gfed20180930_10q.htm
 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)  
  OF THE SECURITIES EXCHANGE ACT OF 1934  

 

For the quarterly period ended September 30, 2018

OR

[   ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _______ to _______

 

Commission file number 0-23325


Guaranty Federal Bancshares, Inc.

 (Exact name of registrant as specified in its charter)

 

Delaware

43-1792717

(State or other jurisdiction of incorporation or organization)

(IRS Employer Identification No.)

   

2144 E Republic Rd, Suite F200

 

Springfield, Missouri

65804

(Address of principal executive offices)

(Zip Code)

 

Registrant’s telephone number, including area code: (417) 520-4333

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes [X] 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 such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See 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 [X] Emerging growth company [  ]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period of 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 in Rule 12b-2 of the Exchange Act. Yes [  ] No [X]

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

Class

Outstanding as of November 1, 2018

Common Stock, Par Value $0.10 per share

4,451,723 Shares

 

 

 
 

 

 

GUARANTY FEDERAL BANCSHARES, INC.

 
     

TABLE OF CONTENTS

   

  Page

PART I. FINANCIAL INFORMATION

       
Item 1. Financial Statements  

Condensed Consolidated Financial Statements (Unaudited):

 
 

Condensed Consolidated Balance Sheets

3

 

Condensed Consolidated Statements of Income

 

4

 

Condensed Consolidated Statements of Comprehensive Income

5

 

Condensed Consolidated Statements of Stockholders’ Equity

6

 

Condensed Consolidated Statements of Cash Flows

 

7

 

Notes to Condensed Consolidated Financial Statements

8

       

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

37

       

Item 3. Quantitative and Qualitative Disclosures about Market Risk

45

       

Item 4. Controls and Procedures

 

46

       

PART II. OTHER INFORMATION

     

Item 1. Legal Proceedings

47

     

Item 1A. Risk factors

47

     

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

47

     

Item 3. Defaults Upon Senior Securities

47

     

Item 4. Mine Safety Disclosures

47

     

Item 5. Other Information

47

     

Item 6. Exhibits

47

     

Signatures

  48

 

2

 
 

 

PART I FINANCIAL INFORMATION

Item 1. Financial Statements

 

 

 

 

GUARANTY FEDERAL BANCSHARES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

SEPTEMBER 30, 2018 (UNAUDITED) AND DECEMBER 31, 2017

 

 

 

9/30/18

   

12/31/17

 
ASSETS                

Cash and due from banks

  $ 5,222,458     $ 4,094,694  

Interest-bearing deposits in other financial institutions

    25,989,332       33,312,236  

Cash and cash equivalents

    31,211,790       37,406,930  

Available-for-sale securities

    85,605,143       81,478,673  

Held-to-maturity securities

    12,722       16,457  

Stock in Federal Home Loan Bank, at cost

    5,043,200       4,597,500  

Mortgage loans held for sale

    961,654       1,921,819  

Loans receivable, net of allowance for loan losses of September 30, 2018 - $7,731,707 - December 31, 2017 - $7,107,418

    780,316,319       629,605,009  

Accrued interest receivable

    3,403,810       2,449,847  

Prepaid expenses and other assets

    7,518,208       3,846,686  

Goodwill

    2,615,352       -  

Core deposit intangible

    3,205,714       -  

Foreclosed assets held for sale

    1,133,160       282,785  

Premises and equipment, net

    22,158,095       10,607,094  

Bank owned life insurance

    20,083,039       19,740,623  

Deferred and income taxes receivable

    3,112,541       2,506,097  
    $ 966,380,747     $ 794,459,520  
                 

LIABILITIES AND STOCKHOLDERS' EQUITY

               
                 

LIABILITIES

               

Deposits

  $ 760,729,322     $ 607,364,350  

Federal Home Loan Bank advances

    96,700,000       94,300,000  

Note payable to bank

    5,000,000       -  

Subordinated debentures

    21,782,794       15,465,000  

Advances from borrowers for taxes and insurance

    730,438       180,269  

Accrued expenses and other liabilities

    2,032,290       1,962,865  

Accrued interest payable

    791,216       295,543  
      887,766,060       719,568,027  
                 

COMMITMENTS AND CONTINGENCIES

    -       -  
                 

STOCKHOLDERS' EQUITY

               

Capital Stock:

               

Common stock, $0.10 par value; authorized 10,000,000 shares; issued September 30, 2018 and December 31, 2017 - 6,895,503 and 6,878,503 shares; respectively

    689,550       687,850  

Additional paid-in capital

    51,266,714       50,856,069  

Retained earnings, substantially restricted

    64,025,061       60,679,308  

Accumulated other comprehensive loss

    (391,610 )     (206,193 )
      115,589,715       112,017,034  

Treasury stock, at cost; September 30, 2018 and December 31, 2017 - 2,443,780 and 2,453,728 shares, respectively

    (36,975,028 )     (37,125,541 )
      78,614,687       74,891,493  
    $ 966,380,747     $ 794,459,520  

 

See Notes to Condensed Consolidated Financial Statements

 

3

 

 

 

GUARANTY FEDERAL BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME

THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (UNAUDITED)

 

   

Three months ended

   

Nine months ended

 
   

9/30/2018

   

9/30/2017

   

9/30/2018

   

9/30/2017

 

Interest Income

                               

Loans

  $ 12,773,881     $ 7,052,544     $ 29,971,163     $ 20,042,667  

Investment securities

    523,736       431,560       1,466,036       1,361,069  

Other

    80,258       41,083       276,117       134,361  
      13,377,875       7,525,187       31,713,316       21,538,097  

Interest Expense

                               

Deposits

    1,825,559       893,197       4,967,743       2,261,752  

FHLB advances

    481,968       419,918       1,221,312       1,269,543  

Subordinated debentures

    282,393       160,075       728,954       467,665  

Other

    58,949       -       62,782       -  
      2,648,869       1,473,190       6,980,791       3,998,960  

Net Interest Income

    10,729,006       6,051,997       24,732,525       17,539,137  

Provision for Loan Losses

    200,000       450,000       925,000       1,500,000  

Net Interest Income After Provision for Loan Losses

    10,529,006       5,601,997       23,807,525       16,039,137  

Noninterest Income

                               

Service charges

    475,484       311,070       1,344,661       869,102  

Net gain (loss) on sale of investment securities

    (885 )     11,199       (8,090 )     73,473  

Gain on sale of mortgage loans held for sale

    595,384       618,732       1,591,869       1,550,880  

Gain on sale of Small Business Administration loans

    263,755       228,895       659,996       484,240  

Net gain (loss) on foreclosed assets

    (459,308 )     47,787       (338,496 )     56,051  

Other income

    587,328       353,186       1,484,669       1,133,548  
      1,461,758       1,570,869       4,734,609       4,167,294  

Noninterest Expense

                               

Salaries and employee benefits

    3,887,582       3,052,417       11,162,747       8,844,836  

Occupancy

    1,112,702       591,961       2,920,774       1,563,344  

FDIC deposit insurance premiums

    101,762       63,522       296,897       176,011  

Impairment on investment tax credits

    -       146,857       -       146,857  

Data processing

    328,692       268,508       1,095,584       730,260  

Advertising

    131,250       131,250       397,150       393,750  

Merger costs

    150,877       -       3,570,927       -  

Other expense

    952,984       757,317       2,920,262       2,144,310  
      6,665,849       5,011,832       22,364,341       13,999,368  

Income Before Income Taxes

    5,324,915       2,161,034       6,177,793       6,207,063  

Provision for Income Taxes

    1,390,673       443,651       1,230,790       1,467,866  

Net Income Available to Common Shareholders

  $ 3,934,242     $ 1,717,383     $ 4,947,003     $ 4,739,197  
                                 

Basic Income Per Common Share

  $ 0.89     $ 0.39     $ 1.12     $ 1.08  

Diluted Income Per Common Share

  $ 0.88     $ 0.39     $ 1.10     $ 1.07  

 

See Notes to Condensed Consolidated Financial Statements

 

4

 

 

 

GUARANTY FEDERAL BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (UNAUDITED)

 

   

Three months ended

   

Nine months ended

 
   

9/30/2018

   

9/30/2017

   

9/30/2018

   

9/30/2017

 

NET INCOME

  $ 3,934,242     $ 1,717,383     $ 4,947,003     $ 4,739,197  

OTHER ITEMS OF COMPREHENSIVE INCOME:

                               

Change in unrealized gain (loss) on investment securities available-for-sale, before income taxes

    (766,021 )     (39,661 )     (2,455,951 )     1,408,504  

Change in unrealized gain (loss) on interest rate swaps, before income taxes

    430,248       (76,222 )     2,198,977       151,420  

Less: Reclassification adjustment for realized (gains) losses on investment securities included in net income, before income taxes

    885       (11,199 )     8,090       (73,473 )

Total other items of comprehensive income (loss)

    (334,888 )     (127,082 )     (248,884 )     1,486,451  

Income tax expense related to other items of comprehensive income (loss)

    (85,397 )     (47,022 )     (63,467 )     549,986  

Other comprehensive income (loss)

    (249,491 )     (80,060 )     (185,417 )     936,465  

TOTAL COMPREHENSIVE INCOME

  $ 3,684,751     $ 1,637,323     $ 4,761,586     $ 5,675,662  

 

See Notes to Condensed Consolidated Financial Statements

 

5

 

 

 

GUARANTY FEDERAL BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2018 (UNAUDITED)

 

   

Common

Stock

   

Additional Paid-

In Capital

   

Treasury

Stock

   

Retained

Earnings

   

Accumulated

Other

Comprehensive

Loss

   

Total

 

Balance, January 1, 2018

  $ 687,850     $ 50,856,069     $ (37,125,541 )   $ 60,679,308     $ (206,193 )   $ 74,891,493  

Net income

    -       -       -       4,947,003       -       4,947,003  

Other comprehensive income (loss)

    -       -       -       -       (185,417 )     (185,417 )

Dividends on common stock ($0.36 per share)

    -       -       -       (1,601,250 )     -       (1,601,250 )

Stock award plans

    -       125,878       150,513       -       -       276,391  

Stock options exercised

    1,700       284,767       -       -       -       286,467  

Balance, September 30, 2018

  $ 689,550     $ 51,266,714     $ (36,975,028 )   $ 64,025,061     $ (391,610 )   $ 78,614,687  

 

See Notes to Condensed Consolidated Financial Statements

 

6

 

 

 
GUARANTY FEDERAL BANCSHARES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017 (UNAUDITED)

 

   

9/30/2018

   

9/30/2017

 

CASH FLOWS FROM OPERATING ACTIVITIES

               

Net income

  $ 4,947,003     $ 4,739,197  

Items not requiring (providing) cash:

               

Deferred income taxes

    706,286       (603,683 )

Depreciation

    1,096,490       791,473  

Provision for loan losses

    925,000       1,500,000  

Gain on sale of mortgage loans held for sale and investment securities

    (1,583,779 )     (1,624,353 )

Gain (loss) on sale of foreclosed assets

    308,811       (119,157 )

Gain on sale of Small Business Administration Loans

    (659,996 )     (484,240 )

Amortization of deferred income, premiums and discounts

    453,575       728,144  

Amortization of intangible assets

    314,286       -  

Accretion of purchase accounting adjustments

    (3,282,074 )     -  

Stock award plan expense

    276,391       330,985  

Origination of loans held for sale

    (52,789,116 )     (52,757,873 )

Proceeds from sale of loans held for sale

    55,341,150       53,975,866  

Increase in cash surrender value of bank owned life insurance

    (342,416 )     (350,826 )

Changes in:

               

Accrued interest receivable

    (953,963 )     (217,215 )

Prepaid expenses and other assets

    6,203,190       44,393  

Accounts payable and accrued expenses

    (1,441,136 )     529,150  

Income taxes receivable

    (8,972 )     232,186  

Net cash provided by operating activities

    9,510,730       6,714,047  

CASH FLOWS FROM INVESTING ACTIVITIES

               

Proceeds on sale of loans

    9,489,176       24,919,859  

Net change in loans

    (13,591,488 )     (105,083,322 )

Principal payments on available-for-sale securities

    12,202,207       5,153,878  

Principal payments on held-to-maturity securities

    3,735       9,104  

Purchase of premises and equipment

    (2,581,491 )     (1,633,608 )

Net cash received for acquisition

    2,455,964       -  

Purchase of available-for-sale securities

    (25,151,079 )     (13,350,996 )

Proceeds from sale of available-for-sale securities

    13,602,508       18,388,216  

Redemption (purchase) of Federal Home Loan Bank stock

    (445,700 )     473,500  

Purchase of tax credit investments

    (3,617,366 )     (1,214,781 )

Proceeds from sale of foreclosed assets held for sale

    187,468       2,433,660  

Net cash used in investing activities

    (7,446,066 )     (69,904,490 )

CASH FLOWS FROM FINANCING ACTIVITIES

               

Cash dividends paid on common stock

    (1,598,016 )     (1,325,308 )

Net increase in demand deposits, NOW accounts and savings accounts

    69,132,414       50,768,740  

Net increase (decrease) in certificates of deposit

    (76,871,838 )     27,957,127  

Proceeds from Federal Home Loan Bank advances

    470,835,000       333,700,000  

Repayments of Federal Home Loan Bank and Federal Reserve advances

    (470,435,000 )     (346,600,000 )

Proceeds from issuance of notes payable

    5,000,000       -  

Repayment of notes payable

    (3,000,000 )     -  

Net decrease of securities sold under agreements to repurchase

    (2,159,000 )     -  

Advances from borrowers for taxes and insurance

    550,169       322,627  

Stock options exercised

    286,467       -  

Net cash provided by (used in) financing activities

    (8,259,804 )     64,823,186  

INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

    (6,195,140 )     1,632,743  

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD

    37,406,930       9,088,441  

CASH AND CASH EQUIVALENTS, END OF PERIOD

  $ 31,211,790     $ 10,721,184  

 

See Notes to Condensed Consolidated Financial Statements

 

7

 

 

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note 1: Basis of Presentation

 

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles (GAAP) for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included.

 

These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in Guaranty Federal Bancshares, Inc.’s (the “Company”) Annual Report on Form 10-K for the year ended December 31, 2017 (“2017 Annual Report”) filed with the Securities and Exchange Commission (the “SEC”). The results of operations for the periods are not necessarily indicative of the results to be expected for the full year. The condensed consolidated balance sheet of the Company as of December 31, 2017, has been derived from the audited consolidated balance sheet of the Company as of that date. Certain information and note disclosures normally included in the Company’s annual financial statements prepared in accordance with GAAP have been condensed or omitted.

 

 

Note 2: Principles of Consolidation

 

The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Guaranty Bank (the “Bank”). All significant intercompany transactions and balances have been eliminated in consolidation.

 

 

Note 3: Acquisition

 

On April 2, 2018, the Company completed the acquisition of Carthage, Missouri-based Hometown Bancshares, Inc. (“Hometown”), including its wholly owned bank subsidiary, Hometown Bank, National Association. Under the terms of the Agreement and Plan of Merger, each share of Hometown common stock was exchanged for $20.00 in cash and the transaction was valued at approximately $4.6 million. Hometown’s subsidiary bank, Hometown Bank, National Association, was merged into Guaranty Bank on June 8, 2018.

 

Including the effects of the acquisition method accounting adjustments, the Company acquired approximately $178.8 million in assets, including approximately $143.9 million in loans (inclusive of loan discounts) and approximately $161.2 million in deposits. Goodwill of $2.6 million was recorded as a result of the transaction. The merger strengthened the Company’s position in Southwest Missouri and the Company will be able to achieve cost savings by integrating the two companies and combining accounting, data processing, and other administrative functions all of which gave rise to the goodwill recorded. The goodwill will not be deductible for tax purposes.

 

8

 

 

A summary, at fair value, of the assets acquired and liabilities assumed in the Hometown transaction, as of acquisition date, is as follows:

 

Guaranty Federal Bancshares, Inc.

Net Assets Acquired from Hometown

April 2, 2018

(In Thousands)

 

                         
   

Acquired from

   

Fair Value

   

Fair

 
   

Hometown

   

Adjustments

   

Value

 

Assets Acquired

                       

Cash and Due From Banks

  $ 7,083     $ -     $ 7,083  

Investment Securities

    7,521       -       7,521  

Loans

    150,390       (6,471 )     143,919  

Allowance for Loan Losses

    (2,348 )     2,348       -  

Net Loans

    148,042       (4,123 )     143,919  
                         

Fixed Assets

    9,268       798       10,066  

Foreclosed Assets held for sale

    1,647       (400 )     1,247  

Core Deposit Intangible

    -       3,520       3,520  

Other Assets

    4,146       1,283       5,429  
                         

Total Assets Acquired

  $ 177,707     $ 1,078     $ 178,785  
                         

Liabilities Assumed

                       

Deposits

    161,001       247       161,248  

Federal Home Loan Bank advances

    2,000       -       2,000  

Securities Sold Under Agreements to Repurchase

    2,159       -       2,159  

Other borrowings

    3,000       -       3,000  

Subordinated debentures

    6,186       176       6,362  

Other Liabilities

    2,003       -       2,003  

Total Liabilities Assumed

    176,349     $ 423       176,772  
                         

Stockholders' Equity

                       

Common Stock

    231       (231 )     -  

Capital Surplus

    18,936       (18,936 )     -  

Retained Earnings

    (17,587 )     17,587       -  

Accumulated Other Comprehensive Loss

    (222 )     222       -  

Treasury Stock

    -       -       -  

Total Stockholders' Equity Assumed

    1,358     $ (1,358 )     -  
                         

Total Liabilities and Stockholders' Equity Assumed

  $ 177,707     $ (935 )   $ 176,772  
                         

Net Assets Acquired

                  $ 2,013  

Purchase Price

                    4,628  

Goodwill

                  $ 2,615  

 

9

 

 

The following is a description of the methods used to determine the fair values of significant assets and liabilities presented in the acquisitions above.

 

Cash and due from banks – The carrying amount of these assets is a reasonable estimate of fair value based on the short-term nature of these assets.

 

Investment securities – Investment securities were acquired with an adjustment to fair value based upon quoted market prices if material. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

 

Loans acquired – Fair values for loans were based on a discounted cash flow methodology that considered factors including the type of loan and related collateral, classification status, fixed or variable interest rate, term of loan and whether or not the loan was amortizing, and current discount rates. The discount rates used for loans are based on current market rates for new originations of comparable loans and include adjustments for liquidity concerns. The discount rate does not include a factor for credit losses as that has been included in the estimated cash flows. Loans were grouped together according to similar characteristics and were treated in the aggregate when applying various valuation techniques.

 

Fixed assets – Fixed assets were acquired with an adjustment to fair value, which represents the difference between the Company’s current analysis of property and equipment values completed in connection with the acquisition and book value acquired.

 

Foreclosed assets held for sale – These assets are presented at the estimated present values that management expects to receive when the properties are sold, net of related costs of disposal.

 

Core deposit intangible – This intangible asset represents the value of the relationships that Hometown had with its deposit customers. The fair value of this intangible asset was estimated based on a discounted cash flow methodology that gave appropriate consideration to expected customer attrition rates, cost of the deposit base and the net maintenance cost attributable to customer deposits.

 

Other assets – The fair value adjustment results from recording additional deferred tax assets related to the transaction. Otherwise, the carrying amount of these assets was deemed to be a reasonable estimate of fair value.

 

Deposits – The fair values used for the demand and savings deposits that comprise the transaction accounts acquired, by definition equal the amount payable on demand at the acquisition date. The Company performed a fair value analysis of the estimated weighted average interest rate of the certificates of deposits compared to the current market rates and recorded a fair value adjustment for the difference when material.

 

Federal Home Loan Bank advances and Other borrowings – The fair value of Federal Home Loan Bank advances and other borrowings are estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities.

 

Securities sold under agreement to repurchase – The carrying amount of securities sold under agreement to repurchase is a reasonable estimate of fair value based on the short-term nature of these liabilities.

 

Subordinated debentures – The fair value of subordinated debentures is estimated based on borrowing rates currently available to the Company for borrowings with similar terms and maturities.

 

Other liabilities – The carrying amount of these other liabilities was deemed to be reasonable estimate of fair value.

 

10

 

 

Pro Forma Financial Information

 

The results of operations of Hometown have been included in the Company’s consolidated financial statements since the acquisition date. The following schedule includes pro forma results (unaudited) for the three and nine months ended September 30, 2018 and 2017, as if the Hometown acquisition occurred as of the beginning of the reporting periods presented.

 

   

Three months ended September 30,

 
   

2018

   

2017

 
   

(In Thousands, Except Per Share Data)

 

Summary of Operations

               

Net interest income

  $ 10,729     $ 7,597  

Provision for loan losses

    200       437  

Net interest income after provision for loan losses

    10,529       7,160  

Non interest income

    1,462       1,753  

Non interest expense

    6,666       6,898  

Income before income taxes

    5,325       2,015  

Provision for income taxes

    1,391       680  

Net income

  $ 3,934     $ 1,335  

Basic income per common share

  $ 0.89     $ 0.31  

Diluted income per common share

  $ 0.88     $ 0.30  

 

   

Nine months ended September 30,

 
   

2018

   

2017

 
   

(In Thousands, Except Per Share Data)

 

Summary of Operations

               

Net interest income

  $ 26,445     $ 22,792  

Provision for loan losses

    925       1,313  

Net interest income after provision for loan losses

    25,520       21,479  

Non interest income

    5,036       5,258  

Non interest expense

    24,391       20,693  

Income before income taxes

    6,165       6,044  

Provision for income taxes

    1,260       2,040  

Net income

  $ 4,905     $ 4,004  

Basic income per common share

  $ 1.12     $ 0.92  

Diluted income per common share

  $ 1.10     $ 0.90  

 

The pro forma information is presented for information purposes only and not indicative of the results of operations that actually would have been achieved had the acquisition been consummated as of that time, nor is it intended to be a projection of future results. The pro forma information includes net losses from Hometown of approximately ($163,000) and ($313,000) for the three and nine months ended September 30, 2017, respectively.

 

11

 

 

 

Note 4: Securities

 

The amortized cost and approximate fair values of securities classified as available-for-sale were as follows:

 

   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

(Losses)

   

Approximate

Fair

Value

 

As of September 30, 2018

                               

Debt Securities:

                               

Municipals

  $ 34,569,371     $ 2,046     $ (1,231,864 )   $ 33,339,553  

Corporates

    3,000,000       -       (17,024 )     2,982,976  

Government sponsored mortgage-backed securities and SBA loan pools

    51,197,672       22,354       (1,937,412 )     49,282,614  
    $ 88,767,043     $ 24,400     $ (3,186,300 )   $ 85,605,143  

 

   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

(Losses)

   

Approximate

Fair

Value

 

As of December 31, 2017

                               

Debt Securities:

                               

Municipals

  $ 33,908,207     $ 253,872     $ (263,621 )   $ 33,898,458  

Corporates

    3,000,000       65,000       -       3,065,000  

Government sponsored mortgage-backed securities and SBA loan pools

    45,414,845       9,283       (908,913 )     44,515,215  
    $ 82,323,052     $ 328,155     $ (1,172,534 )   $ 81,478,673  

 

 

Maturities of available-for-sale debt securities as of September 30, 2018:

 

   

Amortized

Cost

   

Approximate

Fair Value

 

Less than 1 year

    -       -  

1-5 years

    430,889       428,979  

6-10 years

    11,928,256       11,601,504  

After 10 years

    25,210,226       24,292,046  

Government sponsored mortgage-backed securities and SBA loan pools not due on a single maturity date

    51,197,672       49,282,614  
    $ 88,767,043     $ 85,605,143  

 

 

The amortized cost and approximate fair values of securities classified as held to maturity are as follows:

 

   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

(Losses)

   

Approximate

Fair Value

 

As of September 30, 2018

                               

Debt Securities:

                               

Government sponsored mortgage-backed securities

  $ 12,722     $ 154     $ (71 )   $ 12,805  

 

12

 

 

   

Amortized

Cost

   

Gross

Unrealized

Gains

   

Gross

Unrealized

(Losses)

   

Approximate

Fair Value

 

As of December 31, 2017

                               

Debt Securities:

                               

Government sponsored mortgage-backed securities

  $ 16,457     $ 327     $ (55 )   $ 16,729  

 

 

Maturities of held-to-maturity securities as of September 30, 2018:

 

   

Amortized

Cost

   

Approximate

Fair Value

 

Government sponsored mortgage-backed securities not due on a single maturity date

  $ 12,722     $ 12,805  

 

 

The book value of securities pledged as collateral, to secure public deposits and for other purposes, amounted to $29,466,642 and $35,774,863 as of September 30, 2018 and December 31, 2017, respectively. The approximate fair value of pledged securities amounted to $28,493,596 and $35,355,969 as of September 30, 2018 and December 31, 2017, respectively.

 

Realized gains and losses are recorded as net securities gains. Gains on sales of securities are determined on the specific identification method. Gross gains (losses) of ($8,090) and $73,473 as of September 30, 2018 and September 30, 2017, respectively, were realized from the sale of available-for-sale securities. The tax effect of these net gains (losses) was ($2,063) and $27,185 as of September 30, 2018 and September 30, 2017, respectively.

 

The Company evaluates all securities quarterly to determine if any unrealized losses are deemed to be other than temporary. Certain investment securities are valued at less than their historical cost. These declines are primarily the result of the rate for these investments yielding less than current market rates, or declines in stock prices of equity securities. Based on evaluation of available evidence, management believes the declines in fair value for these securities are temporary. It is management’s intent to hold the debt securities to maturity or until recovery of the unrealized loss. Should the impairment of any of these debt securities become other than temporary, the cost basis of the investment will be reduced and the resulting loss recognized in net income in the period the other-than-temporary impairment is identified, to the extent the loss is related to credit issues, and to other comprehensive income to the extent the decline on debt securities is related to other factors and the Company does not intend to sell the security prior to recovery of the unrealized loss.

 

               Certain other investments in debt and equity securities are reported in the financial statements at an amount less than their historical cost. Total fair value of these investments at September 30, 2018 and December 31, 2017, was $80,223,968 and $62,107,660, respectively, which is approximately 94% and 76% of the Company’s investment portfolio.

 

13

 

 

The following table shows gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2018 and December 31, 2017.

 

   

September 30, 2018

 
       
   

Less than 12 Months

   

12 Months or More

   

Total

 
                   

Description of Securities

 

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

Losses

 
                                                 

Corporates

  $ 2,982,976     $ (17,024 )   $ -     $ -     $ 2,982,976     $ (17,024 )

Municipals

    15,318,000       (360,210 )     16,854,043       (871,654 )     32,172,043       (1,231,864 )

Government sponsored mortgage-backed securities and SBA loan pools

    13,890,846       (324,934 )     31,178,103       (1,612,549 )     45,068,949       (1,937,483 )
    $ 32,191,822     $ (702,168 )   $ 48,032,146     $ (2,484,203 )   $ 80,223,968     $ (3,186,371 )

 

 

 

   

December 31, 2017

 
       
   

Less than 12 Months

   

12 Months or More

   

Total

 
                   

Description of Securities

 

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

Losses

   

Fair Value

   

Unrealized

Losses

 
                                                 

Municipals

  $ 11,024,593     $ (103,747 )   $ 8,802,796     $ (159,874 )   $ 19,827,389     $ (263,621 )

Government sponsored mortgage-backed securities and SBA loan pools

    20,088,694       (253,907 )     22,191,577       (655,006 )     42,280,271       (908,913 )
    $ 31,113,287     $ (357,654 )   $ 30,994,373     $ (814,880 )   $ 62,107,660     $ (1,172,534 )

 

14

 
 

 

 

Note 5: Loans and Allowance for Loan Losses

 

Categories of loans at September 30, 2018 and December 31, 2017 include:

 

   

September 30,

   

December 31,

 
   

2018

   

2017

 

Real estate - residential mortgage:

               

One to four family units

  $ 135,292,752     $ 106,300,790  

Multi-family

    93,320,376       85,225,074  

Real estate - construction

    90,819,134       64,743,582  

Real estate - commercial

    313,283,043       261,866,285  

Commercial loans

    122,288,207       94,522,840  

Consumer and other loans

    33,745,549       24,716,447  

Total loans

    788,749,061       637,375,018  

Less:

               

Allowance for loan losses

    (7,731,707 )     (7,107,418 )

Deferred loan fees/costs, net

    (701,035 )     (662,591 )

Net loans

  $ 780,316,319     $ 629,605,009  

 

Classes of loans by aging at September 30, 2018 and December 31, 2017 were as follows:

 

As of September 30, 2018

                                                       
   

30-59 Days
Past Due

   

60-89 Days
Past Due

   

90 Days

and more

Past Due

   

Total Past
Due

   

Current

   

Total Loans
Receivable

   

Total Loans >
90 Days and
Accruing

 
   

(In Thousands)

 

Real estate - residential mortgage:

                                                 

One to four family units

  $ 68     $ 181     $ 2,238     $ 2,487     $ 132,806     $ 135,293     $ -  

Multi-family

    -       5,990       -       5,990       87,330       93,320       -  

Real estate - construction

    323       -       -       323       90,496       90,819       -  

Real estate - commercial

    2,667       1,054       698       4,419       308,864       313,283       -  

Commercial loans

    1,386       73       212       1,671       120,617       122,288       -  

Consumer and other loans

    909       9       7       925       32,821       33,746       -  

Total

  $ 5,353     $ 7,307     $ 3,155     $ 15,815     $ 772,934     $ 788,749     $ -  

 

 

As of December 31, 2017

                                                       
   

30-59 Days
Past Due

   

60-89 Days
Past Due

   

90 Days

and more

Past Due

   

Total Past
Due

   

Current

   

Total Loans
Receivable

   

Total Loans >
90 Days and
Accruing

 
   

(In Thousands)

 

Real estate - residential mortgage:

                                                 

One to four family units

  $ 510     $ 731     $ 2,495     $ 3,736     $ 102,565     $ 106,301     $ -  

Multi-family

    775       -       -       775       84,450       85,225       -  

Real estate - construction

    -       -       -       -       64,744       64,744       -  

Real estate - commercial

    243       135       -       378       261,488       261,866       -  

Commercial loans

    276       -       588       864       93,659       94,523       -  

Consumer and other loans

    8       8       -       16       24,700       24,716       -  

Total

  $ 1,812     $ 874     $ 3,083     $ 5,769     $ 631,606     $ 637,375     $ -  

 

15

 

 

At September 30, 2018, there were purchased credit impaired loans of $2,015,591 30-59 days past due, $560,683 60-89 days past due and $387,003 that were greater than 90 days past due.

 

Nonaccruing loans are summarized as follows:

 

   

September 30,

   

December 31,

 
   

2018

   

2017

 

Real estate - residential mortgage:

               

One to four family units

  $ 4,407,862     $ 4,423,074  

Multi-family

    -       -  

Real estate - construction

    4,179,409       4,452,409  

Real estate - commercial

    4,212,886       161,491  

Commercial loans

    1,167,417       802,628  

Consumer and other loans

    16,561       121,915  

Total

  $ 13,984,135     $ 9,961,517  

 

At September 30, 2018, purchased credit impaired loans comprised $3.0 million of nonaccrual loans.

 

The following tables present the activity in the allowance for loan losses based on portfolio segment for the three and nine months ended September 30, 2018 and 2017:

 

Three months ended September 30, 2018

 

Construction

   

Commercial
Real Estate

   

One to four

family

   

Multi-

family

   

Commercial

   

Consumer
and Other

   

Unallocated

   

Total

 

Allowance for loan losses:

 

(In Thousands)

 

Balance, beginning of period

  $ 2,484     $ 1,787     $ 1,237     $ 553     $ 1,085     $ 367     $ 60     $ 7,573  

Provision charged to expense

    (219 )     158       96       97       (44 )     65       47     $ 200  

Losses charged off

    -       -       (3 )     -       (14 )     (74 )     -     $ (91 )

Recoveries

    36       -       1       -       4       9       -     $ 50  

Balance, end of period

  $ 2,301     $ 1,945     $ 1,331     $ 650     $ 1,031     $ 367     $ 107     $ 7,732  

 

Nine months ended September 30, 2018

 

Construction

   

Commercial
Real Estate

   

One to four

family

   

Multi-

family

   

Commercial

   

Consumer
and Other

   

Unallocated

   

Total

 

Allowance for loan losses:

 

(In Thousands)

 

Balance, beginning of period

  $ 2,244     $ 1,789     $ 946     $ 464     $ 1,031     $ 454     $ 179     $ 7,107  

Provision charged to expense

    (13 )     155       386       186       98       185       (72 )   $ 925  

Losses charged off

    -       -       (3 )     -       (110 )     (301 )     -     $ (414 )

Recoveries

    70       1       2       -       12       29       -     $ 114  

Balance, end of period

  $ 2,301     $ 1,945     $ 1,331     $ 650     $ 1,031     $ 367     $ 107     $ 7,732  

 

16

 

 

Three months ended September 30, 2017

 

Construction

   

Commercial
Real Estate

   

One to four

family

   

Multi-

family

   

Commercial

   

Consumer
and Other

   

Unallocated

   

Total

 

Allowance for loan losses:

 

(In Thousands)

 

Balance, beginning of period

  $ 1,739     $ 1,954     $ 936     $ 323     $ 1,226     $ 335     $ 127     $ 6,640  

Provision charged to expense

    524       (116 )     (81 )     52       (99 )     126       44     $ 450  

Losses charged off

    -       (71 )     -       -       -       (46 )     -     $ (117 )

Recoveries

    16       -       1       -       7       12       -     $ 36  

Balance, end of period

  $ 2,279     $ 1,767     $ 856     $ 375     $ 1,134     $ 427     $ 171     $ 7,009  

 

Nine months ended September 30, 2017

 

Construction

   

Commercial
Real Estate

   

One to four

family

   

Multi-

family

   

Commercial

   

Consumer
and Other

   

Unallocated

   

Total

 

Allowance for loan losses:

 

(In Thousands)

 

Balance, beginning of period

  $ 1,377     $ 1,687     $ 856     $ 206     $ 1,168     $ 337     $ 111     $ 5,742  

Provision charged to expense

    847       151       2       169       40       231       60     $ 1,500  

Losses charged off

    -       (71 )     (11 )     -       (85 )     (169 )     -     $ (336 )

Recoveries

    55       -       9       -       11       28       -     $ 103  

Balance, end of period

  $ 2,279     $ 1,767     $ 856     $ 375     $ 1,134     $ 427     $ 171     $ 7,009  

 

The following tables present the recorded investment in loans based on portfolio segment and impairment method as of September 30, 2018 and December 31, 2017:

 

As of September 30, 2018

 

Construction

   

Commercial
Real Estate

   

One to four

family

   

Multi-

family

   

Commercial

   

Consumer
and Other

   

Unallocated

   

Total

 
Allowance for loan losses:                                                                

Ending balance: individually evaluated for impairment

  $ 552     $ 51     $ 606     $ -     $ 231     $ 26     $ -     $ 1,466  

Ending balance: collectively evaluated for impairment

  $ 1,749     $ 1,894     $ 725     $ 650     $ 800     $ 341     $ 107     $ 6,266  

Ending balance: loans acquired with deteriorated credit quality

  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  

Loans:

                                                               

Ending balance: individually evaluated for impairment

  $ 4,180     $ 922     $ 4,405     $ 5,990     $ 863     $ 153     $ -     $ 16,513  

Ending balance: collectively evaluated for impairment

  $ 86,639     $ 309,488     $ 130,888     $ 87,330     $ 121,382     $ 33,145     $ -     $ 768,872  

Ending balance: loans acquired with deteriorated credit quality

  $ -     $ 2,873     $ -     $ -     $ 43     $ 448     $ -     $ 3,364  

 

December 31, 2017

 

Construction

   

Commercial
Real Estate

   

One to four

family

   

Multi-

family

   

Commercial

   

Consumer
and Other

   

Unallocated

   

Total

 
Allowance for loan losses:                                                                

Ending balance: individually evaluated for impairment

  $ 738     $ -     $ 127     $ -     $ 246     $ 138     $ -     $ 1,249  

Ending balance: collectively evaluated for impairment

  $ 1,506     $ 1,789     $ 819     $ 464     $ 785     $ 316     $ 179     $ 5,858  

Loans:

                                                               

Ending balance: individually evaluated for impairment

  $ 4,452     $ 161     $ 4,424     $ 775     $ 739     $ 276     $ -     $ 10,827  

Ending balance: collectively evaluated for impairment

  $ 60,292     $ 261,705     $ 101,877     $ 84,450     $ 93,784     $ 24,440     $ -     $ 626,548  

 

17

 

 

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

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

 

The allowance consists of allocated and general components. The allocated component relates to loans that are classified as impaired. For those loans that are classified as impaired, an allowance is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of that loan. The general component covers nonclassified loans and is based on historical charge-off experience and expected loss given default derived from the Bank’s internal risk rating process. Other adjustments may be made to the allowance for pools of loans after an assessment of internal or external influences on credit quality that are not fully reflected in the historical loss or risk rating data.

 

Included in the Company’s loan portfolio are certain loans acquired in accordance with ASC 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. These loans were written down at acquisition to an amount estimated to be collectible. As a result, certain ratios regarding the Company’s loan portfolio and credit quality cannot be used to compare the Company to peer companies or to compare the Company’s current credit quality to prior periods. The ratios particularly affected by accounting under ASC 310-30 include the allowance for loan losses as a percentage of loans, nonaccrual loans, and performing assets, and nonaccrual loans and nonperforming loans as a percentage of total loans.

 

A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent.

 

Groups of loans with similar risk characteristics are collectively evaluated for impairment based on the group’s historical loss experience adjusted for changes in trends, conditions and other relevant factors that affect repayment of the loans.    

 

18

 

 

The following table summarizes the recorded investment in impaired loans at September 30, 2018 and December 31, 2017:

 

   

September 30, 2018

   

December 31, 2017

 
   

Recorded
Balance

   

Unpaid
Principal
Balance

   

Specific
Allowance

   

Recorded
Balance

   

Unpaid
Principal
Balance

   

Specific
Allowance

 
   

(In Thousands)

 

Loans without a specific valuation allowance

                                         

Real estate - residential mortgage:

                                               

One to four family units

  $ 836     $ 836     $ -     $ 3,180     $ 3,180     $ -  

Multi-family

    -       -       -       775       775       -  

Real estate - construction

    -       -       -       2,840       2,840       -  

Real estate - commercial

    3,549       3,549       -       161       161       -  

Commercial loans

    242       242       -       465       465       -  

Consumer and other loans

    457       457       -       3       3       -  

Loans with a specific valuation allowance

                                         

Real estate - residential mortgage:

                                               

One to four family units

  $ 3,569     $ 3,569     $ 606     $ 1,244     $ 1,244     $ 127  

Multi-family

    5,990       5,990       -       -       -       -  

Real estate - construction

    4,180       5,413       552       1,612       2,845       738  

Real estate - commercial

    246       246       51       -       -       -  

Commercial loans

    664       664       231       274       274       246  

Consumer and other loans

    144       144       26       273       273       138  

Total

                                               

Real estate - residential mortgage:

                                               

One to four family units

  $ 4,405     $ 4,405     $ 606     $ 4,424     $ 4,424     $ 127  

Multi-family

    5,990       5,990       -       775       775       -  

Real estate - construction

    4,180       5,413       552       4,452       5,685       738  

Real estate - commercial

    3,795       3,795       51       161       161       -  

Commercial loans

    906       906       231       739       739       246  

Consumer and other loans

    601       601       26       276       276       138  

Total

  $ 19,877     $ 21,110     $ 1,466     $ 10,827     $ 12,060     $ 1,249  

 

 

The above amounts include purchased credit impaired loans. At September 30, 2018, purchased credit impaired loans comprised $3.4 million of impaired loans without a specific valuation allowance.

 

19

 

 

The following table summarizes average impaired loans and related interest recognized on impaired loans for the three and nine months ended September 30, 2018 and 2017:

 

   

For the Three Months Ended

   

For the Three Months Ended

 
   

September 30, 2018

   

September 30, 2017

 
   

Average
Investment
in Impaired
Loans

   

Interest
Income
Recognized

   

Average
Investment
in Impaired
Loans

   

Interest
Income
Recognized

 
   

(In Thousands)

 

Loans without a specific valuation allowance

                         

Real estate - residential mortgage:

                               

One to four family units

  $ 1,025     $ -     $ 1,946     $ -  

Multi-family

    2,001       25       -       -  

Real estate - construction

    -       -       2,937       -  

Real estate - commercial

    2,496       -       161       -  

Commercial loans

    143       -       504       -  

Consumer and other loans

    93       -       2       -  

Loans with a specific valuation allowance

                         

Real estate - residential mortgage:

                               

One to four family units

  $ 3,308     $ -     $ 183     $ -  

Multi-family

    1,997       -       -       -  

Real estate - construction

    4,212       -       2,373       -  

Real estate - commercial

    190       -       -       -  

Commercial loans

    566       -       431       -  

Consumer and other loans

    84       -       123       -  

Total

                               

Real estate - residential mortgage:

                               

One to four family units

  $ 4,333     $ -     $ 2,129     $ -  

Multi-family

    3,998       25       -       -  

Real estate - construction

    4,212       -       5,310       -  

Real estate - commercial

    2,686       -       161       -  

Commercial loans

    709       -       935       -  

Consumer and other loans

    177       -       125       -  

Total

  $ 16,115     $ 25     $ 8,660     $ -  

 

20

 

 

   

For the Nine Months Ended

   

For the Nine Months Ended

 
   

September 30, 2018

   

September 30, 2017

 
   

Average
Investment
in Impaired
Loans

   

Interest
Income
Recognized

   

Average
Investment
in Impaired
Loans

   

Interest
Income
Recognized

 
   

(In Thousands)

 

Loans without a specific valuation allowance

                         

Real estate - residential mortgage:

                               

One to four family units

  $ 1,649     $ -     $ 1,886     $ -  

Multi-family

    1,006       25       -       -  

Real estate - construction

    1,525       -       2,964       -  

Real estate - commercial

    2,383       46       360       -  

Commercial loans

    658       -       557       -  

Consumer and other loans

    37       -       8       -  

Loans with a specific valuation allowance

                         

Real estate - residential mortgage:

                               

One to four family units

  $ 2,671     $ -     $ 90     $ -  

Multi-family

    666       -       -       -  

Real estate - construction

    2,774       -       2,395       -  

Real estate - commercial

    81       -       -       -  

Commercial loans

    457       -       481       -  

Consumer and other loans

    116       -       94       -  

Total

                               

Real estate - residential mortgage:

                               

One to four family units

  $ 4,320     $ -     $ 1,976     $ -  

Multi-family

    1,672       25       -       -  

Real estate - construction

    4,299       -       5,359       -  

Real estate - commercial

    2,464       46       360       -  

Commercial loans

    1,115       -       1,038       -  

Consumer and other loans

    153       -       102       -  

Total

  $ 14,023     $ 71     $ 8,835     $ -  

 

 

At September 30, 2018, the Bank’s impaired loans shown in the table above included loans that were classified as troubled debt restructurings (“TDR”). The restructuring of a loan is considered a TDR if both (i) the borrower is experiencing financial difficulties and (ii) the creditor has granted a concession.

 

In assessing whether or not a borrower is experiencing financial difficulties, the Bank considers information currently available regarding the financial condition of the borrower. This information includes, but is not limited to, whether (i) the debtor is currently in payment default on any of its debt; (ii) a payment default is probable in the foreseeable future without the modification; (iii) the debtor has declared or is in the process of declaring bankruptcy and (iv) the debtor’s projected cash flow is sufficient to satisfy the contractual payments due under the original terms of the loan without a modification.

 

The Bank considers all aspects of the modification to loan terms to determine whether or not a concession has been granted to the borrower. Key factors considered by the Bank include the debtor’s ability to access funds at a market rate for debt with similar risk characteristics, the significance of the modification relative to unpaid principal balance or collateral value of the debt, and the significance of a delay in the timing of payments relative to the original contractual terms of the loan. The most common concessions granted by the Bank generally include one or more modifications to the terms of the debt, such as (i) a reduction in the interest rate for the remaining life of the debt, (ii) an extension of the maturity date at an interest rate lower than the current market rate for new debt with similar risk, (iii) a reduction on the face amount or maturity amount of the debt as stated in the original loan, (iv) a temporary period of interest-only payments, (v) a reduction in accrued interest, and (vi) an extension of amortization.

 

21

 

 

The following table summarizes, by class, loans that were newly classified as TDRs for the three months ended September 30, 2018:

 

   

Number of

Loans

   

Pre-Modification
Outstanding
Recorded Balance

   

Post-Modification
Outstanding
Recorded Balance

 

Real estate - residential mortgage:

                       

One to four family units

    -     $ -     $ -  

Multi-family

    -       -       -  

Real estate - construction

    -       -       -  

Real estate - commercial

    -       -       -  

Commercial loans

    3       225,046       225,046  

Consumer and other loans

    -       -       -  

Total

    3     $ 225,046     $ 225,046  

 

The following table summarizes, by type of concession, loans that were newly classified as TDRs for the three months ended September 30, 2018:

 

   

Interest Rate

   

Term

   

Combination

   

Total Modification

 

Real estate - residential mortgage:

                               

One to four family units

  $ -     $ -     $ -     $ -  

Multi-family

    -       -       -       -  

Real estate - construction

    -       -       -       -  

Real estate - commercial

    -       -       -       -  

Commercial loans

    -       30,130       194,916       225,046  

Consumer and other loans

    -       -       -       -  

Total

  $ -     $ 30,130     $ 194,916     $ 225,046  

 

The following table presents the carrying balance of TDRs as of September 30, 2018 and December 31, 2017:

 

   

September 30,

2018

   

December 31,

2017

 

Real estate - residential mortgage:

               

One to four family units

  $ 1,219,575     $ 1,290,462  

Multi-family

    -       -  

Real estate - construction

    4,179,409       4,452,409  

Real estate - commercial

    5,551,695       5,666,096  

Commercial loans

    748,827       214,529  

Consumer and other loans

    -       118,855  

Total

  $ 11,699,506     $ 11,742,351  

 

22

 

 

The Bank has allocated $877,637 and $372,321 of specific reserves to customers whose loan terms have been modified in TDR as of September 30, 2018 and December 31, 2017, respectively.

 

There were no TDRs for which there was a payment default within twelve months following the modification during the three and nine months ending September 30, 2018 and 2017. A loan is considered to be in payment default once it is 90 days contractually past due under the modified terms.

 

As part of the on-going monitoring of the credit quality of the Bank’s loan portfolio, management tracks loans by an internal rating system. All loans are assigned an internal credit quality rating based on an analysis of the borrower’s financial condition. The criteria used to assign quality ratings to extensions of credit that exhibit potential problems or well-defined weaknesses are primarily based upon the degree of risk and the likelihood of orderly repayment, and their effect on the Bank’s safety and soundness. The following are the internally assigned ratings:

 

Pass: This rating represents loans that have strong asset quality and liquidity along with a multi-year track record of profitability.

 

Special mention: This rating represents loans that are currently protected but are potentially weak. The credit risk may be relatively minor, yet constitute an increased risk in light of the circumstances surrounding a specific loan.

 

Substandard: This rating represents loans that show signs of continuing negative financial trends and unprofitability and therefore, is inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any.

 

Doubtful: This rating represents loans that have all the weaknesses of substandard classified loans with the additional characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

Risk characteristics applicable to each segment of the loan portfolio are described as follows.

 

Real estate-Residential 1-4 family: The residential 1-4 family real estate loans are generally secured by owner-occupied 1-4 family residences. Repayment of these loans is primarily dependent on the personal income and credit rating of the borrowers. Credit risk in these loans can be impacted by economic conditions within the Bank’s market areas that might impact either property values or a borrower’s personal income. Risk is mitigated by the fact that the loans are of smaller individual amounts and spread over a large number of borrowers.

 

Real estate-Construction: Construction and land development real estate loans are usually based upon estimates of costs and estimated value of the completed project and include independent appraisal reviews and a financial analysis of the developers and property owners. Sources of repayment of these loans may include permanent loans, sales of developed property or an interim loan commitment from the Bank until permanent financing is obtained. These loans are considered to be higher risk than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, general economic conditions and the availability of long-term financing. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economies in the Bank’s market areas.

 

Real estate-Commercial: Commercial real estate loans typically involve larger principal amounts, and repayment of these loans is generally dependent on the successful operations of the property securing the loan or the business conducted on the property securing the loan. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Credit risk in these loans may be impacted by the creditworthiness of a borrower, property values and the local economies in the Bank’s market areas.

 

Commercial: The commercial portfolio includes loans to commercial customers for use in financing working capital needs, equipment purchases and expansions. The loans in this category are repaid primarily from the cash flow of a borrower’s principal business operation. Credit risk in these loans is driven by creditworthiness of a borrower and the economic conditions that impact the cash flow stability from business operations.

 

23

 

 

Consumer: The consumer loan portfolio consists of various term and line of credit loans such as automobile loans and loans for other personal purposes. Repayment for these types of loans will come from a borrower’s income sources that are typically independent of the loan purpose. Credit risk is driven by consumer economic factors (such as unemployment and general economic conditions in the Bank’s market area) and the creditworthiness of a borrower.

 

The following tables provide information about the credit quality of the loan portfolio using the Bank’s internal rating system as of September 30, 2018 and December 31, 2017:

 

 

September 30, 2018

 

Construction

   

Commercial
Real Estate

   

One to four

family

   

Multi-family

   

Commercial

   

Consumer
and Other

   

Total

 
   

(In Thousands)

 

Rating:

                                                       

Pass

  $ 86,547     $ 299,714     $ 128,506     $ 87,330     $ 118,593     $ 33,193     $ 753,883  

Special Mention

    -       5,574       1,095       -       2,238       -       8,907  

Substandard

    4,272       7,995       5,692       5,990       1,457       553       25,959  

Doubtful

    -       -       -       -       -       -       -  

Total

  $ 90,819     $ 313,283     $ 135,293     $ 93,320     $ 122,288     $ 33,746     $ 788,749  

 

 

 

December 31, 2017

 

Construction

   

Commercial
Real Estate

   

One to four family

   

Multi-family

   

Commercial

   

Consumer
and Other

   

Total

 
   

(In Thousands)

 

Rating:

                                                       

Pass

  $ 60,291     $ 254,658     $ 96,723     $ 84,450     $ 93,102     $ 24,440     $ 613,664  

Special Mention

    -       5,578       3,799       -       200       -       9,577  

Substandard

    4,453       1,630       5,779       775       708       276       13,621  

Doubtful

    -       -       -       -       513       -       513  

Total

  $ 64,744     $ 261,866     $ 106,301     $ 85,225     $ 94,523     $ 24,716     $ 637,375  

 

The above amounts include purchased credit impaired loans. At September 30, 2018, purchased credit impaired loans comprised of $3.4 million were rated “Substandard”.

 

For loans amortized at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees net of certain direct origination costs, are deferred and amortized as a level yield adjustment over the respective term of the loan.

 

The accrual of interest on loans is discontinued at the time the loan is 90 days past due unless the loan is well-secured and in process of collection. Past due status is based on contractual terms of the loan. In all cases, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

 

All interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

24

 
 

 

 

Note 6: Accounting for Certain Loans Acquired

 

The Company acquired loans during the quarter ended June 30, 2018. At acquisition, certain acquired loans evidenced deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.

 

Loans purchased with evidence of credit deterioration since origination and for which it is probable that all contractually required payments will not be collected are considered to be credit impaired. Evidence of credit quality deterioration as of the purchase date may include information such as past-due and nonaccrual status, borrower credit scores and recent loan to value percentages. Purchased credit impaired loans are accounted for under the accounting guidance for loans and debt securities acquired with deteriorated credit quality (ASC 310-30) and initially measured at fair value, which includes estimated future credit losses expected to be incurred over the life of the loan. Accordingly, an allowance for credit losses related to these loans is not carried over and recorded at the acquisition date. Management estimated the cash flows expected to be collected at acquisition using our internal risk models, which incorporate the estimate of current key assumptions, such as default rates, severity and prepayment speeds. During the three months ended September 30, 2018, the Company had $4.3 million of unexpected full payoffs of certain purchased credit impaired loans and recognized $1.8 million of yield accretion due to these payoffs.

 

The carrying amount of purchased credit impaired loans are included in the balance sheet amounts of loans receivable at September 30, 2018. The amount of these loans is shown below:

 

   

September 30,

 
   

2018

 
   

(In Thousands)

 

Real estate - commercial

  $ 3,491  

Commercial loans

    50  

Consumer and other loans

    680  

Outstanding balance

  $ 4,221  

Carrying amount, net of fair value adjustment of $857 at September 30, 2018

  $ 3,364  

 

 

Changes in the carrying amount of the accretable yield for all purchased credit impaired loans were as follows for the three and nine months ended September 30, 2018:

 

   

Three months ended

   

Nine months ended

 
   

September 30,

   

September 30,

 
   

2018

   

2018

 
   

(In Thousands)

   

(In Thousands)

 

Balance at beginning of period

  $ 204     $ 238  

Additions

    -       -  

Accretion

    (1,724 )     (1,758 )

Reclassification from nonaccretable difference

    1,554       1,554  

Disposals

    -       -  

Balance at end of period

  $ 34     $ 34  

 

During the three and nine months ended September 30, 2018, the Company did not increase or reverse the allowance for loan losses related to these purchased credit impaired loans.

 

25

 
 

 

 

Note 7: Goodwill and Other Intangible Assets

 

The Company recorded $2.6 million of goodwill as a result of its 2018 Hometown acquisition and the goodwill is not deductible for tax purposes. Goodwill impairment was neither indicated nor recorded during the three months ended September 30, 2018.

 

Goodwill is tested annually, or more often if circumstances warrant, for impairment. If the implied fair value of goodwill is lower than its carrying amount, goodwill impairment is indicated, and goodwill is written down to its implied fair value. Subsequent increases in goodwill value are not recognized in the financial statements. Goodwill totaled $2.6 million at September 30, 2018.

 

Core deposit premiums are amortized over a seven year period and are periodically evaluated, at least annually, as to the recoverability of their carrying value. Core deposit premiums of $3.5 million were recorded during the second quarter of 2018 as part of the Hometown acquisition.

 

The Company’s goodwill and other intangibles (carrying basis and accumulated amortization) at September 30, 2018 were as follows:

 

   

September 30,

 
   

2018

 
   

(In Thousands)

 

Goodwill

  $ 2,615  

Core deposit intangible:

       

Gross carrying amount

    3,520  

Accumulated amortization

    (314 )

Core deposit intangible, net

    3,206  

Outstanding balance

  $ 5,821  

 

The Company’s estimated remaining amortization expense on intangibles as of September 30, 2018 is as follows:

 

   

Amortizaton

Expense

 
   

(In Thousands)

 

Remainder of 2018

  $ 94  

2019

    377  

2020

    377  

2021

    377  

2022

    377  

2023

    377  

Thereafter

    1,227  

Total

  $ 3,206  

 

 

 

Note 8: Benefit Plans

 

The Company has stock-based employee compensation plans, which are described in the Company’s 2017 Annual Report.     

 

26

 

 

The following tables below summarize transactions under the Company’s equity plans for the nine months ended September 30, 2018:

 

Stock Options

 

   

Number of shares

         
   

Incentive

Stock

Option

   

Non-

Incentive

Stock

Option

   

Weighted

Average

Exercise

Price

 
                         

Balance outstanding as of January 1, 2018

    46,000       25,000     $ 15.74  

Granted

    -       -       -  

Exercised

    (12,000 )     (5,000 )     7.78  

Forfeited

    (20,000 )     (10,000 )     28.71  

Balance outstanding as of September 30, 2018

    14,000       10,000     $ 5.16  

Options exercisable as of September 30, 2018

    14,000       10,000     $ 5.16  

 

 

The total intrinsic value of stock options exercised for the nine months ended September 30, 2018 and 2017 was $267,366 and $0, respectively. The total intrinsic value of outstanding stock options (including exercisable) was $452,100 and $669,800 at September 30, 2018 and 2017, respectively.

 

   

Number of

Shares

   

Weighted

Average Grant-

Date Fair Value

 
                 

Balance of shares non-vested as of January 1, 2018

    45,550     $ 16.44  

Granted

    12,838       22.41  

Vested

    (25,063 )     16.31  

Forfeited

    -       -  

Balance of shares non-vested as of September 30, 2018

    33,325     $ 18.83  

 

In February 2018, the Company granted 5,852 shares of restricted stock to directors pursuant to the 2015 Equity Plan that have a cliff vesting at the end of one year and thus, expensed over that same period. These shares had a grant date market price of $22.41 per share. The total amount of expense for restricted stock grants to directors (including all previous years grants) during the nine months ended September 30, 2018 and 2017 was $103,926 and $101,099, respectively.

 

For the nine months ended September 30, 2018 and 2017, the Company granted 6,986 and 6,426 shares, respectively, of restricted stock to officers that have a cliff vesting at the end of three years. The expense is being recognized over the applicable vesting period. The total amount of expense for restricted stock grants to officers (including all previous years grants) during the nine months ended September 30, 2018 and 2017 was $135,810 and $159,413, respectively.

 

27

 

 

Performance Stock Units

 

 

   

Performance

Stock Units

   

Weighted

Average Grant-

Date Fair Value

 
                 

Balance of shares non-vested as of January 1, 2018

    55,823     $ 20.48  

Granted

    -       -  

Vested

    -       -  

Forfeited

    -       -  

Balance of shares non-vested as of September 30, 2018

    55,823     $ 20.48  

 

On March 29, 2017, the Company granted restricted stock units representing 55,823 hypothetical shares of common stock to officers. There are three possible levels of incentive awards: threshold (25%); target (50%); and maximum (100%). The restricted stock units vest based on two financial performance factors over the period from March 29, 2017 to December 31, 2019 (the “Performance Period”). The two performance measurements of the Company (and the weight given to each measurement) applicable to each award level are as follows: (i) Total Assets (50%) and (ii) Return on Average Assets (50%). In determining compensation expense, the fair value of the restricted stock unit awards was determined based on the closing price of the Company’s common stock on the date of grant, which was $20.48 per share. The expense is being recognized over the applicable vesting period. Due to the fact that the measurements cannot be determined at the time of the grant, the Company currently estimates that the most likely outcome is the achievement between the target and maximum levels. If during the Performance Period, additional information becomes available to lead the Company to believe a different level will be achieved for the Performance Period, the Company will reassess the number of units that will vest for the grant and adjust its compensation expense accordingly on a prospective basis. The total amount of expense for restricted stock units during the nine months ended September 30, 2018 and 2017 was $253,513 and $102,529, respectively.

 

Total stock-based compensation expense recognized for the three months ended September 30, 2018 and 2017 was $159,115 and $136,263, respectively. Total stock-based compensation expense recognized for the nine months ended September 30, 2018 and 2017 was $493,249 and $363,041, respectively. As of September 30, 2018, there was $712,949 of unrecognized compensation expense related to nonvested restricted stock awards, which will be recognized over the remaining vesting period.

 

 

Note 9: Income Per Common Share

 

   

For three months ended September 30, 2018

   

For nine months ended September 30, 2018

 
   

Income

Available to

Common

Shareholders

   

Average

Common

Shares

Outstanding

   

Per

Common

Share

   

Income

Available to

Common

Shareholders

   

Average

Common

Shares

Outstanding

   

Per

Common

Share

 

Basic Income Per Common Share

  $ 3,934,242       4,418,196     $ 0.89     $ 4,947,003       4,406,830     $ 1.12  

Effect of Dilutive Securities

            72,389                       72,058          

Diluted Income Per Common Share

  $ 3,934,242       4,490,585     $ 0.88     $ 4,947,003       4,478,888     $ 1.10  

 

28

 

 

   

For three months ended September 30, 2017

   

For nine months ended September 30, 2017

 
   

Income

Available to

Common

Shareholders

   

Average

Common

Shares

Outstanding

   

Per

Common

Share

   

Income

Available to

Common

Shareholders

   

Average

Common

Shares

Outstanding

   

Per

Common

Share

 

Basic Income Per Common Share

  $ 1,717,383       4,374,725     $ 0.39     $ 4,739,197       4,370,877     $ 1.08  

Effect of Dilutive Securities

            72,841                       64,815          

Diluted Income Per Common Share

  $ 1,717,383       4,447,566     $ 0.39     $ 4,739,197       4,435,692     $ 1.07  

 

Stock options to purchase 32,500 shares of common stock were outstanding during the three and nine months ended September 30, 2017 but were not included in the computation of diluted income per common share because their exercise price was greater than the average market price of the common shares.

 

 

Note 10: New Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, (Topic 606): Revenue from Contracts with Customers (“ASU 2014-09”). The scope of the guidance applies to revenue arising from contracts with customers, except for the following: lease contracts, insurance contracts, contractual rights and obligations within the scope of other guidance and nonmonetary exchanges between entities in the same line of business to facilitate sales to customers. The core principle of the new guidance was that an entity should recognize revenue to reflect the transfer of goods and services to customers in an amount equal to the consideration that the entity receives or expects to receive. ASU 2014-09 did not significantly impact the timing or approach to revenue recognition for financial institutions. Initially, the amendments were effective for public entities for annual reporting periods beginning after December 15, 2016, however, the FASB issued ASU 2015-14 Revenue from Contracts with Customers (Topic 606) – Deferral of the Effective Date” which deferred the effective date of ASU 2014-09 by one year to annual and interim periods beginning after December 15, 2017. The guidance does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under GAAP, which comprises a significant portion of our revenue stream. The Company adopted ASU 2014-09 during the first quarter of 2018 and completed an evaluation of the impact of the revenue streams which are included in the scope of these updates, such as deposit fees and revenue from the sale of other real estate owned. The Company analyzed each revenue stream under Topic 606 and determined that there were no material changes to existing recognition practices. The Company concluded that the adoption of this update did not change significantly from our current practice of recognizing the in-scope non-interest income. In addition, we did not retroactively revise prior period amount or record a cumulative adjustment to retained earnings upon adoption.   

 

Descriptions of our significant revenue-generating transactions that are within the scope of the new revenue recognition standards, which are presented in the consolidated statements of comprehensive income as components of non-interest income, are as follows:

 

 

Service Charges on Deposit Accounts – Services charges on deposit accounts include general service fees for monthly account maintenance, account analysis fees, non-sufficient funds fees, wire transfer fees and other deposit account related fees. Revenue is recognized when the performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for service charges on deposit accounts is received immediately or in the following month through a direct charge to customers’ accounts.

 

 

Gains/Losses on Sales of OREOGains/Losses on sales of OREO are recorded from the sale when control of the property transfers to the buyer, which generally occurs at the time of an executed deed.

 

29

 

 

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”). ASU 2016-01 simplifies the impairment assessment of equity investments, clarifies reporting disclosure requirements for financial instruments measured at amortized cost, and requires the exit price notion be disclosed when measuring fair value of financial instruments. ASU 2016-01 details the required separate presentation in other comprehensive income for the change in fair value of a liability related to change in instrument specific credit risk and details the required separate presentation of financial assets and liabilities by measurement category and clarifies the guidance for a valuation allowance on deferred tax assets related to available-for-sale securities. ASU 2016-01 was effective for annual and interim reporting periods beginning after December 15, 2017. ASU 2016-01 was effective for the Company on January 1, 2018 and did not have a material impact on our consolidated financial statements. See Note 9- Disclosures about Fair Value of Assets and Liabilities for further information regarding the valuation method for loans.

 

In February 2016, the FASB issued ASU 2016-02, Leases (“ASU 2016-02”). ASU 2016-02 establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.  ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  The Company is currently evaluating the impact and have determined that the provisions of ASU 2016-02 will result in an increase in assets to recognize the present value of the lease obligations with a corresponding increase in liabilities; however, we do not expect this to have a material impact to the Company’s results of operations or cash flows.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. Among other things, the amendments in this ASU require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. For SEC filers, the amendments in this ASU are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019, with later effective dates for non-SEC registrant public companies and other organizations. Early adoption will be permitted for all organizations for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company has formed a committee that is assessing our data and evaluating the impact of adopting ASU 2016-13. The Company has also selected a third party vendor to assist in generating loan level cash flows and disclosures.

 

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The update was intended to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows with respect to eight types of cash flows. This new accounting guidance was effective for interim and annual reporting periods beginning after December 15, 2017. Adoption of ASU 2016-15 did not significantly impact the Company’s consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Subtopic 718): Scope of Modification Accounting. ASU 2017-09 clarifies when changes to terms or conditions of a share-based payment award must be accounted for as a modification. Under the new guidance, an entity does not apply modification accounting to a share-based payment award if all of the following are the same immediately before and after the change: (i) the fair value of the award, (ii) the vesting conditions of the award, and (iii) the classification of the award as either an equity or liability instrument. ASU 2017-09 was effective for the fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The guidance requires companies to apply the requirements prospectively to awards modified on or after the adoption date. ASU 2017-09 was effective for the Company on January 1, 2018 and did not have a material impact on our consolidated financial statements.

 

30

 

 

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The purpose of this updated guidance is to better align financial reporting for hedging activities with the economic objectives of those activities. The amendments in this update are effective for fiscal years beginning after December 15, 2018, with early adoption, including adoption in an interim period, permitted.  The standard requires the modified retrospective transition approach as of the date of adoption.  The Company is currently evaluating the adoption of this standard on its Consolidated Financial Statements, but at this time do not believe the standard will have a significant impact on the financial statements.

 

In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU provides financial statement preparers with an option to reclassify stranded tax effects within accumulated other comprehensive income to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) are recorded. This standard is effective for all organizations for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. Organizations should apply the proposed amendments either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. The Company elected to early adopt ASU 2018-02 and, as a result, reclassified $31,818 from accumulated other comprehensive income to retained earnings as of December 31, 2017. The reclassification impacted the Consolidated Balance Sheet and the Consolidated Statement of Stockholder’s Equity as of and for the year ended December 31, 2017.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. This ASU applies to all entities that are required, under existing GAAP, to make disclosures about recurring or nonrecurring fair value measurements. Disclosures removed by this ASU are the amount and reasons for transfers between Level 1 and Level 2, the policy for timing of transfers between levels and the valuation processes for Level 3 measurements. This ASU modifies disclosures relating to investments in certain entities that calculate net asset value. Additional disclosures required by this ASU include: 1) change in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period and 2) range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The prospective method of transition is required for the new disclosure requirements. The other amendments should be applied retrospectively. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years or January 1, 2020 for the Company. Early adoption is permitted. The Company is currently evaluating the impact of the new standard on our consolidated financial statements, but at this time do not believe the standard will have a significant impact on the financial statements.

 

31

 

 

 

Note 11: Derivative Financial Instruments

 

The Company records all derivative financial instruments at fair value in the financial statements. Derivatives are used as a risk management tool to hedge the exposure to changes in interest rates or other identified market risks.

 

When a derivative is intended to be a qualifying hedged instrument, the Company prepares written hedge documentation that designates the derivative as 1) a hedge of fair value of a recognized asset or liability (fair value hedge) or 2) a hedge of a forecasted transaction, such as, the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). The written documentation includes identification of, among other items, the risk management objective, hedging instrument, hedged item, and methodologies for assessing and measuring hedge effectiveness and ineffectiveness, along with support for management’s assertion that the hedge will be highly effective.

 

In June 2017, the Company entered into a forward start interest rate swap agreement totaling $50 million notional amount to hedge against interest rate risk on FHLB advances. As a cash flow hedge, the portion of the change in the fair value of the derivative that has been deemed highly effective is recognized in other comprehensive income until the related cash flows from the hedged item are recognized in earnings. At September 30, 2018, the Company reported a $1,995,892 unrealized gain, net of a $683,158 tax effect, in other comprehensive income related to this cash flow hedge, with the offset recorded in Prepaid expenses and other assets on the balance sheet. The Company documents, both at inception and periodically over the life of the hedge, its analysis of actual and expected hedge effectiveness. To the extent that the hedge of future cash flows is deemed ineffective, changes in the fair value of the derivative are recognized in earnings as a component of other noninterest expense. For the quarter ended September 30, 2018, there was no ineffectiveness attributable to the cash flow hedge.

 

A summary of the Company’s derivative financial instruments at September 30, 2018 is shown in the following table:

 

Forward Start
Inception Date

 

Termination
Date

 

Derivative
Type

 

Notional
Amount

   

Rate
Paid

 

Rate
Hedged

 

Estimated Fair Value
at September 30, 2018

 
                                   

2/28/2018

 

2/28/2025

 

Interest rate swap

  $ 50,000,000       2.12 %

3 month

LIBOR

Floating

  $ 2,679,050  

 

 

Note 12: Disclosures about Fair Value of Assets and Liabilities

 

ASC Topic 820, Fair Value Measurements, defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Topic 820 also specifies a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1:      Quoted prices in active markets for identical assets or liabilities

 

Level 2: Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities

 

32

 

 

Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities

 

The following is a description of the inputs and valuation methodologies used for assets measured at fair value on a recurring basis and recognized in the accompanying condensed consolidated balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy.

 

Available-for-sale securities: Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include equity securities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. For these investments, the inputs used by the pricing service to determine fair value may include one or a combination of observable inputs such as benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bid offers and reference data market research publications and are classified within Level 2 of the valuation hierarchy. Level 2 securities include U.S. government agencies, municipal securities and government sponsored mortgage-backed securities. The Company has no Level 3 securities.

 

Derivative financial instruments (Cash flow hedge): The Company’s open derivative positions are interest rate swap agreements. Those classified as Level 2 open derivative positions are valued using externally developed pricing models based on observable market inputs provided by a third party and validated by management. The Company has considered counterparty credit risk in the valuation of its interest rate swap assets.

 

The following table presents the fair value measurements of assets recognized in the accompanying condensed consolidated balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2018 and December 31, 2017 (dollar amounts in thousands):

 

9/30/2018

                               

Financial assets:

                               
   

Level 1 inputs

   

Level 2 inputs

   

Level 3 inputs

   

Total fair value

 

Debt securities:

                               

Municipals

  $ -     $ 33,339     $ -     $ 33,339  

Corporates

    -       2,983       -       2,983  

Government sponsored mortgage-backed securities and SBA loan pools

    -       49,283       -       49,283  

Available-for-sale securities

  $ -     $ 85,605     $ -     $ 85,605  

 

   

Level 1 inputs

   

Level 2 inputs

   

Level 3 inputs

   

Total fair value

 

Interest rate swaps

  $ -     $ 2,679     $ -     $ 2,679  

 

33

 

 

 

12/31/2017

                               

Financial assets:

                               
   

Level 1 inputs

   

Level 2 inputs

   

Level 3 inputs

   

Total fair value

 

Debt securities:

                               

Municipals

  $ -     $ 33,898     $ -     $ 33,898  

Corporates

    -       3,065       -       3,065  

Government sponsored mortgage-backed securities and SBA loan pools

    -       44,515       -       44,515  

Available-for-sale securities

  $ -     $ 81,478     $ -     $ 81,478  

 

   

Level 1 inputs

   

Level 2 inputs

   

Level 3 inputs

   

Total fair value

 

Interest rate swaps

  $ -     $ 568     $ -     $ 568  

 

The following is a description of the valuation methodologies used for assets measured at fair value on a nonrecurring basis and recognized in the accompanying statements of financial condition, as well as the general classification of such assets pursuant to the valuation hierarchy.

 

Foreclosed Assets Held for Sale:   Fair value is estimated using recent appraisals, comparable sales and other estimates of value obtained principally from independent sources, adjusted for selling costs and discounts based on management’s assessment of the condition and marketability of the collateral. Foreclosed assets held for sale are classified within Level 3 of the valuation hierarchy.

 

Impaired loans (Collateral Dependent):   Loans for which it is probable that the Company will not collect all principal and interest due according to contractual terms are measured for impairment. Allowable methods for determining the amount of impairment include estimating fair value using the fair value of the collateral for collateral dependent loans.

 

If the impaired loan is identified as collateral dependent, then the fair value method of measuring the amount of impairment is utilized. This method requires obtaining a current independent appraisal of the collateral and applying a discount factor to the value. Impaired loans that are collateral dependent are classified within Level 3 of the fair value hierarchy when impairment is determined using the fair value method.

 

The following table presents the fair value measurement of assets measured at fair value on a nonrecurring basis and the level within the fair value hierarchy in which the fair value measurements fall at September 30, 2018 and December 31, 2017 (dollar amounts in thousands):

 

Impaired loans:

                               
   

Level 1 inputs

   

Level 2 inputs

   

Level 3 inputs

   

Total fair value

 

September 30, 2018

  $ -     $ -     $ 9,574     $ 9,574  
                                 

December 31, 2017

  $ -     $ -     $ 2,224     $ 2,224  

 

Foreclosed assets held for sale:                        
   

Level 1 inputs

   

Level 2 inputs

   

Level 3 inputs

   

Total fair value

 

September 30, 2018

  $ -     $ -     $ 976     $ 976  
                                 

December 31, 2017

  $ -     $ -     $ -     $ -  

 

34

 

 

There were no transfers between valuation levels for any asset during the nine months ended September 30, 2018 or 2017. If valuation techniques are deemed necessary, the Company considers those transfers to occur at the end of the period when the assets are valued.

 

The following table presents quantitative information about unobservable inputs used in recurring and nonrecurring Level 3 fair value measurement (dollar amounts in thousands):

 

   

Fair Value
September 30, 2018

 

Valuation

Technique

 

Unobservable

Input

 

Range
(Weighted Average)

                           

Impaired loans (collateral dependent)

  $ 9,574  

Market Comparable

 

Discount to reflect

realizable value

    0% - 100% (5%)
                           

Foreclosed assets held for sale

  $ 976  

Market Comparable

 

Discount to reflect

realizable value

      N/A    

 

 

The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying condensed consolidated balance sheets at amounts other than fair value.

 

Cash and cash equivalents, interest-bearing deposits and Federal Home Loan Bank stock

The carrying amounts reported in the condensed consolidated balance sheets approximate those assets' fair value.

 

Held-to-maturity securities

Fair value is based on quoted market prices, if available. If a quoted market price is not available, fair value is estimated using quoted market prices for similar securities.

 

Loans

For September 30, 2018, the fair value of loans is estimated on an exit price basis incorporating contractual cash flow, prepayments discount spreads, credit loss and liquidity premiums. For December 31, 2017, the fair value of loans was estimated by discounting the future cash flows using the market rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans with similar characteristics were aggregated for purposes of the calculations. The carrying amount of accrued interest approximates its fair value.

 

Deposits

Deposits include demand deposits, savings accounts, NOW accounts and certain money market deposits. The carrying amount approximates fair value. The fair value of fixed-maturity certificates of deposit is estimated by discounting the future cash flows using rates currently offered for deposits of similar remaining maturities.

 

Federal Home Loan Bank advances

The fair value of advances is estimated by using rates on debt with similar terms and remaining maturities.

 

Subordinated debentures

For these variable rate instruments, the carrying amount is a reasonable estimate of fair value. There is currently a limited market for similar debt instruments and the Company has the option to call the subordinated debentures at an amount close to its par value.

 

Interest payable

The carrying amount approximates fair value.

 

35

 

 

Commitments to originate loans, letters of credit and lines of credit

The fair value of commitments to originate loans is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit and lines of credit are based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date.

 

The following tables present estimated fair values of the Company’s financial instruments at September 30, 2018 and December 31, 2017.

 

   

September 30, 2018

 
   

Carrying

Amount

   

Fair Value

   

Hierarchy
Level

 

Financial assets:

                       

Cash and cash equivalents

  $ 31,211,790     $ 31,211,790       1  

Held-to-maturity securities

    12,722       12,805       2  

Federal Home Loan Bank stock

    5,043,200       5,043,200       2  

Mortgage loans held for sale

    961,654       961,654       2  

Loans, net

    780,316,319       775,577,411       3  

Interest receivable

    3,403,810       3,403,810       2  

Financial liabilities:

                       

Deposits

    760,729,322       758,855,539       2  

Federal Home Loan Bank advances

    96,700,000       96,728,237       2  

Subordinated debentures

    21,782,794       21,782,794       3  

Notes payable

    5,000,000       5,000,000       2  

Interest payable

    791,216       791,216       2  

Unrecognized financial instruments (net of contractual value):

                       

Commitments to extend credit

    -       -       -  

Unused lines of credit

    -       -       -  

 

36

 

 

   

December 31, 2017

 
   

Carrying

Amount

   

Fair Value

   

Hierarchy
Level

 

Financial assets:

                       

Cash and cash equivalents

  $ 37,406,930     $ 37,406,930       1  

Held-to-maturity securities

    16,457       16,729       2  

Federal Home Loan Bank stock

    4,597,500       4,597,500       2  

Mortgage loans held for sale

    1,921,819       1,921,819       2  

Loans, net

    629,605,009       627,498,508       3  

Interest receivable

    2,449,847       2,449,847       2  

Financial liabilities:

                       

Deposits

    607,364,350       606,548,280       2  

Federal Home Loan Bank advances

    94,300,000       94,417,733       2  

Subordinated debentures

    15,465,000       15,465,000       3  

Interest payable

    295,543       295,543       2  

Unrecognized financial instruments (net of contractual value):

                       

Commitments to extend credit

    -       -       -  

Unused lines of credit

    -       -       -  

 

 

 

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

 

General

 

The primary function of the Company is to monitor and oversee its investment in the Bank. The Company engages in few other activities, and the Company has no significant assets other than its investment in the Bank. As a result, the results of operations of the Company are derived primarily from operations of the Bank. The Bank’s results of operations are primarily dependent on net interest margin, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. The Bank’s income is also affected by the level of its noninterest expenses, such as employee salaries and benefits, occupancy expenses and other expenses. The following discussion reviews material changes in the Company’s financial condition as of September 30, 2018, and the results of operations for the three and nine months ended September 30, 2018 and 2017.

 

These forward-looking statements involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations, estimates and intentions of Guaranty Federal Bancshares, Inc. (“Guaranty Federal Bancshares”) and its wholly-owned subsidiary, Guaranty Bank (the “Bank”, with Guaranty Federal Bancshares and the Bank being referred to collectively hereinafter as the “Company”) that are subject to change based on various important factors (some of which are beyond the Company's control).  The following factors, among others, could cause the Company's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the real estate values and the local economies in which the Company conducts operations; risks associated with the Company’s acquisition of Hometown Bancshares, Inc. (“Hometown”) and its wholly-owned subsidiary Hometown Bank, National Association (“Hometown Bank”) and the integration of Hometown Bank with the Bank, including the possibility that we may not realize the anticipated benefits of the acquisition; the impact of recent and potential future changes in the laws, rules, regulations, interpretations and policies relating to financial institutions, accounting, tax, monetary and fiscal matters and their application by our regulators; the effects of, and changes in, trade, monetary and fiscal policies and laws, changes in interest rates; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services; the impact of changes in financial services' laws and regulations (including laws concerning taxes, banking, securities and insurance); asset quality deterioration; environmental liability associated with real estate collateral; technological changes and cybersecurity risks; acquisitions; employee retention; the success of the Company at managing the risks resulting from these factors; and other factors set forth in reports and other documents filed by the Company with the Securities and Exchange Commission from time to time.  For further information about these and other risks, uncertainties and factors, please review the disclosure included in Item 1A. “Risk Factors” of the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2017.

 

37

 

 

The Company cautions that the listed factors are not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

 

On April 2, 2018, pursuant to the previously announced Agreement and Plan of Merger dated as of November 30, 2017 (the “Merger Agreement”) by and between Guaranty Federal Bancshares and Hometown, Hometown merged with and into Guaranty Federal Bancshares with Guaranty Federal Bancshares being the surviving corporation (the “Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each share of Hometown common stock was converted into the right to receive $20.00 in cash. In the aggregate, the Company paid $4.6 million in respect of the outstanding shares of Hometown common stock. Hometown’s subsidiary bank, Hometown Bank, was merged into Guaranty Bank on June 8, 2018.

 

In connection with the Merger, pursuant to a Second Supplemental Indenture, dated as of April 2, 2018, by and among the Company, Hometown, and Wilmington Trust Company, as trustee (the “Trustee”), the Company assumed Hometown’s rights, duties, and obligations under the Indenture, dated as of October 29, 2002, as supplemented by that certain First Supplemental Indenture, dated as of May 19, 2014, by and between Hometown and the Trustee, under which Hometown issued approximately $6.1 million aggregate principal amount of its Floating Rate Junior Subordinated Debt Securities due 2032.

 

Financial Condition

 

The Company’s total assets increased $171,921,227 (22%) from $794,459,520 as of December 31, 2017, to $966,380,747 as of September 30, 2018. The increase is primarily due to the Hometown assets acquired of $178,785,000.

 

Available-for-sale securities increased $4,126,470 (5%) from $81,478,673 as of December 31, 2017, to $85,605,143 as of September 30, 2018. The increase was attributable primarily to $7,521,000 in securities acquired in the Hometown acquisition. The Company also had purchases of $25,151,079 offset by sales and principal payments of $25,804,714 and an increase in unrealized losses of $2,317,521 when compared December 31, 2017.

 

Net loans receivable increased by $150,711,310 (24%) from $629,605,009 as of December 31, 2017 to $780,316,319 as of September 30, 2018. The increase was attributable in large part to the Hometown acquisition, which added loans totaling $143,919,000 at fair value. The Company continues to focus its lending efforts in the commercial, owner occupied real estate and small business lending categories.

 

Allowance for loan losses increased $624,289 (9%) from $7,107,418 as of December 31, 2017 to $7,731,707 as of September 30, 2018. In addition to the provision for loan losses of $925,000 recorded by the Company for the nine months ended September 30, 2018, charge-offs of specific loans (classified as nonperforming at December 31, 2017) exceeded loan recoveries by $300,711. The allowance for loan losses, as a percentage of gross loans outstanding (excluding mortgage loans held for sale), as of September 30, 2018 and December 31, 2017 was 0.98% and 1.12%, respectively. The allowance for loan losses including the discount and premiums on acquired loans, as a percentage of gross loans outstanding (excluding mortgage loans held for sale), as of September 30, 2018 was 1.36%. The allowance for loan losses, as a percentage of nonperforming loans outstanding, as of September 30, 2018 and December 31, 2017 was 55.3% and 71.3%, respectively. Management believes the allowance for loan losses is at a level to be sufficient in providing for potential loan losses in the Bank’s existing loan portfolio.

 

38

 

 

Goodwill increased $2,615,532 (100%) and core deposit intangible increased $3,205,714 (100%) as of September 30, 2018 when compared to December 31, 2017. The increases are due to the Hometown acquisition and are further discussed in Note 7 to the Condensed Consolidated Financial Statements.

 

Premises and equipment increased $11,551,001 (109%) from $10,607,094 as of December 31, 2017 to $22,158,095 as of September 30, 2018. This is increase is primarily due to the $10,066,000 of fixed assets acquired from the Hometown acquisition.

 

Deposits increased $153,364,972 (25%) from $607,364,350 as of December 31, 2017, to $760,729,322 as of September 30, 2018. The deposit growth was attributable in large part to the Hometown acquisition, which added deposits of $161,248,424 at fair value. For the nine months ended September 30, 2018, checking and savings accounts increased by $69,132,414 and certificates of deposit decreased by $76,871,838. See also the discussion under Item 3 - “Quantitative and Qualitative Disclosure about Market Risk – Asset/Liability Management.”

 

Federal Home Loan Bank advances increased $2,400,000 (3%) from $94,300,000 as of December 31, 2017 to $96,700,000 as of September 30, 2018. The Company acquired $2,000,000 in Federal Home Loan Bank advances due to the Hometown acquisition but the increase was offset by net principal reductions.

 

Note payable to bank increased $5,000,000 (100%) when compared to December 31, 2017. The Company opened a $5,000,000 revolving line of credit with a variable interest rate tied to Libor which matures on June 28, 2020. The funds were used to provide additional capital for funding Bank asset growth.

 

Subordinated debentures increased $6,317,794 (41%) from $15,465,000 as of December 31, 2017 to $21,782,794 as of September 30, 2018. The increase is due to the Hometown acquisition, which added $6,362,000 of subordinated debentures at fair value.

 

Stockholders’ equity (including net unrealized loss on available-for-sale securities and interest rate swaps) increased $3,723,194 (5%) from $74,891,493 as of December 31, 2017, to $78,614,687 as of September 30, 2018. The Company’s net income during this period exceeded dividends paid or declared by $3,345,753. On a per common share basis, tangible book value decreased from $17.10 as of December 31, 2017 to $16.48 as of September 30, 2018 due to the Hometown acquisition.

 

Average Balances, Interest and Average Yields

 

The Company’s profitability is primarily dependent upon net interest income, which represents the difference between interest and fees earned on loans and debt and equity securities, and the cost of deposits and borrowings. Net interest income is dependent on the difference between the average balances and rates earned on interest-earning assets and the average balances and rates paid on interest-bearing liabilities. Non-interest income, non-interest expense, and income taxes also impact net income.

 

39

 

 

The following table sets forth certain information relating to the Company’s average consolidated statements of financial condition and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense annualized by the average balance of assets or liabilities, respectively, for the periods shown. Average balances were derived from average daily balances. The average balance of loans includes loans on which the Company has discontinued accruing interest. The yields and costs include fees which are considered adjustments to yields. All dollar amounts are in thousands.

 

   

Three months ended 9/30/2018

   

Three months ended 9/30/2017

 
   

Average

Balance

   

Interest

   

Yield /

Cost

   

Average

Balance

   

Interest

   

Yield /

Cost

 

ASSETS

                                               

Interest-earning:

                                               

Loans

  $ 787,638     $ 12,774       6.43 %   $ 618,652     $ 7,052       4.52 %

Investment securities

    87,182       524       2.38 %     84,577       432       2.03 %

Other assets

    18,257       80       1.74 %     10,418       41       1.56 %

Total interest-earning

    893,077       13,378       5.94 %     713,647       7,525       4.18 %

Noninterest-earning

    59,509                       40,386                  
    $ 952,586                     $ 754,033                  

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                         

Interest-bearing:

                                               

Savings accounts

  $ 42,412       29       0.27 %   $ 30,026       15       0.20 %

Transaction accounts

    405,230       1,175       1.15 %     348,925       524       0.60 %

Certificates of deposit

    208,534       622       1.18 %     133,198       354       1.05 %

FHLB advances

    88,750       482       2.15 %     89,246       420       1.87 %

Other borrowed funds

    5,000       59       4.68 %     -       -       0.00 %

Subordinated debentures

    21,797       282       5.13 %     15,465       160       4.10 %

Total interest-bearing

    771,723       2,649       1.36 %     616,860       1,473       0.95 %

Noninterest-bearing

    103,817                       62,599                  

Total liabilities

    875,540                       679,459                  

Stockholders’ equity

    77,046                       74,574                  
    $ 952,586                     $ 754,033                  

Net earning balance

  $ 121,354                     $ 96,787                  

Earning yield less costing rate

                    4.58 %                     3.24 %

Net interest income, and net yield spread on interest earning assets

          $ 10,729       4.77 %           $ 6,052       3.36 %

Ratio of interest-earning assets to interest-bearing liabilities

            116 %                     116 %        

 

40

 

 

   

Nine months ended 9/30/2018

   

Nine months ended 9/30/2017

 
   

Average

Balance

   

Interest

   

Yield /

Cost

   

Average B

alance

   

Interest

   

Yield /

Cost

 

ASSETS

                                               

Interest-earning:

                                               

Loans

  $ 759,354     $ 29,971       5.28 %   $ 598,925     $ 20,043       4.47 %

Investment securities

    86,457       1,466       2.27 %     88,783       1,361       2.05 %

Other assets

    19,358       276       1.91 %     12,623       134       1.42 %

Total interest-earning

    865,169       31,713       4.90 %     700,331       21,538       4.11 %

Noninterest-earning

    58,903                       40,512                  
    $ 924,072                     $ 740,843                  

LIABILITIES AND STOCKHOLDERS’ EQUITY

                                               

Interest-bearing:

                                               

Savings accounts

  $ 40,325       76       0.25 %   $ 29,360       43       0.20 %

Transaction accounts

    407,895       3,231       1.06 %     345,247       1,346       0.52 %

Certificates of deposit

    198,879       1,661       1.12 %     119,011       873       0.98 %

FHLB advances

    77,436       1,221       2.11 %     98,306       1,269       1.73 %

Other borrowed funds

    3,671       63       2.29 %     -       -       0.00 %

Subordinated debentures

    20,705       729       4.71 %     15,465       468       4.05 %

Total interest-bearing

    748,911       6,981       1.25 %     607,389       3,999       0.88 %

Noninterest-bearing

    97,388                       60,478                  

Total liabilities

    846,299                       667,867                  

Stockholders’ equity

    77,773                       72,976                  
    $ 924,072                     $ 740,843                  

Net earning balance

  $ 116,258                     $ 92,942                  

Earning yield less costing rate

                    3.65 %                     3.23 %

Net interest income, and net yield spread on interest earning assets

          $ 24,732       3.82 %           $ 17,539       3.35 %

Ratio of interest-earning assets to interest-bearing liabilities

            116 %                     115 %        

 

 

Results of Operations - Comparison of Three and Nine Month Periods Ended September 30, 2018 and 2017

 

Net income for the three and nine months ended September 30, 2018 was $3,934,242 and $4,947,003, respectively, compared to $1,717,383 and $4,739,197 for the three and nine months ended September 30, 2017, respectively, which represents an increase in earnings of $2,216,859 (129%) and $207,806 (4%) for the three and nine month periods, respectively.

 

Net Interest Income

 

Net interest income for the three and nine months ended September 30, 2018 increased $4,677,009 (77%) and $7,193,388 (41%), respectively, when compared to the same periods in 2017. For the three and nine month periods ended September 30, 2018, the average balance of net interest earning assets over liabilities increased by approximately $24,567,000 and $23,316,000, respectively, when compared to the same periods in 2017. For the three and nine month periods ended September 30, 2018, the net interest margin increased 141 basis points to 4.77% and 47 basis points to 3.82%, respectively, when compared to the same periods in 2017.

 

Loan discount accretion and amortization of fair value adjustments for time deposits and subordinated debentures from the Hometown acquisition resulted in an additional $2,639,322 and $2,906,154 in net interest income for the three and nine months ended September 30, 2018, with no comparable amounts during the same periods in 2017. The loan discount accretion for the three months ended September 30, 2018 was $2,733,302 of yield accretion, of which $1,766,977 was recognized upon the unexpected full payoffs of certain PCI loans totaling $4,302,563 during the quarter ended September 30, 2018. The total loan accretion income was significantly greater than originally projected during the quarter due to the accelerated cash flows received from loan principal paydowns and payoffs overall. Combined, these components of net interest income contributed 123 and 51 basis points to net interest margin for the three and nine months ended September 30, 2018.     

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Interest Income

 

Total interest income for the three and nine months ended September 30, 2018 increased $5,852,688 (78%) and $10,175,219 (47%), respectively, as compared to the three and nine months ended September 30, 2017. For the three and nine-month period ended September 30, 2018 compared to the same periods in 2017, the average yield on interest earning assets increased 176 basis points to 5.94% and increased 79 basis points to 4.90%, while the average balance of interest earning assets increased approximately $179,430,000 for the three-month period and increased approximately $164,838,000 for the nine-month period. Increased average interest-earning balances were primarily attributable to the Hometown acquisition along with organic loan growth when compared to the same periods in 2017. The increase in the average yield on interest-earning assets was primarily due to loan discount accretion of $2,733,302 and $3,094,114 for the three and nine months ended September 30, 2018, as discussed above.

 

Interest Expense

 

Total interest expense for the three and nine months ended September 30, 2018 increased $1,175,679 (80%) and $2,981,831 (75%), respectively, when compared to the three and nine months ended September 30, 2017. For the three and nine-month period ended September 30, 2018 compared to the same periods in 2017, the average cost of interest bearing liabilities increased 41 basis points to 1.36% and increased 37 basis points to 1.25%, while the average balance of interest bearing liabilities increased approximately $154,863,000 for the three-month period and increased approximately $141,522,000 for the nine-month period. Increased average interest-bearing balances were primarily attributable to the deposit and subordinated debenture growth, which was due to the Hometown acquisition, offset by a decline in average balances of FHLB advances. The increase in the average cost of interest-bearing liabilities was primarily due to increased rates on retail deposits and FHLB borrowings which was partially offset by the deposit and subordinated debentures adjustments, discussed above.

 

Provision for Loan Losses

 

Provisions for loan losses are charged or credited to earnings to bring the total allowance for loan losses to a level considered adequate by the Company to provide for potential loan losses in the existing loan portfolio. When making its assessment, the Company considers prior loss experience, volume and type of lending, local banking trends and impaired and past due loans in the Company’s loan portfolio. In addition, the Company considers general economic conditions and other factors related to collectability of the Company’s loan portfolio.

 

Based on its internal analysis and methodology, management recorded a provision for loan losses of $200,000 and $925,000 for the three months and nine months ended September 30, 2018, respectively, compared to $450,000 and $1,500,000 for the same periods in 2017.

 

The Company’s decrease in provision was primarily due to the decrease in construction loan balances to permanent commercial real estate loans which carry a lower general reserve based on risk. The Bank will continue to monitor its allowance for loan losses and make future additions based on economic and regulatory conditions. Management may need to increase the allowance for loan losses through charges to the provision for loan losses if anticipated growth in the Bank’s loan portfolio continues to increase or other circumstances warrant.    

 

Although the Bank maintains its allowance for loan losses at a level which it considers to be sufficient to provide for potential loan losses in its existing loan portfolio, there can be no assurance that future loan losses will not exceed internal estimates.  In addition, the amount of the allowance for loan losses is subject to review by regulatory agencies which can order the establishment of additional loan loss provisions.

 

42

 

 

Noninterest Income

 

Noninterest income decreased $109,111 (7%) for the three months and increased $567,315 (14%) for the nine months ended September 30, 2018, respectively, when compared to the three months and nine months ended September 30, 2017. The decline for three months ended September 30, 2018 is primarily due to the Company’s write-downs of foreclosed assets held for sale, including two properties acquired from Hometown. The re-measurements and write-downs were due to a lack of sales activity, further review of surrounding property values and reductions in the property’s listing price (in most cases). Net loss on foreclosed assets were $459,308 and $338,496 for the three and nine months ended September 30, 2018 compared to net gains on foreclosed assets of $47,787 and 56,051 for the three and nine months ended September 30, 2017. The Company had increase in gains on sale of SBA loans of $34,860 and $175,756 for the three and nine months ended September 30, 2018, respectively, when compared to the same periods in 2017. Increases in service charges of $164,418 and $475,563 for the three and nine months ended September 30, 2018 were attributable primarily to the April 2018 Hometown acquisition.

 

Noninterest Expense

 

Noninterest expenses increased $1,654,017 (33%) and $8,364,973 (60%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. The increase is due to a few significant factors.        

 

Due to the Company’s acquisition of Hometown, $150,877 and $3,570,927 of one-time, nonrecurring merger costs were incurred for the three and nine months ended September 30, 2018. The costs relate to legal, accounting and investment advisory fees, as well as the cost incurred for termination of a specific vendor core processing contract of approximately $2 million.

 

Salaries and employee benefits increased $835,165 (27%) and $2,317,911 (26%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. The increase is primarily due to the Company’s existing expansion in the Joplin, Missouri market (pre-acquisition) and the Hometown acquisition which contributed approximately $521,000 and $1,390,000 of additional expense for the three and nine months ended September 30,2018.

 

Occupancy expenses increased $520,741 (88%) and $1,357,430 (87%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. Lease expense on the new headquarters facility began in January 2018 and total expense was approximately $155,000 and $465,000 for the three and nine months ended September 30, 2018. The remaining increases relate to depreciation on furniture and fixtures for the new facility and the newly acquired assets from the Hometown acquisition.

 

Data processing expenses increased $60,184 (22%) and $365,324 (50%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. The increase is primarily due to increased technology investments for the new headquarters facility and additional core processing expense associated with the Hometown acquisition.

 

Amortization expense of the core deposit intangible from the Hometown acquisition was $94,286 and $314,286 for the three and nine months ended September 30, 2018. There was no amortization expense for the same periods in 2017.

 

Provision for Income Taxes

 

The provision for income taxes increased by $947,022 (213%) and decreased by $237,076 (16%) for the three and nine months ended September 30, 2018 when compared to the same periods of 2017. The decrease in the provision for income taxes is primarily due to the increased utilization of tax credits and the decline in federal tax rates as a result of the Tax Cuts and Jobs Act signed into law on December 22, 2017, and the three month increase was due to the significantly higher income in 2018.   

 

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Nonperforming Assets

 

The allowance for loan losses is calculated based upon an evaluation of pertinent factors underlying the various types and quality of the Bank’s existing loan portfolio.  When making such evaluation, management considers such factors as the repayment status of loans, the estimated net realizable value of the underlying collateral, borrowers’ intent (to the extent known by the Bank) and ability to repay the loan, local economic conditions and the Bank’s historical loss ratios.  The allowance for loan losses, as a percentage of nonperforming loans outstanding, as of September 30, 2018 and December 31, 2017 was 55.3% and 71.3%, respectively.  Total loans classified as substandard, doubtful or loss as of September 30, 2018, were $25,823,000 or 2.67% of total assets as compared to $14,134,000 or 1.78% of total assets at December 31, 2017.  The Company downgraded to substandard one multi-family real estate loan for approximately $6.0 million during the three months ending September 30, 2018.  In addition, acquired loans from Hometown made up $4.1 million of loans classified as substandard at September 30, 2018.  Management considered nonperforming and total classified loans in evaluating the adequacy of the Bank’s allowance for loan losses.

 

The ratio of nonperforming assets to total assets is another useful tool in evaluating exposure to credit risk. Nonperforming assets of the Bank are comprised of nonperforming loans (including troubled debt restructurings) and assets which have been acquired as a result of foreclosure or deed-in-lieu of foreclosure. All dollar amounts are in thousands.

 

   

9/30/2018

   

12/31/2017

   

12/31/2016

 

Nonperforming loans

  $ 13,984     $ 9,962     $ 8,632  

Real estate acquired in settlement of loans

    1,133       283       2,682  

Total nonperforming assets

  $ 15,117     $ 10,245     $ 11,314  
                         

Total nonperforming assets as a percentage of total assets

    1.56 %     1.29 %     1.64 %

Allowance for loan losses

  $ 7,732     $ 7,107     $ 5,742  

Allowance for loan losses as a percentage of gross loans

    0.98 %     1.12 %     1.05 %

 

Included in the table above is $4.1 million of nonperforming loans acquired from Hometown and $863,603 in real estate acquired in settlement of loans.

 

Liquidity and Capital Resources

 

Liquidity refers to the ability to manage future cash flows to meet the needs of depositors and borrowers and fund operations. Maintaining appropriate levels of liquidity allows the Company to have sufficient funds available for customer demand for loans, withdrawal of deposit balances and maturities of deposits and other liabilities. The Company’s primary sources of liquidity include cash and cash equivalents, customer deposits and Federal Home Loan Bank of Des Moines borrowings. The Company also has established borrowing lines available from the Federal Reserve Bank which is considered a secondary source of funds.

 

The Company’s most liquid assets are cash and cash equivalents, which are cash on hand, amounts due from financial institutions, and certificates of deposit with other financial institutions that have an original maturity of three months or less. The levels of such assets are dependent on the Bank’s operating, financing, and investment activities at any given time. The Company’s cash and cash equivalents totaled $31,211,790 as of September 30, 2018 and $37,406,930 as of December 31, 2017, representing a decrease of $6,195,140. The variations in levels of cash and cash equivalents are influenced by many factors but primarily loan originations and payments, deposit flows and anticipated future deposit flows, which are subject to, and influenced by, many factors.

 

In July 2013, the Board of Governors of the Federal Reserve Board and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks (commonly known as Basel III). Under the final rules, which began for the Bank on January 1, 2015 and are subject to a phase-in period through January 1, 2019, minimum requirements will increase for both the quantity and quality of capital held by the Bank. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), effectively resulting in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures. We expect that the capital ratios for the Bank under Basel III will continue to exceed the well capitalized minimum capital requirements, when fully phased in.

 

44

 

 

The Bank’s capital ratios are above the levels required to be considered a well-capitalized financial institution. As of September 30, 2018, the Bank’s common equity Tier 1 ratio was 10.94%, the Bank’s Tier 1 leverage ratio was 10.17%, its Tier 1 risk-based capital ratio was 10.94% and the Bank’s total risk-based capital ratio was 11.81% - all exceeding the minimums of 6.5%, 5.0%, 8.0% and 10.0%, respectively, as of September 30, 2018.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Asset/Liability Management

 

The goal of the Bank’s asset/liability policy is to manage interest rate risk so as to maximize net interest income over time in changing interest rate environments. Management monitors the Bank’s net interest spreads (the difference between yields received on assets and paid on liabilities) and, although constrained by market conditions, economic conditions, and prudent underwriting standards, the Bank offers deposit rates and loan rates designed to maximize net interest income. Management also attempts to fund the Bank’s assets with liabilities of a comparable duration to minimize the impact of changing interest rates on the Bank’s net interest income. Since the relative spread between financial assets and liabilities is constantly changing, the Bank’s current net interest income may not be an indication of future net interest income.

 

As a part of its asset and liability management strategy and throughout the past several years, the Bank has continued to emphasize the origination of short-term commercial real estate, commercial business and consumer loans, while originating fixed-rate, one- to four-family residential loans primarily for immediate resale in the secondary market.

 

The Bank constantly monitors its deposits in an effort to decrease their interest rate sensitivity. Rates of interest paid on deposits at the Bank are priced competitively in order to meet the Bank’s asset/liability management objectives and spread requirements. The Bank believes, based on historical experience, that a substantial portion of such accounts represents non-interest rate sensitive core deposits.

 

Interest Rate Sensitivity Analysis

 

The following table sets forth as of September 30, 2018 management’s estimates of the projected changes in net portfolio value (“NPV”) in the event of 100 and 200 basis point (“BP”) instantaneous and permanent increases and decreases in market interest rates. Dollar amounts are expressed in thousands.

 

BP Change

   

Estimated Net Portfolio Value

   

NPV as % of PV of Assets

 

in Rates

   

$ Amount

   

$ Change

   

% Change

   

NPV Ratio

   

Change

 

+200

    $ 146,714     $ 8,549       6 %     15.55 %     1.20 %

+100

      143,843       5,678       4 %     15.08 %     0.73 %

NC

      138,165       -       0 %     14.36 %     0.00 %
-100       133,615       (4,550 )     -3 %     13.78 %     -0.58 %
-200       120,359       (17,806 )     -13 %     12.34 %     -2.01 %

 

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Computations of prospective effects of hypothetical interest rate changes are based on an internally generated model using actual maturity and repricing schedules for the Bank’s loans and deposits, and are based on numerous assumptions, including relative levels of market interest rates, loan repayments and deposit run-offs, and should not be relied upon as indicative of actual results. Further, the computations do not contemplate any actions the Bank may undertake in response to changes in interest rates. For further discussion of the Company’s market risk, see the Interest Rate Sensitivity Analysis Section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2017.

 

Management cannot predict future interest rates or their effect on the Bank’s NPV in the future. Certain shortcomings are inherent in the method of analysis presented in the computation of NPV. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in differing degrees to changes in market interest rates. Additionally, certain assets, such as adjustable-rate loans, have an initial fixed rate period typically from one to five years, and over the remaining life of the asset changes in the interest rate are restricted. In addition, the proportion of adjustable-rate loans in the Bank’s portfolio could decrease in future periods due to refinancing activity if market interest rates remain steady in the future. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in the table. Finally, the ability of many borrowers to service their adjustable-rate debt may decrease in the event of an interest rate increase.

 

The Bank’s Board of Directors (the “Board”) is responsible for reviewing the Bank’s asset and liability management policies. The Board meets quarterly to review interest rate risk and trends, as well as liquidity and capital ratios and requirements. The Bank’s management is responsible for administering the policies and determinations of the Board with respect to the Bank’s asset and liability goals and strategies.

 

Item 4. Controls and Procedures 

 

(a) The Company maintains disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in the Company’s Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

During the quarter ended September 30, 2018, the Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2018.

 

(b) There have been no changes in the Company’s internal control over financial reporting during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

46

 

 

PART II

 

Item 1.     Legal Proceedings

 

None.

 

Item 1A. Risk Factors

 

Not applicable.

 

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

 

ISSUER PURCHASES OF EQUITY SECURITIES

 

The Company has a repurchase plan which was announced on August 20, 2007. This plan authorizes the purchase by the Company of up to 350,000 shares of the Company’s common stock. There is no expiration date for this plan. There are no other repurchase plans in effect at this time. The Company had no repurchase activity of the Company’s common stock during the quarter ended September 30, 2018.

 

Item 3.     Defaults Upon Senior Securities

 

Not applicable.

 

Item 4.     Mine Safety Disclosures

 

Not applicable.

 

Item 5.     Other Information

 

None

 

Item 6.     Exhibits

 

 

10.1

Written Description of 2018 Executive Incentive Compensation Annual Plans-Chief Executive, Chief Financial, Chief Operating, Chief Lending and Chief Credit Officers* (1)

 

11.

Statement re: computation of per share earnings (set forth in “Note 9: Income Per Common Share” of the Notes to Condensed Consolidated Financial Statement (unaudited))

 

31(i).1

Certification of the Principal Executive Officer pursuant to Rule 13a -14(a) of the Exchange Act

 

31(i).2

Certification of the Principal Financial Officer pursuant to Rule 13a - 14(a) of the Exchange Act

 

32

Officer certifications pursuant to 18 U.S.C. Section 1350

 

101

The following materials from Guaranty Federal Bancshares, Inc.’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2018 formatted in Extensible Business Reporting Language (XBRL): (i) Condensed Consolidated Balance Sheets (unaudited), (ii) Condensed Consolidated Statements of Income (unaudited), (iii) Condensed Consolidated Statements of Comprehensive Income (unaudited), (iv) Condensed Consolidated Statement of Stockholders’ Equity (unaudited), (v) the Condensed Consolidated Statements of Cash Flows (unaudited), and (vi) related notes.*

 

*Pursuant to Regulation S-T, the interactive data files on Exhibit 101 hereto are deemed not filed or part of   a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as

 amended, and otherwise are not subject to liability under those sections.

________________________________________________________

 

(1)

Filed as Exhibit 10.1 through 10.5 to the Current Report on Form 8-K filed by the Registrant on May 7, 2018 and incorporated herein by reference.

 

47

 

 

SIGNATURES

 

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

 

Guaranty Federal Bancshares, Inc.  
   
   
Signature and Title Date
   
/s/ Shaun A. Burke                                      November 9, 2018 
Shaun A. Burke  
President and Chief Executive Officer  
(Principal Executive Officer and Duly Authorized Officer)  
   
   
   

/s/ Carter Peters                                          

November 9, 2018
Carter Peters  
Executive Vice President and Chief Financial Officer  

(Principal Financial and Accounting Officer)

 

 

48