10-K 1 t1402436-10k.htm FORM 10-K t1402436-10k - none - 13.5233522s
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
Annual report pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the fiscal year ended: September 30, 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 Number: 000-54835
MALVERN BANCORP, INC.
(Exact name of Registrant as specified in its charter)
Pennsylvania
45-5307782
(State or Other Jurisdiction of
Incorporation or Organization)
(I.R.S. Employer
Identification Number)
42 E. Lancaster Avenue, Paoli, Pennsylvania
19301
(Address of Principal Executive Offices)
(Zip Code)
Registrant’s telephone number, including area code: (610) 644-9400
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, $.01 par value per share
The NASDAQ Stock Market, LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒ No 
Indicate by check mark whether the registrant has submitted electronically 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 ☒ No 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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. (Check one):
Large accelerated filer Accelerated filer 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 Act).  Yes  No ☒
The aggregate market value of the voting and non-voting common equity held by non-affiliates was approximately $61.9 million, based on the last sale price on NASDAQ Stock Market for the last business day of the Registrant’s most recently completed second fiscal quarter.
The number of shares of the Issuer’s common stock, par value $0.01 per share, outstanding as of December 17, 2014 was 6,558,473.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the definitive Proxy Statement for the 2015 Annual Meeting of Shareholders are incorporated by reference into Part III, Items 10-14 of this Form 10-K.

MALVERN BANCORP, INC.
2014 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Page
PART I
1
15
19
19
19
19
PART II
20
21
23
54
F-1
55
55
55
PART III
56
56
56
56
56
PART IV
57
59
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PART I
Forward-Looking Statements
This Annual Report contains certain “forward-looking statements” that 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 that 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 or regulatory policies and procedures, and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services. Because of this and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.
Item 1. Business
General
Malvern Bancorp, Inc., a Pennsylvania company (the “Company” or “Malvern Bancorp”), is the holding company for Malvern Federal Savings Bank (“Malvern Federal Savings” or the “Bank”) and owns all of the issued and outstanding shares of the common stock of the Bank. In connection with the “second-step” conversion and reorganization which we completed in October 2012, 3,636,875 shares of common stock, par value $0.01 per share, of Malvern Bancorp were sold in a subscription offering to certain depositors of the Bank and other investors for $10 per share, or $36.4 million in the aggregate, and 2,921,598 shares of common stock were issued in exchange for the outstanding shares of common stock of the former federally chartered mid-tier holding company, Malvern Federal Bancorp, Inc. (the “Mid-Tier Holding Company”), held by the “public” shareholders of the Mid-Tier Holding Company (all shareholders except Malvern Federal Mutual Holding Company). Each share of common stock of the Mid-Tier Holding Company was converted into the right to receive 1.0748 shares of common stock of the new Malvern Bancorp, Inc. in the conversion and reorganization.
The Bank has one subsidiary, Strategic Asset Management Group, Inc. (“SAMG”), a Pennsylvania corporation and insurance brokerage engaged in sales of property and casualty insurance, commercial insurance and life and health insurance. During September 2014, the Bank and Malvern Bancorp dissolved two former investment subsidiaries, Malvern Federal Holdings, Inc. and Malvern Federal Investments, Inc., which were Delaware corporations which previously held and managed certain investment securities.
Malvern Federal Savings Bank is a federally chartered savings bank which was originally organized in 1887. The Bank conducts business from its main office located in Paoli, Pennsylvania and its seven full service financial center offices located in Chester and Delaware Counties, Pennsylvania. The Bank’s principal business consists of attracting deposits from businesses and the general public primarily in Chester County, Pennsylvania and investing those deposits, together with borrowings and funds generated from operations, in one- to four-family residential real estate loans, construction and development loans, commercial and multi-family real estate loans, commercial business loans, home equity loans and lines of credit and other consumer loans, as well as investing in investment securities. In addition to Chester County, our lending efforts are focused in neighboring Montgomery County and Delaware County, both of which are also in southeastern Pennsylvania. To a lesser extent, we provide services to other areas in the greater Philadelphia market area. The Bank’s revenues are derived principally from interest on loans and investment securities, loan commitment and customer service fees and our mortgage banking operation. Our primary sources of funds are deposits, borrowings and principal and interest payments on loans and securities, as well as the sale of residential loans in the secondary market. The Bank’s primary expenses are interest expense on deposits and borrowings, provisions for loan losses and general operating expenses.
In October 2010, the Bank, the Mid-Tier Holding Company and the Mutual Holding Company entered into Supervisory Agreements (the “Supervisory Agreement(s)”) with the Office of Thrift Supervision (the “OTS”). As a result of the Dodd-Frank Wall Street Reform and Consumer Protection Act
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(the “Dodd-Frank Act”), effective as of July 21, 2011, the OTS was abolished, the regulatory oversight functions and authority of the OTS related to the Bank were transferred to the Office of the Comptroller of the Currency (the “OCC”) and the regulatory oversight functions and authority of the OTS related to the Company and previously, the Mid-Tier Holding Company were transferred to the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “FRB”).
In October 2013, we completed the sale of a substantial portion of our problem loans in a bulk transaction to a single investor. The loans had an aggregate book balance of  $20.4 million and were sold at a loss of approximately $10.1 million. This transaction dramatically reduced our non-performing asset balances and significantly improved our credit quality metrics. As a result of the sale, the Company significantly reduced its exposure to sectors that experienced economic weakness and significant declines in collateral valuations and has substantially reduced the amount of non-accruing loans completing the transformation of the Bank.
Our headquarters is located at 42 East Lancaster Avenue, Paoli, Pennsylvania, and our telephone number is (610) 644-9400. We maintain a website at www.malvernfederal.com and we provide our customers with on-line banking and telephone banking services. The Company files annual, quarterly, and current reports, proxy statements, and other information with the Securities and Exchange Commission (the “SEC”). These filings are available free of charge on the Company’s website under the tab “Investor Relations”. Such documents are available as soon as reasonably practicable after filing or furnishing them to the SEC. Also available on the website are the Company’s corporate code of ethics that applies to all of the Company’s employees, including principal officers and directors, and charters for the Audit Committee, Compensation Committee and Nominating Committee.
Market Area and Competition
We face significant competition from other financial institutions. There are several larger commercial banks which have a significant presence in our market area including Wells Fargo Bank, PNC Financial and TD Bank. In addition, we compete directly with savings banks, savings and loan associations, finance companies, credit unions, mortgage brokers, insurance companies, securities brokerage firms, mutual funds, money market funds, private lenders and other institutions for deposits, commercial loans, mortgages and consumer loans, as well as other services. Competition among financial institutions is based upon a number of factors, including the quality of services rendered, interest rates offered on deposit accounts, interest rates charged on loans and other credit services, service charges, the convenience of banking facilities, locations and hours of operation and, in the case of loans to larger commercial borrowers, applicable lending limits. Many of the financial institutions with which we compete have greater financial resources than we do, and offer a wider range of deposit and lending products.
Product and Services
The Bank offers a range of competitively priced banking products and services, including consumer and commercial deposit accounts, checking accounts, interest-bearing demand accounts, money market accounts, certificates of deposit, savings accounts, individual retirement accounts, safety deposit boxes, Automated Teller Machine (ATM), ATM and Visa debit cards, online banking, business banking, secured and unsecured commercial loans, real estate loans, construction and land development loans, automobile loans, home improvement loans, mortgages, home equity and overdraft lines of credit, and other products. We attempt to offer a high level of personalized service to both our retail and commercial customers.
Our lending activities generally are focused on small and medium sized businesses within the communities that we serve. One- to four-family residential real estate loans represent the largest category within our loan portfolio, amounting to approximately 60% of total loans outstanding at September 30, 2014. Repayment of these loans is, in part, dependent on general economic conditions affecting our customers. As a lender, we are subject to credit risk. Economic and financial conditions in recent years have adversely affected many of our borrowers. To manage the challenges of this economic environment we have adopted a more conservative loan classification system, enhanced our allowance for loan loss methodology, and undertaken a comprehensive review of our loan portfolio.
The types of loans that we originate are subject to federal and state law and regulations. Interest rates charged by us on loans are affected principally by the demand for such loans and the supply of money
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available for lending purposes and the rates offered by our competitors. These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters.
Supervision and Regulation
The banking industry is highly regulated. Earnings of the Company are affected by state and federal laws and regulations and by policies of various regulatory authorities. Changes in applicable law or in the policies of various regulatory authorities could affect materially the business and prospects of the Company and the Bank. The following discussion of supervision and regulation is qualified in its entirety by reference to the statutory and regulatory provisions discussed.
On October 7, 2014, the Bank entered into a formal written agreement (the “Formal Agreement”) with the OCC. Management is committed to addressing and resolving the issues raised by the OCC and has substantially completed corrective actions to comply with the agreement. The Formal Agreement provides, among other things, that within specified time frames, the Bank will:

establish a Compliance Committee of its Board of directors to monitor and coordinate the Bank’s adherence to the Formal Agreement and to prepare periodic reports describing the Bank’s progress in complying with the Formal Agreement;

ensure that it has competent management in place, undertake periodic reviews of the Bank’s management, implement a program to enhance and improve the skills the Bank’s management team, where necessary, act to fill any vacancies among the Bank’s senior executive officers within prescribed timeframes and in accordance with regulations of the OCC;

revise its written strategic plan and submit such revised plan to the OCC for review, with such strategic plan establishing objectives for the Bank’s overall risk profile, earnings performance, growth, balance sheet mix, off-balance sheet activities, liability structure, capital and liquidity adequacy, and tolerance for interest rate risk, together with strategies to achieve the Bank’s objectives;

revise its capital plan consistent with its revised strategic plan, and submit such revised capital plan to the OCC, with such revised capital plan providing specific plans for the Bank’s maintenance of adequate capital, determining the Bank’s capital needs in relation to material risks and the Bank’s strategic direction, identifying and establishing a strategy to maintain capital adequacy and strengthen capital if necessary, and providing for specific plans detailing how the Bank will comply with the restrictions and requirements included in the Formal Agreement which impact the Bank’s capital;

declare or pay a dividend or make a capital distribution only if the Bank is, and will continue to be in compliance with its capital plan and its minimum capital ratios, and only after receipt of written non-objection by the OCC; and

take all necessary steps to correct each violation of law, rule or regulation cited in the most recent report of examination by the OCC.
The Formal Agreement supersedes and replaces the Supervisory Agreement (the “Supervisory Agreement”) that the Bank previously entered into with the Office of Thrift Supervision (the “OTS”) in October 2010. The Supervisory Agreement required the Bank to revise and/or implement and monitor various identified policies and procedures, and placed numerous operating restrictions and reporting requirements on the Bank. Among other things, the Supervisory Agreement prohibited us from making any new commercial real estate loans and/or commercial and industrial loans and limited our growth in any quarter to the amount of net interest credited on our deposits, in each case without the prior written non-objection of the OCC. In April 2013, we were advised that we were no longer subject to such restrictions on commercial real estate lending, commercial and industrial lending and asset growth, provided that the level of loan growth remains consistent with our business plan filed with the OCC and meets the requirements of the Supervisory Agreement.
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As a result of the Formal Agreement with Malvern Federal Savings Bank, which continues to be in force and effect, it is subject to certain additional restrictions pursuant to Federal banking regulations, including the following:

Malvern Federal Savings Bank is required to provide the OCC with prior notice of any new director or senior executive officer;

Malvern Federal Savings Bank is restricted from making any “golden parachute payments,” as defined;

Malvern Federal Savings Bank may not enter into, renew, extend or revise any contractual arrangements related to compensation or benefits with any director or officer without receiving prior written non-objection from the OCC;

Malvern Federal Savings Bank may not declare or pay any dividends or make other capital distributions, such as repurchases of common stock, without the prior written approval of the OCC;

Malvern Federal Savings Bank’s ability to engage in transactions with affiliates, as defined, is restricted; and

Malvern Federal Savings Bank may not engage in the use of brokered deposits without the prior written non-objection of the OCC.
In December 2013, the Company’s board of directors adopted a resolution (the “Supervisory Resolution”), as recommended by the Federal Reserve Bank of Philadelphia (the “Reserve Bank”) which, among other things, requires the Company to serve as a source of strength to the Bank, prohibits the Company from declaring or paying dividends unless it receives the prior written approval of the Reserve Bank, prohibits the Company from receiving any dividends from the Bank without the prior written approval of the Reserve Bank, and requires the Company to provide various reports and a plan to strengthen oversight.
Dodd-Frank Act
On July 21, 2010, Congress enacted the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act has significantly changed the bank regulatory structure and significantly impacted the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies have been given significant discretion in drafting the implementing rules and regulations, and consequently, many of the details and future impact of the Dodd-Frank Act may not be known for many months or years. The discussion below generally discusses the material provisions of the Dodd-Frank Act applicable to the Company and the Bank and is not complete or meant to be an exhaustive discussion.
The following aspects of the financial reform and consumer protection act are related to the operations of the Bank:

The Office of Thrift Supervision has been merged into the OCC and the authority of the other remaining bank regulatory agencies restructured. The federal thrift charter has been preserved under the jurisdiction of the OCC.

A new independent consumer financial protection bureau was established within the Federal Reserve Board, empowered to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. Smaller financial institutions, like the Bank, are subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws.

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

The prohibition on payment of interest on demand deposits was repealed.
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State consumer financial law is preempted only if it would have a discriminatory effect on a federal savings association, prevents or significantly interferes with the exercise by a federal savings association of its powers or is preempted by any other federal law. The OCC must make a preemption determination on a case-by-case basis with respect to a particular state law or other state law with substantively equivalent terms.

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

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

The minimum reserve ratio of the Deposit Insurance Fund increased to 1.35 percent of estimated annual insured deposits or assessment base; however, the FDIC was directed to “offset the effect” of the increased reserve ratio for insured depository institutions with total consolidated assets of less than $10 billion.
The following aspects of the financial reform and consumer protection act are related to the operations of the Company:

Authority over savings and loan holding companies transferred to the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or the “FRB”).

The Home Owners’ Loan Act was amended to provide that leverage capital requirements and risk based capital requirements applicable to depository institutions and bank holding companies was extended to thrift holding companies.

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

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

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

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

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

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

Item 402 of Regulation S-K will be amended to require companies to disclose the ratio of the Chief Executive Officer’s annual total compensation to the median annual total compensation of all other employees.

