Toggle SGML Header (+)


Section 1: 10-K (FORM 10-K)

Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the fiscal year 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: 000-54835

 

 

MALVERN BANCORP, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

 

Pennsylvania   45-5307782

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification Number)

42 E. Lancaster Avenue, Paoli, Pennsylvania   19301
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s telephone number, including area code: (610) 644-9400

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

  

Name of each exchange on which registered

Common Stock, $.01 par value per share    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 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 and post such files).    YES  ☒    NO  ☐

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the 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, 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. (Check one):

 

Large accelerated filer      Accelerated filer  
Non-accelerated filer      Smaller reporting company  
     Emerging growth company  

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

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $155.2 million, based on the last sale price on the NASDAQ Stock Market for the last business day of the Registrant’s most recently completed second fiscal quarter.

The number of shares of the Issuer’s common stock, par value $0.01 per share, outstanding as of December 14, 2018 was 7,771,356.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement for the 2019 Annual Meeting of Shareholders are incorporated by reference into Part III, Items 10-14 of this Form 10-K.

 

 

 


Table of Contents

MALVERN BANCORP, INC.

TABLE OF CONTENTS

 

         Page  
PART I      2  
Item 1.  

Business

     2  
Item 1A.  

Risk Factors

     15  
Item 1B.  

Unresolved Staff Comments

     20  
Item 2.  

Properties

     20  
Item 3.  

Legal Proceedings

     20  
Item 4.  

Mine Safety Disclosures

     20  
PART II      20  
Item 5.  

Market for the Registrant’s Common Equity, Related Shareholders’ Matters and Issuer Purchases of Equity Securities

     20  
Item 6.  

Selected Financial Data

     23  
Item 7.  

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

     25  
Item 7A.  

Quantitative and Qualitative Disclosures about Market Risk

     59  
Item 8.  

Financial Statements and Supplementary Data

     60  
Item 9.  

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

     126  
Item 9A  

Controls and Procedures

     126  
Item 9B.  

Other Information

     127  
PART III      127  
Item 10.  

Directors, Executive Officers and Corporate Governance

     127  
Item 11.  

Executive Compensation

     127  
Item 12.  

Security Ownership of Certain Beneficial Owners and Management and Related Shareholders’ Matters

     127  
Item 13.  

Certain Relationships and Related Transactions, and Director Independence

     128  
Item 14.  

Principal Accounting Fees and Services

     128  
PART IV      128  
Item 15.  

Exhibits and Financial Statement Schedules

     128  
Item 16.  

Form 10-K Summary

     130  
SIGNATURES      131  

 

-1-


Table of Contents

Information included in or incorporated by reference in this Annual Report on Form 10-K, other filings with the Securities and Exchange Commission, the Company’s press releases or other public statements, contain or may contain forward looking statements. Please refer to a discussion of the Corporation’s forward looking statements and associated risks in “Item 1 — Business” and “Item 1A — Risk factors” in this Annual Report on Form 10-K.

PART I.

This report, in Item 1, Item 7 and elsewhere, includes forward-looking statements within the meaning of Sections 27A of the Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, that involve inherent risks and uncertainties. This report contains certain forward-looking statements with respect to the financial condition, results of operations, plans, objectives, future performance and business of Malvern Bancorp, Inc. and its subsidiaries, including statements preceded by, followed by or that include words or phrases such as “believes,” “expects,” “anticipates,” “plans,” “trend,” “objective,” “continue,” “remain,” “pattern” or similar expressions or future or conditional verbs such as “will,” “would,” “should,” “could,” “might,” “can,” “may” or similar expressions. There are a number of important factors that could cause future results to differ materially from historical performance and these forward-looking statements. Factors that might cause such a difference include, but are not limited to: (1) competitive pressures among depository institutions may increase significantly; (2) changes in the interest rate environment may reduce interest margins; (3) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions may vary substantially from period to period; (4) general economic conditions may be less favorable than expected; (5) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions may adversely affect the businesses in which Malvern Bancorp, Inc. is engaged; (7) changes and trends in the securities markets may adversely impact Malvern Bancorp, Inc.; (8) difficulties in integrating any businesses that we may acquire, which may increase our expenses and delay the achievement of any benefits that we may expect from such acquisitions; (9) the impact of reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; and (10) the outcome of any regulatory or legal investigations and proceedings may not be anticipated. Further information on other factors that could affect the financial results of Malvern Bancorp, Inc. are included in Item 1A of this Annual Report on Form 10-K and in Malvern Bancorp’s other filings with the Securities and Exchange Commission. These documents are available free of charge at the Commission’s website at http://www.sec.gov and/or from Malvern Bancorp, Inc. Malvern Bancorp, Inc. assumes no obligation to update forward-looking statements at any time.

Item 1. Business

General

Malvern Bancorp, Inc. (the “Company” or “Malvern Bancorp”), a Pennsylvania corporation, is a registered bank holding company under the Bank Holding Company Act of 1956, as amended (the “Holding Company Act”). Malvern Bancorp is the holding company for Malvern Bank, National Association (“Malvern Bank” or the “Bank”), a national bank that was originally organized in 1887 as a federally-chartered savings bank. Malvern Bank now serves as one of the oldest banks headquartered on the Philadelphia Main Line. For more than a century, the Bank has been committed to helping people build prosperous communities as a trusted financial partner, forging lasting relationships through teamwork, respect and integrity. Effective February 12, 2018, the Bank converted from a federal savings bank charter to a national bank charter and Malvern Bancorp converted from a savings and loan holding company to a bank holding company. As previously disclosed in the Company’s Form 8-K filed on October 9, 2018, the Company closed an underwritten public offering of shares of our common stock for gross proceeds of $25.0 million and net proceeds of approximately $23.4 million (after deducting the underwriting discount and other estimated offering expenses).

 

-2-


Table of Contents

The Bank conducts business from its headquarters in Paoli, Pennsylvania, a suburb of Philadelphia, and through its nine other banking locations in Chester, Delaware and Bucks counties, Pennsylvania, Palm Beach, Florida, and Morristown, New Jersey, its New Jersey regional headquarters. The Bank also maintains a representative office in Montchanin, Delaware. The Bank’s primary market niche is providing personalized service to its client base.

The Bank, through its Private Banking division and strategic partnership with Bell Rock Capital in Rehoboth Beach, Delaware, provides personalized wealth management and advisory services to high net worth individuals and families. Those services include banking, liquidity management, investment services, 401(k) accounts and planning, custody, tailored lending, wealth planning, trust and fiduciary services, family wealth advisory services and philanthropic advisory services. The Bank offers insurance services though Malvern Insurance Associates, LLC, which provides clients a rich array of financial services, including commercial and personal insurance and commercial and personal lending.

The Bank’s principal business consists of attracting deposits from businesses and the general public and investing those deposits, together with borrowings and funds generated from operations, in one- to four-family residential real estate loans, construction and development loans, commercial and multi-family real estate loans, commercial business loans, home equity loans and lines of credit and other consumer loans, as well as investing in investment securities. In addition to the Pennsylvania counties referred to above, the Bank also serves client needs in the New Jersey, New York, Delaware, and greater Philadelphia market area.

The Bank’s revenues are derived principally from interest on loans and investment securities, loan commitment and customer service fees and our mortgage banking operation. Our primary sources of funds are deposits, borrowings and principal and interest payments on loans and securities, as well as the sale of residential loans in the secondary market. The Bank’s primary expenses are interest expense on deposits and borrowings, provisions for loan losses and general operating expenses.

The Bank owns 100% of Malvern Insurance Associates, LLC (“Malvern Associates”), a Pennsylvania limited liability company. Malvern Associates is a licensed insurance broker under Pennsylvania and New Jersey law.

The Bank owns a 10% non-controlling interest in Bell Rock Capital, LLC (“Bell Rock”), a Delaware limited liability company and investment advisor registered with the SEC, and headquartered in Rehoboth Beach, Delaware.

Certain mortgage-backed securities of the Bank are held through Delaware statutory trusts, 5% of which are owned by the Bank and 95% of which are owned by Coastal Asset Management Co., a Delaware corporation which is wholly owned by the Bank.

The Bank owns a 3.39% interest in Bankers Settlement Services Capital Region, LLC, a Pennsylvania limited liability company which acts as a title insurance agent or agency.

The Bank has a representative office which is not a branch, in Montchanin, Delaware.

SEC Reports and Corporate Governance

The Company makes its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K and amendments thereto available on its website at ir.malvernbancorp.com without charge as soon as reasonably practicable after filing or furnishing them to the SEC. Also available on the website are the Company’s corporate code of ethics that applies to all of the Company’s employees, including principal officers and directors, and charters for the Audit Committee, Compensation Committee and Nominating Committee.

Additionally, the Company will provide without charge, a copy of its Annual Report on Form 10-K to any shareholder by mail, upon request. Requests should be sent to Malvern Bancorp, Inc., Attention: Shareholder Relations, 42 East Lancaster Avenue, Paoli, Pennsylvania, 19301. Our telephone number is (610) 644-9400.

 

-3-


Table of Contents

Market Area and Competition

The banking business is highly competitive. We face substantial immediate competition and potential future competition both in attracting deposits and in originating loans. We compete with numerous commercial banks, savings banks and savings and loan associations, many of which have assets, capital and lending limits larger than those that we have. Other competitors include money market mutual funds, mortgage bankers, insurance companies, stock brokerage firms, regulated small loan companies, credit unions and issuers of commercial paper and other securities.

Our larger competitors have greater financial resources to finance wide-ranging advertising campaigns.

Additionally, we endeavor to compete for business by providing high quality, personal service to customers, customer access to our decision-makers and competitive interest rates and fees. We seek to hire and retain quality employees who desire greater responsibility than may be available working for a larger employer. Additionally, the local real estate and other business activities of the members of our Board of Directors help us develop business relationships by increasing our profile in our communities.

Products and Services

We derive substantially all of our income from our net interest income (i.e., the difference between the interest we receive on our loans and securities and the interest we pay on deposits and other borrowings). We offer a broad range of deposit and loan products. In addition, to attract the business of consumer and business customers, we also provide a broad array of other banking services. Products and services provided include personal and business checking accounts, retirement accounts, money market accounts, time and savings accounts, credit cards, wire transfers, access to automated teller services, internet banking, ACH origination, telephone banking, and mobile banking by phone. In addition, we offer safe deposit boxes. The Bank also offers remote deposit capture banking for business customers, providing the ability to electronically scan and transmit checks for deposit, reducing time and cost. In addition, the Bank offers mobile remote deposit capture banking for both retail and business customers, providing the convenience to deposit on the go.

Checking account products consist of both retail and business demand deposit products. Retail products include free checking and, for businesses, both interest-bearing accounts, which require a minimum balance, and non-interest-bearing accounts. NOW accounts consist of both retail and business interest-bearing transaction accounts that have minimum balance requirements. Money market accounts consist of products that provide a market rate of interest to depositors but have limited check writing capabilities. Our savings accounts consist of statement type accounts. Time deposits consist of certificates of deposit, including those held in IRA accounts. CDARS/ICS Reciprocal deposits are offered through the Bank’s participation in Promontory Interfinancial Network, LLC. Customers who are FDIC insurance sensitive are able to place large dollar deposits with the Company and the Company uses CDARS to place those funds into certificates of deposit issued by other banks in the Network. This occurs in increments of less than the FDIC insurance limits so that both the principal and interest are eligible for complete FDIC insurance coverage. The FDIC currently considers these funds as brokered deposits.

The Bank, through its partnership with Bell Rock, offers through its wealth management division personalized wealth management and advisory services to high net worth individuals and families. Services provided include liquidity management, investment services, custody, wealth planning, trust and fiduciary services, insurance and 401(k) services.

The Bank, through its wholly-owned subsidiary, Malvern Associates, offers insurance services.

Deposits serve as the primary source of funding for our interest-earning assets, but also generate non-interest revenue through insufficient funds fees, stop payment fees, safe deposit rental fees, card income,

 

-4-


Table of Contents

including credit and debit card interchange fees, gift card fees, and other miscellaneous fees. In addition, the Bank generates additional non-interest revenue associated with residential loan origination and sale, loan servicing, late fees and merchant services.

We offer personal and commercial business loans on a secured and unsecured basis, revolving lines of credit, commercial mortgage loans, and residential mortgages on both primary and secondary residences, home equity loans, bridge loans and other personal purpose loans. However, we are not and have not historically been a participant in the sub-prime lending market.

Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, inventory and equipment, and liens on commercial and residential real estate.

Commercial construction loans are loans to finance the construction of commercial or residential properties secured by first liens on such properties. Commercial real estate loans include loans secured by first liens on completed commercial properties, including multi-family properties, to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Home equity loans and lines of credit include loans secured by first or second liens on residential real estate for primary or secondary residences.

Consumer loans are made to individuals who qualify for auto loans, cash reserve, credit cards and installment loans.

The Bank’s lending policies generally provide for lending inside of our primary market area. However, the Bank will make loans to persons outside of our primary market area when we deem it prudent to do so. In an effort to promote a high degree of asset quality, the Bank focuses primarily upon offering secured loans. However, the Bank does make unsecured loans to borrowers with high net worth and income profiles. The Bank generally requires loan customers to maintain deposit accounts with the Bank. In addition, the Bank generally provides for a minimum required rate of interest in its variable rate loans. We believe that having senior management on-site allows for an enhanced local presence and rapid decision-making that attracts borrowers.

As a national bank, the Bank’s lending limit to any one borrower is 15% of the Bank’s capital and surplus (defined as Tier 1 and Tier 2 capital calculated under the risk-based capital standards applicable to the Bank plus the allowance for loan losses (“ALLL”, “allowance”) not included in the Bank’s Tier 2 capital) for most loans ($21.1 million) and 25% of the Bank’s capital and surplus for loans secured by readily marketable collateral ($35.2 million). At September 30, 2018, the Bank’s largest committed relationship totaled $18.5 million.

Our business model includes using industry best practices for community banks, including personalized service, state-of-the-art technology and extended hours. We believe that this will generate deposit accounts with larger average balances than we might attract otherwise. We also use pricing techniques in our efforts to attract banking relationships having larger than average balances.

Supervision and Regulation

The banking industry is highly regulated. Earnings of the Company are affected by state and federal laws and regulations and by policies of various regulatory authorities. Changes in applicable law or in the policies of various regulatory authorities could affect materially the business and prospects of the Company and the Bank. The following discussion of supervision and regulation is qualified in its entirety by reference to the statutory and regulatory provisions discussed.

 

-5-


Table of Contents

Regulation of Malvern Bancorp, Inc.

Malvern Bancorp is a bank holding company within the meaning of the Holding Company Act. As a bank holding company, Malvern Bancorp is supervised by the Federal Reserve Board (the “FRB”) and is required to file reports with the FRB and provide such additional information as the FRB may require.

The Holding Company Act prohibits Malvern Bancorp, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to subsidiary banks, except that it may, upon application, engage in, and may own shares of companies engaged in, certain businesses found by the FRB to be so closely related to banking “as to be a proper incident thereto.” The Holding Company Act requires prior approval by the FRB of the acquisition by Malvern Bancorp of more than five percent of the voting stock of any other bank. Satisfactory capital ratios, Community Reinvestment Act ratings, and anti-money laundering policies are generally prerequisites to obtaining federal regulatory approval to make acquisitions. The policy of the FRB provides that a bank holding company is expected to act as a source of financial strength to its subsidiary bank and to commit resources to support its subsidiary bank in circumstances in which it might not do so absent that policy. Acquisitions by Malvern Bank require approval of the Office of the Comptroller of the Currency (the “OCC”).

The Holding Company Act does not place territorial restrictions on the activities of non-bank subsidiaries of bank holding companies.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 enables bank holding companies to acquire banks in states other than the bank holding company’s home state and to open branches in other states, subject to certain restrictions. The Dodd-Frank Act, discussed below, authorized interstate de novo branching regardless of state law.

Regulation of Malvern Bank

As a national bank, Malvern Bank is subject to the supervision of, and to regular examination by the OCC. Various laws and the regulations promulgated thereunder applicable to Malvern Bancorp and Malvern Bank impose restrictions and requirements in many areas, including capital requirements, the maintenance of reserves, establishment of new offices, the making of loans and investments, consumer protection, employment practices, bank acquisitions and entry into new types of business. There are various legal limitations, including Sections 23A and 23B of the Federal Reserve Act, which govern the extent to which a bank subsidiary may finance or otherwise supply funds to its holding company or its holding company’s non-bank subsidiaries. Under federal law, no bank subsidiary may, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, its parent or the non-bank subsidiaries of its parent (other than direct subsidiaries of such bank which are not financial subsidiaries) or take their securities as collateral for loans to any borrower. Each bank subsidiary is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.

Capital Requirements

Pursuant to the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), each federal banking agency has promulgated regulations, specifying the levels at which a financial institution would be considered “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized,” and to take certain mandatory and discretionary supervisory actions based on the capital level of the institution.

In July 2013, the FRB and the OCC published final rules establishing a new comprehensive capital framework for U.S. banking organizations, referred to as the Basel III rules. The Basel III rules implement the

 

-6-


Table of Contents

Basel Committee’s December 2010 framework, commonly referred to as Basel III, for strengthening international capital standards as well as certain provisions of the Dodd-Frank Act. Basel III substantially revised the risk-based capital requirements applicable to bank holding companies and depository institutions, including Malvern Bancorp and Malvern Bank. Basel III became effective for us on January 1, 2015 (subject to phase-in periods for certain components).

Basel III (i) introduced a new capital measure called “Common Equity Tier 1,” or CET1, (ii) specified that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) applied most deductions/adjustments to regulatory capital measures to CET1 and not to the other components of capital, thus potentially requiring higher levels of CET1 in order to meet minimum ratios, and (iv) expanded the scope of the reductions/adjustments from capital as compared to existing regulations.

Under Basel III, the minimum capital ratios for Malvern Bancorp and Malvern Bank are as follows:

 

   

4.5 percent CET1 to risk-weighted assets.

 

   

6.0 percent Tier 1 capital (i.e., CET1 plus Additional Tier 1) to risk-weighted assets.

 

   

8.0 percent Total capital (i.e., Tier 1 plus Tier 2) to risk-weighted assets.

 

   

4.0 percent Tier 1 capital to average consolidated assets as reported on consolidated financial statements (known as the “leverage ratio”).

When fully phased in on January 1, 2019, Basel III also requires Malvern Bancorp and Malvern Bank to maintain a 2.5 percent “capital conservation buffer”, composed entirely of CET1, on top of the minimum risk-weighted asset ratios, effectively resulting in minimum ratios of (i) CET1 to risk-weighted assets of at least 7.0 percent, (ii) Tier 1 capital to risk-weighted assets of at least 8.5 percent, and (iii) total capital to risk-weighted assets of at least 10.5 percent. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of (i) CET1 to risk-weighted assets, (ii) Tier 1 capital to risk-weighted assets or (iii) total capital to risk-weighted assets above the respective minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and discretionary bonus payments to executive officers based on the amount of the shortfall. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625 percent level and will increase by 0.625 percent on each subsequent January 1st, until it reaches 2.5 percent on January 1, 2019. As of September 30, 2018, Malvern Bancorp and Malvern Bank were required to maintain a capital conservation buffer of 1.875% percent.

Basel III provides for a number of deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in common equity issued by nonconsolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10 percent of CET1 or all such categories in the aggregate exceed 15 percent of CET1. The deductions and other adjustments to CET1 were being phased in incrementally between January 1, 2015 and January 1, 2018. However, in November 2017, banking regulators announced that the phase in of certain of these adjustments for non-advanced approaches banking organizations, such as Malvern Bank, was frozen.

Under current capital standards, the effects of accumulated other comprehensive income items included in capital are excluded for the purposes of determining regulatory capital ratios. Under Basel III, the effects of certain accumulated other comprehensive items are not excluded; however, non-advanced approaches banking organizations, including Malvern Bancorp and Malvern Bank, were permitted to make a one-time permanent election to continue to exclude these items effective as of January 1, 2015. We made this one-time election in the applicable bank regulatory reports as of March 31, 2015.

With respect to Malvern Bank, Basel III also revised the “prompt corrective action” regulations pursuant to Section 38 of FDICIA, by (i) introducing a CET1 ratio requirement at each capital quality level (other than

 

-7-


Table of Contents

critically undercapitalized); (ii) increasing the minimum Tier 1 capital ratio requirement for each category; and (iii) requiring a leverage ratio of 5 percent to be well-capitalized. The OCC’s regulations implementing these provisions of FDICIA provide that an institution will be classified as “well capitalized” if it (i) has a total risk-based capital ratio of at least 10.0 percent, (ii) has a Tier 1 risk-based capital ratio of at least 8.0 percent, (iii) has a CET1 ratio of at least 6.5 percent, (iv) has a Tier 1 leverage ratio of at least 5.0 percent, and (v) meets certain other requirements. An institution will be classified as “adequately capitalized” if it meets the aforementioned minimum capital ratios under Basel III. An institution will be classified as “undercapitalized” if it (i) has a total risk-based capital ratio of less than 8.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 6.0 percent, (iii) has a CET1 ratio of less than 4.5 percent or (iv) has Tier 1 leverage ratio of less than 4.0 percent. An institution will be classified as “significantly undercapitalized” if it (i) has a total risk-based capital ratio of less than 6.0 percent, (ii) has a Tier 1 risk-based capital ratio of less than 4.0 percent, (iii) has a CET1 ratio of less than 3.0 percent or (iv) has a Tier 1 leverage ratio of less than 3.0 percent. An institution will be classified as “critically undercapitalized” if it has a tangible equity to total assets ratio that is equal to or less than 2.0 percent. An insured depository institution may be deemed to be in a lower capitalization category if it receives an unsatisfactory examination rating. Similar categories apply to bank holding companies. When the capital conservation buffer is fully phased in, the capital ratios applicable to depository institutions under Basel III will exceed the ratios to be considered well-capitalized under the prompt corrective action regulations.

Basel III prescribes a standardized approach for calculating risk-weighted assets that expand the risk-weighting categories from the four Basel I-derived categories (0 percent, 20 percent, 50 percent and 100 percent) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets.

As indicated in the following tables, the capital ratios of Malvern Bank and Malvern Bancorp met all regulatory requirements as of September 30, 2018. In addition, we believe that as of September 30, 2018, Malvern Bancorp and Malvern Bank would meet all capital adequacy requirements under Basel III on a fully phased-in basis if such requirements were currently effective.

Malvern Bank’s capital ratios as of September 30, 2018 are as follows:

 

     Actual     Required for
Capital

Adequacy
Purposes
    To Be Well
Capitalized

Under Prompt
Corrective Action
Provisions
    Excess Over
Well-Capitalized
Provision
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio     Amount      Ratio  
     (Dollars in thousands)  

Tier 1 leverage capital (to adjusted tangible assets)

   $ 131,746        12.71   $ 41,450        4.00   $ 51,812        5.00   $ 79,934        7.71

Common equity Tier 1 (to risk-weighted assets)

   $ 131,746        15.09       39,293        4.50       56,756        6.50       74,990        8.59  

Tier 1 risk-based capital (to risk-weighted assets)

   $ 131,746        15.09       52,390        6.00       69,853        8.00       61,893        7.09  

Total risk-based capital (to risk-weighted assets)

   $ 140,833        16.13       69,853        8.00       87,317        10.00       53,516        6.13  

Failure to meet any of the capital requirements could result in enforcement actions by the regulators, including a capital directive, a cease and desist order, civil money penalties, the establishment of restrictions on the institution’s operations, termination of federal deposit insurance and the appointment of a conservator or receiver.

 

-8-


Table of Contents

Malvern Bancorp’s capital ratios as of September 30, 2018 are as follows:

 

     Actual     Required for
Capital

Adequacy
Purposes
    To Be Well
Capitalized

Under Prompt
Corrective Action
Provisions
    Excess Over
Well-Capitalized
Provision
 
     Amount      Ratio     Amount      Ratio     Amount      Ratio     Amount      Ratio  
     (Dollars in thousands)  

Tier 1 leverage capital (to adjusted tangible assets)

   $ 110,239        10.63   $ 41,491        4.00   $ 51,864        5.00   $ 58,375        5.63

Common equity Tier 1 (to risk-weighted assets)

   $ 110,239        12.62       39,322        4.50       56,799        6.50       53,440        6.12  

Tier 1 risk-based capital (to risk-weighted assets)

   $ 110,239        12.62       52,430        6.00       69,906        8.00       40,333        4.62  

Total risk-based capital (to risk-weighted assets)

   $ 143,787        16.45       69,906        8.00       87,383        10.00       56,404        6.45  

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010

On July 21, 2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act has significantly changed the bank regulatory structure and significantly impacted the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies have been given significant discretion in drafting the implementing rules and regulations. The discussion below generally discusses the material provisions of the Dodd-Frank Act applicable to the Company and the Bank and is not complete or meant to be an exhaustive discussion.

The following aspects of the Dodd-Frank Act are related to the operations of the Bank:

 

   

A new independent consumer financial protection bureau was established within the Federal Reserve Board, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. Financial institutions with assets of $10 billion or less, such as the Bank, are subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws.

 

   

Tier 1 capital treatment for “hybrid” capital items like trust preferred securities was eliminated subject to various grandfathering and transition rules.

 

   

The prohibition on payment of interest on demand deposits was repealed.

 

   

State consumer financial law is preempted only if it would have a discriminatory effect on a national bank, prevents or significantly interferes with the exercise by a national bank of its powers or is preempted by any other federal law. The OCC must make a preemption determination on a case-by-case basis with respect to a particular state law or another state law with substantively equivalent terms.

 

   

Deposit insurance has been permanently increased to $250,000.

 

   

The deposit insurance assessment base calculation equals the depository institution’s total assets minus the sum of its average tangible equity during the assessment period.

 

   

The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent of estimated annual insured deposits or assessment base; however, the Federal Deposit Insurance Corporation (the “FDIC”) was directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion.

 

-9-


Table of Contents

The following aspects of the Dodd-Frank Act are related to the operations of the Company:

 

   

The Federal Deposit Insurance Act was amended to direct federal regulators to require depository institution holding companies to serve as a source of strength for their depository institution subsidiaries.

 

   

Public companies are required to provide their shareholders with a non-binding vote: (i) at least once every three years on the compensation paid to executive officers, and (ii) at least once every six years on whether they should have a “say on pay” vote every one, two or three years.

 

   

A separate, non-binding shareholder vote is required regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments.

 

   

Securities exchanges are required to prohibit brokers from using their own discretion to vote shares not beneficially owned by them for certain “significant” matters, which include votes on the election of directors, executive compensation matters, and any other matter determined to be significant.

 

   

Stock exchanges, which includes The NASDAQ Stock Market, LLC (“NASDAQ”), will be prohibited from listing the securities of any issuer that does not have a policy providing for (i) disclosure of its policy on incentive compensation payable on the basis of financial information reportable under the securities laws, and (ii) the recovery from current or former executive officers, following an accounting restatement triggered by material noncompliance with securities law reporting requirements, of any incentive compensation paid erroneously during the three-year period preceding the date on which the restatement was required that exceeds the amount that would have been paid on the basis of the restated financial information. See “Incentive Compensation” below.

 

   

Disclosure in annual proxy materials will be required concerning the relationship between the executive compensation paid and the financial performance of the issuer.

 

   

Item 402 of Regulation S-K has been amended to require companies to disclose the ratio of the Chief Executive Officer’s annual total compensation to the median annual total compensation of all other employees. This information must be reported for the first time for the first full fiscal year beginning on or after January 1, 2017; accordingly, this information will be included in the Company’s proxy statement for its 2019 annual meeting of shareholders.

Volcker Rule Regulations

Regulations adopted by the federal banking agencies to implement the provisions of the Dodd Frank Act commonly referred to as the Volcker Rule contain prohibitions and restrictions on the ability of financial institution holding companies and their affiliates to engage in proprietary trading and to hold certain interests in, or to have certain relationships with, various types of investment funds, including hedge funds and private equity funds. The Company is in compliance with the various provisions of the Volcker Rule regulations.

Incentive Compensation

The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities with at least $1 billion in total assets, such as Malvern Bancorp and the Bank, that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these agencies must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011 and subsequently proposed revised regulations in May 2016, but the revised regulations have not been finalized. If the revised regulations are adopted in the form proposed, they will impose limitations on the manner in which Malvern Bancorp may structure compensation for its executives and employees.

 

-10-


Table of Contents

In 2010, the FRB, OCC and FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors. These three principles are incorporated into the proposed joint compensation regulations under the Dodd-Frank Act.

The FRB will review, as part of its regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as Malvern Bancorp, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.

Dividend Limitations

Malvern Bancorp is a legal entity separate and distinct from its subsidiaries. Malvern Bancorp’s revenues (on a parent company only basis) result in substantial part from dividends paid by the Bank. The Bank’s dividend payments, without prior regulatory approval, are subject to regulatory limitations. Under the National Bank Act, dividends may be declared only if, after payment thereof, capital would be unimpaired and remaining surplus would equal 100 percent of capital. Moreover, a national bank may declare, in any one year, dividends only in an amount aggregating not more than the sum of its net profits for such year and its retained net profits for the preceding two years. However, declared dividends in excess of net profits in either of the preceding two years can be offset by retained net profits in the third and fourth years preceding the current year when determining the Bank’s dividend limitation. In addition, the bank regulatory agencies have the authority to prohibit the Bank from paying dividends or otherwise supplying funds to Malvern Bancorp if the supervising agency determines that such payment would constitute an unsafe or unsound banking practice.

Loans to Related Parties

Malvern Bank’s authority to extend credit to its directors, executive officers and 10 percent shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of the National Bank Act, Sarbanes-Oxley Act and Regulation O of the FRB thereunder. Among other things, these provisions require that extensions of credit to insiders (i) 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 (ii) 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 the Bank’s Board of Directors. Under the Sarbanes-Oxley Act, Malvern Bancorp and its subsidiaries, other than the Bank under the authority of Regulation O, may not extend or arrange for any personal loans to its directors and executive officers.

Community Reinvestment

Under the Community Reinvestment Act (CRA), as implemented by OCC regulations, a national bank has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of

 

-11-


Table of Contents

its entire community, including low and moderate-income neighborhoods. 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. The CRA requires the OCC, in connection with its examination of a national bank, to assess the association’s record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications by such association. The CRA also requires all institutions to make public disclosure of their CRA ratings. Malvern Bank received an overall “satisfactory” CRA rating in its most recent examination. A bank which does not have a CRA program that is deemed satisfactory by its regulator will be prevented from making acquisitions.

Corporate Governance

The Sarbanes-Oxley Act of 2002 added new legal requirements for public companies affecting corporate governance, accounting and corporate reporting, to increase corporate responsibility and to protect investors. Among other things, the Sarbanes-Oxley Act of 2002:

 

   

required our management to evaluate our disclosure controls and procedures and our internal control over financial reporting, and required our auditors to issue a report on our internal control over financial reporting;

 

   

imposed on our chief executive officer and chief financial officer additional responsibilities with respect to our external financial statements, including certification of financial statements within the Annual Report on Form 10-K and Quarterly Reports on Form 10-Q by the chief executive officer and the chief financial officer;

 

   

established independence requirements for audit committee members and outside auditors;

 

   

created the Public Company Accounting Oversight Board which oversees public accounting firms; and

 

   

increased various criminal penalties for violations of securities laws.

NASDAQ, where Malvern Bancorp’s common stock is listed, has corporate governance listing standards, including rules strengthening director independence requirements for boards, as well as the audit committee and the compensation committee, and requiring the adoption of charters for the nominating, corporate governance, compensation and audit committees.

USA PATRIOT Act

As part of the USA PATRIOT Act, Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (the “Anti Money Laundering Act”). The Anti Money Laundering Act authorizes the Secretary of the U.S. Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to financial institutions such as banks, bank holding companies, broker-dealers and insurance companies. Among its other provisions, the Anti Money Laundering Act requires each financial institution: (i) to establish an anti-money laundering program; (ii) to establish due diligence policies, procedures and controls that are reasonably designed to detect and report instances of money laundering in United States private banking accounts and correspondent accounts maintained for non-United States persons or their representatives; and (iii) to avoid establishing, maintaining, administering, or managing correspondent accounts in the United States for, or on behalf of, a foreign shell bank that does not have a physical presence in any country.

Regulations implementing the due diligence requirements require minimum standards to verify customer identity and maintain accurate records, encourage cooperation among financial institutions, federal banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, prohibit the anonymous use of “concentration accounts,” and require all covered financial institutions to have in place an anti-money laundering compliance program.

 

-12-


Table of Contents

The OCC, along with other banking agencies, have strictly enforced various anti-money laundering and suspicious activity reporting requirements using formal and informal enforcement tools to cause banks to comply with these provisions.

A bank which is issued a formal or informal enforcement requirement with respect to its Anti Money Laundering program will be prevented from making acquisitions.

Insurance of Accounts

The deposits of the Bank are insured to the maximum extent permitted by the Deposit Insurance Fund and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, insured institutions. It also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against national banks, after giving the OCC an opportunity to take such action.

The FDIC’s risk-based premium system provides for quarterly assessments. Each insured institution is placed in one of four risk categories depending on supervisory and capital considerations. Within its risk category, an institution is assigned to an initial base assessment rate which is then adjusted to determine its final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. To implement the Dodd Frank Act, the FDIC amended its deposit insurance regulations (1) to change the assessment base for insurance from domestic deposits to average assets minus average tangible equity and (2) to lower overall assessment rates. The revised assessments rates are between 2.5 to 9 basis points for banks in the lowest risk category and between 30 to 45 basis points for banks in the highest risk category.

In addition, all institutions with deposits insured by the FDIC are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, or FICO, a mixed-ownership government corporation established to recapitalize the predecessor to the Deposit Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2019.

The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances which could result in termination of the Bank’s deposit insurance.

As noted above, the Dodd Frank Act raises the minimum reserve ratio of the Deposit Insurance Fund from 1.15% to 1.35% and requires the FDIC to offset the effect of this increase on insured institutions with assets of less than $10 billion (small institutions). The FDIC has adopted a rule to accomplish this by imposing a surcharge on larger institutions commencing when the reserve ratio reaches 1.15% and ending when it reaches 1.35%. The reserve ratio reached 1.15% on June 30, 2016. Accordingly, surcharges began on July 1, 2016. Small institutions will receive credits for the portion of their regular assessments that contributed to growth in the reserve ratio between 1.15% and 1.35%. The credits will apply for each quarter the reserve ratio is above 1.38%, in amounts as determined by the FDIC.

Federal Home Loan Bank System.

Malvern Bank is a member of the Federal Home Loan Bank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks (“FHLB”). Each FHLB serves as a reserve or central bank for its members within its

 

-13-


Table of Contents

assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. At September 30, 2018, the Bank had $118.0 million of FHLB advances and $150.0 million available on its line of credit with the FHLB.

As a member, the Bank is required to purchase and maintain stock in the FHLB of Pittsburgh in an amount equal to at least 1.0% of its aggregate unpaid residential mortgage loans or similar obligations at the beginning of each year. At September 30, 2018, Malvern Bank had $6.1 million in FHLB stock, which was in compliance with this requirement.

Federal Reserve System. The FRB, requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. Because required reserves must be maintained in the form of vault cash or a noninterest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce an institution’s earning assets. At September 30, 2018, the Bank had met its reserve requirement.

Federal Securities Laws. Malvern Bancorp has registered its common stock with the Securities and Exchange Commission (the “SEC”) under Section 12(b) of the Securities Exchange Act of 1934 (the “Exchange Act”). Accordingly, Malvern Bancorp is subject to the proxy and tender offer rules, insider trading reporting requirements and restrictions, and certain other requirements under the Exchange Act.

Employees

As of September 30, 2018, we had a total of 85 full-time equivalent employees. No employees are represented by a collective bargaining group, and we believe that our relationship with our employees is excellent.

 

-14-


Table of Contents

Item 1A. Risk Factors.

In analyzing whether to make or to continue an investment in our securities, investors should consider, among other factors, the following risk factors.

We are subject to credit risk in connection with our lending activities, and our financial condition and results of operations may be negatively impacted by economic conditions and other factors that adversely affect our borrowers.

Our financial condition and results of operations are affected by the ability of our borrowers to repay their loans, and in a timely manner. Lending money is a significant part of the banking business. Borrowers, however, do not always repay their loans. The risk of non-payment is assessed through our underwriting and loan review procedures based on several factors including credit risks of a particular borrower, changes in economic conditions, the duration of the loan and in the case of a collateralized loan, uncertainties as to the future value of the collateral and other factors. Despite our efforts, we do and will experience loan losses, and our financial condition and results of operations will be adversely affected. Our non-performing assets were approximately $3.1 million at September 30, 2018. Our allowance for loan losses was approximately $9.0 million at September 30, 2018. Our loans between thirty and eighty-nine days delinquent totaled $9.2 million at September 30, 2018.

Our results of operations and financial condition may be adversely affected by changing economic conditions.    

While the economy and real estate market conditions have significantly improved in recent years, a return to a recessionary period could adversely affect our customers in a manner that would adversely affect our results of operations and financial condition. Volatility in the housing markets, real estate values and unemployment levels, and the deterioration of economic conditions in our market area, could affect our customers’ ability to repay loans and adversely affect our results of operations and future growth potential in the following ways:

 

   

Loan delinquencies may increase;

 

   

Problem assets and foreclosures may increase;

 

   

Demand for our products and services may decline;

 

   

The carrying value of our other real estate owned may decline further; and

 

   

Collateral for loans made by us, especially real estate, may continue to decline in value, in turn reducing a customer’s borrowing power, and reducing the value of assets and collateral associated with our loans.

Changes in interest rates could adversely affect our financial condition and results of operation.

Our net income depends primarily upon our net interest income. Net interest income is the difference between interest income earned on loans, investments and other interest-earning assets and the interest expense incurred on deposits and borrowed funds. The level of net interest income is primarily a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-bearing liabilities which, in turn, are impacted by such external factors as the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board of Governors (the “FOMC”), and market interest rates.

Different types of assets and liabilities may react differently, and at different times, to changes in market interest rates. We expect that we will periodically experience gaps in the interest rate sensitivities of our assets and liabilities. That means either our interest-bearing liabilities will be more sensitive to changes in market

 

-15-


Table of Contents

interest rates than our interest-earning assets, or vice versa. When interest-bearing liabilities mature or re-price more quickly than interest-earning assets, an increase in market rates of interest could reduce our net interest income. Likewise, when interest-earning assets mature or re-price more quickly than interest-bearing liabilities, falling interest rates could reduce our net interest income. We are unable to predict changes in market interest rates, which are affected by many factors beyond our control, including inflation, deflation, recession, unemployment, money supply, domestic and international events and changes in the United States and other financial markets.

We also attempt to manage risk from changes in market interest rates, in part, by controlling the mix of interest rate sensitive assets and interest rate sensitive liabilities. However, interest rate risk management techniques are not exact. A rapid increase or decrease in interest rates could adversely affect our results of operations and financial performance.

Our high concentration of commercial real estate loans exposes us to increased lending risk.

As of September 30, 2018, the primary composition of our total loan portfolio was as follows:

 

   

commercial real estate loans of $493.9 million, or 54.2% of total loans;

 

   

construction and development loans of $46.7 million, or 5.1% of total loans;

 

   

commercial and industrial loans of $137.2 million, or 15.1% of total loans;

 

   

residential real estate loans of $197.2 million, or 21.7% of total loans and

 

   

consumer loans of $35.6 million, or 3.9% of total loans

Commercial real estate loans, which comprised 54.2% of our total loan portfolio as of September 30, 2018, expose us to a greater risk of loss than do residential mortgage loans. Commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to residential loans. Consequently, an adverse development with respect to one commercial loan or one credit relationship exposes us to a significantly greater risk of loss compared to an adverse development with respect to one residential mortgage loan. Any significant failure to pay on time by our customers or a significant default by our customers would materially and adversely affect us.

Although the economy in our market area generally, and the real estate market in particular, is improving, we can give you no assurance that it will continue to grow or that the rate of growth will accelerate to historic levels. Many factors could reduce or halt growth in our local economy and real estate market. Accordingly, it may be more difficult for commercial real estate borrowers to repay their loans in a timely manner in the current economic climate, as commercial real estate borrowers’ ability to repay their loans frequently depends on the successful development of their properties. The deterioration of one or a few of our commercial real estate loans could cause a material increase in our level of nonperforming loans, which would result in a loss of revenue from these loans and could result in an increase in the provision for loan and lease losses and/or an increase in charge-offs, all of which could have a material adverse impact on our net income. We also may incur losses on commercial real estate loans due to declines in occupancy rates and rental rates, which may decrease property values and may decrease the likelihood that a borrower may find permanent financing alternatives. Given the continued weaknesses in the commercial real estate market in general, there may be loans where the value of our collateral has been negatively impacted. Any weakening of the commercial real estate market may increase the likelihood of default of these loans, which could negatively impact our loan portfolio’s performance and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, we could incur material losses. Any of these events could increase our costs, require management time and attention, and materially and adversely affect us.

 

-16-


Table of Contents

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

Like all financial institutions, we maintain an allowance for loan losses to provide for loan defaults and nonperformance. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. If our assumptions are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio.

In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities might have a material adverse effect on our financial condition and results of operations.

A new accounting standard will likely require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.

The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for the Company and the Bank for fiscal years beginning after December 15, 2019. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which would likely require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.

Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business and stock price.

Section 404 of the Sarbanes-Oxley Act requires us to evaluate periodically the effectiveness of our internal controls over financial reporting and to include a management report assessing the effectiveness of our internal controls over financial reporting in our Annual Report on Form 10-K. Section 404 also requires our independent registered public accounting firm to report on our internal controls over financial reporting. If we fail to maintain the adequacy of our internal controls, we cannot assure you that we will be able to conclude in the future that we have effective internal controls over financial reporting. If we fail to maintain effective internal controls, we might be subject to sanctions or investigation by regulatory authorities, such as the SEC or NASDAQ. Any such action could adversely affect our financial results and the market price of our common stock and may also result in delayed filings with the SEC.

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

The banking and financial services industry in our market area is highly competitive. We may not be able to compete effectively in our markets, which could adversely affect our results of operations. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems, and consolidation among financial service providers. Larger institutions have greater access to capital markets, with higher lending limits and a broader array of services. Competition may require increases in deposit rates and decreases in loan rates, and adversely impact our net interest margin.

We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.

We are subject to extensive regulation, supervision and examination by the FRB, our primary federal regulator, the OCC, the Bank’s primary federal regulator, and by the FDIC, as insurer of the Bank’s deposits.

 

-17-


Table of Contents

Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.

The fair value of our investment securities can fluctuate due to market conditions outside of our control.

As of September 30, 2018, the fair value of our investment securities portfolio was approximately $54.4 million. We have historically taken a conservative investment strategy, with concentrations of securities that are backed by government sponsored enterprises. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could have a material adverse effect on us. The process for determining whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security.

Our growth-oriented business strategy could be adversely affected if we are not able to attract and retain skilled employees or if we lose the services of our senior management team.

Our ability to manage growth will depend upon our ability to continue to attract, hire and retain skilled employees. The loss of members of our senior management team, including those officers named in the summary compensation table of our proxy statement, could have a material adverse effect on our results of operations and ability to execute our strategic goals. Our success will also depend on the ability of our officers and key employees to continue to implement and improve our operational and other systems, to manage multiple, concurrent customer relationships and to hire, train and manage our employees.

We are dependent on our information technology and telecommunications systems and third-party servicers, and cyber-attacks, systems failures, interruptions or breaches of security could have a material adverse effect on us.

Information technology systems are critical to our business. We use various technology systems to manage our customer relationships, general ledger, securities, deposits, and loans. We have established policies and procedures to prevent or limit the impact of system failures, interruptions, and security breaches (including privacy breaches), but such events may still occur and may not be adequately addressed if they do occur. In addition any compromise of our systems could deter customers from using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission of data, these precautions may not protect our systems from compromises or breaches of security.

In addition, we outsource a majority of our data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.

The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and business thereby subjecting us to additional regulatory scrutiny, or could expose

 

-18-


Table of Contents

us to litigation and possible financial liability. Furthermore, we may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures arising from operational and security risks. Any of these events could have a material adverse effect on our financial condition and results of operations.

The effects of the Tax Cuts and Jobs Act on our business have not yet been fully analyzed and could have an adverse effect on our net income.

On December 22, 2017, the Tax Cuts and Jobs Act (the “Tax Act”) was signed into law. As a result of the Tax Act, during the first quarter of fiscal 2018, the Company revised its estimated annual effective rate to reflect a change in the federal statutory rate from 34% to 21%. The rate change was administratively effective at the beginning of our fiscal year, using a blended rate for the annual period. As a result, the blended statutory tax rate for the 2018 fiscal year is 24.25%. Net deferred income taxes decreased $3.5 million to $3.2 million at September 30, 2018 compared to $6.7 million at September 30, 2017.

The Company recorded $4.3 million in income tax expense in fiscal 2018 compared to $2.9 million in income tax expense in fiscal 2017. Included in the income tax expense for the current fiscal year is a provisional amount of $2.0 million related to adjusting our deferred tax balance to reflect the new corporate tax rate. The effective tax rates for the Company for the years ended September 30, 2018 and 2017 were 36.9 percent and 33.4 percent, respectively.

Given the significant changes resulting from and complexities associated with the Tax Act, the financial impacts are provisional and subject to further analysis, interpretation and clarification of the Tax Act, which could result in changes to these estimates during fiscal 2019.

Recent New Jersey legislative changes may increase our tax expense.

In connection with adopting the 2019 fiscal year budget, the New Jersey legislature adopted, and the Governor signed, legislation that imposes a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and of 1.5% for tax years beginning on or after January 1, 2020 through December 31, 2021. The legislation also requires combined filing for members of an affiliated group for tax privilege periods ending on or after July 31, 2019, changing New Jersey’s current status as a separate return state, and limits the deductibility of dividends received. These changes are not temporary. Regulations implementing the legislative changes have not yet been issued, and the Company cannot yet fully evaluate the impact of the legislation on overall tax expense or the valuation of the deferred tax asset. It is likely that the Company will lose benefits of various tax management strategies, and as a result, the total tax expense will increase.

Our ability to pay cash dividends is limited, and we may be unable to pay future dividends even if we desire to do so.

We are a legal entity separate and distinct from our banking and other subsidiaries. Our principal source of cash flow, including cash flow to pay dividends to our shareholders if we desire to do so in the future, and to pay the principal of and interest on our outstanding debt, is dividends from the Bank. There are various regulations that limit the Bank’s ability to pay dividends to us, and our ability to pay dividends to shareholders. In particular, the prior approval of the FRB and OCC may be required in certain circumstances prior to the payment of dividends by us or the Bank. There can be no assurances that we would receive such approval, if it were required.

In addition, the OCC has the authority to prohibit a national bank from paying dividends if such payment is deemed to be an unsafe or unsound practice. The FRB and the FDIC also have the authority to prohibit or to limit the payment of dividends by a banking organization under its jurisdiction if, in the regulator’s opinion, the organization is engaged in or is about to engage in an unsafe or unsound practice. Depending on the financial condition of the Bank, we may be deemed to be engaged in an unsafe or unsound practice if the Bank were to pay dividends.

 

-19-


Table of Contents

Payment of dividends could also be subject to regulatory limitations if the Bank became “under-capitalized” for purposes of the “prompt corrective action” regulations of the federal bank regulatory agencies.

No assurances can be given that the Bank will, in any particular circumstances, pay dividends to us. If the Bank fails to make dividend payments to us, and sufficient cash or liquidity is not otherwise available, we may not be able to make principal and interest payments on our outstanding debt, or dividend payments on our common stock even if we desire to pay cash dividends in the future.

Item 1B. Unresolved Staff Comments.

Not applicable.

Item 2. Properties.

At September 30, 2018, the Bank owns and maintains the premises in which the headquarters and six full-service financial centers are located, and leases a financial center in Glen Mills, Pennsylvania and in Villanova, Pennsylvania and private banking offices in Morristown, New Jersey and Palm Beach, Florida. The Bank also leases a representative office in Montchanin, Delaware. The location of each of the offices is as follows:

 

Paoli Headquarters    42 East Lancaster Avenue, Paoli, PA 19301
Paoli Financial Center    34 East Lancaster Avenue, Paoli, PA 19301
Malvern Financial Center    100 West King Street, Malvern, PA 19355
Coventry Financial Center    1000 Ridge Road, Pottstown, PA 19465
Berwyn Financial Center    650 Lancaster Avenue, Berwyn, PA 19312
Lionville Financial Center    537 West Uwchlan Avenue, Downingtown, PA 19335
Glen Mills Financial Center    940 Baltimore Pike, Glen Mills, PA 19342
Palm Beach Private Banking Office    205 Worth Avenue, Suite 308, Palm Beach, Florida 33480
Villanova Private Banking Office    801 East Lancaster Avenue, Villanova, PA 19085

Morristown Private Banking Office

Montchanin Representative Office

  

163 Madison Avenue, 3rd Floor, Morristown, NJ 07960

16 W. Rockland Road, Montchanin, Delaware 19710

Item 3. Legal Proceedings.

The Company and its subsidiaries are subject to various legal actions arising in the normal course of business. In the opinion of management, the resolution of these legal actions is not expected to have a material adverse effect on the Company’s financial condition or results of operations.

Item 4. Mine Safety Disclosures.

Not Applicable.

PART II.

Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

The common stock of the Company is traded on the NASDAQ Global Select Market under the symbol “MLVF”. As of September 30, 2018, the Company had 405 stockholders of record, not including the number of persons or entities whose stock is held in nominee or “street” name through various brokerage firms and banks. On September 28, 2018, the closing sale price was $23.95.

 

-20-


Table of Contents

The following table sets forth the high and low closing sales price of a share of the Company’s common stock for the years ended September 30, 2018 and 2017.

 

     Year Ended September 30,  
     2018      2017  
     High      Low      High      Low  

First Quarter

   $ 28.20      $ 24.75      $ 21.25      $ 16.36  

Second Quarter

   $ 26.83      $ 21.00      $ 22.00      $ 19.35  

Third Quarter

   $ 27.25      $ 23.57      $ 24.60      $ 21.10  

Fourth Quarter

   $ 25.65      $ 22.78      $ 26.95      $ 22.50  

For the years ended September 30, 2018 and 2017, no cash dividends per share of common stock were declared by the Company.

 

-21-


Table of Contents

Stockholders Return Comparison

Set forth below is a line graph presentation comparing the cumulative stockholder return on the Company’s common stock, on a dividend reinvested basis, against the cumulative total returns of the Standard & Poor’s Composite, the SNL Mid-Atlantic Bank Index and the SNL Mid-Atlantic Thrift Index for the period from October 1, 2013 through September 30, 2018. Effective February 12, 2018, the bank converted from a federal savings bank charter to a national bank charter.

Malvern Bancorp, Inc.

 

 

LOGO

 

     Period Ending                       

Index

  

09/30/13

    

09/30/14

    

09/30/15

    

09/30/16

    

09/30/17

    

09/30/18

 

Malvern Bancorp, Inc.

     100.00        89.40        122.84        128.73        209.97        187.99  

S&P 500 Index

     100.00        119.73        119.00        137.36        162.92        192.10  

SNL Mid-Atlantic U.S. Bank Index

     100.00        114.66        117.45        124.02        181.73        198.92  

SNL Mid-Atlantic U.S. Thrift Index

     100.00        110.63        129.84        130.06        151.39        145.83  

 

-22-


Table of Contents

Item 6. Selected Financial Data.

The following tables set forth selected consolidated financial data as of the dates and for the periods presented. The selected consolidated statement of financial condition data as of September 30, 2018 and 2017 and the selected consolidated summary of operating data for the years ended September 30, 2018, 2017 and 2016 have been derived from our audited consolidated financial statements and related notes that we have included elsewhere in this Annual Report. The selected consolidated statement of financial condition data as of September 30, 2016, 2015 and 2014 and the selected consolidated summary of operating data for the years ended September 30, 2015 and 2014 have been derived from audited consolidated financial statements that are not presented in this Annual Report.

The selected historical consolidated financial data as of any date and for any period are not necessarily indicative of the results that may be achieved as of any future date or for any future period. You should read the following selected statistical and financial data in conjunction with the more detailed information contained in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes that we have presented elsewhere in this Annual Report.

 

    At September 30,  
    2018     2017     2016     2015     2014  
    (Dollars in thousands)  

Summary of Operating Data:

         

Total interest and dividend income

  $ 40,030     $ 33,782     $ 25,244     $ 20,462     $ 20,167  

Total interest expense

    12,995       9,446       6,732       5,248       5,071  

Net interest income

    27,035       24,336       18,512       15,214       15,096  

Provision for loan losses

    954       2,791       947       90       263  

Net interest income after provision for loan losses

    26,081       21,545       17,565       15,124       14,833  

Total other income

    3,304       2,341       2,333       2,535       2,155  

Total other expenses

    17,803       15,147       13,922       13,961       16,644  

Income tax expense (benefit)

    4,276       2,922       (6,174     (970     (367

Net income

  $ 7,306     $ 5,817     $ 12,150     $ 4,668     $ 711  

Earnings per share

  $ 1.13     $ 0.90     $ 1.90     $ 0.73     $ 0.11  

Statement of Financial Condition Data

         

Securities available for sale

  $ 24,298     $ 14,587     $ 66,387     $ 128,354     $ 100,943  

Securities held to maturity

    30,092       34,915       40,551       57,221       —    

Loans receivable, net

    902,136       834,331       574,160       391,307       386,074  

Total assets

    1,033,951       1,046,012       821,272       655,690       542,264  

Deposits

    774,163       790,396       602,046       465,522       412,953  

FHLB borrowings

    118,000       118,000       118,000       103,000       48,000  

Other short-term borrowing

    2,500       5,000       —         —         —    

Shareholders’ equity

    110,823       102,520       96,157       82,749       77,160  

Allowance for loan losses

    9,021       8,405       5,434       4,667       4,589  

Non-accrual loans in portfolio

    2,687       1,038       1,617       1,399       2,391  

Non-performing assets in portfolio

    3,061       1,211       2,313       2,567       4,355  

Performing troubled debt restructurings in portfolio

    18,640       2,238       2,039       1,091       1,009  

Non-performing assets and performing troubled debt restructurings in portfolio

    21,701       3,449       4,352       3,658       5,364  

 

-23-


Table of Contents
    At September 30,  
    2018     2017     2016     2015     2014  
    (Dollars in thousands)  

Performance Ratios:

         

Return on average assets

    0.69     0.62     1.61     0.75     0.12

Return on average equity

    6.88       5.93       14.07       5.79       0.94  

Interest rate spread(1)

    2.48       2.57       2.53       2.48       2.59  

Net interest margin(2)

    2.66       2.72       2.65       2.62       2.74  

Non-interest expenses to average total assets

    1.69       1.62       1.85       2.25       2.84  

Efficiency ratio(3)

    57.88       56.82       67.22       76.48       96.63  

Asset Quality Ratios:

         

Non-accrual loans as a percent of gross loans

    0.30       0.12       0.28       0.35       0.62  

Non-performing assets as a percent of total assets

    0.30       0.12       0.28       0.39       0.80  

Non-performing assets and performing troubled debt restructurings as a percent of total assets

    2.10       0.33       0.53       0.56       0.99  

Allowance for loan losses as a percent of gross loans

    0.99       1.00       0.94       1.18       1.18  

Allowance for loan losses as a percent of non-performing loans

    293.65       694.04       234.93       333.60       191.93  

Net (recovery) charge-offs to average loans outstanding

    0.04       (0.02     0.04       —         0.19  

Capital Ratios(4):

         

Total risk-based capital to risk weighted assets

    16.13       15.78       15.42       17.30       20.87  

Tier 1 risk-based capital to risk weighted assets

    15.09       14.75       14.50       16.21       19.62  

Tangible capital to tangible assets

    N/A       N/A       N/A       N/A       12.17  

Tier 1 leverage (core) capital to adjustable tangible assets

    12.71       12.02       10.98       11.01       12.17  

Shareholders’ equity to total assets

    10.72       9.80       11.71       12.62       14.23  

 

(1)

Represents the difference between the weighted average yield on interest earning assets and the weighted average cost of interest bearing liabilities.

(2)

Net interest income divided by average interest earning assets.

(3)

Efficiency ratio, which is a non-GAAP financial measure, is computed by dividing other expense, less non-core items, by net interest income on a tax equivalent basis plus other income, excluding net securities gains (losses). Included in non-core items are costs which include expenses related to the Company’s corporate restructuring initiatives. The Company believes these adjustments are necessary to provide the most accurate measure of core operating results as a means to evaluate comparative results. See table below for the calculation of the efficiency ratio.

(4)

Other than shareholders’ equity to total assets, all capital ratios are for the Bank only.

The following table presents the calculation of efficiency ratio.

 

     At September 30,  
     2018     2017     2016     2015     2014  
     (Dollars in thousands)  

Other expense

   $ 17,803     $ 15,147     $ 13,922     $ 13,961     $ 16,644  

Less: non-core items

     844       159       111       639       —    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other expense, excluding non-core items

     16,959       14,988       13,811       13,322       16,644  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (tax-equivalent basis)

     27,183       24,498       18,777       15,400       15,152  

Other income, excluding net investment securities gains and gains on sale of real estate (Non-GAAP)

     2,118       1,878       1,768       2,020       2,072  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     29,301       26,376       20,545       17,420       17,224  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Efficiency ratio (Non-GAAP)

     57.88     56.82     67.22     76.48     96.63

 

-24-


Table of Contents

Item 7. Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations.

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Company’s results of operations for each of the past three years and financial condition for each of the past two years. To fully appreciate this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing under Item 8 of this report, and statistical data presented in this document.

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

See the first page of this Annual Report on Form 10-K for information regarding forward-looking statements.

Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 2 to our audited consolidated financial statements contains a summary of our significant accounting policies. Management believes our policy with respect to the methodology for the determination of the allowance for loan losses involves more complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and our Board of Directors.

Allowance for Loan Losses

The allowance for loan losses represents management’s estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses on pools of homogeneous loans based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan portfolio also represents the largest asset type on the Company’s Consolidated Statements of Financial Condition.

The evaluation of the adequacy of the allowance for loan losses includes, among other factors, an analysis of historical loss rates by loan category applied to current loan totals and qualitative factors. However, actual loan losses may be higher or lower than historical trends, which vary. Actual losses on specified problem loans, which also are provided for in the evaluation, may vary from estimated loss percentages, which are established based upon a limited number of potential loss classifications. The allowance for loan losses is established through a provision for loan losses charged to expense. Management believes that the current allowance for loan losses will be adequate to absorb loan losses on existing loans that may become uncollectible based on the evaluation of known and inherent risks in the loan portfolio. The evaluation takes into consideration such factors as changes in the nature and size of the portfolio, overall portfolio quality, and specific problem loans and current economic conditions which may affect our borrowers’ ability to pay.

The evaluation also details historical losses by loan category and the resulting loan loss rates which are projected for current loan total amounts. Loss estimates for specified problem loans are also detailed. In addition, OCC, as an integral part of their examination process, periodically review our allowance for loan losses. The OCC may require us to make additional provisions for loan losses based upon information available to them at

 

-25-


Table of Contents

the time of their examination. All of the factors considered in the analysis of the adequacy of the allowance for loan losses may be subject to change. To the extent actual outcomes differ from management estimates, additional provisions for loan losses may be required that could materially adversely impact earnings in future periods.

Qualitative or environmental factors that may result in further adjustments to the quantitative analyses include items such as changes in lending policies and procedures, economic and business conditions, nature and volume of the portfolio, changes in delinquency, concentration of credit trends, and value of underlying collateral. The total net adjustments due to all qualitative factors increased the allowance for loan losses by approximately $6.2 million and $4.6 million at September 30, 2018 and September 30, 2017, respectively.

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.

Other Real Estate Owned

Assets acquired through foreclosure consist of other real estate owned and financial assets acquired from debtors. Other real estate owned is carried at the lower of cost or fair value, less estimated selling costs. The fair value of other real estate owned is determined using current market appraisals obtained from approved independent appraisers, agreements of sale, and comparable market analysis from real estate brokers, where applicable. Changes in the fair value of assets acquired through foreclosure at future reporting dates or at the time of disposition will result in an adjustment in assets acquired through foreclosure expense or net gain (loss) on sale of assets acquired through foreclosure, respectively.

Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Investment and mortgage-backed securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.

Under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements, the Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

   

Level 1 — Valuation is based upon quoted prices for identical instruments traded in active markets.

 

   

Level 2 — Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

 

   

Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset.

Under FASB ASC Topic 820, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820.

 

-26-


Table of Contents

Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon the Company’s or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future valuations. At September 30, 2018, the Company had $15.6 million of assets that were measured at fair value on a non-recurring basis using Level 3 measurements.

Income Taxes

We make estimates and judgments to calculate some of our tax liabilities and determine the recoverability of some of our deferred tax assets (“DTAs”), which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. Historically, our estimates and judgments to calculate our deferred tax accounts have not required significant revision to our initial estimates.

In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, we make assumptions for taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.

Realization of a deferred tax asset requires us to exercise significant judgment and is inherently uncertain because it requires the prediction of future occurrences. Our net deferred tax asset amounted to $3.2 million and $6.7 million at September 30, 2018 and at September 30, 2017, respectively. As a result of the previously disclosed enactment of the Tax Act, our total deferred tax assets decreased to $3.7 million at September 30, 2018 compared to $7.0 million at September 30, 2017. In accordance with ASC Topic 740, the Company evaluates on a quarterly basis, all evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance for DTAs is needed. In conducting this evaluation, management explores all possible sources of taxable income available under existing tax laws to realize the net deferred tax asset beginning with the most objectively verifiable evidence first, including available carry back claims and viable tax planning strategies. If needed, management will look to future taxable income as a potential source. Management reviews the Company’s current financial position and its results of operations for the current and preceding years. That historical information is supplemented by all currently available information about future years. The Company understands that projections about future performance are subjective. The Company did not have a DTA valuation allowance as of September 30, 2018 and September 30, 2017.

Due to the improvement in the Company’s earnings performance, both on a book (“GAAP”) and taxable income basis, the Company achieved five consecutive fiscal years of positive book (“GAAP”) income for the fiscal year ended September 30, 2018.

Other-Than-Temporary Impairment of Securities

Securities are evaluated on a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether declines in their value are other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the

 

-27-


Table of Contents

magnitude and duration of the decline and whether management intends to sell or expects that it is more likely than not that it will be required to sell the security prior to an anticipated recovery of the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.

Derivatives

The Company enters derivative financial instruments to manage exposures that arise from business activities that result in the payment of future uncertain cash amounts, the value of which are determined by interest rates. The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. The Company primarily uses interest rate swaps as part of its interest rate risk management strategy.

Interest rate swaps are valued by a third party, using models that primarily use market observable inputs, such as yield curves, and are validated by comparison with valuations provided by the respective counterparties. The credit risk associated with derivative financial instruments that are subject to master netting agreements is measured on a net basis by counterparty portfolio. The significant assumptions used in the models, which include assumptions for interest rates, are independently verified against observable market data where possible. Where observable market data is not available, the estimate of fair value becomes more subjective and involves a high degree of judgment. In this circumstance, fair value is estimated based on management’s judgment regarding the value that market participants would assign to the asset or liability. This valuation process takes into consideration factors such as market illiquidity. Imprecision in estimating these factors can impact the amount recorded on the balance sheet for an asset or liability with related impacts to earnings or other comprehensive income.

Overview and Strategy

Our business strategy is to operate as a well-capitalized and profitable financial institution dedicated to providing exceptional personal service to our individual and business customers. Highlights of our business strategy are discussed below:

Improving Core Earnings. With interest rates steadily increasing and the FRB signaling additional interest rate hikes, the Bank is focusing on pricing its loan growth at floating rates or rate resets within 5 years. This focus throughout fiscal year-end 2018, partially impacted by higher deposit betas and borrowing costs, have allowed for an expansion in the Banks’ net interest margin. In an effort to continue consistent sustainable earnings, i.e. improve the net interest margin, we are implementing specific product and pricing strategies designed to increase the yield on loans and control the cost of funding. We are focused on increasing our core deposits, which we define as all deposit accounts other than certificates of deposit. At September 30, 2018, our core deposits amounted to 69.9% of total deposits ($541.2 million), compared to 65.6% of total deposits ($518.6 million) at September 30, 2017. We have continued our promotional efforts to increase core deposits. We review our deposit products on an ongoing basis and we are considering additional deposit products and are currently offering more flexible delivery options, such as mobile banking, as part of our efforts to increase core

 

-28-


Table of Contents

deposits. We expect to increase our commercial checking and business accounts and we plan to enhance our cross-marketing as part of our efforts to gain additional deposit relationships with our loan customers and private banking clients.

Maintain Low Levels of Problem Assets. We are continuing our efforts to maintain low levels of problem assets. At September 30, 2018, our total non-performing assets in portfolio were $3.1 million or 0.30% of total assets, reflecting a reduction of $1.3 million, or 29.5%, compared to $4.4 million of total non-performing assets at September 30, 2014 (when total non-performing assets amounted to 0.80% of total assets).

Growing Our Loan Portfolio and Resuming Commercial Real Estate and Construction and Development Lending. While commercial real estate loans and construction and development loans were the primary component of the portfolio in fiscal 2018, the Bank is focused on diversification of the mix moving into our fiscal 2019 year. That diversification will include owner occupied, C&I and 1-4 family loans. These loans are being underwritten in accordance with our strengthened loan underwriting standards and our enhanced credit review and administration procedures. With the continued improvements in economic conditions and real estate values, we believe that the continued lending strategy in a planned, deliberative fashion with the loan underwriting and administrative enhancements that we have implemented in recent periods, will increase our interest income and our returns in future periods.

Increasing Market Share Penetration. The Company continued to move forward with momentum in expanding our presence in key markets in fiscal 2018. We continue to execute on our business plans and are positioning the Company to take advantage of the growth activity we are achieving in our markets, which included our new representative office in Montchanin, Delaware. With the recent entry into Florida and Delaware markets, we are working to solidify and expand the service relationship with our new and existing customers. We remain excited by the potential to create incremental shareholder value from our strategic growth. We believe that our earnings performance demonstrates the Company’s commitment to achieving meaningful growth, an essential component of providing consistent and favorable long-term returns to our shareholders. However, while we continue to see an improvement in balance sheet strength and core earnings performance, we remain cautious about the credit stability of the broader markets. We operate in a competitive market area for banking products and services. In recent years, we have been working to increase our deposit share in Chester and Delaware counties and we increased our marketing and promotional efforts. In our effort to increase market share as well as non-interest income, we plan to evaluate increasing our business in non-traditional products, such as wealth management and insurance services.

Continuing to Provide Exceptional Customer Service. As a community-oriented bank, we take pride in providing exceptional customer service as a means to attract and retain customers. We deliver personalized service to our customers that distinguish us from the large regional banks operating in our market area. Our management team has strong ties to and deep roots in, the local community. We believe that we know our customers’ banking needs and can respond quickly to address them.

Introduction

The following sections discuss the Company’s Results of Operations, Asset and Liability Management, Liquidity and Capital Resources.

Results of Operations

Net income for the year ended September 30, 2018 was $7.3 million as compared to $5.8 million earned in fiscal 2017 and $12.2 million earned in fiscal 2016. Our net income for fiscal 2018 increased by 25.6 percent compared to fiscal 2017. For fiscal 2018, the fully diluted earnings per common share was $1.13 as compared with $0.90 per share in fiscal 2017 and $1.90 per share in fiscal 2016. Net income prior to income tax expense was $11.6 million for 2018 and $8.7 million for 2017, an increase of $2.8 million or 32.5%.

 

-29-


Table of Contents

For the year ended September 30, 2018, the Company’s return on average shareholders’ equity (‘‘ROE’’) was 6.88 percent and its return on average assets (‘‘ROA’’) was 0.69 percent. The comparable ratios for the year ended September 30, 2017 were ROE of 5.93 percent and ROA of 0.62 percent.

Earnings for fiscal 2018 benefitted from an increase in net interest income, as well as an increase in non-interest income. The increase in non-interest income was primarily a result of an increase in service charges and other fees, rental income, and a net gain on the sale of real estate, which were partially offset by a decrease in net gain on sale of investments, earnings on bank owned life insurance and net gain on sale of loans. The increase in non-interest expenses was due to increases in salaries and benefits, occupancy expenses, FDIC insurance, professional fees and other operating expenses. The increase was offset by decreases in advertising expenses, and data processing expense.

Use of Non-GAAP Disclosures

Reported amounts are presented in accordance with U.S. GAAP. The Company’s management believes that the supplemental non-GAAP information contained herein, including the efficiency ratio, are utilized by regulators and market analysts to evaluate a company’s financial condition and therefore, such information is useful to investors. These disclosures should not be viewed as a substitute for financial results determined in accordance with U.S. GAAP, nor are they necessarily comparable to non-GAAP performance measures which may be presented by other companies.

Net Interest Income and Margin on a Fully Tax-Equivalent Basis, Non-GAAP Financial Measure

Net interest income is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets. Net interest income is presented on a fully tax-equivalent basis, a non-GAAP financial measure, by adjusting tax-exempt income (primarily interest earned on obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues. We believe this to be the preferred measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.

The following table shows the Company’s calculation of Net Interest Income and Margin on a Fully Tax-Equivalent Basis, non-GAAP financial measure.

 

     Year Ended September 30,  
(Dollars in thousands)    2018      2017      2016  

Net interest income

   $ 27,035      $ 24,336      $ 18,512  

Tax-equivalent adjustment, investment income(1)

     55        153        255  

Tax-equivalent adjustment, loan interest(1)

     93        9        10  
  

 

 

    

 

 

    

 

 

 

Net interest income on a fully tax-equivalent Basis (Non-GAAP)

   $ 27,183      $ 24,498      $ 18,777  
  

 

 

    

 

 

    

 

 

 

 

(1)

Computed using a federal income tax rate of 24.25 percent for the year ended September 30, 2018 and 34 percent for the years ended September 30, 2017 and 2016.

 

-30-


Table of Contents

The following table presents the components of net interest income on a fully tax-equivalent basis, a non-GAAP measure, for the periods indicated, together with a reconciliation of net interest income as reported under GAAP.

 

    Year Ended September 30,  
    2018     2017     2016  
(Dollars in thousands)   Amount     Increase
(Decrease)
from Prior
Year
    Percent
Change
    Amount     Increase
(Decrease)
from Prior
Year
    Percent
Change
    Amount     Increase
(Decrease)
from Prior
Year
    Percent
Change
 

Interest income:

                 

Loans, including fees

  $ 36,955     $ 6,105       19.79     $ 30,850     $ 9,634       45.41     $ 21,216     $ 4,724       28.64  

Investment securities

    1,400       (806     (36.54     2,206       (1,624     (42.40     3,830       57       1.51  

Dividends, restricted stock

    467       210       81.71       257       7       2.80       250       (61     (19.61

Interest-bearing cash accounts

    1,356       725       114.90       631       418       196.24       213       141       195.83  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest income

    40,178       6,234       18.37       33,944       8,435       33.07       25,509       4,861       23.54  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest expense:

                 

Deposits

    9,200       2,964       47.53       6,236       1,699       37.45       4,537       1,106       32.24  

Short-term borrowings

    68       34       100.00       34       34       100.00       —         —         —    

Long-term borrowings

    2,200       24       1.10       2,176       (19     (0.87     2,195       378       20.80  

Subordinated debt

    1,527       527       52.70       1,000       1,000       100.00       —         —         —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest expense

    12,995       3,549       37.57       9,446       2,714       40.31       6,732       1,484       28.28  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income on a fully tax- equivalent basis

    27,183       2,685       10.96       24,498       5,721       30.47       18,777       3,377       21.93  

Tax-equivalent adjustment(1)

    (148     14       8.64       (162     103       38.87       (265     (79     42.47  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income, as reported under GAAP

  $ 27,035     $ 2,699       11.09     $ 24,336     $ 5,824       31.46     $ 18,512     $ 3,298       21.68  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1)

Computed using a federal income tax rate of 24.25 percent for the year ended September 30, 2018. Computed using a federal income tax rate of 34 percent for the years ended September 30, 2017 and 2016.

Net interest income is directly affected by changes in the volume and mix of interest-earning assets and interest-bearing liabilities, which support those assets, as well as changes in the rates earned and paid. Net interest income is presented in this financial review on a tax equivalent basis by adjusting tax-exempt income (primarily interest earned on various obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues, and then in accordance with the Company’s consolidated financial statements. Accordingly, the net interest income data presented in this financial review differ from the Company’s net interest income components of the Consolidated Financial Statements presented elsewhere in this report.

Net interest income on a fully tax-equivalent basis, a non-GAAP financial measure, for the year ended September 30, 2018 increased $2.7 million, or 11.0 percent, to $27.2 million, from $24.5 million for fiscal 2017. The Company’s net interest margin decreased six basis points to 2.66 percent in fiscal 2018 from 2.72 percent for the fiscal year ended September 30, 2017. From fiscal 2016 to fiscal 2017, net interest income on a tax equivalent basis increased by $5.7 million and the net interest margin increased by seven basis points. During fiscal 2018, our net interest margin was impacted by decreases in the yield on investments, as well as an increase in the cost of deposits and borrowings.

The increase in net interest income during fiscal 2018 was attributable in part to the slight increase in short-term interest rates that continued to increase throughout 2018. The Company experienced a slight decrease of

 

-31-


Table of Contents

$444,000 in non-interest bearing deposits during fiscal 2018 and an increase of $14.9 million in interest-bearing demand, savings, money market and time deposits under $100,000 during fiscal 2018. During the twelve months ended September 30, 2018, the Company’s net interest spread decreased by nine basis points reflecting a 16 basis points increase in the average yield on interest-earning assets as well as a 25 basis points increase in the average interest rates paid on interest-bearing liabilities.

For the year ended September 30, 2018, average interest-earning assets increased by $121.5 million to $1,022.2 million, as compared with the year ended September 30, 2017. The fiscal 2018 change in average interest-earning asset volume was primarily due to increased loan volume. Average interest-bearing liabilities increased by $108.2 million in fiscal 2018 compared to fiscal 2017, due primarily to an increase in average interest-bearing deposits of $98.8 million and a $9.4 million increase in average borrowings.

For the year ended September 30, 2017, average interest-earning assets increased by $191.3 million to $900.7 million, as compared with the year ended September 30, 2016. The fiscal 2017 change in average interest-earning asset volume was primarily due to increased loan volume. Average interest-bearing liabilities increased by $158.5 million in fiscal 2017 compared to fiscal 2016, due primarily to an increase in average interest-bearing deposits of $137.2 million and a $21.3 million increase in average borrowings.

The factors underlying the year-to-year changes in net interest income on a tax-equivalent basis, a non-GAAP financial measure, are reflected in the tables presented on page 30, each of which have been presented on a tax-equivalent basis (assuming a 24.25 percent tax rate for fiscal 2018, and a 34 percent tax rate for 2017 and 2016). The table on page 32 (Average Statements of Condition with Interest and Average Rates) shows the Company’s consolidated average balance of assets, liabilities and shareholders’ equity, the amount of income produced from interest-earning assets and the amount of expense incurred from interest-bearing liabilities, and net interest income as a percentage of average interest-earning assets.

Net Interest Margin on a Fully Tax-Equivalent Basis, Non-GAAP Financial Measure

The following table quantifies the impact on net interest income on a fully tax-equivalent basis, a non-GAAP financial measure, resulting from changes in average balances and average rates over the past three years. Any change in interest income or expense attributable to both changes in volume and changes in rate has been allocated in proportion to the relationship of the absolute dollar amount of change in each category.

 

-32-


Table of Contents

Analysis of Variance in Net Interest Income Due to Volume and Rates

 

     Fiscal 2018/2017
Increase (Decrease)
Due to Change in:
    Fiscal 2017/2016
Increase (Decrease)
Due to Change in:
 
(In thousands)    Average
Volume
    Average
Rate
    Net
Change
    Average
Volume
    Average
Rate
    Net
Change
 

Interest-earning assets:

            

Loans, including fees

   $ 4,914     $ 1,191     $  6,105     $ 9,628     $ 6     $ 9,634  

Investment securities

     (403     (403     (806     (1,656     32       (1,624

Interest-bearing cash accounts

     154       571       725       116       302       418  

Dividends, restricted stock

     91       119       210       9       (3     6  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     4,756       1,478       6,234       8,097       337       8,434  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

            

Money market deposits

     381       1,137       1,518       599       597       1,196  

Savings deposits

     1       (2     (1     (1     6       5  

Certificates of deposit

     (329     620       291       440       (72     368  

Other interest-bearing deposits

     203       953       1,156       20       110       130  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

     256       2,708       2,964       1,058       641       1,699  

Borrowings

     219       366       585       403       611       1,014  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     475       3,074       3,549       1,461       1,252       2,713  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in net interest income

   $ 4,281     $ (1,596   $ 2,685     $ 6,636     $ (915   $ 5,721  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest income on a fully tax-equivalent basis, a non-GAAP financial measure, for the year ended September 30, 2018 increased by approximately $6.2 million or 18.4 percent as compared with the year ended September 30, 2017. This increase was due primarily to increases in the balances of the Company’s loans. Interest income on a fully tax-equivalent basis, a non-GAAP financial measure, for the year ended September 30, 2017 increased by approximately $8.4 million or 33.1 percent as compared with the year ended September 30, 2016. This increase was due primarily to increases in the balances of the Company’s loans.

The average balance of the Company’s loan portfolio increased $117.6 million in fiscal 2018 to $856.1 million from $738.5 million in fiscal 2017, primarily driven by an increase in commercial real estate loans.

The average loan portfolio represented approximately 83.7 percent of the Company’s interest-earning assets (on average) during fiscal 2018 and 82.0 percent for fiscal 2017. Average investment securities decreased during fiscal 2018 by $15.5 million compared to fiscal 2017. The average yield on interest-earning assets increased from 3.77 percent in fiscal 2017 to 3.93 percent in fiscal 2018.

Interest expense for the year ended September 30, 2018 was principally impacted by rate related factors. The changes resulted in increased expense of $3.5 million primarily due to an increase in rate paid on interest bearing liabilities and to a lesser degree, the $108.2 million increase in interest -bearing liabilities from fiscal 2017 to fiscal 2018. For the year ended September 30, 2017, interest expense increased $2.7 million as compared with fiscal 2016, principally reflecting an increase in deposits and borrowings. Average interest-bearing liabilities increased $158.5 million from fiscal 2016 to fiscal 2017.

The Company’s net interest spread on a fully tax-equivalent basis, a non-GAAP financial measure, (i.e., the average yield on average interest-earning assets, calculated on a tax equivalent basis, minus the average rate paid on interest-bearing liabilities) decreased nine basis points to 2.48 percent in fiscal 2018 from 2.57 percent for the year ended September 30, 2017. The decrease in fiscal 2018 reflected a spread decrease between yields earned on investments and an increase in overall cost of funds. The net interest spread increased four basis points in fiscal

 

-33-


Table of Contents

2017 as compared with fiscal 2016, primarily as a result of an increase of spreads between yields earned on investments and interest-bearing cash accounts and rates paid for supporting funds.

The cost of total average interest-bearing liabilities increased to 1.45 percent, an increase of 25 basis points, for the year ended September 30, 2018, from 1.20 percent for the year ended September 30, 2017, which followed an increase of thirteen basis points from 1.07 percent for the year ended September 30, 2016.

The following table, ‘‘Average Statements of Condition with Interest and Average Rates’’, on a tax-equivalent basis presents for the years ended September 30, 2018, 2017 and 2016, the Company’s average assets, liabilities and shareholders’ equity. The Company’s net interest income, net interest spreads and net interest income as a percentage of interest-earning assets (net interest margin) are also reflected.

 

    Year Ended September 30,  
    2018     2017     2016  
    Average
Outstanding
Balance
    Interest
Earned/
Paid
    Average
Yield/

Rate
    Average
Outstanding
Balance
    Interest
Earned/
Paid
    Average
Yield/

Rate
    Average
Outstanding
Balance
    Interest
Earned/
Paid
    Average
Yield/

Rate
 
    (Dollars in thousands)  

ASSETS

                 

Interest earning assets:

                 

Loans receivable(1)

  $ 856,066     $ 36,955       4.32   $ 738,496     $ 30,850       4.18   $ 507,973     $ 21,216       4.18

Investment

securities

    69,485       1,400       2.01       85,030       2,206       2.59       149,812       3,830       2.56  

Deposits in other

banks

    89,304       1,356       1.52       71,754       631       0.88       46,429       213       0.46  

FHLB stock

    7,359       467       6.35       5,436       257       4.72       5,243       250       4.77  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest earning assets(1)

    1,022,214       40,178       3.93       900,716       33,944       3.77       709,457       25,509       3.60  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest earning assets

                 

Cash and due from banks

    1,524           1,789           15,585      

Bank owned life insurance

    19,173           18,683           18,165      

Other assets

    18,668           20,151           14,177      

Allowance for loan losses

    (8,629         (6,930         (4,968    
 

 

 

       

 

 

       

 

 

     

Total non-interest earning assets

    30,736           33,693           42,959      
 

 

 

       

 

 

       

 

 

     

Total assets

  $ 1,052,950         $ 934,409         $ 752,416      
 

 

 

       

 

 

       

 

 

     

 

-34-


Table of Contents
    Year Ended September 30,  
    2018     2017     2016  
    Average
Outstanding
Balance
    Interest
Earned/
Paid
    Average
Yield/

Rate
    Average
Outstanding
Balance
    Interest
Earned/
Paid
    Average
Yield/

Rate
    Average
Outstanding
Balance
    Interest
Earned/
Paid
    Average
Yield/

Rate
 
    (Dollars in thousands)  

LIABILITIES AND SHAREHOLDERS’ EQUITY

                 

Interest bearing liabilities:

                 

Money Market accounts

  $ 277,449     $ 3,587       1.29   $ 234,204     $ 2,069       0.88   $ 138,997     $ 874       0.63

Savings accounts

    44,357       36       0.08       43,937       37       0.08       45,060       32       0.07  

Certificate accounts

    247,029       4,152       1.68       270,054       3,861       1.43       239,810       3,492       1.46  

Other interest-bearing deposits

    181,087       1,425       0.79       102,936       269       0.26       90,054       139       0.15  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total deposits

    749,922       9,200       1.23       651,131       6,236       0.96       513,921       4,537       0.88  

Borrowed funds

    146,245       3,795       2.59       136,885       3,210       2.34       115,598       2,195       1.90  
 

 

 

   

 

 

     

 

 

   

 

 

     

 

 

   

 

 

   

Total interest- bearing liabilities

    896,167       12,995       1.45       788,016       9,446       1.20       629,519       6,732       1.07  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest bearing liabilities

                 

Demand deposits

    42,821           40,759           31,263      

Other liabilities

    7,723           6,044           5,262      
 

 

 

       

 

 

       

 

 

     

Total non-interest- bearing liabilities

    50,544           46,803           36,525      

Shareholders’ equity

    106,239           99,590           86,372      
 

 

 

       

 

 

       

 

 

     

Total liabilities and shareholders’ equity

  $ 1,052,950         $ 934,409         $ 752,416      
 

 

 

       

 

 

       

 

 

     

Net interest income (tax-equivalent basis)

    $ 27,183         $ 24,498         $ 18,777    
   

 

 

       

 

 

       

 

 

   

Net interest spread

        2.48         2.57         2.53
     

 

 

       

 

 

       

 

 

 

Net interest margin

        2.66         2.72         2.65
     

 

 

       

 

 

       

 

 

 

Tax-equivalent adjustment(2)

      (148         (162         (265  
   

 

 

       

 

 

       

 

 

   

Net Interest income

    $ 27,035         $ 24,336         $ 18,512    
   

 

 

       

 

 

       

 

 

   

 

(1)

Includes non-accrual loans during the respective periods. Calculated net of deferred loan fees and loan discounts.

(2)

The tax-equivalent adjustment was computed based on a statutory Federal income tax rate of 24.25 percent for fiscal years 2018.The tax-equivalent adjustment was computed based on a statutory Federal income tax rate of 34 percent for fiscal years 2017 and 2016.

Investment Portfolio

For the year ended September 30, 2018, the average volume of investment securities decreased by $15.5 million to approximately $69.5 million or 6.8 percent of average interest-earning assets, from $85.0 million on average, or 9.4 percent of average interest-earning assets, in fiscal 2017. At September 30, 2018, the total investment portfolio amounted to $54.4 million, an increase of $4.9 million from September 30, 2017. The increase in the investment portfolio was primarily due to the purchase of U.S. Treasury notes during the first quarter of fiscal 2018. At September 30, 2018, the principal components of the investment portfolio were government Treasury notes, government agency obligations, federal agency obligations including

 

-35-


Table of Contents

mortgage-backed securities, obligations of U.S. states and political subdivision, corporate bonds and notes, and equity securities.

During the year ended September 30, 2018, volume related factors and rate related factors each decreased investment revenue by $403,000. The tax-equivalent yield on investments decreased by 58 basis points to 2.01 percent from a yield of 2.59 percent during the year ended September 30, 2017. The decrease in the investment portfolio was attributed to the sales, amortization, and calls recorded during fiscal 2018. The yield on the portfolio decreased in fiscal 2018 compared to fiscal 2017 due primarily to lower rates earned on taxable securities.

As of September 30, 2018, the estimated fair value of the available-for-sale securities disclosed below was primarily dependent upon the movement in market interest rates, particularly given the negligible inherent credit risk associated with these securities. These investment securities are comprised of securities that are rated investment grade by at least one bond credit rating service. Although the fair value will fluctuate as the market interest rates move, management believes that these fair values will recover as the underlying portfolios mature and are reinvested in market rate yielding investments. As of September 30, 2018, the Company held one U.S. government treasury note, two U.S. government agency securities, seventeen municipal bonds, four corporate securities, thirty-seven mortgage-backed securities, and one single issuer trust preferred security which were in an unrealized loss position. The Company does not intend to sell and expects that it is not more likely than not that it will be required to sell these securities until such time as the value recovers or the securities mature. Management does not believe any individual unrealized loss as of September 30, 2018 represents other-than-temporary impairment.

Securities available-for-sale are a part of the Company’s interest rate risk management strategy and may be sold in response to changes in interest rates, changes in prepayment risk, liquidity management and other factors. The Company continues to reposition the investment portfolio as part of an overall corporate-wide strategy to produce reasonable and consistent margins where feasible, while attempting to limit risks inherent in the Company’s balance sheet.

For fiscal 2018, no available-for-sale investment securities were sold. For fiscal 2017, proceeds of investment securities sold amounted to approximately $51.1 million. Gross realized gains on investment securities sold amounted to approximately $464,000, while gross realized losses amounted to approximately $1,000, for the period. For fiscal 2016, proceeds of investment securities sold amounted to approximately $62.8 million. Gross realized gains on investment securities sold amounted to approximately $595,000, while gross realized losses amounted to approximately $30,000, for the period.

The varying amount of sales from the available-for-sale portfolio over the past few years, reflect the significant volatility present in the market. Given the historic low interest rates prevalent in the market, it is necessary for the Company to protect itself from interest rate exposure. Securities that once appeared to be sound investments can, after changes in the market, become securities that the Company has the flexibility to sell to avoid losses and mismatches of interest-earning assets and interest-bearing liabilities at a later time.

 

-36-


Table of Contents

The table below illustrates the maturity distribution and weighted average yield on a tax-equivalent basis for investment securities at September 30, 2018 on a contractual maturity basis.

 

    One year or less     More than One Year
through Five Years
    More than Five
Years through Ten Years
    More than Ten Years     Total  
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Fair
Value
    Weighted
Average

Yield
 
    (Dollars in thousands)  

Available for Sale Securities:

                     

U.S. treasury notes

  $ 9,996       1.61   $ —         —     $ —         —     $ —         —     $ 9,996     $ 9.986       1.61

State and municipal obligations

    1,004       1.98       4,050       2.49       1,444       2.19       455       3.40     $ 6,953       6,887       2.54  

Single issuer trust preferred security

    —         —         —         —         1,000       2.97       —         —         1,000       921       2.97  

Corporate debt securities

    —         —         3,105       3.01       3,500       2.77       —         —         6,605       6,254       2.89  

Mutual fund

    —         —         250       2.00       —         —         —         —         250       250       2.00  
 

 

 

   

 

 

   

 

 

     

 

 

     

 

 

     

 

 

   

 

 

   

Total

  $ 11,000       1.80   $ 7,405       2.34   $ 5,944       2.66   $ 455       3.40   $ 24,804     $ 24,298       2.13
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Held to Maturity Securities:

                     

U.S. government agencies and obligations

  $ 1,000       1.21   $ 999       1.37   $ —         —     $ —         —     $ 1,999       1,979       1.29

State and municipal obligations

    —         —         —         —         1,863       2.24       6,318       1.49       8,181       8,115       1.66  

Corporate debt securities

    —         —         —         —         3,715       3.82       —         —         3,715       3,666       3.82  

Mortgage- backed securities

    —         —         —         —         806       1.86       15,391       1.76       16,197       15,208       1.76  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

 

   

Total

  $ 1,000       1.21   $ 999       1.37   $ 6,384       2.97   $ 21,709       1.70   $ 30,092     $ 28,968       2.41
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Investment Securities

  $ 12,000       1.59   $ 8,404       2.21   $ 12,328       2.89   $ 22,164       1.80   $ 54,896     $ 53,266       2.07
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For information regarding the carrying value of the investment portfolio, see Note 5 and Note 11 of the Notes to the Consolidated Financial Statements.

The following table sets forth the carrying value of the Company’s investment securities, as of September 30, for each of the last three years.

 

(In thousands)    2018      2017      2016  

Investment Securities Available-for-Sale:

        

U.S. treasury notes

   $ 9,986      $ —        $ —    

State and municipal obligations

     6,887        7,029        25,307  

Single issuer trust preferred security

     921        934        878  

Corporate debt securities

     6,254        6,374        40,202  

Mutual Fund

     250        250        —    
  

 

 

    

 

 

    

 

 

 

Total available-for-sale

   $ 24,298      $ 14,587      $ 66,387  
  

 

 

    

 

 

    

 

 

 

Investment Securities Held-to-Maturity:

        

U.S. government agencies

   $ 1,999      $ 1,999      $ 2,999  

State and municipal obligations

     8,181        9,574        9,826  

Corporate debt securities

     3,715        3,818        3,916  

Mortgage-backed securities:

        

Collateralized mortgage obligations, fixed- rate

     16,197        19,524        23,810  
  

 

 

    

 

 

    

 

 

 

Total held-to-maturity

   $ 30,092      $ 34,915      $ 40,551  
  

 

 

    

 

 

    

 

 

 

Total investment securities

   $ 54,390      $ 49,502      $ 106,938  
  

 

 

    

 

 

    

 

 

 

 

-37-


Table of Contents

For information regarding the Company’s investment portfolio, see Note 5 and Note 11 of the Notes to the Consolidated Financial Statements.

Loan Portfolio

Lending is one of the Company’s primary business activities. The Company’s loan portfolio consists of residential, construction and development, commercial and consumer loans, serving the diverse customer base in its market area. The composition of the Company’s portfolio continues to change due to the local economy. Factors such as the economic climate, interest rates, real estate values and employment all contribute to these changes. Growth is generated through business development efforts, repeat customer requests for new financings, penetration into existing markets and entry into new markets.

The Company seeks to create growth in commercial lending by offering customer-focused products and competitive pricing and by capitalizing on the positive trends in its market area. Products offered are designed to meet the financial requirements of the Company’s customers. It is the objective of the Company’s credit policies to diversify the commercial loan portfolio to limit concentrations in any single industry.

At September 30, 2018, total gross loans amounted to $910.6 million, an increase of $68.4 million or 8.1 percent as compared to September 30, 2017. For the year ended September 30, 2018, growth of $77.0 million in commercial loans and $4.7 million in residential mortgage loans were partially offset by decreases of $7.3 million in construction and development loans and $6.0 million in total consumer loans. Even though the Company continues to be challenged by the competition for lending relationships that exists within its market, growth in volume has been achieved through successful lending sales efforts to build on continued customer relationships.

The average balance of our total loans increased $117.6 million or 15.9 percent for the year ended September 30, 2018 as compared to September 30, 2017, while the average yield on loans increased 14 basis points to 4.32% in fiscal 2018 from 4.18% in fiscal 2017. The increase in average total loan volume was due primarily to the volume of new loan originations. During fiscal 2018 compared to fiscal 2017, the volume-related factors during the period contributed to an increase of interest income on loans of $4.9 million, while the rate-related changes increased interest income by $1.2 million.

 

-38-


Table of Contents

The following table presents information regarding the components of the Company’s loan portfolio on the dates indicated.

 

     September 30,  
     2018     2017     2016     2015     2014  
     (In thousands)  

Residential mortgage

   $  197,219     $  192,500     $  209,186     $  214,958     $  231,324  

Construction and Development:

          

Residential and commercial

     37,433       35,622       18,579       5,677       5,964  

Land

     9,221       18,377       10,013       2,142       1,033  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total construction and development

     46,654       53,999       28,592       7,819       6,997  

Commercial:

          

Commercial real estate

     493,929       437,760       231,439       87,686       71,579  

Multi-family

     45,102       39,768       19,515       7,444       1,032  

Farmland

     12,066       1,723       —         —         —    

Other

     80,059       74,837       38,779       13,380       5,480  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total commercial

     631,156       554,088       289,733       108,510       78,091  

Consumer:

          

Home equity lines of credit

     14,884       16,509       19,757       22,919       22,292  

Second mortgages

     18,363       22,480       29,204       37,633       47,034  

Other

     2,315       2,570       1,914       2,359       2,839  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer

     35,562       41,559       50,875       62,911       72,165  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans

     910,591       842,146       578,386       394,198       388,577  

Deferred loan fees and costs, net

     566       590       1,208       1,776       2,086  

Allowance for loan losses

     (9,021     (8,405     (5,434     (4,667     (4,589
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans receivable, net

   $ 902,136     $ 834,331     $ 574,160     $ 391,307     $ 386,074  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

At September 30, 2018, our net loan portfolio totaled $902.1 million or 87.3% of total assets. Our principal lending activity has been the origination of commercial and commercial real estate loans. Through our loan policy strict underwriting guidelines maintain low average loan-to-value (“LTV”) ratios, maximum gross debt ratios and minimum debt coverage ratios. We have invested in software which facilitates our ability to internally review and grade loans in our portfolio and to monitor loan performance. Our Credit Department’s primary focus has been to review and maintain the loan portfolio, along with the review of underwriting of all new credits.

In prior years, the Company purchased single-family residential mortgage loans and consumer loans from a network of mortgage brokers.

The types of loans that we originate are subject to federal and state law and regulations. Interest rates charged by us on loans are affected principally by the demand for such loans and the supply of money available for lending purposes and the rates offered by our competitors. These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters.

The loans receivable portfolio is segmented into residential mortgage loans, construction and development loans, commercial loans and consumer loans. The residential mortgage loan segment has one class, one- to four-family first lien residential mortgage loans. The construction and development loan segment consists of the following classes: residential and commercial construction loans and land loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built and occupied by the home-owner. Commercial construction loans are made for the purpose of acquiring, developing and constructing a commercial use structure and for acquisition, development and construction of

 

-39-


Table of Contents

residential properties by residential developers. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The consumer loan segment consists of the following classes: home equity lines of credit, second mortgage loans and other consumer loans, primarily unsecured consumer lines of credit.

Residential Lending. Residential mortgage originations are secured primarily by properties located in the Company’s primary market area and surrounding areas. At September 30, 2018, $197.2 million, or 21.7%, of our total loans in portfolio consisted of single-family residential mortgage loans. During fiscal 2018, we had $60,000 of charge-offs of residential loans, as compared to zero charge-offs at fiscal 2017.

