Prime Meridian Holding Earnings 2019-06-30

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

[X] 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:

333-191801

 

PRIME MERIDIAN HOLDING COMPANY

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(Exact Name of registrant as specified in its charter)

 

Florida	27-2980805
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification Number)
1897 Capital Circle NE, Second Floor, Tallahassee, Florida	32308
(Address of principal executive offices)	(Zip Code)

 

(850) 907-2301

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(Registrant’s telephone number, including area code)

 

Not Applicable

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(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☐ Yes☑ No

 

Explanatory Note: Prime Meridian Holding Company has filed, on a voluntary basis, all Securities Exchange Act of 1934 reports for the preceeding 12 months.

 

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

 

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 definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one) 

Large accelerated filer:     ☐	Accelerated filer:                       ☐
Nonaccelerated 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.    ☐

 

Securities Registered pursuant to Section 12(b) of the Act:
Title of each class None.	Trading Symbol(s) N/A	Name of exchange on which registered N/A

 

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 August 5, 2019: 3,145,431

 

 

 

INDEX

 

PART I. FINANCIAL INFORMATION	PAGE
Item 1. Financial Statements
Condensed Consolidated Balance Sheets June 30, 2019 (unaudited) and December 31, 2018	2
Condensed Consolidated Statements of Earnings Three and Six Months ended June 30, 2019 and 2018 (unaudited)	3
Condensed Consolidated Statements of Comprehensive Income Three and Six Months ended June 30, 2019 and 2018 (unaudited)	4
Condensed Consolidated Statements of Stockholders’ Equity Three and Six Months ended June 30, 2019 and 2018 (unaudited)	5
Condensed Consolidated Statements of Cash Flows Six Months ended June 30, 2019 and 2018 (unaudited)	6
Notes to Condensed Consolidated Financial Statements (unaudited)	7-29
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	30-42
Item 3. Quantitative and Qualitative Disclosures about Market Risk	42
Item 4. Controls and Procedures	43
PART II. OTHER INFORMATION
Item 1. Legal Proceedings	44
Item 1A. Risk Factors	44
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	44
Item 3. Defaults Upon Senior Securities	44
Item 4. Mine Safety Disclosures	44
Item 5. Other Information	44
Item 6. Exhibits	45-46
Signatures	47
Certifications

 

 

 

		June 30,				December 31,
		2019				2018
(in thousands)		(Unaudited)
Assets
Cash and due from banks		$	10,807			$	7,866
Federal funds sold			35,707				34,777
Interest-bearing deposits			25,528				5,395
Total cash and cash equivalents			72,042				48,038
Securities available for sale			52,431				45,384
Loans held for sale			6,223				4,767
Loans, net of allowance for loan losses of $4,006 and $3,661			299,949				290,113
Federal Home Loan Bank stock			404				355
Premises and equipment, net			7,311				4,656
Right of use lease asset			3,768				-
Accrued interest receivable			1,100				1,034
Bank-owned life insurance			6,413				6,323
Other assets			1,086				1,032
Total assets		$	450,727			$	401,702
Liabilities and Stockholders' Equity
Liabilities:
Noninterest-bearing demand deposits		$	89,608			$	80,097
Savings, NOW and money-market deposits			247,804				227,674
Time deposits			52,912				41,296
Total deposits			390,324				349,067
Other borrowings			770				-
Official checks			1,496				837
Operating lease liability			3,827				-
Other liabilities			1,314				978
Total liabilities			397,731				350,882
Stockholders' equity:
Preferred stock, undesignated; 1,000,000 shares authorized, none issued or outstanding			-				-
Common stock, $.01 par value; 9,000,000 shares authorized, 3,144,456 and 3,138,945 issued and outstanding			31				31
Additional paid-in capital			38,450				38,330
Retained earnings			14,269				13,015
Accumulated other comprehensive income (loss)			246				(556	)
Total stockholders' equity			52,996				50,820
Total liabilities and stockholders' equity		$	450,727			$	401,702

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		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands, except per share amounts)		2019				2018				2019				2018
Interest income:
Loans		$	3,916			$	3,543			$	7,772			$	6,817
Securities			333				287				629				575
Other			361				82				709				156
Total interest income			4,610				3,912				9,110				7,548
Interest expense-
Deposits			851				500				1664				897
Net interest income			3,759				3,412				7,446				6,651
Provision for loan losses			179				155				344				409
Net interest income after provision for loan losses			3,580				3,257				7,102				6,242
Noninterest income:
Service charges and fees on deposit accounts			68				89				139				176
Mortgage banking revenue			197				105				303				215
Income from bank-owned life insurance			45				10				90				21
Gain on sale of securities available for sale			-				-				7				-
Other income			152				110				285				212
Total noninterest income			462				314				824				624
Noninterest expense:
Salaries and employee benefits			1,579				1,218				3,136				2,446
Occupancy and equipment			427				226				702				461
Professional fees			106				97				183				181
Marketing			194				133				393				340
FDIC/State assessment			44				38				87				74
Software maintenance, amortization and other			167				159				319				307
Other			516				370				956				729
Total noninterest expense			3,033				2,241				5,776				4,538
Earnings before income taxes			1,009				1,330				2,150				2,328
Income taxes			245				328				519				572
Net earnings		$	764			$	1,002			$	1,631			$	1,756
Earnings per common share:
Basic		$	0.24			$	0.32			$	0.52			$	0.56
Diluted			0.24				0.32				0.52				0.56
Cash dividends per common share(1)			-				-				0.12				0.10

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		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands)		2019				2018				2019				2018
Net earnings		$	764			$	1,002			$	1,631			$	1,756
Other comprehensive income (loss) :
Change in unrealized gain (loss) on securities:
Unrealized gain (loss) arising during the period			653				(108	)			1,081				(838	)
Reclassification adjustment for realized gain			(7	)			-				(7	)			-
Net change in unrealized gain (loss)			646				(108	)			1,074				(838	)
Deferred income tax (expense) benefit on above change			(164	)			27				(272	)			212
Total other comprehensive income (loss)			482				(81	)			802				(626	)
Comprehensive income		$	1,246			$	921			$	2,433			$	1,130

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																		Accumulated
										Additional								Other				Total
		Common Stock								Paid-in				Retained				Comprehensive				Stockholders'
		Shares				Amount				Capital				Earnings				Income (Loss)				Equity
(in thousands)
Balance at December 31, 2017			3,118,977			$	31			$	37,953			$	9,285			$	(296	)		$	46,973
Net earnings for the three months ended March 31, 2018 (unaudited)			-				-				-				754				-				754
Dividends paid (unaudited)			-				-				-				(312	)			-				(312	)
Net change in unrealized loss on securities available for sale, net of income tax benefit (unaudited)			-				-				-				-				(545	)			(545	)
Stock options exercised (unaudited)			3,000				-				30				-				-				30
Common stock issued as compensation to directors (unaudited)			792				-				17				-				-				17
Stock-based compensation (unaudited)			-				-				23				-				-				23
Balance at March 31, 2018 (unaudited)			3,122,769			$	31			$	38,023			$	9,727			$	(841	)		$	46,940
Net earnings for the three months ended June 30, 2018 (unaudited)			-				-				-				1,002				-				1,002
Net change in unrealized loss on securities available for sale, net of income tax benefit (unaudited)			-				-				-				-				(81	)			(81	)
Stock options exercised (unaudited)			1,700				-				17				-				-				17
Common stock issued as compensation to directors (unaudited)			764				-				17				-				-				17
Stock-based compensation (unaudited)			-				-				41				-				-				41
Balance at June 30, 2018 (unaudited)			3,125,233			$	31			$	38,098			$	10,729			$	(922	)		$	47,936
Balance at December 31, 2018			3,138,945			$	31			$	38,330			$	13,015			$	(556	)		$	50,820
Net earnings for the three months ended March 31, 2019 (unaudited)			-				-				-				867				-				867
Dividends paid (unaudited)			-				-				-				(377	)			-				(377	)
Net change in unrealized loss on securities available for sale, net of income tax expense (unaudited)			-				-				-				-				320				320
Common stock issued as compensation to directors (unaudited)			595				-				12				-				-				12
Issuance of restricted stock (unaudited)			3,600				-				-				-				-				-
Stock-based compensation (unaudited)			-				-				42				-				-				42
Balance at March 31, 2019 (unaudited)			3,143,140			$	31			$	38,384			$	13,505			$	(236	)		$	51,684
Net earnings for the three months ended June 30, 2019 (unaudited)			-				-				-				764				-				764
Net change in unrealized loss on securities available for sale, net of income tax expense (unaudited)			-				-				-				-				482				482
Stock options exercised (unaudited)			300				-				3				-				-				3
Common stock issued as compensation to directors (unaudited)			1,016				-				19				-				-				19
Stock-based compensation (unaudited)			-				-				44				-				-				44
Balance at June 30, 2019 (unaudited)			3,144,456			$	31			$	38,450			$	14,269			$	246			$	52,996

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		Six Months Ended
		June 30,
(in thousands)		2019				2018
Cash flows from operating activities:
Net earnings		$	1,631			$	1,756
Adjustments to reconcile net earnings to net cash provided by operating activities:
Depreciation and amortization			319				265
Provision for loan losses			344				409
Net amortization of deferred loan fees			(2	)			(15	)
Gain on sale of securities available for sale			(7	)			-
Amortization of premiums and discounts on securities available for sale			142				205
Gain on sale of loans held for sale			(303	)			(168	)
Proceeds from the sale of loans held for sale			39,414				37,011
Loans originated as held for sale			(40,567	)			(38,284	)
Stock-based compensation expense			117				98
Income from bank-owned life insurance			(90	)			(21	)
Net increase in accrued interest receivable			(66	)			(49	)
Net change in operating leases			59				-
Net increase in other assets			(326	)			(13	)
Net increase (decrease) in other liabilities and official checks			995				(664	)
Net cash provided by operating activities			1,660				530
Cash flows from investing activities:
Loan originations, net of principal repayments			(10,178	)			(35,608	)
Purchase of securities available for sale			(13,806	)			(1,003	)
Principal repayments of securities available for sale			2,680				3,083
Proceeds from sale of securities available for sale			4,245				-
Maturities and calls of securities available for sale			773				29
Purchase of Federal Home Loan Bank stock			(49	)			(39	)
Purchase of premises and equipment			(2,974	)			(221	)
Net cash used in investing activities			(19,309	)			(33,759	)
Cash flows from financing activities:
Net increase in deposits			41,257				33,526
Change in other borrowings			770				-
Proceeds from stock options exercised			3				47
Common stock dividends paid			(377	)			(312	)
Net cash provided by financing activities			41,653				33,261
Net increase in cash and cash equivalents			24,004				32
Cash and cash equivalents at beginning of period			48,038				32,397
Cash and cash equivalents at end of period		$	72,042			$	32,429
Supplemental disclosure of cash flow information
Cash paid during the period:
Interest		$	1,656			$	875
Income taxes		$	750			$	610
Noncash transactions:
Accumulated other comprehensive income (loss), net change in unrealized gain (loss) on securities available for sale, net of taxes		$	802			$	(626	)
Right of use lease assets obtained in exchange for operating lease liabilities		$	3,818			$	-

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(1)

General

 

Prime Meridian Holding Company (“PMHG”) owns 100% of the outstanding common stock of Prime Meridian Bank (the "Bank") (collectively the "Company"). PMHG’s primary activity is the operation of the Bank. The Bank is a Florida state-chartered commercial bank, and the deposit accounts of the Bank are insured up to the applicable limits by the Federal Deposit Insurance Corporation ("FDIC"). The Bank offers a variety of community banking services to individual and corporate clients through its three banking offices located in Tallahassee and Crawfordville, Florida and its online banking platform. A fourth office opened in Lakeland, Florida on April 16, 2019.

 

The accounting and financial reporting policies of the Company conform, in all material respects, to accounting principles generally accepted in the United States (“GAAP”) and to general practices within the banking industry. The condensed consolidated financial statements in the Quarterly Report on Form 10-Q have not been audited by an independent registered public accounting firm, but in the opinion of management, reflect all necessary adjustments for a fair presentation of the Company’s financial position and results of operations. All adjustments were of a normal and recurring nature. The condensed consolidated financial statements have been prepared in accordance with GAAP and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (the “SEC”). Accordingly, the condensed consolidated financial statements do not include all information and footnotes required by GAAP for complete financial presentation and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2018, included in our Annual Report on Form 10-K filed with the SEC on March 21, 2019. The results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of the results to be expected for the full year or any future period.

 

Comprehensive Income. GAAP generally requires that recognized revenue, expenses, gains and losses be included in earnings. Although certain changes in assets and liabilities, such as unrealized gains and losses on available-for-sale securities, are reported as a separate component of the equity section of the condensed consolidated balance sheet, such items along with net earnings, are components of comprehensive income. The only component of other comprehensive income (loss) is the net change in the unrealized gain (loss) on securities available for sale.

 

Stock-Based Compensation. The Company expenses the fair value of stock options and restricted stock granted. The Company recognizes stock-based compensation expense in the condensed consolidated statements of earnings over the vesting period.

 

Mortgage Banking Revenue. Mortgage banking revenue includes gains and losses on the sale of mortgage loans originated for sale and wholesale brokerage fees, net of commissions and deferred loan costs. The Company recognizes mortgage banking revenue from mortgage loans originated in the condensed consolidated statements of earnings upon sale of the loans.

 

Reclassifications. Certain reclassifications of prior period amounts have been made to conform to the current period presentation.

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited)

 

(1)	General, Continued

 

Recent Accounting Standards Update.

 

In February 2016, the FASB issued ASU No. 2016-2, Leases (Topic 842) which required lessees to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases with terms of more than twelve months. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. The new ASU requires both types of leases to be recognized on the balance sheet. The ASU also requires disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements, providing additional information about the amounts recorded in the financial statements. For public companies, the ASU became effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The effect of this ASU increased the Company's assets and liabilities by approximately $288,000 at January 1, 2019. 

 

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326). The ASU improves financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by the Company. The ASU requires the Company 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. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. The Company will continue to use judgment to determine which loss estimation method is appropriate for its circumstances. The ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization's portfolio. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. Additionally, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration.

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(1)	General, Continued

 

Recent Accounting Standards Update, Continued.

 

The new guidance was originally set to be effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with early adoption permitted.  However, on July 17, 2019, FASB voted to ask its staff to prepare an exposure draft proposing to delay implementation of CECL for certain smaller financial institutions until January, 2023.  The FASB is expected to issue a statement in August, 2019 with the new established timeframes.  The Company is still in the process of determining the effect of the ASU on its condensed consolidated financial statements.

 

In March 2017, the FASB issued ASU No. 2018-08, “Premium Amortization on Purchased Callable Debt Securities”, to amend the amortization period for certain purchased callable debt securities held at a premium.  Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument.  The amendments in this update require the premium to be amortized to the earliest call date.  No accounting change is required for securities held at a discount.  For public business entities, the amendments in this update become effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity should apply the amendments in this update on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. The Company has adhered to this practice since its inception.

 

In June 2018, the FASB issued ASU No. 2018-07, Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The ASU is intended to reduce the cost and complexity and to improve financial reporting for nonemployee share-based payments. The ASU expands the scope of Topic 718. Compensation Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. The ASU supersedes Subtopic 505-50, Equity-Equity-Based payments to Non-Employees. The ASU is effective for the Company for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. Early adoption is permitted, but no earlier than a company’s adoption date of Topic 606, Revenue from Contracts with Customers. The ASU had no impact on the Company’s condensed consolidated financial statements.

 

 

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

 

(2)	Securities Available for Sale

 

Securities are classified according to management's intent. The amortized cost of securities and fair values are as follows:

 

 

The following table summarizes the sale of securities available for sale.

 

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(2)	Securities Available for Sale, Continued

 

Securities with gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position, are as follows:

 

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(2)	Securities Available for Sale, Continued

 

The unrealized losses at June 30, 2019 and December 31, 2018 on twelve and thirty-nine securities, respectively, were caused by market conditions. It is expected that the securities would not be settled at a price less than the par value of the investments. Because the decline in fair value is attributable to market conditions and not credit quality, and because the Company has the ability and intent to hold these investments until a market price recovery or maturity, these investments are not considered other-than-temporarily impaired. Securities available for sale measured at fair value on a recurring basis are summarized below:

 

 

During the three and six months ended June 30, 2019 and 2018, no securities were transferred in or out of Levels 1, 2 or 3.

 

The scheduled maturities of securities are as follows:

 

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

 

(3)

Loans

 

Segments and classes of loans, excluding loans held for sale, are as follows:

 

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(3)	Loans, Continued

 

An analysis of the change in allowance for loan losses follows:

 

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(3)	Loans, Continued

 

The Company has divided the loan portfolio into three portfolio segments and five portfolio classes, each with different risk characteristics and methodologies for assessing risk. All loans are underwritten based upon standards set forth in the policies approved by the Company’s Board of Directors. The Company identifies the portfolio segments and classes as follows:

 

Real Estate Mortgage Loans. Real estate mortgage loans are typically divided into three classes: commercial, residential and home equity, and construction loans.

 

Commercial. Loans of this type are typically our more complex loans. This category of real estate loans is comprised of loans secured by mortgages on commercial property that are typically owner-occupied, but also includes nonowner-occupied investment properties. Commercial loans that are secured by owner-occupied commercial real estate are repaid through operating cash flows of the borrower. The maturity for this type of loan is generally limited to three to five years; however, payments may be structured on a longer amortization basis. Typically, interest rates on our commercial real estate loans are fixed for five years or less after which they adjust based upon a predetermined spread over a market index rate. At times, a rate may be fixed for longer than five years. As part of our credit underwriting standards, the Company typically requires personal guarantees from the principal owners of the business supported by a review of the principal owners’ personal financial statements and tax returns. As part of the enterprise risk management process, it is understood that risks associated with commercial real estate loans include fluctuations in real estate values, the overall strength of the borrower and the economy, new job creation trends, tenant vacancy rates, environmental contamination, and the quality of the borrowers’ management. In order to mitigate and limit these risks, we analyze the borrowers’ cash flows and evaluate collateral value. Currently, the collateral securing our commercial real estate loans includes a variety of property types, such as office, warehouse, and retail facilities. Other types include multifamily properties, hotels, mixed-use residential and commercial properties. Generally, commercial real estate loans present a higher risk profile than our consumer real estate loan portfolio.

 

Residential and Home Equity. The Company offers first and second one-to-four family mortgage loans and home equity lines of credit; the collateral for these loans is generally the clients' owner-occupied residences. Although these types of loans present lower levels of risk than commercial real estate loans, risks do still exist because of possible fluctuations in the value of the real estate collateral securing the loan, as well as changes in the borrowers' financial condition. The nonowner-occupied investment properties are more similar in risk to commercial real estate loans, and therefore, are underwritten by assessing the property’s income potential and appraised value. In both cases, we underwrite the borrower’s financial condition and evaluate his or her global cash flow position. Borrowers may be affected by numerous factors, including job loss, illness, or other personal hardship. As part of our product mix, the Bank offers both portfolio and secondary market mortgages; portfolio loans generally are based on a 1-year, 3-year, 5-year, or 7-year adjustable rate mortgage; while 15-year or 30-year fixed-rate loans are generally sold in the secondary market.

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(3)	Loans, Continued

 

Construction. Typically, these loans have a construction period of one to two years and the interest is paid monthly. Once the construction period terminates, some of these loans convert to a term loan with a maturity of one to ten years. This portion of our loan portfolio includes loans to small and midsized businesses to construct owner-user properties, loans to developers of commercial real estate investment properties, and residential developments. This type of loan is also made to individual clients for construction of single-family homes in our market area. An independent appraisal is used to determine the value of the collateral and confirm that the ratio of the loan principal to the value of the collateral will not exceed policies of the Bank. As the construction project progresses, loan proceeds are requested by the borrower to complete phases of construction and funding is only disbursed after the project has been inspected by a third-party inspector or experienced construction lender. Risks associated with construction loans include fluctuations in the value of real estate, project completion risk, and changes in market trends. The ability of the construction loan borrower to finance the loan or sell the property upon completion of the project is another risk factor that also may be affected by changes in market trends since the initial funding of the loan.

 

Commercial Loans. The Company offers a wide range of commercial loans, including business term loans, equipment financing, lines of credit, and U.S. Small Business Administration (SBA) loans. Small-to-medium sized businesses, retail, and professional establishments, make up our target market for commercial loans. Our Relationship Managers primarily underwrite these loans based on the borrower's ability to service the loan from cash flow. Lines of credit and loans secured by accounts receivable and/or inventory are monitored periodically by our staff. Loans secured by "all business assets," or a "blanket lien" are typically only made to highly qualified borrowers due to the nonspecific nature of the collateral and do not require a formal valuation of the business collateral. When commercial loans are secured by specifically identified collateral, then the valuation of the collateral is generally supported by an appraisal, purchase order, or third-party physical inspection. Personal guarantees of the principals of business borrowers are usually required. Equipment loans generally have a term of five years or less and may have a fixed or variable rate; we use conservative margins when pricing these loans. Working capital loans generally do not exceed one year and typically, they are secured by accounts receivable, inventory, and personal guarantees of the principals of the business. The Bank currently offers SBA 504 and SBA 7A loans. SBA 504 loans provide financing for major fixed assets such as real estate and equipment while SBA 7A loans are generally used to establish a new business or assist in the acquisition, operation, or expansion of an existing business. With both SBA loan programs, there are set eligibility requirements and underwriting standards outlined by SBA that can change as the government alters its fiscal policy. Significant factors affecting a commercial borrower's creditworthiness include the quality of management and the ability both to evaluate changes in the supply and demand characteristics affecting the business' markets for products and services and to respond effectively to such changes. These loans may be made unsecured or secured, but most are made on a secured basis. Risks associated with our commercial loan portfolio include local, regional, and national market conditions.

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

 Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(3)	Loans, Continued

 

Other factors of risk could include changes in the borrower's management and fluctuations in collateral value. Additionally, there may be refinancing risk if a commercial loan includes a balloon payment which must be refinanced or paid off at loan maturity. In reference to our risk management process, our commercial loan portfolio presents a higher risk profile than our consumer real estate and consumer loan portfolios. Therefore, we require that all loans to businesses must have a clearly stated and reasonable payment plan to allow for timely retirement of debt, unless secured by liquid collateral or as otherwise justified. 

 

Consumer and Other Loans. These loans are made for various consumer purposes, such as the financing of automobiles, boats, and recreational vehicles. The payment structure of these loans is normally on an installment basis. The risk associated with this category of loans stems from the reduced collateral value for a defaulted loan; the collateral may not provide an adequate source of repayment of the principal. The underwriting on these loans is primarily based on the borrower's financial condition. In many cases, these are unsecured credits that subject us to risk when the borrower's financial condition declines or deteriorates. Based upon our current trend in consumer loans, management does not anticipate consumer loans will become a substantial component of our loan portfolio at any time in the foreseeable future. Consumer loans are made at fixed and variable interest rates and are based on the appropriate amortization for the asset and purpose.

 

The following summarizes the loan credit quality:

 

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

 Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(3)	Loans, Continued

 

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company analyzes loans individually by classifying the loans as to credit risk. Loans classified as substandard or special mention are reviewed quarterly by the Company for further deterioration or improvement to determine if they are appropriately classified and whether there is any impairment. All loans are graded upon initial issuance. Furthermore, construction loans, nonowner-occupied commercial real estate loans, and commercial loan relationships in excess of $500,000 are reviewed at least annually. The Company determines the appropriate loan grade during the renewal process and reevaluates the loan grade in situations when a loan becomes past due.

 

Loans excluded from the review process above are generally classified as pass credits until: (a) they become past due; (b) management becomes aware of deterioration in the credit worthiness of the borrower; or (c) the client contacts the Company for a modification. In these circumstances, the loan is specifically evaluated for potential classification as to special mention, substandard or even charged-off. The Company uses the following definitions for risk ratings:

 

Pass – A Pass loan's primary source of loan repayment is satisfactory, with secondary sources very likely to be realized if necessary.

 

Special Mention – A Special Mention loan has potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in the deterioration of the repayment prospects for the asset or the Company's credit position at some future date. Special Mention loans are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

 

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

 

Doubtful – A loan classified Doubtful has all the weaknesses inherent in one classified Substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.

 

Loss – A loan classified Loss is considered uncollectible and of such little value that continuance as a bankable asset is not warranted. This classification does not necessarily preclude the potential for recovery, but rather signifies it is no longer practical to defer writing off the asset.

 

(continued)

 

 

PRIME MERIDIAN HOLDING COMPANY AND SUBSIDIARY

 

Notes to Condensed Consolidated Financial Statements (unaudited), Continued

 

(3)	Loans, Continued

 

 

Age analysis of past due loans is as follows: