FCAP 10-Q Quarter ended Sept. 30, 2018

- 2 -

		September 30, 2018				December 31, 2017
		(In thousands)
ASSETS
Cash and due from banks		$	22,322			$	19,478
Interest bearing deposits with banks			2,660				730
Federal funds sold			25,169				5,707
Total cash and cash equivalents			50,151				25,915
Interest-bearing time deposits			8,935				9,258
Securities available for sale, at fair value			253,213				271,172
Securities-held to maturity			-				1
Loans, net			428,423				409,618
Loans held for sale			2,339				2,630
Federal Home Loan Bank and other restricted stock, at cost			1,988				1,979
Foreclosed real estate			3,142				3,971
Premises and equipment			14,443				15,031
Accrued interest receivable			2,689				2,694
Cash value of life insurance			8,011				7,279
Goodwill			6,472				6,472
Core deposit intangible			1,002				1,112
Other assets			9,733				1,824
Total Assets		$	790,541			$	758,956
LIABILITIES
Deposits:
Noninterest-bearing		$	146,171			$	129,828
Interest-bearing			555,908				534,734
Total deposits			702,079				664,562
Advances from Federal Home Loan Bank			-				10,000
Accrued interest payable			145				107
Accrued expenses and other liabilities			6,974				3,237
Total liabilities			709,198				677,906
EQUITY
Preferred stock of $.01 par value per share
Authorized 1,000,000 shares; none issued			-				-
Common stock of $.01 par value per share
Authorized 7,500,000 shares; issued 3,782,933 shares (3,762,933 in 2017); outstanding 3,356,144 shares (3,336,964 in 2017)			38				38
Additional paid-in capital			40,263				39,515
Retained earnings-substantially restricted			56,413				51,972
Unearned stock compensation			(807	)			(212	)
Accumulated other comprehensive loss			(6,323	)			(2,060	)
Less treasury stock, at cost - 426,789 shares (425,969 in 2017)			(8,349	)			(8,315	)
Total First Capital, Inc. stockholders' equity			81,235				80,938
Noncontrolling interest in subsidiary			108				112
Total equity			81,343				81,050
Total Liabilities and Equity		$	790,541			$	758,956

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		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
INTEREST INCOME		(In thousands, except per share data)
Loans, including fees		$	5,896			$	5,283			$	16,755			$	15,363
Securities:
Taxable			918				969				2,815				2,875
Tax-exempt			347				368				1,086				1,059
Federal Home Loan Bank dividends			21				20				75				53
Federal funds sold and interest bearing deposits with banks			251				88				529				299
Total interest income			7,433				6,728				21,260				19,649
INTEREST EXPENSE
Deposits			424				336				1,140				1,041
Advances from Federal Home Loan Bank			0				7				21				7
Total interest expense			424				343				1,161				1,048
Net interest income			7,009				6,385				20,099				18,601
Provision for loan losses			455				150				968				617
Net interest income after provision for loan losses			6,554				6,235				19,131				17,984
NONINTEREST INCOME
Service charges on deposit accounts			1,198				1,155				3,495				3,288
Commission income			84				106				302				351
Gain (loss) on sale of securities			-				(7	)			(95	)			54
Gain on sale of loans			320				417				850				1,028
Increase in cash surrender value of life insurance			51				41				179				154
Other income			45				36				229				182
Total noninterest income			1,698				1,748				4,960				5,057
NONINTEREST EXPENSE
Compensation and benefits			2,914				2,842				8,750				8,276
Occupancy and equipment			434				389				1,261				1,158
Data processing			784				696				2,292				2,022
Professional fees			203				190				562				522
Advertising			78				94				266				269
Net (gain) loss on foreclosed real estate			(185	)			(66	)			336				145
Other operating expenses			967				901				2,679				2,612
Total noninterest expense			5,195				5,046				16,146				15,004
Income before income taxes			3,057				2,937				7,945				8,037
Income tax expense			530				825				1,178				2,175
Net Income			2,527				2,112				6,767				5,862
Less: net income attributable to noncontrolling interest in subsidiary			3				3				10				10
Net Income Attributable to First Capital, Inc.		$	2,524			$	2,109			$	6,757			$	5,852
Earnings per common share attributable to First Capital, Inc.:
Basic		$	0.76			$	0.63			$	2.03			$	1.76
Diluted		$	0.76			$	0.63			$	2.03			$	1.76
Dividends per share		$	0.23			$	0.22			$	0.69			$	0.64

