It was a year in which sound administration, effective risk

Transcription

1 Annual Report 2016

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3 Another year of successful operations! It was a year in which sound administration, effective risk management and strong strategic planning played an instrumental role in continuing the success and growth of our organization. The progress Providence continues to achieve is a testament to the abilities of our staff to actively listen and recognize customers needs, building and involving our team in the development of future business opportunities and providing our employees the tools to continue to deliver quality products and unsurpassed service to the communities we serve. As we look forward to the coming year, our collective goal is to maintain excellence for every member of our family shareholders, employees, customers and neighbors. Together we will Achieve more!

4 dear shareholders it has been an exciting year and look what we accomplished... To our Shareholders: We are pleased to present the annual report of Providence Financial Corporation (PFC) for the year ended December 31, 2016 that includes the results of the primary operating businesses, Providence Bank & Trust (PB&T) and Providence Wealth Advisors, LLC. Net income after taxes for PFC for the year ended 12/31/16 totaled $ 5.3 million. This resulted in a 9.9 % return on average equity. The earnings per average share outstanding is $ 1.91, up 6.1 % from 2015 levels of $ PFC continued its growth in 2016 with loans ending the year at $ million, up 4.8 % or over $ 17.5 million from 2015 levels. Deposits grew $ 31.7 million ending the year at $ million, a 7.4% increase. Non-interest income for 2016 totaled $ 3.8 million, up a strong $ 0.7 million or 22.2 % from year ago levels. PFC operations continue to perform well with very low non-performing assets, healthy reserves and a very strong capital position. Our high asset quality, strong balance sheet and growing capital ratios position our company favorably for ongoing organic growth and possible future strategic acquisitions. During 2016, PB&T closed on the acquisition of Cobra Capital, a nationwide equipment financing service firm specializing in providing equipment

5 Our high asset quality, strong balance sheet and growing capital ratios position our company favorably for ongoing organic growth and possible future strategic acquisitions. NEW & UPGRADED L O C A T I O N S OPENING May1 st 2 EAST ROOSEVELT ROAD VILLA PARK ELMHURST RELOCATION This 2,400 square foot facility will accommodate a full array of banking services OPENING IN June CALUMET AVE & 101ST ST ST JOHN DYER RELOCATION NEW, freestanding, 6,000 square foot facility is under way financing solutions, including leases, for small and mid-sized businesses. Cobra brings us expertise in the large and growing lease financing industry and opens us to national markets. With the rapidly growing Northwest Indiana market and the need for additional space to accommodate our growing operations, we decided to relocate our existing leased Dyer office to a new, freestanding full service banking facility. In January of 2016, we purchased a parcel of land at the southwest corner of Calumet Avenue and 101st Street that was annexed into St. John, Indiana. Construction of a new 6,000 square foot facility is currently under way with an anticipated completion and move in date scheduled for June of In December of 2016, PB&T entered into a contract for the purchase of an existing full service banking facility located at 2 East Roosevelt Road in Villa Park, IL. We completed the purchase in January of 2017, and work is ongoing to redecorate and fit this property for the relocation of our Elmhurst office. This 2,400 square foot facility will accommodate a full array of banking services including a drive-up, 24-hour ATM and night depository that were not available at our existing Elmhurst office. We plan for a May 2017 move and opening of this new facility.

6 Recently we added key personnel in our retail, residential lending, wealth advisory and trust areas with the goal of increasing our non-interest income and deposits We continue to drive growth through our highly skilled and dedicated associates. Recently we added key personnel in our Retail, Residential Lending, Wealth Advisory and Trust areas with the goal of increasing our non-interest income and deposits. We have already seen promising results that we anticipate will benefit PFC s financial performance in 2018 and beyond as these new revenue streams materialize. In addition, we continue to explore expansion opportunities through whole bank acquisitions, branch acquisitions and new branch developments. The board has identified communities where the PB&T mission, products and services will be received well, but where we do not have a branch location. It is in these communities where we are focusing our attention for expansion opportunities. The board of directors, management and staff of PFC would like to thank you for your ongoing encouragement and support over the past 12 years. The trust that you have placed with us is greatly appreciated and we will continue to strive to care for and enhance your investment in our bank. Above all, we give thanks to our God for guiding us. It is according to His providence that we are able to operate and have this success. Steven G. VanDrunen President & Chief Executive Officer

7 Independent Auditor s Report and Consolidated Financial Statements

8 Contents Independent Auditor s Report...1 Consolidated Financial Statements Balance Sheets... 3 Statements of Income and Comprehensive Income... 4 Statements of Shareholders Equity... 5 Statements of Cash Flows... 6 Notes to Financial Statements... 7

9 Independent Auditor s Report Board of Directors and Audit Committee Providence Financial Corporation South Holland, Illinois We have audited the accompanying consolidated financial statements of Providence Financial Corporation and its subsidiary, which comprise the consolidated balance sheets as of December 31, 2016 and 2015, and the related consolidated statements of income and comprehensive income, shareholders equity and cash flows for the years then ended, and the related notes to the consolidated financial statements. Management s Responsibility for the Financial Statements Management is responsible for the preparation and fair presentation of these consolidated financial statements in accordance with accounting principles generally accepted in the United States of America; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of consolidated financial statements that are free from material misstatement, whether due to fraud or error. Auditor s Responsibility Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the consolidated financial statements. The procedures selected depend on the auditor s judgment, including the assessment of the risks of material misstatement of the consolidated financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity s preparation and fair presentation of the consolidated financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

10 Opinion In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Providence Financial Corporation and its subsidiary as of, and the results of their operations and their cash flows for the years then ended in accordance with accounting principles generally accepted in the United States of America. Indianapolis, Indiana April 21,

11 Consolidated Balance Sheets Assets Cash and due from banks $ 18,258 $ 14,407 Federal funds sold 3, Total cash and cash equivalents 22,217 15,296 Interest-bearing time deposits in other financial institutions 1,480 2,215 Securities available for sale 95,382 94,302 Loans and leases held for sale Loans and leases, net of allowance for loan and lease losses of $6,976 in 2016 and $6,860 in , ,967 Federal Home Loan Bank stock 1,927 1,927 Foreclosed assets Premises and equipment, net 14,804 13,954 Accrued interest receivable 1,496 1,507 Intangible assets 1,399 1,022 Goodwill Other assets 3,177 2,433 Total assets $ 526,339 $ 500,552 Liabilities and Shareholders Equity Liabilities Deposits Noninterest-bearing $ 104,565 $ 97,591 Interest-bearing 352, ,297 Total deposits 457, ,888 Securities sold under agreements to repurchase 7,040 7,019 Federal Home Loan Bank advances 3,000 13,000 Accrued interest payable Escrow advances 2,216 1,807 Other liabilities Total liabilities 470, ,578 Shareholders' Equity Common stock, $1 par value; 5,000,000 shares authorized; 2016: 2,788,555 shares issued and outstanding; 2015: 2,776,555 shares issued and outstanding; 2,789 2,777 Additional paid-in capital 31,169 30,793 Retained earnings 22,511 17,642 Accumulated other comprehensive income (loss) (648) 762 Total shareholders equity 55,821 51,974 Total liabilities and shareholders' equity $ 526,339 $ 500,552 See 3

12 Consolidated Statements of Income and Comprehensive Income Years Ended (Dollar amounts in thousands) Interest Income Loans and leases, including fees $ 20,024 $ 18,734 Taxable securities 1,012 1,453 Nontaxable securities Federal funds sold and other Total interest income 22,021 21,165 Interest Expense Deposits 1,389 1,385 Repurchase agreements and other short-term borrowings Federal Home Loan Bank advances Total interest expense 1,525 1,506 Net Interest Income 20,496 19,659 Provision for Loan and Lease Losses Net Interest Income After Provision for Loan Losses 20,496 19,059 Noninterest Income Investment advisory income Service charges on deposit accounts Servicing fee income Gain on sale of securities, net (includes accumulated other comprehensive income reclassifications for net gains on available-for-sale securities; $329, $175) Gain on sale of land Gain on sale of loans and leases Gain on bargain purchase 12 - Gain on foreclosed assets, net Other operating income Total noninterest income 3,759 3,076 Noninterest Expense Salaries and employee benefits 9,810 8,567 Occupancy and equipment 2,162 1,858 Data processing Advertising and marketing FDIC insurance Stewardship and charitable contributions Other expense 2,190 1,983 Total noninterest expense 16,002 14,283 Income Before Income Tax 8,253 7,852 Income tax expense (includes reclassification items from accumulated other comprehensive income; $128, $68) 2,940 2,868 Net Income 5,313 4,984 Other Comprehensive Loss Holding losses on securities available for sale (1,976) (11) Reclassification adjustment for net gains included in income (329) (175) Tax effect Total other comprehensive loss (1,410) (114) Comprehensive Income $ 3,903 $ 4,870 4 See

13 Consolidated Statements of Shareholders Equity Years Ended Accumulated Additional Other Paid-in Retained Comprehensive Shares Capital Earnings Income (Loss) Total Balance, January 1, 2015 $ 2,774 $ 30,394 $ 13,103 $ 876 $ 47,147 Net income 4,984 4,984 Other comprehensive loss (114) (114) Stock options exercised 3 (18) (15) Cash dividends ($0.16 per share) (445) (445) Tax benefit from exercise of options Share-based compensation expense Balance, December 31, ,777 30,793 17, ,974 Net income 5,313 5,313 Other comprehensive loss (1,410) (1,410) Stock options exercised Cash dividends ($0.16 per share) (444) (444) Tax benefit from exercise of options Share-based compensation expense Balance, December 31, 2016 $ 2,789 $ 31,169 $ 22,511 $ (648) $ 55,821 See 5

14 Consolidated Statements of Cash Flows Years Ended (Dollar amounts in thousands) O perating Activities Net income $ 5,313 $ 4,984 Items not requiring (providing) cash Provision for loan losses Depreciation Amortization of intangible assets Securities gains, net (329) (175) Net premium amortization of securities 1,266 1,651 Gain on sale of loans (727) (479) Gain on sale of land - (194) Bargain purchase gain on Cobra Capital acquisition (12) - Share-based compensation expense Tax benefit from exercise of options Originations of loans held for sale (30,373) (23,123) Proceeds from loans sold 36,167 22,965 Changes in Other assets and accrued interest receivable 171 (159) Other liabilities and accrued interest payable (231) (758) Net cash provided by operating activities 12,666 6,671 Investing Activities Net change in interest-bearing deposits in other financial institutions Proceeds from sales of available-for-sale securities 15,643 12,757 Proceeds from maturities and calls of available-for-sale securities 1,175 2,460 Proceeds from principal paydowns of available-for-sale securities 12,705 17,189 Purchases of available-for-sale securities (33,844) (16,701) Net change in loans and leases (22,250) (44,004) Purchases of premises and equipment (1,040) (1,213) Proceeds from sale of land Purchase of land (788) - Proceeds from sales of other real estate owned Cash paid for Cobra Capital (500) - Net cash used in investing activities (27,552) (28,191) Financing Activities Net increase (decrease) in: Deposits 31,653 (6,919) Securities sold under agreements to repurchase 21 2,540 Escrow advances 409 (64) Proceeds from Federal Home Loan Bank advances - 8,000 Payment of Federal Home Loan Bank advances (10,000) - Payment of dividend (444) (445) Proceeds from the exercise of stock options Net cash provided by financing activities 21,807 3,117 Net Change in Cash and Cash Equivalents 6,921 (18,403) Cash and Cash Equivalents, Beginning of Year 15,296 33,699 Cash and Cash Equivalents, End of Year $ 22,217 $ 15,296 Supplemental Cash Flows Information Interest paid $ 1,525 $ 1,513 Income taxes paid 3,127 3,040 Transfer from loans to foreclosed assets Loans provided for sale of real estate owned Liabilities assumed, net of cash received 88-6

15 Consolidated Statements of Cash Flows Years Ended (Dollar amounts in thousands) Note 1: Nature of Operations and Summary of Significant Accounting Policies Nature of Operations and Principles of Consolidation Providence Financial Corporation (the Company), and its wholly owned subsidiary, Providence Bank & Trust (the Bank), provide loan and deposit services to customers primarily located in northwest Indiana and in the south and west suburbs of Chicago, Illinois. Most loans are secured by various forms of collateral, including real estate, business assets, consumer property, and other items, although borrower cash flow is the primary source of repayment. There are no significant concentrations of loans to any one industry or customer. However, the customers ability to repay loans is dependent, to a significant degree, on the real estate and general economic conditions in the Bank s market area. In May 2010, Providence Wealth Advisors, LLC (PWA), a wholly owned subsidiary of the Bank, commenced operations. PWA is a Registered Investment Advisor and provides investment advisory and wealth planning services. The Bank obtained trust powers in September 2010, and PWA assists in managing each trust and wealth advisory account s investment portfolio. As of, the Bank and PWA had, in total, approximately $242,257 and $220,565, respectively, in assets under management. In April 2016, Providence Bank & Trust purchased certain assets of Cobra Capital, LLC, a nicheoriented commercial equipment leasing service firm. As a result of this purchase and through a division of the Bank, the Company provides equipment financing solutions, including leases, for small and mid-sized businesses throughout the United States. Consolidation The consolidated financial statements include the accounts of the Company, the Bank and its subsidiary after elimination of all material intercompany transactions and accounts. Use of Estimates To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ. The allowance for loan losses, carrying values of foreclosed assets, deferred tax assets and fair value of financial instruments are particularly subject to change. 7

16 Cash and Cash Equivalents The Company considers all liquid investments with original maturities of three months or less to be cash equivalents, which includes cash and due from banks and federal funds sold. At, cash equivalents consisted primarily of money market accounts with brokers and certificates of deposit. At December 31, 2016, the Company s cash accounts exceeded federally insured limits by approximately $15,000. The Company also had uninsured accounts of approximately $229 at Federal Home Loan Bank. Interest-Bearing Time Deposits in Other Financial Institutions Interest-bearing time deposits in other financial institutions are invested in individual banks in increments fully covered by FDIC insurance and mature within one year and are carried at cost. Securities Debt securities are classified as available for sale when they might be sold before maturity. Securities available for sale are carried at fair value, with unrealized holding gains and losses reported in other comprehensive income (loss), net of tax. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are amortized on the level-yield method without anticipating prepayments, except for mortgage-backed securities where prepayments are anticipated. Gains and losses on sales are recorded on the trade date and determined using the specific identification method. Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income (loss). The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity securities, the entire amount of impairment is recognized through earnings. 8

17 Loans Held for Sale Mortgage loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or market, as determined by outstanding commitments from investors. Net unrealized losses, if any, are recorded as a valuation allowance and charged to earnings. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold. Loans Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at the principal balance outstanding, adjusted for unamortized deferred loan fees and costs and an allowance for loan losses. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using the level-yield method without anticipating prepayments. For all classes of loans, interest income is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Past due status is based on the contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is moved to nonaccrual status in accordance with the Company s policy, typically after 90 days of nonpayment. All interest accrued but not received for loans placed on nonaccrual is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. Discounts and premiums on purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method. 9

18 Allowance for Loan Losses The allowance for loan losses is a valuation allowance for probable incurred credit losses, increased by the provision for loan losses and decreased by charge-offs less recoveries. Loan losses are charged against the allowance when management believes that the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management s judgment, should be charged off. The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. 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. Construction, land, commercial and commercial real estate loans are individually evaluated for impairment. Large groups of smaller balance homogeneous loans, such as consumer, home equity and residential real estate loans are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses. 10

19 The general component covers nonimpaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent five years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures and practices; experience, ability and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. Cash payments on impaired loans representing interest income are reported as such. Other cash payments are recorded as reductions in carrying value. Premises and Equipment Land is carried at cost. Premises and equipment are stated at cost, less accumulated depreciation. Depreciation is calculated on the straight-line method over the assets estimated useful lives. Federal Home Loan Bank Stock The Company is a member of the FHLB system. Members are required to own a certain amount of stock based on the level of borrowings and other factors, and may invest in additional amounts. FHLB stock is carried at cost, classified as a restricted security, and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. Mortgage-Servicing Rights When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on sales of loans. Fair value is based on market prices for comparable mortgage-servicing contract, when available, or alternatively, on a valuation model that calculates the present value of estimated future net servicing income. All classes of servicing assets are subsequently measured using the amortization method which requires servicing rights to be amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Fair value is based on market prices for comparable mortgage-servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. 11

20 Impairment is evaluated based on the fair value of the servicing rights, using groupings of the underlying loans as to interest rates and then, secondarily, as to loan type and investor. Any impairment of a grouping is reported as a valuation allowance, to the extent that fair value is less than the capitalized amount for a grouping. Servicing rights were $625 and $464 at December 31, 2016 and 2015, respectively, and are included in other assets on the consolidated balance sheets. Amortization of servicing rights is netted against servicing revenue, which is included in other operating income on the consolidated statements of income. Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of loans serviced for others totaled $117,392 and $98,285 at, respectively. Transfers of Financial Assets Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Securities Sold Under Repurchase Agreements All repurchase agreement liabilities represent amounts advanced by various customers. Securities are pledged to cover these liabilities, which are not covered by federal deposit insurance. Long-Term Assets Premises and equipment and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. Foreclosed Assets Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed. Loan Commitments and Related Financial Investments Financial instruments include off-balance-sheet credit instruments, such as commitments to make loans, unused lines of credit and standby letters of credit issued to meet customer financing needs. The face amount for these items represents the exposure to loss before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded. 12

21 Share-Based Compensation Compensation cost is recognized for options issued to employees based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of options. Compensation cost is recognized on a straight-line basis over the three year vesting period. Income Taxes The Company accounts for income taxes in accordance with income tax accounting guidance (ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur. Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized. Tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the morelikely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management s judgment. The Company recognizes interest and penalties on income taxes as a component of income tax expense. 13

22 Comprehensive Income Comprehensive income consists of net income and other comprehensive income (loss). Other comprehensive income (loss) includes unrealized gains and losses on securities available for sale, which are recognized as a separate component of equity, net of tax. Loss Contingencies Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there are any such matters that will have a material effect on the consolidated financial statements. Fair Value of Financial Instruments Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risks, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates. Goodwill and Core Deposit Intangible Goodwill is determined as the excess of the fair value of the consideration transferred, plus the fair value of any noncontrolling interests in the acquiree, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill acquired in a business combination and determined to have an indefinite useful life is not amortized, but tested for impairment at least annually or more frequently if events and circumstances exists that indicate that a goodwill impairment test should be performed. Goodwill is the only intangible asset with an indefinite life on the consolidated balance sheets. Core deposit intangibles arising from the acquisitions are amortized on an accelerated method over their estimated useful lives of seven to ten years. Goodwill and core deposit intangibles recognized as part of the acquisition will not be deducted for tax purposes. 14

23 Note 2: Securities Year-end securities available for sale were as follows: Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 2016: U.S. Government-sponsored agencies $ 1,026 $ 4 $ (12) $ 1,018 State and political subdivision 38, (806) 38,509 Mortgage-backed securities - government-sponsored enterprises (GSE) residential 41, (664) 40,785 Collateralized mortgage obligations 15,280 7 (217) 15,070 $ 96,449 $ 632 $ (1,699) $ 95,382 Gross Gross Amortized Unrealized Unrealized Fair Cost Gains Losses Value December 31, 2015: U.S. Government-sponsored agencies $ 1,080 $ 11 $ (8) $ 1,083 State and political subdivision 32,076 1,259 (23) 33,312 Mortgage-backed securities - government-sponsored enterprises (GSE) residential 43, (242) 43,895 Collateralized mortgage obligations 16, (111) 16,012 $ 93,064 $ 1,622 $ (384) $ 94,302 At, all of the mortgage-backed securities and collateralized mortgage obligations held by the Company were issued by U.S. Government-sponsored entities and agencies, including Government National Mortgage Association, Federal Home Loan Bank Corporation or Federal National Mortgage Association. 15

24 The amortized cost and fair value of debt securities are shown by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately. Available-for-Sale Amortized Fair Cost Value Within one year $ 1,504 $ 1,522 One to five years 8,902 8,988 Five to ten years 13,126 13,277 After ten years 16,258 15,740 39,790 39,527 Mortgage-backed securities - GSE residential 41,379 40,785 Collateralized mortgage obligations 15,280 15,070 Totals $ 96,449 $ 95,382 Securities with a carrying amount of $20,567 and $14,203 at, were pledged to secure repurchase agreements. At year-end 2016 and 2015, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of shareholders equity. Certain investments in debt securities are reported in the financial statements less than their historical cost. Total fair value of these investments at, was approximately $65,178 and $39,634 which is approximately 68% and 42%, respectively, of the Company s available-for-sale and held-to-maturity investment portfolio. These declines primarily resulted from recent changes in market interest rates, failure of certain investment to maintain consistent credit quality ratings, changes in the market s perception of the current risks or failure to meet projected earnings targets. The following tables summarize securities with unrealized losses at, aggregated by major security type and length of time in a continuous unrealized loss position: 16

25 December 31, 2016 Less Than 12 Months 12 Months or More Total Description of Fair Unrealized Fair Unrealized Fair Unrealized Securities Value Losses Value Losses Value Losses U.S. Government-sponsored agencies $ 738 $ (12) $ - $ - $ 738 $ (12) State and political subdivision 18,001 (801) 328 (5) 18,329 (806) Mortgage-backed securities - GSE residential 26,615 (547) 5,029 (117) 31,644 (664) Collateralized mortgage obligations 12,308 (171) 2,159 (46) 14,467 (217) Total temporarily impaired securities $ 57,662 $ (1,531) $ 7,516 $ (168) $ 65,178 $ (1,699) December 31, 2015 Less Than 12 Months 12 Months or More Total Description of Fair Unrealized Fair Unrealized Fair Unrealized Securities Value Losses Value Losses Value Losses U.S. Government-sponsored agencies $ 742 $ (8) $ - $ - $ 742 $ (8) State and political subdivision 1,496 (5) 1,997 (18) 3,493 (23) Mortgage-backed securities - GSE residential 16,071 (142) 7,678 (100) 23,749 (242) Collateralized mortgage obligations 10,589 (101) 1,061 (10) 11,650 (111) Total temporarily impaired securities $ 28,898 $ (256) $ 10,736 $ (128) $ 39,634 $ (384) U.S. Government Agencies The unrealized losses on the Company s investments in direct obligations of U.S. Government agencies were caused by interest rate changes. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be otherthan-temporarily impaired at December 31,

26 State and Political Subdivisions The unrealized losses on the Company s investments in securities of state and political subdivisions were caused by interest rate changes and illiquidity. The contractual terms of those investments do not permit the issuer to settle the securities at a price less than the amortized cost basis of the investments. Because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider those investments to be otherthan-temporarily impaired at December 31, Residential Mortgage-Backed Securities and Collateralized Mortgage Obligations The unrealized losses on the Company s investment in residential mortgage-backed securities and collateralized mortgage obligations were caused by interest rate changes and illiquidity. The Company expects to recover the amortized cost basis over the term of the securities. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company does not intend to sell the investments and it is not more likely than not the Company will be required to sell the investments before recovery of their amortized cost basis, which may be at maturity, the Company does not consider those investments to be other-thantemporarily impaired at December 31, Proceeds from sale of available-for-sale securities and gains and losses on sales and calls of securities were as follows: Sales proceeds $ 15,643 $ 12,757 Gross gains on sale of securities Gross losses on sale of securities (24) (52) 18

27 Note 3: Loans Receivable, Net Loans are summarized as follows: Construction $ 11,200 $ 23,907 Land 4,851 5,388 Commercial 85,652 75,291 Commercial real estate 235, ,313 Residential real estate 30,667 38,587 Home equity 23,457 23,776 Consumer Total loans 392, ,634 Less: Allowance for loan losses 6,976 6,860 Fair value adjustments on purchased loans 770 2,332 Deferred gains on sale of foreclosed assets Deferred loan origination fees and costs, net Deferred interest income on nonaccrual loans Unearned lease income and lease residuals Premium - (2) Loans, net $ 383,462 $ 365,967 19

28 Loans to executive officers and directors totaled $3,705 and $3,744 at year-end 2016 and 2015, respectively. The following tables present the balance in the allowance for loan losses and the recorded investment in loans based on portfolio segment and impairment method as of December 31, 2016 and 2015: Provision 2016 Loans Beginning for Loan Charged Ending Balance Losses Off Recoveries Balance Construction $ 311 $ (168) $ - $ - $ 143 Land 236 (113) Commercial 1, ,630 Commercial real estate 2, ,152 Residential real estate 1, (107) 10 1,485 Home equity 733 (501) Consumer 2 - (1) - 1 $ 6,860 $ - $ (108) $ 224 $ 6,976 Provision 2015 Loans Beginning for Loan Charged Ending Balance Losses Off Recoveries Balance Construction $ 107 $ 204 $ - $ - $ 311 Land (12) Commercial 1, ,461 Commercial real estate 2, (127) 4 2,560 Residential real estate 1, (37) - 1,557 Home equity (22) Consumer $ 6,443 $ 600 $ (198) $ 15 $ 6,860 20

29 The following tables present the balance in the allowance for loan losses by portfolio segment based on impairment method as of : Individually 2016 Allowance for Loan Losses Loans Collectively Acquired Individually Collectively Loan Balances Loans Acquired Evaluated for Evaluated for With Credit Evaluated for Evaluated for With Credit Impairment Impairment Deterioration Total Impairment Impairment Deterioration Total Construction $ - $ 143 $ - $ 143 $ - $ 11,200 $ - $ 11,200 Land ,733-4,851 Commercial 82 1,548-1, ,246-85,652 Commercial real estate - 3,152-3, , ,942 Residential real estate 1, ,485 3,410 27,257-30,667 Home equity ,164 22,293-23,457 Consumer $ 1,416 $ 5,560 $ - $ 6,976 $ 5,370 $ 386,711 $ - $ 392,081 Individually 2015 Allowance for Loan Losses Loans Collectively Acquired Individually Collectively Loan Balances Loans Acquired Evaluated for Evaluated for With Credit Evaluated for Evaluated for With Credit Impairment Impairment Deterioration Total Impairment Impairment Deterioration Total Construction $ - $ 311 $ - $ 311 $ - $ 23,907 $ - $ 23,907 Land ,265-5,388 Commercial 60 1,401-1, ,681-75,291 Commercial real estate 46 2,514-2, , ,313 Residential real estate 1, ,557 3,831 34, ,587 Home equity ,285 22,491-23,776 Consumer $ 1,547 $ 5,313 $ - $ 6,860 $ 6,081 $ 369,245 $ 308 $ 375,634 21

30 The following tables present information related to impaired loans by class of loans as of and for the years ended : Unpaid Allowance for Average Interest Principal Recorded Loan Losses Recorded Income Balance Investment Allocated Investment Recognized Loans without a specific valuation allowance Construction $ - $ - $ - $ - $ - Land Commercial Commercial real estate Residential real estate Home equity Consumer ,727 1,727-1, Loans with a specific valuation allowance Construction Land Commercial Commercial real estate Residential real estate 2,816 2,816 1,119 2, Home equity Consumer ,643 3,643 1,416 3, Total impaired loans $ 5,370 $ 5,370 $ 1,416 $ 5,497 $ Unpaid Allowance for Average Interest Principal Recorded Loan Losses Recorded Income Balance Investment Allocated Investment Recognized Loans without a specific valuation allowance Construction $ - $ - $ - $ - $ - Land Commercial Commercial real estate Residential real estate 1, , Home equity Consumer ,806 1,574-2, Loans with a specific valuation allowance Construction Land Commercial Commercial real estate Residential real estate 3,370 3,370 1,175 3, Home equity Consumer ,815 4,815 1,547 5, Total impaired loans $ 6,621 $ 6,389 $ 1,547 $ 7,095 $

