1.	Summary of Significant Accounting Policies

The accounting and reporting policies of Farmers Capital Bank Corporation and subsidiaries conform to accounting principles generally accepted in the United States of America

(“U.S. GAAP”) and general practices applicable to the banking industry. Significant accounting policies are summarized below.

Principles of Consolidation and Nature of Operations

The consolidated financial statements include the accounts of Farmers Capital Bank Corporation (the “

Company” or “Parent Company”), a financial holding company, its wholly

-owned subsidiaries bank subsidiary, United Bank & Capital Trust Company (“United Bank” or the “Bank”) in Frankfort, KY, and its wholly-owned nonbank subsidiary, FFKT Insurance Services, Inc. (“FFKT Insurance”).

February 2017,

the Company merged

three

of its subsidiary banks (United Bank & Trust Company in Versailles, KY; First Citizens Bank, Inc. in Elizabethtown, KY; and Citizens Bank of Northern Kentucky, Inc. in Newport, KY) and its data processing subsidiary (FCB Services, Inc. in Frankfort, KY) into its subsidiary bank Farmers Bank & Capital Trust Company in Frankfort, KY, the name of which was immediately changed under the merger to United Bank & Capital Trust Company. The Company accounted for the transfer of assets and liabilities of the merged subsidiaries at their respective historical cost amounts as of the date of the merger.

FFKT Insurance is a captive insurance company

in Frankfort, KY that provides property and casualty coverage to the Parent Company and its subsidiaries for risk management purposes or where insurance

may

not

be available or economically feasible. The Company has

two

subsidiaries organized as Delaware statutory trusts that are

not

consolidated into its financial statements. These trusts were formed in

2005

and

2007

for the purpose of issuing trust preferred securities.

United

Bank’s significant subsidiaries include EG Properties, Inc. and Farmers Capital Insurance Corporation (“Farmers Insurance”). EG Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of United Bank. Farmers Insurance is an insurance agency in Frankfort, KY.

The Company provides financial services at its

locations in

communities throughout Central and Northern Kentucky to individual, business, agriculture, government, and educational customers. Its primary deposit products are checking, savings, and term certificate accounts. Its primary lending products are residential mortgage, commercial lending, and consumer installment loans. Substantially all loans are secured by specific items of collateral including business assets, consumer assets, and commercial and residential real estate. Commercial loans are expected to be repaid from cash flow from operations of businesses. Other services include, but are

not

limited to, cash management services, issuing letters of credit, safe deposit box rental, and providing funds transfer services. Other financial instruments, which could potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

Use of Estimates

The preparation of financial statements in conformity with

U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Estimates used in the preparation of the financial statements are based on various factors including the current interest rate environment and the general strength of the local economy. Changes in the overall interest rate environment can significantly affect the Company’s net interest income and the value of its recorded assets and liabilities. Actual results could differ from those estimates used in the preparation of the financial statements. The allowance for loan losses, carrying value of other real estate owned, actuarial assumptions used to calculate postretirement benefits, and the fair values of financial instruments are estimates that are particularly subject to change.

Reclassifications

Certain amounts in the accompanying consolidated financial statements presented for prior years have been rec

lassified to conform to the

2017

presentation. These reclassifications do

not

affect net income or total shareholders’ equity as previously reported.

Segment Information

The Company provides a broad range of financial services to individuals, corporations, and others through its

banking locations throughout Central and Northern Kentucky. These services primarily include the activities of lending, receiving deposits, providing cash management services, safe deposit box rental, and trust activities.

While the chief decision-makers monitor the revenue streams of the various products and services, operations are managed and financial performance is evaluated on a Company-wide basis. Operating segments are aggregated into

one

as operating results for all segments are similar. Accordingly, all of the financial service operations are considered by management to be aggregated in

one

reportable segment.

Cash Flows

For purposes of

reporting cash flows, cash and cash equivalents include the following: cash on hand, deposits from other financial institutions that have an initial maturity of less than

days when acquired by the Company, federal funds sold and securities purchased under agreements to resell, and money market mutual funds. Generally, federal funds sold and securities purchased under agreements to resell are purchased and sold for

one

-day periods. Net cash flows are reported for loan

deposit, and short-term borrowing transactions.

Investment Securities

Investments in debt and equity securities are classified into

three

categories. Securities that management has the positive intent and ability to hold until maturity are classified as held to maturity. Securities that ar

e bought and held specifically for the purpose of selling them in the near term are classified as trading securities. The Company had

securities classified as trading during

2017,

2016,

2015.

All other securities are classified as available for sale. Securities are designated as available for sale if they might be sold before maturity. Securities classified as available for sale are carried at estimated fair value. Unrealized holding gains and losses for available for sale securities are reported net of deferred income taxes in other comprehensive income. Investments classified as held to maturity are carried at amortized cost. Amortized cost basis for investment securities includes adjustments made to the cost for previous other-than-temporary impairment (“OTTI”) recognized in earnings, amortization, accretion, and collection of cash.

Interest income includes amortization and accretion of purchase premiums or discounts. Premiums and discounts on securities are amortized

using the interest method over the expected life of the securities

without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Realized gains and losses on the sales of securities are recorded on the trade date and computed on the basis of specific identification of the adjusted cost of each security and are included in noninterest income.

The Company evaluates investment securities for OTTI at least on a quarterly basis, and more frequently when economic or market conditions warrant such a

n evaluation. A decline in the market value of investment securities below cost that is deemed other

-than

-temporary results in a charge to earnings and the establishment of a new cost basis for the security. Substantially all of the Company’s investment securities are debt securities.

In estimating OTTI for debt securities, management considers each of the following: (

) the length of time and extent to which fair value has been less than cost, (

) the financial condition and near-term prospects of the issuer, (

) whether market decline was affected by macroeconomic conditions, and (

) whether the Company has the intent to sell the debt security or more likely than

not

will be required to sell the debt security before its anticipated recovery in fair value. The assessment of whether an OTTI charge exists involves a high degree of subjectivity and judgment and is based on the information available to the Company at a point in time. The Company had

OTTI losses during any year in each of the

three

years in the period ended

December 31, 2017.

Investment securities classified as available for sale or held-to-maturity are generally evaluated for OTTI under

Financial Accounting Standard Board (“

FASB”) Accounting Standards Codification

(“ASC”) Topic

320,

“

Investments-Debt and Equity Securities

”

In determining OTTI under ASC Topic

320

the Company considers many factors, including those enumerated above. When OTTI occurs, the amount of the OTTI recognized in earnings depends on whether the Company intends to sell the security or it is more likely than

not

it will be required to sell the security before recovery of its amortized cost basis. If the Company intends to sell or it is more likely than

not

it will be required to sell the security before recovery of its amortized cost basis, OTTI is recognized in earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at the balance sheet date. If the Company does

not

intend to sell the security and it is

not

more likely than

not

that it will be required to sell the security before recovery of its amortized cost basis, OTTI is separated into the amount representing the credit loss and the amount related to all other factors. The amount of the total OTTI related to the credit loss is determined based on the present value of cash flows expected to be collected and is recognized in earnings. The amount of the total OTTI related to other factors is recognized in other comprehensive income, net of applicable taxes. The previous amortized cost basis less OTTI recognized in earnings becomes the new amortized cost basis of the investment.

Federal Home Loan Bank and Federal Reserve

Bank

Stock

Federal Home Loan Bank (“

FHLB”) and Federal Reserve Bank stock is carried at cost and recognized in other assets on the consolidated balance sheets under the caption “Other assets

.” These stocks are classified as restricted securities and periodically evaluated for impairment based on ultimate recovery of par value. Both cash and stock dividends are reported as income. The amount outstanding at

December 31, 2017

and

2016

was

$13.2

million and

$9.8

million, respectively

Loans and Interest Income

Loans that management has the intent and ability to hold for the foreseeable future or

until maturity or pay-off are reported at their unpaid principal amount outstanding adjusted for any charge-offs

deferred fees or costs on originated loans, and unamortized premiums and discounts on purchased loans. Interest income on loans is recognized using the interest method based on loan principal amounts outstanding during the period. Interest income also includes amortization and accretion of any premiums or discounts over the expected life of acquired loans at the time of purchase or business acquisition. Loan origination fees, net of certain direct origination costs

are deferred and amortized as yield adjustments over the contractual term of the loans.

The Company disaggregates

certain disclosure information related to loans, the related allowance for loan losses, and credit quality measures by either portfolio segment or by loan class. The Company segregates its loan portfolio segments based on similar risk characteristics as follows: real estate loans, commercial loans, and consumer loans. Portfolio segments are further disaggregated into classes for certain required disclosures as follows:

Portfolio Segment	Class

Real estate loans	Real estate mortgage – construction and land development Real estate mortgage – residential Real estate mortgage – farmland and other commercial enterprises
Commercial loans	Commercial and industrial Depository institutions Agriculture production and other loans to farmers States and political subdivisions Other
Consumer loans	Secured Unsecured

oan disclosures include presenting certain disaggregated information based on recorded investment. The recorded investment in a loan includes its principal amount outstanding adjusted for certain items that include net deferred loan costs or fees, unamortized premiums or discounts, charge offs, and accrued interest. The Company had a total of

$83

thousand of net deferred loan fees at year-end

2017

and

$301

thousand of net deferred loan costs at year-end

2016

included in the carrying amount of loans on the balance sheet, which represents

.01%

and

.03%

of loans outstanding at year-end

2017

and

2016,

respectively. The amount of net deferred loans costs and fees are

not

material and are omitted from the computation of the recorded investment included in Note

that follows. Similarly, accrued interest receivable on loans was

$3.1

million and

$2.8

million at year-end

2017

and

2016,

respectively, or

.3%

of loans for both years and has also been omitted from certain information presented in Note

The Company has a loan policy in place that is amended and approved from time to time as needed to reflect current economic conditions and product offerings in its markets. The policy

establishes written procedures concerning areas such as the lending authorities of loan officers, committee review and approval of certain credit requests, underwriting criteria, policy exceptions, appraisal requirements, and loan review. Credit is extended to borrowers based primarily on their ability to repay as demonstrated by income and cash flow analysis.

Loans secured by real estate make up the largest segment of the Company

’s loan portfolio. If a borrower fails to repay a loan secured by real estate, the Company

may

liquidate the collateral in order to satisfy the amount owed. Determining the value of real estate is a key component to the lending process for real estate backed loans. If the fair value of real estate (less estimated cost to sell) securing a collateral dependent loan declines below the outstanding loan amount, the Company will write down the carrying value of the loan and thereby incur a loss. The Company uses independent

third

party state certified or licensed appraisers in accordance with its loan policy to mitigate risk when underwriting real estate loans. Cash flow analysis of the borrower, loan to value limits as adopted by loan policy, and other customary underwriting standards are also in place which are designed to maximize credit quality and mitigate risks associated with real estate lending.

Commercial loans are made to businesses and are secured mainly by assets such as inventory, accounts receivable,

machinery, fixtures and equipment, or other business assets. Commercial lending involves significant risk, as loan repayments are more dependent on the successful operation or management of the business and its cash flows. Consumer lending includes loans to individuals mainly for personal autos, boats, or a variety of other personal uses and

may

be secured or unsecured. Loan repayment associated with consumer loans is highly dependent upon the borrower’s continuing financial stability, which is heavily influenced by local unemployment rates. The Company mitigates its risk exposure to each of its loan segments by analyzing the borrower’s repayment capacity, imposing restrictions on the amount it will loan compared to estimated collateral values, limiting the payback periods, and following other customary underwriting practices as adopted in its loan policy.

he accrual of interest on loans is discontinued when it is determined that the collection of interest or principal is doubtful, or when a default of interest or principal has existed for

days or more, unless such loan is well secured and in the process of collection. Past due status is based on the contractual terms of the loan. Interest accrued but

not

received for a loan placed on nonaccrual status is reversed against interest income. Cash payments received on nonaccrual loans generally are applied to principal until qualifying for return to accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Company’s policy for placing a loan on nonaccrual status or subsequently returning a loan to accrual status does

not

differ based on its portfolio class or segment.

Commercial and real estate l

oans delinquent in excess of

120

days and consumer loans delinquent in excess of

180

days are charged off

unless the collateral securing the debt is of such value that any loss appears to be unlikely. In all cases, loans are charged off at an earlier date if classified as loss under the Company’s loan grading process or as a result of regulatory examination. The Company’s charge-off policy for impaired loans does

not

differ from the charge-off policy for loans outside the definition of impaired

Loans Held for Sale

Mortgage banking activitie

s include the origination of fixed-rate residential mortgage loans for sale to various

third

-party investors. Mortgage loans originated and intended for sale in the secondary market, principally under programs with the Federal National Mortgage Association

are carried at the lower of cost or estimated fair value determined in the aggregate and included in net loans on the balance sheet until sold. These loans are sold with the related servicing rights either retained or released by the Company depending on the economic conditions present at the time of origination. The Company had

mortgage loans held for sale at

December 31, 2017.

Mortgage loans held for sale included in net loans at

December 31, 2016

totaled

$1.7

million. Mortgage banking revenues, including origination fees, servicing fees, net gains on sales of mortgage loans, and other fee income were

1.4%,

1.6%,

and

1.6%

the Company’s total revenue for the years ended

December 31, 2017,

2016,

and

2015,

respectively

Provision and Allowance for

Loan Losses

The provision for loan losses represents charges

or credits made to earnings to maintain an allowance for loan losses at a level considered adequate to provide for probable incurred credit losses at the balance sheet date. The allowance for loan losses is a valuation allowance increased by the provision for loan losses and decreased by net charge-offs. Loan losses are charged against the allowance when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The Company estimates the adequacy of the allowance using a risk-rated methodology which is based on the Company

’s past loan loss experience, known and inherent risks in the loan portfolio, adverse situations that

may

affect the borrower’s ability to repay, the estimated value of any underlying collateral securing loans, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective as it requires significant judgment and the use of estimates that

may

be susceptible to change.

The allowance for loan losses consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general compo

nent covers non-impaired loans and is based on historical loss experience adjusted for current risk factors. Allocations of the allowance

may

be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged off. Actual loan losses could differ significantly from the amounts estimated by management.

The

general portion of the Company’s loan portfolio is segregated into portfolio segments having similar risk characteristics identified as follows: real estate loans, commercial loans, and consumer loans. Each of these portfolio segments is assigned a loss percentage based on their respective rolling historical loss rates, adjusted for the qualitative risk factors summarized below. During the

first

quarter of

2017,

the Company shortened the look-back period it uses to determine historical loss rates to the previous

twelve

quarters from

sixteen

quarters. The change in the look-back period is the result of the Company’s ongoing monitoring and evaluation of the adequacy of its allowance for loan losses. The shorter look-back period better reflects the Company’s loss estimates based on current market conditions. Shortening the look-back period increased the allowance for loan losses by

$49

thousand compared to the previous

sixteen

quarter look-back period

The qualitative risk factors used in the methodology are consistent with the guidance in the most recent Interagency Policy Statement on the Allowance for Loan Losses issued. Each factor is supported by a detailed analysis and is both measureable and supportable. Some factors include a minimum allocation in instances where loss levels are extremely low and it is determined to be prudent from a safety and soundness perspective. Qualitative risk factors that are used in the methodology include the following for each loan portfolio segment:

●

Delinquency trends

●

Trends in net charge-offs

●

Trends in loan volume

●

Lending philosophy risk

●

Management experience risk

●

Concentration of credit risk

●

Economic conditions risk

A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modif

ied resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are

not

classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.

The Company accounts for impaired loans in accordance with

ASC Topic

310,

“Receivables

”

ASC Topic

310

requires that impaired loans be measured at the present value of expected future cash flows, discounted at the loan’s effective interest rate, at the loan’s observable market price, or at the fair value of the collateral if the loan is collateral dependent. Impaired loans

may

also be classified as nonaccrual. In many circumstances, however, the Company continues to accrue interest on an impaired loan. Cash receipts on accruing impaired loans are applied to the recorded investment in the loan, including any accrued interest receivable. Cash payments received on nonaccrual impaired loans generally are applied to principal until qualifying for return to accrual status

Loans that are part of a large group of smaller-balance homogeneous loans, such as residential mortgage

consumer, and smaller-balance commercial loans, are collectively evaluated for impairment. Troubled debt restructurings are measured at the present value of estimated future cash flows using the loan’s effective interest rate at inception, or at the fair value of collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of the allowance in accordance with its accounting policy for the allowance for loan losses on loans individually identified as impaired

Mortgage Servicing Rights

Mortgage servicing rights are recognized

in other assets on the Company’s consolidated balance sheet at their initial fair value on loans sold with servicing retained. Fair value is based on market prices for comparable mortgage servicing contracts when available

or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income. Mortgage servicing rights are subsequently measured using the amortization method in which the mortgage servicing right is expensed in proportion to, and over the period of, the estimated future net servicing income of the underlying loans. Impairment is evaluated based on the fair value of the rights, grouping the underlying loans by interest rates. Impairment of a grouping is reported as a valuation allowance. Capitalized mortgage servicing rights were

$719

thousand and

$731

thousand at

December 31, 2017

and

2016,

respectively.

impairment of the asset was determined to exist on either of these dates. Mortgage loans serviced for others totaled

$198

million and

$202

million at

December 31, 2017

and

2016,

respectively. Mortgage loans serviced for others are

not

included in the Company’s balance sheets.

Fair Value of Financial Instruments

Fair values of financial

instruments are estimated using relevant market information and other assumptions, as more fully disclosed in Note

19.

Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Loan Commitments and Related Financial Instruments

Financial instruments include off

-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, which are issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Intangible Assets

Intangible assets

consist of core deposit and customer relationship intangible assets arising from business acquisitions. Intangible assets are initially measured at fair value and then amortized on an accelerated method over their estimated useful lives, which range between

seven

and

ten

years. Such assets are evaluated for impairment whenever changes in circumstances indicate that such an evaluation is necessary

The Company had

core deposit or customer relationship intangible assets recorded at any of the years ending

December 31, 2017,

2016,

2015

Other Real Estate

Owned

Other real estate owned

(“OREO”) and held for sale in the accompanying consolidated balance sheets includes properties acquired by the Company through, or in lieu of, actual loan foreclosures. OREO is initially carried at fair value less estimated costs to sell. Fair value is generally based on

third

party appraisals of the property that includes comparable sales data. If the carrying amount exceeds fair value less estimated costs to sell, an impairment loss is recorded through expense. These assets are subsequently accounted for at the lower of carrying amount or fair value less estimated costs to sell. Operating costs after acquisition are expensed.

Income Taxes

Income tax expense is the total of current year income ta

due or refundable and the change in deferred tax assets and liabilities, except for the deferred tax assets and liabilities related to business combinations or components of other comprehensive income.

Deferred income tax assets and liabilities result from temporary differences between the tax basis of assets and liabilities and their reported amounts in the consolidated financial statements that will result in taxable or deductible amounts in future years. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in years in which those temporary differences are expected to be recovered or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through income tax expense. A valuation allowance, if needed, reduces deferred tax assets to the amount expected to be realized.

A tax position is recognized as a benefit only if it is “more likely than

not”

that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than

50%

likely of being realized on examination. For tax positions

not

meeting the “more likely than

not”

test,

tax benefit is recorded.

The Company files a consolidated federal income tax return with its subsidiaries. Federal income tax expense or benefit has been allocated to subsidiaries on a separate return basis.

The Company’s policy is to record the accrual of interest and/or penalties relative to income tax matters, if any, in income tax expense

Premises and Equipment

Premises, equipment, and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation is computed primarily on the straight-line method over the estimated useful lives generally ranging from

two

seven

years for

furniture and equipment and generally

ten

years for buildings and related components. Leasehold improvements are amortized over the shorter of the estimated useful lives or terms of the related leases on the straight-line method. Maintenance, repairs, and minor improvements are charged to operating expenses as incurred and major improvements are capitalized. The cost of assets sold or retired and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in noninterest income. Land is carried at cost.

Company-owned Life Insurance

The Company has purchased life insurance policies on certain key employees with their knowledge and

written consent. Company-owned life insurance is recorded on the consolidated balance sheet at its cash surrender value, which is the amount that can be realized under the insurance contract at the balance sheet date. The related change in cash surrender value and proceeds received under the policies are reported on the consolidated statements of income under the caption “Income from company-owned life insurance.”

Related Party Transactions

In the ordinary course of business, the Company offers loan

and deposit products to its directors, executive officers, and principal shareholders – including affiliated companies of which they are principal owners (“Related Parties”). These products are offered on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties, and these receivables and deposits are included in loans and deposits in the Company’s consolidated balance sheets. Additional information related to these transactions can be found in Note

and Note

The Company makes payments to Related Parties in the normal course of business

for various services, primarily related to legal fees. For example, certain directors of the Parent Company and its subsidiary bank are partners in law firms that act as counsel to the Company. The following table represents the amount and type of payments to Related Parties, other than director fees, for the periods indicated:


(In thousands) Years Ended December 31,	201 7		201 6		201 5
Legal fees	$	139	$	257	$	221
Commissions and fees related to the sale of repossessed commercial real estate and property management		-		-		9
Insurance premiums/commissions		-		-		1
Other		27		2		5
Total	$	166	$	259	$	236

Retirement Plans

The Company maintains a

401

(k) salary savings plan and records expense based on the amount of its matching contributions of employee deferrals. The Company also has a nonqualified supplemental retirement plan for certain key employees that it acquired in connection with the Citizens Bank of Northern Kentucky, Inc. acquisition. Supplemental retirement plan expense allocates the benefits over years of service.

Net Income Per Common Share

Basic net income per common share is determined by dividing net income available to common sh

areholders by the weighted average total number of common shares issued and outstanding. Net income available to common shareholders represents net income adjusted for preferred stock dividends including dividends declared, accretion of discounts on preferred stock issuances, and cumulative dividends related to the current dividend period that have

not

been declared as of the end of the period. There were

dilutive instruments at

year-end

2017,

2016,

and

2015.

Net income per common share computations were as follows

for the years ended

December 31, 2017,

2016,

and

2015


(In thousands, except per share data) Years Ended December 31,	201 7		201 6		201 5
Net income, basic and diluted	$	11,688	$	16,605	$	14,992
Less p referred stock dividends and discount accretion		-		-		395
Net income available to common shareholders, basic and diluted	$	11,688	$	16,605	$	14,597

Average common shares issued and outstanding, basic and diluted		7,513		7,504		7,494

Net income per common share, basic and diluted	$	1.56	$	2.21	$	1.95

Comprehensive Income

Comprehensive income is defined as the change in equity (net assets) of a business enterprise during a period from transactions and other events and circumstances from nonowner

sources. For the Company this includes net income

the after tax effect of changes in the net unrealized gains and losses on available for sale investment securities, and the after tax changes to the funded status of postretirement benefit plans

Dividend Restrictions

Banking regulations require maintaining certain capital levels

which limit the amount of dividends paid to the Company by its bank subsidiary. Generally, capital distributions are limited to undistributed net income for the current and prior

two

years.

Restrictions on Cash

The Company

is required to maintain funds in cash and/or on deposit with the Federal Reserve Bank in accordance with reserve requirements specified by the Federal Reserve Board of Governors. The required reserve was

$17.3

million and

$18.0

million at

December 31, 2017

and

2016,

respectively

Equity

Outstanding common shares purchased by the Company are retired. When common shares are purchased, the Company allocates a portion of the purchase price of the common shares that are retired to each of the following balance sheet line items: common stock, capital surplus, and retained earnings.

The Company did

not

purchase any of its outstanding common shares during

2017

2016.

Trust

Assets

Assets of the

Company’s trust department, other than cash on deposit by trust customers at the Bank, are

not

included in the accompanying financial statements because they are

not

assets of the Company.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does

not

maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.

Long-term Assets

Premises and equipment,

core deposit and other intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount

may

not

be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Stock-Based Compensation

The Company recognizes c

ompensation cost for its Employee Stock Purchase Plan (“ESPP”) based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of shares issued under the ESPP. Compensation cost is recognized over the required service period, generally defined as the vesting period, on a straight-line basis.

The ESPP was approved by

the Company’s shareholders in

2004.

The purpose of the ESPP is to provide a means by which eligible employees

may

purchase, at a discount, shares of the Company’s common stock through payroll withholding. The purchase price of the shares is equal to

85%

of their fair market value on specified dates as defined in the plan. The ESPP was effective beginning

July 1, 2004.

There were

5,367,

6,631,

and

6,329

shares issued under the plan during

2017,

2016,

and

2015,

respectively. Compensation expense related to the ESPP included in the accompanying statements of income was

$33

thousand,

$32

thousand, and

$31

thousand in

2017,

2016,

and

2015,

respectively.

ollowing are the weighted average assumptions used and estimated fair market value for the ESPP, which is considered a compensatory plan under ASC Topic

718,

“

Compensation-Stock Compensation

”


	ESPP
	201 7			201 6			201 5
Expected volatility		23.2	%		26.3	%		32.6	%
Dividend yield		1.04			.83			-
Risk-free interest rate		.85			.26			.02
Expected life (in years)		.25			.25			.25

Fair value	$	7.43		$	5.31		$	5.08

Recen

ly Issued But

Not

Yet Effective Accounting Standards

May 2014,

the FASB

issued

Accounting Standards Update (“ASU”)

No.

2014

09,

Revenue from Contracts with Customers (Topic

606

)

, and subsequently issued several amendments to the standard during

2015,

2016,

and

2017.

The primary principle of ASU

No.

2014

is that entities should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

As amended,

ASU

No.

2014

is effective for the Company in annual reporting periods beginning after

December 15, 2017,

including interim periods within that reporting period.

Earlier application is permitted, but only as of annual reporting periods beginning after

December 15, 2016,

including interim reporting periods within those reporting periods. The majority of the Company’s revenues earned are excluded from the scope of the new standard. Revenue streams within the scope of this ASU include services charges and fees on deposits, allotment processing fees, trust income, and components of other service charges, commission, and fees. The Company adopted

ASU

No.

2014

effective

January 1, 2018

using a modified retrospective approach with

material impact to the Company’s consolidated financial statements. The Company is in the process of finalizing the additional disclosures required by the new standard.

January 2016,

the FASB issued ASU

No.

2016

01,

Financial Instruments – Overall (Subtopic

825

)

: Recognition and

Measurement of Financial

Assets and Financial Liabilities

and, in

February 2018,

issued an amendment for technical corrections and improvements related to this ASU. The amendments in this ASU require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). In addition, this ASU eliminates the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. Public business entities will be required to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes. For public business entities, the amendments in this ASU are effective for fiscal years beginning after

December 15, 2017,

including interim periods within those fiscal years. The amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. The Company adopted

ASU

No.

2016

effective

January 1, 2018

with

material impact to the Company’s consolidated financial statements.

February 2016,

the FASB issued ASU

No.

2016

02,

“Leases (Topic

842

),”

to improve financial reporting about leasing transactions. This ASU will require organizations that lease assets (“lessees”) to recognize a lease liability and a right-of-use asset on its balance sheet for all leases with terms of more than

twelve

months. A lease liability is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis and a right-of-use asset represents the lessee’s right to use, or control use of, a specified asset for the lease term. The amendments in this ASU simplify the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. This ASU leaves the accounting for the organizations that own the assets leased to the lessee (“lessor”) largely unchanged except for targeted improvements to align it with the lessee accounting model and Topic

606,

Revenue from Contracts with Customers

For public companies, ASU

No.

2016

is effective for fiscal years beginning after

December 15, 2018,

including interim periods within those fiscal years. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would

not

require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors

may

not

apply a full retrospective transition approach. The Company has identified a project team to review its leases and to assess the impact of ASU

No.

2016

on its consolidated financial position, results of operations, and cash flows.

June 2016,

the FASB issued ASU

No.

2016

13,

“Financial Instruments—Credit Losses (Topic

326

): Measurement of Credit Losses on Financial Instruments,”

to improve financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial institutions and other organizations.

The ASU requires an organization to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The ASU requires enhanced disclosures, including

qualitative and quantitative requirements, which provide additional information about the amounts recorded in the financial statements.

Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.

ASU

No.

2016

is effective for the Company in annual and interim reporting periods beginning after

December 15, 2019.

Although early adoption is permitted for fiscal years beginning after

December 15, 2018,

the Company does

not

plan to early adopt. The

Company has been preserving certain historical loan information from its core processing system in anticipation of adopting the standard. The Company has identified a project team to assess the impact of this ASU on its consolidated financial position, results of operations, and cash flows. The project team has developed a timeline for implementing the standard, has begun working with a

third

party software solution provider, and has identified an independent

third

party for validation of the impending changes to our credit loss methodologies and processes.

The team continues to assess the impact of the standard; however, the Company expects adopting this ASU will result in an increase in its allowance for loan losses. The amount of the increase in the allowance for loan losses upon adoption will be dependent upon the characteristics of the portfolio at the adoption date, as well as macroeconomic conditions and forecasts at that date. A cumulative effect adjustment will be made to retained earnings for the impact of the standard at the beginning of the period the standard is adopted.

March 2017,

the FASB issued ASU

NO.

2017

07,

“Compensation—Retirement Benefits (Topic

715

): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost,”

which requires that employers offering benefit plans accounted for under Topic

715

report the service cost component in the same line item or items as other compensation costs arising from services rendered by the pertinent employees during the period. The other components of net benefit cost are required to be presented in the income statement separately from the service cost component. If a separate line item or items are

not

used, the line item or items used in the income statement to present the other components of net benefit cost must be disclosed. This ASU is effective for the Company in annual and interim reporting periods beginning after

December 15, 2017.

The Company does

not

expect ASU

No.

2017

to have a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

March 2017,

the FASB issued ASU

No.

2017

08,

“Receivables—Nonrefundable Fees and Other Costs (Subtopic

310

): Premium Amortization on Purchased Callable Debt Securities.”

This ASU shortens the amortization period for certain callable debt securities held at a premium and requires the premium to be amortized to the earliest call date. The ASU does

not

change the accounting for securities held at a discount; the discount will continue to be amortized to maturity. This ASU is effective for the Company in annual and interim reporting periods beginning after

December 15, 2018,

with early adoption permitted. The Company early adopted this standard with

material impact on its consolidated financial position, results of operations, or cash flows.

February 2018,

the FASB issued ASU

No.

2018

02,

“

Income Statement—Reporting Comprehensive Income (Topic

220

): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income

”

which allows entities to reclassify the stranded tax effects caused by the

Tax Cuts and Jobs Act (“Tax Act”), which was enacted in

December 2017,

from

accumulated other comprehensive income (“AOCI”) to retained earnings. This ASU will be effective for annual and interim periods beginning after

December 15, 2018,

with early adoption permitted. The Company early adopted this standard

, resulting in the reclassification of

$633

thousand from AOCI to retained earnings for the year ended

December 31, 2017.

There was

impact on total equity. Additional information related to the reclassification can be found in Note

Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are

not

expected to have a material impact on the Company

’s financial position, results of operations or cash flows.