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Section 1: 10-K (10-K)

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Fiscal Year Ended December 31, 2017

 

or

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

Commission File Number 001-37778

 

HarborOne Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Massachusetts

 

81-1607465

(State or other jurisdiction of
incorporation or organization)

 

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

 

770 Oak Street, Brockton, Massachusetts

02301

(Address of principal executive offices)

(Zip Code)

 

(508) 895-1000

(Registrant’s telephone number, including area code)

 

 

 

 

 

Title of Each Class

 

Name of Each Exchange on Which Registered

 

Common Stock, $0.01 par value

The NASDAQ Stock Market, LLC

 

Securities Registered Pursuant to Section 12(g) of the Act:

None  

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒ No

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ No

 

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 ☐ No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). ☒ Yes ☐ No

 

Indicate by checkmark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K. ☒

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer  ☐

Accelerated filer  ☒

Non-accelerated filer  ☐
(Do not check if a smaller reporting company)

Smaller reporting company  ☐

Emerging growth company  ☒

 

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No

 

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the Registrant as of its last completed second fiscal quarter was $258,984,000.

 

As of March 6, 2018 there were 32,622,695 shares of the Registrant’s common stock, par value $0.01 per share, outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Proxy Statement dated March 30, 2018 for the Annual Meeting of Shareholders to be held on May 10, 2018 are incorporated by reference into Part III of this Form 10-K.

 

 

 

 


 

Table of Contents

Index

 

 

PAGE

 

PART I

 

 

 

 

ITEM 1. 

Business

3

 

 

 

ITEM 1A. 

Risk Factors

19

 

 

 

ITEM 1B. 

Unresolved Staff Comments

27

 

 

 

ITEM 2. 

Properties

27

 

 

 

ITEM 3. 

Legal Proceedings

27

 

 

 

ITEM 4. 

Mine Safety Disclosures

27

 

 

 

 

PART II

 

 

 

 

ITEM 5. 

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities

27

 

 

 

ITEM 6. 

Selected Financial Data

31

 

 

 

ITEM 7. 

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

32

 

 

 

ITEM 7A. 

Quantitative and Qualitative Disclosures about Market Risk

58

 

 

 

ITEM 8. 

Financial Statements and Supplementary Data

59

 

 

 

ITEM 9. 

Changes in and Disagreements with Accountants or Accounting and Financial Disclosure

118

 

 

 

ITEM 9A. 

Controls and Procedures

118

 

 

 

ITEM 9B. 

Other Information

119

 

 

 

 

PART III

 

 

 

 

ITEM 10. 

Directors, Executive Officers, and Corporate Governance

119

 

 

 

ITEM 11. 

Executive Compensation

119

 

 

 

ITEM 12. 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

119

 

 

 

ITEM 13. 

Certain Relationships and Related Transactions, and Director Independence

120

 

 

 

ITEM 14. 

Principal Accounting Fees and Services

120

 

 

 

 

PART IV

 

 

 

 

ITEM 15. 

Exhibits and Financial Statement Schedules

120

 

 

 

ITEM 16. 

Form 10-K Summary

122

 

 

 

SIGNATURES 

 

123

 

 

 

 


 

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Forward-Looking Statements

 

Certain statements contained in this Annual Report on Form 10-K that are not historical facts may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements, which are based on certain current assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions. These statements include, among others, statements regarding our strategy, goals and expectations; evaluations of future interest rate trends and liquidity; expectations as to growth in assets, deposits and results of operations, future operations, market position and financial position; and prospects, plans and objectives of management. You should not place undue reliance on our forward-looking statements. You should exercise caution in interpreting and relying on forward-looking statements because they are subject to significant risks, uncertainties and other factors which are, in some cases, beyond our control.

 

Forward-looking statements are based on the current assumptions and beliefs of management and are only expectations of future results. The Company’s actual results could differ materially from those projected in the forward-looking statements as a result of, among others, factors referenced under the section captioned “Risk Factors” at Part I, Item 1A of this Form 10-K adverse conditions in the capital and debt markets and the impact of such conditions on our business activities; changes in interest rates; competitive pressures from other financial institutions; the effects of general economic conditions on a national basis or in the local markets in which we operate, including changes that adversely affect borrowers’ ability to service and repay our loans; changes in the value of securities in our investment portfolio; changes in loan default and charge-off rates; fluctuations in real estate values; the adequacy of loan loss reserves; decreases in deposit levels necessitating increased borrowing to fund loans and investments; operational risks including, but not limited to, cybersecurity, fraud and natural disasters; changes in government regulation; changes in accounting standards and practices; the risk that goodwill and intangibles recorded in our financial statements will become impaired; demand for loans in our market area; our ability to attract and maintain deposits; risks related to the implementation of acquisitions, dispositions, and restructurings; the risk that we may not be successful in the implementation of our business strategy; and changes in assumptions used in making such forward-looking statements. Forward-looking statements speak only as of the date on which they are made. The Company does not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made.

 

PART I

 

ITEM 1.  BUSINESS

 

HarborOne Bancorp, Inc.

 

HarborOne Bancorp, Inc. (hereafter referred to as “we”, “our”, “us”, “HarborOne Bancorp” or the “Company”) is a Massachusetts corporation that was formed in 2016 as part of the reorganization of HarborOne Bank (“HarborOne Bank” or the “Bank”) into a two-tier mutual holding company structure with a mid-tier stock holding company. The Company sold 14,454,396 shares of common stock at $10.00 per share, including 1,187,188 shares purchased by the Company’s Employee Stock Ownership Plan (“ESOP”). In addition, the Company issued 17,281,034 shares to HarborOne Mutual Bancshares, the Company’s mutual holding company parent (the “MHC”) and 385,450 shares to The HarborOne Foundation (the “Foundation”), a charitable foundation that was formed in connection with the stock offering and is dedicated to supporting charitable organizations operating in the Bank’s local community. A total of 32,120,880 shares of common stock were outstanding following the completion of the stock offering. At December 31, 2017 the Company had total assets of $2.68 billion, deposits of $2.01 billion and shareholders’ equity of $343.5 million on a consolidated basis. The Consolidated Financial Statements include the accounts of the Company, Legion Parkway Company LLC, a security corporation and subsidiary of the Company formed on July 13, 2016, the Bank and the Bank’s wholly-owned subsidiaries including Merrimack Mortgage Company, LLC (“Merrimack Mortgage” or “MMC”).

 

HarborOne Bancorp, Inc.’s corporate offices are located at 770 Oak Street, Brockton, Massachusetts 02301 and the telephone number is (508) 895-1000. 

 

HarborOne Bank

 

HarborOne Bank is the largest state-chartered co-operative bank in New England. The Bank, originally established in 1917 as a state-chartered credit union, converted to a state-chartered co-operative bank on July 1, 2013.  The Bank provides a variety of financial services to individuals and businesses online and through its fourteen full-service branches located in Abington, Attleboro, Bridgewater,

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Brockton, Canton, Easton, Mansfield, Middleboro, Plymouth, Randolph and Raynham, Massachusetts and two limited-service bank offices in Brockton and Attleboro, Massachusetts, a commercial lending office in Providence, Rhode Island, and a loan office in Westford, Massachusetts.  Acquired in 2015 and operated as a wholly owned subsidiary of the Bank, Merrimack Mortgage Company, LLC is a residential mortgage company headquartered in New Hampshire that maintains 34 offices in Massachusetts, New Hampshire and Maine, and is also licensed to lend in seven additional states. 

 

We also provide a range of educational services through "HarborOne U," with classes on small business, financial literacy and personal enrichment at classroom sites adjacent to our Brockton and Mansfield locations.

 

Employees

 

As of December 31, 2017, the Company had 581 full time equivalent employees. None of the Company’s employees are represented by a labor union and management considers its relationship with employees to be good.

 

Available Information

 

Under Section 13(a) or 15(d) of the Exchange Act of 1934, as amended (the “Exchange Act”) HarborOne Bancorp, Inc. is required to file reports, proxy and information statements and other information with the Securities and Exchange Commission (“SEC”). The Company electronically files its annual report on Form 10-K, proxy, quarterly reports on Form 10-Q, and current reports on Form 8-K and other reports as required with the SEC. The SEC website www.sec.gov provides access to all forms which have been filed electronically. Additionally, the Company’s SEC filings and additional shareholder information are available free of charge on the Company’s website, www.harborone.com (within the Investor Relations section). Information on our website is not and should not be considered part of this annual report. 

 

The Company’s common stock is traded on the NASDAQ stock market under the symbol “HONE”.

 

Market Area and Competition

 

The Company provides financial services to individuals, families, small to middle-market businesses and municipalities throughout Southeastern New England. While our primary deposit-gathering area is concentrated within our branch office communities located in the Massachusetts counties of Norfolk, Bristol and Plymouth, our lending area encompasses the broader market of Eastern Massachusetts, the greater Providence, Rhode Island metropolitan area and through our subsidiary Merrimack Mortgage, New Hampshire and southern Maine.

 

The Company faces significant competition both in attracting deposits and generating loans. Our primary competitors are savings banks, commercial and co-operative banks, credit unions, internet banks, as well as, other nonbank institutions that offer financial alternatives such as brokerage firms and insurance companies.

 

Our competition for loans comes from savings banks, commercial and co-operative banks, credit unions, internet banks and from other financial service providers, such as mortgage companies, mortgage brokers and the finance arms of auto makers. Competition for loans also comes from non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.

 

Many of the banks that operate in our primary market area are owned by large national and regional holding companies, are larger than we are and therefore may have greater resources or offer a broader range of products and services. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks and other financial services companies to expand their geographic reach by providing services over the internet, and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Increased competition for deposits and the origination of loans could limit our growth in the future.

 

Lending Activities

 

The total gross loan portfolio amounted to $2.19 billion on December 31, 2017, or 81.8% of total assets. The portfolio consists of commercial loans, residential real estate loans, and consumer loans. Commercial loans consists of commercial real estate loans, commercial and industrial loans, commercial construction and small business loans. Residential real estate loans consists of residential mortgages, home equity lines of credit, second mortgages and construction loans that are secured primarily by owner-occupied

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residences. Consumer loans are primarily auto loans and other personal loans. The Company also originates residential mortgages for sale, primarily through Merrimack Mortgage, as discussed further in Mortgage Banking Activity below.

 

Commercial Real Estate Loans.   Our commercial real estate loans are generally secured by properties used for business purposes such as office buildings, retail development, manufacturing facilities, warehouse distribution, hospitality and apartment buildings. We currently focus our commercial real estate efforts on small- and mid-size owner occupants and investors in our market area seeking loans between $350,000 and $20 million. At December 31, 2017, commercial real estate loans were $655.4 million, or 30.0% of total loans, and consisted of $262.9 million of fixed-rate loans and $392.5 million of adjustable rate loans.

 

We originate fixed- and adjustable-rate commercial real estate loans typically with terms of five to ten years, though loans may be for terms of up to 20 years. Interest rates and payments on our adjustable-rate loans typically adjust in accordance with a designated index every three, five or seven years. Most of our adjustable-rate commercial real estate loans adjust every five years to a specified percentage above the corresponding FHLB Classic Advance borrowing rate and amortize over a 25-year term. We also offer interest rate swaps to accommodate customer needs. Loan amounts generally do not exceed 80.0% of the property's appraised value at the time the loan is originated.

 

We consider a number of factors when underwriting commercial real estate loans that include projected net cash flow to the loan’s debt service requirement, the age and condition of the collateral, the financial resources and income level of the sponsor and their experience in owning or managing similar properties. When circumstances warrant, personal guarantees are obtained from the principals of the borrower on commercial real estate. To monitor cash flows on income properties, we require borrowers and loan guarantors, where applicable, to provide annual financial statements on commercial real estate loans.  In reaching a decision on whether to make a commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise, credit history, profitability and the value of the underlying property.  We generally require an independent appraisal or valuation, an environmental survey and a property condition report for commercial real estate loans.

 

In addition to originating these loans, we participate in commercial real estate loans with other financial institutions located primarily in Massachusetts and sell participation interests in commercial real estate loans to local financial institutions, primarily the portion of loans that exceed our borrowing limits or are in an amount that is considered prudent to manage our credit risk, see below Loan “Underwriting Risks – Loan Participations”.

 

At December 31, 2017, the average loan size of our outstanding commercial real estate loans was $3.3 million, and our four largest credits ranged from $15.0 million to $13.5 million. These loans were performing in accordance with their original terms at December 31, 2017. Our largest commercial real estate relationship totaled $28.4 million and financed medical and office buildings.

 

Commercial Loans.  We originate commercial loans and lines of credit to a variety of professionals, sole proprietorships and small- to medium-sized businesses, primarily in Massachusetts and Rhode Island, with sales up to $50 million and borrowing needs up to $10 million, for working capital and other business purposes. At December 31, 2017, commercial loans were $109.5 million, or 5.0% of total loans and consisted of $35.2 million of fixed-rate loans and $74.3 million of adjustable rate loans.

 

Commercial loans are made with either variable or fixed rates of interest. Variable rates are based on a margin over the LIBOR index or the Prime rate as published in The Wall Street Journal, plus a margin. Fixed-rate business loans are generally indexed to a corresponding FHLB rate, plus a margin. Commercial loans typically have shorter maturity terms and higher interest spreads than real estate loans, but generally involve more credit risk because of the type and nature of the collateral. We generally require that our commercial customers maintain a deposit relationship with the Bank.

 

When making commercial loans, we consider the financial statements and the experience of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral, primarily accounts receivable, inventory and equipment. Commercial loan amounts are determined based on the capacity for debt service and an evaluation of the age, condition and collectability of the collateral but generally, advance rates for certain asset classes would not exceed 80%. 

 

At December 31, 2017,  the average loan size of our outstanding commercial loans was $208,000 and our four largest commercial loan exposures ranged from $4.5 million to $5.5 million.  These loans are secured by all business assets of the borrower and were performing according to their original terms at December 31, 2017.  

 

Construction Loans.    We originate commercial construction loans for commercial development projects, including industrial buildings, retail and office buildings and speculative residential real estate. We also originate residential real estate construction loans

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to professional developers, contractors and builders, and to a lesser extent, individuals, to finance the construction of residential dwellings. At December 31, 2017, construction loan balances were $128.6 million, or 5.9% of total loans. Commercial construction balances were $116.7 million and homeowner construction balances were $11.9 million. At December 31, 2017, our commercial construction loan portfolio consisted of $5.1 million in loan balances that were secured by speculative residential real estate loan projects, $90.2 million in loans that were secured by commercial real estate speculative projects and $21.4 million secured by owner occupied commercial real estate projects.  At December 31, 2017 unadvanced funds on total construction loans was $143.5 million, $137.3 million for commercial real estate construction and $6.2 million on residential real estate construction loans.

 

Our commercial construction loans generally call for the payment of interest only with interest rates tied to LIBOR or Prime rate as published in The Wall Street Journal, plus a margin. Construction loans for commercial real estate can be originated with principal balances of up to $20.0 million, but generally are lower; the average originated principal balance at December 31, 2017 was $5.7 million.  Advances on commercial construction loans are made in accordance with a schedule reflecting the cost of construction and repayment is generally expected from permanent financing upon completion of construction.

 

Our residential real estate construction loans generally are fixed-rate loans that provide for the payment of interest only during the construction phase, which is usually 12 to 36 months. At the end of the construction phase, the loan may be paid in full or converted to a permanent mortgage loan. Before making a commitment to fund a construction loan, we generally require an appraisal of the property by an independent licensed appraiser. Our loan policy dictates a minimum equity contribution by the borrower of 20.0% and loan-to-value ratio not greater than 80.0% of the appraised market value estimated upon completion of the project. All borrowers are underwritten and evaluated for creditworthiness based on past experience, debt service ability, net worth analysis including available liquidity, and other credit factors. Advances are only made following an inspection of the property confirming completion of the required progress on the project and an update to the title completed by a bank approved attorney. 

 

At December 31, 2017, our largest outstanding commercial construction loan relationship was $17.0 million. This project is secured by a first mortgage to develop an apartment building and was performing according to its original repayment terms at December 31, 2017.

 

One- to Four-Family Residential Real Estate Loans.    We provide residential real estate loans for home purchase or refinancing on existing homes, most of which serve as the primary residence of the owner. At December 31, 2017, residential mortgage loans were $677.8 million, or 31.0% of total loans, and consisted of $585.5 million and $92.4 million of fixed-rate and adjustable-rate loans, respectively. We offer fixed-rate and adjustable-rate residential mortgage loans with terms up to 30 years

 

Our one- to four-family residential mortgage originations are generally underwritten to conform to Federal National Mortgage Association, or "Fannie Mae," and Federal National Home Loan Mortgage Corporation, or "Freddie Mac," underwriting guidelines. Our adjustable-rate mortgage loans generally adjust annually or after an initial fixed period that ranges from three to seven years and are adjusted to a rate equal to a specified percentage above the LIBOR or U.S. Treasury index. Depending on the loan type, the maximum amount by which the interest rate may be increased or decreased is generally 2.0% per adjustment period with the lifetime interest rate caps ranging from 5.0% to 6.0% over the initial interest rate of the loan.

 

Borrower demand for adjustable-rate compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to the interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.

 

While residential mortgage loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.

 

We originate one- to four-family residential mortgage loans with loan-to-value ratios up to 80.0% and we generally require private mortgage insurance for residential loans secured by a first mortgage with a loan-to-value ratio over 80.0%. We generally require all properties securing mortgage loans to be appraised by a licensed real estate appraiser. We generally require title insurance on all first mortgage loans. Exceptions to these lending policies are based on an evaluation of credit risk related to the borrower and the size of the loan. Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.

 

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In an effort to provide financing for first-time buyers, we offer adjustable- and fixed-rate loans to qualified individuals and originate the loans using modified underwriting guidelines, reduced interest rates and loan conditions and reduced closing costs. We also participate in publicly sponsored loan programs which provide competitive terms for low and moderate income home buyers.

 

The majority of the conforming fixed-rate one- to four-family residential mortgage loans we originate are sold to the secondary market mainly to Fannie Mae and Freddie Mac with servicing retained other than for specialized governmental programs that require servicing to be released.  Generally, we hold in our portfolio nonconforming loans, shorter-term fixed-rate loans and adjustable-rate loans.

 

We generally do not (i) originate "interest only" mortgage loans on one- to four-family residential properties, (ii) offer loans that provide for negative amortization of principal such as "option ARM" loans where the borrower can pay less than the interest owed on their loan, (iii) offer "subprime" loans (loans that are made with low down payments to borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies or borrowers with questionable repayment capacity) or (iv) offer "Alt-A" loans (loans to borrowers having less than full documentation).

 

Second Mortgages and Equity Lines of Credit.    We offer second mortgages and equity lines of credit, which are secured by owner-occupied residences. At December 31, 2017, second mortgages and equity lines of credit were $89.1 million, or 4.1% of total loans. Second mortgages are made at fixed interest rates and terms of up to fifteen years. Equity lines of credit have adjustable rates of interest that are indexed to the Prime rate as published in The Wall Street Journal plus or minus a margin, and generally are subject to an interest rate floor, with 10-year draws and repayment terms of between five and twenty years. We offer second mortgages and equity lines of credit with cumulative loan-to-value ratios generally up to 80.0%, when taking into account both the balance of the home equity loan and first mortgage loan. We hold a first mortgage position on the homes that secure second mortgages or equity lines of credit in approximately one-third of the portfolio.

 

The procedures for underwriting home equity lines of credit include an assessment of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral to the proposed loan amount. The procedures for underwriting residential mortgage loans apply equally to second mortgages and equity lines of credit.

 

Auto and Other Consumer Loans.   We primarily focus on the origination of auto loans through indirect loans and lease assignments from Credit Union Leasing of America that are accounted for as loans. At December 31, 2017, auto loans were $513.7 million, or 23.5% of total loans and 97.3% of consumer loans. Other consumer loans, consisting primarily of unsecured lines of credit and personal loans, were $14.1 million, or 0.6% of total loans.

 

We originate auto loans through a network of approximately 275 auto dealers secured by new and used vehicles primarily in Massachusetts and Rhode Island. Our primary considerations when originating these loans are the borrower's ability to pay and the value of the underlying collateral. An indirect auto loan is originated when the borrower purchases or leases a motor vehicle at an auto dealership and elects to finance a portion of that purchase. The procedures for underwriting consumer loans include an assessment of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.

 

Loan Originations, Purchases and Sales.    Loan originations come from a number of sources. The primary source of loan originations are our in-house loan originators, and to a lesser extent, local mortgage brokers and third party originators of residential loans, advertising and referrals from customers. We sell to the secondary market newly originated 30-year or longer term conforming fixed-rate residential mortgage loans and we hold in our portfolio nonconforming loans, shorter-term fixed-rate loans and adjustable-rate residential mortgage loans. Our decision to sell loans is based on prevailing market interest rate conditions and interest rate risk management. Loans are sold to third parties with servicing either retained or released. We occasionally purchase commercial business loans or participation interests in commercial real estate loans. In addition, we sell participation interests in commercial real estate loans to local financial institutions, primarily the portion of loans that exceed our borrowing limits or are in an amount that is considered prudent to manage our credit risk.

 

For the years ended December 31, 2017 and 2016, we originated loans of $1.70 billion and $2.21 billion of loans, respectively. During the same periods, we sold $1.16 billion and $1.50 billion of loans, respectively. 

 

Mortgage Banking Activity.    In addition to the lending activities previously discussed, we also originate residential mortgage loans for sale in the secondary market through Merrimack Mortgage. For the year ended December 31, 2017, Merrimack Mortgage

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originated $1.02 billion in mortgage loans. Merrimack Mortgage sells loans on both a servicing-released and a servicing-retained basis. Merrimack Mortgage has contracted with a third party to service the loans for which it retains servicing.

 

Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed or insured by the federal government, such as a Federal Housing Authority Veterans’ Administration loan.

 

Loan Underwriting Risks.

 

Commercial Real Estate Loans.    Loans secured by commercial real estate generally have larger balances and involve a greater degree of risk than residential mortgage loans. Of primary concern in commercial real estate lending is the borrower's creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than residential real estate loans. If we are forced to foreclose on a commercial real estate property due to default, we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

 

Commercial Loans.    Commercial loans also involve a greater degree of risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are typically made on the basis of the borrower's ability to make repayment from the cash flows of the borrower's business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

 

Construction Loans.    Construction financing is considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a project having a value which is insufficient to assure full repayment. As a result of the foregoing, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If we are forced to foreclose on a project before or at completion due to a default, we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

 

Residential Real Estate Loans.    Due to historically low interest rate levels, borrowers generally have preferred fixed-rate loans in recent years. While we anticipate that our adjustable-rate loans will better offset the adverse effects on our net interest income of an increase in interest rates as compared to fixed-rate loans, the increased mortgage payments required of adjustable-rate loans in a rising interest rate environment could cause an increase in delinquencies and defaults. If we are forced to foreclose on a residential property due to default, the marketability of the underlying property also may be adversely affected in a high interest rate environment, and we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.  In addition, although adjustable-rate loans help make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.  

 

Consumer Loans.    Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower's continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. 

 

Loan Participations.    We cultivate relationships with other financial institutions to mitigate the risk of our lending activities by participating either as the lead bank or as a participant in various loan transactions. We purchase participation interests in larger balance loans from other financial institutions generally in our market area. Such participations are reviewed for compliance, are

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underwritten and approved in accordance with our underwriting criteria. We actively monitor the performance of such loans and periodically receive updated financial statements of the borrower from the lead lender. These loans are subjected to regular internal reviews in accordance with our loan policy. We joined a community bank lending network operated by BancAlliance in 2014 in order to have the opportunity to participate in commercial loans and lines of business referred by the network. HarborOne Bank has adopted a loan policy specifically for loans originated through this program that provides for underwriting standards and limits maximum loans to one entity to $2.5 million as well as a total portfolio of $40 million. As of December 31, 2017, total exposure for this program was $26.0 million comprising 15 credits. All but one of these relationships were performing in accordance with their payment terms. There is one $2.0 million loan that is rated substandard, on nonaccrual and under a forbearance agreement. At December 31, 2017, the outstanding balances of commercial loan participations purchased outside of the BancAlliance network totaled $4.4 million. We also participate in commercial real estate loans that total $120.8 million and commercial construction loans that total $21.6 million.  We were the lead bank in commercial real estate loans $170.7 million and commercial construction loans of $30.5 million with participation balances sold that totaled $70.4 million and $14.8 million, respectively, at December 31, 2017.

 

Loan Approval Procedures and Authority.    Our lending activities follow written, nondiscriminatory underwriting standards and loan origination procedures established by our board of directors and management. Our board of directors has granted loan approval authority to certain executive officers. Commercial loans in excess of any officer's individual authority must be approved by a lending committee comprised of several executive officers. Commercial loans in excess of the lending committee authority must be approved by the board of directors or by the executive committee, which is comprised of our president and chief executive officer and three independent members of our Board of Directors. Commercial loans in excess of the "in-house limit" must be approved by the board of directors. The executive committee of the board of directors reviews all commercial and commercial real estate loan requests greater than $3 million. All mortgage and commercial real estate loans to any single borrower that exceed $3 million and commercial loans that exceed $3 million must be approved by the board of directors.

 

Loans-to-One Borrower Limit.    The maximum amount that the Bank may lend to one borrower and the borrower's related entities is generally limited, by statute, to 20.0% of the Bank's capital, which is defined under Massachusetts law as the sum of the Bank's capital stock, surplus account and undivided profits. At December 31, 2017, the Bank's regulatory limit on loans-to-one borrower was $65.9 million. At that date, our largest lending relationship totaled $28.4 million and was comprised of eight loans to finance medical and general office space. These loans were performing in accordance with their original repayment terms at December 31, 2017. Our internal loans-to-one borrower limit is $38.5 million. 

 

 

Investment Activities

 

General.    At December 31, 2017, securities totaled $217.7 million. The securities portfolio consists of U.S. government obligations, residential mortgage-backed securities and collateralized mortgage obligations, state, county and municipal bonds and small business administration asset-backed securities. The goals of our investment policy are to provide and maintain liquidity to meet deposit withdrawal and loan funding needs, to help mitigate interest rate and market risk, to diversify our assets, and to generate a reasonable rate of return on funds within the context of our interest rate and credit risk objectives. Our board of directors approves our investment policy which is reviewed annually by the board of directors. Authority to make investments under the approved investment policy guidelines is delegated to our chief financial officer and chief executive officer. All investment transactions are reviewed at the next regularly scheduled meeting of the board of directors. We classify the majority of our securities as available-for-sale.

 

We have legal authority to invest in various types of securities, including U.S. Treasury obligations, securities of various government-sponsored enterprises and municipal governments, deposits at the Federal Home Loan Bank (“FHLB”), certificates of deposit of federally insured institutions and investment grade corporate bonds. We also are required to maintain an investment in FHLB stock. While we have the authority under applicable law to invest in marketable equity securities and derivative securities, we had no investments in such securities at December 31, 2017.  

 

Sources of Funds

 

General.    Deposits, borrowings and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.

 

Deposit Accounts.    At December 31, 2017, total deposits were $2.01 billion. Deposits are attracted from within our market area by sales efforts of our retail branch network, municipal department and commercial loan officers, advertising and through our website. We offer a broad selection of deposit instruments, including noninterest-bearing demand deposits (such as checking accounts),

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interest-bearing demand accounts (such as NOW and money market accounts), savings accounts and term certificates of deposit. We also offer a variety of deposit accounts designed for businesses and municipalities operating in our market area. Our business banking deposit products include a commercial checking account, sweep accounts, money market accounts and checking accounts specifically designed for small businesses. We also offer remote deposit capture products,  for business customers to meet their online banking needs. Additionally, the Bank has a municipal banking department that provides core depository services to local municipalities. At December 31, 2017 municipal deposits totaled $231.6 million. The Bank also participates in a reciprocal deposit program that provides access to FDIC insured deposit products in aggregate amounts exceeding the current insurance limits for depositors. At December 31, 2017 total reciprocal deposits were $174.3 million and included $116.0 million of municipal deposits.

 

The Bank utilizes a deposit listing service which targets institutional funds throughout the country. We generally prohibit the withdrawal of our listing service deposits prior to maturity. Also, when rates and terms are favorable, the Bank supplements the customer deposit base with brokered deposits. At December 31, 2017, we had $30.4 million of institutional deposits and $73.5 million of brokered deposits, which represented 5.2% of total deposits at December 31, 2017 with such funds having a weighted average remaining term to maturity of 9.1 months. In a rising rate environment, we may be unwilling or unable to pay a competitive rate. To the extent that such deposits do not remain with us, they may need to be replaced with borrowings, which could increase our cost of funds and negatively impact our interest rate spread, financial condition and results of operation.

 

Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our liquidity needs, profitability to us, and customer preferences and concerns. We generally review our deposit mix and pricing on a weekly basis. Our deposit pricing strategy has generally been to offer competitive rates and to offer periodically special rates in order to attract deposits of a specific type or term.

 

Borrowings.    As of December 31, 2017, total borrowings were $290.4 million. Borrowings consist of short-term and long-term obligations from the FHLB.  The Bank is a member of the FHLB Boston which provides access to wholesale funding to supplement our supply of investable funds. The FHLB functions as a central reserve bank providing credit for its member financial institutions. As a member, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of such stock and certain of our whole first mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution's net worth or on the FHLB's assessment of the institution's creditworthiness. At December 31, 2017, based on available collateral and our ownership of FHLB stock, and based upon our internal policy, we had access to additional FHLB advances of up to $197.7 million. All of our borrowings from the FHLB are secured by a blanket lien on residential real estate.

 

The Share Insurance Fund of the Co-operative Central Bank provides for borrowings for liquidity purposes and is available to all co-operative member banks. Loan advances will generally be made on an unsecured basis provided that the aggregate loan balance is less than 5.0% of total deposits of the member bank; the member bank's primary capital ratio is in excess of 5.0%; the member bank meets the required CAMELS rating; and the quarterly and year-to-date net income before extraordinary items is positive. At December 31, 2017, we had $5.0 million of borrowing capacity with the Co-operative Central Bank, none of which was outstanding. 

 

The Company also has an available line of credit with the Federal Reserve Bank of Boston secured by 75% of the carrying value of indirect auto loans with an amortized balance amounting to $136.1 million of which no amount was outstanding at December 31, 2017.

 

Supervision and Regulation

 

General

 

The Bank is a Massachusetts stock co-operative bank and the wholly-owned subsidiary of the Company, which in turn is majority owned by the MHC. The MHC and the Company are registered bank holding companies. The Bank’s deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation (“FDIC”) and by the Share Insurance Fund established by Massachusetts General Laws, or the “MGL,” for amounts in excess of the FDIC insurance limits. The Bank is subject to regulation, supervision and examination by the Massachusetts Commissioner of Banks, as its chartering agency, and by the FDIC, its primary federal regulator and deposit insurer. The Bank must also comply with consumer protection regulations issued by the Consumer Financial Protection Bureau (“CFPB”), as enforced by the FDIC.

 

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As a bank holding company, the Company is subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”).  The Company is also subject to the rules and regulations of the SEC under the federal securities laws.

 

The federal and state regulatory framework applicable to bank holding companies and their subsidiaries is intended primarily for the protection of depositors and the deposit insurance funds, rather than for the protection of other creditors or shareholders. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies concerning the establishment of deposit insurance assessment fees, classification of assets and establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Massachusetts legislature, the Massachusetts Commissioner of Banks, the FDIC, the Federal Reserve or the United States Congress, could have a material adverse impact on the financial condition and results of operations of the Company and the Bank.

   

Set forth below are certain material regulatory requirements that are applicable to the Bank and the Company. This description of statutes and regulations is not intended to be a complete description of such statutes and regulations and their effects on the Bank and the Company.  

 

Holding Company Regulation

 

General.     The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, or BHCA. As such, the Company is registered with the Federal Reserve and subject to regulation, examination, supervision and reporting requirements applicable to bank holding companies. In addition, the Federal Reserve has enforcement authority over the Company. Among other things, this authority enables the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the Bank.

 

Permissible Activities. A bank holding company is generally prohibited from engaging in non-banking activities, or acquiring direct or indirect control of more than 5.0% of any class of the voting securities of any company engaged in non-banking activities. One of the principal exceptions to this prohibition is for activities that the Federal Reserve had determined to be closely related to banking or managing and controlling banks as of November 11, 1999. Some of the principal activities that the Federal Reserve had determined by regulation to be so closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings association whose direct and indirect activities are limited to those permitted for bank holding companies.

 

Acquisition of Control.    The BHCA provides that no company may directly or indirectly acquire control of a bank without the prior approval of the Federal Reserve. Any company that acquires control of a bank becomes a "bank holding company" subject to registration, examination and regulation by the Federal Reserve. Pursuant to federal regulations, the term "company" is defined to include banks, corporations, partnerships, associations, and certain trusts and other entities, and a company has "control" of a bank or other company if the company owns, controls or holds with power to vote 25.0% or more of any class of voting stock of the bank or other company, controls in any manner the election of a majority of the directors of the bank or other company or if the Federal Reserve determines, after notice and opportunity for hearings that the Company has the power to exercise a controlling influence over the management or policies of the bank or other company. In addition, a bank holding company must obtain Federal Reserve approval prior to acquiring voting securities of a bank or bank holding company if, after such acquisition, the bank holding company would control more than 5.0% of any class of voting stock of the bank or bank holding company.

 

Under the federal Change in Bank Control Act, no person, directly or indirectly or acting in concert with one or more other persons, may acquire control of an insured depository institution or a depository institution holding company unless the appropriate federal banking agency has been given 60 days prior written notice and has not issued a notice disapproving the proposed acquisition. The Federal Reserve is the appropriate federal banking agency with respect to an acquisition of control of a bank holding company. Acquisitions subject to approval under the BHCA are exempt from the prior notice requirement. Control, as defined under the Change in Bank Control Act, as implemented by the Federal Reserve with respect to bank holding companies, means the power to directly or indirectly direct the management or policies of a bank holding company or to vote 25.0% or more of any class of voting securities of the bank holding company. Acquisition of more than 10.0% of any class of a bank holding company's voting stock is subject to a rebuttable presumption of control by the Federal Reserve if the bank holding company has registered securities under section 12 of the Securities Exchange Act or if no other person will own, control or hold the power to vote a greater percentage of that class of voting stock immediately after the acquisition. There are also rebuttable presumptions in the regulations concerning whether a group is "acting in concert," including presumed concerted action among members of an "immediate family." Accordingly, the filing of a notice with

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the Federal Reserve would be required before any person or group of persons acting in concert could acquire 10.0% or more of the common stock of the Company, unless the person or group of persons files a rebuttal of control that is accepted by the Federal Reserve.

 

Capital.    The Company is subject to the Federal Reserve's capital adequacy regulations for bank holding companies (on a consolidated basis). These capital standards have historically been similar to, though less stringent than, those of the FDIC for the Bank. Subject to certain exceptions, including an exception for bank holding companies with less than $1 billion of assets, the Dodd-Frank Act required the Federal Reserve to establish, for all bank holding companies, minimum consolidated capital requirements that are as stringent as those required for insured depository institutions. Under regulations enacted by the Federal Reserve and generally effective January 1, 2015, all such bank holding companies are subject to regulatory capital requirements that are the same as or more stringent than the capital requirements applicable to the Bank. These capital requirements include provisions that, when applicable, might limit the ability of the Company to pay dividends to its shareholders or repurchase its shares. For a description of these capital requirements, see "—Federal Banking Regulation—Capital Requirements."

 

Source of Strength.    The Dodd-Frank Act codified the requirement that holding companies act as a source of financial strength. The Federal Reserve policy requires bank holding companies to act as a source of financial and managerial strength to their depository institution subsidiaries by providing capital, liquidity and other support in times of financial stress.

 

Dividends.    The Federal Reserve has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization's capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company's net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company's overall rate or earnings retention is inconsistent with the company's capital needs and overall financial condition. The policy statement also states that a bank holding company should inform and consult with the Federal Reserve supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the bank holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect the ability of the Company to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions. In addition, the ability of the Company to pay dividends may be restricted if the Bank becomes undercapitalized.

 

Massachusetts Holding Company Regulation.    Under the Massachusetts banking laws, a company owning or controlling two or more banking institutions, including a co-operative bank, is regulated as a bank holding company. The term "company" is defined by the Massachusetts banking laws similarly to the definition of "company" under the Bank Holding Company Act. Each Massachusetts bank holding company: (i) must obtain the approval of the Massachusetts Board of Bank Incorporation before engaging in certain transactions, such as the acquisition of more than 5.0% of the voting stock of another banking institution; (ii) must register and file reports with the Massachusetts Commissioner of Banks; and (iii) is subject to examination by the Massachusetts Commissioner of Banks. Recent legislation enacted in Massachusetts provides an exemption from the requirement to obtain Board of Bank Incorporation approval for certain transactions involving a bank merger or consolidation subject to approval by the Massachusetts Commissioner of Banks. In addition, for a period of three years following completion of a stock issuance by a subsidiary of a mutual holding company, no person may directly or indirectly offer to acquire or acquire beneficial ownership of more than 10.0% of any class of equity security of such subsidiary without prior written approval of the Massachusetts Commissioner of Banks.

 

Federal Banking Regulation

 

Business Activities.    Under federal law, all state-chartered FDIC-insured banks, including co-operative banks, have been limited in their activities as principal and in their equity investments to the type and the amount authorized for national banks, notwithstanding state law. Federal law permits exceptions to these limitations, including an exception that permits banks with grandfathered rights to make investments in common and preferred stock listed on a national securities exchange.  The maximum permissible investment is the lesser of 100.0% of Tier 1 capital or the maximum amount permitted by Massachusetts law. Such grandfathered authority may be terminated under certain circumstances, including a change in charter or a determination by the FDIC that such investments pose a safety and soundness risk.

 

The FDIC is also authorized to permit state banks to engage in state authorized activities or investments not permissible for national banks (other than non-subsidiary equity investments) if they meet all applicable capital requirements and it is determined that such activities or investments do not pose a significant risk to the FDIC insurance fund. The FDIC has adopted regulations governing the procedures for institutions seeking approval to engage in such activities or investments. The Gramm-Leach-Bliley Act of 1999

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specified that a state bank may control a subsidiary that engages in activities as principal that would only be permitted for a national bank to conduct in a "financial subsidiary," if a bank meets specified conditions and deducts its investment in the subsidiary for regulatory capital purposes.

 

Capital Requirements.    The Federal Reserve has issued risk-based and leverage capital rules applicable to bank holding companies such as the Company, and the FDIC has issued similar rules that apply to insured state nonmember banks, such as the Bank. These rules are intended to reflect the relationship between the banking organization's capital and the degree of risk associated with its operations based on transactions recorded on-balance sheet as well as off-balance sheet items. The Federal Reserve and the FDIC may from time to time require that a banking organization maintain capital above the minimum levels discussed below, due to the banking organization's financial condition or actual or anticipated growth.

 

The capital adequacy rules define qualifying capital instruments and specify minimum amounts of capital as a percentage of assets that banking organizations are required to maintain. Common equity Tier 1 capital for banks and bank holding companies consists of common stockholders' equity and related surplus. Tier 1 capital for banks and bank holding companies generally consists of the sum of common shareholders' equity, non-cumulative perpetual preferred stock, and related surplus and, in certain cases and subject to limitations, minority interest in consolidated subsidiaries, less goodwill, other non-qualifying intangible assets and certain other deductions. Tier 2 capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities, cumulative perpetual preferred stock, term subordinated debt and intermediate-term preferred stock, and, subject to limitations, allowances for loan losses. The sum of Tier 1 and Tier 2 capital less certain required deductions represents qualifying total risk-based capital.

 

Under the capital rules, risk-based capital ratios are calculated by dividing Tier 1 and total risk-based capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of several risk-weight categories, based primarily on relative risk. The rules require banks and bank holding companies to maintain a minimum common equity Tier 1 capital ratio of 4.5%, a minimum Tier 1 capital ratio of 6.0%, a total capital ratio of 8.0% and a leverage ratio of 4.0%. Additionally, subject to a transition schedule, the capital rules require a bank holding company to establish a capital conservation buffer of common equity Tier 1 capital in an amount above the minimum risk-based capital requirements equal to 2.5% of total risk weighted assets, or face restrictions on the ability to pay dividends, pay discretionary bonuses, and to engage in share repurchases.  The new capital conservation buffer requirement began phasing in on January 1, 2016 and is 1.25% at December 31, 2017.

 

Under the FDIC’s prompt corrective action rules, an insured state nonmember bank is considered “well capitalized” if it (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (v) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure.  The Bank is considered “well capitalized” under this definitions

   

Current capital rules do not establish standards for determining whether a bank holding company is well capitalized.  However, for purposes of processing regulatory applications and notices, the Federal Reserve Regulation Y provides that a bank holding company is considered “well capitalized” if (i) on a consolidated basis, the bank holding company maintains a total risk-based capital ratio of 10% or greater, (ii) on a consolidated basis, the bank holding company maintains a Tier I risk-based ratio of 6% or greater, and (ii) the bank holding company is not subject to any written agreement, order capital directive, or prompt corrective action directive issued by the Board to meet and maintain a specific capital level for any capital measure.  The Company is considered well capitalized under this definition.

 

Bank Dividends.    A state non-member bank may not make a capital distribution that would reduce its regulatory capital below the amount required by the FDIC’s regulatory capital regulations or for the liquidation account established in connection with its conversion to stock form. In addition, the Bank’s ability to pay dividends is limited if the Bank does not have the capital conservation buffer required by new capital rules, which may limit the ability of the Bancorp to pay dividends to its shareholders. See “—Capital Requirements.” 

 

Community Reinvestment Act and Fair Lending Laws.    All institutions have a responsibility under the Community Reinvestment Act, or the "CRA," and related regulations to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a state non-member bank, the FDIC is required to assess the institution's record of compliance with the CRA. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA does require the FDIC, in connection with its examination of a state non-member bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its

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evaluation of certain applications by such institution, including applications to acquire branches and other financial institutions. The CRA requires the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system. An institution's failure to comply with the provisions of the CRA could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. The CRA requires all institutions insured by the FDIC to publicly disclose their rating. The Bank received a "Satisfactory" CRA rating in its most recent federal examination.

 

Massachusetts has its own statutory counterpart to the CRA that is applicable to the Bank. The Massachusetts version is generally similar to the CRA but uses a five-tiered descriptive rating system. Massachusetts law requires the Massachusetts Commissioner of Banks to consider, but not be limited to, a bank's record of performance under Massachusetts law in considering any application by the bank to establish a branch or other deposit-taking facility, to relocate an office or to merge or consolidate with or acquire the assets and assume the liabilities of any other banking institution. The Bank's most recent rating under Massachusetts law was "Satisfactory."

 

In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, as well as other federal regulatory agencies and the Department of Justice.

 

 Transactions with Related Parties.    An insured depository institution's authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and federal regulation. An affiliate is generally a company that controls, is controlled by or is under common control with an insured depository institution such as the Bank; however, a subsidiary of a bank that engages in bank permissible activities is generally not treated as an affiliate. The MHC and the Company will be affiliates of HarborOne Bank because of their control of HarborOne Bank. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative limits and collateral requirements. Transactions with affiliates also must be consistent with safe and sound banking practices, generally not involve the purchase of low-quality assets and be on terms that are as favorable to the insured depository institution as comparable transactions with non-affiliates.

 

The Bank's authority to extend credit to its directors, executive officers and 10.0% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve. Among other things, these provisions generally require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank's capital.

 

In addition, extensions of credit in excess of certain limits must be approved by HarborOne Bank's loan committee or board of directors. Extensions of credit to executive officers are subject to additional limits based on the type of extension involved.

 

Enforcement.    The FDIC has extensive enforcement responsibility over state non-member banks and has authority to bring enforcement actions against all "institution-affiliated parties," including directors, officers, shareholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution. Formal enforcement action by the FDIC may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state non-member bank if that bank was "critically undercapitalized" on average during the calendar quarter beginning 270 days after the date on which the institution became "critically undercapitalized." The FDIC may also appoint itself as conservator or receiver for an insured state non-member bank under specified circumstances, including: (1) insolvency; (2) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (3) existence of an unsafe or unsound condition to transact business; (4) insufficient capital; or (5) the incurrence of losses that will deplete substantially all of the institution's capital with no reasonable prospect of replenishment without federal assistance. The FDIC also has the authority to terminate deposit insurance.

 

Standards for Safety and Soundness.    Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate

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federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.

 

Interstate Banking and Branching.    Federal law permits well-capitalized and well-managed bank holding companies to acquire banks in any state, subject to Federal Reserve approval, certain concentration limits and other specified conditions. Interstate mergers of banks are also authorized, subject to regulatory approval and other specified conditions. In addition, pursuant to the Dodd-Frank Act, banks are now permitted to establish de novo branches on an interstate basis provided that branching is authorized by the law of the host state for banks chartered by the host state.

 

Prompt Corrective Action Regulations.    The FDIC is required by law to take supervisory action against undercapitalized institutions under its jurisdiction, the severity of which depends upon the institution's level of capital.

 

An institution that has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a common equity Tier 1 ratio of less than 4.5% or a Tier 1 leverage ratio of less than 4.0% is considered to be "undercapitalized." An institution that has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a common equity Tier 1 ratio of less than 3.0% or a Tier 1 leverage ratio of less than 3.0% is considered to be "significantly undercapitalized." An institution that has a tangible capital to assets ratio equal to or less than 2.0% is deemed to be "critically undercapitalized."

 

Generally, a receiver or conservator must be appointed for an institution that is "critically undercapitalized" within specific time frames. The regulations also provide that a capital restoration plan must be filed with the FDIC within 45 days of the date that an institution is deemed to have received notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Any holding company of an institution that is required to submit a capital restoration plan must guarantee performance under the plan in an amount of up to the lesser of 5.0% of the institution's assets at the time it was deemed to be undercapitalized by the FDIC or the amount necessary to restore the institution to adequately capitalized status. This guarantee remains in place until the FDIC notifies the institution that it has maintained adequately capitalized status for each of four consecutive calendar quarters. Institutions that are undercapitalized become subject to certain mandatory measures such as restrictions on capital distributions and asset growth. The FDIC may also take any one of a number of discretionary supervisory actions against undercapitalized institutions, including the issuance of a capital directive and the replacement of senior executive officers and directors.

 

Insurance of Deposit Accounts.    The Deposit Insurance Fund of the FDIC insures deposits at FDIC-insured depository institutions such as the Bank. Deposit accounts in the Bank are insured by the FDIC up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The FDIC charges insured depository institutions premiums to maintain the Deposit Insurance Fund.

 

 Deposit premiums are based on assets.  To determine its deposit insurance premium, the Bank computes the base amount of its average consolidated assets less its average tangible equity (defined as the amount of Tier 1 capital) and the applicable assessment rate. On April 26, 2016, the FDIC’s Board of Directors adopted a final rule that changed the manner in which deposit insurance assessment rates are calculated for established small banks, generally those banks with less than $10 billion of assets that have been insured for at least five years. Under the final rule, each of seven financial ratios and a weighted average of CAMELS component ratings will be multiplied by a corresponding pricing multiplier. The sum of these products is added to a uniform amount, with the resulting sum being an institution’s initial base assessment rate (subject to minimum or maximum assessment rates based on a bank’s CAMELS composite rating).  This method takes into account various measures, including an institution’s leverage ratio, brokered deposit ratio, one year asset growth, the ratio of net income before taxes to total assets and considerations related to asset quality.    Assessments for established small banks with a CAMELS rating of 1 or 2 range from 1.5 to 16 basis points, after adjustments, while assessment rates for established small banks with a CAMELS composite rating of 4 or 5 range from 11 to 30 basis points, after adjustments.  Assessments for established small banks with a CAMELS rating of 3 range from 3 to 30 basis points.

 

The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what assessment rates will be in the future.

 

Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.

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Prohibitions Against Tying Arrangements.    State non-member banks are prohibited, subject to certain exceptions, from extending credit or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.

 

Federal Reserve System.    Federal Reserve regulations require depository institutions to maintain noninterest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Bank’s required reserves can be in the form of vault cash and, if vault cash does not fully satisfy the required reserves, in the form of a balance maintained with the Federal Reserve Bank of Boston. The Federal Reserve regulations currently require that reserves be maintained against aggregate transaction accounts except for transaction accounts up to $16.0 million, which are exempt. Transaction accounts greater than $16.0 million up to $122.3 million have a reserve requirement of 3.0%, and those greater than $123.3 million have a reserve requirement of approximately $3.2 million plus 10.0% of the amount over $122.3 million. The Federal Reserve generally makes annual adjustments to the tiered reserves. The Bank is in compliance with these requirements.

 

Federal Home Loan Bank System.    The Bank is a member of the FHLB of Boston, which is one of the 12 regional Federal Home Loan Banks comprising the FHLB System. Each FHLB serves as a central credit facility primarily for its member institutions as well as other entities involved in home mortgage lending. As a member of the FHLB, HarborOne Bank is required to acquire and hold shares of capital stock in the FHLB. As of December 31, 2017, HarborOne Bank was in compliance with this requirement. Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost. HarborOne Bank reviews for impairment based on the ultimate recoverability of the cost basis of the FHLB stock. As of December 31, 2017, no impairment has been recognized.

 

At its discretion, the FHLB may declare dividends on the stock. In 2015 and 2016 and 2017, the FHLB of Boston paid quarterly dividends with an annual yield of 2.54%, 3.63% and 4.14%, respectively. There can be no assurance that such dividends will continue in the future. Further, there can be no assurance that the impact of recent or future legislation on the FHLBs also will not cause a decrease in the value of the FHLB stock held by the Bank.

 

Massachusetts Banking Laws and Supervision

 

General.    As a Massachusetts stock co-operative bank, the Bank is subject to supervision, regulation and examination by the Massachusetts Commissioner of Banks and to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts and payment of dividends. In addition, the Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The approval of the Massachusetts Commissioner of Banks is required for a Massachusetts-chartered bank to establish or close branches, merge with other financial institutions, issue stock and undertake certain other activities. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Massachusetts Commissioner of Banks may be sanctioned. The Massachusetts Commissioner of Banks may suspend or remove directors or officers of a bank who have violated the law, conducted a bank's business in a manner that is unsafe, unsound or contrary to the depositors' interests, or been negligent in the performance of their duties. In addition, the Massachusetts Commissioner of Banks has the authority to appoint a receiver or conservator if it is determined that the bank is conducting its business in an unsafe or unauthorized manner, and under certain other circumstances.

 

Lending Activities.    A Massachusetts co-operative bank may make a wide variety of mortgage loans including fixed-rate loans, adjustable-rate loans, variable-rate loans, participation loans, graduated payment loans, construction and development loans, condominium and co-operative loans, second mortgage loans and other types of loans that may be made in accordance with applicable regulations. Commercial loans may be made to corporations and other commercial enterprises with or without security. Consumer and personal loans may also be made with or without security.

 

Insurance Sales.    A Massachusetts bank may engage in insurance sales activities if the Massachusetts Commissioner of Banks has approved a plan of operation for insurance activities and the bank obtains a license from the Massachusetts Division of Insurance. A bank may be licensed directly or indirectly through an affiliate or a subsidiary corporation established for this purpose. HarborOne Bank does not sell or refer insurance products, and has not sought approval for insurance sales activities.

 

Dividends.    A Massachusetts co-operative bank may declare cash dividends from net profits not more frequently than quarterly. Non-cash dividends may be declared at any time. No dividends may be declared, credited or paid if the bank's capital stock is impaired. The approval of the Massachusetts Commissioner of Banks is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. Net profits for this

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purpose means the remainder of all earnings from current operations plus actual recoveries on loans and investments and other assets after deducting current operating expenses, actual losses, accrued dividends on preferred stock, if any, and all federal and state taxes.

 

Parity Authority.    A Massachusetts bank may, after providing 30 days' prior notice to the Massachusetts Commissioner of Banks, exercise any power and engage in any activity that has been authorized for national banks, federal savings associations or state banks in a state other than Massachusetts, provided that the activity is permissible under applicable federal law and not specifically prohibited by Massachusetts law. Such powers and activities must be subject to the same limitations and restrictions imposed on the national bank, federal thrift or out-of-state bank that exercised the power or activity.

 

Loans-to-One Borrower Limitations.    Massachusetts banking law grants broad lending authority. However, with certain limited exceptions, total obligations to one borrower may not exceed 20.0% of the total of the bank's capital stock, surplus and undivided profits.

 

Loans to a Bank's Insiders.    Massachusetts banking law prohibits any executive officer or director of a bank from borrowing or guaranteeing extensions of credit by such bank except to the extent permitted by federal law.

 

Regulatory Enforcement Authority.    Any Massachusetts co-operative bank that does not operate in accordance with the regulations, policies and directives of the Massachusetts Commissioner of Banks may be subject to sanctions for non-compliance, including revocation of its charter. The Massachusetts Commissioner of Banks may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the bank's business in an unsafe or unsound manner or contrary to the depositors interests or been negligent in the performance of their duties. Upon finding that a bank has engaged in an unfair or deceptive act or practice, the Massachusetts Commissioner of Banks may issue an order to cease and desist and impose a fine on the bank concerned. The Massachusetts Commissioner of Banks also has authority to take possession of a bank and appoint a liquidating agent under certain conditions such as an unsafe and unsound condition to transact business, the conduct of business in an unsafe or unauthorized manner of impaired capital. In addition, Massachusetts consumer protection and civil rights statutes applicable to HarborOne Bank permit private individual and class action law suits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damage and attorney's fees in the case of certain violations of those statutes.

 

Co-operative Central Bank and Share Insurance Fund.    All Massachusetts-chartered co-operative banks are required to be members of the Co-operative Central Bank, which maintains the Share Insurance Fund that insures co-operative bank deposits in excess of federal deposit insurance coverage. The Co-operative Central Bank is authorized to charge co-operative banks an annual assessment fee on deposit balances in excess of amounts insured by the FDIC. Assessment rates are based on the institution's risk category, similar to the method currently used to determine assessments by the FDIC discussed above under "—Federal Banking Regulation—Insurance of Deposit Accounts."

 

Protection of Personal Information.    Massachusetts has adopted regulatory requirements intended to protect personal information. The requirements, which became effective March 1, 2010, are similar to existing federal laws such as the Gramm-Leach-Bliley Act that require organizations to establish written information security programs to prevent identity theft. The Massachusetts regulation also contains technology system requirements, especially for the encryption of personal information sent over wireless or public networks or stored on portable devices.

 

Massachusetts has additional statutes and regulations that are similar to certain of the federal provisions discussed below.

 

Other Regulations

 

Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank's operations are also subject to federal laws applicable to credit transactions, such as the:

 

·

Truth-In-Lending Act, which governs disclosures of credit terms to consumer borrowers;

·

Real Estate Settlement Procedures Act, which requires that borrowers of mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;

·

Home Mortgage Disclosure Act, which requires financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

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·

Equal Credit Opportunity Act, which prohibits discrimination on the basis of race, creed or other prohibited factors in extending credit;

·

Fair Credit Reporting Act, which governs the use and provision of information to credit reporting agencies;

·

Biggert-Waters Flood Insurance Reform Act of 2012, which mandates flood insurance for mortgage loans secured by residential real estate in certain areas; and rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

In addition, the CFPB issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting "ability to repay" and "qualified mortgage" standards for residential mortgage loans and mortgage loan servicing and originator compensation standards. The Bank is evaluating recent regulations and proposals, and devotes significant compliance, legal and operational resources to compliance with consumer protection regulations and standards.

 

 

The operations of the Bank also are subject to the:

 

·

Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

·

Truth in Savings Act, which governs the disclosure of terms and conditions regarding interest and fees related to deposit accounts;

·

Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services;

·

Check Clearing for the 21st Century Act (also known as "Check 21"), which gives "substitute checks," such as digital check images and copies made from that image, the same legal standing as the original paper check;

·

USA PATRIOT Act, which requires depository institutions to, among other things, establish broadened anti-money laundering compliance programs, and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and

·

Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution's privacy policy and provide such customers the opportunity to "opt out" of the sharing of certain personal financial information with unaffiliated third parties.

 

Federal Securities Laws

 

Our common stock is registered with the Securities and Exchange Commission under Section 12(b) of the securities Exchange Act of 1934, as amended.  We are subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange Act.

 

Emerging Growth Company Status

 

We qualify as an “emerging growth company” under the Jumpstart Our Business startups Act of 2012. For as long as we are an emerging growth company, we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved, and an exemption from having outside auditors attest as to our internal control over financial reporting. In addition, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to use the extended transition period to delay

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adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies.

 

We could be an emerging growth company for up to five years. We will cease to be an emerging growth company upon the earliest of: (i) the end of the fiscal year following the fifth anniversary of our initial public offering in 2016, (ii) the first fiscal year after our annual gross revenues are $1.0 billion or more, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities or (iv) the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeds $700 million as of the end of the second quarter of that fiscal year.

 

ITEM 1A.  RISK FACTORS

 

Risks Related to Our Business

 

The geographic concentration of our loan portfolio and lending activities makes us vulnerable to a downturn in the local economy.

 

While there is not a single employer or industry in our market area on which a significant number of our customers are dependent, a substantial portion of our loan portfolio is composed of loans secured by property located in the greater Boston metropolitan area. This makes us vulnerable to a downturn in the local economy and real estate markets. Adverse conditions in the local economy such as unemployment, recession, a catastrophic event or other factors beyond our control could impact the ability of our borrowers to repay their loans, which could impact our net interest income. Decreases in local real estate values caused by economic conditions or other events could adversely affect the value of the property used as collateral for our loans, which could cause us to realize a loss in the event of a foreclosure. For more information about our market area, see the sections of this Form 10-K entitled "Business of HarborOne Bank—Market Area" and "—Competition."

 

Commercial and commercial real estate loans carry greater credit risk than loans secured by owner occupied one- to four-family real estate.

 

We intend to continue our focus on prudently growing our commercial real estate, commercial construction and commercial loan portfolio.  Our total commercial loan portfolio consisting of commercial real estate, commercial construction and commercial loans was $881.7 million, or 40.3% of total loans, at December 31, 2017. Given their larger balances and the complexity of the underlying collateral, commercial real estate, commercial construction and commercial loans generally expose a lender to greater credit risk than loans secured by owner occupied one- to four-family real estate. Also, many of our borrowers or related groups of borrowers have more than one of these types of loans outstanding. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential real estate loan. If loans that are collateralized by real estate or other business assets become troubled and the value of the collateral has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses which would in turn adversely affect our operating results and financial condition. Further, if we foreclose on the collateral, our holding period for the collateral may be longer than for one- to four-family real estate loans because there are fewer potential purchasers of the collateral, which can result in substantial holding costs.

 

The unseasoned nature of our commercial and commercial real estate portfolio may result in changes to our estimates of collectability, which may lead to additional provisions or charge-offs, which could hurt our profits.

 

Our commercial real estate, commercial construction and commercial loan portfolio has increased $241.9 million, or 37.8%, from $639.8 million at December 31, 2016 to $881.7 million at December 31, 2017. A large portion of our commercial real estate, commercial construction and commercial loan portfolio is unseasoned and does not provide us with a significant payment or charge-off history pattern from which to judge future collectability. Currently we estimate potential charge-offs using peer data adjusted for qualitative factors specific to us. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our historical experience or current estimates, which could adversely affect our future performance. Further, these types of loans generally have larger balances and involve a greater risk than one- to four-family residential mortgage loans. Accordingly, if we make any errors in judgment in the collectability of our commercial or commercial real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred historically with our residential mortgage loan or consumer loan portfolios.

 

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Our construction loans are subject to various lending risks depending on the nature of the borrower’s business, its cash flow and our collateral.

 

At December 31, 2017, we had $128.6 million of construction loans, representing 5.9% of our total loan portfolio at that date. Additionally, we had $143.5 million in unadvanced construction funds as of December 31, 2017. Our construction loans are based upon estimates of costs to construct and the value associated with the completed project. These estimates may be inaccurate due to the uncertainties inherent in estimating construction costs, as well as the market value of the completed project, making it relatively difficult to accurately evaluate the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. Delays in completing the project may arise from labor problems, material shortages and other unpredictable contingencies. If the estimate of construction costs is inaccurate, we may be required to advance additional funds to complete construction. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project.

 

Our portfolio of indirect auto lending exposes us to increased credit risks.

 

At December 31, 2017, $513.7 million, or 23.5% of our total loan portfolio, consisted of auto loans, primarily originated through automobile dealers for the purchase of new or used automobiles. We serve customers that cover a range of creditworthiness and the required terms and rates are reflective of those risk profiles. Auto loans are inherently risky as they are often secured by assets that may be difficult to locate and can depreciate rapidly. In some cases, repossessed collateral for a defaulted auto loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency may not warrant further substantial collection efforts against the borrower. Auto loan collections depend on the borrower's continuing financial stability, and therefore, are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Additional risk elements associated with indirect lending include the limited personal contact with the borrower as a result of indirect lending through non-bank channels, namely automobile dealers. 

 

Our business may be adversely affected by credit risk associated with residential property.

 

At December 31, 2017, one- to four-family residential real estate loans comprised $677.8 million, or 31.0% of our total loan portfolio, and second mortgage and equity lines of credit comprised $89.1 million, or 4.1% of our total loan portfolio. One- to four-family residential mortgage lending, whether owner occupied or non-owner occupied, is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations. Declines in real estate values could cause some of our residential mortgages to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral.

 

Residential loans with combined higher loan-to-value ratios are more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, they may be unable to repay their loans in full from the sale proceeds. For those home equity loans and lines of credit secured by a second mortgage, it is unlikely that we will be successful in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property. For these reasons, we may experience higher rates of delinquencies, default and losses on our home equity loans.

 

If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings and capital could decrease.

 

At December 31, 2017, our allowance for loan losses totaled $18.5 million, which represented 0.84% of total loans. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for many of our loans. In determining the amount of the allowance for loan losses, we review our loans, loss and delinquency experience, and commercial and commercial real estate peer data and we evaluate other factors including, among other things, current economic conditions. If our assumptions are incorrect, or if delinquencies or non-performing loans increase, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to our allowance, which could materially decrease our net income.

 

In addition, our regulators, as an integral part of their examination process, periodically review the allowance for loan losses and may require us to increase the allowance for loan losses by recognizing additional provisions for loan losses charged to income, or

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to charge off loans, which, net of any recoveries, would decrease the allowance for loan losses. Any such additional provisions for loan losses or charge-offs could have a material adverse effect on our financial condition and results of operations.