31 The following tables present the aging of the recorded investment in past due loans as of, by class of loans: Delinquent Loans 2016 Total Loans Days Days 90 Days Total Past Loans Not Nonaccrual > 90 Days Past Due Past Due and Over Due Past Due Total Loans Accruing Construction $ - $ - $ - $ - $ 11,200 $ 11,200 $ - $ - Land ,851 4, Commercial ,494 85, Commercial real estate , , Residential real estate ,667 30, Home equity ,015 23, Consumer Total $ 348 $ 37 $ 252 $ 637 $ 391,444 $ 392,081 $ 631 $ - Delinquent Loans 2015 Total Loans Days Days 90 Days Total Past Loans Not Nonaccrual > 90 Days Past Due Past Due and Over Due Past Due Total Loans Accruing Construction $ - $ - $ - $ - $ 23,907 $ 23,907 $ - $ - Land ,388 5, Commercial ,133 75, Commercial real estate , , Residential real estate ,164 38, Home equity ,522 23, Consumer Total $ 395 $ 181 $ 558 $ 1,134 $ 374,500 $ 375,634 $ 1,265 $ 32 Troubled debt restructurings totaled $3,693 and $4,300 at, respectively. The Company has allocated $1,252 and $1,299 of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of December 31, 2016 and 2015, respectively. The Company has not committed to lend any additional amounts as of to customers with outstanding loans that are classified as troubled debt restructurings. No loans were modified in 2016 as troubled debt restructurings. During 2015, the terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; a change in payment amount; or a permanent reduction of the recorded investment in the loan. Modifications involving a reduction of the stated interest rate of the loan were for periods ranging from 3 to 10 years. Modifications involving an extension of the maturity date were for periods ranging from 19 months to 12 years. 23

32 No troubled debt restructurings occurred during the year ended December 31, The following tables present loans by class modified as troubled debt restructurings that occurred during the year ended December 31, 2015: 2015 Pre- Post- Modification Modification Number of Recorded Recorded Loans Balance Balance Land Residential real estate 2 $ 632 $ 632 Home equity $ 1,064 $ 1,064 Newly restructured loans by type of modification: 2015 Interest Only Term Combination Balance Commercial $ - $ 632 $ - $ 632 Residential real estate $ - $ 1,064 $ - $ 1,064 The troubled debt restructurings described above impacted the provision for loan losses by $44 and resulted in no charge-offs during the year ended December 31, A loan is considered to be in payment default once it is 30 days contractually past due under the modified terms. 24

33 The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within 12 months following the modification during the year ended December 31, No loans modified in a troubled debt restructuring subsequently defaulted in Number of Recorded Loans Investment Commercial $ 201 Credit Quality Indicators: The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. Highest Quality Loans classified as highest quality have no apparent or very minimal risk. These loans are secured with cash on deposit with the institution. Good Quality Loans classified as good quality have limited risk. These loans are extended to highperforming borrowers exhibiting consistently strong financial condition and paying capacity. Satisfactory Quality Loans classified as satisfactory quality have average risk. These loans have sound primary repayment sources, and if secured, the quality and marketability of the collateral is sufficient to protect the institution from loss. Acceptable Quality Loans classified as acceptable quality have above average risk, which is mitigated by the structure of the loan, documented performance, and/or internal monitoring by the institution. Loan characteristics may include: borrowers who exhibit marginal financial condition; limited or nonexistent alternative sources of income; illiquid collateral. 25

34 Transitory Loans classified as transitory have weaknesses with the potential to be remedied, generally within a year, through defined corrective measures or events, such as borrower efforts to reduce expenses to improve profitability, or the liquidation of collateral to retire debt. These loans are subject to management s close attention to monitor performance. Below Average Loans classified as below average have a potential weakness that deserves management s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution s credit position at some future date. Substandard Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Loans not meeting the Below Average, Substandard or Doubtful criteria above that are analyzed individually as part of the above-described process are considered to be pass-rated loans. Loans listed as not rated are included in groups of homogeneous loans. Management evaluates the risk category of these unrated loans based on past due status, which was previously presented. The risk characteristics of each loan portfolio segment are as follows: Commercial Mortgage Commercial mortgage loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial mortgage lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial mortgage loans may be more adversely affected by conditions in the real estate markets or in the general economy. The characteristics of properties securing the Company s commercial mortgage portfolio are diverse, but with geographic location almost entirely in the Company s market area. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In general, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk. In addition, management tracks the level of owner-occupied commercial real estate versus nonowner-occupied loans. 26

35 Construction and Land Development Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews and financial analysis of the developers and property owners. Construction loans are generally based on estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing. Commercial and Industrial Commercial and industrial loans are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial loans are secured by the assets being financed or other business assets, such as accounts receivable or inventory, and may include a personal guarantee. Short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Equipment Leases Equipment leases are primarily based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. The equipment leases are secured by the assets being leased and, generally include a personal guarantee. Lease terms are typically 1 year to 5 years. 27

36 Residential Mortgage and Consumer Residential and consumer loans consist of two segments - residential mortgage loans and consumer loans. For residential mortgage loans that are secured by 1-4 family residences and are generally owner-occupied, the Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Home equity loans are typically secured by a subordinate interest in 1-4 family residences, and consumer personal loans are secured by consumer personal assets, such as automobiles or recreational vehicles. Some consumer personal loans are unsecured, such as small installment loans and certain lines of credit. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Repayment can also be impacted by changes in property values on residential properties. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers. Based on the most recent analysis performed, the risk category of loans by class of loans as of is as follows: 2016 Below Not Rated Pass Average Substandard Doubtful Total Construction $ 3,317 $ 7,883 $ - $ - $ - $ 11,200 Land 829 4, ,851 Commercial - 84, ,652 Commercial real estate - 232,657 3, ,942 Residential real estate 20,549 7, ,956-30,667 Home equity 22, ,457 Consumer $ 47,981 $ 336,458 $ 4,773 $ 2,869 $ - $ 392, Not Rated Pass Below Average Substandard Doubtful Total Construction $ 2,849 $ 21,058 $ - $ - $ - $ 23,907 Land 771 4, ,388 Commercial - 74, ,291 Commercial real estate - 205,709 2, ,313 Residential real estate 27,067 7,530 1,333 2,657-38,587 Home equity 23, ,776 Consumer $ 54,236 $ 313,476 $ 4,244 $ 3,678 $ - $ 375,634 28

37 Note 4: Accounting for Purchased Credit-impaired Loans The Company acquired loans in a transfer during the year ended December 31, At acquisition, the transferred loans evidenced deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchased credit-impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC ) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. Management estimated the cash flows expected to be collected at acquisition using our internal risk models, which incorporate the estimate of current key assumptions, such as default rates, severity and prepayment speeds. The carrying amount of those loans is included in the balance sheet amounts of loans receivable at December 31. The amounts of loans at are as follows: Residential real estate Outstanding balance $ - $ 539 Carrying amount, net of allowance of $0 and $231, respectively $ - $ 308 Changes in accretable yield, or income expected to be collected, are as follows: Accretable yield Beginning balance $ 231 $ 686 Additions - - Accretion (231) (455) Ending balance $ - $

38 During the year ended, the Company did not increase the allowance for loan losses by a charge to the income statement. No allowances for loan losses were reversed in 2016 or The balance of the allowance for loan losses for loans acquired and accounted for under this guidance (ASC ) was $0 and $231 at, respectively. Note 5: Premises and Equipment, Net Premises and equipment were as follows at December 31: Land $ 5,599 $ 4,821 Building 12,739 11,486 Furniture and equipment 4,488 4,320 22,826 20,627 Less accumulated depreciation (8,022) (6,673) Net premises and equipment $ 14,804 $ 13,954 The Company leases two branch facilities under operating leases. Rent commitments, before considering renewal options that generally are present, are as follows: 2017 $ 68 Rent expense was $118 and $31 in 2016 and 2015, respectively 30

39 Note 6: Deposits Time deposit accounts with balances of $250 or more were $22,403 and $17,201 at December 31, 2016 and 2015, respectively. Scheduled maturities of time deposits were as follows: 2017 $ 66, , , , ,639 Thereafter 131 $ 100,582 Deposits from executive officers, directors and their affiliates were $2,720 and $3,191 at, respectively. Note 7: Repurchase Agreements Securities sold under agreements to repurchase consist of obligations of the Company to other parties. The maximum amount of outstanding agreements at any month end during 2016 and 2015 totaled $8,968 and $8,955, respectively, and the monthly average of such agreements totaled $7,773 and $6,666 for 2016 and 2015, respectively. Securities sold under agreement to repurchase are secured by mortgage-backed securities and such collateral is held by the Company. The Company may be required to provide additional collateral securing the borrowings in the event of principal pay downs or a decrease in the market value of the pledged securities. The Company mitigates this risk by monitoring the market value and liquidity of the collateral and ensuring that it holds a sufficient level of eligible securities to cover potential increases in collateral requirements. The following table represents the remaining contractual maturity of repurchase agreements disaggregated by the class of securities pledged as of December Overnight & Continuous < 30 Days Days > 90 Days Total Mortgage-backed securities - government-sponsored enterprises (GSE) residential $ 7,040 $ - $ - $ - $ 7,040 31

40 Securities underlying these agreements at December 31 were as follows: Book value of securities $ 9,909 $ 9,656 Fair value 9,771 9,594 Note 8: Core Deposit and Other Intangibles Acquired intangible assets were as follows at December 31: Gross Gross Carrying Accumulated Carrying Accumulated Amount Amortization Amount Amortization Core deposit intangible $ 1,479 $ 623 $ 1,479 $ 457 Intellectual property Total intangible assets $ 2,079 $ 680 $ 1,479 $ 457 Amortization expense was $223 and $166 for 2016 and 2015, respectively. Estimated amortization expense for each of the next five years: 2017 $

41 Note 9: Federal Home Loan Bank Advances At December 31, advances from the FHLB were as follows: Advance due January 5, 2016; interest payable monthly at a fixed rate of 0.32% - 5,000 Advance due December 23, 2016; interest payable monthly at a fixed rate of 1.46% - 5,000 Advance due August 21, 2018; interest payable monthly at a fixed rate of 1.10% 3,000 3,000 Balances, end of year $ 3,000 $ 13,000 Each advance is payable at its maturity date, with a prepayment penalty for fixed rate advances. The Company has pledged $34,696 and $35,137 of first mortgage loans as collateral to secure the advances at, respectively. The Company has the ability to borrow up to 75% of the collateral balance. Note 10: Income Taxes Income tax expense consists of: Current expense $ 3,152 $ 3,458 Deferred tax expense (benefit) (212) (590) Income tax expense $ 2,940 $ 2,868 33

42 A reconciliation of income tax expense at the statutory rate to the Company s actual income tax expense is shown below: Computed at the statutory rate (34%) Increase (decrease) resulting from $ 2,806 $ 2,670 Tax-exempt interest (297) (309) Tax effect of bargain purchase - - State income taxes Other Income tax expense $ 2,940 $ 2,868 The tax effects of temporary differences related to deferred taxes shown on the consolidated balance sheets were: Deferred tax assets Allowance for loan losses $ 2,535 $ 2,452 Unrealized loss on available-for-sale securities Depreciation Lease obligation Share-based compensation Other 27-3,351 2,716 Deferred tax liabilities Bargain purchase gain (617) (645) State tax (129) (114) Mortgage-servicing rights (260) (193) Intangible assets (104) (145) Unrealized gain on available-for-sale securities - (483) Other (58) (59) (1,168) (1,639) Net deferred tax asset $ 2,183 $ 1,077 34

43 There were no interest and penalties recorded in the income statements for the years ended. The Company and its subsidiaries are subject to U.S. federal income tax as well as income tax of the state of Illinois and Indiana. The Company is no longer subject to examination by authorities for years before Note 11: Retirement Plan The Company s 401(k) plan allows substantially all bank employee participants to defer a portion of their salaries. Matching contributions are made by the Company at a rate of 100% of each participant s contributions to a maximum of 3% of each participant s salary. Contribution expense was $215 and $193 in 2016 and Note 12: Share-Based Compensation 320,000 shares were reserved for issuance under the Incentive Equity Option Plan. Options granted under the plan become exercisable over a three-year period from the date of the grant and expire ten years from the date of grant. On March 28, 2014, the 2014 Equity Incentive Plan (share option plan) was created in correlation with the formation of the Company, with 400,000 shares available for issuance. Options granted under the Equity Incentive Plan become exercisable over a three-year period from the date of the grant and expire ten years from the date of grant. At year-end 2016, no options were available for future grants under the Incentive Equity Option Plan and 277,000 options were available for future grants under the Company s 2014 Equity Incentive Plan. The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that used the assumptions noted in the table below. Expected volatilities are based on the approximate historical volatilities of selected micro-cap banks and bank holding companies that are publicly traded. The expected term represents the period of time that options granted are expected to be outstanding, which takes into account that the options are not transferable. The risk-free interest rate for the expected term of the options is based on the U.S. Treasury yield curve in effect at the date of grant. The fair value of options granted was determined using the following weighted-average assumptions as of the grant date. 35

44 Expected term 7 years 7 years Risk-free interest rate 2.25% 1.93% Volatility 20.00% 20.00% Price $ $ Fair value of date of grant $ 6.31 $ 5.88 Option plan activity under the Incentive Equity Option Plan in 2016 is summarized as follows: Weighted- Average Weighted- Remaining Aggregate Average Contractual Intrisic Options Exercise Price Terms (Years) Value Outstanding at beginning of year 52,000 $ Granted - - Exercised (12,000) Forfeited - - Outstanding at end of year 40,000 $ $ 311 Exercisable at end of year 40,000 $ $ 311 Share option plan activity under the Company s 2014 Equity Incentive Plan in 2016 is summarized as follows: Weighted- Average Weighted- Remaining Aggregate Average Contractual Intrisic Options Exercise Price Terms (Years) Value Outstanding at beginning of year 81,667 $ Granted 41, Exercised - - Forfeited - - Outstanding at end of year 122, $ 348 Exercisable at end of year 40, $

45 As of December 31, 2016, there was $481 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the option plans. That cost is expected to be recognized over a weighted-average period of 2 years. The following information relates to the share options exercised under the share option plan during 2016 and 2015: Intrisic value of options exercised $ 115 $ 74 Cash received from option exercises Tax benefit realized from option exercises A summary of the status of the Company s nonvested shares for the Incentive Equity Option Plan as of December 31, 2016, and changes during the year then ended, is presented below: Weighted Average Grant-Date Shares Fair Value Nonvested, beginning of year 2,667 $ 4.33 Granted - Vested (2,667) 4.33 Nonvested, end of year - $ - A summary of the status of the Company s nonvested shares for the 2014 Incentive Equity Option Plan as of December 31, 2016, and changes during the year then ended, is presented below: Weighted Average Grant-Date Shares Fair Value Nonvested, beginning of year 68,333 $ 5.25 Granted 41, Vested (27,333) 5.17 Nonvested, end of year 82,000 $

46 Note 13: Loan Commitments Some financial instruments are used in the normal course of business to meet the financing needs of customers. These financial instruments include commitments to make loans, unused lines of credit and letters of credit. These commitments to extend credit involve, to varying degrees, credit and interest-rate risk in excess of the amounts reported in the consolidated financial statements. The same credit policies are used for commitments as are used for loans. 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 used, the total commitments do not necessarily represent future cash requirements. A summary of the contractual amounts of financial instruments with off-balance-sheet risk at each year end is as follows: Commitments to extend credit $ 14,900 $ 15,350 Unused lines of credit 120, ,839 Standby letters of credit 3,375 1,860 Note 14: Regulatory Matters Banks are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings and other factors, and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. At year-end 2016 and 2015, the most recent regulatory notifications categorized the Company as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the institution s category. Management believes as of, the Company meets all capital adequacy requirements to which it is subject. 38

47 Capital amounts and ratios for the Company and Bank at year end were as follows: Minimum Required Minimum Required To Be Well Capitalized For Capital Adequacy Under Prompt Actual Purposes Corrective Action Company Amount Ratio Amount Ratio Amount Ratio As of December 31, 2016 Total capital (to risk-weighted assets) Tier I (core) capital (to risk-weighted assets) Common equity Tier 1 capital (to risk-weighted assets) Tier I (core) capital (to average assets) $ 60, % $ 36, % 55, % 27, % 55, % 21, % $ 45, % 36, % 55, % 20, % 29, % 26, % As of December 31, 2015 Total capital (to risk-weighted assets) Tier I (core) capital (to risk-weighted assets) Common equity Tier 1 capital (to risk-weighted assets) Tier I (core) capital (to average assets) $ 55, % $ 32, % $ 40, % 50, % 24, % 32, % 50, % 18, % 26, % 50, % 19, % 24, % Minimum Required To Minimum Be Well Capitalized Required Actual For Capital Adequacy Under Prompt Bank Amount Ratio Amount Ratio Amount Ratio As of December 31, 2016 Total capital (to risk-weighted assets) Tier I (core) capital (to risk-weighted assets) Common equity Tier 1 capital (to risk-weighted assets) Tier I (core) capital (to average assets) $ 60, % $ 36, % $ 45, % 54, % 27, % 36, % 54, % 20, % 29, % 54, % 21, % 26, % As of December 31, 2015 Total capital (to risk-weighted assets) Tier I (core) capital (to risk-weighted assets) Common equity Tier 1 capital (to risk-weighted assets) Tier I (core) capital (to average assets) $ 55, % $ 32, % $ 40, % 50, % 24, % 32, % 50, % 18, % 26, % 50, % 19, % 24, % 39

48 Basel III Capital Rules In July 2013, the three federal bank regulatory agencies jointly published final ruls (the Basel III Capital Rules) establishing a new comprehensive capital framework for U.S. banking organizations. The rules implement the Basel Committee s December 2010 framework known as Basel III for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. These rules substantially revise the risk-based capital requirements applicable to bank holding companies and depository institutions, compared to the current U.S. risk-based capital rules. The Basel III Capital Rules define the components of capital and address other issues affecting the numerator in banking institutions regulatory capital ratios. These rules also address risk weights and other issues affecting the denominator in banking institutions regulatory capital ratios and replace the existing risk-weighting approach with a more risk-sensitive approach. The Basel III Capital Rules were effective for the Company on January 1, 2015 (subject to a four-year phase-in period). The Basel III Capital Rules, among other things, (i) introduce a new capital measure called Common Equity Tier 1 (CET1), (ii) specify that Tier 1 capital consist of CET1 and Additional Tier 1 Capital instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions/adjustments as compared to existing regulations. The above minimum capital requirements exclude the capital conservation buffer required to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. The capital conservation buffer is being phased in from 0.0% for 2015 to 2.50% by The capital conservation buffer was 0.625% at December 31, The net unrealized gain or loss on available-for-sale securities is not included in computing regulatory capital. Note 15: Disclosures About Fair Values of Financial Instruments Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value: Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data Level 3: Significant unobservable inputs that reflect a reporting entity s own assumptions about the assumptions that market participants would use in pricing an asset or liability 40

49 Following is a description of the valuation methodologies and inputs used for assets measured at fair value and recognized in the accompanying consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There have been no significant changes in the valuation techniques during the year ended December 31, For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below. Securities The fair values of securities available for sale are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities relationship to other benchmark quoted securities (Level 2 inputs). Impaired Loans The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Level 3 Valuation Process Fair value determinations for Level 3 measurements of impaired loans are the responsibility of the Executive Vice-President, Credit Administration. For each impaired loan, an appraisal is obtained utilizing the comparable sales and/or income approaches. Three comparable sales are then used by the Executive Vice-President, Credit Administration to determine the range and weighted average for disclosure. 41

50 Assets Measured on a Recurring Basis Assets measured at fair value on a recurring basis are summarized below: 2016 Fair Value Measurements Using Quoted Prices in Active Significant Markets for Other Significant Identical Observable Unobservable Fair Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) Available-for-sale securities U.S. Government-sponsored agencies $ 1,018 $ - $ 1,018 $ - State and political subdivisions 38,509-38,509 - Mortgage-backed securities - GSE residential 40,785-40,785 - Collateralized mortgage obligations 15,070-15,070 - $ 95,382 $ - $ 95,382 $ Fair Value Measurements Using Quoted Prices in Active Significant Markets for Other Significant Identical Observable Unobservable Fair Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) Available-for-sale securities U.S. Government-sponsored agencies $ 1,083 $ - $ 1,083 $ - State and political subdivisions 33,312-33,312 - Mortgage-backed securities - GSE residential 43,895-43,895 - Collateralized mortgage obligations 16,012-16,012 - $ 94,302 $ - $ 94,302 $ - 42

51 Assets Measured on a Nonrecurring Basis Assets measured at fair value on a nonrecurring basis are summarized below: 2016 Fair Value Measurements Using Quoted Prices in Active Significant Markets for Other Significant Identical Observable Unobservable Fair Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) Impaired loans Land $ 43 $ - $ - $ 43 Commercial Residential real estate 1, ,307 Home equity Fair Value Measurements Using Quoted Prices in Active Significant Markets for Other Significant Identical Observable Unobservable Fair Assets Inputs Inputs Value (Level 1) (Level 2) (Level 3) Impaired loans Land $ 45 $ - $ - $ 45 Commercial real estate Residential real estate 1, ,385 Home equity Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had total balances of $3,230 and $3,565, with a valuation allowance of $1,393 and $1,498, resulting in an additional provision for loan losses of $4 and $206 for the years ended, respectively. 43

52 The following tables present quantitative information about unobservable inputs used in Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at : 2016 Range Fair Valuation (Weighted- Value Technique Unobservable Inputs Average) Impaired loans Land $ 43 Sales comparison Adjustment for differences between (17)% - 33% approach the comparable sales 7% Commercial 150 Sales comparison Adjustment for differences between (28)% - 0% approach the comparable sales -23% Residential real estate 1,307 Sales comparison Adjustment for differences between (28)% - 21% approach the comparable sales (5)% Home equity 337 Sales comparison Adjustment for differences between (10)% - 21% approach the comparable sales (6)% 2015 Range Fair Valuation (Weighted- Value Technique Unobservable Inputs Average) Impaired loans Land $ 45 Sales comparison Adjustment for differences between (17)% - 33% approach the comparable sales 7% Commercial real estate 187 Sales comparison Adjustment for differences between (34)% - 77% approach the comparable sales (11)% Residential real estate 1,385 Sales comparison Adjustment for differences between (28)% - 15% approach the comparable sales (5)% Home equity 450 Sales comparison Adjustment for differences between (11)% - 21% approach the comparable sales 3% 44

53 Fair Value of Financial Instruments Carrying amount and estimated fair values of financial instruments at December 31 were as follows: Estimated Estimated Carrying Fair Carrying Fair Amount Value Amount Value Financial assets Cash and cash equivalents $ 22,217 $ 22,217 $ 15,296 $ 15,296 Interest-bearing time deposits in other financial institutions 1,480 1,503 2,215 2,223 Loans held for sale Loans, net 383, , , ,365 FHLB stock 1,927 1,927 1,927 1,927 Accrued interest receivable 1,496 1,496 1,507 1,507 Financial liabilities Deposits 457, , , ,923 Securities sold under agreements to repurchase 7,040 7,040 7,019 7,019 FHLB advances 3,000 2,990 13,000 13,015 Accrued interest payable The methods and assumptions used to estimate fair value for other financial instruments in the table above are summarized as follows. Cash and Cash Equivalents, Interest-bearing Time Deposits in Other Financial Institutions and FHLB Stock The carrying amount approximates fair value. Loans Held for Sale The carrying amount approximates fair value due to the insignificant time between origination and date of sale. The carrying amount is the amount funded and accrued interest. 45

54 Loans Fair value is estimated by discounting the future cash flows using the market rates at which similar notes would be made to borrowers with similar credit ratings and for the same remaining maturities. The market rates used are based on current rates the Banks would impose for similar loans and reflect a market participant assumption about risks associated with nonperformance, illiquidity, and the structure and term of the loans along with local economic and market conditions Accrued Interest Receivable and Payable The carrying amount approximates fair value. The carrying amount is determined using the interest rate, balance and last payment date. Deposits Fair value of term deposits is estimated by discounting the future cash flows using rates of similar deposits with similar maturities. The market rates used were obtained from a knowledgeable independent third party and reviewed by the Company. The rates were the average of current rates offered by loan competitors of bank subsidiaries. The estimated fair value of demand, NOW, savings and money market deposits is the book value since rates are regularly adjusted to market rates and amounts are payable on demand at the reporting date. Securities Sold Under Agreements to Repurchase Fair value of term repurchase agreements and other term borrowing is estimated based on current repurchase rates and borrowing rates currently available to the Bank for repurchases and borrowings with similar term and maturities. The estimated fair value for overnight repurchase agreements, federal funds purchased and other borrowings is book value. FHLB Advances Fair value is estimated by discounting the future cash flows using rates of similar advances with similar maturities. These rates were obtained from current rates offered by FHLB. 46

55 Note 16: Business Combination Cobra Capital, LLC On April 20, 2016, the Company purchased substantially all of the assets and assumed the operations of Cobra Capital, LLC (Cobra), a niche-oriented national equipment finance company, located in Darien, Illinois. Under the terms of the Asset Purchase Agreement, the Company paid $508 for the assets of Cobra Capital, LLC and assumed none of its liabilities. Simultaneous with the Cobra asset purchase, the Company entered into an employment agreement with the principal of Cobra whereby incentive payments will be made upon exceeding certain annual net revenue goals of the Cobra division. As a result of this employment agreement, the Company recorded an earn-out liability of $88. The transaction was accounted for under the acquisition method of accounting. The intangible assets of Cobra were recorded at the respective acquisition date fair values. The Company recorded a net gain on the Cobra acquisition of $12. Note 17: Subsequent Events Subsequent events have been evaluated through the date of the Independent Auditor s Report, which is the date the consolidated financial statements were available to be issued. On February 28, 2017 the $4,000 line of credit with United Bankers Bank was renewed, effective January 31, 2017, with a maturity date of January 31, This credit facility is collateralized by shares of the Company s stock. There were no draws on this credit facility in

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57 in the communities we serve through... The Providence Bank & Trust Stewardship Program designed so that 10% of the Bank s profits are donated to local civic, non-profit and Christian organizations.

58 The Providence Bank & Trust Stewardship Program 2016OVERVIEW All God s Children American Cancer Society Association House of Chicago Berwyn Historical Society Bethshan Foundation Bible League Bridge Communities Bright Hope International Bright Promise Fund By The Hand Club for Kids Calvary Academy Inc. Calvin Christian School Calvin College Campagna Academy CareNet Pregnancy Services Catholic Charities Cedar Lake Ministries Chicago Christian Counseling Center Chicago First Fund: The Chicago Public Schools Foundation Chicago Football Classic Chicago Southland Economic Development Corporation Chicagoland Prison Outreach Christ Our Savior Catholic School Clare Woods Academy CRCNA Foundation Ignite Crown Point Christian School Daystar School Divine Hope Reformed Seminary EasterSeals Joliet Region Elim Christian Services Faith & Action Free The Girls Freedom Bound Jail Ministry Friends of DCACC (DuPage County Animal Care Control) Girls On The Run Grande Prairie Choral Arts Heritage Christian High School Highland Christian School Hispanic Heritage Foundation Hope College Illiana Christian High School Illiana Right to Life Joliet Catholic Academy Journey Pregnancy & Life Hub Junior Achievement Kiwanis Clubs Lampstand Ministries Lansing Christian School LARC/Serving People with Developmental Disabilities Life in Messiah Love Christian Clearing House Manitoqua Ministries/Camp Manitoqua Medi/Mex Inc. Mid-America Reformed Seminary Midwest Shelter for Homeless Veterans Mission India Multiplication Network Ministries Munster Firefighters Association Munster Little League Nathan C. Splant Foundation New Hope Center New Leaf Resources NWI Symphony Orchestra Outreach Community Ministries PASS Pregnancy Care Centers Planting Possibilities Port Ministries Protestant Reformed Christian School Providence Christian Academy Association Providence Life Services Reformed Faith & Life Restoration Ministries Roseland Christian Ministries Rotary Clubs Schererville Baseball Sertoma Centre, Inc. Servantworks South Holland Little League South Holland Professional Firefighters South Suburban College Foundation Southwest Chicago Christian Schools Spanish Community Center St. Mary Catholic Community School Tabitha House The Bridge Teen Center The Cancer Support Center Thornton Township School District #205 Timothy Christian Schools Trinity Christian College Trinity Christian School University of St. Francis Joliet VFW Posts Wheaton Academy Wheaton Christian Grammar School Will County Children s Advocacy Center Women s Center of NW Indiana World Renew YMCA Young Life Young Men s Christian Association BELONG providencebank.com Conveniently located throughout the Chicagoland area & Northwest Indiana. While we do our best to include as many organizations as possible that we give to throughout the year, not all may be included above. We are humbled and privileged to provide support to the important work of groups who provide such a positive impact on our communities. Se Habla Español