Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
General
The primary function of the Company is to monitor and oversee its investment in the Bank. The Company engages in few other activities, and the Company has no significant assets other than its investment in the Bank. As a result, the results of operations of the Company are derived primarily from operations of the Bank. The Bank’s results of operations are primarily dependent on net interest margin, which is the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities. The Bank’s income is also affected by the level of its noninterest expenses, such as employee salaries and benefits, occupancy expenses and other expenses. The following discussion reviews material changes in the Company’s financial condition as of September 30, 2018, and the results of operations for the three and nine months ended September 30, 2018 and 2017.
These forward-looking statements involve risks and uncertainties, such as statements of the Company's plans, objectives, expectations, estimates and intentions of Guaranty Federal Bancshares, Inc. (“Guaranty Federal Bancshares”) and its wholly-owned subsidiary, Guaranty Bank (the “Bank”, with Guaranty Federal Bancshares and the Bank being referred to collectively hereinafter as the “Company”) that are subject to change based on various important factors (some of which are beyond the Company's control). The following factors, among others, could cause the Company's financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: the strength of the United States economy in general and the strength of the real estate values and the local economies in which the Company conducts operations; risks associated with the Company’s acquisition of Hometown Bancshares, Inc. (“Hometown”) and its wholly-owned subsidiary Hometown Bank, National Association (“Hometown Bank”) and the integration of Hometown Bank with the Bank, including the possibility that we may not realize the anticipated benefits of the acquisition; the impact of recent and potential future changes in the laws, rules, regulations, interpretations and policies relating to financial institutions, accounting, tax, monetary and fiscal matters and their application by our regulators; the effects of, and changes in, trade, monetary and fiscal policies and laws, changes in interest rates; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors' products and services; the impact of changes in financial services' laws and regulations (including laws concerning taxes, banking, securities and insurance); asset quality deterioration; environmental liability associated with real estate collateral; technological changes and cybersecurity risks; acquisitions; employee retention; the success of the Company at managing the risks resulting from these factors; and other factors set forth in reports and other documents filed by the Company with the Securities and Exchange Commission from time to time. For further information about these and other risks, uncertainties and factors, please review the disclosure included in Item 1A. “Risk Factors” of the Company’s Annual Report on Form 10-K for its fiscal year ended December 31, 2017.
The Company cautions that the listed factors are not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.
On April 2, 2018, pursuant to the previously announced Agreement and Plan of Merger dated as of November 30, 2017 (the “Merger Agreement”) by and between Guaranty Federal Bancshares and Hometown, Hometown merged with and into Guaranty Federal Bancshares with Guaranty Federal Bancshares being the surviving corporation (the “Merger”). Subject to the terms and conditions of the Merger Agreement, at the effective time of the Merger, each share of Hometown common stock was converted into the right to receive $20.00 in cash. In the aggregate, the Company paid $4.6 million in respect of the outstanding shares of Hometown common stock. Hometown’s subsidiary bank, Hometown Bank, was merged into Guaranty Bank on June 8, 2018.
In connection with the Merger, pursuant to a Second Supplemental Indenture, dated as of April 2, 2018, by and among the Company, Hometown, and Wilmington Trust Company, as trustee (the “Trustee”), the Company assumed Hometown’s rights, duties, and obligations under the Indenture, dated as of October 29, 2002, as supplemented by that certain First Supplemental Indenture, dated as of May 19, 2014, by and between Hometown and the Trustee, under which Hometown issued approximately $6.1 million aggregate principal amount of its Floating Rate Junior Subordinated Debt Securities due 2032.
Financial Condition
The Company’s total assets increased $171,921,227 (22%) from $794,459,520 as of December 31, 2017, to $966,380,747 as of September 30, 2018. The increase is primarily due to the Hometown assets acquired of $178,785,000.
Available-for-sale securities increased $4,126,470 (5%) from $81,478,673 as of December 31, 2017, to $85,605,143 as of September 30, 2018. The increase was attributable primarily to $7,521,000 in securities acquired in the Hometown acquisition. The Company also had purchases of $25,151,079 offset by sales and principal payments of $25,804,714 and an increase in unrealized losses of $2,317,521 when compared December 31, 2017.
Net loans receivable increased by $150,711,310 (24%) from $629,605,009 as of December 31, 2017 to $780,316,319 as of September 30, 2018. The increase was attributable in large part to the Hometown acquisition, which added loans totaling $143,919,000 at fair value. The Company continues to focus its lending efforts in the commercial, owner occupied real estate and small business lending categories.
Allowance for loan losses increased $624,289 (9%) from $7,107,418 as of December 31, 2017 to $7,731,707 as of September 30, 2018. In addition to the provision for loan losses of $925,000 recorded by the Company for the nine months ended September 30, 2018, charge-offs of specific loans (classified as nonperforming at December 31, 2017) exceeded loan recoveries by $300,711. The allowance for loan losses, as a percentage of gross loans outstanding (excluding mortgage loans held for sale), as of September 30, 2018 and December 31, 2017 was 0.98% and 1.12%, respectively. The allowance for loan losses including the discount and premiums on acquired loans, as a percentage of gross loans outstanding (excluding mortgage loans held for sale), as of September 30, 2018 was 1.36%. The allowance for loan losses, as a percentage of nonperforming loans outstanding, as of September 30, 2018 and December 31, 2017 was 55.3% and 71.3%, respectively. Management believes the allowance for loan losses is at a level to be sufficient in providing for potential loan losses in the Bank’s existing loan portfolio.
Goodwill increased $2,615,532 (100%) and core deposit intangible increased $3,205,714 (100%) as of September 30, 2018 when compared to December 31, 2017. The increases are due to the Hometown acquisition and are further discussed in Note 7 to the Condensed Consolidated Financial Statements.
Premises and equipment increased $11,551,001 (109%) from $10,607,094 as of December 31, 2017 to $22,158,095 as of September 30, 2018. This is increase is primarily due to the $10,066,000 of fixed assets acquired from the Hometown acquisition.
Deposits increased $153,364,972 (25%) from $607,364,350 as of December 31, 2017, to $760,729,322 as of September 30, 2018. The deposit growth was attributable in large part to the Hometown acquisition, which added deposits of $161,248,424 at fair value. For the nine months ended September 30, 2018, checking and savings accounts increased by $69,132,414 and certificates of deposit decreased by $76,871,838. See also the discussion under Item 3 - “Quantitative and Qualitative Disclosure about Market Risk – Asset/Liability Management.”
Federal Home Loan Bank advances increased $2,400,000 (3%) from $94,300,000 as of December 31, 2017 to $96,700,000 as of September 30, 2018. The Company acquired $2,000,000 in Federal Home Loan Bank advances due to the Hometown acquisition but the increase was offset by net principal reductions.
Note payable to bank increased $5,000,000 (100%) when compared to December 31, 2017. The Company opened a $5,000,000 revolving line of credit with a variable interest rate tied to Libor which matures on June 28, 2020. The funds were used to provide additional capital for funding Bank asset growth.
Subordinated debentures increased $6,317,794 (41%) from $15,465,000 as of December 31, 2017 to $21,782,794 as of September 30, 2018. The increase is due to the Hometown acquisition, which added $6,362,000 of subordinated debentures at fair value.
Stockholders’ equity (including net unrealized loss on available-for-sale securities and interest rate swaps) increased $3,723,194 (5%) from $74,891,493 as of December 31, 2017, to $78,614,687 as of September 30, 2018. The Company’s net income during this period exceeded dividends paid or declared by $3,345,753. On a per common share basis, tangible book value decreased from $17.10 as of December 31, 2017 to $16.48 as of September 30, 2018 due to the Hometown acquisition.
Average Balances, Interest and Average Yields
The Company’s profitability is primarily dependent upon net interest income, which represents the difference between interest and fees earned on loans and debt and equity securities, and the cost of deposits and borrowings. Net interest income is dependent on the difference between the average balances and rates earned on interest-earning assets and the average balances and rates paid on interest-bearing liabilities. Non-interest income, non-interest expense, and income taxes also impact net income.
The following table sets forth certain information relating to the Company’s average consolidated statements of financial condition and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense annualized by the average balance of assets or liabilities, respectively, for the periods shown. Average balances were derived from average daily balances. The average balance of loans includes loans on which the Company has discontinued accruing interest. The yields and costs include fees which are considered adjustments to yields. All dollar amounts are in thousands.
|
|
Three months ended 9/30/2018
|
|
|
Three months ended 9/30/2017
|
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Yield /
Cost
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Yield /
Cost
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
$
|
787,638
|
|
|
$
|
12,774
|
|
|
|
6.43
|
%
|
|
$
|
618,652
|
|
|
$
|
7,052
|
|
|
|
4.52
|
%
|
Investment securities
|
|
|
87,182
|
|
|
|
524
|
|
|
|
2.38
|
%
|
|
|
84,577
|
|
|
|
432
|
|
|
|
2.03
|
%
|
Other assets
|
|
|
18,257
|
|
|
|
80
|
|
|
|
1.74
|
%
|
|
|
10,418
|
|
|
|
41
|
|
|
|
1.56
|
%
|
Total interest-earning
|
|
|
893,077
|
|
|
|
13,378
|
|
|
|
5.94
|
%
|
|
|
713,647
|
|
|
|
7,525
|
|
|
|
4.18
|
%
|
Noninterest-earning
|
|
|
59,509
|
|
|
|
|
|
|
|
|
|
|
|
40,386
|
|
|
|
|
|
|
|
|
|
|
|
$
|
952,586
|
|
|
|
|
|
|
|
|
|
|
$
|
754,033
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings accounts
|
|
$
|
42,412
|
|
|
|
29
|
|
|
|
0.27
|
%
|
|
$
|
30,026
|
|
|
|
15
|
|
|
|
0.20
|
%
|
Transaction accounts
|
|
|
405,230
|
|
|
|
1,175
|
|
|
|
1.15
|
%
|
|
|
348,925
|
|
|
|
524
|
|
|
|
0.60
|
%
|
Certificates of deposit
|
|
|
208,534
|
|
|
|
622
|
|
|
|
1.18
|
%
|
|
|
133,198
|
|
|
|
354
|
|
|
|
1.05
|
%
|
FHLB advances
|
|
|
88,750
|
|
|
|
482
|
|
|
|
2.15
|
%
|
|
|
89,246
|
|
|
|
420
|
|
|
|
1.87
|
%
|
Other borrowed funds
|
|
|
5,000
|
|
|
|
59
|
|
|
|
4.68
|
%
|
|
|
-
|
|
|
|
-
|
|
|
|
0.00
|
%
|
Subordinated debentures
|
|
|
21,797
|
|
|
|
282
|
|
|
|
5.13
|
%
|
|
|
15,465
|
|
|
|
160
|
|
|
|
4.10
|
%
|
Total interest-bearing
|
|
|
771,723
|
|
|
|
2,649
|
|
|
|
1.36
|
%
|
|
|
616,860
|
|
|
|
1,473
|
|
|
|
0.95
|
%
|
Noninterest-bearing
|
|
|
103,817
|
|
|
|
|
|
|
|
|
|
|
|
62,599
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
875,540
|
|
|
|
|
|
|
|
|
|
|
|
679,459
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
|
|
|
77,046
|
|
|
|
|
|
|
|
|
|
|
|
74,574
|
|
|
|
|
|
|
|
|
|
|
|
$
|
952,586
|
|
|
|
|
|
|
|
|
|
|
$
|
754,033
|
|
|
|
|
|
|
|
|
|
Net earning balance
|
|
$
|
121,354
|
|
|
|
|
|
|
|
|
|
|
$
|
96,787
|
|
|
|
|
|
|
|
|
|
Earning yield less costing rate
|
|
|
|
|
|
|
|
|
|
|
4.58
|
%
|
|
|
|
|
|
|
|
|
|
|
3.24
|
%
|
Net interest income, and net yield spread on interest earning assets
|
|
|
|
|
|
$
|
10,729
|
|
|
|
4.77
|
%
|
|
|
|
|
|
$
|
6,052
|
|
|
|
3.36
|
%
|
Ratio of interest-earning assets to interest-bearing liabilities
|
|
|
|
|
|
|
116
|
%
|
|
|
|
|
|
|
|
|
|
|
116
|
%
|
|
|
|
|
|
|
Nine months ended 9/30/2018
|
|
|
Nine months ended 9/30/2017
|
|
|
|
Average
Balance
|
|
|
Interest
|
|
|
Yield /
Cost
|
|
|
Average B
alance
|
|
|
Interest
|
|
|
Yield /
Cost
|
|
ASSETS
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-earning:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
|
$
|
759,354
|
|
|
$
|
29,971
|
|
|
|
5.28
|
%
|
|
$
|
598,925
|
|
|
$
|
20,043
|
|
|
|
4.47
|
%
|
Investment securities
|
|
|
86,457
|
|
|
|
1,466
|
|
|
|
2.27
|
%
|
|
|
88,783
|
|
|
|
1,361
|
|
|
|
2.05
|
%
|
Other assets
|
|
|
19,358
|
|
|
|
276
|
|
|
|
1.91
|
%
|
|
|
12,623
|
|
|
|
134
|
|
|
|
1.42
|
%
|
Total interest-earning
|
|
|
865,169
|
|
|
|
31,713
|
|
|
|
4.90
|
%
|
|
|
700,331
|
|
|
|
21,538
|
|
|
|
4.11
|
%
|
Noninterest-earning
|
|
|
58,903
|
|
|
|
|
|
|
|
|
|
|
|
40,512
|
|
|
|
|
|
|
|
|
|
|
|
$
|
924,072
|
|
|
|
|
|
|
|
|
|
|
$
|
740,843
|
|
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Savings accounts
|
|
$
|
40,325
|
|
|
|
76
|
|
|
|
0.25
|
%
|
|
$
|
29,360
|
|
|
|
43
|
|
|
|
0.20
|
%
|
Transaction accounts
|
|
|
407,895
|
|
|
|
3,231
|
|
|
|
1.06
|
%
|
|
|
345,247
|
|
|
|
1,346
|
|
|
|
0.52
|
%
|
Certificates of deposit
|
|
|
198,879
|
|
|
|
1,661
|
|
|
|
1.12
|
%
|
|
|
119,011
|
|
|
|
873
|
|
|
|
0.98
|
%
|
FHLB advances
|
|
|
77,436
|
|
|
|
1,221
|
|
|
|
2.11
|
%
|
|
|
98,306
|
|
|
|
1,269
|
|
|
|
1.73
|
%
|
Other borrowed funds
|
|
|
3,671
|
|
|
|
63
|
|
|
|
2.29
|
%
|
|
|
-
|
|
|
|
-
|
|
|
|
0.00
|
%
|
Subordinated debentures
|
|
|
20,705
|
|
|
|
729
|
|
|
|
4.71
|
%
|
|
|
15,465
|
|
|
|
468
|
|
|
|
4.05
|
%
|
Total interest-bearing
|
|
|
748,911
|
|
|
|
6,981
|
|
|
|
1.25
|
%
|
|
|
607,389
|
|
|
|
3,999
|
|
|
|
0.88
|
%
|
Noninterest-bearing
|
|
|
97,388
|
|
|
|
|
|
|
|
|
|
|
|
60,478
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
|
846,299
|
|
|
|
|
|
|
|
|
|
|
|
667,867
|
|
|
|
|
|
|
|
|
|
Stockholders’ equity
|
|
|
77,773
|
|
|
|
|
|
|
|
|
|
|
|
72,976
|
|
|
|
|
|
|
|
|
|
|
|
$
|
924,072
|
|
|
|
|
|
|
|
|
|
|
$
|
740,843
|
|
|
|
|
|
|
|
|
|
Net earning balance
|
|
$
|
116,258
|
|
|
|
|
|
|
|
|
|
|
$
|
92,942
|
|
|
|
|
|
|
|
|
|
Earning yield less costing rate
|
|
|
|
|
|
|
|
|
|
|
3.65
|
%
|
|
|
|
|
|
|
|
|
|
|
3.23
|
%
|
Net interest income, and net yield spread on interest earning assets
|
|
|
|
|
|
$
|
24,732
|
|
|
|
3.82
|
%
|
|
|
|
|
|
$
|
17,539
|
|
|
|
3.35
|
%
|
Ratio of interest-earning assets to interest-bearing liabilities
|
|
|
|
|
|
|
116
|
%
|
|
|
|
|
|
|
|
|
|
|
115
|
%
|
|
|
|
|
Results of Operations - Comparison of Three and Nine Month Periods Ended September 30, 2018 and 2017
Net income for the three and nine months ended September 30, 2018 was $3,934,242 and $4,947,003, respectively, compared to $1,717,383 and $4,739,197 for the three and nine months ended September 30, 2017, respectively, which represents an increase in earnings of $2,216,859 (129%) and $207,806 (4%) for the three and nine month periods, respectively.
Net Interest Income
Net interest income for the three and nine months ended September 30, 2018 increased $4,677,009 (77%) and $7,193,388 (41%), respectively, when compared to the same periods in 2017. For the three and nine month periods ended September 30, 2018, the average balance of net interest earning assets over liabilities increased by approximately $24,567,000 and $23,316,000, respectively, when compared to the same periods in 2017. For the three and nine month periods ended September 30, 2018, the net interest margin increased 141 basis points to 4.77% and 47 basis points to 3.82%, respectively, when compared to the same periods in 2017.
Loan discount accretion and amortization of fair value adjustments for time deposits and subordinated debentures from the Hometown acquisition resulted in an additional $2,639,322 and $2,906,154 in net interest income for the three and nine months ended September 30, 2018, with no comparable amounts during the same periods in 2017. The loan discount accretion for the three months ended September 30, 2018 was $2,733,302 of yield accretion, of which $1,766,977 was recognized upon the unexpected full payoffs of certain PCI loans totaling $4,302,563 during the quarter ended September 30, 2018. The total loan accretion income was significantly greater than originally projected during the quarter due to the accelerated cash flows received from loan principal paydowns and payoffs overall. Combined, these components of net interest income contributed 123 and 51 basis points to net interest margin for the three and nine months ended September 30, 2018.
Interest Income
Total interest income for the three and nine months ended September 30, 2018 increased $5,852,688 (78%) and $10,175,219 (47%), respectively, as compared to the three and nine months ended September 30, 2017. For the three and nine-month period ended September 30, 2018 compared to the same periods in 2017, the average yield on interest earning assets increased 176 basis points to 5.94% and increased 79 basis points to 4.90%, while the average balance of interest earning assets increased approximately $179,430,000 for the three-month period and increased approximately $164,838,000 for the nine-month period. Increased average interest-earning balances were primarily attributable to the Hometown acquisition along with organic loan growth when compared to the same periods in 2017. The increase in the average yield on interest-earning assets was primarily due to loan discount accretion of $2,733,302 and $3,094,114 for the three and nine months ended September 30, 2018, as discussed above.
Interest Expense
Total interest expense for the three and nine months ended September 30, 2018 increased $1,175,679 (80%) and $2,981,831 (75%), respectively, when compared to the three and nine months ended September 30, 2017. For the three and nine-month period ended September 30, 2018 compared to the same periods in 2017, the average cost of interest bearing liabilities increased 41 basis points to 1.36% and increased 37 basis points to 1.25%, while the average balance of interest bearing liabilities increased approximately $154,863,000 for the three-month period and increased approximately $141,522,000 for the nine-month period. Increased average interest-bearing balances were primarily attributable to the deposit and subordinated debenture growth, which was due to the Hometown acquisition, offset by a decline in average balances of FHLB advances. The increase in the average cost of interest-bearing liabilities was primarily due to increased rates on retail deposits and FHLB borrowings which was partially offset by the deposit and subordinated debentures adjustments, discussed above.
Provision for Loan Losses
Provisions for loan losses are charged or credited to earnings to bring the total allowance for loan losses to a level considered adequate by the Company to provide for potential loan losses in the existing loan portfolio. When making its assessment, the Company considers prior loss experience, volume and type of lending, local banking trends and impaired and past due loans in the Company’s loan portfolio. In addition, the Company considers general economic conditions and other factors related to collectability of the Company’s loan portfolio.
Based on its internal analysis and methodology, management recorded a provision for loan losses of $200,000 and $925,000 for the three months and nine months ended September 30, 2018, respectively, compared to $450,000 and $1,500,000 for the same periods in 2017.
The Company’s decrease in provision was primarily due to the decrease in construction loan balances to permanent commercial real estate loans which carry a lower general reserve based on risk. The Bank will continue to monitor its allowance for loan losses and make future additions based on economic and regulatory conditions. Management may need to increase the allowance for loan losses through charges to the provision for loan losses if anticipated growth in the Bank’s loan portfolio continues to increase or other circumstances warrant.
Although the Bank maintains its allowance for loan losses at a level which it considers to be sufficient to provide for potential loan losses in its existing loan portfolio, there can be no assurance that future loan losses will not exceed internal estimates. In addition, the amount of the allowance for loan losses is subject to review by regulatory agencies which can order the establishment of additional loan loss provisions.
Noninterest Income
Noninterest income decreased $109,111 (7%) for the three months and increased $567,315 (14%) for the nine months ended September 30, 2018, respectively, when compared to the three months and nine months ended September 30, 2017. The decline for three months ended September 30, 2018 is primarily due to the Company’s write-downs of foreclosed assets held for sale, including two properties acquired from Hometown. The re-measurements and write-downs were due to a lack of sales activity, further review of surrounding property values and reductions in the property’s listing price (in most cases). Net loss on foreclosed assets were $459,308 and $338,496 for the three and nine months ended September 30, 2018 compared to net gains on foreclosed assets of $47,787 and 56,051 for the three and nine months ended September 30, 2017. The Company had increase in gains on sale of SBA loans of $34,860 and $175,756 for the three and nine months ended September 30, 2018, respectively, when compared to the same periods in 2017. Increases in service charges of $164,418 and $475,563 for the three and nine months ended September 30, 2018 were attributable primarily to the April 2018 Hometown acquisition.
Noninterest Expense
Noninterest expenses increased $1,654,017 (33%) and $8,364,973 (60%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. The increase is due to a few significant factors.
Due to the Company’s acquisition of Hometown, $150,877 and $3,570,927 of one-time, nonrecurring merger costs were incurred for the three and nine months ended September 30, 2018. The costs relate to legal, accounting and investment advisory fees, as well as the cost incurred for termination of a specific vendor core processing contract of approximately $2 million.
Salaries and employee benefits increased $835,165 (27%) and $2,317,911 (26%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. The increase is primarily due to the Company’s existing expansion in the Joplin, Missouri market (pre-acquisition) and the Hometown acquisition which contributed approximately $521,000 and $1,390,000 of additional expense for the three and nine months ended September 30,2018.
Occupancy expenses increased $520,741 (88%) and $1,357,430 (87%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. Lease expense on the new headquarters facility began in January 2018 and total expense was approximately $155,000 and $465,000 for the three and nine months ended September 30, 2018. The remaining increases relate to depreciation on furniture and fixtures for the new facility and the newly acquired assets from the Hometown acquisition.
Data processing expenses increased $60,184 (22%) and $365,324 (50%) for the three and nine months ended September 30, 2018 when compared to the same periods in 2017. The increase is primarily due to increased technology investments for the new headquarters facility and additional core processing expense associated with the Hometown acquisition.
Amortization expense of the core deposit intangible from the Hometown acquisition was $94,286 and $314,286 for the three and nine months ended September 30, 2018. There was no amortization expense for the same periods in 2017.
Provision
for Income Taxes
The provision for income taxes increased by $947,022 (213%) and decreased by $237,076 (16%) for the three and nine months ended September 30, 2018 when compared to the same periods of 2017. The decrease in the provision for income taxes is primarily due to the increased utilization of tax credits and the decline in federal tax rates as a result of the Tax Cuts and Jobs Act signed into law on December 22, 2017, and the three month increase was due to the significantly higher income in 2018.
Nonperforming Assets
The allowance for loan losses is calculated based upon an evaluation of pertinent factors underlying the various types and quality of the Bank’s existing loan portfolio. When making such evaluation, management considers such factors as the repayment status of loans, the estimated net realizable value of the underlying collateral, borrowers’ intent (to the extent known by the Bank) and ability to repay the loan, local economic conditions and the Bank’s historical loss ratios. The allowance for loan losses, as a percentage of nonperforming loans outstanding, as of September 30, 2018 and December 31, 2017 was 55.3% and 71.3%, respectively. Total loans classified as substandard, doubtful or loss as of September 30, 2018, were $25,823,000 or 2.67% of total assets as compared to $14,134,000 or 1.78% of total assets at December 31, 2017. The Company downgraded to substandard one multi-family real estate loan for approximately $6.0 million during the three months ending September 30, 2018. In addition, acquired loans from Hometown made up $4.1 million of loans classified as substandard at September 30, 2018. Management considered nonperforming and total classified loans in evaluating the adequacy of the Bank’s allowance for loan losses.
The ratio of nonperforming assets to total assets is another useful tool in evaluating exposure to credit risk. Nonperforming assets of the Bank are comprised of nonperforming loans (including troubled debt restructurings) and assets which have been acquired as a result of foreclosure or deed-in-lieu of foreclosure. All dollar amounts are in thousands.
|
|
9/30/2018
|
|
|
12/31/2017
|
|
|
12/31/2016
|
|
Nonperforming loans
|
|
$
|
13,984
|
|
|
$
|
9,962
|
|
|
$
|
8,632
|
|
Real estate acquired in settlement of loans
|
|
|
1,133
|
|
|
|
283
|
|
|
|
2,682
|
|
Total nonperforming assets
|
|
$
|
15,117
|
|
|
$
|
10,245
|
|
|
$
|
11,314
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total nonperforming assets as a percentage of total assets
|
|
|
1.56
|
%
|
|
|
1.29
|
%
|
|
|
1.64
|
%
|
Allowance for loan losses
|
|
$
|
7,732
|
|
|
$
|
7,107
|
|
|
$
|
5,742
|
|
Allowance for loan losses as a percentage of gross loans
|
|
|
0.98
|
%
|
|
|
1.12
|
%
|
|
|
1.05
|
%
|
Included in the table above is $4.1 million of nonperforming loans acquired from Hometown and $863,603 in real estate acquired in settlement of loans.
Liquidity and Capital Resources
Liquidity refers to the ability to manage future cash flows to meet the needs of depositors and borrowers and fund operations. Maintaining appropriate levels of liquidity allows the Company to have sufficient funds available for customer demand for loans, withdrawal of deposit balances and maturities of deposits and other liabilities. The Company’s primary sources of liquidity include cash and cash equivalents, customer deposits and Federal Home Loan Bank of Des Moines borrowings. The Company also has established borrowing lines available from the Federal Reserve Bank which is considered a secondary source of funds.
The Company’s most liquid assets are cash and cash equivalents, which are cash on hand, amounts due from financial institutions, and certificates of deposit with other financial institutions that have an original maturity of three months or less. The levels of such assets are dependent on the Bank’s operating, financing, and investment activities at any given time. The Company’s cash and cash equivalents totaled $31,211,790 as of September 30, 2018 and $37,406,930 as of December 31, 2017, representing a decrease of $6,195,140. The variations in levels of cash and cash equivalents are influenced by many factors but primarily loan originations and payments, deposit flows and anticipated future deposit flows, which are subject to, and influenced by, many factors.
In July 2013, the Board of Governors of the Federal Reserve Board and the FDIC approved the final rules implementing the Basel Committee on Banking Supervision's capital guidelines for U.S. banks (commonly known as Basel III). Under the final rules, which began for the Bank on January 1, 2015 and are subject to a phase-in period through January 1, 2019, minimum requirements will increase for both the quantity and quality of capital held by the Bank. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer, effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), effectively resulting in a minimum total capital to risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of 4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures. We expect that the capital ratios for the Bank under Basel III will continue to exceed the well capitalized minimum capital requirements, when fully phased in.
The Bank’s capital ratios are above the levels required to be considered a well-capitalized financial institution. As of September 30, 2018, the Bank’s common equity Tier 1 ratio was 10.94%, the Bank’s Tier 1 leverage ratio was 10.17%, its Tier 1 risk-based capital ratio was 10.94% and the Bank’s total risk-based capital ratio was 11.81% - all exceeding the minimums of 6.5%, 5.0%, 8.0% and 10.0%, respectively, as of September 30, 2018.