Edgar Filing: FARMERS CAPITAL BANK CORP

ffkt20150930_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT

Pursuant to Section 13 OR 15(d) of

The Securities Exchange Act of 1934

For the quarterly period ended September 30, 2015

Farmers Capital Bank Corporation

(Exact name of registrant as specified in its charter)

Kentucky

000-14412

61-1017851

(State or other jurisdiction of incorporation or organization)

(Commission

File Number)

(IRS Employer

Identification No.)

P.O. Box 309

202 West Main St.

Frankfort, KY

40601

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code – (502) 227-1668

Not Applicable

(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 ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒ No ☐

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

Large accelerated filer ☐	Accelerated filer ☒

Non-accelerated filer ☐ (Do not check if a smaller reporting company)	Smaller reporting company ☐

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.

Common stock, par value $0.125 per share

7,497,615 shares outstanding at November 5, 2015

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements
Unaudited Condensed Consolidated Balance Sheets	3
Unaudited Condensed Consolidated Statements of Income	4
Unaudited Condensed Consolidated Statements of Comprehensive Income	5
Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity	6
Unaudited Condensed Consolidated Statements of Cash Flows	7
Notes to Unaudited Condensed Consolidated Financial Statements	8

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	32

Item 3. Quantitative and Qualitative Disclosures About Market Risk	54

Item 4. Controls and Procedures	54

PART II - OTHER INFORMATION

Item 1. Legal Proceedings	54

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	54

Item 6. Exhibits	55

SIGNATURES	57

PART I – FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements

Unaudited Condensed Consolidated Balance Sheets

	September 30,			December 31,
(Dollars in thousands, except share data)	2015			2014
Assets
Cash and cash equivalents:
Cash and due from banks	$	20,732		$	26,770
Interest bearing deposits in other banks		72,360			67,152
Federal funds sold and securities purchased under agreements to resell		3,563			6,992
Money market mutual funds		11,200			-
Total cash and cash equivalents		107,855			100,914
Investment securities:
Available for sale, amortized cost of $599,532 (2015) and $618,429 (2014)		608,510			626,388
Held to maturity, fair value of $3,893 (2015) and $3,923 (2014)		3,689			3,728
Total investment securities		612,199			630,116
Loans, net of unearned income		935,145			931,943
Allowance for loan losses		(11,277	)		(13,968	)
Loans, net		923,868			917,975
Premises and equipment, net		33,924			34,933
Company-owned life insurance		30,039			29,363
Intangible assets, net		112			449
Other real estate owned		22,868			31,960
Other assets		33,890			36,896
Total assets	$	1,764,755		$	1,782,606
Liabilities
Deposits:
Noninterest bearing	$	302,114		$	292,788
Interest bearing		1,054,354			1,094,373
Total deposits		1,356,468			1,387,161
Federal funds purchased and other short-term borrowings		34,757			28,590
Securities sold under agreements to repurchase and other long-term borrowings		120,115			119,724
Subordinated notes payable to unconsolidated trusts		48,970			48,970
Dividends payable, preferred		-			113
Other liabilities		30,867			25,119
Total liabilities		1,591,177			1,609,677
Shareholders’ Equity
Preferred stock, no par value 1,000,000 shares authorized; none and 10,000 Series A shares issued and outstanding at September 30, 2015 and December 31, 2014		-			10,000
Common stock, par value $.125 per share 14,608,000 shares authorized; 7,496,522 and 7,489,388 shares issued and outstanding at September 30, 2015 and December 31, 2014, respectively		937			936
Capital surplus		51,524			51,344
Retained earnings		116,787			105,774
Accumulated other comprehensive income		4,330			4,875
Total shareholders’ equity		173,578			172,929
Total liabilities and shareholders’ equity	$	1,764,755		$	1,782,606

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Income

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(In thousands, except per share data)	2015			2014			2015			2014
Interest Income
Interest and fees on loans	$	11,919		$	12,441		$	36,006		$	37,759
Interest on investment securities:
Taxable		2,508			2,857			7,944			8,917
Nontaxable		661			644			1,982			1,905
Interest on deposits in other banks		32			32			123			96
Interest on federal funds sold and securities purchased under agreements to resell		3			2			9			4
Total interest income		15,123			15,976			46,064			48,681
Interest Expense
Interest on deposits		725			1,030			2,283			3,337
Interest on federal funds purchased and other short-term borrowings		13			12			33			42
Interest on securities sold under agreements to repurchase and other long-term borrowings		1,201			1,259			3,564			3,802
Interest on subordinated notes payable to unconsolidated trusts		219			212			643			631
Total interest expense		2,158			2,513			6,523			7,812
Net interest income		12,965			13,463			39,541			40,869
Provision for loan losses		(898	)		(1,536	)		(2,707	)		(2,792	)
Net interest income after provision for loan losses		13,863			14,999			42,248			43,661
Noninterest Income
Service charges and fees on deposits		1,955			1,993			5,634			5,900
Allotment processing fees		1,066			1,276			3,358			3,795
Other service charges, commissions, and fees		1,442			1,316			4,056			3,950
Trust income		667			812			1,821			1,880
Investment securities gain (losses), net		(2	)		8			163			(67	)
Gains on sale of mortgage loans, net		220			123			558			343
Income from company-owned life insurance		234			511			702			990
Other		107			103			346			715
Total noninterest income		5,689			6,142			16,638			17,506
Noninterest Expense
Salaries and employee benefits		7,774			7,530			23,946			22,223
Occupancy expenses, net		1,177			1,229			3,623			3,720
Equipment expenses		691			637			1,918			1,824
Data processing and communication expenses		1,114			979			3,243			2,953
Bank franchise tax		608			585			1,820			1,807
Amortization of intangibles		112			101			337			303
Deposit insurance expense		397			426			1,201			1,327
Other real estate expenses, net		262			1,974			1,033			3,976
Legal expenses		292			293			693			715
Other		1,854			1,997			5,451			5,656
Total noninterest expense		14,281			15,751			43,265			44,504
Income before income taxes		5,271			5,390			15,621			16,663
Income tax expense		1,439			1,283			4,213			4,362
Net income		3,832			4,107			11,408			12,301
Less preferred stock dividends and discount accretion		-			450			395			1,550
Net income available to common shareholders	$	3,832		$	3,657		$	11,013		$	10,751
Per Common Share
Net income - basic and diluted	$	.51		$	.49		$	1.47		$	1.44
Cash dividends declared		N/A			N/A			N/A			N/A
Weighted Average Common Shares Outstanding
Basic and diluted		7,495			7,485			7,492			7,482

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Comprehensive Income

	Three Months Ended		Nine Months Ended
	September 30,		September 30,
(In thousands)	2015	2014	2015	2014
Net Income	$3,832	$4,107	$11,408	$12,301
Other comprehensive income (loss):
Unrealized holding gain (loss) on available for sale securities arising during the period on securities held at end of period, net of tax of $1,026, $(820) $402 and $3,796, respectively	1,905	(1,522)	747	7,049

Reclassification adjustment for prior period unrealized (gain) loss previously reported in other comprehensive income recognized during current period, net of tax of $3, $4, $46 and $(36), respectively	(5)	(7)	(86)	66

Change in unfunded portion of postretirement benefit obligation, net of tax of $8, $12, $(649) and $37, respectively	15	22	(1,206)	68
Other comprehensive income (loss)	1,915	(1,507)	(545)	7,183
Comprehensive income	$5,747	$2,600	$10,863	$19,484

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Changes in Shareholders’ Equity

(Dollars in thousands, except per share data)													Accumulated
													Other			Total
Nine months ended	Preferred			Common Stock				Capital		Retained			Comprehensive			Shareholders’
September 30, 2015 and 2014	Stock			Shares		Amount		Surplus		Earnings			Income (Loss)			Equity
Balance at January 1, 2015	$	10,000			7,489	$	936	$	51,344	$	105,774		$	4,875		$	172,929
Net income		-			-		-		-		11,408			-			11,408
Other comprehensive loss		-			-		-		-		-			(545	)		(545	)
Cash dividends declared – preferred, $39.50 per share		-			-		-		-		(395	)		-			(395	)
Redemption of preferred stock		(10,000	)		-		-		-		-			-			(10,000	)
Shares issued under director compensation plan		-			3		-		64		-			-			64
Shares issued pursuant to employee stock purchase plan		-			5		1		92		-			-			93
Expense related to employee stock purchase plan		-			-		-		24		-			-			24
Balance at September 30, 2015	$	-			7,497	$	937	$	51,524	$	116,787		$	4,330		$	173,578



Balance at January 1, 2014	$	29,988			7,479	$	935	$	51,102	$	91,242		$	(3,212	)	$	170,055
Net income		-			-		-		-		12,301			-			12,301
Other comprehensive income		-			-		-		-		-			7,183			7,183
Cash dividends declared – preferred, $62.50 per share		-			-		-		-		(1,538	)		-			(1,538	)
Preferred stock discount accretion		12			-		-		-		(12	)		-			-
Redemption of preferred stock		(10,000	)		-		-		-		-			-			(10,000	)
Shares issued under director compensation plan		-			3		-		64		-			-			64
Shares issued pursuant to employee stock purchase plan		-			5		1		93		-			-			94
Expense related to employee stock purchase plan		-			-		-		28		-			-			28
Balance at September 30, 2014	$	20,000			7,487	$	936	$	51,287	$	101,993		$	3,971		$	178,187

See accompanying notes to unaudited condensed consolidated financial statements.

Unaudited Condensed Consolidated Statements of Cash Flows

Nine months ended September 30, (In thousands)	2015			2014
Cash Flows from Operating Activities
Net income	$	11,408		$	12,301
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		3,067			3,033
Net premium amortization of investment securities:
Available for sale		3,278			2,889
Held to maturity		39			29
Provision for loan losses		(2,707	)		(2,792	)
Deferred income tax expense		274			1,145
Noncash employee stock purchase plan expense		24			28
Noncash director fee compensation		64			64
Mortgage loans originated for sale		(21,490	)		(19,289	)
Proceeds from sale of mortgage loans		21,879			23,177
Gain on sale of mortgage loans, net		(558	)		(343	)
Loss (gain) on disposal and write downs of premises and equipment, net		16			(5	)
Net loss on sale and write downs of other real estate		724			2,622
Net (gain) loss on sale of available for sale investment securities		(163	)		67
Increase in cash surrender value of company-owned life insurance		(676	)		(694	)
Death benefits in excess of cash surrender value on company-owned life insurance		-			(276	)
Decrease in accrued interest receivable		379			281
Decrease in other assets		2,436			231
Decrease in accrued interest payable		(85	)		(123	)
Increase in other liabilities		3,950			1,869
Net cash provided by operating activities		21,859			24,214
Cash Flows from Investing Activities
Proceeds from maturities and calls of available for sale investment securities		95,665			68,702
Proceeds from sale of available for sale investment securities		12,674			12,866
Purchase of investment securities:
Available for sale		(92,557	)		(79,133	)
Held to maturity		-			(3,065	)
Proceeds from sale of restricted stock investments, net		-			148
Loans originated for investment (greater) less than principal collected, net		(3,806	)		34,554
Purchase of premises and equipment		(1,606	)		(1,620	)
Proceeds from sale of other real estate		9,239			6,819
Proceeds from disposals of premises and equipment		23			5
Net cash provided by investing activities		19,632			39,276
Cash Flows from Financing Activities
Net decrease in deposits		(30,693	)		(45,057	)
Net increase in federal funds purchased and other short-term borrowings		6,167			3,684
Proceeds from securities sold under agreements to repurchase and other long-term borrowings		507			7
Repayments of securities sold under agreements to repurchase and other long-term borrowings		(116	)		(8,128	)
Redemption of preferred stock		(10,000	)		(10,000	)
Dividends paid, preferred stock		(508	)		(1,500	)
Shares issued under employee stock purchase plan		93			94
Net cash used in financing activities		(34,550	)		(60,900	)
Net increase in cash and cash equivalents		6,941			2,590
Cash and cash equivalents at beginning of year		100,914			68,253
Cash and cash equivalents at end of period	$	107,855		$	70,843
Supplemental Disclosures
Cash paid during the period for:
Interest	$	6,608		$	7,935
Income taxes		1,200			1,850
Transfers from loans to other real estate		1,192			7,630
Sale and financing of other real estate		403			1,771
Cash dividends payable, preferred		-			225

See accompanying notes to unaudited condensed consolidated financial statements.

Notes to Unaudited Condensed Consolidated Financial Statements

1. Basis of Presentation and Nature of Operations

The condensed consolidated financial statements include the accounts of Farmers Capital Bank Corporation (the “Company” or “Parent Company”), a bank holding company, and its bank and nonbank subsidiaries. Bank subsidiaries include Farmers Bank & Capital Trust Company (“Farmers Bank”) in Frankfort, KY, United Bank & Trust Company (“United Bank”) in Versailles, KY, First Citizens Bank, Inc. (“First Citizens”) in Elizabethtown, KY, and Citizens Bank of Northern Kentucky, Inc. (“Citizens Northern”) in Newport, KY.

Farmers 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 Farmers Bank and Farmers Insurance is an insurance agency in Frankfort, KY. United Bank has one wholly-owned subsidiary, EGT Properties, Inc. EGT Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of United Bank. First Citizens has one wholly-owned subsidiary, HBJ Properties, LLC. HBJ Properties, LLC is involved in real estate management and liquidation for certain repossessed properties of First Citizens. Citizens Northern has one wholly-owned subsidiary, ENKY Properties, Inc. ENKY Properties, Inc. is involved in real estate management and liquidation for certain repossessed properties of Citizens Northern.

The Company has two active nonbank subsidiaries, FCB Services, Inc. (“FCB Services”), and FFKT Insurance Services, Inc. (“FFKT Insurance”). FCB Services is a data processing subsidiary located in Frankfort, KY that provides services to the Company’s banks as well as unaffiliated entities. FFKT Insurance is a captive property and casualty insurance company insuring primarily deductible exposures and uncovered liability related to properties of the Company. The Company has three subsidiaries organized as Delaware statutory trusts that are not consolidated into its financial statements. These trusts were formed for the purpose of issuing trust preferred securities.

The Company provides financial services at its 35 locations in 22 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 and leases 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 potentially represent concentrations of credit risk, include deposit accounts in other financial institutions and federal funds sold.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States (“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 condensed financial statements are based on various factors including the current interest rate environment and the general strength of the local and state 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 condensed 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.

The consolidated balance sheet as of December 31, 2014 has been derived from the audited financial statements of the Company as of that date. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2014 included in the Company’s annual report on Form 10-K. The accompanying condensed consolidated financial statements have been prepared in accordance with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X and do not include all of the information and the footnotes required by U.S. GAAP for complete statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of such condensed financial statements, have been included. The results of operations for the interim periods are not necessarily indicative of the results to be expected for the full year. All significant intercompany transactions and balances are eliminated in consolidation.

2. Reclassifications

Certain reclassifications have been made to the consolidated financial statements of prior periods to conform to the current period presentation. These reclassifications do not affect net income or total shareholders’ equity as previously reported.

3. Accumulated Other Comprehensive Income

The following table presents changes in accumulated other comprehensive income by component, net of tax, for the periods indicated.

Three months ended September 30,	2015								2014
(In thousands)	Unrealized Gains and Losses on Available for Sale Investment Securities			Postretirement Benefit Obligation			Total		Unrealized Gains and Losses on Available for Sale Investment Securities			Postretirement Benefit Obligation		Total
Beginning balance	$	3,935		$	(1,520	)	$	2,415	$	5,021		$	457	$	5,478
Other comprehensive income (loss) before reclassifications		1,905			-			1,905		(1,522	)		-		(1,522	)
Amounts reclassified from accumulated other comprehensive income		(5	)		15			10		(7	)		22		15
Net current-period other comprehensive income (loss)		1,900			15			1,915		(1,529	)		22		(1,507	)
Ending balance	$	5,835		$	(1,505	)	$	4,330	$	3,492		$	479	$	3,971

Nine months ended September 30,	2015									2014
(In thousands)	Unrealized Gains and Losses on Available for Sale Investment Securities			Postretirement Benefit Obligation			Total			Unrealized Gains and Losses on Available for Sale Investment Securities			Postretirement Benefit Obligation		Total
Beginning balance	$	5,174		$	(299	)	$	4,875		$	(3,623	)	$	411	$	(3,212	)
Other comprehensive income (loss) before reclassifications		747			(1,251	)		(504	)		7,049			-		7,049
Amounts reclassified from accumulated other comprehensive income		(86	)		45			(41	)		66			68		134
Net current-period other comprehensive income (loss)		661			(1,206	)		(545	)		7,115			68		7,183
Ending balance	$	5,835		$	(1,505	)	$	4,330		$	3,492		$	479	$	3,971

The following table presents amounts reclassified out of accumulated other comprehensive income by component for the period indicated. Line items in the statement of income affected by the reclassification are also presented.

	Amount Reclassified from Accumulated Other Comprehensive Income												Affected Line Item in the Statement Where Net Income is Presented
	Three months ended September 30,						Nine months ended September 30,
(In thousands)	2015			2014			2015			2014
Unrealized gains and losses on available for sale investment securities	$	8		$	11		$	132		$	(102	)	Investment securities gains (losses), net
		(3	)		(4	)		(46	)		36		Income tax (expense) benefit
	$	5		$	7		$	86		$	(66	)	Net of tax

Amortization related to postretirement benefits
Prior service costs	$	(13	)	$	(51	)	$	(38	)	$	(155	)	Salaries and employee benefits
Actuarial (losses) gains		(10	)		17			(31	)		50		Salaries and employee benefits
		(23	)		(34	)		(69	)		(105	)	Total before tax
		8			12			24			37		Income tax benefit
	$	(15	)	$	(22	)	$	(45	)	$	(68	)	Net of tax

Total reclassifications for the period	$	(10	)	$	(15	)	$	41		$	(134	)	Net of tax

4. Accounting Policy

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 and deferred fees or costs on originated 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 Leases Other
Consumer loans	Secured Unsecured

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.

The 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 90 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 loans 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.

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 component 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 sixteen quarter rolling historical loss rates, adjusted for the qualitative risk factors summarized below.

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 performed at each subsidiary bank and is both measureable and supportable. Some factors include a minimum allocation in some 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 modified 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 Accounting Standards Codification (“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. The Company determines the amount of reserve for troubled debt restructurings that subsequently default in accordance with its accounting policy for the allowance for loan losses.

Recently Issued Accounting Standards

In January 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-01, “Income Statement—Extraordinary and Unusual Items (Subtopic 225-20): Simplifying Income Statement Presentation by Eliminating the Concept of Extraordinary Items.” This ASU amends U.S. GAAP by removing the concept of extraordinary items, including deleting the definition of “extraordinary items” from the FASB Master Glossary. The revised guidance provides that the nature and financial effects of each event or transaction that is unusual in nature or occurs infrequently or both shall be presented as a separate component of income from continuing operations or, alternatively, disclosed in notes to the financial statements.

The amendments are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early adoption permitted. A reporting entity may apply the amendments prospectively or retrospectively. The Company does not expect there to be a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

In April 2015, the FASB issued ASU No. 2015-03, “Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This ASU addresses balance sheet presentation requirements for debt issuance costs and debt discount and premiums. ASU No. 2015-03 requires that debt issuance costs related to a recognized debt liability be presented on the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This ASU is effective for financial statements issued for fiscal years beginning after December 15, 2015, and for interim periods within those fiscal years. The Company does not expect there to be a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

In May 2015, the FASB issued ASU No. 2015-07, “Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent).” This ASU applies to entities that elect to measure the fair value of an investment using the net asset value per share (or its equivalent) practical expedient. The amendments in this ASU remove the requirement to categorize within the fair value hierarchy all investments for which fair value is measured using the net asset value per share practical expedient. The amendments also clarify that certain disclosure requirements are limited to investments for which the entity has elected to measure the fair value using the practical expedient, and not all investments eligible to be measured at fair value using the practical expedient. The amendments in ASU 2015-07 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015, with early application permitted. Entities are required to apply the amendments retrospectively to all periods presented. The Company does not expect there to be a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

In August 2015, the FASB issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date.” This ASU defers the effective date of the guidance in ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU No. 2015-14 permits public business entities to apply the guidance in ASU No. 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within those reporting periods. 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 Company is evaluating the potential impact of ASU 2014-09 on its consolidated financial position, results of operations, and cash flows.

In August 2015, the FASB issued ASU No. 2015-15, “Interest—Imputation of Interest (Subtopic 835-30): Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements—Amendments to SEC Paragraphs Pursuant to Staff Announcement at June 18, 2015 EITF Meeting.” This ASU amends FASB ASC Subtopic 835-30 by adding paragraphs which concern line-of-credit arrangements. According to the FASB, ASU No. 2015-03, Interest—Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs, which requires entities to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability, did not address presentation or subsequent measurement of debt issuance costs related to line-of-credit arrangements. ASU 2015-15 states that the SEC staff would not object to the deferral and presentation of debt issuance costs as an asset and subsequent amortization of the deferred costs over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. The Company does not expect there to be a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

In September 2015, the FASB issued ASU No. 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments,” to amend the guidance for amounts that are adjusted in a merger or acquisition. The amendments in this ASU require that a company that makes an acquisition recognize adjustments to provisional amounts identified during the measurement period in the reporting period in which it determines the adjustment amounts. The amendments require that the buyer record, in the same period's financial statements, the effect on earnings of changes in depreciation, amortization, or other effects on earnings as a result of the change to the provisional amounts and calculate them as if the accounting had been completed at the acquisition date. For public companies this ASU is effective for fiscal years that start after December 15, 2015, including interim periods within those fiscal years. This ASU should be applied prospectively to adjustments to provisional amounts that occur after the effective date of this ASU. Early application is permitted for financial statements that have not been issued. The Company does not expect there to be a material impact on its consolidated financial position, results of operations, or cash flows upon adoption.

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.

5. Net Income Per Common Share

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

Diluted net income per common share is determined by dividing net income available to common shareholders by the total weighted average number of common shares issued and outstanding plus amounts representing the dilutive effect of stock options outstanding. The effects of stock options outstanding are excluded from the computation of diluted earnings per common share in periods in which the effect would be antidilutive. Dilutive potential common shares are calculated using the treasury stock method.

Net income per common share computations were as follows for the periods indicated.

	Three Months Ended September 30,				Nine Months Ended September 30,
(In thousands, except per share data)	2015		2014		2015		2014

Net income, basic and diluted	$	3,832	$	4,107	$	11,408	$	12,301
Less preferred stock dividends and discount accretion		-		450		395		1,550
Net income available to common shareholders, basic and diluted	$	3,832	$	3,657	$	11,013	$	10,751


Average common shares issued and outstanding, basic and diluted		7,495		7,485		7,492		7,482

Net income per common share, basic and diluted	$	.51	$	.49	$	1.47	$	1.44

Stock options for 18,049 shares of common stock were not included in the determination of diluted net income per common share for each period presented for 2014 because they were antidilutive. All previous options expired during the fourth quarter of 2014.

6. Investment Securities

The following tables summarize the amortized costs and estimated fair value of the securities portfolio at September 30, 2015 and December 31, 2014. The summary is divided into available for sale and held to maturity investment securities.

September 30, 2015 (In thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Available For Sale
Obligations of U.S. government-sponsored entities	$	126,197	$	642	$	155	$	126,684
Obligations of states and political subdivisions		143,502		2,648		240		145,910
Mortgage-backed securities – residential		306,466		7,254		460		313,260
Mortgage-backed securities – commercial		15,870		205		1		16,074
Corporate debt securities		6,879		16		865		6,030
Mutual funds and equity securities		618		-		66		552
Total securities – available for sale	$	599,532	$	10,765	$	1,787	$	608,510
Held To Maturity
Obligations of states and political subdivisions	$	3,689	$	204	$	-	$	3,893

December 31, 2014 (In thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value
Available For Sale
Obligations of U.S. government-sponsored entities	$	110,094	$	369	$	1,015	$	109,448
Obligations of states and political subdivisions		133,563		2,600		397		135,766
Mortgage-backed securities – residential		363,729		7,959		1,199		370,489
Mortgage-backed securities – commercial		2,515		7		10		2,512
Corporate debt securities		6,639		26		358		6,307
Mutual funds and equity securities		1,889		2		25		1,866
Total securities – available for sale	$	618,429	$	10,963	$	3,004	$	626,388
Held To Maturity
Obligations of states and political subdivisions	$	3,728	$	195	$	-	$	3,923

The amortized cost and estimated fair value of the debt securities portfolio at September 30, 2015, by contractual maturity, are detailed below. The summary is divided into available for sale and held to maturity securities. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Mutual funds and equity securities in the available for sale portfolio consist of investments attributed to the Company’s captive insurance subsidiary. These securities have no stated maturity and are not included in the maturity schedule that follows.

Mortgage-backed securities are stated separately due to the nature of payment and prepayment characteristics of these securities, as principal is not due at a single date.

	Available For Sale				Held To Maturity
	Amortized		Estimated		Amortized		Estimated
September 30, 2015 (In thousands)	Cost		Fair Value		Cost		Fair Value
Due in one year or less	$	12,156	$	12,183	$	-	$	-
Due after one year through five years		167,082		168,576		-		-
Due after five years through ten years		80,840		82,061		705		800
Due after ten years		16,500		15,804		2,984		3,093
Mortgage-backed securities		322,336		329,334		-		-
Total	$	598,914	$	607,958	$	3,689	$	3,893

Gross realized gains and losses on the sale of available for sale investment securities were as follows:

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(In thousands)	2015			2014		2015		2014

Gross realized gains	$	5		$	8	$	185	$	186
Gross realized losses		7			-		22		253
Net realized (loss) gain	$	(2	)	$	8	$	163	$	(67	)

Investment securities with unrealized losses at September 30, 2015 and December 31, 2014 not recognized in income are presented in the tables below. The tables segregate investment securities that have been in a continuous unrealized loss position for less than twelve months from those that have been in a continuous unrealized loss position for twelve months or more. The tables also include the fair value of the related securities.

	Less than 12 Months				12 Months or More				Total
September 30, 2015 (In thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Obligations of U.S. government-sponsored entities	$	10,201	$	71	$	17,468	$	84	$	27,669	$	155
Obligations of states and political subdivisions		27,192		159		8,714		81		35,906		240
Mortgage-backed securities – residential		26,332		74		22,958		386		49,290		460
Mortgage-backed securities – commercial		3,167		1		-		-		3,167		1
Corporate debt securities		304		11		5,038		854		5,342		865
Mutual funds and equity securities		489		45		63		21		552		66
Total	$	67,685	$	361	$	54,241	$	1,426	$	121,926	$	1,787

	Less than 12 Months				12 Months or More				Total
December 31, 2014 (In thousands)	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Obligations of U.S. government-sponsored entities	$	22,696	$	76	$	60,892	$	939	$	83,588	$	1,015
Obligations of states and political subdivisions		20,746		81		21,272		316		42,018		397
Mortgage-backed securities – residential		37,451		82		71,311		1,117		108,762		1,199
Mortgage-backed securities – commercial		-		-		723		10		723		10
Corporate debt securities		76		4		5,525		354		5,601		358
Mutual funds and equity securities		305		11		95		14		400		25
Total	$	81,274	$	254	$	159,818	$	2,750	$	241,092	$	3,004

Unrealized losses included in the tables above have not been recognized in income since they have been identified as temporary. The Company evaluates investment securities for other-than-temporary impairment (“OTTI”) at least quarterly, and more frequently when economic or market conditions warrant. Many factors are considered, including: (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was effected by macroeconomic conditions, and (4) whether the Company has the intent to sell the security or more likely than not will be required to sell the security before its anticipated recovery. 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.

Corporate debt securities in the Company’s investment securities portfolio at September 30, 2015 include single-issuer trust preferred capital securities with an unrealized loss of $854 thousand and a carrying value of $5.0 million. At year-end 2014, these securities had an unrealized loss of $354 thousand. These securities were issued by a national and global financial services firm and purchased by the Company during 2007. The securities are currently performing and continue to be rated as investment grade by the rating agencies. The issuer of the securities announced in the first quarter of 2015 an increase in per share common dividend payments and authorization of a common equity repurchase plan. The Company does not intend to sell these securities nor does the Company believe it is likely that it will be required to sell these securities prior to their anticipated recovery. The Company believes these securities are not impaired due to reasons of credit quality or other factors, but rather the unrealized loss is primarily attributed to continuing global economic issues and market volatility. The Company believes that it will collect all amounts due according to the contractual terms of these securities and that the fair values of these securities will recover as they approach their maturity dates.

The Company attributes the unrealized losses in other sectors of its investment securities portfolio to changes in market interest rates and volatility. Investment securities with unrealized losses at September 30, 2015 are performing according to their contractual terms, and the Company does not expect to incur a loss on these securities unless they are sold prior to maturity. The Company does not have the intent to sell these securities nor does it believe it is likely that it will be required to sell these securities prior to their anticipated recovery. The Company does not consider any of the securities to be impaired due to reasons of credit quality or other factors.

7. Loans and Allowance for Loan Losses

Major classifications of loans outstanding are summarized as follows:

(In thousands)	September 30, 2015		December 31, 2014

Real Estate:
Real estate mortgage – construction and land development	$	107,130	$	97,045
Real estate mortgage – residential		355,258		361,022
Real estate mortgage – farmland and other commercial enterprises		368,870		375,277
Commercial:
Commercial and industrial		51,187		47,112
States and political subdivisions		18,428		22,369
Lease financing		25		159
Other		22,218		15,547
Consumer:
Secured		6,787		7,963
Unsecured		5,242		5,450
Total loans		935,145		931,944
Less unearned income		-		1
Total loans, net of unearned income	$	935,145	$	931,943

Activity in the allowance for loan losses by portfolio segment was as follows for the periods indicated.

(In thousands)	Real Estate			Commercial			Consumer			Total
Three months ended September 30, 2015
Balance, beginning of period	$	10,806		$	1,057		$	336		$	12,199
Provision for loan losses		(765	)		(136	)		3			(898	)
Recoveries		38			145			28			211
Loans charged off		(151	)		(42	)		(42	)		(235	)
Balance, end of period	$	9,928		$	1,024		$	325		$	11,277

Nine months ended September 30, 2015
Balance, beginning of period	$	12,542		$	1,153		$	273		$	13,968
Provision for loan losses		(2,552	)		(237	)		82			(2,707	)
Recoveries		376			176			91			643
Loans charged off		(438	)		(68	)		(121	)		(627	)
Balance, end of period	$	9,928		$	1,024		$	325		$	11,277

(In thousands)	Real Estate			Commercial			Consumer			Total
Three months ended September 30, 2014
Balance, beginning of period	$	15,448		$	1,338		$	337		$	17,123
Provision for loan losses		(1,036	)		(496	)		(4	)		(1,536	)
Recoveries		114			691			20			825
Loans charged off		(436	)		(230	)		(54	)		(720	)
Balance, end of period	$	14,090		$	1,303		$	299		$	15,692

Nine months ended September 30, 2014
Balance, beginning of period	$	18,716		$	1,409		$	452		$	20,577
Provision for loan losses		(3,395	)		634			(31	)		(2,792	)
Recoveries		471			736			94			1,301
Loans charged off		(1,702	)		(1,476	)		(216	)		(3,394	)
Balance, end of period	$	14,090		$	1,303		$	299		$	15,692

The following tables present individually impaired loans by class of loans for the dates indicated.

September 30, 2015 (In thousands)	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Allowance for Loan Losses Allocated
Real Estate
Real estate mortgage – construction and land development	$	10,410	$	4,373	$	3,379	$	7,752	$	543
Real estate mortgage – residential		9,304		2,588		6,660		9,248		1,149
Real estate mortgage – farmland and other commercial enterprises		21,182		4,200		16,848		21,048		687
Commercial
Commercial and industrial		436		-		438		438		261
Consumer
Unsecured		161		-		161		161		161
Total	$	41,493	$	11,161	$	27,486	$	38,647	$	2,801

December 31, 2014 (In thousands)	Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Total Recorded Investment		Allowance for Loan Losses Allocated
Real Estate
Real estate mortgage – construction and land development	$	13,656	$	6,902	$	3,917	$	10,819	$	744
Real estate mortgage – residential		10,256		3,473		6,649		10,122		1,172
Real estate mortgage – farmland and other commercial enterprises		23,003		5,247		17,649		22,896		1,359
Commercial
Commercial and industrial		93		22		71		93		71
Consumer
Unsecured		25		-		25		25		25
Total	$	47,033	$	15,644	$	28,311	$	43,955	$	3,371

Three Months Ended September 30,	2015						2014
(In thousands)	Average		Interest Income Recognized		Cash Basis Interest Recognized		Average		Interest Income Recognized		Cash Basis Interest Recognized
Real Estate
Real estate mortgage – construction and land development	$	9,650	$	49	$	47	$	13,157	$	46	$	46
Real estate mortgage – residential		9,416		109		109		10,651		150		143
Real estate mortgage – farmland and other commercial enterprises		20,999		255		252		27,014		359		358
Commercial
Commercial and industrial		449		5		5		375		2		2
Consumer
Unsecured		161		2		2		30		-		-
Total	$	40,675	$	420	$	415	$	51,227	$	557	$	549

Nine Months Ended September 30,	2015						2014
(In thousands)	Average		Interest Income Recognized		Cash Basis Interest Recognized		Average		Interest Income Recognized		Cash Basis Interest Recognized
Real Estate
Real estate mortgage – construction and land development	$	10,382	$	265	$	258	$	14,735	$	279	$	275
Real estate mortgage – residential		10,199		364		352		11,137		412		393
Real estate mortgage – farmland and other commercial enterprises		22,931		780		771		29,141		839		816
Commercial
Commercial and industrial		563		11		11		290		6		5
Consumer
Secured								6		-		-
Unsecured		118		4		4		56		4		3
Total	$	44,193	$	1,424	$	1,396	$	55,365	$	1,540	$	1,492

The following tables present the balance of the allowance for loan losses and the recorded investment in loans by portfolio segment based on impairment method as of September 30, 2015 and December 31, 2014.

September 30, 2015 (In thousands)	Real Estate		Commercial		Consumer		Total
Allowance for Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	2,379	$	261	$	161	$	2,801
Collectively evaluated for impairment		7,549		763		164		8,476
Total ending allowance balance	$	9,928	$	1,024	$	325	$	11,277

Loans
Loans individually evaluated for impairment	$	38,048	$	438	$	161	$	38,647
Loans collectively evaluated for impairment		793,210		91,420		11,868		896,498
Total ending loan balance, net of unearned income	$	831,258	$	91,858	$	12,029	$	935,145

December 31, 2014 (In thousands)	Real Estate		Commercial		Consumer		Total
Allowance for Loan Losses
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	3,275	$	71	$	25	$	3,371
Collectively evaluated for impairment		9,267		1,082		248		10,597
Total ending allowance balance	$	12,542	$	1,153	$	273	$	13,968

Loans
Loans individually evaluated for impairment	$	43,837	$	93	$	25	$	43,955
Loans collectively evaluated for impairment		789,507		85,093		13,388		887,988
Total ending loan balance, net of unearned income	$	833,344	$	85,186	$	13,413	$	931,943

The following tables present the recorded investment in nonperforming loans by class of loans as of September 30, 2015 and December 31, 2014.

September 30, 2015 (In thousands)	Nonaccrual		Restructured Loans		Loans Past Due 90 Days or More and Still Accruing
Real Estate:
Real estate mortgage – construction and land development	$	1,861	$	3,679	$	-
Real estate mortgage – residential		2,527		4,350		-
Real estate mortgage – farmland and other commercial enterprises		3,739		15,594		-
Commercial:
Commercial and industrial		55		385		-
Other		9		-		-
Consumer:
Secured		10		-		-
Unsecured		-		147		-
Total	$	8,201	$	24,155	$	-

December 31, 2014 (In thousands)	Nonaccrual		Restructured Loans		Loans Past Due 90 Days or More and Still Accruing
Real Estate:
Real estate mortgage – construction and land development	$	3,744	$	3,742	$	-
Real estate mortgage – residential		3,474		4,674		-
Real estate mortgage – farmland and other commercial enterprises		4,202		16,004		-
Commercial:
Commercial and industrial		81		-		-
Lease financing		7		-		-
Consumer:
Unsecured		-		9		-
Total	$	11,508	$	24,429	$	-

The Company has allocated $1.9 million and $2.2 million of specific reserves to customers whose loan terms have been modified in troubled debt restructurings and that are in compliance with those terms as of September 30, 2015 and December 31, 2014, respectively. The Company had no commitments to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings at September 30, 2015 and December 31, 2014.

The Company had three credits modified as troubled debt restructurings during 2015. Additionally, troubled debt restructurings increased as a result of the purchase of a previously-participated portion of a loan to a nonaffiliated bank during the first quarter of 2015. This loan was participated prior to it being restructured. The purchase price paid represented a discount of $482 thousand or 15% of the purchased principal amount. The loan is performing under the terms of the restructuring and the borrower’s financial position has steadily improved. Accretion of the discount was recognized over the contractual life of the loan, which ended in June 2015. There is no further accretion to be recognized. The total outstanding balance related to this credit, which was renewed during June 2015, was $11.3 million at September 30, 2015. This represents 46.8% of the Company’s total restructured loans and is the largest such individual credit. This credit was restructured in 2012 following an interest rate concession and extended amortization term.

The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2015. There were no loans modified as troubled debt restructurings during the three months ended September 30, 2015 or during 2014.

(Dollars in thousands) Troubled Debt Restructurings:	Number of Loans		Pre-Modification Outstanding Recorded Investment		Post-Modification Outstanding Recorded Investment
Nine Months Ended September 30, 2015
Commercial:
Commercial and industrial		2	$	388	$	388
Consumer:
Secured		1		145		145
Total		3	$	533	$	533

The troubled debt restructurings identified above increased the allowance for loan losses by $356 thousand in the nine month period ended September 30, 2015. There were no charge-offs related to these loans. There were no payment defaults during the first nine months of 2015 or 2014 for credits that were restructured during the previous twelve months.

The tables below present an age analysis of past due loans 30 days or more by class of loans as of the dates indicated. Past due loans that are also classified as nonaccrual are included in their respective past due category.

September 30, 2015 (In thousands)	30-89 Days Past Due		90 Days or More Past Due		Total		Current		Total Loans
Real Estate:
Real estate mortgage – construction and land development	$	2	$	227	$	229	$	106,901	$	107,130
Real estate mortgage – residential		1,706		698		2,404		352,854		355,258
Real estate mortgage – farmland and other commercial enterprises		876		2,125		3,001		365,869		368,870
Commercial:
Commercial and industrial		-		19		19		51,168		51,187
States and political subdivisions		-		-		-		18,428		18,428
Lease financing, net		25		-		25		-		25
Other		19		-		19		22,199		22,218
Consumer:
Secured		4		-		4		6,783		6,787
Unsecured		23		-		23		5,219		5,242
Total	$	2,655	$	3,069	$	5,724	$	929,421	$	935,145

December 31, 2014 (In thousands)	30-89 Days Past Due		90 Days or More Past Due		Total		Current		Total Loans
Real Estate:
Real estate mortgage – construction and land development	$	-	$	272	$	272	$	96,773	$	97,045
Real estate mortgage – residential		1,395		1,595		2,990		358,032		361,022
Real estate mortgage – farmland and other commercial enterprises		75		3,484		3,559		371,718		375,277
Commercial:
Commercial and industrial		-		13		13		47,099		47,112
States and political subdivisions		-		-		-		22,369		22,369
Lease financing, net		-		-		-		158		158
Other		40		7		47		15,500		15,547
Consumer:
Secured		58		-		58		7,905		7,963
Unsecured		16		1		17		5,433		5,450
Total	$	1,584	$	5,372	$	6,956	$	924,987	$	931,943

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 and conditions. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes large-balance loans and non-homogeneous loans, such as commercial real estate and certain residential real estate loans. Loan rating grades, as described further below, are assigned based on a continuous process. The amount and adequacy of the allowance for loan loss is determined on a quarterly basis. The Company uses the following definitions for its risk ratings:

Special Mention. Loans classified as special mention have a potential weakness that deserves management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the borrower’s repayment ability, weaken the collateral or inadequately protect the Company’s credit position at some future date. These credits pose elevated risk, but their weaknesses do not yet justify a substandard classification.

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

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

Loans not meeting the criteria above which are analyzed individually as part of the above described process are considered to be pass rated loans, which are considered to have a low risk of loss. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows for the dates indicated. Each of the following tables excludes immaterial amounts attributed to accrued interest receivable.

	Real Estate						Commercial
September 30, 2015 (In thousands)	Real Estate Mortgage –Construction and Land Development		Real Estate Mortgage –Residential		Real Estate Mortgage –Farmland and Other Commercial Enterprises		Commercial and Industrial		States and Political Subdivisions		Lease Financing		Other
Credit risk profile by internally assigned rating grades:
Pass	$	92,979	$	323,928	$	327,195	$	49,697	$	18,428	$	25	$	22,196
Special Mention		4,018		15,791		24,191		999		-		-		-
Substandard		10,133		15,539		17,484		491		-		-		22
Doubtful		-		-		-		-		-		-		-
Total	$	107,130	$	355,258	$	368,870	$	51,187	$	18,428	$	25	$	22,218

	Real Estate						Commercial
December 31, 2014 (In thousands)	Real Estate Mortgage – Construction and Land Development		Real Estate Mortgage –Residential		Real Estate Mortgage –Farmland and Other Commercial Enterprises		Commercial and Industrial		States and Political Subdivisions		Lease Financing		Other
Credit risk profile by internally assigned rating grades:
Pass	$	81,438	$	326,124	$	327,019	$	45,665	$	22,369	$	158	$	15,526
Special Mention		2,674		16,429		27,855		946		-		-		14
Substandard		12,933		18,469		19,941		501		-		-		7
Doubtful		-		-		462		-		-		-		-
Total	$	97,045	$	361,022	$	375,277	$	47,112	$	22,369	$	158	$	15,547

The Company considers the performance of the loan portfolio and its impact on the allowance for loan losses. For consumer loan classes, the Company evaluates credit quality based on the aging status of the loan, which was previously presented, and by payment activity. The following table presents the consumer loans outstanding based on payment activity as of September 30, 2015 and December 31, 2014.

	September 30, 2015				December 31, 2014
	Consumer				Consumer
(In thousands)	Secured		Unsecured		Secured		Unsecured
Credit risk profile based on payment activity:
Performing	$	6,777	$	5,095	$	7,963	$	5,441
Nonperforming		10		147		-		9
Total	$	6,787	$	5,242	$	7,963	$	5,450

8. Other Real Estate Owned

Other real estate owned (“OREO”) was as follows as of the date indicated:

(In thousands)	September 30, 2015		December 31, 2014
Construction and land development	$	13,576	$	17,628
Residential real estate		1,084		2,219
Farmland and other commercial enterprises		8,208		12,113
Total	$	22,868	$	31,960

OREO activity for the nine months ended September 30, 2015 and 2014 was as follows:

Nine months ended September 30, (In thousands)	2015			2014
Beginning balance	$	31,960		$	37,826
Transfers from loans and other increases		1,274			8,152
Proceeds from sales		(9,642	)		(8,590	)
Loss on sales, net		(129	)		(546	)
Write downs and other decreases, net		(595	)		(2,076	)
Ending balance	$	22,868		$	34,766

At September 30, 2015, the Company had a total of $1.9 million of loans secured by residential real estate mortgages that were in the process of foreclosure.

9. Securities Sold under Agreements to Repurchase

Securities sold under agreements to repurchase represent transactions where the Company sells certain of its investment securities and agrees to repurchase them at a specific date in the future. Securities sold under agreements to repurchase are accounted for as secured borrowing and reflect the amount of cash received in connection with the transaction.

Securities sold under agreements to repurchase are collateralized by U.S. government agency securities, primarily mortgage-backed securities. The Company may be required to provide additional collateral securing the borrowings in the event of principal pay downs or a decrease in the market value of the pledged securities. The Company mitigates this risk by monitoring the market value and liquidity of the collateral and ensuring that it holds a sufficient level of eligible securities to cover potential increases in collateral requirements.

The following table represents the remaining maturity of repurchase agreements disaggregated by the class of securities pledged.

	Remaining Contractual Maturity of the Agreements
September 30, 2015 (In thousands)	Overnight/ Continuous		Less Than 30 Days		30-89 Days		90 Days to One Year		Over One Year to Four Years		Total
U.S. government agency securities	$	33,357	$	200	$	-	$	1,714	$	100,756	$	136,027
Total	$	33,357	$	200	$	-	$	1,714	$	100,756	$	136,027

10. Postretirement Medical Benefits

The Company provides lifetime medical and dental benefits upon retirement for certain employees meeting the eligibility requirements as of December 31, 1989 (“Plan 1”). Additional participants are not eligible to be included in Plan 1 unless they met the requirements on this date. During 2003, the Company implemented an additional postretirement health insurance program (“Plan 2”). Under Plan 2, any employee meeting the service requirement of 20 years of full time service to the Company and is at least age 55 upon retirement is eligible to continue their health insurance coverage. Under both plans, retirees not yet eligible for Medicare have coverage identical to the coverage offered to active employees. Under both plans, Medicare-eligible retirees are provided with a Medicare Advantage plan. The Company pays 100% of the cost of Plan 1. The Company and the retirees each pay 50% of the cost under Plan 2. Both plans are unfunded.

The following disclosures of the net periodic benefit cost components of Plan 1 and Plan 2 were measured at January 1, 2015 and 2014.

	Three Months Ended					Nine Months Ended
	September 30,					September 30,
(In thousands)	2015		2014			2015		2014
Service cost	$	185	$	121		$	554	$	362
Interest cost		162		142			487		427
Recognized prior service cost		13		51			38		155
Recognized net actuarial loss (gain)		10		(15	)		31		(47	)
Net periodic benefit cost	$	370	$	299		$	1,110	$	897

The Company expects benefit payments of $359 thousand for 2015, of which $72 thousand and $214 thousand have been made during the three and nine months ended September 30, 2015, respectively.

11. Regulatory Matters

The Company and its subsidiary banks are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements will initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the banks must meet specific capital guidelines that involve quantitative measures of the banks’ assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company and its subsidiary banks’ capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

In July 2013, U.S. banking regulators adopted final rules related to standards on bank capital adequacy and liquidity (commonly referred to “Basel III”). The new rules were effective for the Company beginning on January 1, 2015, subject to a phase-in period for certain provisions extending through January 1, 2019. The rules include a new common equity Tier 1 capital ratio, an increase to the minimum Tier 1 capital ratio, an increase to risk-weightings of certain assets, implementation of a new capital conservation buffer in excess of the required minimum (which is set to be phased in beginning in 2016), and changes to how regulatory capital is defined. The Company and each of its bank subsidiaries meet the minimum capital ratios and a fully phased-in capital conservation buffer under the new rules.

The regulatory ratios of the consolidated Company and its subsidiary banks were as follows for the dates indicated.

	September 30, 2015												December 31, 2014
	Common Equity Tier 1 Risk-based Capital¹			Tier 1 Risk-based Capital¹			Total Risk-based Capital¹			Tier 1 Leverage²				Common Equity Tier 1 Risk-based Capital¹		Tier 1 Risk-based Capital¹			Total Risk-based Capital¹			Tier 1 Leverage²
Consolidated		14.93	%		19.13	%		20.12	%		12.27	%			N/A		19.75	%		21.00	%		12.04	%
Farmers Bank		16.74			16.74			17.65			9.63				N/A		17.71			18.70			9.40
United Bank		19.04			19.04			20.20			12.82				N/A		18.00			19.26			11.08
First Citizens		14.47			14.47			15.09			9.85				N/A		13.66			14.30			9.44
Citizens Northern		14.26			14.26			15.51			10.31				N/A		14.46			15.71			10.11

¹Common Equity Tier 1 Risked-based, Tier 1 Risk-based, and Total Risk-based Capital ratios are computed by dividing a bank’s Common Equity Tier 1, Tier 1 or Total Capital, as defined by regulation, by a risk-weighted sum of the bank’s assets, with the risk weighting determined by general standards established by regulation. The safest assets (e.g., government obligations) are assigned a weighting of 0% with riskier assets receiving higher ratings (e.g., ordinary commercial loans are assigned a weighting of 100%).

²Tier 1 Leverage ratio is computed by dividing a bank’s Tier 1 Capital, as defined by regulation, by its total quarterly average assets.

N/A – Not applicable.

On June 8, 2015, the Company redeemed the final 10,000 shares of its remaining outstanding Series A preferred stock. The shares were redeemed at the stated liquidation value of $1,000 per share, plus accrued dividends of $58 thousand. The Company originally issued 30,000 shares of its Series A preferred stock in 2009. The redemption was the third and final partial redemption of the original shares issued. No additional debt or equity was issued in connection with any of the shares redeemed.

Summary of Regulatory Agreements

Citizens Northern.

The Federal Deposit Insurance Corporation (“FDIC”) and Kentucky Department of Financial Institutions (“KDFI”) entered into a Memorandum of Understanding (“Memorandum”) with Citizens Northern in September 2010. This Memorandum was terminated and replaced in July 2013. The updated Memorandum included provisions that required the bank to maintain a Tier 1 leverage ratio at or above 9.0% and to obtain regulatory approval before declaring or paying a dividend to the Parent Company. The Memorandum was terminated in August 2015 following a joint examination by the FDIC and KDFI, which found satisfactory compliance with the terms of the Memorandum and overall improvement in financial condition.

12. Fair Value Measurements

ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value, and sets forth disclosures about fair value measurements. ASC Topic 825, “Financial Instruments,” allows entities to choose to measure certain financial assets and liabilities at fair value. The Company has not elected the fair value option for any of its financial assets or liabilities.

ASC Topic 820 defines fair value as the price that would be received to sell 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 at the measurement date. It also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. This Topic describes three levels of inputs that may be used to measure fair value:

Level 1:

Quoted prices for identical assets or liabilities in active markets that the entity has the ability to access at the measurement date.

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; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3:

Significant unobservable inputs that reflect a reporting entity’s own assumptions supported by little or no market activity, about the assumptions that market participants would use in pricing the asset or liability.

Following is a description of the valuation method used for financial instruments measured at fair value on a recurring basis. For this disclosure, the Company only has available for sale investment securities and money market mutual funds classified as cash equivalents that meet the requirement. The carrying value of the $11.2 million in money market mutual funds is equivalent to its fair value and based on Level 1 inputs.

Available for sale investment securities

Valued primarily by independent third party pricing services under the market valuation approach that include, but are not limited to, the following inputs:

●

Mutual funds and equity securities are priced utilizing real-time data feeds from active market exchanges for identical securities and are considered Level 1 inputs.

●

Government-sponsored agency debt securities, obligations of states and political subdivisions, mortgage-backed securities, corporate bonds, and other similar investment securities are priced with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among others sources and are considered Level 2 inputs.

Available for sale investment securities are the Company’s only balance sheet item that meets the disclosure requirements for instruments measured at fair value on a recurring basis. Disclosures as of September 30, 2015 and December 31, 2014 are as follows:

			Fair Value Measurements Using
(In thousands) Available For Sale Investment Securities	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

September 30, 2015
Obligations of U.S. government-sponsored entities	$	126,684	$	-	$	126,684	$	-
Obligations of states and political subdivisions		145,910		-		145,910		-
Mortgage-backed securities – residential		313,260		-		313,260		-
Mortgage-backed securities – commercial		16,074		-		16,074		-
Corporate debt securities		6,030		-		6,030		-
Mutual funds and equity securities		552		552		-		-
Total	$	608,510	$	552	$	607,958	$	-

			Fair Value Measurements Using
(In thousands) Available For Sale Investment Securities	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

December 31, 2014
Obligations of U.S. government-sponsored entities	$	109,448	$	-	$	109,448	$	-
Obligations of states and political subdivisions		135,766		-		135,766		-
Mortgage-backed securities – residential		370,489		-		370,489		-
Mortgage-backed securities – commercial		2,512		-		2,512		-
Corporate debt securities		6,307		-		6,307		-
Mutual funds and equity securities		1,866		1,866		-		-
Total	$	626,388	$	1,866	$	624,522	$	-

The Company is required to measure and disclose certain other assets and liabilities at fair value on a nonrecurring basis in periods following their initial recognition. The Company’s disclosure about assets and liabilities measured at fair value on a nonrecurring basis consists of impaired loans and OREO. The carrying value of these assets are adjusted to fair value on a nonrecurring basis through impairment charges as described more fully below.

Impairment charges on collateral-dependent loans are recorded by either an increase to the provision for loan losses and related allowance or by direct loan charge-offs. The fair value of collateral-dependent impaired loans with specific allocations of the allowance for loan losses is measured based on recent appraisals of the underlying collateral. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Appraisers take absorption rates into consideration and adjustments are routinely made in the appraisal process to identify differences between the comparable sales and income data available. Such adjustments consist mainly of estimated costs to sell that are not included in certain appraisals or to update appraised collateral values as a result of market declines of similar properties for which a newer appraisal is available. These adjustments can be significant and typically result in a Level 3 classification of the inputs for determining fair value.

OREO includes properties acquired by the Company through, or in lieu of, actual loan foreclosures and is carried at fair value less estimated costs to sell. Fair value of OREO at acquisition is generally based on third party appraisals of the property that includes comparable sales data and is considered as Level 3 inputs. The carrying value of each OREO property is updated at least annually and more frequently when market conditions significantly impact the value of the property. If the carrying amount of the OREO exceeds fair value less estimated costs to sell, an impairment loss is recorded through noninterest expense.

The following tables represent the carrying amount of assets measured at fair value on a nonrecurring basis and still held by the Company as of the dates indicated. The amounts in the table only represent assets whose carrying amount has been adjusted by impairment charges during the period in a manner as described above; therefore, these amounts will differ from the total amounts outstanding. Collateral-dependent impaired loan amounts in the tables below exclude restructured loans since they are measured based on present value techniques, which are outside the scope of the fair value reporting framework.

			Fair Value Measurements Using
(In thousands) Description	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

September 30, 2015
Collateral-dependent Impaired Loans
Real estate mortgage – construction and land development	$	227					$	227
Real estate mortgage – residential		678	$	-	$	-		678
Total	$	905	$	-	$	-	$	905

OREO
Construction and land development	$	857	$	-	$	-	$	857
Residential real estate		475		-		-		475
Farmland and other commercial enterprises		1,614		-		-		1,614
Total	$	2,946	$	-	$	-	$	2,946

			Fair Value Measurements Using
(In thousands) Description	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
December 31, 2014
Collateral-dependent Impaired Loans
Real estate mortgage – construction and land development	$	284	$	-	$	-	$	284
Real estate mortgage – residential		946		-		-		946
Real estate mortgage – farmland and other commercial enterprises		340		-		-		340
Total	$	1,570	$	-	$	-	$	1,570

OREO
Construction and land development	$	8,123	$	-	$	-	$	8,123
Residential real estate		863		-		-		863
Farmland and other commercial enterprises		5,459		-		-		5,459
Total	$	14,445	$	-	$	-	$	14,445

The following table represents impairment charges recorded in earnings for the periods indicated on assets measured at fair value on a nonrecurring basis.

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(In thousands)	2015		2014		2015		2014
Impairment charges:
Collateral-dependent impaired loans	$	24	$	395	$	45	$	611
OREO		29		662		276		1,549
Total	$	53	$	1,057	$	321	$	2,160

The following table presents quantitative information about unobservable inputs for assets measured on a nonrecurring basis using Level 3 measurements. As described above, the fair value of real estate securing collateral-dependent impaired loans and OREO are based on current third party appraisals. It is often necessary, however, for the Company to discount the appraisal amounts supporting its impaired loans and OREO. These discounts relate primarily to marketing and other holding costs that are not included in certain appraisals or to update values as a result of market declines of similar properties for which newer appraisals are available. Discounts also result from contracts to sell properties entered into during the period. The range of discounts is presented in the table below for 2015. The upper end of the range identified in the table below related to OREO is the result of a small dollar property written down to the contract sales price. The weighted average column represents a better indicator of the discounts applied to the appraisals.

(In thousands)

Fair Value at
September 30,

2015

Valuation Technique

Unobservable Inputs

Range

Average

Collateral-dependent impaired loans

905

Discounted appraisals

Marketability discount

8.0

6.0

OREO

2,946

Discounted appraisals

Marketability discount

2.3%

26.9

6.1

Fair Value of Financial Instruments

The table that follows represents the estimated fair values of the Company’s financial instruments made in accordance with the requirements of ASC 825, “Financial Instruments.” ASC 825 requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet for which it is practicable to estimate that value. The estimated fair value amounts have been determined by the Company using available market information and present value or other valuation techniques. These derived fair values are subjective in nature, involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. ASC 825 excludes certain financial instruments and all nonfinancial instruments from the disclosure requirements. Accordingly, the aggregate fair value amounts presented are not intended to represent the underlying value of the Company.

The following methods and assumptions were used to estimate the fair value of each of the financial instruments in the table that follows.

Cash and Cash Equivalents, Accrued Interest Receivable, and Accrued Interest Payable

The carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization or settlement.

Investment Securities Held to Maturity

Fair value is based on quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities or with available market information through processes using benchmark yields, matrix pricing, prepayment speeds, cash flows, live trading data, and market spreads sourced from new issues, dealer quotes, and trade prices, among others sources.

Loans

The fair value of loans is estimated by discounting expected future cash flows using current discount rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Expected future cash flows are projected based on contractual cash flows adjusted for estimated prepayments.

Federal Home Loan Bank and Federal Reserve Bank Stock

It is not practical to determine the fair value of Federal Home Loan Bank and Federal Reserve Bank stock due to restrictions placed on its transferability.

Deposit Liabilities

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date and fair value approximates carrying value. The fair value of fixed maturity certificates of deposit is estimated by discounting the expected future cash flows using the rates currently offered for certificates of deposit with similar remaining maturities.

Federal Funds Purchased and Other Short-term Borrowings

The carrying amount is the estimated fair value for these borrowings which reprice frequently in the near term.

Securities Sold Under Agreements to Repurchase, Subordinated Notes Payable, and Other Long-term Borrowings

The fair value of these borrowings is estimated by discounting the expected future cash flows using rates currently available for debt with similar terms and remaining maturities. For subordinated notes payable, the Company uses its best estimate to determine an appropriate discount rate since active markets for similar debt transactions are very limited.

Commitments to Extend Credit and Standby Letters of Credit

Pricing of these financial instruments is based on the credit quality and relationship, fees, interest rates, probability of funding, compensating balance, and other covenants or requirements. Loan commitments generally have fixed expiration dates, variable interest rates and contain termination and other clauses that provide for relief from funding in the event there is a significant deterioration in the credit quality of the customer. Many loan commitments are expected to, and typically do, expire without being drawn upon. The rates and terms of the Company’s commitments to lend and standby letters of credit are competitive with others in the various markets in which the Company operates. There are no unamortized fees relating to these financial instruments, as such the carrying value and fair value are both zero.

The following table presents the estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2015 and December 31, 2014. Information for available for sale investment securities is presented within this footnote in greater detail above.

					Fair Value Measurements Using
(In thousands)	Carrying Amount		Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
September 30, 2015
Assets
Cash and cash equivalents	$	107,855	$	107,855	$	107,855	$	-	$	-
Held to maturity investment securities		3,689		3,893		-		3,893		-
Loans, net		923,868		922,241		-		-		922,241
Accrued interest receivable		5,246		5,246		-		5,246		-
Federal Home Loan Bank and Federal Reserve Bank Stock		9,368	N/A			-		-		-

Liabilities
Deposits		1,356,468		1,357,045		1,016,440		-		340,605
Federal funds purchased and other short-term borrowings		34,757		34,757		-		34,757		-
Securities sold under agreements to repurchase and other long-term borrowings		120,115		128,505		-		128,505		-
Subordinated notes payable to unconsolidated trusts		48,970		29,203		-		-		29,203
Accrued interest payable		859		859		-		859		-

December 31, 2014
Assets
Cash and cash equivalents	$	100,914	$	100,914	$	100,914	$	-	$	-
Held to maturity investment securities		3,728		3,923		-		3,923		-
Loans, net		917,975		918,697		-		-		918,697
Accrued interest receivable		5,625		5,625		-		5,625		-
Federal Home Loan Bank and Federal Reserve Bank Stock		9,368	N/A			-		-		-

Liabilities
Deposits		1,387,161		1,388,614		991,630		-		396,984
Federal funds purchased and other short-term borrowings		28,590		28,590		-		28,590		-
Securities sold under agreements to repurchase and other long-term borrowings		119,724		129,244		-		129,244		-
Subordinated notes payable to unconsolidated trusts		48,970		22,594		-		-		22,594
Accrued interest payable		944		944		-		944		-

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

FORWARD-LOOKING STATEMENTS

This report contains forward-looking statements with the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), under the Private Securities Litigation Reform Act of 1995 that involve risks and uncertainties. Statements in this report that are not statements of historical fact are forward-looking statements. In general, forward-looking statements relate to a discussion of future financial results or projections, future economic performance, future operational plans and objectives, and statements regarding the underlying assumptions of such statements. Although management of Farmers Capital Bank Corporation (the “Company” or “Parent Company”) believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore, there can be no assurance that the forward-looking statements included herein will prove to be accurate.

Various risks and uncertainties may cause actual results to differ materially from those indicated by the Company’s forward-looking statements. In addition to the risks described under Part 1, Item 1A “Risk Factors” in the Company’s most recent annual report on Form 10-K, factors that could cause actual results to differ from the results discussed in the forward-looking statements include, but are not limited to: economic conditions (both generally and more specifically in the markets in which the Company and its subsidiaries operate) and lower interest margins; competition for the Company’s customers from other providers of financial services; deposit outflows or reduced demand for financial services and loan products; government legislation, regulation, and changes in monetary and fiscal policies (which changes from time to time and over which the Company has no control); changes in interest rates; changes in prepayment speeds of loans or investment securities; inflation; material unforeseen changes in the liquidity, results of operations, or financial condition of the Company’s customers; changes in the level of non-performing assets and charge-offs; changes in the number of common shares outstanding; the capability of the Company to successfully enter into a definitive agreement for and close anticipated transactions; unexpected claims or litigation against the Company; expected insurance recoveries; technological or operational difficulties; the impact of new accounting pronouncements and changes in policies and practices that may be adopted by regulatory agencies; acts of war or terrorism; the ability of the parent company to receive dividends from its subsidiaries; the impact of larger or similar financial institutions encountering difficulties, which may adversely affect the banking industry or the Company; the Company or its subsidiary banks’ ability to maintain required capital levels and adequate funding sources and liquidity; and other risks or uncertainties detailed in the Company’s filings with the Securities and Exchange Commission, all of which are difficult to predict and many of which are beyond the control of the Company.

The Company’s forward-looking statements are based on information available at the time such statements are made. The Company expressly disclaims any intent or obligation to update any forward-looking statements to reflect changes in underlying assumptions or factors, new information, future events, or other changes.

RESULTS OF OPERATIONS

Third Quarter 2015 Compared to Third Quarter 2014

The Company reported net income of $3.8 million for the quarter ended September 30, 2015, a decrease of $275 thousand or 6.7% compared with net income of $4.1 million for the third quarter of 2014. On a per common share basis, net income was $.51 and $.49 for the current and year-ago quarters, respectively. This represents an increase of $.02 or 4.1%. Per common share net income was positively impacted $.06 by the Company’s redemption of its outstanding preferred shares, which decreased preferred stock dividends by $450 thousand in the quarterly comparison. The preferred share redemptions took place in three separate transactions of 10,000 shares each, beginning in the second quarter of 2014 and concluding in the second quarter of 2015.

Selected income statement amounts and related data are summarized in the table below.

(In thousands, except per share data)
Three Months Ended September 30,	2015			2014			Increase (Decrease)
Interest income	$	15,123		$	15,976		$	(853	)
Interest expense		2,158			2,513			(355	)
Net interest income		12,965			13,463			(498	)
Provision for loan losses		(898	)		(1,536	)		638
Net interest income after provision for loan losses		13,863			14,999			(1,136	)
Noninterest income		5,689			6,142			(453	)
Noninterest expenses		14,281			15,751			(1,470	)
Income before income taxes		5,271			5,390			(119	)
Income tax expense		1,439			1,283			156
Net income		3,832			4,107			(275	)
Less preferred stock dividends and discount accretion		-			450			(450	)
Net income available to common shareholders	$	3,832		$	3,657		$	175

Basic and diluted net income per common share	$	.51		$	.49		$	.02

Weighted average common shares outstanding – basic and diluted		7,495			7,485			10
Return on average assets		.86	%		.91	%	(5) bp
Return on average equity		8.95	%		9.17	%	(22) bp

bp – basis points.

The decrease in net income is primarily attributed to a lower credit to the provision for loan losses of $638 thousand or 41.5%, lower net interest income of $498 thousand or 3.7%, and lower noninterest income of $453 thousand or 7.4%. These were partially offset by a decrease to noninterest expense of $1.5 million or 9.3%. Further information related to the more significant components making up the increase in net income follows.

Net Interest Income

The overall interest rate environment at September 30, 2015, as measured by the Treasury yield curve, remained at very low levels when compared with historical trends. During the current quarter, yields for the three and six-month maturities were relatively unchanged, while the three-year maturity decreased 15 basis points. Yields on longer-term maturities declined 33 and 25 basis points for the ten and thirty-year maturity periods, respectively. At September 30, 2015, the short-term federal funds target interest rate remained between zero and 0.25%, unchanged since December 2008. The Federal Reserve Board (“Federal Reserve”) has indicated that it will be appropriate to raise the federal funds target interest rate when it sees further improvement in the labor market and is reasonably confident that inflation will return to its 2 percent objective over the medium term. At September 30, 2015, the national and Kentucky unemployment rate was 5.1% and 5.0%, respectively. However, labor force participation rates remain near 40-year lows. The national inflation rate at September 30, 2015 was minus 0.04% based on the Consumer Price Index published by the Bureau of Labor Statistics.

Net interest income was $13.0 million for the current quarter, a decrease of $498 thousand or 3.7% compared to $13.5 million for the prior year third quarter. The decrease in net interest income was driven by lower interest income of $853 thousand or 5.3%, partially offset by a decrease in interest expense of $355 thousand or 14.1%. Interest income on loans and investment securities decreased $522 thousand or 4.2% and $332 thousand or 9.5%, respectively. Interest expense on deposits decreased $305 thousand or 29.6% in the comparison.

The decrease to interest income on loans resulted from a decline in average balances outstanding and a lower average rate earned on loans. The decrease in loan volume has been accelerated by early payoffs of several larger balance credits that were refinanced by competitors with terms below the Company’s underwriting standards. In recent years, the Company has focused on strengthening its credit underwriting standards, which has improved the overall credit quality of the loan portfolio.

Interest income on investment securities decreased mainly due to lower rates, partially offset by an increase in volume. In periods when quality loan demand is low, available funds are invested in lower yielding investment securities or cash equivalents at then-current market rates, or otherwise used to manage liquidity, such as for deposit outflows or for the repayment of long-term debt. Average investment securities for the quarter increased $7.9 million or 1.3% from a year ago.

The decrease in interest expense on deposits was driven by rate declines and, to a lesser extent, lower average outstanding balances. The decrease in interest expense was primarily attributed to lower interest on time deposits.

Overall declines in interest income on loans and interest paid on deposits are the result of a slow growing economy and low interest rate environment, competitive pressures, and the Company’s strategy of being more selective in pricing its loans and deposits. The goal of this strategy is to improve credit quality, net interest income, overall profitability, and the capital position.

The Company is generally earning and paying less interest from its earning assets and funding sources as the average rates earned and paid have decreased. This includes repricing of variable and floating rate assets and liabilities that have reset to overall lower amounts since their previous repricing date as well as activity related to new earning assets and funding sources in a low interest rate environment. The Company continues to reprice its higher-rate maturing time deposits downward to lower market rates or allowing them to mature without renewal, as liquidity has been adequate.

The net interest margin on a taxable equivalent basis was 3.25% and 3.33% in the current and year-ago quarters, respectively. Net interest spread was 3.09% and 3.18% in the comparison. The Company expects its net interest margin to remain relatively flat or trend downward in the near term according to internal modeling using expectations about future market interest rates, the maturity structure of the Company’s earning assets and liabilities, and other factors. Future results could be significantly different than expectations.

The following tables present an analysis of net interest income for the quarterly periods ended September 30.

Distribution of Assets, Liabilities and Shareholders’ Equity: Interest Rates and Interest Differential

Three Months Ended September 30,	2015									2014
(In thousands)	Average Balance			Interest			Average Rate			Average Balance			Interest			Average Rate
Earning Assets
Investment securities
Taxable	$	499,835		$	2,508			1.99	%	$	500,365		$	2,857			2.27	%
Nontaxable¹		129,692			984			3.01			121,271			957			3.13
Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell		68,012			35			.20			64,018			34			.21
Loans^1,2,3		936,988			12,001			5.08			960,914			12,552			5.18
Total earning assets		1,634,527		$	15,528			3.77	%		1,646,568		$	16,400			3.94	%
Allowance for loan losses		(12,022	)								(16,878	)
Total earning assets, net of allowance for loan losses		1,622,505									1,629,690
Nonearning Assets
Cash and due from banks		23,515									24,503
Premises and equipment, net		33,934									35,650
Other assets		86,572									102,495
Total assets	$	1,766,526								$	1,792,338
Interest Bearing Liabilities
Deposits
Interest bearing demand	$	326,645		$	49			.06	%	$	315,380		$	45			.06	%
Savings		392,320			136			.14			362,702			149			.16
Time		345,403			540			.62			425,052			836			.78
Federal funds purchased and other short-term borrowings		31,330			13			.16			27,661			12			.17
Securities sold under agreements to repurchase and other long-term borrowings		167,827			1,420			3.36			172,971			1,471			3.37
Total interest bearing liabilities		1,263,525		$	2,158			.68	%		1,303,766		$	2,513			.76	%
Noninterest Bearing Liabilities
Demand deposits		303,878									285,522
Other liabilities		29,192									25,438
Total liabilities		1,596,595									1,614,726
Shareholders’ equity		169,931									177,612
Total liabilities and shareholders’ equity	$	1,766,526								$	1,792,338
Net interest income					13,370									13,887
TE basis adjustment					(405	)								(424	)
Net interest income				$	12,965								$	13,463
Net interest spread								3.09	%								3.18	%
Impact of noninterest bearing sources of funds								.16									.15
Net interest margin								3.25	%								3.33	%

¹Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

²Loan balances include principal balances on nonaccrual loans.

³Loan fees included in interest income amounted to $301 thousand and $312 thousand in 2015 and 2014, respectively.

Analysis of Changes in Net Interest Income (tax equivalent basis)

(In thousands)	Variance			Variance Attributed to
Three Months Ended September 30,	2015/2014¹			Volume			Rate

Interest Income
Taxable investment securities	$	(349	)	$	(3	)	$	(346	)
Nontaxable investment securities²		27			205			(178	)
Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell		1			7			(6	)
Loans²		(551	)		(310	)		(241	)
Total interest income		(872	)		(101	)		(771	)
Interest Expense
Interest bearing demand deposits		4			4			-
Savings deposits		(13	)		52			(65	)
Time deposits		(296	)		(141	)		(155	)
Federal funds purchased and other short-term borrowings		1			5			(4	)
Securities sold under agreements to repurchase and other long-term borrowings		(51	)		(46	)		(5	)
Total interest expense		(355	)		(126	)		(229	)
Net interest income	$	(517	)	$	25		$	(542	)
Percentage change		100.0	%		(4.8	)%		104.8	%

¹The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation.

²Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

Provision for Loan Losses

The provision for loan losses represents charges or credits to earnings that are necessary to maintain an allowance for loan losses at an adequate level to cover credit losses specifically identified in the loan portfolio, as well as management’s best estimate of incurred probable loan losses in the remainder of the portfolio at the balance sheet date. The credit quality of the Company’s loan portfolio continued to improve in the comparable periods, including certain credit quality metrics which are at or near recent quarterly bests.

The Company recorded a credit to the provision for loan losses in the amount of $898 thousand and $1.5 million in the current and year ago quarters, respectively. The allowance for loan losses as a percentage of outstanding loans was 1.21% at September 30, 2015 compared to 1.50% and 1.65% at year-end 2014 and September 30, 2014, respectively. The credit to the provision for loan losses is attributed to continuing improvement in the credit quality of the loan portfolio and a decline in outstanding loans. Net charge-offs were $24 thousand in the current quarter compared to net recoveries of $105 thousand a year earlier. Loan recoveries for the prior-year quarter include $671 thousand related to a group of fraudulent loans that were charged off during the first quarter of 2014.

Nonperforming loans, early stage delinquencies, and watch list loans have each declined when compared with a year earlier. Historical loss rates have also improved as lower recent charge-off activity has replaced the higher levels experienced in the early part of the Company’s rolling quarterly four year look-back period used when evaluating the allowance for loan losses. While historical loss rates are expected to continue improving throughout 2015 due to elevated charge-offs falling out of the look-back period, this expected improvement may not necessarily correlate to a lower provision for loan losses. Other qualitative factors, such as changes in loan volume, the overall makeup of the portfolio, economic conditions, and other risk factors applied to historical loss rates may offset to some degree the impact of decreases to the historical loss rates. For further information about improvements in the Company’s overall credit quality, please refer to the discussion under the captions “Allowance for Loan Losses” and “Nonperforming Loans” that follows.

Noninterest Income

The components of noninterest income are as follows for the periods indicated:

(Dollars in thousands) Three Months Ended September 30,	2015			2014		Increase (Decrease)			%
Service charges and fees on deposits	$	1,955		$	1,993	$	(38	)		(1.9	)%
Allotment processing fees		1,066			1,276		(210	)		(16.5	)
Other service charges, commissions, and fees		1,442			1,316		126			9.6
Trust income		667			812		(145	)		(17.9	)
Investment securities (losses) gains, net		(2	)		8		(10	)	N/M
Gain on sale of mortgage loans, net		220			123		97			78.9
Income from company-owned life insurance		234			511		(277	)		(54.2	)
Other		107			103		4			3.9
Total noninterest income	$	5,689		$	6,142	$	(453	)		(7.4	)%

N/M – Not meaningful.

The decrease in noninterest income is attributed mainly to lower income from company-owned life insurance, which was due to a tax-free death benefit that exceeded the cash surrender value by $276 thousand during the year-ago quarter.

The decrease in allotment processing fees is a result of lower processing volume stemming from the U.S. Department of Defense policy restrictions that went into effect on January 1, 2015. As previously disclosed by the Company, the new policy restricts active duty service members from entering into certain types of allotment arrangements. These restrictions have resulted in lower processing volumes for the Company. While the Company continues to diversify its allotment customer base and product offerings, the future impact on processing revenue remains uncertain and challenging to predict.

The decrease in trust income was driven by an unusually large nonrecurring estate fee of $250 thousand recorded during the prior-year third quarter, partially offset by a nonrecurring fee of $73 thousand in the current quarter. Service charges and fees on deposits decreased primarily due to lower overdraft fees of $68 thousand or 5.7% related to volume declines.

The increase in nondeposit service charges, commissions, and fees was driven by a nonrecurring fee of $63 thousand received during the current quarter related to credit card merchant activity and higher interchange fees of $35 thousand or 4.8% due to higher transaction volume. The higher net gains on sale of mortgage loans relates to higher sales volume of $1.7 million or 25.7%.

Noninterest Expense

The components of noninterest expense are as follows for the periods indicated:

(Dollars in thousands) Three Months Ended September 30,	2015		2014		Increase (Decrease)			%
Salaries and employee benefits	$	7,774	$	7,530	$	244			3.2	%
Occupancy expenses, net		1,177		1,229		(52	)		(4.2	)
Equipment expenses		691		637		54			8.5
Data processing and communication expense		1,114		979		135			13.8
Bank franchise tax		608		585		23			3.9
Amortization of intangibles		112		101		11			10.9
Deposit insurance expense		397		426		(29	)		(6.8	)
Other real estate expenses, net		262		1,974		(1,712	)		(86.7	)
Legal expenses		292		293		(1	)		(.3	)
Other		1,854		1,997		(143	)		(7.2	)
Total noninterest expense	$	14,281	$	15,751	$	(1,470	)		(9.3	)%

Total decrease in noninterest expense was driven by lower expenses related to repossessed real estate. Development, maintenance, and operating costs related to repossessed real estate decreased $765 thousand and impairment charges were down $633 thousand in the comparison. The prior-year quarter expenses include costs incurred to increase the marketability of two real estate construction properties and to better position them for sale. The two properties have subsequently been sold. Net losses from the sale of repossessed real estate decreased $314 thousand.

The most significant increases to noninterest expense in the comparison include salaries and employee benefits and data processing and communication expense. Salaries and related payroll taxes were up $161 thousand or 2.7%. Employee benefits increased $85 thousand or 5.8%, mainly due to an increase in the actuary-determined postretirement benefit expense. The Company had an average of 508 full time equivalent employees during the quarter, down from 514 a year earlier. The increase in data processing and communication expense was led by higher costs related to technology updates in the normal course of business.

Income Taxes

Income tax expense was $1.4 million for the current quarter, an increase of $156 thousand or 12.2% compared to $1.3 million for the same quarter of 2014. The effective income tax rates were 27.3% and 23.8% for the current and year-ago quarters, respectively. The prior-year third quarter included tax-free revenue related to a death benefit from company-owned life insurance which lowered the effective tax rate.

First Nine Months of 2015 Compared to First Nine Months of 2014

The Company reported net income of $11.4 million for the first nine months of 2015, a decrease of $893 thousand or 7.3% compared with net income of $12.3 million for 2014. On a per common share basis, net income for the current nine months was $1.47, an increase of $.03 or 2.1% compared to $1.44 reported a year earlier. Per common share net income was positively impacted $.15 by the Company’s redemption of its outstanding preferred shares, which decreased preferred dividends by $1.2 million and resulted in an increase in net income available to common shareholders. The preferred share redemptions took place in three separate transactions of 10,000 shares each, beginning in the second quarter of 2014 and concluding in June 2015.

Selected income statement amounts and related data are presented in the table below.

(In thousands, except per share data)
Nine Months Ended September 30,	2015			2014			Increase (Decrease)
Interest income	$	46,064		$	48,681		$	(2,617	)
Interest expense		6,523			7,812			(1,289	)
Net interest income		39,541			40,869			(1,328	)
Provision for loan losses		(2,707	)		(2,792	)		85
Net interest income after provision for loan losses		42,248			43,661			(1,413	)
Noninterest income		16,638			17,506			(868	)
Noninterest expenses		43,265			44,504			(1,239	)
Income before income taxes		15,621			16,663			(1,042	)
Income tax expense		4,213			4,362			(149	)
Net income		11,408			12,301			(893	)
Less preferred stock dividends and discount accretion		395			1,550			(1,155	)
Net income available to common shareholders	$	11,013		$	10,751		$	262

Basic and diluted net income per common share	$	1.47		$	1.44		$	.03

Weighted average common shares outstanding – basic and diluted		7,492			7,482			10
Return on average assets		.85	%		.91	%	(6) bp
Return on average equity		8.76	%		9.31	%	(55) bp

bp – basis points.

The $893 thousand decrease in net income is attributed primarily to lower net interest income of $1.3 million or 3.2%, and a decrease in noninterest income of $868 thousand or 5.0%. These amounts were partially offset by a decrease in noninterest expense of $1.2 million or 2.8%. Income tax expense was down $149 thousand or 3.4%. Further information related to the more significant components making up the decrease in net income follows.

Net Interest Income

Net interest income was $39.5 million for the first nine months of 2015, a decrease of $1.3 million or 3.2% compared to $40.9 million for the first nine months of 2014. The decrease in net interest income resulted from a decline in interest income of $2.6 million or 5.4%, partially offset by a decrease in interest expense of $1.3 million or 16.5%. Interest income on loans and investment securities decreased $1.8 million or 4.6% and $896 thousand or 8.3%, respectively. Interest expense on deposits decreased $1.1 million or 31.6%.

The decrease to interest income on loans resulted primarily from a decline in average balances outstanding, which offset a slight increase in the average rate in the comparison. The decrease in loan volume has been accelerated by early payoffs of several larger balance credits that were refinanced by competitors with terms below the Company’s underwriting standards. In recent years, the Company has focused on strengthening its credit underwriting standards, which has improved the overall credit quality of the loan portfolio. The average rate earned on loans for the current nine months was boosted $482 thousand from accretion related to a loan purchased at a discount during the first quarter of 2015. Accretion was recognized over the contractual life of the purchased loan, which ended in June 2015. There is no further accretion to be recognized.

Interest income on investment securities decreased mainly due to lower rates, partially offset by an increase in volume. In periods when quality loan demand is low, available funds are invested in lower yielding investment securities or cash equivalents at then-current market rates, or otherwise used to manage liquidity, such as for deposit outflows or for the repayment of long-term debt. Average investment securities increased $18.3 million or 2.9% from the year-ago comparable period.

The decrease in interest expense on deposits was driven primarily by rate declines and, to a lesser extent, lower average outstanding balances. The decrease in interest expense was primarily attributed to lower interest on time deposits.

The net interest margin on a taxable equivalent basis was 3.30% and 3.38% for the first nine months of 2015 and 2014, respectively. Net interest spread was 3.15% and 3.22% in the comparison. As discussed above, interest income for the current nine months includes discount accretion related to a loan purchased during the first quarter of 2015. There is no further accretion to be recognized on this loan; therefore, the Company expects its net interest margin to remain relatively flat or trend downward in the near term according to internal modeling using expectations about future market interest rates, the maturity structure of the Company’s earning assets and liabilities, and other factors. Future results could be significantly different than expectations.

The following tables present an analysis of net interest income for the nine months ended September 30.

Distribution of Assets, Liabilities and Shareholders’ Equity: Interest Rates and Interest Differential

Nine Months Ended September 30,	2015									2014
(In thousands)	Average Balance			Interest			Average Rate			Average Balance			Interest			Average Rate
Earning Assets
Investment securities
Taxable	$	512,721		$	7,944			2.07	%	$	504,022		$	8,917			2.37	%
Nontaxable¹		128,093			2,951			3.08			118,462			2,830			3.19
Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell		79,225			132			.22			60,309			100			.22
Loans^1,2,3		930,775			36,284			5.21			977,759			38,051			5.20
Total earning assets		1,650,814		$	47,311			3.83	%		1,660,552		$	49,898			4.01	%
Allowance for loan losses		(12,734	)								(18,303	)
Total earning assets, net of allowance for loan losses		1,638,080									1,642,249
Nonearning Assets
Cash and due from banks		23,405									23,524
Premises and equipment, net		34,341									35,944
Other assets		91,822									100,377
Total assets	$	1,787,648								$	1,802,094
Interest Bearing Liabilities
Deposits
Interest bearing demand	$	337,601		$	148			.06	%	$	320,383		$	142			.06	%
Savings		384,008			371			.13			356,183			460			.17
Time		364,714			1,764			.65			443,557			2,735			.82
Federal funds purchased and other short-term borrowings		29,371			33			.15			29,701			42			.19
Securities sold under agreements to repurchase and other long-term borrowings		167,867			4,207			3.35			175,023			4,433			3.39
Total interest bearing liabilities		1,283,561		$	6,523			.68	%		1,324,847		$	7,812			.79	%
Noninterest Bearing Liabilities
Demand deposits		302,380									275,897
Other liabilities		27,682									24,775
Total liabilities		1,613,623									1,625,519
Shareholders’ equity		174,025									176,575
Total liabilities and shareholders’ equity	$	1,787,648								$	1,802,094
Net interest income					40,788									42,086
TE basis adjustment					(1,247	)								(1,217	)
Net interest income				$	39,541								$	40,869
Net interest spread								3.15	%								3.22	%
Impact of noninterest bearing sources of funds								.15									.16
Net interest margin								3.30	%								3.38	%

¹Income and yield stated at a fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

²Loan balances include principal balances on nonaccrual loans.

³Loan fees included in interest income amounted to $941 thousand and $978 thousand in 2015 and 2014, respectively.

Analysis of Changes in Net Interest Income (tax equivalent basis)

(In thousands)	Variance			Variance Attributed to
Nine Months Ended September 30,	2015/2014¹			Volume			Rate

Interest Income
Taxable investment securities	$	(973	)	$	246		$	(1,219	)
Nontaxable investment securities²		121			268			(147	)
Interest bearing deposits in banks, federal funds sold and securities purchased under agreements to resell		32			32			-
Loans²		(1,767	)		(1,887	)		120
Total interest income		(2,587	)		(1,341	)		(1,246	)
Interest Expense
Interest bearing demand deposits		6			6			-
Savings deposits		(89	)		48			(137	)
Time deposits		(971	)		(448	)		(523	)
Federal funds purchased and other short-term borrowings		(9	)		(1	)		(8	)
Securities sold under agreements to repurchase and other long-term borrowings		(226	)		(175	)		(51	)
Total interest expense		(1,289	)		(570	)		(719	)
Net interest income	$	(1,298	)	$	(771	)	$	(527	)
Percentage change		100.0	%		59.4	%		40.6	%

¹The changes that are not solely due to rate or volume are allocated on a percentage basis using the absolute values of rate and volume variances as a basis for allocation.

²Income stated at fully tax equivalent basis using the marginal corporate Federal tax rate of 35%.

Provision for Loan Losses

The Company recorded a credit to the provision for loan losses in the amount of $2.7 million and $2.8 million for the first nine months of 2015 and 2014, respectively. The allowance for loan losses as a percentage of outstanding loans was 1.21% at September 30, 2015 compared to 1.50% and 1.65% at year-end 2014 and September 30, 2014, respectively. The credit to the provision for loan losses is attributed to continuing improvement in the credit quality of the loan portfolio and a decline in outstanding loans. The Company had net loan recoveries of $16 thousand in the current period compared to net charge-offs of $2.1 million a year earlier.

Nonperforming loans, early stage delinquencies, and watch list loans have each declined compared to a year earlier. Historical loss rates have also improved as lower recent charge-off activity has replaced the higher levels experienced in the early part of the Company’s rolling quarterly four year look-back period used when evaluating the allowance for loan losses. While historical loss rates are expected to continue improving throughout 2015 due to elevated charge-offs falling out of the look-back period, this expected improvement may not necessarily correlate to a lower provision for loan losses. Other qualitative factors, such as changes in loan volume, the overall makeup of the portfolio, economic conditions, and other risk factors applied to historical loss rates may offset to some degree the impact of decreases to the historical loss rates. For further information about improvements in the Company’s overall credit quality, please refer to the discussion under the captions “Allowance for Loan Losses” and “Nonperforming Loans” that follows.

Noninterest Income

The components of noninterest income are as follows for the periods indicated:

(Dollars in thousands) Nine Months Ended September 30,	2015		2014			Increase (Decrease)			%
Service charges and fees on deposits	$	5,634	$	5,900		$	(266	)		(4.5	)%
Allotment processing fees		3,358		3,795			(437	)		(11.5	)
Other service charges, commissions, and fees		4,056		3,950			106			2.7
Trust income		1,821		1,880			(59	)		(3.1	)
Investment securities gains (losses), net		163		(67	)		230		N/M
Gain on sale of mortgage loans, net		558		343			215			62.7
Income from company-owned life insurance		702		990			(288	)		(29.1	)
Other		346		715			(369	)		(51.6	)
Total noninterest income	$	16,638	$	17,506		$	(868	)		(5.0	)%

N/M – Not meaningful.

The decrease in noninterest income was driven mainly by lower allotment processing fees, lower income related to the Company’s equity interest in its tax credit partnerships, lower income from company-owned life insurance, and lower service charges and fees on deposits.

The decrease in allotment processing fees is a result of lower processing volume related to the U.S. Department of Defense policy restrictions that went into effect on January 1, 2015. As previously disclosed by the Company, the new policy restricts active duty service members from entering into certain types of allotment arrangements. These restrictions have resulted in lower processing volumes. While the Company continues to diversify its allotment customer base and product offerings, the future impact on processing revenue remains uncertain and challenging to predict.

The Company recorded income of $358 thousand related to its tax credit partnerships in the year-ago period compared with none for the current period. The Company liquidated its interest in one of the partnerships in December 2014 and the carrying value of the remaining two is zero. Income from company-owned life insurance decreased due to a tax-free death benefit that exceeded the cash surrender value by $276 thousand in the third quarter of 2014. Service charges and fees on deposits decreased primarily due to lower overdraft fees of $340 thousand or 9.8% as a result of volume declines.

The net loss on investment securities in the prior year includes $95 thousand attributed to a municipal bond where the issuer participated in the Build America Bond (“BAB”) program. BAB is a federal government program whereby the U.S. Treasury pays a direct subsidy to the issuer to support interest costs of qualified bonds. Federal budget sequestration reduced the subsidy to the issuer, triggering an extraordinary redemption feature related to these bonds. The issuer exercised their extraordinary redemption privilege. Since the carrying value of the bond exceeded the par value due to unamortized premium, the Company recorded a loss on this investment.

The Company recorded a net gain on the sale of mortgage loans of $558 thousand, up $215 thousand or 62.7%. The volume of mortgage loans sold decreased $1.1 million in the comparison; however, the net gain for the prior year includes a nonrecurring loss of $92 thousand, made up of a $46 thousand loss related to a group of loans reclassified from held for sale to held for investment and a group of loans sold for a loss of $46 thousand. The increase in nondeposit service charges, commissions, and fees was driven by higher interchange fees of $133 thousand or 6.1% due to higher transaction volume.

Noninterest Expense

The components of noninterest expense are as follows for the periods indicated:

(Dollars in thousands) Nine Months Ended September 30,	2015		2014		Increase (Decrease)			%
Salaries and employee benefits	$	23,946	$	22,223	$	1,723			7.8	%
Occupancy expenses, net		3,623		3,720		(97	)		(2.6	)
Equipment expenses		1,918		1,824		94			5.2
Data processing and communication expense		3,243		2,953		290			9.8
Bank franchise tax		1,820		1,807		13			.7
Amortization of intangibles		337		303		34			11.2
Deposit insurance expense		1,201		1,327		(126	)		(9.5	)
Other real estate expenses, net		1,033		3,976		(2,943	)		(74.0	)
Legal expenses		693		715		(22	)		(3.1	)
Other		5,451		5,656		(205	)		(3.6	)
Total noninterest expense	$	43,265	$	44,504	$	(1,239	)		(2.8	)%

The most significant components impacting noninterest expense include a decrease related to repossessed real estate and a decrease in deposit insurance expense, partially offset by an increase in salaries and employee benefits and an increase in data processing and communication expense.

The decrease in expenses related to repossessed real estate properties was driven by lower impairment charges of $1.5 million or 71.3% and lower development, maintenance, and operating costs of $1.0 million. The prior year expenses include costs incurred to increase the marketability of two real estate construction properties and to better position them for sale. The two properties were subsequently sold. The current year period includes a net loss on the sale of properties of $129 thousand, a decrease of $417 thousand or 76.4% compared with a loss of $546 thousand in the prior period. The reduction in deposit insurance expense is due to the improvement in the risk ratings at the Company’s subsidiary banks, which is used in the determination of the amount payable.

Salaries and employee benefits were up $1.7 million or 7.8% in the comparison. Salaries and related payroll taxes increased $885 thousand or 4.9%. Employee benefits increased $842 thousand or 21.0%, mainly due to claims activity related to the Company’s self-funded health insurance plan and an increase in the actuary-determined postretirement benefit expense. The Company had an average of 510 full time equivalent employees for the nine-month period, down from 512 a year earlier. Data processing and communication expense increased mainly due to higher costs related to technology updates in the normal course of business.

Income Taxes

Income tax expense was $4.2 million for the current nine months, a decrease of $149 thousand or 3.4% compared to $4.4 million for the prior year. The effective income tax rates were 27.0% and 26.2% for the current and year-ago periods, respectively. The prior-year third quarter included tax-free revenue related to a death benefit from company-owned life insurance which lowered the effective tax rate.

FINANCIAL CONDITION

Total assets were $1.8 billion at September 30, 2015, a decrease of $17.9 million or 1.0% from year-end 2014. Cash and cash equivalents increased $6.9 million or 6.9%. Other real estate owned (“OREO”) and investment securities decreased $9.1 million or 28.4% and $17.9 million or 2.8%, respectively. Loans edged up $3.2 million or 0.3%.

The increase in cash and cash equivalents from year-end is a result of the Company’s overall net funding position, which includes a decline in investment securities of $17.9 million or 2.8% and an increase in short-term borrowings of $6.2 million or 21.6%. The Company also received several larger-balance temporary deposits at quarter-end that totaled $7.8 million. While loans outstanding increased in the comparison, generating high quality loan demand remains a challenge. OREO continued to trend downward primarily due to property sales, which outpaced new additions.

Total liabilities were $1.6 billion at September 30, 2015, a decrease of $18.5 million or 1.1% compared to year-end 2014. The decrease in total liabilities is mainly attributed to the reduction in total deposits. Interest bearing deposits are down $40.0 million or 3.7%, partially offset by an increase in noninterest bearing deposits of $9.3 million or 3.2%. The decrease in interest bearing deposits was driven by lower time deposits of $55.5 million or 14.0%.

Selected balance sheet amounts and related data are presented in the table below and discussion that follows.

(Dollars in thousands, except per share amounts)	September 30, 2015		December 31, 2014		Increase (Decrease)			%
Cash and cash equivalents	$	107,855	$	100,914	$	6,941			6.9	%
Investment securities		612,199		630,116		(17,917	)		(2.8	)
Loans, net of allowance of $11,277 and $13,968		923,868		917,975		5,893			.6
Other real estate owned		22,868		31,960		(9,092	)		(28.4	)
Other assets		97,965		101,641		(3,676	)		(3.6	)
Total assets	$	1,764,755	$	1,782,606	$	(17,851	)		(1.0	)%

Deposits	$	1,356,468	$	1,387,161	$	(30,693	)		(2.2	)%
Federal funds purchased and other short-term borrowings		34,757		28,590		6,167			21.6
Other borrowings		169,085		168,694		391			.2
Other liabilities		30,867		25,232		5,635			22.3
Total liabilities		1,591,177		1,609,677		(18,500	)		(1.1	)

Preferred stock		-		10,000		(10,000	)		(100.0	)
Common stock		937		936		1			.1
Capital surplus		51,524		51,344		180			.4
Retained earnings		116,787		105,774		11,013			10.4
Accumulated other comprehensive income		4,330		4,875		(545	)		(11.2	)
Total shareholders’ equity		173,578		172,929		649			.4
Total liabilities and shareholders’ equity	$	1,764,755	$	1,782,606	$	(17,851	)		(1.0	)%

End of period tangible book value per common share¹	$	23.14	$	21.69	$	1.45			6.7	%
End of period per common share closing price		24.85		23.29		1.56			6.7

¹Represents total common equity less intangible assets divided by the number of common shares outstanding at the end of the period.

Temporary Investments

Temporary investments consist of interest bearing deposits in other banks, federal funds sold and securities purchased under agreements to resell, and money market mutual funds. The Company uses these funds in the management of liquidity and interest rate sensitivity or as a short-term holding prior to subsequent movement into other investments with higher yields or for other purposes. At September 30, 2015, temporary investments were $87.1 million, an increase of $13.0 million or 17.5% from year-end 2014.

Investment Securities

The investment securities portfolio is comprised primarily of residential mortgage-backed securities, tax-exempt securities of states and political subdivisions, and debt securities issued by U.S. government-sponsored agencies. Substantially all of the Company’s investment securities are designated as available for sale. Principal payment received on mortgage-backed securities and proceeds from maturing or called investment securities not needed to fund higher-earning loans are either reinvested in similar investments or used to manage liquidity, such as for deposit outflows or other payment obligations. Total investment securities had a carrying amount of $612 million at September 30, 2015, a decrease of $17.9 million or 2.8% compared to $630 million at year-end 2014.

The decrease in investment securities was driven by net maturities, calls, and sales of $108 million in the aggregate, which outpaced purchases totaling $92.6 million. Net premium amortization of $3.3 million also made up part of the decrease, partially offset by an increase in the market value adjustment related to the available for sale portfolio of $1.0 million. The increase in the market value adjustment of the available for sale securities portfolio is attributed to higher bond prices related to longer term maturity periods. Yields for the five, ten and 30-year Treasury securities decreased 32 basis points, 15 basis points, and 10 basis points, respectively, since year-end 2014. Generally, as market interest rates decrease, the value of fixed rate investments increase.

Investment securities include single-issuer trust preferred capital securities of a U.S. based global financial services firm. The carrying value of this investment at September 30, 2015 was $5.0 million, which includes an unrealized loss of $854 thousand. At year-end 2014, these securities had an unrealized loss of $354 thousand.

The Company’s investment in the single-issuer trust preferred capital securities continue to perform according to contractual terms and continue to be rated as investment grade by major rating agencies. The issuer of the securities announced in the first quarter of 2015 an increase in per share common dividend payments and authorization of a common equity repurchase plan. The Company does not intend to sell these securities nor does the Company believe it is likely that it will be required to sell these securities prior to their anticipated recovery. The Company believes these securities are not impaired due to reasons of credit quality or other factors, but rather the unrealized loss is primarily attributed to continuing global economic issues and market volatility. The Company believes that it will collect all amounts due according to the contractual terms of these securities and that the fair values of these securities will recover as they approach their maturity dates.

Loans

Loans were $935 million at September 30, 2015, an increase of $3.2 million or 0.3% compared to year-end 2014. The Company has had two consecutive quarterly increases in loans, which totaled $7.8 million in the aggregate. High quality loan demand remains soft, and the Company continues a measured and cautious approach to loan originations while working to further reduce its level of nonperforming assets in a slow growth economy. Generating high quality loan demand continues to be a challenge, and the increase in loans occurred despite early payoffs of several larger balance credits. These early payoffs were primarily the result of several larger credits that were refinanced by competitors with terms below the Company’s underwriting standards. Loan payments include $3.8 million related to nonaccrual loans during 2015.

The composition of the loan portfolio is summarized in the table below.

	September 30, 2015					December 31, 2014
(Dollars in thousands)	Amount		%			Amount		%

Real estate mortgage – construction and land development	$	107,130		11.5	%	$	97,045		10.4	%
Real estate mortgage – residential		355,258		38.0			361,022		38.7
Real estate mortgage – farmland and other commercial enterprises		368,870		39.4			375,277		40.3
Commercial, financial, and agriculture		91,833		9.8			85,028		9.1
Installment		12,029		1.3			13,413		1.5
Lease financing		25		-			158		-
Total	$	935,145		100.0	%	$	931,943		100.0	%

On an average basis, loans represented 56.4% of earning assets for the current nine month period, a decrease of 192 basis points compared to 58.3% for the year 2014. The decrease in the level of loans as a percentage of earning assets reflects the overall lack of high quality loan demand for which the Company desires. As loan demand changes, available funds are reallocated between temporary investments or investment securities, which typically involve a decrease in credit risk and result in lower yields.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level believed to be adequate by management to cover probable losses in the loan portfolio. The calculation of the appropriate level of allowance for loan losses requires significant judgment in order to reflect credit losses specifically identified in the Company’s loan portfolio as well as management's best estimate of probable incurred credit losses in the loan portfolio 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 allowance for loan losses and the related provision for loan losses generally fluctuate as the relative level of nonperforming and impaired loans vary. However, other factors impact the amount of the allowance for loan losses such as the Company’s historical loss experience, the borrowers’ financial condition, general economic conditions, and other qualitative risk factors as described in greater detail in the Company’s most recent annual report on Form 10-K.

The allowance for loan losses was $11.3 million or 1.21% of outstanding loans at September 30, 2015. This compares to $14.0 million or 1.50% of net loans outstanding at year-end 2014. The decrease in the allowance as a percentage of net loans outstanding from the prior year-end is resulted primarily from a credit to the provision for loan losses of $2.7 million for the current nine-month period. As a percentage of nonperforming loans, the allowance for loan losses was 34.9% at September 30, 2015 compared to 38.9% at year-end 2014. The relatively low amount of the allowance for loan losses as a percentage of nonperforming loans is due mainly to the makeup of nonperforming loans.

Nonperforming loans include $24.2 million of accruing restructured loans, which represents 75% of total nonperforming loans at September 30, 2015. At year-end 2014, this amount was $24.4 million or 68%. The increase in restructured loans as a percentage of nonperforming loans was driven by the overall decrease in total nonperforming loans. The allowance attributed to credits that are restructured with lower interest rates generally represents the difference in the present value of future cash flows calculated at the loan’s original effective interest rate and the new lower rate. This typically results in a reserve for loan losses that is less severe than for other loans that are collateral dependent. The allowance specifically allocated to impaired loans, which includes restructured loans, was $2.8 million or 7.2% and $3.4 million or 7.7% of such loans at September 30, 2015 and year-end, respectively. As a percentage of nonaccrual loans and loans past due 90 days or more and still accruing, the allowance for loan losses was 138% and 121% at the current quarter-end and year-end 2014, respectively.

The overall improvement in the credit quality of the loan portfolio experienced during 2014 continued during the first nine months of 2015. Certain credit quality measures are summarized in the table that follows for the periods indicated. Several of these measures are at the best level in the last three years.

(In thousands)	September 30, 2015		December 31, 2014		September 30, 2014		Three-year High¹		Three-year Low¹
Nonperforming loans	$	32,356	$	35,937	$	40,819	$	54,605	$	32,356
Nonaccrual loans		8,201		11,508		15,530		27,994		8,201
Loans past due 30-89 days and still accruing		1,918		1,352		3,016		7,831		1,312
Loans graded substandard or below		43,669		52,313		66,185		90,855		43,669
Impaired loans		38,647		43,955		48,881		63,889		38,647
Loans, net of unearned income		935,145		931,943		953,832		1,017,977		927,389

¹Based on quarter-end balances over the previous three years.

Nonperforming Loans

Nonperforming loans consist of nonaccrual loans, accruing restructured loans, and loans 90 days or more past due and still accruing interest. The 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 90 days or more, unless such loan is well secured and in the process of collection. Restructured loans occur when a lender, because of economic or legal reasons related to a borrower’s financial difficulty, grants a concession to the borrower that it would not otherwise consider. Restructured loans typically include a reduction of the stated interest rate or an extension of the maturity date, among other possible concessions. The Company gives careful consideration to identifying which of its challenged credits merit a restructuring of terms that it believes will result in maximum loan repayments and mitigate possible losses. Cash flow projections are carefully scrutinized prior to restructuring any credits; past due credits are typically not granted concessions.

Nonperforming loans were $32.4 million at September 30, 2015, a decrease of $3.6 million or 10.0% compared to $35.9 million at year-end 2014. Nonaccrual loans and accruing restructured loans decreased $3.3 million or 28.7% and $274 thousand or 1.1%, respectively. Accruing restructured loans make up $24.2 million or 75% of the Company’s nonperforming loans at September 30, 2015 compared with $8.2 million or 25% related to nonaccrual loans. Nonaccrual loans have decreased to the lowest level since the second quarter of 2007.

Nonperforming loans, presented by class, were as follows for the periods indicated.

Nonperforming Loans

(In thousands)	September 30, 2015			December 31, 2014
Nonaccrual Loans
Real Estate:
Real estate mortgage – construction and land development	$	1,861		$	3,744
Real estate mortgage – residential		2,527			3,474
Real estate mortgage – farmland and other commercial enterprises		3,739			4,202
Commercial:
Commercial and industrial		55			81
Other		9			7
Consumer:
Secured		10			-
Total nonaccrual loans	$	8,201		$	11,508

Restructured Loans
Real Estate:
Real estate mortgage – construction and land development	$	3,679		$	3,742
Real estate mortgage – residential		4,350			4,674
Real estate mortgage – farmland and other commercial enterprises		15,594			16,004
Commercial:
Commercial and industrial		385			-
Consumer:
Unsecured		147			9
Total restructured loans	$	24,155		$	24,429

Total nonperforming loans	$	32,356		$	35,937

Ratio of total nonperforming loans to total loans (net of unearned income)		3.5	%		3.9	%

The most significant components of nonperforming loans include nonaccrual and accruing restructured loans. Activity during 2015 related to these two components was as follows:

(In thousands)	Nonaccrual Loans			Restructured Loans
Balance at December 31, 2014	$	11,508		$	24,429
Additions		2,515			3,270
Principal paydowns		(3,824	)		(3,544	)
Transfers to performing status		(456	)		-
Transfers to other real estate owned/other foreclosed assets		(1,191	)		-
Charge-offs		(351	)		-
Balance at September 30, 2015	$	8,201		$	24,155

The Company’s comprehensive risk-grading and loan review program includes a review of loans to assess risk and assign a grade to those loans, a review of delinquencies, and an assessment of loans for needed charge-offs or placement on nonaccrual status. The Company had loans in the amount of $56.9 million and $64.7 million at September 30, 2015 and year-end 2014, respectively, which were performing but considered potential problem loans and are not included in the nonperforming loan totals in the table above. These loans, however, are considered in establishing an appropriate allowance for loan losses. The balance outstanding for potential problem credits is mainly attributed to lingering weaknesses in the overall economy which continue to strain many of the Company’s customers. Potential problem loans include a variety of borrowers and are secured primarily by various types of real estate including commercial, construction properties, and residential real estate developments. At September 30, 2015, the five largest potential problem credits were $12.3 million in the aggregate compared to $13.9 million at year-end 2014.

Potential problem loans are identified on the Company’s watch list and consist of loans that require close monitoring by management. Credits may be considered as a potential problem loan for reasons that are temporary or correctable, such as for a deficiency in loan documentation or absence of current financial statements of the borrower. Potential problem loans may also include credits where adverse circumstances are identified that may affect the borrower’s ability to comply with the contractual terms of the loan. Other factors which might indicate the existence of a potential problem loan include the delinquency of a scheduled loan payment, deterioration in a borrower’s financial condition identified in a review of periodic financial statements, a decrease in the value of the collateral securing the loan, or a change in the economic environment in which the borrower operates. Certain loans on the Company’s watch list are also considered impaired and specific allowances related to these loans are established in accordance with the appropriate accounting guidance.

Other Real Estate

OREO includes real estate properties acquired by the Company through, or in lieu of, actual foreclosure. At September 30, 2015, OREO was $22.9 million, a decrease of $9.1 million or 28.4% compared to $32.0 million at year-end 2014. The decrease was driven by sales activity, including three larger-balance residential real estate development properties that sold for $3.5 million, and three larger-balance commercial real estate properties sold for $3.1 million. OREO has declined $29.7 million or 56.5% from its peak of $52.6 million, which occurred at year-end 2012. A summary of OREO activity for 2015 follows.

(In thousands)	Amount
Balance at December 31, 2014	$	31,960
Transfers from loans		1,274
Proceeds from sales		(9,642	)
Net gain on sales		(129	)
Write-downs and other decreases, net		(595	)
Balance at September 30, 2015	$	22,868

Deposits

A summary of the Company’s deposits are as follows for the periods indicated.

	End of Period										Average
(In thousands)	September 30, 2015		December 31, 2014		Increase (Decrease)			%			Nine Months September 30, 2015		Twelve Months December 31, 2014		Increase (Decrease)			%
Noninterest Bearing	$	302,114	$	292,788	$	9,326			3.2	%	$	302,380	$	281,025	$	21,355			7.6	%

Interest Bearing
Demand		322,240		335,657		(13,417	)		(4.0	)		337,601		320,947		16,654			5.2
Savings		392,086		363,185		28,901			8.0			384,008		357,156		26,852			7.5
Time		340,028		395,531		(55,503	)		(14.0	)		364,714		433,756		(69,042	)		(15.9	)
Total interest bearing		1,054,354		1,094,373		(40,019	)		(3.7	)		1,086,323		1,111,859		(25,536	)		(2.3	)

Total Deposits	$	1,356,468	$	1,387,161	$	(30,693	)		(2.2	)%	$	1,388,703	$	1,392,884	$	(4,181	)		(0.3	)%

The decrease in total end of period deposits was driven by lower time deposits and is primarily attributed to the Company’s overall high liquidity position and strategy to lower overall funding costs, mainly by allowing higher-rate certificates of deposit to roll off or to reprice at lower interest rates. Many of those balances have been rolled into either demand or savings accounts by the customer. As rates have decreased throughout the deposit portfolio, many customers have opted to transfer funds from maturing time deposits or investments from other sources into short-term demand or savings accounts. The Company has not sought out or accepted brokered deposits in the past nor does it have plans to do so in the future.

Borrowed Funds

Total borrowed funds were $204 million at September 30, 2015, an increase of $6.6 million or 3.3% from year-end 2014. Short-term borrowings were $34.8 million at quarter-end. This represents an increase of $6.2 million or 21.6%, which is attributed to an increase in repurchase agreements with commercial depositors in the normal course of business. Short-term borrowings primarily represent funds that have been swept out of the deposit accounts of certain qualifying commercial customers into repurchase agreements and accounted for as secured borrowings by the Company. Long-term borrowings were relatively unchanged at $169 million.

LIQUIDITY

The primary source of funds for the Parent Company is the receipt of dividends from its subsidiary banks, balances of cash and cash equivalents maintained, and borrowings from nonaffiliated sources. Primary uses of cash include the payment of dividends to its preferred and common shareholders, injecting capital into subsidiaries, paying interest expense on borrowings, and payments for general operating expenses.

Payment of dividends to the Parent Company by its subsidiary banks is subject to certain regulatory restrictions as set forth in national and state banking laws and regulations. A depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. The federal banking agencies may prevent the payment of a dividend if they determine that the payment would be an unsafe and unsound banking practice. Moreover, the federal agencies have issued policy statements that provide bank holding companies and insured banks should generally only pay dividends out of current operating earnings. Capital ratios at each of the Company’s four subsidiary banks exceed regulatory established “well-capitalized” status at September 30, 2015 under the prompt corrective action regulatory framework.

The Parent Company had cash and cash equivalents of $29.8 million and $32.1 million at September 30, 2015 and year-end 2014, respectively. Significant cash receipts by the Parent Company for 2015 include dividend payments from its bank subsidiaries of $7.4 million, return of capital amounts from nonbank subsidiaries of $1.4 million, and management fees from subsidiaries of $1.9 million. Significant cash payments by the Parent Company in 2015 include $10.0 million to redeem the final portion of its outstanding preferred stock, $2.2 million for salaries, payroll taxes, and employee benefits, $641 thousand for the payment of interest expense on subordinated notes payable, and $508 thousand for the payment of dividends on preferred stock.

The Company's objective as it relates to liquidity is to ensure that its subsidiary banks have funds available to meet deposit withdrawals and credit demands without unduly penalizing profitability. In order to maintain a proper level of liquidity, the subsidiary banks have several sources of funds available on a daily basis. For assets, those sources of funds include liquid assets that are readily marketable or that can be pledged, or which mature in the near future. These assets primarily include cash and due from banks, federal funds sold, investment securities, and cash flow generated by the repayment of principal and interest on loans and investment securities. For liabilities, sources of funds primarily include the subsidiary banks' core deposits, Federal Home Loan Bank (“FHLB”) and other borrowings, and federal funds purchased and securities sold under agreements to repurchase. While maturities and scheduled amortization of loans and investment securities are generally a predictable source of funds, deposit outflows and mortgage prepayments are influenced significantly by general interest rates, economic conditions, and competition in our local markets.

As of September 30, 2015, the Company had $228 million of additional borrowing capacity under various FHLB, federal funds, and other borrowing agreements. However, there is no guarantee that these sources of funds will continue to be available to the Company, or that current borrowings can be refinanced upon maturity, although the Company is not aware of any events or uncertainties that are likely to cause a decrease in the Company’s liquidity from these sources. The Company’s borrowing capacity was $224 million at year-end 2014.

For the longer term, the liquidity position is managed by balancing the maturity structure of the balance sheet. This process allows for an orderly flow of funds over an extended period of time. The Company’s Asset and Liability Management Committees, at both the Parent Company and bank subsidiary level, meet regularly to monitor the composition of the balance sheet to ensure comprehensive management of interest rate risk and liquidity.

Liquid assets consist of cash and cash equivalents and available for sale investment securities. At September 30, 2015, consolidated liquid assets were $716 million, a decrease of $10.9 million or 1.5% compared to $727 million at year-end 2014. Although liquid assets decreased in the comparison, the Company’s liquidity position remains elevated mainly as a result of the Company’s overall net funding position and weak, high-quality loan demand. The overall funding position of the Company changes as loan demand, deposit levels, and other sources and uses of funds fluctuate.

Net cash provided by operating activities was $21.9 million and $24.2 million for the first nine months of 2015 and 2014, respectively. This represents a decrease of $2.4 million or 9.7%, led by a decrease of $3.4 million related to net mortgage loans originated for sale activity. Net cash flow provided by investing activities was $19.6 million and $39.3 million for 2015 and 2014, respectively. The $19.7 million decrease was primarily driven by loan activity. The Company had net cash outflow representing overall principal advances in the current period of $3.8 million compared with net principal collections a year earlier in the amount of $34.6 million. Proceeds from the sale of OREO increased $2.4 million in the comparison. Net cash inflows related to investment securities were $15.8 million for 2015, compared to net cash outflows of $630 thousand a year earlier.

Net cash used in financing activities was $34.6 million for the first nine months of 2015, a decrease of $26.3 million compared with $60.9 million a year earlier. The decrease was driven primarily by deposit activity. Deposits decreased $30.7 million and $45.1 million for 2015 and 2014, respectively. For 2015, the Company had net proceeds from long-term borrowings of $391 thousand compared to net repayments of $8.1 million for 2014.

Commitments to extend credit are entered into with customers in the ordinary course of providing traditional banking services and are considered in addressing the Company’s liquidity management. The Company does not expect these commitments to significantly affect the liquidity position in future periods. The Company has not entered into any contracts for financial derivative instruments such as futures, swaps, options, or similar instruments.

CAPITAL RESOURCES

Shareholders’ equity was $174 million at September 30, 2015, an increase of $649 thousand or 0.4% compared to $173 million at year-end 2014. Net income increased shareholders’ equity $11.4 million, which was partially offset by the redemption of the remaining portion of the Company’s preferred stock in the amount of $10.0 million during the second quarter and other comprehensive loss of $545 thousand. The other comprehensive loss was made up of a $1.2 million decrease in the after-tax amount related to the Company’s liability for postretirement medical benefits plan, partially offset by a $661 thousand increase in the after-tax unrealized gain related to the available for sale investment securities portfolio. The decrease related to postretirement medical benefits reflects changes in actuarial assumptions attributed to plan valuation. The increase in the unrealized gain on available for sale investment securities correlates to the decrease in long term market interest rates at the end of the period compared with year-end 2014. As market interest rates decrease, the value of fixed rate investments generally increases.

On January 9, 2009, the Company issued 30,000 shares of Series A, no par value cumulative perpetual preferred stock. The Company redeemed 20,000 of the preferred shares during 2014. On June 8, 2015, the Company redeemed the final 10,000 shares at the stated liquidation value of $1,000 per share, plus accrued dividends of $58 thousand. There was no additional debt or equity issued by the Company in connection with any of the shares redeemed.

At September 30, 2015, the Company’s tangible capital ratio was 9.83%, an increase of 15 basis points compared to 9.68% at year-end 2014. The increase in the tangible capital ratio was driven primarily by a reduction in tangible assets of $17.5 million or 1.0% and, to a lesser degree, a $986 thousand or 0.6% increase in tangible equity. The tangible capital ratio represents tangible equity as a percentage of tangible assets, which excludes intangible assets. Tangible common equity to tangible assets, which further excludes outstanding preferred stock, was 9.83% and 9.12% at September 30, 2015 and year-end 2014, respectively. This represents an increase of 71 basis points in the comparison. The increase in the tangible common equity ratio was driven by an increase in tangible common equity of $11.0 million, primarily made up of net income of $11.4 million.

In July 2013, U.S. banking regulators adopted final rules related to standards on bank capital adequacy and liquidity (commonly referred to as “Basel III”). The new rules were effective for the Company beginning on January 1, 2015, subject to a phase-in period for certain provisions extending through January 1, 2019. The rules include a new common equity Tier 1 capital ratio, an increase to the minimum Tier 1 capital ratio, an increase to risk-weightings of certain assets, implementation of a new capital conservation buffer in excess of the required minimum (which is set to be phased in beginning in 2016), and changes to how regulatory capital is defined. The Company and each of its bank subsidiaries meet the minimum capital ratios and a fully phased-in capital conservation buffer under the new rules.

Consistent with the objective of operating a sound financial organization, the Company’s goal is to maintain capital ratios well above the regulatory minimum requirements. The capital ratios of the Company and its subsidiary banks are presented in the following table for the dates indicated.

	September 30, 2015												December 31, 2014
	Common Equity Tier 1 Risk-based Capital¹			Tier 1 Risk-based Capital¹			Total Risk-based Capital¹			Tier 1 Leverage²			Common Equity Tier 1 Risk-based Capital¹	Tier 1 Risk-based Capital¹			Total Risk-based Capital¹			Tier 1 Leverage²
Consolidated		14.93	%		19.13	%		20.12	%		12.27	%	N/A		19.75	%		21.00	%		12.04	%
Farmers Bank & Capital Trust Company		16.74			16.74			17.65			9.63		N/A		17.71			18.70			9.40
United Bank & Trust Company		19.04			19.04			20.20			12.82		N/A		18.00			19.26			11.08
First Citizens Bank, Inc.		14.47			14.47			15.09			9.85		N/A		13.66			14.30			9.44
Citizens Bank of Northern Kentucky³		14.26			14.26			15.51			10.31		N/A		14.46			15.71			10.11

Regulatory minimum		4.50			6.00			8.00			4.00		N/A		4.00			8.00			4.00
Well-capitalized status		6.50			8.00			10.00			5.00		N/A		6.00			10.00			5.00

²Tier 1 Leverage ratio is computed by dividing a bank’s Tier 1 Capital, as defined by regulation, by its total quarterly average assets.

³See Note 11 to the Company’s unaudited condensed consolidated financial statements included as part of this Form 10-Q for minimum capital ratios required at December 31, 2014 as part of the banks previous regulatory agreement.

N/A – Not applicable.

Regulatory Agreements

The agreement originally entered into during 2013 between the Citizens Bank of Northern Kentucky, Inc. and its primary regulators was terminated during the third quarter of 2015 as a result of continued satisfactory compliance and overall improvement in financial condition. This agreement is summarized in Note 11 to the unaudited condensed consolidated financial statements of this Form 10-Q. The agreement is discussed in significantly greater detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014 under the caption “Capital Resources” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

The agreement originally entered into during 2009 between the United Bank & Trust Company and its primary regulators was terminated during the first quarter of 2015 as a result of continued satisfactory compliance.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The Company uses a simulation model as a tool to monitor and evaluate interest rate risk exposure. The model is designed to measure the sensitivity of net interest income and net income to changing interest rates over future time periods. Forecasting net interest income and its sensitivity to changes in interest rates requires the Company to make assumptions about the volume and characteristics of many attributes, including assumptions relating to the replacement of maturing earning assets and liabilities. Other assumptions include, but are not limited to, projected prepayments, projected new volume, and the predicted relationship between changes in market interest rates and changes in customer account balances. These effects are combined with the Company’s estimate of the most likely rate environment to produce a forecast of net interest income and net income. The forecasted results are then adjusted for the effect of a gradual increase and decrease in market interest rates on the Company’s net interest income and net income. Because assumptions are inherently uncertain, the model cannot precisely estimate net interest income or net income or the effect of interest rate changes on net interest income and net income. Actual results could differ significantly from simulated results.

At September 30, 2015, the model indicated that if rates were to gradually increase by 75 basis points during the remainder of the calendar year, then net interest income and net income would increase 0.1% and 0.3%, respectively for the year ending December 31, 2015 when compared to the forecasted results for the most likely rate environment. The model indicated that if rates were to gradually decrease by 75 basis points over the same period, then net interest income and net income would decrease 0.1% and 0.3%, respectively.

Item 4. Controls and Procedures

The Company’s Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report, and have concluded that the Company’s disclosure controls and procedures were adequate and effective to ensure that all material information required to be disclosed in this report has been made known to them in a timely fashion.

The Company’s Chief Executive Officer and Chief Financial Officer have also concluded that there were no significant changes during the quarter ended September 30, 2015 in the Company’s internal control over financial reporting or in other factors that have materially affected, or are reasonably likely to materially affect, the registrant’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

As of September 30, 2015, there were various pending legal actions and proceedings against the Company arising from the normal course of business and in which claims for damages are asserted. It is the opinion of management, after discussion with legal counsel, that the disposition or ultimate resolution of such claims and legal actions will not have a material effect upon the consolidated financial statements of the Company.

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

During 2014, the Company changed the form of payment to its directors for board meeting and quarterly fees from 100% cash to 50% in cash and 50% in Company common stock. The shares are issued as part of a plan adopted by the board of directors. Each director has elected to participate by entering into an agreement with the Company to accept common stock in lieu of cash for 50% of the director’s board meeting and quarterly fees. As the shares are only issued to directors as part of a plan approved by the board, the shares are exempt from the registration requirements of the Securities Act of 1933, as amended (the “1933 Act”), as a sale not involving any public offering under Section 4(2) of the 1933 Act. Attendance for committee meetings continue to be paid completely in cash. As employee directors are not paid director’s fees, only non-employee directors receive stock under this plan.

The Company issued 638 shares and 2,523 shares of common stock to its non-employee directors under this plan in the three and nine months ended September 30, 2015, respectively, as compensation for director fees of $18 thousand and $64 thousand for those respective periods. The cash retained by the Company by issuing common stock in lieu of paying cash is used for general corporate purposes. There are no brokers involved in the issuance of stock to directors and no commissions or other broker fees are paid.

At various times, the Company’s Board of Directors has authorized the purchase of shares of the Company’s outstanding common stock. No stated expiration dates have been established under any of the previous authorizations. There were no shares of common stock repurchased by the Company during the quarter ended September 30, 2015. There are 84,971 shares that may still be purchased under the various authorizations, although no shares have been purchased since 2008.

Item 6. Exhibits

List of Exhibits

	3.1	Second Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation (incorporated by reference to the Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2006 (File No. 000-14412)).

	3.2	Articles of Amendment to Second Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation dated January 6, 2009 (incorporated by reference to the Current Report on Form 8-K dated January 13, 2009 (File No. 000-14412)).

	3.3	Articles of Amendment to Second Amended and Restated Articles of Incorporation of Farmers Capital Bank Corporation dated November 16, 2009 (incorporated by reference to the Current Report on Form 8-K dated November 17, 2009 (File No. 000-14412)).

	3.4**	Amended and Restated Bylaws of Farmers Capital Bank Corporation.

	4.1*	Junior Subordinated Indenture, dated as of July 21, 2005, between Farmers Capital Bank Corporation and Wilmington Trust Company, as Trustee, relating to unsecured junior subordinated deferrable interest notes that mature in 2035.

	4.2*	Amended and Restated Trust Agreement, dated as of July 21, 2005, among Farmers Capital Bank Corporation, as Depositor, Wilmington Trust Company, as Property and Delaware Trustee, the Administrative Trustees (as named therein), and the Holders (as defined therein).

	4.3*	Guarantee Agreement, dated as of July 21, 2005, between Farmers Capital Bank Corporation, as Guarantor, and Wilmington Trust Company, as Guarantee Trustee.

	4.4*	Junior Subordinated Indenture, dated as of July 26, 2005, between Farmers Capital Bank Corporation and Wilmington Trust Company, as Trustee, relating to unsecured junior subordinated deferrable interest notes that mature in 2035.

	4.5*	Amended and Restated Trust Agreement, dated as of July 26, 2005, among Farmers Capital Bank Corporation, as Depositor, Wilmington Trust Company, as Property and Delaware Trustee, the Administrative Trustees (as named therein), and the Holders (as defined therein).

	4.6*	Guarantee Agreement, dated as of July 26, 2005, between Farmers Capital Bank Corporation, as Guarantor, and Wilmington Trust Company, as Guarantee Trustee.

	4.7*	Indenture, dated as of August 14, 2007 between Farmers Capital Bank Corporation, as Issuer, and Wilmington Trust Company, as Trustee, relating to fixed/floating rate junior subordinated debt due 2037.

	4.8*	Amended and Restated Declaration of Trust, dated as of August 14, 2007, by Farmers Capital Bank Corporation, as Sponsor, Wilmington Trust Company, as Delaware and Institutional Trustee, the Administrative Trustees (as named therein), and the Holders (as defined therein).

	4.9*	Guarantee Agreement, dated as of August 14, 2007, between Farmers Capital Bank Corporation, as Guarantor, and Wilmington Trust Company, as Guarantee Trustee.

	4.10	Form of Certificate for Fixed Rate Cumulative Perpetual Preferred Stock, Series A (incorporated by reference to the Current Report on Form 8-K dated January 13, 2009 (File No. 000-14412)).

	4.11	Letter Agreement, dated January 9, 2009, between Farmers Capital Bank Corporation and the United States Treasury, with respect to the issuance and sale of the Series A Preferred Stock and the Warrant, and Securities Purchase Agreement-Standard Terms attached thereto as Exhibit A (incorporated by reference to the Current Report on Form 8-K dated January 13, 2009 (File No. 000-14412)).

	10.1	Employee Stock Purchase Plan of Farmers Capital Bank Corporation (incorporated by reference to Form S-8 effective June 24, 2004 (File No. 333-116801)).

	10.2	Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K/A filed December 26, 2012 (File No. 000-14412)).

	10.3	Amendment No. 1 to Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K filed December 30, 2013 (File No. 000-14412)).

	10.4	Amendment No. 2 to Employment agreement dated December 10, 2012 between Farmers Capital Bank Corporation and Lloyd C. Hillard, Jr. (incorporated by reference to Exhibit 10.1 to Form 8-K filed December 8, 2014).

	10.5	Employment agreement dated December 17, 2013 between Farmers Capital Bank Corporation and Rickey D. Harp (incorporated by reference to Exhibit 10.1 to Form 8-K filed December 30, 2013 (File No. 000-14412)).

	10.6	Employment agreement dated October 28, 2014 between Farmers Capital Bank Corporation and Mark A. Hampton (incorporated by reference to Exhibit 10.1 to Form 8-K filed October 28, 2014 (File No. 000-14412)).

	31.1**	CEO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	31.2**	CFO Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

	32**	CEO & CFO Certifications Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	101**	Interactive Data Files

* Exhibit not included pursuant to Item 601(b)(4)(iii) and (v) of Regulation S-K. The Company will provide a copy of such exhibit to the Securities and Exchange Commission upon request.

** Filed with this Quarterly Report on Form 10-Q.

SIGNATURES

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

Date:	November 6, 2015	/s/ Lloyd C. Hillard, Jr.
		Lloyd C. Hillard, Jr.
		President and CEO
		(Principal Executive Officer)

Date:	November 6, 2015	/s/ Mark A. Hampton
		Mark A. Hampton
		Executive Vice President, CFO, and Secretary
		(Principal Financial and Accounting Officer)