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, 2019

Or

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

For the transition period from              to             

Commission file number: 001-33033

LIMESTONE BANCORP, INC.

(Exact name of registrant as specified in its charter)

Kentucky	61-1142247
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
2500 Eastpoint Parkway, Louisville, Kentucky	40223
(Address of principal executive offices)	(Zip Code)

(502) 499-4800

(Registrant’s telephone number, including area code)

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 shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒     No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Securities registered pursuant to Section 12(b) of the Exchange Act:

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common shares	LMST	Nasdaq

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company in Rule 12b-2 of the Exchange Act.

Large accelerated filer  ☐	Accelerated filer  ☒
Non-accelerated filer  ☐	Smaller reporting company  ☒
	Emerging growth company  ☐

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

6,250,593 Common Shares and 1,220,000 Non-Voting Common Shares were outstanding at July 31, 2019.

1

INDEX

	Page
PART I –	FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS	3
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	32
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	45
ITEM 4.	CONTROLS AND PROCEDURES	45
PART II –	OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	46
ITEM 1A.	RISK FACTORS	46
ITEM 2.	UNREGISTERED SALES ON EQUITY SECURITIES AND USE OF PROCEEDS	46
ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	46
ITEM 4.	MINE SAFETY DISCLOSURES	46
ITEM 5.	OTHER INFORMATION	46
ITEM 6.	EXHIBITS	47

2

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

The following consolidated financial statements of Limestone Bancorp, Inc. and subsidiary, Limestone Bank, Inc. are submitted:

Unaudited Consolidated Balance Sheets for June 30, 2019 and December 31, 2018

Unaudited Consolidated Statements of Income for the three and six months ended June 30, 2019 and 2018

Unaudited Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2019 and 2018

Unaudited Consolidated Statement of Changes in Stockholders’ Equity for the three and six months ended June 30, 2019 and 2018

Unaudited Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and 2018

Notes to Unaudited Consolidated Financial Statements

3

LIMESTONE BANCORP, INC.

Unaudited Consolidated Balance Sheets

(dollars in thousands except share data)

	June 30, 2019			December 31, 2018
Assets
Cash and due from banks	$	6,860		$	6,963
Interest bearing deposits in banks		40,755			28,398
Cash and cash equivalents		47,615			35,361
Securities available for sale		208,614			201,192
Loans, net of allowance of $8,832 and $8,880, respectively		794,282			756,364
Premises and equipment, net		14,827			14,655
Premises held for sale		995			1,050
Other real estate owned		3,225			3,485
Federal Home Loan Bank stock		6,693			7,233
Bank owned life insurance		15,853			15,646
Deferred taxes, net		28,708			29,282
Accrued interest receivable and other assets		5,976			5,424
Total assets	$	1,126,788		$	1,069,692
Liabilities and Stockholders’ Equity
Deposits
Non-interest bearing	$	141,448		$	142,618
Interest bearing		797,029			751,613
Total deposits		938,477			894,231
Federal Home Loan Bank advances		51,470			46,549
Accrued interest payable and other liabilities		4,419			5,815
Junior subordinated debentures		21,000			21,000
Senior debt		10,000			10,000
Total liabilities		1,025,366			977,595
Commitments and contingent liabilities (Note 13)		—			—
Stockholders’ equity
Common stock, no par, 39,000,000 shares authorized, 6,237,832 and 6,242,720 voting, and 1,220,000 and 1,220,000 non-voting issued and outstanding, respectively		140,639			140,639
Additional paid-in capital		24,147			24,287
Retained deficit		(59,729	)		(66,201	)
Accumulated other comprehensive loss		(3,635	)		(6,628	)
Total stockholders' equity		101,422			92,097
Total liabilities and stockholders’ equity	$	1,126,788		$	1,069,692

See accompanying notes to unaudited consolidated financial statements.

4

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Income

(dollars in thousands, except per share data)

	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Interest income
Loans, including fees	$	10,465		$	9,094		$	20,719		$	17,884
Taxable securities		1,608			1,198			3,181			2,141
Tax exempt securities		88			96			181			192
Federal funds sold and other		215			197			481			383
		12,376			10,585			24,562			20,600
Interest expense
Deposits		2,965			1,649			5,552			2,993
Federal Home Loan Bank advances		255			216			536			372
Senior debt		98			98			194			194
Junior subordinated debentures		258			236			521			447
Subordinated capital note		—			12			—			39
		3,576			2,211			6,803			4,045
Net interest income		8,800			8,374			17,759			16,555
Provision (negative provision) for loan losses		—			(150	)		—			(150	)
Net interest income after provision for loan losses		8,800			8,524			17,759			16,705
Non-interest income
Service charges on deposit accounts		571			591			1,067			1,159
Bank card interchange fees		596			446			1,104			847
Income from bank owned life insurance		118			138			217			237
Net loss on sales and calls of investment securities		(5	)		(6	)		(5	)		(6	)
Other		166			178			347			361
		1,446			1,347			2,730			2,598
Non-interest expense
Salaries and employee benefits		3,915			3,885			7,830			7,673
Occupancy and equipment		854			880			1,752			1,775
Professional fees		179			222			344			427
Marketing expense		212			308			439			608
FDIC Insurance		103			139			211			321
Data processing expense		315			307			628			631
State franchise and deposit tax		315			282			630			564
Deposit account related expense		310			221			591			440
Other real estate owned expense		142			237			308			319
Litigation and loan collection expense		34			48			80			101
Other		845			876			1,692			1,715
		7,224			7,405			14,505			14,574
Income before income taxes		3,022			2,466			5,984			4,729
Income tax expense (benefit)		(611	)		483			(488	)		812
Net income		3,633			1,983			6,472			3,917
Basic and diluted income per common share	$	0.49		$	0.27		$	0.87		$	0.57

See accompanying notes to unaudited consolidated financial statements.

5

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Comprehensive Income (Loss)

(in thousands)

	Three Months Ended June 30,						Six Months Ended June 30,
	2019			2018			2019			2018
Net income	$	3,633		$	1,983		$	6,472		$	3,917
Other comprehensive income (loss):
Unrealized gain (loss) on securities:
Unrealized gain (loss) arising during the period		1,882			(523	)		3,877			(2,234	)
Reclassification adjustment for gains (losses) included in net income		(5	)		(6	)		(5	)		(6	)
Net unrealized gain (loss) recognized in comprehensive income		1,887			(517	)		3,882			(2,228	)
Tax effect		(471	)		109			(889	)		469
Other comprehensive income (loss)		1,416			(408	)		2,993			(1,759	)
Comprehensive income	$	5,049		$	1,575		$	9,465		$	2,158

See accompanying notes to unaudited consolidated financial statements.

6

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Three and Six Months Ended June 30, 2019 and 2018

(Dollar amounts in thousands except share and per share data)

	Shares												Amount
	Preferred				Common								Preferred				Common
	Series E		Series F		Common			Non-Voting Common		Total Common			Series E		Series F		Common and Non-Voting Common		Additional Paid-In Capital			Retained Deficit			Accumulated Other Comprehensive Income (Loss)			Total
Balances, January 1, 2019		—		—		6,242,720			1,220,000		7,462,720		$	—	$	—	$	140,639	$	24,287		$	(66,201	)	$	(6,628	)	$	92,097
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award		—		—		1,642			—		1,642			—		—		—		(276	)		—			—			(276	)
Forfeited unvested stock		—		—		(3,748	)		—		(3,748	)		—		—		—		—			—			—			—
Stock-based compensation expense		—		—		—			—		—			—		—		—		82			—			—			82
Net income		—		—		—			—		—			—		—		—		—			2,839			—			2,839
Net change in accumulated other comprehensive income, net of taxes		—		—		—			—		—			—		—		—		—			—			1,577			1,577
Balances, March 31, 2019		—		—		6,240,614			1,220,000		7,460,614		$	—	$	—	$	140,639	$	24,093		$	(63,362	)	$	(5,051	)	$	96,319
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award		—		—		(2,532	)		—		(2,532	)		—		—		—		(39	)		—			—			(39	)
Forfeited unvested stock		—		—		(250	)		—		(250	)		—		—		—		—			—			—			—
Stock-based compensation expense		—		—		—			—		—			—		—		—		93			—			—			93
Net income		—		—		—			—		—			—		—		—		—			3,633			—			3,633
Net change in accumulated other comprehensive income, net of taxes		—		—		—			—		—			—		—		—		—			—			1,416			1,416
Balances, June 30, 2019		—		—		6,237,832			1,220,000		7,457,832		$	—	$	—	$	140,639	$	24,147		$	(59,729	)	$	(3,635	)	$	101,422

See accompanying notes to unaudited consolidated financial statements.

7

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Changes in Stockholders’ Equity

For Three and Six Months Ended June 30, 2019 and 2018

(Dollar amounts in thousands except share and per share data)

	Shares												Amount
	Preferred						Common						Preferred						Common
	Series E			Series F			Common		Non-Voting Common		Total Common		Series E			Series F			Common and Non-Voting Common		Additional Paid-In Capital			Retained Deficit			Accumulated Other Comprehensive Income (Loss)			Total
Balances, January 1, 2018		6,198			4,304			6,039,864		220,000		6,259,864	$	1,644		$	1,127		$	125,729	$	24,497		$	(75,108	)	$	(5,216	)	$	72,673
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award		—			—			—		—		—		—			—			—		—			—			—			—
Forfeited unvested stock		—			—			—		—		—		—			—			—		—			—			—			—
Issuance of stock		—			—			150,000		1,000,000		1,150,000		—			—			14,910		—			—			—			14,910
Stock-based compensation expense		—			—			—		—		—		—			—			—		64			—			—			64
Net income		—			—			—		—		—		—			—			—		—			1,934			—			1,934
Reclassification of disproportionate tax effect
due to change in federal tax rate		—			—			—		—		—		—			—			—		—			113			(113	)		—
Net change in accumulated other comprehensive income, net of taxes		—			—			—		—		—		—			—			—		—			—			(1,351	)		(1,351	)
Balances, March 31, 2018		6,198			4,304			6,189,864		1,220,000		7,409,864	$	1,644		$	1,127		$	140,639	$	24,561		$	(73,061	)	$	(6,680	)	$	88,230
Stock issued for share-based awards, net of withholdings to satisfy employee tax obligations upon award		—			—			45,129		—		45,129		—			—			—		—			—			—			—
Forfeited unvested stock		—			—			—		—		—		—			—			—		—			—			—			—
Redemption and retirement of preferred shares		(6,198	)		(4,304	)		—		—		—		(1,644	)		(1,127	)		—		(734	)		—			—			(3,505	)
Stock-based compensation expense		—			—			—		—		—		—			—			—		99			—			—			99
Net income		—			—			—		—		—		—			—			—		—			1,983			—			1,983
Net change in accumulated other comprehensive income, net of taxes		—			—			—		—		—		—			—			—		—			—			(408	)		(408	)
Balances, June 30, 2018		—			—			6,234,993		1,220,000		7,454,993	$	—		$	—		$	140,639	$	23,926		$	(71,078	)	$	(7,088	)	$	86,399

See accompanying notes to unaudited consolidated financial statements.

8

LIMESTONE BANCORP, INC.

Unaudited Consolidated Statements of Cash Flows

For Six Months Ended June 30, 2019 and 2018

(dollars in thousands)

	2019			2018
Cash flows from operating activities
Net income	$	6,472		$	3,917
Adjustments to reconcile net income to net cash from operating activities
Depreciation and amortization		979			477
Provision (negative provision) for loan losses		—			(150	)
Net amortization on securities		363			444
Stock-based compensation expense		175			163
Deferred taxes, net		(317	)		1,158
Net gain on sales of loans held for sale		—			(1	)
Proceeds from sales of loans held for sale		—			71
Net gain on sales of other real estate owned		—			(50	)
Net write-down of other real estate owned		260			325
Net realized loss on sales and calls of investment securities		5			6
Net write-down on premises held for sale		55			—
Earnings on bank owned life insurance, net of premium expense		(207	)		(227	)
Net change in accrued interest receivable and other assets		(552	)		(767	)
Net change in accrued interest payable and other liabilities		(1,780	)		(795	)
Net cash from operating activities		5,453			4,571
Cash flows from investing activities
Purchases of available for sale securities		(13,894	)		(41,911	)
Sales and calls of available for sale securities		2,452			6,054
Maturities and prepayments of available for sale securities		7,534			7,003
Proceeds from mandatory redemptions of FHLB stock		540			—
Proceeds from sale of other real estate owned		—			354
Loan originations and payments, net		(38,476	)		(37,372	)
Purchases of premises and equipment, net		(208	)		(449	)
Proceeds from sale of premises and equipment		1			—
Net cash from investing activities		(42,051	)		(66,321	)
Cash flows from financing activities
Net change in deposits		44,246			(794	)
Repayment of Federal Home Loan Bank advances		(65,079	)		(40,167	)
Advances from Federal Home Loan Bank		70,000			100,000
Repayment of subordinated capital note		—			(2,250	)
Issuance of common stock		—			14,910
Common shares withheld for taxes		(315	)		—
Redemption of preferred stock		—			(3,505	)
Net cash from financing activities		48,852			68,194
Net change in cash and cash equivalents		12,254			6,444
Beginning cash and cash equivalents		35,361			34,103
Ending cash and cash equivalents	$	47,615		$	40,547
Supplemental cash flow information:
Interest paid	$	6,771		$	4,973
Supplemental non-cash disclosure:
Transfer from loans to other real estate		—			730
Initial recognition of right-of-use lease assets		507			—

See accompanying notes to unaudited consolidated financial statements.

9

LIMESTONE BANCORP, INC.

Notes to Unaudited Consolidated Financial Statements

Note 1 – Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation – The consolidated financial statements include Limestone Bancorp, Inc. (Company) and its subsidiary, Limestone Bank (Bank). The Company owns a 100% interest in the Bank. All significant inter-company transactions and accounts have been eliminated in consolidation.

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, the financial statements do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the entire year. A description of other significant accounting policies is presented in the notes to the Consolidated Financial Statements for the year ended December 31, 2018 included in the Company’s Annual Report on Form 10-K.

Use of Estimates – To prepare financial statements in conformity with U.S. generally accepted accounting principles, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and future results could differ.

Reclassifications – Some items in the prior year financial statements were reclassified to conform to the current presentation. The reclassifications did not impact net income or stockholders’ equity.

New Accounting Standards – In February 2016, the FASB issued an update ASU No. 2016-02, Leases (Topic 842). Under the new guidance, lessees are required to recognize the following for all leases, with the exception of short-term leases, at the commencement date: 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. Under the new guidance, lessor accounting is largely unchanged. The amendments in this update became effective for annual periods and interim periods within those annual periods beginning after December 15, 2018. Based on the Company’s existing lease agreements, the impact of adopting the new guidance on the consolidated financial statements was the recording of a $507,000 lease liability and a right of use asset, which is included in other liabilities and premises and equipment, respectively, on the consolidated balance sheet. The adoption of this ASU did not have a meaningful impact on the Company’s performance metrics, including regulatory capital ratios and return on average assets. The Company’s leases mature through 2024 and have a weighted average discount rate of 6%. The operating lease cost was approximately $65,000 and $130,000 for the three and six months ended June 30, 2019. At June 30, 2019, the Company had entered into one lease that has yet to commence. The right of use asset and lease liability for the lease yet to commence are estimated to be approximately $1.1 million.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The final standard will change estimates for credit losses related to financial assets measured at amortized cost such as loans, held-to-maturity debt securities, and certain other contracts. For estimating credit losses, the FASB is replacing the incurred loss model with an expected loss model, which is referred to as the current expected credit loss (CECL) model. Under the CECL model, certain financial assets that are carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, are required to be presented at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current GAAP, which delays recognition until it is probable a loss has been incurred. The change could materially affect how the allowance for loan losses is determined. The standard is effective for public companies for fiscal years beginning after December 15, 2019. As previously disclosed, management has formed a cross functional committee that has overseen the enhancement of existing technology required to source and model data for the purpose of meeting this standard. The committee has selected a vendor to assist in generating loan level cash flows and disclosures. The project plan involved data and model validation during the first half of 2019, with parallel processing the existing model with the CECL model for two to three quarters prior to implementation, depending on how model completion and validation occurs. During 2019, management is focused on refining assumptions and continued review of the model. Additionally, management is researching and resolving interpretive accounting issues in the ASU, contemplating various accounting policies, developing processes and related controls, and considering various reporting disclosures. The impact of CECL model implementation is being evaluated, but it is expected that a one-time cumulative-effect adjustment to the allowance for loan losses will be recognized in retained earnings on the consolidated balance sheet as of the beginning of the first reporting period in which the new standard is effective, as is consistent with regulatory expectations set forth in interagency guidance. In December 2018, the OCC, The Board of Governors of the Federal Reserve System, and the FDIC approved a final rule to address changes to the credit loss accounting under GAAP, including banking organizations’ implementation of CECL. The final rule provides banking organizations the option to phase in over a three-year period the day-one adverse effects on regulatory capital that may result from adoption of the new accounting standard. In July 2019, the FASB voted for a proposal to delay implementation for smaller reporting companies, private companies, and not-for-profit entities. The Company currently qualifies as a smaller reporting company. Companies benefiting from the delay will have to implement CECL for fiscal year and interim periods beginning after December 15, 2022. The proposal will undergo a 30-day public comment period in August 2019.

10

In March 2017, the FASB issued ASU No. 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization of Purchased Callable Debt Securities. The final standard will shorten the amortization period for premiums on callable debt securities by requiring that premiums be amortized to the first (or earliest) call date instead of as an adjustment to the yield over the contractual life. The standard was effective for public companies for fiscal years beginning after December 15, 2018. Adoption of this new guidance did not have a material impact on the consolidated financial statements.

Note 2 – Securities

Securities are classified as available for sale (AFS). AFS securities may be sold if needed for liquidity, asset liability management, or other reasons. AFS securities are reported at fair value, with unrealized gains or losses included as a separate component of equity, net of tax.

The amortized cost and fair value of securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:

	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
	(in thousands)
June 30, 2019
Available for sale
U.S. Government and federal agency	$	23,920	$	293	$	(118	)	$	24,095
Agency mortgage-backed: residential		93,238		1,008		(288	)		93,958
Collateralized loan obligations		49,875		7		(200	)		49,682
State and municipal		30,236		565		(4	)		30,797
Corporate bonds		9,913		179		(10	)		10,082
Total available for sale	$	207,182	$	2,052	$	(620	)	$	208,614

December 31, 2018	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Available for sale
U.S. Government and federal agency	$	23,280	$	2	$	(722	)	$	22,560
Agency mortgage-backed: residential		87,689		192		(1,891	)		85,990
Collateralized loan obligations		49,942		—		(103	)		49,839
State and municipal		32,841		230		(259	)		32,812
Corporate bonds		9,890		127		(26	)		9,991
Total available for sale	$	203,642	$	551	$	(3,001	)	$	201,192

Sales and calls of securities were as follows:

	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
	(in thousands)				(in thousands)
Proceeds	$	1,452	$	6,054	$	2,452	$	6,054
Gross gains		1		—		1		—
Gross losses		6		6		6		6

11

The amortized cost and fair value of our debt securities are shown by contractual maturity. Expected maturities may differ from actual maturities when borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Mortgage-backed securities not due at a single maturity date are shown separately. 

	June 30, 2019
	Amortized Cost		Fair Value
	(in thousands)
Maturity
Available for sale
Within one year	$	49,728	$	49,643
One to five years		39,779		40,287
Five to ten years		24,437		24,726
Agency mortgage-backed: residential		93,238		93,958
Total	$	207,182	$	208,614

Securities pledged at June 30, 2019 and December 31, 2018 had carrying values of approximately $69.9 million and $64.4 million, respectively, and were pledged to secure public deposits.

At June 30, 2019 and December 31, 2018, the Bank held securities issued by the Commonwealth of Kentucky or Kentucky municipalities having a book value of $14.9 million. At June 30, 2019 and December 31, 2018, there were no other holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

The Bank owns Collateralized Loan Obligations (CLOs), which are debt securities secured by professionally managed portfolios of senior-secured loans to corporations. CLO managers are typically large non-bank financial institutions or banks and are typically $300 million to $1 billion in size, contain one hundred or more loans, have five to six credit tranches ranging from AAA, AA, A, BBB, BB, B and equity tranche. Interest and principal are paid first to the AAA tranche then to the next lower rated tranche. Losses are borne first by the equity tranche then by the subsequently higher rated tranche. CLOs may be less liquid than government securities from time to time and volatility in the CLO market may cause the value of these investments to decline.

The market value of CLOs may be affected by, among other things, changes in composition of the underlying loans, changes in the cash flows from the underlying loans, defaults and recoveries on the underlying loans, capital gains and losses on the underlying loans, and prepayments on the underlying loans.

At June 30, 2019, $33.0 million and $16.7 million of our CLOs were AA and A rated, respectively. There were no CLOs rated below A and none of the CLOs were subject to ratings downgrade in the six months ended June 30, 2019. All of our CLOs are floating rate, with rates set on a quarterly basis at three month LIBOR plus a spread.

The Company evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than cost, the financial condition and near-term prospects of the issuer, underlying credit quality of the issuer, and 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. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, the sector or industry trends and cycles affecting the issuer, and the results of reviews of the issuer’s financial condition. As of June 30, 2019, management does not believe any securities in the portfolio with unrealized losses should be classified as other than temporarily impaired.

12

Securities with unrealized losses at June 30, 2019 and December 31, 2018, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, are as follows:

	Less than 12 Months					12 Months or More					Total
Description of Securities	Fair Value		Unrealized Loss			Fair Value		Unrealized Loss			Fair Value		Unrealized Loss
	(in thousands)
June 30, 2019
Available for sale
U.S. Government and federal agency	$	—	$	—		$	11,818	$	(118	)	$	11,818	$	(118	)
Agency mortgage-backed:
residential		—		—			26,788		(288	)		26,788		(288	)
Collateralized loan obligations		27,933		(161	)		9,612		(39	)		37,545		(200	)
State and municipal		429		(1	)		1,457		(3	)		1,886		(4	)
Corporate bonds		1,592		(10	)		—		—			1,592		(10	)
Total temporarily impaired	$	29,954	$	(172	)	$	49,675	$	(448	)	$	79,629	$	(620	)
December 31, 2018
Available for sale
U.S. Government and federal agency	$	3,431	$	(57	)	$	17,212	$	(665	)	$	20,643	$	(722	)
Agency mortgage-backed:
residential		30,229		(343	)		40,932		(1,548	)		71,161		(1,891	)
Collateralized loan obligations		48,294		(103	)		—		—			48,294		(103	)
State and municipal		6,133		(29	)		7,252		(230	)		13,385		(259	)
Corporate Bonds		3,569		(26	)		—		—			3,569		(26	)
Total temporarily impaired	$	91,656	$	(558	)	$	65,396	$	(2,443	)	$	157,052	$	(3,001	)

Note 3 – Loans

Loans net of unearned income, deferred loan origination costs, and net premiums on acquired loans by class were as follows:

	June 30,			December 31,
	2019			2018
	(in thousands)
Commercial	$	140,666		$	129,368
Commercial Real Estate:
Construction		64,472			86,867
Farmland		78,634			77,937
Nonfarm nonresidential		187,217			172,177
Residential Real Estate:
Multi-family		63,107			49,757
1-4 Family		171,687			175,761
Consumer		55,252			39,104
Agriculture		41,586			33,737
Other		493			536
Subtotal		803,114			765,244
Less: Allowance for loan losses		(8,832	)		(8,880	)
Loans, net	$	794,282		$	756,364

13

The following table presents the activity in the allowance for loan losses by portfolio segment for the three months ended June 30, 2019 and 2018:

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture			Other			Total
	(in thousands)
June 30, 2019:
Beginning balance	$	1,447		$	4,498		$	2,227		$	159		$	353		$	2		$	8,686
Provision (negative provision)		(45	)		(46	)		52			(16	)		55			–			–
Loans charged off		–			–			(35	)		(34	)		(3	)		–			(72	)
Recoveries		90			1			83			44			–			–			218
Ending balance	$	1,492		$	4,453		$	2,327		$	153		$	405		$	2		$	8,832
June 30, 2018:
Beginning balance	$	1,077		$	4,112		$	2,833		$	84		$	419		$	1		$	8,526
Provision (negative provision)		51			(83	)		(48	)		(27	)		(40	)		(3	)		(150	)
Loans charged off		–			(197	)		(69	)		(7	)		(12	)		(8	)		(293	)
Recoveries		5			402			62			16			–			12			497
Ending balance	$	1,133		$	4,234		$	2,778		$	66		$	367		$	2		$	8,580

The following table presents the activity in the allowance for loan losses by portfolio segment for the six months ended June 30, 2019 and 2018: 

	Commercial			Commercial Real Estate			Residential Real Estate			Consumer			Agriculture			Other			Total
	(in thousands)
June 30, 2019:
Beginning balance	$	1,299		$	4,676		$	2,452		$	130		$	321		$	2		$	8,880
Provision (negative provision)		98			(211	)		(152	)		177			88			–			–
Loans charged off		–			(15	)		(117	)		(214	)		(4	)		–			(350	)
Recoveries		95			3			144			60			–			–			302
Ending balance	$	1,492		$	4,453		$	2,327		$	153		$	405		$	2		$	8,832
June 30, 2018:
Beginning balance	$	892		$	4,032		$	2,900		$	64		$	313		$	1		$	8,202
Provision (negative provision)		(4	)		(20	)		(164	)		(14	)		55			(3	)		(150	)
Loans charged off		–			(198	)		(88	)		(34	)		(12	)		(8	)		(340	)
Recoveries		245			420			130			50			11			12			868
Ending balance	$	1,133		$	4,234		$	2,778		$	66		$	367		$	2		$	8,580

14

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and based on the impairment method as of June 30, 2019:

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1	$	37	$	157	$	–	$	–	$	–	$	195
Collectively evaluated for impairment		1,491		4,416		2,170		153		405		2		8,637
Total ending allowance balance	$	1,492	$	4,453	$	2,327	$	153	$	405	$	2	$	8,832
Loans:
Loans individually evaluated for impairment	$	109	$	738	$	2,150	$	–	$	65	$	–	$	3,062
Loans collectively evaluated for impairment		140,557		329,585		232,644		55,252		41,521		493		800,052
Total ending loans balance	$	140,666	$	330,323	$	234,794	$	55,252	$	41,586	$	493	$	803,114

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

	Commercial		Commercial Real Estate		Residential Real Estate		Consumer		Agriculture		Other		Total
	(in thousands)
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	–	$	35	$	168	$	–	$	–	$	–	$	203
Collectively evaluated for impairment		1,299		4,641		2,284		130		321		2		8,677
Total ending allowance balance	$	1,299	$	4,676	$	2,452	$	130	$	321	$	2	$	8,880
Loans:
Loans individually evaluated for impairment	$	53	$	510	$	2,348	$	–	$	–	$	–	$	2,911
Loans collectively evaluated for impairment		129,315		336,471		223,170		39,104		33,737		536		762,333
Total ending loans balance	$	129,368	$	336,981	$	225,518	$	39,104	$	33,737	$	536	$	765,244

Impaired Loans

Impaired loans include restructured loans and loans on nonaccrual or classified as doubtful, whereby collection of the total amount is improbable, or loss, whereby all or a portion of the loan has been written off or a specific allowance for loss has been provided.

15

The following tables present information related to loans individually evaluated for impairment by class of loans as of June 30, 2019 and December 31, 2018 and for the three and six months ended June 30, 2019 and 2018:

	As of June 30, 2019						Three Months Ended June 30, 2019				Six Months Ended June 30, 2019
	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	171	$	82	$	—	$	66	$	—	$	62	$	—
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		346		205		—		156		3		134		8
Nonfarm nonresidential		701		240		—		246		4		251		7
Residential real estate:
Multi-family		—		—		—		—		—		—		—
1-4 Family		2,605		1,437		—		1,448		28		1,508		50
Consumer		179		—		—		14		2		9		2
Agriculture		65		65		—		65		—		43		—
Other		—		—		—		—		—		—		—
Subtotal		4,067		2,029		—		1,995		37		2,007		67
With An Allowance Recorded:
Commercial		27		27		1		13		1		9		1
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		293		293		37		225		—		203		—
Nonfarm nonresidential		—		—		—		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—		—		—		—
1-4 Family		713		713		157		715		10		717		21
Consumer		—		—		—		—		—		—		—
Agriculture		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—
Subtotal		1,033		1,033		195		953		11		929		22
Total	$	5,100	$	3,062	$	195	$	2,948	$	48	$	2,936	$	89

	As of December 31, 2018						Three Months Ended June 30, 2018				Six Months Ended June 30, 2018
	Unpaid Principal Balance		Recorded Investment		Allowance For Loan Losses Allocated		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
	(in thousands)
With No Related Allowance Recorded:
Commercial	$	120	$	53	$	—	$	14	$	1	$	172	$	1
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		1,860		89		—		1,340		83		1,580		281
Nonfarm nonresidential		402		262		—		271		3		373		8
Residential real estate:
Multi-family		—		—		—		—		—		—		—
1-4 Family		2,678		1,628		—		1,894		27		2,191		35
Consumer		12		—		—		1		—		1		—
Agriculture		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—
Subtotal		5,072		2,032		—		3,520		114		4,317		325
With An Allowance Recorded:
Commercial		—		—		—		100		2		100		4
Commercial real estate:
Construction		—		—		—		—		—		—		—
Farmland		—		—		—		86		—		57		—
Nonfarm nonresidential		159		159		35		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—		—		—		—
1-4 Family		720		720		168		1,460		16		1,361		32
Consumer		—		—		—		—		—		—		—
Agriculture		—		—		—		—		—		—		—
Other		—		—		—		—		—		—		—
Subtotal		879		879		203		1,646		18		1,518		36
Total	$	5,951	$	2,911	$	203	$	5,166	$	132	$	5,835	$	361

16

Cash basis income recognized for the three and six months ended June 30, 2019 was $30,000 and $60,000, respectively, compared to $111,000 and $317,000 for the three and six months ended June 30, 2018, respectively.

Troubled Debt Restructuring

A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession for a borrower who is experiencing financial difficulty. The Bank’s TDRs may involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower.

The following table presents the types of TDR loan modifications by portfolio segment outstanding as of June 30, 2019 and December 31, 2018:

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
June 30, 2019
Commercial Real Estate:
Nonfarm nonresidential
Rate reduction	$	190		—	$	190
Residential Real Estate:
1-4 Family
Rate reduction		715		—		715
Total TDRs	$	905	$	—	$	905

	TDRs Performing to Modified Terms		TDRs Not Performing to Modified Terms		Total TDRs
	(in thousands)
December 31, 2018
Commercial Real Estate:
Nonfarm nonresidential
Rate reduction	$	190	$	—	$	190
Residential Real Estate:
1-4 Family
Rate reduction		720		—		720
Total TDRs	$	910	$	—	$	910

At June 30, 2019 and December 31, 2018, 100% of the Company’s TDRs were performing according to their modified terms. The Company allocated $157,000 and $168,000 in reserves to borrowers whose loan terms have been modified in TDRs as of June 30, 2019, and December 31, 2018, respectively. The Company has committed to lend no additional amounts as of June 30, 2019 and December 31, 2018 to borrowers with outstanding loans classified as TDRs.

No TDR loan modifications occurred during the three or six months ended June 30, 2019 or June 30, 2018. During the first six months of 2019 and 2018, no TDRs defaulted on their restructured loan within the 12 month period following the loan modification. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual.

17

Non-performing Loans

Non-performing loans include impaired loans and smaller balance homogeneous loans, such as residential mortgage and consumer loans, that are collectively evaluated for impairment. The following table presents the recorded investment in nonaccrual and loans past due 90 days and still on accrual by class of loan as of June 30, 2019, and December 31, 2018: 

	Nonaccrual				Loans Past Due 90 Days And Over Still Accruing
	June 30, 2019		December 31, 2018		June 30, 2019		December 31, 2018
	(in thousands)
Commercial	$	82	$	53	$	—	$	—
Commercial Real Estate:
Construction		—		—		—		—
Farmland		498		249		—		—
Nonfarm nonresidential		48		61		—		—
Residential Real Estate:
Multi-family		—		—		—		—
1-4 Family		1,335		1,628		—		—
Consumer		—		—		—		—
Agriculture		65		—		—		—
Other		—		—		—		—
Total	$	2,028	$	1,991	$	—	$	—

The following table presents the aging of the recorded investment in past due loans as of June 30, 2019 and December 31, 2018:

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual
	(in thousands)
June 30, 2019
Commercial	$	19	$	—	$	—	$	82	$	101
Commercial Real Estate:
Construction		—		—		—		—		—
Farmland		221		274		—		498		993
Nonfarm nonresidential		26		—		—		48		74
Residential Real Estate:
Multi-family		—		—		—		—		—
1-4 Family		545		741		—		1,335		2,621
Consumer		40		—		—		—		40
Agriculture		7		—		—		65		72
Other		—		—		—		—		—
Total	$	858	$	1,015	$	—	$	2,028	$	3,901

18

	30 – 59 Days Past Due		60 – 89 Days Past Due		90 Days And Over Past Due		Nonaccrual		Total Past Due And Nonaccrual
	(in thousands)
December 31, 2018
Commercial	$	39	$	—	$	—	$	53	$	92
Commercial Real Estate:
Construction		—		—		—		—		—
Farmland		244		107		—		249		600
Nonfarm nonresidential		—		52		—		61		113
Residential Real Estate:
Multi-family		—		—		—		—		—
1-4 Family		1,299		137		—		1,628		3,064
Consumer		8		35		—		—		43
Agriculture		3		—		—		—		3
Other		—		—		—		—		—
Total	$	1,593	$	331	$	—	$	1,991	$	3,915

Credit Quality Indicators 

Management categorizes all loans into risk categories at origination based upon original underwriting. Thereafter, management categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends. Additionally, loans are analyzed through internal and external loan review processes. Borrower relationships in excess of $500,000 are routinely analyzed through credit administration processes which classify the loans as to credit risk. The following definitions are used for risk ratings:

Watch – Loans classified as watch are those loans which have or may experience a potentially adverse development which necessitates increased monitoring.

Special Mention – Loans classified as special mention do not have all of the characteristics of substandard or doubtful loans. They have one or more deficiencies which warrant special attention and which corrective action, such as accelerated collection practices, may remedy.

Substandard – Loans classified as substandard are those loans with clear and defined weaknesses such as a highly leveraged position, unfavorable financial ratios, uncertain repayment sources or poor financial condition which may jeopardize the repayment of the debt as contractually agreed. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful are those loans which have characteristics similar to substandard loans but with an increased risk that collection or liquidation in full is highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described process are considered to be “Pass” rated loans. As of June 30, 2019, and December 31, 2018, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

	Pass		Watch		Special Mention		Substandard		Doubtful		Total
	(in thousands)
June 30, 2019
Commercial	$	127,849	$	8,339	$	—	$	4,478	$	—	$	140,666
Commercial Real Estate:
Construction		64,472		—		—		—		—		64,472
Farmland		73,219		4,114		—		1,301		—		78,634
Nonfarm nonresidential		179,475		4,996		—		2,746		—		187,217
Residential Real Estate:
Multi-family		60,869		2,034		—		204		—		63,107
1-4 Family		165,434		2,587		—		3,666		—		171,687
Consumer		55,182		8		—		62		—		55,252
Agriculture		40,669		851		—		66		—		41,586
Other		493		—		—		—		—		493
Total	$	767,662	$	22,929	$	—	$	12,523	$	—	$	803,114

19

	Pass		Watch		Special Mention		Substandard		Doubtful		Total
	(in thousands)
December 31, 2018
Commercial	$	129,106	$	141	$	—	$	121	$	—	$	129,368
Commercial Real Estate:
Construction		86,867		—		—		—		—		86,867
Farmland		74,054		2,741		—		1,142		—		77,937
Nonfarm nonresidential		169,551		1,983		—		643		—		172,177
Residential Real Estate:
Multi-family		44,697		5,060		—		—		—		49,757
1-4 Family		169,342		2,209		113		4,097		—		175,761
Consumer		38,768		11		—		325		—		39,104
Agriculture		32,683		1,019		—		35		—		33,737
Other		536		—		—		—		—		536
Total	$	745,604	$	13,164	$	113	$	6,363	$	—	$	765,244

Note 4 – Other Real Estate Owned

Other real estate owned (OREO) is real estate acquired as a result of foreclosure or by deed in lieu of foreclosure. It is classified as real estate owned until such time as it is sold. When property is acquired as a result of foreclosure or by deed in lieu of foreclosure, it is recorded at its fair market value less estimated cost to sell. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses.

Fair value of OREO is determined on an individual property basis. When foreclosed properties are acquired, management obtains a new appraisal of the subject property or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Updated appraisals are typically obtained within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a marketing price is lowered below the appraised amount. 

The following table presents the major categories of OREO at the period-ends indicated: 

	June 30, 2019		December 31, 2018
	(in thousands)
Commercial Real Estate:
Construction, land development, and other land	$	3,225	$	3,485
	$	3,225	$	3,485

Residential loans secured by 1-4 family residential properties in the process of foreclosure totaled $401,000 and $771,000 at June 30, 2019 and December 31, 2018, respectively.

Activity relating to OREO during the six months ended June 30, 2019 and 2018 is as follows:

	For the Six Months Ended June 30,
	2019			2018
	(in thousands)
OREO Activity
OREO as of January 1	$	3,485		$	4,409
Real estate acquired		—			730
Valuation adjustment write-downs		(260	)		(325	)
Net gain on sales		—			50
Proceeds from sales of properties		—			(354	)
OREO as of June 30	$	3,225		$	4,510

20

Expenses related to other real estate owned include:

	Three Months Ended June 30,					Six Months Ended June 30,
	2019		2018			2019		2018
	(in thousands)					(in thousands)
Net gain on sales	$	—	$	(54	)	$	—	$	(50	)
Valuation adjustment write-downs		110		265			260		325
Operating expense		32		26			48		44
Total	$	142	$	237		$	308	$	319

Note 5 – Deposits

The following table details deposits by category:

	June 30, 2019		December 31, 2018
	(in thousands)
Non-interest bearing	$	141,448	$	142,618
Interest checking		95,296		94,269
Money market		162,917		171,924
Savings		33,553		34,534
Certificates of deposit		505,263		450,886
Total	$	938,477	$	894,231

Time deposits of $250,000 or more were $28.9 million and $28.1 million at June 30, 2019 and December 31, 2018, respectively.

Scheduled maturities of total time deposits at June 30, 2019 for each of the next five years are as follows (in thousands):

Year 1	$	436,467
Year 2		43,768
Year 3		4,717
Year 4		10,710
Year 5		9,250
Thereafter		351
	$	505,263

Note 6 – Advances from the Federal Home Loan Bank

Advances from the Federal Home Loan Bank were as follows:

	June 30,		December 31,
	2019		2018
	(in thousands)
Short term advances (fixed rates 2.37% to 2.41%) maturing July 2019	$	50,000	$	45,000
Long term advances (fixed rates 0.00% to 5.24%) maturing April 2021 to August 2033		1,470		1,549
Total advances from the Federal Home Loan Bank	$	51,470	$	46,549

FHLB advances had a weighted-average rate of 2.37% at June 30, 2019 and 2.45% at December 31, 2018. Each advance is payable per terms on agreement, with a prepayment penalty. No prepayment penalties were incurred during 2019 or 2018. The advances were collateralized by approximately $126.8 million and $130.4 million of first mortgage loans, under a blanket lien arrangement at June 30, 2019 and December 31, 2018, respectively. At June 30, 2019, our additional borrowing capacity with the FHLB was $38.3 million.

21

Scheduled principal payments on the above during the next five years and thereafter (in thousands):

	Advances
Year 1	$	50,495
Year 2		738
Year 3		99
Year 4		93
Year 5		30
Thereafter		15
	$	51,470

Note 7 – Senior Debt

The Company’s $10.0 million senior secured loan matures on June 30, 2022. Interest is payable quarterly at a rate of three-month LIBOR plus 250 basis points through June 30, 2020, at which time quarterly principal payments of $250,000 plus interest will commence. The loan is secured by a first priority pledge of 100% of the issued and outstanding stock of the Bank. The Company may prepay any amount due under the promissory note at any time without premium or penalty. Subsequent to quarter end, the Company made a $5.0 million principal reduction on this loan.

The loan agreement contains customary representations, warranties, covenants and events of default, including the following financial covenants: (i) the Company must maintain minimum cash on hand of not less than $2,500,000, (ii) the Company must maintain a total risk based capital ratio at least equal to 10% of risk-weighted assets, (iii) the Bank must maintain a total risk based capital ratio at least equal to 11% of risk-weighted assets, and (iv) non-performing assets of the Bank may not exceed 2.5% of the Bank’s total assets. Both the Company and Bank were in compliance with the covenants as of June 30, 2019.

Note 8 – Fair Values Measurement

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Various valuation techniques are used to determine fair value, including market, income and cost approaches. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that an entity has the ability to access as of the measurement date, or observable inputs.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, and other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. When that occurs, the fair value hierarchy is classified on the lowest level of input that is significant to the fair value measurement. The following methods and significant assumptions are used to estimate fair value.

Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges, if available. This valuation method is classified as Level 1 in the fair value hierarchy. For securities where quoted prices are not available, fair values are calculated on market prices of similar securities, or matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Matrix pricing relies on the securities’ relationship to similarly traded securities, benchmark curves, and the benchmarking of like securities. Matrix pricing utilizes observable market inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, reference data, and industry and economic events. In instances where broker quotes are used, these quotes are obtained from market makers or broker-dealers recognized to be market participants. This valuation method is classified as Level 2 in the fair value hierarchy. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators. This valuation method is classified as Level 3 in the fair value hierarchy. Discounted cash flows are calculated using spread to swap and LIBOR curves that are updated to incorporate loss severities, volatility, credit spread and optionality. During times when trading is more liquid, broker quotes are used (if available) to validate the model. Rating agency and industry research reports as well as defaults and deferrals on individual securities are reviewed and incorporated into the calculations.

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Impaired Loans: An impaired loan is evaluated at the time the loan is identified as impaired and is recorded at fair value less costs to sell. Fair value is measured based on the value of the collateral securing the loan and is classified as Level 3 in the fair value hierarchy. Fair value is determined using several methods. Generally, the fair value of real estate is determined based on appraisals by qualified licensed appraisers. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. These routine adjustments are made to adjust the value of a specific property relative to comparable properties for variations in qualities such as location, size, and income production capacity relative to the subject property of the appraisal. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value.

Management routinely applies internal discounts to the value of appraisals used in the fair value evaluation of our impaired loans. The deductions to the appraisal take into account changing business factors and market conditions, as well as potential value impairment in cases where our appraisal date predates a likely change in market conditions. These deductions range from 10% for routine real estate collateral to 25% for real estate that is determined to have a thin trading market or to be specialized collateral. This is in addition to estimated discounts for cost to sell of six to ten percent.

Management also applies discounts to the expected fair value of collateral for impaired loans where the likely resolution involves litigation or foreclosure. Resolution of this nature generally results in receiving lower values for real estate collateral in a more aggressive sales environment. Discounts ranging from 10% to 33% have been utilized in our impairment evaluations when applicable.

Impaired loans are evaluated quarterly for additional impairment. Management obtains updated appraisals on properties securing our loans when circumstances are warranted such as at the time of renewal or when market conditions have significantly changed. This determination is made on a property-by-property basis in light of circumstances in the broader economic climate and the assessment of deterioration of real estate values in the market in which the property is located.

Other Real Estate Owned (OREO): OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal evaluation less estimated cost to sell. Quarterly evaluations of OREO for impairment are driven by property type. For smaller dollar single family homes, management consults with staff from the Bank’s special assets group as well as external realtors and appraisers. Based on these consultations, management determines asking prices for OREO properties being marketed for sale. If the internally evaluated fair value or asking price is below the recorded investment in the property, appropriate write-downs are taken.

For larger dollar commercial real estate properties, management obtains a new appraisal of the subject property or has staff in the special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management generally obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. When an asking price is lowered below the most recent appraised value, appropriate write-downs are taken.

Financial assets measured at fair value on a recurring basis at June 30, 2019 and December 31, 2018 are summarized below:

			Fair Value Measurements at June 30, 2019 Using
			(in thousands)
			Quoted Prices In				Significant
			Active Markets for		Significant Other		Unobservable
	Carrying		Identical Assets		Observable Inputs		Inputs
Description	Value		(Level 1)		(Level 2)		(Level 3)
Available for sale securities
U.S. Government and federal agency	$	24,095	$	—	$	24,095	$	—
Agency mortgage-backed: residential		93,958		—		93,958		—
Collateralized loan obligations		49,682		—		49,682		—
State and municipal		30,797		—		30,797		—
Corporate bonds		10,082		—		10,082		—
Total	$	208,614	$	—	$	208,614	$	—

23

			Fair Value Measurements at December 31, 2018 Using
			(in thousands)
Description	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Available for sale securities
U.S. Government and federal agency	$	22,560	$	—	$	22,560	$	—
Agency mortgage-backed: residential		85,990		—		85,990		—
Collateralized loan obligations		49,839		—		49,839		—
State and municipal		32,812		—		32,812		—
Corporate bonds		9,991		—		9,991		—
Total	$	201,192	$	—	$	201,192	$	—

There were no transfers between Level 1 and Level 2 during 2019 or 2018.

Financial assets measured at fair value on a non-recurring basis are summarized below: 

			Fair Value Measurements at June 30, 2019 Using
			(in thousands)
Description	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans:
Commercial	$	26	$	—	$	—	$	26
Commercial real estate:
Construction		—		—		—		—
Farmland		256		—		—		256
Nonfarm nonresidential		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		556		—		—		556
Consumer		—		—		—		—
Agriculture		—		—		—		—
Other		—		—		—		—
Other real estate owned:
Commercial real estate:
Construction, land development, and other land		3,225		—		—		3,225
Farmland		—		—		—		—
Nonfarm nonresidential		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		—		—		—		—

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			Fair Value Measurements at December 31, 2018 Using
			(in thousands)
Description	Carrying Value		Quoted Prices In Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired loans:
Commercial	$	—	$	—	$	—	$	—
Commercial real estate:
Construction		—		—		—		—
Farmland		—		—		—		—
Nonfarm nonresidential		124		—		—		124
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		552		—		—		552
Consumer		—		—		—		—
Agriculture		—		—		—		—
Other		—		—		—		—
Other real estate owned, net:
Commercial real estate:
Construction		3,485		—		—		3,485
Farmland		—		—		—		—
Nonfarm nonresidential		—		—		—		—
Residential real estate:
Multi-family		—		—		—		—
1-4 Family		—		—		—		—

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $1.0 million at June 30, 2019 with a valuation allowance of $195,000, resulting in $2,000 and no additional provision for loan losses for the three and six months ended June 30, 2019, respectively. Impaired loans had a carrying amount of $1.7 million with a valuation allowance of $319,000, resulting in additional provision for loan losses of $37,000 and $91,000, respectively, for the three and six months ended June 30, 2018. At December 31, 2018, impaired loans had a carrying amount of $879,000, with a valuation allowance of $203,000.

OREO, which is measured at the lower of carrying or fair value less costs to sell, had a net carrying amount of $3.2 million as of June 30, 2019, compared with $4.5 million at June 30, 2018 and $3.5 million at December 31, 2018. Write-downs of $110,000 and $260,000, respectively, were recorded on OREO for the three and six months ended June 30, 2019, compared to write-downs of $265,000 and $325,000 for the three and six months ended June 30, 2018.

The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at June 30, 2019:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(in thousands)
Impaired loans – Residential real estate	$	556	Sales comparison approach	Adjustment for differences between the comparable sales	0%	-	26%	(11%)
Other real estate owned – Commercial real estate	$	3,225	Sales comparison approach	Adjustment for differences between the comparable sales	0%	-	35%	(18%)
			Income approach	Discount or capitalization rate	25%		(25%)

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The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value on a non-recurring basis at December 31, 2018:

	Fair Value		Valuation Technique(s)	Unobservable Input(s)	Range (Weighted Average)
	(in thousands)
Impaired loans – Residential real estate	$	552	Sales comparison approach	Adjustment for differences between the comparable sales	0%	-	26%	(11%)
Other real estate owned – Commercial real estate	$	3,485	Sales comparison approach	Adjustment for differences between the comparable sales	0%	-	35%	(18%)
			Income approach	Discount or capitalization rate	25%		(25%)

Carrying amount and estimated fair values of financial instruments were as follows for the periods indicated:

			Fair Value Measurements at June 30, 2019 Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	47,615	$	47,615	$	—	$	—	$	47,615
Securities available for sale		208,614		—		208,614		—		208,614
Federal Home Loan Bank stock		6,693		N/A		N/A		N/A		N/A
Loans, net		794,282		—		—		799,642		799,642
Accrued interest receivable		4,045		—		1,224		2,821		4,045
Financial liabilities
Deposits	$	938,477	$	141,448	$	795,928	$	—	$	937,376
Federal Home Loan Bank advances		51,470		—		51,467		—		51,467
Junior subordinated debentures		21,000		—		—		16,933		16,933
Senior Debt		10,000		—		—		9,830		9,830
Accrued interest payable		690		—		636		54		690

			Fair Value Measurements at December 31, 2018 Using
	Carrying Amount		Level 1		Level 2		Level 3		Total
	(in thousands)
Financial assets
Cash and cash equivalents	$	35,361	$	35,361	$	—	$	—	$	35,361
Securities available for sale		201,192		—		201,192		—		201,192
Federal Home Loan Bank stock		7,233		N/A		N/A		N/A		N/A
Loans, net		756,364		—		—		744,076		744,076
Accrued interest receivable		3,665		—		1,222		2,443		3,665
Financial liabilities
Deposits	$	894,231	$	142,618	$	750,015	$	—	$	892,633
Federal Home Loan Bank advances		46,549		—		46,519		—		46,519
Junior subordinated debentures		21,000		—		—		16,226		16,226
Senior Debt		10,000		—		—		9,585		9,585
Accrued interest payable		658		—		598		60		658

In accordance with the Company’s adoption of ASU 2016-01 as of January 1, 2018, the methods utilized to measure the fair value of financial instruments at June 30, 2019 and December 31, 2018 represent an approximation of exit price; however, an actual exit price may differ.

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Note 9 – Income Taxes

Deferred tax assets and liabilities were due to the following as of:

	June 30,		December 31,
	2019		2018
	(in thousands)
Deferred tax assets:
Net operating loss carry-forward	$	23,743	$	23,390
Allowance for loan losses		2,204		1,865
OREO write-down		2,665		2,611
Alternative minimum tax credit carry-forward		173		346
Net assets from acquisitions		286		290
Net unrealized loss on securities		—		515
New market tax credit carry-forward		208		208
Nonaccrual loan interest		291		235
Accrued expenses		195		239
Deferred compensation		—		267
Other		385		241
		30,150		30,207
Deferred tax liabilities:
FHLB stock dividends		605		557
Fixed assets		88		94
Deferred loan costs		159		136
Net unrealized gain on securities		357		—
Other		233		138
		1,442		925
Net deferred tax asset	$	28,708	$	29,282

During the first quarter of 2019, the Company benefited $341,000, or approximately $0.05 per basic and diluted share, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during the first quarter. The new law eliminates the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021.

In addition, the Company has state net operating loss carryforwards (“NOLs”) of $30.2 million, which were previously subject to a full valuation allowance and will begin to expire in 2025. In April 2019, tax legislation was enacted which allowed for certain Kentucky NOLs to be utilized in a combined filing return. Therefore, the Company will begin filing a Kentucky combined filing in 2021 and, as a result, a state NOL tax benefit, net of federal impact, of $1.2 million, or approximately $0.16 per basic and diluted share, was recognized in the second quarter of 2019.

At June 30, 2019, the Company had net federal operating loss carryforwards of $107.4 million, which will begin to expire in 2031. As of June 30, 2019, a total of $173,000 in alternative minimum tax credit carry-forward was reclassified to other assets as it is currently refundable for the 2019 tax year.

The Company does not have any beginning and ending unrecognized tax benefits. The Company does not expect the total amount of unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest and penalties recorded in the income statement or accrued for the three or six months ended June 30, 2019 or June 30, 2018 related to unrecognized tax benefits.

Under Section 382 of the Internal Revenue Code, as amended (“Section 382”), the Company’s net operating loss carryforwards and other deferred tax assets can generally be used to offset future taxable income and therefore reduce federal income tax obligations. However, the Company's ability to use its NOLs would be limited if there was an “ownership change” as defined by Section 382. This would occur if shareholders owning (or deemed to own under the tax rules) 5% or more of the Company's voting and non-voting common shares increase their aggregate ownership of the Company by more than 50 percentage points over a defined period of time.

27

In 2015, the Company took two measures to preserve the value of its NOLs. First, the Company adopted a tax benefits preservation plan designed to reduce the likelihood of an “ownership change” occurring as a result of purchases and sales of the Company's common shares. Upon adoption of this plan, the Company declared a dividend of one preferred stock purchase right for each common share outstanding as of the close of business on July 10, 2015. Any shareholder or group that acquires beneficial ownership of 5% or more of the Company (an “acquiring person”) could be subject to significant dilution in its holdings if the Company's Board of Directors does not approve such acquisition. Existing shareholders holding 5% or more of the Company will not be considered acquiring persons unless they acquire additional shares, subject to certain exceptions described in the plan. In addition, the Board of Directors has the discretion to exempt certain transactions and certain persons whose acquisition of securities is determined by the Board not to jeopardize the Company's deferred tax assets. The rights plan was extended in May 2018 to expire upon the earlier of (i) June 30, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefits may be carried forward, (iii) the repeal or amendment of Section 382 or any successor statute, if the Board of Directors determines that the plan is no longer needed to preserve the tax benefits, and (iv) certain other events as described in the plan.

On September 23, 2015, the Company’s shareholders approved an amendment to its articles of incorporation to further help protect the long-term value of the Company’s NOLs. The amendment provides a means to block transfers of our common shares that could result in an ownership change under Section 382. The transfer restrictions were extended in May 2018 by shareholder vote and will expire on the earlier of (i) May 23, 2021, (ii) the beginning of a taxable year with respect to which the Board of Directors determines that no tax benefit may be carried forward, (iii) the repeal of Section 382 or any successor statute if our Board determines that the transfer restrictions are no longer needed to preserve the tax benefits of our NOLs, or (iv) such date as the Board otherwise determines that the transfer restrictions are no longer necessary.

The Company and its subsidiaries are subject to U.S. federal income tax and the Company is subject to income tax in the Commonwealth of Kentucky. The Company is no longer subject to examination by taxing authorities for years before 2015.

Note 10 – Stock Plans and Stock Based Compensation

Shares available for issuance under the 2018 Omnibus Equity Compensation Plan (“2018 Plan”) total 306,640. Shares issued to employees under the plan vest annually on the anniversary date of the grant over three years. Shares issued annually to non-employee directors have a fair market value of $25,000 and vest on December 31 in the year of grant.

The fair value of the 2019 unvested shares issued was $292,000, or $14.53 per weighted-average share. The Company recorded $93,000 and $175,000 of stock-based compensation to salaries for the three and six months ended June 30, 2019, respectively, and $99,000 and $163,000 for the three and six months ended June 30, 2018, respectively. Management expects substantially all of the unvested shares outstanding at the end of the period to vest according to the vesting schedule. A deferred tax benefit of $19,000 and $37,000 was recognized related to this expense during the three and six months ended June 30, 2019, respectively, and $21,000 and $34,000 for the three and six months ended June 30, 2018.

The following table summarizes unvested share activity as of and for the periods indicated for the Stock Compensation Plan:

	Six Months Ended					Twelve Months Ended
	June 30, 2019					December 31, 2018
				Weighted					Weighted
				Average					Average
				Grant					Grant
	Shares			Price		Shares			Price
Outstanding, beginning		116,909		$	8.69		142,334		$	5.67
Granted		20,108			14.53		52,856			13.94
Vested		(75,981	)		6.57		(78,281	)		6.75
Forfeited		(3,998	)		13.04		—			—
Outstanding, ending		57,038		$	13.26		116,909		$	8.69

Unrecognized stock based compensation expense related to unvested shares for the remainder of 2019 and beyond is estimated as follows (in thousands):

July 2019 – December 2019	$	180
2020		295
2021		181
2022		11

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Note 11 – Earnings per Share

The factors used in the basic and diluted earnings per share computations follow:

	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
	(in thousands, except share and per share data)
Net income	$	3,633	$	1,983	$	6,472	$	3,917
Less:
Earnings allocated to unvested shares		32		27		71		66
Net income available to common shareholders, basic and diluted	$	3,601	$	1,956	$	6,401	$	3,851
Basic
Weighted average common shares including unvested common shares outstanding		7,459,631		7,424,742		7,464,743		6,858,228
Less:
Weighted average unvested common shares		64,974		101,505		82,285		115,115
Weighted average common shares outstanding		7,394,657		7,323,237		7,382,458		6,743,113
Basic income per common share	$	0.49	$	0.27	$	0.87	$	0.57
Diluted
Add: Dilutive effects of assumed exercises of common stock warrants		—		—		—		—
Weighted average common shares and potential common shares		7,394,657		7,323,237		7,382,458		6,743,113
Diluted income per common share	$	0.49	$	0.27	$	0.87	$	0.57

The Company had no outstanding stock options at June 30, 2019 or 2018. A warrant for the purchase of 66,113 shares of the Company’s common stock at an exercise price of $79.41 was outstanding at June 30, 2018, but was not included in the diluted EPS computation as inclusion would have been anti-dilutive. The warrant expired on November 21, 2018.

Note 12 – Regulatory Capital Matters

Banks and bank holding companies are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators. Failure to meet capital requirements can result in regulatory action.

The final rules implementing Basel Committee on Banking Supervision’s capital guidelines for U.S. Banks (Basel III rules) became effective for the Company and Bank on January 1, 2015 with full compliance with all of the requirements being phased in over a multi-year schedule through January 1, 2019. The final rules allowed 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 and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum risk-based capital ratios. With the capital conservation buffer fully phased in as of January 1, 2019, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total risk-based capital ratio of 10.5%. The capital conservation buffer for 2019 is 2.5% and was 1.875% for 2018. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions without prior regulatory approval.

As of June 30, 2019, Management believes the Company and Bank meet all capital adequacy requirements to which they are subject. As of June 30, 2019, the most recent regulatory notifications categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since the notification that management believes have changed the institution’s category.

29

The following tables show the ratios (excluding capital conservation buffer) and amounts of common equity Tier 1, Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios for the Bank at the dates indicated (dollars in thousands):

	Actual				Minimum Requirement for Capital Adequacy Purposes				Minimum Requirement to be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
As of June 30, 2019:
Total risk-based capital (to risk-weighted assets)	$	116,730		13.26	$	70,424		8.00	$	88,030		10.00	%
Total common equity Tier 1 risk-based capital (to risk-weighted assets)		107,898		12.26		39,613		4.50		57,219		6.50
Tier 1 capital (to risk-weighted assets)		107,898		12.26		52,818		6.00		70,424		8.00
Tier 1 capital (to average assets)		107,898		10.01		43,111		4.00		53,889		5.00

	Actual					Minimum Requirement for Capital Adequacy Purposes					Minimum Requirement to be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
As of December 31, 2018:
Total risk-based capital (to risk-weighted assets)	$	109,309		12.88	%	$	67,920		8.00	%	$	84,900		10.00	%
Total common equity Tier 1 risk-based capital (to risk-weighted assets)		100,429		11.83			38,205		4.50			55,185		6.50
Tier 1 capital (to risk-weighted assets)		100,429		11.83			50,940		6.00			67,920		8.00
Tier 1 capital (to average assets)		100,429		9.60			41,837		4.00			52,297		5.00

Kentucky banking laws limit the amount of dividends that may be paid to a holding company by its subsidiary banks without prior approval. These laws limit the amount of dividends that may be paid in any calendar year to current year’s net income, as defined in the laws, combined with the retained net income of the preceding two years, less any dividends declared during those periods. In addition, a bank must have positive retained earnings.

Note 13 – Off Balance Sheet Risks, Commitments, and Contingent Liabilities

The Company, in the normal course of business, is party to financial instruments with off balance sheet risk. The financial instruments include commitments to extend credit and standby letters of credit. The contract or notional amounts of these instruments reflect the potential future obligations of the Company pursuant to those financial instruments. Creditworthiness for all instruments is evaluated on a case-by-case basis in accordance with the Company’s credit policies. Collateral from the client may be required based on the Company’s credit evaluation of the client and may include business assets of commercial clients, as well as personal property and real estate of individual clients or guarantors.

An approved but unfunded loan commitment represents a potential credit risk and a liquidity risk, since the Company’s client(s) may demand immediate cash that would require funding. In addition, unfunded loan commitments represent interest rate risk as market interest rates may rise above the rate committed to the Company’s client. Since a portion of these loan commitments normally expire unused, the total amount of outstanding commitments at any point in time may not require future funding. Commitments to make loans are generally made for periods of one year or less.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a client to a third party. The terms and risk of loss involved in issuing standby letters of credit are similar to those involved in issuing loan commitments and extending credit. In addition to credit risk, the Company also has liquidity risk associated with standby letters of credit because funding for these obligations could be required immediately. The Company does not deem this risk to be material. No liability is currently established for standby letters of credit.

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The following table presents the contractual amounts of financial instruments with off-balance sheet risk for each period ended:

	June 30, 2019				December 31, 2018
	Fixed Rate		Variable Rate		Fixed Rate		Variable Rate
	(in thousands)
Commitments to make loans	$	6,977	$	14,850	$	5,317	$	11,236
Unused lines of credit		9,863		70,779		7,410		73,024
Standby letters of credit		377		1,752		541		1,752

Commitments to make loans are generally made for periods of one year or less.

In connection with the purchase of loan participations, the Bank entered into risk participation agreements, which had notional amounts totaling $26.6 million at June 30, 2019 and December 31, 2018. The risk participation agreements are not designated against specific assets or liabilities under ASC 815, Derivatives and Hedging, and, therefore, do not qualify for hedge accounting. The derivatives are recorded in other liabilities on the balance sheet at fair value and changes in fair value of both the borrower and the offsetting swap agreements are recorded (and essentially offset) in non-interest income.

In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amounts of damages.

The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated. The Company is not currently involved in any material litigation.

Note 14 – Revenue from Contracts with Customers

All of the Company’s revenue from customers within the scope of ASC 606 is recognized as non-interest income. A description of the Company’s revenue streams accounted for under ASC 606 follows:

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

Bank Card Interchange Income: The Company earns interchange fees from bank cardholder transactions conducted through a third party payment network. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value and are recognized daily, concurrently with the transaction processing services provided to the cardholder. Prior to adopting ASC 606, the Company reported bank card interchange fees net of expenses. Under ASC 606, bank card interchange fees are reported gross.

Gains/Losses on Sales of OREO: The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. Gains and losses on sales of OREO are netted with OREO expense and reported in non-interest expense.

Other Non-interest Income: Other non-interest income includes revenue from several sources that are within the scope of ASC 606, including title insurance commissions, income from secondary market loan sales, and other transaction-based revenue that is individually immaterial. Other non-interest income included approximately $119,000 and $255,000 of revenue for the three and six months ended June 30, 2019, respectively, within the scope of ASC 606. Other non-interest income included approximately $115,000 and $245,000 of revenue for the three and six months ended June 30, 2018, respectively, within the scope of ASC 606. The remaining other non-interest income for the three and six months is excluded from the scope of ASC 606.

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Note 15 – Subsequent Events

On July 23, 2019, the Company completed the issuance of a $17.0 million 10-year subordinated note. The note carries interest at a fixed rate of 5.75% for the first five years and qualifies as Tier 2 regulatory capital. The Company contributed $10.0 million of the proceeds to the Bank as Tier 1 capital, used $5.0 million to reduce senior debt, and retained the remaining proceeds for general corporate purposes.

On July 24, 2019, the Bank entered into a Branch Purchase and Assumption Agreement to acquire four branch banking centers located in the Kentucky cities of Elizabethtown, Frankfort, and Owensboro from Louisville, Kentucky based Republic Bank and Trust. Under the terms of the agreement, the Bank will acquire the four branch offices, which includes $153 million in deposits and $112 million in loans. In addition, the Bank will acquire substantially all the fixed assets of these locations. The transaction has received approvals from each party’s board of directors and is expected to close in the fourth quarter of 2019, subject to regulatory approvals and other customary closing conditions.

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

This item analyzes the Company’s financial condition, change in financial condition and results of operations. It should be read in conjunction with the unaudited consolidated financial statements and accompanying notes presented in Part I, Item 1 of this report.

Preliminary Note Concerning Forward-Looking Statements

This report contains statements about the future expectations, activities and events that constitute forward-looking statements. Forward-looking statements express our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we expressed or implied in any forward-looking statements. These risks and uncertainties can be difficult to predict and may be out of management’s control. Factors that could contribute to differences in results include, but are not limited to the following:

● Changes in fiscal, monetary, regulatory and tax policies;

● Changes in political and economic conditions;

• The magnitude and frequency of changes to the Federal Funds Target Rate implemented by the Federal Open Market Committee of the Federal Reserve Bank;

• Long-term and short-term interest rate fluctuations as well as the overall steepness of the yield curve;

• Competitive product and pricing pressures;

• Equity and fixed income market fluctuations;

• Client bankruptcies and loan defaults;

• Inflation;

• Recession;

• Natural disasters impacting Company operations;

• Future acquisitions;

• Integrations of acquired businesses;

• Changes in technology and regulations or the interpretation and enforcement thereof;

● Changes in accounting standards;

● Changes to the Company’s overall internal control environment;

● Success in gaining regulatory approvals when required;

● Information security breaches or cyber security attacks involving either the Company or one of the Company’s third-party service providers; and

● Other risks and uncertainties reported from time to time in the Company’s filings with the Securities and Exchange Commission (“SEC”), including Part 1 Item 1A “Risk Factors” of the Company’s December 31, 2018 Annual Report on Form 10-K for the year ended December 31, 2018.

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Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include the assumptions or bases underlying the forward-looking statement. Management has made assumptions and bases in good faith and believe they are reasonable. However, that estimates based on such assumptions or bases frequently differ from actual results, and the differences can be material. The forward-looking statements included in this report speak only as of the date of the report. Management does not intend to update these statements unless required by applicable laws.

Overview

The Company is a bank holding company headquartered in Louisville, Kentucky. The Company’s common stock is traded on Nasdaq’s Capital Market under the symbol LMST. The Company operates Limestone Bank (the Bank), our wholly owned subsidiary and the twelfth largest bank domiciled in the Commonwealth of Kentucky based on total assets. The Bank operates banking offices in twelve counties in Kentucky. The Bank’s markets include metropolitan Louisville in Jefferson County and the surrounding counties of Henry and Bullitt. The Bank serves south central Kentucky and southern Kentucky from banking offices in Butler, Green, Hart, Edmonson, Barren, Warren, Ohio, and Daviess Counties. The Bank also has an office in Lexington, the second largest city in Kentucky. The Bank is a community bank with a wide range of commercial and personal banking products. As of June 30, 2019, the Company had total assets of $1.1 billion, total loans of $803.1 million, total deposits of $938.5 million and stockholders’ equity of $101.4 million.

The Company reported net income of $3.6 million and $6.5 million for the three and six months ended June 30, 2019, compared with net income of $2.0 million and $3.9 million for the same periods of 2018. Income tax benefit was $611,000 and $488,000 for the second quarter of 2019 and for the first six months of 2019, respectively, compared to income tax expense of $483,000 and $812,000 for the second quarter of 2018 and for the first six months of 2018, respectively.

During the first quarter of 2019, the Company benefited $341,000, or approximately $0.05 per basic and diluted share, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during the first quarter. The new law eliminates the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021.

In addition, the Company has state net operating loss carryforwards (“NOLs”) of $30.2 million, which were previously subject to a full valuation allowance and will begin to expire in 2025. In April 2019, tax legislation was enacted which allowed for certain Kentucky NOLs to be utilized in a combined filing return. Therefore, the Company will begin filing a Kentucky combined filing in 2021 and, as a result, a state NOL tax benefit, net of federal impact, of $1.2 million, or approximately $0.16 per basic and diluted share, was recognized in the second quarter of 2019.

Highlights for the six months ended June 30, 2019 are as follows:

● Loan growth outpaced paydowns during the period. Average loans receivable increased approximately $50.6 million or 6.9% to $780.1 million for the six months ended June 30, 2019, compared with $729.5 million for the first six months of 2018. This resulted in an increase in interest revenue volume of approximately $1.3 million for the six months June 30, 2019 compared with the six months of 2018.

● Net interest margin decreased nine basis points to 3.51% in the first six months of 2019 compared with 3.60% in the first six months of 2018. The yield on earning assets increased to 4.86% for the first six months of 2019, compared to 4.48% for the first six months of 2018. The cost of interest bearing liabilities increased from 1.05% in the first six months of 2018 to 1.62% in the first six months of 2019 as a result of increases in short-term interest rates during 2018.

● The Company recorded no provision for loan losses expense during the first six months of 2019, compared to a negative provision for loan losses of $150,000 during the first six months of 2018. Historical loss experience, risk grade classification metrics, charge-off levels, and past due trends remain at historically strong levels and were stable between periods. Net loan charge-offs were $48,000 for the first six months of 2019, compared to net recoveries of $528,000 for the first six months of 2018.

● Loans past due 30-59 days decreased from $1.6 million at December 31, 2018 to $858,000 at June 30, 2019, and loans past due 60-89 days increased from $331,000 at December 31, 2018 to $1.1 million at June 30, 2019. Total loans past due and nonaccrual loans remained unchanged at $3.9 million from December 31, 2018 to June 30, 2019.

● Foreclosed properties were $3.2 million at June 30, 2019, compared with $3.5 million at December 31, 2018, and $4.5 million at June 30, 2018. Operating expenses and fair value write downs totaled $308,000 for the first six months of 2019 compared to operating expenses, fair value write downs, and a net gain on sales of $319,000 for the first six months of 2018.

● The ratio of non-performing assets to total assets decreased to 0.55% at June 30, 2019, compared with 0.60% at December 31, 2018, and 0.83% at June 30, 2018.

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● Deposits were $938.5 million at June 30, 2019, compared with $894.2 million at December 31, 2018. Certificate of deposit balances increased $54.4 million during the first six months of 2019 to $505.3 million at June 30, 2019, from $450.9 million at December 31, 2018. Interest checking accounts increased $1.0 million and money market declined $9.0 million during the first six months of 2019 compared with December 31, 2018.

● Subsequent to quarter end on July 23, 2019, the Company completed the issuance of a $17.0 million 10-year subordinated note. The note carries interest at a fixed rate of 5.75% for the first five years and qualifies as Tier 2 regulatory capital. The Company contributed $10.0 million of the proceeds to the Bank as Tier 1 capital, used $5.0 million to reduce senior debt, and retained the remaining proceeds for general corporate purposes.

● Subsequent to quarter end on July 24, 2019, the Bank entered into a Branch Purchase and Assumption Agreement to acquire four branch banking centers located in the Kentucky cities of Elizabethtown, Frankfort, and Owensboro from Louisville, Kentucky based Republic Bank and Trust. Under the terms of the agreement, the Bank will acquire the four branch offices, which includes $153 million in deposits and $112 million in loans. In addition, the Bank will acquire substantially all the fixed assets of these locations. The transaction has received approvals from each party’s board of directors and is expected to close in the fourth quarter of 2019, subject to regulatory approvals and other customary closing conditions. The transaction includes an all-in blended deposit premium of approximately $9.3 million. This results in tangible book value dilution of approximately 9%. The tangible book value earn back period based upon preliminary earnings estimates for the acquired branches is expected to be less than three years. The final calculated premium will be primarily based on the trailing 10-day average amount of the deposits as of the closing date, as well as the branch location for the deposits.

Application of Critical Accounting Policies

Management continually reviews accounting policies and financial information disclosures. The Company’s more significant accounting policies that require the use of estimates and judgments in preparing the financial statements are summarized in “Application of Critical Accounting Policies” in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operation of our Annual Report on Form 10-K for the calendar year ended December 31, 2018. Management has discussed the development, selection, and application of our critical accounting policies with our Audit Committee. During the first six months of 2019, there were no material changes in the critical accounting policies and assumptions.

Results of Operations

The following table summarizes components of income and expense and the change in those components for the three months ended June 30, 2019, compared with the same period of 2018:

	For the Three Months						Change from
	Ended June 30,						Prior Period
	2019			2018			Amount			Percent
	(dollars in thousands)
Gross interest income	$	12,376		$	10,585		$	1,791			16.9	%
Gross interest expense		3,576			2,211			1,365			61.7
Net interest income		8,800			8,374			426			5.1
Provision (negative provision) for loan losses		—			(150	)		150			100.0
Non-interest income		1,446			1,347			99			7.3
Non-interest expense		7,224			7,405			(181	)		(2.4	)
Net income before taxes		3,022			2,466			556			22.5
Income tax (benefit) expense		(611	)		483			(1,094	)		(226.5	)
Net income		3,633			1,983			1,650			83.2

Net income for the three months ended June 30, 2019 totaled $3.6 million, compared with $2.0 million for the comparable period of 2018. Net income before taxes and income tax benefit was $3.0 million and $611,000, respectively for the second quarter of 2019, compared with $2.5 million and income tax expense of $483,000, respectively for the second quarter of 2018. The Company has state net operating loss carryforwards (“NOLs”) of $30.2 million, which were previously subject to a full valuation allowance and will begin to expire in 2025. In April 2019, tax legislation was enacted which allowed for certain Kentucky NOLs to be utilized in a combined filing return. Therefore, the Company will begin filing a Kentucky combined filing in 2021 and, as a result, a state NOL tax benefit, net of federal impact, of $1.2 million, or approximately $0.16 per basic and diluted share, was recognized in the second quarter of 2019.

Net interest income increased $426,000 from the 2018 second quarter as a result of an increase in earning assets. Net interest margin decreased 15 basis points to 3.42% in the second quarter of 2019 compared with 3.57% in the second quarter of 2018. The cost of interest bearing liabilities increased from 1.13% for the second quarter of 2018 to 1.68% for the second quarter of 2019. Average earning assets increased from $943.0 million for the second quarter of 2018 to $1.0 billion for the second quarter of 2019. Non-interest income increased by $99,000 to $1.4 million from $1.3 million in the second quarter of 2018 primarily due to an increase in bankcard interchange fees of $150,000. Non-interest expense decreased from $7.4 million in the second quarter of 2018 to $7.2 million in the second quarter of 2019 primarily due to decreases in marketing expense of $96,000 and OREO expense of $95,000.

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The following table summarizes components of income and expense and the change in those components for the six months ended June 30, 2019, compared with the same period of 2018:

	For the Six Months						Change from
	Ended June 30,						Prior Period
	2019			2018			Amount			Percent
	(dollars in thousands)
Gross interest income	$	24,562		$	20,600		$	3,962			19.2	%
Gross interest expense		6,803			4,045			2,758			68.2
Net interest income		17,759			16,555			1,204			7.3
Provision (negative provision) for loan losses		—			(150	)		150			100.0
Non-interest income		2,730			2,598			132			5.1
Non-interest expense		14,505			14,574			(69	)		(0.5	)
Net income before taxes		5,984			4,729			1,255			26.5
Income tax (benefit) expense		(488	)		812			(1,300	)		(160.1	)
Net income		6,472			3,917			2,555			65.2

Net income for the six months ended June 30, 2019 totaled $6.5 million, compared with net income of $3.9 million for the comparable period of 2018. Net income before taxes and income tax benefit was $6.0 million and $488,000, respectively, for the six months ended June 30, 2019, compared with $4.7 million and income tax expense of $812,000, respectively, for the six months ended June 30, 2018. Income tax expense for the first six months of 2019 benefitted $1.2 million from the establishment of a state net deferred tax asset related to the April 2019 tax law enactment discussed previously. In addition, during the first quarter of 2019, the Company benefited $341,000, or approximately $0.05 per basic and diluted share, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during the first quarter. The new law eliminates the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021.

Net interest income increased $1.2 million from the first six months of 2018 as a result of an increase in earning assets. Net interest margin decreased nine basis points to 3.51% in the first six months of 2019 compared with 3.60% in the first six months of 2018. The cost of interest bearing liabilities increased from 1.05% for the first six months of 2018 to 1.62% for the first six months of 2019. Average earning assets increased from $929.5 million for the first six months of 2018 to $1.0 billion for the first six months of 2019. Non-interest income increased by $132,000 to $2.7 million from $2.6 million in the first six months of 2018 primarily due to an increase in bankcard interchange fees of $257,000, partially offset by a decrease in service charges on deposit accounts of $92,000. Non-interest expense decreased from $14.6 million in the first six months of 2018 to $14.5 million in the first six months of 2019 primarily due to a decreases in marketing expense of $169,000 and in FDIC insurance of $110,000 reflecting the Bank’s lower risk profile, partially offset by a $157,000 increase in salaries and employee benefits, as well as an increase in deposit account related expense of $151,000.

Net Interest Income – Net interest income was $8.8 million for the three months ended June 30, 2019, an increase of $426,000, or 5.1%, compared with $8.4 million for the same period in 2018. Net interest spread and margin were 3.13% and 3.42%, respectively, for the second quarter of 2019, compared with 3.38% and 3.57%, respectively, for the second quarter of 2018. Net average non-accrual loans were $2.1 million and $3.9 million for the second quarters of 2019 and 2018, respectively.

Average loans receivable increased approximately $58.8 million for the second quarter of 2019 compared with the second quarter of 2018. This resulted in an increase in interest revenue of approximately $753,000 attributable to volume and an increase of $618,000 attributable to increasing interest rates for the quarter ended June 30, 2019, compared with the second quarter of 2018. Interest foregone on non-accrual loans totaled $86,000 for the second quarter of 2019, compared with $74,000 for the second quarter of 2018.

Net interest margin decreased 15 basis points from 3.57% in the prior year second quarter to 3.42% for the second quarter of 2019. The yield on earning assets increased 30 basis points and rates paid on interest-bearing liabilities increased 55 basis points from the second quarter of 2018. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2018.

Net interest income was $17.8 million for the six months ended June 30, 2019, an increase of $1.2 million, or 7.3%, compared with $16.6 million for the same period in 2018. Net interest spread and margin were 3.24% and 3.51%, respectively, for the first six months of 2019, compared with 3.43% and 3.60%, respectively, for the first six months of 2018. Net average non-accrual loans were $2.1 million and $4.4 million for the first six months of 2019 and 2018, respectively.

Average loans receivable increased approximately $50.6 million for the six months ended June 30, 2019 compared with the first six months of 2018. This resulted in an increase in interest revenue of approximately $1.3 million attributable to volume and an increase of $1.5 million attributable to increasing in interest rates for the six months ended June 30, 2019 compared with the prior year period. Interest foregone on non-accrual loans totaled $164,000 for the six months ended June 30, 2019, compared with $162,000 for the six months ended June 30, 2018.

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Net interest margin decreased nine basis points to 3.51% for the first six months of 2019 from 3.60% in the first six months of 2018. The yield on earning assets increased 38 basis points for the first six months of 2019 from the first six months of 2018, compared with an increase in rates paid on interest-bearing liabilities of 57 basis points between the two periods. Both the yield on earning assets and cost of interest-bearing liabilities were impacted by increases in short-term interest rates during 2018.

Average Balance Sheets

The following table presents the average balance sheets for the three month periods ended June 30, 2019 and 2018, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Three Months Ended June 30,
	2019								2018
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	793,460		$	10,465		5.29	%	$	734,709		$	9,094		4.96	%
Securities
Taxable		195,379			1,608		3.30			161,232			1,198		2.98
Tax-exempt (3)		12,710			88		3.52			14,183			96		3.44
FHLB stock		6,778			96		5.68			7,323			104		5.70
Federal funds sold and other		25,254			119		1.89			25,576			93		1.46
Total interest-earning assets		1,033,581			12,376		4.81	%		943,023			10,585		4.51	%
Less: Allowance for loan losses		(8,730	)							(8,886	)
Non-interest earning assets		75,608								78,871
Total assets	$	1,100,459							$	1,013,008
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	487,651		$	2,416		1.99	%	$	429,123		$	1,308		1.22	%
NOW and money market deposits		261,579			536		0.82			241,826			327		0.54
Savings accounts		33,881			13		0.15			35,965			14		0.16
FHLB advances		40,989			255		2.50			44,252			216		1.96
Junior subordinated debentures		21,000			258		4.93			21,957			248		4.53
Senior debt		10,000			98		3.93			10,000			98		3.93
Total interest-bearing liabilities		855,100			3,576		1.68	%		783,123			2,211		1.13	%
Non-interest-bearing liabilities:
Non-interest-bearing deposits		143,619								135,843
Other liabilities		4,010								5,341
Total liabilities		1,002,729								924,307
Stockholders’ equity		97,730								88,701
Total liabilities and stockholders’ equity	$	1,100,459							$	1,013,008
Net interest income				$	8,800							$	8,374
Net interest spread							3.13	%							3.38	%
Net interest margin							3.42	%							3.57	%

(1)	Includes loan fees in both interest income and the calculation of yield on loans.
(2)	Calculations include non-accruing loans averaging $2.1 million and $3.9 million, respectively, in average loan amounts outstanding.
(3)	Taxable equivalent yields are calculated assuming a federal income tax rate of 21%.

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The following table presents the average balance sheets for the six month periods ended June 30, 2019 and 2018, along with the related calculations of tax-equivalent net interest income, net interest margin and net interest spread for the related periods.

	Six Months Ended June 30,
	2019								2018
	Average Balance			Interest Earned/Paid		Average Yield/Cost			Average Balance			Interest Earned/Paid		Average Yield/Cost
	(dollars in thousands)
ASSETS
Interest-earning assets:
Loan receivables (1)(2)	$	780,057		$	20,719		5.36	%	$	729,485		$	17,884		4.94	%
Securities
Taxable		193,528			3,181		3.31			152,585			2,141		2.83
Tax-exempt (3)		13,109			181		3.52			14,203			192		3.45
FHLB stock		6,922			205		5.97			7,323			210		5.78
Federal funds sold and other		28,214			276		1.97			25,872			173		1.35
Total interest-earning assets		1,021,830			24,562		4.86	%		929,468			20,600		4.48	%
Less: Allowance for loan losses		(8,792	)							(8,611	)
Non-interest earning assets		75,037								79,413
Total assets	$	1,088,075							$	1,000,270
LIABILITIES AND STOCKHOLDERS’ EQUITY
Interest-bearing liabilities:
Certificates of deposit and other time deposits	$	473,757		$	4,464		1.90	%	$	425,703		$	2,370		1.12	%
NOW and money market deposits		263,204			1,061		0.81			243,857			595		0.49
Savings accounts		33,720			27		0.16			35,446			28		0.16
FHLB advances		43,244			536		2.50			42,547			372		1.76
Junior subordinated debentures		21,000			521		5.00			22,595			486		4.34
Senior debt		10,000			194		3.91			10,000			194		3.91
Total interest-bearing liabilities		844,925			6,803		1.62	%		780,148			4,045		1.05	%
Non-interest-bearing liabilities:
Non-interest-bearing deposits		143,170								133,742
Other liabilities		4,358								5,384
Total liabilities		992,453								919,274
Stockholders’ equity		95,622								80,996
Total liabilities and stockholders’ equity	$	1,088,075							$	1,000,270
Net interest income				$	17,759							$	16,555
Net interest spread							3.24	%							3.43	%
Net interest margin							3.51	%							3.60	%

(1) Includes loan fees in both interest income and the calculation of yield on loans.

(2) Calculations include non-accruing loans averaging $2.1 million and $4.4 million, respectively, in average loan amounts outstanding.

(3) Taxable equivalent yields are calculated assuming a federal income tax rate of 21%.

37

Rate/Volume Analysis 

The table below sets forth certain information regarding changes in interest income and interest expense for the periods indicated. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (1) changes in rate (changes in rate multiplied by old volume); (2) changes in volume (changes in volume multiplied by old rate); and (3) changes in rate-volume (change in rate multiplied by change in volume). Changes in rate-volume are proportionately allocated between rate and volume variance.

	Three Months Ended June 30, 2019 vs. 2018									Six Months Ended June 30, 2019 vs. 2018
	Increase (decrease) due to change in									Increase (decrease) due to change in
	Rate			Volume			Net Change			Rate			Volume			Net Change
	(in thousands)
Interest-earning assets:
Loan receivables	$	618		$	753		$	1,371		$	1,548		$	1,287		$	2,835
Securities		145			257			402			418			611			1,029
FHLB stock		—			(8	)		(8	)		7			(12	)		(5	)
Federal funds sold and other		27			(1	)		26			86			17			103
Total increase (decrease) in interest income		790			1,001			1,791			2,059			1,903			3,962
Interest-bearing liabilities:
Certificates of deposit and other time deposits		910			198			1,108			1,800			294			2,094
NOW and money market accounts		180			29			209			416			50			466
Savings accounts		—			(1	)		(1	)		—			(1	)		(1	)
FHLB advances		56			(17	)		39			158			6			164
Junior subordinated debentures		21			(11	)		10			71			(36	)		35
Senior debt		—			—			—			—			—			—
Total increase (decrease) in interest expense		1,167			198			1,365			2,445			313			2,758
Increase (decrease) in net interest income	$	(377	)	$	803		$	426		$	(386	)	$	1,590		$	1,204

Non-Interest Income – The following table presents the major categories of non-interest income for the three and six months ended June 30, 2019 and 2018:

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2019			2018			2019			2018
	(dollars in thousands)
Service charges on deposit accounts	$	571		$	591		$	1,067		$	1,159
Bank card interchange fees		596			446			1,104			847
Income from bank owned life insurance		118			138			217			237
Net gain (loss) on sales and calls of securities		(5	)		(6	)		(5	)		(6	)
Other		166			178			347			361
Total non-interest income	$	1,446		$	1,347		$	2,730		$	2,598

Non-interest income for the second quarter of 2019 increased by $99,000, or 7.3%, compared with the second quarter of 2018. The increase in non-interest income for the second quarter of 2019 compared to the second quarter of 2018 was primarily driven by an increase in bankcard interchange fees of $150,000 due to an increase in transaction volume. For the six months ended June 30, 2019, non-interest income increased by $132,000, or 5.1% to $2.7 million compared with $2.6 million for the same period of 2018. The increase in non-interest income between the six month comparative periods was primarily due to a $257,000 increase in bankcard interchange fees partially offset by a decrease in service charges on deposit accounts of $92,000.

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Non-interest Expense – The following table presents the major categories of non-interest expense for the three and six months ended June 30, 2019 and 2018:

	For the Three Months				For the Six Months
	Ended June 30,				Ended June 30,
	2019		2018		2019		2018
	(dollars in thousands)
Salary and employee benefits	$	3,915	$	3,885	$	7,830	$	7,673
Occupancy and equipment		854		880		1,752		1,775
Professional fees		179		222		344		427
Marketing expense		212		308		439		608
FDIC insurance		103		139		211		321
Data processing expense		315		307		628		631
State franchise and deposit tax		315		282		630		564
Deposit account related expenses		310		221		591		440
Other real estate owned expense		142		237		308		319
Litigation and loan collection expense		34		48		80		101
Other		845		876		1,692		1,715
Total non-interest expense	$	7,224	$	7,405	$	14,505	$	14,574

Non-interest expense for the second quarter ended June 30, 2019 decreased $181,000, or 2.4%, compared with the second quarter of 2018. This decrease was primarily due to decreases in marketing expense of $96,000 and OREO expense of $95,000. For the six months ended June 30, 2019, non-interest expense decreased $69,000, or 0.5% to $14.5 million compared with $14.6 million for the first six months of 2018. The decrease in non-interest expense for the six months ended June 30, 2019 was primarily attributable to a decrease in marketing expense of $169,000 and a decrease in FDIC insurance of $110,000 reflecting the Bank’s lower risk profile, partially offset by a $157,000 increase in salaries and employee benefits, as well as, an increase of $151,000 in deposit account related expense.

Income Tax Expense – Effective tax rates differ from the federal statutory rate of 21% applied to income before income taxes due to the following:

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2019			2018			2019			2018
	(dollars in thousands)
Federal statutory rate times financial statement income	$	634		$	518		$	1,256		$	993
Effect of:
Tax-exempt income		(18	)		(20	)		(37	)		(40	)
Establish state deferred tax asset		(1,209	)		—			(1,550	)		—
Non-taxable life insurance income		(25	)		(29	)		(46	)		(50	)
Restricted stock vesting		(2	)		(5	)		(128	)		(116	)
Other, net		9			19			17			25
Total	$	(611	)	$	483		$	(488	)	$	812

Net income before taxes and income tax benefit was $3.0 million and $611,000, respectively for the three months ended June 30, 2019, compared with $2.5 million and income tax expense of $483,000, respectively for the three months ended June 30, 2018.

The Company had state net operating loss carryforwards (“NOLs”) of $30.2 million, which were previously subject to a full valuation allowance and will begin to expire in 2025. In April 2019, tax legislation was enacted which allowed for certain Kentucky NOLs to be utilized in a combined filing return. Therefore, the Company will begin filing a Kentucky combined filing in 2021 and, as a result, a state NOL tax benefit, net of federal impact, of $1.2 million, or $0.16 per basic and diluted share, was recognized in the second quarter of 2019.

Net income before taxes and income tax benefit was $6.0 million and $488,000, respectively for the six months ended June 30, 2019, compared with $4.7 million and income tax expense of $812,000, respectively for the six months ended June 30, 2018. Income tax expense for the first six months of 2019 benefitted $1.2 million from the establishment of a state net deferred tax asset related to the April 2019 tax law enactment discussed above. In addition, during the first quarter of 2019, the Company benefited $341,000, or approximately $0.05 per basic and diluted share, from the establishment of a net deferred tax asset related to a change in Kentucky tax law enacted during the first quarter. The new law eliminates the Kentucky bank franchise tax, which is assessed at a rate of 1.1% of average capital, and implements a state income tax for the Bank at a statutory rate of 5%. The new Kentucky income tax will go into effect on January 1, 2021.

39

Analysis of Financial Condition

Total assets increased $57.1 million, or 5.3%, to $1.13 billion at June 30, 2019, from $1.07 billion at December 31, 2018. This increase was primarily attributable to an increase in net loans of $37.9 million, as well as an increase in cash and cash equivalents of $12.3 million.

Loans Receivable – Loans receivable increased $37.9 million, or 4.9%, during the six months ended June 30, 2019 to $803.1 million as loan growth outpaced paydowns. Our commercial and commercial real estate portfolios increased by an aggregate of $4.6 million, or 1.0% during the first six months of 2019 and comprised 58.7% of the loan portfolio at June 30, 2019. Residential real estate and consumer portfolios increased by an aggregate of $25.4 million, or 9.6% during the first six months of 2019 and comprised 36.1% of the loan portfolio at June 30, 2019. Construction loans decreased $22.4 million as several commercial construction projects were completed and sold or migrated to permanent financing.

Loan Portfolio Composition – The following table presents a summary of the loan portfolio at the dates indicated, net of deferred loan fees, by type. There are no foreign loans in our portfolio and other than the categories noted, there is no concentration of loans in any industry exceeding 10% of total loans.

	As of June 30,					As of December 31,
	2019					2018
	Amount		Percent			Amount		Percent
			(dollars in thousands)
Commercial	$	140,666		17.52	%	$	129,368		16.91	%
Commercial Real Estate
Construction		64,472		8.03			86,867		11.35
Farmland		78,634		9.79			77,937		10.18
Nonfarm nonresidential		187,217		23.31			172,177		22.50
Residential Real Estate
Multi-family		63,107		7.86			49,757		6.50
1-4 Family		171,687		21.38			175,761		22.97
Consumer		55,252		6.88			39,104		5.11
Agriculture		41,586		5.18			33,737		4.41
Other		493		0.05			536		0.07
Total loans	$	803,114		100.00	%	$	765,244		100.00	%

Loan Portfolio by Risk Category – The following table presents a summary of the loan portfolio at the dates indicated, by risk category.

	June 30, 2019					December 31, 2018
	Loans		% to Total			Loans		% to Total
	(dollars in thousands)
Pass	$	767,662		95.6	%	$	745,604		97.4	%
Watch		22,929		2.9			13,164		1.8
Special Mention		—		—			113		—
Substandard		12,523		1.5			6,363		0.8
Doubtful		—		—			—		—
Total	$	803,114		100.0	%	$	765,244		100.00	%

Loans receivable increased $37.9 million, or 4.9%, during the six months ended June 30, 2019. Since December 31, 2018, the pass category increased approximately $22.1 million, the watch category increased approximately $9.8 million, and the substandard category increased approximately $6.2 million. The $6.2 million increase in loans classified as substandard was primarily driven by $8.3 million in loans moved to substandard, offset by $473,000 in loans upgraded from substandard, $1.3 million in payments, and $328,000 in charge-offs during the first six months of 2019.

40

Loan Delinquency – The following table presents a summary of loan delinquencies at the dates indicated.

	June 30, 2019		December 31, 2018
	(in thousands)
Past Due Loans:
30-59 Days	$	858	$	1,593
60-89 Days		1,015		331
90 Days and Over		—		—
Total Loans Past Due 30-90+ Days		1,873		1,924
Nonaccrual Loans		2,028		1,991
Total Past Due and Nonaccrual Loans	$	3,901	$	3,915

During the six months ended June 30, 2019, nonaccrual loans increased by $37,000 to $2.0 million. During the six months ended June 30, 2019, loans past due 30-59 days decreased from $1.6 million at December 31, 2018 to $858,000 at June 30, 2019. Loans past due 60-89 days increased from $331,000 at December 31, 2018 to $1.0 million at June 30, 2019. This represents a $51,000 decrease from December 31, 2018 to June 30, 2019 in loans past due 30-89 days. This trend in delinquency levels is considered during the evaluation of qualitative trends in the portfolio when establishing the general component of our allowance for loan losses.

Troubled Debt Restructuring - A troubled debt restructuring (TDR) occurs when the Bank has agreed to a loan modification in the form of a concession to a borrower who is experiencing financial difficulty. The Bank’s TDRs may involve a reduction in interest rate, a deferral of principal for a stated period of time, or an interest only period. All TDRs are considered impaired, and the Bank has allocated reserves for these loans to reflect the present value of the concessionary terms granted to the borrower. If the loan is considered collateral dependent, it is reported net of allocated reserves, at the fair value of the collateral less cost to sell.

At June 30, 2019 and December 31, 2018, the Bank had two restructured loans totaling $905,000 and $910,000, respectively, with borrowers who experienced deterioration in financial condition. In general, these loans were granted interest rate reductions to provide cash flow relief to borrowers experiencing cash flow difficulties. The Bank had no restructured loans that had been granted principal payment deferrals until maturity at June 30, 2019 or December 31, 2018. There were no concessions made to forgive principal relative to these loans, although partial charge-offs have been recorded for certain restructured loans. In general, these loans are secured by first liens on 1-4 residential properties, commercial real estate properties, or farmland. Both TDRs were performing according to their modified terms at June 30, 2019 and December 31, 2018.

There were no modifications granted during 2019 or 2018 that resulted in loans being identified as TDRs. See “Note 3 – Loans,” to the financial statements for additional disclosure related to troubled debt restructuring.

Non-Performing Assets – Non-performing assets consist of certain restructured loans for which interest rate or other terms have been renegotiated, loans past due 90 days or more still on accrual, loans on which interest is no longer accrued, real estate acquired through foreclosure and repossessed assets. The following table sets forth information with respect to non-performing assets as of June 30, 2019 and December 31, 2018.

	June 30, 2019			December 31, 2018
	(dollars in thousands)
Loans on nonaccrual status	$	2,028		$	1,991
Troubled debt restructurings on accrual		905			910
Past due 90 days or more still on accrual		—			—
Total non-performing loans		2,933			2,901
Real estate acquired through foreclosure		3,225			3,485
Other repossessed assets		—			—
Total non-performing assets	$	6,158		$	6,386
Non-performing loans to total loans		0.37	%		0.38	%
Non-performing assets to total assets		0.55	%		0.60	%
Allowance for non-performing loans	$	76		$	83
Allowance for non-performing loans to non-performing loans		2.59	%		2.86	%

Nonperforming loans at June 30, 2019, were $2.9 million, or 0.37% of total loans, compared with $2.9 million, or 0.38% of total loans at December 31, 2018, and $3.2 million, or 0.42% of total loans at June 30, 2018.

41

Allowance for Loan Losses – The allowance for loan losses is based on management’s continuing review and evaluation of individual loans, loss experience, current economic conditions, risk characteristics of various categories of loans and such other factors that, in management’s judgment, require current recognition in estimating loan losses.

Management has established loan grading procedures that result in specific allowance allocations for any estimated inherent risk of loss. For loans not individually evaluated, a general allowance allocation is computed using factors developed over time based on actual loss experience. The specific and general allocations plus consideration of qualitative factors represent management’s estimate of probable losses contained in the loan portfolio at the evaluation date. Although the allowance for loan losses is comprised of specific and general allocations, the entire allowance is available to absorb any credit losses.

An analysis of changes in the allowance for loan losses and selected ratios for the three and six month periods ended June 30, 2019 and 2018, and for the year ended December 31, 2018 follows:

	Three Months Ended June 30,						Six Months Ended June 30,						December 31,
	2019			2018			2019			2018			2018
	(in thousands)
Balance at beginning of period	$	8,686		$	8,526		$	8,880		$	8,202		$	8,202
Loans charged-off:
Real estate		35			266			132			286			450
Commercial		—			—			—			—			50
Consumer		34			7			214			34			95
Agriculture		3			12			4			12			13
Other		—			8			—			8			8
Total charge-offs		72			293			350			340			616
Recoveries
Real estate		84			464			147			550			1,437
Commercial		90			5			95			245			261
Consumer		44			16			60			50			69
Agriculture		—			—			—			11			15
Other		—			12			—			12			12
Total recoveries		218			497			302			868			1,794
Net charge-offs (recoveries)		(146	)		(204	)		48			(528	)		(1,178	)
Provision (negative provision) for loan losses		—			(150	)		—			(150	)		(500	)
Balance at end of period	$	8,832		$	8,580		$	8,832		$	8,580		$	8,880
Allowance for loan losses to period-end loans		1.10	%		1.15	%		1.10	%		1.15	%		1.16	%
Net charge-offs (recoveries) to average loans		(0.07	)%		(0.11	)%		0.01	%		(0.16	)%		(0.16	)%
Allowance for loan losses to non-performing loans		301.13	%		209.99	%		301.13	%		209.99	%		306.10	%

The allowance for loan losses is a reserve established through charges to earnings in the form of a provision for loan losses. The allowance for loan losses is comprised of general reserves and specific reserves. The loan loss reserve, as a percentage of total loans at June 30, 2019, decreased to 1.10% from 1.16% at December 31, 2018 and from 1.15% at June 30, 2018. New loans continue to be underwritten with lower loss expectations. Historical loss experience, risk grade classification metrics, charge-off levels, and past due trends remain at historically strong levels and were stable between periods. The allowance for loan losses to non-performing loans was 301.13% at June 30, 2019, compared with 306.10% at December 31, 2018, and 209.99% at June 30, 2018. Net loan charge-offs in the first six months of 2019 totaled $48,000 compared to net recoveries of $528,000 in the first six months of 2018.      

The majority of nonperforming loans are secured by real estate collateral, and the underlying collateral coverage for nonperforming loans supports the likelihood of collection of principal. Management has assessed these loans for collectability and considered, among other things, the borrower’s ability to repay, the value of the underlying collateral, and other market conditions to ensure the allowance for loan losses is adequate to absorb probable incurred losses. The allowance for loan losses to non-performing loans and TDRs on accrual was 301.13% at June 30, 2019 compared with 306.10% at December 31, 2018, and 270.66% at June 30, 2018. The decrease in this ratio from December 31, 2018 to June 30, 2019 was primarily attributable to the improving non-performing loan trends during the period.

42

Based on prior charge-offs, the current recorded investment in loans individually evaluated for impairment in the commercial real estate and residential real estate segments of the portfolio are significantly below the unpaid principal balance for those loans. The recorded investment net of the allocated allowance was 52.31% and 60.07% of the unpaid principal balance in the commercial real estate and residential real estate segments of the portfolio, respectively, at June 30, 2019.

Provision for Loan Losses – Based upon historically strong trends in asset quality and management’s assessment of risk in the loan portfolio, no provision for loan losses was recorded for the second quarter or the first six months of 2019. A negative provision for loan losses of $150,000 was recorded for the second quarter and first six months of 2018. The pass category increased approximately $22.1 million, the watch category increased approximately $9.8 million, and the substandard category increased approximately $6.2 million. Net loan charge-offs were $48,000 for the six months ended June 30, 2019, compared with net recoveries of $528,000 for the six months ended June 30, 2018. Management considers the size and volume of our portfolio as well as the credit quality of the loan portfolio based upon risk category classification when determining the loan loss provision for each period and the allowance for loan losses at period end.

Foreclosed Properties – Foreclosed properties at June 30, 2019 were $3.2 million compared with $4.5 million at June 30, 2018 and $3.5 million at December 31, 2018. See Note 4 – “Other Real Estate Owned,” to the financial statements. Management values foreclosed properties at fair value less estimated costs to sell when acquired and expects to liquidate these properties to recover the investment in the due course of business.

OREO is recorded at fair market value less estimated cost to sell at time of acquisition. Any write-down of the property at the time of acquisition is charged to the allowance for loan losses. When foreclosed properties are acquired, management obtains a new appraisal or has staff from the Bank’s special assets group evaluate the latest in-file appraisal in connection with the transfer to OREO. Management typically obtains updated appraisals within five quarters of the anniversary date of ownership unless a sale is imminent. Subsequent reductions in fair value are recorded as non-interest expense when a new appraisal indicates a decline in value or in cases where a listing price is lowered below the appraisal amount.

Write-downs and operating expenses for OREO totaled $308,000 for the six months ended June 30, 2019, compared to net gain (loss) on sales, write-downs, and operating expenses of $319,000 for the six months ending June 30, 2018. During the six months ended June 30, 2019, fair value write-downs of $260,000 were recorded due to changing marketing strategies compared with write-downs of $325,000 for the six months ended June 30, 2018.

Liabilities – Total liabilities at June 30, 2019 were $1.0 billion compared with $977.6 million at December 31, 2018, an increase of $47.8 million, or 4.9%. This increase was primarily attributable to an increase in certificate of deposits of $54.4 million, offset by a decrease in money market accounts of $9.0 million.

Deposits are the Bank’s primary source of funds. The following table sets forth the average daily balances and weighted average rates paid for our deposits for the periods indicated:

	For the Six Months					For the Year
	Ended June 30,					Ended December 31,
	2019					2018
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
	(dollars in thousands)
Demand	$	143,170				$	136,947
Interest checking		96,368		0.23	%		90,583		0.13	%
Money market		166,836		1.15			158,832		0.90
Savings		33,720		0.16			34,866		0.16
Certificates of deposit		473,757		1.90			439,597		1.35
Total deposits	$	913,851		1.23	%	$	860,825		0.88	%

The following table sets forth the average daily balances and weighted average rates paid for our certificates of deposit for the periods indicated:

	For the Six Months					For the Year
	Ended June 30,					Ended December 31,
	2019					2018
	Average		Average			Average		Average
	Balance		Rate			Balance		Rate
	(dollars in thousands)
Less than $250,000	$	445,109		1.89	%	$	410,942		1.34	%
$250,000 or more		28,648		2.09	%		28,655		1.51	%
Total	$	473,757		1.90	%	$	439,597		1.35	%

43

The following table shows at June 30, 2019 the amount of our time deposits of $250,000 or more by time remaining until maturity (in thousands):

Maturity Period
Three months or less	$	2,732
Three months through six months		6,315
Six months through twelve months		15,808
Over twelve months		4,023
Total	$	28,878

Liquidity

Liquidity risk arises from the possibility the Company may not be able to satisfy current or future financial commitments, or may become unduly reliant on alternative funding sources. The objective of liquidity risk management is to ensure that we meet the cash flow requirements of depositors and borrowers, as well as operating cash needs, taking into account all on- and off-balance sheet funding demands. Liquidity risk management also involves ensuring that cash flow needs are met at a reasonable cost. Management maintains an investment and funds management policy, which identifies the primary sources of liquidity, establishes procedures for monitoring and measuring liquidity, and establishes minimum liquidity requirements in compliance with regulatory guidance. The Asset Liability Committee regularly monitors and reviews our liquidity position.

Funds are available to the Bank from a number of sources, including the sale of securities in the available for sale investment portfolio, principal pay-downs on loans and mortgage-backed securities, customer deposit inflows, and other wholesale funding.

The Bank also borrows from the FHLB to supplement funding requirements. At June 30, 2019, the Bank had an unused borrowing capacity with the FHLB of $38.3 million. Advances are collateralized by first mortgage residential loans and borrowing capacity is based on the underlying book value of eligible pledged loans.

The Bank also has available on an unsecured basis federal funds borrowing lines from a correspondent bank totaling $5.0 million. Management believes the sources of liquidity are adequate to meet expected cash needs for the foreseeable future. The Bank has also in the past utilized brokered and wholesale deposits to supplement its funding strategy. At June 30, 2019, the Bank had no brokered deposits.

The Company uses cash on hand to service senior debt, junior subordinated debentures, and to provide for operating cash flow needs. The Company also may issue common equity, preferred equity and debt to support cash flow needs and liquidity requirements. At June 30, 2019, cash on hand totaled $4.1 million, of which, $223,000 is held in escrow by the Company’s senior debt holder to service interest payments.

Capital

Stockholders’ equity increased $9.3 million to $101.4 million at June 30, 2019, compared with $92.1 million at December 31, 2018 primarily due to current year net income of $6.5 million and other comprehensive income for the first six months of 2019 of $3.0 million.

The following table shows the ratios of Tier 1 capital, common equity Tier 1 capital, and total capital to risk-adjusted assets and the leverage ratios (excluding the capital conservation buffer) for the Bank at the dates indicated:

	Regulatory Minimums			Well-Capitalized Minimums			June 30, 2019			December 31, 2018
Tier 1 Capital		6.0	%		8.0	%		12.26	%		11.83	%
Common equity Tier 1 capital		4.5			6.5			12.26			11.83
Total risk-based capital		8.0			10.0			13.26			12.88
Tier 1 leverage ratio		4.0			5.0			10.01			9.60

Failure to meet minimum capital requirements could result in discretionary actions by regulators that, if taken, could have a materially adverse effect on our financial condition.

Each of the federal bank regulatory agencies has established risk-based capital requirements for banking organizations. The Basel III regulatory capital reforms became effective for the Company and Bank on January 1, 2015, and include new minimum risk-based capital and leverage ratios. These rules refine the definition of what constitutes “capital” for purposes of calculating those ratios, including the definitions of Tier 1 capital and Tier 2 capital. 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 and the Bank opted out of this requirement. The rules also establish a “capital conservation buffer” of 2.5%, to be phased in over three years, above the regulatory minimum risk-based capital ratios. With the capital conservation buffer as fully phased in effective January 1, 2019, the minimum ratios are a common equity Tier 1 risk-based capital ratio of 7.0%, a Tier 1 risk-based capital ratio of 8.5%, and a total capital to total risk-weighted assets (“total risk-based capital ratio”) of 10.5%. The capital conservation buffer for 2019 is 2.50% and was 1.875% for 2018. An institution is subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if capital levels fall below minimum levels plus the buffer amounts. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Given an instantaneous 100 basis point increase in interest rates, the base net interest income would increase by an estimated 1.5% at June 30, 2019, compared with an increase of 2.0% at December 31, 2018. Given a 200 basis point increase in interest rates, base net interest income would increase by an estimated 2.6% at June 30, 2019, compared with an increase of 3.9% at December 31, 2018.

The following table indicates the estimated impact on net interest income under various interest rate scenarios for the twelve months following June 30, 2019, as calculated using the static shock model approach:

	Change in Future Net Interest Income
	Dollar Change			Percentage Change
	(dollars in thousands)
+ 200 basis points	$	918			2.64	%
+ 100 basis points		510			1.47
- 100 basis points		(1,100	)		(3.17	)
- 200 basis points		(1,632	)		(4.70	)

Item 4. Controls and Procedures

As of the end of the quarterly period covered by this report, an evaluation was carried out under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934 (“Exchange Act”)). Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were, to the best of their knowledge, effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms as of such date.

There was no change in the Company’s internal control over financial reporting that occurred during the Company’s fiscal quarter covered by this report that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II – OTHER INFORMATION

Item 1. Legal Proceedings

In the normal course of business, the Company and its subsidiaries have been named, from time to time, as defendants in various legal actions. Certain of the actual or threatened legal actions may include claims for substantial compensatory and/or punitive damages or claims for indeterminate amount of damages. Litigation is subject to inherent uncertainties and unfavorable outcomes could occur.

The Company contests liability and/or the amount of damages as appropriate in each pending matter. In view of the inherent difficulty of predicting the outcome of such matters, particularly in cases where claimants seek substantial or indeterminate damages or where investigations and proceedings are in the early stages, the Company cannot predict with certainty the loss or range of loss, if any, related to such matters, how or if such matters will be resolved, when they will ultimately be resolved, or what the eventual settlement, or other relief, if any, might be. Subject to the foregoing, the Company believes, based on current knowledge and after consultation with counsel, that the outcome of such pending matters will not have a material adverse effect on the consolidated financial condition of the Company, although the outcome of such matters could be material to the Company’s operating results and cash flows for a particular future period, depending on, among other things, the level of the Company’s revenues or income for such period. The Company will accrue for a loss contingency if (1) it is probable that a future event will occur and confirm the loss and (2) the amount of the loss can be reasonably estimated.

The Company is not currently involved in any material litigation.

Item 1A. Risk Factors

Refer to the detailed cautionary statements and discussion of risks that affect the Company and its business in “Item 1A – Risk Factors” of the Annual Report on Form 10-K, for the year ended December 31, 2018. There have been no material changes from the risk factors previously discussed in those reports.

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

The following chart depicts information regarding the shares of restricted stock that were withheld to satisfy required tax withholdings upon vesting of restricted stock awarded under the Company’s equity compensation plan.

Period	Total Shares Purchased (Withheld)	Average Price Paid (Credited) Per Share
March 2019	18,466	$14.95
June 2019	2,532	$14.98

The Company does not have a publicly announced share plan or program.

Item 3. Default Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable

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Item 6. Exhibits

(a) Exhibits

The following exhibits are filed or furnished as part of this report:

Exhibit Number	Description of Exhibit
3.1	Articles of Incorporation of the Company, restated to reflect amendments. Exhibit 3.1 to Form 10-Q filed August 2, 2018 is incorporated by reference.
3.3	Amended and Restated Bylaws of Limestone Bancorp, Inc. dated June 18, 2018. Exhibit 3.2 to Form 8-K filed June 6, 2018 is hereby incorporated by reference.
4.1	Tax Benefits Preservation Plan, dated as of June 25, 2015, between the Company and American Stock Transfer Company, as Rights Agent. Exhibit 3.1 to Form 8-K filed June 29, 2015 is incorporated by reference.
4.2	Amendment No. 1 to the Tax Benefits Preservation Plan, dated August 4, 2015. Exhibit 4.2 to the Quarterly Report on Form 10-Q filed August 5, 2015 is incorporated by reference.
4.3	Amendment No. 2 to the Tax Benefits Preservation Plan dated May 23, 2018. Exhibit 4 to the Form 8-K filed May 23, 2018 is incorporated by reference.
10.1	Employment Agreement with John T. Taylor. Exhibit 10.1 to Form 8-K filed April 26, 2019 is incorporated by reference.
10.2	Employment Agreement with Phillip W. Barnhouse. Exhibit 10.2 to Form 8-K filed April 26, 2019 is incorporated by reference.
10.3	Employment Agreement with John R. Davis. Exhibit 10.3 to Form 8-K filed April 26, 2019 is incorporated by reference.
10.4	Employment Agreement with Joseph C. Seiler. Exhibit 10.4 to Form 8-K filed April 26, 2019 is incorporated by reference.
10.5	Branch Purchase and Assumption Agreement between Republic Bank & Trust Company and Limestone Bank, Inc. dated July 24, 2019. Exhibit 2.1 to Form 8-K filed July 25, 2019 is incorporated by reference.
10.6	Indenture, dated July 23, 2019, by and between Limestone Bancorp, Inc. and Wilmington Trust National Association, as trustee. Exhibit 4.1 to Form 8-K filed July 25, 2019 is incorporated by reference.
10.7	Form of 5.75% Fixed-to-Floating Subordinated Notes due 2029 of Limestone Bancorp, Inc. Exhibit 4.2 to Form 8-K filed July 25, 2019 is incorporated by reference.
10.8	Form of Subordinated Note Purchase Agreement, dated July 23, 2019, by and among Limestone Bancorp, Inc. and the Purchasers. Exhibit 10.1 to Form 8-K filed July 25, 2019 is incorporated by reference.
31.1	Certification of Principal Executive Officer, pursuant to Rule 13a - 14(a).
31.2	Certification of Principal Financial Officer, pursuant to Rule 13a - 14(a).
32.1	Certification of Principal Executive Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	Certification of Principal Financial Officer, pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101	The following financial statements from the Company’s Quarterly Report on Form 10Q for the quarter ended June 30, 2019, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statement of Changes in Stockholders’ Equity, (v) Consolidated Statements of Cash Flows, (vi) Notes to Consolidated Financial Statements.

The Company has other long-term debt agreements that meet the exclusion set forth in Section 601 (b)(4)(iii)(A) of Regulation S-K. The Company hereby agrees to furnish a copy of such agreements to the Securities and Exchange Commission upon request.

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SIGNATURES

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

	LIMESTONE BANCORP, INC.
	(Registrant)
August 2, 2019	By:	/s/ John T. Taylor
		John T. Taylor
		Chief Executive Officer
August 2, 2019	By:	/s/ Phillip W. Barnhouse
		Phillip W. Barnhouse
		Chief Financial Officer

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