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		Three Months Ended September 30,								Nine Months Ended September 30,
		2018				2017				2018				2017
		(In thousands)
Net Income		$	2,527			$	2,112			$	6,767			$	5,862
OTHER COMPREHENSIVE INCOME (LOSS)
Unrealized gains (losses) on securities available for sale:
Unrealized holding gains (losses) arising during the period			(1,120	)			(419	)			(5,771	)			2,937
Income tax (expense) benefit			279				161				1,436				(1,124	)
Net of tax amount			(841	)			(258	)			(4,335	)			1,813
Less:  reclassification adjustment for realized (gains) losses included in net income			-				7				95				(54	)
Income tax expense (benefit)			-				(3	)			(23	)			18
Net of tax amount			-				4				72				(36	)
Other Comprehensive Income (Loss), net of tax			(841	)			(254	)			(4,263	)			1,777
Comprehensive Income			1,686				1,858				2,504				7,639
Less: comprehensive income attributable to the noncontrolling interest in subsidiary			3				3				10				10
Comprehensive Income Attributable to First Capital, Inc.		$	1,683			$	1,855			$	2,494			$	7,629

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(In thousands, except share and per share data)		Common Stock				Additional Paid-in Capital				Retained Earnings				Accumulated Other Comprehensive Loss				Unearned Stock Compensation				Treasury Stock				Noncontrolling Interest				Total
Balances at January 1, 2017		$	38			$	39,515			$	47,051			$	(2,277	)		$	(300	)		$	(8,297	)		$	112			$	75,842
Net income			-				-				5,852				-				-				-				10				5,862
Other comprehensive income			-				-				-				1,777				-				-				-				1,777
Cash dividends			-				-				(2,136	)			-				-				-				(14	)			(2,150	)
Stock compensation expense			-				-				-				-				65				-				-				65
Purchase of treasury shares			-				-				-				-				-				(18	)			-				(18	)
Balances at September 30, 2017		$	38			$	39,515			$	50,767			$	(500	)		$	(235	)		$	(8,315	)		$	108			$	81,378
Balances at January 1, 2018		$	38			$	39,515			$	51,972			$	(2,060	)		$	(212	)		$	(8,315	)		$	112			$	81,050
Net income			-				-				6,757				-				-				-				10				6,767
Other comprehensive loss			-				-				-				(4,263	)			-				-				-				(4,263	)
Cash dividends			-				-				(2,316	)			-				-				-				(14	)			(2,330	)
Restricted stock grants			-				748				-				-				(748	)			-				-				-
Stock compensation expense			-				-				-				-				153				-				-				153
Purchase of treasury shares			-				-				-				-				-				(34	)			-				(34	)
Balances at September 30, 2018		$	38			$	40,263			$	56,413			$	(6,323	)		$	(807	)		$	(8,349	)		$	108			$	81,343

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		Nine Months Ended September 30,
		2018				2017
CASH FLOWS FROM OPERATING ACTIVITIES		(In thousands)
Net income		$	6,767			$	5,862
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
Amortization of premiums and accretion of discounts on securities, net			1,277				1,296
Depreciation and amortization expense			927				915
Deferred income taxes			(242	)			64
Stock compensation expense			153				65
Increase in cash value of life insurance			(179	)			(154	)
Gain on life insurance			(94	)			(18	)
(Gain) loss on sale of securities			95				(54	)
Provision for loan losses			968				617
Proceeds from sales of loans			42,466				47,991
Loans originated for sale			(41,325	)			(43,456	)
Gain on sale of loans			(850	)			(1,028	)
Amortization of tax credit investment			247				-
Net realized and unrealized loss on foreclosed real estate			442				225
Decrease (increase) in accrued interest receivable			5				(232	)
Increase (decrease) in accrued interest payable			38				(24	)
Net change in other assets/liabilities			(252	)			(379	)
Net Cash Provided By Operating Activities			10,443				11,690
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in interest-bearing time deposits			(2,100	)			(2,235	)
Proceeds from maturities and sales of interest-bearing time deposits			2,423				6,675
Purchase of securities available for sale			(25,691	)			(43,925	)
Proceeds from maturities of securities available for sale			2,930				3,405
Proceeds from sales of securities available for sale			14,345				1,644
Principal collected on mortgage-backed obligations			19,425				19,336
Investment in cash value of life insurance			(1,000	)			-
Net increase in loans receivable			(19,872	)			(20,630	)
Investment in tax credit entities			(691	)			-
Proceeds from sale of foreclosed real estate			486				972
Purchase of Federal Home Loan Bank stock			(9	)			(329	)
Purchase of premises and equipment			(229	)			(1,138	)
Purchase of equity investment			(1,922	)			-
Proceeds from settlement of bank-owned life insurance policies			545				804
Net Cash Used In Investing Activities			(11,360	)			(35,421	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits			37,517				862
Net increase (decrease) in advances from Federal Home Loan Bank			(10,000	)			4,000
Purchase of treasury stock			(34	)			(18	)
Dividends paid			(2,330	)			(2,150	)
Net Cash Provided By Financing Activities			25,153				2,694
Net Increase (Decrease) in Cash and Cash Equivalents			24,236				(21,037	)
Cash and cash equivalents at beginning of period			25,915				45,835
Cash and Cash Equivalents at End of Period		$	50,151			$	24,798

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1.	Presentation of Interim Information

First Capital, Inc. (“Company”) is the financial holding company for First Harrison Bank (“Bank”), an Indiana chartered commercial bank and wholly-owned subsidiary. First Harrison Investments, Inc. and First Harrison Holdings, Inc. are wholly-owned Nevada corporate subsidiaries of the Bank that jointly own First Harrison, LLC, a Nevada limited liability corporation that holds and manages an investment portfolio. First Harrison REIT, Inc. (“REIT”) is a wholly-owned subsidiary of First Harrison Holdings, Inc. that holds a portion of the Bank’s real estate mortgage loan portfolio. FHB Risk Mitigation Services, Inc. (“Captive”) is a wholly-owned insurance subsidiary of the Company that provides property and casualty insurance coverage to the Company, the Bank and the Bank’s subsidiaries, and reinsurance to eight other third party insurance captives for which insurance may not be currently available or economically feasible in the insurance marketplace. Heritage Hill, LLC is a wholly-owned subsidiary of the Bank that holds and manages certain foreclosed real estate properties.

On September 20, 2017, the Bank filed applications with the Indiana Department of Financial Institutions (“IDFI”) and the Federal Deposit Insurance Corporation (“FDIC”) to convert from a federal savings association into an Indiana chartered commercial bank (the “Conversion”). The Conversion has been completed and, as of June 30, 2018, the IDFI is the Bank’s primary regulator and the FDIC is the Bank’s primary federal regulator. The Conversion did not affect the Bank’s clients in any way and did not affect FDIC deposit insurance on eligible accounts.

Additionally, in connection with the Conversion, the Company filed an application with the Federal Reserve Bank of St. Louis to change from a savings and loan holding company to a financial holding company. This change occurred simultaneously with the Conversion discussed above.