 

Changes in interest rates may hurt our profits and asset value.

 

Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and interest paid on deposits and borrowings. Changes in the general level of interest rates can affect our net interest income by affecting the difference between the weighted-average yield earned on our interest-earning assets and the weighted-average rate paid on our interest-bearing liabilities, or interest rate spread, and the average life of our interest-earning assets and interest-bearing liabilities. Interest rates are highly sensitive to many factors, including government monetary policies, domestic and international economic and political conditions and other factors beyond our control.

 

While we pursue an asset/liability strategy designed to mitigate our risk from changes in interest rates, changes in interest rates may still have a material adverse effect on our financial condition and results of operations. Changes in the level of interest rates also may negatively affect our ability to originate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.

 

An increase in interest rates may reduce our mortgage banking revenues, which would negatively impact our non-interest income.

 

We sell residential mortgage loans in the secondary market, which provides a significant portion of our non-interest income. We generate mortgage banking revenues primarily from gains on the sale of mortgage loans to investors on a servicing-released and retained basis. We also earn interest on loans held for sale while they are awaiting delivery to our investors. In a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage banking revenues. In addition, our results of operations are affected by the amount of non-interest expenses associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity.

 

We may not be able to successfully implement our strategic plan.

 

Our growth is essential to improving our profitability, and we expect to continue to incur expenses related to the implementation of our strategic plan, including hiring initiatives and the development and marketing of new products and services. We may not be able to successfully implement our strategic plan, and therefore may not be able to increase profitability in the timeframe that we expect or at all, and could experience a decrease in profitability.

 

The successful implementation of our strategic plan will require, among other things that we attract new customers that currently bank at other financial institutions in our market area or adjacent markets. In addition, our ability to successfully grow will depend on several factors, including continued favorable market conditions, the competitive responses from other financial institutions in our market area, our ability to attract and retain experienced lenders, and our ability to maintain high asset quality as we increase our loan portfolio. While we believe we have the management resources and internal systems in place to successfully manage our future growth, growth opportunities may not be available and we may not be successful in implementing our business strategy. Further, it will take time to implement our business strategy, especially for our lenders to originate enough loans and for our branch network to attract enough favorably priced deposits to generate the revenue needed to offset the associated expenses. Our strategic plan, even if successfully implemented, may not ultimately produce positive results.

 

Our efficiency ratio is high, and we anticipate that it may remain high, as a result of the ongoing implementation of our business strategy.

 

Our non-interest expense totaled $109.4 million and $114.7 million for the years ended December 31, 2017 and 2016, respectively. Although we continue to analyze our expenses and pursue efficiencies where available, our efficiency ratio remains high as a result of our implementation of our business strategy. Our efficiency ratio totaled 88.34% and 89.47% for the years ended December 31, 2017 and 2016, respectively. If we are unable to successfully implement our business strategy and increase our revenues, our profitability could be adversely affected.

 

 

 

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The building of market share through de novo branching and expansion of our commercial lending capacity will cause our expenses to increase faster than revenues.

 

We intend to continue to build market share through de novo branching, the establishment of additional loan production offices and the expansion of our commercial lending capacity. There can be considerable costs involved in opening branches and loan production offices and expanding our lending capacity that generally require a period of time to generate the necessary revenues to offset their costs, especially in areas in which we do not have an established presence. Accordingly, any such business expansion can be expected to negatively impact our earnings for some period of time until certain economies of scale are reached. Our expenses could be further increased if we encounter delays in the opening of any of our new branches or loan production offices. Finally, our business expansion may not be successful after establishment.

 

Our wholesale funding sources may prove insufficient to replace deposits at maturity and support our future growth.

 

We and our bank subsidiary must maintain sufficient funds to respond to the needs of depositors and borrowers. To manage liquidity, we draw upon a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources, include Federal Home Loan Bank advances, proceeds from the sale of investments and loans, and liquidity resources at the holding company.  Our ability to manage liquidity will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable costs.  In addition, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.  Turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.

 

We use significant assumptions and estimates in our financial models to determine the fair value of certain assets, including mortgage servicing rights, origination commitments and loans held for sale. If our assumptions or estimates are incorrect, that may have a negative impact on the fair value of such assets and adversely affect our earnings.

 

We use internal and third party financial models that utilize market data to value certain assets, including mortgage servicing rights when they are initially acquired and on a quarterly basis thereafter. The methodology used to estimate these values is complex and uses asset-specific collateral data and market inputs for interest and discount rates and liquidity dates. Valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships that drive the results of our valuation methodologies. If prepayment speeds increase more than estimated, or if delinquency or default levels are higher than anticipated, we may be required to write down the value of certain assets, which could adversely affect our earnings. Prepayment speeds are significantly impacted by fluctuations in interest rates and are therefore difficult to predict. During periods of declining interest rates, prepayment speeds increase resulting in a decrease in the fair value of the mortgage servicing rights. In addition, there can be no assurance that, even if our models are correct, these assets could be sold for our carrying value should we chose or be forced to sell them in the open market.

 

Strong competition within our market area could hurt our profits and slow growth.

 

We face intense competition in making loans and attracting deposits. Price competition for loans and deposits sometimes results in us charging lower interest rates on our loans and paying higher interest rates on our deposits and may reduce our net interest income. Competition also makes it more difficult and costly to attract and retain qualified employees. Many of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. If we are not able to effectively compete in our market area, our profitability may be negatively affected. The greater resources and broader offering of deposit and loan products of some of our competitors may also limit our ability to increase our interest-earning assets or deposits.

 

We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.

 

We are a community bank and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our market area and nearby Boston, Massachusetts, and Providence, Rhode Island. As a community bank, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we

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serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or by events beyond our control, our business and operating results may be adversely affected.

 

Changes in accounting standards could affect reported earnings.

 

The bodies responsible for establishing accounting standards, including the Financial Accounting Standards Board (“FASB”), the SEC and other regulatory bodies, periodically change the financial accounting and reporting guidance that governs the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply new or revised guidance retroactively.

 

Of the newly issued guidance, the most significant to us is the FASB Accounting Standards Update (ASU) 2016-13, Financial Instruments – Credit Losses (Topic 326), commonly referred to as “CECL,” which introduces new guidance for the accounting for credit losses on instruments within its scope.  CECL requires loss estimates for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts.  It also modifies the impairment model for debt securities available for sale and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination.  The impact of this Update will be dependent on the portfolio composition, credit quality and economic conditions at the time of adoption.

 

Our banking business is highly regulated, which could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.

 

We are subject to regulation and supervision by the Federal Reserve, and the Bank is subject to regulation and supervision by the Massachusetts Commissioner of Banks and the FDIC. Federal and state laws and regulations govern numerous matters affecting us, including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts and terms of extensions of credit and investments, permissible non-banking activities, the level of reserves against deposits and restrictions on dividend payments. The FDIC and the Massachusetts Commissioner of Banks have the power to issue cease and desist orders to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the Federal Reserve possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which we and HarborOne Bank may conduct business and obtain financing.

 

Because our business is highly regulated, the laws, rules, regulations, and supervisory guidance and policies applicable to us are subject to regular modification and change.  Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on our business, financial condition, and results of operations. See the section of Form 10-K entitled "Supervision and Regulation" for a discussion of the regulations to which we are subject.

 

We are subject to capital and liquidity standards that require banks and bank holding companies to maintain more and higher quality capital and greater liquidity than has historically been the case.

 

We became subject to new capital requirements in 2015. These new standards, which now apply and will be fully phased-in over the next several years, force bank holding companies and their bank subsidiaries to maintain substantially higher levels of capital as a percentage of their assets, with a greater emphasis on common equity as opposed to other components of capital. The need to maintain more and higher quality capital, as well as greater liquidity, and generally increased regulatory scrutiny with respect to capital levels, may at some point limit our business activities, including lending, and our ability to expand. It could also result in our being required to take steps to increase our regulatory capital and may dilute shareholder value or limit our ability to pay dividends or otherwise return capital to our investors through stock repurchases. Pursuant to the Dodd-Frank Act, we were permitted to make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. We made this election.

 

An increase in FDIC or Co-operative Central Bank insurance assessments could significantly increase our expenses.

 

The Dodd-Frank Act eliminated the maximum Deposit Insurance Fund ratio of 1.5% of estimated deposits, and the FDIC has established a long-term ratio of 2.0%. The FDIC has the authority to increase assessments in order to maintain the Deposit Insurance

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Fund ratio at particular levels. In addition, if our regulators issue downgraded ratings of the Bank in connection with their examinations, the FDIC could impose significant additional fees and assessments on us. All Massachusetts-chartered co-operative banks are required to be members of the Co-operative Central Bank, which maintains the Share Insurance Fund that insures co-operative bank deposits in excess of federal deposit insurance coverage. The Co-operative Central Bank is authorized to charge co-operative banks an annual assessment fee on deposit balances in excess of amounts insured by the FDIC. Increases in assessments by either the FDIC or the Co-operative Central Bank could significantly increase our expenses.

 

If we are required to repurchase mortgage loans that we have previously sold, it could negatively affect our earnings.

 

In connection with selling residential mortgage loans in the secondary market, our agreements with investors contain standard representations and warranties and early payment default clauses that could require us to repurchase mortgage loans sold to these investors or reimburse the investors for losses incurred on loans in the event of borrower default within a defined period after origination or, in the event of breaches of contractual representations or warranties made at the time of sale that are not remedied within a defined period after we receive notice of such breaches, or refund the profit received from the sale of a loan to an investor if the borrower pays off the loan within a defined period after origination. If we are required to repurchase mortgage loans or provide indemnification or other recourse, this could significantly increase our costs and thereby affect our future earnings.

 

Changes in the valuation of our securities could adversely affect us.

 

Most of the securities in our portfolio are classified as available-for-sale. Accordingly, a decline in the fair value of our securities could cause a material decline in our reported equity and/or net income. At least quarterly, and more frequently when warranted by economic or market conditions, management evaluates all securities classified as available-for-sale with a decline in fair value below the amortized cost of the investment to determine whether the impairment is deemed to be other-than-temporary, or "OTTI." For impaired debt securities that are intended to be sold, or more likely than not will be required to be sold, the full amount of market decline is recognized as OTTI through earnings. Credit-related OTTI for all other impaired debt securities is recognized through earnings. Non-credit related OTTI for such debt securities is recognized in other comprehensive income, net of applicable taxes. A decline in the market value of our securities portfolio could adversely affect our earnings.

 

Changes in the valuation of goodwill could adversely affect us.

 

When the purchase price of an acquired business exceeds the fair value of its tangible assets, the excess is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price that is allocated to goodwill is determined by the excess of the purchase price over the net identifiable assets acquired. At December 31, 2017, our goodwill and net intangible assets totaled $13.6 million. Under current accounting standards, if we determine goodwill or intangible assets are impaired, we will be required to write down the value of these assets. We may be required to take impairment charges in the future, which would have a negative effect on our shareholders' equity and financial results.

 

Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.

 

We are required by our regulators to maintain adequate levels of capital to support our operations, we may at some point need to raise additional capital to support continued growth.

 

Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we may not be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, if we are unable to raise additional capital when required by the Massachusetts Commissioner of Banks or the Federal Reserve, we may be subject to adverse regulatory action.

 

We may incur fines, penalties and other negative consequences from regulatory violations, possibly even inadvertent or unintentional violations.

 

The financial services industry is subject to intense scrutiny from bank supervisors in the examination process and aggressive enforcement of federal and state regulations, particularly with respect to mortgage-related practices and other consumer compliance

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matters, and compliance with anti-money laundering, Bank Secrecy Act and Office of Foreign Assets Control regulations, and economic sanctions against certain foreign countries and nationals. Enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices.  We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations; however, some legal and regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there was in place at the time systems and procedures designed to ensure compliance. Failure to comply with these and other regulations, and supervisory expectations related thereto, may result in fines, penalties, lawsuits, regulatory sanctions, reputation damage, or restrictions on our business. 

 

Natural disasters, acts of terrorism and other external events could harm our business.

 

Natural disasters can disrupt our operations, result in damage to our properties, reduce or destroy the value of the collateral for our loans and negatively affect the economies in which we operate, which could have a material adverse effect on our results of operations and financial condition. A significant natural disaster, such as a tornado, hurricane, earthquake, fire or flood, could have a material adverse impact on our ability to conduct business, and our insurance coverage may be insufficient to compensate for losses that may occur. Acts of terrorism, war, civil unrest, violence or human error could cause disruptions to our business or the economy as a whole. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.

 

We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.

 

The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose community investment and nondiscriminatory lending requirements on financial institutions. The Consumer Financial Protection Bureau, the Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act or other fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions, restrictions on expansion and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations.

 

We face continuing and growing security risks to our information base, including the information we maintain relating to our customers.

 

We are subject to certain operational risks, including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. In the ordinary course of business, we rely on electronic communications and information systems to conduct our business and to store sensitive data, including financial information regarding customers.  Our electronic communications and information systems infrastructure could be susceptible to cyberattacks, hacking, identity theft or terrorist activity.  We have implemented and regularly review and update extensive systems of internal controls and procedures as well as corporate governance policies and procedures intended to protect our business operations, including the security and privacy of all confidential customer information. In addition, we rely on the services of a variety of vendors to meet our data processing and communication needs. No matter how well designed or implemented our controls are, we cannot provide an absolute guarantee to protect our business operations from every type of problem in every situation. A failure or circumvention of these controls could have a material adverse effect on our business operations and financial condition.

 

We regularly assess and test our security systems and disaster preparedness, including back-up systems, but the risks are substantially escalating. As a result, cybersecurity and the continued enhancement of our controls and processes to protect our systems, data and networks from attacks, unauthorized access or significant damage remain a priority. Accordingly, we may be required to expend additional resources to enhance our protective measures or to investigate and remediate any information security vulnerabilities or exposures. Any breach of our system security could result in disruption of our operations, unauthorized access to confidential customer information, significant regulatory costs, litigation exposure and other possible damages, loss or liability. Such costs or losses could exceed the amount of available insurance coverage, if any, and would adversely affect our earnings. Also, any failure to prevent a security breach or to quickly and effectively deal with such a breach could negatively impact customer confidence, damaging our reputation and undermining our ability to attract and keep customers.

 

 

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We may not be able to successfully implement future information technology system enhancements, which could adversely affect our business operations and profitability.

 

We invest significant resources in information technology system enhancements in order to provide functionality and security at an appropriate level. We may not be able to successfully implement and integrate future system enhancements, which could adversely impact the ability to provide timely and accurate financial information in compliance with legal and regulatory requirements, which could result in sanctions from regulatory authorities. Such sanctions could include fines and suspension of trading in our stock, among others. In addition, future system enhancements could have higher than expected costs and/or result in operating inefficiencies, which could increase the costs associated with the implementation as well as ongoing operations.

 

Failure to properly utilize system enhancements that are implemented in the future could result in impairment charges that adversely impact our financial condition and results of operations and could result in significant costs to remediate or replace the defective components. In addition, we may incur significant training, licensing, maintenance, consulting and amortization expenses during and after systems implementations, and any such costs may continue for an extended period of time.

 

We rely on other companies to provide key components of our business infrastructure.

 

Third-party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant delay and expense.

 

If our risk management framework does not effectively identify or mitigate our risks, we could suffer losses.

 

Our risk management framework seeks to mitigate risk and appropriately balance risk and return. We have established processes and procedures intended to identify, measure, monitor and report the types of risk to which we are subject, including credit risk, operations risk, compliance risk, reputation risk, strategic risk, market risk and liquidity risk. We seek to monitor and control our risk exposure through a framework of policies, procedures and reporting requirements. Management of our risks in some cases depends upon the use of analytical and/or forecasting models. If the models used to mitigate these risks are inadequate, we may incur losses. In addition, there may be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated. If our risk management framework does not effectively identify or mitigate our risks, we could suffer unexpected losses and could be materially adversely affected.

 

Changes in tax laws and regulations and differences in interpretation of tax laws and regulations may adversely impact our financial statements.

 

From time to time, local, state or federal tax authorities change tax laws and regulations, which may result in a decrease or increase to our deferred tax asset.  In December 2017, we recognized a write-down of $243,000 in our deferred assets in connection with the adoption of the Tax Cuts and Jobs Act.

 

Local, state or federal tax authorities may interpret laws and regulations differently than we do and challenge tax positions that we have taken on tax returns.  This may result in differences in the treatment of revenues, deductions, credits and/or differences in the timing of these items.  The differences in treatment may result in payment of additional taxes, interest, penalties, or litigation costs that could have a material adverse effect on our results.

 

Acquisitions may disrupt our business and dilute stockholder value.

 

We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us either significant market presence or the potential to expand our market footprint and improve profitability through economies of scale or expanded services.

 

Acquiring other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks commonly associated with acquisitions, including, among other things:

 

·

difficulty in estimating the value of the target company;

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·

payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term;

·

potential exposure to unknown or contingent tax or other liabilities of the target company;

·

exposure to potential asset quality problems of the target company;

·

potential volatility in reported income associated with goodwill impairment losses;

·

difficulty and expense of integrating the operations and personnel of the target company;

·

inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits;

·

potential disruptions to our business;

·

potential diversion of our management’s time and attention;

·

the possible loss of key employees and customers of the target company; and

·

potential changes in banking or tax laws or regulations that may affect the target company.

 

ITEM 1B.  UNRESOLVED STAFF COMMENTS

 

Not applicable.

 

 

ITEM 2.  PROPERTIES

 

At December 31, 2017, we conducted business throughout our Southeastern Massachusetts network of 14 full-service branches, two limited service branches, a commercial loan office in Providence, Rhode Island, a lending office in Westford, Massachusetts, 13 free-standing ATMs, and two campuses providing a range of educational services through “HarborOne U”.  Merrimack Mortgage Company, LLC, a subsidiary of HarborOne Bank, is a full-service mortgage lender with 34 office in Massachusetts, New Hampshire and Maine, and also does business in seven additional states.  We own 10 and lease 41 of our offices.  At December 31, 2017, the total net book value of our land, buildings, furniture, fixtures and equipment was $24.5 million.

 

 

ITEM 3.  LEGAL PROCEEDINGS

 

We are not involved in any material pending legal proceedings as a plaintiff or as a defendant other than routine legal proceedings occurring in the ordinary course of business.  We are not involved in any legal proceedings the outcome of which we believe would be material to our financial condition or results of operations.

 

 

ITEM  4.  MINE SAFETY DISCLOSURES

 

Not applicable.

 

 

PART II

 

ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

(a)The Company’s shares of common stock are traded on the NASDAQ Global Select Market under the symbol “HONE”.  The approximate number of shareholders of record of the Company’s common stock as of March 6, 2018 was 1,488.  The number of record-holders may not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms and other nominees.

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The Company completed its initial public offering on June 29, 2016, and its stock commenced trading on June 30, 2016.  The following table sets forth for the periods indicated the intra-day high and low sales prices per share of common stock as reported by NASDAQ.  The Company has not paid any dividends to its stockholders to date.  See “Dividends” below.  On March 6, 2018, the closing market price of the Company’s common stock was $19.89.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Market Prices

 

 

Dividends

 

 

High

 

Low

 

 

Declared

 

 

 

 

 

 

 

 

 

 

2017

 

 

 

 

 

 

 

 

 

Fourth quarter

 

$

20.19

 

$

18.03

 

$

 —

Third quarter

 

$

20.08

 

$

15.92

 

$

 —

Second quarter

 

$

22.29

 

$

18.41

 

$

 —

First quarter

 

$

20.00

 

$

17.30

 

$

 —

 

 

 

 

 

 

 

 

 

 

2016

 

 

 

 

 

 

 

 

 

Fourth quarter

 

$

20.19

 

$

15.13

 

$

 —

Third quarter

 

$

15.99

 

$

12.53

 

$

 —

Second quarter

 

 

N/A

 

 

N/A

 

 

N/A

First quarter

 

 

N/A

 

 

N/A

 

 

N/A

 

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Stock Performance Graph

 

The Company’s shares of common stock began trading on the NASDAQ Global Select Market on June 30, 2016.  Accordingly, no comparative stock performance information is available for periods ending prior to this date.  The performance graph below compares the Company’s cumulative shareholder return on its common stock since inception of trading on June 30, 2016 to the cumulative total return of the Russell 2000 index of small capitalization companies and the SNL U.S. Thrift Composite comprising thrifts with total assets of $1.0 billion to $5.0 billion.  The initial offering price of the Company’s shares was $10.00 per share, however the graph below depicts the cumulative return on the stock since inception of trading at $12.99 per share on June 30, 2016.  Total shareholder return is measured by dividing total dividends (assuming dividend reinvestment) for the measurement period plus share price change for the period from the share price at the beginning of the measurement period.  The return is based on the initial investment of $100.00.

 

The following information in this Item 5 of this Annual Report 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to be liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates it by reference to such filing.  The stock price performance shown on the stock performance graph and associated table below is not necessarily indicative of future price performance.  Information used in the graph and table was obtained from a third party provider, a source believed to be reliable, but the Company is not responsible for any errors or omissions in such information.

 

The following chart depicts the total return performance of the Company:

 

 

Picture 5

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Period Ending

Index

07/01/16

 

09/30/16

 

12/31/16

 

03/31/17

 

06/30/17

 

09/30/17

 

12/31/17

HarborOne Bancorp, Inc.

100.00

 

123.03

 

150.98

 

148.24

 

155.82

 

146.84

 

149.57

Russell 2000 Index

100.00

 

108.58

 

118.18

 

121.09

 

124.07

 

131.11

 

135.49

SNL Thrift $1B-$5B Index

100.00

 

108.78

 

136.19

 

130.65

 

132.50

 

137.54

 

137.94

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Source : SNL Financial, an offering of S&P Global Market Intelligence

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(b) Not applicable.

 

(c) The Company adopted a share repurchase program on October 27, 2017. The Company may repurchase up to 1,633,155 shares of the Company’s common stock, or approximately 5% of the Company’s current issued and outstanding shares.

 

The following table sets forth information regarding the Company’s repurchases of its common stock during the three months ended December 31, 2017.

 

 

 

 

 

 

 

 

 

 

Issuer Purchases of Equity Securities

 

 

Total Number

 

 

 

 

 

of Shares

 

Average Price

Period

 

Purchased

 

Paid Per Share

October 1 to October 31, 2017

 

 

 —

 

$

 —

November 1 to November 30, 2017

 

 

13,400

 

 

18.82

December 1 to December 31, 2017

 

 

1,500

 

 

18.78

Total

 

 

14,900

 

$

18.82

 

 

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ITEM 6.  SELECTED FINANCIAL DATA

 

The selected financial and other data of the Company, as of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015, set forth below are derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere herein.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

 

 

 

(in thousands)

 

Financial Condition Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total assets

 

$

2,684,920

 

$

2,448,310

 

$

2,163,142

 

$

2,041,879

 

$

1,957,671

 

Cash and cash equivalents

 

 

80,791

 

 

50,215

 

 

40,652

 

 

52,983

 

 

75,342

 

Securities available for sale, at fair value

 

 

170,853

 

 

136,469

 

 

128,541

 

 

148,015

 

 

135,418

 

Securities held to maturity, at cost

 

 

46,869

 

 

47,877

 

 

63,579

 

 

58,384

 

 

57,277

 

Loans held for sale, at fair value(1)

 

 

59,460

 

 

86,443

 

 

63,797

 

 

3,525

 

 

2,061

 

Loans receivable, net

 

 

2,176,478

 

 

1,981,747

 

 

1,729,388

 

 

1,651,894

 

 

1,591,814

 

Deposits

 

 

2,013,738

 

 

1,804,753

 

 

1,691,212

 

 

1,500,115

 

 

1,414,960

 

Borrowings

 

 

290,365

 

 

275,119

 

 

249,598

 

 

329,602

 

 

339,606

 

Total equity

 

 

343,484

 

 

329,384

 

 

190,688

 

 

183,458

 

 

180,803

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Year Ended December 31, 

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

 

 

 

(in thousands)

 

Selected Operating Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest and dividend income

 

$

90,284

 

$

74,756

 

$

66,800

 

$

61,079

 

$

59,973

 

Interest expense

 

 

15,936

 

 

13,761

 

 

14,575

 

 

15,878

 

 

16,381

 

Net interest income

 

 

74,348

 

 

60,995

 

 

52,225

 

 

45,201

 

 

43,592

 

Provision for loan losses

 

 

2,416

 

 

4,172

 

 

1,257

 

 

2,589

 

 

2,235

 

Net interest income, after provision for loan losses

 

 

71,932

 

 

56,823

 

 

50,968

 

 

42,612

 

 

41,357

 

Mortgage banking income(1)

 

 

37,195

 

 

50,999

 

 

20,230

 

 

1,433

 

 

2,293

 

Gains on sale and calls of securities

 

 

 —

 

 

283

 

 

295

 

 

483

 

 

794

 

Other noninterest income

 

 

17,339

 

 

15,821

 

 

14,848

 

 

13,694

 

 

13,191

 

Noninterest expense

 

 

109,414

 

 

114,698

 

 

78,014

 

 

54,302

 

 

53,370

 

Income before income taxes

 

 

17,052

 

 

9,228

 

 

8,327

 

 

3,920

 

 

4,265

 

Income tax expense (benefit)

 

 

6,673

 

 

3,297

 

 

2,559

 

 

1,350

 

 

(2,909)

 

Net income

 

$

10,379

 

$

5,931

 

$

5,768

 

$

2,570

 

$

7,174

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Reflects the acquisition of Merrimack Mortgage on July 1, 2015.  Mortgage loans held for sale were carried at the lower of cost or fair value prior to July 1, 2015.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

At or For the Year Ended December 31, 

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

 

 

 

 

 

Performance Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Return on average assets (ratio of net income to average total assets)

 

 

0.40

%  

 

0.26

%  

 

0.27

%  

 

0.13

%  

 

0.38

%  

Return on average equity (ratio of net income to average equity)

 

 

3.09

 

 

2.26

 

 

3.04

 

 

1.38

 

 

3.98

 

Interest rate spread(1)

 

 

2.88

 

 

2.71

 

 

2.50

 

 

2.26

 

 

2.23

 

Net interest margin(2)

 

 

3.04

 

 

2.85

 

 

2.61

 

 

2.39

 

 

2.37

 

Efficiency ratio(3)

 

 

84.83

 

 

89.47

 

 

88.85

 

 

88.99

 

 

88.88

 

Average interest-earning assets to average interest-bearing liabilities

 

 

124.78

 

 

121.83

 

 

115.38

 

 

115.72

 

 

115.73

 

Average equity to average total assets

 

 

13.00

 

 

11.50

 

 

8.93

 

 

9.40

 

 

9.54

 

Asset Quality Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-performing assets to total assets

 

 

0.69

%  

 

0.94

%  

 

1.47

%  

 

1.87

%  

 

1.90

%  

Non-performing loans to total loans

 

 

0.81

 

 

1.06

 

 

1.69

 

 

2.12

 

 

2.13

 

Allowance for loan losses to non-performing loans

 

 

103.55

 

 

80.11

 

 

46.56

 

 

39.49

 

 

42.44

 

Allowance for loan losses to total loans

 

 

0.84

 

 

0.85

 

 

0.79

 

 

0.84

 

 

0.90

 

Net loans charged off as a percent of average loans outstanding

 

 

0.04

 

 

0.05

 

 

0.09

 

 

0.20

 

 

0.32

 

Capital Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Common equity tier 1 to risk weighted assets

 

 

15.1

%  

 

16.2

%  

 

10.8

%  

 

N/A

%  

 

N/A

%  

Tier 1 capital to risk weighted assets

 

 

15.1

 

 

16.2

 

 

10.8

 

 

12.2

 

 

14.0

 

Total capital to risk weighted assets

 

 

16.0

 

 

17.0

 

 

11.7

 

 

13.1

 

 

13.0

 

Tier 1 capital to average assets

 

 

12.5

 

 

13.2

 

 

8.3

 

 

8.9

 

 

9.1

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(1) Represents the difference between the weighted average yield on average interest-earning assets on a fully tax equivalent basis and the weighted average cost of interest-bearing liabilities.

 

(2) Represents net interest income as a percent of average interest-earning assets on a fully tax equivalent basis.

 

(3) Represents noninterest expense divided by the sum of net interest income and noninterest income.

 

 

 

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Table of Contents

HarborOne Bancorp, Inc.

Management’s Discussion and Analysis

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

All material intercompany balances and transactions have been eliminated in consolidation. When necessary, certain amounts in prior year financial statements have been reclassified to conform to the current year’s presentation. The following discussion and analysis is presented to assist the reader in understanding and evaluating of the Company's financial condition and results of operations. It is intended to complement the Consolidated Financial Statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-K and should be read in conjunction therewith.

 

Overview 

 

On June 29, 2016, the Company completed its conversion from the mutual holding company to the stock holding company form of organization. The Company sold 32,120,880 shares of common stock at $10.00 per share, including 17,281,188 shares to the MHC.   The Company’s principal subsidiary is the Bank. The Bank is a state chartered co-operative bank whose primary subsidiary is a residential mortgage company, Merrimack Mortgage Company, LLC., acquired on July 1, 2015. 

 

As described in the notes to Consolidated Financial Statements, we have two reportable segments: HarborOne Bank and Merrimack Mortgage. The Bank segment provides consumer and business banking products and services to customers. Consumer products include loan and deposit products, and business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts.  The Merrimack Mortgage segment consists of originating residential mortgage loans primarily for sale in the secondary market and the servicing of those loans.

 

The HarborOne Bank segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses.  The Merrimack Mortgage segment generates the significant majority of our noninterest income.  We have provided below a discussion of the material results of operations for each segment on a separate basis for the year ended December 31, 2017 and 2016, which focuses on noninterest income and noninterest expenses.  We have also provided a discussion of the consolidated operations of the Company, which includes the operations of HarborOne Bank and Merrimack Mortgage, for the same periods.

 

For revenue, net income, assets, and other financial information for each of the Company’s reportable segments, see Part II, Item 8. “Financial Statements and Supplementary Data – Note 23: Segment Reporting.”

 

Critical Accounting Policies

 

Certain of our accounting policies, which are important to the portrayal of our financial condition, require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain.  Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances.  Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers.  Our significant accounting policies are discussed in detail in Note 1 to our Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K.

 

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an "emerging growth company" we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our Consolidated Financial Statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of December 31, 2017, there is no significant difference in the comparability of the financial statements as a result of the extended transition period.

 

Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Management believes that the most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:

 

Allowance for Loan Losses.    The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which

32


 

Table of Contents

HarborOne Bancorp, Inc.

Management’s Discussion and Analysis

is charged to income. The allowance consists of general, allocated and unallocated components. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: the likelihood of default; the loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the Massachusetts Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See Note 6, “Loans” within Notes to Consolidated Financial Statements included in item 8 of this annual report.

 

Goodwill.     The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition.  Goodwill is recognized for the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized.  Identifiable intangible assets include core deposit premium and non-compete contracts and are being amortized on a straight-line basis over their estimated lives.  Management assesses the recoverability of goodwill at least on an annual basis and all intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable.  The impairment test uses a combined qualitative and quantitative approach.  The initial qualitative approach assesses whether the existence of events or circumstances led to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after this assessment, the Company determines that it is more likely than not that the fair value is less than the carrying value, a quantitative impairment test is performed.  The quantitative impairment test compares book value to the fair value of the reporting unit.    If the carrying amount exceeds fair value, an impairment charge is recorded through earnings.  Management has identified two reporting units for purposes of testing goodwill for impairment.  The Company’s reporting units are the same as the segments used for segment reporting - the Bank, including the two security corporations, and MMC.

 

Deferred Tax Assets.    Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. Management reviews deferred tax assets on a quarterly basis to identify any uncertainties pertaining to realization of such assets. In determining whether a valuation allowance is required against deferred tax assets, management assesses historical and forecasted operating results, including a review of eligible carryforward periods, tax planning opportunities and other relevant considerations. We believe the accounting estimate related to the valuation allowance is a critical estimate because the underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance. Should actual factors and conditions differ materially from those used by management, the actual realization of net deferred tax assets could differ materially from the amounts recorded in the financial statements. If we were not able to realize all or part of our deferred tax assets in the future, an adjustment to the related valuation allowance would be charged to income tax expense in the period such determination was made and could have a negative impact on earnings. In addition, if actual factors and conditions differ materially from those used by management, we could incur penalties and interest imposed by taxing authorities.

 

Derivatives.  Derivative instruments are used in relation to our mortgage banking activities and require significant judgment and estimates in determining their fair value.  We hold derivative instruments, which consist of interest rate lock agreements related to expected funding of fixed-rate mortgage loans to customers and forward commitments to sell mortgage loans.  Our objective in obtaining the forward commitments is to mitigate the interest rate risk associated with the interest rate lock commitments and the mortgage loans that are held for sale.  Derivatives related to these commitments are recorded as either a derivative asset or a derivative liability in the balance sheet and are measured at fair value, with adjustments recorded in “Mortgage banking income”.

 

Mortgage Servicing Rights. We recognize the rights to service mortgage loans for others as a separate asset referred to as “mortgage servicing rights” or “MSRs”. MSRs are generally recognized when loans are sold and the servicing is retained by us and are recorded at fair value. We base the fair value of our MSRs on a valuation performed by a third-party valuation specialist. This specialist determines fair value based on the present value of estimated future net servicing income cash flows, and incorporates assumptions that market participants would use to estimate fair value, including estimates of prepayment speeds, discount rates, default rates, servicing costs, contractual servicing fee income, and ancillary income. Changes in the fair value of MSRs occur primarily in connection with the collection/realization of expected cash flows, as well as changes in the valuation inputs and assumptions. Changes in the fair value of residential MSRs are reported in “Mortgage banking income”.

 

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Table of Contents

HarborOne Bancorp, Inc.

Management’s Discussion and Analysis

Please see the Notes to the Consolidated Financial Statements for additional discussion of accounting policies.

 

 

Comparison of Financial Condition at December 31, 2017 and December 31, 2016

 

Total Assets.    Total assets increased $236.6 million, or 9.7%, to $2.68 billion at December 31, 2017 from $2.45 billion at December 31, 2016. The increase was primarily due to a $194.7 million, or 9.8% increase in net loans as we continued to focus on commercial loan growth.

 

Cash and Cash Equivalents.  At December 31, 2017 cash and cash equivalents were $80.8 million, an increase of 60.9% from $50.2 million. The increase was primarily due to HarborOne Bancorp, Inc.’s participation in the Bank’s reciprocal deposit program that was established in June of 2017. Through the program, $38.0 million of the Company’s $69.4 million deposit at the Bank was converted to multiple deposits at other financial institutions which are not eliminated in consolidation.    

 

Loans Held for Sale.    Loans held for sale at December 31, 2017 were $59.5 million, a decrease of $26.9 million from $86.4 million at December 31, 2016, primarily due to a decrease in mortgage origination activity. Of the loans held for sale at December 31, 2017, $55.5 million were originated by Merrimack Mortgage and $4.0 million were originated by the Bank. 

 

Loans, net.    At December 31, 2017, net loans were $2.18 billion, an increase of $194.7 million, or 9.8%, from $1.98 billion at December 31, 2016, primarily due to an increase in commercial real estate, commercial, and construction loans, reflecting the continued execution of our commercial loan growth strategy. Commercial real estate loans increased $159.6 million, or 32.2%, to $655.4 million at December 31, 2017 from $495.8 million at December 31, 2016. Commercial loans increased $9.0 million, or 9.0%, to $109.5 million at December 31, 2017 and construction loans increased $70.2 million, or 120.1%, to $128.6 million at December 31, 2017, primarily due to commercial construction loan originations and disbursements.  Consumer loans decreased $35.3 million, or 6.3%, including the sale of $5.0 million of indirect auto loans. Our residential portfolio decreased by $4.0 million, or 0.5%, for the same period due to decreased mortgage loan demand in 2017 as interest rates increased and resulted in our portfolio payoffs outpacing originations. The allowance for loan losses was $18.5 million at December 31, 2017 and $17.0 million December 31, 2016.

 

The following table provides the composition of our loan portfolio at the dates indicated:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

 

 

2017

 

2016

 

2015

 

2014

 

2013

 

 

    

Amount

    

Percent

    

    Amount

    

Percent

 

    Amount

    

Percent

    

    Amount

    

Percent

    

    Amount

    

Percent

    

 

 

(dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential real estate:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family

 

$

677,837

 

31.0

%  

$

677,946

 

34.1

%

$

710,969

 

41.1

%  

$

768,129

 

46.5

%  

$

806,371

 

50.7

%  

Second mortgages and equity lines of credit

 

 

89,080

 

4.1

 

 

92,989

 

4.7

 

 

99,374

 

5.7

 

 

95,465

 

5.8

 

 

96,194

 

6.0

 

Commercial real estate

 

 

655,419

 

30.0

 

 

495,801

 

24.9

 

 

265,482

 

15.3

 

 

142,452

 

8.6

 

 

63,795

 

4.0

 

Construction

 

 

128,643

 

5.9

 

 

58,443

 

2.9

 

 

35,830

 

2.1

 

 

26,125

 

1.6

 

 

29,822

 

1.9

 

Total real estate

 

 

1,550,979

 

70.9

 

 

1,325,179

 

66.6

 

 

1,111,655

 

64.2

 

 

1,032,171

 

62.5

 

 

996,182

 

62.6

 

Commercial

 

 

109,523

 

5.0

 

 

100,501

 

5.1

 

 

70,472

 

4.1

 

 

47,453

 

2.9

 

 

22,969

 

1.4

 

Consumer: