FFIC 10-Q Quarter ended June 30, 2017

i

		June 30,				December 31,
(Dollars in thousands, except per share data)		2017				2016
ASSETS
Cash and due from banks		$	48,539			$	35,857
Securities held-to-maturity:
Mortgage-backed securities (none pledged) (fair value of $7,816 at at June 30, 2017)			7,983				-
Other securities (none pledged) (fair value of $22,777 and $35,408 at June 30, 2017 and December 31, 2016, respectively)			24,451				37,735
Securities available for sale:
Mortgage-backed securities (including assets pledged of $89,197 and $145,860 at June 30, 2017 and December 31, 2016, respectively; $1,801 and $2,016 at fair value pursuant to the fair value option at June 30, 2017 and December 31, 2016, respectively)			520,012				516,476
Other securities (including assets pledged of $143,261 and $82,064 at June 30, 2017 and December 31, 2016, respectively; $28,706 and $28,429 at fair value pursuant to the fair value option at June 30, 2017 and December 31, 2016, respectively)			317,693				344,905
Loans held for sale			30,565				-
Loans:
Multi-family residential			2,243,643				2,178,504
Commercial real estate			1,349,634				1,246,132
One-to-four family ― mixed-use property			556,906				558,502
One-to-four family ― residential			181,213				185,767
Co-operative apartments			7,069				7,418
Construction			16,842				11,495
Small Business Administration			10,591				15,198
Taxi medallion			18,303				18,996
Commercial business and other			644,262				597,122
Net unamortized premiums and unearned loan fees			17,217				16,559
Allowance for loan losses			(22,157	)			(22,229	)
Net loans			5,023,523				4,813,464
Interest and dividends receivable			21,439				20,228
Bank premises and equipment, net			26,592				26,561
Federal Home Loan Bank of New York stock			66,630				59,173
Bank owned life insurance			130,631				132,508
Goodwill			16,127				16,127
Other assets			51,051				55,453
Total assets		$	6,285,236			$	6,058,487
LIABILITIES
Due to depositors:
Non-interest bearing		$	349,302			$	333,163
Interest-bearing:
Certificate of deposit accounts			1,332,377				1,372,115
Savings accounts			325,815				254,283
Money market accounts			837,565				843,370
NOW accounts			1,368,441				1,362,484
Total interest-bearing deposits			3,864,198				3,832,252
Mortgagors' escrow deposits			41,303				40,216
Borrowed funds
Federal Home Loan Bank advances			1,317,087				1,159,190
Subordinated Debentures			73,555				73,414
Junior subordinated debentures, at fair value			35,137				33,959
Total borrowed funds			1,425,779				1,266,563
Other liabilities			70,563				72,440
Total liabilities			5,751,145				5,544,634
STOCKHOLDERS' EQUITY
Preferred stock ($0.01 par value; 5,000,000 shares authorized; none issued)			-				-
Common stock ($0.01 par value; 100,000,000 shares authorized; 31,530,595 shares issued at June 30, 2017 and December 31, 2016; 28,803,937 shares and 28,632,904 shares outstanding at June 30, 2017 and December 31, 2016, respectively)			315				315
Additional paid-in capital			216,447				214,462
Treasury stock, at average cost (2,726,658 shares and 2,897,691 shares at June 30, 2017 and December 31, 2016, respectively)			(51,483	)			(53,754	)
Retained earnings			375,388				361,192
Accumulated other comprehensive loss, net of taxes			(6,576	)			(8,362	)
Total stockholders' equity			534,091				513,853
Total liabilities and stockholders' equity		$	6,285,236			$	6,058,487

