SAVI FINANCIAL CORPORATION, INC. AND SUBSIDIARY BURLINGTON, WASHINGTON

Transcription

1 SAVI FINANCIAL CORPORATION, INC. AND SUBSIDIARY BURLINGTON, WASHINGTON AUDITED FINANCIAL STATEMENTS AND OTHER FINANCIAL INFORMATION

2 C O N T E N T S AUDITED FINANCIAL STATEMENTS: PAGE Report of Independent Registered Public Accounting Firm... 1 Balance Sheets (Bank only)... 3 Statements of Income (Bank only)... 4 Statements of Comprehensive Income (Bank only)... 5 Statements of Changes in Shareholders Equity (Bank only)... 6 Statements of Cash Flows (Bank only)... 7 Notes to Financial Statements... 8 OTHER FINANCIAL INFORMATION: Consolidated Balance Sheet Consolidating Balance Sheet... 44

3 REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM To the Shareholders and the Board of Directors of Savi Financial Corporation, Inc. Burlington, Washington Opinion on the Financial Statements We have audited the accompanying balance sheets of SaviBank (the Bank ) as of December 31, 2017 and 2016, the related statements of income, comprehensive income, changes in shareholders equity and cash flows for the years then ended, and the related notes (collectively referred to as the financial statements ). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Bank as of December 31, 2017 and 2016, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Savi Financial Corporation, Inc. was activated on December 31, For comparative purposes, we have not included the Corporation in the basic financial statements. The consolidated balance sheet is presented as supplemental financial information. Basis for Opinion These financial statements are the responsibility of the Bank s management. Our responsibility is to express an opinion on the Bank s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ( PCAOB ) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Bank is not required to have, nor were we engaged to perform, and audit of its internal control over financial reporting. As a part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Bank s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. We have served as the Bank s auditor since 2007.

4 Other Matters Our audits were conducted for the purpose of forming an opinion on the financial statements taken as a whole. The other financial information on pages is presented for the purposes of additional analysis and is not a required part of the financial statements. Such information is the responsibility of management and was derived from and relates directly to the underlying accounting and other records used to prepare the financial statements. Such information has been subjected to the auditing procedures applied in the audit of the financial statements and certain additional procedures, including comparing and reconciling such information directly to the underlying accounting and other records used to prepare the financial statements or to the financial statements themselves, and other additional procedures in accordance with auditing standards generally accepted in the United States of America. In our opinion, the other financial information is fairly stated in all material aspects in relation to the financial statements taken as a whole. STOVALL, GRANDEY & ALLEN, LLP Fort Worth, Texas March 13,

5 SAVIBANK BALANCE SHEETS (BANK ONLY) ASSETS Cash and due from banks - Note 2 $ 2,860,735 $ 3,579,938 Interest-bearing deposits with financial institutions 9,885,556 8,581,723 Cash and cash equivalents 12,746,291 12,161,661 Investment securities - Note 3 9,978,557 8,952,860 Federal Home Loan Bank stock, at cost - Note 2 583,700 1,307,600 Pacific Coast Bankers' Bank stock, at cost - Note 2 190, ,000 Loans receivable, net of allowance for loan losses and deferred loan fees - Note 4 181,900, ,495,813 Other real estate owned 470,723 1,510,685 Premises and equipment, net - Note 6 7,541,987 5,917,739 Accrued interest receivable 530, ,979 Deferred tax asset - Note 8 2,334,350 4,597,932 Other assets 1,055, ,551 Total Assets $ 217,331,916 $ 186,342,820 LIABILITIES Deposits - Note 7 $ 178,273,874 $ 137,162,179 Federal Home Loan Bank borrowings - Note 10 9,000,000 28,500,000 Dividend payable 500,000 - Accrued interest payable 157,130 56,385 Accrued expenses and other liabilities 1,001, ,997 Total Liabilities 188,932, ,230,561 Commitments and contingencies - Notes 6, 10, 11, 12 and 13 SHAREHOLDERS' EQUITY - Notes 14, 15 and 16 Common stock, no par value; authorized: 20,000,000 shares Issued and outstanding: 17,113,064 and 11,695,061 shares at December 31, 2017 and 2016, respectively 37,465,527 28,838,101 Additional paid-in capital 321, ,623 Retained deficit (9,302,955) (8,905,685) Accumulated other comprehensive loss, net of tax benefit of $22,612 and $44,190 at December 31, 2017 and 2016, respectively (85,066) (85,780) Total Shareholders' Equity 28,399,066 20,112,259 Total Liabilities and Shareholders' Equity $ 217,331,916 $ 186,342,820 The accompanying notes are an integral part of these financial statements. 3

6 SAVIBANK STATEMENTS OF INCOME (BANK ONLY) FOR THE YEARS ENDED Interest income Interest and fees on loans $ 9,083,490 $ 7,173,963 Interest on investment securities 182,858 89,710 Interest on interest-bearing deposits with financial institutions 81,352 11,986 Total interest income 9,347,700 7,275,659 Interest expense On deposits 848, ,295 On borrowed funds 336, ,461 Total interest expense 1,184, ,756 Net interest income 8,163,104 6,413,903 Provision for loan losses - Note 4 23, ,663 Net interest income after provision for loan losses 8,140,104 6,100,240 Non-interest income Service charges on deposit accounts 246, ,294 Gain on sales of SBA loans (guaranteed portion) 930, ,379 Net gain on sales of other real estate owned 10, ,255 Rental income 125,457 95,881 Other 400, ,963 Total non-interest income 1,714,448 1,323,772 Non-interest expense Salaries and employee benefits 4,894,761 3,866,254 Occupancy and equipment 888, ,910 Data processing fees 241, ,035 Professional fees 140, ,674 FDIC assessment 69, ,433 OREO expense and writedowns 47, ,162 Directors and officers insurance 89,888 90,940 Director fees 125, ,532 Regulatory examination fees 49,474 41,319 B & O taxes 161,912 99,699 Other expense 800, ,317 Total non-interest expense 7,509,817 6,249,275 Income before federal income tax (benefit) 2,344,735 1,174,737 Federal income tax (benefit) - Note 8 2,256,003 (4,553,742) Net Income $ 88,732 $ 5,728,479 The accompanying notes are an integral part of these financial statements. 4

7 SAVIBANK STATEMENTS OF COMPREHENSIVE INCOME (BANK ONLY) FOR THE YEARS ENDED Net Income $ 88,732 $ 5,728,479 Other Comprehensive Income (Loss) Securities available-for-sale: Change in net unrealized gains/losses, net of tax (benefit), during the year 14,712 (59,281) Other comprehensive income (loss), net of tax (benefit) 14,712 (59,281) Comprehensive Income $ 103,444 $ 5,669,198 The accompanying notes are an integral part of these financial statements. 5

8 SAVIBANK STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (BANK ONLY) FOR THE YEARS ENDED Accumulated Shares of Additional Other Common Common Paid-in Retained Comprehensive Stock Stock Capital Deficit Loss Total Balance at January 1, ,630,161 $ 28,757,066 $ 218,069 $ (14,634,164) $ (26,499) $ 14,314,472 Stock-based compensation, stock options 47,554 47,554 Stock options exercised 900 1,035 1,035 Sales of common stock 64,000 80,000 80,000 Comprehensive income (loss) for the year ended December 31, ,728,479 (59,281) 5,669,198 Balance at December 31, ,695,061 28,838, ,623 (8,905,685) (85,780) 20,112,259 Stock-based compensation, stock options 55,937 55,937 Stock options exercised 14,708 17,839 17,839 Sales of common stock 5,403,295 8,609,587 8,609,587 Dividend declared (500,000) (500,000) Reclassification for federal income tax rate change from 34% to 21% 13,998 (13,998) Comprehensive income for the year ended December 31, ,732 14, ,444 Balance at December 31, ,113,064 $ 37,465,527 $ 321,560 $ (9,302,955) $ (85,066) $ 28,399,066 The accompanying notes are an integral part of these financial statements. 6

9 SAVIBANK STATEMENTS OF CASH FLOWS (BANK ONLY) FOR THE YEARS ENDED CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 88,732 $ 5,728,479 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 338, ,074 Provision for loan losses 23, ,663 Writedowns on other real estate owned - 54,801 Net loss on sales of investment securities Gain on sales of SBA loans (930,926) (616,379) Net gain on sales of other real estate owned (10,828) (157,255) Net amortization on investment securities 40,070 28,310 Stock-based compensation 55,937 47,554 Deferred income tax (benefit) 2,242,005 (4,553,742) Increase in other assets (377,773) (192,963) Increase in other liabilities 590, ,532 Total adjustments 1,971,049 (4,676,405) Net Cash Provided by Operating Activities 2,059,781 1,052,074 CASH FLOWS FROM INVESTING ACTIVITIES: Purchases of investment securities (3,416,041) (4,833,577) Principal payments on investment securities 1,235, ,686 Proceeds from sales of investment securities 1,136,750 - Purchases of FHLB stock (3,396,100) (4,999,100) Redemptions of FHLB stock 4,120,000 4,040,000 Net increase in loans receivable (30,434,206) (35,197,618) Cash proceeds from sales of other real estate owned 1,002, ,506 Purchases of property and equipment (1,962,792) (1,461,520) Net Cash Used by Investing Activities (31,714,272) (41,093,623) CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in deposits 41,111,695 17,325,867 Proceeds from FHLB borrowings 9,000,000 23,500,000 Payments on FHLB borrowings (28,500,000) - Proceeds from exercise of incentive stock options 17,839 1,035 Net proceeds from common stock issued 8,609,587 80,000 Net Cash Provided by Financing Activities 30,239,121 40,906,902 Net increase in cash and cash equivalents 584, ,353 Cash and cash equivalents at beginning of year 12,161,661 11,296,308 Cash and cash equivalents at end of year $ 12,746,291 $ 12,161,661 SUPPLEMENTAL SCHEDULE OF OPERATING AND INVESTING ACTIVITIES: Cash paid for interest $ 1,083,851 $ 863,549 Other real estate owned, acquired through foreclosure - 367,287 Federal income taxes paid 31,000 34,000 Bank financed sales of other real estate owned 48, ,000 The accompanying notes are an integral part of these financial statements. 7

10 Note 1 Description of Business SaviBank is a commercial bank chartered in the State of Washington. The Bank began operations April 11, 2005 and has five branch locations in Burlington, Bellingham, Mt. Vernon, Oak Harbor, and Freeland, Washington. A loan production center was opened in Anacortes, Washington in May The Bank provides loan and deposit services to customers who are predominantly small and middlemarket businesses and individuals in and around Skagit, Island, and Whatcom counties. The Bank operates under a state bank charter and is subject to regulation by the State of Washington Department of Financial Institutions and the Federal Deposit Insurance Corporation (FDIC). On July 6, 2017, Savi Financial Corporation, Inc. (the Corporation) was formed in the State of Washington as a financial holding company. Effective December 31, 2017, the Corporation and SaviBank entered into a Share Exchange Agreement in order to effect the transfer of 100% of the issued and outstanding common stock of the Bank. Each issued and outstanding share of common stock of the Bank was automatically converted into one share of common stock of the Corporation. As a result of the Share Exchange, the Corporation became the sole shareholder of common stock of the Bank and the Bank will continue in existence as a wholly-owned subsidiary of the Corporation. Note 2 Summary of Significant Accounting Policies Financial Statement Presentation The financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and practices within the banking industry. These financial statements are presented as Bank only because the transfer of shares occurred on the last day of the year and no Bank earnings are attributable to the Corporation. Refer to Note 21 for Parent Only financial statements as of December 31, Also refer to the consolidated balance sheet as of December 31, 2017 which is presented in Other Financial Information on page 43. The consolidated balance sheet of the Corporation includes its accounts and those of its one hundred percent (100%) owned subsidiary, SaviBank. All significant intercompany accounts and transactions have been eliminated upon consolidation. Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The determination of the adequacy of the allowance for loan losses is based on estimates that are particularly susceptible to significant changes in the economic environment and market conditions. In connection with the determination of the estimated losses on loans, management obtains independent appraisals for significant collateral. The Bank s loans are generally secured by specific items of collateral including real property, consumer assets and business assets. Although the Bank has a diversified loan portfolio, a substantial portion of its debtors ability to honor their contracts is dependent on local economic conditions. While management uses available information to recognize losses on loans, further reductions in the carrying amounts of loans may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the estimated 8

11 Note 2 Summary of Significant Accounting Policies, continued Estimates, continued losses on loans. Such agencies may require the Bank to recognize additional losses based on their judgments about information available to them at the time of their examination. Because of these factors, it is reasonably possible that the estimated losses on loans may change materially in the near term. However, the amount of the change that is reasonably possible cannot be estimated. Cash and Cash Equivalents Cash and due from banks consists of vault cash, cash items in the process of collection, and non-interestbearing deposits with financial institutions. For purposes of the statements of cash flows, the Bank considers cash and cash equivalents to include cash, due from banks, interest-bearing deposits, and investments with an original maturity of three months or less and federal funds sold. Restrictions on Cash and Due from Banks SaviBank is required to maintain reserve funds in cash or on deposit with Pacific Coast Bankers Bank. The required reserve at December 31, 2017 and 2016 was $404,000 and $625,000, respectively. Investment Securities The Bank accounts for investment securities according to authoritative guidance issued by the Financial Accounting Standards Board (FASB). Under the provisions of the FASB authoritative guidance, debt securities that management has the ability and intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. The amortization of premiums and accretion of discounts are recognized in interest income using methods approximating the interest method over the period to maturity. Debt securities not classified as held-to-maturity are classified as available-for-sale. Securities availablefor-sale are carried at fair value with unrealized gains and losses reported in other comprehensive income. Realized gains (losses) on securities available-for-sale are included in other income, and when applicable, are reported as a reclassification adjustment, in other comprehensive income. Gains and losses on sales of securities are determined on the specific-identification method. Declines in the fair value of individual held-to-maturity and available-for-sale securities below their amortized cost that are other than temporary result in writedowns of the individual securities to their fair value. The related writedowns are included in earnings as realized losses. In estimating other-than temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Bank to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Federal Home Loan Bank and Pacific Coast Bankers Bank Stock The Bank s investment in Federal Home Loan Bank (FHLB) stock is a restricted investment carried at cost ($100 per share par value), which reasonably approximates its fair value. As a member of the FHLB system, the Bank is required to maintain a minimum level of investment in FHLB stock based on specific percentages of its outstanding FHLB advances. The Bank is required to purchase or redeem shares as the level of outstanding advances increase or decrease. This stock is classified as a restricted investment security, carried at cost and evaluated annually for impairment. No impairment loss was recorded in 2017 or

12 Note 2 Summary of Significant Accounting Policies, continued Federal Home Loan Bank and Pacific Coast Bankers Bank Stock, continued The Bank owns stock in Pacific Coast Bankers Bank (PCBB). The investment in PCBB stock is a restricted investment carried at cost, which reasonably approximates its fair value. As a holder of PCBB stock, the Bank is allowed to borrow at a lower interest rate than a non-holder and to receive dividends. Loans Loans that management has the intent and ability to hold for the foreseeable future are stated at the principal amount outstanding, net of allowance for loan losses and deferred loan fees. Loan fees and certain direct loan origination costs are deferred, and the net fee or cost is recognized as an adjustment to interest income using the interest method. Interest on loans is calculated using the simple interest method based on the daily balance of principal amount outstanding and is credited to income when earned. Interest is accrued as earned unless management doubts the collectibility of interest or principal, at which time the loan is placed on nonaccrual status and accrued but unpaid interest is charged against income in that period. Any loan delinquent 90 days or more is placed on nonaccrual. Accrual of interest income is resumed when the borrower demonstrates the ability to make scheduled payments of both principal and interest. Management considers loans impaired when it is probable the Bank will not be able to collect all amounts as scheduled under a loan agreement. Impaired loans are measured based on the present value of expected future cash flows, discounted at the loan s effective interest rate, or, as a practical expedient, at the loan s observable market price or the fair value of the collateral if the loan is collateral dependent. Changes in these values will be reflected in income and as adjustments to the allowance for possible loan losses. The accrual of interest on impaired loans is discontinued when, in management s opinion, the borrower may be unable to meet payments as they become due, unless the loan is well secured and in the process of collection. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received, or payment is considered certain. Allowance for Loan Losses The allowance for loan losses is maintained at a level believed to be sufficient to absorb potential losses in the portfolio. The allowance for specific loan losses is provided on loans, which are considered impaired when full collectibility may not be assured. The allowance is established by a charge against operations in the period the loss is identified. General loan loss reserves are established to provide for inherent risks in the portfolio. The reserves are based on management s continuing evaluation of the pertinent factors underlying the credit quality of the loan portfolio, including changes in the size and composition of the loan portfolio, actual loan loss experience, and current and anticipated economic conditions. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. Additionally, loans are subject to examinations by state and federal regulators, who, based upon their judgment, may require the Bank to make additional provisions or adjustments to its allowance for loan losses. Past due status is determined based on contractual terms. 10

13 Note 2 Summary of Significant Accounting Policies, continued Transfers of Financial Assets Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when: (1) the assets have been isolated from the Bank, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Reserve for Unfunded Commitments The Bank has established a reserve for possible losses associated with commitments to lend funds under existing agreements. Management determines the adequacy of the reserve for unfunded commitments by evaluating the outstanding commitment levels, the expected conversion to loans, historical loss estimates and other relevant factors. This evaluation is inherently subjective and actual losses may vary from current estimates. Changes in the reserve are reported in earnings in the periods they become known. The reserve for unfunded commitments is included in accrued expenses and other liabilities in the accompanying balance sheets. At December 31, 2017 and 2016, the recorded liability was $71,529. Premises and Equipment Property, equipment and leasehold improvements are recorded at cost, net of accumulated depreciation and amortization. Gains and losses on dispositions are reflected in operations. Expenditures for improvements and major renewals are capitalized, and ordinary maintenance, repairs and small purchases are charged to operations as incurred. Depreciation and Amortization Property, equipment and leasehold improvements are depreciated or amortized over the estimated useful life of the related asset, which ranges from three to fifty years. The Bank uses the straight-line method of recognizing depreciation and amortization expenses. Leasehold improvements are amortized over lease terms on a straight-line basis. Other Real Estate Owned Other real estate owned is foreclosed property held pending disposition and is initially recorded at fair value less estimated selling costs when acquired, establishing a new cost basis. At foreclosure, if the fair value of the real estate acquired less estimated selling costs is less than the Bank s recorded investment in the related loan, a writedown is recognized through a charge to the allowance for loan losses. Costs of significant property improvements are capitalized, whereas costs relating to holding property are expensed. Valuations are periodically performed by management, and any subsequent writedowns are recorded as a charge to income, if necessary, to reduce the carrying value of the property to its fair value less estimated selling costs. Sales of other real estate owned are accounted for according to authoritative guidance issued by the FASB. 11

14 Note 2 Summary of Significant Accounting Policies, continued Income Taxes Income taxes are provided for the tax effects of the transactions reported in the financial statements and consist of taxes currently due plus deferred taxes related primarily to differences between the tax and financial reporting of the allowance for loan losses, accumulated depreciation, organization costs and conversion from accrual to cash basis. The deferred tax assets and liabilities represent the future tax return consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Effective beginning in 2017, the Corporation and the Bank will file consolidated federal income tax returns. The Corporation and the Bank maintain their records for both financial reporting and income tax reporting on the accrual basis of accounting. In accordance with authoritative guidance issued by the FASB, the Bank performed an evaluation to determine if there were any uncertain tax positions that would have an impact on the financial statements. No uncertain tax positions were identified. The December 31, 2014 through December 31, 2017 tax years remain subject to examination by the Internal Revenue Service. The Bank does not believe that any reasonably possible changes will occur within the next 12 months which will have a material impact on the financial statements. The Bank records incurred penalties and interest in other non-interest expense. There were no penalties and interest assessed by taxing authorities during 2017 or Advertising Costs The Bank expenses advertising costs as they are incurred. Total advertising expense was $166,603 and $84,797 for the years ended December 31, 2017 and 2016, respectively. Stock-Based Employee Compensation The Bank has a stock-based compensation plan described more fully in Note 16. The Bank has adopted authoritative guidance issued by the FASB regarding stock compensation. The Bank s statements of income include $55,937 and $47,554 of compensation expense related to stockbased compensation for options for the years ended December 31, 2017 and 2016, respectively. Financial Instruments In the ordinary course of business, the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and commercial letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. 12

15 Note 2 Summary of Significant Accounting Policies, continued Fair Values of Financial Instruments The FASB has issued authoritative guidance which requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. The FASB authoritative guidance excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank. The following methods and assumptions were used by the Bank in estimating its fair value disclosures for financial instruments: Cash and due from banks: The carrying amounts reported in the balance sheet for cash and due from banks approximate those assets fair values. Interest-bearing deposits with financial institutions: The carrying amounts of interest-bearing deposits at other financial institutions approximate fair values. Investment securities: Fair values for investment securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. FHLB stock and PCBB stock: These are restricted investments carried at cost which approximates fair value. Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans (for example, fixed rate commercial real estate and rental property mortgage loans and commercial and industrial loans) are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The fair value of impaired loans is estimated using discounted cash flow analysis or underlying collateral values, where applicable. Deposits: The fair values disclosed for demand deposits (for example, interest-bearing checking accounts and savings accounts) are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The fair values for time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. Long-Term Borrowings: The fair values of the Bank s long-term borrowings are estimated using discounted cash flow analyses based on the Bank s current incremental borrowing rates for similar types of borrowing arrangements. Short-Term Borrowings: The carrying amount of short-term borrowings approximates their fair values. Accrued Interest: The carrying amount of accrued interest approximates its fair value. 13

16 Note 2 Summary of Significant Accounting Policies, continued Reclassifications Certain reclassifications have been made to the 2016 financial statements to conform to current year presentations. Such reclassifications have had no effect upon previously reported net income. Subsequent Events Subsequent events are events or transactions that occur after the balance sheet date but before the financial statements are available to be issued. The Bank recognizes in the financial statements the effects of all subsequent events that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing the financial statements. The Bank s financial statements do not recognize subsequent events that provide evidence about conditions that did not exist at the date of the balance sheet but arose after the balance sheet date and before the financial statements are available to be issued. The Bank has evaluated subsequent events from December 31, 2017 through March 13, 2018, the date the financial statements were available to be issued. Refer to Note 22 for subsequent events identified for disclosure. New Accounting Standards In May 2014, the FASB issued ASU , Revenue from Contracts with Customers (Topic 606). This guidance is a comprehensive new revenue recognition standard that will supersede substantially all existing revenue recognition guidance. The new standard s core principle is that a bank will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the bank expects to be entitled in exchange for those goods or services. In doing so, banks will need to use more judgement and make more estimates than under existing guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. On July 9, 2015, the FASB agreed to delay the effective date of the standard by one year. Therefore, the new standard will be effective for annual reporting periods beginning after December 31, Implementation of this standard is not expected to have a significant impact on the Bank s financial statements. In April 2015, FASB issued ASU , Interest Imputation of Interest (Subtopic ), which amended its authoritative guidance related to debt issuance costs. The amendment requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of the debt liability. However, the recognition and measurement guidance related to debt issuance costs is not affected by this amendment. The amendment is effective for annual and interim reporting periods beginning after December 15, 2015 and is to be applied on a retrospective basis. This amendment became effective in 2016 and did not have a significant impact on the Bank s financial statements. 14

17 Note 2 Summary of Significant Accounting Policies, continued New Accounting Standards, continued In January 2016, the FASB issued ASU No , Financial Instruments Overall: Recognition and Measurement of Financial Assets and Financial Liabilities. The amendment has a number of provisions including the requirements that public business entities use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, a separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e. securities or loans receivables), and eliminating the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendment is effective for annual and interim reporting periods beginning after December 15, The Bank is evaluating the potential impact of the amendment on the Bank s financial statements. In February 2016, the FASB issued ASU No , Leases (Topic 842) intended to improve financial reporting regarding leasing transactions. The new standard affects all companies and organizations that lease assets. The standard will require organizations to recognize on the statement of financial condition the assets and liabilities for the rights and obligations created by those leases if the lease terms are more than 12 months. The guidance also will require qualitative and quantitative disclosures providing additional information about the amounts recorded in the financial statements. The amendments in this update are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Bank is evaluating the potential impact of the amendment on the Bank s financial statements. In June 2016, the FASB issued ASU No , Financial Instruments Credit Losses (Topic 326) intended to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations. The standard requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. The standard also requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization s portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. Additionally, the standard amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The amendments in this update are effective for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. All entities may adopt the amendments in this update earlier as of the fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. An entity will apply the amendments in this update through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (that is, a modified-retrospective approach). The Bank believes the amendments in this update will have an impact on the Bank s financial statements and is working to evaluate the significance of that impact. 15

