(5)

LOANS AND ALLOWANCE FOR LOAN LOSSES

Loans at

December

31,

2016

and

2015

consisted of the following:

(In thousands)	2016			2015

Real estate mortgage loans:
Residential	$	137,842		$	147,933
Land		13,895			12,962
Residential construction		29,561			16,391
Commercial real estate		96,462			84,493
Commercial real estate construction		8,921			1,090
Commercial business loans		24,056			23,095
Consumer loans:
Home equity and second mortgage loans		42,908			38,476
Automobile loans		34,279			28,828
Loans secured by savings accounts		1,879			2,096
Unsecured loans		3,912			4,350
Other consumer loans		9,025			7,210
Gross loans		402,740			366,924
Less undisbursed portion of loans in process		(19,037	)		(4,926	)

Principal loan balance		383,703			361,998

Deferred loan origination fees, net		837			583
Allowance for loan losses		(3,386	)		(3,415	)

Loans, net	$	381,154		$	359,166

December

31,

2016

and

2015,

the net unaccreted discount on loans acquired from Peoples, excluding PCI loans, was

$137,000

and

$590,000,

respectively.

December

31,

2016

and

2015,

residential mortgage loans secured by residential properties without private mortgage insurance or government guarantee and with loan-to-value ratios exceeding

90%

amounted to approximately

$3.7

million and

$2.5

million, respectively.

Mortgage loans serviced for the benefit of others amounted to

$126,000

and

$156,000

December

31,

2016

and

2015,

respectively.

The Bank has entered into loan transactions with certain directors, officers and their affiliates (i.e., related parties). In the opinion of management, such indebtedness was incurred in the ordinary course of business on substantially the same terms, including interest rate and collateral, as those prevailing at the time for comparable transactions with unrelated persons.

The following table represents the aggregate activity for related party loans during the year ended

December

31,

2016.

The beginning balance has been adjusted to reflect new directors and officers, as well as directors and officers that are no longer with the Company.

(In thousands)

Beginning balance	$	7,275
New loans		2,897
Payments		(2,328	)

Ending balance	$	7,844

Off-balance-sheet commitments (including commitments to make loans, unused lines of credit and letters of credit) to related parties at

December

31,

2016

and

2015

were

$2.4

million and

$3.2

million, respectively.

The following table provides the components of the Company’s recorded investment in loans at

December

31,

2016

and

2015:

	Residential Real Estate		Land		Construction		Commercial Real Estate			Commercial Business			Home Equity and Second Mortgage		Other Consumer		Total
	(In thousands)
December 31, 2016:
Principal loan balance	$	137,842	$	13,895	$	19,445	$	96,462		$	24,056		$	42,908	$	49,095	$	383,703

Accrued interest receivable		455		42		44		249			67			141		226		1,224

Net deferred loan origination fees and costs		80		14		0		(42	)		3			782		0		837

Recorded investment in loans	$	138,377	$	13,951	$	19,489	$	96,669		$	24,126		$	43,831	$	49,321	$	385,764


December 31, 2015:
Principal loan balance	$	147,933	$	12,962	$	12,555	$	84,493		$	23,095		$	38,476	$	42,484	$	361,998

Accrued interest receivable		584		70		61		281			64			130		171		1,361

Net deferred loan origination fees and costs		58		6		0		(46	)		(6	)		571		0		583

Recorded investment in loans	$	148,575	$	13,038	$	12,616	$	84,728		$	23,153		$	39,177	$	42,655	$	363,942

An analysis of the allowance for loan losses and recorded investment in loans as of and for the year ended

December

31,

2016

is as follows:

	Residential Real Estate			Land			Construction		Commercial Real Estate			Commercial Business			Home Equity and Second Mortgage			Other Consumer			Total
	(In thousands)
Allowance for Loan Losses:

Beginning balance	$	527		$	157		$	47	$	1,541		$	261		$	626		$	256		$	3,415
Provisions		(87	)		(92	)		33		157			187			79			368			645
Charge-offs		(118	)		(9	)		0		(82	)		(264	)		(36	)		(409	)		(918	)
Recoveries		58			0			0		54			14			14			104			244

Ending balance	$	380		$	56		$	80	$	1,670		$	198		$	683		$	319		$	3,386

Ending allowance balance attributable to loans:

Individually evaluated for impairment	$	23		$	0		$	0	$	0		$	43		$	13		$	6		$	85
Collectively evaluated for impairment		357			56			80		1,670			155			670			313			3,301
Acquired with deteriorated credit quality		0			0			0		0			0			0			0			0

Ending balance	$	380		$	56		$	80	$	1,670		$	198		$	683		$	319		$	3,386

Recorded Investment in Loans:

Individually evaluated for impairment	$	2,083		$	0		$	0	$	1,217		$	143		$	244		$	20		$	3,707
Collectively evaluated for impairment		135,904			13,951			19,489		95,212			23,983			43,587			49,301			381,427
Acquired with deteriorated credit quality		390			0			0		240			0			0			0			630

Ending balance	$	138,377		$	13,951		$	19,489	$	96,669		$	24,126		$	43,831		$	49,321		$	385,764

An analysis of the allowance for loan losses and recorded investment in loans as of and for the year ended

December

31,

2015

is as follows:

	Residential Real Estate			Land			Construction			Commercial Real Estate		Commercial Business			Home Equity and Second Mortgage			Other Consumer			Total
	(In thousands)
Allowance for Loan Losses:

Beginning balance	$	609		$	201		$	60		$	1,501	$	1,480		$	720		$	275		$	4,846
Provisions		35			(44	)		(13	)		6		(23	)		(49	)		138			50
Charge-offs		(128	)		0			0			0		(1,205	)		(78	)		(268	)		(1,679	)
Recoveries		11			0			0			34		9			33			111			198

Ending balance	$	527		$	157		$	47		$	1,541	$	261		$	626		$	256		$	3,415

Ending allowance balance attributable to loans:

Individually evaluated for impairment	$	6		$	0		$	0		$	49	$	100		$	11		$	0		$	166
Collectively evaluated for impairment		521			157			47			1,492		161			615			256			3,249
Acquired with deteriorated credit quality		0			0			0			0		0			0			0			0

Ending balance	$	527		$	157		$	47		$	1,541	$	261		$	626		$	256		$	3,415

Recorded Investment in Loans:

Individually evaluated for impairment	$	1,996		$	24		$	0		$	3,623	$	167		$	136		$	0		$	5,946
Collectively evaluated for impairment		145,695			13,014			12,616			80,639		22,986			39,041			42,655			356,646
Acquired with deteriorated credit quality		884			0			0			466		0			0			0			1,350

Ending balance	$	148,575		$	13,038		$	12,616		$	84,728	$	23,153		$	39,177		$	42,655		$	363,942

December

31,

2016

and

2015,

management applied specific qualitative factor adjustments to various portfolio segments as they determined that the historical loss experience was not indicative of the level of risk in the remaining balance of those portfolio segments. These adjustments increased the historical loss factors by

0.33%

20%

for certain loan groups, and increased the estimated allowance for loan losses related to those portfolio segments by approximately

$1.8

million and

$1.4

million, respectively. These changes were made to reflect management’s estimates of inherent losses in these portfolio segments at

December

31,

2016

and

2015.

December

31,

2016

and

2015,

for each loan portfolio segment management applied an overall qualitative factor of

1.18

to the Company’s historical loss factors. The overall qualitative factor is derived from management’s analysis of changes and trends in the following qualitative factors:

Underwriting Standards – Management reviews the findings of periodic internal audit loan reviews, independent outsourced loan reviews and loan reviews performed by the banking regulators to evaluate the risk associated with changes in underwriting standards. At

December

31,

2016

and

2015,

management assessed the risk associated with this component as neutral, requiring no adjustment to the historical loss factors.

Economic Conditions – Management analyzes trends in housing and unemployment data in the Louisville, Kentucky metropolitan area, the Company’s primary market area, to evaluate the risk associated with economic conditions. Due to a decrease in new home construction and an increase in unemployment in the Company’s primary market area, management assigned a risk factor of

1.20

for this component at

December

31,

2016

and

2015.

Past Due Loans – Management analyzes trends in past due loans for the Company to evaluate the risk associated with delinquent loans. In general, past due loan ratios have remained at elevated levels compared to historical amounts since

2007,

and management assigned a risk factor of

1.20

for this component at

December

31,

2016

and

2015.

Other Internal and External Factors – This component includes management’s consideration of other qualitative factors such as loan portfolio composition. The Company has focused on the origination of commercial business and real estate loans in an effort to convert the Company’s balance sheet from that of a traditional thrift institution to a commercial bank. In addition, the Company has increased its investment in mortgage loans in which it does not hold a

first

lien position. Commercial loans and

second

mortgage loans generally entail greater credit risk than residential mortgage loans secured by a

first

lien. As a result of changes in the loan portfolio composition and other factors, management has maintained the elevated risk factor of

1.30

for this component at

December

31,

2016

and

2015.

Each of the

four

factors above was assigned an equal weight to arrive at an average for the overall qualitative factor of

1.18

December

31,

2016

and

2015.

The effect of the overall qualitative factor was to increase the estimated allowance for loan losses by

$501,000

and

$457,000

December

31,

2016

and

2015,

respectively.

Management also adjusts the historical loss factors for loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The adjustments consider the increased likelihood of loss on classified loans based on the Company’s separate historical experience for classified loans. The effect of the adjustments for classified loans was to increase the estimated allowance for loan losses by

$559,000

and

$410,000

December

31,

2016

and

2015,

respectively.

The following table summarizes the Company’s impaired loans as of and for the year ended

December

31,

2016.

The Company did not recognize any interest income on impaired loans using the cash receipts method of accounting for the year ended

December

31,

2016.

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(In thousands)

Loans with no related allowance recorded :
Residential real estate	$	1,871	$	2,223	$	0	$	1,904	$	26
Land		0		0		0		5		0
Construction		0		0		0		0		3
Commercial real estate		1,217		1,540		0		2,959		60
Commercial business		75		81		0		66		0
Home equity and second mortgage		231		237		0		88		2
Other consumer		0		0		0		4		1

	$	3,394	$	4,081	$	0	$	5,026	$	92

Loans with an allowance recorded :
Residential real estate	$	212	$	217	$	23	$	148	$	0
Land		0		0		0		0		0
Construction		0		0		0		0		0
Commercial real estate		0		0		0		99		0
Commercial business		68		68		43		54		0
Home equity and second mortgage		13		14		13		27		0
Other consumer		20		20		6		22		0

	$	313	$	319	$	85	$	350	$	0

Total :
Residential real estate	$	2,083	$	2,440	$	23	$	2,052	$	26
Land		0		0		0		5		0
Construction		0		0		0		0		3
Commercial real estate		1,217		1,540		0		3,058		60
Commercial business		143		149		43		120		0
Home equity and second mortgage		244		251		13		115		2
Other consumer		20		20		6		26		1

	$	3,707	$	4,400	$	85	$	5,376	$	92

The following table summarizes the Company’s impaired loans as of and for the year ended

December

31,

2015.

The Company did

t recognize any interest income on impaired loans using the cash receipts method of accounting for the year ended

December

31,

2015.

	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
	(In thousands)

Loans with no related allowance recorded :
Residential real estate	$	1,938	$	2,330	$	0	$	1,356	$	19
Land		24		27		0		20		0
Construction		0		0		0		0		0
Commercial real estate		3,389		3,706		0		2,092		76
Commercial business		67		67		0		19		0
Home equity and second mortgage		56		65		0		64		2
Other consumer		0		0		0		0		0

	$	5,474	$	6,195	$	0	$	3,551	$	97

Loans with an allowance recorded :
Residential real estate	$	58	$	62	$	6	$	190	$	0
Land		0		0		0		0		0
Construction		0		0		0		0		0
Commercial real estate		234		260		49		78		0
Commercial business		100		100		100		355		0
Home equity and second mortgage		80		81		11		80		0
Other consumer		0		0		0		0		0

	$	472	$	503	$	166	$	703	$	0

Total :
Residential real estate	$	1,996	$	2,392	$	6	$	1,546	$	19
Land		24		27		0		20		0
Construction		0		0		0		0		0
Commercial real estate		3,623		3,966		49		2,170		76
Commercial business		167		167		100		374		0
Home equity and second mortgage		136		146		11		144		2
Other consumer		0		0		0		0		0

	$	5,946	$	6,698	$	166	$	4,254	$	97

Nonperforming loans consists of nonaccrual loans and loans over

days past due and still accruing interest. The following table presents the recorded investment in nonperforming loans at

December

31,

2016

and

2015:

	December 31, 2016						December 31, 2015
	Nonaccrual Loans		Loans 90+ Days Past Due Still Accruing		Total Nonperforming Loans		Nonaccrual Loans		Loans 90+ Days Past Due Still Accruing		Total Nonperforming Loans
	(In thousands)

Residential real estate	$	1,634	$	55	$	1,689	$	1,648	$	271	$	1,919
Land		0		0		0		24		75		99
Construction		0		0		0		0		0		0
Commercial real estate		924		0		924		2,267		0		2,267
Commercial business		142		0		142		167		0		167
Home equity and second mortgage		226		0		226		116		0		116
Other consumer		20		23		43		0		9		9

Total	$	2,946	$	78	$	3,024	$	4,222	$	355	$	4,577

The following table presents the aging of the recorded investment in loans at

December

31,

2016:

	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Current		Purchased Credit Impaired Loans		Total Loans
			(In thousands)

Residential real estate	$	2,444	$	707	$	1,021	$	4,172	$	133,815	$	390	$	138,377
Land		0		52		0		52		13,899		0		13,951
Construction		0		0		0		0		19,489		0		19,489
Commercial real estate		0		0		27		27		96,402		240		96,669
Commercial business		155		0		83		238		23,888		0		24,126
Home equity and second mortgage		352		0		13		365		43,466		0		43,831
Other consumer		319		66		43		428		48,893		0		49,321

Total	$	3,270	$	825	$	1,187	$	5,282	$	379,852	$	630	$	385,764

The following table presents the aging of the recorded investment in loans at

December

31,

2015:

	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Current		Purchased Credit Impaired Loans		Total Loans
			(In thousands)

Residential real estate	$	3,078	$	786	$	1,256	$	5,120	$	142,571	$	884	$	148,575
Land		55		26		99		180		12,858		0		13,038
Construction		71		0		0		71		12,545		0		12,616
Commercial real estate		435		773		396		1,604		82,658		466		84,728
Commercial business		0		100		67		167		22,986		0		23,153
Home equity and second mortgage		365		6		80		451		38,726		0		39,177
Other consumer		464		13		9		486		42,169		0		42,655

Total	$	4,468	$	1,704	$	1,907	$	8,079	$	354,513	$	1,350	$	363,942

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, public information, historical payment experience, credit documentation, and current economic trends, among other factors. The Company classifies loans based on credit risk at least quarterly. The Company uses the following regulatory definitions for risk ratings:

Special Mention:

Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses

may

result in deterioration of the repayment prospects for the loan or of the Company’s credit position at some future date.

Substandard:

Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

Doubtful:

Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loss:

Loans classified as loss are considered uncollectible and of such little value that their continuance on the Company’s books as an asset is not warranted.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be pass rated loans.

The following table presents the recorded investment in loans by risk category as of the date indicated:

	Residential Real Estate		Land		Construction		Commercial Real Estate		Commercial Business		Home Equity and Second Mortgage		Other Consumer		Total
(In thousands)
December 31, 2016:
Pass	$	135,328	$	13,795	$	19,489	$	87,782	$	23,246	$	43,601	$	49,256	$	372,497
Special mention		403		86		0		1,892		661		0		45		3,087
Substandard		721		70		0		5,991		77		4		0		6,863
Doubtful		1,925		0		0		1,004		142		226		20		3,317
Loss		0		0		0		0		0		0		0		0

Total	$	138,377	$	13,951	$	19,489	$	96,669	$	24,126	$	43,831	$	49,321	$	385,764

December 31, 2015:
Pass	$	140,438	$	10,077	$	12,286	$	76,389	$	22,365	$	38,956	$	42,553	$	343,064
Special mention		3,657		125		330		4,446		471		0		53		9,082
Substandard		1,948		2,812		0		1,195		150		105		49		6,259
Doubtful		2,532		24		0		2,698		167		116		0		5,537
Loss		0		0		0		0		0		0		0		0

Total	$	148,575	$	13,038	$	12,616	$	84,728	$	23,153	$	39,177	$	42,655	$	363,942

Troubled Debt Restructurings

The following table summarizes the Company’s TDRs by accrual status as of

December

31,

2016

and

2015:

	December 31, 2016								December 31, 2015
	Accruing		Nonaccrual		Total		Related Allowance for Loan Losses		Accruing		Nonaccrual		Total		Related Allowance for Loan Losses
	(In thousands)

Residential real estate	$	433	$	229	$	662	$	0	$	342	$	315	$	657	$	0
Commercial real estate		291		168		459		0		1,348		294		1,642		0
Home equity and second mortgage		18		0		18		0		20		0		20		0

Total	$	742	$	397	$	1,139	$	0	$	1,710	$	609	$	2,319	$	0

December

31,

2016

and

2015,

there were

commitments to lend additional funds to debtors whose loan terms have been modified in a TDR.

There were

TDRs that were restructured during the years ended

December

31,

2016

and

2015.

The Company had payment defaults (defined as the loan becoming more than

days past due, being moved to nonaccrual status, or the collateral being foreclosed upon) for TDRs modified with the previous

months on

two

TDRs to the same borrower totaling

$187,000

during the year ended

December

31,

2015.

There were

such defaults during the year ended

December

31,

2016.

In the event that a TDR subsequently defaults, the Company evaluates the restructuring for possible impairment. As a result, the related allowance for loan losses

may

be increased or charge-offs

may

be taken to reduce the carrying amount of the loan. The Company did

not

recognize any provisions for loan losses or net charge-offs as a result of defaulted TDRs for the years ended

December

31,

2016

and

2015.

Purchased Credit Impaired (“PCI”) Loans

Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan and lease losses. Such loans are accounted for individually or aggregated into pools of loans based on common risk characteristics such as credit score, loan type and date of origination. In determining the estimated fair value of purchased loans or pools, management considers a number of factors including the remaining life, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received, among others. Purchased loans are accounted for in accordance with guidance for certain loans acquired in a transfer (FASB ASC

310

30),

when the loans have evidence of credit deterioration since origination and it is probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. The difference between the expected cash flows and the fair value at acquisition is recorded as interest income over the remaining life of the loan or pool of loans and is referred to as the accretable yield. Subsequent decreases to the expected cash flows will generally result in a provision for loan and lease losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which is recognized as future interest income.

The following table presents the carrying amount of PCI loans accounted for under FASB ASC

310

December

31,

2016

and

2015:

(In thousands)	2016		2015

Residential real estate	$	390	$	884
Commercial real estate		240		466

	$	630	$	1,350

The outstanding balance of PCI loans accounted for under FASB ASC

310

30,

including contractual principal, interest, fees and penalties was

$754,000

and

$1.6

million at

December

31,

2016

and

2015,

respectively.

There was

allowance for loan losses related to PCI loans at

December

31,

2016

2015.

In addition, there were

losses recognized or reductions of the allowance for loan losses on PCI loans for the years ended

December

31,

2016

and

2015.

Accretable yield, or income expected to be collected, is as follows for the years ended

December

31,

2016

and

2015:

(In thousands)	2016			2015

Balance at January 1	$	319		$	-
New loans purchased		-			331
Accretion to income		(75	)		(12	)
Disposals of loans		(93	)		-
Reclassification (to) from nonaccretable difference		101			-

Balance at December 31	$	252		$	319