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		For the three months								For the six months
		ended June 30,								ended June 30,
(Dollars in thousands, except per share data)		2017				2016				2017				2016
Interest and dividend income
Interest and fees on loans		$	51,631			$	48,413			$	102,516			$	95,971
Interest and dividends on securities:
Interest			6,432				6,510				12,527				13,102
Dividends			123				120				244				239
Other interest income			129				48				282				142
Total interest and dividend income			58,315				55,091				115,569				109,454
Interest expense
Deposits			9,510				8,097				18,490				16,070
Other interest expense			5,188				5,105				10,073				10,362
Total interest expense			14,698				13,202				28,563				26,432
Net interest income			43,617				41,889				87,006				83,022
Provision for loan losses			-				-				-				-
Net interest income after provision for loan losses			43,617				41,889				87,006				83,022
Non-interest income
Banking services fee income			1,014				973				1,888				1,949
Net gain on sale of securities			-				2,363				-				2,363
Net gain on sale of loans			34				3				244				344
Net gain on sale of buildings			-				33,814				-				33,814
Net loss from fair value adjustments			(1,159	)			(1,115	)			(1,537	)			(2,102	)
Federal Home Loan Bank of New York stock dividends			643				582				1,466				1,205
Gain from life insurance proceeds			6				-				1,167				411
Bank owned life insurance			807				694				1,602				1,389
Other income			603				403				807				884
Total non-interest income			1,948				37,717				5,637				40,257
Non-interest expense
Salaries and employee benefits			15,424				13,968				32,528				30,229
Occupancy and equipment			2,654				2,352				5,150				4,722
Professional services			1,919				2,027				3,915				4,177
FDIC deposit insurance			503				940				829				1,844
Data processing			1,321				1,199				2,524				2,290
Depreciation and amortization			1,155				1,062				2,320				2,094
Other real estate owned/foreclosure expense (income)			(96	)			405				255				558
Prepayment penalty on borrowings			-				2,082				-				2,082
Other operating expenses			3,185				4,419				8,108				8,955
Total non-interest expense			26,065				28,454				55,629				56,951
Income before income taxes			19,500				51,152				37,014				66,328
Provision for income taxes
Federal			5,576				15,203				10,325				19,950
State and local			1,199				5,514				1,704				6,382
Total taxes			6,775				20,717				12,029				26,332
Net income		$	12,725			$	30,435			$	24,985			$	39,996
Basic earnings per common share		$	0.44			$	1.05			$	0.86			$	1.38
Diluted earnings per common share		$	0.44			$	1.05			$	0.86			$	1.38
Dividends per common share		$	0.18			$	0.17			$	0.36			$	0.34

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		For the three months ended								For the six months ended
		June 30,								June 30,
(In thousands)		2017				2016				2017				2016
Net income		$	12,725			$	30,435			$	24,985			$	39,996
Other comprehensive income, net of tax:
Amortization of actuarial losses, net of taxes of ($64) and ($82) for the three months ended June 30, 2017 and 2016, respectively and of ($128) and ($165) for the six months ended June 30, 2017 and 2016, respectively.			87				110				174				219
Amortization of prior service credits, net of taxes of $5 for each of the three months ended June 30, 2017 and 2016, respectively and $9 and $10 for the six months ended June 30, 2017 and 2016, respectively.			(6	)			(7	)			(13	)			(13	)
Reclassification adjustment for net gains included in income, net of taxes of $1,013 for the three and six months ended June 30, 2016.			-				(1,350	)			-				(1,350	)
Net unrealized gains on securities, net of taxes of ($436) and $2,252 for the three months ended June 30, 2017 and 2016, respectively and of ($1,247) and ($7,280) for the six months ended June 30, 2017 and 2016, respectively.			601				3,024				1,749				9,794
Net unrealized loss on cash flow hedge, net of taxes of $90 for the three and six months ended June 30, 2017.			(124	)			-				(124	)			-
Total other comprehensive income, net of tax			558				1,777				1,786				8,650
Comprehensive income		$	13,283			$	32,212			$	26,771			$	48,646

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		For the six months ended
		June 30,
(Dollars in thousands)		2017				2016
CASH FLOWS FROM OPERATING ACTIVITIES
Net income		$	24,985			$	39,996
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization of bank premises and equipment			2,320				2,094
Amortization of premium, net of accretion of discount			3,657				4,099
Net loss from fair value adjustments			1,537				2,102
Net gain from sale of loans			(244	)			(344	)
Net gain from sale of securities			-				(2,363	)
Net gain from sale of buildings			-				(33,814	)
Net (gain) loss from sale of OREO			(50	)			897
Income from bank owned life insurance			(1,602	)			(1,389	)
Gain from life insurance proceeds			(1,167	)			(411	)
Stock-based compensation expense			4,190				3,673
Deferred compensation			(1,930	)			(2,629	)
Excess tax benefit from stock-based payment arrangements			-				(421	)
Deferred income tax provision			1,005				83
(Increase) decrease in other assets			(21	)			3,857
Increase in other liabilities			4				16,102
Net cash provided by operating activities			32,684				31,532
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of bank premises and equipment			(2,351	)			(1,460	)
Net purchases of Federal Home Loan Bank of New York shares			(7,457	)			(11,129	)
Purchases of securities held-to-maturity			(8,030	)			(27,705	)
Proceeds from maturities of securities held-to-maturity			13,330				5,475
Purchases of securities available for sale			(40,641	)			(61,615	)
Proceeds from sales and calls of securities available for sale			27,500				66,996
Proceeds from maturities and prepayments of securities available for sale			38,161				53,856
Proceeds from bank owned life insurance			3,911				2,236
Proceeds from sale of buildings			-				34,332
Net originations of loans			(201,438	)			(160,139	)
Purchases of loans			(58,431	)			(137,994	)
Proceeds from sale of real estate owned			583				853
Proceeds from sale of loans			21,575				8,360
Net cash used in investing activities			(213,288	)			(227,934	)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in non-interest bearing deposits			16,139				47,643
Net increase (decrease) in interest-bearing deposits			31,629				(8,448	)
Net increase in mortgagors' escrow deposits			1,087				9,061
Net proceeds from short-term borrowed funds			66,500				215,000
Proceeds from long-term borrowings			173,066				150,000
Repayment of long-term borrowings			(82,049	)			(190,637	)
Purchases of treasury stock			(2,599	)			(9,085	)
Excess tax benefit from stock-based payment arrangements			-				421
Proceeds from issuance of common stock upon exercise of stock options			-				127
Cash dividends paid			(10,487	)			(9,878	)
Net cash provided by financing activities			193,286				204,204
Net increase in cash and cash equivalents			12,682				7,802
Cash and cash equivalents, beginning of period			35,857				42,363
Cash and cash equivalents, end of period		$	48,539			$	50,165
SUPPLEMENTAL CASHFLOW DISCLOSURE
Interest paid		$	27,840			$	28,250
Income taxes paid			10,646				9,270
Taxes paid if excess tax benefits were not tax deductible			10,646				9,691
Non-cash activities:
Loans transferred to Other Real Estate Owned			-				486
Loans held for investment transferred to loans available for sale			30,565				-

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(Dollars in thousands, except per share data)		Total				Common Stock				Additional Paid-in Capital				Retained Earnings				Treasury Stock				Accumulated Other Comprehensive Income (Loss)
Balance at December 31, 2016		$	513,853			$	315			$	214,462			$	361,192			$	(53,754	)		$	(8,362	)
Net Income			24,985				-				-				24,985				-				-
Award of common shares released from Employee Benefit Trust (111,470 shares)			2,363				-				2,363				-				-				-
Vesting of restricted stock unit awards (258,165 shares)			-				-				(4,562	)			(262	)			4,824				-
Exercise of stock options (4,400 shares)			-				-				(6	)			(40	)			46				-
Stock-based compensation expense			4,190				-				4,190				-				-				-
Purchase of treasury shares (10,000 shares)			(278	)			-				-				-				(278	)			-
Repurchase of shares to satisfy tax obligation (80,303 shares)			(2,321	)			-				-				-				(2,321	)			-
Dividends on common stock ($0.36 per share)			(10,487	)			-				-				(10,487	)			-				-
Other comprehensive income			1,786				-				-				-				-				1,786
Balance at June 30, 2017		$	534,091			$	315			$	216,447			$	375,388			$	(51,483	)		$	(6,576	)
Balance at December 31, 2015		$	473,067			$	315			$	210,652			$	316,530			$	(48,868	)		$	(5,562	)
Net Income			39,996				-				-				39,996				-				-
Award of common shares released from Employee
Benefit Trust (134,005 shares)			1,912				-				1,912				-				-				-
Vesting of restricted stock unit awards (245,111 shares)			-				-				(4,047	)			(396	)			4,443				-
Exercise of stock options (27,945 shares)			127				-				2				(34	)			159				-
Stock-based compensation expense			3,673				-				3,673				-				-				-
Stock-based income tax benefit			421				-				421				-				-				-
Purchase of treasury shares (378,695 shares)			(7,492	)			-				-				-				(7,492	)			-
Repurchase of shares to satisfy tax obligation (77,212 shares)			(1,593	)			-				-				-				(1,593	)			-
Dividends on common stock ($0.34 per share)			(9,878	)			-				-				(9,878	)			-				-
Other comprehensive income			8,650				-				-				-				-				8,650
Balance at June 30, 2016		$	508,883			$	315			$	212,613			$	346,218			$	(53,351	)		$	3,088

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PART I – FINANCIAL INFORMATION

FLUSHING FINANCIAL CORPORATION and SUBSIDIARIES

Notes to Consolidated Financial Statements

(Unaudited)

1.             Basis of Presentation

The primary business of Flushing Financial Corporation (the “Holding Company”), a Delaware corporation, is the operation of its wholly owned subsidiary, Flushing Bank (the “Bank”).

The unaudited consolidated financial statements presented in this Quarterly Report on Form 10-Q (“Quarterly Report”) include the collective results of the Holding Company and its direct and indirect wholly-owned subsidiaries, including the Bank, Flushing Preferred Funding Corporation, Flushing Service Corporation, and FSB Properties Inc., which are collectively herein referred to as “we,” “us,” “our” and the “Company.”

The Holding Company also owns Flushing Financial Capital Trust II, Flushing Financial Capital Trust III, and Flushing Financial Capital Trust IV (the “Trusts”), which are special purpose business trusts. The Trusts are not included in the Company’s consolidated financial statements, as the Company would not absorb the losses of the Trusts if any losses were to occur.

The accompanying unaudited consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and general practices within the banking industry. The information furnished in these interim statements reflects all adjustments that are, in the opinion of management, necessary for a fair statement of the results for such presented periods of the Company. Such adjustments are of a normal recurring nature, unless otherwise disclosed in this Quarterly Report. All inter-company balances and transactions have been eliminated in consolidation. The results of operations in the interim statements are not necessarily indicative of the results that may be expected for the full year.

The accompanying unaudited consolidated financial statements have been prepared in conformity with the instructions to Quarterly Report on Form 10-Q and Article 10, Rule 10-01 of Regulation S-X for interim financial statements. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The unaudited consolidated interim financial information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

When necessary, certain reclassifications were made to prior-year amounts to conform to the current-year presentation.

2. Use of Estimates

The preparation of financial statements in conformity with 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 reported amounts of revenue and expenses during the reporting period. Estimates that are particularly susceptible to change in the near term are used in connection with the determination of the allowance for loan losses (“ALLL”), the evaluation of goodwill for impairment, the review of the need for a valuation allowance of the Company’s deferred tax assets, the fair value of financial instruments and the evaluation of other-than-temporary impairment (“OTTI”) on securities. Actual results could differ from these estimates.

3.               Earnings Per Share

Basic earnings per common share is computed by dividing net income available to common shareholders by the total weighted average number of common shares outstanding, which includes unvested participating securities. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and as such are included in the calculation of earnings per share. The Company’s unvested restricted stock unit awards are considered participating securities. Therefore, weighted average common shares outstanding used for computing basic earnings per common share includes common shares outstanding plus unvested restricted stock unit awards. The computation of diluted earnings per share includes the additional dilutive effect of stock options outstanding and other common stock equivalents during the period. Common stock equivalents that are anti-dilutive are not included in the computation of diluted earnings per common share. The numerator for calculating basic and diluted earnings per common share is net income available to common shareholders. The shares held in the Company’s Employee Benefit Trust are not included in shares outstanding for purposes of calculating earnings per common share.

Earnings per common share have been computed based on the following:

(1)

For the three and six months ended June 30, 2017 and 2016, there were no stock options that were anti-dilutive.

4.

Debt and Equity Securities

The Company’s investments in equity securities that have readily determinable fair values and all investments in debt securities are classified in one of the following three categories and accounted for accordingly: (1) trading securities, (2) securities available for sale and (3) securities held-to-maturity.

The Company did not hold any trading securities at June 30, 2017 and December 31, 2016. Securities available for sale are recorded at fair value. Securities held-to-maturity are recorded at amortized cost.

The following table summarizes the Company’s portfolio of securities held-to-maturity at June 30, 2017:

The following table summarizes the Company’s portfolio of securities held-to-maturity at December 31, 2016:

The following table summarizes the Company’s portfolio of securities available for sale at June 30, 2017:

The following table summarizes the Company’s portfolio of securities available for sale at December 31, 2016:

Mortgage-backed securities shown in the table above include one private issue CMO that is collateralized by commercial real estate mortgages with an amortized cost and market value of $0.1 million and $0.2 million at June 30, 2017 and December 31, 2016, respectively.

The corporate securities held by the Company at June 30, 2017 and December 31, 2016 are issued by U.S. banking institutions.

The following tables detail the amortized cost and fair value of the Company’s securities classified as held-to-maturity and available for sale at June 30, 2017 by contractual maturity. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

The following tables show the Company’s securities with gross unrealized losses and their fair value, aggregated by category and length of time that individual securities have been in a continuous unrealized loss position, at the dates indicated:

OTTI losses on impaired securities must be fully recognized in earnings if an investor has the intent to sell the debt security or if it is more likely than not that the investor will be required to sell the debt security before recovery of its amortized cost. However, even if an investor does not expect to sell a debt security in an unrealized loss position, the investor must evaluate the expected cash flows to be received and determine if a credit loss has occurred. In the event that a credit loss has occurred, only the amount of impairment associated with the credit loss is recognized in earnings in the Consolidated Statements of Income. Amounts relating to factors other than credit losses are recorded in accumulated other comprehensive loss (“AOCL”) within Stockholders’ Equity. Unrealized losses on available for sale securities, that are deemed to be temporary, are recorded in AOCL, net of tax.

The Company reviewed each investment that had an unrealized loss at June 30, 2017 and December 31, 2016. The unrealized losses in FNMA securities held-to-maturity at June 30, 2017 were caused by movements in interest rates. The unrealized losses in municipal securities held-to-maturity at June 30, 2017 and December 31, 2016 were caused by illiquidity in the market and movements in interest rates. The unrealized losses in securities available for sale at June 30, 2017 and December 31, 2016 were caused by movements in interest rates.

It is not anticipated that these securities would be settled at a price that is less than the amortized cost of the Company’s investment. Each of these securities is performing according to its terms and, in the opinion of management, will continue to perform according to its terms. The Company does not have the intent to sell these securities and it is more likely than not the Company will not be required to sell the securities before recovery of the securities’ amortized cost basis. This conclusion is based upon considering the Company’s cash and working capital requirements and contractual and regulatory obligations, none of which the Company believes would cause the sale of the securities. Therefore, the Company did not consider these investments to be other-than-temporarily impaired at June 30, 2017 and December 31, 2016.

Realized gains and losses on the sales of securities are determined using the specific identification method. The Company sold available for sale securities totaling $64.6 million during the three and six months ended June 30, 2016. The Company did not sell any securities available for sale during the three and six months ended June 30, 2017.

The following table represents the gross gains and gross losses realized from the sale of securities available for sale for the periods indicated:

5.             Loans

Loans are reported at their principal outstanding balance net of any unearned income, charge-offs, deferred loan fees and costs on originated loans and unamortized premiums or discounts on purchased loans. Interest on loans is recognized on the accrual basis. The accrual of income on loans is generally discontinued when certain factors, such as contractual delinquency of 90 days or more, indicate reasonable doubt as to the timely collectability of such income. Uncollected interest previously recognized on non-accrual loans is reversed from interest income at the time the loan is placed on non-accrual status. A non-accrual loan can be returned to accrual status when contractual delinquency returns to less than 90 days delinquent. Subsequent cash payments received on non-accrual loans that do not bring the loan to less than 90 days delinquent are recorded on a cash basis. Subsequent cash payments can also be applied first as a reduction of principal until all principal is recovered and then subsequently to interest, if in management’s opinion, it is evident that recovery of all principal due is likely to occur. Loan fees and certain loan origination costs are deferred. Net loan origination costs and premiums or discounts on loans purchased are amortized into interest income over the contractual life of the loans using the level-yield method. Prepayment penalties received on loans which pay in full prior to their scheduled maturity are included in interest income in the period they are collected.

The Company maintains an allowance for loan losses at an amount, which, in management’s judgment, is adequate to absorb probable estimated losses inherent in the loan portfolio. Management’s judgment in determining the adequacy of the allowance is based on evaluations of the collectability of loans. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revisions as more information becomes available. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses.  The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. The allowance is established through a provision for loan losses based on management’s evaluation of the risk inherent in the various components of the loan portfolio and other factors, including historical loan loss experience (which is updated quarterly), current economic conditions, delinquency and non-accrual trends, classified loan levels, risk in the portfolio and volumes and trends in loan types, recent trends in charge-offs, changes in underwriting standards, experience, ability and depth of the Company’s lenders, collection policies and experience, internal loan review function and other external factors. The Company segregated its loans into two portfolios based on year of origination. One portfolio was reviewed for loans originated after December 31, 2009 and a second portfolio for loans originated prior to January 1, 2010. Our decision to segregate the portfolio based upon origination dates was based on changes made in our underwriting standards during 2009. By the end of 2009, all loans were being underwritten based on revised and tightened underwriting standards. Loans originated prior to 2010 have a higher delinquency rate and loss history. Each of the years in the portfolio for loans originated prior to 2010 has a similar delinquency rate. The determination of the amount of the allowance for loan losses includes estimates that are susceptible to significant changes due to changes in appraisal values of collateral, national and local economic conditions and other factors. We review our loan portfolio by separate categories with similar risk and collateral characteristics. Impaired loans are segregated and reviewed separately. All non-accrual loans are classified as impaired loans. The Company’s Board of Directors reviews and approves management’s evaluation of the adequacy of the allowance for loan losses on a quarterly basis.

The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. Increases and decreases in the allowance other than charge-offs and recoveries are included in the provision for loan losses. When a loan or a portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance, and subsequent recoveries, if any, are credited to the allowance.

The Company recognizes a loan as non-performing when the borrower has demonstrated the inability to bring the loan current, or due to other circumstances which, in management’s opinion, indicate the borrower will be unable to bring the loan current within a reasonable time. All loans classified as non-performing, which includes all loans past due 90 days or more, are classified as non-accrual unless there is, in our opinion, compelling evidence the borrower will bring the loan current in the immediate future. Appraisals are obtained and/or updated internal evaluations are prepared as soon as practical, and before the loan becomes 90 days delinquent. The loan balances of collateral dependent impaired loans are compared to the property’s updated fair value. The Company considers fair value of collateral dependent loans to be 85% of the appraised or internally estimated value of the property, except for taxi medallion loans. The fair value of the underlying collateral of taxi medallion loans is the value of the underlying medallion based upon the most recently reported arm’s length transaction. The balance which exceeds fair value is generally charged-off. In addition, taxi medallion loans on accrual status with a loan-to-value greater than 100% are classified as impaired and allocated a portion of the ALLL in the amount of the excess of the loan-to-value over the loan’s principal balance. The 85% is based on the actual net proceeds the Bank has received from the sale of other real estate owned (“OREO”) as a percentage of OREO’s appraised value.

A loan is considered impaired when, based upon current information, the Company believes it is probable that it will be unable to collect all amounts due, both principal and interest, in accordance with the original terms of the loan. Impaired loans are measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or at the loan’s observable market price or, as a practical expedient, the fair value of the collateral if the loan is collateral dependent. Interest income on impaired loans is recorded on the cash basis.

The Company reviews each impaired loan on an individual basis to determine if either a charge-off or a valuation allowance needs to be allocated to the loan. The Company does not charge-off or allocate a valuation allowance to loans for which management has concluded the current value of the underlying collateral will allow for recovery of the loan balance either through the sale of the loan or by foreclosure and sale of the property.

The Company evaluates the underlying collateral through a third party appraisal, or when a third party appraisal is not available, the Company will use an internal evaluation. The internal evaluations are prepared using an income approach or a sales approach. The income approach is used for income producing properties and uses current revenues less operating expenses to determine the net cash flow of the property. Once the net cash flow is determined, the value of the property is calculated using an appropriate capitalization rate for the property. The sales approach uses comparable sales prices in the market. When an internal evaluation is used, we place greater reliance on the income approach to value the collateral.

In preparing internal evaluations of property values, the Company seeks to obtain current data on the subject property from various sources, including: (1) the borrower; (2) copies of existing leases; (3) local real estate brokers and appraisers; (4) public records (such as for real estate taxes and water and sewer charges); (5) comparable sales and rental data in the market; (6) an inspection of the property and (7) interviews with tenants. These internal evaluations primarily focus on the income approach and comparable sales data to value the property.

As of June 30, 2017, we utilized recent third party appraisals of the collateral to measure impairment for $41.9 million, or 82.4%, of collateral dependent impaired loans, and used internal evaluations of the property’s value for $8.9 million, or 17.6%, of collateral dependent impaired loans.

The Company may restructure a loan to enable a borrower experiencing financial difficulties to continue making payments when it is deemed to be in the Company’s best long-term interest. This restructure may include reducing the interest rate or amount of the monthly payment for a specified period of time, after which the interest rate and repayment terms revert to the original terms of the loan. We classify these loans as Troubled Debt Restructured (“TDR”).

These restructurings have not included a reduction of principal balance. The Company believes that restructuring these loans in this manner will allow certain borrowers to become and remain current on their loans. All loans classified as TDR are considered impaired, however TDR loans which have been current for six consecutive months at the time they are restructured as TDR remain on accrual status and are not included as part of non-performing loans. Loans which were delinquent at the time they are restructured as a TDR are placed on non-accrual status and reported as non-accrual loans until they have made timely payments for six consecutive months.

The allocation of a portion of the allowance for loan losses for a performing TDR loan is based upon the present value of the future expected cash flows discounted at the loan’s original effective rate, or for a non-performing TDR, which is collateral dependent, the fair value of the collateral. At June 30, 2017, there were no commitments to lend additional funds to borrowers whose loans were modified to a TDR. The modification of loans to a TDR did not have a significant effect on our operating results, nor did it require a significant allocation of the allowance for loan losses.

The following tables shows loans modified and classified as TDR during the periods indicated:

The recorded investment of the loans modified and classified as TDR presented in the tables above, were unchanged as there was no principal forgiven in this modification.

The following table shows our recorded investment for loans classified as TDR that are performing according to their restructured terms at the periods indicated:

The following table shows our recorded investment for loans classified as TDR that are not performing according to their restructured terms at the periods indicated:

During the three and six months ended June 30, 2017 and 2016 there were no TDR loans transferred to non-performing status.

The following table shows our non-performing loans at the dates indicated:

The following is a summary of interest foregone on non-accrual loans and loans classified as TDR for the periods indicated:

The following tables show an age analysis of our recorded investment in loans, including loans past maturity, at the periods indicated:

The following tables show the activity in the allowance for loan losses for the three month periods indicated:

The following tables show the activity in the allowance for loan losses for the six month periods indicated:

The following tables show the manner in which loans were evaluated for impairment at the periods indicated:

The following table shows our recorded investment, unpaid principal balance and allocated allowance for loan losses for impaired loans at the dates indicated:

The following table shows our average recorded investment and interest income recognized for impaired loans for the three months ended:

The following table shows our average recorded investment and interest income recognized for impaired loans for the six months ended:

In accordance with our policy and the current regulatory guidelines, we designate loans as “Special Mention,” which are considered “Criticized Loans,” and “Substandard,” “Doubtful,” or “Loss,” which are considered “Classified Loans.” If a loan does not fall within one of the previous mentioned categories, then the loan would be considered “Pass.” These loan designations are updated quarterly. We designate a loan as Substandard when a well-defined weakness is identified that jeopardizes the orderly liquidation of the debt. We designate a loan Doubtful when it displays the inherent weakness of a Substandard loan with the added provision that collection of the debt in full, on the basis of existing facts, is highly improbable. We designate a loan as Loss if it is deemed the debtor is incapable of repayment. The Company does not hold any loans designated as loss, as loans that are designated as Loss are charged-off. Loans that are non-accrual are designated as Substandard, Doubtful or Loss. We designate a loan as Special Mention if the asset does not warrant classification within one of the other classifications, but does contain a potential weakness that deserves closer attention.

The following table sets forth the recorded investment in loans designated as Criticized or Classified at the dates indicated:

Commitments to extend credit (principally real estate mortgage loans) and lines of credit (principally home equity lines of credit and business lines of credit) amounted to $77.1 million and $243.0 million, respectively, at June 30, 2017.