nbn20180930_10q.htm
 

 

Table of Contents

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, 2018

 

Commission File Number: 1-14588

 

 

Northeast Bancorp


(Exact name of registrant as specified in its charter)

 

Maine

 

01-0425066

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

     

500 Canal Street, Lewiston, Maine

 

04240

(Address of Principal executive offices)

 

(Zip Code)

 

(207) 786-3245

Registrant's telephone number, including area code

 

 

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 subjected to such filing requirements for the past 90 days. Yes ☑ No ___

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit 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 an emerging growth company. See definition of “accelerated filer,” and “large accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 Large accelerated filer ☐

 

Accelerated filer ☒

  

 

  

Non-accelerated filer ☐

 

Smaller reporting company ☐

 

 

  

Emerging growth company ☐

  

  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐ 

 

Indicate by check mark whether the registrant is a shell company (as defined by 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. As of November 2, 2018, the registrant had outstanding 8,235,943 shares of voting common stock, $1.00 par value per share and 811,946 shares of non-voting common stock, $1.00 par value per share. 

 

 

 

Part I.

Financial Information

 

 

Item 1.

Financial Statements (Unaudited)

3

 

 

Consolidated Balance Sheets September 30, 2018 and June 30, 2018

3

 

 

 

 

 

 

Consolidated Statements of Income Three Months Ended September 30, 2018 and 2017

4
       
   

Consolidated Statements of Comprehensive Income Three Months Ended September 30, 2018 and 2017

5
       

 

 

Consolidated Statements of Changes in Shareholders' Equity Three Months Ended September 30, 2018 and 2017

6

 

 

 

 

 

 

Consolidated Statements of Cash Flows Three Months Ended September 30, 2018 and 2017

7

 

 

 

 

 

 

Notes to Unaudited Consolidated Financial Statements

8

 

 

 

 

 

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

27

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

40

 

 

 

 

 

Item 4.

Controls and Procedures

41
       

Part II.

Other Information

 

 

 

 

 

 

Item 1.

Legal Proceedings

42

 

 

 

 

 

Item 1A.

Risk Factors

42

 

 

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

42

 

 

 

 

 

Item 3.

Defaults Upon Senior Securities

42

 

 

 

 

 

Item 4.

Mine Safety Disclosures

42

 

 

 

 

 

Item 5.

Other Information

42

 

 

 

 

 

Item 6.

Exhibits

42
       
   

Signatures

43

 

 

PART 1- FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

(Unaudited)

(Dollars in thousands, except share and per share data)

   

September 30, 2018

   

June 30, 2018

 

Assets

               

Cash and due from banks

  $ 2,668     $ 3,889  

Short-term investments

    203,049       153,513  

Total cash and cash equivalents

    205,717       157,402  
                 
                 

Available-for-sale debt securities, at fair value

    79,157       81,068  

Equity securities, at fair value

    6,620       6,619  

Total investment securities

    85,777       87,687  
                 

Residential real estate loans held for sale

    1,940       3,405  

SBA loans held for sale

    1,350       3,750  

Total loans held for sale

    3,290       7,155  
                 
                 

Loans

               

Commercial real estate

    599,624       579,450  

Commercial and industrial

    191,286       188,852  

Residential real estate

    93,308       100,256  

Consumer

    2,978       3,244  

Total loans

    887,196       871,802  

Less: Allowance for loan losses

    5,288       4,807  

Loans, net

    881,908       866,995  
                 
                 

Premises and equipment, net

    6,314       6,591  

Real estate owned and other repossessed collateral, net

    1,549       2,233  

Federal Home Loan Bank stock, at cost

    1,652       1,652  

Intangible assets, net

    758       867  

Servicing rights, net

    3,010       2,970  

Bank-owned life insurance

    16,729       16,620  

Other assets

    7,013       7,564  

Total assets

  $ 1,213,717     $ 1,157,736  
                 

Liabilities and Shareholders' Equity

               

Deposits

               

Demand

  $ 67,500     $ 72,272  

Savings and interest checking

    109,564       109,637  

Money market

    398,423       420,886  

Time

    440,020       352,145  

Total deposits

    1,015,507       954,940  
                 

Federal Home Loan Bank advances

    15,000       15,000  

Subordinated debt

    24,043       23,958  

Capital lease obligation

    536       605  

Other liabilities

    15,240       24,803  

Total liabilities

    1,070,326       1,019,306  
                 

Commitments and contingencies

    -       -  
                 
                 

Shareholders' equity

               

Preferred stock, $1.00 par value, 1,000,000 shares authorized; no shares issued and outstanding at September 30, 2018 and June 30, 2018

    -       -  

Voting common stock, $1.00 par value, 25,000,000 shares authorized; 8,226,648 and 8,056,527 shares issued and outstanding at September 30, 2018 and June 30, 2018, respectively

    8,226       8,057  

Non-voting common stock, $1.00 par value, 3,000,000 shares authorized; 820,742 and 882,314 shares issued and outstanding at September 30, 2018 and June 30, 2018, respectively

    821       882  

Additional paid-in capital

    77,075       77,016  

Retained earnings

    58,501       54,236  

Accumulated other comprehensive loss

    (1,232 )     (1,761 )

Total shareholders' equity

    143,391       138,430  

Total liabilities and shareholders' equity

  $ 1,213,717     $ 1,157,736  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

(Dollars in thousands, except share and per share data)

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 

Interest and dividend income:

               

Interest and fees on loans

  $ 17,525     $ 15,383  

Interest on investment securities

    362       266  

Other interest and dividend income

    880       529  

Total interest and dividend income

    18,767       16,178  
                 

Interest expense:

               

Deposits

    3,682       2,176  

Federal Home Loan Bank advances

    118       172  

Subordinated debt

    601       508  

Obligation under capital lease agreements

    7       11  

Total interest expense

    4,408       2,867  

Net interest and dividend income before provision for loan losses

    14,359       13,311  

Provision for loan losses

    532       354  

Net interest and dividend income after provision for loan losses

    13,827       12,957  
                 

Noninterest income:

               

Fees for other services to customers

    492       526  

Gain on sales of SBA loans

    851       1,019  

Gain on sales of residential loans held for sale

    174       291  

Net unrealized loss on equity securities

    (40 )     -  

Loss on real estate owned, other repossessed collateral and premises and equipment, net

    (40 )     -  

Bank-owned life insurance income

    110       112  

Other noninterest income

    7       10  

Total noninterest income

    1,554       1,958  
                 

Noninterest expense:

               

Salaries and employee benefits

    5,509       5,254  

Occupancy and equipment expense

    1,127       1,109  

Professional fees

    534       442  

Data processing fees

    601       604  

Marketing expense

    124       87  

Loan acquisition and collection expense

    439       365  

FDIC insurance premiums

    81       80  

Intangible asset amortization

    109       109  

Other noninterest expense

    831       664  

Total noninterest expense

    9,355       8,714  

Income before income tax expense

    6,026       6,201  

Income tax expense

    1,492       1,615  

Net income

  $ 4,534     $ 4,586  
                 

Weighted-average common shares outstanding:

               

Basic

    8,995,925       8,841,511  

Diluted

    9,183,729       9,089,936  
                 

Earnings per common share:

               
                 

Basic

  $ 0.50     $ 0.52  

Diluted

    0.49       0.50  
                 

Cash dividends declared per common share

  $ 0.01     $ 0.01  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

(Dollars in thousands)

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 
                 

Net income

  $ 4,534     $ 4,586  
                 

Other comprehensive income, before tax:

               

Available-for-sale debt securities:

               

Change in net unrealized loss on available-for-sale debt securities

    (74 )     122  

Derivatives and hedging activities:

               

Change in accumulated loss on effective cash flow hedges

    482       22  

Reclassification adjustments included in interest expense

    70       23  

Total derivatives and hedging activities

    552       45  

Total other comprehensive income, before tax

    478       167  

Income tax expense related to other comprehensive income

    129       63  

Other comprehensive income, net of tax

    349       104  

Comprehensive income

  $ 4,883     $ 4,690  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

(Dollars in thousands, except share and per share data)

 

                                                                   

Accumulated

         
                                                                   

Other

   

Total

 
   

Preferred Stock

   

Voting Common Stock

   

Non-voting Common Stock

   

Additional

   

Retained

   

Comprehensive

   

Shareholders'

 
   

Shares

   

Amount

   

Shares

   

Amount

   

Shares

   

Amount

   

Paid-in Capital

   

Earnings

   

Loss

   

Equity

 
                                                                                 

Balance at June 30, 2017

    -       -       7,840,460     $ 7,841       991,194     $ 991     $ 77,455     $ 38,142     $ (1,632 )   $ 122,797  

Net income

    -       -       -       -       -       -       -       4,586       -       4,586  

Other comprehensive income, net of tax

    -       -       -       -       -       -       -       -       104       104  

Conversions between voting common stock and non- voting common stock, net

    -       -       -       -       -       -       -       -       -       -  

Dividends on common stock at $0.01 per share

    -       -       -       -       -       -       -       (87 )     -       (87 )

Stock-based compensation

    -       -       -       -       -       -       220       -       -       220  

Issuance of restricted common stock

    -       -       10,000       10       -       -       (10 )     -       -       -  

Cancellation and forfeiture of restricted common stock

    -       -       (15,089 )     (15 )     -       -       (39 )     -       -       (54 )

Stock options exercised, net

    -       -       63,788       63       -       -       (917 )     -       -       (854 )

Balance at September 30, 2017

    -     $ -       7,899,159     $ 7,899       991,194     $ 991     $ 76,709     $ 42,641     $ (1,528 )   $ 126,712  
                                                                                 

Balance at June 30, 2018

    -       -       8,056,527     $ 8,057       882,314     $ 882     $ 77,016     $ 54,236     $ (1,761 )   $ 138,430  

Net income

    -       -       -       -       -       -       -       4,534       -       4,534  

Other comprehensive income, net of tax

    -       -       -       -       -       -       -       -       349       349  

Conversions between voting common stock and non- voting common stock, net

    -       -       61,572       61       (61,572 )     (61 )     -       -       -       -  

Dividends on common stock at $0.01 per share

    -       -       -       -       -       -       -       (89 )     -       (89 )

Stock-based compensation

    -       -       -       -       -       -       299       -       -       299  

Issuance of restricted common stock

    -       -       114,925       114       -       -       (114 )     -       -       -  

Cancellation and forfeiture of restricted common stock

    -       -       (6,376 )     (6 )     -       -       (126 )     -       -       (132 )

Stock options exercised, net

    -       -       -       -       -       -       -       -       -       -  

Adjustment for adoption of ASU 2016-01

    -       -       -       -       -       -       -       (180 )     180       -  

Balance at September 30, 2018

    -     $ -       8,226,648     $ 8,226       820,742     $ 821     $ 77,075     $ 58,501     $ (1,232 )   $ 143,391  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 

 

NORTHEAST BANCORP AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

 

   

Three Months Ended September 30,

 
   

2018

   

2017

 

Operating activities:

               

Net income

  $ 4,534     $ 4,586  

Adjustments to reconcile net income to net cash used in operating activities:

               

Provision for loan losses

    532       354  

Loss on sale and impairment of real estate owned and other repossessed collateral, net

    40       -  

Net unrealized loss on equity securities

    40       -  

Accretion of fair value adjustments on loans, net

    (1,592 )     (2,938 )

Accretion of fair value adjustments on borrowings, net

    57       50  

Amortization of subordinated debt issuance costs

    28       28  

Originations of loans held for sale

    (25,271 )     (30,545 )

Net proceeds from sales of loans held for sale

    26,523       29,450  

Gain on sales of residential loans held for sale

    (174 )     (291 )

Gain on sales of SBA and other loans held for sale

    (851 )     (1,019 )

Net increase in servicing rights

    (40 )     (109 )

Amortization of intangible assets

    109       109  

Bank-owned life insurance income, net

    (110 )     (112 )

Depreciation of premises and equipment

    333       292  

Stock-based compensation

    299       220  

Amortization of available-for-sale debt securities, net

    109       240  

Changes in other assets and liabilities:

               

Other assets

    496       (990 )

Other liabilities

    (9,085 )     (3,992 )

Net cash used in operating activities

    (4,023 )     (4,667 )

Investing activities:

               

Purchases of available-for-sale debt securities

    (15,992 )     -  

Proceeds from maturities and principal payments on investment securities, net

    17,680       2,067  

Loan purchases

    (34,803 )     (3,651 )

Loan originations, principal collections, and purchased loan paydowns, net

    24,538       22,599  

Purchases and disposals of premises and equipment, net

    (56 )     (629 )

Proceeds from sales of real estate owned and other repossessed collateral

    694       -  

Net cash (used in) provided by investing activities

    (7,939 )     20,386  

Financing activities:

               

Net increase (decrease) in deposits

    60,567       (27,127 )

Dividends paid on common stock

    (89 )     (87 )

Repayment of capital lease obligation

    (69 )     (65 )

Repurchases for tax withholdings on restricted common stock

    (132 )     (54 )

Stock options exercised, net

    -       (854 )

Net cash provided by (used in) financing activities

    60,277       (28,187 )

Net increase (decrease) in cash and cash equivalents

    48,315       (12,468 )

Cash and cash equivalents, beginning of period

    157,402       163,283  

Cash and cash equivalents, end of period

  $ 205,717     $ 150,815  

Supplemental schedule of noncash investing activities:

               

Transfers from loans to real estate owned and other repossessed collateral, net

  $ 50     $ 1,214  

 

The accompanying notes are an integral part of these unaudited consolidated financial statements.

 

 

NORTHEAST BANCORP AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

September 30, 2018

 

 

1. Basis of Presentation

 

The accompanying unaudited interim consolidated financial statements include the accounts of Northeast Bancorp (“Northeast” or the “Company”) and its wholly-owned subsidiary, Northeast Bank (the “Bank”).

 

These unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the accompanying consolidated financial statements contain all adjustments (consisting principally of normal recurring accruals) considered necessary for a fair presentation of the Company's financial position, results of operations, and cash flows for the interim periods presented. These accompanying unaudited financial statements and notes should be read in conjunction with the audited consolidated financial statements and notes thereto for the fiscal year ended June 30, 2018 (“Fiscal 2018”) included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission.

 

 

2. Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 implements a common revenue standard that clarifies the principles for recognizing revenue. The core principle of ASU 2014-09 is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2015-14, Revenue from Contracts with Customers (Topic 606) (“ASU 2015-14”) was issued in August 2015 which deferred adoption to annual reporting periods beginning after December 15, 2017, which was adopted during the three months ended September 30, 2018. The timing of the Company’s revenue recognition did not change. The Company’s largest portions of revenue, interest and fees on loans, interest and dividend income on securities and short-term investments, bank-owned life insurance income, and gain on sales of loans, are specifically excluded from the scope of the guidance. Additionally, fees for other services to customers includes loan servicing fee income which is accounted for under ASC Topic 860, Transfers and Servicing, (“Topic 860”), and is not subject to Topic 606. The other component of fees for other services to customers is deposit fees. The majority of the Company’s deposit fees are specifically related to a customer accessing its funds, in which case the revenue is currently recognized in a consistent manner with Topic 606. Revenue that is not specifically related to a customer accessing its funds (i.e. account maintenance fees), can be waived; however, the amount of waived fees is not considered material, and thus the revenue is consistently recognized with Topic 606.  All other revenue is also recognized in a manner consistent with Topic 606. Because of the above, management believes that revenue recognized under the new guidance approximates revenue recognized under current GAAP.

 

In January 2016, the FASB issued ASU 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). This guidance changes how entities account for equity investments that do not result in consolidation and are not accounted for under the equity method of accounting. Entities will be required to measure these investments at fair value at the end of each reporting period and recognize changes in fair value in net income. A practicability exception will be available for equity investments that do not have readily determinable fair values; however, the exception requires the Company to adjust the carrying amount for impairment and observable price changes in orderly transactions for the identical or a similar investment of the same issuer. This guidance also changes certain disclosure requirements and other aspects of current GAAP. The Company adopted this guidance during the three months ended September 30, 2018. This adoption resulted in a reclassification of $180 thousand from accumulated other comprehensive loss to retained earnings in the consolidated financial statements, with no net effect on shareholders' equity. In addition, the disclosure of the fair value of “Loans, net” in “Notes to Unaudited Consolidated Financial Statements – Note 11: Fair Value Measurements” is now calculated based on an exit pricing strategy versus an entry pricing strategy.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). The new guidance establishes the principles to report transparent and economically neutral information about the assets and liabilities that arise from leases. Entities will be required to recognize the lease assets and lease liabilities that arise from leases in the statement of financial position and to disclose qualitative and quantitative information about lease transactions, such as information about variable lease payments and options to renew and terminate leases. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within the fiscal year. The Company is currently evaluating the impact of the adoption of ASU 2016-02 to determine the potential impact it will have on its consolidated financial statements. The Company’s assets and liabilities will increase based on the present value of the remaining lease payments for leases in place at the adoption date; however, this is not expected to be material to the Company’s results of operations.

 

 

In June 2016, the FASB issued ASU 2016-13, Financial InstrumentsCredit Losses (Topic 326) (“ASU 2016-13”). This guidance is intended to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this guidance replace the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. This ASU will be effective for fiscal years beginning after December 15, 2019. Early adoption is available as of the fiscal year beginning after December 15, 2018. The Company is evaluating the provisions of the guidance, and will closely monitor developments and additional guidance to determine the potential impact on the Company’s consolidated financial statements. Management is in the process of identifying the methodologies and the additional data requirements necessary to implement the guidance and has engaged an existing third-party service provider to assist in implementation.

  

In May 2017, the FASB issued ASU 2017-09, Compensation – Stock Compensation (Topic 718): Scope of Modification Accounting (“ASU 2017-09”) which amends the scope of modification accounting for share-based payment arrangements. This update provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions, and classification of the awards are the same immediately before and after the modification. This update was adopted during the three months ended September 30, 2018 and did not have an impact on the Company’s consolidated financial statements.

 

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815) (“ASU 2017-12”). This guidance permits hedge accounting for risk components in hedging relationships involving nonfinancial risk and interest rate risk, and improves the financial reporting of hedging relationships to better portray the economic results of an entity’s risk management activities in its financial statements. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

 

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases (“ASU 2018-10”) and ASU 2018-11, Leases (Topic 842) (“ASU 2018-11”). The guidance provides clarification on the application of ASU 2016-02, specifically on certain narrow aspects of the guidance issued under ASU 2016-02, including comparative reporting requirements for initial adoption and, for lessors only, separating lease and non-lease components in a contract and allocating the consideration in the contract to the separate components. For entities that have not adopted ASU 2016-02 before the issuance of these updates, the amendments in this guidance are the same as the effective date and transition requirements in ASU 2016-02. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurements (Topic 820) (“ASU 2018-13”). This update modifies disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement. This includes removing requirements related to transfers between Level 1 and Level 2, the policy of timing of transfers between levels, and the valuation process for Level 3 fair value measurements, modifying disclosure requirements related to investments in certain entities that calculate net asset value, and adding disclosure requirements for changes in unrealized gains and losses for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The adoption of this guidance is not expected to have a significant impact on the Company’s consolidated financial statements.

 

 

 

3. Investment Securities

 

The following presents a summary of the amortized cost, gross unrealized holding gains and losses, and fair value of investment securities.

 

   

September 30, 2018

 
   

Amortized

   

Gross Unrealized

   

Gross Unrealized

   

Fair

 
   

Cost

   

Gains

    Losses    

Value

 
   

(Dollars in thousands)

 

U.S. Government agency securities

  $ 57,085     $ -     $ (264 )   $ 56,821  

Agency mortgage-backed securities

    23,483       -       (1,147 )     22,336  

Equity investments measured at net asset value

    6,907       -       (287 )     6,620  
Total investment securities   $ 87,475     $ -     $ (1,698 )   $ 85,777  

 

   

June 30, 2018

 
   

Amortized

   

Gross Unrealized

   

Gross Unrealized

   

Fair

 
    Cost    

Gains

   

Losses

   

Value

 
   

(Dollars in thousands)

 

U.S. Government agency securities

  $ 57,129     $ -     $ (242 )   $ 56,887  

Agency mortgage-backed securities

    25,276       -       (1,095 )     24,181  

Equity investments measured at net asset value

    6,866       -       (247 )     6,619  
Total investment securities   $ 89,271     $ -     $ (1,584 )   $ 87,687  

 

At September 30, 2018 and June 30, 2018, the Company held no securities of any single issuer (excluding the U. S. Government and government agencies) with a book value that exceeded 10% of shareholders’ equity.

 

When securities are sold, the adjusted cost of the specific security sold is used to compute the gain or loss on sale. There were no securities sold during the three months ended September 30, 2018 or 2017. At September 30, 2018, no investment securities were pledged as collateral to secure outstanding borrowings.

 

The following summarizes the Company’s gross unrealized losses and fair values aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position.

 

   

September 30, 2018

 
   

Less than 12 Months

   

More than 12 Months

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
   

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 
   

(Dollars in thousands)

 
                                                 

U.S. Government agency securities

  $ 41,873     $ (213 )   $ 14,948     $ (51 )   $ 56,821     $ (264 )

Agency mortgage-backed securities

    554       (15 )     21,782       (1,132 )     22,336       (1,147 )

Equity investments measured at net asset value

    -       -       5,067       (287 )     5,067       (287 )
Total investment securities   $ 42,427     $ (228 )   $ 41,797     $ (1,470 )   $ 84,224     $ (1,698 )

 

   

June 30, 2018

 
   

Less than 12 Months

   

More than 12 Months

   

Total

 
   

Fair

   

Unrealized

   

Fair

   

Unrealized

   

Fair

   

Unrealized

 
    Value     Losses     Value     Losses     Value     Losses  
   

(Dollars in thousands)

 

U.S. Government agency securities

  $ 57,168     $ (233 )   $ -     $ -     $ 57,168     $ (233 )

Agency mortgage-backed securities

    19,571       (298 )     13,332       (322 )     32,903       (620 )

Equity investments measured at net asset value

    5,115       (95 )     -       -       5,115       (95 )
Total investment securities   $ 81,854     $ (626 )   $ 13,332     $ (322 )   $ 95,186     $ (948 )

 

 

There were no other-than-temporary impairment losses on securities during the three months ended September 30, 2018 or 2017.

 

At September 30, 2018, the Company had 41 securities in an unrealized loss position. At September 30, 2018, all of the Company’s available-for-sale securities were issued or guaranteed by either government agencies or government-sponsored enterprises. The decline in fair value of the Company’s investment securities at September 30, 2018 is attributable to changes in interest rates.

 

In addition to considering current trends and economic conditions that may affect the quality of individual securities within the Company’s investment portfolio, management of the Company also considers the Company’s ability and intent to hold such securities to maturity or recovery of cost. At September 30, 2018, the Company does not intend to sell and it is not more likely than not that the Company will be required to sell the investment securities before recovery of its amortized cost. As such, management does not believe any of the Company’s investment securities are other-than-temporarily impaired at September 30, 2018.

 

The investments measured at net asset value include a fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies, as well as a fund that primarily invests in the federally guaranteed portion of SBA 7(a) loans that adjust quarterly or monthly and are indexed to the Prime Rate. The underlying composition of these funds is primarily government agencies, other investment-grade investments, or the guaranteed portion of SBA 7(a) loans, as applicable. As of September 30, 2018, the effective duration of the fund that seeks to invest in securities either issued or guaranteed by the U.S. government or its agencies is 4.58 years.

 

 

ASU 2016-01, Recognition and Measurements of Financial Assets and Financial Liabilities, was adopted on July 1, 2018, and a cumulative effect adjustment of $180 thousand was recorded to reclassify the amount of accumulated unrealized losses, net, related to equity securities from accumulated other comprehensive loss to retained earnings. For the three months ended September 30, 2018, there were $40 thousand of net unrealized losses on equity securities recognized in the consolidated statement of income.

 

The amortized cost and fair values of available-for-sale debt securities by contractual maturity are shown below as of September 30, 2018. Actual maturities may differ from contractual maturities because borrowers may have the right to prepay obligations with or without prepayment penalties.

 

   

Amortized Cost

   

Fair Value

 
   

(Dollars in thousands)

 

Due within one year

  $ 16,992     $ 16,938  

Due after one year through five years

    40,093       39,883  

Due after five years through ten years

    -       -  

Due after ten years

    -       -  

Total U.S. Government agency securities

    57,085       56,821  

Agency mortgage-backed securities

    23,483       22,336  

Total available-for-sale debt securities

  $ 80,568     $ 79,157  

 

 

 

4. Loans, Allowance for Loan Losses and Credit Quality

 

Loans are carried at the principal amounts outstanding, or amortized acquired fair value in the case of acquired loans, adjusted by partial charge-offs and net of deferred loan costs or fees. Loan fees and certain direct origination costs are deferred and amortized into interest income over the expected term of the loan using the level-yield method. When a loan is paid off in full, the unamortized portion is recognized in interest income. Interest income is accrued based upon the daily principal amount outstanding, except for loans on nonaccrual status.

 

Loans purchased by the Company are accounted for under ASC 310-30, Receivables—Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"). At acquisition, the effective interest rate is determined based on the discount rate that equates the present value of the Company's estimate of cash flows with the purchase price of the loan. Prepayments are not assumed in determining a purchased loan's effective interest rate and income accretion. The application of ASC 310-30 limits the yield that may be accreted on the purchased loan, or the "accretable yield," to the excess of the Company's estimate, at acquisition, of the expected undiscounted principal, interest, and other cash flows over the Company's initial investment in the loan. The excess of contractually required payments receivable over the cash flows expected to be collected on the loan represents the purchased loan's "nonaccretable difference." Subsequent improvements in expected cash flows of loans with nonaccretable differences result in a prospective increase to the loan's effective yield through a reclassification of some, or all, of the nonaccretable difference to accretable yield. The effect of subsequent credit-related declines in expected cash flows of purchased loans are recorded through a specific allocation in the allowance for loan losses. 

 

Loans are generally placed on nonaccrual status when they are past due 90 days as to either principal or interest, or when in management's judgment the collectability of interest or principal of the loan has been impaired. Loans accounted for under ASC 310-30 are placed on nonaccrual when it is not possible to reach a reasonable expectation of the timing and amount of cash flows to be collected on the loan. When a loan has been placed on nonaccrual status, previously accrued and uncollected interest is reversed against interest on loans. Interest on nonaccrual loans is accounted for on a cash-basis or using the cost-recovery method when collectability is doubtful. A loan is returned to accrual status when collectability of principal and interest is reasonably assured and the loan has performed for a reasonable period of time.

 

In cases where a borrower experiences financial difficulties and the Company makes certain concessionary modifications to contractual terms, the loan is classified as a troubled debt restructuring ("TDR"), and therefore by definition is an impaired loan. Concessionary modifications may include adjustments to interest rates, extensions of maturity, and other actions intended to minimize economic loss and avoid foreclosure or repossession of collateral. For loans accounted for under ASC 310-30, the Company evaluates whether it has granted a concession by comparing the restructured debt terms to the expected cash flows at acquisition plus any additional cash flows expected to be collected arising from changes in estimate after acquisition. As a result, if an ASC 310-30 loan is modified to be consistent with, or better than, the Company's expectations at acquisition, the modified loan would not qualify as a TDR. Nonaccrual loans that are restructured generally remain on nonaccrual status for a minimum period of six months to demonstrate that the borrower can meet the restructured terms. If the restructured loan is on accrual status prior to being modified, it is reviewed to determine if the modified loan should remain on accrual status. If the borrower's ability to meet the revised payment schedule is not reasonably assured, the loan is classified as a nonaccrual loan. With limited exceptions, loans classified as TDRs remain classified as such until the loan is paid off.

 

 

The composition of the Company’s loan portfolio is as follows on the dates indicated.

 

 

    September 30, 2018     June 30, 2018  
    Originated    

Purchased

   

Total

   

Originated

   

Purchased

   

Total

 
   

(Dollars in thousands)

 

Residential real estate

  $ 69,776     $ 14,398     $ 84,174     $ 75,873     $ 13,926     $ 89,799  

Home equity

    9,134       -       9,134       10,457       -       10,457  

Commercial real estate

    314,394       285,230       599,624       303,399       276,051       579,450  

Commercial and industrial

    190,366       920       191,286       187,857       995       188,852  

Consumer

    2,978       -       2,978       3,244       -       3,244  

Total loans

  $ 586,648     $ 300,548     $ 887,196     $ 580,830     $ 290,972     $ 871,802  

 

 

Total loans include deferred loan origination costs, net, of $339 thousand and $223 thousand as of September 30, 2018 and June 30, 2018, respectively.

 

Past Due and Nonaccrual Loans

 

The following is a summary of past due and nonaccrual loans:

 

   

September 30, 2018

 
                   

Past Due

   

Past Due

                                 
    Past Due     Past Due     90 Days or     90 Days or                                  
    30-59     60-89     More-Still     More-    

Total Past

   

Total

   

Total

   

Nonaccrual

 
    Days     Days     Accruing     Nonaccrual    

Due

   

Current

   

Loans

   

Loans

 
   

(Dollars in thousands)

 

Originated portfolio:

                                                               

Residential real estate

  $ 351     $ 220     $ -     $ 1,536     $ 2,107     $ 67,669     $ 69,776     $ 2,633  

Home equity

    -       -       -       10       10       9,124       9,134       152  

Commercial real estate

    854       -       -       1,244       2,098       312,296       314,394       1,703  

Commercial and industrial

    100       -       -       807       907       189,459       190,366       1,453  

Consumer

    53       -       -       100       153       2,825       2,978       185  

Total originated portfolio

    1,358       220       -       3,697       5,275       581,373       586,648       6,126  

Purchased portfolio:

                                                               

Residential real estate

    421       -       -       202       623       13,775       14,398       202  

Commercial real estate

    1,074       16       -       2,395       3,485       281,745       285,230       4,815  

Commercial and industrial

    149       5       -       104       258       662       920       358  

Total purchased portfolio

    1,644       21       -       2,701       4,366       296,182       300,548       5,375  

Total loans

  $ 3,002     $ 241     $ -     $ 6,398     $ 9,641     $ 877,555     $ 887,196     $ 11,501  

 

   

June 30, 2018

 
                   

Past Due

   

Past Due

                                 
    Past Due     Past Due     90 Days or     90 Days or                                  
    30-59     60-89     More-Still     More-    

Total Past

   

Total

   

Total

   

Nonaccrual

 
    Days     Days     Accruing     Nonaccrual    

Due

   

Current

   

Loans

   

Loans

 
   

(Dollars in thousands)

 

Originated portfolio:

                                                               

Residential real estate

  $ 404     $ 181     $ -     $ 1,201     $ 1,786     $ 74,087     $ 75,873     $ 2,914  

Home equity

    89       -       -       154       243       10,214       10,457       298  

Commercial real estate

    27       210       -       169       406       302,993       303,399       1,499  

Commercial and industrial

    -       -       -       792       792       187,065       187,857       1,368  

Consumer

    77       82       -       19       178       3,066       3,244       134  

Total originated portfolio

    597       473       -       2,335       3,405       577,425       580,830       6,213  
                                                                 

Purchased portfolio:

                                                               

Residential real estate

    -       -       -       202       202       13,724       13,926       202  

Commercial real estate

    659       274       -       3,086       4,019       272,032       276,051       5,180  

Commercial and industrial

    17       -       -       91       108       887       995       363  

Total purchased portfolio

    676       274       -       3,379       4,329       286,643       290,972       5,745  

Total loans

  $ 1,273     $ 747     $ -     $ 5,714     $ 7,734     $ 864,068     $ 871,802     $ 11,958  

 

 

Allowance for Loan Losses and Impaired Loans

 

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. For residential and consumer loans, a charge-off is recorded no later than the point at which a loan is 180 days past due if the loan balance exceeds the fair value of the collateral, less estimated costs to sell. For commercial loans, a charge-off is recorded on a case-by-case basis when all or a portion of the loan is deemed to be uncollectible. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses consists of general, specific, and unallocated reserves and reflects management’s estimate of probable loan losses inherent in the loan portfolio at the balance sheet date. Management uses a consistent and systematic process and methodology to evaluate the appropriateness of the allowance for loan losses on a quarterly basis. The calculation of the allowance for loan losses is segregated by portfolio segments, which include: residential real estate, commercial real estate, commercial and industrial, consumer, purchased loans, and SBA loans. Risk characteristics relevant to each portfolio segment are as follows:

 

Residential real estate: All loans in this segment are collateralized by residential real estate and repayment is primarily dependent on the credit quality, loan-to-value ratio and income of the individual borrower. The overall health of the economy, particularly unemployment rates and housing prices, has a significant effect on the credit quality in this segment. For purposes of the Company’s allowance for loan loss calculation, home equity loans and lines of credit are included in residential real estate.

 

Commercial real estate: Loans in this segment are primarily income-producing properties. For owner-occupied properties, the cash flows are derived from an operating business, and the underlying cash flows may be adversely affected by deterioration in the financial condition of the operating business. The underlying cash flows generated by non-owner occupied properties may be adversely affected by increased vacancy rates. Management periodically obtains rent rolls and operating statements, with which it monitors the cash flows of these loans. Adverse developments in either of these areas will have an adverse effect on the credit quality of this segment. For purposes of the allowance for loan losses, this segment also includes construction loans.

 

Commercial and industrial: Loans in this segment are made to businesses and are generally secured by the assets of the business. Repayment is expected from the cash flows of the business. This segment also includes loans to non-bank lenders, which are generally secured by a collateral assignment of the notes and mortgages on loans originated by the non-bank lenders. Weakness in national or regional economic conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect on the credit quality of this segment.

 

Consumer: Loans in this segment are generally secured, and repayment is dependent on the credit quality of the individual borrower. Repayment of consumer loans is generally based on the earnings of individual borrowers, which may be adversely impacted by regional labor market conditions.

 

Purchased: Loans in this segment are typically secured by commercial real estate, multi-family residential real estate, or business assets and have been acquired by the Bank’s Loan Acquisition and Servicing Group (“LASG”). Loans acquired by the LASG are, with limited exceptions, performing loans at the date of purchase. Repayment of loans in this segment is largely dependent on cash flow from the successful operation of the property, in the case of non-owner occupied property, or operating business, in the case of owner-occupied property. Loan performance may be adversely affected by factors affecting the general economy or conditions specific to the real estate market, such as geographic location or property type. Loans in this segment are evaluated for impairment under ASC 310-30. The Company reviews expected cash flows from purchased loans on a quarterly basis. The effect of a decline in expected cash flows subsequent to the acquisition of the loan is recognized through a specific allocation in the allowance for loan losses.

 

SBA: Loans in this segment are comprised of both commercial real estate and commercial and industrial loans to small businesses, underwritten and originated by the Bank’s national SBA group (“SBA Division”). Loans are underwritten and originated primarily in accordance with SBA 7(a) guidelines, and are partially guaranteed by the SBA. Loans are primarily secured by income-producing properties and/or assets of the businesses. Adverse developments in national or regional economic conditions, and a corresponding weakness in consumer or business spending, will have an adverse effect on the credit quality of this segment.

 

The general component of the allowance for loan losses for originated loans is based on historical loss experience adjusted for qualitative factors stratified by loan segment. The Company does not weight periods used in that analysis to determine the average loss rate in each portfolio segment. This historical loss factor is adjusted for the following qualitative factors:

 

 

Levels and trends in delinquencies;

 

 

Trends in the volume and nature of loans;

 

 

Trends in credit terms and policies, including underwriting standards, procedures and practices, and the experience and ability of lending management and staff;

 

 

 

Trends in portfolio concentration;

 

 

National and local economic trends and conditions;

 

 

Effects of changes or trends in internal risk ratings; and

 

 

Other effects resulting from trends in the valuation of underlying collateral.

 

The allocated component of the allowance for loan losses relates to loans that are classified as impaired. 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 or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of the loan.

 

For all portfolio segments, except loans accounted for under ASC 310-30, 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. 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. For the purchased loan segment, a loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to realize cash flows as expected at acquisition. For loans accounted for under ASC 310-30 for which cash flows can reasonably be estimated, loan impairment is measured based on the decrease in expected cash flows from those estimated at acquisition, excluding changes due to changes in interest rate indices and other non-credit related factors, discounted at the loan’s effective rate assumed at acquisition. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting the scheduled principal and interest payments when due.

 

The following table sets forth activity in the Company’s allowance for loan losses.

 

   

Three Months Ended September 30, 2018

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Beginning balance

  $ 605     $ 1,527     $ 620     $ 39     $ 587     $ 1,429     $ 4,807  

Provision (credit)

    99       93       164       (12 )     10       178       532  

Recoveries

    2       7       7       18       -       -       34  

Charge-offs

    (81 )     -       (2 )     (2 )     -       -       (85 )

Ending balance

  $ 625     $ 1,627     $ 789     $ 43     $ 597     $ 1,607     $ 5,288  

 

   

Three Months Ended September 30, 2017

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Beginning balance

  $ 472     $ 1,219     $ 394     $ 53     $ 303     $ 1,224     $ 3,665  

Provision (credit)

    41       29       184       (14 )     7       107       354  

Recoveries

    7       -       18       6       -       -       31  

Charge-offs

    (12 )     -       -       (4 )     -       -       (16 )

Ending balance

  $ 508     $ 1,248     $ 596     $ 41     $ 310     $ 1,331     $ 4,034  

 

 

The following table sets forth information regarding the allowance for loan losses by portfolio segment and impairment methodology.

 

   

September 30, 2018

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Allowance for loan losses:

                                                       

Individually evaluated

  $ 337     $ 128     $ 3     $ 22     $ -     $ 342     $ 832  

Collectively evaluated

    288       1,499       786       21       -       1,265       3,859  

ASC 310-30

    -       -       -       -       597       -       597  

Total

  $ 625     $ 1,627     $ 789     $ 43     $ 597     $ 1,607     $ 5,288  
                                                         

Loans:

                                                       

Individually evaluated

  $ 5,137     $ 2,541     $ 47     $ 340     $ -     $ 3,585     $ 11,650  

Collectively evaluated

    73,773       250,588       184,372       2,638       -       63,627       574,998  

ASC 310-30

    -       -       -       -       300,548       -       300,548  

Total

  $ 78,910     $ 253,129     $ 184,419     $ 2,978     $ 300,548     $ 67,212     $ 887,196  

 

 

   

June 30, 2018

 
   

Residential

   

Commercial

   

Commercial

                                 
   

Real Estate

   

Real Estate

   

and Industrial

   

Consumer

   

Purchased

   

SBA

   

Total

 
   

(Dollars in thousands)

 

Allowance for loan losses:

                                                       

Individually evaluated

  $ 322     $ 139     $ 8     $ 6     $ -     $ 112     $ 587  

Collectively evaluated

    283       1,388       612       33       -       1,317       3,633  

ASC 310-30

    -       -       -       -       587       -       587  

Total

  $ 605     $ 1,527     $ 620     $ 39     $ 587     $ 1,429     $ 4,807  
                                                         

Loans:

                                                       

Individually evaluated

  $ 5,682     $ 2,687     $ 33     $ 292     $ -     $ 3,170     $ 11,864  

Collectively evaluated

    80,520       246,742       181,767       2,952       -       56,985       568,966  

ASC 310-30

    -       -       -       -       290,972       -       290,972  

Total

  $ 86,202     $ 249,429     $ 181,800     $ 3,244     $ 290,972     $ 60,155     $ 871,802  

 

The following table sets forth information regarding impaired loans. Loans accounted for under ASC 310-30 that have performed based on cash flow and accretable yield expectations determined at date of acquisition are not considered impaired assets and have been excluded from the tables below.

 

   

September 30, 2018

   

June 30, 2018

 
           

Unpaid

                   

Unpaid

         
   

Recorded

   

Principal

   

Related

   

Recorded

   

Principal

   

Related

 
   

Investment

   

Balance

   

Allowance

   

Investment

   

Balance

   

Allowance

 
   

(Dollars in thousands)

 

Impaired loans without a valuation allowance:

                                               

Originated:

                                               

Residential real estate

  $ 3,031     $ 3,024     $ -     $ 3,162     $ 3,154     $ -  

Commercial real estate

    1,458       1,453       -       1,641       1,634       -  

Commercial and industrial

    1,659       1,659       -       2,401       2,401       -  

Consumer

    279       302       -       271       296       -  

Purchased:

                                               

Residential real estate

    202       217       -       202       217       -  

Commercial real estate

    6,381       9,064       -       6,601       9,330       -  

Commercial and industrial

    95       173       -       108       186       -  

Total

    13,105       15,892       -       14,386       17,218       -  
                                                 

Impaired loans with a valuation allowance:

                                               

Originated:

                                               

Residential real estate

    2,106       2,086       337       2,520       2,497       322  

Commercial real estate

    1,621       1,612       191       1,241       1,233       139  

Commercial and industrial

    1,435       1,434       282       607       607       120  

Consumer

    61       62       22       21       22       6  

Purchased: