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Section 1: 10-Q (10-Q)

Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission file number:   000-51889
  
TWO RIVER BANCORP
  
  
(Exact Name of Registrant as Specified in Its Charter)
  
New Jersey
  
20-3700861
(State of Other Jurisdiction
of Incorporation or Organization)
  
(I.R.S. Employer Identification No.)
766 Shrewsbury Avenue, Tinton Falls, New Jersey
  
07724
(Address of Principal Executive Offices)
  
(Zip Code)
 
(732) 389-8722
 
 
(Registrant’s Telephone Number, Including Area Code)
 
  
   
  
  
(Former name, former address and former fiscal year, if changed since last report)
  

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 every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).   Yes ☒      No ☐
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 ☐
Accelerated filer
 ☒
Non-accelerated filer
 ☐ 
Smaller reporting company
 ☒
Emerging growth company
 ☐
 
 
    
 If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ☐    No ☒  
 
As of November 6, 2018, there were 8,589,364 shares of the registrant’s common stock, no par value, outstanding.



TWO RIVER BANCORP
 
FORM 10-Q
 
INDEX
 
 
      
Page
 
  
  
  
  
  
  
  
  
 
 
  
  
  
Consolidated Balance Sheets (unaudited) at September 30, 2018 and December 31, 2017
  
  
  
  
 
  
  
  
Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 2018 and 2017
  
  
  
 
 
  
  
  
Consolidated Statements of Comprehensive Income (unaudited) for the three and nine months ended September 30, 2018 and 2017
  
  
  
 
 
  
  
  
Consolidated Statements of Shareholders' Equity (unaudited) for the nine months ended September 30, 2018 and 2017
  
  
  
 
 
  
  
  
Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2018 and 2017
  
  
  
  
 
  
  
  
  
  
  
  
 
  
  
  
  
  
  
 
  
  
  
  
  
  
 
  
  
  
  
  
  
 
  
 
 
 
 
 
 
 
Item 1.
 
Legal Proceedings
 
 
 
 
 
 
Item 1A.
 
Risk Factors
  
  
 
  
 
 
 
 
 
 
 
 
 
Item 3.
 
Defaults Upon Senior Securities
 
 
 
 
 
 
Item 4.
 
Mine Safety Disclosures
 
 
 
 
 
 
Item 5.
 
Other Information
 
 
 
 
 
  
  
  
  
  
  
 



PART I.   FINANCIAL INFORMATION
Item 1.        Financial Statements
TWO RIVER BANCORP
CONSOLIDATED BALANCE SHEETS (Unaudited)
(in thousands, except share data)
 
September 30,
2018
 
December 31,
2017
ASSETS
 
 
 
Cash and due from banks
$
17,880

 
$
29,575

Interest-bearing deposits in bank
29,733

 
18,644

Cash and cash equivalents
47,613

 
48,219

 
 
 
 
Securities available for sale (amortized cost of $26,027 and $29,127 at September 30, 2018 and December 31, 2017, respectively)
25,281

 
28,684

Securities held to maturity (fair value of $56,868 and $58,549 at September 30, 2018 and December 31, 2017, respectively)
57,606

 
58,002

Equity securities (amortized cost of $2,544 and $2,503 at September 30, 2018 and December 31, 2017, respectively)
2,412

 
2,448

Restricted investments, at cost
5,997

 
5,430

Loans held for sale
1,461

 
2,581

Loans
900,895

 
850,874

Allowance for loan losses
(11,390
)
 
(10,668
)
Net loans
889,505

 
840,206

 
 
 
 
Other real estate owned ("OREO")
585

 

Bank owned life insurance
21,968

 
21,573

Premises and equipment, net
6,011

 
6,239

Accrued interest receivable
2,982

 
2,554

Goodwill
18,109

 
18,109

Other assets
6,769

 
5,753

 
 
 
 
Total Assets
$
1,086,299

 
$
1,039,798

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits:
 
 
 
Non-interest-bearing
$
173,906

 
$
167,297

Interest-bearing
731,839

 
694,260

Total Deposits
905,745

 
861,557

 
 
 
 
Securities sold under agreements to repurchase
22,153

 
27,120

FHLB and other borrowings
24,500

 
25,800

Subordinated debt
9,914

 
9,888

Accrued interest payable
97

 
70

Other liabilities
9,999

 
8,792

 
 
 
 
Total Liabilities
972,408

 
933,227

 
 
 
 
Shareholders' Equity
 
 
 
Preferred stock, no par value; 6,500,000 shares authorized, no shares issued and outstanding

 

Common stock, no par value; 25,000,000 shares authorized;
 

 
 

Issued – 8,896,273 and 8,782,124 at September 30, 2018 and December 31, 2017, respectively
 

 
 

Outstanding – 8,584,179 and 8,470,030 at September 30, 2018 and December 31, 2017, respectively
80,294

 
79,678

Retained earnings
36,535

 
29,593

Treasury stock, at cost; 312,094 shares at September 30, 2018 and December 31, 2017
(2,396
)
 
(2,396
)
Accumulated other comprehensive loss
(542
)
 
(304
)
Total Shareholders' Equity
113,891


106,571

 
 
 
 
Total Liabilities and Shareholders’ Equity
$
1,086,299

 
$
1,039,798

See notes to the unaudited consolidated financial statements.

