10-K 1 d809946d10k.htm 10-K 10-K
Table of Contents

 

 

SECURITIES AND EXCHANGE COMMISSION

100 F Street NE

Washington, D.C. 20549

 

 

FORM 10-K

 

 

 

x Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the Fiscal Year Ended September 30, 2014

or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission File No. 001-33384

 

 

ESSA Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   20-8023072

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

200 Palmer Street, Stroudsburg, Pennsylvania   18360
(Address of Principal Executive Offices)   (Zip Code)

(570) 421-0531

(Registrant’s telephone number)

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

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.01 par value   The NASDAQ Stock Market, LLC

Securities Registered Pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    YES  ¨    NO  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    YES  ¨    NO  x

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such requirements for the past 90 days.    YES  x    NO  ¨.

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of December 8, 2014, there were 18,133,095 shares issued and 11,444,378 shares outstanding of the Registrant’s Common Stock.

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the last sale price on March 31, 2014, was $115,803,969.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

    Proxy Statement for the 2015 Annual Meeting of Stockholders of the Registrant (Part III).

 

 

 


Table of Contents

TABLE OF CONTENTS

 

PART I

  

Item 1.

 

Business

     1   

Item 1A.

 

Risk Factors

     25   

Item 1B.

 

Unresolved Staff Comments

     30   

Item 2.

 

Properties

     31   

Item 3.

 

Legal Proceedings

     32   

Item 4.

 

Mine Safety Disclosures

     32   

PART II

  

Item 5.

 

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

     33   

Item 6.

 

Selected Financial Data

     36   

Item 7.

 

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

     37   

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

     48   

Item 8.

 

Financial Statements and Supplementary Data

     48   

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     48   

Item 9A.

 

Controls and Procedures

     48   

Item 9B.

 

Other Information

     48   

PART III

  

Item 10.

 

Directors, Executive Officers and Corporate Governance

     49   

Item 11.

 

Executive Compensation

     49   

Item 12.

 

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

     49   

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

     49   

Item 14.

 

Principal Accounting Fees and Services

     49   

PART IV

  

Item 15.

 

Exhibits and Financial Statement Schedules

     50   

 

i


Table of Contents

Forward Looking Statements

This Annual Report contains certain “forward-looking statements” which may be identified by the use of words such as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential.” Examples of forward-looking statements include, but are not limited to, estimates with respect to our financial condition, results of operations and business that are subject to various factors which could cause actual results to differ materially from these estimates and most other statements that are not historical in nature. These factors include, but are not limited to, general and local economic conditions, changes in interest rates, deposit flows, demand for mortgage, and other loans, real estate values, competition, changes in accounting principles, policies, or guidelines, changes in legislation or regulation, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services and the ability to successfully complete or close transactions or to integrate acquired entities. Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements. Please also see “Item 1A. Risk Factors.”

PART I

 

Item 1. Business

ESSA Bancorp, Inc.

ESSA Bancorp, Inc. (“ESSA Bancorp” or the “Company”) is the Pennsylvania-chartered stock holding company of ESSA Bank & Trust (the “Bank”). ESSA Bancorp owns 100% of the outstanding shares of common stock of ESSA Bank & Trust. Since being formed in 2006, ESSA Bancorp has engaged primarily in the business of holding the common stock of ESSA Bank & Trust. Our executive offices are located at 200 Palmer Street, Stroudsburg, Pennsylvania 18360. Our telephone number at this address is (570) 421-0531. ESSA Bancorp is subject to comprehensive regulation and examination by the Federal Reserve Board of Governors. On July 31, 2012, ESSA Bancorp completed its acquisition of First Star Bancorp, Inc. and its wholly-owned subsidiary, First Star Bank. The total value of the consideration for the acquisition was $24.6 million, 50% of which was paid in cash and the remainder paid in the form of ESSA Bancorp common stock. The information presented herein includes the combined operations of both companies as of July 31, 2012. On April 4, 2014, ESSA Bancorp completed its acquisition of Franklin Security Bancorp, Inc. and its wholly owned subsidiary, Franklin Security Bank. The total value of the consideration for the acquisition was $15.7 million which was paid in cash. At September 30, 2014, ESSA Bancorp had consolidated assets of $1.6 billion, consolidated deposits of $1.1 billion and consolidated stockholders’ equity of $167.3 million. Consolidated net income for the fiscal year ended September 30, 2014 was $8.5 million.

ESSA Bank & Trust

General

ESSA Bank & Trust was organized in 1916. ESSA Bank & Trust is a Pennsylvania chartered full-service, community-oriented savings bank. We provide financial services to individuals, families and businesses through our 27 full-service banking offices, located in Monroe, Northampton, Lehigh, Lackawanna and Luzerne Counties, Pennsylvania. ESSA Bank & Trust is subject to comprehensive regulation and examination by the Pennsylvania Department of Banking and the Federal Deposit Insurance Corporation. Pursuant to changes in Pennsylvania law, ESSA Bank & Trust converted its charter from a Pennsylvania savings and loan association to a Pennsylvania savings bank. The charter change did not have a material effect on the operations of ESSA Bank & Trust. Additionally, on January 24, 2014, the Bank completed its acquisition of a branch facility, customer deposits and loans from First National Community Bank (“FNCB”), a subsidiary of First National Community Bancorp, Inc. in a cash transaction. The acquired branch is located in the Monroe County, Pennsylvania market. Under the terms of the agreement, the Company acquired all of the branch facilities, customer deposits and loans of FNCB and received net cash of $4.6 million.

ESSA Bank & Trust’s business consists primarily of accepting deposits from the general public and investing those deposits, together with funds generated from operations and borrowings, in residential first mortgage loans (including construction mortgage loans), commercial real estate loans, home equity loans and lines of credit, commercial and consumer loans. We offer a variety of deposit accounts, including checking, savings and certificates of deposits. We also offer asset management and trust services. We offer investment services through our relationship with Cetera Investment Services LLC, a third party broker/dealer and investment advisor. We offer insurance benefit consulting services through our wholly owned subsidiary, ESSA Advisory Services, LLC.

ESSA Bank & Trust’s executive offices are located at 200 Palmer Street, Stroudsburg, Pennsylvania 18360. Our telephone number at this address is (570) 421-0531. Our website address is www.essabank.com.

The Company is a public company, and files interim, quarterly and annual reports with the Securities and Exchange Commission (“SEC”). All filed SEC reports and interim filings can be obtained from the Bank’s website, on the “Investor Relations” page, without charge from the Company.

 

1


Table of Contents

Market Area

At September 30, 2014, our 27 full-service banking offices consisted of 12 offices in Monroe County, six offices in Lehigh County, seven offices in Northampton County, one office in Lackawanna County and one office in Luzerne County, Pennsylvania. Our primary market for deposits is currently concentrated around the areas where our full-service banking offices are located. Our primary lending area consists of the counties where our branch offices are located, and to a lesser extent, the contiguous counties in the Commonwealth of Pennsylvania.

Monroe County is located in eastern Pennsylvania, situated 90 miles north of Philadelphia, 75 miles west of New York and 116 miles northeast of Harrisburg. Monroe County is comprised of 611 square miles of mostly rural terrain. Major industries include tourism, construction and educational facilities. Northampton County is located south of Monroe County and directly borders New Jersey. Lehigh County is located southwest of Monroe County. Luzerne and Lackawanna Counties are located north of Monroe County. As of September 30, 2014, we had a deposit market share of approximately 31.0% in Monroe County, which represented the largest deposit market share in Monroe County, 3.0% in Northampton County, 2.0% in Lehigh County, 0.2% in Lackawanna County and 1.5% in Luzerne County.

Lending Activities

Historically, our principal lending activity has been the origination of first mortgage loans for the purchase, construction or refinancing of one-to-four family residential real property. In recent years, we have increased our originations of commercial loans, commercial real estate loans and indirect auto loans in an effort to increase interest income, diversify our loan portfolio, and better serve the community. Commercial real estate loans have increased from 10.6% of our total loan portfolio at September 30, 2010 to $190.5 million, or 17.9%, of our total loan portfolio at September 30, 2014. One-to-four family residential real estate mortgage loans represented $654.2 million, or 61.3%, of our loan portfolio at September 30, 2014. Home equity loans and lines of credit totaled $41.4 million, or 3.9%, of our loan portfolio at September 30, 2014. Commercial loans totaled $25.8 million, or 2.4%, of our loan portfolio at September 30, 2014 and construction first mortgage loans totaled $1.4 million, or 0.1%, of the total loan portfolio at September 30, 2014. Obligations of states and political subdivisions totaled $49.2 million, or 4.6%, of our loan portfolio at September 30, 2014. Auto loans totaled $100.6 million or 9.4% of the total loan portfolio at September 30, 2014. We originate other consumer loans on a limited basis.

Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio, by type of loan at the dates indicated, excluding loans held for sale.

 

    At September 30,  
    2014     2013     2012     2011     2010  
    Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent     Amount     Percent  
    (Dollars in thousands)  

Residential first mortgage loans:

             

One-to-four family

  $ 654,152        61.3   $ 686,651        73.3   $ 696,696        72.8   $ 583,599        78.1   $ 596,455        80.8

Construction

    1,367        0.1        2,288        0.2        3,805        0.4        691        0.1        1,302        0.2   

Commercial

    25,807        2.4        10,125        1.1        12,818        1.3        14,766        2.0        16,545        2.2   

Commercial real estate

    190,536        17.9        159,469        17.0        160,192        16.7        79,362        10.6        77,943        10.6   

Obligations of states and political subdivisions

    49,177        4.6        33,445        3.6        33,736        3.5        25,869        3.5        —          —     

Home equity loans and lines of credit

    41,387        3.9        41,923        4.5        47,925        5.0        40,484        5.4        43,559        5.9   

Auto loans

    100,571        9.4        61        —          165        —          212        —          361        —     

Other

    3,904        0.4        2,332        0.3        2,320        0.3        1,806        0.3        2,125        0.3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans receivable

  $ 1,066,901        100.0   $ 936,294        100.0   $ 957,657        100.0   $ 746,789        100.0   $ 738,290        100.0
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Allowance for loan losses

    (8,634       (8,064       (7,302       (8,170       (7,448  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total loans receivable, net

  $ 1,058,267        $ 928,230        $ 950,355        $ 738,619        $ 730,842     
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

2


Table of Contents

Loan Portfolio Maturities and Yields. The following table summarizes the scheduled repayments of our loan portfolio at September 30, 2014. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

 

     One-to-four family      Construction      Commercial      Commercial Real Estate  
     Amount      Weighted
Average
Rate
     Amount      Weighted
Average
Rate
     Amount      Weighted
Average
Rate
     Amount      Weighted
Average
Rate
 
     (Dollars in thousands)  

Due During the Years Ending September 30,

                 

2015

     422         5.94         —           —           2,781         4.72         22,328         4.82   

2016

     1,385         5.55         —           —           2,293         4.13         8,270         5.42   

2017

     2,774         5.35         —           —           3,851         4.39         22,325         4.56   

2018 to 2019

     20,100         4.40         —           —           2,056         4.21         27,813         5.47   

2020 to 2024

     99,279         3.89         —           —           8,893         4.27         33,599         4.35   

2025 to 2029

     227,196         3.44         —           —           869         4.03         29,586         4.61   

2029 and beyond

     302,996         4.94         1,367         4.53         5,064         3.49         46,615         4.59   
  

 

 

       

 

 

       

 

 

       

 

 

    

Total

     654,152         4.25         1,367         4.53         25,807         4.16         190,536         4.74   
  

 

 

       

 

 

       

 

 

       

 

 

    

 

     Obligations of States and
Political Subdivisions
     Home Equity Loans and
Lines of Credit
     Auto Loans      Other      Total  
     Amount      Weighted
Average

Rate
     Amount      Weighted
Average
Rate
     Amount      Weighted
Average
Rate
     Amount      Weighted
Average
Rate
     Amount      Weighted
Average
Rate
 
     (Dollars in thousands)  

Due During the Years Ending September 30,

                             

2015

     916         3.30         355         6.11         1,467         7.56         1,166         2.88         29,435         4.85   

2016

     48         1.15         1,318         3.89         4,366         5.66         114         7.58         17,794         5.21   

2017

     18         2.29         1,210         4.31         10,022         4.51         315         7.26         40,515         4.60   

2018 to 2019

     3,434         4.21         4,119         4.10         43,963         3.96         1,045         6.99         102,530         4.50   

2020 to 2024

     7,505         2.78         10,683         5.00         40,753         5.02         294         9.20         201,006         4.24   

2025 to 2029

     21,139         3.08         12,040         3.67         —           —           625         9.64         291,455         3.56   

2029 and beyond

     16,117         4.32         11,662         3.69         —           —           345         9.07         384,166         4.82   
  

 

 

       

 

 

       

 

 

    

 

 

    

 

 

       

 

 

    

Total

     49,177         3.52         41,387         4.11         100,571         4.57         3,904         6.58         1,066,901         4.33   
  

 

 

       

 

 

       

 

 

       

 

 

       

 

 

    

The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at September 30, 2014 that are contractually due after September 30, 2015.

 

     Due After September 30, 2015  
     Fixed      Adjustable      Total  
     (In thousands)  

Residential first mortgage loans:

        

One-to-four family

     614,229         39,501         653,730   

Construction

     1,367         —           1,367   

Commercial

     17,724         5,302         23,026   

Commercial real estate

     49,578         118,630         168,208   

Obligations of states and political subdivisions

     29,700         18,561         48,261   

Home equity loans and lines of credit

     15,141         25,891         41,032   

Auto loans

     99,104         —           99,104   

Other

     2,728         10         2,738   
  

 

 

    

 

 

    

 

 

 

Total

     829,571         207,895         1,037,466   
  

 

 

    

 

 

    

 

 

 

 

3


Table of Contents

Loan Originations and Repayments. We originate residential mortgage loans pursuant to underwriting standards that generally conform to Fannie Mae and Freddie Mac guidelines. Loan origination activities are primarily concentrated in Monroe, Northampton, Lehigh, Lackawanna and Luzerne Counties, Pennsylvania and secondarily in other Pennsylvania counties contiguous to our primary market area. New loans are generated primarily from the efforts of employees and advertising, a network of select mortgage brokers, other parties with whom we do business, customer referrals, and from walk-in customers. Loan applications are centrally underwritten and processed at our corporate center.

One-to-four family Residential Loans. Historically, our principal lending activity has consisted of the origination of one-to-four family residential mortgage loans secured primarily by properties located in Monroe, Northampton, and Lehigh Counties, Pennsylvania. At September 30, 2014, approximately $654.2 million, or 61.3%, of our loan portfolio, consisted of one-to-four family residential loans. Our origination of one-to-four family loans decreased in fiscal year 2014 compared to fiscal years 2013 and 2012. Generally, one-to-four family residential mortgage loans are originated in amounts up to 80% of the lesser of the appraised value or purchase price of the property, although loans may be made with higher loan-to-value ratios if private mortgage insurance is specified to compensate for the risk. Fixed-rate loans are originated for terms of 10, 15, 20 and 30 years. At September 30, 2014, our largest loan secured by one-to-four family real estate had a principal balance of approximately $1.5 million and was secured by a single family house. This loan was performing in accordance with its repayment terms.

We also offer adjustable-rate mortgage loans which have initial fixed terms of one, three, five or seven-years before converting to an annual adjustment schedule based on changes in a designated United States Treasury index. We originated $897,000 of adjustable rate one-to-four family residential loans during the year ended September 30, 2014 and $750,000 during the year ended September 30, 2013. Our adjustable rate mortgage loans provide for maximum rate adjustments of 200 basis points per adjustment, with a lifetime maximum adjustment of 500 basis points. Our adjustable rate mortgage loans amortize over terms of up to 30 years.

Adjustable rate mortgage loans decrease the risk associated with changes in market interest rates by periodically repricing, but involve other risks. As interest rates increase, the principal and interest payments on the loan increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Adjustment of the contractual interest rate is limited by the periodic and lifetime interest rate adjustments specified by our loan documents and therefore, is potentially limited in effectiveness during periods of rapidly rising interest rates. At September 30, 2014, $39.5 million, or 6.0%, of our one-to-four family residential loans had adjustable rates of interest.

All one-to-four family residential mortgage loans that we originate include “due-on-sale” clauses, which provides the right to declare a loan immediately due and payable in the event that the borrower sells or otherwise conveys title to the real property subject to the mortgage and the loan is not repaid.

Regulations limit the amount that a savings bank may lend relative to the value of the real estate securing the loan, as determined by an appraisal of the property at the time the loan is originated. For all purchase money loans, we utilize outside independent appraisers approved by the Board of Directors. All purchase money and most refinance loans require a lender’s title insurance policy. Certain modest refinance requests may utilize an automated valuation model with an exterior inspection report and title search. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

Home Equity Loans and Lines of Credit. Home equity loans and lines of credit are generated by our loan originators. Eligible properties include primary and vacation homes in northeastern Pennsylvania, with the majority of loans being originated in Monroe, Northampton and Lehigh Counties. As of September 30, 2014, home equity loans and lines totaled about $41.4 million, or 3.9%, or our loan portfolio.

The maximum combined loan-to-value originated is currently 80%, depending on the collateral and the holder of the first mortgage. There is a small portion of the portfolio originated in years past that contains original combined loan-to-values of up to 90%. Our home equity lines of credit typically feature a 10 year draw period with interest-only payments permitted, followed by another 10 years of fully amortizing payments with no further ability to draw funds. Similar combined loan-to-value characteristics and standards exist for the lines as are outlined above for the loans.

Loan underwriting standards limit the maximum size of a junior lien loan to between $100,000 and $200,000, depending on the loan type and collateral. All loans exceeding 70-75% of value require an appraisal by bank-approved, licensed appraisers. Loans up to $25,000 with lesser loan-to-value ratios may utilize an automated valuation model. Title/lien searches are secured on all home equity loans and lines greater than $25,000.

Commercial Real Estate Loans. At September 30, 2014, $190.5 million, or 17.9%, of our total loan portfolio consisted of commercial real estate loans. Commercial real estate loans are secured by office buildings, mixed-use properties and other commercial properties. We generally originate adjustable rate commercial real estate loans with an initial term of five years and a repricing option,

 

4


Table of Contents

and a maximum term of up to 25 years. The maximum loan-to-value ratio for most commercial real estate loans is 75% to 80% and 85% for select loans with faster amortizations. At September 30, 2014, our largest commercial real estate loan balance was $5.1 million, which was performing in accordance with its terms. At September 30, 2014, 51 of our loans secured by commercial real estate totaling $10.6 million were not performing in accordance with their terms and were on nonaccrual status.

We consider a number of factors in originating commercial real estate loans. We evaluate the qualifications and financial condition of the borrower, including credit history, profitability and expertise, as well as the value and condition of the mortgaged property securing the loan. When evaluating the qualifications of the borrower, we consider the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with us and other financial institutions. In evaluating the property securing the loan, the factors we consider include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the debt service coverage ratio (the ratio of net operating income to debt service) to ensure that it is at least 120% of the monthly debt service. All commercial real estate loans in excess of $250,000 are appraised by outside independent appraisers approved by the Board of Directors. Personal guarantees are obtained from commercial real estate borrowers although we may occasionally waive this requirement given very strong loan to value and debt service coverage ratios. All purchase money and most asset refinance borrowers are required to obtain title insurance. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

Loans secured by commercial real estate generally are considered to present greater risk than one-to-four family residential loans. Commercial real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on such property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general. Accordingly, the nature of these loans makes them more difficult for management to monitor and evaluate.

First Mortgage Construction Loans. At September 30, 2014, $1.4 million, or 0.1%, of our total loan portfolio consisted of first mortgage construction loans. Our first mortgage construction loans are for the construction of residential properties. We currently offer fixed and adjustable-rate residential first mortgage construction loans. First mortgage construction loans are generally structured for permanent mortgage financing once the construction is completed. At September 30, 2014, our largest first mortgage construction loan balance was $235,000. The loan was performing in accordance with its terms. First mortgage construction loans will generally be made in amounts of up to 80% of the appraised value of the completed property, or the actual cost of the improvements. First mortgage construction loans require only the payment of interest during the construction period. Once converted to permanent financing, they generally repay over a 30 year period. Funds are disbursed based on our inspections in accordance with a schedule reflecting the completion of portions of the project.

First mortgage construction loans generally involve a greater degree of credit risk than other one-to-four family residential mortgage loans. The risk of loss on a construction loan depends, in part, upon the accuracy of the initial estimate of the value of the property at completion of construction compared to the estimated cost of construction and the successful completion of construction within budget.

For all such loans, we utilize outside independent appraisers approved by the Board of Directors. All borrowers are required to obtain title insurance. We also require fire and casualty insurance and, where circumstances warrant, flood insurance on properties.

Obligations of States and Political Subdivisions. At September 30, 2014, $49.2 million, or 4.6%, of our total loan portfolio consisted of loan transactions including tax and revenue anticipation notes, general obligation notes, and authority general revenue notes. The financial strength of the state or political subdivision, type of transaction, relationship efforts, and profitability of return are considered when pricing and structuring each transaction.

Auto Loans. At September 30, 2014, $100.6 million, or 9.4% of our total loan portfolio consisted of auto loans. Franklin Security Bank specialized in indirect automobile lending. After the acquisition of Franklin Security Bank, ESSA retained a number of their experienced employees. Although collateralized, these loans require stringent underwriting standards and procedures. Each loan decision is based primarily on the credit history of the individual(s) and their ability to repay the loan. Collision and comprehensive insurance is required and the Bank must be listed as the loss payee.

Indirect auto loans are inherently risky as they are often secured by assets that depreciate rapidly. In some cases, repossessed collateral for a defaulted automobile loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency may not warrant further substantial collection efforts against the borrower. Automobile loan collections depend on the borrower’s continuing financial stability, and therefore, are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.

 

5


Table of Contents

Other Loans. We offer a variety of loans that are either unsecured or secured by property other than real estate. These loans include loans secured by deposits and personal unsecured loans. At September 30, 2014, these other loans totaled $3.9 million, or 0.4% of the total loan portfolio.

Loan Approval Procedures and Authority. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the property that will secure the loan. To assess the borrower’s ability to repay, we review each borrower’s employment and credit history and information on the historical and projected income and expenses of mortgagors. For all loans the Board has granted lending authority to prescribed loan committees. Larger and more complex loan requests require the involvement of senior management or the Board.

Non-Performing Loans and Problem Assets

After a real estate secured loan becomes 15 days late, we deliver a computer generated late charge notice to the borrower and will attempt to contact the borrower by telephone. When a loan becomes 30 days delinquent, we send a delinquency letter to the borrower. We attempt to make satisfactory arrangements to bring the account current, including interviewing the borrower, until the loan is brought current or a determination is made to recommend foreclosure, deed-in-lieu of foreclosure or other appropriate action. After 120 days, if no satisfactory arrangements have been made, we will commence foreclosure proceedings.

Mortgage loans are reviewed on a regular basis and such loans are placed on non-accrual status when they become more than 90 days delinquent. When loans are placed on non-accrual status, unpaid accrued interest is fully reserved. Further income is recognized only if and when the loan is performing and demonstrates the likelihood of full repayment.

Non-performing Loans. At September 30, 2014, $21.9 million, or 2.08% of our total loans, were non-performing loans. The majority of these loans were commercial real estate loans and residential mortgage loans. Commercial real estate loans totaled $10.6 million at September 30, 2014. Residential first mortgage loans that were 90 days or more past due or classified as non-performing troubled debt restructured loans totaled $10.0 million at September 30, 2014. In connection with the First Star Bank acquisition, the Company acquired loans with deteriorated credit quality totaling $12.9 million. These loans were carried at $7.5 million at September 30, 2012 and contributed to the significant increase in non-performing loans at September 30, 2012 compared to non-performing loans at September 30, 2011. These loans were adjusted to fair market value at the time of acquisition. The Company acquired no loans with deteriorated credit quality in connection with the acquisition of Franklin Security Bank in April 2014, or the assets from First National Community Bank in January 2014.

Real Estate Owned. At September 30, 2014, the Company had $2.8 million of real estate owned consisting of 36 properties. These properties are being carried on the Company’s books at fair value less estimated costs to sell. All these properties are being actively marketed and additional losses may occur.

 

6


Table of Contents

Non-Performing Assets. The table below sets forth the amounts and categories of our non-performing assets at the dates indicated.

 

     At September 30,  
     2014     2013     2012     2011     2010  
     (Dollars in thousands)  

Non-accrual loans:

          

Residential first mortgage loans:

          

One-to-four family

   $ 9,778      $ 10,945      $ 10,536      $ 6,854      $ 8,360   

Construction

     —          —          —          —          —     

Commercial

     1,243        1,177        1,870        306        199   

Commercial real estate

     10,612        10,818        10,909        3,502        1,411   

Home equity loans and lines of credit

     259        339        373        248        200   

Auto loans

     —          —          —          —          —     

Other

     20        —          19        61        346   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

     21,912        23,279        23,707        10,971        10,516   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Accruing loans 90 days or more past due:

          

Residential first mortgage loans:

          

One-to-four family

     —          —          —          —          —     

Construction

     —          —          —          —          —     

Commercial

     —          —          —          —          —     

Commercial real estate

     —          —          —          —          —     

Home equity loans and lines of credit

     —          —          —          —          —     

Auto Loans

     —          —          —          —          —     

Other

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans 90 days or more past due

     —          —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-performing troubled debt restructurings

     238        585        533        529        361   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-performing loans

     22,150        23,864        24,240        11,500        10,877   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Real estate owned

     2,759        2,111        2,998        2,356        2,034   

Other repossessed assets

     69        —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total non-performing assets

   $ 24,978      $ 25,975      $ 27,238      $ 13,856      $ 12,911   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Troubled debt restructurings:*

          

Residential first mortgage loans:

          

One-to-four family

   $ 5,302      $ 6,024      $ 7,342      $ 5,430      $ 5,054   

Construction

     —          —          —          —          —     

Commercial

     —          18        227        120        3   

Commercial real estate

     1,381        1,582        5,344        4,372        1,865   

Home equity loans and lines of credit

     103        197        167        250        21   

Auto loans

     —          —          —          —          —     

Other

     —          —          —          58        59   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

   $ 6,786      $ 7,821      $ 13,080      $ 10,230      $ 7,002   

Ratios:

          

Total non-performing loans to total loans

     2.08     2.55     2.53     1.54     1.47

Total non-performing loans to total assets

     1.41     1.74     1.71     1.05     1.01

Total non-performing assets to total assets

     1.58     1.89     1.92     1.26     1.20

 

* Non-performing troubled debt restructurings are included in total troubled debt restructurings for September 30, 2014 as part of the non-performing assets table.

For the year ended September 30, 2014, gross interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $1.1 million.

At September 30, 2014, the principal balance of troubled debt restructures was $6.8 million as compared to $7.8 million at September 30, 2013. Of the $6.8 million of troubled debt restructures at September 30, 2014, $2.6 million are performing loans and $4.2 million are non-accrual loans. An additional $238,000 of performing troubled debt restructures are classified as non-performing assets because they were non-performing assets at the time they were restructured.

 

7


Table of Contents

Of the 56 loans that make up our troubled debt restructures at September 30, 2014, no loans were granted a rate concession at a below market interest rate, 20 loans with balances totaling $2.8 million were granted market rate and terms concessions, 26 loans with balances totaling $3.2 million were granted terms concessions and 10 loans with balances totaling $849,000 were granted interest rate concessions.

Residential real estate loans made up the vast majority of our troubled debt restructures at September 30, 2014, and were comprised of 44 residential loans totaling $5.3 million, 10 commercial and commercial real estate loans totaling $1.4 million, and two consumer (home equity loans, home equity lines of credit, and other) totaling $103,000.

For the year ended September 30, 2014, 20 loans totaling $2.8 million were removed from TDR status, 5 loans totaling $511,000 were transferred to foreclosed real estate, 9 loans for $1.8 million had completed timely payments, and 6 loans totaling $520,000 were paid off.

We have modified terms of performing loans that do not meet the definition of a TDR. The vast majority of such loans were simply rate modifications of residential first mortgage loans in lieu of refinancing. The non-TDR rate modifications were all performing loans when the rates were reset to current market rates. For the year ended September 30, 2014, we modified 35 loans totaling $4.5 million. With regard to commercial loans, including commercial real estate loans, various non-troubled loans were modified, either for the purpose of a rate reduction to reflect current market rates (in lieu of a refinance) or the extension of a loan’s maturity date. In total we modified 30 commercial loans with an aggregate balance of approximately $19.7 million for the year ended September 30, 2014.

 

8


Table of Contents

Delinquencies. The following table sets forth certain information with respect to our loan portfolio delinquencies at the dates indicated. Loans delinquent for 90 days or more are generally classified as nonaccrual loans.

 

     Loans Delinquent For                
     60-89 Days      90 Days and Over      Total  
     Number      Amount      Number      Amount      Number      Amount  
     (Dollars in thousands)  

At September 30, 2014

                 

Residential first mortgage loans:

                 

One-to-four family

     14       $ 1,393         100       $ 9,778         114       $ 11,171   

Construction

     —           —           —           —           —           —     

Commercial

     3         30         21         1,243         24         1,273   

Commercial real estate

     2         89         54         10,612         56         10,701   

Obligations of states and political subdivisions

     —           —           —           —           —           —     

Home equity loans and lines of credit

     3         33         18         259         21         292   

Auto loans

     4         33         —           —           4         33   

Other

     —           —           2         20         2         20   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     26       $ 1,578         195       $ 21,912         221       $ 23,490   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2013

                 

Residential first mortgage loans:

                 

One-to-four family

     8       $ 990         92       $ 10,945         100       $ 11,935   

Construction

     —           —           —           —           —           —     

Commercial

     —           —           19         1,177         19         1,177   

Commercial real estate

     —           —           61         10,818         61         10,818   

Obligations of states and political subdivisions

     —           —           —           —           —           —     

Home equity loans and lines of credit

     4         77         10         339         14         416   

Auto loans

     —           —           —           —           —           —     

Other

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     12       $ 1,067         182       $ 23,279         194       $ 24,346   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2012

                 

Residential first mortgage loans:

                 

One-to-four family

     11       $ 1,274         78       $ 10,536         89       $ 11,810   

Construction

     —           —           —           —           —           —     

Commercial

     —           —           27         1,870         27         1,870   

Commercial real estate

     3         3,348         59         10,909         62         14,257   

Obligations of states and political subdivisions

     —           —           —           —           —           —     

Home equity loans and lines of credit

     4         138         15         373         19         511   

Auto loans

     —           —           —           —           —           —     

Other

     —           —           1         19         1         19   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     18       $ 4,760         180       $ 23,707         198       $ 28,467   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2011

                 

Residential first mortgage loans:

                 

One-to-four family

     7       $ 928         40       $ 6,854         47       $ 7,782   

Construction

     —           —           —           —           —           —     

Commercial

     1         1         7         306         8         307   

Commercial real estate

     —           —           17         3,502         17         3,502   

Home equity loans and lines of credit

     —           —           —           —           —           —     

Auto loans

     5         187         8         248         13         435   

Other

     1         2         2         61         3         63   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     14       $ 1,118         74       $ 10,971         88       $ 12,089   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2010

                 

Residential first mortgage loans:

                 

One-to-four family

     6       $ 558         50       $ 8,360         56       $ 8,918   

Construction

     —           —           —           —           —           —     

Commercial

     1         151         2         199         3         350   

Commercial real estate

     1         107         8         1,411         9         1,518   

Obligations of states and political subdivisions

     5         146         6         200         11         346   

Home equity loans and lines of credit

     —           —           3         346         3         346   

Auto loans

     —           —           —           —           —           —     

Other

     —           —           —           —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     13       $ 962         69       $ 10,516         82       $ 11,478   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

9


Table of Contents

Classified Assets. Banking regulations and our Asset Classification Policy provide that loans and other assets considered to be of lesser quality should be classified as “Substandard,” “Doubtful” or “Loss” assets. 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 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 loss reserve is not warranted. We classify an asset as “Special Mention” if the asset has a potential weakness that warrants management’s close attention. While such assets are not impaired, management has concluded that if the potential weakness in the asset is not addressed, the value of the asset may deteriorate, thereby adversely affecting the repayment of the asset.

At September 30, 2014, the Company classified approximately $14.4 million of our assets as special mention, of which $8.4 million were commercial and commercial real estate loans, $41.4 million as substandard of which $22.1 million were commercial and commercial real estate loans, $298,000 of commercial real estate as doubtful and none as loss. On the basis of management’s review of its assets, at September 30, 2013, we classified approximately $18.1 million of our assets as special mention of which $9.9 million were commercial and commercial real estate loans, $38.6 million as substandard of which $20.5 million were commercial and commercial real estate loans, none as doubtful, and none as loss.

The loan portfolio is reviewed on a regular basis to determine whether any loans require classification in accordance with applicable regulations. Not all classified assets constitute non-performing assets.

Allowance for Loan Losses

Our allowance for loan losses is maintained at a level necessary to absorb loan losses that are both probable and reasonably estimable. Management, in determining the allowance for loan losses, considers the losses inherent in its loan portfolio and changes in the nature and volume of loan activities, along with the general economic and real estate market conditions. Our allowance for loan losses consists of two elements: (1) an allocated allowance, which comprises allowances established on specific loans and class allowances based on historical loss experience and current trends, and (2) an unallocated allowance based on general economic conditions and other risk factors in our markets and portfolios. We maintain a loan review system, which allows for a periodic review (at least quarterly) of our loan portfolio and the early identification of potential impaired loans. Such system takes into consideration, among other things, delinquency status, size of loans, type and market value of collateral and financial condition of the borrowers. Specific loan loss allowances are established for identified losses based on a review of such information. A loan evaluated for impairment is considered to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due according to the contractual terms of the loan agreement. All loans identified as impaired are evaluated independently. We do not aggregate such loans for evaluation purposes. Loan impairment is measured based on the fair value of collateral method, taking into account the appraised value, any valuation assumptions used, estimated costs to sell and trends in the market since the appraisal date. General loan loss allowances are based upon a combination of factors including, but not limited to, actual loan loss experience, composition of the loan portfolio, current economic conditions, management’s judgment and losses which are probable and reasonably estimable. The allowance is increased through provisions charged against current earnings and recoveries of previously charged-off loans. Loans that are determined to be uncollectible are charged against the allowance. While management uses available information to recognize probable and reasonably estimable loan losses, future loss provisions may be necessary based on changing economic conditions. Payments received on impaired loans generally are either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal. The allowance for loan losses as of September 30, 2014 is maintained at a level that represents management’s best estimate of losses inherent in the loan portfolio, and such losses were both probable and reasonably estimable.

In addition, the Federal Reserve Board of Governors (the “Federal Reserve Board”), the FDIC and the Pennsylvania Department of Banking, as an integral part of their examination process, periodically review our allowance for loan losses. The banking regulators may require that we recognize additions to the allowance based on their analysis and review of information available to them at the time of their examination.

 

10


Table of Contents

The following table sets forth activity in our allowance for loan losses for the periods indicated.

 

     At or For the Years Ended
September 30,
 
     2014     2013     2012     2011     2010  
     (Dollars in thousands)  

Balance at beginning of year

   $ 8,064      $ 7,302      $ 8,170      $ 7,448      $ 5,815   

Charge-offs:

          

Residential first mortgage loans:

          

One-to-four family

     (1,709     (2,401     (2,366     (1,175     (190

Construction

     —          —          —          —          —     

Commercial

     (101 )     —          (31     (131     (53

Commercial real estate

     (120     (403     (987     —          (186

Obligations of states and political subdivisions

     —          —          —          —          —     

Home equity loans and lines of credit

     (145     (243     (380     (188     (107

Auto loans

     —          —          —          —          —     

Other

     (3     (6     (13     (4     (36
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     (2,078     (3,053     (3,777     (1,498     (572
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Residential first mortgage loans:

          

One-to-four family

     163        50        291        146        —     

Construction

     —          —          —          —          —     

Commercial

     20        —          26        2        —     

Commercial real estate

     94        2        7        —          4   

Obligations of states and political subdivisions

     —          —          —          —          —     

Home equity loans and lines of credit

     18        13        33        14        —     

Auto loans

     —          —          —          —          —     

Other

     3        —          2        3        26   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     298        65        359        165        30   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     (1,780     (2,988     (3,418     (1,333     (542

Provision for loan losses

     2,350        3,750        2,550        2,055        2,175   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of year

   $ 8,634      $ 8,064      $ 7,302      $ 8,170      $ 7,448   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Ratios:

          

Net charge-offs to average loans outstanding

     0.17     0.32     0.44     0.18     0.07

Allowance for loan losses to non-performing loans at end of year

     38.98     33.79     30.12     71.04     68.48

Allowance for loan losses to total loans at end of year

     0.81     0.86     0.76     1.09     1.01

Loans acquired by the Company as a result of the Company’s merger with First Star Bank, which closed on July 31, 2012, and Franklin Security Bank which closed on April 4, 2014 were recorded at fair value on the purchase date without the carryover of any related allowance for loan losses. At each reporting date subsequent to their purchase, these loans have been included in the Company’s evaluation of the adequacy of its allowance for loan losses. At September 30, 2012, there were $207.1 million of former First Star loans without an accompanying allowance for loan loss included in the Company’s total loans when calculating the allowance for loan losses to total loans ratio. These loans were a significant factor in the decline of this ratio from 1.09% at September 30, 2011 to 0.76% at September 30, 2012. At September 30, 2013, there were $155.4 million of loans of former First Star loans included in the Company’s total loans when calculating the loan loss to total loans ratio. At September 30, 2013 there was an allowance for loan losses of $257,000 related to First Star loan that was included in the allowance for loan losses. This loan was not a significant factor in the increase in the allowance for loan losses to total loans ratio from 0.76% at September 30, 2012 to 0.86% at September 30, 2013. At September 30, 2014, there were $133.1 million of former First Star loans and $128.6 of former Franklin Security loans without an accompanying allowance for loan loss included in the Company’s total loans when calculating the allowance for loan losses to total loans ratio. These loans were a significant factor in the decline of this ratio from 0.86% at September 30, 2013 to 0.81% at September 30, 2014. At September 30, 2012, there were $9.4 million of former First Star loans, without an accompanying allowance for loan losses included in the Company’s total loans when calculating the allowance for loan losses to non-performing loans (ALL to NPL) ratio. These loans were a significant factor in the decline in the ALL to NPL ratio from 71.04% at September 30, 2011 to 30.12% at September 30, 2012. At September 30, 2013, there were $7.3 million of former First Star loans included in the Company’s total loans when calculating the ALL to NPL ratio. At September 30, 2013 there was an allowance for loan losses of $257,000 related to one of these loans that was included in the allowance for loan losses. These loans were not a significant factor in the increase in the ALL to NPL ratio to 33.79% at September 30, 2013 from 30.12% at September 30, 2012. At September 30, 2014, there were $11.2 million of former First Star loans and $1.6 million of former Franklin Security loans included in the Company’s total loans when calculating the ALL to NPL ratio. At September 30, 2014 there was an allowance for loan losses of

 

11


Table of Contents

$66,000 related to one of these loans included in the Company’s total loans when calculating that was included in the allowance for loan losses. These loans were not a significant factor in the increase in the ALL to NPL ratio from 33.79% at September 30, 2013 to 38.98% at September 30, 2014.

As previously disclosed, the Bank’s primary federal regulator was changed from the Office of Thrift Supervision (“OTS”) to the Federal Deposit Insurance Corporation (“FDIC”) in July of 2011. Because the FDIC places a different emphasis on the timing of charge offs than the OTS did, the Company determined that a change to its allowance for loan loss process was necessary. Previously, where a loan loss was considered likely and that loss was measured, a specific allocation of the Company’s allowance for loan losses was made to cover this loss. Actual losses were charged off when the loan in question was foreclosed upon. Beginning in March of 2012, these likely losses are being charged-off against the allowance for loan losses when determined. The Company does not believe that these additional charge offs reflect any deterioration of the credit quality of the Company’s loan portfolio. These charge offs did, however, reduce the balance of the Company’s allowance for loan losses by a corresponding amount. Further, the Company believes that these charge offs have also reduced the risk perceived in the loan portfolio and that the loans loss allowance at September 30, 2014 is reasonable and adequate.

See “Non-Performing Loans and Problem Assets.” There can be no assurance that we will not experience a deterioration of our loan portfolio, including increases in non-performing loans, problem assets and charge-offs, in the future.

Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category, the percent of the allowance to the total allowance 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.

 

    2014     2013     2012  
    Amount     Percent of
Allowance
to Total
Allowance
    Percent of
Loans in
Category to
Total Loans
    Amount     Percent of
Allowance
to Total
Allowance
    Percent of
Loans in
Category to
Total Loans
    Amount     Percent of
Allowance
to Total
Allowance
    Percent of
Loans in
Category to
Total Loans
 
    (Dollars in thousands)  

Residential first mortgage loans:

                 

One-to-four family

  $ 5,573        64.54     61.30   $ 5,787        71.76     73.34   $ 5,401        73.97     72.75

Construction

    11        0.13        0.13        20        0.25        0.24        29        0.40        0.40   

Commercial

    528        6.12        2.42        337        4.18        1.08        474        6.49        1.34   

Commercial real estate

    663        7.68        17.86        946        11.73        17.03        699        9.57        16.73   

Obligations of states and political subdivisions

    163        1.89        4.61        130        1.61        3.57        127        1.74        3.52   

Home equity loans and lines of credit

    470        5.44        3.88        430        5.33        4.48        499        6.83        5.00   

Auto loans

    459        5.32        9.43        —          —          —          —          —          —     

Other

    32        0.37        0.37        21        0.26        0.26        22        0.30        0.26   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allocated allowance

    7,899        91.49        100.00        7,671        95.12        100.00        7,251        99.30        100.00   

Unallocated allowance

    735        8.51        —          393        4.88        —          51        0.70        —     
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total allowance for loan losses

  $ 8,634        100.00     100.00   $ 8,064        100.00     100.00   $ 7,302        100.00     100.00
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

12


Table of Contents
     2011     2010  
     Amount      Percent of
Allowance to
Total
Allowance
    Percent of
Loans in
Category to
Total Loans
    Amount      Percent of
Allowance to
Total
Allowance
    Percent of
Loans in
Category to
Total Loans
 
     (Dollars in thousands)  

Residential first mortgage loans:

              

One-to-four family

   $ 5,220         63.89     78.10   $ 4,462         59.91     80.80

Construction

     8         0.10        0.10        15         0.20        0.20   

Commercial

     500         6.12        2.00        204         2.74        2.20   

Commercial real estate

     1,329         16.26        14.10        1,556         20.89        10.60   

Obligations of states and political subdivisions

     —           —          —          —           —          —     

Home equity loans and lines of credit

     622         7.62        5.40        569         7.64        5.90   

Auto Loans

     —           —          —          —           —          —     

Other

     80         0.98        0.30        22         0.29        0.30   
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total allocated allowance

     7,759         94.97        100.00        6,828         91.67        100.00   

Unallocated allowance

     411         5.03        —          620         8.33        —     
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

Total allowance for loan losses

   $ 8,170         100.00     100.00     7,448         100.00     100.00
  

 

 

    

 

 

   

 

 

   

 

 

    

 

 

   

 

 

 

We use the accrual method of accounting for all performing loans. The accrual of interest income is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectibility of principal or interest, even though the loan is currently performing. When a loan is placed on nonaccrual status, unpaid interest previously credited to income is reversed. Interest received on nonaccrual loans is applied against principal. Generally, residential and consumer loans are restored to accrual status when the obligation is brought current in accordance with the contractual terms for a reasonable period of time and ultimate collectibility of total contractual principal and interest is no longer in doubt. Commercial 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 ultimate collectibility of total contractual principal and interest no longer is in doubt.

In our collection efforts, we will first attempt to cure any delinquent loan. If a real estate secured loan is placed on nonaccrual status, it will be subject to transfer to the real estate owned (“REO”) portfolio (comprised of properties acquired by or in lieu of foreclosure), upon which our loan servicing department will pursue the sale of the real estate. Prior to this transfer, the loan balance will be reduced, if necessary, to reflect its current market value less estimated costs to sell. Write downs of REO that occur after the initial transfer from the loan portfolio and costs of holding the property are recorded as other operating expenses, except for significant improvements which are capitalized to the extent that the carrying value does not exceed estimated net realizable value.

Fair values for determining the value of collateral are estimated from various sources, such as real estate appraisals, financial statements and from any other reliable sources of available information. For those loans deemed to be impaired, collateral value is reduced for the estimated costs to sell. Reductions of collateral value are based on historical loss experience, current market data, and any other source of reliable information specific to the collateral.

This analysis process is inherently subjective, as it requires us to make estimates that are susceptible to revisions as more information becomes available. Although we believe that we have established the allowance at levels to absorb probable and estimable losses, future additions may be necessary if economic or other conditions in the future differ from the current environment.

Securities Activities

Our securities investment policy is established by our Board of Directors. This policy dictates that investment decisions be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with our interest rate risk management strategy. Our investment policy is reviewed annually by our ALCO/Investment management committee. All policy changes recommended by this management committee must be approved by the Board of Directors. The Committee is comprised of the Chief Executive Officer, Chief Financial Officer, Controller, Lending Services Division Manager, Retail Services Division Manager and the Delivery Systems Division Manager. Authority to make investments under the approved guidelines is delegated by the Committee to appropriate officers. While general investment strategies are developed and authorized by the ALCO/Investment management committee, the execution of specific actions rests with the Chief Financial Officer.

The approved investment officers are authorized to execute investment transactions up to $5.0 million per transaction without the prior approval of the ALCO/Investment management committee and within the scope of the established investment policy. These officers are also authorized to execute investment transactions between $5.0 million and $10.0 million with the additional approval from the Chief Executive Officer. Each transaction in excess of $10.0 million must receive prior approval of the ALCO/Investment Committee.

 

13


Table of Contents

Our current investment policy generally permits investments in debt securities issued by the U.S. government and U.S. agencies, municipal bonds, and corporate debt obligations, as well as investments in the Federal Home Loan Bank of Pittsburgh (federal agency securities) and, to a much lesser extent, other equity securities. Securities in these categories are classified as “investment securities” for financial reporting purposes. The policy also permits investments in mortgage-backed securities, including pass-through securities issued and guaranteed by Fannie Mae, Freddie Mac and Government National Mortgage Association (GNMA) as well as commercial paper, corporate debt and municipal bonds. Our current investment strategy uses a risk management approach of diversified investing in fixed-rate securities with short- to intermediate-term maturities, as well as adjustable-rate securities, which may have a longer term to maturity. The emphasis of this approach is to increase overall investment securities yields while managing interest rate risk.

Our policy is that, at the time of purchase, we designate a security as held to maturity, available-for-sale, or trading, depending on our ability and intent. Securities available-for-sale are reported at fair value, while securities held to maturity are reported at amortized cost. Currently, all securities are classified as available-for-sale.

Mortgage-Backed Securities. We purchase mortgage-backed securities in order to generate positive interest rate spreads with minimal administrative expense, lower credit risk as a result of the guarantees provided by Freddie Mac, Fannie Mae and GNMA and increased liquidity. We invest primarily in mortgage-backed securities issued or sponsored by Fannie Mae, Freddie Mac, and GNMA. At September 30, 2014, our mortgage-backed securities portfolio had a fair value of $265.1 million, consisting primarily of Freddie Mac, Fannie Mae and GNMA mortgage-backed securities.

Mortgage-backed securities are created by pooling mortgages and issuing a security collateralized by the pool of mortgages with an interest rate that is less than the interest rate on the underlying mortgages. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although most of our mortgage-backed securities are collateralized by single-family mortgages. The issuers of such securities (generally U.S. government agencies and U.S. government sponsored enterprises, including Fannie Mae, Freddie Mac and GNMA) pool and resell the participation interests in the form of securities to investors, such as ESSA Bank & Trust, and guarantee the payment of principal and interest to these investors. Investments in mortgage-backed securities involve a risk that actual prepayments will be greater or less than the prepayment rate estimated at the time of purchase, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby affecting the net yield on such securities. We review prepayment estimates for our mortgage-backed securities at the time of purchase to ensure that prepayment assumptions are reasonable considering the underlying collateral for the securities at issue and current interest rates, and to determine the yield and estimated maturity of the mortgage-backed securities portfolio. Periodic reviews of current prepayment speeds are performed in order to ascertain whether prepayment estimates require modification that would cause amortization or accretion adjustments.

Equity Securities. At September 30, 2014, our equity securities had a fair value of $2.0 million.

In addition, we hold Federal Home Loan Bank of Pittsburgh (“FHLB-Pittsburgh”) common stock to qualify for membership in the Federal Home Loan Bank System and to be eligible to borrow funds under the FHLB advance program. There is no market for the common stock.

The aggregate fair value of our FHLB-Pittsburgh common stock as of September 30, 2014 was $14.2 million based on its par value. No unrealized gains or losses have been recorded because we have determined that the par value of the common stock represents its fair value. We owned shares of FHLB-Pittsburgh common stock at September 30, 2014 with a par value that was $703,000 more than we were required to own to maintain our membership in the Federal Home Loan Bank System and to be eligible to obtain advances. We are required to purchase additional stock as our outstanding advances increase. Any excess stock we own is redeemed monthly by the FHLB-Pittsburgh.

We review equity and debt securities with significant declines in fair value on a periodic basis to determine whether they should be considered temporarily or other than temporarily impaired. If a decline in the fair value of a security is determined to be other than temporary, we are required to reduce the carrying value of the security to its fair value and record a non-cash, credit related impairment charge in the amount of the decline, net of tax effect, against our current income.

Our investment securities portfolio contains unrealized losses on securities, including mortgage-related instruments issued or backed by the full faith and credit of the United States government, or generally viewed as having the implied guarantee of the United States government, and debt obligations of a State or political subdivision.

Our policy is to recognize an other-than-temporary impairment of equity securities where the fair value has been significantly below cost for four consecutive quarters. For fixed maturity investments with unrealized losses due to interest rates where the Company does not intend to sell the security and it is more likely than not that the Company will not be required to sell the security before its anticipated recovery in market value, declines in value below cost are not assumed to be other than temporary. We

 

14


Table of Contents

review our position quarterly and concluded that at September 30, 2014, declines included in the table below represent temporary declines due to interest rate change, and we do not intend to sell those securities and it is more likely than not that we will not have to sell those securities before their anticipated recovery in market value.

The following table sets forth the composition of our securities portfolio (excluding FHLB-Pittsburgh common stock) at the dates indicated.

 

     At September 30,  
     2014      2013      2012  
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
     Amortized
Cost
     Fair
Value
 
     (In thousands)  

Investment securities available for sale:

                 

Mortgage-backed securities

   $ 266,088       $ 265,052       $ 218,115       $ 217,837       $ 208,265       $ 215,804   

Obligations of state and political subdivisions

     41,375         42,771         23,754         23,909         18,611         19,517   

U.S. government agency securities

     47,821         47,630         52,775         52,520         74,106         74,484   

Corporate obligations

     13,140         13,328         12,756         12,773         8,602         8,657   

Trust-preferred securities

     5,027         5,621         4,943         5,414         5,852         6,233   

Other debt securities

     6,618         6,651         1,147         1,154         1,476         1,512   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total debt securities

     380,069         381,053         313,490         313,607         316,912         326,207   

Equity securities – financial services

     2,025         2,025         2,025         2,015         3,267         3,378   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total investment securities available-for-sale

   $ 382,094       $ 383,078       $ 315,515       $ 315,622       $ 320,179       $ 329,585   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

15


Table of Contents

Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at September 30, 2014 are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the impact of prepayments or early redemptions that may occur.

 

    One Year or Less     More than One Year
through Five Years
    More than Five Years
through Ten Years
    More than Ten Years     Total Securities  
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Weighted
Average
Yield
    Amortized
Cost
    Fair
Value
    Weighted
Average
Yield
 
    (Dollars in thousands)  

Investment securities available for sale:

                     

U.S. government securities

    —          —          34,774        1.16        9,685        1.07        3,362        0.34        47,821        47,630        1.09   

Obligations of state and political subdivisions

    —          —          7,246        1.35        16,337        1.41        17,792        5.32        41,375        42,771        3.08   

Mortgage-backed securities

    —          —          1,148        3.98        25,315        2.64        239,625        2.31        266,088        265,052        2.35   

Corporate obligations

    2,506        2.83        4,596        3.00        6,038        4.66        —          —          13,140        13,328        3.73   

Trust preferred securities

    —          —          —          —          —          —          5,027        2.92        5,027        5,621        2.92   

Other debt securities

    —          —          —          —          1,798        2.93        4,820        3.51        6,618        6,651        3.35   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

 

   

Total debt securities

    2,506        2.83        47,764        1.44        59,173        2.26        270,626        2.52        380,069        381,053        2.34   

Equity securities

    —          —          —          —          —          —          2,025        4.40        2,025        2,025        4.40   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

 

   

Total investment securities available for-sale

    2,506        2.83        47,764        1.44        59,173        2.26        272,651        2.53        382,094        383,078        2.35   
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

 

   

 

16


Table of Contents

Sources of Funds

General. Deposits, borrowings, repayments and prepayments of loans and securities, proceeds from maturing securities and cash flows from operations are the primary sources of our funds for use in lending, investing and for other general purposes.

Deposits. We offer a variety of deposit accounts with a range of interest rates and terms. Our deposit accounts consist of savings accounts, NOW accounts, checking accounts, money market accounts, club accounts, certificates of deposit and IRAs and other qualified plan accounts. We provide commercial checking accounts for businesses.

At September 30, 2014, our deposits totaled $1.1 billion. Interest-bearing NOW, savings and club and money market deposits totaled $456.8 million at September 30, 2014. At September 30, 2014, we had a total of $607.0 million in certificates of deposit. Noninterest-bearing demand deposits totaled $70.0 million. Although we have a significant portion of our deposits in shorter-term certificates of deposit, we monitor activity on these accounts and, based on historical experience and our current pricing strategy, we believe we will retain a large portion of these accounts upon maturity.

Our deposits are obtained predominantly from the areas in which our branch offices are located. We rely on our favorable locations, customer service and competitive pricing to attract and retain these deposits. While we accept certificates of deposit in excess of $100,000 for which we may provide preferential rates, we generally do not solicit such deposits as they are more difficult to retain than core deposits. At September 30, 2014, we had a total of $218.4 million of brokered certificates of deposits, a decrease of $14.9 million from the prior fiscal year end. Our brokered certificates of deposits range from less than one- to seven-year terms, and are purchased only through pre-approved brokers.

The following table sets forth the distribution of average deposit accounts, by account type, at the dates indicated.

 

     For the Years Ended September 30,  
     2014     2013     2012  
     Average
Balance
     Percent     Average
Rate
Paid
    Average
Balance
     Percent     Average
Rate
Paid
    Average
Balance
     Percent     Average
Rate
Paid
 
     (Dollars in thousands)  

Deposit type:

                     

Noninterest bearing demand accounts

   $ 64,253         6.01     —     $ 56,467         5.68     —     $ 37,064         5.21     —  

Interest bearing NOW

     109,615         10.26     0.07        91,201         9.18     0.06        65,747         9.25        0.04   

Money market

     155,841         14.59     0.20        143,103         14.40     0.23        117,118         16.47        0.28   

Savings and club

     115,347         10.80     0.05        104,234         10.49     0.05        78,943         11.10        0.10   

Certificates of deposit

     623,307         58.34     1.27        598,759         60.25     1.17        412,207         57.97        1.71   
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

   

Total deposits

   $ 1,068,363         100.00     0.78   $ 993,764         100.00     0.75   $ 711,079         100.00     1.05
  

 

 

    

 

 

     

 

 

    

 

 

     

 

 

    

 

 

   

As of September 30, 2014, the aggregate amount of outstanding certificates of deposit in amounts greater than or equal to $100,000 was approximately $201.5 million. The following table sets forth the maturity of those certificates as of September 30, 2014.

 

     At
September 30, 2014
 
     (In thousands)  

Three months or less

     28,430   

Over three months through six months

     29,194   

Over six months through one year

     32,506   

Over one year

     111,321   
  

 

 

 

Total

     201,451   
  

 

 

 

At September 30, 2014, $90.1 million of our certificates of deposit had maturities of one year or less. We monitor activity on these accounts and, based on historical experience and our current pricing strategy, we believe we will retain a significant portion of these accounts upon maturity.

 

17


Table of Contents

Borrowings. Our short-term borrowings consist of Federal Home Loan Bank advances. The following table sets forth information concerning balances and interest rates on all of our short-term borrowings at the dates and for the years indicated.

 

     At or For the Years Ended September 30,  
     2014     2013     2012  
     (Dollars in thousands)  

Balance at end of year

   $ 108,020      $ 23,000      $ 43,281   

Maximum outstanding at any month end

   $ 108,020      $ 84,500      $ 43,281   

Average balance during year

   $ 55,204      $ 45,792      $ 11,712   

Weighted average interest rate at end of year

     0.33     0.29     0.30

Average interest rate during year

     0.33     0.28     0.27

At September 30, 2014, we had the ability to borrow approximately $576.4 million under our credit facilities with the FHLB-Pittsburgh.

Competition

We face significant competition in both originating loans and attracting deposits. The counties in which we operate have a significant concentration of financial institutions, many of which are significantly larger institutions and have greater financial resources, and many of which are our competitors to varying degrees. Our competition for loans comes principally from commercial banks, savings banks, mortgage banking companies, credit unions, leasing companies, insurance companies and other financial service companies. Our most direct competition for deposits has historically come from commercial banks, savings banks and credit unions. We face additional competition for deposits from nondepository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies.

We seek to meet this competition by the convenience of our branch locations, emphasizing personalized banking and the advantage of local decision-making in our banking business. Specifically, we promote and maintain relationships and build customer loyalty within local communities by focusing our marketing and community involvement on the specific needs of individual neighborhoods. As of September 30, 2014, ESSA Bank & Trust had the largest deposit market share in Monroe County, Pennsylvania. We do not rely on any individual, group, or entity for a material portion of our deposits.

Employees

As of September 30, 2014, we had 246 full-time employees and 57 part-time employees. The employees are not represented by a collective bargaining unit and we consider our relationship with our employees to be good.

Subsidiary Activities

ESSA Bank & Trust has four wholly owned subsidiaries, ESSACOR, Inc., Pocono Investment Company, ESSA Advisory Services, LLC, and Integrated Financial Corporation and its fully owned subsidiary Integrated Abstract Incorporated. ESSACOR, Inc. is a Pennsylvania corporation that has been used to purchase properties at tax sales that represent collateral for delinquent loans of the Bank. Pocono Investment Company is a Delaware corporation formed as an investment company subsidiary to hold and manage certain investments of ESSA Bank & Trust, including certain intellectual property. ESSA Advisory Services, LLC is a Pennsylvania limited liability company owned 100% by ESSA Bank & Trust. ESSA Advisory Services, LLC is a full-service insurance benefits consulting company offering group services such as health insurance, life insurance, short term and long term disability, dental, vision and 401(K) retirement planning as well as individual health products. Integrated Financial Corporation is a Pennsylvania Corporation that provided investment advisory services to the general public and is currently inactive. Integrated Abstract Incorporated is a Pennsylvania Corporation that provided title insurance services and is currently inactive.

 

18


Table of Contents

SUPERVISION AND REGULATION

General

The Company is a Pennsylvania corporation. The Company was formerly regulated as a savings and loan holding company, and in November 2014 received approval to become a bank holding company. As a bank holding company, we are required to file certain reports with, and otherwise comply with the rules and regulations of the Federal Reserve Board.

ESSA Bank & Trust is a Pennsylvania-chartered savings bank and its deposit accounts are insured up to applicable limits by the Federal Deposit Insurance Corporation under the Deposit Insurance Fund (“DIF”). We are subject to extensive regulation by the Pennsylvania Department of Banking and Securities (the “Department”), our chartering agency, and by the FDIC, our primary federal regulator. We must file reports with the Department and the FDIC concerning our activities and financial condition, in addition to obtaining regulatory approvals prior to entering into certain transactions including, but not limited to, mergers with or acquisitions of other savings institutions. There are periodic examinations by the Department and the FDIC to test our compliance with various regulatory requirements. This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the FDIC insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and with their examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulation, whether by the Department or the FDIC could have a material adverse impact on us and our operations.

Federal Legislation

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), enacted on July 21, 2010, has significantly changed the bank regulatory structure and is affecting the lending, investment, trading and operating activities of depository institutions and their holding companies. The Dodd-Frank Act eliminated, as of July 21, 2011, our former primary federal regulator, the Office of Thrift Supervision, and required ESSA Bank & Trust to be regulated by the FDIC (the primary federal regulator for state-chartered banks that are not members of the Federal Reserve System). The Dodd-Frank Act also authorized the Federal Reserve Board to supervise and regulate all savings and loan holding companies such as ESSA Bancorp, Inc., in addition to the bank holding companies, that it currently regulates. The Dodd-Frank Act requires the Federal Reserve Board to set minimum capital levels for depository institution holding companies that are as stringent as those required for the insured depository subsidiaries, and the components of Tier 1 capital will be restricted to capital instruments that are currently considered to be Tier 1 capital for insured depository institutions. Under the Dodd-Frank Act, the proceeds of trust preferred securities are excluded from Tier 1 capital unless such securities were issued prior to May 19, 2010 by bank or savings and loan holding companies with less than $15 billion of assets. The legislation also establishes a floor for capital of insured depository institutions that cannot be lower than the standards in effect today, and directs the federal banking regulators to implement new leverage and capital requirements within 18 months from the enactment of the Dodd-Frank Act that take into account off-balance sheet activities and other risks, including risks relating to securitized products and derivatives. The required capital regulations have been issued and are effective January 1, 2015.

The Dodd-Frank Act also established the Consumer Financial Protection Bureau (“CFPB”) with substantial power to implement and oversee consumer protection laws. The CFPB Bureau has broad rulemaking authority for a wide range of consumer protection laws that apply to all banks and savings institutions such as ESSA Bank & Trust, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB 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 assets will continue to be examined for compliance by their applicable bank regulators.

The legislation broadened the base for FDIC insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a depository institution. The Dodd-Frank Act 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, and by authorizing the Securities and Exchange Commission to promulgate rules that would allow stockholders to nominate their own candidates using a company’s proxy materials. The Dodd-Frank Act also provided for originators of certain securitized loans to retain a percentage of the risk for transferred loans, directed the Federal Reserve Board to regulate pricing of certain debit card interchange fees and contained a number of reforms related to mortgage origination.

The Dodd-Frank Act prohibits lenders from making residential mortgages unless the lender makes a reasonable and good faith determination that the borrower has a reasonable ability to repay the mortgage loan according to its terms. A borrower may recover statutory damages equal to all finance charges and fees paid within three years of a violation of the ability-to-repay rule and may raise a violation as a defense to foreclosure at any time. As authorized by the Dodd-Frank Act, the CFPB has adopted regulations defining “qualified mortgages” that would be presumed to comply with the Dodd-Frank Act’s ability-to-repay rules. Under the CFPB

 

19


Table of Contents

regulations, qualified mortgages must satisfy the following criteria: (i) no negative amortization, interest-only payments, balloon payments or a term greater than 30 years; (ii) no points or fees in excess of 3% of the loan amount for loans over $100,000; (iii) borrower’s income and assets are verified and documented; and (iv) the borrower’s debt-to-income ratio generally may not exceed 43%. Qualified mortgages are conclusively presumed to comply with the ability-to-repay rule unless the mortgage is a “higher cost” mortgage, in which case the presumption is rebuttable. ESSA Bank & Trust will not grant a non-qualified mortgage loan unless such loan falls under the “temporary qualified mortgage” guidance and there were additional factors to support the exception (which may include a review of the borrower’s creditworthiness and whether a deposit relationship exists).

Many of the provisions of the Dodd-Frank Act have delayed effective dates and the legislation requires extensive regulations which are still being implemented. Although the substance and scope of these regulations cannot be completely determined at this time, it is expected that the legislation and implementing regulations will increase our operating and compliance costs.

Regulation by the Pennsylvania Department of Banking and Securities

The Pennsylvania Banking Code of 1965, as amended (the “Banking Code”) contains detailed provisions governing the organization, location of offices, rights and responsibilities of directors, officers, employees, and depositors, as well as corporate powers, savings and investment operations and other aspects of ESSA Bank & Trust and its affairs. The Banking Code delegates extensive rulemaking power and administrative discretion to the Department so that the supervision and regulation of state-chartered savings banks may be flexible and readily responsive to changes in economic conditions and in savings and lending practices. The Department may also take enforcement actions against savings banks and may appoint a receiver or conservator for a savings bank under certain circumstances.

The Department generally examines each savings association not less frequently than once every two years. Although the Department may accept the examinations and reports of the FDIC in lieu of the Department’s examination, the current practice is for the Department to conduct individual examinations. The Department may order any savings bank to discontinue any violation of law or unsafe or unsound business practice and may direct any trustee, officer, attorney, or employee of a savings bank engaged in an objectionable activity, after the Department has ordered the activity to be terminated, to show cause at a hearing before the Department why such person should not be removed.

Recent changes to Pennsylvania law have repealed the Savings Association Code. Consequently, ESSA Bank & Trust converted its charter to a Pennsylvania savings bank whose state law powers are primarily governed by Chapter 5 of the Pennsylvania Baking Code of 1965, as amended. The charter conversion is not expected to have material effect on the operations of ESSA Bank & Trust.

Regulation by the Federal Deposit Insurance Corporation

ESSA Bank & Trust is also subject to extensive regulation, examination and supervision, among other things, by the Federal Deposit Insurance Corporation, as its primary federal regulator. Such regulation and supervision:

 

    limits the investment authority of ESSA Bank & Trust;

 

    establishes a continuing and affirmative obligation, consistent with ESSA Bank & Trust’s safe and sound operation, to help meet the credit needs of its community, including low and moderate income neighborhoods;

 

    establishes various capital categories resulting in various levels of regulatory scrutiny applied to the institutions in a particular category; and

 

    establishes standards for safety and soundness.

The FDIC generally examines each savings bank not less frequently than once every two years. The FDIC has the authority to order any savings bank or its directors, trustees, officers, attorneys or employees to discontinue any violation of law or unsafe or unsound banking practice.

Federal law and FDIC regulations generally limit the activities and investments of state-chartered FDIC insured banks and their subsidiaries to those permissible for national banks and their subsidiaries, unless such activities and investments are specifically exempted by law or consented to by the FDIC.

Before making a new investment or engaging in a new activity that is not permissible for a national bank or otherwise permissible under federal law or FDIC regulations, an insured savings bank must seek approval from the FDIC to make such investment or engage in such activity. The FDIC will not approve the activity unless the savings bank meets its minimum capital requirements and the FDIC determines that the activity does not present a significant risk to the FDIC insurance funds. Certain

 

20


Table of Contents

activities of subsidiaries that are engaged in activities permitted for national banks only through a “financial subsidiary” are subject to additional restrictions. Although ESSA Bank & Trust meets all conditions necessary to establish and engage in permitted activities through financial subsidiaries, it has not chosen to engage in such activities.

Transactions with Affiliates

Transactions between an insured bank, such as ESSA Bank & Trust, and any of its affiliates are governed by Sections 23A and 23B of the Federal Reserve Act and implementing regulations. An affiliate of a bank is any company or entity that controls, is controlled by or is under common control with the bank. Generally, a subsidiary of a bank that is not also a depository institution or financial subsidiary is not treated as an affiliate of the bank for purposes of Sections 23A and 23B.

Section 23A:

 

    limits the extent to which a bank or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such bank’s capital stock and retained earnings, and limits all such transactions with all affiliates to an amount equal to 20% of such capital stock and retained earnings; and

 

    requires that all such transactions be on terms that are consistent with safe and sound banking practices.

The term “covered transaction” includes the making of loans, purchase of assets, issuance of guarantees and other similar types of transactions. Most loans by a bank to any of its affiliates must be secured by collateral in amounts ranging from 100% to 130% of the loan amounts, depending on the type of collateral. In addition, any covered transaction by a bank with an affiliate and any purchase of assets or services by a bank from an affiliate must be on terms that are substantially the same, or at least as favorable to the bank, as those that would be provided to a non-affiliate.

Insurance of Accounts and Regulation by the Federal Deposit Insurance Corporation

Deposit accounts in ESSA Bank & Trust 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. ESSA Bank & Trust, therefore, is subject to FDIC deposit insurance assessments.

The FDIC imposes an assessment for deposit insurance against all insured depository institutions. Each institution’s assessment is based on the perceived risk to the insurance fund of the institution, with institutions deemed riskiest paying higher assessments. The Dodd-Frank Act required the FDIC to revise its procedures to base assessments on average total assets less tangible capital, rather than deposits. The FDIC issued a final rule which implemented that directive effective April 1, 2011 and adjusted its assessment schedule so that it now ranges from 2.5 basis points to 45 basis points of average total assets less tangible capital. Small banks, such as ESSA Bank & Trust, are assessed based on a risk classification determined by examination ratings, financial ratios and certain specified adjustments.

Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation 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 Federal Deposit Insurance Corporation. ESSA Bank & Trust does not believe that it is taking or is subject to any action, condition or violation that could lead to termination of its deposit insurance.

All FDIC-insured institutions are required to pay a pro rata portion of the interest due on obligations issued by the Financing Corporation (“FICO”) for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the now defunct Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended September 30, 2014, the annualized FICO assessment was 0.62 basis point of an institution’s total assets less tier 1 capital.

Capital Requirements

Federal regulations require savings banks to meet three minimum capital standards: a 1.5% tangible capital ratio, a 4% leverage ratio (3% for savings banks receiving the highest rating on the CAMELS rating system) and an 8% risk-based capital ratio.

The risk-based capital standard for savings banks requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet assets, are multiplied by a risk-weight factor of 0% to 100%, assigned by the regulatory, based on the risks believed inherent in the type of asset. Core capital is defined as common shareholders’ equity (including retained earnings), certain non-cumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card

 

21


Table of Contents

relationships. The components of supplementary capital currently include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital. Additionally, a savings bank that retains credit risk in connection with an asset sale may be required to maintain additional regulatory capital because of the recourse back to the savings bank.

At September 30, 2014, the ESSA Bank & Trust’s capital exceeded all applicable requirements.

Any state-chartered savings bank that fails any of the capital requirements is subject to possible enforcement actions by the FDIC. Such actions could include a capital directive, a cease and desist order, civil money penalties, the establishment of restrictions on an institution’s operations, termination of federal deposit insurance, and the appointment of a conservator or receiver. Certain corrective actions are required by law.

We are also subject to more stringent capital guidelines of the Department. Although not adopted in regulation form, the Department utilizes capital standards of 6% leverage capital and 10% risk-based capital. The components of leverage and risk-based capital are substantially the same as those defined by the FDIC.

In July 2013, the FDIC and the other federal bank regulatory agencies issued a final rule that will revise their leverage and 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. Among other things, the rule establishes a new common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), establishes a uniform minimum leverage ratio of 4% of total assets, increases the minimum Tier 1 capital to risk-based assets requirement (from 4% to 6% 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 unless a one-time opt-out is exercised and requires more stringent treatment of mortgage servicing assets and certain deferred tax assets. 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 becomes effective for ESSA Bank & Trust on January 1, 2015. 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.

Dividends from ESSA Bank & Trust

Our ability to pay dividends depends, to a large extent, upon ESSA Bank & Trust’s ability to pay dividends to ESSA Bancorp. The Banking Code states, that no dividend may be paid out of surplus without approval of the Department. Dividends may be paid out of accumulated net earnings. No dividend may generally be paid that would result in ESSA Bank & Trust failing to comply with its regulatory capital requirements.

Prompt Corrective Action

Under the federal Prompt Corrective Act regulations, a savings bank is deemed to be (i) “well capitalized” if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of “well capitalized”; (iii) “undercapitalized” if it has a total risk-based capital ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under certain circumstances); (iv) “significantly undercapitalized” if it has a total risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital ratio that is less than 3.0% or a Tier I leverage capital ratio that is less than 3.0%; and (v) “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Federal regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution to comply with supervisory actions as if it were in the next lower category (except that the Federal Deposit Insurance Corporation may not reclassify a significantly undercapitalized institution as critically undercapitalized).

Generally, the FDIC is required to appoint a receiver or conservator for a savings bank that becomes “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 a savings bank receives notice that it is “undercapitalized,” “significantly undercapitalized” or “critically undercapitalized.” Any holding company for the savings bank required to submit a capital restoration plan must guarantee the lesser of: an amount equal to 5% of a savings bank’s assets at the time it was notified or deemed to be undercapitalized by the FDIC, or the

 

22


Table of Contents

amount necessary to restore the savings bank to adequately capitalized status. This guarantee remains in place until the FDIC notifies the savings bank that it has maintained adequately capitalized status for each of four consecutive calendar quarters. The FDIC may also take any one of a number of discretionary supervisory actions against an undercapitalized savings bank, including the issuance of a capital directive and the replacement of senior executive officers and directors.

The final rule will increase regulatory capital requirements under the prompt and corrective action regulations on January 1, 2015.

As of September 30, 2014, the Bank was a “well-capitalized institution” under the prompt corrective action regulations.

The USA PATRIOT Act

The USA PATRIOT Act of 2001 gave the federal government new powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing and broadened anti-money laundering requirements. The USA PATRIOT Act also required the federal banking agencies to take into consideration the effectiveness of controls designed to combat money laundering activities in determining whether to approve a merger or other acquisition application of a member institution. Accordingly, if we engage in a merger or other acquisition, our controls designed to combat money laundering would be considered as part of the application process. We have established policies, procedures and systems designed to comply with these regulations.

Holding Company Regulation

Federal Regulation. The Company is a bank holding company that has elected to be a financial holding company and is subject to examination, regulation and periodic reporting under the Bank Holding Company Act of 1956 (the “Bank Holding Company Act”), as administered by the Federal Reserve Board. The Federal Reserve Board has adopted capital adequacy guidelines for bank holding companies on a consolidated basis. As of September 30, 2014, the Company’s total capital and Tier 1 capital ratios exceeded these minimum capital requirements. The Dodd-Frank Act requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. This will eliminate the inclusion of certain instruments from tier 1 capital, such as trust preferred securities, that are currently includable for bank holding companies. The Dodd-Frank Act grandfathers instruments issued prior to May 19, 2010 by bank holding companies with less than $15 billion in assets. The final capital rule adopted in July 2013 will implement the Dodd-Frank Act’s directive as to holding company capital standards as of July 1, 2015.

Regulations of the Federal Reserve Board provide that a bank holding company must serve as a source of strength to any of its subsidiary banks and must not conduct its activities in an unsafe or unsound manner. The Dodd-Frank Act codified the source of strength policy and requires the issuance of implementing regulations. Under the prompt corrective action provisions of the Federal Deposit Insurance Act, a bank holding company parent of an undercapitalized subsidiary bank must guarantee, within limitations, the capital restoration plan that is required of an undercapitalized bank. If an undercapitalized bank fails to file an acceptable capital restoration plan or fails to implement an accepted plan, the Federal Reserve Board may prohibit the bank holding company parent of the undercapitalized bank from paying any dividend or making any other form of capital distribution without the prior approval of the Federal Reserve Board. In addition, Federal Reserve Board policy is that a bank holding company should pay cash dividends only to the extent that the company’s net income for the past year is consistent with the company’s capital needs, asset quality and overall financial condition.

A bank holding company is required to give the Federal Reserve Board prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding 12 months, will be equal to 10% or more of the company’s consolidated net worth. The Federal Reserve Board may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe and unsound practice, or would violate any law, regulation, Federal Reserve Board order or directive, or any condition imposed by, or written agreement with, the Federal Reserve Board. Such notice and approval is not required for a bank holding company that is as “well capitalized” under applicable regulations of the Federal Reserve Board, that has received a composite “1” or “2” rating, as well as a “satisfactory” rating for management, at its most recent bank holding company examination by the Federal Reserve Board, and that is not the subject of any unresolved supervisory issues.

As a financial holding company, we are permitted (1) to engage in other activities that the Federal Reserve Board determines to be financial in nature, incidental to an activity that is financial in nature, or complementary to a financial activity and that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally, or (2) to acquire shares of companies engaged in such activities. We may not, however, directly or indirectly acquire the ownership or control of more than 5% of any class of voting shares, or substantially all of the assets, of a bank holding company or a bank, without the prior approval of the Federal Reserve Board.

 

23


Table of Contents

In order to maintain our status as a financial holding company, we must remain “well capitalized” and “well managed” under applicable regulations. Failure to meet one or more of the requirements would mean, depending on the requirements not met, that we could not undertake new activities, make acquisitions other than those permitted generally for bank holding companies, or continue certain activities.

Federal Securities Laws

Shares of the Company’s common stock are registered with the SEC under Section 12(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). The Company is also subject to the proxy rules, tender offer rules, insider trading restrictions, annual and periodic reporting, and other requirements of the Exchange Act.

Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 was enacted in response to public concerns regarding corporate accountability in connection with certain accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies, and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies that file or are required to file periodic reports with the Securities and Exchange Commission, under the Securities Exchange Act of 1934.

The Sarbanes-Oxley Act includes specific additional disclosure requirements, requires the Securities and Exchange Commission and national securities exchanges to adopt extensive additional disclosure, corporate governance and other related rules, and mandates further studies of certain issues by the Securities and Exchange Commission. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.

Although we have and will continue to incur additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, management does not expect that such compliance will have a material impact on our results of operations or financial condition.

Regulatory Enforcement Authority

Federal law provides federal banking regulators with substantial enforcement powers. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease-and-desist or removal orders, and to initiate injunctive actions against banking organizations and institution-affiliated parties, as defined. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

FEDERAL AND STATE TAXATION

Federal Taxation

General. ESSA Bancorp, Inc. and ESSA Bank & Trust 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 ESSA Bancorp, Inc. and ESSA Bank & Trust.

Method of Accounting. For federal income tax purposes, ESSA Bancorp, Inc. currently reports its income and expenses on the accrual method of accounting and uses a tax year ending September 30 for filing its consolidated federal income tax returns. The Small Business Protection Act of 1996 eliminated the use of the reserve method of accounting for bad debt reserves by savings institutions, effective for taxable years beginning after 1995.

Bad Debt Reserves. Prior to the Small Business Protection Act of 1996, ESSA Bank & Trust was permitted to establish a reserve for bad debts for tax purposes and to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at ESSA Bank & Trust’s taxable income. As a result of the Small Business Protection Act of 1996, ESSA Bank & Trust must use the specific charge off method in computing its bad debt deduction for tax purposes.

Taxable Distributions and Recapture. Prior to the Small Business Protection Act of 1996, bad debt reserves created prior to 1988 were subject to recapture into taxable income if ESSA Bank & Trust failed to meet certain thrift asset and definition tests. The Small Business Protection Act of 1996 eliminated these thrift-related recapture rules. However, under current law, pre-1988 reserves

 

24


Table of Contents

remain subject to tax recapture should ESSA Bank & Trust make certain distributions from its tax bad debt reserve or cease to maintain a financial institution charter. At September 30, 2014, ESSA Bank & Trust’s total federal pre-1988 reserve was approximately $4.6 million. This reserve reflects the cumulative effects of federal tax deductions by ESSA Bank & Trust for which no federal income tax provision has been made.

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, referred to as “alternative minimum taxable income.” The alternative minimum tax is payable to the extent alternative minimum tax income is in excess of the regular income tax. 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 September 30, 2014, ESSA Bank & Trust had no minimum tax credit carryforward.

Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding two taxable years (five years for losses incurred in 2001, 2002 and 2009) and forward to the succeeding 20 taxable years. At September 30, 2014, ESSA Bank & Trust had no net operating loss carryforward for federal income tax purposes.

Corporate Dividends. We may exclude from our income 100% of dividends received from ESSA Bank & Trust as a member of the same affiliated group of corporations.

Audit of Tax Returns. ESSA Bank & Trust’s federal income tax returns have not been audited in the most recent five-year period. The 2011, 2012 and 2013 tax years remain open.

State Taxation

Pennsylvania State Taxation. ESSA Bancorp, Inc. is subject to the Pennsylvania Corporate Net Income Tax, Capital Stock and Franchise Tax. The Corporation Net Income Tax rate for fiscal year 2014 is 9.9% and is imposed on unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock and Franchise Tax is a property tax imposed on a corporation’s capital stock value at a statutorily defined rate, such value being determined in accordance with a fixed formula based upon average net income and net worth. ESSA Bank & Trust is subject to tax under the Pennsylvania Mutual Thrift Institutions Tax Act, as amended to include thrift institutions having capital stock. Pursuant to the Mutual Thrift Institutions Tax, the tax rate is 11.5%. The Mutual Thrift Institutions Tax exempts ESSA Bank & Trust from other taxes imposed by the Commonwealth of Pennsylvania for state income tax purposes and from all local taxation imposed by political subdivisions, except taxes on real estate and real estate transfers. The Mutual Thrift Institutions Tax is a tax upon net earnings, determined in accordance with generally accepted accounting principles with certain adjustments. The Mutual Thrift Institutions Tax, in computing income according to generally accepted accounting principles, allows for the deduction of interest earned on state and federal obligations, while disallowing a percentage of thrift’s interest expense deduction in the proportion of interest income on those securities to the overall interest income of ESSA Bank & Trust. Net operating losses, if any, thereafter can be carried forward three years for Mutual Thrift Institutions Tax purposes.

 

Item 1A. Risk Factors

The Dodd-Frank Act, Among Other Things, Established the CFPB, Tightened Capital Standards and Will Continue to Result In New Laws and Regulations That Are Expected to Increase Our Costs of Operations.

The Dodd-Frank Act is significantly changing the current bank regulatory structure and affecting the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years. However, it is expected that the legislation and implementing regulations will materially increase our operating and compliance costs.

The Dodd-Frank Act created the CFPB with broad powers to supervise and enforce consumer protection laws. The CFPB has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions, including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The CFPB has examination and enforcement authority over all banks with more than $10 billion in assets. Banks with $10 billion or less in assets, such as ESSA Bank & Trust, will continue to be examined for compliance with the consumer laws by their primary bank regulators. The Dodd-Frank Act also weakens the federal preemption rules that have been applicable for national banks and federal savings associations, and gives state attorneys general the ability to enforce federal consumer protection laws.

 

25


Table of Contents

The Dodd-Frank Act requires minimum leverage (Tier 1) and risk-based capital requirements for bank and savings and loan holding companies that are no less than those applicable to banks, which will exclude certain instruments that previously have been eligible for inclusion by bank holding companies as Tier 1 capital, such as trust preferred securities.

Effective July 21, 2011, the Dodd-Frank Act eliminated the federal prohibitions on paying interest on demand deposits, thus allowing businesses to have interest bearing checking accounts, which could result in an increase in our interest expense.

The Dodd-Frank Act also broadens the base for FDIC deposit insurance assessments. Assessments are now based on the average consolidated total assets less tangible equity capital of a financial institution, rather than deposits. The Dodd-Frank Act also permanently increases the maximum amount of deposit insurance for banks, savings institutions and credit unions to $250,000 per depositor, retroactive to January 1, 2009, and non-interest bearing transaction accounts had unlimited deposit insurance through December 31, 2012. The legislation also increases the required minimum reserve ratio for the Deposit Insurance Fund from 1.15% to 1.35% of insured deposits, and directs the FDIC to offset the effects of increased assessments on depository institutions with less than $10 billion in assets.

The Dodd-Frank Act requires publicly traded companies to give stockholders a non-binding vote on executive compensation and so-called “golden parachute” payments. It also provides that the listing standards of the national securities exchanges shall require listed companies to implement and disclose “clawback” policies mandating the recovery of incentive compensation paid to executive officers in connection with accounting restatements. The legislation also directs the Federal Reserve Board to promulgate rules prohibiting excessive compensation paid to bank holding company executives.

Effective December 10, 2013, pursuant to the Dodd-Frank Act, federal banking and securities regulators issued final rules to implement Section 619 of the Dodd-Frank Act (the “Volcker Rule”). Generally, subject to a transition period and certain exceptions, the Volcker Rule restricts insured depository institutions and their affiliated companies from engaging in short-term proprietary trading of certain securities, investing in funds with collateral comprised of less than 100% loans that are not registered with the Securities and Exchange Commission (“SEC”) and from engaging in hedging activities that do not hedge a specific identified risk. After the transition period, the Volcker Rule prohibitions and restrictions will apply to banking entities, including the Company, unless an exception applies.

New Regulations Could Restrict Our Ability to Originate and Sell Mortgage Loans.

The CFPB has issued a rule designed to clarify for lenders how they can avoid monetary damages under the Dodd-Frank Act, which would hold lenders accountable for ensuring a borrower’s ability to repay a mortgage. Loans that meet this “qualified mortgage” definition will be presumed to have complied with the new ability-to-repay standard. Under the CFPB’s rule, a “qualified mortgage” loan must not contain certain specified features, including:

 

    excessive upfront points and fees (those exceeding 3% of the total loan amount, less “bona fide discount points” for prime loans);

 

    interest-only payments;

 

    negative-amortization; and

 

    terms longer than 30 years.

Also, to qualify as a “qualified mortgage,” a borrower’s total debt-to-income ratio may not exceed 43%. Lenders must also verify and document the income and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximum interest rate during the first five years, taking into account all applicable taxes, insurance and assessments. The CFPB’s rule on qualified mortgages could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability.

Increases to the Allowance for Credit Losses May Cause Our Earnings to Decrease.

Our customers may not repay their loans according to the original terms, and the collateral securing the payment of those loans may be insufficient to pay any remaining loan balance. In addition, the estimates used to determine the fair value of such loans as of the acquisition date may be inconsistent with the actual performance of the acquired loans. Hence, we may experience significant credit losses, which could have a material adverse effect on our operating results. 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 determining the amount of the allowance for credit losses, we rely on loan quality reviews, past loss experience, and an evaluation of economic conditions, among other factors. If our assumptions prove to be incorrect, our allowance for credit losses may not be sufficient to cover losses inherent in our loan portfolio, resulting in additions to the allowance. Material additions to the allowance would materially decrease our net income.

 

26


Table of Contents

Our emphasis on the origination of commercial real estate and business loans is one of the more significant factors in evaluating our allowance for credit losses. As we continue to increase the amount of these loans, additional or increased provisions for credit losses may be necessary and as a result would decrease our earnings.

Bank regulators periodically review our allowance for credit losses and may require us to increase our provision for credit losses or loan charge-offs. Any increase in our allowance for credit losses or loan charge-offs as required by these regulatory authorities could have a material adverse effect on our results of operations and/or financial condition.

Future Changes in Interest Rates Could Reduce Our Profits.

Our ability to make a profit largely depends on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:

 

  1. the interest income we earn on our interest-earning assets, such as loans and securities; and

 

  2. the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.

From September, 2007 through December, 2008, the Federal Reserve Board of Governors decreased its target for the federal funds rate from 5.25% to 0.25%. The federal funds rate has remained at 0.25% since December 2008 and is expected to remain at or around that level for an extended period of time. While these short term market interest rates (which we use as a guide to price our deposits) decreased, longer term market interest rates (which we use as a guide to price our longer term loans) also decreased but not to the same degree. With the decline in shorter term market interest rates the Company’s cost of funds declined. This decline in our cost of funds was initially beneficial to our net interest spread. However, as short term market rates have remained low and longer term interest rates also declined, the Company’s net interest margin decreased from 2.93% for the year ended September 30, 2009 to 2.65% for the year ended September 30, 2012. The Company’s acquisition of First Star Bancorp was effective July 31, 2012. The acquisition, along with increases in longer term interest rates during the third and fourth quarter of our 2013 fiscal year helped to increase our net interest margin to 3.08% for the year ended September 30, 2013. Rates remained low during the fiscal year ended September 30, 2014. The resulting decline in the yield on our interest earning assets outpaced the decline in the cost of our interest bearing liabilities resulting in a decline in our net interest margin to 2.97% for the year ended September 30, 2014 from 3.08% for the year ended September 30, 2013. If shorter term interest rates increase or if longer term interest rates decline, there could be further negative pressure exerted on our net interest margin.

In addition, changes in interest rates can affect the average life of loans and mortgage-backed and related securities. A reduction in interest rates results in increased prepayments of loans and mortgage-backed and related securities, as borrowers refinance their loans in order to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Alternatively, increases in interest rates may decrease loan demand and/or make it more difficult for borrowers to repay adjustable rate loans.

Changes in interest rates also affect the current market value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. At September 30, 2014, the fair value of our debt securities available for sale totaled $383.1 million. Unrealized net gains on these available for sale securities totaled approximately $984,000 at September 30, 2014 and are reported as a separate component of stockholders’ equity. Decreases in the fair value of securities available for sale in future periods would have an adverse effect on stockholders’ equity.

We evaluate interest rate sensitivity by estimating the change in ESSA Bank & Trust’s Economic Value of Equity (EVE) over a range of interest rate scenarios. EVE is the net present value of the Company’s asset cash flows minus the net present value of the Company’s liability cash flows. At September 30, 2014, in the event of an immediate 200 basis point increase in interest rates, the Company’s model projects that we would experience a $33.3 million, or 17.3%, decrease in net portfolio value. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Management of Market Risk.”

Concentration of Loans in Our Primary Market Area, Which Has Experienced an Economic Downturn, May Increase the Risk of Increased Nonperforming Assets.

Our success depends primarily on the general economic conditions in the Pennsylvania counties of Monroe, Northampton, and Lehigh as nearly all of our loans are to customers in these markets. Accordingly, the local economic conditions in these market areas has a significant impact on the ability of borrowers to repay loans as well as our ability to originate new loans. As such, a continuation of the decline in real estate values in these market areas would also lower the value of the collateral securing loans on properties in these market areas. In addition, continued weakening in general economic conditions such as inflation, recession, unemployment or other factors beyond our control could negatively affect our financial results.

 

27


Table of Contents

Continued and Sustained Deterioration in the Housing Sector and Related Markets and Prolonged Elevated Unemployment Levels May Adversely Affect Our Business and Financial Results.

Over the last several years, general economic conditions continued to worsen nationally as well as in our market area. While we did not invest in sub-prime mortgages and related investments, our lending business is tied significantly to the housing market. Declines in home prices, and increases in foreclosures and unemployment levels, have adversely impacted the credit performance of real estate loans, resulting in the write-down of asset values. The continuing housing slump has resulted in reduced demand for the construction of new housing, further declines in home prices, and increased delinquencies on construction, residential and commercial mortgage loans. The ongoing concern about the economy in general has caused many lenders to reduce or cease providing funding to borrowers. These conditions may also cause a further reduction in loan demand, and increases in our non-performing assets, net charge-offs and provisions for loan losses. A worsening of these negative economic conditions could adversely affect our prospects for growth, asset and goodwill valuations and could result in a decrease in our interest income and a material increase in our provision for loan losses.

Our Continued Emphasis On Commercial Real Estate Lending Increases Our Exposure To Increased Lending Risks.

Our business strategy centers on continuing our emphasis on commercial real estate lending. We have grown our loan portfolio in recent years with respect to this type of loan and intend to continue to emphasize this type of lending. At September 30, 2014, $190.5 million, or 17.9%, of our total loan portfolio consisted of commercial real estate loans. Loans secured by commercial real estate generally expose a lender to greater risk of non-payment and loss than one-to-four family residential mortgage loans because repayment of the commercial real estate loans often depends on the successful operation of the property and the income stream of the underlying property. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Accordingly, an adverse development with respect to one loan or one credit relationship can expose us to greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan. We seek to minimize these risks through our underwriting policies, which require such loans to be qualified on the basis of the property’s collateral value, net income and debt service ratio; however, there is no assurance that our underwriting policies will protect us from credit-related losses.

At September 30, 2014, our largest commercial real estate lending relationship was $11.3 million of loans located in Lehigh County, Pennsylvania and secured by real estate. This loan was performing in accordance with its repayment terms. See “Item 1. Business—Lending Activities—Commercial Real Estate Loans.”

Our Increased Auto Lending, As a Result of the Franklin Security Bank Acquisition, Increases Our Exposure to Increased Lending Risks.

At September 30, 2014, $100.6 million, or 9.4% of our total loan portfolio consisted of auto loans. These loans were primarily indirect auto loans. Indirect auto loans are inherently risky as they are often secured by assets that depreciate rapidly. In some cases, repossessed collateral for a defaulted automobile loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency may not warrant further substantial collection efforts against the borrower. Automobile loan collections depend on the borrower’s continuing financial stability, and therefore, are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy.

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 areas, 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 areas. For additional information see “Item 1. Business—Competition.”

Economic Conditions May Adversely Affect Our Liquidity and Financial Condition.

Recent significant declines in the values of mortgage-backed securities and derivative securities issued by financial institutions, government sponsored entities, and major commercial and investment banks have led to decreased confidence in financial markets among borrowers, lenders, and depositors, as well as disruption and extreme volatility in the capital and credit markets and the failure of some entities in the financial sector. As a result, many lenders and institutional investors have reduced or ceased to provide funding to borrowers. Continued turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.

 

28


Table of Contents

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 FDIC and the Pennsylvania Department of Banking and Securities. 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 bank, the classification of assets by a bank, the imposition of higher capital requirements, and the adequacy of a bank’s allowance for credit 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. Notably, the federal banking agencies have recently proposed regulations which, if finalized, would significantly increase regulatory capital requirements for insured depository institutions as well as applying such requirements to savings and loan holding companies. We believe that we are in substantial compliance with applicable federal, state and local laws, rules and regulations. Because our business is highly regulated, the laws, rules and applicable regulations are subject to regular modification and change. There can be no assurance that proposed laws, rules and regulations, or any other laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.

The Soundness of Other Financial Services Institutions May Adversely Affect Our Credit Risk.

We rely on other financial services institutions through trading, clearing, counterparty, and other relationships. We maintain limits and monitor concentration levels of our counterparties as specified in our internal policies. Our reliance on other financial services institutions exposes us to credit risk in the event of default by these institutions or counterparties. These losses could adversely affect our results of operations and financial condition.

Any Future FDIC Insurance Premium Increases May Adversely Affect our Earnings.

We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are additional bank or financial institution failures we may be required to pay even higher FDIC premiums than the recently increased levels. Such increases and any future increases or required prepayments of FDIC insurance premiums may adversely impact our earnings. See “Supervision and Regulation—Deposit Insurance” for more information about FDIC insurance premiums.

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

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

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

Recent Health Care Legislation Could Increase Our Expenses Or Require Us To Pass Further Costs On To Our Employees, Which Could Adversely Affect Our Operations, Financial Condition and Earnings.

Legislation enacted in 2010 requires companies to provide expanded health care coverage to their employees, such as affordable coverage to part-time employees and coverage to dependent adult children of employees. Companies will also be required to enroll new employees automatically into their health plans. Compliance with these and other new requirements of the health care legislation has increased our employee benefits expense, and requires us to pass these costs on to our employees, which could result in a competitive disadvantage in hiring and retaining qualified employees.

 

29


Table of Contents
Item 1B. Unresolved Staff Comments

Not applicable.

 

30


Table of Contents
Item 2. Properties

The following table provides certain information as of September 30, 2014 with respect to our main office located in Stroudsburg, Pennsylvania, and our 27 full service branch offices.

 

Location

  

Leased or Owned

  

Year Acquired

or Leased

  

Square Footage

 
Main Office:         

200 Palmer Street

Stroudsburg, PA 18360

   Owned    2003      36,000   
Full Service Branches:         

249 Route 940

Blakeslee, PA 18610

   Owned    2002      2,688   

1881 Route 209

Brodheadsville, PA 18322

   Owned    1983      4,100   

695 North Courtland Street

East Stroudsburg, PA 18301

   Leased    1999      472   

75 Washington Street

East Stroudsburg, PA 18301

   Owned    1966      3,300   

5120 Milford Rd.

East Stroudsburg, PA 18302

   Owned    2014      3,610   

3236 Route 940, Suite 23

Mt. Pocono, PA 18344

   Leased    1999      536   

1321A Blue Valley Drive

Pen Argyl, PA 18072

   Leased    2001      444   

744 Main Street

Stroudsburg, PA 18360

   Owned    1985      12,000   

Route 611

1070 North Ninth Street

Stroudsburg, PA 18360

   Leased    2000      488   

2836 Route 611, Ste 105

Tannersville, PA 18372

   Leased    1993      611   

924 Weir Lake Road Suite 101

Brodheadsville, PA 18322

   Leased    1997      576   

Tannersville Plaza

2826 Route 611

Tannersville, PA 18372

   Owned    2007      2,500   

975 Route 390

Cresco, PA 18326

   Owned    2010      2,912   

1500 N. Cedar Crest Blvd, Unit 2

Allentown, PA 18104

   Leased    2010      530   

5580 Crawford Drive

Bethlehem, PA 18017

   Leased    2010      468   

5020 Route 873

Schnecksville, PA 18078

   Leased    2010      460   

 

31


Table of Contents

Location

  

Leased or Owned

  

Year Acquired

or Leased

  

Square Footage

 

418 West Broad Street

Bethlehem, PA 18018

   Owned    2012      4,500   

358 South Walnut Street

Bath, PA 18014

   Leased    2012      2,000   

2415 Park Avenue

Easton, PA 18045

   Owned    2012      3,460   

14 South Main Street

Nazareth, PA 18064

   Leased    2012      450   

471 West Wabash Street

Allentown, PA 18103

   Owned    2012      4,411   

11 North Main Street

Alburtis, PA 18011

   Owned    2012      2,091   

1430 Jacobsburg Road

Wind Gap, PA 18091

   Leased    2012      1,400   

Moravian Village Tower

526 Wood Street

Bethlehem, PA 18018

   Leased    2012      160   

6302 Route 309

New Tripoli, PA 18066

   Owned    2012      3,460   

1065 Highway 315

Wilkes Barre, PA 18702

   Leased    2014      7,536   

139 Wyoming Avenue

Scranton, PA 18503

   Leased    2014      3,800   
Other Properties         

746-752 Main Street

Stroudsburg, PA 18360

   Owned    2005      4,650   

414 West Broad Street

Bethlehem, PA 18018

   Owned    2012      3,604   

The net book value of our premises, land and equipment was $17.0 million at September 30, 2014.

 

Item 3. Legal Proceedings

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

 

Item 4. Mine Safety Disclosures

Not applicable.

 

32


Table of Contents

PART II

 

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

The Company’s shares of common stock are traded on the Nasdaq Global Market under the symbol “ESSA.” The approximate number of holders of record of ESSA Bancorp, Inc.’s common stock as of September 30, 2014 was 2,132. Certain shares of ESSA Bancorp, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following tables present quarterly market information for ESSA Bancorp, Inc.’s common stock for the periods ended September 30, 2013 and September 30, 2014. The following information was provided by the Nasdaq Stock Market.

 

Fiscal 2014

   High      Low      Dividends  

Quarter ended September 30, 2014

   $ 11.73       $ 10.96       $ 0.07   

Quarter ended June 30, 2014

     11.23         10.26         0.07   

Quarter ended March 31, 2014

     11.75         10.65         0.07   

Quarter ended December 31, 2013

     11.64         10.33         0.05   

 

Fiscal 2013

   High      Low      Dividends  

Quarter ended September 30, 2013

   $ 11.50       $ 10.26       $ 0.05   

Quarter ended June 30, 2013

     10.99         10.13         0.05   

Quarter ended March 31, 2013

     11.50         10.80         0.05   

Quarter ended December 31, 2012

     10.89         9.50         0.05   

The Board of Directors has the authority to declare cash dividends on shares of common stock, subject to statutory and regulatory requirements. We began to pay quarterly cash dividends in the third quarter of fiscal 2008. Our dividend was increased from $0.05 per share to $0.07 per share in the second quarter of fiscal 2014. In determining whether and in what amount to pay a cash dividend in the future, the Board will take into account a number of factors, including capital requirements, our consolidated financial condition and results of operations, tax considerations, statutory and regulatory limitations and general economic conditions. No assurances can be given that cash dividends will not be reduced or eliminated in the future.

The sources of funds for the payment of a cash dividend are the retained proceeds from the initial sale of shares of common stock and earnings on those proceeds, interest and principal payments with respect to ESSA Bancorp, Inc.’s loan to the Employee Stock Ownership Plan, and dividends from ESSA Bank & Trust. For a discussion of the limitations applicable to ESSA Bank & Trust’s ability to pay dividends, see “Item 1. Business—Supervision and Regulation.”

Stock Performance Graph

Set forth hereunder is a stock performance graph comparing (a) the cumulative total return on the Company’s common stock between September 30, 2009 and September 30, 2014, (b) the cumulative total return on stock included in the SNL Thrift Index over such period, and (c) the cumulative total return on stocks included in the Russell 2000 Index over such period. Cumulative return assumes the reinvestment of dividends, and is expressed in dollars based on an assumed investment of $100.

There can be no assurance that the ESSA Bancorp, Inc.’s stock performance will continue in the future with the same or similar trend depicted in the graph. ESSA Bancorp, Inc. will not make or endorse any predictions as to future stock performance.

 

33


Table of Contents

ESSA BANCORP, INC.

 

LOGO

 

     Period Ending  

Index

   09/30/09      09/30/10      09/30/11      09/30/12      09/30/13      09/30/14  

ESSA Bancorp, Inc.

     100.00         91.10         82.21         82.90         84.72         94.05   

SNL Thrift Index

     100.00         99.87         84.68         110.04         132.48         146.12   

Russell 2000

     100.00         113.35         109.35         144.24         187.59         194.96   

Source: SNL Financial LC, Charlottesville, NC

Beginning in June 2009 through the year ended September 30, 2013, the Company repurchased a total of 6,627,100 shares of its common stock pursuant to five repurchase programs. In February 2014, the Company announced a sixth repurchase program to repurchase up to an additional 5% of its outstanding stock. During the year ended September 30, 2014 the Company purchased 369,225 shares at a weighted average cost of $11.24 per share. The following table presents a summary of the Company’s share repurchases during the quarter ended September 30, 2014.

 

34


Table of Contents

Company Purchases of Common Stock

 

Month Ending

   Total number of
shares purchased
     Average price
paid per share
     Total number of shares
purchased as part of
publicly announced
plans or programs
     Maximum number
of shares that may
yet be purchased
under the plans or
programs
 

July 31, 2014

     70,880         11.07         65,600         —     

August 31, 2014

     182,500         11.52         182,500         —     

September 30, 2014

     —           —           —           178,300   
  

 

 

       

 

 

    

 

 

 

Total

     253,380         11.40         248,100         178,300   
  

 

 

       

 

 

    

 

 

 

 

35


Table of Contents
Item 6. Selected Financial Data

The following information is derived from the audited consolidated financial statements of ESSA Bancorp, Inc. For additional information, reference is made to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of ESSA Bancorp, Inc. and related notes included elsewhere in this Annual Report.

 

                                                                                                        
     At September 30,  
     2014      2013      2012      2011      2010  
     (In thousands)  

Selected Financial Condition Data:

              

Total assets

   $ 1,574,815       $ 1,372,315       $ 1,418,786       $ 1,097,480       $ 1,071,997   

Cash and cash equivalents

     22,301         26,648         15,550         41,694         10,890   

Investment securities:

              

Available for sale

     383,078         315,622         329,585         245,393         252,341   

Held to maturity

     —           —           —           —           12,795   

Loans, net

     1,058,267         928,230         950,355         738,619         730,842   

Regulatory stock

     14,284         9,415         21,914         16,882         20,727   

Premises and equipment

     16,957         15,747         16,170         11,494         12,189   

Bank owned life insurance

     29,720         28,797         27,848         23,256         15,618   

Deposits

     1,133,889         1,041,059         995,634         637,924         540,410   

Borrowed funds

     259,320         152,260         234,741         288,410         350,076   

Equity

     167,309         166,446         175,411         161,679         171,623   

 

                                                                                                        
     For the Years Ended September 30,  
     2014      2013      2012      2011      2010  
     (In thousands)  

Selected Data:

              

Interest income

   $ 50,776       $ 51,102       $ 45,200       $ 47,176       $ 49,257   

Interest expense

     10,627         11,257         16,132         18,280         21,306   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     40,149         39,845         29,068         28,896         27,951   

Provision for loan losses

     2,350         3,750         2,550         2,055         2,175   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     37,799         36,095         26,518         26,841         25,776   

Non-interest income

     7,407         8,024         6,735         6,325         6,708   

Non-interest expense

     33,811         32,462         33,005         26,045         26,128   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income before income tax expense

     11,395         11,657         248         7,121         6,356   

Income tax expense

     2,891         2,834         33         1,863         1,844   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 8,504       $ 8,823       $ 215       $ 5,258       $ 4,512   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share

              

Basic

   $ 0.79       $ 0.76       $ 0.02       $ 0.46       $ 0.36   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Diluted

   $ 0.79       $ 0.76       $ 0.02       $ 0.46       $ 0.36   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

36


Table of Contents
                                                                                              
     At or For the Years Ended September 30,  
     2014     2013     2012     2011     2010  

Selected Financial Ratios and Other Data:

          

Performance Ratios:

          

Return on average assets

     0.59     0.64     0.02     0.48     0.43

Return on average equity

     5.01     5.12     0.13     3.15     2.49

Interest rate spread(1)

     2.89     2.97     2.42     2.47     2.34

Net interest margin(2)

     2.97     3.08     2.65     2.78     2.78

Efficiency ratio(3)

     71.10     67.81     91.90     75.62     75.39

Noninterest expense to average total assets

     2.32     2.34     2.84     2.39     2.49

Average interest-earning assets to average interest-bearing liabilities

     112.36     113.50     116.55     117.90     121.11

Asset Quality Ratios:

          

Non-performing assets as a percent of total assets

     1.59     1.89     1.92     1.26     1.20

Non-performing loans as a percent of total loans

     2.08     2.55     2.53     1.54     1.47

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

     38.98     33.79     30.12     71.04     68.48

Allowance for loan losses as a percent of total loans

     0.81     0.86     0.76     1.09     1.01

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

     65.78     50.33     49.34     —          —     

Allowance for loan losses as a percent of total loans excluding acquired loans

     1.07     1.03     0.97     —          —     

Capital Ratios:

          

Total risk-based capital (to risk weighted assets)

     16.98     20.35     19.71     28.54     32.60

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

     16.08     19.42     18.81     27.30     31.35

Tangible capital (to tangible assets)

     10.04     11.03     11.08     14.18     15.07

Tier 1 leverage (core) capital (to adjusted tangible assets)

     10.04     11.03     11.08     14.18     15.07

Average equity to average total assets

     11.67     12.42     14.30     15.27     17.26

Other Data:

          

Number of full service offices

     27        26        26        17        17   

 

(1) The interest rate spread represents the difference between the weighted-average yield on a fully tax equivalent basis on interest-earning assets and the weighted-average cost of interest-bearing liabilities for the year.
(2) The net interest margin represents net interest income on a fully tax equivalent basis as a percent of average interest-earning assets for the year.
(3) The efficiency ratio represents non-interest expense divided by the sum of net interest income and non-interest income.

 

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Business Strategy

Our business strategy is to grow and improve our profitability by:

 

    Increasing customer relationships through the offering of excellent service and the distribution of that service through effective delivery systems;

 

    Continuing to transform into a full service community bank by meeting the financial services needs of our customers;

 

    Continuing to develop into a high performing financial institution, in part by increasing interest revenue and fee income;

 

    Remaining within our risk management parameters; and

 

    Employing affordable technology to increase profitability and improve customer service.

We intend to continue to pursue our business strategy, subject to changes necessitated by future market conditions and other factors. We also intend to focus on the following:

 

    Increasing customer relationships through a continued commitment to service and enhancing products and delivery systems. We will continue to increase customer relationships by focusing on customer satisfaction with regard to service, products, systems and operations. We have upgraded and expanded certain of our facilities, including our corporate center and added additional branches to provide additional capacity to manage future growth and expand our delivery systems.

 

    Continuing to develop into a high performing financial institution. We will continue to enhance profitability by focusing on increasing non-interest income as well as increasing commercial products, including commercial real estate lending, which often have a higher profit margin than more traditional products. We also will pursue lower-cost commercial deposits as part of this strategy.

 

37


Table of Contents
    Remaining within our risk management parameters. We place significant emphasis on risk management and compliance training for all of our directors, officers and employees. We focus on establishing regulatory compliance programs to determine the degree of such compliance and to maintain the trust of our customers and community.

 

    Employing cost-effective technology to increase profitability and improve customer service. We will continue to upgrade our technology in an efficient manner. We have implemented new software for marketing purposes and have upgraded both our internal and external communication systems.

 

    Continuing our emphasis on commercial real estate lending to improve our overall performance. We intend to continue to emphasize the origination of higher interest rate margin commercial real estate loans as market conditions, regulations and other factors permit. We have expanded our commercial banking capabilities by adding experienced commercial bankers, and enhancing our direct marketing efforts to local businesses.

 

    Expanding our banking franchise through branching and acquisitions. We will attempt to use our stock holding company structure, to expand our market footprint through de novo branching as well as through additional acquisitions of banks, savings institutions and other financial service providers in our primary market area. We will also consider establishing de novo branches or acquiring additional financial institutions in contiguous counties. We will continue to review and assess locations for new branches both within Monroe County and the contiguous counties around Monroe. There can be no assurance that we will be able to consummate any new acquisitions or establish any additional new branches. We may continue to explore acquisition opportunities involving other banks and thrifts, and possibly financial service companies, when and as they arise, as a means of supplementing internal growth, filling gaps in our current geographic market area and expanding our customer base, product lines and internal capabilities, although we have no current plans, arrangements or understandings to make any acquisitions.

 

    Maintaining the quality of our loan portfolio. Maintaining the quality of our loan portfolio is a key factor in managing our growth. We will continue to use customary risk management techniques, such as independent internal and external loan reviews, risk-focused portfolio credit analysis and field inspections of collateral in overseeing the performance of our loan portfolio.

Critical Accounting Policies

We consider accounting policies that require management to exercise significant judgment or discretion or make significant assumptions that have, or could have, a material impact on the carrying value of certain assets or on income, to be critical accounting policies. We consider the following to be our critical accounting policies:

Allowance for Loan Losses. The allowance for loan losses is the estimated amount considered necessary to cover credit losses inherent 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. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.

As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly impact the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans.

Management performs a quarterly evaluation of the adequacy 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 and external loan reviews and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant revision based on changes in economic and real estate market conditions.

The analysis of the allowance for loan losses has two components: specific and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future

 

38


Table of Contents

cash flows or, for collateral-dependent loans, the fair value of the collateral adjusted for market conditions and selling expenses. The general allocation 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. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allocations. Actual loan losses may be significantly more than the allowance for loan losses we have established which could have a material negative effect on our financial results.

Goodwill and Intangible Assets. Goodwill is not amortized, but it is tested at least annually for impairment in the fourth quarter, or more frequently if indicators of impairment are present. If the estimated current fair value of a reporting unit exceeds its carrying value, no additional testing is required and an impairment loss is not recorded. The Company uses market capitalization and multiples of tangible book value methods to determine the estimated current fair value of its reporting unit. Based on this analysis, no impairment was recorded in 2014 or 2013.

The other intangibles assets are assigned useful lives, which are amortized on an accelerated basis over their weighted-average lives. The Company periodically reviews the intangible assets for impairment as events or changes in circumstances indicate that the carrying amount of such asset may not be recoverable. Based on these reviews, no impairment was recorded in 2014 and 2013.

Employee Benefit Plans. The Bank maintains a noncontributory, defined benefit pension plan for all employees who have met age and length of service requirements. The Bank also maintains a defined contribution Section 401(k) plan covering eligible employees. The Company created an ESOP for the benefit of employees who meet certain eligibility requirements. The Company makes cash contributions to the ESOP on an annual basis.

The Company maintains an equity incentive plan to provide for issuance or granting of shares of common stock for stock options or restricted stock. The Company has recorded stock-based employee compensation cost using the fair value method as allowed under generally accepted accounting principles. Management estimated the fair values of all option grants using the Black-Scholes option-pricing model. Management estimated the expected life of the options using the simplified method as allowed under generally accepted accounting principles. The risk-free rate was determined utilizing the treasury yield for the expected life of the option contract.

Fair Value Measurements. We group our assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

    Level I – Valuation is based upon quoted prices for identical instruments traded in active markets.

 

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

 

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

We base our fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in generally accepted accounting principles.

Fair value measurements for most of our assets are obtained from independent pricing services that we have engaged for this purpose. When available, we, or our independent pricing service, use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that incorporate available trade, bid, and other market information. Subsequently, all of our financial instruments use either of the foregoing methodologies to determine fair value adjustments recorded to our financial statements. In certain cases, however, when market observable inputs for model-based valuation techniques may not be readily available, we are required to make judgments about assumptions market participants would use in estimating the fair value of financial instruments. The degree of management judgment involved in determining the fair value of a financial instrument is dependent upon the availability of quoted market prices or observable market parameters. For financial instruments that trade actively and have quoted market prices or observable market parameters, there is minimal subjectivity involved in measuring fair value. When observable market prices and parameters are not fully available, management judgment is necessary to estimate fair value. In addition, changes in the market conditions may reduce the availability of quoted prices or observable data. When market data is not available, we use valuation techniques requiring more management judgment to estimate the appropriate fair value measurement. Therefore, the results cannot be determined with precision

 

39


Table of Contents

and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future valuations.

Other-than-Temporary Investment Security Impairment. Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value is determined to be other-than-temporary, the value of the security is reduced and a corresponding charge to earnings is recognized.

Deferred Income Taxes. 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. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. We consider the determination of this valuation allowance to be a critical accounting policy because of the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income. These judgments and estimates are reviewed on a continual basis as regulatory and business factors change. A valuation allowance for deferred tax assets may be required if the amount of taxes recoverable through loss carryback declines, or if we project lower levels of future taxable income. Such a valuation allowance would be established through a charge to income tax expense which would adversely affect our operating results.

Comparison of Financial Condition at September 30, 2014 and September 30, 2013

Total Assets. Total assets increased $202.5 million, or 14.8%, to $1.6 billion at September 30, 2014, compared to $1.4 billion at September 30, 2013. The acquisition of Franklin Security Bancorp, Inc. accounted for the majority of the increase. The Company completed its acquisition of Franklin Security Bancorp, Inc. on April 4, 2014, adding approximately $217.5 million in total assets, $152.2 million in loans and $162.2 million in deposits.

Interest-Bearing Deposits with Other Institutions. Interest-bearing deposits with other institutions decreased $2.9 million, or 67.4%, to $1.4 million at September 30, 2014 from $4.3 million at September 30, 2013. The primary reason for the decrease was a decrease in the Company’s interest bearing demand deposit account at the FHLB-Pittsburgh of $2.5 million.

Investment Securities Available for Sale. Investment securities available for sale increased $67.5 million, or 21.4%, to $383.1 million at September 30, 2014 from $315.6 million at September 30, 2013. The increase was due primarily to increases in mortgage backed securities of $47.2 million and obligations of states and political subdivisions of $18.9 million. These increases were primarily the result of the Franklin Security Bank acquisition which added approximately $55.9 million in investment securities.

Net Loans. Net loans increased $130.1 million, or 14.0%, to $1.1 billion at September 30, 2014 from $928.2 million at September 30, 2013. The primary reasons for the increase was the April 4, 2014 acquisition of Franklin Security Bank. The Company acquired $152.2 million in loans as a result of the Franklin Security Bank acquisition. Residential real estate loans decreased by $32.5 million to $654.2 million at September 30, 2014 from $686.7 million at September 30, 2013. Commercial real estate loans increased by $31.0 million to $190.5 million at September 30, 2014 from $159.5 million at September 30, 2013. Home equity loans decreased by $536,000 to $41.4 million at September 30, 2014 from $41.9 million at September 30, 2013. Auto loans increased $100.5 million to $100.6 million at September 30, 2014 from $61,000 at September 30, 2013 primarily as a result of indirect auto loans acquired from Franklin Security Bank.

Goodwill. Goodwill increased to $10.3 million at September 30, 2014 from $8.8 million at September 30, 2013 due primarily to an acquisition of a branch from First National Community Bank, on January, 24, 2014 which added $1.4 million of goodwill.

Deposits. Deposits increased by $92.8 million, or 8.9%, to $1.13 billion at September 30, 2014 from $1.0 billion at September 30, 2013 primarily as a result of the Franklin Security Bank acquisition. Overall, the increases in deposits at September 30, 2014 compared to September 30, 2013 included increases in non-interest bearing demand accounts of $11.3 million, or 19.1%, NOW accounts of $64.1 million, or 64.2%, money market accounts of $32.1 million, or 23.3%, and savings and club accounts of $12.5 million or 11.4% offset in part by a decrease in certificates of deposit of $27.2 million, or 4.3%. Included in the certificates of deposit was a decrease of $14.9 million, or 6.4%, in brokered certificates of deposit. The decrease in brokered certificates of deposit was the result of the Company’s decision to not purchase brokered certificates based on cost compared to other available funding sources. At September 30, 2014, the Company had $218.4 million of brokered certificates of deposit outstanding.

 

40


Table of Contents

Borrowed Funds. Borrowed funds, short term and other, increased $107.1 million, or 70.3%, to $259.3 million at September 30, 2014 from $152.3 million at September 30, 2013. All borrowed funds are from the FHLB, which were more competitively priced than other wholesale funding sources.

Stockholders’ Equity. Stockholders’ equity increased by $863,000, or 0.5%, to $167.3 million at September 30, 2014 from $166.4 million at September 30, 2013.

Comparison of Operating Results for the Years Ended September 30, 2014 and September 30, 2013.

Net Income. Net income decreased by $319,000, or 3.6%, to $8.5 million for the fiscal year ended September 30, 2014 from $8.8 million for the fiscal year ended September 30, 2013. An increase in net interest income and a decrease in the provision for loan losses was offset by a decrease in noninterest income and an increase in noninterest expense.

Net Interest Income. Net interest income increased by $304,000, or 0.8%, to $40.1 million for fiscal year 2014 from $39.8 million for fiscal year 2013.

Interest Income. Interest income decreased $326,000, or 0.6%, to $50.8 million for fiscal year 2014 from $51.1 million for fiscal year 2013. The decrease resulted from a 19 basis point decrease in the overall yield on interest earning assets to 3.77% from 3.96% for the prior year which had the effect of decreasing interest income by $2.8 million offset in part by a $60.6 million increase in average interest earning assets, which had the effect of increasing interest income by $2.4 million. The increase in average interest earning assets during 2014 compared to 2013 included increases in average loans of $44.5 million, average investments of $3.9 million and average mortgage backed securities of $15.6 million. These increases were partially offset by a decrease in average regulatory stock of $4.3 million. The average yield on loans decreased to 4.38% for the fiscal year 2014, from 4.73% for the fiscal year 2013. The average yields on investment securities increased to 2.34% from 1.96% and the average yields on mortgage backed securities increased to 2.01% from 1.99% for the 2014 and 2013 periods, respectively.

Interest Expense. Interest expense decreased $630,000, or 5.6%, to $10.6 million for fiscal year 2014 from $11.3 million for fiscal year 2013, while average interest bearing liabilities increased by $65.5 million year over year. The decrease resulted from an 11 basis point decrease in the overall cost of interest-bearing liabilities to 0.88% for fiscal 2014 from 0.99% for fiscal 2013. Average savings and club accounts increased by $11.1 million, average NOW accounts increased $18.4 million, average money market accounts increased $12.7 million and average certificates of deposit increased $24.5 million. For fiscal 2014, average borrowed funds decreased $1.3 million compared to fiscal 2013. The cost of money market accounts decreased to 0.20% for fiscal year 2014 from 0.23% for fiscal year 2013. The cost of savings and club accounts remained unchanged at 0.05% for fiscal 2014. The cost of certificates of deposit increased to 1.20% from 1.17% and the cost of borrowed funds decreased to 1.36% from 1.91% for fiscal years 2014 and 2013, respectively.

Provision for Loan Losses. The Company establishes provisions for loan losses, which are charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. After an evaluation of these factors, the Company made a provision of $2.4 million for fiscal year 2014 compared to a $3.8 million provision for the 2013 fiscal year. The allowance for loan losses was $8.6 million, or 0.81%, of loans outstanding at September 30, 2014, compared to $8.1 million, or 0.86%, of loans outstanding at September 30, 2013.

Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, and establishes the provision for loan losses based on the factors set forth in the preceding paragraph. Historically, the Bank’s loan portfolio has consisted primarily of one-to four-family residential mortgage loans. However, our current business plan calls for increases in commercial real estate loan originations. As management evaluates the allowance for loan losses, the increased risk associated with larger non-homogenous commercial real estate may result in large additions to the allowance for loan losses in future periods. Loans secured by commercial real estate generally expose a lender to greater risk of non-payment and loss than one-to-four family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the underlying property. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Accordingly, an adverse development with respect to one loan or one credit relationship can expose us to greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan.

 

41


Table of Contents

Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary, based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, the Federal Reserve Board, as an integral part of its examination process, will periodically review our allowance for loan losses. This agency may require us to recognize adjustments to the allowance, based on its judgments about information available to it at the time of its examination.

Non-Interest Income. Non-interest income decreased $617,000 million, or 7.7%, to $7.4 million for the year ended September 30, 2014, from $8.0 million for the comparable 2013 period. The decrease was primarily due to a decrease in gain on sale of investments of $416,000, service charges and fees on loans of $162,000 and gain on sale of loans of $426,000, which were partially offset by an increase in gain on acquisition of $241,000.

Non-Interest Expense. Non-interest expense increased $1.3 million, or 4.2%, to $33.8 million for fiscal year 2014 from $32.5 million for the comparable period in 2013. The primary reasons for the increase were increases in merger related costs of $522,000, increased other expenses of $292,000 and increased data processing costs of $363,000 which was partially offset by a decrease in compensation and employee benefits of $82,000.

Income Taxes. Income tax expense of $2.9 million was recognized for fiscal year 2014 compared to an income tax expense of $2.8 million recognized for fiscal year 2013.

Comparison of Operating Results for the Years Ended September 30, 2013 and September 30, 2012

Net Income. Net income increased $8.6 million to $8.8 million for the fiscal year ended September 30, 2013 from $215,000 for the fiscal year ended September 30, 2012. The increase was primarily due to increases in net interest income and noninterest income offset in part by increases in income tax expense.

Net Interest Income. Net interest income increased by $10.8 million, or 37.1%, to $39.8 million for fiscal year 2013 from $29.1 million for fiscal year 2012.

Interest Income. Interest income increased $5.9 million, or 13.1%, to $51.1 million for fiscal year 2013 from $45.2 million for fiscal year 2012. The increase resulted from a $196.0 million increase in average interest earning assets which had the effect of increasing interest income by $8.6 million offset in part by a 17 basis point decrease in the overall yield on interest earning assets to 3.96% for fiscal year 2013 from 4.13% for fiscal year 2012 which decreased interest income by $2.7 million. The increase in average interest earning assets during 2013 compared to 2012 included increases in average loans of $162.9 million, average investments of $34.5 million and average mortgage backed securities of $10.5 million. These increases were partially offset by decreases in average other interest earning assets of $11.1 million and regulatory stock of $886,000. The average yield on loans decreased to 4.73% for the fiscal year 2013, from 4.9% for the fiscal year 2012. The average yields on investment securities decreased to 1.96% from 2.13% and the average yields on mortgage backed securities decreased to 1.99% from 2.61% for the 2013 and 2012 periods, respectively.

Interest Expense. Interest expense decreased $4.9 million, or 30.2%, to $11.3 million for fiscal year 2013 from $16.1 million for fiscal year 2012. The decrease resulted from a 73 basis point decrease in the overall cost of interest-bearing liabilities to 0.99% for fiscal 2013 from 1.71% for fiscal 2012 which decreased interest expense by $5.8 million. A $198.1 million increase in average interest-bearing liabilities had the effect of increasing interest expense by $908,000. Average savings and club accounts increased by $25.3 million, average NOW accounts increased $25.5 million, average money market accounts increased $26.0 million and average certificates of deposit increased $186.6 million. For fiscal 2013, average borrowed funds decreased $65.2 million over 2012. The cost of money market accounts decreased to 0.23% for fiscal year 2013 from 0.28% for fiscal year 2012. The cost of savings and club accounts decreased to 0.05% for fiscal 2013 from 0.10% for fiscal 2012. The cost of certificates of deposit decreased to 1.17% from 1.71% and the cost of borrowed funds decreased to 1.91% from 3.24% for fiscal years 2013 and 2012, respectively. Borrowed funds declined primarily due to prepayments of $10.0 million in repurchase agreements and $27.0 million of FHLB borrowings in 2012.

Provision for Loan Losses. The Company establishes provisions for loan losses, which are charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur. After an evaluation of these factors, the Company made a provision of $3.8 million for fiscal year 2013 compared to a $2.6 million provision for the 2012 fiscal year. The allowance for loan losses was $8.1 million or 0.86% of loans outstanding at September 30, 2013, compared to $7.3 million, or 0.76%, of loans outstanding at September 30, 2012.

 

42


Table of Contents

Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Management reviews the level of the allowance on a quarterly basis, and establishes the provision for loan losses based on the factors set forth in the preceding paragraph. Historically, the Bank’s loan portfolio has consisted primarily of one-to four-family residential mortgage loans. However, our current business plan calls for increases in commercial real estate loan originations. As management evaluates the allowance for loan losses, the increased risk associated with larger non-homogenous commercial real estate may result in large additions to the allowance for loan losses in future periods. Loans secured by commercial real estate generally expose a lender to greater risk of non-payment and loss than one-to-four family residential mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the underlying property. Additionally, such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one-to-four family residential mortgage loans. Accordingly, an adverse development with respect to one loan or one credit relationship can expose us to greater risk of loss compared to an adverse development with respect to a one-to-four family residential mortgage loan.

Although we believe that we use the best information available to establish the allowance for loan losses, future additions to the allowance may be necessary, based on estimates that are susceptible to change as a result of changes in economic conditions and other factors. In addition, the Federal Reserve Board, as an integral part of its examination process, will periodically review our allowance for loan losses. This agency may require us to recognize adjustments to the allowance, based on its judgments about information available to it at the time of its examination.

Non-Interest Income. Non-interest income increased $1.3 million, or 19.1%, to $8.0 million for the year ended September 30, 2013, from $6.7 million for the comparable 2012 period. The increase was primarily due to increases in earnings on gain on sale of investments of $406,000, service charges and fees on loans of $280,000, and service fees on deposit accounts of $262,000, which were partially offset by a decrease in the trust and investment fees of $52,000.

Non-Interest Expense. Non-interest expense decreased $543,000, or 1.7%, to $32.5 million for fiscal year 2013 from $33.0 million for the comparable period in 2012. The primary reasons for the decrease were declines in merger related costs of $1.4 million and prepayment penalties on borrowings of $4.6 million which was partially offset by increases in compensation and employee benefits of $2.7 million.

Income Taxes. Income tax expense of $2.8 million was recognized for fiscal year 2013 compared to an income tax expense of $33,000 recognized for fiscal year 2012. The primary reason for the increase was the increases in income before income taxes of $11.4 million.

 

43


Table of Contents

Average Balances and Yields. The following table sets forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are monthly average balances. The yields set forth below include the effect of deferred fees and discounts and premiums that are amortized or accreted to interest income.

 

     For the Years Ended September 30,  
     2014     2013     2012  
     Average
Balance
    Interest
Income/
Expense
    Yield/
Cost
    Average
Balance
    Interest
Income/
Expense
    Yield/
Cost
    Average
Balance
    Interest
Income/
Expense
    Yield/
Cost
 
     (Dollars in thousands)  

Interest-earning assets:

                  

Loans(1) (2)

     990,877      $ 43,382        4.38   $ 946,358      $ 44,744        4.73   $ 783,444      $ 38,384        4.90

Investment securities

                  

Taxable(3)

     82,465        1,648        2.00     88,757        1,585        1.79     58,643        1,116        1.90

Exempt from federal income tax(3) (4)

     23,386        550        3.56     13,166        272        3.13     8,731        209        3.63
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total investment securities

     105,851        2,198        2.34     101,923        1,857        1.96     67,374        1,325        2.13

Mortgage-backed securities

     235,320        4,737        2.01     219,697        4,373        1.99     209,161        5,467        2.61

Regulatory stock

     11,315        441        3.90     15,635        115        0.74     16,521        —          0.00

Other

     9,711        18        0.19     8,849        13        0.15     19,917        24        0.12
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     1,353,074        50,776        3.77     1,292,462        51,102        3.96     1,096,417        45,200        4.13

Allowance for loan losses

     (8,457         (7,709         (7,899    

Noninterest-earning assets

     109,663            102,057            69,458       
  

 

 

       

 

 

       

 

 

     

Total assets

   $ 1,454,280          $ 1,386,810          $ 1,157,976       
  

 

 

       

 

 

       

 

 

     

Interest-bearing liabilities:

                  

NOW accounts

   $ 109,615        76        0.07   $ 91,201        51        0.06   $ 65,747        25        0.04

Money market accounts

     155,841        315        0.20     143,103        327        0.23     117,118        327        0.28

Savings and club accounts

     115,347        61        0.05     104,234        50        0.05     78,943        80        0.10

Certificates of deposit

     623,307        7,455        1.20     598,759        6,980        1.17     412,207        7,054        1.71

Borrowed funds

     200,152        2,720        1.36     201,483        3,849        1.91     266,691        8,646        3.24
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     1,204,262        10,627        0.88     1,138,780        11,257        0.99     940,706        16,132        1.71

Non-interest bearing demand accounts

     64,253            56,467            37,064       

Noninterest-bearing liabilities

     16,097            19,277            14,618       
  

 

 

       

 

 

       

 

 

     

Total liabilities

     1,284,612            1,214,524            992,388       

Equity

     169,668            172,286            165,588       
  

 

 

       

 

 

       

 

 

     

Total liabilities and equity

   $ 1,454,280          $ 1,386,810          $ 1,157,976       
  

 

 

       

 

 

       

 

 

     

Net interest income

     $ 40,149          $ 39,845          $ 29,068     
    

 

 

       

 

 

       

 

 

   

Interest rate spread

         2.89         2.97         2.42

Net interest-earning assets

   $ 148,812          $ 153,682          $ 155,711       
  

 

 

       

 

 

       

 

 

     

Net interest margin(5)

         2.97         3.08         2.65

Average interest-earning assets to average interest-bearing liabilities

       112.36         113.50         116.55  

 

(1) Non-accruing loans are included in the outstanding loan balances.
(2) Interest income on loans includes net amortized revenues (costs) on loans totaling $10,000 in 2014, $43,000 in 2013, and $1,000 for 2012.
(3) Held to maturity securities are reported as amortized cost. Available for sale securities are reported at fair value.
(4) Yields on tax exempt securities have been calculated on a fully tax equivalent basis assuming a tax rate of 34%.
(5) Represents the difference between interest earned and interest paid, divided by average total interest earning assets.

 

44


Table of Contents

Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the years 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 net 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 proportionately based on the changes due to rate and the changes due to volume.

 

     For the
Years Ended September 30,
2014 vs. 2013
    For the
Years Ended September 30,
2013 vs. 2012
 
     Increase (Decrease)
Due to
          Increase (Decrease)
Due to
       
     Volume     Rate     Net     Volume     Rate     Net  
     (In thousands)  

Interest-earning assets:

            

Loans

     2,045        (3,407     (1,362   $ 7,733      $ (1,373   $ 6,360   

Investment securities

     84        257        341        656        (124     532   

Mortgage-backed securities

     322        42        364        262        (1,356     (1,094

Regulatory stock

     (23     349        326        —          115        115   

Other

     1        4        5        (16     5        (11
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     2,429        (2,755     (326     8,635        (2,733     5,902   

Interest-bearing liabilities:

            

NOW accounts

     39        (14     25        1        25        26   

Money market accounts

     30        (42     (12     65        (65     —     

Savings and club accounts

     11        —          11        54        (84     (30

Certificates of deposit

     309        166        475        2,579        (2,653     (74

Borrowed funds

     (25     (1,104     (1,129     (1,791     (3,006     (4,797
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     364        (994     (630     908        (5,783     (4,875
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net change in interest income

     2,065        (1,761     304      $ 7,727      $ 3,050      $ 10,777   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Management of Market Risk

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits and borrowings. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has approved guidelines for managing the interest rate risk inherent in our assets and liabilities, given our business strategy, operating environment, capital, liquidity and performance objectives. Senior management monitors the level of interest rate risk on a regular basis and the asset/liability committee meets quarterly to review our asset/liability policies and interest rate risk position. We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates.

Net interest income, which is the primary source of the Company’s earnings, is impacted by changes in interest rates and the relationship of different interest rates. To manage the impact of the rate changes, the balance sheet should be structured so that repricing opportunities exist for both assets and liabilities at approximately the same time intervals. The Company uses net interest simulation to assist in interest rate risk management. The process includes simulating various interest rate environments and their impact on net interest income. As of September 30, 2014, the level of net interest income at risk in a 200 basis points increase was within the Company’s policy limit of a decline less than 10% of net interest income. Due to the inability to reduce many deposit rates by the full 200 basis points, the Company’s net interest income at risk in a 100 basis point decline was within the Company’s policy limit of a decline of less than 10% of net interest income.

 

45


Table of Contents

The following table sets forth the results of the twelve month projected net interest income model as of September 30, 2014.

 

     Net Interest Income  

Change in Interest Rates in Basis Points (Rate Ramp)

   Amount
$
     Change
$
    Change
(%)
 
     (Dollars in thousands)  

-100

     41,472         (1,162     (2.7

Static

     42,634         —          —     

+100

     41,360         (1,274     (3.0

+200

     40,172         (2,462     (5.8

+300

     38,239         (4,395     (10.3

The above table indicates that as of September 30, 2014, in the event of a 300 basis point instantaneous increase in interest rates, the Company would experience a 10.3%, or $4.4 million, decrease in net interest income. In the event of a 100 basis point decrease in interest rates, the Company would experience a 2.7%, or $1.2, million decrease in net interest income.

Another measure of interest rate sensitivity is to model changes in the economic value of equity through the use of immediate and sustained interest rate shocks. The following table illustrates the economic value of equity model results as of September 30, 2014.

 

Change in Interest Rates in Basis Points

   Economic Value of Equity  
   Amount
$
     Change
$
    Change
(%)
 
     (Dollars in thousands)  

-100

     198,069         6,021        3.1   

Flat

     192,048         —          —     

+100

     176,343         (15,705     (8.2

+200

     158,738         (33,310     (17.3

+300

     139,815         (52,233     (27.2

The preceding table indicates that as of September 30, 2014, in the event of an immediate and sustained 300 basis point increase in interest rates, the Company would experience a 27.2%, or $52.2 million decrease in the present value of equity. If rates were to decrease 100 basis points, the Company would experience a 3.1%, or $6.0 million increase, in the present value of equity.

Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes in net interest income requires the making of certain assumptions regarding prepayment and deposit decay rates, which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. While management believes such assumptions are reasonable, there can be no assurance that assumed prepayment rates and decay rates will approximate actual future loan prepayment and deposit withdrawal activity. Moreover, the net interest income table presented assumes that the composition of interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the net interest income table provides an indication of the Company’s interest rate risk exposure at a particular point in time, such measurement is not intended to and does not provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results.

Liquidity and Capital Resources

We maintain liquid assets at levels we consider adequate to meet both our short-term and long-term liquidity needs. We adjust our liquidity levels to fund deposit outflows, repay our borrowings and to fund loan commitments. We also adjust liquidity as appropriate to meet asset and liability management objectives.

Our primary sources of liquidity are deposits, amortization and prepayment of loans and mortgage-backed securities, maturities of investment securities and other short-term investments, and earnings and funds provided from operations, as well as access to FHLB advances and other borrowings. While scheduled principal repayments on loans and mortgage-backed securities are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competition. We set the interest rates on our deposits to maintain a desired level of total deposits.

A portion of our liquidity consists of cash and cash equivalents and borrowings, which are a product of our operating, investing and financing activities. At September 30, 2014, $22.3 million of our assets were invested in cash and cash equivalents. Our primary sources of cash are principal repayments on loans, proceeds from the maturities of investment securities, principal repayments of mortgage-backed securities and increases in deposit accounts. Short-term investment securities (maturing in one year or less) totaled $2.5 million at September 30, 2014. As of September 30, 2014, we had $259.3 million in borrowings outstanding from the FHLB-Pittsburgh. We have access to FHLB advances of up to approximately $576.4 million.

 

46


Table of Contents

At September 30, 2014, we had $92.2 million in loan commitments outstanding, which included $2.2 million in undisbursed construction loans, $31.8 million in unused home equity lines of credit and $12.3 million in commercial lines of credit. Certificates of deposit due within one year of September 30, 2014 totaled $278.1 million, or 45.8%, of certificates of deposit. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before September 30, 2014. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

As reported in the Consolidated Statements of Cash Flows, our cash flows are classified for financial reporting purposes as operating, investing or financing cash flows. Net cash provided by operating activities was $14.5 million, $23.2 million, and $5.3 for the years ended September 30, 2014, 2013 and 2012, respectively. These amounts differ from our net income because of a variety of cash receipts and disbursements that did not affect net income for the respective periods. Net cash provided by/(used) in investing activities was $9.7 million, $34.2 million, and $75.4 million in fiscal years 2014, 2013 and 2012, respectively, principally reflecting our loan and investment security activities in the respective periods along with our acquisition of First Star Bank in 2012 and Franklin Security Bank in 2014. Investment security cash flows had the most significant effect, as net cash utilized in purchases amounted to $77.8 million, $131.3 million, and $92.0 million in the years ended September 30, 2014, 2013 and 2012, respectively. Cash proceeds from principal repayments, maturities and sales of investment securities amounted to $66.3 million, $135.1 million, and $117.5 million in the years ended September 30, 2014, 2013 and 2012, respectively. Deposit and borrowing cash flows have traditionally comprised most of our financing activities which resulted in net cash (used)/provided of $(9.1) million in fiscal year 2014, $(46.3) million in fiscal year 2013, and $(106.9) million in fiscal year 2012. In addition, during fiscal 2014 we used $4.2 million and in fiscal 2013 we used $14.5 million to repurchase our stock as part of previously disclosed stock repurchase plans.

The following table summarizes our significant fixed and determinable contractual principal obligations and other funding needs by payment date at September 30, 2014. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments.

 

     Payments Due by Period  

Contractual Obligations

   Less than
One Year
     One to Three
Years
     Three to Five
Years
     More than
Five Years
     Total  
     (In thousands)  

Long-term debt

     13,300         75,550         59,550         2,900         151,300   

Operating leases

     665         1,054         598         1,235         3,552   

Certificates of deposit

     278,101         170,432         138,298         20,182         607,013   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

     292,066         247,036         198,446         24,317         761,865   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Commitments to extend credit

     48,136         —           —           44,039         92,175   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

We also have obligations under our post retirement plan as described in Note 13 to the Consolidated Financial Statements. The post retirement benefit payments represent actuarially determined future payments to eligible plan participants. We expect to contribute $500,000 to our post retirement plan in 2015.

Off-Balance Sheet Arrangements. In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments and lines of credit. For information about our loan commitments, letters of credit and unused lines of credit, see Note 11 of the notes to the Consolidated Financial Statements.

For fiscal year 2014, we did not engage in any off-balance-sheet transactions other than loan origination commitments and standby letters of credit in the normal course of our lending activities.

Impact of Inflation and Changing Prices

The financial statements and related notes of ESSA Bancorp, Inc. have been prepared in accordance with United States generally accepted accounting principles (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

 

47


Table of Contents
Item 7A. Quantitative and Qualitative Disclosures About Market Risk

For information regarding market risk, see “Item 7. Management’s Discussion and Analysis of Financial Conditions and Results of Operation.”

 

Item 8. Financial Statements and Supplementary Data

The Financial Statements are included in Part III, Item 15 of this Form 10-K.

 

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

Not Applicable.

 

Item 9A. Controls and Procedures

 

  (a) Evaluation of disclosure controls and procedures.

Under the supervision and with the participation of our management, including our Principle Executive Officer and Principle Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the fiscal year (the “Evaluation Date”). Based upon that evaluation, the Principle Executive Officer and Principle Financial Officer concluded that, as of the Evaluation Date, our disclosure controls and procedures were effective.

 

  (b) Changes in internal controls.

There were no changes in our internal control over financial reporting that occurred during the fourth quarter of fiscal 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

  (c) Management report on internal control over financial reporting.

The management of ESSA Bancorp, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting. ESSA Bancorp’s internal control system is a process designed to provide reasonable assurance to the Company’s management and board of directors regarding the preparation and fair presentation of published financial statements.

Our internal control over financial reporting includes policies and procedures that pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; provide reasonable assurances that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in accordance with authorizations of management and the directors of ESSA Bancorp; and provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of ESSA Bancorp’s assets that could have a material effect on our financial statements.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

ESSA Bancorp, Inc.’s management assessed the effectiveness of the Company’s internal control over financial reporting as of September 30, 2014. In making this assessment, we used the criteria set forth in 1992, by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework. Based on our assessment we believe that, as of September 30, 2014, the Company’s internal control over financial reporting is effective based on those criteria.

ESSA Bancorp, Inc.’s independent registered public accounting firm that audited the consolidated financial statements has issued an audit report on the effectiveness of the Company’s internal control over financial reporting as of September 30, 2014. See the Consolidated Financial Statements of ESSA Bancorp, Inc. and related notes included elsewhere in this Annual Report.

The Sarbanes-Oxley Act Section 302 Certifications have been filed with the SEC as exhibit 31.1 and exhibit 31.2 to this Annual Report on Form 10-K.

 

Item 9B. Other Information

Not Applicable.

 

48


Table of Contents

PART III

 

Item 10. Directors, Executive Officers and Corporate Governance

Information regarding directors, executive officers and corporate governance of the Company is presented under the headings “Proposal 1 — Election of Directors-General,” “— Nominees for Directors,” “— Continuing Directors,” “— Board Meetings and Committees,” “— Executive Officers of the Bank Who Are Not Also Directors,” “Corporate Governance, Code of Ethics and Business conduct” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive Proxy Statement for the 2015 Annual Meeting of Stockholders to be held on March 5, 2015 (the “Proxy Statement”) and is incorporated herein by reference.

 

Item 11. Executive Compensation

Information regarding executive compensation is presented under the headings “Proposal I—Election of Directors-Director Compensation,” “— Benefit Plans and Arrangements,” and “— Summary Compensation Table” in the Proxy Statement and is incorporated herein by reference.

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Information regarding security ownership of certain beneficial owners and management is presented under the heading “Security Ownership of Certain Beneficial Owners and Management” in the Proxy Statement and is incorporated herein by reference.

Securities Authorized for Issuance Under Equity Compensation Plans

Set forth below is information, as of September 30, 2014 regarding equity compensation plans categorized by those plans that have been approved by stockholders and those plans that have not been approved by stockholders.

 

Plan

   Number of
Securities to be
Issued Upon
Exercise of
Outstanding
Options,
Warrants and
Rights
     Weighted Average
Exercise Price
of Outstanding
Options, Warrants
and Rights $
     Number of
Securities
Remaining
Available For
Future Issuance
Under Equity
Compensation
Plans
 

Equity compensation plans approved by stockholders

     1,443,379       $ 12.35         293,747   

Equity compensation plans not approved by stockholders

     —           —           —     
  

 

 

    

 

 

    

 

 

 

Total

     1,443,379       $ 12.35         293,747   
  

 

 

    

 

 

    

 

 

 

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

Information regarding certain relationships and related transactions, and director independence is presented under the heading “Transactions with Certain Related Persons” and “Proposal II—Election of Directors—Director Independence” in the Proxy Statement and is incorporated herein by reference.

 

Item 14. Principal Accounting Fees and Services

Information regarding principal accounting fees and services is presented under the heading “Proposal 2 — Ratification of Appointment of Independent Registered Public Accountants” in the Proxy Statement and is incorporated herein by reference.

 

49


Table of Contents

PART IV

 

Item 15. Exhibits, Financial Statement Schedules

 

  (a)(1) Financial Statements

The following documents are filed as part of this Form 10-K.

 

  (A) Report of Independent Registered Public Accounting Firm

 

  (B) Consolidated Balance Sheet - at September 30, 2014 and 2013

 

  (C) Consolidated Statement of Income - Years ended September 30, 2014, 2013 and 2012

 

  (D) Consolidated Statement of Changes in Stockholders’ Equity - Years ended September 30, 2014, 2013 and 2012

 

  (E) Consolidated Statement of Cash Flows - Years ended September 30, 2014, 2013 and 2012

 

  (F) Notes to Consolidated Financial Statements.

 

  (a)(2) Financial Statement Schedules

None.

 

  (a)(3) Exhibits

 

    2.1    Agreement and Plan of Merger by and among ESSA Bancorp, Inc., ESSA Acquisition Corp. and Franklin Security Bancorp, Inc. dated November 15, 2013(1)
    3.1    Articles of Incorporation of ESSA Bancorp, Inc.(2)
    3.2    Bylaws of ESSA Bancorp, Inc.(2)
    4    Form of Common Stock Certificate of ESSA Bancorp, Inc.(2)
  10.1    Amended and Restated Employment Agreement for Gary S. Olson(3)
  10.2    Amended and Restated Employment Agreement for Allan A. Muto(3)
  10.3    Amended and Restated Employment Agreement for Diane K. Reimer(3)
  10.4    Amended and Restated Employment Agreement for V. Gail Bryant (Warner)(3)
  10.5    Supplemental Executive Retirement Plan(4)
  10.6    Endorsement Split Dollar Life Insurance Agreement for Gary S. Olson(4)
  10.7    Endorsement Split Dollar Life Insurance Agreement for Allan A. Muto(4)
  10.8    Endorsement Split Dollar Life Insurance Agreement for Diane K. Reimer(4)
  10.9    Endorsement Split Dollar Life Insurance Agreement for V. Gail Warner (Bryant)(4)
  10.10    ESSA Bancorp, Inc. 2007 Equity Incentive Plan(5)
  21    Subsidiaries of Registrant
  23    Consent of S.R. Snodgrass, P.C.
  31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32    Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS    XBRL Instance Document
101.SCH    XBRL Taxonomy Extension Schema Document
101.CAL    XBRL Taxonomy Calculation Linkbase Document
101.DEF    XBRL Taxonomy Definition Linkbase Document
101.LAB    XBRL Taxonomy Label Linkbase Document
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document

 

1 Incorporated by reference to ESSA Bancorp, Inc.’s Current Report on Form 8-K filed with the Securities and Exchange Commission on November 19, 2013.
2 Incorporated by reference to the Registration Statement on Form S-1 of ESSA Bancorp, Inc. (file no. 333-139157), originally filed with the Securities and Exchange Commission on December 7, 2006.
3 Incorporated by reference to ESSA Bancorp, Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on May 1, 2013.
4 Incorporated by reference to ESSA Bancorp, Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on October 6, 2008.
5 Incorporated by reference to Appendix A to the Proxy Statement for the Annual Meeting of Stockholders of ESSA Bancorp, Inc. (file no. 001-33384), filed by ESSA Bancorp, Inc. under the Exchange Act on April 4, 2008.

 

50


Table of Contents

ESSA BANCORP, INC. AND SUBSIDIARY

AUDITED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2014

 

     Page
Number

Report on Management’s Assessment of Internal Control Over Financial Reporting

   F-1

Report of Independent Registered Public Accounting Firm on Internal Control Over Financial Reporting

   F-2 - F-3

Report of Independent Registered Public Accounting Firm on Financial Statements

   F-4

Financial Statements

  

Consolidated Balance Sheet

   F-5

Consolidated Statement of Income

   F-6

Consolidated Statement of Comprehensive Income

   F-7

Consolidated Statement of Changes in Stockholders’ Equity

   F-8

Consolidated Statement of Cash Flows

   F-9 - F-10

Notes to the Consolidated Financial Statements

   F-11 - F-65


Table of Contents

 

LOGO

REPORT ON MANAGEMENT’S ASSESSMENT OF

INTERNAL CONTROL OVER FINANCIAL REPORTING

ESSA Bancorp, lnc. (the “Company”) is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements and notes included in this annual report have been prepared in conformity with United States generally accepted accounting principles and necessarily include some amounts that are based on management’s best estimates and judgments.

We, as management of the Company, are responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with United States generally accepted accounting principles. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.

Management assessed the Company’s system of internal control over financial reporting as of September 30, 2014, in relation to criteria for effective internal control over financial reporting as described in “Internal Control — Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992. Based on this assessment, management concludes that, as of September 30, 2014, its system of internal control over financial reporting is effective and meets the criteria of the “Internal Control — lntegrated Framework”. S.R. Snodgrass P.C., independent registered public accounting firm, has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting.

 

/s/ Gary S. Olson
Gary S. Olson
President and Chief Executive Officer

 

/s/ Allan A. Muto
Allan A. Muto
Executive Vice President and Chief Financial Officer

December 15, 2014

 

F-1


Table of Contents

 

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

ESSA Bancorp, Inc.

We have audited ESSA Bancorp, Inc. and subsidiary’s internal control over financial reporting as of September 30, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992. ESSA Bancorp, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Report on Management’s Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on ESSA Bancorp, Inc.’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

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

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

In our opinion, ESSA Bancorp, Inc. maintained, in all material respects, effective internal control over financial reporting as of September 30, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992.

 

F-2


Table of Contents

LOGO

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of ESSA Bancorp, Inc. and subsidiary as of September 30, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2014, and our report dated December 15, 2014, expressed an unqualified opinion.

/s/ S. R. Snodgrass, P.C.

Wexford, Pennsylvania

December 15, 2014

 

F-3


Table of Contents

 

LOGO

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

ESSA Bancorp, Inc.

We have audited the accompanying consolidated balance sheets of ESSA Bancorp, Inc. and subsidiary as of September 30, 2014 and 2013, and the related consolidated statements of income, comprehensive income, changes in stockholders’ equity, and cash flows for each of the three years in the period ended September 30, 2014. These consolidated financial statements are the responsibility of the ESSA Bancorp, Inc.’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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes 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 ESSA Bancorp, Inc. and subsidiary as of September 30, 2014 and 2013, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2014, in conformity with U.S. generally accepted accounting principles.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), ESSA Bancorp, Inc. and subsidiary’s internal control over financial reporting as of September 30, 2014, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992, and our report dated December 15, 2014, expressed an unqualified opinion on the effectiveness of ESSA Bancorp, Inc.’s internal control over financial reporting.

/s/ S. R. Snodgrass, P.C.

Wexford, Pennsylvania

December 15, 2014

 

F-4


Table of Contents

ESSA BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEET

 

     September 30,  
     2014     2013  
     (dollars in thousands)  

ASSETS

    

Cash and due from banks

   $ 20,884      $ 22,393   

Interest-bearing deposits with other institutions

     1,417        4,255   
  

 

 

   

 

 

 

Total cash and cash equivalents

     22,301        26,648   

Certificates of deposit

     1,767        1,767   

Investment securities available for sale, at fair value

     383,078        315,622   

Loans receivable (net of allowance for loan losses of $8,634 and $8,064)

     1,058,267        928,230   

Regulatory stock, at cost

     14,284        9,415   

Premises and equipment, net

     16,957        15,747   

Bank-owned life insurance

     29,720        28,797   

Foreclosed real estate

     2,759        2,111   

Intangible assets, net

     2,396        2,466   

Goodwill

     10,259        8,817   

Deferred income taxes

     12,027        11,183   

Other assets

     21,000        21,512   
  

 

 

   

 

 

 

TOTAL ASSETS

   $ 1,574,815      $ 1,372,315   
  

 

 

   

 

 

 

LIABILITIES

    

Deposits

   $ 1,133,889      $ 1,041,059   

Short-term borrowings

     108,020        23,000   

Other borrowings

     151,300        129,260   

Advances by borrowers for taxes and insurance

     4,093        4,962   

Other liabilities

     10,204        7,588   
  

 

 

   

 

 

 

TOTAL LIABILITIES

     1,407,506        1,205,869   
  

 

 

   

 

 

 

STOCKHOLDERS’ EQUITY

    

Preferred stock ($.01 par value; 10,000,000 shares authorized, none issued)

     —          —     

Common stock ($.01 par value; 40,000,000 shares authorized, 18,133,095 issued; 11,590,378 and 11,945,564 outstanding at September 30, 2014 and 2013, respectively)

     181        181   

Additional paid-in capital

     182,486        182,440   

Unallocated common stock held by the Employee Stock Ownership Plan (“ESOP”)

     (10,079     (10,532

Retained earnings

     77,413        71,709   

Treasury stock, at cost; 6,542,717 and 6,187,531 shares at September 30, 2014 and 2013, respectively

     (80,113     (76,117

Accumulated other comprehensive loss

     (2,579     (1,235
  

 

 

   

 

 

 

TOTAL STOCKHOLDERS’ EQUITY

     167,309        166,446   
  

 

 

   

 

 

 

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY

   $ 1,574,815      $ 1,372,315   
  

 

 

   

 

 

 

See accompanying notes to the consolidated financial statements.

 

F-5


Table of Contents

ESSA BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF INCOME

 

     Years Ended September 30,  
     2014     2013     2012  
     (dollars in thousands)  

INTEREST INCOME

      

Loans receivable, including fees

   $ 43,382      $ 44,744      $ 38,384   

Investment securities:

      

Taxable

     6,385        5,958        6,583   

Exempt from federal income tax

     550        272        209   

Other investment income

     459        128        24   
  

 

 

   

 

 

   

 

 

 

Total interest income

     50,776        51,102        45,200   
  

 

 

   

 

 

   

 

 

 

INTEREST EXPENSE

      

Deposits

     7,907        7,408        7,486   

Short-term borrowings

     180        129        32   

Other borrowings

     2,540        3,720        8,614   
  

 

 

   

 

 

   

 

 

 

Total interest expense

     10,627        11,257        16,132   
  

 

 

   

 

 

   

 

 

 

NET INTEREST INCOME

     40,149        39,845        29,068   

Provision for loan losses

     2,350        3,750        2,550   
  

 

 

   

 

 

   

 

 

 

NET INTEREST INCOME AFTER PROVISION

      

FOR LOAN LOSSES

     37,799        36,095        26,518   
  

 

 

   

 

 

   

 

 

 

NONINTEREST INCOME

      

Service fees on deposit accounts

     3,185        3,133        2,871   

Services charges and fees on loans

     865        1,027        747   

Trust and investment fees

     906        853        905   

Gain on sale of investments, net

     333        749        343   

Gain on sale of loans, net

     —          426        282   

Earnings on bank-owned life insurance

     923        949        806   

Insurance commissions

     841        838        748   

Gain on acquisition

     241        —          —     

Other

     113        49        33   
  

 

 

   

 

 

   

 

 

 

Total noninterest income

     7,407        8,024        6,735   
  

 

 

   

 

 

   

 

 

 

NONINTEREST EXPENSE

      

Compensation and employee benefits

     18,920        19,002        16,284   

Occupancy and equipment

     4,050        3,895        3,178   

Professional fees

     1,883        1,868        1,368   

Data processing

     3,270        2,907        2,058   

Advertising

     633        574        415   

Federal Deposit Insurance Corporation (“FDIC”) premiums

     1,002        947        783   

(Gain) loss on foreclosed real estate

     (466     (468     112   

Merger-related costs

     522        —          1,379   

Prepayment penalties on borrowings

     —          —          4,644   

Amortization of intangible assets

     959        991        436   

Other

     3,038        2,746        2,348   
  

 

 

   

 

 

   

 

 

 

Total noninterest expense

     33,811        32,462        33,005   
  

 

 

   

 

 

   

 

 

 

Income before income taxes

     11,395        11,657        248   

Income taxes

     2,891        2,834        33   
  

 

 

   

 

 

   

 

 

 

NET INCOME

   $ 8,504      $ 8,823      $ 215   
  

 

 

   

 

 

   

 

 

 

Earnings per share:

      

Basic

   $ 0.79      $ 0.76      $ 0.02   

Diluted

   $ 0.79      $ 0.76      $ 0.02   

Dividends per share

   $ 0.26      $ 0.20      $ 0.20   

See accompanying notes to the consolidated financial statements.

 

F-6


Table of Contents

ESSA BANCORP, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME