Item 1. Business
BUSINESS OF MW BANCORP, INC.
MW Bancorp, Inc. (the “Company,” “we,” “us” or “our”) is incorporated in the State of Maryland and was formed to serve as the stock holding company for Watch Hill Bank (the “Bank”), previously known as Mt. Washington Savings Bank, following its mutual-to-stock conversion. The conversion was completed effective January 29, 2015, and the Company issued 876,163 shares at an offering price of $10.00 per share.
Our business consists primarily of taking deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, in one- to four-family residential real estate loans, commercial real estate and multi-family loans, construction loans, commercial loans and consumer loans. At June 30, 2016, $65.3 million, or 64.3% of our total loan portfolio, was comprised of one- to four-family residential real estate loans. We also invest in securities, which consist primarily of mortgage-backed securities issued by U.S. government sponsored entities and, to a lesser extent, U.S. government agency obligations and certificates of deposit. We offer a variety of deposit accounts, including checking accounts, savings accounts, money market accounts and certificates of deposit. We utilize advances from the Federal Home Loan Bank of Cincinnati (“FHLB-Cincinnati”) for asset/liability management purposes and for additional funding for our operations. At June 30, 2016, we had $25.3 million in FHLB-Cincinnati advances outstanding.
Market Area
We conduct our operations from our main office and one branch office in Cincinnati, Hamilton County, Ohio. Hamilton County is primarily a developed and urban county. Our main office is located approximately 10 miles from downtown Cincinnati, and about five miles from the Ohio-Kentucky border. The Bank opened its new branch in the Columbia-Tusculum neighborhood of Cincinnati in September 2015. We operate primarily on the east side of Cincinnati, Ohio and the surrounding areas. Hamilton County, Ohio represents our primary geographic market area for loans and deposits, with our remaining business operations conducted in the larger Cincinnati metropolitan area, which includes Warren, Butler and Clermont Counties in Ohio. We also conduct a moderate level of business in the northern Kentucky region and make loans secured by properties in Campbell, Kenton and Boone Counties in Kentucky. We will, on occasion, make loans secured by properties located outside of our primary market. The local economy is diversified with services, trade and manufacturing being the most prominent employment sectors in Hamilton County. The employment base is diversified, and there is no dependence on one area of the economy for continued employment. Major employers in the market include Proctor & Gamble, Kroger, Macy’s, Children’s Hospital, city and county governments and the University of Cincinnati. Our future growth opportunities will be influenced by the growth and stability of the regional, state and national economies, other demographic trends and the competitive environment.
Competition
We face competition within our market area both in making loans and attracting deposits. Our market area has a concentration of financial institutions that include large money center and regional banks, community banks and credit unions. We also face competition from commercial banks, savings institutions, mortgage banking firms, consumer finance companies and, with respect to deposits, from money market funds, brokerage firms, mutual funds and insurance companies.
Lending Activities
General. Our principal lending activity is originating one- to four-family residential real estate loans, and, to a lesser extent, commercial real estate and multi-family loans and construction loans. We also originate consumer loans (including home equity lines of credit and automobile loans). Prior to 2012, we engaged in significant non-owner occupied one- to four-family and subprime lending. Since June 2012, we no longer make subprime loans, subject to very limited exceptions, and only make non-owner occupied single-family loans on a limited basis, subject to more stringent underwriting standards. In recent years we have expanded our commercial real estate loan portfolio in an effort to diversify our overall loan portfolio, increase the yield of our loans and shorten asset duration. We intend to continue to expand our commercial real estate, multi-family and construction lending in the future. We also offer commercial loans, secured by assets other than real estate.
Prior to May 2013, our practice was to retain in our portfolio all of the loans we originate. However, since that time, we have implemented a policy of selling in the secondary market most of our newly originated fixed-rate one- to four-family residential mortgage loans with terms to maturity greater than 15 years, while retaining shorter-term fixed-rate and adjustable rate one- to four-family residential mortgages. During the year ended June 30, 2016, we also sold certain jumbo residential real estate loans to another financial institution, retaining the servicing on these loans. Our decision to sell loans is based on our desire to manage our interest rate risk, capital and liquidity needs. We may, at times, retain within our loan portfolio a modest amount of longer-term residential mortgage loans.
Loan Approval Procedures and Authority. Pursuant to applicable law, the aggregate amount of loans that we are permitted to make to any one borrower or a group of related borrowers is generally limited to 15% of the Bank’s unimpaired capital and surplus (25% if the amount in excess of 15% is secured by “readily marketable collateral” or 30% for certain residential development loans). At June 30, 2016, our largest credit relationship totaled $2.2 million and consisted of five loans secured by commercial real estate and a parcel of one- to four-family residential real estate. Our second largest relationship at June 30, 2015 totaled $2.1 million and consisted of four loans secured by multi-family real estate and one loan secured by one- to four-family residential real estate. At June 30, 2016, all of these loans were performing in accordance with their terms.
Our lending is subject to written underwriting standards and origination procedures. Decisions on loan applications are made on the basis of detailed applications submitted by the prospective borrower and property valuations (consistent with our appraisal policy) prepared by outside independent licensed appraisers as well as internal evaluations, where permitted by regulations. The loan applications are designed primarily to determine the borrower’s ability to repay the requested loan, and the more significant items on the application are verified through use of credit reports, financial statements and tax returns.
Generally, we require title insurance on our mortgage loans as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property, depending on the type of loan. We also require flood insurance if the property is in a flood zone.
Our President and Chief Executive Officer and our Executive Vice President, Lending each have approval authority of up to $417,000 for secondary market residential mortgage loans that have also been approved through the secondary market automated approval process. Loans less than or equal to $1.0 million are approved by our management loan committee, which consists of five members of management. Loans greater than $1.0 million, and those less than $1.0 million with policy exceptions, require approval by our Board of Directors.
Loan Originations, Participations, Purchases and Sales
We originate real estate and other loans through advertising and employee marketing efforts, our existing customer base, walk-in customers and referrals. All loans that we originate are underwritten pursuant to our policies and procedures.
In May 2013, as part of our interest rate risk management strategy, we initiated a secondary market program focused on selling some or all of our fixed rate one- to four-family mortgage loan originations with terms to maturity of 15 years or greater. We are approved to sell mortgages to the FHLB-Cincinnati, pursuant to its mortgage purchase program, and to several other private mortgage investors. We may seek approval to sell loans to Fannie Mae in the future. We retain the servicing on all loans that we sell to the FHLB-Cincinnati, and we release the servicing on all loans that are sold to other mortgage investors. We intend to continue this practice in the future, subject to the pricing of retaining such servicing rights.
We sell our loans without recourse, except for customary representations and warranties provided in sales transactions. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent borrowers, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. We retain a portion of the interest paid by the borrower on the loans we service as consideration for our servicing activities. For the years ended June 30, 2016 and 2015, we sold $12.5 million and $3.2 million, respectively, of mortgage loans. We retained servicing on loans sold. At June 30, 2016, we serviced $8.2 million of fixed-rate, one- to four-family residential real estate loans that we originated and sold in the secondary market to the FHLB-Cincinnati. We also serviced certain jumbo residential mortgage loans that we sold to other investors totaling $6.9 million at that date.
We currently do not purchase loans or loan participations from third parties. However, we may in the future elect to do so, depending upon market conditions, in order to supplement our loan production.
Allowance for Loan Losses
Analysis and Determination of the Allowance for Loan Losses. Our allowance for loan losses is the amount considered necessary to reflect probable incurred losses in our loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
When assessing the appropriateness of the allowance for loan losses, we consider its two key elements: (1) specific allowances for identified impaired loans; and (2) a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.
We identify loans that may need to be charged-off as a loss by reviewing all delinquent loans, classified loans, and other loans about which management may have concerns about collectability. For individually reviewed loans, the borrower’s inability to make payments under the terms of the loan, as well as a shortfall in collateral value, could result in our charging-off the loan or the portion of the loan that was impaired.
Among other factors, we consider current general economic conditions in determining the appropriateness of the allowance for loan losses for our residential real estate portfolio. We use evidence obtained from our own loan portfolio as well as published housing data on our local markets from third party sources we believe to be reliable as a basis for assumptions on real estate valuations.
Substantially all of our loans are secured by collateral. Loans 90 days past due and other classified loans are evaluated for impairment and general or specific allowances are established. Typically for a nonperforming real estate loan in the process of collection, the value of the underlying collateral is estimated using either the original independent appraisal, adjusted for current economic conditions and other factors, or a new independent appraisal or evaluation, and related general or specific allowances for loan losses are adjusted quarterly. If a nonperforming real estate loan is in the process of foreclosure and/or there are serious doubts about further collectability of principal or interest, and there is uncertainty about the value of the underlying collateral, we will order a new independent appraisal or evaluation if it has not already been obtained. Any shortfall would result in immediately charging-off that portion of the loan that was impaired.
Specific Allowances for Identified Problem Loans. We establish a specific allowance when loans are determined to be impaired. Loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral less estimated selling expenses. Factors in identifying a specific problem loan include: (1) the strength of the customer’s personal or business cash flows; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrower’s effort to cure the delinquency. In addition, for loans secured by real estate, we consider the extent of any past due and unpaid property taxes applicable to the property serving as collateral on the mortgage.
General Valuation Allowance on the Remainder of the Loan Portfolio. We establish a general allowance for loans that are not identified as impaired to recognize the probable incurred losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends and management’s evaluation of the collectability of the loan portfolio. The allowance may be adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary market area, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are re-evaluated quarterly to ensure their relevance in the current real estate environment.
As an integral part of their examination process, the Federal Deposit Insurance Corporation (the “FDIC”) and the Ohio Division of Financial Institutions (the “ODFI”) will periodically review our allowance for loan losses. Such agencies may require that we recognize additions to the allowance based on their judgments of information available to them at the time of their examination.
Investment Activities
General. The goals of our investment policy are to provide and maintain liquidity to meet day-to-day, cyclical and long-term liquidity needs, to help mitigate interest rate and market risk within the parameters of our interest rate risk policy, and to generate a dependable flow of earnings within the context of our interest rate and credit risk objectives. Subject to loan demand and our interest rate risk analysis, we will increase the balance of our investment securities portfolio when we have excess liquidity.
Our current investment policy permits, with certain limitations, investments in United States Treasury securities; securities issued by the United States Government and its agencies or government sponsored enterprises including mortgage-backed securities (“MBS”) and collateralized mortgage obligations (“CMO”) issued by Fannie Mae, Ginnie Mae and Freddie Mac; corporate bonds and obligations; debt securities of states and municipalities; commercial paper; certificates of deposit in other financial institutions and mutual funds.
Sources of Funds
General. Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also use borrowings, primarily FHLB-Cincinnati advances, to supplement cash flow needs, lengthen the maturities of liabilities for interest rate risk purposes and to manage the cost of funds. In addition, we receive funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. We may utilize repurchase agreements or federal funds purchased as funding sources, although we have not used these funding sources during recent periods.
We have recently expanded and improved the products and services we offer our retail and business deposit customers and have improved our infrastructure for electronic banking services. We began offering both personal and business checking accounts in May 2013. Since May 2013, we have provided our customers with free access to the ATM network of a larger regional bank with numerous offices throughout our market area and beyond. In May 2013, we substantially upgraded our capabilities and commenced offering online banking services, including bill pay, remote deposit capture, eStatements and debit cards. We have enhanced online banking services particularly for our business customers in 2014, including merchant capture, online cash management tools, ACH, wire transfer capabilities, mobile banking and night drop services. In 2016 we installed our first walk-up ATM at our new branch location. We are currently constructing a drive-through facility adjacent to our new branch. This new facility will offer drive-through lanes for ATM and Integrated Teller Machine (ITM) access and is expected to open in the second quarter of fiscal 2017. The deposit infrastructure we have established can accommodate significant increases in retail and business deposit accounts without significant additional capital expenditure.
Deposits. Our deposits are generated primarily from our primary market area. We offer a selection of deposit accounts, including non-interest-bearing and interest-bearing checking accounts, statement savings accounts, variable rate money market accounts, and certificates of deposit. We historically have not used, and currently do not hold any, brokered or Internet deposits. We currently subscribe to the Qwickrate program but have not opened any deposits under that program. Depending on our future needs, we may utilize brokered savings accounts, the Certificate of Deposit Registry Service (“CDARS”) and the Qwickrate program as alternative funding sources.
Borrowings. We may obtain advances from the FHLB-Cincinnati upon the security of our capital stock in the FHLB-Cincinnati and certain of our mortgage loans. Such advances may be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. To the extent such borrowings have different repricing terms than our deposits, they can change our interest rate risk profile. During the past several years, we have increased our balance of FHLB-Cincinnati advances, and have used laddered terms to maturity of between 15 to 20 years and fixed rates. See Note 7 to the Consolidated Financial Statements in Item 8 of Part II for information on the maturity of our FHLB-Cincinnati advances. At June 30, 2016, we had $25.3 million in outstanding advances from the FHLB-Cincinnati. At June 30, 2016, based on available collateral and our ownership of FHLB-Cincinnati stock, and based upon our internal policy, we had access to additional FHLB-Cincinnati advances of up to $20.1 million, and an additional $10.0 million on a line of credit with the FHLB-Cincinnati.
Employees
As of June 30, 2016, we had 15 full-time equivalent employees and 19 total employees. Our employees are not represented by any collective bargaining group. Management believes that we have a good working relationship with our employees.
REGULATION AND SUPERVISION
General
As an Ohio-chartered savings and loan association, the Bank is subject to examination and regulation by the ODFI and the FDIC. The federal and state systems of regulation and supervision establish a comprehensive framework of activities in which the Bank may engage and are intended primarily for the protection of depositors and the FDIC’s Deposit Insurance Fund, and not for the protection of security holders. Under this system of regulation, financial institutions are periodically examined to ensure that they satisfy applicable standards with respect to their capital adequacy, assets, management, earnings, liquidity and sensitivity to market interest rates. The Bank also is regulated to a lesser extent by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”), which governs the reserves to be maintained against deposits and other matters. The Bank must comply with consumer protection regulations issued by the Consumer Financial Protection Bureau. The Bank also is a member of and owns stock in the Federal Home Loan Bank of Cincinnati, which is one of the twelve regional banks in the Federal Home Loan Bank System. The ODFI and the FDIC examine the Bank and prepare reports for the consideration of its board of directors on any operating deficiencies. The Bank’s relationship with its depositors and borrowers also is regulated to a great extent by federal law and, to a much lesser extent, state law, especially in matters concerning the ownership of deposit accounts, the form and content of the Bank’s loan documents and certain consumer protection matters.
As a savings and loan holding company, we are subject to examination and supervision by, and are required to file certain reports with, the Federal Reserve Board. We are also subject to the rules and regulations of the Securities and Exchange Commission (the “SEC”) under the federal securities laws.
Set forth below are descriptions of certain material regulatory requirements that are applicable to the Bank and the Company. The descriptions below are not intended to be a complete description of such statutes and regulations and their effects on the Bank and the Company. Any change in these laws or regulations, whether by Congress or the applicable regulatory agencies, could have a material adverse impact on the Company, the Bank and their operations.
Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) made significant changes to the regulatory structure for depository institutions and their holding companies. However, the Dodd-Frank Act’s changes go well beyond that and affect the lending, investments and other operations of all depository institutions. The Dodd-Frank Act required the Federal Reserve Board to set minimum capital levels for both bank holding companies and savings and loan holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital for holding companies were restricted to capital instruments that were then currently considered to be Tier 1 capital for insured depository institutions. The legislation also established a floor for capital of insured depository institutions that cannot be lower than the standards in effect upon passage, and directed the federal banking regulators to implement new leverage and capital requirements that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives.
The Dodd-Frank Act created a new governmental authority, the Consumer Financial Protection Bureau, with broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, such as the Bank. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10 billion in assets. Banks and savings institutions with $10 billion or less in total assets are still examined for compliance by their applicable bank regulators. The new legislation also gave state attorneys general the ability to enforce applicable federal consumer protection laws.
The Dodd-Frank Act broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution, rather than on total deposits. The legislation also permanently increased the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2008. The Dodd-Frank Act increased stockholder influence over boards of directors by requiring companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives, regardless of whether the company is publicly traded or not. Further, the legislation requires that originators of securitized loans retain a percentage of the risk for transferred loans, directs the Federal Reserve Board to regulate pricing of certain debit card interchange fees and contains a number of reforms related to mortgage origination.
Some provisions of the Dodd-Frank Act have not been fully implemented and, therefore, their impact on our operations cannot yet fully be assessed. However, the Dodd-Frank Act has resulted in an increased regulatory burden and compliance, operating and interest expense for us and the Bank, and further increases in burdens and expenses are possible.
State Banking Regulation
The ODFI is responsible for the regulation and supervision of Ohio savings institutions in accordance with the laws of the State of Ohio. Ohio law prescribes the permissible investments and activities of Ohio savings and loan associations, including the types of lending that such associations may engage in and the investments that such associations may make. The ability of Ohio associations to engage in these state-authorized investments or activities is subject to oversight and approval by the FDIC, if such investments or activities are not permissible for a federally chartered savings and loan association.
The ODFI also has authority to grant the necessary approvals for the payment of dividends and any mergers involving or acquisitions of control of Ohio savings institutions. The ODFI may initiate certain supervisory measures or formal enforcement actions against Ohio associations. Ultimately, if the grounds provided by law exist, the ODFI may place an Ohio association in conservatorship or receivership.
The ODFI conducts regular examinations of the Bank. Such examinations are usually conducted jointly with the FDIC. The ODFI imposes assessments on Ohio associations based on their asset size to cover the cost of supervision and examination.
Federal Banking Regulation
Capital Requirements
On July 9, 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, all top-tier bank holding companies and savings and loan holding companies with total consolidated assets of $1.0 billion or more and holding companies with total consolidated assets of less than $1.0 billion that do not meet certain qualitative criteria.
The rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property.
The rule also includes changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period. Finally, Tier 1 capital will include accumulated other comprehensive income (which includes all unrealized gains and losses on available for sale debt and equity securities), subject to a two-year transition period. The Bank had the one-time option in the first quarter of 2015 to permanently opt out of the inclusion of accumulated other comprehensive income in its capital calculation. The Bank opted out in order to reduce the impact of market volatility on its regulatory capital levels.
The new capital requirements also include changes in the risk-weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and non-residential mortgage loans that are 90 days past due or otherwise on non-accrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital; and increased risk-weights (from 0% to up to 600%) for equity exposures.
Finally, the rule limits capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements.
The final rule became effective for the Bank on January 1, 2015. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019.
At June 30, 2016, the Bank’s capital exceeded all applicable requirements.
Loans-to-One-Borrower. Generally, under federal law, an Ohio savings association, such as the Bank, may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of June 30, 2016, the Bank was in compliance with the loans-to-one-borrower limitations.
Qualified Thrift Lender Test. As an Ohio savings association, the Bank must satisfy the qualified thrift lender, or “QTL,” test. Under the QTL test, the Bank must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” (primarily residential mortgages and related investments, including mortgage-backed securities) in at least nine months of the most recent 12-month period. “Portfolio assets” generally means total assets of a savings association, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings association’s business.
Alternatively, the Bank may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code of 1986, as amended.
An Ohio savings association that fails the qualified thrift lender test must operate under specified restrictions set forth in the Home Owners’ Loan Act. The Dodd-Frank Act made noncompliance with the QTL test subject to enforcement action for a violation of law. At June 30, 2016, the Bank maintained 78% of its portfolio assets in qualified thrift investments and, therefore, satisfied the QTL test. The Bank has satisfied the QTL test in each of the last 12 months.
Capital Distributions. Federal regulations govern capital distributions by an Ohio savings association, which include cash dividends, stock repurchases and other transactions charged to the savings association’s capital account. An Ohio savings association must file an application for approval of a capital distribution if:
·the total capital distributions for the applicable calendar year exceed the sum of the savings association’s net income for that year to date plus the savings association’s retained net income for the preceding two years;
·the savings association would not be at least adequately capitalized following the distribution;
·the distribution would violate any applicable statute, regulation, agreement or regulatory condition; or
·the savings association is not eligible for expedited treatment of its filings.
Even if an application is not otherwise required, every savings association that is a subsidiary of a savings and loan holding company, such as the Bank, must still file a notice with the Federal Reserve Board at least 30 days before the board of directors declares a dividend or approves a capital distribution.
A notice or application related to a capital distribution may be disapproved if:
·the Ohio savings association would be undercapitalized following the distribution;
·the proposed capital distribution raises safety and soundness concerns; or
·the capital distribution would violate a prohibition contained in any statute, regulation or agreement.
In addition, federal law provides that an insured depository institution may not make any capital distribution if, after making such distribution, the institution would fail to meet any applicable regulatory capital requirement. An Ohio savings association also may not make a capital distribution that would reduce its regulatory capital below the amount required for the liquidation account established in connection with its conversion to stock form. In addition, beginning in 2016, the Bank’s ability to pay dividends will be limited if the Bank does not have the capital conservation buffer required by the new capital rules, which may limit the ability of the Company to pay dividends to its stockholders. See “Federal Banking Regulations-Capital Requirements” under this Item 1.
Community Reinvestment Act and Fair Lending Laws. All Ohio savings associations have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of an Ohio savings association, the ODFI and the FDIC are required to assess its record of compliance with the Community Reinvestment Act. A savings association’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the ODFI and the FDIC, as well as other federal regulatory agencies and the U.S. Department of Justice.
The Community Reinvestment Act requires all institutions insured by the FDIC to publicly disclose their ratings. The Bank received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.
Transactions with Related Parties. An Ohio savings association’s authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and Regulation W of the Federal Reserve Board. An affiliate is generally a company that controls, or is under common control with, an insured depository institution, such as the Bank. The Company is an affiliate of the Bank because of its control of the Bank. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative limits and collateral requirements. In addition, transactions with affiliates must be consistent with safe and sound banking practices, not involve the purchase of low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates.
The Bank’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions generally require that extensions of credit to insiders:
·be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and
·not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital.
In addition, extensions of credit in excess of certain limits must be approved by the Bank’s loan committee or board of directors. Extensions of credit to executive officers are subject to additional limits based on the type of extension involved.
Enforcement. The ODFI and the FDIC have primary enforcement responsibility over Ohio savings associations and have authority to bring enforcement action against all “institution-affiliated parties,” including directors, officers, stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an Ohio savings association. Formal enforcement action by the ODFI and the FDIC may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC also has the authority to terminate deposit insurance and to recommend to the ODFI that enforcement action be taken with respect to a particular savings association. If such action is not taken, the FDIC has authority to take the action under specified circumstances.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Prompt Corrective Action Regulations. The FDIC is required by law to take supervisory actions against undercapitalized savings institutions under its jurisdiction, the severity of which depends upon the institution’s level of capital.
Under the FDIC’s prompt corrective action regulations, undercapitalized institutions become subject to mandatory regulatory scrutiny and limitations, which increase as capital decreases. Generally, the FDIC is required to appoint a receiver or conservator for a savings bank that is “critically undercapitalized” within specific time frames. The regulations also provide that a capital restoration plan must be filed with the FDIC within 45 days of the date that an Ohio savings association is deemed to have received notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company of an Ohio savings association that is required to submit a capital restoration plan must guarantee performance under the plan in an amount of up to the lesser of 5% of the savings association’s assets at the time it was deemed to be undercapitalized by the FDIC or the amount necessary to restore the savings bank to adequately capitalized status. This guarantee remains in place until the FDIC notifies the savings association that it has maintained adequately capitalized status for each of four consecutive calendar quarters. Institutions that are undercapitalized become subject to certain mandatory measures such as a restrictions on capital distributions and asset growth. The FDIC may also take any one of a number of discretionary supervisory actions against undercapitalized Ohio savings association, including the issuance of a capital directive and the replacement of senior executive officers and directors.
At June 30, 2016, the Bank met the capital requirements to be considered “well capitalized” under the prompt corrective action rules.
The FDIC’s prompt corrective action standards changed with the new capital ratios. Under the new standards, in order to be considered well-capitalized, the Bank must have a common equity Tier 1 ratio of 6.5% (new), a Tier 1 risk-based capital ratio of 8.0% (increased from 6.0%), a total risk-based capital ratio of 10.0% (unchanged), and a Tier 1 leverage ratio of 5.0% (unchanged). We have determined that the Bank meets the capital requirements necessary to be deemed well-capitalized under these new standards as of June 30, 2016.
Insurance of Deposit Accounts. The Deposit Insurance Fund of the FDIC insures deposits at FDIC-insured financial institutions, such as the Bank. Deposit accounts in the Bank are insured by the FDIC generally up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The FDIC charges insured depository institutions premiums to maintain the Deposit Insurance Fund.
Under the FDIC’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. Rates are based on each institution’s risk category and certain specified risk adjustments. Stronger institutions pay lower rates while riskier institutions pay higher rates.
The assessment base used for calculating deposit insurance assessments is an institution’s average consolidated total assets minus average tangible equity. The assessment rate schedule establishes assessments ranging from 2.5 to 45 basis points.
In addition to the FDIC assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended June 30, 2016, the annualized FICO assessment was equal to 0.56 basis points of total assets less tangible capital.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.
Prohibitions Against Tying Arrangements. Ohio savings associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank System provides a central credit facility primarily for member institutions as well as other entities involved in home mortgage lending. As a member of the FHLB-Cincinnati, the Bank is required to acquire and hold shares of capital stock in the Federal Home Loan Bank. As of June 30, 2016, the Bank was in compliance with this requirement. While the Bank’s ability to borrow from the FHLB-Cincinnati provides an additional source of liquidity, the Bank has from time to time used advances from the FHLB to fund its operations.
Other Regulations
Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:
·Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;
·Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;
·Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
·Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
·Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
·Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;
·Truth in Savings Act; and
·rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
In addition, the Consumer Financial Protection Bureau issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting “ability to repay” and “qualified mortgage” standards for residential mortgage loans and mortgage loan servicing and originator compensation standards. The Bank is evaluating recent regulations and proposals, and devotes significant compliance, legal and operational resources to compliance with consumer protection regulations and standards.
The operations of the Bank also are subject to the:
·Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
·Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;
·Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;
·USA PATRIOT Act, which requires savings banks to, among other things, establish broadened anti-money laundering compliance programs, and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and
·Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution’s privacy policy and provide such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.
Holding Company Regulation
General. The Company is a savings and loan holding company within the meaning of HOLA. As such, we are registered with the Federal Reserve Board and subject to regulations, examinations, supervision and reporting requirements applicable to savings and loan holding companies. In addition, the Federal Reserve Board has enforcement authority over us. The ODFI also has examination and enforcement authority over a savings and loan holding company. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to the subsidiary savings institution.
Permissible Activities. Under present law, our business activities are generally limited to those activities permissible for financial holding companies under Section 4(k) of the Bank Holding Company Act of 1956, as amended, provided certain conditions are met, or for multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, including underwriting equity securities and insurance as well as activities that are incidental to financial activities or complementary to a financial activity.
Federal law prohibits a savings and loan holding company, including the Company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or holding company thereof, without prior regulatory approval. It also prohibits the acquisition or retention of, with certain exceptions, more than 5% of a nonsubsidiary company engaged in activities that are not closely related to banking or financial in nature, or acquiring or retaining control of an institution that is not federally insured. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider the financial and managerial resources, future prospects of the company and institution involved, the effect of the acquisition on the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors.
The Federal Reserve Board is prohibited from approving any acquisition that would result in a savings and loan holding company controlling separate savings associations located in different states, subject to two exceptions:
·the approval of interstate supervisory acquisitions by savings and loan holding companies; and
·the acquisition of a savings association in another state if the laws of the state of the target savings institution specifically permit such acquisition.
The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Capital. Savings and loan holding companies historically have not been subject to consolidated regulatory capital requirements. The Dodd-Frank Act requires the Federal Reserve Board to establish for depository institution holding companies minimum consolidated capital requirements that are as stringent as those required for the insured depository subsidiaries. Under regulations recently enacted by the Federal Reserve Board, savings and loan holding companies with total consolidated assets of $1.0 billion or more, as well as those with total consolidated assets of less than $1.0 billion that do not meet certain other criteria, are subject to regulatory capital requirements that generally are the same as the new capital requirements for the Bank. These new capital requirements include provisions that might limit our ability to pay dividends to our stockholders or repurchase our shares. However, as the Company has total consolidated assets of less than $1.0 billion and meets the stated criteria of the Federal Reserve Board’s Small Bank Holding Company Policy, the Company currently is exempt from such capital requirements. See “Federal Banking Regulation-Capital Requirements and-Capital Distributions” under this Item 1.
Source of Strength. The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies. The Federal Reserve Board has issued regulations requiring that all savings and loan holding companies serve as a source of managerial and financial strength to their subsidiary savings associations by providing capital, liquidity and other support in times of financial stress.
Dividends. The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies and savings and loan holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate or earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a savings and loan holding company to pay dividends may be restricted if a subsidiary savings association becomes undercapitalized. The policy statement also states that a savings and loan holding company should inform the Federal Reserve Board supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the savings and loan holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect our ability to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.
Acquisition. Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person, or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the company’s outstanding voting stock, unless the Federal Reserve Board has found that the acquisition will not result in control of the company. A change in control definitively occurs upon the acquisition of 25% or more of the company’s outstanding voting stock. Under the Change in Bank Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition.
Federal Securities Laws
The Company’s common stock is registered with the SEC under the Securities Exchange Act of 1934, as amended. We are subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.
Shares of common stock purchased by persons who are not our affiliates may be resold without registration. Shares purchased by our affiliates are subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If we meet the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of ours that complies with the other conditions of Rule 144, including those that require the affiliate’s sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of 1% of our outstanding shares, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, we may permit affiliates to have their shares registered for sale under the Securities Act of 1933.
Emerging Growth Company Status
The Jumpstart Our Business Startups Act (the “JOBS Act”), which was enacted in April 2012, has made numerous changes to the federal securities laws to facilitate access to capital markets. Under the JOBS Act, a company with total annual gross revenues of less than $1.0 billion during its most recently completed fiscal year qualifies as an “emerging growth company.” The Company qualifies as an emerging growth company under the JOBS Act.
An “emerging growth company” may choose not to hold stockholder votes to approve annual executive compensation (more frequently referred to as “say-on-pay” votes) or executive compensation payable in connection with a merger (more frequently referred to as “say-on-golden parachute” votes). An emerging growth company also is not subject to the requirement that its auditors attest to the effectiveness of the company’s internal control over financial reporting, and can provide scaled disclosure regarding executive compensation; however, we are not subject to the auditor attestation requirement or additional executive compensation disclosure so long as we remain a “smaller reporting company” under SEC regulations (generally less than $75 million of voting and non-voting equity held by non-affiliates). Finally, an emerging growth company may elect to comply with new or amended accounting pronouncements in the same manner as a private company, but must make such election when the company is first required to file a registration statement. Such an election is irrevocable during the period a company is an emerging growth company. We have elected to comply with new or amended accounting pronouncements in the same manner as a private company.
A company loses emerging growth company status on the earlier of: (i) the last day of the fiscal year of the company during which it had total annual gross revenues of $1.0 billion or more; (ii) the last day of the fiscal year of the issuer following the fifth anniversary of the date of the first sale of common equity securities of the company pursuant to an effective registration statement under the Securities Act of 1933; (iii) the date on which such company has, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; or (iv) the date on which such company is deemed to be a “large accelerated filer” under SEC regulations (generally, at least $700 million of voting and non-voting equity held by non-affiliates).
Sarbanes-Oxley Act of 2002
The Sarbanes-Oxley Act of 2002 addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, our Chief Executive Officer and Chief Financial Officer are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; they have made certain disclosures to our auditors and the audit committee of the board of directors about our internal control over financial reporting; and they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.
TAXATION
Federal Taxation
General. The Company and the Bank are subject to federal income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal taxation is intended only to summarize material federal income tax matters and is not a comprehensive description of the tax rules applicable to us and the Bank.
Method of Accounting. For federal income tax purposes, the Bank currently reports its income and expenses on the accrual method of accounting and uses a tax year ending June 30th for filing its federal income tax returns. We file a consolidated federal income tax return. The Company is not currently under audit with respect to its federal income tax return. The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for income taxes on bad debt reserves by savings institutions, effective for taxable years beginning after 1995.
Minimum Tax. The Internal Revenue Code of 1986, as amended, imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certain tax preferences, less an exemption amount, referred to as “alternative minimum taxable income.” The alternative minimum tax is payable to the extent tax computed this way exceeds tax computed by applying the regular tax rates to regular taxable income. Net operating losses can, in general, offset no more than 90% of alternative minimum taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. At June 30, 2016, the Bank is not subject to the alternative minimum tax and will not be subject to the alternative minimum tax until it exceeds the gross income threshold. At June 30, 2016, the Bank had no minimum tax credit carryforward.
Net Operating Loss Carryovers. Generally, a financial institution may carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. At June 30, 2016, the Bank had $5.7 million of federal net operating loss carryforwards.
Capital Loss Carryovers. A corporation cannot recognize capital losses in excess of capital gains generated. Generally, a financial institution may carry back capital losses to the preceding three taxable years and forward to the succeeding five taxable years. Any capital loss carryback or carryover is treated as a short-term capital loss for the year to which it is carried. As such, it is grouped with any other capital losses for the year to which carried and is used to offset any capital gains. Any undeducted loss remaining after the five year carryover period is not deductible. At June 30, 2016, the Bank had capital loss carryovers totaling $88,000.
Corporate Dividends. We may generally exclude from our income 100% of dividends that receive from the Bank because we are members of the same affiliated group of corporations.
State Taxation
The Company and the Bank are subject to Ohio taxation in the same general manner as other financial institutions. In particular, the Company and the Bank will file a consolidated Ohio Financial Institutions Tax (“FIT”) return. The FIT is based upon the net worth of the consolidated group. For Ohio FIT purposes, savings institutions are currently taxed at a rate equal to 0.8% of taxable net worth. The Bank is not currently under audit with respect to its Ohio FIT returns.
As a Maryland business corporation, the Company will be required to file an annual franchise tax return with the State of Maryland.
Item 1A.
Item 1A. Risk Factors
You should consider carefully the following risk factors in evaluating an investment in the shares of common stock.
We incurred significant operating losses during the past several years and may not achieve profitability by implementing our business strategies.
Although we recorded a net profit for fiscal 2016 and 2015 of $689,000 and $145,000, respectively, we experienced significant losses prior to that. During the years ended June 30, 2014 and 2013, we had net losses of $482,000 and $3.3 million, respectively. These losses were due primarily to provisions for loan losses, losses on impairments and sales of real estate owned, and collection and other expenses related to nonperforming assets as we aggressively focused on reducing classified and nonperforming loans, particularly non-owner occupied residential real estate loans and subprime loans, originated prior to 2012. Our net losses also resulted from expense related to the directors deferred compensation benefits, the valuation allowance applied to our net deferred tax asset, which offset federal income tax benefits from our net losses, and data processing conversion expenses. Our growth is essential to our future profitability, and we expect to incur expenses related to the implementation of our growth plan, including the development and marketing of new products and services and branch expansion. In addition, the conversion has had an adverse impact on our operating results, due to additional costs related to being a public company and increased compensation expenses associated with our employee stock ownership plan and our stock-based benefit plans.
Our ability to achieve profitability depends upon a number of factors, including our ability to successfully implement our business strategy, to manage expenses related to nonperforming and classified assets, general economic conditions, competition with other financial institutions, changes to the interest rate environment that may reduce our profit margins or impair our business strategy, adverse changes in the securities markets, changes in laws or government regulations, changes in consumer spending, borrowing, or saving, and changes in accounting policies, as well as other risks and uncertainties described in this “Risk Factors” section.
We have a significant amount of net operating losses that we may not be able to utilize.
In recent years, we have generated significant net operating losses and unrealized tax losses (collectively, “NOLs”). As of June 30, 2016, we had an estimated federal NOL carryforward of $5.7 million. A valuation allowance has been recorded against a portion of the future tax benefit. These NOLs generally may be carried forward for a 20-year period to offset future taxable income and reduce our federal income tax liability. As a result of our reorganization and conversion from the mutual to stock form of ownership and our contemporaneous stock offering, we may incur an “ownership change” under Section 382 of the Internal Revenue Code (“Section 382”). An ownership change will occur if, over a rolling three-year period, the percentage of the company stock owned by stockholders holding 5% or more of our common stock has increased by more than 50 percentage points over the lowest percentage of common stock owned by such stockholders during the three-year period.
In general, if a company incurs an ownership change under Section 382, the company’s ability to utilize an NOL carryforward to offset its taxable income becomes limited to a certain amount per year. This limitation is computed by multiplying our fair market value immediately before the ownership change (if the ownership change occurs as a result of the conversion and stock offering) by a rate equal to the long-term tax-exemption rate for the month in which the ownership change occurs. The federal NOL carryforwards expire substantially beginning in 2031.
If we are unable to offset our taxable income to the maximum permitted amount, we would incur additional income tax liability, which would adversely affect our results of operations.
We depend on our management team to implement our business strategy and execute successful operations and we could be harmed by the loss of their services.
We are dependent upon the services of the members of our senior management team who direct our strategy and operations. Since 2012, we have replaced our senior management team with experienced executives, with our top three executives each having at least 20 years of financial institution experience. Members of our senior management team, or lending personnel who possess expertise in our markets and key business relationships, could be difficult to replace. Our loss of these persons, or our inability to hire additional qualified personnel, could impact our ability to implement our business strategy and could have a material adverse effect on our results of operations and our ability to compete in our markets.
A portion of our one- to four-family residential mortgage loans is comprised of subprime loans, which have higher delinquency rates and charge-offs than the remainder of our residential loan portfolio.
Prior to 2012, we offered subprime loans to borrowers for the purchase or refinance of one- to four-family residences, primarily owner occupied. Because we applied less stringent underwriting and credit standards to these loans, our subprime loans have greater credit risk than traditional residential real estate mortgage loans. As of June 30, 2016, we had $6.5 million of subprime loans in our portfolio, 3.4% of which were delinquent 30 days or more. We discontinued originations of subprime loans in 2012, subject to very limited exceptions.
A portion of our one- to four-family residential mortgage loans is comprised of non-owner occupied properties which increases the credit risk on this portion of our loan portfolio.
The housing stock in our primary lending market area is comprised in part of single-family rental properties as well as two- to four-unit properties. At June 30, 2016, of the $65.3 million of one- to four-family residential mortgage loans in our portfolio, $12.2 million, or 18.7%, were comprised of non-owner occupied properties. Our non-owner occupied residential loans were secured primarily by single-family properties, and to a much lesser extent, by two- to four-unit properties We believe that there is a greater credit risk inherent in investor-owner and non-owner occupied properties, than in owner-occupied single-family properties since, similar to commercial real estate and multi-family loans, the repayment of these loans may depend, in part, on the successful management of the property and/or the borrower’s ability to lease the units of the property. In addition, the physical condition of non-owner-occupied properties is often below that of owner-occupied properties due to lax property maintenance standards, which has a negative impact on the collateral value. Furthermore, some of our non-owner-occupied borrowers have more than one loan outstanding with us, which may expose us to a greater risk of loss compared to residential and commercial borrowers with only one loan. A downturn in the real estate market or the local economy could adversely affect the value of properties securing these loans or the revenues derived from these properties which could affect the borrower’s ability to repay the loan. At June 30, 2015, none of our non-owner occupied one- to four-family loans were delinquent 30 days or more.
A portion of our loans are commercial real estate and multi-family loans and construction loans, which carry greater credit risk than loans secured by owner occupied one- to four-family real estate. We intend to increase our focus on commercial real estate and multi-family loans and construction loans, and to begin making commercial business loans which also carry greater credit risk.
At June 30, 2016, commercial real estate and multi-family loans totaled $26.6 million, or 26.2%, and construction loans totaled $6.7 million, or 6.6%, of our loan portfolio. We have recently started to originate non-real estate commercial loans. Given their larger balances and the complexity of the underlying collateral, commercial real estate, multi-family, construction and commercial loans generally expose a lender to greater credit risk than loans secured by owner occupied one- to four-family real estate. These loans, as well as consumer loans, also have greater credit risk than owner-occupied residential real estate for the following reasons:
·commercial real estate and multi-family loans - repayment is dependent on income being generated in amounts sufficient to cover operating expenses, property maintenance and debt service;
·construction loans - repayment is generally dependent on the borrower’s ability to sell the completed project, the value of the completed project, or the successful operation of the borrower’s business after completion;
·commercial loans - repayment is generally dependent upon the successful operation of the borrower’s business; and
·consumer loans - repayment is dependent on the borrower’s continuing stability and the collateral may not provide an adequate source of repayment.
If loans that are collateralized by real estate or other business assets or consumer assets become troubled and the value of the collateral has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our operating results and financial condition.
Furthermore, a key component of our business strategy is to increase our origination of commercial real estate and multi-family loans, and, to a lesser extent, construction loans in our market area to diversify our loan portfolio and increase our yields. Our portfolios of both owner-occupied and non-owner occupied commercial real estate and multi-family loans are expected to increase significantly. The proposed increase in these types of loans significantly increases our exposure to the risks inherent in these types of loans.
Commercial real estate and multi-family loans, particularly those secured by non-owner-occupied properties, expose us to greater risk of non-payment and loss than loans secured by owner-occupied one-to four-family properties because repayment of such loans depend primarily on the tenant’s continuing ability to pay rent to the property owner, who is our borrower, or, if the property owner is unable to find a tenant, the property owner’s ability to repay the loan without the benefit of a rental income stream. In addition, the physical condition of non-owner-occupied properties is often below that of owner-occupied properties due to lax property maintenance standards, which has a negative impact on collateral value. Furthermore, some of our non-owner-occupied borrowers have more than one loan outstanding with us, which may expose us to a greater risk of loss compared to residential and commercial borrowers with only one loan.
Our allowance for loan losses may be insufficient.
We maintain an allowance for loan losses to provide for probable loan losses based on management’s quarterly analysis of the loan portfolio. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (“GAAP”) requires management to make significant estimates that affect the financial statements. One of our most critical estimates is the level of the allowance for loan losses. Due to the inherent nature of these estimates, we cannot provide absolute assurance that we will not be required to charge earnings for significant unexpected loan losses. For more information on the sensitivity of these estimates, refer to the discussion of our “Critical Accounting Policies” under Item 7 of Part II.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within the loan portfolio. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. In deciding whether to extend credit or enter into other transactions with customers and counterparties, we may rely on information provided to us by customers and counterparties, including financial statements and other financial information. We may also rely on representations of customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to a business, we may assume that the customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. We may also rely on the audit report covering those financial statements. Our financial condition, results of operations and cash flows could be negatively impacted to the extent that we rely on financial statements that do not comply with GAAP or on financial statements and other financial information that are materially misleading.
Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the future. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions that could have a material adverse impact on our financial condition and results of operations. In addition, federal and state regulators periodically review our allowance for loan losses as part of their examination process and may require management to increase the allowance or recognize further loan charge-offs based on judgments different than those of management. Moreover, the Financial Accounting Standards Board may change its requirements for establishing the allowance. Any increase in the provision for loan losses to raise the allowance to the required amount would decrease our pretax and net income.
If our nonperforming assets increase, our earnings will be adversely affected.
At June 30, 2016, our nonperforming assets, which consist of non-accruing loans, were $1.2 million, or 1.0% of total assets. Our nonperforming assets adversely affect our net income in various ways:
·we record no interest income on non-accrual loans or on any nonperforming investment securities, and we do not record interest income for real estate owned;
·we must provide for probable loan losses through a current period charge to the provision for loan losses;
·noninterest expense increases when we write down the value of properties in our real estate owned portfolio to reflect changing market values; non-interest income decreases when we recognize other-than-temporary impairment on nonperforming investment securities;
·there are legal fees associated with the resolution of problem assets, as well as carrying costs, such as taxes, insurance, and maintenance fees related to our real estate owned; and
·the resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity.
If additional borrowers become delinquent and do not pay their loans and we are unable to successfully manage our nonperforming assets, our losses and troubled assets could increase significantly, which could have a material adverse effect on our financial condition and results of operations.
We have a high concentration of loans secured by real estate in our market area. Adverse economic conditions, both generally and in our market area, could adversely affect our financial condition and results of operations.
We have relatively few loans outside of our market area, and, as a result, we have a greater risk of loan defaults and losses in the event of an economic downturn in our market area, as adverse economic conditions may have a negative effect on the ability of our borrowers to make timely payments of their loans. During the period from 2009 to 2013, economic conditions and real estate values within our market area declined significantly. We believe that such conditions have contributed to our non-performing assets and higher loan charge-offs and our provisions for loan losses during those years.
The overall economy, while showing signs of improvement, remains fragile, and deterioration in real estate values could increase nonperforming assets, require additional increases in loan loss reserves and elevate charge-off levels.
If our real estate owned is not properly valued or if our allowance for loan losses is insufficient, our earnings could be reduced.
We obtain updated valuations when a loan has been foreclosed and the property taken in as real estate owned and at certain other times during the holding period of the asset. Our net book value in the loan at the time of foreclosure and thereafter is compared to the updated fair value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s net book value over its fair value less estimated selling costs. If our valuation process is incorrect, or if property values decline, the fair value of any future acquisitions of real estate owned may not be sufficient to recover our carrying value in such assets, resulting in the need for additional charge-offs. Significant charge-offs to our real estate owned could have a material adverse effect on our financial condition and results of operations. In addition, bank regulators periodically review our real estate owned and may require us to recognize further charge-offs. Any increase in our charge-offs may have a material adverse effect on our financial condition and results of operations.
Changes in interest rates could adversely affect our financial condition and results of operations.
Our results of operations depend substantially on our net interest income, which is the difference between (i) the interest earned on loans, securities and other interest-earning assets and (ii) the interest paid on deposits and borrowings. These rates are highly sensitive to many factors beyond our control, including general economic conditions, inflation, recession, unemployment, money supply and the policies of various governmental and regulatory authorities. If the interest we pay on deposits and other borrowings increases at a faster rate than the interest we receive on loans and other investments, our net interest income and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest we receive on loans and other investments falls more quickly than the interest we pay on deposits and borrowings. While we have taken measures intended to manage the risks of operating in a changing interest rate environment, there can be no assurance that these measures will be effective in avoiding undue interest rate risk.
Increases in interest rates also can affect the value of loans and other assets, including our ability to realize gains on the sale of assets. We originate loans for sale and for our portfolio. Increasing interest rates may reduce the origination of loans for sale and consequently the fee income we earn on such sales. Further, increasing interest rates may adversely affect the ability of borrowers to pay the principal or interest on loans and leases, resulting in an increase in non-performing assets and a reduction of income recognized.
Income from secondary mortgage market operations is volatile, and we may incur losses or charges with respect to our secondary mortgage market operations which would negatively affect our earnings.
We have implemented a policy of selling in the secondary market a large majority of the longer-term fixed-rate residential mortgage loans that we originate, and have sold certain jumbo residential mortgage loans to another financial institution, earning non-interest income in the form of gains on sale. When interest rates rise, the demand for mortgage loans, particularly refinancing of existing mortgage loans, tends to fall and may reduce the number of loans available for sale. In addition to interest rate levels, weak or deteriorating economic conditions also tend to reduce loan demand. Although we originate, and intend to continue originating, loans on a “best efforts” basis, and we sell, and intend to continue selling, loans in the secondary market without recourse, we are required and will continue to be required to give customary representations and warranties to the buyers. If we breach those representations and warranties, the buyers will be able to require us to repurchase the loans and we may incur a loss on the repurchase.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.
Liquidity is essential to our business. An inability to raise funds through deposits, borrowings, the sale of loans and other sources could have a substantial negative effect on our liquidity. We rely on customer deposits and advances from the FHLB-Cincinnati and other borrowings to fund our operations. At June 30, 2016, based on available collateral and our ownership of FHLB stock, and based upon our internal policy, we had access to additional FHLB-Cincinnati advances of up to $20.1 million, including $10.0 million on a line of credit with the FHLB-Cincinnati. Although we have historically been able to replace maturing deposits and advances if desired, we may not be able to replace such funds in the future if, among other things, our financial condition, the financial condition of the FHLB, or market conditions change. Our access to funding sources in amounts adequate to finance our activities or the terms of which are acceptable could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the markets where our loans are concentrated, or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry in light of the recent turmoil faced by banking organizations and deterioration in credit markets.
Our financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. Although we consider our sources of funds adequate for our liquidity needs, we may seek additional debt in the future to achieve our long-term business objectives. Additional borrowings, if sought, may not be available to us or, if available, may not be available on reasonable terms. If additional financing sources are unavailable, or are not available on reasonable terms, our financial condition, results of operations, growth and future prospects could be materially adversely affected. Finally, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.
Our small size makes it more difficult for us to compete.
Our small asset size makes it more difficult to compete with other financial institutions which are generally larger and can more easily afford to invest in the marketing and technologies needed to attract and retain customers. Because our principal source of income is the net interest income we earn on our loans and investments after deducting interest paid on deposits and other sources of funds, our ability to generate the revenues needed to cover our expenses and finance such investments is limited by the size of our loan and investment portfolios. Accordingly, we are not always able to offer new products and services as quickly as our competitors. Our lower earnings also make it more difficult to offer competitive salaries and benefits. In addition, our smaller customer base makes it difficult to generate meaningful non-interest income from such activities as securities and insurance brokerage. Finally, as a smaller institution, we are disproportionately affected by the continually increasing costs of compliance with new banking and other regulations.
Strong competition within our market areas may limit our growth and profitability.
Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Some of our competitors have greater name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively than we do, which could affect our ability to grow and remain profitable on a long-term basis. Our profitability depends upon our continued ability to successfully compete in our market area. If we must raise interest rates paid on deposits or lower interest rates charged on our loans, our net interest margin and profitability could be adversely affected.
The financial services industry could become even more competitive as a result of new legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can.
Government responses to economic conditions may adversely affect our operations, financial condition and earnings.
The Dodd-Frank Act has changed the bank regulatory framework. For example, it has created an independent Consumer Financial Protection Bureau that has assumed the consumer protection responsibilities of the various federal banking agencies, established more stringent capital standards for banks and bank holding companies and gives the Federal Reserve Board exclusive authority to regulate savings and loan holding companies. The legislation has also resulted in new regulations affecting the lending, funding, trading and investment activities of banks and bank holding companies. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as the Bank, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. Banks and savings institutions with $10.0 billion or less in assets will continue to be examined by their applicable bank regulators. The legislation also weakens the federal preemption available for national banks and Ohio savings institutions, and gives state attorneys general the ability to enforce applicable federal consumer protection laws. The Dodd-Frank Act also requires the federal banking agencies to promulgate rules requiring mortgage lenders to retain a portion of the credit risk related to loans that are securitized and sold to investors. We expect that such rules would make it more difficult for us to sell loans into the secondary market. Bank regulatory agencies also have been responding aggressively to concerns and adverse trends identified in examinations. Ongoing uncertainty and adverse developments in the financial services industry and in the domestic and international credit markets, and the effect of new legislation and regulatory actions in response to these conditions, may adversely affect our operations by restricting our business activities, including our ability to originate or sell loans, modify loan terms, or foreclose on property securing loans.
The full impact of the Dodd-Frank Act on our business will not be known until all of the regulations implementing the statute are adopted and implemented. As a result, we cannot at this time predict the extent to which the Dodd-Frank Act will impact our business, operations or financial condition. However, compliance with these new laws and regulations may require us to make changes to our business and operations and will likely result in additional costs and divert management’s time from other business activities, any of which may adversely impact our results of operations, liquidity or financial condition.
Furthermore, the Federal Reserve Board, in an attempt to help the overall economy, has, among other things, adopted a low interest rate policy through its targeted federal funds rate and the purchase of mortgage-backed securities. If the Federal Reserve Board increases the federal funds rate, market interest rates would likely rise, which may negatively affect the housing markets and the U.S. economic recovery.
The short-term and long-term impact of the changing regulatory capital requirements and new capital rules is uncertain.
On July 9, 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that revised their risk-based capital requirements and the method for calculating risk-weighted assets to make them consistent with agreements that were reached by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. The final rule applies to all depository institutions, top-tier bank holding companies and savings and loan holding companies with total consolidated assets of $1.0 billion or more and all holding companies with total consolidated assets of less than $1.0 billion that do not meet certain requirements. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), increases the minimum Tier 1 capital to risk-based assets requirement (from 4.0% to 6.0% of risk-weighted assets) and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The final rule became effective for the Bank on January 1, 2015. The capital conservation buffer requirement phase in period began January 1, 2016 and ends January 1, 2019, when the full capital conservation buffer requirement will be effective.
Under the new capital standards, in order to be well-capitalized under the prompt corrective action regulations, the Bank is required to have a common equity to Tier 1 capital ratio of 6.5% and a Tier 1 capital ratio of 8.0%. As of June 30, 2016, the Bank met the capital requirements to be deemed well-capitalized under these new standards.
The application of more stringent capital requirements for the Bank could, among other things, result in lower returns on invested capital, require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of Basel III could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Implementation of changes to asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy, and could limit our ability to make distributions, including paying out dividends or buying back shares. Specifically, beginning in 2016, the Bank’s ability to pay dividends will be limited if the Bank does not have the capital conservation buffer required by the new capital rules, which may limit our ability to pay dividends to stockholders.
Risks associated with system failures, interruptions, or breaches of security could negatively affect our earnings.
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, 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, subject us to additional regulatory scrutiny or expose us to litigation and possible financial liability. Any of these events could have a material adverse effect on our financial condition and results of operations.
We operate in a highly regulated environment and may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision, and examination by the Federal Reserve Board, the ODFI and the FDIC. Such regulators govern the activities in which we may engage, primarily for the protection of depositors. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operation of a financial institution, the classification of assets by a financial institution, and the adequacy of a financial institution’s allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on us and our operations. Because our business is highly regulated, the laws, rules and applicable regulations are subject to regular modification and change. Laws, rules and regulations may be adopted in the future that could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.
Changes in accounting standards could affect reported earnings.
The bodies responsible for establishing accounting standards, including the Financial Accounting Standards Board, the SEC and other regulatory bodies, periodically change the financial accounting and reporting guidance that governs the preparation of our financial statements. These changes can be hard to predict and can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply new or revised guidance retroactively.
Future legislative or regulatory actions responding to perceived financial and market problems could impair our rights against borrowers.
There have been proposals made by members of Congress and others that would reduce the amount distressed borrowers are otherwise contractually obligated to pay under their mortgage loans and limit an institution’s ability to foreclose on mortgage collateral. If proposals such as these, or other proposals limiting our rights as a creditor, are implemented, we could experience increased credit losses or increased expense in pursuing our remedies as a creditor.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our market area and contiguous areas. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected, by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and, therefore, our operating results may be materially adversely affected.
Trading in our common shares is very limited, which may adversely affect the time and the price at which you can sell your Company stock.
Although the common stock of the Company is quoted on OTC Markets, trading in our common stock is not active, and the spread between the bid and the asked price is often wide. As a result, you may not be able to sell your shares on short notice, and the sale of a large number of shares at one time could temporarily depress the market price. The price at which you may be able to sell your common shares may be significantly lower than the price at which you could buy our stock at that time.
Our organizational documents and the large percentage of shares controlled by management may have the effect of discouraging a third party from acquiring us.
The governing documents of both the Company and the Bank contain provisions, including a staggered board of directors, a supermajority vote requirement, and restrictions on the acquisition of a specified percentage of the outstanding common stock that make it more difficult for a third party to gain control or acquire us without the consent of the board of directors. These provisions could also discourage proxy contests and may make it more difficult for dissident stockholders to elect representatives as directors and take other corporate actions. Moreover, as of September 13, 2016, directors and executive officers controlled the vote of 15.7% of the outstanding common stock of the Company, and participants in the Bank’s ESOP control the vote of 7.9% of the outstanding shares, subject to certain circumstances under which the trustee of the ESOP may control the vote. The provisions in our governing documents and the percentage of voting control by affiliates could have the effect of delaying or preventing a transaction or a change in control that a stockholder might consider to be in the best interests of that stockholder.
We undertake no obligation and disclaim any intention to publish revised information or updates to forward-looking statements contained in the above risk factors or in any other statement made at any time by any director, officer, employee or other representative of the Company, unless and until such revisions or updates are required to be disclosed by applicable securities laws or regulations.
Item 1B.
Item 1B. Unresolved Staff Comments
Not applicable.
Item 2.
Item 2. Properties
At June 30, 2016, the net book value of our properties, including construction in progress, was $570,000, and the net book value of our furniture, fixtures and equipment (including computer software) was $199,000. In September 2015, the Bank opened a new branch office in leased office space near downtown Cincinnati. We believe that these facilities are adequate to meet our present and foreseeable needs, other than modest and customary repair and replacement needs.
Information as to our offices and real estate as of June 30, 2016 is set forth below.
Item 3.
Item 3. Legal Proceedings
We are not involved in any pending legal proceedings other than routine legal proceedings that are incidental to and occur in the ordinary course of our business. At June 30, 2016, we were not involved in any legal proceedings the outcome of which would be material to our financial condition or results of operations.
Item 4.
Item 4. Mine Safety Disclosures
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
(a)There were 884,973 shares of Company common stock outstanding on June 30, 2016, held by approximately 136 stockholders of record.
Our shares trade on the OTC Market under the symbol MWBC. The following table summarizes the quarterly common stock prices as reported by the OTC Markets and dividends declared since the Company’s stock conversion on January 29, 2015.
(b)Not applicable.
Under the capital rules, the Bank is subject to restrictions on the payment of dividends to the Company, which could restrict our ability to pay dividends to our stockholders. The Bank may not pay a dividend if it would cause the Bank not to meet its capital requirements. In addition, without regulatory approval, the Bank is limited to paying dividends equal to net income to date in the fiscal year plus its retained net income for the preceding two years. Our ability to pay dividends to our stockholders may be restricted. Current FRB policy requires savings and loan holding companies to act as a source of financial strength to its banking subsidiaries. Under this policy, the FRB may require the Company to commit resources or contribute additional capital to the Bank, which could restrict the amount of cash available for dividends to our stockholders. The FRB has issued guidance on the payment of dividends by savings and loan holding companies, which includes conditions under which holding companies must provide advance notification of their intentions to declare and pay dividends.
The Company declared a $0.10 per share dividend in July 2016, which was paid in August 2016.
(c) In February 2016, the Company adopted a share repurchase plan and authorized the purchase of up to 10%, or 87,616, of outstanding shares. There is no fixed termination date for the repurchase plan.
Share repurchases for the three months ended June 30, 2016 were as follows:
Issuer Purchases of Equity Securities
Item 6.
Item 6. Selected Financial Data
The following tables set forth selected historical consolidated financial and other data of the Company at and for the years ended June 30, 2016 and 2015.
(1)The interest rate spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities for the period.
(2)The net interest margin represents net interest income as a percent of average interest-earning assets for the period.
(3)The efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.
(4)Bank only capital ratios presented.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis comparing 2016 to prior years should be read in conjunction with the audited consolidated financial statements as of and for the two years ended June 30, 2016 (the “Financial Statements”).
FORWARD-LOOKING STATEMENTS
Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “estimates,” “plans,” “may increase,” “may fluctuate,” “will likely result,” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” and “could” are generally forward-looking in nature and not historical facts. Results could differ materially from those expressed in such forward-looking statements due to a number of factors, including (1) changes in interest rates; (2) changes in national and local economic and political conditions, including the effects of implementation of the Budget Control Act of 2011 and the American Taxpayer Relief Act of 2012, the failure of the federal government to reach an agreement on the federal budget and debt, the continuing economic uncertainty in various parts of the world and the results of elections; (3) competitive pressures in the retail banking, financial services, insurance and other industries; (4) changes in laws and regulations, including changes in accounting standards; (5) changes in policy by regulatory agencies; and (6) changes in the securities markets. Any forward-looking statements are not guarantees of future performance. They involve risks, uncertainties and assumptions, and actual results could differ materially from those contemplated by those forward-looking statements. Many of the factors that will determine these results are beyond the Company’s ability to control or predict. The Company disclaims any duty to update any forward-looking statements, all of which are qualified by the statements in this section. See Item 1.A. “Risk Factors” in this annual report for further discussion of the risks affecting the business of the Company and the value of an investment in its shares.
Critical Accounting Policies
The discussion and analysis of the financial condition and results of operations are based on our financial statements, which are prepared in conformity with GAAP. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of income and expenses. We consider the accounting policies discussed below to be critical accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.
On April 5, 2012, the JOBS Act was signed into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we may delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. We intend to take advantage of the benefits of this extended transition period. Accordingly, our financial statements may not be comparable to companies that comply with such new or revised accounting standards.
The following represent our critical accounting policies:
Allowance for Loan Losses. The allowance for loan losses is the estimated amount considered necessary for probable incurred credit losses in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical accounting policies.
Management performs a quarterly evaluation of the allowance for loan losses. Consideration is given to a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant change.
The analysis has two components, specific and general allowances. The specific percentage allowance is for unconfirmed losses related to loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral as adjusted for market conditions and selling expenses. If the fair value of the loan is less than the loan’s carrying value, a charge is recorded for the difference. The general allowance, which is for loans reviewed collectively, is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We also analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent twelve quarters. All periods are evenly weighted within the 12 quarter loss history. The methodology used in calculation of loss factors is consistently applied to all loan segments. This analysis establishes historical loss percentages and qualitative factors that are applied to the loan groups to determine the amount of the allowance for loan losses necessary for loans that are reviewed collectively. The qualitative component is critical in determining the allowance for loan losses as certain trends may indicate the need for changes to the allowance for loan losses based on factors beyond the historical loss history. Not incorporating a qualitative component could misstate the allowance for loan losses. Actual loan losses may be significantly more than the allowances we have established which could result in a material negative effect on our financial results.
Deferred Tax Assets. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion of the deferred tax asset will not be realized. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Determining the proper valuation allowance for deferred taxes is critical in properly valuing the deferred tax asset and the related recognition of income tax expense or benefit. At June 30, 2016 and 2015, our deferred tax asset was reduced by a valuation allowance totaling $1.4 million and $2.1 million, respectively, which at June 30, 2015, represented a full valuation allowance applied to our net deferred tax assets. The Company reversed $713,000 of its valuation allowance during the year ended June 30, 2016 based upon an analysis of projected future operating results.
Fair Value Measurements. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. The Company estimates the fair value of a financial instrument and any related asset impairment using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, the Company estimates fair value. These estimates are subjective in nature and imprecision in estimating these factors can impact the amount of gain or loss recorded. A more detailed description of the fair values measured at each level of the fair value hierarchy and the methodology utilized by the Company can be found in Note 14 to the Financial Statements - “Disclosures About Fair Value of Assets and Liabilities.”
Comparison of Financial Condition at June 30, 2016 and June 30, 2015
Total Assets. Total assets were $119.0 million at June 30, 2016, an increase of $12.2 million, or 11.4%, over the $106.8 million total at June 30, 2015. The increase was primarily comprised of a $12.8 million increase in net loans and loans held for sale, which was partially offset by a decrease in interest-bearing deposits in other financial institutions of $1.0 million and a decrease in investment securities of $1.4 million.
Net Loans. Net loans, including loans held for sale, increased by $12.8 million, or 14.4%, to $101.7 million at June 30, 2016 from $88.9 million at June 30, 2015. During the year ended June 30, 2016, we originated $48.8 million of loans, which represented approximately 54.0% of our total loan portfolio at June 30, 2015. These new loan originations were comprised primarily of $29.5 million of one- to four-family residential real estate loans, $7.7 million of commercial real estate loans, $5.9 million of construction loans and $4.2 million of multi-family residential real estate loans. During the year ended June 30, 2016, construction loans increased $3.7 million, or 121%, to $6.7 million at June 30, 2016, multi-family residential real estate loans increased $2.9 million, or 45.9%, to $9.1 million at June 30, 2016, commercial non-real estate loans increased $2.4 million and commercial real estate loans increased $1.6 million, or 9.9%, to $17.5 million at June 30, 2016.
Increases in loan balances reflect our strategy to grow and diversify our loan portfolio, with an emphasis on increasing commercial and multi-family residential loans, as a shift in strategy from our traditional focus on one- to four-family residential loans. Such growth has been achieved amid strong competition for commercial real estate, multi-family and one- to four-family residential mortgage loans in our market area in the current low interest rate environment.
During the latter part of fiscal 2013, we initiated a program to sell certain fixed-rate, 30-year term mortgage loans in the secondary market. We have sold loans on both a servicing released and servicing retained basis, in transactions with the FHLB-Cincinnati through its mortgage purchase program, and to other investors. We sold $6.7 million of loans to the FHLB-Cincinnati in the year ended June 30, 2016. Total loans sold and serviced totaled $8.2 million at June 30, 2016. In addition, during the year ended June 30, 2016, we sold certain jumbo residential mortgage loans totaling $5.7 million to another financial institution, retaining servicing on these loans. Management intends to continue this sales activity in future periods.
Interest Bearing Deposits in Other Financial Institutions. Interest-bearing time deposits in other banks decreased by $1.0 million, or 32.3%, to a total of $2.1 million at June 30, 2016, compared to $3.1 million at June 30, 2015. The decrease in 2016 was due to the use of excess cash in 2016 to originate loans.
Investment Securities. Investment securities decreased $1.4 million, or 23.9%, to $4.5 million at June 30, 2016 from June 30, 2015. The decrease consisted primarily of called securities and principal repayments on mortgage-backed securities, which were partially offset by $494,000 in securities purchased during the year ended June 30, 2016.
The yield on our investment securities increased to 2.01% for the year ended June 30, 2016 compared to 1.60% for the year ended June 30, 2015. At June 30, 2016, investment securities classified as available-for-sale and held-to-maturity consisted entirely of government-sponsored mortgage-backed securities.
Foreclosed Assets. The Company had no foreclosed assets at June 30, 2016 compared to $104,000 at June 30, 2015, as we sold the one parcel of foreclosed real estate during the year ended June 30, 2016.
Deposits. Deposits increased by $8.9 million, or 13.0%, to $77.2 million at June 30, 2016 from June 30, 2015. Our core deposits, which consist of all deposit account types except certificates of deposit, increased $12.1 million, or 48.6%, to $37.0 million at June 30, 2016 from $24.9 million at June 30, 2015. Certificates of deposit decreased $3.2 million, or 7.5%, to $40.2 million at June 30, 2016 from $43.4 million at June 30, 2015. During the year ended June 30, 2016, management continued its strategy of pursuing growth in demand accounts and other lower cost core deposits. Demand accounts were first offered by the Company during the year ended June 30, 2013 and totaled $25.3 million at June 30, 2016. Management intends to continue its efforts to increase core deposits, with a special emphasis on growth in consumer and business demand deposits.
Federal Home Loan Bank Advances. Federal Home Loan Bank advances increased $3.0 million, or 13.2%, to $25.3 million at June 30, 2016 from $22.4 million at June 30, 2015. Management has pursued a strategy of periodically increasing these advances, to take advantage of this low-cost source of funding during the low interest rate environment, for growth in the Company’s loans and investments. The aggregate cost of these advances was 1.39% at June 30, 2016, compared to the Company’s cost of deposits of 1.06% at June 30, 2016.
Stockholders’ Equity. Total stockholders’ equity increased $448,000, or 2.9%, to $16.1 million at June 30, 2016 compared to $15.7 million at June 30, 2015. The increase was primarily attributable to net income of $689,000 for the year ended June 30, 2016, and a $12,000 decrease in the accumulated other comprehensive loss, which were partially offset by the purchase of treasury shares totaling $302,000.
Comparison of Results of Operations for the Year Ended June 30, 2016 and June 30, 2015
General. Our net income for the year ended June 30, 2016 was $689,000, compared to $145,000 for the year ended June 30, 2015, an increase of $544,000. The increase in net income was primarily due to a $324,000 increase in net interest income, a $22,000 decrease in the provision for loan losses, a $192,000 increase in noninterest income and a $713,000 federal income tax benefit, which were partially offset by a $707,000 increase in noninterest expenses.
Average Balance Sheets. The following table sets forth average balance sheets, average yields and costs, and certain other information for the years ended June 30, 2016 and 2015. All average balances are daily average balances. Nonaccrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of net deferred costs, discounts and premiums that are accreted to interest income.
(1) Consists of stock in the FHLB and interest-bearing deposits in other banks.
(2) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3) Net interest-earning assets represents total interest-earning assets less total interest-bearing liabilities.
(4) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Table. The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated to the changes due to volume and the changes due to rate in proportion to the relationship of the absolute dollar amounts of change in each.
Interest Income. Interest income increased $528,000, or 15.4%, to $4.0 million for the year ended June 30, 2016 from $3.4 million for the year ended June 30, 2015. This increase was attributable to a $514,000 increase in interest on loans receivable and a $20,000 increase in interest on other interest-earning assets, which were partially offset by a $6,000 decrease in interest on investment securities. The average balance of loans during the year ended June 30, 2016 increased by $19.0 million, or 24.3%, from the balance for the year ended June 30, 2015, while the average yield on loans decreased by 28 basis points to 3.82% for the year ended June 30, 2016 from 4.10% for the year ended June 30, 2015. The decrease in average yield on loans was due to the declining interest rate environment, as well as an increase in payoffs of higher interest rate loans as customers refinanced loans at lower interest rates.
The average balance of investment securities decreased $1.3 million to $5.2 million for the year ended June 30, 2016 from $6.5 million for the year ended June 30, 2015, while the average yield on investment securities increased by 28 basis points to 1.88% for the year ended June 30, 2016 from 1.60% for the year ended June 30, 2015. Interest income on other interest-earning assets, including certificates of deposit in other financial institutions, increased $20,000, or 16.7%, for the year ended June 30, 2016, due primarily to a $3.1 million increase in the average balance, to $10.0 million for the year ended June 30, 2016, partially offset by a 23 basis point decrease in the yield, to 1.40% for the year ended June 30, 2016. The increase in interest income on other interest-earning assets was due primarily to accretion of $39,000 of a total $120,000 Bank Enterprise Award the Company received from the U.S. Government-sponsored Community Development Financial Institutions Fund (“CDFI”) based on certificates of deposit placed with qualifying financial institutions participating in the program. The award is being accreted into interest income over the remaining term of the certificates of deposit, and will result in recognition of interest income totaling approximately $22,000 over the next two quarters.
Interest Expense. Total interest expense increased $204,000, or 20.4%, to $1.2 million for the year ended June 30, 2016 from $1.0 million for the year ended June 30, 2015. Interest expense on deposit accounts increased $169,000, or 23.9%, to $877,000 for the year ended June 30, 2016 from $708,000 for the year ended June 30, 2015. The increase was primarily due to an increase of $14.3 million, or 23.6%, in the average balance of deposits to $75.2 million for the year ended June 30, 2016, and an increase of one basis point in the average cost of interest-bearing deposits to 1.17% for the year ended June 30, 2016 from 1.16% for the year ended June 30, 2015.
Interest expense on FHLB advances increased $35,000 to $329,000 for the year ended June 30, 2016 from $294,000 for the year ended June 30, 2015. The average balance of advances increased by $3.1 million, or 15.8%, to $22.7 million for the year ended June 30, 2016 compared to the year ended June 30, 2015, while the average cost of these advances decreased by five basis points to 1.45% from 1.50%. As noted above, management elected to increase outstanding advances as a source of lower-cost funding.
Net Interest Income. Net interest income increased $324,000, or 13.4%, to $2.7 million for the year ended June 30, 2016 compared to $2.4 million for the year ended June 30, 2015. The interest rate spread declined by 21 basis points to 2.28% for the year ended June 30, 2016. Our net interest margin declined to 2.44% for the year ended June 30, 2016 from 2.65% for the year ended June 30, 2015. The interest rate spread was impacted by a continuation of a low interest rate environment.
Provision for Loan Losses. Based on our analysis of the factors described in “Critical Accounting Policies-Allowance for Loan Losses,” we recorded a provision for loan losses of $13,000 for the year ended June 30, 2016, a decrease of $22,000, or 62.9%, from the $35,000 provision recorded for the year ended June 30, 2015. The allowance for loan losses was $1.6 million, or 1.61% of total loans, at June 30, 2016, compared to $1.6 million, or 1.77% of total loans, at June 30, 2015. The decrease in the provision for loan losses in the year ended June 30, 2016, compared to the year ended June 30, 2015, was due primarily to a continuation of a trend of low balances of loan charge-offs, nonperforming loans and delinquent loans in the fiscal 2016 period. Total nonperforming loans were $1.2 million at June 30, 2016, compared to $1.1 million at June 30, 2015. Classified loans declined to $1.5 million at June 30, 2016, compared to $1.8 million at June 30, 2015, and total loans past due greater than 30 days were $601,000 and $309,000 at those respective dates. Net recoveries totaled $20,000 for the year ended June 30, 2016, compared to net recoveries of $30,000 for the year ended June 30, 2015. As a percentage of nonperforming loans, the allowance for loan losses was 135.2% at June 30, 2016 compared to 147.6% at June 30, 2015. Management has continued a strategy focused on resolution of problem loans and a reduction of our volume of nonperforming loans. The provision for loan losses in the years ended June 30, 2016 and 2015 was attributable primarily to estimated losses recognized on certain impaired loans as well as our overall growth in loans and the change in the loan product mix, as we continued our efforts to diversify the loan portfolio from its traditional focus on one- to four-family residential loans.
The allowance for loan losses reflects the estimate we believe to be appropriate to cover probable incurred losses in the loan portfolio at June 30, 2016 and 2015. While we believe the estimates and assumptions used in our determination of the adequacy of the allowance are reasonable, such estimates and assumptions could be proven incorrect in the future, and the actual amount of future provisions may exceed the amount of past provisions, and the increase in future provisions that may be required may adversely impact our financial condition and results of operations. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management.
Non-Interest Income. Non-interest income increased $192,000, or 103.2%, to $378,000 for the year ended June 30, 2016 from $186,000 for the year ended June 30, 2015. The increase was primarily due to an increase in gain on sale of loans of $169,000 and an increase in gains on sale of foreclosed assets of $6,000. The increase in gains on sales of loans was due to a $3.6 million increase in the volume of loans sold, as the Company continued a program to sell certain fixed-rate loans in the secondary market, and a sale of certain jumbo residential loans totaling $5.7 million to another financial institution.
Non-Interest Expense. Non-interest expense increased $707,000, or 29.1%, to $3.1 million for the year ended June 30, 2016 compared to $2.4 million for the year ended June 30, 2015. The increase was primarily attributable to a $375,000, or 26.7%, increase in salaries and employee benefits, a $96,000, or 71.1%, increase in occupancy and equipment, a $46,000, or 47.4%, increase in data processing, a $31,000, or 48.4%, increase in franchise taxes and a $102,000, or 34.5%, increase in professional services. The increase in salaries and employee benefits expense was due primarily to staffing increases, normal merit increases and bonus compensation, the full year expense associated with the ESOP plan and the effects of the new share-based compensation plan. Occupancy and equipment expense increased due primarily to expenses associated with the new branch location which opened in September 2015. Data processing expense increase due to the Company’s overall growth in loans and deposits over the year. Franchise taxes increased due to the increase in the Company’s shareholders’ equity following the issuance of shares. Professional fees increased as a result of costs associated with the Bank’s name change during the year, the implementation of the new equity compensation plan and related special shareholders meeting held in April 2016, and costs related to the reporting requirements of a public stock company.
Federal Income Taxes. We recorded a federal income benefit provision totaling $713,000 in the year ended June 30, 2016, compared to no federal income tax expense or benefit in the year ended June 30, 2015. The income tax benefit in fiscal 2016 represented a partial reversal of the impairment valuation allowance on the Company’s deferred tax assets. Management evaluated the deferred tax asset based primarily upon a projection of future operating results and determined that a partial reversal of the impairment valuation allowance was required at June 30, 2016. We had a valuation allowance on the net deferred tax assets of $1.4 million and $2.1 million at June 30, 2016 and 2015, respectively. The deferred tax asset will only be recognized in future periods when it is more likely than not that the net deferred tax asset can be realized, primarily through the generation of sustainable taxable income.
SECURITIES
The following table sets forth the composition of our investment securities portfolio at the dates indicated, excluding stock of the FHLB-Cincinnati.
At June 30, 2016, we had no investments in a single entity (other than United States government agency or sponsored securities) that had an aggregate book value in excess of 10% of our total stockholders’ equity.
Securities Portfolio Maturities and Yields. The composition and contractual maturities of the investment securities portfolio at June 30, 2016 are summarized in the following table. Note, however, that mortgage-backed securities are anticipated to be repaid in advance of their contractual maturities as a result of projected mortgage loan prepayments. In addition, under the structure of some of our CMOs, the short- and intermediate-tranche interests have repayment priority over the longer term tranches of the same underlying mortgage pool.
LOANS
Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio, by type of loan at the dates indicated.
Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at June 30, 2016. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. The table presents contractual maturities and does not reflect repricing or the effect of prepayments.
Fixed and Adjustable-Rate Loan Schedule. The following table sets forth our fixed- and adjustable-rate loans at June 30, 2016 that are contractually due after June 30, 2017.
Delinquencies, Classified Assets and Non-Performing Assets
Delinquency Procedures. When a borrower fails to make a required monthly payment by the due date, a late notice is generated stating the payment and late charges due. Our policies provide that a late notice be sent when a loan is 15 days past due. In addition, we may call the borrower when the loan is 15 days past due, and we attempt to cooperate with the borrower to determine the reason for nonpayment and to work with the borrower to establish a repayment schedule that will cure the delinquency. Once the loan is considered in default, generally at 30 days past due, a certified letter is generally sent to the borrower explaining that the entire balance of the loan is due and payable, the loan is placed on non-accrual status, and additional efforts are made to contact the borrower. If the borrower does not respond, we generally consider initiating foreclosure proceedings when the loan is 90 to 120 days past due. If the loan is reinstated, foreclosure proceedings will be discontinued and the borrower will be permitted to continue to make payments. In certain instances, we may modify the loan or grant a limited exemption from loan payments to allow the borrower to reorganize his, her or its financial affairs.
When we acquire real estate as a result of foreclosure or by deed in lieu of foreclosure, the real estate is classified as foreclosed real estate until it is sold. The real estate is recorded at estimated fair value at the date of acquisition less estimated costs to sell, and any write-down resulting from the acquisition is charged to the allowance for loan losses. Subsequent decreases in the value of the property are charged to operations through the creation of a valuation allowance. After acquisition, all costs in maintaining the property are expensed as incurred. Costs relating to the development and improvement of the property, however, are capitalized to the extent of estimated fair value less estimated costs to sell.
Troubled Debt Restructurings. We occasionally modify loans to help a borrower stay current on his or her loan and to avoid foreclosure. We consider modifications only after analyzing the borrower’s current repayment capacity, evaluating the strength of any guarantors based on documented current financial information, and assessing the current value of any collateral pledged. We generally do not forgive principal or interest on loans, but may do so if it is in our best interest and increases the likelihood that we can collect the remaining principal balance. We may modify the terms of loans to lower interest rates (which may be at below market rates), to provide for fixed interest rates on loans where fixed rates are otherwise not available, or to provide for interest-only terms. These modifications are made only when there is a reasonable and attainable workout plan that has been agreed to by the borrower and that is in our best interests. At June 30, 2016, we had 16 loans totaling $1.1 million that were classified as troubled debt restructuring. Of these, 10 loans totaling $539,000 were included in our non-accrual loans at such date because they were either not performing in accordance with their modified terms or had been performing in accordance with their modified terms for less than six months since the date of restructuring.
For the years ended June 30, 2016 and 2015, interest income that would have been recorded had our non-accruing troubled debt restructurings been current in accordance with their original terms was $46,000 and $87,000, respectively. No interest income was recognized on such loans for the years ended June 30, 2016 and 2015.
Delinquent Loans. The following table sets forth our loan delinquencies, including non-accrual loans, by type and amount at the dates indicated.
Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered by the FDIC to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific allowance for loan losses is not warranted. Assets that do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as “special mention” by our management.
When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances in an amount deemed prudent by management to cover losses that were both probable and reasonable to estimate. General allowances represent allowances which have been established to cover accrued losses associated with lending activities that were both probable and reasonable to estimate, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the regulatory authorities, which may require the establishment of additional general or specific allowances.
In connection with the filing of our periodic regulatory reports and in accordance with our classification of assets policy, we regularly review the problem loans in our portfolio to determine whether any loans require classification in accordance with applicable regulations. Loans are listed on the “watch list” initially because of emerging financial weaknesses even though the loan is currently performing as agreed, or delinquency status, or if the loan possesses weaknesses although currently performing. Management reviews the status of each loan on our watch list on a quarterly basis with the board of directors. If a loan deteriorates in asset quality, the classification is changed to “special mention,” “substandard,” “doubtful” or “loss” depending on the circumstances and the evaluation. Generally, loans 90 days or more past due are placed on nonaccrual status and classified “substandard.”
The following table sets forth our amounts of classified assets, assets designated as special mention and total criticized assets (classified assets and loans designated as special mention) as of the date indicated. Amounts shown at June 30, 2016 and 2015, include approximately $1.2 million and $1.1 million of nonaccrual loans, respectively. The related specific valuation allowance in the allowance for loan losses for such nonperforming loans was $188,000 and $204,000 at June 30, 2016 and 2015, respectively.
The decrease in classified assets to $1.5 million at June 30, 2016 from $1.9 million at June 30, 2015, was primarily due to the continued enhanced review of our nonperforming assets by our senior management. At June 30, 2016, substandard assets consisted of $836,000 one- to four-family owner occupied real estate loans and $676,000 of one- to four-family non-owner occupied real estate loans. At June 30, 2016, our largest classified loan relationship was $379,000 secured by five parcels of one- to four-family non-owner-occupied real estate.
Non-Performing Assets. Non-performing assets were $1.2 million, or 1.0% of total assets, at June 30, 2016 compared to $1.2 million, or 1.1% of total assets, at June 30, 2015. Management has continued to focus on collection and resolution of nonperforming assets, while enhanced stringent underwriting practices by our new management team, and a change in lending focus away from non-owner occupied residential loans and subprime loans, has resulted in higher quality loans comprising the growth in our loan portfolio. The largest components of non-performing loans were non-owner occupied residential loans and subprime residential loans originated prior to the change in management that occurred in 2012. At June 30, 2016, our largest non-performing loan relationship consisted of five parcels of one- to four-family non-owner occupied real estate in the amount of $379,000.
We generally cease accruing interest on our loans when contractual payments of principal or interest have become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid interest credited to income is reversed. Interest received on nonaccrual loans is applied against principal. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt. Troubled debt restructurings are loans that have renegotiated loan terms to assist borrowers who are unable to meet the original terms of their loans, with modifications to loan terms including a lower interest rate, a reduction in principal, or a longer term to maturity. Troubled debt restructurings are restored to accrual status when the obligation is brought current, has performed in accordance with the revised contractual terms for six months and the ultimate collectability of the total contractual principal and interest is deemed probable.
The following table sets forth information regarding our non-performing assets at the dates indicated.
(1)Net of loans that are included in both nonaccrual status and troubled debt restructurings of $672,000 and $847,000 at June 30, 2016 and 2015, respectively.
For the years ended June 30, 2016 and 2015, interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $73,000 and $87,000, respectively. No interest income was recognized on such loans for the years ended June 30, 2016 and 2015.
Non-performing owner occupied one- to four-family residential real estate loans totaled $568,000 at June 30, 2016 and consisted of eight loans, the largest of which totaled $93,000. Non-performing non-owner occupied one- to four-family real estate loans totaled $641,000 at June 30, 2016 and consisted of ten loans.
At June 30, 2016, our three largest non-performing loan relationships were loans totaling $379,000 (secured by non-owner occupied real estate), $149,000 (secured by both owner-occupied and non-owner-occupied real estate) and $113,000 (secured by non-owner-occupied real estate).
Other Loans of Concern. There were no other loans at June 30, 2016 that are not already disclosed where there is information about possible credit problems of borrowers that caused management to have serious doubts about the ability of the borrowers to comply with present loan repayment terms and that may result in disclosure of such loans in the future.
Allowance for Loan Losses
Analysis and Determination of the Allowance for Loan Losses. Our allowance for loan losses is the amount considered necessary to reflect probable incurred losses in our loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.
When assessing the appropriateness of the allowance for loan losses, we consider its two key elements: (1) specific allowances for identified impaired loans; and (2) a general valuation allowance on the remainder of the loan portfolio. Although we determine the amount of each element of the allowance separately, the entire allowance for loan losses is available for the entire portfolio.
We identify loans that may need to be charged off as a loss by reviewing all delinquent loans, classified loans, and other loans about which management may have concerns about collectability. For individually reviewed loans, the borrower’s inability to make payments under the terms of the loan, as well as a shortfall in collateral value, could result in our charging off the loan or the portion of the loan that was impaired.
Among other factors, we consider current general economic conditions, including current housing price depreciation, in determining the appropriateness of the allowance for loan losses for our residential real estate portfolio. We use evidence obtained from our own loan portfolio as well as published housing data on our local markets from third-party sources we believe to be reliable as a basis for assumptions about the impact of housing depreciation.
Substantially all of our loans are secured by collateral. Loans 90 days past due and other classified loans are evaluated for impairment and general or specific allowances are established. Typically for a nonperforming real estate loan in the process of collection, the value of the underlying collateral is estimated using either the original independent appraisal, adjusted for current economic conditions and other factors, or a new independent appraisal, or evaluation, and related general or specific allowances for loan losses are adjusted quarterly. If a nonperforming real estate loan is in the process of foreclosure and/or there are serious doubts about further collectability of principal or interest, and there is uncertainty about the value of the underlying collateral, we will order a new independent appraisal or evaluation if it has not already been obtained. Any shortfall would result in immediately charging off that portion of the loan that as impaired.
Specific Allowances for Identified Problem Loans. We establish a specific allowance when loans are determined to be impaired. Loss is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral less estimated selling expenses. Factors in identifying a specific problem loan include: (1) the strength of the customer’s personal or business cash flows; (2) the availability of other sources of repayment; (3) the amount due or past due; (4) the type and value of collateral; (5) the strength of our collateral position; (6) the estimated cost to sell the collateral; and (7) the borrower’s effort to cure the delinquency. In addition, for loans secured by real estate, we consider the extent of any past due and unpaid property taxes applicable to the property serving as collateral on the mortgage.
General Valuation Allowance on the Remainder of the Loan Portfolio. We establish a general allowance for loans that are not classified as impaired to recognize the probable incurred losses associated with lending activities, but which, unlike specific allowances, has not been allocated to particular problem assets. This general valuation allowance is determined by segregating the loans by loan category and assigning allowance percentages based on our historical loss experience, delinquency trends and management’s evaluation of the collectability of the loan portfolio. The allowance may be adjusted for significant factors that, in management’s judgment, affect the collectability of the portfolio as of the evaluation date. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary market area, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are re-evaluated quarterly to ensure their relevance in the current real estate environment.
Allowance for Loan Losses. The following table sets forth activity in our allowance for loan losses for the years ended June 30, 2016 and 2015.
Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.
At June 30, 2016, our allowance for loan losses represented 1.61% of total loans and 135.24% of non-performing loans and at June 30, 2015, our allowance for loan losses represented 1.77% of total loans and 147.65% of non-performing loans. There were $20,000 and $30,000 in net loan recoveries during the years ended June 30, 2016 and 2015, respectively.
Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate and management may determine that increases in the allowance are necessary if the quality of any portion of our loan portfolio deteriorates as a result. Furthermore, as an integral part of its examination process, the FDIC and ODFI periodically review our allowance for loan losses. The FDIC and ODFI may require that we increase our allowance based on its judgments of information available to it at the time of its examination. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.
Deposits
Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also use borrowings, primarily FHLB-Cincinnati advances, to supplement cash flow needs, lengthen the maturities of liabilities for interest rate risk purposes and to manage the cost of funds. In addition, we receive funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition. We may utilize repurchase agreements or federal funds sold as funding sources, although we have not used these funding sources during recent periods.
We have recently expanded and improved the products and services we offer our retail and business deposit customers and have improved our infrastructure for electronic banking services. We began offering both personal and business checking accounts in May 2013. Since May 2013, we have provided our customers with free access to the ATM network of a larger regional bank with numerous offices throughout our market area and beyond. In May 2013, we substantially upgraded our capabilities and commenced offering online banking services, including bill pay, remote deposit capture, eStatements and debit cards. We have enhanced online banking services, particularly for our business customers, in 2014, including merchant capture, online cash management tools, ACH, wire transfer capabilities, mobile banking and night drop services. The deposit infrastructure we have established can accommodate significant increases in retail and business deposit accounts without significant additional capital expenditure.
We offer a selection of deposit accounts, including non-interest-bearing and interest-bearing checking accounts, statement savings accounts, variable rate money market accounts, and certificates of deposit. We have not in the past used, and currently do not hold any, brokered or Internet deposits. Depending on our future needs, we may participate in the CDARS and Qwickrate programs as alternative funding sources, but do not anticipate doing so in the near future.
Our deposits are primarily obtained from areas surrounding our main office, and therefore deposit generation is significantly influenced by general and local economic conditions, changes in prevailing interest rates, internal pricing decisions and competition in our market area, which includes numerous financial institutions of varying sizes offering a wide range of products and services. Interest rates, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. Based on experience, we believe that our deposits are relatively stable. However, the ability to attract and maintain deposits and the rates paid on these deposits has been and will continue to be significantly affected by market conditions, including competition and prevailing interest rates. At June 30, 2016, $40.2 million, or 52.1% of our total deposit accounts, were certificates of deposit, of which $26.3 million had maturities of one year or less.
The following table sets forth the distribution of our average total deposit accounts, by account type, for the years ended June 30, 2016 and 2015.
The following table sets forth our deposit activities for the years ended June 30, 2016 and 2015.
The following table sets forth certificates of deposit classified by interest rate as of June 30, 2016 and 2015.
Maturities of Certificates of Deposit Accounts. The following table sets forth the amount and maturities of certificate of deposit accounts at June 30, 2016.
As of June 30, 2016, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was $19.1 million. At June 30, 2016 and 2015, time deposits in denominations of $250,000 or more were $5.0 million and $3.6 million, respectively.
The following table sets forth the maturity of certificates in amounts of $100,000 or more as of June 30, 2016.
Borrowings. We may obtain advances from the FHLB-Cincinnati upon the security of our capital stock in the FHLB-Cincinnati and certain of our mortgage loans. Such advances may be made pursuant to several different credit programs, each of which has its own interest rate and range of maturities. To the extent such borrowings have different terms to reprice than our deposits, they can change our interest rate risk profile. During the past several years, we have increased our balance of FHLB-Cincinnati advances, and have used laddered terms to maturity of between 15 to 20 years and fixed rates. See Note 7 to the Financial Statements for information on the maturity of our FHLB-Cincinnati advances. At June 30, 2016, we had $25.3 million in outstanding advances from the FHLB-Cincinnati. At June 30, 2016, based on available collateral and our ownership of FHLB stock, and based upon our internal policy, we had access to additional FHLB-Cincinnati advances of up to $20.1 million, including $10.0 million on a line of credit with the FHLB-Cincinnati.
The following table sets forth information concerning balances and interest rates on our FHLB-Cincinnati advances at the dates and for the periods indicated. We did not have any borrowings other than FHLB-Cincinnati advances at or during the years ended June 30, 2016 and 2015.
Liquidity and Capital Resources
Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from the sale of loans, and proceeds from maturities and calls of securities. We also have the ability to borrow from the FHLB-Cincinnati. At June 30, 2016, based on available collateral and our ownership of FHLB stock, and based upon our internal policy, we had access to additional FHLB-Cincinnati advances of up to $20.1 million, and an additional $10.0 million on a line of credit with the FHLB-Cincinnati. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and short-term investments including interest-bearing demand deposits. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.
We are committed to maintaining a strong liquidity position. We monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments.
At June 30, 2016, we exceeded all of our regulatory capital requirements. In addition, at June 30, 2016, the Bank exceeded all capital requirements to be deemed well-capitalized under the prompt corrective action regulations. See “Note 9: Regulatory Matters” to the Financial Statements for requirements and actual capital amounts.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. At June 30, 2016, we had outstanding commitments to originate loans of $9.4 million, including undisbursed funds on construction loans and funds available on undrawn lines of credit. We anticipate that we will have sufficient funds available to meet our current lending commitments. Certificates of deposit that are scheduled to mature in less than one year from June 30, 2016 totaled $26.3 million. Management expects that a substantial portion of the maturing certificates of deposit will be renewed. However, if a substantial portion of these deposits is not retained, we may utilize FHLB advances or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.
Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include data processing services, operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities.
Management of Market Risk
General. Our most significant form of market risk is interest rate risk because, as a financial institution, the majority of our assets and liabilities are sensitive to changes in interest rates. Therefore, a principal part of our operations is to manage interest rate risk and limit the exposure of our financial condition and results of operations to changes in market interest rates. Our Asset-Liability Committee is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the policy and guidelines approved by our board of directors.
Our asset/liability management strategy attempts to manage the impact of changes in interest rates on net interest income, our primary source of earnings. Among the techniques we use to manage interest rate risk are:
·originating commercial real estate and multi-family, construction, consumer and commercial business loans, all of which tend to have shorter terms and higher interest rates than one- to four-family residential real estate loans, and which generate customer relationships that can result in larger non-interest bearing checking accounts;
·selling substantially all of our newly-originated longer-term fixed-rate one- to four-family residential real estate loans and retaining the shorter-term fixed-rate and adjustable-rate one- to four-family residential real estate loans that we originate, subject to market conditions and periodic review of our asset/liability management needs;
·reducing our dependence on certificates of deposit to support lending and investment activities and increasing our reliance on core deposits, including checking accounts, money market accounts and savings accounts, which are less interest rate sensitive than certificates of deposit; and
·lengthening the weighted average maturity of our liabilities through longer-term wholesale funding sources such as fixed-rate advances from the FHLB-Cincinnati with terms to maturity of 15 to 20 years.
Our board of directors is responsible for the review and oversight of our Asset/Liability Committee, which is comprised of our executive management team and other essential operational staff. This committee is charged with developing and implementing an asset/liability management plan, and meets at least quarterly to review pricing and liquidity needs and assess our interest rate risk. We currently utilize a third-party modeling program, prepared on a quarterly basis, to evaluate our sensitivity to changing interest rates, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors.
Economic Value of Equity. We compute amounts by which the economic value of equity from our cash flow from assets, liabilities and off-balance sheet items (“EVE”) would change in the event of a range of assumed changes in market interest rates. We measure our interest rate risk and potential change in our EVE through the use of a financial model provided by an outside consulting firm. This model uses a discounted cash flow analysis and an option-based pricing approach to measure the interest rate sensitivity of EVE. Historically, the model estimated the economic value of each type of asset, liability and off-balance sheet contract under the assumption that the United States Treasury yield curve increases or decreases instantaneously by 100 to 400 basis points in 100 basis point increments. However, given the current low level of market interest rates, an EVE calculation for an interest rate decrease of greater than 100 basis points has not been prepared. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3% to 4% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below.
The table below sets forth, as of June 30, 2016, the estimated changes in the EVE that would result from the designated changes in the United States Treasury yield curve under an instantaneous parallel shift for the Bank. Computations of prospective effects of hypothetical interest rate 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.
(1)Assumes instantaneous parallel changes in interest rates.
(2)EVE or Economic Value of Equity at Risk measures the Bank’s exposure to equity due to changes in a forecast interest rate environment.
(3)EVE Ratio represents Economic Value of Equity divided by the economic value of assets which should translate into built in stability for future earnings.
The table above indicates that at June 30, 2016, in the event of an instantaneous parallel 100 basis point decrease in interest rates, we would experience a 7% increase in EVE. In the event of an instantaneous 100 basis point increase in interest rates, we would experience a 4% decrease in EVE.
The table below sets forth, as of June 30, 2016, the estimated changes in net interest income over the next twelve months that would result for the Bank from the designated changes in the United States Treasury yield curve under an instantaneous parallel shift. Computations of prospective effects of hypothetical interest rate 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. The calculated changes assume an immediate shock of the static yield curve.
Depending on the relationship between long-term and short-term interest rates, market conditions and consumer preference, we may place greater emphasis on maximizing our net interest margin than on strictly matching the interest rate sensitivity of our assets and liabilities. We believe that the increased net income which may result from an acceptable mismatch in the actual maturity or re-pricing of our assets and liabilities can, during periods of declining or stable interest rates, provide sufficient returns to justify an increased exposure to sudden and unexpected increases in interest rates.
We do not engage in hedging activities, such as engaging in futures, options or swap transactions, or investing in high-risk mortgage derivatives, such as collateralized mortgage obligation residual interests, real estate mortgage investment conduit residual interests or stripped mortgage backed securities.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable.
Item 8.
Item 8. Financial Statements and Supplementary Data
MW Bancorp, Inc.
Report of Independent Registered Public Accounting Firm and
Consolidated Financial Statements
June 30, 2016 and 2015
MW Bancorp, Inc.
June 30, 2016 and 2015
Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
MW Bancorp, Inc.
Cincinnati, Ohio
We have audited the accompanying consolidated balance sheets of MW Bancorp, Inc. (the “Company”) as of June 30, 2016 and 2015, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders' equity, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated 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 audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also 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 MW Bancorp, Inc. as of June 30, 2016 and 2015, and the results of their operations and their cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles.
/s/ Elliott Davis Decosimo, LLC
Greenville, South Carolina
September 23, 2016
www.elliottdavis.com
MW Bancorp, Inc.
Consolidated Balance Sheets
June 30, 2016 and 2015
(In thousands, except share data)
See Notes to Consolidated Financial Statements
MW Bancorp, Inc.
Consolidated Statements of Income
Years Ended June 30, 2016 and 2015
(In thousands, except share data)
See Notes to Consolidated Financial Statements
MW Bancorp, Inc.
Consolidated Statements of Comprehensive Income (Loss)
Years Ended June 30, 2016 and 2015
(In thousands)
See Notes to Consolidated Financial Statements
MW Bancorp, Inc.
Consolidated Statements of Shareholders’ Equity
Years Ended June 30, 2016 and 2015
(In thousands)
See Notes to Consolidated Financial Statements
MW Bancorp, Inc.
Consolidated Statements of Cash Flows
Years Ended June 30, 2016 and 2015
(In thousands)
See Notes to Consolidated Financial Statements
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 1:Nature of Operations and Summary of Significant Accounting Policies
Nature of Operations
MW Bancorp, Inc. (the “Company”), headquartered in Cincinnati, Ohio, was formed to serve as the stock holding company for Watch Hill Bank (the “Bank”) following its mutual-to-stock conversion. The conversion was completed effective January 29, 2015. The Company issued 876,163 shares at an offering price of $10.00 per share.
Watch Hill Bank conducts a general banking business in southwestern Ohio which primarily consists of attracting deposits from the general public and applying those funds to the origination of loans for residential, consumer and nonresidential purposes. The Bank’s profitability is significantly dependent on its net interest income, which is the difference between interest income generated from interest-earning assets (i.e. loans and investments) and the interest expense paid on interest-bearing liabilities (i.e. deposits and borrowed funds). Net interest income is affected by the relative amount of interest-earning assets and interest bearing-liabilities and the interest received or paid on those balances. The level of interest rates paid or received by the Bank can be significantly influenced by a number of environmental factors, such as governmental monetary policy, that are outside management’s control.
Principles of Consolidation
The consolidated financial statements include MW Bancorp, Inc. and its wholly owned subsidiary, Watch Hill Bank, together referred to as “the Company.” Intercompany transactions and balances have been eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses, valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, valuation of deferred tax assets and fair values of financial instruments.
Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents are defined as cash and due from banks and interest-bearing deposits with original terms to maturity of less than ninety days. Net cash flows are reported for customer loan and deposit transactions.
From time to time, the Company’s interest-bearing cash accounts may exceed the FDIC’s insured limit of $250,000. Management considers the risk of loss to be low.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Interest-Bearing Deposits in Other Financial Institutions
Interest-bearing deposits in other financial institutions mature within one year and are carried at cost.
Securities
Certain debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. Interest income includes amortization of purchase premium or discount. Premiums and discounts on securities are recognized in interest income using the level-yield method over the terms of the securities, without anticipating prepayments, except for mortgage backed securities where prepayments are anticipated. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, a security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) other-than-temporary impairment (OTTI) related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis.
For equity securities, when the Company has decided to sell an impaired available-for-sale security and the Company does not expect the fair value of the security to fully recover before the expected time of sale, the security is deemed other-than-temporarily impaired in the period in which the decision to sell is made. The Company recognizes an impairment loss when the impairment is deemed other than temporary even if a decision to sell has not been made.
Loans Held for Sale
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or fair value in the aggregate. Net unrealized losses, if any, are recognized through a valuation allowance by charges to noninterest income. Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on loan sales are recorded in noninterest income, and direct loan origination costs and fees are deferred at origination of the loan and are recognized in noninterest income upon sale of the loan.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Loans
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at their outstanding principal balances adjusted for unearned income, charge-offs, the allowance for loan losses and any unamortized deferred fees or costs on originated loans.
For loans amortized at cost, interest income is accrued based on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and amortized as a level yield adjustment over the respective term of the loan.
For all loan classes, the accrual of interest is discontinued at the time the loan is 90 days past due unless the credit is well-secured and in process of collection. Past due status is based on contractual terms of the loan. For all loan classes, the entire balance of the loan is considered past due if the minimum payment contractually required to be paid is not received by the contractual due date. For all loan classes, loans are placed on nonaccrual or charged off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans and loans past due 90 days still on accrual include both smaller balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. A loan is moved to non-accrual status in accordance with the Company’s policy, typically after 90 days of non-payment.
For all loan classes, all interest accrued but not collected for loans that are placed on nonaccrual or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Company requires a period of satisfactory performance of not less than six months before returning a nonaccrual loan to accrual status.
When cash interest payments are received on impaired loans in each loan class, the Company records the payment as interest income unless collection of the remaining recorded principal amount is doubtful, at which time payments are used to reduce the principal balance of the loan.
Concentration of Credit Risk
Most of the Company’s business activity is with customers located within Hamilton County, Ohio. Therefore, the Company’s exposure to credit risk is significantly affected by changes in the economy in the Hamilton County area.
Allowance for Loan Losses
The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations and estimated collateral values, economic conditions, and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Loans for which the terms have been modified resulting in a concession, and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired.
Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed.
Commercial and commercial real estate loan relationships over $250,000 and the loans related to them are individually evaluated for impairment. If a loan is impaired, a portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real estate loans, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures.
Troubled debt restructurings are separately identified for impairment disclosures and are measured at the present value of estimated future cash flows using the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt restructurings that subsequently default, the Company determines the amount of reserve in accordance with the accounting policy for the allowance for loan losses.
The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual loss history experienced by the Company over the most recent five years. This actual loss experience is supplemented with other economic factors based on the risks present for each portfolio segment. These economic factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Transfers of Financial Assets
Transfers of financial assets are accounted for as sales, when control over the assets has been relinquished. Control over transferred assets is deemed to be surrendered when the assets have been isolated from the Company, the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity.
Premises and Equipment
Depreciable assets are stated at cost less accumulated depreciation. Depreciation is charged to expense using the straight-line method over the estimated useful lives of the assets. The estimated useful lives of depreciable assets is 39 years for buildings, 10 years for building improvements, and three to seven years for furniture, fixtures and equipment. Leasehold improvements are capitalized and depreciated using the straight-line method over the terms of the respective leases or the estimated useful lives of the improvements, whichever is shorter. Maintenance and repairs are expensed and major improvements are capitalized.
Federal Home Loan Bank Stock
Federal Home Loan Bank (“FHLB”) stock is a required investment for institutions that are members of the FHLB system. The required investment in the common stock is based on a predetermined formula, carried at cost classified as a restricted security and evaluated for impairment.
Foreclosed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs and reserves after acquisition are expensed.
Income Taxes
The Company accounts for income taxes in accordance with income tax accounting guidance (Accounting Standards Codification (“ASC”) 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax expense reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. The Company determines deferred income taxes using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is based on the tax effects of the differences between the book and tax bases of assets and liabilities, and enacted changes in tax rates and laws are recognized in the period in which they occur.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Deferred income tax expense results from changes in deferred tax assets and liabilities between periods. Deferred tax assets are reduced by a valuation allowance if, based on the weight of evidence available, it is more likely than not that some portion or all of a deferred tax asset will not be realized.
Uncertain tax positions are recognized if it is more likely than not, based on the technical merits, that the tax position will be realized or sustained upon examination. The term more likely than not means a likelihood of more than 50 percent; the terms examined and upon examination also include resolution of the related appeals or litigation processes, if any. A tax position that meets the more-likely-than-not recognition threshold is initially and subsequently measured as the largest amount of tax benefit that has a greater than 50 percent likelihood of being realized upon settlement with a taxing authority that has full knowledge of all relevant information. The determination of whether or not a tax position has met the more-likely-than-not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to the management’s judgment.
With a few exceptions, the Company is no longer subject to tax examinations by tax authorities for fiscal years before 2013. As of June 30, 2016, the Company had no material uncertain tax positions. The Company recognizes interest and/or penalties related to income tax matters in income tax expense.
Bank Owned Life Insurance
The cash surrender value of Bank owned life insurance policies represents the value of life insurance policies on certain officers of the Company for which the Company is the beneficiary. The Company accounts for these assets using the cash surrender value method in determining the carrying value of the insurance policies.
Comprehensive Income
Comprehensive income consists of net income and other comprehensive income, net of applicable income taxes. Other comprehensive income includes unrealized appreciation (depreciation) on available-for-sale securities, including those for which a portion of an other-than-temporary impairment has been recognized in income.
Fair Value of Financial Instruments
Fair values of financial instruments are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect these estimates.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Treasury Stock
Common shares repurchased are recorded at cost.
Stock Options and Restricted Stock Awards
The Company has a share-based compensation plan, which is more fully described in Note 12.
Loss Contingencies
Loss contingencies, including claims and legal actions arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a material effect on the financial statements.
Earnings Per Share
Basic earnings per share excludes dilution and is calculated by dividing net income applicable to common stock by the weighted-average number of shares of common stock outstanding during the period, less unallocated ESOP shares and unvested restricted stock awards. Diluted earnings per share is computed in a manner similar to that of basic earnings per share except that the weighted-average number of common shares outstanding is increased to include the number of incremental common shares that would have been outstanding if all potentially dilutive common stock equivalents were issued during the period, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options and restricted stock awards and are determined using the treasury stock method.
Unallocated common shares held by the Company’s Employee Stock Ownership Plan (the “ESOP”) are shown as a reduction in stockholders’ equity and are excluded from weighted-average common shares outstanding for both basic and diluted earnings per share calculations until they are committed to be released.
Earnings per share disclosures are not applicable to the fiscal year ended June 30, 2015, because the Company did not complete the conversion to stock form until January 29, 2015.
Reclassifications
Certain reclassifications have been made to the 2015 financial statements to conform to the 2016 financial statement presentation. These reclassifications had no effect on the results of operations.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 2:Securities
The amortized cost and approximate fair values, together with gross unrealized gains and losses, of securities are as follows:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The amortized cost and fair value of available-for-sale securities and held-to-maturity securities at June 30, 2016, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date are shown separately.
There were no sales of securities during the years ended June 30, 2016 and 2015.
The Company has pledged securities with a carrying value of $1.4 million and $1.1 million to secure commercial deposits in excess of the FDIC insurance limit as of June 30, 2016 and 2015, respectively.
At June 30, 2016 and 2015, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of the Company’s equity.
On August 1, 2013, the Company reclassified its collateralized mortgage obligation portfolio to held-to-maturity from available-for-sale because management intended to hold these securities to maturity. The securities had a total amortized cost of $2.925 million and a corresponding fair value of $2.894 million; therefore, the gross unrealized loss on these securities at the date of transfer was $31,000. The unrealized holding loss at the time of transfer continues to be reported in accumulated other comprehensive loss and is being amortized over the remaining lives of the securities as an adjustment of the yield. The amortization of the remaining holding loss reported in accumulated other comprehensive income (loss) will offset the effect on interest income of the discount for the transferred securities. The remaining unamortized balance of the losses for securities transferred from available-for-sale to held-to-maturity was $12,000 at June 30, 2016.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The following tables show the Company’s investments’ gross unrealized losses and fair value of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired, aggregated by investment class and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2016 and 2015:
Other-than-temporary Impairment
At June 30, 2016 and 2015, all of the mortgage-backed securities held by the Company were issued by U.S. government-sponsored entities and agencies, primarily Fannie Mae and Ginnie Mae, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates, and not credit quality, and because the Company does not have the intent to sell these mortgage-backed securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at June 30, 2016 and 2015.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 3:	Loans and Allowance for Loan Losses
Loans at June 30, 2016 and 2015 include:
The risk characteristics applicable to each segment of the loan portfolio are described below:
Residential Real Estate including Construction
Residential mortgage loans are secured by one- to four-family residences and are comprised of owner-occupied and non-owner-occupied loans. Construction real estate loans are usually based upon estimates of costs and estimated value of the completed project and include independent appraisal reviews and a financial analysis of the developers and property owners. Sources of repayment of these loans may include permanent loans, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. The Company generally establishes a maximum loan-to-value ratio and requires private mortgage insurance if that ratio is exceeded. Repayment of these loans is primarily dependent on the personal income of the borrowers, which can be impacted by economic conditions in their market areas, such as unemployment levels. Repayment can also be impacted by changes in property values or residential properties. Risk is mitigated by the fact that loans are of smaller individual amounts and spread over a large number of borrowers.
Multi-family Residential Real Estate
Multi-family real estate loans generally involve a greater degree of credit risk than one- to four- family residential mortgage loans and carry larger loan balances. This increased credit risk is a result of several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties, and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family real estate is typically dependent upon the successful operation of the related real estate property. If the cash flow from the project is reduced, the borrower’s ability to repay the loan may be impaired.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Commercial Real Estate
Commercial real estate loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The characteristics of properties securing the Company’s real estate portfolio are diverse, but with geographic location almost entirely in the Company’s market area. Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. In general, the Company avoids financing single purpose projects unless other underwriting factors are present to help mitigate risk.
Commercial
Commercial loans are viewed primarily as cash flow loans. Commercial lending typically involves higher loan principal amounts and the repayment of these loans is generally dependent on the successful operation of the business conducted. Commercial loans may be secured by receivables, inventories and/or guarantees of the borrowers and certain of these loans may be unsecured. Commercial loans may be more adversely affected by conditions in the general economy. The characteristics of businesses comprising the Company’s commercial portfolio are diverse, but with geographic location almost entirely in the Company’s market area. Management monitors and evaluates commercial loans based on collateral, geography and risk grade criteria.
Consumer Loans
Consumer loans entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as automobiles. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In particular, amounts realizable on the sale of repossessed automobiles may be significantly reduced based upon the condition of the automobiles and the lack of demand for used automobiles.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The following tables present by portfolio segment, the activity in the allowance for loan losses for the years ended June 30, 2016 and 2015, and the recorded investment in loans and impairment method as of June 30, 2016 and 2015:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Internal Risk Categories
The Company has adopted a standard loan grading system for all loans:
Definitions are as follows:
Pass: Loans categorized as Pass are higher quality loans that do not fit any of the other categories described below.
Special Mention: These are loans that examiners might label as “OAEM (other assets especially mentioned).” The loans have an obvious flaw or a potential weakness that deserves special management attention, but which has not yet impacted collectability. These flaws or weaknesses, if left uncorrected, may result in the deterioration of the prospects of repayment or the deterioration of the Company’s credit position.
Substandard: These are loans with a well-defined weakness, where the Company has a serious concern about the borrower’s ability to make full repayment if the weaknesses are not corrected. The loan may contain a flaw, which could impact the borrower’s ability to repay, or the borrower’s continuance as a “going concern.” When collateral values are not sufficient to secure the loan and other weaknesses are present, the loan may be rated substandard. A loan will also be graded substandard when full repayment is expected, but it must come from the liquidation of collateral. One-to four-family residential real estate loans and home equity loans that are past due 90 days or more with loan to value ratios greater than 60 percent are classified as substandard.
Doubtful: These are loans with major defined weaknesses, where future charge-off of a part of the credit is highly likely. The primary repayment source is no longer viable and the viability of the secondary source of repayment is in doubt. The amount of loss is uncertain due to circumstances within the credit that are not yet fully developed and the loan is rated “Doubtful” until the loss can be accurately estimated.
Loss: These are near term charge-offs. Loans classified as loss are considered uncollectible and of such little value that it is not desirable to continue carrying them as assets on the Company’s financial statements, even though partial recovery may be possible at some future time.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The following tables present the credit risk profile of the Company’s loan portfolio based on internal rating category and payment activity as of June 30, 2016 and 2015:
The Company has a portfolio of loans designated as subprime, defined as those loans made to borrowers with a credit score below 660. These loans are primarily secured by 1-4 family real estate, including both owner-occupied and non-owner occupied properties. Subprime loans totaled $6.5 million and $7.8 million at June 30, 2016 and 2015, respectively.
The Company evaluates the loan risk grading system definitions and allowance for loan losses methodology on an ongoing basis. No significant changes were made to either during the past fiscal year.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The following tables present the Company’s loan portfolio aging analysis of the recorded investment in loans as of June 30, 2016 and 2015:
A loan is considered impaired, in accordance with the impairment accounting guidance (ASC 310-10-35-16), when based on current information and events, it is probable the Company will be unable to collect all amounts due from the borrower in accordance with the contractual terms of the loan. Impaired loans include nonperforming multi-family and commercial loans but also include loans modified in troubled debt restructurings.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The following tables present impaired loans as of and for the years ended June 30, 2016 and 2015:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The recorded investment in loans excludes accrued interest receivable and net loan origination fees and costs, due to immateriality. For purposes of this disclosure, the unpaid principal balance is not reduced for partial charge-offs.
Interest income recognized on a cash basis was not materially different than interest income recognized.
The following table presents the Company’s nonaccrual loans at June 30, 2016 and 2015. The table excludes performing troubled debt restructurings.
At June 30, 2016 and 2015, the Company had certain loans that were modified in troubled debt restructurings and impaired. The modification of terms of such loans included one or a combination of the following: an extension of maturity, a reduction of the stated interest rate or a permanent reduction of the recorded investment in the loan. The Company had loans modified in a troubled debt restructuring totaling $1.1 million and $1.3 million at June 30, 2016 and 2015, respectively. Troubled debt restructured loans had specific allowances totaling $58,000 and $115,000 at June 30, 2016 and 2015, respectively. The Company had no commitments to lend additional funds on trouble debt restructured loans at June 30, 2016 and 2015.
The Company had no loans modified under a troubled debt restructuring during the years ended June 30, 2016 and 2015.
In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Company’s internal underwriting policy.
During the years ended June 30, 2016 and 2015, the Company originated for sale and sold $6.8 million and $3.2 million, respectively, of mortgage loans, realizing a gain on sale of $162,000 and $50,000 in those respective years. In addition, the Company sold certain jumbo mortgage loans totaling $5.7 million to another financial institution during fiscal 2016, realizing a gain on sale of $57,000. Loans are sold on a servicing retained and servicing released basis. The Company had loans held for sale totaling $1.8 million at June 30, 2016. The Company had no loans held for sale at June 30, 2015.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 4:Foreclosed Assets
Foreclosed assets activity for the years ended June 30, 2016 and 2015 was as follows:
Note 5:Premises and Equipment
Major classifications of premises and equipment, stated at cost, are as follows:
During the year ended June 30, 2016, the Company entered into a contract to build a drive-through banking facility adjacent to its new branch location at a total cost of approximately $730,000.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 6:Time Deposits
Time deposits in denominations of $100,000 or more were $19.1 million and $18.9 million at June 30, 2016 and 2015, respectively. At June 30, 2016 and 2015, time deposits in denominations of $250,000 or more were $5.0 million and $3.6 million, respectively.
At June 30, 2016, the scheduled maturities of time deposits were as follows:
Note 7:Federal Home Loan Bank Advances
Federal Home Loan Bank advances consisted of the following components at June 30, 2016 and 2015:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The Federal Home Loan Bank advances are secured by a blanket pledge of the Company’s eligible mortgage loans and the investment in Federal Home Loan Bank stock. The advances are subject to restrictions or penalties in the event of prepayment.
Note 8:Income Taxes
Income tax benefit for the years ended June 30, 2016 and 2015, was as follows:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
A reconciliation of the federal income tax benefit at the statutory rate to the Company’s actual income tax benefit is shown below:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The composition of the Company’s net deferred tax asset at June 30, 2016 and 2015, is as follows:
As of June 30, 2016 and 2015, the net deferred tax asset, before valuation allowance, was $2.1 million. Management recorded a valuation allowance against the net deferred tax asset at June 30, 2016 and 2015, based on consideration of, but not limited to, its cumulative pre-tax losses during the past three years, the composition of recurring and non-recurring income from operations over the past several years and the magnitude of recent taxable income as compared to net operating loss carryforwards. When determining the amount of deferred tax assets that are more likely than not to be realized, and therefore recorded as a benefit, the Company conducts a regular assessment of all available information. This information includes, but is not limited to, taxable income in prior periods, projected future income and projected future reversals of deferred tax items. Based on these criteria, the Company determined that it was necessary to maintain a full valuation allowance against the entire net deferred tax asset at June 30, 2015. During the year ended June 30, 2016, based on a review of the analysis, management determined that a reversal of a part of the valuation allowance was appropriate and, as a result, recorded a $680,000 reduction to the valuation allowance, crediting the federal income tax provision. At June 30, 2016, the Company had $5.6 million in net operating loss carryforwards, which begin to expire in the year ending in 2031.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Retained earnings at both June 30, 2016 and 2015 includes approximately $2.0 million, respectively, for which no deferred federal income tax liability has been recognized. This amount represents an allocation of income to bad debt deductions for tax purposes only. Reduction of amounts so allocated for purposes other than tax bad debt losses or adjustments arising from carryback of net operating losses would create income for tax purposes only, which would be subject to the then-current corporate income tax rate. The deferred income tax liability on the preceding amount that would have been recorded if it was expected to reverse into taxable income in the foreseeable future was approximately $680,000 at June 30, 2016 and 2015, respectively.
As of June 30, 2016 and 2015, the Company had no unrecognized tax benefits or accrued interest and penalties recorded. The Company does not expect the total amount of unrecognized tax benefits to significantly increase within the next twelve months. The Company will record interest and penalties as a component of income tax expense.
The Company is subject to U.S. federal income tax and Ohio franchise tax. The Company is subject to tax in Ohio based on its net worth. The Company is no longer subject to examination by taxing authorities for fiscal years prior to 2013.
Note 9:Regulatory Matters
The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory- and possibly additional discretionary- actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Furthermore, the Company’s regulators could require adjustments to regulatory capital not reflected in these financial statements. Quantitative measures established by regulation to ensure capital adequacy requires the Company to maintain minimum amounts and ratios as set forth in the table below. Management believes that, as of June 30, 2016 and 2015, the Company met all capital adequacy requirements to which it was subject.
Effective January 1, 2015, the Bank is subject to the new capital requirements set forth by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement and assigns a higher risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The final rule also requires unrealized gains and losses on certain “available-for-sale” securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. The Bank has chosen to exclude unrealized gains and losses from capital. The rule limits the Bank’s capital distributions and certain discretionary bonus payments if the Bank does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets in addition to the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement will be phased in beginning January 1, 2016 and ending January 1, 2019, when the full capital conservation buffer requirement will be effective.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
To be categorized as well capitalized under the regulatory framework for prompt corrective action, the Bank must maintain minimum capital ratios as set forth in the table. Management believes its capital still meets the requirements to be deemed well-capitalized as of the date of this report.
The Bank’s actual capital amounts and ratios are presented in the following table:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 10:Related Party Transactions
At June 30, 2016 and 2015, the Company had loans outstanding to executive officers, directors and their affiliates (related parties), in the amount of approximately $1.3 million and $1.5 million, respectively. During the year ended June 30, 2016, there were no loans originated to related parties and principal repayments from related parties totaled $44,000.
In management’s opinion, such loans and other extensions of credit are consistent with sound lending practices and are within applicable regulatory lending limitations. Further, in management’s opinion, these loans did not involve more than normal risk of collectability or present other unfavorable features.
At June 30, 2016 and 2015, the Company had deposits from certain officers, directors and other related interests totaling approximately $1.9 million and $2.2 million, respectively.
Note 11:Employee Benefits
The Company had a nonqualified Directors Deferred Compensation Plan (the “Plan”) which provided for the payment of benefits upon termination of service with the Company as a director and vesting in the Plan after five years of service. During the year ended June 30, 2013, the Company elected to terminate the Plan and distribute the benefits which had been earned through the date of termination. The Company did not recognize any expense in connection with the Plan for the year ended June 30, 2015. Final distributions of $2.0 million were made from the Plan during the year ended June 30, 2015.
The Company has a simplified employee pension plan for its full-time employees. All full-time employees are eligible and receive matching contributions at a predetermined rate. Expense recognized in connection with the plan totaled approximately $28,000 and $22,000 for the years ended June 30, 2016 and 2015, respectively.
On January 29, 2015, the Bank announced the formation of the Mt. Washington Savings Bank Employee Stock Ownership Plan (“ESOP”), a non-contributory plan for its employees. As part of the Company’s stock conversion, shares were purchased with a loan from MW Bancorp, Inc. All employees of the Bank meeting certain tenure requirements are entitled to participate in the ESOP. Compensation expense related to the ESOP was $55,000 and $20,000 for the years ended June 30, 2016 and 2015, respectively.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
A summary of the unallocated share activity of the Bank’s ESOP is as follows for the years ended June 30, 2016 and 2015:
The stock price at the formation date was $10.00. The aggregate fair value of the 66,589 and 70,093 unallocated shares was $1.0 million and $1.1 million based on the $15.75 and $15.00 closing price of our common stock on June 30, 2016 and 2015, respectively.
Note 12:Equity Incentive Plan
In April 2016, the Company’s stockholders authorized the adoption of the MW Bancorp, Inc. 2016 Equity Incentive Plan (the “2016 Plan”). No more than 122,662 shares of the Company’s common stock may be issued under the 2016 Plan, of which a maximum of 87,616 may be issued pursuant to the exercise of stock options and 35,046 may be issued pursuant to restricted stock awards, restricted stock units and unrestricted share awards. Stock options awarded to employees may be incentive stock options or non-qualified stock options. The shares that may be issued may be authorized but unissued shares or treasury shares. The 2016 Plan permits the grant of incentive awards in the form of options, stock appreciation rights, restricted share and share unit awards, and performance share awards. The 2016 Plan contains annual and lifetime limits on certain types of awards to individual participants.
Awards may vest or become exercisable only upon the achievement of performance measures or based solely on the passage of time after award. Stock options and restricted stock awards provide for accelerated vesting if there is a change in control (as defined in the 2016 Plan).
In May 2016, the Company granted stock options for 60,150 shares to members of the Board of Directors and certain members of management. Each option has an exercise price of $14.88 as determined on the grant date and expires 10 years from the grant date. The fair value of each option award was estimated on the date of grant using the Black-Scholes option valuation model, which resulted in a per share fair value of $4.67. The fair value was calculated for stock options using the following assumptions: expected volatility of 19.46%, a risk-free interest rate of 1.81%, an expected term of ten years and an expected dividend yield of 0.00%.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
A summary of option activity under the Plan as of June 30, 2016, and changes during the year then ended, is presented below:
In May 2016, the Company awarded restricted stock totaling 28,810 shares to members of the Board of Directors and certain members of management. The restricted stock awards have vesting periods ranging from three years to seven years. Shares of restricted stock granted to employees under the 2016 Plan are subject to restrictions as to continuous employment for a specified time period following the date of grant. During this period, the holder is entitled to full voting rights and dividends.
Total compensation cost recognized in the income statement for share-based payment arrangements during the year ended June 30, 2016 was $15,000.
As of June 30, 2016, there was $703,000 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of 6.3 years.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 13:Earnings Per Share
Earnings per share were computed as follows:
Note 14:Commitments and Credit Risk
Commitments to Originate Loans
Commitments to originate loans are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since a portion of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations, including receipt of collateral, as those utilized for on-balance-sheet instruments.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
At June 30, 2016 and 2015, the Company had outstanding commitments to originate loans as follows:
The commitments extended over varying periods of time with the majority being disbursed within a one-year period.
Letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including commercial paper, bond financing and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. At June 30, 2016 and 2015, the Company had the following performance letters of credit outstanding:
The terms of the letters of credit are for one year.
Lines of credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Lines of credit generally have fixed expiration dates. Since a portion of the line may expire without being drawn upon, the total unused lines do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, commercial real estate and residential real estate. Management uses the same credit policies in granting lines of credit as it does for on-balance-sheet instruments.
At June 30, 2016 and 2015, the Company had the following lines of credit outstanding:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The Bank has leased office space for its new branch, which opened in the first quarter of fiscal year 2016. The lease has an initial term of five years with monthly lease payments for the first year at $3,750. The lease is renewable for three five-year terms with escalating monthly payments at the beginning of each year. The lease expense totaled $27,000 for the year ended June 30, 2016. Future lease expense will total approximately $198,000 over the remaining four-year term of the lease.
Note 15:Disclosures about Fair Value of Assets and Liabilities
Fair value is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value measurements must maximize the use of observable inputs and minimize the use of unobservable inputs. There is a hierarchy of three levels of inputs that may be used to measure fair value:
Level 1Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Recurring Measurements
The following table presents the fair value measurement of assets recognized in the accompanying balance sheets measured at fair value on a recurring basis and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2016 and 2015:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. There were no assets classified within Level 3 of the fair value hierarchy measured on a recurring basis. There were no transfers between Level 1 and Level 2 during the years ended June 30, 2016 and 2015.
Available-for-sale Securities
Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. If quoted prices are not available, then fair values are estimated by using quoted prices of securities with similar characteristics or independent asset pricing services and pricing models, the inputs of which are market-based or independently sourced market parameters, including, but not limited to yield curves, interest rates, volatilities, prepayments, defaults, cumulative loss projections and cash flow. Such securities are classified within Level 2 of the valuation hierarchy.
Nonrecurring Measurements
The following table presents fair value measurements of assets measured at fair value on a non-recurring basis and the level within the fair value hierarchy in which fair value measurements fall at June 30, 2016 and 2015:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Following is a description of the valuation methodologies and inputs used for assets measured at fair value on a non-recurring basis and recognized in the accompanying balance sheets, as well as the general classification of such assets pursuant to the valuation hierarchy. For assets classified within Level 3 of the fair value hierarchy, the process used to develop the reported fair value is described below.
Impaired Loans (Collateral Dependent)
The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Foreclosed Assets Held for Sale
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Appraisals for both collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. The Company has determined that a discount of 7% to 10% should be applied to the appraisal value, to cover estimated selling costs, to arrive at fair value of the properties.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Unobservable (Level 3) Inputs
The following table presents quantitative information about unobservable inputs used in nonrecurring Level 3 fair value measurements:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Fair Value of Financial Instruments
The following table presents estimated fair values of the Company’s financial instruments and the level within the fair value hierarchy in which the fair value measurements fall at June 30, 2016 and 2015.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
The following methods were used to estimate the fair value of all other financial instruments recognized in the accompanying balance sheets at amounts other than fair value.
Cash and Cash Equivalents
The carrying amount approximates fair value.
Held-to-Maturity Securities
The fair value of held-to-maturity securities was estimated by using pricing models that contain market pricing and information, quoted prices of securities with similar characteristics or discounted cash flows that use credit-adjusted discount rates.
Loans
Fair value is estimated by discounting the future cash flows using the market rates at which similar notes would be made to borrowers with similar credit ratings and for the same remaining maturities. The market rates used are based on current rates the Bank would impose for similar loans and reflect a market participant assumption about risks associated with nonperformance, illiquidity, and the structure and term of the loans along with local economic and market conditions.
Federal Home Loan Bank Stock
The carrying amounts approximate fair value.
Accrued Interest Receivable and Payable
The carrying amount approximates fair value. The carrying amount is determined using the interest rate, balance and last payment date.
Deposits
Fair value of term deposits is estimated by discounting the future cash flows using rates of similar deposits with similar maturities. The market rates used were obtained from a knowledgeable independent third party and reviewed by the Company. The rates were the average of current rates offered by local competitors of the Company.
The estimated fair value of demand, savings and money market deposits is the book value since rates are regularly adjusted to market rates and amounts are payable on demand at the reporting date.
Federal Home Loan Bank Advances
Fair value is estimated by discounting the future cash flows using rates of similar advances with similar maturities. These rates were obtained from current rates offered by the FHLB.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 16:	Accumulated Other Comprehensive Income (Loss)
Changes in accumulated other comprehensive income (loss) by component, net of tax, for the years ended June 30, 2016 and 2015 are as follows:
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 17:Recent Accounting Pronouncements
FASB ASU 2014-09, Revenue from Contracts with Customers. In May 2014, the Financial Accounting Standards Board (“FASB”) issued amended guidance on revenue recognition from contracts with customers. The standard outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most contract revenue recognition guidance, including industry-specific guidance. The core principle of the amended guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The amended guidance is effective for annual reporting periods beginning after December 15, 2017, and interim periods within the reporting period, and should be applied either retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the amendments recognized at the date of initial application. Early adoption is prohibited. Management is currently in the process of evaluating the impact of the amended guidance on the Company’s financial statements.
FASB ASU 2016-01 Recognition and Measurement of Financial Assets and Financial Liabilities. In January 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities. For public business entities, the amendments in this update include the elimination of the requirement to disclose the method(s) and significant assumptions used to estimate fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, the requirement to use the exit price notion when measuring fair value of financial instruments for disclosure purposes, the requirement to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, the requirement for separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or accompanying notes to the financial statements, and the amendments clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity's other deferred tax assets.
For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. Early adoption of the amendments in this update is not permitted, except that early application by public business entities to financial statements of fiscal years or interim periods that have not yet been issued or, by all other entities, that have not yet been made available for issuance are permitted as of the beginning of the fiscal year of adoption for the following amendment: An entity should present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk if the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. An entity should apply the amendments to this update by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. Management is currently evaluating the impact of adopting this guidance on the Company’s financial statements.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
FASB ASU 2016-02, Leases. In February 2016 the FASB issued ASU 2016-02, Leases. Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date:
● A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and
● A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term.
Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers.
The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing.
Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Early application is permitted for all public business entities upon issuance. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach. Management is currently evaluating the impact of adopting this guidance on the Company’s financial statements.
FASB ASU 2016-13 Financial Instruments-Credit Losses. In June 2016, the FASB issued ASU 2016-13. The amendments in this ASU replace the incurred loss model for recognition of credit losses with a methodology that reflects expected credit losses over the life of the loan and requires consideration of a broader range of reasonable and supportable information to calculate credit loss estimates. The amendments are effective for public business entities for the first interim and annual reporting periods beginning after December 15, 2019. The Company is currently evaluating the impact of these amendments to the Company’s financial position and results of operations.
MW Bancorp, Inc.
Notes to Consolidated Financial Statements
Years Ended June 30, 2016 and 2015
Note 18:Change in Corporate Form
On January 29, 2015, the Company converted into a stock savings bank structure with the establishment of a stock holding company, MW Bancorp, Inc., as parent of the Company.
The Bank converted to the stock form of ownership, followed by the issuance of all of the Bank’s outstanding stock to MW Bancorp, Inc. Pursuant to the Plan, the Bank determined the total offering value and number of shares of common stock based upon an independent appraiser’s valuation. The stock was priced at $10.00 per share. In addition, the Bank’s Board of Directors adopted an employee stock ownership plan (ESOP) which subscribed for 8% of the common stock sold in the offering. Proceeds from the sale of shares totaled $8.8 million. MW Bancorp, Inc. was organized as a corporation under the laws of the State of Maryland and owns all of the outstanding common stock of the Bank upon completion of the conversion.
The costs of issuing the common stock were deducted from the sales proceeds of the offering.
At the completion of the conversion to stock form, the Bank established a liquidation account in the amount of retained earnings contained in the final prospectus. The liquidation account will be maintained for the benefits of eligible savings account holders who maintain deposit accounts in the Bank after conversion.
The conversion was accounted for as a change in corporate form with the historic basis of the Bank’s assets, liabilities and equity unchanged as a result.
Note 19:Subsequent Event
On July 17, 2016, the Company declared a cash dividend of $0.10 per share that was paid on August 31, 2016. The dividend payment totaled $86,000.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
(a)Disclosure Controls and Procedures. An evaluation was performed under the supervision and with the participation of the Company’s management, including the President and Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2016. Based on that evaluation, the Company’s management, including the President and Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.
(b)Internal Control Over Financial Reporting.
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. The internal control process has been designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting purposes in accordance with accounting principles generally accepted in the United States of America.
There have been no significant changes in our internal control over financial reporting during the quarter ended June 30, 2016, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting as of June 30, 2016. This evaluation was based on criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on our evaluation under the COSO framework, our management concluded that our internal control over financial reporting was effective as of June 30, 2016.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to the rules of the Securities and Exchange Commission that permit the Company to provide only management’s report in this annual report.
(c)Management’s Report on Internal Control Over Financial Reporting
September 23, 2016
REPORT BY MW BANCORP, INC.’S MANAGEMENT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management is responsible for establishing and maintaining an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles. There are inherent limitations in the effectiveness of any system of internal control. Accordingly, even an effective system of internal control can provide only reasonable assurance with respect to financial statement preparation.
Management assessed the Company’s system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles as of June 30, 2016. This assessment was based on criteria for effective internal control over financial reporting described in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes that, as of June 30, 2016, MW Bancorp, Inc. maintained an effective system of internal control over financial reporting that is designed to produce reliable financial statements presented in conformity with generally accepted accounting principles based on those criteria.
MW Bancorp, Inc.
By: /s/Gregory P. Niesen
Gregory P. Niesen, President and Chief Executive Officer
By: /s/Julie M. Bertsch
Julie M. Bertsch, Chief Financial Officer
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance
The information contained in the definitive Proxy Statement for the 2016 Annual Meeting of Stockholders of MW Bancorp, Inc. (the “Proxy Statement”) under the captions “PROXY ITEM 1: ELECTION OF DIRECTORS,” “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS-Executive Officers” and “SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE” is incorporated herein by reference.
Information regarding the Company’s Audit Committee under the caption “PROXY ITEM 1: ELECTION OF DIRECTORS - Committees of Directors” in the Proxy Statement is incorporated herein by reference.
MW Bancorp, Inc. has adopted a Code of Ethics applicable to its principal executive officer, principal financial officer, principal accounting officer and others. The Code of Ethics is posted on the registrant’s web site at www.watchhillbank.com under the “Investor Relations” tab. Amendments to the Code of Ethics and waivers of the provisions of the Code of Ethics will also be posted on the registrant’s web site, www.watchhillbank.com under the “Investor Relations” tab.
Directors of MW Bancorp, Inc.
Bernard G. Buerger, Certified Public Accountant, Fermann & Company, LLC
John W. Croxton, Funeral Director, T. P. White and Sons Funeral Home
Gerald E. Grove, Retired Executive Director of Anderson Area Chamber of Commerce
David M. Tedtman, Certified Public Accountant, Consultant, Self-Employed
Bruce N. Thompson, Retired Vice President and Manager of Fifth Third Bank
Gregory P. Niesen, President and Chief Executive Officer, MW Bancorp, Inc., and Watch Hill Bank
Executive Officers of MW Bancorp, Inc.
Gregory P. Niesen, President and Chief Executive Officer, MW Bancorp, Inc, and Watch Hill Bank
Karan A. Kiser, Executive Vice President and Chief Operating Officer of Watch Hill Bank
Julie M. Bertsch, Executive Vice President, Chief Financial Officer and Corporate Secretary of MW Bancorp, Inc., and Watch Hill Bank
Item 11.
Item 11. Executive Compensation
The information contained in the Proxy Statement under the caption “COMPENSATION OF DIRECTORS AND EXECUTIVE OFFICERS” is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters
The information contained in the Proxy Statement under the caption “VOTING SECURITIES AND OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT” is incorporated herein by reference.
In April 2016, the Company’s stockholders approved the adoption of the MW Bancorp, Inc. 2016 Equity Incentive Plan the "2016 Equity Plan"). The following table sets forth certain information regarding that plan:
(1) The only compensatory plan providing for the issuance of the Company's shares is the 2016 Equity Plan. The 2016 Equity Plan authorizes the award of incentive and non-qualified stock options, restricted stock, restricted stock units, dividend equivalent rights and unrestricted share awards. Of the total 122,662 shares that may be issued pursuant to the 2016 Equity Plan, as of June 30, 2016, options to purchase 60,150 shares (all currently outstanding) had been awarded, as well as 28,810 shares of restricted stock. The 2016 Equity Plan restricts the number of shares available for issuance pursuant to options to 87,616 shares and the number of shares that may be issued as restricted stock, restricted stock units or unrestricted shares to 35,046 shares.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence
The information contained in the Proxy Statement under the captions “CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS” and “PROXY ITEM 1: ELECTION OF DIRECTORS - Election of Directors” is incorporated herein by reference.
Item 14.
Item 14. Principal Accountant Fees and Services
The information contained in the Proxy Statement under the caption “PROXY ITEM 2: RATIFICATION OF THE SELECTION OF ELLIOTT DAVIS DECOSIMO, LLC AS THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM” is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits and Financial Statement Schedules
(a)
(1)Financial Statements-See Index to Consolidated Financial Statements in Item 8 of this Form 10-K.
(2)Financial Statement Schedules-None
(b)Exhibits
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MW Bancorp, Inc.
By /s/ GREGORY P. NIESEN
Gregory P. Niesen
President and Chief Executive Officer
September 23, 2016
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
INDEX TO EXHIBITS
Exhibit
Page
Number
Description
Reference
3.1
Articles of Incorporaton of MW Bancorp, Inc.
Incorporated by reference to registrant's Form S-1 filed on September 10, 2014, Exhibit 3.1 (File No. 333-198668).
3.2
Bylaws of MW Bancorp, Inc.
Incorporated by reference to registrant's Form S-1 filed on September 10, 2014, Exhibit 3.2 (File No. 333-198668).
4.1
Agreement to furnish instruments and agreements defining rights of holders of long term debt
Included herewith.
10.1*
Employment agreement between Gregory P. Niesen and Watch Hill Bank
Incorporated by reference to registrant's Form S-1 filed on September 10, 2014, Exhibit 10.1 (File No. 333-198668).
10.2*
Change in Control Agreement between Karan A. Kiser and Watch Hill Bank
Incorporated by reference to registrant's Form S-1 filed on September 10, 2014, Exhibit 10.3 (File No. 333-198668).
10.3*
MW Bancorp, Inc. 2016 Equity Incentive Plan
Incorporated by reference to registrant's Form 8-K filed on April 19, 2016, Exhibit 10.1 (File No. 000-55356).
10.4*
MW Bancorp, Inc. 2016 Equity Incentive Plan Incentive Stock Option Award Agreement
Incorporated by reference to registrant's Form 8-K filed on April 19, 2016, Exhibit 10.1 (File No. 000-55356).