10-Q

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company filer

Emerging growth company

10-Q 1 d574781d10q.htm 10-Q 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended June 30, 2018

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

Commission File Number: 000-23667

HOPFED BANCORP, INC.

(Exact name of registrant as specified in its charter)


Delaware		61-1322555
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

4155 Lafayette Road, Hopkinsville, Kentucky		42240
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (270) 885-1171

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required and posted pursuant to Rule 405 of Regulation S-T (subsection 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated file or a non-accelerated filer. See definition of “accelerated filer”, “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule12b-2 of the Exchange Act: (Check one)

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

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

As of August 8, 2018, the Registrant had outstanding 6,649,493 shares of the Registrant’s Common stock, $0.01 par value per share, issued and outstanding.

CONTENTS

HOPFED BANCORP, INC.


		PAGE
PART I. FINANCIAL INFORMATION

The unaudited consolidated condensed financial statements of the Registrant and its wholly owned subsidiaries are as follows:

Item 1.	Financial Statements

	Interim Consolidated Condensed Statements of Financial Condition as of June 30, 2018 (unaudited) and December 31, 2017		2

	Interim Consolidated Condensed Statements of Income for the Three and Six Month Periods Ended June 30, 2018 and June 30, 2017 (unaudited)		4

	Interim Consolidated Condensed Statements of Comprehensive Income for the Three and Six Month Periods Ended June 30, 2018 and June 30, 2017 (unaudited)		6

	Interim Consolidated Condensed Statement of Stockholders’ Equity for the Six Month Period Ended June 30, 2018 (unaudited)		7

	Interim Consolidated Condensed Statements of Cash Flows for the Six Month Periods Ended June 30, 2018 and June 30, 2017 (unaudited)		8

	Notes to Unaudited Interim Consolidated Condensed Financial Statements		9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		40

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		48

Item 4.	Controls and Procedures		48

PART II OTHER INFORMATION

Item 1.	Legal Proceedings		49

Item 1A.	Risk Factors		49

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		50

Item 3.	Defaults Upon Senior Securities		50

Item 4.	Mine Safety Disclosures		50

Item 5.	Other Information		50

Item 6.	Exhibits		51

SIGNATURES			52

PART I. FINANCIAL INFORMATION

Item 1.

Financial Statements

HOPFED BANCORP, INC.

Interim Consolidated Condensed Statements of Financial Condition

(Dollars in Thousands)


	June 30, 2018		December 31, 2017
	(unaudited)
Assets
Cash and due from banks	$	16,399		37,965
Interest-bearing deposits in banks		2,955		7,111

Cash and cash equivalents		19,354		45,076
Federal Home Loan Bank stock, at cost		4,428		4,428
Securities available for sale		168,983		184,791
Loans held for sale		1,126		1,539
Loans receivable, net of allowance for loan losses of $4,637 at June 30, 2018 and $4,826 at December 31, 2017		672,254		637,102
Accrued interest receivable		3,253		3,589
Foreclosed assets		3,427		3,369
Bank owned life insurance		10,512		10,368
Premises and equipment, net		22,365		22,700
Deferred tax assets		2,320		1,764
Other assets		4,640		2,784

Total assets	$	912,662		917,510

Liabilities and Stockholders’ Equity
Liabilities:
Deposits:
Non-interest-bearing accounts	$	136,004		136,197
Interest-bearing accounts
Checking accounts		198,691		208,496
Savings and money market accounts		97,552		104,347
Other time deposits		300,941		304,969

Total deposits		733,188		754,009

Advances from Federal Home Loan Bank		38,000		23,000
Repurchase agreements		39,648		38,353
Subordinated debentures		10,310		10,310
Advances from borrowers for taxes and insurance		1,256		808
Accrued expenses and other liabilities		3,091		3,618

Total liabilities		825,493		830,098

See accompanying Notes to Unaudited Interim Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Interim Consolidated Condensed Statements of Financial Condition, Continued

(Dollars in Thousands)


	June 30, 2018			December 31, 2017
	(unaudited)
Stockholders’ equity
Preferred stock, par value $0.01 per share; authorized - 500,000 shares; no shares issued and outstanding at June 30, 2018 and December 31, 2017		—			—
Common stock, par value $.01 per share; authorized 15,000,000 shares; 7,989,655 issued and 6,647,675 outstanding at June 30, 2018 and 7,976,131 issued and 6,637,711 outstanding at December 31, 2017		80			80
Additional paid-in-capital		58,948			58,825
Retained earnings		53,179			51,162
Treasury stock, at cost (1,341,980 shares at June 30, 2018 and 1,338,360 shares at December 31, 2017)		(16,706	)		(16,655	)
Unearned Employee Stock Ownership Plan (“ESOP”) shares, at cost (412,091 shares at June 30 2018 and 434,548 share at December 31, 2017)		(5,606	)		(5,901	)
Accumulated other comprehensive income		(2,726	)		(99	)

Total stockholders’ equity		87,169			87,412

Total liabilities and stockholders’ equity	$	912,662			917,510

See accompanying Notes to Unaudited Interim Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Interim Consolidated Condensed Statements of Income

(Dollars in Thousands)

(Unaudited)


	For the Three Month Periods Ended June 30,				For the Six Month Periods Ended June 30,
	2018		2017		2018		2017
Interest and dividend income:
Loans		7,858		6,963		15,335		13,699
Investment in securities, taxable		1,033		1,155		2,112		2,273
Nontaxable securities available for sale		208		280		421		563
Interest-bearing deposits		16		21		45		44

Total interest and dividend income		9,115		8,419		17,913		16,579

Interest expense:
Deposits		1,392		1,197		2,636		2,364
FHLB borrowings		134		30		226		62
Repurchase agreements		171		119		325		222
Subordinated debentures		138		108		260		212

Total interest expense		1,835		1,454		3,447		2,860

Net interest income		7,280		6,965		14,466		13,719
Provision for loan losses		62		59		130		350

Net interest income after provision for loan losses		7,218		6,906		14,336		13,369

Non-interest income:
Service charges		727		800		1,433		1,604
Merchant card		330		315		638		617
Mortgage origination revenue		489		278		808		612
Gain on sale of investments		481		14		508		16
Income from bank owned life insurance		73		72		144		307
Income from financial services		177		145		315		285
Other operating income		87		212		262		691

Total non-interest income		2,364		1,836		4,108		4,132

See accompanying Notes to Unaudited Interim Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Interim Consolidated Condensed Statements of Income, Continued

(Dollars in Thousands, Except Per Share Amounts)

(Unaudited)


	For the Three Month Periods Ended June 30,				For the Six Month Periods Ended June 30,
	2018		2017		2018		2017
Non-interest expenses:
Salaries and benefits		4,116		3,977		8,233		8,213
Occupancy		747		729		1,529		1,504
Data processing		765		546		1,549		1,310
State deposit tax		160		200		329		431
Professional services		499		464		965		812
Advertising		338		368		646		749
Foreclosure, net		21		6		15		114
Loss on sale of asset		9		3		9		3
Other		919		940		1,839		1,786

Total non-interest expense		7,574		7,233		15,114		14,922

Income before income tax expense		2,008		1,509		3,330		2,579
Income tax expense		323		368		519		503

Net income		1,685		1,141		2,811		2,076

Net income per share:
Basic	$	0.28	$	0.18	$	0.46	$	0.33

Diluted	$	0.28	$	0.18	$	0.46	$	0.33

Dividend per share	$	0.07	$	0.05	$	0.12	$	0.09

See accompanying Notes to Unaudited Interim Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Interim Consolidated Condensed Statements of Comprehensive Income (Loss)

(Dollars in Thousands)

(Unaudited)


	For the Three Month Periods Ended June 30,						For the Six Month Periods Ended June 30,
	2018			2017			2018			2017
Net income	$	1,685			1,141			2,811			2,076

Other comprehensive income, net of tax:

Unrealized gain on non-other than temporary impaired investment securities available for sale, net of taxes of of $168 and ($126) for the three month periods ended June 30, 2018 and June 30, 2017, respectively; and $654 and ($247) for the six month periods ended June 30, 2018 and June 30, 2017, respectively.		(629	)		240			(2,459	)		475

Unrealized gain on OTTI securites, net of taxes of none and ($43) for the three month periods ended June 30, 2018 and June 30, 2017; and ($61) and ($14) for the six month periods ended June 30, 2018 and June 30, 2017, respectively.		—			83			233			26

Reclassification adjustment for gains included in net net income, net of taxes of $100 and $5 for the three month periods ended June 30, 2018 and June 30, 2017, respectively; and $106 and $6 for the six month periods ended June 30, 2018 and June 30, 2017, respectively.		(380	)		(9	)		(401	)		(10	)

Total other comprehensive income		(1,009	)		314			(2,627	)		491

Comprehensive income	$	676			1,455			184			2,567

See accompanying Notes to Unaudited Interim Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Interim Consolidated Condensed Statement of Stockholders’ Equity

For the Six Month Period Ended June 30, 2018

(Dollars in Thousands, Except Share Amounts)

(Unaudited)


	Common Shares			Common Stock		Additional Paid in Capital		Retained Earnings			Common Treasury Shares			Unearned ESOP Shares			Accumulated Other Comprehensive Income			Total Stockholders’ Equity
Balance December 31, 2017		6,637,771		$	80		58,825		51,162			(16,655	)		(5,901	)		(99	)		87,412
Restricted stock awards		13,524			—		—		—			—			—			—			—
Net income		—			—		—		2,811			—			—			—			2,811
Repurchase of treasury stock		(3,620	)		—		—		—			(51	)		—			—			(51	)
ESOP shares committed to be released		—			—		—		—			—			295			—			295
Change in price of ESOP shares		—			—		75		—			—			—			—			75
Compensation expense, restricted stock awards		—			—		48		—			—			—			—			48
Net change in unrealized gain on securities available for sale, net of income taxes of $699		—			—		—		—			—			—			(2,627	)		(2,627	)
Cash dividend declared to common shareholders		—			—		—		(794	)		—			—			—			(794	)

Balance June 30, 2018		6,647,675		$	80		58,948		53,179			(16,706	)		(5,606	)		(2,726	)		87,169

See accompanying Notes to Unaudited Interim Consolidated Condensed Financial Statements.

HOPFED BANCORP, INC.

Interim Consolidated Condensed Statements of Cash Flows

(Dollars in Thousands)

(Unaudited)


	For the Six Month Periods
	Ended June 30,
	2018			2017
Cash flows from operating activities:

Net cash provided by operating activities	$	4,660			4,662

Cash flows from investing activities:
Proceeds from sales, calls and maturities of securities available for sale		16,994			27,362
Purchase of securities available for sale		(7,042	)		(23,047	)
Net increase in loans		(35,207	)		(27,474	)
Proceeds from sale of foreclosed assets		88			1,136
Proceeds from sale of premises and equipment		—			—
Purchase of premises and equipment		(292	)		(251	)

Net cash provided by (used in) investing activities		(25,459	)		(22,274	)

Cash flows from financing activities:
Net (decrease) increase in demand deposits		(16,793	)		7,027
Net (decrease) increase in time and other deposits		(4,028	)		6,035
Increase in advances from borrowers for taxes and insurance		448			218
Advances from Federal Home Loan Bank		45,000			32,000
Repayment of advances from Federal Home Loan Bank		(30,000	)		(22,000	)
Net increase (decrease) in repurchase agreements		1,295			(5,835	)
Cash used to repurchase treasury stock		(51	)		(14	)
Dividends paid on common stock		(794	)		(559	)

Net cash (used in) provided by financing activities		(4,923	)		16,872

Increase (decrease) in cash and cash equivalents		(25,772	)		(740	)
Cash and cash equivalents, beginning of period		45,076			25,749

Cash and cash equivalents, end of period	$	19,354		$	25,009

Supplemental disclosures of cash flow information:
Interest paid		3,396			2,840

Income taxes paid		—			388

See accompanying Notes to Unaudited Interim Consolidated Condensed Financial Statements.

NOTES TO UNAUDITED INTERIM CONSOLIDATED CONDENSED FINANCIAL STATEMENTS

(1)	BASIS OF PRESENTATION

The accompanying unaudited interim consolidated condensed financial statements include the accounts of HopFed Bancorp, Inc. (the “Corporation” or “HopFed”) and its subsidiaries (collectively, the “Company”). The Corporation is a parent holding company of Heritage Bank USA, Inc. (the “Bank”). The Banks owns JBMM, LLC, a wholly owned, limited liability company, which owns and manages the Bank’s foreclosed assets. The Bank also owns Heritage USA Title, LLC, which sells title insurance to the Bank’s real estate loan customers. The Bank owns Fort Webb LP, LLC, which owns a limited partnership interest in Fort Webb Elderly Housing LLLP, a low income senior citizen housing facility in Bowling Green, Kentucky. All significant intercompany accounts have been eliminated.

The Bank is a Kentucky commercial bank regulated by the Kentucky Department of Financial Institutions (“KDFI”) and the Federal Deposit Insurance Corporation (“FDIC”). HopFed Bancorp is regulated by the Federal Reserve Bank of Saint Louis (“FED”).

The accompanying unaudited interim consolidated condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring accruals) necessary for fair presentation have been included. The results of operations and other data for the six month period ended June 30, 2018 are not necessarily indicative of results that may be expected the entire fiscal year ending December 31, 2018.

The accompanying unaudited interim consolidated condensed financial statements should be read in conjunction with the Consolidated Financial Statements and the Notes thereto included in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017. The accounting policies followed by the Company are set forth in the Summary of Significant Accounting Policies in the Company’s December 31, 2017 Consolidated Financial Statements.

(2)	EARNINGS PER SHARE

Basic earnings per share (EPS) is computed by dividing net income by the weighted average number of common stock shares outstanding. Diluted EPS is computed by dividing net income by the weighted average number of common stock shares outstanding, adjusted for the effect of potentially dilutive stock awards outstanding during the period. For the three and six month periods ended June 30, 2018 and June 30, 2017, the Company has excluded all unearned shares held by the ESOP.


	For the three month periods Ended June 30,
	2018		2017
Basic EPS:
Net income	$	1,685,000	$	1,141,000
Average common shares outstanding		6,142,680		6,228,894

Earnings per share	$	0.28	$	0.18

Diluted EPS
Net income	$	1,685,000	$	1,141,000
Average common shares outstanding		6,142,680		6,228,894
Dilutive effect of unvested restricted stock		—		—

Average diluted shares outstanding		6,142,680		6,228,894

Earnings per share, diluted	$	0.28	$	0.18


	For the six month periods Ended June 30,
	2018		2017
Basic EPS:
Net income	$	2,811,000	$	2,076,000
Average common shares outstanding		6,165,415		6,223,802

Earnings per share	$	0.46	$	0.33

Diluted EPS
Net income	$	2,811,000	$	2,076,000
Average common shares outstanding		6,165,415		6,223,802
Dilutive effect of unvested restricted stock		—		—

Average diluted shares outstanding		6,165,415		6,223,802

Earnings per share, diluted	$	0.46	$	0.33

(3)	SECURITIES

The carrying amount of securities and their estimated fair values at June 30, 2018 and December 31, 2017 were as follows:


	June 30, 2018
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(Dollars in Thousands)
Restricted:
FHLB stock	$	4,428		—		—			4,428

Available for sale:
U.S. Agency securities	$	77,769		141		(1,756	)		76,154
Taxable municipal bonds		962		—		(7	)		955
Tax free municipal bonds		24,555		227		(165	)		24,617
Mortgage backed securities		69,147		80		(1,970	)		67,257

	$	172,433		448		(3,898	)		168,983


	December 31, 2017
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value
	(Dollars in Thousands)
Restricted:
FHLB stock	$	4,428		—		—			4,428

Available for sale:
U.S. Agency securities		84,210		536		(653	)		84,093
Taxable municipal bonds		1,279		5		(1	)		1,283
Tax free municipal bonds		26,412		637		(83	)		26,966
Trust preferred securities		1,650		35		—			1,685
Mortgage-backed securities		71,389		201		(826	)		70,764

	$	184,940		1,414		(1,563	)		184,791

The scheduled maturities of debt securities available for sale at June 30, 2018 were as follows:


	Amortized Cost		Estimated Fair Value
	(Dollars in Thousands)
Due within one year	$	1,570	$	1,586
Due in one to five years		29,252		28,735
Due in five to ten years		13,297		12,995
Due after ten years		7,252		7,273

		51,371		50,589
Amortizing agency bonds		51,915		51,137
Mortgage-backed securities		69,147		67,257

Total securities available for sale	$	172,433	$	168,983

The estimated fair value and unrealized loss amounts of temporarily impaired investments as of June 30, 2018 were as follows:


	Less than 12 months					12 months or longer					Total
	Estimated		Unrealized			Estimated		Unrealized			Estimated		Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
	(Dollars in Thousands)
Available for sale
U.S. Agency securities	$	45,588		(1,219	)		15,434		(537	)		61,022		(1,756	)
Taxable municipal bonds		955		(7	)		—		—			955		(7	)
Tax free municipal bonds		6,817		(132	)		732		(33	)		7,549		(165	)
Mortgage-backed securities		41,653		(1,103	)		20,722		(867	)		62,375		(1,790	)

Total available for sale	$	95,013		(2,461	)		36,888		(1,437	)		131,901		(3,898	)

The estimated fair value and unrealized loss amounts of temporarily impaired investments as of December 31, 2017 were as follows:


	Less than 12 months					12 months or longer					Total
	Estimated		Unrealized			Estimated		Unrealized			Estimated		Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
	(Dollars in Thousands)
Available for sale
U.S. Agency securities	$	41,501		(431	)		9,846		(222	)		51,347		(653	)
Taxable municipal bonds		521		(1	)		—		—			521		(1	)
Tax free municipal bonds		4,860		(51	)		913		(32	)		5,773		(83	)
Mortgage-backed securities		40,441		(289	)		21,566		(537	)		62,007		(826	)

Total available for sale	$	87,323		(772	)		32,325		(791	)		119,648		(1,563	)

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluations. 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 Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.

At June 30, 2018, the Company has 103 securities with unrealized losses. The losses for all securities are considered to be a direct result of the effect that the prevailing interest rate environment had on the value of debt securities and are not related to the credit worthiness of the issuers. Furthermore, the Company has the intent and ability to retain its investments in the issuers for a period of time that management believes to be sufficient to allow for any anticipated recovery in fair value. Therefore, the Company did not recognize any other-than-temporary impairments as of June 30, 2018.

At June 30, 2018 and December 31, 2017, securities with a book value of approximately $105.5 million and $119.8 million and a market value of approximately $105.1 million and $118.0 million, respectively, were pledged to various municipalities for deposits in excess of FDIC limits as required by law. At June 30, 2018 and December 31, 2017, securities with a market value of $39.6 million and $38.4 million were sold to customers as part of overnight repurchase agreements.

(4)

LOANS

The Company uses the following loan segments as described below:

•

One-to-four family first mortgages are closed-end loans secured by residential housing. Loans may be either owner or non-owner occupied properties. If the loan is owner-occupied, the loan is analyzed and under-written as a consumer loan. Loan terms may be up to 30 years.

•

Home equity lines of credit may be first or second mortgages secured by one-to-four family properties. Home equity loans carry a variable rate and typically are open ended for a period not to exceed ten years with a fifteen year final maturity. Loans secured by home equity lines of credit are under-written under the Company’s consumer loan guidelines.

•

Junior liens are closed-end loans secured by one-to-four family residences with a fixed or variable rate. Typically, the collateral for these loans are owner occupied units with a subordinate lien. Loans secured by junior liens are under-written under the Company’s consumer loan guidelines.

•

Multi-family loans are closed-end loans secured by residential housing with five or more units in a single building. Multi-family loans may carry a variable rate of interest or the interest rate on the loan is a fixed rate (usually five years). After the initial fixed rate period, the loan reverts to a variable rate or has balloon maturity. Multi-family loans have amortization terms of up to twenty years and are under-written under the Company’s commercial loan underwriting guidelines.

•

Constructions loans may consist of residential or commercial properties and carry a fixed or variable rate for the term of the construction period. Construction loans have a maturity of between twelve and twenty-four months depending on the type of property. After the construction period, loans are amortized over a twenty-year period. All construction loans are under written under the Company’s commercial loan underwriting guidelines for the type of property being constructed.

•

Land loans consist of properties currently under development, land held for future development and land held for recreational purposes. Land loans used for recreational purposes are amortized for twenty years and typically carry a fixed rate of interest for one-to-five years with a balloon maturity or floating rate period to follow and are under-written under the Company’s commercial loan underwriting guidelines.

•

Loans classified as farmland by the Company include properties that are used exclusively for the production of grain, livestock, poultry or swine. Loans secured by farmland have a maturity of up to twenty years and carry a fixed rate of interest for five to ten years. Loans secured by farmland are under-written under the Company’s commercial loan underwriting guidelines.

•

Non-residential real estate loans are secured by commercial real estate properties and may be either owner or non-owner occupied. The loans typically have a twenty year maturity and may be fixed for a period of five to ten years. After the initial fixed rate period, the note will either revert to a one year adjustable rate loan or have a balloon maturity. Loans secured by non-residential real estate are under-written under the Company’s commercial loan underwriting standards.

•

The Company originates secured and unsecured consumer loans. Collateral for consumer loans may include deposits, brokerage accounts, automobiles and other personal items. Consumer loans are typically fixed for a term of one to five years and are under-written using the Company’s consumer loan policy.

•

The Company originates unsecured and secured commercial loans. Secured commercial loans may have business inventory, accounts receivable and equipment as collateral. The typical customer may include all forms of manufacturing, retail and wholesale sales, professional services and various forms of agri-business interest. Commercial loans may be fixed or variable rate and typically have terms between one and five years.

Set forth below is selected data relating to the composition of the loan portfolio by type of loan at June 30, 2018 and December 31, 2017.


	June 30, 2018			December 31, 2017
	(Dollars in Thousands)
Real estate loans:
One-to-four family first mortgages	$	171,725		$	163,565
Home equity lines of credit		34,262			35,697
Junior liens		1,109			1,184
Multi-family		37,742			37,445
Construction		40,759			30,246
Land		9,033			14,873
Non-residential real estate		244,769			224,952
Farmland		33,271			36,851

Total mortgage loans		572,670			544,813

Consumer loans		8,525			8,620
Commercial loans		96,214			88,938

Total other loans		104,739			97,558

Total loans		677,409			642,371

Deferred loan fees, net of cost		(518	)		(443	)

Less allowance for loan losses		(4,637	)		(4,826	)

Total loans, net	$	672,254		$	637,102

Although the Company has a diversified loan portfolio, 84.5% and 84.8% of the portfolio was concentrated in loans secured by real estate at June 30, 2018 and December 31, 2017, respectively. At June 30, 2018 and December 31, 2017, the majority of these loans are located within the Company’s general operating area.

Risk Grade Classifications

The Company utilizes a credit grading system that provides a uniform framework for establishing and monitoring credit risk in the loan portfolio. Under this system, each loan is graded based on pre-determined risk metrics and categorized into one of the risk grades discussed below. The Company uses the following risk grade definitions for commercial loans:

Excellent - Loans in this category are to persons or entities of unquestioned financial strength, a highly liquid financial position, with collateral that is liquid and well margined. These borrowers have performed without question on past obligations, and the Bank expects their performance to continue. Internally generated cash flow covers current maturities of long-term debt by a substantial margin. Loans secured by Bank certificates of deposit and savings accounts, with appropriate holds placed on the accounts, are to be rated in this category.

Very Good - These are loans to persons or entities with strong financial condition and above-average liquidity who have previously satisfactorily handled their obligations with the Bank. Collateral securing the Bank’s debt is margined in accordance with policy guidelines. Internally generated cash flow covers current maturities of long-term debt more than adequately. Unsecured loans to individuals supported by strong financial statements and on which repayment is satisfactory may be included in this classification.

Satisfactory - Assets of this grade conform to substantially all the Bank’s underwriting criteria and evidence an average level of credit risk; however, such assets display more susceptibility to economic, technological or political changes since they lack the above average financial strength of credits rated Very Good. Borrower’s repayment capacity is considered to be adequate. Credit is appropriately structured and serviced; payment history is satisfactory.

Acceptable - Assets of this grade conform to most of the Bank’s underwriting criteria and evidence an acceptable, though higher than average, level of credit risk; however, these loans have certain risk characteristics which could adversely affect the borrower’s ability to repay given material adverse trends. Loans in this category require an above average level of servicing and show more reliance on collateral and guaranties to preclude a loss to the Bank should material adverse trends develop. If the borrower is a company, its earnings, liquidity and capitalization are slightly below average when compared to its peers.

Watch - These loans are characterized by borrowers who have marginal cash flow, marginal profitability, or have experienced an unprofitable year and a declining financial condition. The borrower has in the past satisfactorily handled debts with the Bank, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While the Bank continues to be adequately secured, margins have decreased or are decreasing, despite the borrower’s continued satisfactory condition. Other characteristics of borrowers in this class include inadequate credit information, weakness of financial statement and repayment capacity, but with collateral that appears to limit exposure. This classification includes loans to established borrowers that are reasonably margined by collateral, but where potential for improvement in financial capacity appears limited.

Special Mention - Loans in this category have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deteriorating prospects for the asset or in the institution’s credit position at some future date. Borrowers may be experiencing adverse operating trends or market conditions. Non-financial reasons for rating a credit exposure Special Mention include, but are not limited to: management problems, pending litigations, ineffective loan agreement and/or inadequate loan documentation, structural weaknesses and/or lack of control over collateral.

Substandard - A substandard asset is inadequately protected by the current sound worth or paying capacity of the debtor or the collateral pledged. There exists one or more well defined weaknesses that jeopardize the liquidation of the debt. There is a distinct possibility the Bank will experience some loss if the deficiencies are not corrected.

Doubtful - A loan classified as doubtful has all the weaknesses inherent in a loan 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. These are poor quality loans in which neither the collateral, if any, nor the financial condition of the borrower presently ensure collectability in full in a reasonable period of time; in fact, there is permanent impairment in the collateral securing the Bank’s loan. These loans are in a work-out status and have a defined work-out strategy.

Loss - Loans classified as loss are considered uncollectible and of such little value that their continuance as Bankable assets is not warranted. The Bank takes losses in the period in which they become uncollectible.

The following credit risk standards are assigned to consumer loans:

Satisfactory - All consumer open-end and closed-end retail loans shall have an initial risk grade assigned of 3 - Satisfactory.

Substandard - All consumer open-end and closed-end retail loans past due 90 cumulative days from the contractual date will be classified as 7 - Substandard. If a consumer/retail loan customer files bankruptcy, the loan will be classified as 7 - Substandard regardless of payment history.

Loss - All closed-end retail loans that become past due 120 cumulative days and open-end retail loans that become past due 180 cumulative days from the contractual due date will be charged off as loss assets. The charge off will be taken by the end of the month in which the 120-day or 180-day time period elapses. All losses in retail credit will be recognized when the affiliate becomes aware of the loss, but in no case should the charge off exceed the time frames stated within this policy.

The following table provides a detail of the Company’s activity in the allowance for loan loss account by loan type for the six month period ended June 30, 2018:


	Balance 12/31/2017		Charge offs 2018			Recoveries 2018		Provision 2018			Ending Balance 6/30/2018
	(Dollars in Thousands)
One-to-four family mortgages	$	747		(6	)		6		147			894
Home equity line of credit		189		—			5		(33	)		161
Junior liens		5		—			—		—			5
Multi-family		314		—			—		(26	)		288
Construction		161		—			—		23			184
Land		1,223		(40	)		—		(581	)		602
Non-residential real estate		789		—			9		539			1,337
Farmland		367		(2	)		1		(180	)		186
Consumer loans		184		(137	)		41		76			164
Commercial loans		847		(200	)		4		165			816

Total	$	4,826		(385	)		66		130			4,637


The following table provides a detail of the Company’s activity in the allowance for loan loss account by loan type for the year ended December 31, 2017:

	Balance 12/31/2016		Charge offs 2017			Recoveries 2017		Provision 2017			Ending Balance 12/31/2017
	(Dollars in Thousands)
One-to-four family mortgages	$	852		(66	)		13		(52	)		747
Home equity line of credit		260		—			12		(83	)		189
Junior liens		8		—			4		(7	)		5
Multi-family		412		—			417		(515	)		314
Construction		277		—			—		(116	)		161
Land		1,760		(2,608	)		559		1,512			1,223
Non-residential real estate		964		—			16		(191	)		789
Farmland		778		—			10		(421	)		367
Consumer loans		208		(261	)		87		150			184
Commercial loans		593		(224	)		278		200			847

Total	$	6,112		(3,159	)		1,396		477			4,826

The table below presents past due and non-accrual balances, excluding loan fees of $518,000, at June 30, 2018 by loan classification allocated between performing and non-performing:


	Currently Performing		30 - 89 Days Past Due		Past due more than 90 days and Accruing		Non- accrual Loans		Special Mention		Substandard		Total
One-to-four family mortgages	$	169,579		884		—		367		—		895		171,725
Home equity line of credit		33,875		—		—		347		—		40		34,262
Junior liens		1,092		13		—		4		—		—		1,109
Multi-family		37,742		—		—		—		—		—		37,742
Construction		40,759		—		—		—		—		—		40,759
Land		8,535		—		—		—		—		498		9,033
Non-residential real estate		233,294		366		—		322		5,317		5,470		244,769
Farmland		33,271		—		—		—		—		—		33,271
Consumer loans		8,252		15		—		6		—		252		8,525
Commercial loans		91,790		327		—		556		807		2,734		96,214

Total	$	658,189		1,605		—		1,602		6,124		9,889		677,409


The table below presents past due and non-accrual balances, excluding loan fees of $443,000, at December 31, 2017 by loan classification allocated between performing and non-performing:

	Currently Performing		30 - 89 Days Past Due		Past due more than 90 days and Accruing		Non-accrual Loans		Special Mention		Substandard		Total
			(Dollars in Thousands)
One-to-four family mortgages	$	162,724		181		88		266		—		306		163,565
Home equity line of credit		35,285		—		—		402		—		10		35,697
Junior liens		1,180		—		—		4		—		—		1,184
Multi-family		37,445		—		—		—		—		—		37,445
Construction		30,246		—		—		—		—		—		30,246
Land		14,322		—		—		40		—		511		14,873
Non-residential real estate		216,692		209		—		—		979		7,072		224,952
Farmland		35,253		—		—		111		1,147		340		36,851
Consumer loans		8,373		3		—		3		—		241		8,620
Commercial loans		83,892		—		—		459		3,572		1,015		88,938

Total	$	625,412		393		88		1,285		5,698		9,495		642,371

The following table presents the balance in the allowance for loan losses and the recorded investment in loans as of June 30, 2018 and December 31, 2017 by portfolio segment and based on the impairment method.


	Commercial		Land Development / Construction		Commercial Real Estate		Residential Real Estate		Consumer		Total
	(Dollars in Thousands)
June 30, 2018:
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	162		—		—		—		62	$	224
Collectively evaluated for impairment		654		786		1,811		1,060		102		4,413

Total ending allowance balance	$	816		786		1,181		1,060		164	$	4,637

Loans:
Loans individually evaluated for impairment	$	3,019		498		5,394		277		247	$	9,435
Loans collectively evaluated for impairment		93,195		49,294		310,388		206,819		8,278	$	667,974

Total ending loans balance	$	96,214		49,792		315,782		207,096		8,525	$	677,409


	Commercial		Land Development / Construction		Commercial Real Estate		Residential Real Estate		Consumer		Total
	(Dollars in Thousands)
December 31, 2017:
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	233		—		2		—		54	$	289
Collectively evaluated for impairment		614		1,384		1,468		941		130	$	4,537

Total ending allowance balance	$	847		1,384		1,470		941		184	$	4,826

Loans:
Loans individually evaluated for impairment	$	1,416		515		7,532		257		217	$	9,937
Loans collectively evaluated for impairment		87,522		44,604		291,716		200,189		8,403	$	632,434

Total ending loans balance	$	88,938		45,119		299,248		200,446		8,620	$	642,371

The determination of the allowance for loan losses is based on management’s analysis, performed on a quarterly basis. Various factors are considered, including the growth and composition of the loan portfolio, the relationship of the allowance for loan losses to outstanding loans, historical loss experience, delinquency trends and prevailing economic conditions and the market value of the underlying collateral. Although management believes its allowance for loan losses is adequate, there can be no assurance that additional allowances will not be required or that losses on loans will not be incurred.

A loan is considered to be impaired when management determines that it is probable that the Company will be unable to collect all principal and interest payments due in accordance with the contractual terms of the loan agreement. The value of individually impaired loans is measured based on the present value of expected payments or using the fair value of the collateral less cost to sell if the loan is collateral dependent. Currently, it is management’s practice to classify all substandard or doubtful loans as impaired.

Loans by classification type and credit risk indicator at June 30, 2018 and December 31, 2017 were as follows:


June 30, 2018	Pass		Special Mention		Substandard		Doubtful		Total
			(Dollars in Thousands)
One-to-four family mortgages	$	170,463		—		1,262		—		171,725
Home equity line of credit		33,875		—		387		—		34,262
Junior liens		1,105		—		4		—		1,109
Multi-family		37,742		—		—		—		37,742
Construction		40,759		—		—		—		40,759
Land		8,535		—		498		—		9,033
Non-residential real estate		233,660		5,317		5,792		—		244,769
Farmland		33,271		—		—		—		33,271
Consumer loans		8,267		—		258		—		8,525
Commercial loans		92,117		807		3,290		—		96,214

Total	$	659,794		6,124		11,491		—		677,409


December 31, 2017	Pass		Special Mention		Substandard		Doubtful		Total
			(Dollars in Thousands)
One-to-four family mortgages	$	162,993		—		572		—		163,565
Home equity line of credit		35,285		—		412		—		35,697
Junior liens		1,184		—		—		—		1,184
Multi-family		37,445		—		—		—		37,445
Construction		30,246		—		—		—		30,246
Land		14,318		—		555		—		14,873
Non-residential real estate		216,901		979		7,072		—		224,952
Farmland		35,253		1,147		451		—		36,851
Consumer loans		8,376		—		244		—		8,620
Commercial loans		83,892		3,572		1,474		—		88,938

Total	$	625,893		5,698		10,780		—		642,371

Impaired loans by classification type and the related valuation allowance amounts at June 30, 2018 were as follows:


	At June 30, 2018						For the six month period ended June 30, 2018
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(Dollars in Thousands)
Impaired loans with no specific allowance
One-to-four family mortgages	$	1,262		1,262		—		843		31
Home equity line of credit		387		387		—		314		11
Junior liens		4		4		—		3		—
Multi-family		—		—		—		—		—
Construction		—		—		—		—		—
Land		498		498		—		519		15
Non-residential real estate		5,792		5,792		—		6,722		150
Farmland		—		—		—		278		—
Consumer loans		11		11		—		5		—
Commercial loans		3,079		3,079		—		2,650		86

Total	$	11,033		11,033		—		11,334		293

Impaired loans with a specific allowance

One-to-four family mortgages	$	—		—		—		—		—
Home equity line of credit		—		—		—		—		—
Junior liens		—		—		—		—		—
Multi-family		—		—		—		—		—
Construction		—		—		—		—		—
Land		—		—		—		—		—
Non-residential real estate		—		—		—		1		—
Farmland		—		—		—		—		—
Consumer loans		247		247		62		299		—
Commercial loans		211		411		162		297		12

Total		458		658		224		597		—

Total	$	11,491		11,691		224		11,931		305

Impaired loans by classification type and the related valuation allowance amounts at December 31, 2017 were as follows:


	At December 31, 2017						For the year ended December 31, 2017
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
			(Dollars in Thousands)
Impaired loans with no specific allowance
One-to-four family mortgages	$	257		257		—		1,235		35
Home equity line of credit		—		—		—		447		26
Junior liens		—		—		—		6		—
Multi-family		—		—		—		1,135		—
Construction		—		—		—		—		—
Land		515		515		—		837		44
Non-residential real estate		7,086		7,086		—		8,979		395
Farmland		444		444		—		1,094		35
Consumer loans		—		—		—		8		2
Commercial loans		875		875		—		1,571		46

Total		9,177		9,177		—		15,312		583

Impaired loans with a specific allowance

One-to-four family mortgages		—		—		—		—		—
Home equity line of credit		—		—		—		—		—
Junior liens		—		—		—		—		—
Multi-family		—		—		—		—		—
Construction		—		—		—		—		—
Land		—		—		—		4,006		—
Non-residential real estate		2		2		2		88		2
Farmland		—		—		—		195		—
Consumer loans		217		217		54		248		—
Commercial loans		541		541		233		479		13

Total		760		760		289		5,016		15

Total impaired loans	$	9,937		9,937		289		20,328		598

At June 30, 2018, all non-accrual loans with the exception of $4,000 in junior loans are classified as substandard. At June 30, 2018, the Company is not obligated to lend additional funds to borrowers who have been placed in non-accrual status. There are no loans accruing interest that are past due more than 90 days at June 30, 2018. At December 31, 2017, there was one loan, totaling $88,000 that was past due more than 90 days and accruing interest. At June 30, 2018 and December 31, 2017, the Company’s balances in non-accrual loans by loan type is as follows:


	June 30, 2018			December 31, 2017
	(Dollars in Thousands)
One-to-four family mortgages		367			266
Home equity line of credit		347			402
Junior Lien		4			4
Land		—			40
Non-residential real estate		322			—
Farmland		—			111
Consumer loans		6			3
Commercial loans		556			459

Total non-accrual loans		1,602			1,285

Non-accrual loans / Total loans		0.24	%		0.20	%

The following table provides the number of loans remaining in each category as of June 30, 2018 and December 31, 2017 that the Company had previously modified in a TDR:


	Number of Loans		Pre-Modification Outstanding Record Investment		Post Modification Outstanding Record Investment, net of related allowance
June 30, 2018
Non-residential real estate		2	$	3,162,197		3,162,197
Commercial		1		90,327		90,327
December 31, 2017
Non-residential real estate		2		3,163,435		3,163,435

In the six month period ended June 30, 2018, the Company identified one additional commercial loan as a TDR. The loan is secured by equipment and inventory. The TDR classification is the result of the borrower’s declining financial condition, prompting the Company to lengthen the amortization period of the loan to twelve years. The length of the current amortization period is outside of our loan policy and results in a TDR classification. The loan has a one year balloon feature and the borrower’s financial condition will be re-evaluated at that time. There were no loans as of June 30, 2018 that have been modified as TDRs and that subsequently defaulted within twelve months on their modified terms. At June 30, 2018, there are no commitments to lend additional funds to any borrower whose loan terms have been modified in a TDR.

(5)	FORECLOSED ASSETS

The Company’s foreclosed assets have been acquired through customer loan defaults. The property is recorded at the lower of cost or fair value less estimated cost to sell and carrying cost at the date acquired. Any difference between the book value and estimated market value is recognized as a charge off through the allowance for loan loss account. Additional losses on foreclosed assets may be determined on individual properties at specific intervals or at the time of disposal. In general, the Company will obtain a new appraisal on all foreclosed assets with a book balance in excess of $250,000 on an annual basis. Additional losses are recognized as a non-interest expense.

For the six month period ended June 30, 2018, the Company’s activity in foreclosed property included the following:


			Activity During 2018
	Balance 12/31/2017		Foreclosure		Sales			Reduction in Values		Gain (Loss) on Sale		Balance 6/30/2018
	(Dollars in Thousands)
One-to-four family mortgages	$	169		130		(88	)		—		16	$	227
Land		3,200		—		—			—		—		3,200

Total	$	3,369		130		(88	)		—		16	$	3,427

The Company’s activity in foreclosed assets for the twelve month period ended December 31, 2017 is as follows:


			Activity During 2017
	Balance 12/31/2016		Foreclosure		Sales			Reduction in Values			Gain (Loss) on Sale			Balance 12/31/2017
			(Dollars in Thousands)
One-to-four family mortgages	$	135		1,069		(1,182	)		—			147		$	169
HELOC		28		—		(18	)		(10	)		—			—
Land		—		3,200		—			—			—			3,200
Multi-family		1,775		—		(1,761	)		—			(14	)		—
Non-residential		459		43		(500	)		—			(2	)		—

Total	$	2,397		4,312		(3,461	)		(10	)		131		$	3,369

(6)

FAIR VALUE OF ASSETS AND LIABILITIES

Accounting Standards Codification Topic (ASC) 820, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value and expands disclosure about fair value. The statement establishes a fair value hierarchy which requires an entity to maximize the use of observable input and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value.

•

Level 1 is for assets and liabilities that management has obtained quoted prices (unadjusted for transaction cost) or identical assets or liabilities in active markets that the Company has the ability to access as of the measurement date.

•

Level 2 is for assets and liabilities in which significant unobservable inputs other than Level 1 prices such as quoted prices for similar assets and 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 is for assets and liabilities in which 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.

The following are the significant methods and assumptions used by the Company in estimating its fair value disclosures for financial instruments:

Cash and due from banks

The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents approximate those assets’ fair values, because they mature within 90 days or less and do not present credit risk concerns.

Interest-bearing deposits in banks

The carrying amounts reported in the consolidated balance sheets for interest earning deposits approximate those assets’ fair values, because they are considered overnight deposits and may be withdrawn at any time without penalty and do not present credit risk concerns.

Available-for-sale securities

Fair values for investment securities available-for-sale 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 provided by a third-party pricing service. The Company reviews all securities in which the book value is greater than the market value for impairment that is other than temporary. For securities deemed to be other than temporarily impaired, the Company reduces the book value of the security to its market value by recognizing an impairment charge on its income statement.

FHLB stock

The fair value of FHLB stock is recognized at cost.

Loans held for sale

Mortgage loans originated and intended to be sold are carried at the lower of cost or estimated fair value as determined on a loan by loan basis. Gains or losses are recognized at the time of ownership transfer. Net unrealized losses, if any, are recognized through a valuation allowance and charged to income.

Loans receivable

The fair values of fixed-rate loans and variable rate loans that re-price on an infrequent basis is estimated using discounted cash flow analysis which considers future re-pricing dates and estimated repayment dates, and further using interest rates currently being offered for loans of similar type, terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. The estimated fair value of variable-rate loans that re-price frequently and have no significant change in credit risk is approximately the carrying value of the loan.

Accrued interest receivable

Fair value is estimated to approximate the carrying amount because such amounts are expected to be received within 90 days or less and any credit concerns have been previously considered in the carrying value.

Deposits

The fair values disclosed for deposits with no stated maturity such as demand deposits, 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 certificates of deposit and other fixed maturity time deposits are estimated using a discounted cash flow calculation that applies interest rates currently being offered on such type accounts or similar accounts to a schedule of aggregated contractual maturities or similar maturities on such time deposits.

Advances from borrowers for taxes and insurance

The carrying amount of advances from borrowers for taxes and insurance approximates its fair value.

Advances from the Federal Home Loan Bank (FHLB)

The fair value of these advances is estimated by discounting the future cash flows of these advances using the current rates at which similar advances or similar financial instruments could be obtained.

Repurchase agreements

Overnight repurchase agreements have a fair value at book, given that they mature overnight. The fair values of longer date repurchase agreements is estimated using discounted cash flow analysis which considers the current market pricing for repurchase agreements of similar final maturities and collateral requirements.

Subordinated debentures

The book value of subordinated debentures is cost. The subordinated debentures re-price quarterly at a rate equal to three month libor plus 3.10%.

Fair Value Measurements on a Recurring Basis

Where quoted prices are available for identical securities in an active market, securities available for sale are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly liquid government securities and certain other financial products. If quoted market prices are not available, then fair values are estimated by using pricing models that use observable inputs or quoted prices of securities with similar characteristics and are classified within Level 2 of the valuation hierarchy. In certain cases where there is limited activity or less transparency around inputs to the valuation and more complex pricing models or discounted cash flows are used, securities are classified within Level 3 of the valuation hierarchy.

Assets and Liabilities Measured on a Recurring Basis

The assets and liabilities measured at fair value on a recurring basis at June 30, 2018 are summarized below:


Description	Total carrying value in the consolidated balance sheet at 6/30/2018		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Securities available for sale
U.S. Agency securities	$	76,154		—		76,154		—
Taxable municipals		955		—		954		—
Tax-free municipals		24,617		—		24,617		—
Mortgage backed securities		67,257		—		67,257		—

Total	$	168,983		—		168,983		—

The assets and liabilities measured at fair value on a recurring basis at December 31, 2017 are summarized below:


Description	Total carrying value in the consolidated balance sheet at 12/31/2017		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(Dollars in Thousands)
Securities available for sale
U.S. Agency securities		84,093		—		84,093		—
Taxable municipals		1,283		—		1,283		—
Tax-free municipals		26,966		—		26,966		—
Trust preferred securities		1,685		—		—		1,685
Mortgage backed securities		70,764		—		70,764		—

Total	$	184,791		—		183,106		1,685

The assets and liabilities measured at fair value on a non-recurring basis are summarized below for June 30, 2018:


Description	Total carrying value in the consolidated balance sheet at June 30, 2018		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets	(Dollars in Thousands)
Foreclosed assets	$	3,427		—		—	$	3,427
Impaired loans, net of allowance of $224	$	234		—		—	$	234

The assets and liabilities measured at fair value on a non-recurring basis are summarized below for December 31, 2017:


Description	Total carrying value in the consolidated balance sheet at December 31, 2017		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets			(Dollars in Thousands)
Foreclosed assets	$	3,369		—		—	$	3,369
Impaired loans, net of allowance of $289	$	473		—		—	$	473

The following table presents quantitative information about level 3 fair value measurements for assets measured at fair value on a recurring and non-recurring basis at June 30, 2018 and December 31, 2017:


			Level 3 Significant Unobservable Input Assumptions
	Fair Value		Valuation Technique	Unobservable Input	Quantitative Range of Unobservable Inputs
			(Dollars in Thousands)
June 30, 2018
Assets measured on a non-recurring basis
Foreclosed assets	$	3,427	Discount to appraised value of collateral. Auction results	Appraisal comparability adjustments	5% to 10%
Impaired loans		458	Discount to appraised value of collateral	Appraisal comparability adjustments	10% to 25%
Asset measured on a recurring basis

December 31, 2017
Assets measured on a non-recurring basis
Foreclosed assets	$	3,369	Discount to appraised value of collateral	Appraisal comparability adjustments	30% to 55%
Impaired loans		760	Discount to appraised value of collateral	Appraisal comparability adjustments	10% to 15%
Asset measured on a recurring basis
Trust preferred securities		1,685	Discounted cash flow Spread to Libor swap curve	Compare to quotes for sale when available	One month libor 4% to 6%

The estimated fair values of financial instruments were as follows at June 30, 2018:


			Estimated		In Active Markets for Identical		Other Observable		Significant Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
	Amount		Value		Level 1		Level 2		Level 3
	(Dollars in Thousands)
Financial Assets:
Cash and due from banks	$	16,399		16,399		16,399		—		—
Interest-bearing deposits		2,955		2,955		2,955		—		—
Securities available for sale		168,983		168,983		—		168,983		—
Federal Home Loan Bank stock		4,428		4,428		—		—		4,428
Loans held for sale		1,126		1,126		—		1,126		—
Loans receivable		676,891		641,814		—		—		641,814
Accrued interest receivable		3,253		3,253		—		—		3,253
Financial liabilities:
Deposits		733,188		733,317		—		733,317		—
Advances from borrowers for taxes and insurance		1,256		1,256		—		1,256		—
Advances from Federal Home Loan Bank		38,000		37,790		—		37,790		—
Repurchase agreements		39,648		39,648		—		39,648		—
Subordinated debentures		10,310		10,310		—		—		10,310

The estimated fair values of financial instruments were as follows at December 31, 2017:


			Estimated		Quoted Prices In Active Markets for Identical		Using Significant Other Observable		Significant Unobservable
	Carrying		Fair		Assets		Inputs		Inputs
	Amount		Value		Level 1		Level 2		Level 3
	(Dollars in Thousands)
Financial Assets:
Cash and due from banks	$	21,779		21,779		21,779		—		—
Interest-bearing deposits		3,970		3,970		3,970		—		—
Securities available for sale		209,480		209,480		2,001		205,662		1,817
Federal Home Loan Bank stock		4,428		4,428		—		—		4,428
Loans held for sale		1,094		1,094		—		1,094		—
Loans receivable		604,286		593,257		—		—		593,257
Accrued interest receivable		3,799		3,799		—		—		3,799
Financial liabilities:
Deposits		732,882		732,942		—		732,942		—
Advances from borrowers for taxes and insurance		766		766		—		766		—
Advances from Federal Home Loan Bank		11,000		10,979		—		10,979		—
Repurchase agreements		47,655		47,655		—		47,655		—
Subordinated debentures		10,310		10,099		—		—		10,099

(7)	EFFECT OF NEW ACCOUNTING PRONOUNCEMENTS

In May 2014, the FASB issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers.” This guidance supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition, and most industry-specific guidance throughout the ASC. The guidance requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. This guidance is effective for interim and annual reporting periods beginning after December 15, 2016; however, the FASB deferred the effective date reporting periods beginning after December 15, 2017. The implementation of ASC Topic 605 did not have a material impact on the Company’s Consolidated Financial Statements.

ASU 2016-01, “Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates 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 on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. ASU 2016-01 was effective on January 1, 2018 and did not have a material effect on the Company’s Consolidated Financial Statements.

ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 will, among other things, require lessees to recognize a lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. ASU 2016-02 does not significantly change lease accounting requirements applicable to lessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and ASC Topic 606, “Revenue from Contracts with Customers.” ASU 2016-02 will be effective for us on January 1, 2019, and will require transition using a modified retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. We are currently evaluating the potential impact of ASU 2016-02 on the Company’s Consolidated Financial Statements.

ASU 2016-09, “Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” Under ASU 2016-09 all excess tax benefits and tax deficiencies related to share-based payment awards should be recognized as income tax expense or benefit in the income statement during the period in which they occur. Previously, such amounts were recorded in the pool of excess tax benefits included in additional paid-in capital, if such pool was available. Because excess tax benefits are no longer recognized in additional paid-in capital, the assumed proceeds from applying the treasury stock method when computing earnings per share should exclude the amount of excess tax benefits that would have previously been recognized in additional paid-in capital. Additionally, excess tax benefits should be classified along with other income tax cash flows as an operating activity rather than a financing activity, as was previously the case. ASU 2016-09 also provides that an entity can make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest (current GAAP) or account for forfeitures when they occur. ASU 2016-09 changes the threshold to qualify for equity classification (rather than as a liability) to permit withholding up to the maximum statutory tax rates (rather than the minimum as was previously the case) in the applicable jurisdictions. ASU 2016-09 was effective on January 1, 2017. The implementation of ASU 2016-09 did not have a material effect on the Company’s Consolidated Financial Statements.

On June 16, 2016, the FASB released its finalized ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments”. The amendments to U.S. GAAP require businesses and other organization to measure the expected credit losses on financial assets, such as loans, securities, bond insurance, and many receivables, the FASB said. The accounting changes apply to instruments recorded on balance sheets at their historical cost, although there are some limited changes to the accounting for debt instruments classified as available-for-sale. The accounting board added that the write-downs will be based on historical information, current business conditions, and forecasts, and it expects the forecasts to improve the loss estimates on financial assets that are losing value. The board also said the techniques that are employed today to write down loans and other instruments can still be used, although it expects the variables for calculating the losses to change. ASU 2016-13 will become effective for fiscal years beginning after December 15, 2020, and interim periods within fiscal years beginning after December 15, 2021. Companies are permitted to adopt ASU 2016-13 in fiscal years beginning after December 15, 2018. The Company is currently evaluating the potential impact of ASU 2016-13.

ASU 2016-15 “Statement of Cash Flows (Topic 230)” (“ASU 2016-15”) is intended to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows. ASU 2016-15 is effective for public companies for annual periods beginning after December 15, 2017 including interim periods within those fiscal years. Early adoption is permitted with retrospective application. The application of ASU 2016-15 did not have a material impact on the Company’s Consolidated Financial Statements.

In January 2017, the FASB issued ASU 2017-01, “Business Combinations (Topic 805): Clarifying the Definition of a Business,” (“ASU 2017-01”) to improve such definition and, as a result, assist entities with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or as business combinations. The definition of a business impacts many areas of accounting including acquisitions, disposals, goodwill and consolidation. ASU 2017-01 was effective for the Company on January 1, 2018 and is to be applied under a prospective approach. The Company expects the adoption of this new guidance to impact the determination of whether future acquisitions are considered business combinations.

ASU 2017-08, “Receivables – Nonrefundable Fees and Other Cost” (Topic 310) – amends the amortization period for certain purchased callable debt securities held at a premium. Prior to the issuance of this guidance, premiums were amortized as an adjustment of yield over the contractual life of instrument. ASU 2017-08 premiums on purchased callable debt securities that have an explicit, non-contingent call features that are callable at fixed prices to be amortized to the earliest call date. There are no accounting changes for securities held at a discount. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2018 and early adoption is permitted. The adoption of ASU 2017-08 is not expected to have a material impact on the Company’s Consolidated Financial Statements.

ASU 2017-09 “Compensation – Stock Compensation (Topic 718) – clarifies when changes to the terms or conditions of a share-based payment must be accounted for as modifications. Under AUS 2017-09, an entity should account for changes to the terms or conditions of a share-based payment unless all of the following are met:

•

The fair value of the modified award is the same as the fair value of the original award immediately before modification,

•

The vesting conditions of the modified award is the same as the vesting conditions value of the original award immediately before modification, and

•

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 modification.

ASU 2017-09 was effective for the Company on January 1, 2018 and did not have a material impact on our consolidated financial statements.

ASU 2017-12 “Derivatives and Hedging (Topic 815) amends the hedge accounting recognition and presentation requirements in ASC 815 to improve the transparency and understandability of information convey to financial statement users about an entity’s risk management activities to better align the entity’s financial reporting for hedging relationships with those risk management activities and to reduce the complexity of and simplify the application of hedge accounting. ASU 2017-12 will be effective for the Company on January 1, 2019 and is not expected to have a significant impact on the Company’s Consolidated Financial Statements.

ASU 2018-02, “Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” Issued in February 2018, ASU 2018-02 seeks to help entities reclassify certain stranded income tax effects in accumulated other comprehensive income resulting from the Tax Cuts and Jobs Act of 2017 (Tax Reform Act), enacted on December 22, 2017. ASU 2018-02 was issued in response to concerns regarding current guidance in GAAP that requires deferred tax liabilities and assets to be adjusted for the effect of a change in tax laws or rates with the effect included in income from continuing operations in the reporting period that includes the enactment date, even in situations in which the related income tax effects of items in accumulated other comprehensive income were originally recognized in other comprehensive income, rather than net income, and as a result the stranded tax effects would not reflect the appropriate tax rate. The amendments of ASU 2018-02 allow an entity to make a reclassification from accumulated other comprehensive income to retained earnings for the stranded tax effects, which is the difference between the historical corporate income tax rate of 35.0% and the newly enacted corporate income tax rate of 21.0%. ASU 2018-02 is effective for fiscal years, and interim periods within those years, beginning after December 31, 2018; however, public business entities are allowed to early adopt the amendments of ASU 2018-02 in any interim period for which the financial statements have not yet been issued. The amendments of ASU 2018-02 may be applied either at the beginning of the period (annual or interim) of adoption or retrospectively to each of the period(s) in which the effect of the change in the U.S. federal corporate tax rate in the Tax Reform Act is recognized. The Company is currently reviewing the impact of the adoption of ASU 2018-02 on its Consolidated Financial Statements.

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

(8)	INCOME TAXES

The Company files consolidated federal income tax returns and Tennessee excise tax returns. The Company files consolidated Kentucky income tax returns. The Bank is exempt from Kentucky corporate income tax. The Company has no unrecognized tax benefits and has accrued any interest or penalties for uncertain tax positions. The Company’s effective tax rate changed from 34% to 21% effective January 1, 2018 as a result of the Tax Cut and Jobs Act of 2017. The effective tax rate differs from the statutory federal rate of 21% and Tennessee excise rate of 6.5% due to investments in qualified municipal securities, bank owned life insurance, income apportioned to Kentucky and certain non-deductible expenses. The Company’s effective federal income tax rate varies significantly from our federal statutory tax rate for a variety of factors, including:

•

The Company’s investment in Fort Webb LP, LLC generates tax credits and depreciation expense that the Company can use to offset taxable income. At June 30, 2018, the Company’s balance sheet did not include any equity investment in Fort Webb. The Company has other investments that produce both tax credits and depreciation expense that may be used to offset net income.

•

At June 30, 2018, the Company has $10.5 million in Bank owned life insurance policies. The income generated from these policies increase the cash flow of the policies on a tax free basis. Life insurance proceeds are paid upon the death of a covered party. These proceeds, netted against the current cash value of the policy, result in tax free income to the Company. At June 30, 2018, the Company’s investment portfolio includes $24.6 million of tax free municipal securities. Interest income on this portfolio, after netting out a disallowance for interest expense attributable to this portfolio, is tax exempt.

(9)

ESOP

Substantially all of the Company’s employees who are at least 21 years old and have one year of employment with the Company participate in the 2015 HopFed Bancorp, Inc. Employee Stock Ownership Plan (“ESOP”). The ESOP purchased 600,000 shares of the Company’s common stock from the Company on March 2, 2015 at $13.14 per share. The ESOP borrowed $7.9 million from an open-end line of credit from the Company for the purchase of the stock, using the 600,000 shares of common stock as collateral. The Company makes discretionary contributions to the ESOP. The ESOP utilizes these contributions along with the dividends on unearned shares held by the ESOP to repay the loan from the Company. When loan payments are made, ESOP shares are released based on reductions in the principal balance of the loan. The shares are allocated to participants based on relative compensation.

Employees who are not employed on December 31st of each year are not eligible for participation in the ESOP. The Company anticipates that loan payments will be made at the end of each year. Participants receive shares at the end of employment. The Company has the option to repurchase the shares or provide the shares directly to the employee. At June 30, 2018, a total of 2,033 shares have been withdrawn from the plan as a result of former employees making direct common share withdrawals from the plan.

The Company made its third ESOP loan payment in December 2017. At June 30, 2018 and December 31, 2017, shares held by the ESOP were as follows:


	June 30, 2018			December 31, 2017
Accrued for allocation to participants		22,457			—
Earned ESOP shares		165,686			165,686
Shares withdrawn by former participants		(2,033	)		—
Unearned ESOP shares		412,091			434,548

Total ESOP shares		598,201			600,234

Fair value of unearned shares	$	6,832,469		$	6,127,127

(10)	COMMITMENTS AND CONTINGENCIES

At June 30, 2018, the Bank had $32.5 million in outstanding commitments on revolving home equity lines of credit, $17.2 million in outstanding commitments on revolving personal lines of credit and $42.3 million in commitments to originate loans and undisbursed commitments on commercial lines of credit of $69.1 million. At June 30, 2018, the Company had $381,000 in standby letters of credit outstanding.

At June 30, 2018, the Company has $36.4 million in times deposits greater than $100,000 but less than $250,000 that are schedule to mature in one year and $60.4 million in time deposits with balances equal to or greater than $250,000 that are scheduled to mature in one year or less. Management believes that a significant percentage of such deposits will remain with the Bank.

The Bank’s FHLB borrowings are secured by a blanket security agreement pledging the Bank’s 1-4 family first mortgage loans and non-residential real estate loans. At June 30, 2018 and December 31, 2017, the Bank has pledged all eligible 1-4 family first mortgages. At June 30, 2018 and December 31, 2017, the Bank has outstanding borrowings of $38.0 million and $23.0 million from the FHLB. A schedule of FHLB borrowings at June 30, 2018 is provided below:


Balance	Rate	Maturity
$15,000,000	2.02%	Overnight
6,000,000	1.18%	7/6/2018
7,000,000	1.55%	1/10/2019
5,000,000	1.73%	1/10/2020
5,000,000	1.92%	10/6/2020

$38,000,000	1.75%

A schedule of FHLB borrowings at December 31, 2017 is provided below:


Balance	Rate	Maturity
$6,000,000	1.18%	7/6/2018
7,000,000	1.55%	1/10/2019
5,000,000	1.73%	1/10/2020
5,000,000	1.92%	10/6/2020

$23,000,000	1.57%

The Federal Home Loan Bank of Cincinnati has issued letters of credit in the Bank’s name totaling $46.9 million secured by the Bank’s loan portfolio to secure additional municipal deposits. At June 30, 2018, securities with a book value of $39.3 million and a fair market value of $38.1 million were sold under agreements to repurchase from various customers.

The Company is a party to certain ordinary course litigation, and the Company intends to vigorously defend itself in all such matters. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such ordinary course litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations.

(11)	REGULATORY MATTERS

The new minimum capital level requirements applicable to Bank holding companies and Banks subject to the rules are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from current rules); (iv) a Tier 1 leverage ratio of 4% for all institutions. The rules also establish a “capital conservation buffer” of 2.5% (to be phased in over three years) above the new regulatory minimum risk-based capital ratios, and result in the following minimum ratios once the capital conservation buffer is fully phased in: (i) a common equity Tier 1 risk-based capital ratio of 7%, (ii) a Tier 1 risk-based capital ratio of 8.5%, and (iii) a total risk-based capital ratio of 10.5%.

The capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. For 2018, the capital conservation buffer is 1.875%. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

Under these new rules, Tier 1 capital generally consists of common stock (plus related surplus) and retained earnings, limited amounts of minority interest in the form of additional Tier 1 capital instruments, and non-cumulative preferred stock and related surplus, subject to certain eligibility standards, less goodwill and other specified intangible assets and other regulatory deductions.

Cumulative preferred stock and trust preferred securities issued after May 19, 2010 no longer qualify as Tier 1 capital, but such securities issued prior to May 19, 2010, including in the case of bank

holding companies with less than $15.0 billion in total assets, trust preferred securities issued prior to that date, continue to count as Tier 1 capital subject to certain limitations. The definition of Tier 2 capital is generally unchanged for most banking organizations, subject to certain new eligibility criteria.

The final rules allow banks and their holding companies with less than $250 billion in assets a one-time opportunity to opt-out of a requirement to include unrealized gains and losses in accumulated other comprehensive income in their capital calculation. The Company has made the decision to opt-out of this requirement. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of tangible and core capital (as defined in the regulations) to adjusted total assets (as defined), and of total capital (as defined) and Tier 1 to risk weighted assets (as defined). The minimum required capital amounts presented include the minimum required capital levels as of June 30, 2018 and December 31, 2017 to which it is subject. Management believes, as of June 30, 2018 and December 31, 2017, that the Bank meets all capital adequacy requirements to which it is subject, including the phase–in requirements of Basel III. The Company’s consolidated capital ratios and the Bank’s actual capital amounts and ratios as of June 30, 2018 and December 31, 2017 are presented below:


	Actual					Minimum Capital Required					To be Well Capitalized for Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in Thousands, Except Percentages)
As of June 30, 2018
Tier 1 leverage capital to adjusted total assets
Company	$	97,574		10.7	%	$	36,294		4.0	%	$	45,368		5.0	%
Bank	$	95,616		10.5	%	$	36,297		4.0	%	$	45,371		5.0	%

Total capital to risk weighted assets
Company	$	102,211		15.6	%	$	52,513		8.0	%	$	65,641		10.0	%
Bank	$	100,254		15.3	%	$	51,946		8.0	%	$	64,933		10.0	%

Tier 1 capital to risk weighted assets
Company	$	97,574		14.9	%	$	39,384		6.0	%	$	52.513		8.0	%
Bank	$	95,616		14.6	%	$	38,960		6.0	%	$	51,946		8.0	%

Common equity tier 1 capital to risk weighted assets
Company	$	97,574		14.9	%	$	29,538		4.5	%		n/a		n/a
Bank	$	95,616		14.6	%	$	29,220		4.5	%	$	42,207		6.5	%

As of December 31, 2017
Tier 1 leverage capital to adjusted total assets
Company	$	95,709		10.6	%	$	36,137		4.0	%	$	45,171		5.0	%
Bank	$	95,123		10.5	%	$	36,090		4.0	%	$	45,112		5.0	%

Total capital to risk weighted assets
Company	$	100,535		16.0	%	$	50,352		8.0	%	$	62,940		10.0	%
Bank	$	99,949		15.9	%	$	50,314		8.0	%	$	62,892		10.0	%

Tier 1 capital to risk weighted assets
Company	$	95,709		15.2	%	$	37,764		6.0	%	$	50,352		8.0	%
Bank	$	95,123		15.1	%	$	37,735		6.0	%	$	50,314		8.0	%

Common equity tier 1 capital to risk weighted assets
Company	$	95,709		15.2	%	$	28,323		4.5	%		n/a		n/a
Bank	$	95,123		15.1	%	$	28,301		4.5	%	$	40,880		6.5	%

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

Critical Accounting Policies

The preparation of the Company’s consolidated financial statements requires management to make subjective judgments associated with estimates. These estimates are necessary to comply with U.S. GAAP and general banking practices. These estimates include accounting for the allowance for loan losses, foreclosed assets, valuation of deferred tax assets and fair value measurements. A description of these estimates, which significantly affect the Company’s determination of our consolidated financial position, results of operations and cash flows, is set forth in Note 1, “Summary of Significant Accounting Policies” of the Notes to the Company’s consolidated financial statements in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017.

The emphasis of this discussion is a comparison of assets, liabilities and stockholders’ equity as of June 30, 2018 to December 31, 2017, while comparing income and expenses for the three and six month periods ended June 30, 2018 and June 30, 2017. All information should be read in conjunction with the Company’s unaudited interim consolidated condensed financial statements and related notes appearing elsewhere in this report and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in the Company’s Annual Report on Form 10-K as of and for the year ended December 31, 2017.

Comparison of Financial Condition at June 30, 2018, and December 31, 2018

At June 30, 2018, total assets were $912.7 million compared to $917.6 million at December 31, 2017. For the six month period ended June 30, 2018, the Company’s net loan portfolio has increased $35.2 million to $672.3 million. To fund the Company’s loan growth, the Company reduced cash and cash equivalent balances by $25.7 million and securities available for sale by $15.8 million in the six month period ended June 30, 2018.

At June 30, 2018, total deposits declined by $20.8 million to $733.2 million. At June 30, 2018, interest-bearing checking accounts totaled $198.7 million, a decline of $9.8 million compared to December 31, 2017. At June 30, 2018, non-interest bearing checking accounts totaled $136.0 million, 18.5% of total deposits. Historically, the Company’s total deposits are lower at June 30^th than at any other time of the year due to our level of municipal deposits and agri-business interest. In the current year, the pricing of deposits has become more challenging, forcing the Company to increase its interest expense to maintain adequate funding levels.

The Company continues to place an emphasis on core funding while attempting to slow the growth of our deposit cost. However, increased competition and the Company’s continued strong loan demand will force management to increase deposit rates to ensure adequate funding levels to meet liquidity needs. Management anticipates that future loan growth will be funded largely by the recruitment of time deposits. The Company’s investment portfolio may provide additional liquidity. However, a significant portion of the investment portfolio is pledged to municipalities to secure deposits, limiting the Company’s ability to significantly increase our loan to deposit ratio above current levels.

Comparison of Operating Results for the Six Month Periods Ended June 30, 2018 and June 30, 2017.

The Company’s net income was $2.8 million for the six month period ended June 30, 2018 compared to net income of $2.1 million for the six month period ended June 30, 2017. The improved level of net income for the six month period ended June 30, 2018 compared to the six month period ended June 30, 2017 was the result of a $35.9 million increase in the average balance of loans, a $492,000 increase in gains on the sale of investments a $220,000 decline in the Company’s provision for loan loss expense and a reduction in the Company’s federal tax rate from 34% to 21%.

The Company’s total interest income for the six month period ended June 30, 2018 was $17.9 million, compared to $16.6 million for the six month period ended June 30, 2017. The increase in net interest income for the three month period ended June 30, 2018 compared to June 30, 2017 was largely due to the increase in the average balance of loans.

For the six month period ended June 30, 2018, the average balance of total interest bearing liabilities declined by $2.8 million compared to the six month period ended June 30, 2017. Despite the decline in interest bearing liabilities, the Company’s total interest expense for the six month period ended June 30, 2018 increased by $587,000, to $3.4 million compared to the six month period ended June 30, 2017. For the six month period ended June 30, 2018, the cost of average total deposits was 0.71% compared to 0.63% for the six month period ended June 30, 2017. In addition to increases in our cost of deposits, the interest expense on the Company’s floating rate subordinated debt has increased to $260,000 for the six month period ended June 30, 2018 from $212,000 for the six month period ended June 30, 2017 due to increases in the three month Libor rate. For the six month periods ended June 30, 2018 and June 30, 2017, the Company’s cost of interest bearing liabilities was 1.00% and 0.83%, respectively. The increase in interest expense is the result of increases in short term interest rates spurred by the decision of the Open Market Committee of the Federal Reserve Board of Governors to increase its stated overnight Federal Funds (“Fed Funds”) rate.

For the six month period ended June 30, 2018, the Company’s tax equivalent yield on loans was 4.66% compared to 4.44% for the six month period ended June 30, 2017. For the six month period ended June 30, 2018, the Company’s tax equivalent yield on tax free municipal investments was 4.01% compared to 5.04% for the six month period ended June 30, 2017. The reduction in Company’s stated tax rate from 34% to 21% significantly reduced our tax equivalent yield on tax free investments. For the six month periods ended June 30, 2018 and June 30, 2017, the Company’s net interest margin was 3.45% and 3.35%. The increase in net interest margin occurred as result of loan growth and increases in loan yields due to increases in the Prime Rate. At June 30, 2018, the interest rate yield between the two year treasury and ten year treasury was 0.33%, very narrow by historical terms. The continued flattening of the yield curve is likely to reduce the Company’s net interest margins in the future.

Average Balances, Yields and Interest Expenses. The table on the next page summarizes the overall effect of changes in both interest rates and the average balances of interest earning assets and liabilities for the six month periods ended June 30, 2018 and June 30, 2017. Yields on assets and cost of liabilities are derived by dividing income or expense by the average daily balances of interest earning assets and liabilities for the appropriate six month periods. Average balances for loans include loans classified as non-accrual, net of the allowance for loan losses. On January 1, 2018, the Company’s stated tax rate decreased from 34.0% to 21.0%, reducing the tax equivalent yield on tax free loans and tax free municipal investments.

The table adjusts tax-free investment income by $105,000 for the six month period ended June 30, 2018 and $279,000 for the six month period ended June 30, 2017, for a tax equivalent rate using a cost of funds rate of 1.00% for the six month period ended June 30, 2018 and 0.83% for the six month period ended June 30, 2017. The table adjusts tax-free loan income by $9,000 for the six month period ended June 30, 2018 and $21,000 for the six month period ended June 30, 2017, for a tax equivalent rate using the same cost of funds rate.


	Average Balance 6/30/2018		Income and Expense 6/30/2018		Average Rates 6/30/2018			Average Balance 6/30/2017		Income and Expense 6/30/2017		Average Rates 6/30/2017
	(Table Amounts in Thousands, Except Percentages)
Loans receivable, net	$	657,973		15,344		4.66	%		618,430		13,720		4.44	%
Taxable securities, AFS		157,134		2,112		2.69	%		177,044		2,273		2.57	%
Non-taxable securities, AFS		26,254		526		4.01	%		33,391		842		5.04	%
Other interest bearing deposits		4,041		45		2.23	%		7,565		44		1.16	%

Total interest earning assets		845,402		18,027		4.26	%		836,430		16,879		4.04	%

Other assets		65,555							73,072

Total assets	$	910,957						$	909,502

Retail time deposits		238,456		1,397		1.17	%		258,518		1,342		1.04	%
Brokered deposits		56,206		447		1.59	%		47,461		280		1.18	%
Interest bearing checking		215,319		704		0.65	%		221,580		660		0.60	%
Saving / MMDA		100,175		88		0.18	%		99,294		82		0.17	%
FHLB borrowings		27,856		226		1.62	%		12,298		62		1.01	%
Repurchase agreements		38,837		325		1.67	%		40,482		222		1.10	%
Subordinated debentures		10,310		260		5.04	%		10,310		212		4.11	%

Total interest bearing liabilities		687,159		3,447		1.00	%		689,943		2,860		0.83	%

Non-interest bearing deposits		133,244							127,447
Other liabilities		4,059							3,987
Stockholders’ equity		86,495							88,125

Total liabilities and stockholders’ equity	$	910,957							909,502

Net interest income				14,580							14,019

Net interest spread						3.26	%						3.21	%

Net interest margin						3.45	%						3.35	%

Provision for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risk inherent in its loan portfolio and the general economy. Such evaluation considers numerous factors including general economic conditions, loan portfolio composition and prior loss experience, the estimated fair value of the underlying collateral and other factors that warrant recognition in providing for an adequate loan loss allowance. At June 30, 2018, the Company’s reduced level of non-accrual and substandard loans reduced the amount of funding necessary for the allowance for loan loss account. The Company determined that an additional $130,000 in provision for loan loss was required for the six month period ended June 30, 2018 compared to a $350,000 provision for loan loss expense for the six month period ended June 30, 2017.

Non-Interest Expenses. For the six month period ended June 30, 2018, non-interest expenses were $15.1 million compared to $14.9 million for the six month period ended June 30, 2017. For the six month period ended June 30, 2018, data processing expenses increased $239,000 compared to the six month period ended June 30, 2017 due to the Company’s receipt of a $225,000 one-time reimbursement of expenses from a vendor in June of 2017. For the six month period ended June 30, 2018, professional services expenses were $965,000, representing an increase of $153,000 compared to the six month period ended June 30, 2017. The increase in professional services is largely the result of legal expenses incurred in early 2018.

Income Taxes. The effective tax rate for the six month periods ending June 30, 2018 was 15.6% as a result of the Tax Cuts and Jobs Act of 2017. For the six month period ended June 30, 2017, the Company’s effective tax rate was 19.5%.

Comparison of Operating Results for the Three Month Periods Ended June 30, 2018 and June 30, 2017.

The Company’s net income was $1.7 million for the three month period ended June 30, 2018, compared to net income of $1.1 million for the three month period ended June 30, 2017. The improved level of net income for the three month period ended June 30, 2018 compared to the three month period ended June 30, 2017 was largely the result of loan portfolio growth, a $467,000 increase in the gain on sale of investments and a reduction in the federal tax rate.

The Company’s total interest income for the three month period ended June 30, 2018 was $9.1 million, compared to $8.4 million for the three month period ended June 30, 2017. The increase in net interest income for the three month period ended June 30, 2018 compared to June 30, 2017 was largely due to the $43.7 million increase in the average balance of loans outstanding.

For the three month period ended June 30, 2018, total interest expense was $1.8 million compared to $1.5 million for the three month period ended June 30, 2017. For the three month period ended June 30, 2018, total interest bearing liabilities were $689.2 million, representing an increase of $30,000 compared to the three month period ended June 30, 2017. The increase in interest expense is the result of increases in short term interest rates spurred by the decision of the Open Market Committee of the Federal Reserve Board of Governors to increase its stated overnight Fed Funds rate. For the three month period ended June 30, 2018, the cost of average total deposits was 0.75% compared to 0.63% for the three month period ended June 30, 2017. Based on current fed funds future projections, Management anticipates that the Company’s total cost of deposits will continue to increase into the foreseeable future.

For the three month periods ended June 30, 2018 and June 30, 2017, the Company’s cost of interest bearing liabilities was 1.06% and 0.84%. In addition to increases in our cost of deposits, the interest expense on the Company’s floating rate subordinated debt has increased from $122,000 for the three month period ended June 30, 2018 from $102,000 for the three month period ended June 30, 2017 due to increases in the three month Libor rate.

For the three month period ended June 30, 2018, the Company’s tax equivalent yield on loans was 4.72% compared to 4.38% for the three month period ended June 30, 2017. For the three month period ended June 30, 2018, the Company’s tax equivalent yield on tax free municipal investments was 4.04% compared to 5.00% for the three month period ended June 30, 2017. For the three month periods ended June 30, 2018 and June 30, 2017, the Company’s net interest margin was 3.45% and 3.39%. The increase in net interest margin occurred as result of loan growth and increases in the average balance of loans.

Average Balances, Yields and Interest Expenses. The table on the next page summarizes the overall effect of changes in both interest rates and the average balances of interest earning assets and liabilities for the three month periods ended June 30, 2018 and June 30, 2017. Yields on assets and cost of liabilities are derived by dividing income or expense by the average daily balances of interest earning assets and liabilities for the appropriate three month periods. Average balances for loans include loans classified as non-accrual, net of the allowance for loan losses. On January 1, 2018, the Company’s stated tax rate decreased from 34.0% to 21.0%, reducing the tax equivalent yield on tax free loans and tax free municipal investments.

The table adjusts tax-free investment income by $51,000 for the three month period ended June 30, 2018 and $139,000 for the three month period ended June 30, 2017, for a tax equivalent rate using a cost of funds rate of 1.06% for the three month period ended June 30, 2018 and 0.84% for the three month period ended June 30, 2017. The table adjusts tax-free loan income by $4,000 for the three month period ended June 30, 2018 and $12,000 for the three month period ended June 30, 2017, for a tax equivalent rate using the same cost of funds rate.


	Average		Income and		Average			Average		Income and		Average
	Balance		Expense		Rates			Balance		Expense		Rates
	6/30/2018		6/30/2018		6/30/2018			6/30/2017		6/30/2017		6/30/2017
	(Table Amounts in Thousands, Except Percentages)
Loans receivable, net	$	666,301		7,862		4.72	%		622,606		6,975		4.48	%
Taxable securities, AFS		153,723		1,033		2.69	%		177,260		1,155		2.61	%
Non-taxable securities, AFS		25,670		259		4.04	%		32,919		419		5.09	%
Other interest bearing deposits		3,735		16		1.71	%		5,888		21		1.43	%

Total interest earning assets		849,429		9,170		4.32	%		838,673		8,570		4.09	%

Other assets		63,565							70,359

Total assets	$	912,994						$	909,032

Retail time deposits		236,333		723		1.22	%		257,956		678		1.05	%
Brokered deposits		58,476		259		1.77	%		48,866		145		1.19	%
Interest bearing checking		215,286		363		0.67	%		223,444		334		0.60	%
Saving / MMDA		98,217		47		0.19	%		98,317		40		0.16	%
FHLB borrowings		32,011		134		1.67	%		11,176		30		1.07	%
Repurchase agreements		38,604		171		1.77	%		39,138		119		1.22	%
Subordinated debentures		10,310		138		5.35	%		10,310		108		4.19	%

Total interest bearing liabilities		689,237		1,835		1.06	%		689,207		1,454		0.84	%

Non-interest bearing deposits		133,075							128,078
Other liabilities		4,099							3,915
Stockholders’ equity		86,583							87,832

Total liabilities and stockholders’ equity	$	912,994							909,032

Net interest income				7,335							7,116

Net interest spread						3.26	%						3.25	%

Net interest margin						3.45	%						3.39	%

Provision for Loan Losses. The allowance for loan losses is established through a provision for loan losses based on management’s evaluation of the risk inherent in its loan portfolio and the general economy. Such evaluation considers numerous factors including general economic conditions, loan portfolio composition and prior loss experience, the estimated fair value of the underlying collateral and other factors that warrant recognition in providing for an adequate loan loss allowance. The Company determined that an additional $62,000 in provision for loan loss was required for the three month period ended June 30, 2018 compared to a $59,000 provision for loan loss expense for the three month period ended June 30, 2017.

Non-Interest Expenses. For the three month period ended June 30, 2018, non-interest expenses were $7.6 million compared to $7.2 million for the three month period ended June 30, 2017. For the three month period ended June 30, 2018, total salaries and benefits expense was $4.1 million compared to $4.0 million for the three month period ended June 30, 2017. In June of 2017, the Company’s one-time receipt of a $225,000 reimbursement of data processing expenses resulting in the most significant change in total non-interest expenses.

Income Taxes. The effective tax rate for the three month periods ending June 30, 2018 was 16.1% due to the reduction in the Company’s effective tax rate as a result of the Tax Cuts and Jobs Act of 2017. For the three month period ended June 30, 2017, the Company’s effective tax rate was 24.4%.

Liquidity and Capital Resources. The Company has no business other than that of the Bank. Management believes that dividends that may be paid by the Bank to the Company will provide sufficient funds for its current needs. However, no assurance can be given that the Company will not have a need for additional funds in the future. The Bank is subject to certain regulatory limitations with respect to the payment of dividends to the Company.

The Bank uses brokered deposits to supplement its asset liability need for longer term deposits reasonable prices. In addition to the coupon rate listed below, brokered deposits carry an additional fee of approximately 0.25% that includes the cost of selling and servicing the deposits. The Company includes this cost as interest expense on its income statement. At June 30, 2018, the Bank’s brokered deposits consisted of the following:


Issue Date	Coupon Rate			Balance		Date of Maturity
2/15/2018		1.50	%		3,130,000		7/16/2018
8/15/2017		1.45	%		5,854,000		8/15/2018
1/12/2017		1.25	%		5,074,000		9/12/2018
7/10/2017		1.40	%		1,079,000		10/10/2018
7/19/2017		1.50	%		2,060,000		11/19/2018
2/15/2017		1.30	%		4,278,000		12/15/2018
10/11/2017		1.55	%		5,000,000		1/11/2019
8/16/2016		1.00	%		1,008,000		2/16/2019
6/19/2018		2.10	%		2,931,000		3/19/2019
4/12/2018		2.00	%		6,036,000		4/12/2019
7/22/2016		1.00	%		2,138,000		5/22/2019
5/10/2018		2.20	%		4,931,000		7/10/2019
7/29/2016		1.05	%		2,964,000		7/29/2019
8/16/2016		1.10	%		1,978,000		8/16/2019
6/19/2018		2.40	%		2,822,000		9/19/2019
2/15/2018		2.20	%		3,417,000		2/15/2020
4/12/2018		2.50	%		4,190,000		1/12/2021
5/10/2018		2.70	%		5,680,000		3/10/2021
6/19/2018		3.00	%		3,153,000		6/19/2021

Total		1.84	%		67,723,000

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements. Additional written or oral forward-looking statements may be made by the Company from time to time in filings with the Securities and Exchange Commission or otherwise. The words “believe,” “expect,” “seek,” and “intend” and similar expressions identify forward-looking statements, which speak only as of the date the statement is made. Such forward-looking statements are within the meaning of that term in Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such statements may include, but are not limited to, projections of income or loss, expenditures, acquisitions, plans for future operations, financing needs or plans relating to services of the Company, as well as assumptions relating to the foregoing.

Forward-looking statements are inherently subject to risks and uncertainties, some of which cannot be predicted or quantified. Future events and actual results could differ materially from those set forth in, contemplated by or underlying the forward-looking statements. The Company does not undertake, and specifically disclaims, any obligation to publicly release the results of revisions, which may be made to forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

The actual results of the Company’s asset liability management analysis are highly dependent on the prepayment speed of mortgage backed securities and collateralized mortgage obligations. The United States Treasury’s policy of purchasing longer dated Treasury bonds has the result of lowering mortgage loan rates, allowing more consumers to refinance their mortgages and pay-off their current mortgage, resulting in higher prepayment speeds on mortgage investment products.

The effects of rising interest rates are discussed throughout Item 2, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Actual results for the year ending December 31, 2018 will differ from simulations due to timing, magnitude, and the frequency or interest rate changes, market conditions, management strategies, and the timing of the Company’s cash receipts and disbursements.

The Company’s analysis at June 30, 2018 indicates that changes in interest rates are less likely to result in significant changes in the Company’s annual net interest income. A summary of the Company’s analysis at June 30, 2018 for the twelve month period ending June 30, 2019 is as follows:


	Down 1.00%		No change		Up 1.00%		Up 2.00%		Up 3.00%
			(Dollars in Thousands)
Net interest income	$	29,706	$	31,069	$	31,863	$	32,598	$	33,341

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

In accordance with Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), an evaluation was carried out with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the quarter ended June 30, 2018.

Based upon their evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the six month period ended June 30, 2018 to ensure that material information relating to the Company, including its consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this quarterly report on Form 10-Q was being prepared.

Any control system, no matter how well conceived and operated, can provide only reasonable assurance that its objectives are achieved. The design of a control system inherently has limitations, including the controls cost relative to their benefits. Additionally, controls can be circumvented. No cost-effective control system can provide absolute assurance that all control issues and instances of fraud will be detected.

The Company is subject to Section 404 of The Sarbanes-Oxley Act of 2002. Section 404 requires management to assess and report on the effectiveness of the Company’s internal controls over financial reporting.

Changes in Internal Control over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the Company’s fiscal quarter ended June 30, 2018 that have materially affected, or are reasonable likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.

Legal Proceedings

From time to time, the Company is a party to certain ordinary course litigation. The Company will vigorously defend itself in all such matters when the Company determines that it has meritorious defenses. In the opinion of the Company, based on review and consultation with legal counsel, the outcome of such ordinary course litigation should not have a material adverse effect on the Company’s consolidated financial statements or results of operations. The Company and its subsidiaries have adopted policies and procedures intended to minimize the impact of adverse litigation and regulatory actions, and has endeavored to secure reasonable insurance coverage.

Item 1A.

Risk Factors

There have been no material changes to our risk factors as previously disclosed in Part 1, Item 1A of our annual report on Form 10-K for the fiscal year ended December 31, 2017.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

(a)

Unregistered Sales of Equity Securities.

None

(b)

Use of Proceeds.

Not applicable

(c)

Repurchase of Equity Securities


Period	Total Number of Shares Purchased		Average Price Paid Per Share		Total number of shares Purchased as part of Publically Announced Programs		Maximum Number of Shares that Yet may be Purchased Under the Program at the end of the period
April 1, 2018 to April 30, 2018		—		—		1,940,394		297,966
May 1, 2018 to May 31, 2018		1,586	$	14.00		1,941,980		296,380
June 1, 2018 to June 30, 2018		—		—		1,941,980		296,380

Total		1,586	$	14.00		1,941,980		296,380

Item 3.

Defaults Upon Senior Securities

None

Item 4.

Mine Safety Disclosures

Not Applicable

Item 5.

Other Information

None

Item 6.

Exhibits



31.1		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for John E. Peck, Chief Executive Officer.

31.2		Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 for Billy C. Duvall, Chief Financial Officer.

32.1		Certification Pursuant to Section 18 U.S.C. Section 1350 for John E. Peck, Chief Executive Officer.

32.2		Certification Pursuant to Section 18 U.S.C. Section 1350 for Billy C. Duvall, Chief Financial Officer.

101		The following materials from the Company’s quarterly report on Form 10-Q for the three and six month periods ended June 30, 2018 formatted in XBRL (eXtensible Business Reporting Language): (i) Consolidated Condensed Statements of Financial Condition as of June 30, 2018 (unaudited) and December 31, 2017, (ii) Consolidated Condensed Statements of Income for the three and six months periods ended June 30, 2018 and June 30, 2017 (unaudited), (iii) Consolidated Condensed Statements of Comprehensive Income (Loss) for the three and six month periods ended June 30, 2018 and June 30, 2017 (unaudited), (iv) Consolidated Condensed Statements of Stockholders’ Equity for the six month period ended June 30, 2018 (unaudited); and (v) Consolidated Condensed Statements of Cash Flows for the six month periods ended June 30, 2018 and June 30, 2017 (unaudited), and (iv) Notes to Consolidated Condensed Financial Statements (unaudited), tagged as blocks of text.

SIGNATURES

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


						HOPFED BANCORP, INC.

Date: August 8, 2018						/s/ John E. Peck
						John E. Peck
						President and Chief Executive Officer

Date: August 8, 2018						/s/ Billy C. Duvall
						Billy C. Duvall
						Senior Vice President, Chief Financial
						Officer and Treasurer