a process designed under the supervision of the Certifying Officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company, including its subsidiaries, is a party or of which the property of the Company is subject.

Item 1A. Risk Factors

As of the date of this report, there were no material changes to the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

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

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable

Item 5. Other Information

None.

Item 6. Exhibits

Exhibit No.		Description
31.1		Rule 13a-14(a)/15d-14(a) Certification for Chief Executive Officer*
31.2		Rule 13a-14(a)/15d-14(a) Certification for Chief Financial Officer*
32.1		Section 1350 Certifications*
101		Interactive Data File with respect to the following materials from the Company’s Quarterly Report on Form 10-Q for the period ended March 31, 2018 formatted in Extensible Business Reporting Language (XBRL): (i) the Unaudited Consolidated Balance Sheets, (ii) the Unaudited Consolidated Statements of Income, (iii) the Unaudited Consolidated Statements of Comprehensive Income, (iv) the Unaudited Consolidated Statements of Changes in Shareholders’ Equity, (v) the Unaudited Consolidated Statements of Cash Flows, and (vi) Notes to Unaudited Consolidated Financial Statements*

Filed herewith.

SIGNATURES

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

	COMMUNITY BANKERS TRUST CORPORATION
	(Registrant)

	/s/ Rex L. Smith, III
	Rex L. Smith, III
	President and Chief Executive Officer
	(principal executive officer)

Date: May 9, 2018

	/s/ Bruce E. Thomas
	Bruce E. Thomas
	Executive Vice President and Chief Financial Officer
	(principal financial officer)

Date: May 9, 2018