18 Note 2 Summary of Significant Accounting Policies, continued New Accounting Standards, continued In August 2016, the FASB issued ASU No , Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This amendment provides guidance on eight specific cash flow issues, including debt prepayment or debt extinguishment costs, settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporateowned life insurance policies, including bank-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions and separately identifiable cash flows and application of the predominance principle. The amendments in this update are effective for public business entities for fiscal years beginning after December 15, For all other entities, the amendments are effective for fiscal years beginning after December 15, Early adoption is permitted. Implementation of this standard is not expected to have a significant impact on the Bank s financial statements. In March 2017, the FASB issued ASU No , Receivables Nonrefundable Fees and Other Costs (Subtopic ): Premium Amortization on Purchased Callable Debt Securities. The amendments in this update shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. For public entities, the amendments in this update are effective for fiscal years beginning after December 15, For all other entities, the amendments are effective for fiscal years beginning after December 15, Early adoption is permitted. The amendments of this update are applied on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Bank is evaluating the potential impact to the financial statements regarding implementation of this amendment. In May 2017, the FASB issued ASU No , Compensation Stock Compensation (Topic 718). The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. This amendment requires an entity to account for the effects of a modification unless all of the following are met: (1) The fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified; (2) The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and (3) The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendments in this update are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, Early adoption is permitted. Implementation of this standard is not expected to have a significant impact on the Bank s financial statements. In February 2018, the FASB issued ASU No , Income Statement Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This amendment helps organizations reclassify certain stranded income tax effects in accumulated other comprehensive income resulting from the reduction in the federal income tax rate included in the Tax Cuts and Jobs Acts of The amendment is effective for all organizations for fiscal years beginning after December 15, Early adoption is permitted. The Bank early adopted this standard in 2017 and reclassified $13,998 from Accumulated Other Comprehensive Loss to Retained Deficit. 16

19 Note 3 Investment Securities The amortized cost and fair values of investment securities at December 31, 2017 are as follows: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Available-for-Sale: U.S. Government agency $ 1,513,190 $ - $ (30,826) $ 1,482,364 Municipal bonds 1,409,747 - (35,094) 1,374,653 U.S. Government agency mortgage-backed securities 306, (2,293) 304,867 Collateralized mortgage obligations (CMOs) 495,887 2, ,175 SBA pools 6,360,965 10,113 (52,580) 6,318,498 Totals $ 10,086,235 $ 13,115 $ (120,793) $ 9,978,557 The balance sheet as of December 31, 2017 reflects the fair value of available-for-sale securities of $9,978,557. A net unrealized loss of $107,678 is included in the available-for-sale investment securities balance. The unrealized loss, net of tax benefit, is included in shareholders equity. The amortized cost and fair values of investment securities at December 31, 2016 are as follows: Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Fair Value Available-for-Sale: U.S. Government agency $ 1,515,956 $ - $ (38,282) $ 1,477,674 Municipal bonds 1,151,473 - (42,152) 1,109,321 U.S. Government agency mortgage-backed securities 1,104,003 1,287 (2,451) 1,102,839 Collateralized mortgage obligations (CMOs) 499,017 - (6,458) 492,559 SBA pools 4,812,380 2,968 (44,881) 4,770,467 Totals $ 9,082,829 $ 4,255 $ (134,224) $ 8,952,860 The balance sheet as of December 31, 2016 reflects the fair value of available-for-sale securities of $8,952,860. A net unrealized loss of $129,969 is included in the available-for-sale investment securities balance. The unrealized loss, net of tax benefit, is included in shareholders equity. 17

20 Note 3 Investment Securities, continued The amortized cost and estimated fair value of debt securities at December 31, 2017, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mortgagebacked securities, collateralized mortgage obligations and SBA pools are shown separately, since they are not due at a single maturity date. Amortized Cost Available-for-Sale Fair Value Amounts Maturing: One year or less $ - $ - After one year to five years 1,903,405 1,854,574 After five years to ten years 1,019,532 1,002,443 2,922,937 2,857,017 U.S. Govt. agency mortgage-backed securities 306, ,867 Collateralized mortgage obligations 495, ,175 SBA pools 6,360,965 6,318,498 Totals $ 10,086,235 $ 9,978,557 Proceeds from sales of investment securities were $1,136,750 in 2017 with gross realized gains of $100 and gross realized losses of $588. There were no sales of investment securities during Securities with carrying amounts of $65,454 and $4,190 at December 31, 2017 and 2016, respectively, were pledged to secure public deposits and for other purposes as required or permitted by law. 18

21 Note 3 Investment Securities, continued Information pertaining to securities with gross unrealized losses at December 31, 2017 and 2016, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows: Less Than 12 Months 12 Months or Greater Total Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses Fair Value Gross Unrealized Losses December 31, 2017: U.S. Government agency $ - $ - $ 1,482,364 $ (30,826) $ 1,482,364 $ (30,826) Municipal bonds 264,015 (1,393) 1,110,638 (33,701) 1,374,653 (35,094) U.S. Government agency mortgagebacked securities 93,352 (1,477) 97,984 (816) 191,336 (2,293) SBA pools 2,988,826 (17,129) 1,740,070 (35,451) 4,728,896 (52,580) Totals $ 3,346,193 $ (19,999) $ 4,431,056 $ (100,794) $ 7,777,249 $ (120,793) December 31, 2016: U.S. Government agency $ 1,477,674 $ (38,282) $ - $ - $ 1,477,674 $ (38,282) Municipal bonds 1,109,321 (42,152) - - 1,109,321 (42,152) U.S. Government agency mortgagebacked securities 133,266 (288) 588,502 (2,163) 721,768 (2,451) CMOs 492,559 (6,458) ,559 (6,458) SBA pools 2,267,918 (17,325) 2,182,296 (27,556) 4,450,214 (44,881) Totals $ 5,480,738 $ (104,505) $ 2,770,798 $ (29,719) $ 8,251,536 $ (134,224) Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Bank to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Certain investment securities shown above currently have fair values less than amortized cost and therefore contain unrealized losses. At December 31, 2017, there are 29 investment securities with an unrealized loss of 1.53% from their amortized cost. The Bank has evaluated these securities and has determined that the decline in value is temporary and is related to the change in market interest rates since purchase. The decline in value is not related to any company or industry specific event. The Bank anticipates full recovery of amortized cost with respect to these securities at maturity or sooner in the event of a more favorable market interest rate. As management has the ability to hold debt securities until maturity, or for the foreseeable future if classified as available-for-sale, no declines are deemed to be other-than-temporary. 19

22 Note 4 Loans Receivable and Allowance for Loan Losses An analysis of loan categories at December 31, 2017 and 2016 is as follows: Commercial and agricultural loans $ 23,053,497 $ 20,084,974 Real estate (RE) loans: Construction, land and land development 18,618,339 16,455,696 Residential 1-4 family 42,812,049 40,860,583 Commercial RE 90,481,852 67,426,222 Consumer and other loans 9,010,662 7,289, ,976, ,116,594 Less: Deferred loan fees (129,609) (96,826) Allowance for loan losses (1,946,439) (1,523,955) Loans, net $ 181,900,351 $ 150,495,813 Included in total loans above are $28,153 and $842 in overdrawn accounts at December 31, 2017 and 2016, respectively. Transactions in the allowance for loan losses in 2017 are summarized as follows: Commercial and Agricultural Construction, Land and Land Development Residential 1-4 Family Commercial Real Estate Consumer and Other Unallocated 2017 Total Allowance for Loan Losses: Balance, beginning of year $ 290,174 $ 185,434 $ 216,868 $ 251,635 $ 18,350 $ 561,494 $ 1,523,955 Provisions, charged (credited) to income (13,874) (64,056) 163, ,213 56,074 (219,574) 23, , , , ,848 74, ,920 1,546,955 Loans charged-off (50,000) - - (75,000) (11,968) - (136,968) Recoveries of loans previously charged-off 131,155 1,810 5, ,997 5, ,452 Net (charge-offs) recoveries 81,155 1,810 5, ,997 (6,018) - 399,484 Balance, end of year $ 357,455 $ 123,188 $ 385,625 $ 669,845 $ 68,406 $ 341,920 $ 1,946,439 Amounts allocated to: Individually evaluated for impairment $ 29,628 $ 589 $ 103,313 $ 999 $ - $ - $ 134,529 Amounts allocated to: Collectively evaluated for impairment 327, , , ,846 68, ,920 1,811,910 Balance, end of year $ 357,455 $ 123,188 $ 385,625 $ 669,845 $ 68,406 $ 341,920 $ 1,946,439 Loans: Individually evaluated for impairment $ 334,575 $ 313,762 $ 1,065,554 $ 130,839 $ 6,036 $ 1,850,766 Collectively evaluated for impairment 22,718,922 18,304,577 41,746,495 90,351,013 9,004, ,125,633 Ending balance total loans $ 23,053,497 $ 18,618,339 $ 42,812,049 $ 90,481,852 $ 9,010,662 $ 183,976,399 20