Smaller reporting companies are exempt from complying with the internal control auditor attestation requirements of Section 404(b) of the Sarbanes-Oxley Act.
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Regulation of Malvern Bancorp, Inc.
Holding Company Acquisitions. Malvern Bancorp is a savings and loan holding company under the Home Owners’ Loan Act, as amended, and is subject to examination and supervision by the Federal Reserve Board. Federal law generally prohibits a savings and loan holding company, without prior FRB approval, from acquiring the ownership or control of any other savings institution or savings and loan holding company, or all, or substantially all, of the assets or more than 5% of the voting shares of the savings institution or savings and loan holding company. These provisions also prohibit, among other things, any director or officer of a savings and loan holding company, or any individual who owns or controls more than 25% of the voting shares of such holding company, from acquiring control of any savings institution not a subsidiary of such savings and loan holding company, unless the acquisition is approved by the FRB.
The FRB may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions: (1) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (2) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Holding Company Activities. Malvern Bancorp operates as a unitary savings and loan holding company and is permitted to engage only in the activities permitted for financial institution holding companies or for multiple savings and loan holding companies. Multiple savings and loan holding companies are permitted to engage in the following activities: (i) activities permitted for a bank holding company under section 4(c) of the Bank Holding Company Act (unless the Federal Reserve Board prohibits or limits such 4(c) activities); (ii) furnishing or performing management services for a subsidiary savings association; (iii) conducting any insurance agency or escrow business; (iv) holding, managing, or liquidating assets owned by or acquired from a subsidiary savings association; (v) holding or managing properties used or occupied by a subsidiary savings association; (vi) acting as trustee under deeds of trust; or (vii) activities authorized by regulation as of March 5, 1987, to be engaged in by multiple savings and loan holding companies. Under the recently enacted legislation, savings and loan holding companies became subject to statutory capital requirements. While there are no specific restrictions on the payment of dividends or other capital distributions for savings and loan holding companies, federal regulations do prescribe such restrictions on subsidiary savings institutions, as described below. Malvern Federal Savings Bank is required to notify the Federal Reserve Board 30 days before declaring any dividend. In addition, the financial impact of a holding company on its subsidiary institution is a matter that is evaluated by the Federal Reserve Board and the agency has authority to order cessation of activities or divestiture of subsidiaries deemed to pose a threat to the safety and soundness of the institution.
All savings associations subsidiaries of savings and loan holding companies are required to meet a qualified thrift lender, or QTL, test to avoid certain restrictions on their operations. If the subsidiary savings institution fails to meet the QTL, as discussed below, then the savings and loan holding company must register with the Federal Reserve Board as a bank holding company, unless the savings institution requalifies as a QTL within one year thereafter.
Certain of the savings and loan holding company capital requirements promulgated by the FRB in 2013 will become effective as of January 1, 2015. Those requirements establish the following four minimum capital ratios that the Company must comply with as of that date:
Capital Ratio
Regulatory Minimum
Common Equity Tier 1 Capital
4.5%
Tier 1 Leverage Capital
4.0%
Tier 1 Risk-Based Capital
6.0%
Total Risk-Based Capital
8.0%
The leverage capital requirement is calculated as a percentage of total assets and the other three capital requirements are calculated as a percentage of risk-weighted assets. For a more detailed discussion of the 2013 capital rules, see “Recent Regulatory Capital Rules” under “Regulations of Malvern Federal Savings Bank” below.
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Federal Securities Laws. As the successor to Malvern Federal Bancorp, Inc., Malvern Bancorp has registered its common stock with the Securities and Exchange Commission under Section 12(b) of the Securities Exchange Act of 1934. Malvern Bancorp is subject to the proxy and tender offer rules, insider trading reporting requirements and restrictions, and certain other requirements under the Securities Exchange Act of 1934. Pursuant to the FRB regulations and our Plan of Conversion and Reorganization, we have agreed to maintain such registration for a minimum of three years following completion of the second-step conversion.
The Sarbanes-Oxley Act. As a public company, Malvern Bancorp is subject to the Sarbanes-Oxley Act of 2002 which addresses, among other issues, corporate governance, auditing and accounting, executive compensation, and enhanced and timely disclosure of corporate information. As directed by the Sarbanes-Oxley Act, our principal executive officer and principal financial officer are required to certify that our quarterly and annual reports do not contain any untrue statement of a material fact. The rules adopted by the Securities and Exchange Commission under the Sarbanes-Oxley Act have several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of our internal control over financial reporting; they have made certain disclosures to our auditors and the audit committee of the Board of Directors about our internal control over financial reporting; and they have included information in our quarterly and annual reports about their evaluation and whether there have been changes in our internal control over financial reporting or in other factors that could materially affect internal control over financial reporting.
Volcker Rule Regulations
Regulations were recently adopted by the federal banking agencies to implement the provisions of the Dodd Frank Act commonly referred to as the Volcker Rule. The regulations contain prohibitions and restrictions on the ability of financial institutions holding companies and their affiliates to engage in proprietary trading and to hold certain interests in, or to have certain relationships with, various types of investment funds, including hedge funds and private equity funds. The regulations became effective on April 1, 2014 with full compliance being phased in over a period ending on July 21, 2015. The Company is continuously reviewing its investment portfolio to ensure compliance as the various provisions of the Volcker Rule regulations become effective.
Regulation of Malvern Federal Savings Bank
General. Malvern Federal Savings Bank is subject to the regulation of the OCC, as its primary federal regulator and the FDIC, as the insurer of its deposit accounts, and, to a limited extent, the Federal Reserve Board. As the primary federal regulator of Malvern Federal Savings Bank, the OCC has extensive authority over the operations of federally chartered savings institutions. As part of this authority, Malvern Federal Savings Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC and the FDIC. The investment and lending authorities of savings institutions are prescribed by federal laws and regulations, and such institutions are prohibited from engaging in any activities not permitted by such laws and regulations. Such regulation and supervision is primarily intended for the protection of depositors and the Deposit Insurance Fund, administered by the FDIC.
The OCC’s enforcement authority over all savings institutions includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders and to initiate injunctive actions. 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 the OCC.
Insurance of Accounts.  The deposits of Malvern Federal Savings Bank are insured to the maximum extent permitted by the Deposit Insurance Fund and are backed by the full faith and credit of the U.S. Government. As insurer, the FDIC is authorized to conduct examinations of, and to require reporting by, insured institutions. It also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious threat to the FDIC. The FDIC also has the authority to initiate enforcement actions against savings institutions, after giving the OCC an opportunity to take such action.
The Federal Deposit Insurance Corporation’s risk-based premium system provides for quarterly assessments. Each insured institution is placed in one of four risk categories depending on supervisory and
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capital considerations. Within its risk category, an institution is assigned to an initial base assessment rate which is then adjusted to determine its final assessment rate based on its brokered deposits, secured liabilities and unsecured debt. To implement the Dodd Frank Act, the Federal Deposit Insurance Corporation amended its deposit insurance regulations (1) to change the assessment base for insurance from domestic deposits to average assets minus average tangible equity and (2) to lower overall assessment rates. The revised assessments rates are between 2.5 to 9 basis points for banks in the lowest risk category and between 30 to 45 basis points for banks in the highest risk category.
In addition, all institutions with deposits insured by the Federal Deposit Insurance Corporation are required to pay assessments to fund interest payments on bonds issued by the Financing Corporation, a mixed-ownership government corporation established to recapitalize the predecessor to the Deposit Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2019.
The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances which could result in termination of the Bank’s deposit insurance.
Regulatory Capital Requirements. Federally insured savings institutions are required to maintain minimum levels of regulatory capital. The OCC has established capital standards consisting of a “tangible capital requirement,” a “leverage capital requirement” and “a risk-based capital requirement.” The OCC also is authorized to impose capital requirements in excess of these standards on individual institutions on a case-by-case basis. As described below, the OCC has imposed such individual minimum capital ratios (“IMCR”) on the Bank.
Current OCC capital standards require savings institutions to satisfy the following capital requirements:

tangible capital requirement — “tangible” capital equal to at least 1.5% of adjusted total assets;

leverage capital requirement — “core” capital equal to at least 3.0% of adjusted total assets for the most highly rated institutions;

an additional “cushion” of at least 100 basis points of core capital for all but the most highly rated savings associations effectively increasing their minimum Tier 1 leverage ratio to 4.0% or more; and

risk-based capital requirement — “total” capital (a combination of core and “supplementary” capital) equal to at least 8.0% of  “risk-weighted” assets.
Core capital generally consists of common stockholders’ equity (including retained earnings). Tangible capital generally equals core capital minus intangible assets, with only a limited exception for purchased mortgage servicing rights. Malvern Federal Savings Bank had no intangible assets at September 30, 2014. Both core and tangible capital are further reduced by an amount equal to a savings institution’s debt and equity investments in subsidiaries engaged in activities not permissible to national banks (other than subsidiaries engaged in activities undertaken as agent for customers or in mortgage banking activities and subsidiary depository institutions or their holding companies). These adjustments do not affect Malvern Federal Savings Bank’s regulatory capital.
In determining compliance with the risk-based capital requirement, a savings institution is allowed to include both core capital and supplementary capital in its total capital, provided that the amount of supplementary capital included does not exceed the savings institution’s core capital. Supplementary capital generally consists of general allowances for loan losses up to a maximum of 1.25% of risk-weighted assets, together with certain other items. In determining the required amount of risk-based capital, total assets, including certain off-balance sheet items, are multiplied by a risk weight based on the risks inherent in the
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type of assets. The risk weights range from 0% for cash and securities issued by the U.S. Government or unconditionally backed by the full faith and credit of the U.S. Government to 100% for loans (other than qualifying residential loans weighted at 80%) and repossessed assets.
Savings institutions must value securities available for sale at amortized cost for regulatory capital purposes. This means that in computing regulatory capital, savings institutions should add back any unrealized losses and deduct any unrealized gains, net of income taxes, on debt securities reported as a separate component of GAAP capital.
The OCC has imposed IMCRs on the Bank which require it to maintain regulatory capital of not less than the following:

tier 1 capital of 8.5% or adjusted total assets;

tier 1 risk-based capital to risk-weighted assets of 10.5%; and

total risk-based capital to risk-weighted assets of 12.5%.
At September 30, 2014, Malvern Federal Savings Bank exceeded all of its regulatory capital requirements. At such date, the Bank’s tier 1 capital, tier 1 risked-based capital and total risk-based capital ratios were 12.09%, 19.50% and 20.75%, respectively.
Any savings institution that fails any of the capital requirements is subject to possible enforcement actions by the OCC or the FDIC. Such actions could include a capital directive, a cease and desist order, civil money penalties, the establishment of restrictions on the institution’s operations, termination of federal deposit insurance and the appointment of a conservator or receiver. The OCC’s capital regulation provides that such actions, through enforcement proceedings or otherwise, could require one or more of a variety of corrective actions.
Recent Regulatory Capital Rules.  In July of 2013 the respective U.S. federal banking agencies issued final rules implementing Basel III and the Dodd-Frank Act capital requirements to be fully phased in on a global basis on January 1, 2019. The new regulations establish a new tangible common equity capital requirement, increase the minimum requirement for the current Tier 1 risk-weighted asset (“RWA”) ratio, phase out certain kinds of intangibles treated as capital and certain types of instruments and change the risk weightings of certain assets used to determine required capital ratios. The new common equity Tier 1 capital component requires capital of the highest quality — predominantly composed of retained earnings and common stock instruments. For community banks such as Malvern Federal Savings Bank, a common equity Tier 1 capital ratio 4.5% will become effective on January 1, 2015. The new capital rules will also increase the current minimum Tier 1 capital ratio from 4.0% to 6.0% beginning on January 1, 2015. In addition, institutions that seek the freedom to make capital distributions and pay discretionary bonuses to executive officers without restriction must also maintain greater than 2.5% in common equity attributable to a capital conservation buffer to be phased in from January 1, 2016 until January 1, 2019. The new rules also increase the risk weights for several categories of assets, including an increase from 100% to 150% for certain acquisition, development and construction loans and more than 90-day past due exposures. The new capital rules maintain the general structure of the prompt corrective action rules, but incorporate the new common equity Tier 1 capital requirement and the increased Tier 1 RWA requirement into the prompt corrective action framework.
Prompt Corrective Action. The following table shows the amount of capital associated with the different capital categories set forth in the prompt corrective action regulations.
Capital Category
Total
Risk-Based Capital
Tier 1
Risk-Based Capital
Tier 1
Leverage Capital
Well capitalized
10% or more
6% or more
5% or more
Adequately capitalized
8% or more
4% or more
4% or more
Undercapitalized
Less than 8%
Less than 4%
Less than 4%
Significantly undercapitalized
Less than 6%
Less than 3%
Less than 3%
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In addition, an institution is “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Under specified circumstances, a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized).
An institution generally must file a written capital restoration plan which meets specified requirements within 45 days of the date that the institution receives notice or is deemed to have notice that it is undercapitalized, significantly undercapitalized or critically undercapitalized. A federal banking agency must provide the institution with written notice of approval or disapproval within 60 days after receiving a capital restoration plan, subject to extensions by the agency. An institution which is required to submit a capital restoration plan must concurrently submit a performance guaranty by each company that controls the institution. In addition, undercapitalized institutions are subject to various regulatory restrictions, and the appropriate federal banking agency also may take any number of discretionary supervisory actions.
At September 30, 2014, Malvern Federal Savings Bank was not subject to the above mentioned restrictions.
The table below sets forth Malvern Federal Savings Bank’s capital position relative to the OCC’s regulatory capital requirements at September 30, 2014.
Actual
Required for
Capital
Adequacy
Purposes
To Be Well
Capitalized
Under Prompt
Corrective Action
Provisions
Excess Over
Well-Capitalized
Provision
Amount
Ratio
Amount
Ratio
Amount
Ratio
Amount
Ratio
(Dollars in thousands)
Tier 1 leverage capital (to adjusted tangible assets)
$ 64,414 12.09% $ 21,305 4.00% $ 26,632 5.00% $ 37,782 7.09%
Tier 1 risk-based capital (to risk-weighted assets)
$ 64,414 19.50 $ 13,212 4.00 $ 19,818 6.00 $ 44,596 13.50
Total risk-based capital (to risk-weighted assets)
$ 68,549 20.75 $ 26,424 8.00 $ 33,030 10.00 $ 35,519 10.75
Capital Distributions. OCC regulations govern capital distributions by savings institutions, which include cash dividends, stock repurchases and other transactions charged to the capital account of a savings institution to make capital distributions. A savings institution must file an application for OCC approval of the capital distribution if either (1) the total capital distributions for the applicable calendar year exceed the sum of the institution’s net income for that year to date plus the institution’s retained net income for the preceding two years, (2) the institution would not be at least adequately capitalized following the distribution, (3) the distribution would violate any applicable statute, regulation, agreement or OCC-imposed condition, or (4) the institution is not eligible for expedited treatment of its filings. If an application is not required to be filed, savings institutions which are a subsidiary of a savings and loan holding company (as well as certain other institutions) must still file a notice with the OCC at least 30 days before the board of directors declares a dividend or approves a capital distribution if either (1) the institution would not be well capitalized following the distribution; (2) the proposed distribution would reduce the amount or retire any part of our common or preferred stock or (3) the savings institution is a subsidiary of a savings and loan holding company and the proposed dividend is not a cash dividend. If a savings institution, such as Malvern Federal Savings Bank, that is the subsidiary of a savings and loan holding company, has filed a notice with the Federal Reserve Board for a cash dividend and is not required to file an application or notice with the OCC for any of the reasons described above, then the savings institution is only required to provide an informational copy to the OCC of the notice filed with the Federal Reserve Board.
The Company adopted a resolution in December 2013 that provides, among other things, that the Company will not declare or pay any dividends to shareholders and that it will not receive any dividends from the Bank without the prior written approval of the Federal Reserve Bank of Philadelphia.
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An institution that either before or after a proposed capital distribution fails to meet its then applicable minimum capital requirement or that has been notified that it needs more than normal supervision may not make any capital distributions without the prior written approval of the OCC. In addition, the OCC may prohibit a proposed capital distribution, which would otherwise be permitted by OCC regulations, if the OCC determines that such distribution would constitute an unsafe or unsound practice.
Under federal rules, an insured depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it is already undercapitalized. In addition, federal regulators have the authority to restrict or prohibit the payment of dividends for safety and soundness reasons. The FDIC also prohibits an insured depository institution from paying dividends on its capital stock or interest on its capital notes or debentures (if such interest is required to be paid only out of net profits) or distributing any of its capital assets while it remains in default in the payment of any assessment due the FDIC. Malvern Federal Savings Bank is currently not in default in any assessment payment to the FDIC.
Qualified Thrift Lender Test. All savings institutions are required to meet a qualified thrift lender, or QTL, test to avoid certain restrictions on their operations. A savings institution can comply with the QTL test by either qualifying as a domestic building and loan association as defined in the Internal Revenue Code or meeting the QTL test of the OCC.
Currently, the OCC’s QTL test requires that 65% of an institution’s “portfolio assets” (as defined) consist of certain housing and consumer-related assets on a monthly average basis in nine out of every 12 months. To be a qualified thrift lender under the IRS test, the savings institution must meet a “business operations test” and a “60 percent assets test,” each defined in the Internal Revenue Code.
If the savings institution fails to maintain its QTL status, the holding company’s activities are restricted. In addition, it must discontinue any non-permissible business within three years. Nonetheless, any company that controls a savings institution that is not a qualified thrift lender must register as a bank holding company within one year of the savings institution’s failure to meet the QTL test.
Statutory penalty provisions prohibit an institution that fails to remain a QTL from the following:

Making any new investments or engaging in any new activity not allowed for both a national bank and a savings association;

Establishing any new branch office unless allowable for a national bank; and

Paying dividends unless allowable for a national bank.
Three years from the date a savings association should have become or ceases to be a QTL, by failing to meet either QTL test, the institution must comply with the following restriction:

Dispose of any investment or not engage in any activity unless the investment or activity is allowed for both a national bank and a savings association.
Under the Dodd-Frank Act, a savings institution not in compliance with the QTL test is also subject to an enforcement action for violation of the Home Owners’ Loan Act, as amended.
At September 30, 2014, Malvern Federal Savings Bank met the requirements to be deemed a QTL.
Limitations on Transactions with Affiliates. Transactions between savings associations and any affiliate are governed by Sections 23A and 23B of the Federal Reserve Act as made applicable to savings associations by Section 11 of the Home Owners’ Loan Act. An affiliate of a savings association includes any company or entity which controls the savings institution or that is controlled by a company that controls the savings association. In a holding company context, the holding company of a savings association (such as Malvern Bancorp) and any companies which are controlled by such holding company are affiliates of the savings association. Generally, Section 23A limits the extent to which the savings association or its subsidiaries may engage in “covered transactions” with any one affiliate to an amount equal to 10% of such association’s capital stock and surplus, and contains an aggregate limit on all such transactions with all affiliates to an amount equal to 20% of such capital stock and surplus. Section 23B applies to “covered transactions” as well as certain other transactions and requires that all transactions be on terms substantially the same, or at least as favorable, to the savings association as those provided to a
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non-affiliate. The term “covered transaction” includes the making of loans to, purchase of assets from and issuance of a guarantee to an affiliate and similar transactions. Section 23B transactions also include the provision of services and the sale of assets by a savings association to an affiliate. In addition to the restrictions imposed by Sections 23A and 23B, Section 11 of the Home Owners’ Loan Act prohibits a savings association from (i) making a loan or other extension of credit to an affiliate, except for any affiliate which engages only in certain activities which are permissible for bank holding companies, or (ii) purchasing or investing in any stocks, bonds, debentures, notes or similar obligations of any affiliate, except for affiliates which are subsidiaries of the savings association.
In addition, Sections 22(g) and (h) of the Federal Reserve Act as made applicable to savings associations by Section 11 of the Home Owners’ Loan Act, place restrictions on loans to executive officers, directors and principal shareholders of the savings association and its affiliates. Under Section 22(h), loans to a director, an executive officer and to a greater than 10% shareholder of a savings association, and certain affiliated interests of either, may not exceed, together with all other outstanding loans to such person and affiliated interests, the savings association’s loans to one borrower limit (generally equal to 15% of the association’s unimpaired capital and surplus). Section 22(h) also requires that loans to directors, executive officers and principal shareholders be made on terms substantially the same as offered in comparable transactions to other persons unless the loans are made pursuant to a benefit or compensation program that (i) is widely available to employees of the association and (ii) does not give preference to any director, executive officer or principal shareholder, or certain affiliated interests of either, over other employees of the savings association. Section 22(h) also requires prior board approval for certain loans. In addition, the aggregate amount of extensions of credit by a savings association to all insiders cannot exceed the association’s unimpaired capital and surplus. Furthermore, Section 22(g) places additional restrictions on loans to executive officers. Malvern Federal Savings Bank currently is subject to Sections 22(g) and (h) of the Federal Reserve Act and at September 30, 2014, was in compliance with the above restrictions.
Community Reinvestment Act. All federal savings associations have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. An institution’s failure to comply with the provisions of the Community Reinvestment Act could result in restrictions on its activities. Malvern Federal Savings Bank received a “satisfactory” Community Reinvestment Act rating in its most recently completed examination.
Anti-Money Laundering. All financial institutions, including savings and loan associations are subject to federal laws that are designed to prevent the use of the U.S. financial system to fund terrorist activities. Financial institutions operating in the United States are required to develop new anti-money laundering compliance programs, due diligence policies and controls to ensure the detection and reporting of money laundering. Such compliance programs are intended to supplement existing compliance requirements, also applicable to financial institutions, under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations. Malvern Federal Savings Bank has established policies and procedures to ensure compliance with these provisions, and their impact on our operations has not been material.
Federal Home Loan Bank System. Malvern Federal Savings Bank is a member of the Federal Home Loan Bank of Pittsburgh, which is one of 12 regional Federal Home Loan Banks that administers the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans to members (i.e., advances) in accordance with policies and procedures established by the board of directors of the FHLB. At September 30, 2014, Malvern Federal Savings Bank had $48.0 million of FHLB advances and $103.8 million outstanding on its line of credit with the FHLB.
As a member, Malvern Federal Savings Bank is required to purchase and maintain stock in the FHLB of Pittsburgh in an amount equal to at least 1.0% of its aggregate unpaid residential mortgage loans or similar obligations at the beginning of each year. At September 30, 2014, Malvern Federal Savings Bank had $3.5 million in FHLB stock, which was in compliance with this requirement.
The Federal Home Loan Banks are required to provide funds for the resolution of troubled savings institutions and to contribute to affordable housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. The FHLB
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has communicated that it believes the calculation of risk-based capital under the current rules of the FHFA significantly overstates the market risk of the FHLB’s private-label mortgage-backed securities in the current market environment and that it has enough capital to cover the risks reflected in the FHLB’s balance sheet. As a result, an “other than temporary impairment” has not been recorded for the Bank’s investment in FHLB stock. However, continued deterioration in the FHLB’s financial position may result in impairment in the value of those securities. Management will continue to monitor the financial condition of the FHLB as it relates to, among other things, the recoverability of the Bank’s investment.
Federal Reserve System. The Federal Reserve Board requires all depository institutions to maintain reserves against their transaction accounts (primarily NOW and Super NOW checking accounts) and non-personal time deposits. Because required reserves must be maintained in the form of vault cash or a noninterest-bearing account at a Federal Reserve Bank, the effect of this reserve requirement is to reduce an institution’s earning assets. At September 30, 2014, Malvern Federal Savings Bank had met its reserve requirement.
Taxation
Federal Taxation
General. The Company and Malvern Federal Savings Bank are subject to federal income taxation in the same general manner as other corporations with some exceptions listed below. The following discussion of federal, state and local income taxation is only intended to summarize certain pertinent income tax matters and is not a comprehensive description of the applicable tax rules. The Company files a consolidated federal income tax return with Malvern Federal Savings. Malvern Bancorp’s federal and state income tax returns for taxable years through September 30, 2010 have been closed for purposes of examination by the Internal Revenue Service or the Pennsylvania Department of Revenue.
Method of Accounting.  For federal income tax purposes, we report income and expenses on the accrual method of accounting and file our federal income tax return on a fiscal year basis.
Bad Debt Reserves.  The Small Business Job 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. As a result of the Small Business Job Protection Act of 1996, savings associations must use the specific charge-off method in computing their bad debt deduction beginning with their 1996 federal tax return.
Taxable Distributions and Recapture.  Prior to the Small Business Job Protection Act of 1996, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if Malvern Federal Savings Bank failed to meet certain thrift asset and definitional tests. New federal legislation eliminated these savings association related recapture rules. However, under current law, pre-1988 reserves remain subject to recapture should Malvern Federal Savings Bank make certain non-dividend distributions or cease to maintain a bank charter.
At September 30, 2014, the total federal pre-1988 reserve was approximately $1.6 million. The reserve reflects the cumulative effects of federal tax deductions by Malvern Federal Savings for which no federal income tax provisions have been made.
State and Local Taxation
Pennsylvania Taxation. The Company is subject to the Pennsylvania Corporate Net Income Tax, Capital Stock and Franchise Tax. The Corporate Net Income Tax rate for 2014 is 9.99% and is imposed on unconsolidated taxable income for federal purposes with certain adjustments. In general, the Capital Stock and Franchise Tax is a 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.
Malvern Federal Savings Bank 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 Malvern Federal Savings Bank from other taxes imposed by the Commonwealth of Pennsylvania for state income tax purposes and
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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 GAAP with certain adjustments. The Mutual Thrift Institutions Tax, in computing income according to GAAP, allows for the deduction of interest earned on state, federal and local obligations, while disallowing a percentage of a thrift’s interest expense deduction in the proportion of interest income on those securities to the overall interest income of Malvern Federal Savings Bank. Net operating losses, if any, thereafter can be carried forward three years for Mutual Thrift Institutions Tax purposes.
Employees
As of September 30, 2014, we had a total of 93 full-time equivalent employees. No employees are represented by a collective bargaining group, and we believe that our relationship with our employees is excellent.
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Item 1A. Risk Factors
In analyzing whether to make or to continue an investment in our securities, investors should consider, among other factors, the following risk factors.
We are subject to credit risk in connection with our lending activities, and our financial condition and results of operations may be negatively impacted by economic conditions and other factors that adversely affect our borrowers.
Our financial condition and results of operations are affected by the ability of our borrowers to repay their loans, and in a timely manner. Lending money is a significant part of the banking business. Borrowers, however, do not always repay their loans. The risk of non-payment is assessed through our underwriting and loan review procedures based on several factors including credit risks of a particular borrower, changes in economic conditions, the duration of the loan and in the case of a collateralized loan, uncertainties as to the future value of the collateral and other factors. Despite our efforts, we do and will experience loan losses, and our financial condition and results of operations will be adversely affected. Our non-performing assets were approximately $4.4 million at September 30, 2014. Our allowance for loan losses was approximately $4.6 million at September 30, 2014. Our loans between thirty and eighty-nine days delinquent totaled $1.6 million at September 30, 2014.
The changing economic environment may continue to adversely impact our operations and results.
Negative developments in the financial services industry from 2008 into 2014 have resulted in uncertainty in the financial markets in general and a related general economic downturn globally. As a consequence of the recent United States recession, business activities across a wide range of industries face serious difficulties due to the decline in the housing market and lack of consumer spending. Unemployment continues to be higher than historical averages.
As a result of these financial economic crises, many lending institutions, including us, have experienced declines in the performance of their loans, including residential, construction, commercial and consumer loans. In addition, the values of real estate collateral supporting many commercial loans and home mortgages have declined and may continue to decline. Moreover, competition among depository institutions for deposits and quality loans has increased significantly while the significant decline in economic growth has led to a slowdown in banking related activities. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial services industry. In particular, we may face the following risks in connection with these events:

we potentially face increased regulation of our industry and compliance with such regulation may increase our costs and limit our ability to pursue business opportunities;

customer demand for loans secured by real estate could be reduced due to weaker economic conditions, an increase in unemployment, a decrease in real estate values or an increase in interest rates;

the process we use to estimate losses inherent in our credit exposure requires difficult, subjective and complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans; and

the value of the portfolio of investment securities that we hold may be adversely affected.
Changes in interest rates could adversely affect our financial condition and results of operation.
We are unable to predict fluctuations of market interest rates, which are affected by many factors, including inflation, recession, unemployment, monetary policy, domestic and international disorder and instability in domestic and foreign financial markets, and investor and consumer demand.
Our primary source of income is net interest income, which is the difference between the interest earned on our interest-earning assets, such as loans and investments, and the interest paid on our interest-bearing liabilities, such as deposits and borrowings. The level of net interest income is primarily a function of the average balance of our interest-earning assets, the average balance of our interest-bearing
15

liabilities, and the spread between the yield on such assets and the cost of such liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-bearing liabilities which, in turn, are impacted by such external factors as the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Board of Governors of the Federal Reserve System and market interest rates.
A sustained increase in market interest rates would adversely affect our earnings. A significant portion of our loans have fixed interest rates and longer terms than our deposits and borrowings and our net interest income could be adversely affected if the rates we pay on deposits and borrowings increase more rapidly than the rates we earn on loans. In addition, the market value of our fixed-rate assets would decline if interest rates increase. For example, we estimate that as of September 30, 2014, a 300 basis point increase in interest rates would have resulted in our net portfolio value declining by approximately $37.0 million or 44%. Net portfolio value is the difference between incoming and outgoing discounted cash flows from assets, liabilities and off-balance sheet contracts. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — How We Manage Market Risk.”
Our loan portfolio exhibits a high degree of risk.
We have a significant amount of commercial real estate loans, as well as construction and development loans and second mortgages (home equity loans) that have a higher risk of default and loss than single-family residential mortgage loans. Although permanent single-family, owner-occupied loans represent the largest single component of assets and currently impaired loans, commercial real estate loans, as well as construction and development loans and second mortgages (home equity loans) amounted to $125.6 million, or 32.3% of our loan portfolio at September 30, 2014. Commercial real estate and construction and development loans generally are considered to involve a higher degree of risk due to a variety of factors, including generally larger loan balances and loan terms which often do not require full amortization of the loan over its term and, instead, provide for a balloon payment at the stated maturity date. Repayment of commercial real estate loans generally is dependent on income being generated by the rental property or underlying business in amounts sufficient to cover operating expenses and debt service. Repayment of construction and development loans generally is dependent on the successful completion of the project and the ability of the borrower to repay the loan from the sale of the property or obtaining permanent financing. Our second mortgage loans generally are considered to involve a higher degree of risk than single-family residential mortgage loans due to the generally higher loan-to-value ratios and their secondary position in the collateral to the existing first mortgage. Our monitoring of higher risk loans and the internal asset review function may be inadequate in view of current real estate market weaknesses.
Our provisions to our allowance for loan losses and our net charge-offs to our allowance for loan losses have adversely affected, and may continue to adversely affect, our results of operations.
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. While we maintain an allowance for loan losses to provide for loan defaults and non-performance, losses may exceed the value of the collateral securing the loans and the allowance may not fully cover any excess loss.
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. Our allowance for loan losses is based on these judgments, as well as historical loss experience and an evaluation of the other risks associated with our loan portfolio, including but not limited to, the size and composition of the loan portfolio, current economic conditions and geographic concentrations within the portfolio. Federal regulatory agencies, as part of their examination process, review our loans and allowance for loan losses. If our assumptions or judgments used to determine the allowance prove to be incorrect, if the value of the collateral securing the loans decreases substantially or if our regulators disagree with our judgments, we may need to increase the allowance in amounts that exceed our expectations. Additions to the allowance adversely affect our results of operations and financial condition. We recorded a $263,000 provision for loan losses during the year ended September 30, 2014, compared to provisions of  $11.2 million and $810,000 for the years ended September 30, 2013 and 2012, respectively.
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Failure to comply with the Formal Agreement could adversely affect our business, financial condition and operating results.
In October 2014, the Bank, entered into the Formal Agreement. The Formal Agreement imposes a number of operating restrictions and requirements that the Bank revise and/or implement and monitor various identified policies, procedures and reports. Failure to comply with the Formal Agreement could result in additional supervisory and enforcement actions against the Bank and/or its directors and senior executive officers, including the issuance of a cease and desist order or the imposition of civil money penalties. In addition, compliance efforts related to the Formal Agreement have an adverse impact on our non-interest expense.
Our deferred tax asset valuation allowance adversely impacted our results of operations.
We recognize deferred tax assets and liabilities based on differences between the financial statement carrying amounts and the tax bases of assets and liabilities. At September 30, 2014, the net deferred tax asset was approximately $2.4 million, compared to a balance of approximately $2.5 million at September 30, 2013. The decrease in net deferred tax asset resulted mainly from the recognition of a deferred tax asset valuation allowance of  $10.1 million in 2014.
We regularly review our deferred tax assets for recoverability to determine whether it is more likely that not (i.e. likelihood of more that 50%) that some portion, or all, of the deferred tax asset will not be realized within its life cycle, based on the weight of available evidence. If management makes a determination based on the available evidence that it is more likely than not that some portion or all of the deferred tax assets will not be realized in future periods, a valuation allowance is calculated and recorded. The determinations are inherently subjective and dependent upon estimates and judgments concerning management’s evaluation of both positive and negative evidence.
Strong competition within our market area could hurt our profits and slow growth.
The banking and financial services industry in our market area is highly competitive. We may not be able to compete effectively in our markets, which could adversely affect our results of operations. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems, and consolidation among financial service providers. Larger institutions have greater access to capital markets, with higher lending limits and a broader array of services. Competition may require increases in deposit rates and decreases in loan rates, and adversely impact our net interest margin.
The effects of the current economic conditions have been particularly severe in our primary market areas.
Substantially all of our loans are to individuals, businesses and real estate developers in Chester County, Pennsylvania and neighboring areas in southern Pennsylvania and our business depends significantly on general economic conditions in these market areas. Severe declines in housing prices and property values have been particularly acute in our primary market areas. A further deterioration in economic conditions or a prolonged delay in economic recovery in our primary market areas could result in the following consequences, any of which could have a material adverse effect on our business:

Loan delinquencies may increase further;

Problem assets and foreclosures may increase further;

Demand for our products and services may decline;

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

Collateral for loans made by us, especially real estate, may continue to decline in value, in turn reducing a customer’s borrowing power, and reducing the value of assets and collateral associated with our loans.
We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.
We are subject to extensive regulation, supervision and examination by the FRB, our primary federal regulator, the OCC, the Bank’s primary federal regulator, and by the Federal Deposit Insurance
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Corporation, as insurer of the Bank’s deposits. Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of the Bank rather than for holders of our common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.
The fair value of our investment securities can fluctuate due to market conditions outside of our control.
As of September 30, 2014, the fair value of our investment securities portfolio was approximately $100.9 million. We have historically taken a conservative investment strategy, with concentrations of securities that are backed by government sponsored enterprises. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could have a material adverse effect on us. The process for determining whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security in order to assess the probability of receiving all contractual principal and interest payments on the security.
We are dependent on our information technology and telecommunications systems and third-party servicers, and systems failures, interruptions or breaches of security could have a material adverse effect on us.
Our business is highly dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on us.
In addition, we provide our customers with the ability to bank remotely, including over the Internet and over the telephone. The secure transmission of confidential information over the Internet and other remote channels is a critical element of remote banking. Our network could be vulnerable to unauthorized access, computer viruses, phishing schemes and other security breaches. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses. To the extent that our activities or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, regulatory scrutiny, litigation and other possible liabilities. Any inability to prevent security breaches or computer viruses could also cause existing customers to lose confidence in our systems and could materially and adversely affect us.
Additionally, financial products and services have become increasingly technology-driven. Our ability to meet the needs of our customers competitively, and in a cost-efficient manner, is dependent on the ability to keep pace with technological advances and to invest in new technology as it becomes available. Many of our competitors have greater resources to invest in technology than we do and may be better equipped to market new technology-driven products and services. The ability to keep pace with technological change is important, and the failure to do so could have a material adverse impact on our business and therefore on our financial condition and results of operations.
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Item 1B. Unresolved Staff Comments
Not applicable.
Item 2. Properties
The Bank owns and maintains the premises in which the headquarter and six full-service financial centers are located, and lease an office in Concordville. The location of each of the currently operating offices is as follows:
Paoli Headquarters 42 East Lancaster Avenue, Paoli, PA 19301
Paoli Financial Center 34 East Lancaster Avenue, Paoli, PA 19301
Malvern Financial Center 100 West King Street, Malvern, PA 19355
Exton Financial Center 109 North Pottstown Pike, Exton, PA 19341
Coventry Financial Center 100 Ridge Road, Pottstown, PA 19465
Berwyn Financial Center 650 Lancaster Avenue, Berwyn, PA 19312
Lionville Financial Center 537 West Uwchlan Avenue, Downingtown, PA 19335
Concordville Financial Center 940 Baltimore Pike, Glen Mills, PA 19342
The Concordville branch location is now servicing customers from our Westtown branch location, which was closed on June 27, 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 financial condition or results of operations.
Item 4. Mine Safety Disclosures
Not Applicable.
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PART II
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Malvern Bancorp, Inc.’s common stock is listed on the NASDAQ Global Market under the symbol “MLVF”. As of the close of business on September 30, 2014, there were 6,558,473 shares of Mid-Tier Holding Company common stock outstanding, held by approximately 485 stockholders of record, not including the number of persons or entities whose stock is held in nominee or “street” name through various brokerage firms and banks.
The following table sets forth the high and low prices of the Company’s common stock as reported by the NASDAQ Stock Market and cash dividends declared per share for the periods indicated.
Year Ended September 30,
2014
2013
High
Low
High
Low
First Quarter
$ 12.94 $ 10.75 $ 11.73 $ 9.96
Second Quarter
$ 11.30 $ 10.23 $ 12.30 $ 11.10
Third Quarter
$ 11.01 $ 10.13 $ 12.20 $ 11.50
Fourth Quarter
$ 11.39 $ 10.50 $ 13.20 $ 11.75
For the years ended September 30, 2014 and 2013, no cash dividends per share of common stock were declared by the Company. In December 2013, the Company’s board of directors adopted the Supervisory Resolution, as recommended by the Federal Reserve Bank of Philadelphia, that it will not declare or pay any dividends without the prior written approval of the Reserve Bank.
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Item 6. Selected Financial Data
Set forth below is selected financial and other data of Malvern Bancorp, Inc. You should read the consolidated financial statements and related notes contained in Item 8 hereof which provide more detailed information.
At September 30,
2014
2013
2012
2011
2010
(Dollars in thousands)
Selected Financial Condition Data:
Total assets
$ 542,264 $ 601,554 $ 711,812 $ 666,568 $ 720,506
Loans receivable, net
386,074 401,857 457,001 506,019 547,323
Loans held for sale
10,367
Securities held to maturity
3,797 4,716
Securities available for sale
100,943 124,667 80,508 74,389 40,719
FHLB borrowings
48,000 38,000 48,085 49,098 55,334
Deposits
412,953 484,596 540,988 554,455 596,858
Shareholders’ equity
76,772 75,406 62,636 60,284 66,207
Total liabilities
465,492 526,148 649,176 606,284 654,299
Allowance for loan losses
4,589 5,090 7,581 10,101 8,157
Non-accrual loans in portfolio
2,391 1,901 9,749 12,915 19,861
Non-performing assets in portfolio
4,355 5,863 14,343 21,236 25,176
Performing troubled debt restructurings in portfolio
1,009 1,346 8,187 10,340 11,976
Non-performing assets and performing troubled
debt restructurings in portfolio
5,364 7,209 22,530 31,576 37,152
Selected Operating Data:
Total interest and dividend income
$ 20,167 $ 22,301 $ 25,775 $ 29,726 $ 33,148
Total interest expense
5,071 6,944 8,412 10,198 13,641
Net interest income
15,096 15,357 17,363 19,528 19,507
Provision for loan losses
263 11,235 810 12,392 9,367
Net interest income after provision for loan losses
14,833 4,122 16,553 7,136 10,140
Total other income
2,155 2,860 2,427 1,702 2,027
Total other expenses
16,644 19,775 16,393 18,529 17,191
Income tax expense (benefit)
21 6,010 628 (3,579) (1,895)
Net income (loss)
$ 323 $ (18,803) $ 1,959 $ (6,112) $ (3,129)
Earnings (loss) per share(5)
$ 0.05 $ (2.96) $ 0.31 $ (0.96) $ (0.49)
Dividends per share
$ 0.00 $ 0.00 $ 0.00 $ 0.03 $ 0.12
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At September 30,
2014
2013
2012
2011
2010
(Dollars in thousands)
Selected Financial Ratios and Other Data:
Performance Ratios:
Return on assets (ratio of net income to average
total assets)
0.06% (2.79)% 0.30% (0.90)% (0.45)%
Return on average equity (ratio of net income to
average equity)
0.43 (20.24) 3.15 (9.64) (4.53)
Interest rate spread(1)
2.59 2.25 2.66 2.86 2.75
Net interest margin(2)
2.74 2.43 2.79 3.05 2.96
Non-interest expenses to average total assets
2.84 2.93 2.50 2.72 2.49
Efficiency ratio(3)
96.74 110.95 85.95 87.21 79.71
Asset Quality Ratios:
Non-accrual loans as a percent of gross loans
0.62 0.47 2.11 2.52 3.60
Non-performing assets as a percent of total assets
0.80 0.97 2.01 3.19 3.49
Non-performing assets and performing troubled
debt restructurings as a percent of total
assets
0.99 1.20 3.17 4.74 5.16
Allowance for loan losses as a percent of gross loans
1.18 1.26 1.64 1.97 1.48
Allowance for loan losses as a percent of non-accrual loans
191.93 267.75 77.76 78.21 41.07
Net charge-offs to average loans outstanding
0.19 3.07 0.69 1.96 1.18
Capital Ratios(4):
Total risk-based capital to risk weighted assets
20.75 18.97 14.22 12.01 12.85
Tier 1 risk-based capital to risk weighted
assets
19.50 17.72 12.96 10.76 11.83
Tangible capital to tangible assets
12.09 10.91 7.70 7.54 8.24
Tier 1 leverage (core) capital to adjustable tangible assets
12.09 10.91 7.70 7.54 8.24
Shareholders’ equity to total assets
14.16 12.54 8.80 9.04 9.19
(1)
Represents the difference between the weighted average yield on interest earning assets and the weighted average cost of interest bearing liabilities.
(2)
Net interest income divided by average interest earning assets.
(3)
Efficiency ratio, which is a non-GAAP financial measure, is computed by dividing other expense by net interest income on a tax equivalent basis plus other income, excluding net securities gains (losses). See Item 7, MD&A, “— Other Income,” page 34.
(4)
Other than shareholders’ equity to total assets, all capital ratios are for the Bank only.
(5)
The calculation for the years end September 2012 has been adjusted for the exchange and additional share issuance in the reorganization and offering completed on October 11, 2012.
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Item 7. Management’s Discussion and Analysis (“MD&A”) of Financial Condition and Results of Operations
The following discussion and analysis of the results of operations and financial condition should be read in conjunction with Item 6 “Selected Financial Data” and the consolidated financial statements and the notes thereto included in Item 8 of this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Certain risks, uncertainties and other factors, including but not limited to those set forth in Item 1A, entitled, “Risk Factors” and elsewhere in this report may cause actual results to differ materially from those projected in the forward-looking statements.
The Company’s results of operations are primarily dependent on the results of the Bank, which is a wholly owned subsidiary of the Company. Our results of operations depend, to a large extent, on net interest income, which is the difference between the income earned on our loan and investment portfolios and interest expense on deposits and borrowings. Our net interest income is largely determined by our net interest spread, which is the difference between the average yield earned on interest-earning assets and the average rate paid on interest-bearing liabilities, and the relative amounts of interest-earning assets and interest-bearing liabilities. Results of operations are also affected by our provision for loan losses, fee income and other, non-interest income and non-interest expenses. Our other, or non-interest, expenses principally consist of compensation and employee benefits, office occupancy and equipment expense, data processing, advertising and business promotion, professional fees, other real estate owned expense and other expense. Our results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact our financial conditions and results of operations.
Reported amounts are presented in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The Company’s management believes that the supplemental non-GAAP information provided in is utilized by market analysts and others to evaluate a company’s financial condition and, therefore, that such information is useful to investors. These disclosures should not be viewed as a substitute for financial results determined in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures presented by other companies.
Our business strategy currently is focused on improving core earnings, seeking relief from the Formal Agreement, maintaining low levels of problem assets and conducting our traditional community-oriented banking business. Below are certain of the highlights of our business strategy in recent years:

Improving Core Earnings. With interest rates falling to historically low levels, it has become increasingly difficult for financial institutions to maintain acceptable levels of net interest income. In recent years, with the Bank unable to grow its asset base and loan portfolio, increasing interest income has been a challenge. This lack of growth in the loan portfolio, combined with higher deposit and borrowing costs, have all contributed to a decline in the Banks’ net interest margin. In an effort to achieve consistent sustainable earnings, i.e. improve the net interest margin, we are implementing specific product and pricing strategies designed to increase the yield on loans and reduce the cost of funding. During fiscal 2014, we resumed originating commercial real estate loans and commercial business loans, which have higher yields than single-family residential mortgage loans, on a relatively modest basis in accordance with our business plan and our strengthened loan underwriting and loan administration policies and procedures. We also have established a funding composition plan, which is designed to increase checking accounts, primarily non-interest bearing accounts, as well as savings and money market accounts. We are attempting to increase our core deposits, which we define as all deposit accounts other than certificates of deposit. At September 30, 2014, our core deposits amounted to 50.7% of total deposits ($209.4 million), compared to 41.2% of total deposits ($222.8 million) at September 30, 2012. We have continued our promotional efforts to increase core deposits. We review our deposit products on an ongoing basis and we are considering additional deposit products and are currently offering more flexible delivery options, such as mobile banking, as part of our efforts to increase core deposits. We expect to increase our commercial checking accounts and we plan to enhance our cross-marketing as part of our efforts to gain additional deposit relationships with our loan customers.
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Seek Supervisory Relief. We entered into the Formal Agreement with the OCC in October 2014. Among other things, the Formal Agreement requires that we provide the OCC with relatively extensive reports and data on our business and operations on a quarterly basis. In light of the numerous reporting requirements and operating restrictions imposed by the Formal Agreement, we plan to seek relief from the Formal Agreement that the Bank entered into in 2014 as well as the IMCRs that the OCC has imposed as promptly as practicable.

Maintain Low Levels of Problem Assets. We are continuing in our efforts to maintain low levels of problem assets. At September 30, 2014, our total non-performing assets in portfolio were $4.4 million or 0.80% of total assets, reflecting a reduction of  $16.9 million, or 79.5%, compared to $21.2 million of total non-performing assets at September 30, 2011 (when total non-performing assets amounted to 3.19% of total assets). The October 2013 bulk sale of problem loans resulted in a dramatic reduction of the Company’s non-performing assets. The bulk sale was undertaken as an efficient mechanism for disposing of non-performing and underperforming assets and improving the Bank’s credit quality in the process. As a result of the sale, the Company significantly reduced its exposure to sectors that experienced economic weakness and significant declines in collateral valuations and has substantially reduced the amount of non-accruing loans.

Growing Our Loan Portfolio and Resuming Commercial Real Estate and Construction and Development Lending. We have resumed, on a relatively modest basis, the origination of commercial real estate loans and construction and development loans in our market area. Such loans are being underwritten in accordance with our strengthened loan underwriting standards and our enhanced credit review and administration procedures. We continue to believe that we can be a successful niche lender to small and mid-sized commercial borrowers and homebuilders in our market area. In light of the improvements in economic conditions and real estate values, we believe that the resumption of commercial real estate and construction and development lending in a planned, deliberative fashion with the loan underwriting and administrative enhancements that we have implemented in recent periods, together with modest loan growth, will increase our interest income and our returns in future periods.

Increasing Market Share Penetration. We operate in a competitive market area for banking products and services. In recent years, we have been working to increase our deposit share in Chester and Delaware counties and we increased our marketing and promotional efforts. However, as a result of the shrinkage of our balance sheet and the reduction in total deposits in fiscal 2014, our deposit market share in Chester County decreased from 4.69% in 2013 to 3.57% in 2014. In our effort to increase market share as well as non-interest income, we plan to evaluate increasing our business in non-traditional products, such as wealth management.

Continuing to Provide Exceptional Customer Service. As a community-oriented savings bank, we take pride in providing exceptional customer service as a means to attract and retain customers. We deliver personalized service to our customers that distinguish us from the large regional banks operating in our market area. Our management team has strong ties to and deep roots in, the local community. We believe that we know our customers’ banking needs and can respond quickly to address them.
Critical Accounting Policies
The financial condition and results of operations for the Company presented in the Consolidated Financial Statements, accompanying notes to the Consolidated Financial Statements and management’s discussion and analysis are, to a large degree, dependent upon the Company’s accounting policies. The selection and application of these accounting policies involve judgments, estimates and uncertainties that are susceptible to change.
Presented below is a discussion of the accounting policies that management believes are the most important to the portrayal and understanding of the Company’s financial condition and results of operations. These policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail,
24

and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood. Also, see Note 2 of the Consolidated Financial Statements for additional information related to significant accounting policies.
Allowance for Loan Losses. The allowance for loan losses consists of the allowance for loan losses and the reserve for unfunded lending commitments. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the statement of financial condition date and is recorded as a reduction to loans. The reserve for unfunded lending commitments represents management’s estimate of losses inherent in the Company’s unfunded loan commitments and is recorded in other liabilities on the consolidated statement of financial condition. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment or collateral recovery of all, or part, of the principal balance is highly unlikely. Non-residential consumer loans are generally charged off no later than when they become 120 days past due on a contractual basis or earlier in the event of the borrower’s bankruptcy, or if there is an amount deemed uncollectible. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, the composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, a charge-off is recognized when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class including commercial loans not considered impaired, as well as smaller balance homogeneous loans, such as residential real estate, home equity and other consumer loans. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, as adjusted for qualitative factors.
An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Once all factor adjustments are applied, general reserve allocations for each segment are calculated, summarized and reported on the ALLL summary. ALLL final schedules, calculations and the resulting evaluation process are reviewed quarterly.
In addition, Federal bank regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not previously have been available to management. Based on management’s comprehensive analysis of the loan portfolio, management believes the level of the allowance for loan losses at September 30, 2014 was appropriate under accounting principles generally accepted in the United States of America (“U.S. GAAP”).
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and
25

payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and industrial loans, commercial real estate loans and commercial construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent.
The allowance is adjusted for other significant factors that affect the collectibility of the loan portfolio as of the evaluation date including changes in lending policy and procedures, loan volume and concentrations, seasoning of the portfolio, loss experience in particular segments of the portfolio, and bank regulatory examination results. Other factors include changes in economic and business conditions affecting our primary lending areas and credit quality trends. Loss factors are reevaluated each reporting period to ensure their relevance in the current economic environment. We review key ratios such as the allowance for loan losses to total loans receivable and as a percentage of non-performing loans; however, we do not try to maintain any specific target range for these ratios.
While management uses the best information available to make loan loss allowance evaluations, adjustments to the allowance may be necessary based on changes in economic and other conditions or changes in accounting guidance. In addition, the OCC, as an integral part of its examination processes, periodically reviews our allowance for loan losses. The OCC may require the recognition of adjustments to the allowance for loan losses based on their judgment of information available to them at the time of their examinations. To the extent that actual outcomes differ from management’s estimates, additional provisions to the allowance for loan losses may be required that would adversely impact earnings in future periods.
Other Real Estate Owned. Assets acquired through foreclosure consist of other real estate owned and financial assets acquired from debtors. Other real estate owned is carried at the lower of cost or fair value, less estimated selling costs. The fair value of other real estate owned is determined using current market appraisals obtained from approved independent appraisers, agreements of sale, and comparable market analysis from real estate brokers, where applicable. Changes in the fair value of assets acquired through foreclosure at future reporting dates or at the time of disposition will result in an adjustment in assets acquired through foreclosure expense or net gain (loss) on sale of assets acquired through foreclosure, respectively.
Fair Value Measurements. The Company uses fair value measurements to record fair value adjustments to certain assets to determine fair value disclosures. Investment and mortgage-backed securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.
Under the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 820, Fair Value Measurements, the Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

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

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

Level 3 — Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset.
Under FASB ASC Topic 820, the Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy in FASB ASC Topic 820.
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Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon the Company’s or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other such factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, that could significantly affect the results of current or future valuations. At September 30, 2014, the Company had $1.9 million of assets that were measured at fair value on a non-recurring basis using Level 3 measurements.
Income Taxes. We make estimates and judgments to calculate some of our tax liabilities and determine the recoverability of some of our deferred tax assets (“DTAs”), which arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We also estimate a reserve for deferred tax assets if, based on the available evidence, it is more likely than not that some portion or all of the recorded deferred tax assets will not be realized in future periods. These estimates and judgments are inherently subjective. Historically, our estimates and judgments to calculate our deferred tax accounts have not required significant revision to our initial estimates.
In evaluating our ability to recover deferred tax assets, we consider all available positive and negative evidence, including our past operating results and our forecast of future taxable income. In determining future taxable income, we make assumptions for the amount of taxable income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require us to make judgments about our future taxable income and are consistent with the plans and estimates we use to manage our business. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in the period and could have a significant impact on our future earnings.
Realization of a deferred tax asset requires us to exercise significant judgment and is inherently uncertain because it requires the prediction of future occurrences. Our net deferred tax asset amounted to $2.4 million at September 30, 2014 compared to $2.5 million at September 30, 2013. In evaluating the need for a valuation allowance, we estimated our viable tax planning strategies that we could employ so that the asset would not go unused. We feel that the DTA balance of  $2.4 million as of September 30, 2014 is appropriate since it is the amount of such estimated tax planning strategies. Our total deferred tax assets decreased to $12.6 million at September 30, 2014 compared to $15.0 million at September 30, 2013. Our DTA valuation allowance amounted to $10.1 million at September 30, 2014 compared to $12.5 million at September 30, 2013. In the future, the DTA allowance may be reversed, depending on the Company’s financial position and results of operations in the future, among other factors, and, in such event, may be available to increase future net income. There can be no assurance, however, as to when we could be in a position to recapture our DTA allowance.
Other-Than-Temporary Impairment of Securities. Securities are evaluated on a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether declines in their value are other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and whether or not management intends to sell or expects that it is more likely than not that it will be required to sell the security prior to an anticipated recovery of the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income.
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How We Manage Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises primarily from the interest rate risk which is inherent in our lending and deposit taking activities. To that end, management actively monitors and manages interest rate risk exposure. In addition to market risk, our primary risk is credit risk on our loan portfolio. We attempt to manage credit risk through our loan underwriting and oversight policies.
In recent years, we primarily have utilized the following strategies to manage interest rate risk:

we have attempted to match fund a portion of our loan portfolio with borrowings having similar expected lives;

on occasion, we have sold long-term (30-year) fixed-rate mortgage loans with servicing retained;

we have attempted, where possible, to extend the maturities of our deposits and borrowings; and

we have invested in securities with relatively short anticipated lives, generally one to three years, and we hold significant amounts of liquid assets.
As part of our asset/liability management efforts, during fiscal year ended September 30, 2014, we sold $23.2 million of long-term, fixed-rate residential mortgage loans with the servicing retained. This transaction resulted in a gain of  $352,000. Finally, in light of the removal of the lending restrictions from the Bank’s 2010 Supervisory Agreement, we have resumed, on a relatively modest basis subject to our business plan and our strengthened loan underwriting and loan administration policies and procedures, origination of commercial real estate loans and commercial business loans, both of which generally have higher yields than single-family residential mortgage loans.
Gap Analysis. The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a bank’s interest rate sensitivity “gap.” An asset and liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets. During a period of rising interest rates, a negative gap would tend to affect adversely net interest income while a positive gap would tend to result in an increase in net interest income. Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to affect adversely net interest income. Our one-year cumulative gap was a negative 23.7% at September 30, 2014 compared to a negative 31.06% at September 30, 2013.
The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at September 30, 2014, which we expect, based upon certain assumptions, to reprice or mature in each of the future time periods shown (the “GAP Table”). Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability. The table sets forth approximation of the projected repricing of assets and liabilities at September 30, 2014, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals. The loan amounts in the table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans.
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6 Months
or Less
More than
6 Months
to 1 Year
More than
1 Year
to 3 Years
More than
3 Year
to 5 Years
More than
5 Years
Total
Amount
(Dollars in thousands)
Interest-earning assets(1):
Loans receivable(2)
$ 90,309 $ 33,850 $ 87,266 $ 66,588 $ 108,554 $ 386,567
Investment securities and restricted securities
7,743 6,174 37,961 19,476 35,828 107,182
Other interest-earning assets
17,984 17,984
Total interest-earning assets
116,036 40,024 125,227 86,064 144,382 511,733
Interest-bearing liabilities:
Demand and NOW accounts
81,922 81,922
Money market accounts
59,529 59,529
Savings accounts
44,916 44,916
Certificate accounts
46,941 41,321 75,769 36,450 3,046 203,527
FHLB advances
10,000 5,000 33,000 48,000
Total interest-bearing
liabilities
233,308 51,321 80,769 69,450 3,046 437,894
Interest-earning assets less interest-bearing liabilities
$ (117,272) $ (11,297) $ 44,458 $ 16,614 $ 141,336 $ 73,839
Cumulative interest-rate sensitivity
gap(3)
$ (117,272) $ (128,569) $ (84,111) $ (67,497) $ 73,839
Cumulative interest-rate gap as a percentage of total assets at September 30, 2014
(21.63)% (23.71)% (15.51)% (12.45)% 13.62%
Cumulative interest-earning assets as a percentage of cumulative interest-bearing liabilities at September 30, 2014
49.74% 54.83% 76.98% 84.48% 116.86%
(1)
Interest-earning assets are included in the period in which the balances are expected to be redeployed and/or repriced as a result of anticipated prepayments, scheduled rate adjustments and contractual maturities.
(2)
For purposes of the gap analysis, loans receivable includes non-performing loans gross of the allowance for loan losses, undisbursed loan funds, unamortized discounts and deferred loan fees.
(3)
Interest-rate sensitivity gap represents the net cumulative difference between interest-earning assets and interest-bearing liabilities.
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest rates both on a short-term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the table. Finally, the ability of many borrowers to service their adjustable-rate loans may decrease in the event of an interest rate increase.
Net Portfolio Value and Net Interest Income Analysis. Our interest rate sensitivity also is monitored by management through the use of models which generate estimates of the change in its net portfolio value (“NPV”) and net interest income (“NII”) over a range of interest rate scenarios. NPV is the present value of
29

expected cash flows from assets, liabilities, and off-balance sheet contracts. The NPV ratio, under any interest rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario.
The table below sets forth as of September 30, 2014 and 2013, the estimated changes in our net portfolio value that would result from designated instantaneous changes in the United States Treasury yield curve. Computations of prospective effects of hypothetical interest rates changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
As of September 30, 2014
As of September 30, 2013
Changes in Interest Rates (basis points)(1)
Amount
Dollar
Change
from Base
Percentage
Change from
Base
Amount
Dollar
Change
from Base
Percentage
Change from
Base
(Dollars in thousands)
+300
$ 47,569 $ (36,962) (44)% $ 41,315 $ (35,859) (46)%
+200
62,081 (22,450) (27) 54,957 (22,217) (29)
+100
74,013 (10,518) (12) 67,966 (9,208) (12)
0
84,531 77,174
-100
86,879 2,348 3 78,841 1,667 2
(1)
Assumes an instantaneous uniform change in interest rates. A basis point equals 0.01%.
In addition to modeling changes in NPV, we also analyze potential changes to NII for a twelve-month period under rising and falling interest rate scenarios. The following table shows our NII model as of September 30, 2014.
Changes in Interest Rates in Basis Points (Rate Shock)
Net Interest
Income
$ Change
% Change
(Dollars in thousands)
200
$ 14,234 $ (357) (2.45)%
100
14,440 (151) (1.03)
Static
14,591
(100)
13,929 (662) (4.54)
As is the case with the GAP Table, certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in NPV and NII require the making of certain assumptions which may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the models presented assume that the composition of our interest sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Accordingly, although the NPV measurements and net interest income models provide an indication of interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on net interest income and will differ from actual results.
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Average Balances, Net Interest Income, and Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. Tax-exempt income and yields have been adjusted to a tax-equivalent basis. All average balances are based on monthly balances. Management does not believe that the monthly averages differ significantly from what the daily averages would be.
Year Ended September 30,
2014
2013
2012
Average
Outstanding
Balance
Interest
Earned/​
Paid
Average
Yield/​
Rate
Average
Outstanding
Balance
Interest
Earned/​
Paid
Average
Yield/​
Rate
Average
Outstanding
Balance
Interest
Earned/​
Paid
Average
Yield/​
Rate
(Dollars in thousands)
ASSETS
Interest earning assets:
Loans receivable(1)
$ 407,169 $ 17,743 4.36% $ 447,196 $ 20,179 4.51% $ 481,424 $ 24,054 5.00%
Investment securities
117,366 2,303 1.96 106,903 2,051 1.92 86,722 1,699 1.96
Deposits in other banks
25,714 54 0.21 78,902 137 0.17 51,185 51 0.10
FHLB stock
3,342 123 3.68 3,696 19 0.51 4,772 4 0.08
Total interest earning assets(1)
553,591 20,223 3.65 636,696 22,386 3.52 624,103 25,808 4.14
Non-interest earning assets
Cash and due from banks
1,356 2,943 1,538
Bank owned life insurance
21,092 19,083 15,006
Other assets
14,164 22,287 24,584
Allowance for loan losses
(4,893) (6,839) (8,809)
Total non-interest earning assets
31,719 37,474 32,319
Total assets
$ 585,310 $ 674,170 $ 656,422
LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest bearing liabilities:
Money Market accounts
$ 64,499 $ 164 0.25% $ 68,782 $ 228 0.33% $ 79,977 $ 446 0.56%
Savings accounts
44,379 27 0.06 43,382 24 0.06 46,316 48 0.10
Certificate accounts
237,090 3,693 1.56 298,229 4,908 1.65 300,956 5,942 1.97
Other interest-bearing deposits
87,283 85 0.10 90,085 119 0.13 90,963 256 0.28
Total deposits
433,251 3,969 0.92 500,478 5,279 1.05 518,212 6,692 1.29
Borrowed funds
45,007 1,102 2.45 47,593 1,665 3.50 48,593 1,720 3.54
Total interest-bearing liabilities
478,258 5,071 1.06 548,071 6,944 1.27 566,805 8,412 1.48
Non-interest bearing liabilities
Demand deposits
25,499 26,899 22,812
Other liabilities
5,733 6,306 4,627
Total non-interest-bearing liabilities
31,232 33,205 27,439
Shareholders’ equity
75,820 92,894 62,178
Total liabilities and shareholders’ equity
$ 585,310 $ 674,170 $ 656,422
Net interest-earning assets
$ 75,333 $ 88,626 $ 57,298
Net interest income (tax-equivalent basis) 
$ 15,152 $ 15,442 $ 17,396
Net interest spread
2.59% 2.25% 2.66%
Net interest margin
2.74% 2.43% 2.79%
Average interest-earning assets to average
interest-bearing liabilities
115.75% 116.17% 110.11%
Tax-equivalent adjustment(2)
(56) (85) (33)
Net Interest income
$ 15,096 $ 15,357 $ 17,363
(1)
Includes non-accrual loans during the respective periods. Calculated net of deferred loan fees and loan discounts.
(2)
The tax-equivalent adjustment was computed based on a statutory Federal income tax rate of 34 percent for fiscal years 2014, 2013 and 2012.
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The following table presents the dollar amount of changes in interest income (on a tax-equivalent basis) and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the increase related to higher outstanding balances and that due to the unprecedented levels and volatility of interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e., changes in volume multiplied by old rate) and (ii) changes in rate (i.e., changes in rate multiplied by old volume). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the change due to volume and the change due to rate.
Year Ended September 30,
2014 vs. 2013
2013 vs. 2012
Volume
Rate
Net
Change
Volume
Rate
Net
Change
(In thousands)
Interest Earning Assets:
Loans receivable
$ (1,805) $ (631) $ (2,436) $ (1,711) $ (2,164) $ (3,875)
Investment securities
201 51 252 396 (44) 352
Deposits in other banks
(90) 7 (83) 28 58 86
FHLB stock
(2) 106 104 (1) 16 15
Total interest earning assets
$ (1,696) $ (467) $ (2,163) $ (1,288) $ (2,134) $ (3,422)
Interest Bearing Liabilities
Money market accounts
$ (14) $ (50) $ (64) $ (63) $ (155) $ (218)
Savings accounts
1 2 (3) (3) (21) (24)
Certificate accounts
(1,009) (206) (1,215) (54) (980) (1,034)
Other interest-bearing accounts
(4) (30) (34) (2) (155) (218)
Total deposits
(1,026) (284) (1,310) (122) (1,291) (1,413)
Borrowed funds
(91) (472) (563) (35) (20) (55)
Total interest-bearing liabilities
$ (1,117) $ (756) $ (1,873) $ (157) $ (1,311) $ (1,468)
Net interest income
$ (579) $ 289 $ (290) $ (1,131) $ (824) $ (1,954)
Comparison of Financial Condition at September 30, 2014 and September 30, 2013
Total assets decreased $59.3 million or 9.9% to $542.3 million at September 30, 2014 compared to $601.6 million at September 30, 2013. The decrease was primarily due to a $4.5 million or 19.0% decrease in cash and cash equivalents, a $23.7 million or 19.1% decrease in investment securities, a $10.4 million or 100.0% decrease in loans held for sale, a $15.8 million or 3.9% decrease in net loans receivable, a $3.1 million or 14.4% decrease in bank owned life insurance and a $2.0 million or 50.4% reduction in other real estate owned (“REO”). The decrease in loans held for sale was due to the completion of our bulk sale of $10.4 million of loans in October 2013. The loans sold were designated as held for sale at September 30, 2013 and were comprised of non-accruing loans, performing troubled debt restructurings (“TDRs”) and classified and other loans which had an aggregate book balance of  $20.4 million prior to an aggregate of $10.1 million in charge-offs taken in the quarter ended September 30, 2013. The decrease in investment securities was due primarily to the sale of approximately $9.1 million of our tax-free municipal bonds during fiscal 2014. The decrease in net loans receivable was due primarily to the bulk sale of  $15.3 million of seasoned, fixed-rate long-term residential mortgage loans to one investor.
Total liabilities decreased by $60.6 million, or 11.5% to $465.5 million at September 30, 2014 compared to $526.1 million at September 30, 2013. The decrease was primarily due to a $69.9 million or 15.2% decrease in interest bearing deposits. Total deposits decreased to $413.0 million at September 30, 2014 compared to $484.6 million at September 30, 2013. The decrease was partially offset by a $10.0 million or 26.3% increase in FHLB advances and a $668,000 increase in advances from borrowers for taxes and insurance.
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Shareholders’ equity increased $1.4 million to $76.8 million at September 30, 2014 compared to $75.4 million at September 30, 2013. The increase was due primarily to an $883,000 reduction in accumulated other comprehensive loss as well as net income during fiscal 2014 which increased retained earnings to $20.1 million at September 30, 2014. Our ratio of equity to assets was 14.16% at September 30, 2014.
Comparison of Operating Results for the Years Ended September 30, 2014 and September 30, 2013
General. Our net income was $323,000 for the year ended September 30, 2014 compared to net loss of  $18.8 million for the year ended September 30, 2013. On a per share basis, the net income was $0.05 per share for the year ended September 30, 2014, compared to net loss of  $2.96 per share for the year ended September 30, 2013. The reason for the $19.1 million difference in our results of operations in fiscal 2014 compared to the prior fiscal year was due to a decrease in the provision of loan losses of  $11.0 million, a $3.1 million decrease in other expenses, a $1.9 million decrease in interest expense, and a $6.0 million decrease in income tax expense, which were partially offset by a $2.1 million decrease in interest and dividend income. Our interest rate spread was 2.59% and our net interest margin was 2.74% for the year ended September 30, 2014, compared to a net interest spread of 2.25% and a net interest margin of 2.43% for the year ended September 30, 2013.
Interest and Dividend Income. Our interest and dividend income decreased for the year ended September 30, 2014 by $2.1 million or 9.6% over fiscal 2013 to $20.2 million. Interest income on loans decreased for the year ended September 30, 2014 over fiscal 2013 by $2.4 million, or 12.1%. The decrease in interest earned on loans in fiscal 2014 was due to a 15 basis point decrease in the average yield earned on our loan portfolio compared to fiscal 2013 as well as a $40.0 million or 9.0%, decrease in the average balance of our outstanding loan portfolio. Interest income on investment securities increased by $281,000, or 14.2%, in fiscal 2014 over the prior fiscal year. The increase in interest income on investment securities in fiscal 2014 was due to a $10.5 million, or 9.8%, increase in the average balance of our investment securities portfolio. The average yield on investment securities increased four basis points to 1.96% for fiscal 2014 from 1.92% over fiscal 2013.
Interest Expense. Our interest expense for the year ended September 30, 2014 was $5.1 million, a decrease of  $1.9 million from the year ended September 30, 2013. The decrease was due to a $1.3 million or 24.8% decrease in interest expense on deposits and a $563,000 or 33.8% decrease in interest expense on FHLB borrowings. The decrease in interest expense on deposits was due to a $67.2 million or 13.4% decrease in the average balance of deposits, as well as a 13 basis point decrease in the average rate paid on deposits. The average rate paid on total deposits decreased to 0.92% for fiscal 2014 from 1.05% for fiscal 2013. During fiscal 2014, we focused on letting our relatively higher costing certificates of deposit run off while attempting to increase our relatively lower costing core deposits as a source of funds. The decrease in interest expense on FHLB borrowings was due to a $2.6 million or 5.4% decrease in the average balance of FHLB borrowings and a 105 basis point decrease in the rates paid on borrowings. The average rate paid on borrowed funds decreased to 2.45% in fiscal 2014 compared to 3.50% in fiscal 2013.
Provision for Loan Losses. Management has identified the evaluation of the allowance for loan losses as a critical accounting policy. This policy is significantly affected by our judgment and uncertainties and there is likelihood that materially different amounts would be reported under different, but reasonably plausible, conditions or assumptions. Our activity in the provision for loan losses, which are charges or recoveries to operating results, is undertaken in order to maintain a level of total allowance for losses that management believes covers all known and inherent losses that are both probable and reasonably estimable at each reporting date. Our evaluation process typically includes, among other things, an analysis of delinquency trends, non-performing loan trends, the level of charge-offs and recoveries, prior loss experience, total loans outstanding, the volume of loan originations, the type, size and geographic concentration of our loans, the value of collateral securing the loan, the borrower’s ability to repay and repayment performance, the number of loans requiring heightened management oversight, local economic conditions and industry experience. The establishment of the allowance for loan losses is significantly affected by management judgment and uncertainties and there is likelihood that different amounts would be reported under different conditions or assumptions. Various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to make additional provisions for estimated loan losses based upon judgments different from those of management.
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The provision for loan losses was $263,000 for the year ended September 30, 2014, compared to $11.2 million for the year ended September 30, 2013. Our total gross charge-offs for the year ended September 30, 2014 were $941,000, a $13.4 million, or 93.4%, decrease compared to $14.3 million of charge-offs during the year ended September 30, 2013. As of September 30, 2014, the balance of the allowance for loan losses was $4.6 million, or 1.18% of gross loans and 191.9% of non-accruing loans in portfolio, compared to an allowance for loan losses of  $5.1 million or 1.26% of gross loans and 267.75% of non-accruing loans at September 30, 2013. We will continue to monitor and modify our allowance for loan losses as conditions dictate. No assurances can be given that our level of allowance for loan losses will cover all of the inherent losses on our loans or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.
Other Income. Our other, or non-interest, income decreased by $705,000, or 24.7%, to $2.2 million for the year ended September 30, 2014 compared to $2.9 million for the year ended September 30, 2013. The decrease in other income during fiscal 2014 was primarily as a result of a $396,000 reduction in net securities gains, a decrease of  $102,000 in service charges on deposit accounts and a decrease of  $617,000 relating to income on bank owned life insurance, offset in part by an increase of  $446,000 in net gain on sale of loans. The decrease in service charges for the year ended September 30, 2014 was primarily due to a decrease of  $42,000 in other loan fee income, a $17,000 decrease in demand deposit fee income and a decrease of  $38,000 other fees. Excluding net securities gains and losses, a non-GAAP measure, the Company recorded other income of  $2.1 million for the year ended September 30, 2014 compared to other income, excluding net securities gains and losses, of  $2.4 million for the comparable period in 2013, representing a decrease of  $309,000 or 13.0 percent.
The Company’s other income is presented in the table below excluding net investment security gains.
For the Year Ended September 30,
2014
2013
(In thousands)
Other income
$ 2,155 $ 2,860
Less: Net investment securities gains
83 479
Other income, excluding net investment securities gains
$ 2,072 $ 2,381
Other Expenses. Our other, or non-interest, expenses decreased by $3.1 million, or 15.8%, to $16.6 million for the year ended September 30, 2014 compared to $19.8 million for the year ended September 30, 2013. The decrease in other expenses in fiscal 2014 compared to fiscal 2013 was due primarily to a $1.9 million reduction in other real estate owned expense and the absence in fiscal 2014 of a FHLB prepayment penalty of  $1.5 million recognized in fiscal 2013. In addition, salaries and employee benefits were $36,000 lower in fiscal 2014 compared to fiscal 2013, even after payment of an aggregate of  $145,000 in severance payments in fiscal 2014, and advertising expenses and federal deposit insurance premiums were lower by $176,000 and $121,000, respectively, in fiscal 2014 compared to fiscal 2013. These decreases were partially offset by increases in professional fees of  $449,000 and other operating expense of  $193,000 in fiscal 2014 compared to fiscal 2013. The increase in professional fees was due in large part to approximately $247,000 paid to a third party consultant that we utilized prior to the selection of our new President and Chief Executive Officer. Other real estate owned expense decreased in part due to a $500,000 insurance reimbursement of a fire claim for a property located in Melrose Park, Pennsylvania. This property subsequently was sold in October 2014 resulting in a gain of  $13,000.
Income Tax Expense. Our income tax expense was $21,000 for the year ended September 30, 2014 compared to an income tax expense of  $6.0 million for the year ended September 30, 2013. The $21,000 in income tax expense was due to federal taxes associated with the cash surrender of BOLI policies. The tax expense of  $6.0 million at September 30, 2013 was due to the net effect of a tax benefit of  $4.7 million due to the net loss before taxes of  $12.8 million for fiscal 2013 and the DTA valuation expense of  $10.7 million for fiscal year end 2013. We evaluate our tax obligations on a quarterly basis and do not expect to resume making provisions for Federal income tax expense until we have reported net income before taxes for several consecutive fiscal quarters.
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Comparison of Operating Results for the Years Ended September 30, 2013 and September 30, 2012
General. Our net loss was $18.8 million for the year ended September 30, 2013 compared to net income of  $2.0 million for the year ended September 30, 2012. On a per share basis, the net loss was $2.96 per share for the year ended September 30, 2013, compared to net income of  $0.31 per share (as adjusted for our “second-step” conversion) for the year ended September 30, 2012. The reason for the $20.8 million difference in our results of operations in fiscal 2013 compared to the prior fiscal year was due to an increase in the provision of loan losses of  $10.4 million, a $2.0 million decrease in net interest income, a $3.4 million increase in other expenses, as well as $5.4 million increase in income tax expense. Our interest rate spread was 2.25% and our net interest margin was 2.43% for the year ended September 30, 2013, compared to a net interest spread of 2.66% and a net interest margin of 2.79% for the year ended September 30, 2012.
Interest and Dividend Income. Our interest and dividend income decreased for the year ended September 30, 2013 by $3.5 million or 13.5% over fiscal 2012 to $22.3 million. Interest income on loans decreased for the year ended September 30, 2013 over fiscal 2012 by $3.9 million, or 16.1%. The decrease in interest earned on loans in fiscal 2013 was due to a 49 basis point decrease in the average yield earned on our loan portfolio in fiscal 2013 compared to fiscal 2012 as well as a $34.2 million or 7.1%, decrease in the average balance of our outstanding loan portfolio. Interest income on investment securities increased by $299,000, or 17.9%, in fiscal 2013 over the prior fiscal year. The increase in interest income on investment securities in fiscal 2013 was due to a $20.2 million, or 23.3%, increase in the average balance of our investment securities portfolio.
Interest Expense. Our interest expense for the year ended September 30, 2013 was $6.9 million, a decrease of  $1.5 million from the year ended September 30, 2012. The reason for the decrease in interest expense in fiscal 2013 compared to fiscal 2012 was a 24 basis point decrease in average rate paid on total deposits together with a decrease in the average balance of our total deposits of  $17.7 million, or 3.4%, in fiscal 2013 compared to fiscal 2012 due primarily to a $11.2 million decrease in the average balance of money market accounts. The average rate paid on total deposits decreased to 1.05% for fiscal 2013 from 1.29% for fiscal 2012. Our expense on borrowings was relatively constant, and amounted to $1.7 million in fiscal 2013 and 2012. The average balance of our borrowings decreased by $1.0 million in fiscal 2013 compared to fiscal 2012, and the average rate paid on borrowed funds decreased to 3.50% in fiscal 2013 compared to 3.54% in fiscal 2012. As previously described, during the fourth quarter of fiscal 2013 we prepaid $20.0 million of FHLB advances which had a weighted average cost of 3.84%. During the fourth quarter of fiscal 2013, we replaced a portion of the prepaid advances with $10.0 million of new FHLB advances which have a weighted average cost of 1.06%.
Provision for Loan Losses. The provision for loan losses was $11.2 million for the year ended September 30, 2013, compared to $810,000 for the year ended September 30, 2012. The $11.2 million provision recorded in 2013 was primarily driven by $10.2 million of charge-offs taken upon our assessment of the fair value of the $20.4 million of loans transferred to held for sale status at September 30, 2013 in connection with our proposed bulk sale of problem loans. Our total gross charge-offs for the year ended September 30, 2013 were $14.3 million, a $9.7 million, or 209.8%, increase compared to $4.6 million of charge-offs during the year ended September 30, 2012. The increase in our charge-offs for fiscal 2013 primarily reflects our proposed sale of problem loans, which was completed in October 2013. As of September 30, 2013, the balance of the allowance for loan losses was $5.1 million, or 1.26% of gross loans and 267.75% of non-accruing loans in portfolio, compared to an allowance for loan losses of  $7.6 million or 1.64% of gross loans and 77.76% of non-accruing loans at September 30, 2012. See “Asset Quality — Non-Performing Loans and Real Estate Owned.” We will continue to monitor and modify our allowance for loan losses as conditions dictate. No assurances can be given that our level of allowance for loan losses will cover all of the inherent losses on our loans or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses.
Other Income. Our other, or non-interest, income increased by $433,000, or 17.9%, to $2.9 million for the year ended September 30, 2013 compared to $2.4 million for the year ended September 30, 2012. The increase in other income during fiscal 2013 was primarily due to a non-recurring, tax free death benefit of approximately $596,000 received pursuant to BOLI. In addition, we sold approximately $27.8 million in fixed-rate residential mortgage loans in the secondary market which resulted in a net gain of approximately
35

$366,000 during fiscal 2013. Also, our gain on sale of investments in fiscal 2013 decreased by $272,000 compared to fiscal 2012, and we recognized a $416,000 loss on the sale of a $2.1 million commercial real estate loan which had been classified as substandard during the year ended September 30, 2013.
Other Expenses. Our other, or non-interest, expenses increased by $3.4 million, or 20.6%, to $19.8 million for the year ended September 30, 2013 compared to $16.4 million for the year ended September 30, 2012. The increase in other expenses in fiscal 2013 compared to fiscal 2012 was due primarily to the $1.5 million in FHLB pre-payment penalties recognized as well as a $1.1 million increase in salaries and employee benefits. The increase in salaries and employee benefits expense during the year ended September 30, 2013 primarily reflects an increase in the number of employees in our secondary market program as well as the increase in support staff in the Credit Review Department and Mortgage Loan Department. There was an increase of  $283,000 in professional fees and a $302,000 increase in REO expense in the fiscal year ended September 30, 2013 compared to fiscal 2012.
Income Tax Expense. Our income tax expense was $6.0 for the year ended September 30, 2013 compared to an income tax expense of  $628,000 for the year ended September 30, 2012. The increased income tax expense for the year ended September 30, 2013 was primarily due to an increase in our DTA valuation allowance to $12.5 million.
Investment Activities
General. At September 30, 2014, our investment and mortgage-backed securities amounted to $100.9 million in the aggregate or 18.6% of total assets at such date. Our securities portfolio is comprised of mortgage-backed pass-through securities, as well as collateralized mortgage obligations, which amounted to $76.8 million in the aggregate or 76.1% of the securities portfolio at September 30, 2014. Our agency debt securities often have call provisions which provide the agency with the ability to call the securities at specified dates. We typically invest in securities with relatively short terms to maturity (less than 10 years). At September 30, 2014, $11.1 million of our investment securities had contractual maturities of one year or less and the estimated duration of our mortgage-backed securities portfolio was 5.0 years at such date.
At September 30, 2014, we had an aggregate of  $2.9 million in gross unrealized losses on our investment securities portfolio available for sale. Securities are evaluated on a quarterly basis, and more frequently when market conditions warrant such an evaluation, to determine whether a decline in their value is other-than-temporary. To determine whether a loss in value is other-than-temporary, management utilizes criteria such as the reasons underlying the decline, the magnitude and duration of the decline and whether or not management intends to sell or expects that it is more likely than not that it will be required to sell the security prior to an anticipated recovery of the fair value. The term “other-than-temporary” is not intended to indicate that the decline is permanent, but indicates that the prospects for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the investment. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated into (a) the amount of the total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of the total other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to the credit loss is recognized in earnings. The amount of the total other-than-temporary impairment related to all other factors is recognized in other comprehensive income. For equity securities, the full amount of the other-than-temporary impairment is recognized in earnings. Available for sale securities can be sold at any time based upon needs or market conditions. Available for sale securities are accounted for at fair value, with unrealized gains and losses on these securities, net of income tax, reflected in shareholders’ equity as accumulated other comprehensive income. At September 30, 2014, all of our securities were classified as available for sale.
We do not purchase mortgage-backed derivative instruments that would be characterized “high-risk” under Federal banking regulations at the time of purchase, nor do we purchase corporate obligations which are not rated investment grade or better.
Our mortgage-backed securities consist primarily of mortgage pass-through certificates and collateralized mortgage obligations issued by the Government National Mortgage Association (“GNMA” or “Ginnie Mae”), Fannie Mae or Freddie Mac. At September 30, 2014, all of our mortgage-backed
36

securities and collateralized mortgage obligations were issued by GNMA, FNMA or FHLMC, and we held no mortgage-backed securities from private issuers. We do not purchase mortgage-backed derivative instruments that would be characterized “high-risk” under Federal banking regulations at the time of purchase.
Investments in mortgage-backed securities involve a risk that actual prepayments will be greater than estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or in the event such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates.
In analyzing an issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and industry analysts’ reports. The Company does not intend to sell and it is not more likely than not that it will be required to sell these securities until such time as the value recovers or the securities mature. Management does not believe any individual unrealized loss as of September 30, 2014 represents other-than-temporary impairment.
At September 30, 2014, we owned one single issuer trust preferred security, which had an unrealized loss of  $120,000 at such date, compared to $190,000 at September 30, 2013. The Company has continued to receive contractual payments in a timely manner and management expects to continue to receive timely payments in the future based on the credit rating and performance of the issuer. On a quarterly basis, management reviews the credit rating and performance of the issuer, as well as the impact that the overall economy is expected to have on those measurements and the fair value of this security. Management does not believe any unrealized loss as of September 30, 2014 represents other-than-temporary impairment.
Investment Securities Portfolio, Maturities and Yields. The following table sets forth the scheduled maturities, amortized cost and weighted average yields for our investment portfolio, at September 30, 2014. Due to repayments of the underlying loans, the average life maturities of mortgage-backed and asset-backed securities generally are substantially less than the final maturities.
The composition and maturities of the investment securities portfolio are indicated in the following table.
One year or less
More than One Year
through Five Years
More than Five Years
through Ten Years
More than Ten Years
Total
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Weighted
Average
Yield
Amortized
Cost
Fair
Value
Weighted
Average
Yield
(Dollars in thousands)
Available for Sale Securities:
U.S. government agencies
and obligations(1)
$ % $ 7,791 1.35% $ 11,928 1.64% $ % $ 19,719 $ 19,256 1.52%
State and municipal obligations
843 0.89 1,700 1.27 2,543 2,500 1.14
Mortgage-backed securities
11,739 1.93 33,225 1.95 20,974 2.00 12,975 2.15 78,913 76,782 2.00
Single issuer trust preferred security
1,000 0.87 1,000 880 0.87
Corporate debt
securities
1,504 1.87 1,504 1,525 1.84
Total debt securities
$ 11,739 1.93 $ 43,363 1.85 $ 34,602 1.84 $ 13,975 2.06 $ 103,679 $ 100,943 1.89
(1)
Includes FHLB notes
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The following table sets forth the composition of the Company’s investment portfolio at the dates indicated.
At September 30,
2014
2013
2012
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
Amortized
Cost
Fair
Value
(In thousands)
Securities available for sale:
U.S. government agencies(1)
$ 19,719 $ 19,256 $ 20,108 $ 19,432 $ 24,369 $ 24,617
State and municipal obligations
2,543 2,500 12,381 11,938 9,217 9,387
Single issuer trust preferred security 
1,000 880 1,000 810 1,000 764
Corporate debt securities
1,504 1,525 1,756 1,782 2,006 2,057
Mortgage-backed securities:
Federal National Mortgage Association
17,793 17,226 20,934 20,105 1,791 1,925
Federal Home Loan Mortgage Corporation
15,898 15,591 18,423 17,871 248 261
Government National Mortgage Association
1 1
Collateralized mortgage
obligations
45,222 43,965 54,137 52,729 40,904 41,496
Total available for sale
$ 103,679 $ 100,943 $ 128,739 $ 124,667 $ 79,536 $ 80,508
(1)
Includes FHLB notes.
For other information regarding the Company’s investment securities portfolio, see Note 5 of the Notes to the Consolidated Financial Statements.
Lending Activities
General. At September 30, 2014, our net loan portfolio totaled $386.1 million or 71.2% of total assets. Our principal lending activity has been the origination of loans collateralized by one- to four-family, also known as “single-family,” residential real estate loans located in our market area. In light of the increased levels of our non-performing and problem assets in recent fiscal years, we have taken certain actions to strengthen and enhance our loan underwriting policies and procedures and our loan administration and oversight policies and procedures. We have revised both our consumer loan policy and our commercial loan policy to strengthen certain of our minimum loan-to-value (“LTV”) ratios, maximum gross debt ratios and minimum debt coverage ratio policy requirements. We have invested in and implemented software which facilitates our ability to internally review and grade loans in our portfolio and to monitor loan performance. Our Credit Review Department’s primary focus has been to review and maintain the loan portfolio, along with the review of underwriting of all new credits.
At times, the Company purchases single-family residential mortgage loans and consumer loans from a network of mortgage brokers. These loans are underwritten at the Bank and closed in the Bank’s name.
The types of loans that we originate are subject to federal and state law and regulations. Interest rates charged by us on loans are affected principally by the demand for such loans and the supply of money available for lending purposes and the rates offered by our competitors. These factors are, in turn, affected by general and economic conditions, the monetary policy of the federal government, including the Federal Reserve Board, legislative tax policies and governmental budgetary matters.
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Loan Portfolio Composition. The following table shows the composition of our loan portfolio by type of loan at the dates indicated. In addition to total loans in portfolio, which amounted to $404.7 million at September 30, 2013, we held $10.4 million of loans held for sale at such date.
September 30,
2014
2013
2012
2011
2010
(In thousands)
Residential mortgage
$ 231,324 $ 239,900 $ 231,803 $ 229,330 $ 230,966
Construction and Development:
Resident and commercial
5,964 6,672 20,500 26,005 30,429
Land
1,033 2,439 632 2,722 2,989
Total Construction and Development
6,997 9,111 21,132 28,727 33,418
Commercial:
Commercial real estate
71,579 70,571 112,199 131,225 143,095
Multi-family
1,032 1,971 2,087 5,507 6,493
Other
5,480 5,573 7,517 10,992 11,398
Total Commercial
78,091 78,115 121,803 147,724 160,986
Consumer:
Home equity lines of credit
22,292 20,431 20,959 20,735 19,927
Second mortgages
47,034 54,532 65,703 85,881 105,825
Other
2,839 2,648 762 788 1,086
Total Consumer
72,165 77,611 87,424 107,404 126,838
Total loans
388,577 404,737 462,162 513,185 552,208
Deferred loan costs, net
2,086 2,210 2,420 2,935 3,272
Allowance for loan losses
(4,589) (5,090) (7,581) (10,101) (8,157)
Loans receivable, net
$ 386,074 $ 401,857 $ 457,001 $ 506,019 $ 547,323
The loans receivable portfolio is segmented into residential mortgage loans, construction and development loans, commercial loans and consumer loans. The residential mortgage loan segment has one class, one- to four-family first lien residential mortgage loans. The construction and development loan segment consists of the following classes: residential and commercial and land loans. Residential construction loans are made for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built and occupied by the home-owner. Commercial construction loans are made for the purpose of acquiring, developing and constructing a commercial use structure and for acquisition, development and construction of residential properties by residential developers. The commercial loan segment consists of the following classes: commercial real estate loans, multi-family real estate loans, and other commercial loans, which are also generally known as commercial and industrial loans or commercial business loans. The consumer loan segment consists of the following classes: home equity lines of credit, second mortgage loans and other consumer loans, primarily unsecured consumer lines of credit.
Residential Lending. Residential mortgage originations are secured primarily by properties located in the Company’s primary market area and surrounding areas. At September 30, 2014, $231.3 million, or 59.5%, of our total loans in portfolio consisted of single-family residential mortgage loans.
Our single-family residential mortgage loans generally are underwritten on terms and documentation conforming to guidelines issued by Freddie Mac and Fannie Mae. Applications for one- to four-family residential mortgage loans are taken by our loan origination officers and are accepted at any of our banking offices and are then referred to the lending department at our main office in order to process the loan, which consists primarily of obtaining all documents required by Freddie Mac and Fannie Mae underwriting standards, and completing the underwriting, which includes making a determination whether the loan meets our underwriting standards such that the Bank can extend a loan commitment to the
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customer. We generally have retained for portfolio a substantial portion of the single-family residential mortgage loans that we originate. We currently originate fixed-rate, fully amortizing mortgage loans with maturities of 10 to 30 years. We also offer adjustable rate mortgage (“ARM”) loans where the interest rate either adjusts on an annual basis or is fixed for the initial one, three or five years and then adjusts annually. However, due to the low interest rate environment and demand for fixed rate products, we have not originated a significant amount of ARM loans in recent years. At September 30, 2014, $14.5 million, or 6.3%, of our one- to four-family residential mortgage loans consisted of ARM loans. Our no income/no asset (“NINA”) loans consisted of nine loans with an aggregated balance of  $1.6 million at September 30, 2014. Due to the high level of risk associated with NINA loans, we stopped originating such loans during August 2008. One of our NINA loans with an outstanding balance of approximately $99,000 was impaired and on non-accrual status at September 30, 2014.
We underwrite one- to four-family residential mortgage loans with loan-to-value ratios of up to 95%, provided that the borrower obtains private mortgage insurance on loans that exceed 80% of the appraised value or sales price, whichever is less, of the secured property. We also require that title insurance, hazard insurance and, if appropriate, flood insurance be maintained on all properties securing real estate loans. We require that a licensed appraiser from our list of approved appraisers perform and submit to us an appraisal on all properties secured by a first mortgage on one- to four-family first mortgage loans. Our mortgage loans generally include due-on-sale clauses which provide us with the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property. Due-on-sale clauses are an important means of adjusting the yields of fixed-rate mortgage loans in portfolio and we generally exercise our rights under these clauses.
Construction and Development Loans. The amount of our outstanding construction and development loans in portfolio decreased to $7.0 million or 1.8% of total loans at September 30, 2014 from $9.1 million or 2.2% of total loans as of September 30, 2013. From October 2009 through September 30, 2013, we ceased originating any new construction and development loans, with certain limited exceptions. During fiscal 2014, we resumed originating construction loans to builders and developers in our market area, on a relatively modest basis consistent with our business plan filed with the OCC. During the four year period that we generally ceased making new construction loans, we continued to originate single-family residential construction loans which, by their terms, converted to permanent, long-term mortgage loans upon completion of construction (“construction/perm.” loans). We had 15 of such construction/perm loans in portfolio with an aggregate outstanding balance of  $5.9 million at September 30, 2014. During the initial or construction phase, these construction/perm loans require payment of interest only, which generally is tied to prime rate, as the home is being constructed. On residential construction to perm loans the interest rate is the same as permanent loan rate during the construction period. Upon the earlier of the completion of construction or one year, these loans automatically convert to long-term (generally 30 years), amortizing, fixed-rate single-family mortgage loans. We generally limit construction loans to builders and developers with whom we had an established relationship, or who were otherwise known to officers of the Bank.
Our construction and development loans currently in the portfolio typically have variable rates of interest tied to the prime rate which improves the interest rate sensitivity of our loan portfolio. At September 30, 2014, all of our construction loans had variable rates of interest and 24.3% of such loans had two years or less in their remaining terms to maturity at such date.
Our current portfolio of construction loans generally have a maximum term to maturity of one year (for individual, owner-occupied dwellings), and loan-to-value ratios less than 80%. Residential construction loans to developers are made on either a pre-sold or speculative (unsold) basis. Limits are placed on the number of units that can be built on a speculative basis based upon the reputation and financial position of the builder, his/her present obligations, the location of the property and prior sales in the development and the surrounding area. Generally, a limit of two unsold homes (one model home and one speculative home) is placed per project.
Prior to committing to a construction loan, we require that an independent appraiser prepare an appraisal of the property. Each project also is reviewed and inspected at its inception and prior to every disbursement of loan proceeds. Disbursements are made after inspections based upon a percentage of project completion and monthly payment of interest is required on all construction loans.
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Our construction loans also include loans for the acquisition and development of land for sale (i.e. roads, sewer and water lines). We typically made these loans only in conjunction with a commitment for a construction loan for the units to be built on the site. These loans are secured by a lien on the property and were limited to a loan-to-value ratio not exceeding 75% of the appraised value at the time of origination. The loans have a variable rate of interest and require monthly payments of interest. The principal of the loan is repaid as units are sold and released. We limited loans of this type to our market area and to developers with whom we had established relationships. In most cases, we also obtained personal guarantees from the borrowers.
Our loan portfolio included one loan secured by unimproved real estate and lots (“land loan”), with an outstanding balance of  $1.0 million, constituting 0.3% of total loans, at September 30, 2014.
Construction and development loans generally are considered to involve a higher level of risk than one-to four-family residential lending, due to the concentration of principal in a limited number of loans and borrowers and the effect of economic conditions on developers, builders and projects. The average size of our construction loans was approximately $356,000 at September 30, 2014 compared to $380,000 at September 30, 2013. Additional risk is also associated with construction lending because of the inherent difficulty in estimating both a property’s value at completion and the estimated cost (including interest) to complete a project. The nature of these loans is such that they are more difficult to evaluate and monitor. In addition, speculative construction loans to a builder are not pre-sold and thus pose a greater potential risk than construction loans to individuals on their personal residences.
In order to mitigate some of the risks inherent to construction lending, we inspect properties under construction, review construction progress prior to advancing funds, work with builders with whom we have established relationships, require annual updating of tax returns and other financial data of developers and obtain personal guarantees from the principals. At September 30, 2014, $304,000, or 6.6%, of our allowance for loan losses was attributed to construction and development loans. We had $78,000 in non-performing construction and development loans in portfolio at September 30, 2014 compared to zero at September 30, 2013. During the fiscal year ended September 30, 2014, we charged off a total of  $37,000 in construction and development. See “Asset Quality — Non-Performing Loans and Real Estate Owned.” In addition to our non-performing construction and development loans, at September 30, 2014 and 2013, we had $109,000 and $446,000, respectively, in construction and development loans that were performing troubled debt restructurings.
Commercial Lending. At September 30, 2014, our loans in portfolio secured by commercial real estate amounted to $71.6 million and constituted 18.4% of our total loans at such date. During the year ended September 30, 2014, the commercial real estate loan portfolio increased by an aggregate of  $1.0 million, or 1.4%. During fiscal 2014 we had $183,000 in charge-offs of commercial real estate loans.
Our commercial real estate loan portfolio consists primarily of loans secured by office buildings, retail and industrial use buildings, strip shopping centers, mixed-use and other properties used for commercial purposes located in its market area. Loans in our commercial real estate portfolio tend to be in an amount less than $3.0 million, but some exceed that amount. At September 30, 2014, the average amount outstanding on our commercial real estate loans in portfolio was $304,000. During the year ended September 30, 2014, the average yield on our commercial real estate loans was 4.9% compared to 4.0% for our single-family residential mortgage loans. Commercial real estate loans are much more likely to have adjustable interest rates than single-family residential mortgage loans, which adds to the interest rate sensitivity of commercial real estate loans and makes them attractive. At September 30, 2014, approximately 66.2% of our commercial real estate loans in portfolio had adjustable interest rates compared to 6.3% of our single-family residential mortgage loans with adjustable rates at such date.
Although terms for commercial real estate and multi-family loans vary, our underwriting standards generally allow for terms up to 10 years with the interest rate being reset in the fifth year and with monthly amortization not greater than 25 years and loan-to-value ratios of not more than 80%. Interest rates are either fixed or adjustable, based upon the prime rate plus a margin, and fees ranging from 0.5% to 1.50% are charged to the borrower at the origination of the loan. Prepayment fees are charged on most loans in the event of early repayment. Generally, we obtain personal guarantees of the principals as additional collateral for commercial real estate and multi-family real estate loans.
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Commercial and multi-family real estate loans generally present a higher level of risk than loans secured by one- to four-family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effect of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by commercial and multi-family real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed, a bankruptcy court modifies a lease term, or a major tenant is unable to fulfill its lease obligations), the borrower’s ability to repay the loan may be impaired. As of September 30, 2014, $504,000 of our commercial real estate mortgage loans were on non-accrual status and an aggregate of  $2.7 million of our commercial real estate loans at such date were classified for regulatory reporting purposes as substandard. See “Asset Quality — Asset Classification.” As of September 30, 2014, $1.2 million, or 27.2% of our allowance for loan losses was allocated to commercial real estate mortgage loans. In addition, at September 30, 2014 and 2013, we held $833,000 and $1.9 million, respectively, of real estate owned which was acquired from foreclosures on, or our acceptance of a deed-in-lieu of foreclosure, on commercial real estate loans. See “Asset Quality — Non-Performing Assets and Real Estate Owned.” None of our commercial real estate loans held in portfolio were deemed performing troubled debt restructurings at September 30, 2014 or at September 30, 2013.
At September 30, 2014, our loan portfolio included four loans with an aggregate book value of  $1.0 million secured by multi-family (more than four units) properties, constituting 0.3% of our total loans at such date. These loans are for properties located in Chester County and Delaware County, Pennsylvania, respectively. As of September 30, 2014, we had no non-accruing multi-family loans.
At September 30, 2014, we had $5.5 million in commercial business loans (1.4% of gross loans outstanding) in portfolio. Our commercial business loans generally have been made to small to mid-sized businesses located in our market area. The commercial business loans in our portfolio assist us in our asset/liability management since they generally provide shorter maturities and/or adjustable rates of interest in addition to generally having higher rates of return which are designed to compensate for the additional credit risk associated with these loans. The commercial business loans which we have originated may be either a revolving line of credit or for a fixed term of generally 10 years or less. Interest rates are adjustable, indexed to a published prime rate of interest, or fixed. Generally, equipment, machinery, real property or other corporate assets secure such loans. Personal guarantees from the business principals are generally obtained as additional collateral. At September 30, 2014, the average balance of our commercial business loans was $249,000.
Generally, commercial business loans are characterized as having higher risks associated with them than single-family residential mortgage loans. As of September 30, 2014, we had no non-accruing commercial business loans in portfolio. At such date, $50,000 or 1.1% of the allowance for loan losses was allocated to commercial business loans. At September 30, 2014 and at September 30, 2013, $900,000 of our commercial business loans held in portfolio were deemed performing troubled debt restructurings.
In our underwriting procedures, consideration is given to the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, our practice in recent periods is to impose a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. Appraisal reports prepared by independent appraisers are obtained on each loan to substantiate the property’s market value, and are reviewed by us prior to the closing of the loan.
Consumer Lending. In our efforts to provide a full range of financial services to our customers, we offer various types of consumer loans. Our consumer loans amounted to $72.2 million or 18.6% of our total loan portfolio at September 30, 2014. The largest components of our consumer loans are loans secured by second mortgages, consisting primarily of home equity loans, which amounted to $47.0 million at September 30, 2014, and home equity lines of credit, which amounted to $22.3 million at such date. Our consumer loans also include automobile loans, unsecured personal loans and loans secured by deposits. Consumer loans are originated primarily through existing and walk-in customers and direct advertising.
Our home equity lines of credit are variable rate loans tied to the prime rate. Our second mortgages may have fixed or variable rates, although they generally have had fixed rates in recent periods. Our second
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mortgages have a maximum term to maturity of 15 years. Both our second mortgages and our home equity lines of credit generally are secured by the borrower’s primary residence. However, our security generally consists of a second lien on the property. Our lending policy provides that our home equity loans have loan-to-value ratios of 80% or less when combined with any Malvern Federal Savings Bank’s first mortgage. Our lending policy also provides that our home equity loans have loan-to-value ratios of 75% or less when combined with any first mortgage with any other financial institution. The maximum loan-to-value ratio on our home equity lines of credit is 80%, when Malvern Federal Savings has the first mortgage. However, the maximum loan-to-value ratio on our home equity lines of credit is reduced to 75%, when the Bank does not have the first mortgage. At September 30, 2014, the unused portion of our home equity lines of credit was $14.9 million.
Consumer loans generally have higher interest rates and shorter terms than residential loans; however, they have additional credit risk due to the type of collateral securing the loan or in some cases the absence of collateral. In the year ended September 30, 2014, we charged-off  $638,000 of consumer loans mostly consisting of second mortgage loans. We are continuing to evaluate and monitor the credit conditions of our consumer loan borrowers and the real estate values of the properties securing our second mortgage loans as part of our on-going efforts to assess the overall credit quality of the portfolio in connection with our review of the allowance for loan losses. As of September 30, 2014, we had an aggregate of  $577,000 of non-accruing second mortgage loans and home equity lines of credit, representing an improvement of $29,000 over the amount of non-accruing second mortgage loans and home equity lines of credit at September 30, 2013. At September 30, 2014, $836,000 of our consumer loans were classified as substandard and we had no doubtful consumer loans. At September 30, 2014, an aggregate of  $1.2 million of our allowance for loan losses was allocated to second mortgages and home equity lines of credit.
Loan Maturity. The following table presents the contractual maturity of our loans held in portfolio at September 30, 2014. The table does not include the effect of prepayments or scheduled principal amortization. Loans having no stated repayment schedule or maturity and overdraft loans are reported as being due in one year or less.
At September 30,
In One Year
or Less
After One Year
through
Five Years