Our single-family residential mortgage loans generally are underwritten on terms and documentation conforming to guidelines issued by Freddie Mac and Fannie Mae. Applications for one- to four-family residential mortgage loans are taken by our loan origination officers and are accepted at any of our banking offices and are then referred to the lending department at our Morristown office in order to process the loan, which consists primarily of obtaining all documents required by Freddie Mac and Fannie Mae underwriting standards, and completing the underwriting, which includes making a determination whether the loan meets our underwriting standards such that the Bank can extend a loan commitment to the customer. We generally have retained for portfolio a substantial portion of the single-family residential mortgage loans that we originate. We currently originate fixed-rate, fully amortizing mortgage loans with maturities of 10 to 30 years. We also offer adjustable rate mortgage (“ARM”) loans where the interest rate either adjusts on an annual basis or is fixed for the initial one, three, five or seven years and then adjusts annually. However, due to the low interest rate environment and demand for fixed rate products, we have not originated a significant amount of ARM loans in recent years. At September 30, 2018, $57.6 million, or 29.2%, of our one- to four-family residential mortgage loans consisted of ARM loans.

We underwrite one- to four-family residential mortgage loans with loan-to-value ratios of up to 95%, provided that the borrower obtains private mortgage insurance on loans that exceed 80% of the appraised value or sales price, whichever is less, of the secured property. We also require that title insurance, hazard insurance and, if appropriate, flood insurance be maintained on all properties securing real estate loans. We require that a licensed appraiser from our list of approved appraisers perform and submit to us an appraisal on all properties secured by a first mortgage on one- to four-family first mortgage loans. Our mortgage loans generally include due-on-sale clauses which provide us with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property. Due-on-sale clauses are an important means of adjusting the yields of fixed-rate mortgage loans in portfolio and we generally exercise our rights under these clauses.

Construction and Development Loans. The amount of our outstanding construction and development loans in portfolio decreased to $46.7 million or 5.1% of gross loans at September 30, 2018 from $54.0 million or 6.4% of total loans as of September 30, 2017. From October 2009 through September 30, 2013, we ceased originating any new construction and development loans, with certain limited exceptions. We generally limit construction loans to builders and developers with whom we have an established relationship, or who are otherwise known to officers of the Bank. Our construction loans also include single-family residential construction loans which may if approved convert to permanent, long-term mortgage loans upon completion of construction (“construction/perm” loans). During the initial or construction phase, these construction/perm loans require payment of interest only, which generally is tied to prime rate, as the home is being constructed. On residential construction to perm loans the interest rate is as approved. Upon the earlier of the completion of construction or one year, these loans if approved by the appropriate approving authority convert to long-term (generally 30 years), amortizing, fixed-rate single-family mortgage loans.

Our current portfolio of construction loans generally have a maximum term as approved based upon the underwriting (for individual, owner-occupied dwellings), and loan-to-value ratios less than 80%. Residential

 

-40-


Table of Contents

construction loans to developers are made on either a pre-sold or speculative (unsold) basis. Limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Generally, a limit of two unsold homes (one model home and one speculative home) is placed per project.

Prior to committing to a construction loan, we require that an independent appraiser prepare an appraisal of the property. Each project also is reviewed and inspected at its inception and prior to every disbursement of loan proceeds. Disbursements are made after inspections based upon a percentage of project completion and monthly payment of interest is required on all construction loans.

Our construction loans also include loans for the acquisition and development of land for sale (i.e. roads, sewer and water lines). We typically make these loans only in conjunction with a commitment for a construction loan for the units to be built on the site. These loans are secured by a lien on the property and are limited to a loan-to-value ratio not exceeding 75% of the appraised value at the time of origination. The loans have a variable rate of interest and require monthly payments of interest. The principal of the loan is repaid as units are sold and released. We limit loans of this type to our market area and to developers with whom we have established relationships. In most cases, we also obtain personal guarantees from the borrowers.

Our loan portfolio included six loans secured by unimproved real estate and lots (“land loan”), with an outstanding balance of $9.2 million, constituting 1.0% of total loans, at September 30, 2018.

In order to mitigate some of the risks inherent to construction lending, we inspect properties under construction, review construction progress prior to advancing funds, work with builders with whom we have established relationships, require annual updating of tax returns and other financial data of developers and obtain personal guarantees from the principals. At September 30, 2018, $442,000, or 4.9 percent, of our allowance for loan losses was attributed to construction and development loans. We had no loans in non-performing construction and development loans in portfolio at September 30, 2018 and at September 30, 2017. At September 30, 2018 and 2017, we had $76,000 and $94,000, respectively, in construction and development loans that were performing troubled debt restructurings.

Commercial Lending. At September 30, 2018, our loans in portfolio secured by commercial real estate amounted to $493.9 million and constituted 54.2 percent of our gross loans at such date. During the year ended September 30, 2018, the commercial real estate loan portfolio increased by $56.2 million, or 12.8 percent. During fiscal 2018, we had $276,000 of charge-offs of commercial real estate loans and $45,000 of charge-offs of other commercial loans, as compared to zero charge-offs for fiscal 2017.

Our commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes located in our market area.

Although terms for commercial real estate and multi-family loans vary, our underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the fifth year and with amortization typically not greater than 25 years and loan-to-value ratios of not more than 80%. Interest rates are either fixed or adjustable, based upon the index rate plus a margin, and fees ranging from 0.5% to 1.50% are charged to the borrower at the origination of the loan. Prepayment fees are charged on most loans in the event of early repayment. Generally, we obtain personal guarantees of the principals as additional collateral for commercial real estate and multi-family real estate loans.

Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing

 

-41-


Table of Contents

properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired. As of September 30, 2018, we had one non-accruing commercial real estate mortgage loan with an outstanding balance of approximately $520,000 and an aggregate of $18.7 million of our commercial real estate loans at such date were classified for regulatory reporting purposes as substandard. As of September 30, 2018, $4.4 million, or 48.6% of our allowance for loan losses was allocated to commercial real estate mortgage loans. In addition, at September 30, 2018 and 2017, we had no real estate owned which were acquired from foreclosures, or our acceptance of a deed-in-lieu of foreclosure, on commercial real estate loans. As of September 30, 2018, our commercial real estate loans held in portfolio that were deemed performing troubled debt restructurings increased to $16.9 million from $554,000 at September 30, 2017 primarily due to two commercial real estate loans with an aggregate outstanding balance of approximately $16.4 million moving to performing troubled debt restructured (“TDR”) status in the second fiscal quarter of 2018. In November 2018, one TDR with an aggregate outstanding balance of approximately $7.0 million ceased to perform under modified terms and as a result the Company is in the process of accepting a deed in lieu.

At September 30, 2018, our loan portfolio included 14 loans with an aggregate book value of $45.1 million secured by multi-family (more than four units) properties, constituting 5.0% of our gross loans at such date. As of September 30, 2018, we had no non-accruing multi-family loans.

At September 30, 2018, we had $80.1 million in commercial business loans (8.8% of gross loans outstanding) in portfolio. Our commercial business loans generally have been made to small to mid-sized businesses located in our market area. The commercial business loans in our portfolio assist us in our asset/liability management since they generally provide shorter maturities and/or adjustable rates of interest in addition to generally having higher rates of return which are designed to compensate for the additional credit risk associated with these loans. The commercial business loans which we have originated may be either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral.

Generally, commercial business loans (“other commercial loans”) are characterized as having higher risks associated with them than single-family residential mortgage loans. As of September 30, 2018, we had no non-accruing other commercial loans in our loan portfolio. At such date, $467,000 or 5.2% of the allowance for loan losses was allocated to other commercial loans. At September 30, 2018 and 2017, we held no other commercial loans in portfolio that were deemed performing troubled debt restructurings.

In our underwriting procedures, consideration is given to the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, our practice in recent periods is to impose a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value, and are reviewed by us prior to the closing of the loan.

Consumer Lending. In our efforts to provide a full range of financial services to our customers, we offer various types of consumer loans. Our consumer loans amounted to $35.6 million or 3.9% of our total loan portfolio at September 30, 2018. The largest components of our consumer loans are loans secured by second mortgages, consisting primarily of home equity loans, which amounted to $18.4 million at September 30, 2018, and home equity lines of credit, which amounted to $14.9 million at such date. Our consumer loans also include automobile loans, unsecured personal loans and loans secured by deposits. Consumer loans are originated primarily through existing and walk-in customers and direct advertising.

 

-42-


Table of Contents

Our home equity lines of credit are variable rate loans tied to the prime rate. Our second mortgages may have fixed or variable rates, although they generally have had fixed rates in recent periods. Our second mortgages have a maximum term to maturity of 15 years. Both our second mortgages and our home equity lines of credit generally are secured by the borrower’s primary residence. However, our security generally consists of a second lien on the property. Our lending policy provides that the maximum loan-to-value ratio on our home equity lines of credit is 80%, when Malvern Bank has the first mortgage. However, the maximum loan-to-value ratio on our home equity lines of credit is reduced to 75%, when the Bank does not have the first mortgage. At September 30, 2018, the unused portion of our home equity lines of credit was $26.5 million.

Consumer loans generally have higher interest rates and shorter terms than residential loans; however, they have additional credit risk due to the type of collateral securing the loan or in some cases the absence of collateral. In the year ended September 30, 2018, we charged-off $90,000 of consumer loans mostly consisting of second mortgage loans, as compared to $223,000 of charge-offs at fiscal 2017. We are continuing to evaluate and monitor the credit conditions of our consumer loan borrowers and the real estate values of the properties securing our second mortgage loans as part of our on-going efforts to assess the overall credit quality of the portfolio in connection with our review of the allowance for loan losses. As of September 30, 2018, we had an aggregate of $324,000 of non-accruing second mortgage loans and home equity lines of credit, representing an increase of $112,000 over the amount of non-accruing second mortgage loans and home equity lines of credit at September 30, 2017. At September 30, 2018, $1.1 million of our consumer loans were classified as substandard consumer loans. At September 30, 2018, an aggregate of $408,000 of our allowance for loan losses was allocated to second mortgages and home equity lines of credit.

 

-43-


Table of Contents

The following table presents the contractual maturity of our loans held in portfolio at September 30, 2018. The table does not include the effect of prepayments or scheduled principal amortization. Loans having no stated repayment schedule or maturity and overdraft loans are reported as being due in one year or less.

 

     At September 30, 2018, Maturing  
     In One
Year or
Less
     After One
Years
Through
Five Years
     After Five
Years
     Total  
     (In thousands)  

Residential mortgage

   $ 111      $ 5,905      $ 191,203      $ 197,219  

Construction and Development:

           

Residential and commercial

     33,141        4,292        —          37,433  

Land

     6,310        2,463        448        9,221  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total construction and development

     39,451        6,755        448        46,654  

Commercial:

           

Commercial real estate

     56,761        77,388        359,780        493,929  

Farmland

     —          10,391        1,675        12,066  

Multi-family

     13,857        13,226        18,019        45,102  

Other

     33,978        33,293        12,788        80,059  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total commercial

     104,596        134,298        392,262        631,156  

Consumer:

           

Home equity lines of credit

     —          —          14,884        14,884  

Second mortgages

     25        3,776        14,562        18,363  

Other

     35        1,926        354        2,315  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total consumer

     60        5,702        29,800        35,562  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 144,218      $ 152,660      $ 613,713      $ 910,591  
  

 

 

    

 

 

    

 

 

    

 

 

 

Loans with:

           

Fixed rates

   $ 5,926      $ 24,659      $ 264,886      $ 295,471  

Variable rates

     138,292        128,001        348,827        615,120  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 144,218      $ 152,660      $ 613,713      $ 910,591  
  

 

 

    

 

 

    

 

 

    

 

 

 

For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.

Allowance for Loan Losses and Related Provision

The purpose of the allowance for loan losses is to absorb the impact of probable losses inherent in the loan portfolio. Additions to the allowance are made through provisions charged against current operations and through recoveries made on loans previously charged-off. The allowance for loan losses is maintained at an amount considered adequate by management to provide for potential credit losses based upon a periodic evaluation of the risk characteristics of the loan portfolio. In establishing an appropriate allowance, an assessment of the individual borrowers, a determination of the value of the underlying collateral, a review of historical loss experience and an analysis of the levels and trends of loan categories, delinquencies and problem loans are considered. Such qualitative factors as changes in lending policies and procedures, economic and business conditions, nature and volume of the portfolio, changes in delinquency, concentration of credit trends, value of underlying collateral, the level and trend of interest rates, and peer group statistics are also reviewed. At fiscal 2018 year-end, the level of the allowance was $9.0 million as compared to a level of $8.4 million at September 30, 2017. The Company made loan loss provisions of $954,000 in fiscal 2018 compared with $2.8 million in fiscal 2017 and $947,000 in fiscal 2016. The level of the allowance during the respective annual fiscal periods of 2018, 2017 and 2016 reflects the change in average volume, credit quality within the loan portfolio, the level of charge-offs, loan

 

-44-


Table of Contents

volume recorded during the periods and the Company’s focus on the changing composition of the commercial and residential real estate loan portfolios.

At September 30, 2018, the allowance for loan losses amounted to 0.99 percent of total loans. In management’s view, the level of the allowance at September 30, 2018 is adequate to cover losses inherent in the loan portfolio. Management’s judgment regarding the adequacy of the allowance constitutes a ‘‘Forward Looking Statement’’ under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from management’s analysis, based principally upon the factors considered by management in establishing the allowance.

Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to increase the allowance based on their analysis of information available to them at the time of their examination. Furthermore, the majority of the Company’s loans are secured by real estate in the State of Pennsylvania. Future adjustments to the allowance may be necessary due to economic factors impacting Pennsylvania real estate and a further deterioration of the economic climate, as well as, operating, regulatory and other conditions beyond the Company’s control. The allowance for loan losses as a percentage of total loans amounted to 0.99 percent, 1.00 percent and 0.94 percent at September 30, 2018, 2017 and 2016, respectively. Provision expense was added throughout the fiscal year commensurate with loan growth.

Net charge-offs were $338,000 in fiscal 2018, compared to net recoveries of $180,000 in fiscal 2017 and net charge-offs of $180,000 in fiscal 2016. During fiscal 2018, the Company experienced an increase in charge-offs and a decrease in recoveries compared to fiscal 2017. Charge-offs were higher in most of the portfolio segments in fiscal 2018 than in fiscal 2017. Charge-offs related to residential mortgage loans, commercial real estate loans, and other commercial loans increased $60,000, $276,000, and $45,000, respectively in fiscal 2018 compared to fiscal 2017.

 

-45-


Table of Contents

Five-Year Statistical Allowance for Loan Losses

The following table reflects the relationship of loan volume, the provision and allowance for loan losses and net charge-offs for the past five years.

 

     September 30,  
     2018     2017     2016     2015     2014  
     (Dollars in thousands)  

Average loans outstanding

   $  856,066     $  738,496     $  507,973     $  384,125     $  407,169  

Total loans at end of period

   $ 910,591     $ 842,146     $ 578,386     $ 394,198     $ 388,577  

Analysis of the Allowance of Loan Losses

          

Balance at beginning of year

   $ 8,405     $ 5,434     $ 4,667     $ 4,589     $ 5,090  

Charge-offs:

          

Residential mortgage

     60       —         9       —         83  

Construction and Development:

          

Residential and commercial

     —         —         91       1       37  

Commercial:

          

Commercial real estate

     276       —         99       48       183  

Other

     45       —         —         —         —    

Consumer:

          

Home equity lines of credit

     —         —         —         —         14  

Second mortgages

     88       218       291       138       618  

Other

     2       5       70       34       6  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     471       223       560       221       941  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Residential mortgage

     58       2       17       17       23  

Construction and Development:

          

Residential and commercial

     —         90       243       98       1  

Commercial:

          

Commercial real estate

     11       40       3       9       9  

Other

     4       9       3       3       3  

Consumer:

          

Home equity lines of credit

     1       18       1       2       1  

Second mortgages

     52       232       100       69       136  

Other

     7       12       13       11       4  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     133       403       380       209       177  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs (recoveries)

     338       (180     180       12       764  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     954       2,791       947       90       263  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

   $ 9,021     $ 8,405     $ 5,434     $ 4,667     $ 4,589  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratio of net charge-offs (recoveries) during the year to average loans outstanding during the year

     0.04     (0.02 )%      0.04     0.00     0.19

Allowance for loan losses as a percentage of total loans at end of year

     0.99     1.00     0.94     1.18     1.18

For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.

Implicit in the lending function is the fact that loan losses will be experienced and that the risk of loss will vary with the type of loan being made, the creditworthiness of the borrower and prevailing economic conditions.

 

-46-


Table of Contents

The allowance for loan losses has been allocated in the table below according to the estimated amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans at September 30, for each of the past five years.

The table below shows, for three types of loans, the amounts of the allowance allocable to such loans and the percentage of such loans to total loans.

 

    September 30,  
    2018     2017     2016     2015     2014  
    Amount     Loans
to Total
Loans
    Amount     Loans
to Total
Loans
    Amount     Loans
to Total
Loans
    Amount     Loans
to Total
Loans
    Amount     Loans
to Total
Loans
 
    (Dollars in thousands)  

Residential mortgage

  $ 1,062       21.7   $ 1,004       22.8   $ 1,201       36.2   $ 1,486       54.5   $ 1,672       59.5

Construction and Development:

                   

Residential and commercial

    393       4.1       523       4.2       199       3.2       30       1.5       291       1.5  

Land loans

    49       1.0       132       2.2       97       1.7       35       0.5       13       0.3  

Commercial:

                   

Commercial real estate

    5,031       54.2       3,581       52.0       1,874       40.0       1,235       22.2       1,248       18.4  

Farmland

    66       1.3       9       0.2              

Multi-family

    232       5.0       224       4.7       109       3.4       104       1.9       29       0.3  

Other

    467       8.8       541       8.9       158       6.7       108       3.4       50       1.4  

Consumer:

                   

Home equity lines of credit

    82       1.6       90       2.0       116       3.4       139       5.8       168       5.8  

Second mortgages

    326       2.0       402       2.7       467       5.0       761       9.6       1,033       12.1  

Other

    51       0.3       27       0.3       34       0.4       24       0.6       23       0.7  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allocated

    7,759       100.0       6,533       100.0       4,255       100.0       3,922       100.0       4,527       100.0  
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Unallocated

    1,262       —         1,872       —         1,179       —         745       —         62       —    
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

  $ 9,021       100.0   $ 8,405       100.0   $ 5,434       100.0   $ 4,667       100.0   $ 4,589       100.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

In assessing the adequacy of the ALLL, it is recognized that the process, methodology and underlying assumptions require a significant degree of judgment. The estimation of credit losses is not precise; the range of factors considered is wide and is significantly dependent upon management’s judgment, including the outlook and potential changes in the economic environment. At present, components of the commercial loan segments of the portfolio are new originations and the associated volumes continue to see increased growth. At the same time, historical loss levels have decreased as factors in assessing the portfolio. Any unallocated portion of the allowance reflects management’s estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors.

Asset Quality

The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans and delinquencies, with particular attention to portfolio dynamics and mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of current collateral values, and to maintain an adequate allowance for loan losses at all times.

 

-47-


Table of Contents

It is generally the Company’s policy to discontinue interest accruals once a loan is past due as to interest or principal payments for a period of ninety days. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may only be restored to an accruing basis when it again becomes well secured and in the process of collection or all past due amounts have been collected and a satisfactory period of ongoing repayment exists. Accruing loans past due 90 days or more are generally well secured and in the process of collection. For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.

Non-Performing and Past Due Loans and OREO

Non-performing loans include non-accrual loans and accruing loans which are contractually past due 90 days or more. Non-accrual loans represent loans on which interest accruals have been suspended. It is the Company’s general policy to consider the charge-off of loans at the point they become past due in excess of 90 days, with the exception of loans that are both well-secured and in the process of collection. Troubled debt restructurings represent loans on which a concession was granted to a borrower, such as a reduction in interest rate to a rate lower than the current market rate for new debt with similar risks, and which are currently performing in accordance with the modified terms. For additional information regarding loans, see Note 6 of the Notes to the Consolidated Financial Statements.

The following table sets forth, as of the dates indicated, the amount of the Company’s non-accrual loans, accruing loans past due 90 days or more, other real estate owned (‘‘OREO’’) and troubled debt restructurings.

 

     At September 30,  
     2018      2017      2016      2015      2014  
     (In thousands)  

Non-accrual loans

   $ 2,687      $ 1,038      $ 1,617      $ 1,399      $ 2,391  

Accruing loans past due 90 days or more

     374        173        696        —          —    
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-performing loans

     3,061        1,211        2,313        1,399        2,391  

Other real estate owned

     —          —          —          1,168        1,964  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total non-performing assets

   $ 3,061      $ 1,211      $ 2,313      $ 2,567      $ 4,355  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Troubled debt restructured loans —  performing

   $ 18,640      $ 2,238      $ 2,039      $ 1,091      $ 1,009  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2018, non-performing assets totaled $3.1 million, or 0.30% of total assets, as compared with $1.2 million, or 0.12%, at September 30, 2017. The increase in non-performing assets at September 30, 2018 compared to September 30, 2017 was primarily due to the addition of eight residential mortgage loans with an aggregate outstanding balance of approximately $1.3 million, one commercial loan with an outstanding balance of approximately $520,000 and ten consumer loans with an aggregate outstanding balance of approximately $306,000 moving into non-accrual status and a $308,000 increase in residential mortgage loans receivable greater than 90 days and accruing.

TDR loans, totaled $18.9 million and $2.3 million at September 30, 2018 and at September 30, 2017, respectively. A total of $18.6 million and $2.2 million of troubled debt restructured loans were performing pursuant to the terms of their respective modifications at September 30, 2018 and September 30, 2017, respectively. At September 30, 2018, three troubled debt restructured loans with an outstanding balance of approximately $289,000, were deemed non-performing, while one troubled debt restructured loan with an outstanding balance of approximately $22,000 was deemed non-performing at September 30, 2017. The performing troubled debt restructured loans increased by $16.4 million at September 30, 2018 compared to September 30, 2017 primarily due to two commercial real estate loans with an aggregate outstanding balance of approximately $16.4 million moving to performing TDR status in the second fiscal quarter of 2018. In November 2018, one TDR with an aggregate outstanding balance of approximately $7.0 million ceased to perform under modified terms and as a result the Company is in the process of accepting a deed in lieu.

 

-48-


Table of Contents

Total non-performing assets decreased $1.1 million from September 30, 2016 to September 30, 2017. The reduction in non-performing assets from September 30, 2016 was attributable to four loans with an outstanding balance of approximately $435,000 at September 30, 2016 which were returned to accruing status during fiscal 2017, as well as, an aggregate balance of $413,000 of paid-offs loans, principal payments of $180,000, offset in part by the addition of three single residential loans (totaling approximately $318,000) and two consumer loans (totaling approximately $151,000) into non-accrual status.

Other Income

The following table presents the principal categories of non-interest income for each of the years in the three-year period ended September 30, 2018.

 

    Year Ended September 30,  
    2018     2017     Increase
(Decrease)
    % Change     2017     2016     Increase
(Decrease
    % Change  
    (Dollars in thousands)  

Service charges and other fees

  $  1,268     $ 992     $ 276       27.82   $ 992     $ 923     $ 69       7.48

Rental income-other

    268       227       41       18.06       227       211       16       7.58  

Net gains on sale of investments

    —         463       (463     (100.00     463       565       (102     (18.05

Net gains on sale of loans

    102       154       (52     (33.77     154       116       38       32.76  

Net gains on sale of real estate

    1,186       —         1,186       100.00       —         1       (1     (100.00

Earnings on bank-owned life insurance

    480       505       (25     (4.95     505       517       (12     (2.32
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other income

  $ 3,304     $  2,341     $ 963       41.14   $  2,341     $  2,333     $ 8     0.34
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

For the year ended September 30, 2018, total other income increased $963,000 compared to fiscal 2017. This was primarily as a result of a $1.2 million net gain on the sale of the Exton, Pennsylvania branch location, an increase of $276,000 in other fees and service charges and a $41,000 increase in rental income partially offset by a $463,000 decrease in net gains on sales of investment securities, a $52,000 decrease in net gains on sale of loans, and a $25,000 decrease in earnings on bank-owned insurance.

Excluding net investment securities gains and losses and net gains on sale of real estate, a non-GAAP measure, the Company recorded other income of $2.1 million for the twelve months ended September 30, 2018 compared to $1.9 million for the comparable period in fiscal 2017, an increase of $240,000, or 12.8 percent.

For fiscal 2017, total other income increased $8,000 compared to fiscal 2016. This was primarily a result of a $69,000 increase in service charges, a $16,000 increase in rental income, and an increase of $38,000 in net gain on sale of loans, partially offset by a decrease of $102,000 in net gains on sales of investment securities and a decrease in earnings on bank-owned insurance of $12,000.

Excluding net securities gains and losses, a non-GAAP measure, the Company recorded other income of $1.9 million for the twelve months ended September 30, 2017 compared to $1.8 million for the comparable period in fiscal 2016, an increase of $110,000, or 6.2 percent.

 

-49-


Table of Contents

The Company’s other income is presented in the table below excluding net investment security gains and gains on sale of real estate.

 

    For the Year Ended September 30,  
        2018             2017             2016      
    (In thousands)  

Other income (GAAP basis)

  $ 3,304     $ 2,341     $ 2,333  

Less: Net investment securities gains and gains on sale of real estate

    1,186       463       565  
 

 

 

   

 

 

   

 

 

 

Other income, excluding net investment securities gains and gains on sale of real estate (Non-GAAP)

  $ 2,118     $ 1,878     $ 1,768  
 

 

 

   

 

 

   

 

 

 

Other Expense

The following table presents the principal categories of other expense for each of the years in the three-year period ended September 30, 2018.

 

    Year Ended September 30,  
    2018     2017     Increase
(Decrease)
    % Change     2017     2016     Increase
(Decrease)
    % Change  
    ( Dollars in thousands)  

Salaries and employee benefits

  $ 8,193     $ 7,114     $ 1,079       15.17   $ 7,114     $ 6,290     $ 824       13.10

Occupancy expense

    2,295       2,084       211       10.12       2,084       1,820       264       14.51  

Federal deposit insurance premium

    298       244       54       22.13       244       579       (335     (57.86

Advertising

    152       216       (64     (29.63     216       131       85       64.89  

Data processing

    1,098       1,195       (97     (8.12     1,195       1,128       67       5.94  

Professional fees

    2,891       1,894       997       52.64       1,894       1,683       211       12.54  

Other operating expense

    2,876       2,400       476       19.83       2,400       2,291       109       4.76  
 

 

 

   

 

 

   

 

 

     

 

 

   

 

 

   

 

 

   

Total other expense

  $ 17,803     $ 15,147     $ 2,656       17.53   $ 15,147     $ 13,922     $ 1,225       8.80
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense increased $2.7 million, or 17.5 percent, in fiscal 2018 from fiscal 2017 as compared with an increase of $1.2 million, or 8.8 percent, from fiscal 2016 to fiscal 2017. The increase from fiscal 2017 to fiscal 2018 was primarily reflected increases in salaries and employee benefits of $1.1 million, a $997,000 increase in professional fees, a $476,000 increase in other operating expense, a $211,000 increase in occupancy expense, and a $54,000 increase in the federal deposit insurance premium. The increase was partially offset by a $97,000 decrease in data processing expense and a $64,000 decrease in advertising expense.

Prudent management of operating expenses has been and will continue to be a key objective of management in an effort to improve earnings performance. The Company’s ratio of other expenses to average assets increased slightly to 1.69 percent in fiscal 2018 compared to 1.62 percent in fiscal 2017 and was 1.85 percent in fiscal 2016.

Salaries and employee benefits increased $1.1 million or 15.2 percent in fiscal 2018 compared to fiscal 2017 and increased $824,000 or 13.1 percent from fiscal 2016 to fiscal 2017. The increase in salaries and employee benefits during fiscal 2018 primarily reflects higher compensation to officers and employees to support overall franchise growth. Salaries and employee benefits accounted for 46.0 percent of total non-interest expense in fiscal 2018, as compared to 47.0 percent and 45.2 percent in fiscal 2017 and fiscal 2016, respectively.

Occupancy expense for fiscal 2018 increased by $211,000 or 10.1 percent, over fiscal 2017. Occupancy expense for fiscal 2017 increased by $264,000 or 14.5 percent, compared to fiscal 2016. The increase in occupancy expense during fiscal 2018 was primarily due to an increase in rent expense of $141,000, a $61,000 increase in depreciation expense, and a $16,000 increase in building and equipment maintenance expense.

 

-50-


Table of Contents

Federal deposit insurance premium for fiscal 2018 increased $54,000, or 22.1 percent, compared to fiscal 2017. The increase in the federal deposit insurance premium is due to adjustments in fiscal 2018 as a result of the new regulatory calculation in fiscal 2017. For the year ended September 30, 2017, FDIC insurance expense decreased $335,000 compared to fiscal 2016. The decrease in the federal deposit insurance premium for fiscal 2017 is due to the new regulatory calculation.

Advertising expense for fiscal 2018 decreased $64,000, or 29.6 percent, compared to fiscal 2017. The decrease for fiscal 2018 is due to decrease in advertising retainers. For fiscal 2017, these expenses increased $85,000, or 64.9 percent compared to fiscal 2016.

Data processing expense for fiscal 2018 decreased $97,000, or 8.1 percent, compared to fiscal 2017. For fiscal 2017, data processing expense increased $67,000, or 5.9 percent, over fiscal 2016.

Professional fees for fiscal 2018 increased $997,000, or 52.6 percent, compared to fiscal 2017. Professional fees reflect increased legal and accounting fees for the period related to prior period restatements, which the Company does not expect to continue into future periods. The increase is due to a $720,000 increase in legal fees, a $227,000 increase in fees associated with audit and accounting services, a $45,000 increase in fees associated with other professional services, and an increase of $5,000 in fees associated with payroll services. Professional fees increased $211,000 in fiscal 2017 from fiscal 2016 primarily due to a $130,000 increase in legal fees and a $132,000 increase in fees associated with professional services. The increase was offset by $53,000 reduction in fees associated with audit and accounting services.

Other operating expense increased in fiscal 2018 by approximately $476,000, or 19.8 percent, compared to fiscal 2017. The increase during the year ended September 30, 2018 was primarily due to a $118,000 increase in subordinated debt amortization costs, a $40,000 increase in business expenses related to personnel agency fees, a $39,000 increase in expenses associated with the OCC assessment, and a $172,000 decrease in other real estate owned credits. Other operating expense increased in fiscal 2017 by approximately $109,000, or 4.8 percent, compared to fiscal 2016. The increase during the year ended September 30, 2017 was primarily due to a $41,000 increase in business expenses related to entertainment and meals and auto expense, and a $37,000 increase in expenses associated with annual credit review such as appraisals.

Provision for Income Taxes

The Company recorded $4.3 million in income tax expense in fiscal 2018, compared to $2.9 million in income tax expense in fiscal 2017 and $6.2 million in income tax benefit in fiscal 2016, respectively. The effective tax rates for the Company for the years ended September 30, 2018, 2017 and 2016 were 36.9 percent, 33.4 percent and (103.3) percent, respectively. For a more detailed description of income taxes see Note 12 of the Notes to Consolidated Financial Statements.

In the first quarter of fiscal 2018, the Company revised its estimated annual effective rate to reflect a change in the federal statutory rate from 34% to 21%, resulting from the Tax Cuts and Jobs Act that was enacted on December 22, 2017. The rate change was administratively effective at the beginning of our fiscal year, using a blended rate for the annual period. As a result, the blended statutory tax rate for the fiscal year is 24.25%. Net deferred income taxes decreased $3.5 million to $3.2 million at September 30, 2018 compared to $6.7 million at September 30, 2017.

In addition, we recognized a tax expense in our tax provision for the quarter ended December 31, 2017 related to adjusting our deferred tax balance to reflect the new corporate tax rate. As a result, income tax expense reported for the first three months was adjusted to reflect the effects of the change in the tax law and resulted in an increase in income tax expense of $2.0 million during the quarter ended December 31, 2017. This amount is the result of a reduction of $323,000 in income tax expense for the three-month period ended December 31, 2017 related to the lower corporate rate and a $2.3 million increase from the application of the newly enacted rates to existing deferred tax assets balances.

 

-51-


Table of Contents

Recent Accounting Pronouncements

Please refer to the note on Recent Accounting Pronouncements in Note 2 to the consolidated financial statements in Item 8 for a detailed discussion of new accounting pronouncements.

Asset and Liability Management

Asset and Liability management encompasses an analysis of market risk, the control of interest rate risk (interest sensitivity management) and the ongoing maintenance and planning of liquidity and capital. The composition of the Company’s statement of condition is planned and monitored by the Asset and Liability Committee (“ALCO”). In general, management’s objective is to optimize net interest income and minimize market risk and interest rate risk by monitoring the components of the statement of condition and the interaction of interest rates.

Short-term interest rate exposure analysis is supplemented with an interest sensitivity gap model. The Company utilizes interest sensitivity analysis to measure the responsiveness of net interest income to changes in interest rate levels. Interest rate risk arises when an earning asset matures or when its interest rate changes in a time period different than that of a supporting interest-bearing liability, or when an interest-bearing liability matures or when its interest rate changes in a time period different than that of an earning asset that it supports. While the Company matches only a small portion of specific assets and liabilities, total earning assets and interest-bearing liabilities are grouped to determine the overall interest rate risk within a number of specific time frames. The difference between interest-sensitive assets and interest-sensitive liabilities is referred to as the interest sensitivity gap. At any given point in time, the Company may be in an asset-sensitive position, whereby its interest-sensitive assets exceed its interest-sensitive liabilities, or in a liability-sensitive position, whereby its interest-sensitive liabilities exceed its interest-sensitive assets, depending in part on management’s judgment as to projected interest rate trends.

The Company’s interest rate sensitivity position in each time frame may be expressed as assets less liabilities, as liabilities less assets, or as the ratio between rate sensitive assets (“RSA”) and rate sensitive liabilities (“RSL”). For example, a short-funded position (liabilities repricing before assets) would be expressed as a net negative position, when period gaps are computed by subtracting repricing liabilities from repricing assets. When using the ratio method, a RSA/RSL ratio of 1 indicates a balanced position, a ratio greater than 1 indicates an asset-sensitive position and a ratio less than 1 indicates a liability-sensitive position.

A negative gap and/or a rate sensitivity ratio less than 1 tends to expand net interest margins in a falling rate environment and reduce net interest margins in a rising rate environment. Conversely, when a positive gap occurs, generally margins expand in a rising rate environment and contract in a falling rate environment. From time to time, the Company may elect to deliberately mismatch liabilities and assets in a strategic gap position.

At September 30, 2018, the Company reflected a negative interest sensitivity gap with an interest sensitivity ratio of 0.91:1.00 at the cumulative one-year position. Based on management’s perception of interest rates remaining low through 2018, emphasis has been, and is expected to continue to be, placed on controlling liability costs while extending the maturities of liabilities in our efforts to insulate the net interest spread from rising interest rates in the future. However, no assurance can be given that this objective will be met.

The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at September 30, 2018, which we expect, based upon certain assumptions, to reprice or mature in each of the future time periods shown (the “GAP Table”). Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The table sets forth approximation of the projected repricing of assets and liabilities at September 30, 2018, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected

 

-52-


Table of Contents

time intervals. The loan amounts in the table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans.

 

    

6 Months

or Less

   

More than

6 Months

to 1 Year

   

More than

1 Year

to 3 Years

   

More than

3 Year

to 5 Years

   

More than

5 Years

    Total
Amount
 
     (Dollars in thousands)  

Interest-earning assets(1):

            

Loans receivable(2)

   $  268,573     $ 44,853     $ 221,268     $ 198,266     $ 174,565     $ 907,525  

Investment securities and restricted securities

     18,278       5,751       10,217       9,438       19,732       63,416  

Other interest-earning assets

     29,271       —         —         —         —         29,271  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     316,122       50,604       231,485       207,704       194,297       1,000,212  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-bearing liabilities:

            

Demand and NOW accounts

     8,932       8,932       35,728       35,728       116,472       205,792  

Money market accounts

     25,172       25,172       100,689       96,670       924       248,627  

Savings accounts

     1,938       1,938       7,752       7,752       25,271       44,651  

Certificate accounts

     71,004       39,871       93,933       11,064       17,063       232,935  

FHLB advances

     87,500       5,000       28,000       25,000       —         145,500  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     194,546       80,913       266,102       176,214       159,730       877,505  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-earning assets less interest-bearing liabilities

   $ 121,576     $ (30,309   $ (34,617   $ 31,490     $ 34,567     $ 122,707  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Cumulative interest-rate sensitivity gap(3)

   $ 121,576     $ 91,267     $ 56,650     $ 88,140     $ 122,707    
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Cumulative interest-rate gap as a percentage of total assets at September 30, 2018

     11.76     8.83     5.48     8.52     11.87  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities at September 30, 2018

     162.49     133.13     110.46     112.28     113.98  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

(1)

Interest-earning assets are included in the period in which the balances are expected to be redeployed and /or repriced as a result of anticipated prepayments, scheduled rate adjustments and contractual maturities.

(2)

For purposes of the gap analysis, loans receivable includes non-performing loans gross of the allowance for loan losses, undisbursed loan funds, unamortized discounts and deferred loans fees.

(3)

Interest-rate sensitivity gap represents the net cumulative difference between interest-earning assets and interest- bearing liabilities.

Net Portfolio Value and Net Interest Income Analysis. Our interest rate sensitivity also is monitored by management through the use of models which generate estimates of the change in its net portfolio value (“NPV”) and net interest income (“NII”) over a range of interest rate scenarios. NPV is the present value of expected cash flows from assets, liabilities, and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario.

The table below sets forth as of September 30, 2018 and 2017, the estimated changes in our net portfolio value that would result from designated instantaneous changes in the United States Treasury yield curve.

 

-53-


Table of Contents

Computations of prospective effects of hypothetical interest rates changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.

 

Changes in
Interest Rates
(basis points)(1)
   As of September 30, 2018     As of September 30, 2017  
   Amount      Dollar
Change from
Base
    Percentage
Change from
Base
    Amount      Dollar
Change from
Base
    Percentage
Change from
Base
 
     (Dollars in thousands)  
+300      $124,186        $(25,162     (17 )%      $110,780        $(20,923     (16 )% 
+200      133,197        (16,151     (11     119,631        (12,072     (9
+100      142,132        (7,216     (5     127,334        (4,369     (3
      0      149,348        —         —         131,703        —         —    
-100      152,538        3,190       2       134,634        2,931       2  

 

(1)

Assumes an instantaneous uniform change in interest rates. A basis point equals 0.01%.

In addition to modeling changes in NPV, we also analyze potential changes to NII for a twelve-month period under rising and falling interest rate scenarios. The following table shows our NII model as of September 30, 2018.

 

Changes in Interest Rates in Basis Points (Rate Shock)

   Net Interest
Income
     $ Change      % Change  
     (Dollars in thousands)  

200

   $ 28,187      $ 1,588        5.97

100

     27,437        838        3.15  

Static

     26,599        —          —    

(100)

     25,812        (787      (2.96

As is the case with the GAP Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and NII require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the models presented assume that the composition of our interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV measurements and net interest income models provide an indication of interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results.

Estimates of Fair Value

The estimation of fair value is significant to a number of the Company’s assets, including investment securities available-for-sale. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, discount rates, or market interest rates. Fair values for most available-for-sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Impact of Inflation and Changing Prices

The financial statements and notes thereto presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating

 

-54-


Table of Contents

results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations; unlike most industrial companies, nearly all of the Company’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

Liquidity

The liquidity position of the Company is dependent primarily on successful management of the Bank’s assets and liabilities so as to meet the needs of both deposit and credit customers. Liquidity needs arise principally to accommodate possible deposit outflows and to meet customers’ requests for loans. Scheduled principal loan repayments, maturing investments, short-term liquid assets and deposit inflows, can satisfy such needs. The objective of liquidity management is to enable the Company to maintain sufficient liquidity to meet its obligations in a timely and cost-effective manner.

Management monitors current and projected cash flows, and adjusts positions as necessary to maintain adequate levels of liquidity. Under its liquidity risk management program, the Company regularly monitors correspondent bank funding exposure and credit exposure in accordance with guidelines issued by the banking regulatory authorities. Management uses a variety of potential funding sources and staggering maturities to reduce the risk of potential funding pressure. Management also maintains a detailed contingency funding plan designed to respond adequately to situations which could lead to stresses on liquidity. Management believes that the Company has the funding capacity to meet the liquidity needs arising from potential events. The Company maintains borrowing capacity through the Federal Home Loan Bank of Pittsburgh secured with loans and marketable securities.

The Company’s primary sources of short-term liquidity consist of cash and cash equivalents and investment securities available-for-sale.

At September 30, 2018, the Company had $30.8 million in cash and cash equivalents compared to $117.1 million at September 30, 2017. In addition, our investment securities available-for-sale amounted to $24.3 million at September 30, 2018 and $14.6 million at September 30, 2017.

Deposits

Total deposits decreased to $774.2 million at September 30, 2018 from $790.4 million at September 30, 2017. Total interest-bearing deposits decreased from $748.3 million at September 30, 2017 to $732.5 million at September 30, 2018, a decrease of $15.8 million or 21.1 percent. Interest-bearing demand, savings, money market and time deposits under $100,000 increased $14.9 million to a total of $572.6 million at September 30, 2018 as compared to $557.7 million at September 30, 2017. Time deposits $100,000 and over decreased $30.7 million at September 30, 2018 as compared to September 30, 2017. Time deposits $100,000 and over represented 20.7 percent of total deposits at September 30, 2018 compared to 24.1 percent at September 30, 2017. We had brokered deposits totaling $88.3 million at September 30, 2018 compared to $103.7 million at September 30, 2017.

The Company derives a significant proportion of its liquidity from its core deposit base. Total demand deposits, savings and money market accounts of $541.2 million at September 30, 2018 increased by $22.6 million, or 4.4 percent, from September 30, 2017. Total demand deposits, savings and money market accounts were 69.9 percent of total deposits at September 30, 2018 and 65.6 percent at September 30, 2017. Alternatively, the Company uses a more stringent calculation for the management of its liquidity positions internally, which calculation consists of total demand, savings accounts and money market accounts (excluding money market accounts and certificates of deposit greater than $100,000) as a percentage of total deposits. This number increased by $19.1 million, or 5.7 percent, from $337.7 million at September 30, 2017 to $356.8 million

 

-55-


Table of Contents

at September 30, 2018 and represented 46.1 percent of total deposits at September 30, 2018 as compared with 42.7 percent at September 30, 2017.

The Company continues to place the main focus of its deposit gathering efforts in the maintenance, development, and expansion of its core deposit base. Management believes that the emphasis on serving the needs of our communities will provide a long-term relationship base that will allow the Company to efficiently compete for business in its market. The success of this strategy is reflected in the growth of the demand, savings and money market balances during fiscal 2018.

The following table depicts the Company’s core deposit mix at September 30, 2018 and 2017 based on the Company’s alternative calculation:

 

     September 30,  
     2018     2017     Net Change
2018 vs. 2017
 
     Amount      Percentage     Amount      Percentage  
     (Dollars in thousands)  

Non interest-bearing demand

   $ 41,677        11.7   $ 42,121        12.5   $ (444

Interest-bearing demand

     184,073        51.6       155,579        46.1       28,494  

Savings

     44,642        12.5       44,526        13.2       116  

Money market deposits under $100,000

     13,374        3.7       14,299        4.2       (925

Certificates of deposit under $100,000

     73,013        20.5       81,166        24.0       (8,153
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total core deposits

   $ 356,779        100.0   $ 337,691        100.0   $ 19,088  
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Total deposits

   $ 774,163        $ 790,396        $ (16,233

Core deposits to total deposits

        46.1        42.7  

At September 30, 2018, our certificates of deposit and other time deposits with a balance of $100,000 or more amounted to $159.9 million, of which $86.8 million are scheduled to mature within twelve months. At September 30, 2018, the weighted average remaining maturity of our certificate of deposit accounts was 19.4 months. The following table presents the maturity of our certificates of deposit and other time deposits with balances of $100,000 or more.

 

     Amount  
     (In thousands)  

Maturity Period:

  

Three months or less

   $ 29,563  

Over three months through six months

     26,653  

Over six months through twelve months

     30,605  

Over twelve months

     73,102  
  

 

 

 

Total

   $ 159,923  
  

 

 

 

Borrowings

Borrowings from the FHLB of Pittsburgh are available to supplement the Company’s liquidity position and, to the extent that maturing deposits do not remain with the Company, management may replace such funds with advances. As of September 30, 2018 and 2017, the Company’s outstanding balance of FHLB advance, totaled $118.0 million. Of the $118.0 million in advances, $28.0 million represents long-term, fixed-rate advances maturing in 2020 that have terms enabling the FHLB to call the borrowing at their option prior to maturity. The remaining balance of long-term, fixed rate advances totaled $55.0 million, representing five separate advances maturing during fiscal year 2019. At September 30, 2018, there were two short-term FHLB advances totaling $35.0 million of fixed-rate borrowing with rollover of 90 days.

 

-56-


Table of Contents

During fiscal 2018 the Company had purchased securities sold under agreements to repurchase as a short-term funding source. At September 30, 2018, the Company had $2.5 million in securities sold under agreements to repurchase at a rate of 2.5%. At September 30, 2017, the Company had $5.0 million in securities sold under agreements to repurchase at a rate of 1.46%. The Company had no securities sold under agreements to repurchase at September 30, 2016.

Cash Flows

The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents resulting from the Company’s operating, investing and financing activities. During the year ended September 30, 2018, cash and cash equivalents decreased by $86.3 million over the balance at September 30, 2017. Net cash of $9.1 million was provided by operating activities in fiscal 2018 compared to net cash of $9.8 million provided by operating activities in fiscal 2017. Net cash used in investing activities amounted to approximately $76.4 million in fiscal 2018 compared to net cash used in investing activities of approximately $207.0 million in fiscal 2017. Net cash of $19.0 million was used in financing activities in fiscal 2018 compared to net cash of $217.5 million provided by financing activities in fiscal 2017.

Payments Due Under Contractual Obligations

The following table presents information relating to the Company’s payments due under contractual obligations as of September 30, 2018.

 

     Payments Due by Period  
     Less than
One Year
     One to
Three Years
     Three to
Five Years
     More than
Five Years
     Total  
     (In thousands)  

Long-term debt obligations(1)

   $ 35,070      $ 84,400      $ —        $ —        $ 119,470  

Certificates of deposit(1)

     112,878        95,791        11,286        17,420        237,375  

Operating lease obligations

     514        966        950        1,285        3,715  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 148,462      $ 181,157      $ 12,236      $ 18,705      $ 360,560  
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1)

Includes interest payments.

Off-Balance Sheet Arrangements

In the normal course of operations, the Company engages in a variety of financial transactions that, in accordance with U.S. GAAP, are not recorded in its financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments, lines of credit and letters of credit.

 

-57-


Table of Contents

The contractual amounts of commitments to extend credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer defaults and the value of any existing collateral becomes worthless. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Financial instruments whose contract amounts represent credit risk at September 30, 2018 and 2017 were as follows:

 

     September 30,  
     2018      2017  
     (In thousands)  

Commitments to extend credit:(1)

     

Future loan commitments

   $ 52,390      $ 80,273  

Undisbursed construction loans

     25,128        37,064  

Undisbursed home equity lines of credit

     26,498        26,440  

Undisbursed Commercial lines of credit

     71,391        55,346  

Overdraft protection lines

     1,312        1,339  

Standby letters of credit

     7,122        4,650  
  

 

 

    

 

 

 

Total commitments

   $ 183,841      $ 205,112  
  

 

 

    

 

 

 

 

(1)

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments may require payment of a fee and generally have fixed expiration dates or other termination clauses.

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.

Shareholders’ Equity

Total shareholders’ equity amounted to $110.8 million, or 10.7 percent of total assets, at September 30, 2018, compared to $102.5 million, or 9.8 percent of total assets at September 30, 2017. Book value per common share was $16.84 at September 30, 2018, compared to $15.60 at September 30, 2017.

Capital

At September 30, 2018, the Bank’s common equity tier 1 ratio was 15.09 percent, tier 1 leverage ratio was 12.71 percent, tier 1 risk-based capital ratio was 15.09 percent and the total risk-based capital ratio was 16.13 percent. At September 30, 2017, the Bank’s common equity tier 1 ratio was 14.75 percent, tier 1 leverage ratio was 12.02 percent, tier 1 risk-based capital ratio was 14.75 percent and the total risk-based capital ratio was 15.78 percent. At September 30, 2018, the Bank was in compliance with all applicable regulatory capital requirements.

At September 30, 2018, the Company’s common equity tier 1 ratio was 12.62 percent, tier 1 leverage ratio was 10.63 percent, tier 1 risk-based capital ratio was 12.62 percent and the total risk-based capital ratio was 16.45 percent. At September 30, 2017, the Company’s common equity tier 1 ratio was 12.28 percent, tier 1 leverage ratio was 10.00 percent, tier 1 risk-based capital ratio was 12.28 percent and the total risk-based capital ratio was 16.27 percent. At September 30, 2018, the Bank was in compliance with all applicable regulatory capital requirements.

Looking Forward

As previously disclosed in the Company’s Form 8-K filed on October 9, 2018, the Company closed an underwritten public offering of shares of our common stock for gross proceeds of $25.0 million and net proceeds of approximately $23.4 million (after deducting the underwriting discount and other estimated offering expenses).

 

-58-


Table of Contents

One of the Company’s primary objectives is to achieve balanced asset and revenue growth, and at the same time expand market presence and diversify its financial products. However, it is recognized that objectives, no matter how focused, are subject to factors beyond the control of the Company, which can impede its ability to achieve these goals. The following factors should be considered when evaluating the Company’s ability to achieve its objectives:

The financial market place is rapidly changing. Banks are no longer the only place to obtain loans, nor the only place to keep financial assets. The banking industry has lost market share to other financial service providers. The future is predicated on the Company’s ability to adapt its products, provide superior customer service and compete in an ever-changing marketplace. Net interest income, the primary source of earnings, is impacted favorably or unfavorably by changes in interest rates. Although the impact of interest rate fluctuations is mitigated by ALCO strategies, significant changes in interest rates can have a material adverse impact on profitability.

The ability of customers to repay their obligations is often impacted by changes in the regional and local economy. Although the Company sets aside loan loss provisions toward the allowance for loan losses when management determines such action to be appropriate, significant unfavorable changes in the economy could impact the assumptions used in the determination of the adequacy of the allowance.

Technological changes will have a material impact on how financial service companies compete for and deliver services. It is recognized that these changes will have a direct impact on how the marketplace is approached and ultimately on profitability. The Company has taken steps to improve its traditional delivery channels. However, continued success will likely be measured by the Company’s ability to anticipate and react to future technological changes.

This ‘‘Looking Forward’’ discussion constitutes a forward-looking statement under the Private Securities Litigation Reform Act of 1995. Actual results could differ materially from those projected in the Company’s forward-looking statements due to numerous known and unknown risks and uncertainties, including the factors referred to above, on the first page of this Annual Report on Form 10-K and in other sections of this Annual Report on Form 10-K.

Item 7A. Quantitative and Qualitative Disclosures about Market Risk.

The information contained in the section captioned “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Asset and Liability Management” in Item 7 hereof is incorporated herein by reference.

 

-59-


Table of Contents

Item 8. Financial Statements and Supplementary Data.

Report of Independent Registered Public Accounting Firm

Board of Directors and Shareholders

Malvern Bancorp, Inc. and Subsidiaries

Opinions on the Financial Statements and Internal Control over Financial Reporting

We have audited the accompanying consolidated statement of financial condition of Malvern Bancorp, Inc. and Subsidiaries (the “Company”) as of September 30, 2018, and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows, for the year then ended, and the related notes (collectively referred to as the “consolidated financial statements”). We also have audited the Company’s internal control over financial reporting as of September 30, 2018, based on criteria established in Internal Control — Integrated Framework: (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”).

In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2018, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of September 30, 2018, based on criteria established in Internal Control — Integrated Framework: (2013) issued by COSO.

Basis for Opinion

The Company’s management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Assessment of Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s consolidated financial statements and an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud and whether effective internal control over financial reporting was maintained in all material respects.

Our audit of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provide a reasonable basis for our opinion.

 

-60-


Table of Contents

Definition and Limitations of Internal Control Over Financial Reporting

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ Baker Tilly Virchow Krause, LLP

We have served as the Company’s auditor since 2018.

Allentown, Pennsylvania

December 14, 2018

 

-61-


Table of Contents

Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders

Malvern Bancorp, Inc. and Subsidiaries

Paoli, Pennsylvania

We have audited the accompanying consolidated statements of financial condition of Malvern Bancorp, Inc. and its subsidiaries (collectively the “Company”) as of September 30, 2017 and the related consolidated statements of operations, comprehensive income, changes in shareholders’ equity, and cash flows for each of the two years in the period ended September 30, 2017. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Malvern Bancorp, Inc. and its subsidiaries at September 30, 2017, and the results of their operations and their cash flows for each of the two years in the period ended September 30, 2017, in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO USA, LLP

Philadelphia, Pennsylvania

December 29, 2017

 

-62-


Table of Contents

Malvern Bancorp, Inc. and Subsidiaries

 

Consolidated Statements of Financial Condition

 

     September 30,  
     2018     2017  
     (Dollars in thousands, except
per share and share data)
 

Assets

    

Cash and due from depository institutions

   $ 1,563     $ 1,615  

Interest bearing deposits in depository institutions

     29,271       115,521  
  

 

 

   

 

 

 

Cash and Cash Equivalents

     30,834       117,136  

Investment securities available for sale, at fair value (amortized cost of $24,804 and $14,869 at September 30, 2018 and 2017, respectively)

     24,298       14,587  

Investment securities held to maturity, at cost (fair value of $28,968 and $34,566 at September 30, 2018 and 2017, respectively)

     30,092       34,915  

Restricted stock, at cost

     8,537       5,559  

Loans receivable, net of allowance for loan losses of $9,021 and $8,405 at September 30, 2018 and 2017, respectively

     902,136       834,331  

Accrued interest receivable

     3,800       3,139  

Property and equipment, net

     7,181       7,507  

Deferred income taxes, net

     3,195       6,671  

Bank-owned life insurance

     19,403       18,923  

Other assets

     4,475       3,244  
  

 

 

   

 

 

 

Total Assets

   $ 1,033,951     $ 1,046,012  
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Liabilities

    

Deposits:

    

Deposits-noninterest-bearing

   $ 41,677     $ 42,121  

Deposits-interest-bearing

     732,486       748,275  
  

 

 

   

 

 

 

Total Deposits

     774,163       790,396  

FHLB advances

     118,000       118,000  

Other short-term borrowings

     2,500       5,000  

Subordinated debt

     24,461       24,303  

Advances from borrowers for taxes and insurance

     1,305       1,553  

Accrued interest payable

     784       694  

Other liabilities

     1,915       3,546  
  

 

 

   

 

 

 

Total Liabilities

     923,128       943,492  
  

 

 

   

 

 

 

Commitments and Contingencies

     —         —    

Shareholders’ Equity

    

Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued

     —         —    

Common stock, $0.01 par value, 50,000,000 shares authorized, issued and outstanding: 6,580,879 shares at September 30, 2018 and 6,572,684 shares at September 30, 2017

     66       66  

Additional paid-in-capital

     61,099       60,736  

Retained earnings

     50,412       43,139  

Unearned Employee Stock Ownership Plan (ESOP) shares

     (1,338     (1,483

Accumulated other comprehensive income

     584       62  
  

 

 

   

 

 

 

Total Shareholders’ Equity

     110,823       102,520  
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 1,033,951     $ 1,046,012  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

-63-


Table of Contents

Malvern Bancorp, Inc. and Subsidiaries

 

Consolidated Statements of Operations

 

     Year Ended September 30,  
             2018                      2017                     2016          
     (Dollars in thousands, except per share and share data)  

Interest and Dividend Income

       

Loans, including fees

   $ 36,862      $ 30,841     $ 21,206  

Investment securities, taxable

     1,094        1,561       2,824  

Investment securities, tax-exempt

     251        492       751  

Dividends, restricted stock

     467        257       250  

Interest-bearing cash accounts

     1,356        631       213  
  

 

 

    

 

 

   

 

 

 

Total Interest and Dividend Income

     40,030        33,782       25,244  
  

 

 

    

 

 

   

 

 

 

Interest Expense

       

Deposits

     9,200        6,236       4,537  

Short-term borrowings

     68        34       —    

Long-term borrowings

     2,200        2,176       2,195  

Subordinated debt

     1,527        1,000       —    
  

 

 

    

 

 

   

 

 

 

Total Interest Expense

     12,995        9,446       6,732  
  

 

 

    

 

 

   

 

 

 

Net Interest Income

     27,035        24,336       18,512  

Provision for Loan Losses

     954        2,791       947  
  

 

 

    

 

 

   

 

 

 

Net Interest Income after Provision for Loan Losses

     26,081        21,545       17,565  
  

 

 

    

 

 

   

 

 

 

Other Income

       

Service charges and other fees

     1,268        992       923  

Rental income-other

     268        227       211  

Net gains on sale of investments

     —          463       565  

Net gains on sale of real estate

     1,186        —         1  

Net gains on sale of loans

     102        154       116  

Earnings on bank-owned life insurance

     480        505       517  
  

 

 

    

 

 

   

 

 

 

Total Other Income

     3,304        2,341       2,333  
  

 

 

    

 

 

   

 

 

 

Other Expense

       

Salaries and employee benefits

     8,193        7,114       6,290  

Occupancy expense

     2,295        2,084       1,820  

Federal deposit insurance premium

     298        244       579  

Advertising

     152        216       131  

Data processing

     1,098        1,195       1,128  

Professional fees

     2,891        1,894       1,683  

Other real estate owned (income) expense, net

     —          (172     27  

Other operating expenses

     2,876        2,572       2,264