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, 2017

 

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 and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

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, 2017, the registrant had outstanding 7,930,565 shares of voting common stock, $1.00 par value per share and 996,823 shares of non-voting common stock, $1.00 par value per share.

 

 

Table of Contents

 

Part I.	Financial Information
	Item 1.	Financial Statements (Unaudited)
		Consolidated Balance Sheets September 30, 2017 and June 30, 2017	3
		Consolidated Statements of Income Three Months Ended September 30, 2017 and 2016	4
		Consolidated Statements of Comprehensive Income Three Months Ended September 30, 2017 and 2016	5
		Consolidated Statements of Changes in Shareholders' Equity Three Months Ended September 30, 2017 and 2016	6
		Consolidated Statements of Cash Flows Three Months Ended September 30, 2017 and 2016	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	41
	Item 4.	Controls and Procedures	42
Part II.	Other Information
	Item 1.	Legal Proceedings	43
	Item 1A.	Risk Factors	43
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	43
	Item 3.	Defaults Upon Senior Securities	43
	Item 4.	Mine Safety Disclosures	43
	Item 5.	Other Information	43
	Item 6.	Exhibits	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, 2017				June 30, 2017
Assets
Cash and due from banks		$	3,528			$	3,582
Short-term investments			147,287				159,701
Total cash and cash equivalents			150,815				163,283
Available-for-sale securities, at fair value			94,508				96,693
Residential real estate loans held for sale			7,106				4,508
SBA loans held for sale			2,400				191
Total loans held for sale			9,506				4,699
Loans:
Commercial real estate			471,846				498,004
Commercial and industrial			183,493				175,654
Residential real estate			100,124				101,168
Consumer			4,121				4,369
Total loans			759,584				779,195
Less: Allowance for loan losses			4,034				3,665
Loans, net			755,550				775,530
Premises and equipment, net			7,274				6,937
Real estate owned and other repossessed collateral, net			2,040				826
Federal Home Loan Bank stock, at cost			1,938				1,938
Intangible assets, net			1,191				1,300
Servicing rights, net			2,955				2,846
Bank owned life insurance			16,291				16,179
Other assets			7,569				6,643
Total assets		$	1,049,637			$	1,076,874
Liabilities and Shareholders' Equity
Liabilities
Deposits:
Demand		$	74,731			$	69,827
Savings and interest checking			105,691				108,417
Money market			380,992				374,569
Time			301,309				337,037
Total deposits			862,723				889,850
Federal Home Loan Bank advances			20,004				20,011
Subordinated debt			23,705				23,620
Capital lease obligation			808				873
Other liabilities			15,685				19,723
Total liabilities			922,925				954,077
Commitments and contingencies			-				-
Shareholders' equity
Preferred stock, $1.00 par value, 1,000,000 shares authorized; no shares issued and outstanding at September 30, 2017 and June 30, 2017			-				-
Voting common stock, $1.00 par value, 25,000,000 shares authorized; 7,899,159 and 7,840,460 shares issued and outstanding at September 30, 2017 and June 30, 2017, respectively			7,899				7,841
Non-voting common stock, $1.00 par value, 3,000,000 shares authorized; 991,194 shares issued and outstanding at both September 30, 2017 and June 30, 2017			991				991
Additional paid-in capital			76,709				77,455
Retained earnings			42,641				38,142
Accumulated other comprehensive loss			(1,528	)			(1,632	)
Total shareholders' equity			126,712				122,797
Total liabilities and shareholders' equity		$	1,049,637			$	1,076,874

 

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,
		2017				2016
Interest and dividend income:
Interest and fees on loans		$	15,383			$	11,803
Interest on available-for-sale securities			266				239
Other interest and dividend income			529				215
Total interest and dividend income			16,178				12,257
Interest expense:
Deposits			2,176				1,754
Federal Home Loan Bank advances			172				255
Subordinated debt			508				459
Obligation under capital lease agreements			11				14
Total interest expense			2,867				2,482
Net interest and dividend income before provision for loan losses			13,311				9,775
Provision for loan losses			354				193
Net interest and dividend income after provision for loan losses			12,957				9,582
Noninterest income:
Fees for other services to customers			526				408
Gain on sales of residential real estate loans held for sale			291				542
Gain on sales of SBA loans held for sale			1,019				743
Loss recognized on real estate owned and other repossessed collateral, net			-				(14	)
Bank owned life insurance income			112				114
Other noninterest income			10				15
Total noninterest income			1,958				1,808
Noninterest expense:
Salaries and employee benefits			5,254				5,314
Occupancy and equipment expense			1,109				1,229
Professional fees			442				496
Data processing fees			604				421
Marketing expense			87				87
Loan acquisition and collection expense			365				227
FDIC insurance premiums			80				124
Intangible asset amortization			109				109
Other noninterest expense			664				619
Total noninterest expense			8,714				8,626
Income before income tax expense			6,201				2,764
Income tax expense			1,615				1,013
Net income		$	4,586			$	1,751
Weighted-average shares outstanding:
Basic			8,841,511				9,106,144
Diluted			9,089,936				9,133,383
Earnings per common share:
Basic		$	0.52			$	0.19
Diluted			0.50				0.19
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,
		2017				2016
Net income		$	4,586			$	1,751
Other comprehensive income, before tax:
Available-for-sale securities:
Change in net unrealized loss on available-for-sale securities			122				(78	)
Derivatives and hedging activities:
Change in accumulated loss on effective cash flow hedges			22				154
Reclassification adjustments included in net income			23				-
Total derivatives and hedging activities			45				154
Total other comprehensive income, before tax			167				76
Income tax expense related to other comprehensive income			63				31
Other comprehensive income, net of tax			104				45
Comprehensive income		$	4,690			$	1,796

 

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)

 

		Preferred Stock								Voting Common Stock								Non-voting Common Stock								Additional Paid-in				Retained			Accumulated Other Comprehensive					Total Shareholders'
		Shares				Amount				Shares				Amount				Shares				Amount				Capital				Earnings				Loss				Equity
Balance at June 30, 2016			-			$	-				8,089,790			$	8,089				1,227,683			$	1,228			$	83,020			$	26,160			$	(1,906	)		$	116,591
Net income			-				-				-				-				-				-				-				1,751				-				1,751
Other comprehensive loss, net of tax			-				-				-				-				-				-				-				-				45				45
Common stock repurchased			-				-				(645,238	)			(645	)			-				-				(6,298	)			-				-				(6,943	)
Conversion of voting common stock to non-voting common stock			-				-				(116,000	)			(116	)			116,000				116				-				-				-				-
Dividends on common stock at $0.01 per share			-				-				-				-				-				-				-				(93	)			-				(93	)
Stock-based compensation			-				-				-				-				-				-				202				-				-				202
Issuance of restricted common stock			-				-				160,000				160				-				-				(160	)			-				-				-
Cancellation and forfeiture of restricted common stock			-				-				(1,000	)			(1	)			-				-				1				-				-				-
Balance at September 30, 2016			-			$	-				7,487,552			$	7,487				1,343,683			$	1,344			$	76,765			$	27,818			$	(1,861	)		$	111,553
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 loss, net of tax			-				-				-				-				-				-				-				-				104				104
Conversion of voting common stock to non- voting common stock			-				-				-				-				-				-				-				-				-				-
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

 

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,
		2017				2016
Operating activities:
Net income		$	4,586			$	1,751
Adjustments to reconcile net income to net cash used in operating activities:
Provision for loan losses			354				193
Loss recognized on real estate owned, other repossessed collateral and premises and equipment, net			-				14
Accretion of fair value adjustments on loans, net			(2,938	)			(2,133	)
Accretion of fair value adjustments on deposits, net			-				(1	)
Accretion of fair value adjustments on borrowings, net			50				(29	)
Amortization of subordinated debt issuance costs			28				62
Originations of loans held for sale			(30,545	)			(33,459	)
Net proceeds from sales of loans held for sale			29,450				33,758
Gain on sales of residential loans held for sale, net			(291	)			(542	)
Gain on sales of SBA and other loans held for sale, net			(1,019	)			(743	)
Amortization of intangible assets			109				109
Bank owned life insurance income, net			(112	)			(114	)
Depreciation of premises and equipment			292				395
Stock-based compensation			220				202
Amortization of available-for-sale securities, net			240				286
Changes in other assets and liabilities:
Other assets			(1,099	)			(15	)
Other liabilities			(3,992	)			(345	)
Net cash used in operating activities			(4,667	)			(611	)
Investing activities:
Purchases of available-for-sale securities			-				(9,056	)
Proceeds from maturities and principal payments on available-for-sale securities			2,067				14,681
Loan purchases			(3,651	)			(13,853	)
Loan originations, principal collections, and purchased loan paydowns, net			22,599				(13,969	)
Purchases of premises and equipment			(629	)			(47	)
Proceeds from sales of real estate owned and other repossessed collateral			-				67
Net cash provided by (used in) investing activities			20,386				(22,177	)
Financing activities:
Net (decrease) increase in deposits			(27,127	)			4,978
Repurchase of common stock			-				(6,943	)
Dividends paid on common stock			(87	)			(93	)
Repayment of capital lease obligation			(65	)			(62	)
Repurchases for tax withholdings on stock options and restricted common stock			(908	)			-
Net cash used in financing activities			(28,187	)			(2,120	)
Net decrease in cash and cash equivalents			(12,468	)			(24,908	)
Cash and cash equivalents, beginning of period			163,283				151,157
Cash and cash equivalents, end of period		$	150,815			$	126,249
Supplemental schedule of noncash investing activities:
Transfers from loans to real estate owned and other repossessed collateral		$	1,214			$	2,188

 

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, 2017

 

1. Basis of Presentation

 

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

 

These financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“US 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 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, 2017 (“Fiscal 2017”) 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 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 defers adoption to annual reporting periods beginning after December 15, 2017. The timing of the Company’s revenue recognition is not expected to materially change. The Company is currently performing an assessment of revenue streams and reviewing contracts potentially affected by the ASU to determine the impact of the new guidance. The Company’s largest portions of revenue, interest and fees on loans and gain on sales of loans, are specifically excluded from the scope of the guidance, and the Company currently recognizes the majority of the remaining revenue sources in a manner that management believes is consistent with the new guidance. Because of this, management believes that revenue recognized under the new guidance will generally approximate revenue recognized under current GAAP. These observations are subject to change as the evaluation is completed.

 

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 US GAAP. This guidance is effective for fiscal years beginning after December 15, 2017, including interim periods within the fiscal year. Early adoption is permitted for only one of the six amendments. The Company is currently evaluating the impact of the adoption of ASU 2016-01 on its consolidated financial statements.

 

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 March 2016, the FASB issued ASU 2016-05, Derivatives and Hedging (Topic 815): Effect of Derivative Contract Novations on Existing Hedge Accounting Relationships (“ASU 2016-05”). The new guidance clarifies that a change in the counterparty to a derivative instrument that has been designated as the hedging instrument under Topic 815 does not, in and of itself, require de-designation of that hedging relationship provided that all other hedge accounting criteria continue to be met. This guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. The adoption of this guidance did not have an impact on the Company’s financial statements.

 

 

In March 2016, the FASB issued ASU 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The new guidance simplified several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Entities are required to recognize the income tax effects of awards in the income statement when the awards vest or are settled. This guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those annual periods. For interim reporting purposes the excess tax benefits or deficiencies shall be recorded as discrete items in the period in which they occur. In addition to the excess tax benefit treatment, the amendment removed the assumed proceeds related to the excess tax benefit from the calculation of diluted shares.

 

Upon adoption, the most significant impact of this amendment resulted from the prospective application of current excess tax benefits and deficiencies being recognized in income tax expense, which would previously have been recognized in additional paid-in capital. In the three months ended September 30, 2017, this item reduced income tax expense and increased net income by approximately $818 thousand, representing an income tax benefit arising from individuals who exercised non-qualified stock options and restricted stock awards that vested during the period. For the year ended June 30, 2017, the Company recognized $27 thousand in additional paid-in-capital related to the excess tax benefit, which, if under the new ASU, would have been recognized as an income tax benefit in the income statement. These amounts, treated as discrete items in the period in which they occur, will vary from year to year as a function of the volume of share-based payments vested or exercised and the then fair market value of the Company's stock in comparison to the compensation cost recognized in the financial statements. In addition to the excess tax benefit treatment, the amendment removed the assumed proceeds related to the excess tax benefit from the calculation of diluted shares which increased diluted weighted average common shares outstanding by 40,966 shares to 9,089,936. This amendment is applied on a prospective basis, and no prior periods were adjusted. Additionally upon adoption, the Company made a policy election to record forfeitures as they occur rather than make use of an estimate. The other provisions did not have a material impact on the Company's financial statements upon adoption.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit 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 US 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 plans to engage an existing third party service provider to assist in implementation.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230) (“ASU 2016-15”). This guidance clarifies and provides guidance on several cash receipt and cash payment classification issues, including debt prepayment and extinguishment costs, settlement of zero-coupon debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies, distributions received from equity method investees, beneficial interests in securitization transactions, and separately identifiable cash flows and application of the predominance principle. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2017, 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 financial statements.

 

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) (“ASU 2016-18”). This guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. The amendments in this guidance are effective for public business entities for fiscal years beginning after December 15, 2017, 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 financial statements.

 

In March 2017, the FASB issued ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20) (“ASU 2017-08”). This guidance amends the amortization period for certain purchased callable debt securities held at a premium, and shortens the amortization period for the premium to the earliest call date. Under current GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. 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 financial statements.

 

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 is effective for public business entities for annual periods being after December 15, 2017, including interim periods within those annual periods. Early adoption is permitted including adopting in any interim period. This update should be applied prospectively to awards modified on or after the effective date. The adoption of this guidance is not expected to have a significant impact on the Company’s 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 financial statements.

 

 

3. Securities Available-for-Sale

 

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

 

		September 30, 2017
		Amortized				Gross Unrealized				Gross Unrealized				Fair
		Cost				Gains				Losses				Value
		(Dollars in thousands)
U.S. Government agency securities		$	57,261			$	-			$	(192	)		$	57,069
Agency mortgage-backed securities			31,318				3				(546	)			30,775
Other investments measured at net asset value			6,755				-				(91	)			6,664
		$	95,334			$	3			$	(829	)		$	94,508

 

		June 30, 2017
		Amortized				Gross Unrealized				Gross Unrealized				Fair
		Cost				Gains				Losses				Value
		(Dollars in thousands)
U.S. Government agency securities		$	57,401			$	-			$	(233	)		$	57,168
Agency mortgage-backed securities			33,523				-				(620	)			32,903
Other investments measured at net asset value			6,717				-				(95	)			6,622
		$	97,641			$	-			$	(948	)		$	96,693

  

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, 2017 or 2016. At September 30, 2017, 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, 2017
		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		$	20,961			$	(38	)		$	36,108			$	(154	)		$	57,069			$	(192	)
Agency mortgage-backed securities			14,565				(233	)			14,404				(313	)			28,969				(546	)
Other investments measured at net asset value			5,149				(91	)			-				-				5,149				(91	)
		$	40,675			$	(362	)		$	50,512			$	(467	)		$	91,187			$	(829	)

 

		June 30, 2017
		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	)
Other investments measured at net asset value			5,115				(95	)			-				-				5,115				(95	)
		$	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, 2017 or 2016.

 

At September 30, 2017, the Company had eighteen securities in a continuous loss position for greater than twelve months. At September 30, 2017, 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 available-for-sale securities at September 30, 2017 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, 2017, 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 available-for-sale securities are other-than-temporarily impaired at September 30, 2017.

 

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, 2017, 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 4.80 years.

 

 

The amortized cost and fair values of available-for-sale debt securities by contractual maturity are shown below as of September 30, 2017. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

		Amortized				Fair
		Cost				Value
		(Dollars in thousands)
Due within one year		$	42,251			$	42,118
Due after one year through five years			24,251				24,078
Due after five years through ten years			22,077				21,648
Due after ten years			-				-
Total		$	88,579			$	87,844

     

 

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, 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 significantly 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 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, 2017												June 30, 2017
		Originated				Purchased				Total				Originated				Purchased				Total
		(Dollars in thousands)
Residential real estate		$	83,864			$	3,208			$	87,072			$	83,759			$	3,377			$	87,136
Home equity			12,954				98				13,052				13,931				101				14,032
Commercial real estate			246,241				225,605				471,846				256,280				241,724				498,004
Commercial and industrial			182,390				1,103				183,493				174,468				1,186				175,654
Consumer			4,121				-				4,121				4,369				-				4,369
Total loans		$	529,570			$	230,014			$	759,584			$	532,807			$	246,388			$	779,195

 

Total loans include net deferred loan origination costs of $286 thousand and $507 thousand as of September 30, 2017 and June 30, 2017, respectively.

 

 

Past Due and Nonaccrual Loans

 

The following is a summary of past due and non-accrual loans:

 

		September 30, 2017
										Past Due				Past Due
										90 Days or				90 Days or				Total												Non-
		30-59				60-89				More-Still				More-				Past				Total				Total				Accrual
		Days				Days				Accruing				Nonaccrual				Due				Current				Loans				Loans
		(Dollars in thousands)
Originated portfolio:
Residential real estate		$	1,570			$	51			$	-			$	2,073			$	3,694			$	80,170			$	83,864			$	3,667
Home equity			50				-				-				58				108				12,846				12,954				58
Commercial real estate			184				517				-				123				824				245,417				246,241				2,409
Commercial and industrial			40				-				-				-				40				182,350				182,390				2,629
Consumer			98				25				-				44				167				3,954				4,121				131
Total originated portfolio			1,942				593				-				2,298				4,833				524,737				529,570				8,894
Purchased portfolio:
Residential real estate and home equity			95				-				-				1,064				1,159				2,147				3,306				1,078
Commercial and industrial			-				-				-				-				-				1,103				1,103				27
Commercial real estate			979				2,002				-				3,172				6,153				219,452				225,605				6,653
Total purchased portfolio			1,074				2,002				-				4,236				7,312				222,702				230,014				7,758
Total loans		$	3,016			$	2,595			$	-			$	6,534			$	12,145			$	747,439			$	759,584			$	16,652

 

		June 30, 2017
										Past Due				Past Due
										90 Days or				90 Days or				Total												Non-
		30-59				60-89				More-Still				More-				Past				Total				Total				Accrual
		Days				Days				Accruing				Nonaccrual				Due				Current				Loans				Loans
		(Dollars in thousands)
Originated portfolio:
Residential real estate		$	141			$	574			$	-			$	1,398			$	2,113			$	81,646			$	83,759			$	3,337
Home equity			49				-				-				58				107				13,824				13,931				58
Commercial real estate			2,266				-				-				124				2,390				253,890				256,280				413
Commercial and industrial			-				-				-				2,433				2,433				172,035				174,468				2,600
Consumer			69				50				-				32				151				4,218				4,369				103
Total originated portfolio			2,525				624				-				4,045				7,194				525,613				532,807				6,511
Purchased portfolio:
Residential real estate and home equity			-				1,082				-				16				1,098				2,380				3,478				1,056
Commercial and industrial			-				-				-				-				-				1,186				1,186				32
Commercial real estate			173				1,997				-				2,922				5,092				236,632				241,724				6,364
Total purchased portfolio			173				3,079				-				2,938				6,190				240,198				246,388				7,452
Total loans		$	2,698			$	3,703			$	-			$	6,983			$	13,384			$	765,811			$	779,195			$	13,963

 

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 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, and purchased 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. 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.

 

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, 2017
		Residential Real Estate				Commercial Real Estate				Commercial and Industrial				Consumer				Purchased				Unallocated				Total
		(Dollars in thousands)
Beginning balance		$	477			$	2,312			$	520			$	53			$	303			$	-			$	3,665
Provision			41				131				189				(14	)			7				-				354
Recoveries			7				-				18				6				-				-				31
Charge-offs			(12	)			-				-				(4	)			-				-				(16	)
Ending balance		$	513			$	2,443			$	727			$	41			$	310			$	-			$	4,034

 

		Three Months Ended September 30, 2016
		Residential Real Estate				Commercial Real Estate				Commercial and Industrial				Consumer				Purchased				Unallocated				Total
		(Dollars in thousands)
Beginning balance		$	663			$	1,195			$	297			$	62			$	133			$	-			$	2,350
Provision			(99	)			226				17				24				25				-				193
Recoveries			2				-				5				11				-				-				18
Charge-offs			(25	)			-				(1	)			(29	)			-				-				(55	)
Ending balance		$	541			$	1,421			$	318			$	68			$	158			$	-			$	2,506

 

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

 

		September 30, 2017
		Residential Real Estate				Commercial Real Estate				Commercial and Industrial				Consumer				Purchased				Unallocated				Total
		(Dollars in thousands)
Allowance for loan losses:
Individually evaluated		$	280			$	142			$	153			$	1			$	-			$	-			$	576
Collectively evaluated			233				2,301				574				40				-				-				3,148
ASC 310-30			-				-				-				-				310				-				310
Total		$	513			$	2,443			$	727			$	41			$	310			$	-			$	4,034
Loans:
Individually evaluated		$	5,739			$	3,817			$	2,696			$	317			$	-			$	-			$	12,569
Collectively evaluated			91,079				242,424				179,694				3,804				-				-				517,001
ASC 310-30			-				-				-				-				230,014				-				230,014
Total		$	96,818			$	246,241			$	182,390			$	4,121			$	230,014			$	-			$	759,584

 

		June 30, 2017
		Residential Real Estate				Commercial Real Estate				Commercial and Industrial				Consumer				Purchased				Unallocated				Total
		(Dollars in thousands)
Allowance for loan losses:
Individually evaluated		$	252			$	147			$	149			$	4			$	-			$	-			$	552
Collectively evaluated			225				2,165				371				49				-				-				2,810
ASC 310-30			-				-				-				-				303				-				303
Total		$	477			$	2,312			$	520			$	53			$	303			$	-			$	3,665
Loans:
Individually evaluated		$	5,676			$	1,759			$	2,694			$	296			$	-			$	-			$	10,425
Collectively evaluated			92,014				254,521				171,774				4,073				-				-				522,382
ASC 310-30			-				-				-				-				246,388				-				246,388
Total		$	97,690			$	256,280			$	174,468			$	4,369			$	246,388			$	-			$	779,195

 

 

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, 2017												June 30, 2017
						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		$	4,136			$	4,162			$	-			$	4,052			$	4,084			$	-
Consumer			293				321				-				250				271				-
Commercial real estate			2,426				2,420				-				359				354				-
Commercial and industrial			1,830				1,830				-				1,870				1,870				-
Purchased:
Residential real estate			1,078				1,121				-				1,056				1,099				-
Commercial real estate			9,039				11,817				-				8,696				11,468
Commercial and industrial			27				60				-				32				65				-
Total			18,829				21,731				-				16,315				19,211				-
Impaired loans with a valuation allowance:
Originated:
Residential real estate			1,603				1,577				280				1,624				1,595				252
Consumer			24				27				1				46				55				4
Commercial real estate			1,391				1,380				142				1,400				1,388				147
Commercial and industrial			866				866				153				824				824				149
Purchased:
Commercial real estate			3,540				3,914				182				3,528				3,929				176
Commercial and industrial			94				108				54				94				108				55
Total			7,518				7,872				812				7,516				7,899				783
Total impaired loans		$	26,347			$	29,603			$	812			$	23,831			$	27,110			$	783

  

The following tables set forth information regarding interest income recognized on impaired loans.

 

		Three Months Ended September 30,
		2017								2016
		Average				Interest				Average				Interest
		Recorded				Income				Recorded				Income
		Investment				Recognized				Investment				Recognized
		(Dollars in thousands)
Impaired loans without a valuation allowance:
Originated:
Residential real estate		$	4,095			$	36			$	3,730			$	49
Consumer			272				6				243				3
Commercial real estate			1,393				93				447				8
Commercial and industrial			1,850				37				180				3
Purchased:
Residential real estate			1,067				-				1,117				3
Commercial real estate			8,868				80				4,736				52
Commercial and industrial			30				-				24				-
Total			17,575				252				10,477				118
Impaired loans with a valuation allowance:
Originated:
Residential real estate			1,614				21				1,685				16
Consumer			35				1				104				2
Commercial real estate			1,396				22				1,179				18
Commercial and industrial			845				4				2				-
Purchased:
Commercial real estate			3,534				27				1,529				17
Commercial and industrial			94				-				-				-
Total			7,518				75				4,499			$	53
Total impaired loans		$	25,093			$	327			$	14,976			$	171

    

 

Credit Quality

 

The Company utilizes a ten-point internal loan rating system for commercial real estate, construction, commercial and industrial, and certain residential loans as follows:

 

Loans rated 1 – 6: Loa