3




TWO RIVER BANCORP
CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)
For the Three and Nine Months Ended September 30, 2018 and 2017
(in thousands, except per share data)     
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Interest Income
 
 
 
 
 
 
 
Loans, including fees
$
10,656

 
$
9,227

 
$
30,720

 
$
26,363

Securities:
 
 
 
 
 
 
 

Taxable
274

 
247

 
861

 
715

Tax-exempt
280

 
267

 
842

 
831

Interest-bearing deposits
132

 
83

 
293

 
257

Total Interest Income
11,342

 
9,824

 
32,716

 
28,166

Interest Expense
 
 
 
 
 
 
 
Deposits
1,924

 
1,069

 
4,923

 
3,170

Securities sold under agreements to repurchase
14

 
18

 
43

 
50

FHLB and other borrowings
136

 
157

 
382

 
449

Subordinated debt
165

 
164

 
495

 
493

Total Interest Expense
2,239

 
1,408

 
5,843

 
4,162

Net Interest Income
9,103

 
8,416

 
26,873

 
24,004

Provision for Loan Losses
150

 
255

 
775

 
855

Net Interest Income after Provision for Loan Losses
8,953

 
8,161

 
26,098

 
23,149

 
 
 
 
 
 
 
 
Non-Interest Income
 
 
 
 
 
 
 
Service fees on deposit accounts
236

 
224

 
713

 
535

Mortgage banking
239

 
358

 
986

 
1,258

Other loan fees
378

 
188

 
626

 
402

Earnings from investment in bank owned life insurance
133

 
137

 
395

 
411

Gain on sale of SBA loans
203

 
306

 
921

 
817

Other income
166

 
240

 
520

 
693

Total Non-Interest Income
1,355

 
1,453

 
4,161

 
4,116

 
 
 
 
 
 
 
 
Non-Interest Expenses
 
 
 
 
 
 
 
Salaries and employee benefits
4,024

 
3,641

 
11,919

 
10,554

Occupancy and equipment
966

 
1,112

 
3,099

 
3,215

Professional
432

 
366

 
1,260

 
1,102

Insurance
59

 
57

 
180

 
158

FDIC insurance and assessments
128

 
123

 
374

 
354

Advertising
90

 
110

 
280

 
345

Data processing
184

 
151

 
510

 
406

Outside services fees
89

 
120

 
250

 
347

OREO expenses, impairments and sales, net
7

 
25

 
(8
)
 
44

Loan workout expenses
28

 
8

 
124

 
174

Other operating
454

 
462

 
1,251

 
1,324

Total Non-Interest Expenses
6,461

 
6,175

 
19,239

 
18,023

 
 
 
 
 
 
 
 
Income before Income Taxes
3,847

 
3,439

 
11,020

 
9,242

Income tax expense
1,013

 
1,202

 
2,860

 
3,075

Net Income
$
2,834

 
$
2,237

 
$
8,160

 
$
6,167

 
 
 
 
 
 
 
 
Earnings Per Common Share:
 
 
 
 
 
 
 
Basic
$
0.33

 
$
0.27

 
$
0.96

 
$
0.74

Diluted
$
0.33

 
$
0.26

 
$
0.94

 
$
0.71

Weighted average common shares outstanding
 
 
 
 
 
 
 

Basic
8,513

 
8,393

 
8,489

 
8,373

Diluted
8,700

 
8,656

 
8,695

 
8,647

See notes to the unaudited consolidated financial statements.

4


TWO RIVER BANCORP
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Unaudited)
For the Three and Nine Months Ended September 30, 2018 and 2017
(in thousands)
 
 
 
Three Months Ended
 
September 30,
 
2018
 
2017
Net income
$
2,834

 
$
2,237

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Unrealized holdings (losses)/gains on securities available for sale, net of income tax (benefit)/expense 2018: ($11), 2017: $1
(24
)
 
3

 
 
 
 
Other comprehensive (loss) income:
(24
)
 
3

 
 
 
 
Total comprehensive income
$
2,810

 
$
2,240

 
 
Nine Months Ended
 
September 30,
 
2018
 
2017
Net income
$
8,160

 
$
6,167

Other comprehensive (loss) income:
 
 
 
 
 
 
 
Unrealized holdings (loss)/gains on securities available for sale, net of income tax (benefit)/expense 2018: ($85), 2017: $127
(218
)
 
198

 
 
 
 
Other comprehensive (loss) income:
(218
)
 
198

 
 
 
 
Total comprehensive income
$
7,942

 
$
6,365

 
 
 
 

See notes to the unaudited consolidated financial statements.

5


TWO RIVER BANCORP
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (Unaudited)
For the Nine Months Ended September 30, 2018 and 2017
(dollars in thousands, except per share data)
 
Common Stock
 
 
 
 
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
Shareholders’
Equity
 
Outstanding
Shares
 
Amount
 
Retained
Earnings
 
Treasury
Stock
 
 
Balance, January 1, 2018
8,470,030

 
$
79,678

 
$
29,593

 
$
(2,396
)
 
$
(304
)
 
$
106,571

Net income

 

 
8,160

 

 

 
8,160

Other comprehensive loss

 

 

 

 
(218
)
 
(218
)
Stock-based compensation expense

 
222

 

 

 

 
222

Cash dividends on common stock ($0.145 per share)

 

 
(1,238
)
 

 

 
(1,238
)
Options exercised
92,560

 
345

 

 

 

 
345

AOCI reclassification related to Tax Reform

 

 
59

 

 
(59
)
 

AOCI reclassification due to adoption of ASU 2016-01

 

 
(39
)
 

 
39

 

Employee stock purchase program
2,689

 
49

 

 

 

 
49

Restricted stock and other awards
19,400

 

 

 

 

 

Shares forfeited
(500
)
 

 

 

 

 

Balance, September 30, 2018
8,584,179

 
$
80,294

 
$
36,535

 
$
(2,396
)
 
$
(542
)
 
$
113,891

 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2017
8,365,442

 
$
79,056

 
$
24,447

 
$
(2,396
)
 
$
(391
)
 
$
100,716

Net income

 

 
6,167

 

 

 
6,167

Common stock dividend – adjustment
(1,069
)
 

 

 

 

 

Other comprehensive income

 

 

 

 
198

 
198

Stock-based compensation expense

 
202

 

 

 

 
202

Cash dividends on common stock ($0.125 per share)

 

 
(1,034
)
 

 

 
(1,034
)
Options exercised
65,948

 
266

 

 

 

 
266

Restricted stock and other awards
21,018

 

 

 

 

 

Employee stock purchase program
3,144

 
52

 

 

 

 
52

Balance, September 30, 2017
8,454,483

 
$
79,576

 
$
29,580

 
$
(2,396
)
 
$
(193
)
 
$
106,567

 
See notes to the unaudited consolidated financial statements.

6


TWO RIVER BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
For the Nine Months Ended September 30, 2018 and 2017  
 
Nine Months Ended September 30,
 
2018
 
2017
 
(in thousands)
Cash Flows From Operating Activities
 
 
 
Net income
$
8,160

 
$
6,167

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
480

 
588

Provision for loan losses
775

 
855

Amortization of subordinated debt issuance costs
26

 
24

 Deferred income tax benefit
(111
)
 
(371
)
Net amortization of securities premiums and discounts
597

 
637

Earnings from investment in bank owned life insurance
(395
)
 
(411
)
Proceeds from sale of mortgage loans held for sale
37,904

 
56,620

Origination of mortgage loans held for sale
(37,210
)
 
(53,429
)
Gain on sale of mortgage loans held for sale
(655
)
 
(1,003
)
Gain on sale of loans transferred from held for investment to held for sale
(200
)
 
(177
)
Net realized loss on sale of OREO

 
17

OREO writedown

 
26

Stock-based compensation expense
222

 
202

Proceeds from sale of SBA loans held for sale
3,088

 
9,172

Origination of SBA loans held for sale
(1,086
)
 
(7,088
)
Gain from sale of SBA loans held for sale
(921
)
 
(817
)
    Unrealized loss on CRA Mutual Fund
77

 

    Increase in assets:
 
 
 
    Accrued interest receivable
(428
)
 
(79
)
    Other assets
(922
)
 
(243
)
    Increase (decrease) in liabilities:
 
 
 
   Accrued interest payable
27

 
14

   Other liabilities
1,207

 
1,179

Net Cash Provided by Operating Activities
10,635

 
11,883

Cash Flows From Investing Activities
 
 
 
Purchase of securities available for sale
(4,245
)
 

Purchase of securities held to maturity
(5,035
)
 
(3,295
)
Proceeds from repayments, calls and maturities of securities available for sale
7,148

 
4,431

Proceeds from repayments, calls and maturities of securities held to maturity
5,092

 
3,740

Proceeds from sale of loans transferred from held for investment to held for sale
10,030

 
8,357

Net increase in loans
(60,489
)
 
(71,363
)
Purchases of premises and equipment
(252
)
 
(1,276
)
Purchase of restricted investments, net
(567
)
 
(717
)
Proceeds from sale of OREO

 
216

Net Cash Used In Investing Activities
(48,318
)
 
(59,907
)
Cash Flows From Financing Activities
 
 
 
Net increase in deposits
44,188

 
45,305

Net (decrease) increase in securities sold under agreements to repurchase
(4,967
)
 
2,661

Proceeds from FHLB and other borrowings

 
7,500

Repayment of FHLB and other borrowings
(1,300
)
 
(2,500
)
Cash dividends paid – common stock
(1,238
)
 
(1,034
)
Proceeds from employee stock purchase plan
49

 
52

Proceeds from exercise of stock options
345

 
266

Net Cash Provided by Financing Activities
37,077

 
52,250

Net (Decrease) Increase in Cash and Cash Equivalents
(606
)
 
4,226

Cash and Cash Equivalents – Beginning
48,219

 
42,077

Cash and Cash Equivalents - Ending
$
47,613

 
$
46,303


7



TWO RIVER BANCORP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Continued)
For the Nine Months Ended September 30, 2018 and 2017
 
 
 
 
 
Nine Months Ended September 30,
 
2018
 
2017
 
(in thousands)
Supplementary cash flow information:
 
 
 
Interest paid
$
3,577

 
$
4,148

Income taxes paid
$
3,539

 
$
3,857

Supplemental schedule of non-cash activities:
 
 
 
Other real estate acquired in settlement of loans
$
585

 
$

Transfer of loans held for investment to loans held for sale
$
9,830

 
$
8,180

See notes to the unaudited consolidated financial statements.

8




TWO RIVER BANCORP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
NOTE 1 – BASIS OF PRESENTATION
 
The accompanying unaudited consolidated financial statements include the accounts of Two River Bancorp (the “Company”), a bank holding company, and its wholly-owned subsidiary, Two River Community Bank (“Two River” or the “Bank”); Two River’s wholly-owned subsidiaries, TRCB Investment Corporation and TRCB Holdings Eight LLC. All inter-company balances and transactions have been eliminated in the consolidated financial statements.
 
The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”), including the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for full year financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and are of a normal, recurring nature. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2018 (the “2017 Form 10-K”). For a description of the Company’s significant accounting policies, refer to Note 1 of the Notes to Consolidated Financial Statements in the 2017 Form 10-K.
 
The Company has evaluated events and transactions occurring subsequent to the balance sheet date of September 30, 2018 for items that should potentially be recognized or disclosed in these consolidated financial statements.
 

NOTE 2 – NEW ACCOUNTING STANDARDS
 
ASU 2014-09: In May 2014, the Financial Accounting Standards Board ("FASB") issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), superseding the revenue recognition requirements in ASC 605. This ASU requires an entity to recognize revenue for the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amendment includes a five-step process to assist an entity in achieving the main principle(s) of revenue recognition under ASC 605. In March 2016, the FASB also issued ASU 2016-08, an amendment to the guidance in ASU 2014-09, which reframed the structure of the indicators of when an entity is acting as an agent and focused on evidence that an entity is acting as the principal or agent in a revenue transaction. ASU 2016-08 also eliminated two of the indicators (the entity’s consideration is in the form of a commission, and the entity is not exposed to credit risk) in making that determination. This amendment also clarifies that each indicator may be more or less relevant to the assessment depending on the terms and conditions of the contract. In May 2016, the FASB issued ASU 2016-12, an amendment to ASU 2014-09, which provided practical expedients related to disclosures of remaining performance obligations, as well as other amendments to guidance on transition, collectability, non-cash consideration and presentation of sales and other similar taxes. The amendments, collectively, should be applied retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption (modified retrospective approach).

Because the ASU does not apply to revenue associated with financial instruments (including loans and securities), the Company concluded that the new guidance did not have a material impact on the elements of its consolidated statements of operations most closely associated with financial instruments (such as interest income, interest expense and securities gains). The Company completed its identification of all revenue streams included in its financial statements and has identified its deposit- related fees, service charges, debit and interchange income to be within the scope of the standard. The Company has also completed its review of the related contracts and its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). The Company's overall assessment indicates that adoption of this ASU will not materially change its current method and timing of recognizing revenue for the identified revenue streams. Based on its evaluation, the Company determined that the classification of certain debit card interchange costs should change (i.e. costs previously recorded as expenses are now recorded as contra-revenue). The Company adopted this ASU on January 1, 2018, on a modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Consistent with the modified retrospective approach, the Company did not adjust prior period amounts for the debit card interchange costs noted above. See Note 3, Revenue Recognition,

9

NOTE 2 - NEW ACCOUNTING STANDARDS (Continued)

for more information. The adoption of this ASU, as discussed above, did not have a significant impact to the Company's financial condition, results of operations and consolidated financial statements.
 
ASU 2016-01: In January 2016, the FASB issued ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. In February 2018, the FASB issued ASU 2018-03, Technical Corrections and Improvements to Financial Instruments -- Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities, that clarifies the guidance in ASU 2016-01. ASU 2016-01 requires equity investments to be measured at fair value with changes in fair value recognized in net income; provides for a practicability exception election for equity investments without readily determinable fair values; simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; eliminates the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; requires separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the accompanying notes to the financial statements and clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU 2016-01 is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company completed its evaluation of the provisions of ASU 2016-01 and determined that the CRA Mutual Fund falls under ASU 2016-01. The Company adopted this ASU effective January 1, 2018 and the impact amounted to a cumulative effect adjustment of $39,000, net of tax, as a reclassification from accumulated other comprehensive loss to retained earnings. Additionally, all future unrealized gains and losses will be recognized in the Statements of Operations. As such, for the three and nine months ended September 30, 2018, an unrealized loss of $19,000 and $77,000, respectively, was recorded in Other Income (see Note 6, Securities, for more information). In connection with the adoption of this ASU, the Company elected the practicability exception to fair value measurement for the Solomon Hess SBA Loan Fund, which does not have a readily determinable fair value. Under the practicability exception, the Fund is measured at cost, less impairment, plus or minus observable price changes (in orderly transactions) of identical or similar investment of the same issuer. Additionally, the Company measured the fair value of its loan portfolio as of March 31, 2018 using an exit price notion, as required in ASC 820. The guidance was applied on a prospective approach resulting in prior periods no longer being comparable (see Note 13, Fair Value Measurements).

ASU 2016-02: In February 2016, the FASB issued ASU No. 2016-02, Leases. From the lessee’s perspective, the new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessee. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards, as well as control of the underlying asset, to the lessee. If risks and rewards are conveyed without the transfer of control, the lease is treated as a financing. If the lessor doesn’t convey risks and rewards or control, an operating lease results. The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. A modified retrospective transition approach is required for lessors for sales-type, direct financing, and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company has not adopted the new accounting policy as of the filing date. The Company has yet to make an election on the method of adoption or which practical expedients, if any, will be elected. Our operating leases relate primarily to office space and bank branches. Under current accounting standards, substantially all of the Company’s leases are considered operating leases and, as such, are not recognized on the Company’s Consolidated Balance Sheet. Based on our current lease portfolio, upon adoption of the new accounting standard, we anticipate recognizing a lease liability and related right-of-use asset on our balance sheet. Management is continuing to evaluate the Company’s outstanding inventory of leases and determining the effect of recognizing operating leases on the Consolidated Statements of Financial Condition which is expected to be material. However, the final impact of the standard will depend on the composition of the Company’s leases as of the adoption date.

 

10

NOTE 2 - NEW ACCOUNTING STANDARDS (Continued)

ASU 2016-13: In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326). This ASU requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Entities will now use forward-looking information to better form their credit loss estimates. The ASU also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. For public entities that are SEC filers, this ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. While the Company is currently evaluating the provisions of ASU 2016-13 to determine the potential impact the new standard will have on its consolidated financial statements, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, selecting an outside vendor, gathering pertinent data, and running quarterly update reports to evaluate output.

ASU 2016-15: In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 addresses changes to reduce the presentation diversity of certain cash receipts and cash payments in the statement of cash flows, including debt prepayment or extinguishment costs, settlement of certain debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of insurance claims, and distributions received from equity method investees. The guidance becomes effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, with early adoption permitted. An entity that elects early adoption must adopt all of the amendments in the same period. The new standard will be applied retrospectively, but may be applied prospectively if retrospective application would be impracticable. The Company adopted this ASU and the impact is not material on the financial statements.
 
ASU 2016-18: In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. ASU 2016-18 was issued to address divergence in the way restricted cash is classified and presented. The amendments in the update require that a statement of cash flows explain the change during a reporting period in the total of cash, cash equivalents, and amounts generally described as restricted cash and restricted cash equivalents. The amendments in this update apply to entities that have restricted cash or restricted cash equivalents and are required to present a statement of cash flows under Topic 230. The amendment says that transfers between cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents are not part of the entity's operating, investing, and financing activities. For public business entities, ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company adopted this ASU and the impact is not material on the financial statements.
 
ASU 2017-04: In January 2017, the FASB issued ASU 2017-04, Intangibles—Goodwill and Other (Topic 350). ASU 2017-04 removes Step 2 from the goodwill impairment test. Under the amendments in this update, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The Board also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. For public entities that are SEC filers, this ASU is effective for its annual, or any goodwill impairment tests in fiscal years, beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is currently evaluating the new guidance but has determined that this standard should not have a material impact on its consolidated financial statements.

ASU 2017-09: In May 2017, the FASB issued ASU No. 2017-09, Stock Compensation, Scope of Modification Accounting. This ASU clarifies when changes to the terms of conditions of a share-based payment award must be accounted for as modifications. Companies will apply the modification accounting guidance if the value, vesting conditions or classification of the award changes. The new guidance should reduce diversity in practice and result in fewer changes to the terms of an award being accounted for as modifications, as the guidance will allow companies to make certain non-substantive changes to awards without accounting for them as modifications. It does not change the accounting for modifications. ASU No. 2017-09 is effective for interim and annual reporting periods beginning after December 15, 2017; early adoption is permitted. The Company adopted this ASU and the impact is not material on the financial statements.

ASU 2018-02: In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220) - Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This ASU was issued to address

11

NOTE 2 - NEW ACCOUNTING STANDARDS (Continued)

a narrow-scope financial reporting issue that arose as a result of the enactment of the Tax Cuts and Jobs Act (“Tax Reform”) on December 22, 2017. The objective of ASU 2018-02 is to address the tax effects of items within accumulated other comprehensive income (referred to as “stranded tax effects”) that do not reflect the appropriate tax rate enacted in the Tax Reform. As a result, the ASU 2018-02 allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the newly enacted federal corporate income tax rate. The amount of the reclassification would be the difference between the historical corporate income tax rate of 35 percent and the newly enacted corporate income tax rate of 21 percent. ASU 2018-02 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted, including adoption in an interim period. The amendments in this ASU may be applied retrospectively to each period in which the effect of the change in the U.S. Federal corporate income tax rate in the Tax Reform is recognized. The Company adopted ASU 2018-02 effective January 1, 2018, and the impact amounted to $59,000 as a reclassification from accumulated other comprehensive loss to retained earnings.

ASU 2018-13: In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 includes certain removals, modifications and additions to the disclosure requirements on fair value measurements in Topic 820. The updated guidance is effective for fiscal years and interim periods beginning after December 15, 2019. Early adoption is permitted. The Company is permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until their effective date. The impact on the consolidated financial statements of the Company will depend on the facts and circumstances of any specific future transactions. The Company has elected not to early adopt the additional disclosures required by the ASU until their effective date.


12



NOTE 3 - REVENUE RECOGNITION
On January 1, 2018, the Company adopted ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), and all subsequent ASUs that modified Topic 606. As stated in Note 1, New Accounting Standards, the implementation of the new standard did not have a material impact on the measurement or recognition of revenue; as such, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts were not adjusted and continue to be reported in accordance with our historic accounting under Topic 605.

Topic 606 does not apply to revenue associated with financial instruments, including revenue from loans and securities. In addition, certain non-interest income streams such as fees associated with mortgage servicing rights, financial guarantees, derivatives, and certain credit card fees are also not in scope of the new guidance. Topic 606 is applicable to non-interest revenue streams, such as deposit related fees, interchange fees, merchant income, and brokerage and investment advisory service commissions. However, the recognition of these revenue streams did not change significantly upon adoption of Topic 606. Substantially all of the Company’s revenue is generated from contracts with customers. Non-interest revenue streams in-scope of Topic 606 are discussed below.

Service Fees on Deposit Accounts

Service charges on deposit accounts consist of account analysis fees (i.e., net fees earned on analyzed business and public checking accounts), monthly service fees, check orders, and other deposit account related fees. The Company’s performance obligation for account analysis fees and monthly service fees is generally satisfied, and the related revenue recognized, over the period in which the service is provided. Check orders and other deposit account related fees are largely transactional based, and therefore, the Company’s performance obligation is satisfied, and related revenue recognized, at a point in time. Payment for service charges on deposit accounts is primarily received immediately or in the following month through a direct charge to customers’ accounts.

Other Income

Other non-interest income consists of other recurring revenue streams such as debit card income, credit card income, ATM fees, merchant services income, commissions from sales of mutual funds and other investments provided through a third party brokerage and investment advisory service firm, safe deposit box rental fees, and other miscellaneous revenue streams. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are processed through card payment networks, such as MasterCard. Credit card income is realized through a third party provider who issues credit cards as private label in the Company's name. ATM fees are primarily generated when a non-Company cardholder uses a Company ATM. The income is primarily comprised as a percentage of interchange fees earned whenever the issuer's card is processed through card payment networks, such as Visa and/or American Express. Merchant services income is realized through a third party service provider who is contracted by the Bank under a referral arrangement. Such fees represent fees charged to merchants to process their debit card transactions, in addition to account management fees. Other service charges include revenue from processing wire transfers, cashier’s checks, and other services. The Company’s performance obligation for fees, exchange, and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically received immediately or in the following month. Commissions received from the third party brokerage and investment advisory service firm from the sale of mutual funds and other investments are recognized when the firm has satisfied its performance obligation. The Company also receives periodic service fees (i.e., trailers) from this advisory service firm typically based on a percentage of net asset value. Trailer revenue is recorded over time, usually monthly or quarterly, as net asset value is determined. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

The following presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, three and nine months ended September 30, 2018 and 2017.

13

NOTE 3 - REVENUE RECOGNITION (Continued)

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
 
(Dollars in Thousands)
 
(Dollars in Thousands)
Non-Interest Income
 
 
 
 
 
 
 
In-scope of Topic 606
 
 
 
 
 
 
 
   Service fees on Deposit Accounts
$
236

 
$
224

 
$
713

 
$
535

   Other income
127

 
195

 
405

 
549

Non-Interest Income (in-scope of Topic 606)
363

 
419

 
1,118

 
1,084

Non-Interest Income (out-of-scope of Topic 606)
992

 
1,034

 
3,043

 
3,032

Total Non-Interest Income
$
1,355

 
$
1,453

 
$
4,161

 
$
4,116


Contract Balances

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s non-interest revenue streams are largely based on transactional activity, or standard month-end revenue accruals. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of September 30, 2018 and December 31, 2017, the Company did not have any significant contract balances.

Contract Acquisition Costs

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition cost.

NOTE 4 – GOODWILL

The Company’s goodwill was recognized in connection with the acquisition of The Town Bank (“Town Bank”) in April 2006. GAAP requires that goodwill be tested for impairment annually or more frequently if impairment indicators arise utilizing a two-step methodology. However, a qualitative factor test can be performed to determine whether it is necessary to perform the two-step quantitative impairment test. If this qualitative test determines it is not likely (less than 50% probability) the fair value of the reporting unit is less than book value, then the Company does not have to perform a step one quantitative test and goodwill can be considered not impaired. The Company reviewed the requirements of ASU 350-20 and examples of qualitative assessments to determine whether the weight of evidence indicates greater than 50% likelihood exists that the carrying value of the reporting unit exceeds it's fair value. The nine qualitative assessments used are macroeconomic factors, banking industry conditions, banking industry merger and acquisition trends, bank historical performance, parent stock price, expected bank performance, change of control premium (parent), change of control premium (peer), and other factors.

The Company performed its annual qualitative factor impairment test as of August 31, 2018. Based on the results of this analysis, the Company determined that there was no impairment on the current goodwill balance of $18,109,000.


14


NOTE 5 – EARNINGS PER COMMON SHARE
 
Basic earnings per common share is calculated by dividing net income available to common shareholders by the weighted average number of shares of common stock outstanding excluding restricted stock awards outstanding during the period. Diluted earnings per common share reflects additional shares of common stock that would have been outstanding if dilutive potential shares of common stock had been issued relating to outstanding stock options and restricted stock awards. Potential shares of common stock issuable upon the exercise of stock options are determined using the treasury stock method. All share and per share data have been adjusted to reflect a 5% stock dividend paid on February 28, 2017. 
 
The following table sets forth the computations of basic and diluted earnings per common share:
 
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
 
(In Thousands, Except Per Share Data)
Net income
$
2,834

 
$
2,237

 
$
8,160

 
$
6,167

 
 
 
 
 
 
 
 
Weighted average common shares outstanding – Basic
8,513

 
8,393

 
8,489

 
8,373

Effect of dilutive securities, stock options and restricted stock
187

 
263

 
206

 
274

 
 
 
 
 
 
 
 
Weighted average common shares outstanding – Diluted
8,700

 
8,656

 
8,695

 
8,647

 
 
 
 
 
 
 
 
Basic earnings per common share
$
0.33

 
$
0.27

 
$
0.96

 
$
0.74

 
 
 
 
 
 
 
 
Diluted earnings per common share
$
0.33

 
$
0.26

 
$
0.94

 
$
0.71

 
Dilutive securities in the table above exclude common stock options with exercise prices that exceed the average market price of the Company’s common stock during the periods presented. Inclusion of these common stock options would be anti-dilutive to the diluted earnings per common share calculation. There were no stock options that were anti-dilutive for the three and nine months ended September 30, 2018 and 2017.


15



 NOTE 6 - SECURITIES

The amortized cost, gross unrealized gains and losses, and fair values of the Company’s securities are summarized as follows:
(In Thousands)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
 
 
 
 
September 30, 2018:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
 
U.S. Government agency securities
 
$
12,096

 
$

 
$
(203
)
 
$
11,893

Municipal securities
 
489

 

 
(1
)
 
488

U.S. Government-sponsored enterprises (“GSE”) – residential mortgage-backed securities
 
6,567

 
1

 
(243
)
 
6,325

U.S. Government collateralized residential mortgage obligations
 
4,876

 
2

 
(248
)
 
4,630

 Corporate debt securities, primarily financial institutions
 
1,999

 
6

 
(60
)
 
1,945

 
 
 
 
 
 
 
 
 
Total securities available for sale
 
$
26,027

 
$
9

 
$
(755
)
 
$
25,281

 
 
 
 
 
 
 
 
 
Total equity securities
 
$
2,544

 
$

 
$
(132
)
 
$
2,412

 
 
 
 
 
 
 
 
 
Securities held to maturity:
 
 
 
 
 
 
 
 
Municipal securities
 
$
46,202

 
$
157

 
$
(380
)
 
$
45,979

GSE – Residential mortgage-backed securities
 
7,709

 

 
(325
)
 
7,384

U.S. Government collateralized residential mortgage obligations
 
1,868

 

 
(78
)
 
1,790

Corporate debt securities, primarily financial institutions
 
1,827

 

 
(112
)
 
1,715

 
 
 
 
 
 
 
 
 
Total securities held to maturity
 
$
57,606

 
$
157

 
$
(895
)
 
$
56,868


16


NOTE 6 – SECURITIES (Continued)


(In Thousands)
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair
Value
 
 
 
 
 
 
 
 
 
December 31, 2017:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Securities available for sale:
 
 
 
 
 
 
 
 
U.S. Government agency securities
 
$
10,105

 
$

 
$
(48
)
 
$
10,057

Municipal securities
 
494

 
1

 

 
495

GSE – residential mortgage-backed securities
 
8,362

 

 
(143
)
 
8,219

U.S. Government collateralized residential mortgage obligations
 
7,672

 
1

 
(191
)
 
7,482

Corporate debt securities, primarily financial institutions
 
2,494

 
9

 
(72
)
 
2,431

 
 
 
 
 
 
 
 
 
Total securities available for sale
 
$
29,127

 
$
11

 
$
(454
)
 
$
28,684

 
 
 
 
 
 
 
 
 
Total equity securities
 
$
2,503

 
$

 
$
(55
)
 
$
2,448

 
 
 
 
 
 
 
 
 
Securities held to maturity:
 
 
 
 
 
 
 
 
Municipal securities
 
$
46,614

 
$
812

 
$
(20
)
 
$
47,406

GSE – residential mortgage-backed securities
 
7,339

 

 
(98
)
 
7,241

U.S. Government collateralized residential mortgage obligations
 
2,224

 

 
(46
)
 
2,178

Corporate debt securities, primarily financial institutions
 
1,825

 

 
(101
)
 
1,724

 
 
 
 
 
 
 
 
 
Total securities held to maturity
 
$
58,002

 
$
812

 
$
(265
)
 
$
58,549

 
The amortized cost and fair value of the Company’s debt securities at September 30, 2018, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 
 
 
 
Available for Sale
 
Held to Maturity
 
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
 
 
(In Thousands)
 
 
 
 
 
 
 
 
 
Due in one year or less
 
$
1,255

 
$
1,242

 
$
14,600

 
$
14,616

Due in one year through five years
 
7,579

 
7,509

 
1,772

 
1,790

Due in five years through ten years
 
723

 
707

 
8,087

 
7,999

Due after ten years
 
5,027

 
4,868

 
23,570

 
23,289

 
 
 
 
 
 
 
 
 
Sub-total
 
14,584

 
14,326

 
48,029

 
47,694

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
GSE – residential mortgage-backed securities
 
6,567

 
6,325

 
7,709

 
7,384

U.S. Government collateralized residential mortgage obligations
 
4,876

 
4,630

 
1,868

 
1,790

 
 
 
 
 
 
 
 
 
Total
 
$
26,027


$
25,281

 
$
57,606

 
$
56,868



The Company had no security sales for the three and nine months ended September 30, 2018 or 2017.


17


NOTE 6 – SECURITIES (Continued)


Investment securities with a carrying value of $32.5 million and $34.6 million at September 30, 2018 and December 31, 2017, respectively, were pledged as collateral to secure securities sold under agreements to repurchase and public deposits as required or permitted by law. 
 
The tables below indicate the length of time individual securities have been in a continuous unrealized loss position at September 30, 2018 and December 31, 2017:
 
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
September 30, 2018:
 
(In Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agency securities
 
$
8,653

 
$
(148
)
 
$
3,140

 
$
(55
)
 
$
11,793

 
$
(203
)
Municipal securities
 
21,077

 
(346
)
 
954

 
(35
)
 
22,031

 
(381
)
GSE – residential mortgage-backed securities
 
1,662

 
(34
)
 
11,920

 
(534
)
 
13,582

 
(568
)
U.S. Government collateralized residential mortgage obligations
 
1,361

 
(51
)
 
4,837

 
(275
)
 
6,198

 
(326
)
Corporate debt securities, primarily financial institutions
 
494

 
(5
)
 
2,160

 
(167
)
 
2,654

 
(172
)
Total temporarily impaired securities
 
$
33,247

 
$
(584
)
 
$
23,011

 
$
(1,066
)
 
$
56,258

 
$
(1,650
)
 
 
 
Less than 12 Months
 
12 Months or More
 
Total
 
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
December 31, 2017:
 
(In Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Government agency securities
 
$
8,229

 
$
(46
)
 
$
1,766

 
$
(2
)
 
$
9,995

 
$
(48
)
Municipal securities
 
14,170

 
(20
)
 

 

 
14,170

 
(20
)
GSE – residential mortgage-backed securities
 
6,302

 
(66
)
 
9,123

 
(175
)
 
15,425

 
(241
)
U.S. Government collateralized residential mortgage obligations
 
1,806

 
(20
)
 
7,500

 
(217
)
 
9,306

 
(237
)
Corporate debt securities, primarily financial institutions
 

 

 
2,648

 
(173
)
 
2,648

 
(173
)
Equity securities
 

 

 
2,449

 
(55
)
 
2,449

 
(55
)
Total temporarily impaired securities
 
$
30,507

 
$
(152
)
 
$
23,486

 
$
(622
)
 
$
53,993

 
$
(774
)
 
The Company had 78 securities in an unrealized loss position at September 30, 2018. In management’s opinion, the unrealized losses in corporate debt, U.S. Government agencies, municipals, U.S. Government collateralized residential mortgage obligations and GSE residential mortgage-backed securities reflect changes in interest rates subsequent to the acquisition of specific securities. The unrealized loss for corporate debt securities also reflects a widening of spreads due to the liquidity and credit concerns in the financial markets. The Company may, if conditions warrant, elect to sell debt securities at a loss and redeploy the proceeds into other investments in an effort to improve returns, risk profile and overall portfolio diversification. The Company will recognize any losses when the decision is made. As of September 30, 2018, the Company did not intend to sell these debt securities prior to market recovery.


18


NOTE 6 – SECURITIES (Continued)


Included in corporate debt securities are three individual trust preferred securities issued by large financial institutions with Moody’s ratings from Baa1to Baa2. During the second quarter of 2018, one of our trust preferred securities was called at par value. At September 30, 2018, all of these securities are current with their scheduled interest payments. These single issue securities are all from large money center banks. Management concluded that these securities were not other-than-temporarily impaired as of September 30, 2018. These three securities have an amortized cost value of $2.3 million and a fair value of $2.2 million at September 30, 2018
 
There were no other-than-temporary impairments recognized during the three and nine months ended September 30, 2018 and 2017.

Equity securities consist solely of the Community Reinvestment Act ("CRA") Mutual Fund. As a result of the adoption of ASU 2016-01 in January 2018, the Company determined that the CRA Mutual Fund falls under the provisions of ASU 2016-01and accordingly, this fund was transferred from available for sale and reclassified into equity securities on the balance sheet. These securities are measured at fair value with unrealized holding gains and losses reflected in net income. Effective January 1, 2018, the Company recorded a cumulative effect adjustment of $39,000 as a reclassification from accumulated other comprehensive loss to retained earnings. Additionally as noted above, all future unrealized gains and losses will be recognized in the Statements of Operations. As such, during the three and nine months ended September 30, 2018, an unrealized loss of $19,000 and $77,000 respectively, was recorded in Other Income.


NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES
 
Loans receivable, which management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees or costs. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the yield (interest income) of the related loans. The Company is generally amortizing these amounts over the contractual life of the loan.
 
Loans held for sale are designated at time of origination. They generally consist of newly originated fixed rate residential mortgage loans and salable SBA loans and are recorded at the lower of aggregate cost or estimated fair value in the aggregate. The Company typically retains adjustable-rate mortgages ("ARM") loans in its portfolio, however occasionally, the Company may elect to sell a small pool of these loans as a part of its strategy to manage interest rate risk. During the three months ended September 30, 2018 and 2017, the Company had no transfers from held for investment to held for sale, therefore there were no gains from such sales for the three months ended September 30, 2018 and 2017. For the nine months ended September 30, 2018 and 2017, the Company transferred $9.8 million and $8.2 million, with gains from such sales of $200,000 and $177,000, respectively. Transfers from held for investment occur at the lower of cost or fair value, less costs to sell. Gains are recognized on a settlement-date basis and are determined by the difference between the net sales proceeds and the carrying value of the loans, including any net deferred fees or costs. Depending on the type of loan sold, servicing may or may not be retained.
 
The loans receivable portfolio is segmented into five categories, those being a) Commercial and industrial, b) Real estate-construction (consisting of both residential and commercial construction), c) Real estate-commercial, d) Real estate-residential, and e) Consumer.
 
For all classes of loans receivable, the accrual of interest is discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest previously accrued on these loans is reversed from income. Interest received on nonaccrual loans, including impaired loans, generally is either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time (generally six months) and the ultimate collectability of the total contractual principal and interest is no longer in doubt. The past due status of all classes of loans receivable is determined based on contractual due dates for loan payments.
 
The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated balance sheet, which at September 30, 2018 and December 31, 2017, the Company had no such reserves. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectable are charged against the allowance for loan losses,

19


NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)


and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely.
 
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a monthly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.
  
The allowance consists of specific, general and unallocated components. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of the loan. The specific component relates to loans that are classified as impaired. When a loan is impaired, there are three acceptable methods under ASC 310-10-35 for measuring the impairment:
 
1.
The loan’s observable market price;

2.
The fair value of the underlying collateral; or

3.
The present value (PV) of expected future cash flows.
 
Loans that are considered “collateral-dependent” should be evaluated under the “Fair market value of collateral.” Loans that are still expected to be supported by repayment from the borrower should be evaluated under the “Present value of future cash flows.”
 
For the most part, the Company measures impairment under the “Fair market value of collateral” for any loan that would rely on the value of collateral for recovery in the event of default. The individual impairment analysis for each loan is clearly documented as to the chosen valuation method.

The general component covers pools of loans by loan class including commercial and industrial, real estate-construction and real estate-commercial not considered impaired as well as smaller balance homogeneous loans such as real estate-residential and consumer.
 
These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These qualitative risk factors include: 

1.
Changes in lending policy and procedures, including changes in underwriting standards and collection practices not previously considered in estimating credit losses.
 
2.
Changes in relevant economic and business conditions.

3.
Changes in nature and volume of the loan portfolio and in the terms of loans.

4.
Changes in experience, ability and depth of lending management and staff.

5.
Changes in the volume and severity of past due loans, the volume of non-accrual loans and the volume and severity of adversely classified loans.

6.
Changes in the quality of the loan review system.

7.
Changes in the value of underlying collateral for collateral-dependent loans.

8.
The existence and effect of any concentration of credit and changes in the level of such concentrations.

9.
The effect of other external forces such as competition, legal and regulatory requirements on the level of estimated credit losses in the existing portfolio.
 
Each factor is assigned a risk value to reflect low, moderate or high risk assessments based on management’s best judgment using current market, macro and other relevant information available at the time of the evaluation. Adjustments to the factors are supported through documentation in each factor and accompany the allowance for loan loss calculation.
 

20


NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)


An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
A loan is considered impaired when it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial, real estate-commercial, real estate-construction, real estate-residential and consumer loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
 
An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured based on the estimated fair value of the loan’s collateral.
 
For commercial loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
 
For commercial loans secured by non-real estate collateral, such as accounts receivable, inventory and equipment, estimated fair values are determined based on the borrower’s financial statements, inventory reports, accounts receivable aging or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for commercial loans or when credit deficiencies arise, such as delinquent loan payments, for commercial and consumer loans. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans classified special mention have potential weaknesses that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristics that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectable and are charged to the allowance for loan losses. Loans not classified are rated pass.
 
In addition, federal and state regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.

21


NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)


 
The components of the loan portfolio held for investment at September 30, 2018 and December 31, 2017 are as follows: 
 
 
September 30,
 
December 31,
 
 
2018
 
2017
 
 
(In Thousands)
 
 
 
 
 
Commercial and industrial
 
$
104,118

 
$
101,371

Real estate – construction
 
141,881

 
118,094

Real estate – commercial
 
548,763

 
537,733

Real estate – residential
 
75,973

 
64,238

Consumer
 
30,895

 
30,203

 
 
 
 
 
 
 
901,630

 
851,639

Allowance for loan losses
 
(11,390
)
 
(10,668
)
Net unearned fees
 
(735
)
 
(765
)
 
 
 
 
 
Net Loans
 
$
889,505

 
$
840,206


The performance and credit quality of the loan portfolio is monitored by analyzing the age of the loans receivable as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the past due status as of September 30, 2018 and December 31, 2017:
 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90 Days &
Greater
 
Total Past
Due
 
Current
 
Total Loans
Receivable
 
Loans
Receivable
>90 Days and
Accruing
September 30, 2018:
 
 
 
 
 
(In Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
 
$
87

 
$

 
$
765

 
$
852

 
$
103,266

 
$
104,118

 
$

Real estate – construction
 
3,390

 

 
150

 
3,540

 
138,341

 
141,881

 

Real estate – commercial
 
19

 
147

 
54

 
220

 
548,543

 
548,763

 

Real estate – residential
 

 
286

 
227

 
513

 
75,460

 
75,973

 

Consumer
 
77

 

 
194

 
271

 
30,624

 
30,895

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
3,573

 
$
433

 
$
1,390

 
$
5,396

 
$
896,234

 
$
901,630

 
$


 
 
30-59 Days
Past Due
 
60-89 Days
Past Due
 
90 Days &
Greater
 
Total Past
Due
 
Current
 
Total Loans
Receivable
 
Loans
Receivable
>90 Days and
Accruing
December 31, 2017:
 
 
 
 
 
(In Thousands)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Commercial and industrial
 
$
224

 
$

 
$
790

 
$
1,014

 
$
100,357

 
$
101,371

 
$

Real estate – construction
 

 

 
150

 
150

 
117,944

 
118,094

 

Real estate – commercial
 
146

 
150

 
219

 
515

 
537,218

 
537,733

 

Real estate – residential
 
290

 

 
717

 
1,007

 
63,231

 
64,238

 

Consumer
 
92

 

 
194

 
286

 
29,917

 
30,203

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
$
752

 
$
150

 
$
2,070

 
$
2,972

 
$
848,667

 
$
851,639

 
$



22


NOTE 7 – LOANS RECEIVABLE AND ALLOWANCE FOR LOAN LOSSES (Continued)


The following table presents non-accrual loans by classes of the loan portfolio at September 30, 2018 and December 31, 2017:
 
 
 
September 30,
 
December 31,
 
 
2018
 
2017
 
 
(In Thousands)
 
 
 
 
 
Commercial and industrial
 
$
765

 
$
790

Real estate – construction
 
150

 
150

Real estate – commercial
 
54

 
219

Real estate – residential
 
227

 
717

Consumer
 
194