In the opinion of management, the unaudited consolidated financial statements include all adjustments considered necessary to present fairly the financial position as of September 30, 2018, and the results of operations for the three months and nine months ended September 30, 2018 and 2017 and the cash flows for the nine months ended September 30, 2018 and 2017. All of these adjustments are of a normal, recurring nature. Such adjustments are the only adjustments included in the unaudited consolidated financial statements. Interim results are not necessarily indicative of results for a full year or any other period.

The accompanying unaudited consolidated financial statements and notes have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial statements and are presented as permitted by the instructions to Form 10-Q. Accordingly, they do not contain certain information included in the Company’s annual audited consolidated financial statements and related footnotes for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K.

The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. Certain prior period amounts have been reclassified to conform with the current period presentation. The reclassifications had no effect on net income or stockholders’ equity.

- 8 -

2.	Investment Securities

Debt securities have been classified in the consolidated balance sheets according to management’s intent. Investment securities at September 30, 2018 and December 31, 2017 are summarized as follows:

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(2 – continued)

Agency notes and bonds, agency mortgage-backed securities and agency collateralized mortgage obligations (“CMO”) include securities issued by the Government National Mortgage Association (“GNMA”), a U.S. government agency, and the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Federal Home Loan Bank (“FHLB”), which are government-sponsored enterprises.

The amortized cost and fair value of debt securities as of September 30, 2018, by contractual maturity, are shown below. Expected maturities of mortgage-backed securities and CMO may differ from contractual maturities because the mortgages underlying the obligations may be prepaid without penalty.

Information pertaining to investment securities available for sale with gross unrealized losses at September 30, 2018, aggregated by investment category and the length of time that individual investment securities have been in a continuous position, follows.

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(2 – continued)

Information pertaining to investment securities available for sale with gross unrealized losses at December 31, 2017, aggregated by investment category and the length of time that individual investment securities have been in a continuous position, follows. At December 31, 2017, the Company did not have any securities held to maturity with an unrealized loss.

Management evaluates securities for other-than-temporary impairment at least quarterly, and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (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, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recover in fair value.

At September 30, 2018, the U.S. government agency debt securities, including agency notes and bonds, mortgage-backed securities and CMO, and municipal obligations in a loss position had depreciated approximately 3.6% from the amortized cost basis. All of the U.S. government agency securities and municipal obligations are issued by U.S. government agencies, government-sponsored enterprises and municipal governments, or are secured by first mortgage loans and municipal project revenues. These unrealized losses related principally to current interest rates for similar types of securities. In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government, its agencies or other governments, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. As the Company has the ability to hold the debt securities until maturity, or the foreseeable future if classified as available for sale, no declines are deemed to be other-than-temporary.

While management does not anticipate any credit-related impairment losses at September 30, 2018, additional deterioration in market and economic conditions may have an adverse impact on credit quality in the future.

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(2 – continued)

During the three months ended September 30, 2018, the Company did not have any security sales. During the nine months ended September 30, 2018, the Company realized gross gains of $218,000 and gross losses of $307,000 on sales of available for sale municipal securities and gross losses of $6,000 on sales of U.S. government agency mortgage-backed CMO’s. During the three months ended September 30, 2017, the Company realized gross losses on sales of available for sale municipal securities of $7,000. During the nine months ended September 30, 2017, the Company realized gross gains on sales of available for sale agency mortgage backed securities and CMO’s of $58,000 and $3,000, respectively, and gross losses on sales of available for sale municipal securities of $7,000.

Certain available for sale debt securities were pledged to secure public fund deposits at September 30, 2018 and December 31, 2017.

Equity Security Investment

In September 2018, the Company acquired 90,000 shares of common stock in another bank holding company, representing approximately 5% of the outstanding common stock of the entity, for a total investment of $1.9 million. The equity investment is included in other assets on the consolidated balance sheet.

3.	Loans and Allowance for Loan Losses

The Company’s loan and allowance for loan loss policies are as follows:

Loans are stated at unpaid principal balances, less net deferred loan fees and the allowance for loan losses. The Company grants real estate mortgage, commercial business and consumer loans. A substantial portion of the loan portfolio is represented by mortgage loans to customers in the Louisville, Kentucky metropolitan statistical area (MSA). The ability of the Company’s customers to honor their loan agreements is largely dependent upon the real estate and general economic conditions in this area.

Loan origination and commitment fees, as well as certain direct costs of underwriting and closing loans, are deferred and amortized as a yield adjustment to interest income over the lives of the related loans using the interest method. Amortization of net deferred loan fees is discontinued when a loan is placed on nonaccrual status.

The recognition of income on a loan is discontinued and previously accrued interest is reversed, when interest or principal payments become ninety (90) days past due unless, in the opinion of management, the outstanding interest remains collectible. Past due status is determined based on contractual terms. Generally, by applying the cash receipts method, interest income is subsequently recognized only as received until the loan is returned to accrual status. The cash receipts method is used when the likelihood of further loss on the loan is remote. Otherwise, the Company applies the cost recovery method and applies all payments as a reduction of the unpaid principal balance until the loan qualifies for return to accrual status. Interest income on impaired loans is recognized using the cost recovery method, unless the likelihood of further loss on the loan is remote.

A loan is restored to accrual status when all principal and interest payments are brought current and the borrower has demonstrated the ability to make future payments of principal and interest as scheduled, which generally requires that the borrower demonstrate a period of performance of at least six consecutive months.

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

For portfolio segments other than consumer loans, the Company’s practice is to charge-off any loan or portion of a loan when the loan is determined by management to be uncollectible due to the borrower’s failure to meet repayment terms, the borrower’s deteriorating or deteriorated financial condition, the depreciation of the underlying collateral, the loan’s classification as a loss by regulatory examiners, or for other reasons. A partial charge-off is recorded on a loan when the uncollectibility of a portion of the loan has been confirmed, such as when a loan is discharged in bankruptcy, the collateral is liquidated, a loan is restructured at a reduced principal balance, or other identifiable events that lead management to determine the full principal balance of the loan will not be repaid. A specific reserve is recognized as a component of the allowance for estimated losses on loans individually evaluated for impairment. Partial charge-offs on nonperforming and impaired loans are included in the Company’s historical loss experience used to estimate the general component of the allowance for loan losses as discussed below. Specific reserves are not considered charge-offs in management’s analysis of the allowance for loan losses because they are estimates and the outcome of the loan relationship is undetermined. At September 30, 2018, the Company had five loans on which partial charge-offs of $97,000 had been recorded.

Consumer loans not secured by real estate are typically charged off at 90 days past due, or earlier if deemed uncollectible, unless the loans are in the process of collection. Overdrafts are charged off after 45 days past due. Charge-offs are typically recorded on loans secured by real estate when the property is foreclosed upon.

The allowance for loan losses reflects management’s judgment of probable loan losses inherent in the loan portfolio at the balance sheet date. Additions to the allowance for loan losses are made by the provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

The Company uses a disciplined process and methodology to evaluate the allowance for loan losses on at least a quarterly basis that is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

The allowance consists of specific and general components. The specific component relates to loans that are individually evaluated for impairment or loans otherwise classified as doubtful, substandard, or special mention. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan.

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

The general component covers non-classified loans and classified loans that are found, upon individual evaluation, to not be impaired. Such loans are pooled by segment and losses are modeled using annualized historical loss experience adjusted for qualitative factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent twelve calendar quarters unless the historical loss experience is not considered indicative of the level of risk in the remaining balance of a particular portfolio segment, in which case an adjustment is determined by management. The Company’s historical loss experience is then adjusted by an overall loss factor based on a qualitative analysis prepared by management and reviewed on a quarterly basis. The overall loss factor considers changes in underwriting standards, economic conditions, changes and trends in past due and classified loans and other internal and external factors.

Management also applies additional loss factor multiples to loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The loss factor multiples for classified loans are based on management’s assessment of historical trends regarding losses experienced on classified loans in prior periods. See below for additional discussion of the overall loss factor and loss factor multiples for classified loans as of September 30, 2018 and December 31, 2017.

Management exercises significant judgment in evaluating the relevant historical loss experience and the qualitative factors. Management also monitors the differences between estimated and actual incurred loan losses for loans considered impaired in order to evaluate the effectiveness of the estimation process and make any changes in the methodology as necessary.

Management utilizes the following portfolio segments in its analysis of the allowance for loan losses: residential real estate, land, construction, commercial real estate, commercial business, home equity and second mortgage, and other consumer loans. Additional discussion of the portfolio segments and the risks associated with each segment can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. 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. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

Values for collateral dependent loans are generally based on appraisals obtained from independent licensed real estate appraisers, with adjustments applied for estimated costs to sell the property, costs to complete unfinished or repair damaged property and other factors. New appraisals are generally obtained for all significant properties when a loan is identified as impaired, and a property is considered significant if the value of the property is estimated to exceed $200,000. Subsequent appraisals are obtained as needed or if management believes there has been a significant change in the market value of the property. In instances where it is not deemed necessary to obtain a new appraisal, management bases its impairment and allowance for loan loss analysis on the original appraisal with adjustments for current conditions based on management’s assessment of market factors and management’s inspection of the property.

At September 30, 2018 and December 31, 2017, the recorded investments in loans secured by residential real estate properties for which formal foreclosure proceedings are in process was $634,000 and $588,000, respectively.

Loans at September 30, 2018 and December 31, 2017 consisted of the following:

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

The following table provides the components of the Company’s recorded investment in loans at September 30, 2018:

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

The following table provides the components of the Company’s recorded investment in loans at December 31, 2017:

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

An analysis of the allowance for loan losses as of September 30, 2018 is as follows:

An analysis of the allowance for loan losses as of December 31, 2017 is as follows:

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

An analysis of the changes in the allowance for loan losses for the three months and nine months ended September 30, 2018 is as follows:

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

An analysis of the changes in the allowance for loan losses for the three months and nine months ended September 30, 2017 is as follows:

FIRST CAPITAL, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(3 – continued)

At September 30, 2018 and December 31, 2017, management applied qualitative factor adjustments to various portfolio segments as they determined that the historical loss experience was not indicative of the level of risk in the remaining balance of those portfolio segments. As part of their analysis of qualitative factors, management considers changes in underwriting standards, economic conditions, past due loan trends, collateral valuations, loan concentrations and other internal and external factors. Had these qualitative factor adjustments not been considered, the allowance for loan losses based on historical loss factors would have been $2.4 million and $2.6 million lower at September 30, 2018 and December 31, 2017, respectively. These changes were made to reflect management’s estimates of inherent losses in these portfolio segments at September 30, 2018 and December 31, 2017.

Management also adjusts the historical loss factors for loans classified as watch, special mention and substandard that are not individually evaluated for impairment. The adjustments consider the increased likelihood of loss on classified loans based on the Company’s separate historical experience for classified loans. Had the adjustments for classified loans not been considered, the allowance for loan losses would have been $479,000 and $506,000 lower at September 30, 2018 and December 31, 2017, respectively. These factors were not adjusted during the period from December 31, 2017 to September 30, 2018.

Additional discussion of the Bank’s allowance for loan loss methodology can be found in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

FIRST CAPITAL, INC.

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The following table summarizes the Company’s impaired loans as of September 30, 2018 and for the three months and nine months ended September 30, 2018. The Company did not recognize any interest income on impaired loans using the cash receipts method of accounting for the three or nine month periods ended September 30, 2018:

FIRST CAPITAL, INC.

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The following table summarizes the Company’s impaired loans for the three months and nine months ended September 30, 2017. The Company did not recognize any interest income on impaired loans using the cash receipts method of accounting for the three or nine month periods ended September 30, 2017:

FIRST CAPITAL, INC.

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The following table summarizes the Company’s impaired loans as of December 31, 2017:

FIRST CAPITAL, INC.

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Nonperforming loans consists of nonaccrual loans and loans over 90 days past due and still accruing interest. The following table presents the recorded investment in nonperforming loans at September 30, 2018 and December 31, 2017:

The following table presents the aging of the recorded investment in loans at September 30, 2018:

FIRST CAPITAL, INC.

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The following table presents the aging of the recorded investment in loans at December 31, 2017:

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

Special Mention: Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

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

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

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

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

FIRST CAPITAL, INC.

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

FIRST CAPITAL, INC.

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The following table summarizes the Company’s troubled debt restructurings (TDRs) by accrual status as of September 30, 2018 and December 31, 2017:

At September 30, 2018 and December 31, 2017, there were no commitments to lend additional funds to debtors whose loan terms have been modified in a TDR.

The following table summarizes information in regard to TDRs that were restructured during the three and nine months ended September 30, 2018:

For the TDRs listed above, the terms of modification included the deferral of contractual principal payments.

FIRST CAPITAL, INC.

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The following table summarizes information in regard to TDRs that were restructured during the three and nine months ended September 30, 2017:

For the TDR listed above, the terms of modification included the deferral of contractual principal payments.

There were no principal charge-offs recorded as a result of TDRs and there was no specific allowance for loan losses related to TDRs modified during the three and nine months ended September 30, 2018 or 2017.

There were no TDRs modified within the previous 12 months for which there was a subsequent payment default (defined as the loan becoming more than 90 days past due, being moved to nonaccrual status, or the collateral being foreclosed upon) during the three and nine months ended September 30, 2018 and 2017. In the event that a TDR subsequently defaults, the Company evaluates the restructuring for possible impairment. As a result, the related allowance for loan losses may be increased or charge-offs may be taken to reduce the carrying amount of the loan.

Purchased Credit Impaired (PCI) Loans

Purchased loans acquired in a business combination are recorded at estimated fair value on their purchase date with no carryover of the related allowance for loan and lease losses. Such loans are accounted for individually or aggregated into pools of loans based on common risk characteristics such as credit score, loan type and date of origination. In determining the estimated fair value of purchased loans or pools, management considers a number of factors including the remaining life, estimated prepayments, estimated loss ratios, estimated value of the underlying collateral, and net present value of cash flows expected to be received, among others. Purchased loans that have evidence of credit deterioration since origination for which it is deemed probable at the date of acquisition that the acquirer will not collect all contractually required principal and interest payments are accounted for in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 310-30. The difference between contractually required payments and the cash flows expected to be collected at acquisition is referred to as the nonaccretable difference. The difference between the expected cash flows and the fair value at acquisition is recorded as interest income over the remaining life of the loan or pool of loans and is referred to as the accretable yield. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses. Subsequent increases in expected cash flows will result in a reversal of the provision for loan losses to the extent of prior charges and then an adjustment to accretable yield, which is recognized as future interest income.

FIRST CAPITAL, INC.

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The following table presents the carrying amount of PCI loans accounted for under ASC 310-30 at September 30, 2018 and December 31, 2017:

The outstanding balance of PCI loans accounted for under ASC 310-30, including contractual principal, interest, fees and penalties was $530,000 and $625,000 at September 30, 2018 and December 31, 2017, respectively.

There was no allowance for loan losses related to PCI loans at September 30, 2018. The allowance for loan losses related to PCI loans was $2,000 at December 31, 2017. There was a $2,000 reduction of the allowance for loan losses related to PCI loans for the nine-month period ended September 30, 2018. There were no net provisions for loans losses related to PCI loans for the three-month period ended September 30, 2018. Provisions for loan losses related to PCI loans were $4,000 for the three-month and nine-month periods ended September 30, 2017.

Accretable yield, or income expected to be collected, is as follows for the three and nine month periods ended September 30, 2018 and 2017: