10-K 1 trcb-123117x10k.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549 
FORM 10-K
(Mark One)
 
ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
 
TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _______
Commission file number:  000-51889
TWO RIVER BANCORP
(Exact Name of Registrant as Specified in Its Charter)
New Jersey
  
20-3700861
(State or Other Jurisdiction of
Incorporation or Organization)
  
(I.R.S. Employer Identification Number)
 
  
766 Shrewsbury Avenue, Tinton Falls, New Jersey 07724
  
  
(Address of Principal Executive Offices, including Zip Code)
  
  
(732) 389-8722
  
  
(Registrant’s telephone number, including area code)
  
Securities registered pursuant to Section 12(b) of the Act:
 
Common Stock, no par value 
  
The NASDAQ Stock Market LLC
Title of each class
  
Name of each exchange on which registered 
Securities registered pursuant to Section 12(g) of the Act:
  
Preferred Stock Purchase Rights
  
  
(Title of Class)
  
 
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 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 (or for such shorter period that the registrant was required to file such reports), 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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes ☒     No ☐

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Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 ☐
Accelerated filer
 x
Non-accelerated filer (Do not check if a smaller reporting company)
 ☐
Smaller reporting company
 ☐
Emerging growth company
 ☐
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).   Yes ☐    No ☒
The aggregate market value of the registrant’s voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the price at which the common stock was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter, is $132,975,441.
As of March 1, 2018, 8,501,628 shares of the registrant’s common stock were outstanding.
Documents incorporated by reference
Portions of the registrant’s definitive Proxy Statement for its 2018 Annual Meeting of Shareholders are incorporated by reference into Part III of this report and will be filed within 120 days of December 31, 2017.

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FORM 10-K
TABLE OF CONTENTS
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  
  

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PART I
Forward-Looking Statements

From time to time, Two River Bancorp (the “Company”) may include forward-looking statements relating to such matters as anticipated financial performance, business prospects, technological developments, new products, research and development activities and similar matters in this and other filings with the Securities and Exchange Commission (the “SEC”). The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. When used in this and in future filings by us with the SEC, in our press releases and in oral statements made with the approval of one of our authorized executive officers, the words or phrases “will,” “will likely result,” “could,” “anticipates,” “believes,” “continues,” “expects,” “plans,” “will continue,” “is anticipated,” “estimated,” “project” or “outlook” or similar expressions (including confirmations by one of our authorized executive officers of any such expressions made by a third party with respect to us) are intended to identify forward-looking statements. We wish to caution readers not to place undue reliance on any such forward-looking statements, each of which speaks only as of the date made, even if subsequently made available on our website or otherwise. Such statements are subject to certain risks and uncertainties, many of which are beyond our control, that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. The forward-looking statements are and will be based on management’s then-current views and assumptions regarding future events and operating performance, and are applicable only as of the dates of such statements.
 
Factors that may cause actual results to differ from those results expressed or implied, include, but are not limited to, those listed in this report under the heading “Risk Factors”; the ability of customers to repay their obligations; the adequacy of the allowance for loan losses; developments in the financial services industry and U.S. and global credit markets; downward changes in the direction of the economy nationally or in New Jersey; changes in interest rates; competition; loss of management and key personnel; government regulation; environmental liability; failure to implement new technologies in our operations; changes in our liquidity; changes in our funding sources; failure of our controls and procedures; disruptions of our operational systems and relationships with vendors; and our success in managing risks involved in the foregoing. Although management has taken certain steps to mitigate any negative effect of the aforementioned items, significant unfavorable changes could severely impact the assumptions used and have an adverse effect on profitability. Such risks and other aspects of our business and operations are described in Item 1. “Business,” Item 1A. “Risk Factors” and Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this report. We have no obligation to publicly release the result of any revisions which may be made to any forward-looking statements to reflect anticipated or unanticipated events or circumstances occurring after the date of such statements.
 
Item 1. Business.
 
The disclosures set forth in this item are qualified by Item 1A. “Risk Factors,” Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other statements set forth in this report.
 
Two River Bancorp – General Overview
 
Two River Bancorp, which we refer to herein as the “Company,” “we,” “us” and “our,” is a business corporation incorporated under the laws of the State of New Jersey in August 2005.
 
The principal place of business of Two River Bancorp is located at 766 Shrewsbury Avenue, Tinton Falls, New Jersey 07724 and its telephone number is (732) 389-8722. Effective June 28, 2013, the Company changed its name from Community Partners Bancorp to Two River Bancorp.
 
Two River Bancorp serves as a holding company for Two River Community Bank (“Two River” or the “Bank”), a New Jersey state-chartered commercial bank, having a branch network consisting of 14 branches and two loan production offices (“LPOs”) throughout Monmouth, Middlesex, Union and Ocean Counties, New Jersey. The Company’s website is www.tworiverbank.com.

As of December 31, 2017 the Company had consolidated assets of $1.04 billion, total loans of $850.9 million, total deposits of $861.6 million and shareholders’ equity of $106.6 million.


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Other than its investment in the Bank, Two River Bancorp currently conducts no other significant business activities. Two River Bancorp may determine to operate its own business or acquire other commercial banks, thrift institutions or bank holding companies, or engage in or acquire such other activities or businesses as may be permitted by applicable law, although it has no present plans or intentions to do so. When we refer to the business conducted by Two River Bancorp in this document, including any lending or other banking activities, we are referring to the business that Two River Bancorp conducts through the Bank.

Employees

As of December 31, 2017, the Company and its subsidiaries had 157 full-time equivalent employees, of whom 153 were full-time and 8 were part-time. None of the Company's employees are represented by a union or covered by a collective bargaining agreement. Management of the Company and the Bank believe that, in general, their employee relations are good.
 
Two River Community Bank
 
Two River Community Bank was organized in January 2000 as a New Jersey state-chartered commercial bank to engage in the business of commercial and retail banking.
 
As a community bank, the Bank offers a wide range of banking services including demand, savings and time deposits and commercial, residential and consumer/installment loans to small and medium-sized businesses, not-for-profit organizations, professionals and individuals primarily in Monmouth, Middlesex, Union and Ocean Counties, New Jersey.
 
The Bank also offers its customers numerous banking products such as safe deposit boxes, night depository, wire transfers, money orders, automated teller machines, direct deposit, telephone and internet banking and corporate business services. The Company markets to consumers in geographic areas around its branch network not only through existing bricks and mortar, but also with alternative delivery mechanisms and new product development such as online banking, remote deposit capture, mobile banking and telephonic banking. In addition, the Company attracts new customers by making its service through these distribution points convenient. All of the Company’s existing markets are prime targets for expanding the consumer side of its business with full loan and deposit relationships, and the Company has restructured its retail group to accommodate growth.
 
The Bank currently operates 14 banking offices in Monmouth, Middlesex and Union Counties, New Jersey and a corporate headquarters building.
 
The Bank’s corporate headquarters is located at 766 Shrewsbury Avenue, Tinton Falls, New Jersey, while its principal banking office is located at 1250 Highway 35 South, Middletown, New Jersey. Other banking offices are located in Atlantic Highlands, Navesink, Port Monmouth, Freehold, Red Bank, Sea Girt, Tinton Falls (2), West Long Branch, New Brunswick, Westfield, Cranford and Fanwood, New Jersey.
 
The Bank also operates two regional LPOs, one each in Union and Ocean Counties, New Jersey, for the purpose of expanding our presence in these communities.
 
We believe that the Bank’s customers still want to do business and have a relationship with their banker. To accomplish this objective, we emphasize to our employees the importance of delivering exemplary customer service and seeking out opportunities to build further relationships with the Bank’s customers. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) up to the statutory limits.
 
Growth Strategy
 
Profitable and sustainable growth is the Company’s primary goal. In order to achieve our goal, our strategic plan centers on the following:

Aligning resources to support strategy and productivity;
Increase fee and other non-interest income, primarily through mortgage banking and SBA lending;
Continued improvement in net interest income through controlled balance sheet growth; and
Growth in earnings per share.

We will also consider the acquisition of a smaller financial institution, in whole or branch acquisition, should the opportunity arise and economics support, as an avenue to achieve our desired growth.
 

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Securing deposits to support expansion across our key lines of business remains a priority for us. Technology initiatives will assist us as well.
 
During 2017, we focused on growth in core markets by increasing loan production, increasing fee-based income and improving profitability. The Company grew loans by $97.8 million and achieved annual net income of $6.5 million.
 
We are focusing on establishing a market presence in the communities between Union and Ocean Counties by adding strategically located new branches and loan production offices. We will accomplish this goal while operating in a safe and sound manner to provide a desirable return to our shareholders.
 
In the third quarter of 2017, the Company closed and consolidated its Allaire and Manasquan branches into a new and more visible location in Sea Girt, New Jersey. The closure of these offices was in line with our strategic plans of optimizing the profitability of our branch network.

We have taken the approach of opening low-cost LPOs in contiguous markets, and once a certain level of business is achieved, we will consider replacing these LPOs with a full-service branch at an appropriate location within that market. Currently, we have two active LPOs.
 
We believe that this strategy continues to build shareholder value and increase revenues and earnings per share by creating a larger base of lending and deposit relationships while achieving economics of scale and other efficiencies.
 
Our efforts include looking for potential new retail banking offices in markets where we have established lending relationships, as well as exploring opportunities to grow and add other profitable banking-related businesses. We believe that by establishing banking offices in attractive growth markets while providing high level customer service, our core deposits will naturally increase.
 
Our priorities also include the following:

Organically growing the size of the loan portfolio;
Utilizing technology to attract new customers and lower costs; and
Enhancing our electronic delivery channels.

Competitive Advantages
 
Attractive franchise in demographically desirable markets in New Jersey
 
We believe that the Bank has a strong regional presence in Monmouth, Middlesex, Union and Ocean Counties, which consist of densely populated areas with average household incomes above the US national average. The Company currently has 10 branches in Monmouth County, which currently ranks as the fourth highest median household income county in New Jersey.
 
Commercial lending expertise
 
We believe we have a strong track record of quality commercial loans, highlighted by a niche expertise in our Private Banking Division (medical practitioners and business owners) and SBA lending without any reliance on wholesale loan purchases.
 
Local brand recognition
 
We believe we have competed effectively by leveraging a branch network and a full assortment of banking products to facilitate loan growth in our core locations.
 

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Conservative underwriting parameters utilizing local expertise
 
The majority of our portfolio is secured by New Jersey properties, with average loan-to-value ("LTV") at origination of 75% or less, predominantly owner-occupied along with strong cash flow. We believe this local presence allows our loan underwriters to be able to assess loan candidates better than our peers.

 High touch regional banking service
 
The Bank strives to compete against local and national competition through personalized customer service, operating upon the principle that a locally owned and operated bank dedicated to the needs of the local community can meaningfully outperform large regional banks managed from outside of this region, in terms of outstanding customer care, responsiveness, and commitment to the community.
 
Products and Services
 
The Bank offers a full range of banking services to our customers. These services include a wide variety of business and consumer lending products as well as corporate services for businesses and professionals. We offer a range of deposit products including checking, savings, money market accounts and certificates of deposit (“CD”). The Bank also participates in the Certificate of Deposit Account Registry Service (“CDARS”), a service that enables us to provide our customers with additional FDIC insurance on CD products. Other products and services include remote deposit capture, safe deposit boxes, ACH services, debit and ATM cards, money orders, direct deposit and coin counting. We also offer customers the convenience of a full complement of electronic banking services accessible either through the web, mobile device or telephone. These services allow customers to perform various transactions, such as making mobile check deposits (consumer), monitoring account balances, receiving email alerts, transferring funds (internal and external), sending and receiving person-to-person payments, initiating stop payment requests, reordering checks and paying bills. The Bank continues to invest in technology solutions for its customers and plans to expand and enhance its electronic services.

Lending Activities
 
The Bank engages in a variety of lending activities, which are primarily categorized as either:
(i)
commercial;
(ii)commercial real estate; and
(iii)
residential or consumer lending.

The strategy is to focus our lending activities on small and medium-sized business customers and retain customers by offering them a wide range of products and personalized service. Commercial and real estate mortgage lending (consisting of commercial real estate, commercial business, construction, residential and other commercial lending, including medical lending and private banking) are currently our main lending focus. Loans are funded primarily from deposits, although we do borrow to fund loan growth or meet deposit outflows.
 
The Bank presently generates virtually all of our loans from borrowers located in the State of New Jersey, with a significant portion in Monmouth, Middlesex, Union and Ocean Counties. Loans are generated through marketing efforts, the Bank’s present base of customers, walk-in customers, referrals, our directors and members of the Bank’s advisory boards. The Bank strives to maintain a high overall credit quality through the establishment of and adherence to prudent lending policies and practices. The Bank has an established written loan policy that has been adopted by the Board of Directors, which is reviewed at least annually. Any loans to members of the Board of Directors or their affiliates must be reviewed and approved by the Bank’s Board of Directors in accordance with the loan policy as well as applicable state and federal banking laws. In accordance with our loan policy, approvals of affiliated transactions are made only by independent board members.
 
In managing the growth and quality of the Bank’s loan portfolio, we have focused on:
(i)
the application of prudent underwriting criteria;
(ii)
the active involvement by senior management and the Bank’s Board of Directors in the loan approval process;
(iii)
the active monitoring of loans to ensure timely repayment and early detection of potential problems; and
(iv)
a loan review process by an independent loan review firm, which conducts in-depth reviews of portions of the loan portfolio on a quarterly basis and an annual stress test of the commercial real estate portfolio.

Our principal earning assets are loans originated or participated in by the Bank. The risk that certain borrowers will not be able to repay their loans under the existing terms of the loan agreement is inherent in the lending function. Risk elements in a

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loan portfolio include non-accrual loans (as defined below), past due and restructured loans, potential problem loans, loan concentrations (by industry or geographically) and other real estate owned acquired through foreclosure or a deed in lieu of foreclosure. Because the Bank makes loans to borrowers located in Monmouth, Middlesex, Union and Ocean Counties, New Jersey and elsewhere, each loan or group of loans presents a geographical and credit risk based upon the condition of the local economy. The local economy is influenced by conditions such as housing prices, employment conditions and changes in interest rates.
 
Construction Loans
 
We originate fixed-rate and adjustable-rate loans to individuals and builders to finance the construction of residential dwellings. We also originate construction loans for commercial development projects, including shopping centers, medical office space and owner-occupied properties used for businesses. Within these project types, the Bank also offers land development loans. Our construction loans generally provide for the payment of interest only during the construction phase which is usually twelve months for residential owner occupied properties and twelve to eighteen months for commercial properties and upwards to 36 months for land development projects, depending on the size and scope of the project. At the end of the commercial or residential construction phase, the loan can either be converted to a permanent loan or paid in full.
 
Before making a commitment to fund a construction loan, we require an appraisal of the property by a bank approved independent licensed appraiser, appropriate environmental due diligence, a construction cost review, an inspection of the property before disbursement of funds during the stages of the construction process, and pre-qualification from an identified source for the permanent takeout.
 
Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a building having a value which is insufficient to assure full repayment. If we are forced to foreclose on a building before or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

Commercial and Industrial and Commercial Real Estate Loans
 
The Bank originates commercial and industrial loans for business purposes to sole proprietorships, partnerships, corporations, limited liability companies, and small businesses in our lending market areas. We extend commercial business loans on a secured and unsecured basis. Secured commercial loans are generally collateralized by residential and nonresidential real estate, marketable securities, accounts receivable, inventory, industrial/commercial machinery and equipment, and furniture and fixtures. To further enhance our security position, we typically require personal guarantees of the principal owners of the entities to which we extend credit. These loans are made on both lines of credit and fixed-term basis ranging from one to five years in duration.
 
When making commercial business loans, we consider the financial statements and/or tax returns of the borrower, the borrower’s payment history along with the principal owners’ payment history, the debt service capabilities of the borrower, the projected cash flows of the business, the value of the collateral and the financial strength of the guarantor.
 
Commercial real estate loans are made to local commercial, retail and professional firms and individuals for the acquisition of property or the refinancing of existing property. These loans are typically related to commercial businesses and secured by the underlying real estate used in these businesses or real property of the principals. These loans are generally offered on a fixed or variable rate basis, subject to rate re-adjustments every five years and amortization schedules ranging from 5 to 25 years.

Our established written underwriting guidelines for commercial loans are periodically reviewed and enhanced as needed. Pursuant to these guidelines, in granting commercial loans, we look primarily to the borrower’s cash flow as the principal source of loan repayment. To monitor cash flows on income properties, we require borrowers and loan guarantors of loan relationships to provide annual financial statements, rent rolls and/or tax returns. Collateral and personal guarantees of the principals of the entities to which we lend are consistent with the requirements of our loan policy.
 


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 Commercial loans are often larger and may involve greater risks than other types of lending. Because payments of such loans are often dependent on the successful operation of the business involved, repayment of such loans may be more sensitive than other types of loans and are subject to adverse conditions in the real estate market, or the general economy. We are also involved with off-balance sheet financial instruments, which include collateralized commercial and standby letters of credit. We seek to minimize these risks through our underwriting guidelines and prudent risk management techniques. Any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value. Environmental surveys and inspections are obtained when circumstances suggest the possible presence of hazardous materials. There can be no assurances, however, of success in the efforts to minimize these risks.
 
Unlike residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income and which are secured by real property the value of which tends to be more easily ascertainable, commercial loans are of higher risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business operation. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself as the primary source of repayment. Further, any collateral securing such loans may depreciate over time and may be difficult to appraise as values fluctuate.
 
Residential Real Estate Loans / Mortgage Banking

The Company’s mortgage banking activity is primarily related to the origination of one-to-four family residential real estate located within our primary market areas in Monmouth, Middlesex, Union and Ocean Counties of New Jersey. We offer a full range of residential real estate loans. We do not originate subprime or negative amortization loans. Residential real estate loans consist of single-family detached units, individual condominium units, two-to-four family dwelling units and townhouses.
 
We typically retain adjustable-rate mortgage (“ARM”) loans in our portfolio. In recent periods, borrowers have largely trended towards fixed-rate loans as a result of the continuation of the historically low interest rate market. The Company’s fixed-rate mortgage banking activities typically have contractual maturities exceeding fifteen years and beyond. These loans are sold, on a case-by-case basis, in the secondary market as part of the Company’s efforts to manage interest rate risk.

Consumer Loans
 
The Bank offers consumer loans that are extended to individuals for personal or household purposes. These loans consist of home equity lines of credit, home equity loans, personal loans, automobile loans and overdraft protection.
 
Our home equity revolving lines of credit come with a floating interest rate tied to the prime rate. Lines of credit are available to qualified applicants in amounts up to $350,000 for up to 15 years. We also offer fixed rate home equity loans in amounts up to $350,000 for a term of up to 15 years. Credit is based on the income and cash flow of the individual borrowers, properly margined real estate collateral supporting the mortgage debt and past credit history.
 
Consumer loans may entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that are in junior mortgage position. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
 
Participation Loans
 
The Bank underwrites all loan participations in accordance with our underwriting standards. We will not participate in a loan transaction unless each participant has a substantial interest in the loan relationship. In addition, we also consider the financial strength and reputation of the lead lender. To monitor cash flows on loan participations, we look for the lead lender to provide at a minimum, tax returns and annual financial statements for the borrower. Generally, we also conduct an annual internal loan review for participations.
 

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Small Business Administration (“SBA”) Loans
 
The Bank offers SBA loans and achieved Preferred Lending status in 2011, which allows us to have delegated authority to approve and close SBA loans up to $5.0 million. Our risk philosophy in SBA lending is an extension of our existing credit culture and focused on the cash flow of the businesses while maintaining our commitment to providing small and mid-sized companies access to the credit they need to expand and hire. The Bank participates in SBA’s 7(a), including 7(a) sub-program such as SBA Express, and 504 loan programs. The 7(a) program typically provides guarantees ranging from 50% to 85%. The 504 program provides fixed rate financing with a first lien position for a conventional loan followed by a SBA debenture loan in a subordinated position. The 504 program is administered through SBA’s Certified Development Companies (“CDCs”). A typical 504 structure transaction is broken down by a 10% equity injection by the borrower, a 40% SBA debenture and a 50% conventional mortgage.
 
Market Area
 
Our primary market area consists of Monmouth, Middlesex, Union and Ocean Counties, New Jersey. Our customer base is primarily made up of business and personal banking relationships within these market areas.
 
We attract deposit relationships from individuals, merchants, small to medium-sized businesses, municipalities, not-for-profit organizations and professionals who live and/or work in the communities comprising our market areas. As of December 31, 2017, approximately 55% of our deposits are from businesses and 45% from consumers.
 
Competition
 
The Bank faces substantial competition for deposits and creditworthy borrowers. It competes with New Jersey and regionally based commercial banks, savings banks and savings and loan associations, as well as national financial institutions, many of which have assets, capital and lending limits greater than that of the Bank. Other competitors include money market mutual funds, mortgage bankers, insurance companies, stock brokerage firms, regulated small loan companies, credit unions and issuers of commercial paper and other securities.
 
We face significant competition from banks with much larger branch networks nationwide, as well as credit unions and other community banks.
 
Asset Quality
 
We believe that strong asset quality is a key to long-term financial success. We have sought to grow and diversify the loan portfolio, while maintaining a high level of asset quality and moderate credit risk, using underwriting standards that we believe are conservative along with diligent monitoring. As we continue to grow and leverage our capital, we envision that loans will continue to be our principal earning assets. An inherent risk in lending is the borrower’s ability to repay the loan under its existing terms. Risk elements in a loan portfolio include non-accrual loans (as defined below), past due and restructured loans, potential problem loans, loan concentrations (by industry or geographically) and other real estate owned acquired through foreclosure or a deed in lieu of foreclosure.

Non-performing assets include loans that are not accruing interest (non-accrual loans) as a result of principal or interest being in default for a period of 90 days or more, loans past due 90 days or more and still accruing and other real estate owned, which consists of real estate acquired as the result of a defaulted loan. When a loan is classified as non-accrual, interest accruals cease and all past due interest is reversed and charged against current income. Until the loan becomes current as to principal or interest, as applicable, any payments received from the borrower are applied to outstanding principal and fees and costs to the Bank, unless we determine that the financial condition of the borrower and other factors merit recognition of such payments as interest.
 
A troubled debt restructuring (“TDR”) is a loan in which the contractual terms have been modified resulting in the Bank granting a concession to a borrower who is experiencing financial difficulties in order for the Bank to have a greater opportunity of collecting the indebtedness from the borrower. Non-accruing TDRs are included in non-performing loans.
 

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We utilize a risk system, as described below under the section titled “Allowance for Loan Losses,” as an analytical tool to assess risk and set appropriate reserves. In addition, the FDIC has a classification system for problem loans and other lower quality assets, classifying them as “substandard,” “doubtful” or “loss.” A loan is classified as “substandard” when it is inadequately protected by the current value and paying capacity of the obligor or the collateral pledged, if any. Loans with this classification have a well-defined weakness or a weakness that jeopardizes the liquidation of the debt. They are characterized by the distinct possibility that some loss may occur if the deficiencies are not corrected. A loan is classified “doubtful” when it has all the weaknesses inherent in a loan classified as substandard with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing factors, conditions, and values, highly questionable and improbable. A loan is classified as “loss” when it is considered uncollectible and such little value that the loan’s continuance as an asset on the balance sheet is not warranted.
 
In addition to categories for non-accrual loans and loans past due 90 days or more that are still accruing interest, we maintain a “watch list” of performing loans where management has identified conditions which potentially could cause such loans to be downgraded into higher risk categories in future periods. Loans on this list are subject to heightened scrutiny and more frequent review by management. See Note 1-I in the Notes to Consolidated Financial Statements for more information. Non-performing assets are further discussed within the “Asset Quality” section under Item 7 of this report.

Allowance for Loan Losses
 
We maintain an allowance for loan losses at a level that we believe is adequate to provide for probable losses inherent in the loan portfolio. Loan losses are charged directly to the allowance when they occur and any recovery is credited to the allowance when realized. Risks from the loan portfolio are analyzed on a continuous basis by the Bank’s senior management, outside independent loan reviewers, the directors’ asset quality loan committee, the Board of Directors and our regulators.
 
The level of the allowance is determined by assigning specific reserves to impaired loans and general reserves on all other loans. The portion of the allowance that is allocated to impaired loans is determined by estimating the inherent loss on each credit after giving consideration to the value of the underlying collateral. A risk system, consisting of multiple grading categories, is utilized as an analytical tool to assess risk and set appropriate general reserves. Along with the risk system, senior management evaluates risk characteristics of the loan portfolio under current and anticipated economic conditions and considers such factors as the financial condition of the borrower, past and expected loss experience, and other factors management feels deserve recognition in establishing an appropriate reserve. These estimates are reviewed at least quarterly, and as adjustments become necessary, they are realized in the periods in which they become known. Additions to the allowance are made by provisions charged to expense and the allowance is reduced by net charge-offs (i.e., loans judged to be uncollectible and charged against the reserve, less any recoveries on such loans).
 
Although management attempts to maintain the allowance at a level deemed adequate to cover any losses, future additions to the allowance may be necessary based upon any changes in market conditions, either generally or specific to our area, or changes in the circumstances of particular borrowers. In addition, various regulatory agencies periodically review our allowance for loan losses, and may require us to take additional provisions based on their judgments about information available to them at the time of their examination. See Note 1-J in the Notes to Consolidated Financial Statements for more information.
 
Risk Management
 
Managing risk is an essential part of a successful financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available for sale securities that are accounted for on a fair value basis. Other risks that we face are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, and technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue. 


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The management of and authority to assume interest rate risk is the responsibility of the Asset/Liability Committee (“ALCO”), which is comprised of senior management and board members. The primary objective of Asset/Liability management is to establish prudent risk management guidelines and to coordinate balance sheet composition with interest rate risk management to sustain a reasonable and stable net interest income throughout various interest rate cycles. We have policies and practices for measuring and reporting interest rate risk exposure, through analysis of the net interest margin, gap position, simulation testing, liquidity ratios and the Economic Value of Portfolio Equity. In addition, we annually review our interest rate risk policy, which includes limits on the impact to earnings from shifts in interest rates.
 
Credit Risk Management
 
Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. The Bank conducts annual commercial real estate stress testing. To further enhance our credit risk management strategy, we engage a third party loan review firm to provide additional portfolio surveillance. When a borrower fails to make a required loan payment, we take a number of steps to attempt to have the borrower cure the delinquency and restore the loan to current status. When the loan becomes 15 days past due, a late charge notice is generated and sent to the borrower and a representative of the Bank attempts to communicate by phone with the borrower to discuss the late payment. If payment is not then received by the 30th day of delinquency, a further notification is sent to the borrower. If no resolution can be achieved, after a loan becomes 90 days delinquent, we may commence foreclosure or other legal proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. We may consider loan workout arrangements with certain borrowers under certain circumstances.
 
Management reports to the Board of Directors monthly regarding the amount of loans delinquent more than 30 days, all loans in foreclosure and all foreclosed and repossessed property that we own.
 
Investment Portfolio
 
Our investment portfolio consists primarily of obligations of U.S. Government sponsored agencies as well as municipal and government authority bonds, with corporate bonds accounting for less than 10% of the portfolio. Government regulations limit the type and quality of instruments in which the Company may invest its funds.
 
We conduct our asset/liability management through consultation with members of our Board of Directors, senior management and an outside financial advisor. The ALCO, which is comprised of the president, senior officers and certain members of our Board of Directors, is responsible for the review of interest rate risk and evaluates future liquidity needs over various time periods.
 
We have established a written investment policy which is reviewed annually by the ALCO and our Board of Directors that applies to Two River Bancorp and the Bank. The investment policy identifies investment criteria and states specific objectives in terms of risk, interest rate sensitivity and liquidity and emphasizes the quality, term and marketability of the securities acquired for our investment portfolio.
 
The ALCO is responsible for monitoring the investment portfolio and ensuring that investments comply with the investment policy. The ALCO may from time to time consult with investment advisors. The Bank’s president and its chief financial officer may purchase or sell securities on behalf of the Bank in accordance with the guidelines of the ALCO committee. The Board of Directors reviews the composition and performance of the investment portfolio, including all transactions, on a monthly basis.
 
Deposit Products
 
We strive to develop relationships and serve as the primary financial institution for commercial and individual customers. A key priority in this mission is obtaining transaction accounts, which are frequently non-interest bearing deposits or lower cost interest bearing checking, savings and money market deposit accounts.
 
Deposits are the primary source of funds used in lending and other general business purposes. In addition to deposits, we may derive additional funds from principal repayments on loans, the sale of investment securities and borrowings from other financial institutions. Loan amortization payments have historically been a relatively predictable source of funds. The level of deposit liabilities can vary significantly and is influenced by prevailing interest rates, money market conditions, general economic conditions and competition.
 

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The Bank’s deposits consist of checking accounts, savings accounts, money market accounts and CDs. All deposits are obtained from individuals, partnerships, corporations and unincorporated businesses. The Bank participates in CDARS, a service that enables us to provide our customers with additional FDIC insurance on CD products. We attempt to control the flow of deposits primarily by pricing our accounts to remain competitive with other financial institutions in our market area.

Supervision and Regulation
 
Overview
 
Two River Bancorp operates within a system of banking laws and regulations intended to protect bank customers and depositors, and these laws and regulations govern the permissible operations and management, activities, reserves, loans and investments of the Company.
 
Two River Bancorp is a bank holding company under the Federal Bank Holding Company Act of 1956 (“BHCA”), as amended, and is subject to the supervision of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). In general, the BHCA limits the business of bank holding companies to banking, managing or controlling banks, and performing certain servicing activities for subsidiaries and, as a result of the Gramm-Leach-Bliley Act amendments, permits bank holding companies that are also financial holding companies to engage in any activity, or acquire and retain the shares of any company engaged in any activity, that is either (1) financial in nature or incidental to such financial activity or (2) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. In order for a bank holding company to engage in the broader range of activities that are permitted by the BHCA for bank holding companies that are also financial holding companies, upon satisfaction of certain regulatory criteria, the bank holding company must file a declaration with the Federal Reserve Board that it elects to be a “financial holding company.” Two River Bancorp is also subject to other federal laws and regulations as well as the corporate laws and regulations of New Jersey, the state of its incorporation.
 
The BHCA prohibits the Company, with certain exceptions, from acquiring direct or indirect ownership or control of more than five percent of the voting shares of any company which is not a bank and from engaging in any business other than that of banking, managing and controlling banks or furnishing services to subsidiary banks. The BHCA requires prior approval by the Federal Reserve Board of the acquisition by the Company of more than five percent of the voting stock of any other bank. Satisfactory capital ratios, Federal Community Reinvestment Act ratings and anti-money laundering policies are generally prerequisites to obtaining federal regulatory approval to make acquisitions.
 
The Bank is a commercial bank chartered under the laws of the State of New Jersey and is subject to the New Jersey Banking Act of 1948 (the “Banking Act”). As such, it is subject to regulation, supervision and examination by the New Jersey Department of Banking and Insurance and by the FDIC. Each of these agencies regulates aspects of activities conducted by the Bank and Two River Bancorp, as discussed below. The Bank is not a member of the Federal Reserve Bank of New York.
 
The following descriptions summarize some of the key laws and regulations to which the Bank is subject, and to which Two River Bancorp is subject as a registered bank holding company. These descriptions are not intended to be complete and are qualified in their entirety by reference to the full text of the statutes and regulations. Future changes in these laws and regulations, or in the interpretation and application thereof by their administering agencies, cannot be predicted, but could have a material effect on the business and results of Two River Bancorp and the Bank.

Dividend Restrictions
 
The primary source of cash to pay dividends to the Company’s shareholders and to meet the Company’s obligations is dividends paid to the Company by the Bank. Dividend payments by the Bank to the Company are subject to the laws of the State of New Jersey, the Banking Act, the Federal Deposit Insurance Act (“FDIA”) and the regulation of the New Jersey Department of Banking and Insurance and of the Federal Reserve. Under the Banking Act and the FDIA, a bank may not pay any dividends if, after paying such dividends, it would be undercapitalized under applicable capital requirements. In addition to these explicit limitations, the federal regulatory agencies are authorized to prohibit a banking subsidiary or bank holding company from engaging in unsafe or unsound banking practices. Depending upon the circumstances, the agencies could take the position that paying a dividend would constitute an unsafe or unsound banking practice.

It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available from the immediately preceding year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not

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maintain a level of cash dividend that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiary. A bank holding company may not pay dividends when it is insolvent.
 
In 2017, Two River Bancorp paid $1.4 million in cash dividends to common shareholders.
 
Transactions with Affiliates
 
Banking laws and regulations impose certain restrictions on the ability of bank holding companies to borrow from and engage in other transactions with their subsidiary banks. Generally, these restrictions require that any extensions of credit must be secured (at levels of 100% and more) by designated amounts of specified collateral and be limited to (i) 10% of the bank’s capital stock and surplus per non-bank affiliated borrower, and (ii) 20% of the bank’s capital stock and surplus aggregated as to all non-bank affiliated borrowers. In addition, certain transactions with affiliates must be on terms and conditions, including credit standards, at least as favorable to the institution as those prevailing for arms-length transactions.
 
Deposit Insurance
 
All U.S. banks are required to have their deposits insured by the FDIC. The maximum amount of deposit insurance per depositor is $250,000. The FDIC charges premiums or “assessments” to pay for the deposit insurance provided. These assessments are based on the average total assets of a bank minus the bank’s average tangible equity.
 
Deposit insurance assessments have been “risk based,” in that the riskier a bank’s perceived business activities, the higher deposit insurance rate it has to pay. All banks are assigned to one of four “risk categories” by the FDIC, pursuant to their capital levels and examination results. The assignment to a particular risk category is made by the FDIC each quarter based on the most recent information available. Then, the FDIC applies certain adjustments to each bank based on its specific asset attributes to determine a final assessment ratio. As discussed above, these assessments are based on assets, not deposits, and the assessment rates will range from 2.5 basis points to 45 basis points.
 
The Dodd-Frank Act requires the deposit insurance fund to reach a reserve level of 1.35% of all insured deposits by September 2020, and authorizes the FDIC to implement changes in assessment rates in order to achieve such level. The Dodd-Frank Act authorizes the FDIC to establish a “designated reserve ratio” (which the FDIC has now set at 2.0%), and to reduce or eliminate assessments if the designated reserve ratio is met. If the deposit fund reserve ratio is 2.5% or more, the FDIC is authorized, but not required, to return assessments to banks. Given that most experts believe that the deposit fund will continue to incur losses over the short term for bank failures that have occurred and will occur from the financial crisis, it is expected that all banks will have to pay significant amounts of deposit insurance assessments for the foreseeable future, with little likelihood of reductions in deposit insurance assessments (or return of assessments paid) unless there is a material improvement in the economy and the health of the financial industry.
 
Capital Adequacy
 
The Federal banking regulators have adopted risk-based capital guidelines for banks and bank holding companies. The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. At least half of the total capital is to be comprised of common stock, retained earnings, minority interests in the equity accounts of consolidated subsidiaries, noncumulative perpetual preferred stock and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and certain other intangibles (“Tier 1 Capital”). The remainder may consist of other preferred stock, certain other instruments and a portion of the loan loss allowance (“Tier 2 Capital”). “Total Capital” is the sum of Tier 1 Capital and Tier 2 Capital.
 
In addition, the Federal banking regulators have established minimum leverage ratio guidelines for banks and bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average total assets of 3% for banks that meet certain specified criteria, including having the highest regulatory rating. All other banks and bank holding companies generally are required to maintain a leverage ratio of at least 3% plus an additional cushion of 100 to 200 basis points. At December 31, 2017, Two River Bancorp’s leverage ratio was 8.85%.
 
Our minimum capital to risk-adjusted assets requirements are a common equity Tier 1 Capital ratio of 4.5% (6.5% to be considered “well capitalized”), a Tier 1 Capital ratio of 6.0%, (8.0% to be considered “well capitalized”); and a total capital ratio of 8.0% (10.0% to be considered “well capitalized”).

The Company’s and the Bank’s capital ratios at December 31, 2017 and 2016 are set forth in “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Capital Resource.”


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In order to avoid limitations on capital distributions (including dividend payments and certain discretionary bonus payments to executive officers), a banking organization must hold a capital conservation buffer comprised of common equity Tier 1 Capital above its minimum risk-based capital requirements in an amount greater than 2.5% of total risk-weighted assets. The capital conservation buffer requirements are being phased in over a three-year period beginning January 1, 2016.
 
As of December 31, 2017, the Company and the Bank are "well-capitalized" and each of them has a capital conservation buffer greater than 2.5%.
 
Prompt Corrective Action
 
The Federal Deposit Insurance Act ("FDIA") requires federal banking regulators to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. Failure to meet minimum requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have an adverse material effect on Two River Bancorp’s financial condition. Under the FDIA’s Prompt Corrective Action Regulations, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices.
 
The Prompt Corrective Action Regulations define specific capital categories based on an institution’s capital ratios. The capital categories, in declining order, are “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” The FDIA imposes progressively more restrictive constraints on operations, management and capital distributions, depending on the capital category by which the institution is classified. Institutions categorized as “undercapitalized” or worse may be subject to requirements to file a capital plan with their primary federal regulator, prohibitions on the payment of dividends and management fees, restrictions on asset growth and executive compensation, and increased supervisory monitoring, among other things. Other restrictions may be imposed on the institution by the regulatory agencies, including requirements to raise additional capital, sell assets or sell the entire institution. Once an institution becomes “critically undercapitalized,” it generally must be placed in receivership or conservatorship within 90 days.
 
The appropriate federal banking agency may, under certain circumstances, reclassify a well-capitalized insured depository institution as adequately capitalized. The appropriate agency is also permitted to require an adequately capitalized or undercapitalized institution to comply with the supervisory provisions as if the institution were in the next lower category (but not to treat a significantly undercapitalized institution as critically undercapitalized) based on supervisory information other than an institution’s capital levels.
 
Unsafe and Unsound Practices
 
Notwithstanding its Prompt Corrective Action Regulations category dictated by risk-based capital ratios, the FDIA permits the appropriate bank regulatory agency to reclassify an institution if it determines, after notice and a hearing, that the condition of the institution is unsafe or unsound, or if it deems the institution to be engaging in an unsafe or unsound practice. Also, if a federal regulatory agency with jurisdiction over a depository institution believes that the depository institution will engage, is engaging, or has engaged in an unsafe or unsound practice, the regulator may require that the bank cease and desist from such practice, following notice and a hearing on the matter.
 
The USA PATRIOT Act
 
The USA PATRIOT Act of 2001 is a comprehensive anti-terrorism law. Title III of the USA PATRIOT Act imposes significant anti-money-laundering compliance and due diligence obligations on financial institutions, imposes crimes and penalties and expands the extra-territorial jurisdiction of the United States. The Treasury has issued a number of implementing regulations which apply various requirements of the USA PATRIOT Act to financial institutions such as the Bank. Those regulations impose new obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing.
 
Failure of a financial institution to comply with the USA PATRIOT Act’s requirements could have serious legal consequences for the institution and adversely affect its reputation. Two River Bancorp and the Bank adopted policies, procedures and controls designed to address compliance with the requirements of the USA PATRIOT Act under the existing regulations and will continue to revise and update its policies, procedures and controls to reflect changes required by the USA PATRIOT Act and by Treasury regulations.


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Community Reinvestment Act
 
The Federal Community Reinvestment Act (“CRA”) requires banks to respond to the full range of credit and banking needs within their communities, including the needs of low and moderate-income individuals and areas. A bank’s failure to address the credit and banking needs of all socio-economic levels within its markets may result in restrictions on growth and expansion opportunities for the bank, including restrictions on new branch openings, relocation, formation of subsidiaries, mergers and acquisitions. Upon completion of a CRA examination, an overall CRA rating is assigned using a four-tiered rating system. These ratings are: Outstanding, Satisfactory, Needs to Improve, and Substantial Noncompliance.
 
In the latest CRA performance evaluation examination report with respect to the Bank, dated October 26, 2015, the Bank received a rating of Outstanding.
 
Consumer Privacy
 
The Gramm-Leach-Bliley Act’s financial privacy provisions generally prohibit financial institutions, including Two River Bancorp and the Bank, from disclosing or sharing nonpublic personal financial information to third parties for marketing or other purposes not related to transactions, unless customers have an opportunity to “opt out” of authorizing such disclosure, and have not elected to do so. It has never been the policy of Two River Bancorp or the Bank, to release such information except as may be required by law.
 
Loans to One Borrower
 
Federal banking laws limit the amount a bank may lend to a single borrower to 15% of the bank’s capital base, unless the entire amount of the loan is secured by adequate amounts of readily marketable collateral. However, no loan to one borrower may exceed 25% of a bank’s statutory capital, notwithstanding collateral pledged to secure it.
 
New Jersey banking law limits the total loans and extensions of credit by a bank to one borrower at one time to 15% of the capital funds of the bank when the loan is fully secured by collateral having a market value at least equal to the amount of the loans and extensions of credit. Such loans and extensions of credit are limited to 10% of the capital funds of the bank when the total loans and extensions of credit by a bank to one borrower at one time are fully secured by readily available marketable collateral having a market value (as determined by reliable and continuously available price quotations) at least equal to the amount of funds outstanding. This 10% limitation is separate from and in addition to the 15% limitation noted in the first paragraph. If a bank’s lending limit is less than $500,000, the bank may nevertheless have total loans and extensions of credit outstanding to one borrower at one time not to exceed $500,000. At December 31, 2017, the Bank’s lending limit to one borrower was $16.3 million.
 
Executive Compensation
 
SEC regulations provide for a say on pay for shareholders of all public companies. Under these regulations, each company must give its shareholders the opportunity to vote on the compensation of its executives at least once every three years. SEC regulations also have disclosure and voting requirements for golden parachute compensation that is payable to named executive officers in connection with sale transactions.
 
On August 5, 2015, the SEC adopted final rules requiring disclosure of the ratio of the CEO’s compensation to that of their median employee (“pay ratio”). Two River Bancorp will become subject to these rules with respect to its proxy statements and 10-Ks filed starting in 2019.
 
Concentration and Risk Guidance

The federal banking regulatory agencies promulgated joint interagency guidance regarding material direct and indirect asset and funding concentrations. The guidance defines a concentration as any of the following: (i) asset concentrations of 25% or more of Total Capital (loan related) or Tier 1 Capital (non-loan related) by individual borrower, small interrelated group of individuals, single repayment source or individual project; (ii) asset concentrations of 100% or more of Total Capital (loan related) or Tier 1 Capital (non-loan related) by industry, product line, type of collateral, or short-term obligations of one financial institution or affiliated group; (iii) funding concentrations from a single source representing 10% or more of Total Assets; or (iv) potentially volatile funding sources that when combined represent 25% or more of Total Assets (these sources may include brokered, large, high-rate, uninsured, internet listing service deposits, Federal funds purchased or other potentially volatile deposits or borrowings). If a concentration is present, management must employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis

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and stress testing, third party review and increasing capital requirements. The Bank adheres to the practices recommended in this guidance.

Overall Impact of New Legislation and Regulations
 
Various legislative initiatives are from time to time introduced in Congress and in the New Jersey State Legislature. It cannot be predicted whether or to what extent the business and condition of Two River Bancorp or the Bank will be affected by new legislation or regulations, and legislation or regulations as yet to be proposed or enacted. Given that the financial industry remains under stress and severe scrutiny, and given that the U.S. economy has not yet fully recovered to pre-crisis levels of activity, we fully suspect that there will be significant legislation and regulatory actions that will materially affect the banking industry generally and our bank specifically for the foreseeable future.
 
Available Information
 
The Company maintains a website at www.tworiverbank.com. The Company makes available on its website free of charge its annual reports on Form 10-K, quarterly reports on Form 10-Q, Extensible Business Reporting Language (“XBRL”), a standards-based way to communicate and exchange business information between business systems, and current reports on Form 8-K, and amendments to those reports which are filed with or furnished to the SEC pursuant to Section 13(a) of the Securities Exchange Act of 1934. These documents are made available on the Company’s website as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. Also available on the website are our Code of Conduct, our Shareholder Communications Policy and the charters of our Nominating and Corporate Governance Committee, Audit Committee, and Compensation Committee.

Item 1A. Risk Factors.
 
The following are some important factors that could cause the Company’s actual results to differ materially from those referred to or implied in any forward-looking statement. These are in addition to the risks and uncertainties discussed elsewhere in this Annual Report on Form 10-K and the Company’s other filings with the SEC.
 
Our dependence on loans secured by real estate subjects us to risks relating to fluctuations in the real estate market and related interest rates, and to legislation that could result in significant additional costs and capital requirements, which could adversely affect our financial condition and results of operations.
 
Approximately 92.6% of our loan portfolio as of December 31, 2017 was comprised of loans collateralized by real estate, with 98.4% of the real estate located in New Jersey. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. A weakening of the real estate market in our primary market areas could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing the loans and the value of real estate owned by us. As real estate values decline, it is also more likely that we would be required to make provisions for additional loan losses, which could adversely affect our financial condition and results of operations.

As of December 31, 2017, we had $118.1 million, or 13.9%, of our total loans in real estate construction loans. Of this amount, $7.2 million were land loans and $82.3 million were made to finance residential construction. Substantially all of these loans are located in Monmouth, Middlesex, Union and Ocean Counties, New Jersey. Further, $28.6 million of real estate construction loans were made to finance commercial construction. Construction loans are subject to risks during the construction phase that are not present in standard residential real estate and commercial real estate loans. These risks include:
 
the viability of the contractor;
the value of the project being subject to successful completion;
the contractor’s ability to complete the project, to meet deadlines and time schedules and to stay within cost estimates; and
concentrations of such loans with a single contractor and its affiliates.

Real estate construction loans also present risks of default in the event of declines in property values or volatility in the real estate market during the construction phase. If we are forced to foreclose on a project prior to completion, we may not be able to recover the entire unpaid portion of the loan, may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate amount of time. If any of these risks were to occur, it could adversely affect our financial condition, results of operations and cash flows.
 

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The federal banking agencies have issued guidance regarding high concentrations of commercial real estate loans within bank loan portfolios. The guidance requires financial institutions that exceed certain levels of commercial real estate lending compared with their total capital to maintain heightened risk management practices that address the following key elements: including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending. If there is any deterioration in our commercial real estate or real estate construction portfolios or if our regulators conclude that we have not implemented appropriate risk management practices, it could adversely affect our business and result in a requirement of increased capital levels, and such capital may not be available at that time.
 
Our commercial real estate and commercial loans expose us to increased credit risks, and these risks will increase if we succeed in increasing these types of loans.
 
We focus our lending efforts on commercial-related loans and intend to grow commercial real estate and commercial loans further as a percentage of our portfolio. As of December 31, 2017, commercial real estate loans and commercial and industrial loans totaled $639.1 million. In general, commercial real estate loans and commercial and industrial loans yield higher returns and often generate a deposit relationship, but also pose greater credit risks than do owner-occupied residential real estate loans. As our various commercial-related loan portfolios increase, the corresponding risks and potential for losses from these loans will also increase.
 
We make both secured and some unsecured commercial and industrial loans. Unsecured loans generally involve a higher degree of risk of loss than do secured loans because, without collateral, repayment is wholly dependent upon the success of the borrowers’ businesses or the guarantor(s). Secured commercial and industrial loans are generally collateralized by accounts receivable, inventory, equipment or other assets owned by the borrower and include a personal guaranty of the business owner. Compared to real estate, that type of collateral is more difficult to monitor, its value is harder to ascertain, it may depreciate more rapidly and it may not be as readily saleable if repossessed. Further, commercial and industrial loans generally will be serviced primarily from the operation of the business, which may not be successful, and commercial real estate loans generally will be serviced from income on the properties securing the loans.
 
Our financial condition and results of operations could be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses or if we are required to increase our allowance.
 
Despite our underwriting criteria, we may experience loan delinquencies and losses. In order to absorb losses associated with non-performing loans, we maintain an allowance for loan losses based on, among other things, historical experience, an evaluation of economic conditions, and regular reviews of delinquencies and loan portfolio quality. Determination of the allowance inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. At any time there are likely to be loans in our portfolio that will result in losses but that have not been identified as non-performing or potential problem credits. We cannot be sure that we will be able to identify deteriorating credits before they become non-performing assets or that we will be able to limit losses on those loans that are identified.

At December 31, 2017, the Bank’s allowance for loan losses was $10.7 million, which equaled 1.25% of the Bank’s total loans.

We may be required to increase our allowance for loan losses for any of several reasons. State and federal regulators, in reviewing our loan portfolio as part of a regulatory examination, may request that we increase our allowance for loan losses. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in our allowance. In addition, if charge-offs in future periods exceed our allowance for loan losses, we will need additional increases in our allowance for loan losses. Any increases in our allowance for loan losses will result in a decrease in our net income and, possibly, our capital, and may materially affect our results of operations in the period in which the allowance is increased.

Changes in tax laws could have an adverse effect on the Company, the banking industry, the Bank’s customers, the value of collateral securing loans and demand for loans.

Changes in tax laws contained in the recently enacted Tax Cuts and Jobs Act (the “Tax Act”) contain a number of provisions which could have an impact on the banking industry, borrowers and the market for single family residential and commercial real estate. Among the changes are: lower limits on the deductibility of mortgage interest on single family residential mortgages; a broad limitation on deductibility of business interest expense which will affect commercial borrowers; and limitations

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on the deductibility of property taxes and state and local income taxes. We cannot predict the ultimate impact of these changes. However, such changes may have an adverse effect on the market for and valuation of single family residential properties and commercial real estate, the economics of borrowing by businesses, and on the demand for residential and commercial mortgage and business loans in the future. If home ownership or business borrowing become less attractive, demand for our loans would decrease. The value of the properties securing loans in our portfolio may be adversely impacted as a result of the changing economics of home ownership and borrowing, which could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations. Additionally, certain borrowers could become less able to service their debts if these changes become effective. These changes could adversely affect our business, financial condition and results of operations.

We may not be able to successfully integrate any banks or other businesses that we may acquire.
 
Our strategy has been to carefully evaluate each acquisition opportunity presented to us to determine whether it fits into our strategic growth plan and ensure that it does not involve excessive risk to the Company. Should we decide to pursue any acquisition opportunity, we may not be able to successfully integrate the assets, liabilities, customers, systems and management personnel we acquire into our operations, and we may not be able to realize related revenue synergies and cost savings within our expected time frames. In addition, we will incur substantial legal, investment banking, accounting and other expenses in pursuing any acquisitions. In respect to any completed acquisition, there will be potential goodwill impairment charges and fluctuations in the fair values of assets in the event projected financial results are not achieved within expected time frames.
 
Negative developments in the financial services industry and the U.S. and global credit markets may adversely impact our operations and results.
 
Financial institution regulatory agencies have been very aggressive in responding to concerns and trends identified in examinations, including the expected issuance of many formal enforcement actions. Negative developments in the financial services industry and the impact of new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate or sell loans, and adversely impact our financial performance.
 
The effects of another Superstorm Sandy or similar natural disaster may negatively impact collateral values or loan originations in the areas in which we do business.
 
On October 29, 2012, Superstorm Sandy made landfall in New Jersey, causing widespread property damage throughout the northeastern United States, including our primary market area in New Jersey. A similar or worse natural disaster than Superstorm Sandy could have a material adverse effect. Natural disasters can disrupt our operations, result in damage to our properties, reduce or destroy the value of the collateral for our loans and negatively affect the local economies in which we operate, which could have a material adverse effect on our results of operations and financial condition. The occurrence of a natural disaster could result in one or more of the following: (i) an increase in loan delinquencies; (ii) an increase in problem assets and foreclosures; (iii) a decrease in the demand for our products and services; or (iv) a decrease in the value of the collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with problem loans and collateral coverage.
 
The Company’s profitability depends significantly on local economic conditions.
 
The Company’s success depends primarily on the general economic conditions of the primary markets in New Jersey in which it operates and where its loans are concentrated. Unlike nationwide banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in Monmouth, Middlesex, Union and Ocean Counties, New Jersey. The local economic conditions in these areas have a significant impact on the Company’s commercial and industrial, real estate and construction loans, the ability of its borrowers to repay their loans and the value of the collateral securing these loans. In addition, if the population or income growth in the Company’s market areas is slower than projected, income levels, deposits and housing starts could be adversely affected and could result in a reduction of the Company’s expansion, growth and profitability. If the Company’s market areas experience a downturn or a recession for a prolonged period of time, the Company could experience significant increases in nonperforming loans, which could lead to operating losses, impaired liquidity and eroding capital. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreaks of hostilities or other international or domestic calamities, unemployment, monetary and fiscal policies of the federal government or other factors could impact these local economic conditions and could negatively affect the Company’s financial condition, results of operations and cash flows.
 

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The small to medium-sized businesses that the Company lends to may have fewer resources to weather a downturn in the economy, which may impair a borrower’s ability to repay a loan to the Company that could materially harm the Company’s operating results.
 
The Company targets its business development and marketing strategy primarily to serve the banking and financial services needs of small to medium-sized businesses. These small to medium-sized businesses frequently have smaller market share than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience significant volatility in operating results. Any one or more of these factors may impair the borrower’s ability to repay a loan. In addition, the success of a small to medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay a loan. Economic downturns and other events that negatively impact the Company’s market areas could cause the Company to incur substantial credit losses that could negatively affect the Company’s results of operations and financial condition.
 
Changes in interest rates could reduce our income, cash flows and asset values.
 
Our income and cash flows and the value of our assets depend to a great extent on the difference between the interest rates we earn on interest-earning assets, such as loans and investment securities, and the interest rates we pay on interest-bearing liabilities such as deposits and borrowings. These rates are highly sensitive to many factors which are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. Changes in monetary policy, including changes in interest rates, will influence not only the interest we receive on our loans and investment securities and the amount of interest we pay on deposits and borrowings but will also affect our ability to originate loans and obtain deposits and the value of our investment portfolio. If the rate of interest we pay on our deposits and other borrowings increases more than the rate of interest we earn on our loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Our earnings also could be adversely affected if the rates on our loans and other investments fall more quickly than those on our deposits and other borrowings.

Competition may decrease our growth or profits.
 
We face substantial competition in all phases of our operations from a variety of different competitors, including commercial banks, savings and loan associations, mutual savings banks, credit unions, consumer finance companies, factoring companies, leasing companies, insurance companies and money market mutual funds. There is very strong competition among financial services providers in our principal service area. Our competitors may have greater resources, higher lending limits or larger branch systems than we do. Accordingly, they may be able to offer a broader range of products and services as well as better pricing for those products and services than we can.
 
In addition, some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on federally insured financial institutions such as the Bank. As a result, those non-bank competitors may be able to access funding and provide various services more easily or at less cost than we can, adversely affecting our ability to compete effectively.
 
We rely on our management and other key personnel, and the loss of any of them may adversely affect our operations.
 
We are and will continue to be dependent upon the services of our executive management team. The Company’s performance is largely dependent on the talents and efforts of highly skilled individuals. There is intense competition in the financial services industry for qualified employees. In addition, the Company faces increasing competition with businesses outside the financial services industry for the most highly skilled individuals. The unexpected loss of services of any key management personnel or commercial loan officers could have an adverse effect on our business and financial condition because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. The Company’s business operations could be adversely affected if it were unable to attract new employees and retain and motivate its existing employees.
 
We may be adversely affected by government regulation.
 
The banking industry is heavily regulated. Banking regulations are primarily intended to protect the federal deposit insurance funds and depositors, not shareholders. Changes in the laws, regulations, and regulatory practices affecting the banking industry may increase our costs of doing business or otherwise adversely affect us and create competitive advantages for others. Regulations affecting banks and financial services companies undergo continuous change, and we cannot predict the ultimate effect of these changes, which could have a material adverse effect on our profitability or financial condition.

17



 
The anti-money laundering or AML, and bank secrecy, or BSA, laws have imposed far-reaching and substantial requirements on financial institutions. The enforcement policy with respect to AML/BSA compliance has been vigorously applied throughout the industry, with regulatory action taking various forms. We believe that our policies and procedures with respect to combating money laundering are effective and that our AML/BSA policies and procedures are reasonably designed to comply with current applicable standards. We cannot provide assurance that in the future we will not face a regulatory action, adversely affecting our ability to acquire banks or open new branches.
 
Additionally, the federal government has passed a variety of other reforms related to banking and the financial industry. See “Item 1. Business – Supervision and Regulation.”
 
Future banking laws and regulations could limit our business activities, require changes to certain of our business practices, impose upon us more stringent capital, liquidity and leverage requirements or otherwise materially and adversely affect us. These changes may also require us to invest significant management attention and resources to evaluate and make any changes necessary to comply with new statutory and regulatory requirements. Failure to comply with any new requirements could also materially and adversely affect us.

The short-term and long-term impact of our regulatory capital requirements is uncertain and could adversely affect us.
 
The Company and the Bank are subject to capital requirements under regulations adopted by the federal banking regulators. The application of these capital requirements could, among other things, result in lower returns on invested capital, over time require the raising of additional capital, and result in regulatory actions if we were to be unable to comply with such requirements. Asset risk weightings for risk based capital calculations, items included or deducted in calculating regulatory capital and/or additional capital conservation buffers could result in management modifying its business strategy. Furthermore, the imposition of liquidity requirements in connection with these capital requirements could result in our having to lengthen the term of our funding, restructure our business models, and/or increase our holdings of liquid assets. Any additional changes in our regulation and oversight, in the form of new laws, rules and regulations could make compliance more difficult or expensive or otherwise materially adversely affect our business, financial condition or prospects.
 
We depend upon the accuracy and completeness of information about customers.
 
In deciding whether to extend credit to customers, we may rely on information provided to us by our customers, including financial statements and other financial information. We may also rely on representations of customers as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. Our financial condition and results of operations could be negatively impacted to the extent that we extend credit in reliance on financial statements or other information provided by customers that is false or misleading.
 
Our information systems may experience an interruption or breach in security.
 
We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer-relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur; or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny or expose us to civil litigation and possible financial liability; any of which could have a material adverse effect on our financial condition and results of operations.
 
We face the risk of cyber-attack to our computer systems.
 
Our computer systems, software and networks have been and will continue to be vulnerable to unauthorized access, loss or destruction of data (including confidential client information), account takeovers, unavailability of service, computer viruses or other malicious code, cyber-attacks and other events. These threats may derive from human error, fraud or malice on the part of employees or third parties, or may result from accidental technological failure. If one or more of these events occurs, it could result in the disclosure of confidential client information, damage to our reputation with our clients and the market, additional costs to us (such as repairing systems or adding new personnel or protection technologies), regulatory penalties and financial losses, to both us and our clients and customers. Such events could also cause interruptions or malfunctions in our operations (such as the lack of availability of our online banking system), as well as the operations of our clients, customers or other third parties.

18



Although we maintain safeguards to protect against these risks, there can be no assurance that we will not suffer losses in the future that may be material in amount.
 
We rely on third parties to provide key components of our business infrastructure, and a failure of these parties to perform for any reason could disrupt our operations.
 
Third parties provide key components of our business infrastructure such as data processing, internet connections, network access, core application processing, statement production and account analysis. Our business depends 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. Replacing vendors or addressing other issues with our third-party service providers could entail significant delay and expense. If we are unable to efficiently replace ineffective service providers, or if we experience a significant, sustained or repeated, system failure or service denial, it could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our business, financial condition, results of operations and future prospects.
 
Environmental liability associated with lending activities could result in losses.
 
In the course of our business, we may foreclose on and take title to properties securing our loans. If hazardous substances were discovered on any of these properties, we could be liable to governmental entities or third parties for the costs of remediation of the hazard, as well as for personal injury and property damage. Many environmental laws can impose liability regardless of whether we knew of, or were responsible for, the contamination. In addition, if we arrange for the disposal of hazardous or toxic substances at another site, we may be liable for the costs of cleaning up and removing those substances from the site even if we neither own nor operate the disposal site. Environmental laws may require us to incur substantial expenses and may materially limit use of properties we acquire through foreclosure, reduce their value or limit our ability to sell them in the event of a default on the loans they secure. In addition, future laws or more stringent interpretations or enforcement policies with respect to existing laws may increase our exposure to environmental liability.

Failure to implement new technologies in our operations may adversely affect our growth or profits.
 
The market for financial services, including banking services and consumer finance services is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, Internet-based banking and telebanking. Our ability to compete successfully in our markets may depend on the extent to which we are able to exploit such technological changes. However, we can provide no assurance that we will be able to properly or timely anticipate or implement such technologies or properly train our staff to use such technologies. Any failure to adapt to new technologies could adversely affect our business, financial condition or operating results.
 
We are subject to liquidity risk.
 
Liquidity risk is the potential that we will be unable to meet our obligations as they become due, capitalize on growth opportunities as they arise, or pay regular cash dividends because of an inability to liquidate assets or obtain adequate funding in a timely basis, at a reasonable cost and within acceptable risk tolerances.
 
Liquidity is required to fund various obligations, including credit commitments to borrowers, mortgage and other loan originations, withdrawals by depositors, repayment of borrowings, dividends to shareholders, operating expenses and capital expenditures. Liquidity is derived primarily from retail deposit growth and retention; principal and interest payments on loans; principal and interest payments on and the sale, maturity and prepayment of investment securities; net cash provided from operations and access to other funding sources.
 
Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption of the financial markets or negative views and expectations about the prospects for the financial services industry as a whole.
 

19



Future offerings of debt or other securities may adversely affect the market price of our stock.
 
In the future, we may attempt to increase our capital resources or, if our or the Bank’s capital ratios fall below the required minimums, the Company could be forced to raise additional capital by making additional offerings of debt or equity securities, including common or preferred stock and senior or subordinated debentures. The Company currently has a shelf registration statement on file with the Securities and Exchange Commission to allow us to access the capital markets more quickly should the need or desire arise. Upon liquidation, holders of any debt securities and shares of preferred stock and lenders with respect to other borrowings will receive distributions of our available assets prior to the holders of our common stock. Additional equity offerings may dilute the holdings of our existing shareholders or reduce the market price of our common stock, or both. Holders of our common stock are not entitled to preemptive rights or other protections against dilution.
 
The Company may lose lower-cost funding sources.
 
Checking, savings, and money market deposit account balances and other forms of customer deposits can decrease when customers perceive alternative investments, such as the stock market, as providing a better risk/return tradeoff. If customers move money out of bank deposits and into other investments, the Company could lose a relatively low-cost source of funds, increasing its funding costs and reducing the Company’s net interest income and net income.

Changes in consumers’ use of banks and changes in consumers’ spending and saving habits could adversely affect the Company’s financial results.
 
Technology and other changes now allow many consumers to complete financial transactions without using banks. For example, consumers can pay bills and transfer funds directly without going through a bank. This disintermediation could result in the loss of fee income, as well as the loss of customer deposits and income generated from those deposits. In addition, changes in consumer spending and saving habits could adversely affect our operations, and we may be unable to timely develop competitive new products and services in response to these changes that are accepted by new and existing customers.
 
The Company is subject to operational risk.
 
The Company faces the risk that the design of its controls and procedures, including those to mitigate the risk of fraud by employees or outsiders, may prove to be inadequate or are circumvented, thereby causing delays in detection of errors or inaccuracies in data and information. Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
 
The Company may also be subject to disruptions of its systems arising from events that are wholly or partially beyond its control (including, for example, computer viruses or electrical or telecommunications outages), which may give rise to losses in service to customers and to financial loss or liability. The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as is the Company) and to the risk that the Company’s (or its vendors’) business continuity and data security systems prove to be inadequate.
 
Negative publicity could damage our reputation and adversely impact our business and financial results.
 
Reputation risk, or the risk to our earnings and capital from negative publicity, is inherent in our business. Negative publicity can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance, acquisitions, and actions taken by government regulators and community organizations in response to those activities. Negative publicity can adversely affect our ability to keep and attract customers and can expose us to litigation and regulatory action. Although we take steps to minimize reputation risk in dealing with customers and other constituencies, as a financial services company with a high profile in our market area, we are inherently exposed to this risk.

Our SBA lending program is dependent upon the federal government and we face specific risks associated with originating SBA loans.
 
Our SBA lending program is dependent upon the federal government. As an SBA Preferred Lender, we enable our clients to obtain SBA loans without being subject to the potentially lengthy SBA approval process necessary for lenders that are

20



not SBA Preferred Lenders. The SBA periodically reviews the lending operations of participating lenders to assess, among other things, whether the lender exhibits prudent risk management. When weaknesses are identified, the SBA may request corrective actions or impose enforcement actions, including revocation of the lender’s Preferred Lender status. If we lose our status as a Preferred Lender, we may lose some or all of our customers to lenders who are SBA Preferred Lenders. Also, any changes to the SBA program, including changes to the level of guarantee provided by the federal government on SBA loans, could adversely affect our business and earnings.
 
We generally sell the guaranteed portion of our SBA 7(a) program loans in the secondary market. These sales have resulted in premium income for us at the time of sale and created a stream of future servicing income. We may not be able to continue originating these loans or selling them in the secondary market. Furthermore, even if we are able to continue originating and selling SBA 7(a) program loans in the secondary market, we might not continue to realize premiums upon the sale of the guaranteed portion of these loans. When we sell the guaranteed portion of our SBA 7(a) program loans, we incur credit risk on the non-guaranteed portion of the loans, and if a customer defaults on the non-guaranteed portion of a loan, we share any loss and recovery related to the loan pro-rata with the SBA. If the SBA establishes that a loss on an SBA guaranteed loan is attributable to significant technical deficiencies in the manner in which the loan was originated, funded or serviced by us, the SBA may seek recovery of the principal loss related to the deficiency from us, which could adversely affect our business and earnings.
 
The laws, regulations and standard operating procedures that are applicable to SBA loan products may change in the future. We cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, changes in the laws, regulations and procedures applicable to SBA loans could adversely affect our business and earnings.

New lines of business or new products and services may subject the Bank to additional risks.
From time to time, the Bank may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, the Bank may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business and/or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Bank’s system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business and new products or services could have a material adverse effect on the Company’s business, financial condition, and results of operations.

The FASB has recently issued an accounting standard update that will result in a significant change in how we recognize credit losses and may have a material impact on our financial condition or results of operations.

In June 2016, the Financial Accounting Standards Board (“FASB”) issued an accounting standard update, “Financial Instruments-Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments,” which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the Current Expected Credit Loss (“CECL”) model. Under the CECL model, banks will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current generally accepted accounting principles (“GAAP”), which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses, and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of the allowance for loan losses. If we are required to materially increase the level of its allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.

The new CECL standard will become effective for the Company for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years. We are evaluating the impact the CECL model will have on our accounting, but we expect to recognize a one-time cumulative-effect adjustment to the allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on its financial condition or results of operations.

21



The increasing use of social media platforms presents new risks and challenges and the inability or failure to recognize, respond to, and effectively manage the accelerated impact of social media could materially adversely impact the Bank’s business.

There has been a marked increase in the use of social media platforms, including weblogs (blogs), social media websites, and other forms of Internet-based communications which allow individuals access to a broad audience of consumers and other interested persons. Social media practices in the banking industry are evolving, which creates uncertainty and risk of noncompliance with regulations applicable to the Bank’s business. Consumers value readily available information concerning businesses and their goods and services and often act on such information without further investigation and without regard to its accuracy. Many social media platforms immediately publish the content their subscribers and participants post, often without filters or checks on accuracy of the content posted. Information posted on such platforms at any time may be adverse to the Bank’s interests and/or may be inaccurate. The dissemination of information online could harm the Bank’s business, prospects, financial condition, and results of operations, regardless of the information’s accuracy. The harm may be immediate without affording the Bank an opportunity for redress or correction.

Other risks associated with the use of social media include improper disclosure of proprietary information, negative comments about the Bank’s business, exposure of personally identifiable information, fraud, out-of-date information, and improper use by employees, directors and customers. The inappropriate use of social media by the Bank’s customers, directors or employees could result in negative consequences such as remediation costs including training for employees, additional regulatory scrutiny and possible regulatory penalties, litigation, or negative publicity that could damage the Bank’s reputation adversely affecting customer or investor confidence.

Item 1B. Unresolved Staff Comments.
 
Not applicable.

22



Item 2. Properties.
 
The following table provides certain information with respect to properties used by the Company or the Bank in their operations:  
Office Location
 
Address
 
Description
 
Opened
 
Corporate Headquarters:
  
766 Shrewsbury Avenue
Tinton Falls, NJ
  
17,626 sq. ft. building (leased)
  
10/12
 
  
  
  
  
  
  
  
 
The Bank’s Main Office:
  
1250 Highway 35 South
Middletown, NJ
  
5,300 sq. ft. first-floor stand-alone building (leased)
  
02/00
 
  
  
  
  
  
  
  
 
Atlantic Highlands:
  
84 First Avenue
Atlantic Highlands, NJ
  
817 sq. ft. store front (leased)
  
03/02
 
  
  
  
  
  
  
  
 
Cranford Office:
  
245-249 North Avenue
Cranford, NJ
  
2,438 sq. ft. stand-alone building (owned)
  
01/15
 
  
  
  
  
  
  
  
 
Fanwood:
  
328 South Avenue
Fanwood, NJ
  
2,966 sq. ft. stand-alone building (leased)
  
03/08
 
  
  
  
  
  
  
  
 
Freehold:
 
31 East Main Street
Freehold, NJ
 
2,060 sq. ft. in strip shopping center (leased)
 
05/15
 
 
 
 
 
 
 
 
 
Navesink:
  
Eastpointe Shopping Center
2345 Route 36
Atlantic Highlands, NJ
  
2,080 sq. ft. in strip shopping center (leased)
  
09/05
 
  
  
  
  
  
  
  
 
New Brunswick:
 
Kilmer Square
94 Albany Street
New Brunswick, NJ
 
1,162 sq. ft. in strip shopping center (leased)
 
04/14
 
 
 
 
 
 
 
 
 
Port Monmouth:
  
357 Highway 36
Port Monmouth, NJ
  
2,180 sq. ft. stand-alone building (leased)
  
06/01
 
  
  
  
  
  
  
  
 
Red Bank:
  
140 Broad Street
Red Bank, NJ
  
2,459 sq. ft. store front (leased)
  
11/12
 
  
  
  
  
  
  
  
 
Sea Girt:
 
1314 Sea Girt Avenue
Sea Girt, NJ
 
1,537 sq. ft. stand-alone building (owned)
 
09/17
 
 
 
 
 
 
 
 
 
Tinton Falls:
  
4050 Asbury Avenue
Tinton Falls, NJ
  
2,500 sq. ft. stand-alone building (leased)
  
10/06
 
 
  
  
  
  
  
  
 
Tinton Falls:
  
656 Shrewsbury Avenue
Tinton Falls, NJ
  
3,650 sq. ft. stand-alone building (leased)
  
08/00
 
 
  
  
  
  
  
  
 
West Long Branch:
  
359 Monmouth Road
West Long Branch, NJ
  
3,100 sq. ft. in strip shopping center (leased)
  
01/04
 
 
  
  
  
  
  
  
 
Westfield:
  
520 South Avenue
Westfield, NJ
  
3,630 sq. ft. stand-alone building (leased)
  
10/98
 
 
The Company leases one property in Toms River, New Jersey utilized as an LPO, which has a lease expiration date of January 31, 2022 with two (2) five (5) year options. The Company also leases one property in Summit, New Jersey utilized as a LPO, which has a lease expiration date of February 28, 2019.


23



Item 3. Legal Proceedings.
 
The Company may, in the ordinary course of business, become a party to litigation involving collection matters, contract claims and other legal proceedings relating to the conduct of its business. The Company may also have various commitments and contingent liabilities which are not reflected in the accompanying consolidated balance sheet. At December 31, 2017, we were not involved in any material legal proceedings.
 
Item 4. Mine Safety Disclosures.
 
Not applicable.
 

24



PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
 
The common stock of the Company trades on the Nasdaq Global Market under the trading symbol “TRCB.” The following are the high and low sales prices per share, which have been adjusted for the 5% stock dividend declared January 19, 2017:

  
2017
 
2016
  
High

 
Low

 
High

 
Low

First Quarter
$
18.13

 
$
13.70

 
$
9.36

 
$
8.56

Second Quarter
18.70

 
15.90

 
10.65

 
8.92

Third Quarter
19.85

 
17.33

 
11.23

 
10.28

Fourth Quarter
20.58

 
17.81

 
14.57

 
10.84


As of March 1, 2018, there were approximately 516 record holders of the Company’s common stock.
 
On January 19, 2017, the Company announced that it declared a 5% stock dividend, which was paid on February 28, 2017 to shareholders of record as of February 9, 2017.
 
For the year ended December 31, 2017, the Company paid total cash dividends of $0.17 per share. Such dividends were paid quarterly.

For the year ended December 31, 2016, the Company paid total cash dividends of $0.14 per share. Such dividends were also paid quarterly. For a description of regulatory restrictions on the ability of the Company and the Bank to pay dividends, see Note 17 “Regulatory Matters” included in the Notes to the Consolidated Financial Statements included herein under Item 8.

During the quarter ended December 31, 2017, no shares were repurchased under the Company’s share repurchase program.

All shares repurchased to date have been transacted under the Company’s then-applicable share repurchase program. Future purchases will be made subject to a new share repurchase program, approved and adopted on December 14, 2017, whereby the Company may repurchase up to $2.0 million of its common stock from January 1, 2018 to December 31, 2018.

The Company maintains a Shareholder Rights Plan pursuant to which each outstanding share of the Company’s common stock also carries with it one right (a “Right”) entitling the holder to purchase from the Company one one-thousandth of a share of Series B Junior Participating Preferred Stock, at a purchase price of $25.00, subject to adjustment (as so adjusted, the “Exercise Price”). Upon the acquisition or attempted acquisition of 10% or more of the Company’s outstanding common stock, and in certain other instances, the Rights have certain benefits designed to protect shareholders from abusive takeover tactics and attempts to acquire control of the Company at an inadequate price. The Rights are not exercisable or transferable unless certain specified events occur and will expire on July 20, 2021.


25



The following chart compares the Company's cumulative total shareholder return over the past five years with the NASDAQ Market Index and the Peer Group Index. The Peer Group Index is the SNL U.S. Bank Index, which was prepared by S&P Global Market Intelligence, and contains 320 Banks.




chart-d6069ba8b1cfab04840a02.jpg

 
 
Period Ending
 
Index
12/31/12
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
Two River Bancorp, Inc.
100.00
130.08
154.19
184.61
280.76
361.72
NASDAQ Composite Index
100.00
140.12
160.78
171.97
187.22
242.71
SNL U.S. Bank Index
100.00
137.30
153.48
156.10
197.23
232.91



26



Item 6. Selected Financial Data.

The following selected consolidated financial data as of December 31 for each of the five years presented should be read in conjunction with our audited consolidated financial statements and the accompanying notes.
 
 
 
 
 
As of and for the Years Ended December 31,
 
 
2017
 
2016
 
2015
 
2014
 
2013
 
 
(in thousands, except per share data)
Income Statement
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
38,240

 
$
34,624

 
$
32,103

 
$
30,386

 
$
30,316

Interest expense
 
5,707

 
5,164

 
3,863

 
3,452

 
3,799

   Net interest income
 
32,533

 
29,460

 
28,240

 
26,934

 
26,517

Provision for loan losses
 
1,530

 
515

 
490

 
621

 
910

   Net interest income after provision for loan losses
 
31,003

 
28,945

 
27,750

 
26,313

 
25,607

Non-interest income
 
5,459

 
5,489

 
3,537

 
2,932

 
2,705

Non-interest expenses
 
23,942

 
21,475

 
21,355

 
19,667

 
20,180

   Income before income taxes
 
12,520

 
12,959

 
9,932

 
9,578

 
8,132

Income tax expense
 
6,018

 
4,328

 
3,585

 
3,561

 
2,973

   Net income
 
6,502

 
8,631

 
6,347

 
6,017

 
5,159

Preferred stock dividend
 

 

 
(57
)
 
(117
)
 
(261
)
   Net income available to common shareholders
 
$
6,502

 
$
8,631

 
$
6,290

 
$
5,900

 
$
4,898

 
 
 
 
 
 
 
 
 
 
 
Per Share Data (1)
 
 
 
 
 
 
 
 
 
 
Weighted average shares outstanding:
 
 
 
 
 
 
 
 
 
 
   Basic
 
8,388

 
8,321

 
8,304

 
8,329

 
8,443

   Diluted
 
8,658

 
8,530

 
8,507

 
8,519

 
8,600

Earnings per common share:
 
 
 
 
 
 
 
 
 
 
   Basic
 
$
0.78

 
$
1.04

 
$
0.76

 
$
0.71

 
$
0.58

   Diluted
 
0.75

 
1.01

 
0.74

 
0.69

 
0.57

Cash dividends per common share
 
0.17

 
0.14

 
0.12

 
0.10

 
0.06

 
 
 
 
 
 
 
 
 
 
 
Balance Sheet
 
 
 
 
 
 
 
 
 
 
Loans, net of unearned discounts and fees
 
$
850,874

 
$
753,092

 
$
693,150

 
$
627,614

 
$
602,816

Goodwill and other intangibles
 
18,109

 
18,109

 
18,118

 
18,166

 
18,252

Total assets
 
1,039,798

 
940,211

 
863,696

 
781,196

 
769,707

Total deposits
 
861,557

 
776,567

 
708,436

 
642,390

 
633,449

Total shareholders' equity
 
106,571

 
100,716

 
93,002

 
93,932

 
95,427

 
 
 
 
 
 
 
 
 
 
 
Performance Ratios
 
 
 
 
 
 
 
 
 
 
Return on average assets
 
0.66
%
 
0.96
 %
 
0.76
 %
 
0.78
%
 
0.69
%
Return on average equity
 
6.22
%
 
8.94
 %
 
6.59
 %
 
6.21
%
 
5.49
%
Net interest margin
 
3.53
%
 
3.53
 %
 
3.68
 %
 
3.79
%
 
3.84
%
Efficiency ratio (2)
 
63.02
%
 
61.45
 %
 
67.20
 %
 
65.85
%
 
69.06
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

27



 
 
As of and for the Years Ended December 31,
 
 
2017
 
2016
 
2015
 
2014
 
2013
 
 
(in thousands, except per share data)
Capital Ratios
 
 
 
 
 
 
 
 
 
 
Tier 1 capital to average assets
 
8.85
%
 
8.94
 %
 
8.97
 %
 
9.95
%
 
10.40
%
Tier 1 capital to risk weighted assets
 
9.68
%
 
10.33
 %
 
10.13
 %
 
11.36
%
 
11.99
%
Total capital to risk weighted assets
 
11.93
%
 
12.76
 %
 
12.65
 %
 
12.57
%
 
13.21
%
Common equity Tier 1 capital to risk weighted assets
 
9.68
%
 
10.33
 %
 
10.13
 %
 
N/A
 
N/A
 
 
 
 
 
 
 
 
 
 
 
Asset Quality Ratios
 
 
 
 
 
 
 
 
 
 
Non-performing loans to total loans (3)
 
0.24
%
 
0.21
 %
 
0.46
 %
 
0.99
%
 
1.00
%
Non-performing assets to total assets (4)
 
0.20
%
 
0.19
 %
 
0.42
 %
 
1.00
%
 
1.14
%
Net loan charge-offs (recoveries) to average loans
 
0.05
%
 
(0.05
)%
 
(0.02
)%
 
0.07
%
 
0.18
%
Allowance for loan losses to total loans at period-end
 
1.25
%
 
1.27
 %
 
1.26
 %
 
1.29
%
 
1.31
%
Allowance for loan losses to non-performing loans at period-end
515.36
%
 
617.89
 %
 
274.17
 %
 
129.37
%
 
131.00
%
 
 
 
 
 
 
 
 
 
 
 
(1) Restated for 5% stock dividend in 2017
 
 
 
 
 
 
 
 
(2) Efficiency ratio is total non-interest expense divided by net interest income and non-interest income
(3) Non-performing loans include non-accrual loans and loans past due 90 days and still accruing
(4) Non-performing assets include non-accrual loans, loans past due 90 days and still accruing and other real estate owned
 




28



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

The following management’s discussion and analysis of financial condition and results of operations is intended to provide a better understanding of the significant changes and trends relating to the financial condition, results of operations, capital resources, liquidity and interest rate sensitivity of Two River Bancorp and should be read in conjunction with the audited consolidated financial statements, including the related notes thereto. As used in the following discussion, the term "Company" refers to Two River Bancorp and "the Bank" or "Two River" refers to the Company's wholly owned banking subsidiary, Two River Community Bank.

The following discussion is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses.
 
Note 1 to our audited consolidated financial statements contains a summary of the Company’s significant accounting policies. Management believes the following critical accounting policies encompass the more significant judgments and estimates used in the preparation of our consolidated financial statements.
 
Allowance for Loan Losses. Management believes our policy with respect to the methodology for the determination of the allowance for loan losses (“ALLL”) involves a high degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact the results of operations. This critical policy and its application are reviewed quarterly with our audit committee, Board of Directors and management.
 
Management is responsible for preparing and evaluating the ALLL on a quarterly basis in accordance with Bank policy, and the Interagency Policy Statement on the ALLL released by the Board of Governors of the Federal Reserve System on December 13, 2006 as well as GAAP. We believe that our allowance for loan losses is adequate to cover specifically identifiable loan losses, as well as estimated losses inherent in our portfolio for which certain losses are probable but not specifically identifiable. The allowance for loan losses is based upon management’s evaluation of the adequacy of the allowance account, including an assessment of known and inherent risks in the loan portfolio, giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management utilizes the best information available, the level of the allowance for loan losses remains an estimate that is subject to significant judgment and short term change. Various regulatory agencies may require us and our banking subsidiaries to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of our loans are secured by real estate in New Jersey, primarily in Monmouth, Middlesex and Union Counties. Accordingly, the collectability of a substantial portion of the carrying value of our loan portfolio is susceptible to changes in local market conditions and may be adversely affected should real estate values decline or the New Jersey and/or our local market areas experience economic shock.
 
Stock-Based Compensation. Stock-based compensation cost has been measured using the fair value of an award on the grant date and is recognized over the service period, which is usually the vesting period. The fair value of each option is amortized into compensation expense on a straight-line basis between the grant date for the option and each vesting date. The Company estimates the fair value of stock options on the date of grant using the Black-Scholes option pricing model. The model requires the use of numerous assumptions, many of which are highly subjective in nature.
 
Goodwill Impairment. Although goodwill is not subject to amortization, the Company must test the carrying value for impairment at least annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Impairment testing requires that the fair value of our reporting unit be compared to the carrying amount of its net assets, including goodwill. Our reporting unit was identified as our community bank operations. If the fair value of the reporting unit exceeds the book value, no write-down of recorded goodwill is necessary. If the fair value of a reporting unit is less than book value, an expense may be required on the Company’s books to write-down the related goodwill to the proper carrying value. Impairment testing during 2017 and 2016 for goodwill and intangibles was completed, and the Company did not require any impairment charge during the years ended December 31, 2017 and 2016. See Note 5 in the Notes to Consolidated Financial Statements for more information.
 
Investment Securities Impairment Valuation. Securities are evaluated on at least 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. The analysis of other-than-temporary impairment requires the use of various assumptions including, but not limited to, the length of time the investment’s book value has been greater than fair value, the severity of the investment’s decline and the credit deterioration of the issuer. For debt securities, management assesses whether (a) it has the intent to sell the security and (b) it is more likely

29



than not that it will be required to sell the security prior to its anticipated recovery. These steps are done before assessing whether the entity will recover the cost basis of the investment.

In instances when a determination is made that an other-than-temporary impairment exists but the investor does not intend to sell the debt security, and it is more likely than not that it will not be required to sell the debt security prior to its anticipated recovery, 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.
 
Other Real Estate Owned. Other Real Estate Owned (“OREO”) includes real estate acquired through foreclosure or by deed in lieu of foreclosure. OREO is carried at the lower of cost or fair value of the property, adjusted by management for factors such as economic conditions and other market factors, less estimated costs to sell. When a property is acquired, the excess of the loan balance over fair value, less selling costs, is charged to the allowance for loan losses. Operating results from real estate owned, including rental income, operating expenses, and gains and losses realized from the sales of real estate owned are recorded as incurred. OREO is periodically reviewed to ensure that the fair value of the property supports the carrying value.
 
Deferred Tax Assets and Liabilities. We recognize deferred tax assets and liabilities for future tax effects of temporary differences, net operating loss carry forwards and tax credits. Deferred tax assets are subject to management’s judgment based upon available evidence, primarily management’s forecast of its ability to generate future earnings, that future realization is more likely than not. If management determines that we may be unable to realize all or part of net deferred tax assets in the future, a direct charge to income tax expense may be required to reduce the recorded value of the net deferred tax asset to the expected realizable amount.

The Tax Cuts and Jobs Act (the "Tax Act") was signed into law on December 22, 2017. Pursuant to the SEC Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act ("SAB 118"), given the amount and complexity of the changes in tax law resulting from the Tax Act, the Company has not finalized the accounting for the income tax effects of the Tax Act. This includes the measurement of deferred taxes. The impact of the Tax Act may differ from this estimate, during the one-year measurement period due to, among other things, further refinement of the Company's calculations, changes in interpretations and assumptions the Company has made, guidance that may be issued and actions the Company may take as a result of the Tax Act. As a result of the Tax Act, the Company recorded a non-cash charge to income tax expense of approximately $1.8 million in the fourth quarter of 2017 primarily due to the re-measurement of deferred tax assets and liabilities.

Financial Overview

Net Income
 
The Company reported net income of $6.5 million for the year ended December 31, 2017, compared to $8.6 million in 2016, an decrease of $2.1 million, or 24.7%. Basic and diluted earnings per common share were $0.78 and $0.75, respectively, for the year ended December 31, 2017 compared to basic and diluted earnings per common share of $1.04 and $1.01, respectively, for the same period in 2016. Our results for 2017 include a non-cash charge of $1.78 million, or $0.21 per diluted share, in income tax expense, associated with the enactment of the Tax Act passed in December, which relates to the revaluation of the Company's net deferred tax asset, due to the reduction in the Federal corporate income tax rate from 34% to 21%, effective January 1, 2018. During 2016, the Company received a tax-free Bank Owned Life Insurance (“BOLI”) death benefit of $862,000, or $0.10 per diluted share, which was included in non-interest income. Excluding the charge to income tax expense and the BOLI event in the prior year, 2017 net income increased 6.6%. All share and per share data for all referenced reporting periods have been retroactively adjusted for a 5% stock dividend declared on January 19, 2017, payable on February 28, 2017 to shareholders of record as of February 9, 2017.
 
Total Assets

Total assets increased by $99.6 million, or 10.6%, to $1.04 billion at December 31, 2017 from $940.2 million at December 31, 2016. The increase in total assets was primarily the result of $97.8 million in loan growth funded mainly by core deposit growth during the year.
 
Total Loans and Deposits

Total loans amounted to $850.9 million at December 31, 2017, which was an increase of $97.8 million, or 13.0%, compared to the December 31, 2016 amount of $753.1 million. The Company continues to provide commercial, residential and

30



consumer lending to our market customers, while maintaining our high credit standards in a challenging market. The allowance for loan losses totaled $10.7 million, or 1.25% of total loans, at December 31, 2017, compared to $9.6 million, or 1.27% of total loans, at December 31, 2016.
 
Deposits increased to $861.6 million at December 31, 2017 from $776.6 million at December 31, 2016, an increase of $85.0 million, or 10.9%. The increase in deposits is primarily attributable to the growth in our core checking deposits resulting from increased business and consumer activity, along with certificates of deposit.
 
Shareholders’ Equity and Tangible Book Value per Common Share
 
Shareholders’ equity amounted to $106.6 million at December 31, 2017 from $100.7 million at December 31, 2016, an increase of $5.9 million, or 5.8%. At year-end 2017, book value per common share increased to $12.58 compared to $12.04 at December 31, 2016. At year-end 2017, tangible book value per common share (a Non-GAAP Financial Measure) increased to $10.44 compared to $9.88 at December 31, 2016.

Results of Operations
 
Our principal source of revenue is net interest income, the difference between interest income on interest earning assets and interest expense on deposits and borrowings. Interest earning assets consist primarily of loans, investment securities and federal funds sold. Sources to fund interest earning assets consist primarily of deposits and borrowed funds. Our net income is also affected by our provision for loan losses, non-interest income and non-interest expenses. Non-interest income consists primarily of gains on the sale of loans, service charges, commissions and fees, while non-interest expenses are comprised of salaries and employee benefits, occupancy costs and other operating expenses.


31



The following table provides certain performance ratios for the dates and periods indicated. 
 
2017
 
2016
 
2015
 
 
 
 
 
 
Return on average assets
0.66
%
 
0.96
%
 
0.76
%
Return on average tangible assets (1)
0.67
%
 
0.98
%
 
0.78
%
Return on average shareholders’ equity
6.22
%
 
8.94
%
 
6.59
%
Return on average tangible shareholders’ equity (1)
7.52
%
 
11.00
%
 
8.12
%
Net interest margin
3.53
%
 
3.53
%
 
3.68
%
Average equity to average assets
10.55
%
 
10.70
%
 
11.57
%
Average tangible equity to average tangible assets (1)
8.89
%
 
8.87
%
 
9.60
%

(1)     The following table provides the reconciliation of non-GAAP Financial Measures for the dates indicated:
(in thousands except per share data and percentages)
2017
 
2016
 
2015
 
 
 
 
 
 
Total shareholders’ equity
$
106,571

 
$
100,667

 
$
93,002

Less: goodwill and other intangible assets
(18,109
)
 
(18,109
)
 
(18,118
)
Tangible common shareholders’ equity
$
88,462

 
$
82,558

 
$
74,884

 
 
 
 
 
 
Common shares outstanding
8,470

 
8,365

 
8,325

Book value per common share
$
12.58

 
$
12.04

 
$
11.17

 
 
 
 
 
 
Book value per common share
$
12.58

 
$
12.04

 
$
11.17

Effect of intangible assets
(2.14
)
 
(2.16
)
 
(2.17
)
Tangible book value per common share
$
10.44

 
$
9.88

 
$
9.00

 
 
 
 
 
 
Return on average assets
0.66
 %
 
0.96
 %
 
0.76
 %
Effect of intangible assets
0.01
 %
 
0.02
 %
 
0.02
 %
Return on average tangible assets
0.67
 %
 
0.98
 %
 
0.78
 %
 
 
 
 
 
 
Return on average equity
6.22
 %
 
8.94
 %
 
6.59
 %
Effect of average intangible assets
1.30
 %
 
2.06
 %
 
1.53
 %
Return on average tangible equity
7.52
 %
 
11.00
 %
 
8.12
 %
 
 
 
 
 
 
Average equity to average assets
10.55
 %
 
10.70
 %
 
11.57
 %
Effect of average intangible assets
(1.66
%)
 
(1.83
%)
 
(1.97
%)
Average tangible equity to average tangible assets
8.89
 %
 
8.87
 %
 
9.60
 %
 
This Report contains certain financial information determined by methods other than in accordance with GAAP. These non-GAAP financial measures are “tangible book value per common share,” “return on average tangible assets,” “return on average tangible equity,” and “average tangible equity to average tangible assets.” This non-GAAP disclosure has limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP, nor is it necessarily comparable to non-GAAP performance measures that may be presented by other companies. Our management uses these non-GAAP measures in its analysis of our performance because it believes these measures are material and will be used as a measure of our performance by investors.

32




Financial Results for the Three Years Ended December 31, 2017

Net Interest Income

For the year ended December 31, 2017, net interest income amounted to $32.5 million, as compared to $29.5 million for the year ended December 31, 2016. This increase of $3.0 million, or 10.4%, was primarily the result of a higher volume of average interest-earning assets and a higher level of average core checking deposits. The Federal Reserve raised short-term interest rates three times during 2017 for a total of 0.75%, as compared to 0.25% increases in both 2016 and 2015. Our average earning assets increased by $86.0 million, or 10.3%, to $921.0 million for the year ended December 31, 2017 from $835.0 million for the year ended December 31, 2016, while our net interest spread remained unchanged at 3.35% for both years ended December 31, 2017 and 2016. Our net interest margin also remained unchanged at 3.53% for both years ended December 31, 2017 and 2016.
 
For the year ended December 31, 2016, net interest income amounted to $29.5 million, as compared to $28.2 million for the year ended December 31, 2015. This increase of $1.3 million, or 4.3%, was primarily the result of a higher volume of average interest earning assets and higher level of average core checking deposits. Our average earning assets increased by $67.0 million, or 8.7%, to $835.0 million for the year ended December 31, 2016 from $768.0 million for the year ended December 31, 2015, while our net interest spread decreased by 17 basis points to 3.35% for the year ended December 31, 2016 as compared to 3.52% for the same period in 2015. Our net interest margin decreased by 15 basis points to 3.53% for year ended December 31, 2016 as compared to 3.68% for the same period in 2015. These decreases were primarily the result of the maturity, prepayment or contractual repricing of loans and investment securities in this prolonged low interest rate environment as well as the interest expense associated with the Company’s issuance of subordinated debentures in aggregate principal amount of $10 million in December 2015. This subordinated debt impacted our margin by approximately 8 basis points.

For the year ended December 31, 2017, total interest income increased to $38.2 million from $34.6 million for the year ended December 31, 2016. This increase of $3.6 million, or 10.4%, was primarily due to volume-related increases in interest income of $3.4 million, and by interest rate-related increases in interest income of $252,000, for the year ended December 31, 2017 as compared to the prior year. The average yield on our interest earning assets remained unchanged at 4.15% for the years ended December 31, 2017 and 2016.
 
For the year ended December 31, 2016, total interest income increased to $34.6 million from $32.1 million for the year ended December 31, 2015. This increase of $2.5 million, or 7.9%, was primarily due to volume-related increases in interest income of $3.0 million, partially offset by interest rate-related decreases in interest income of $495,000, for the year ended December 31, 2016 as compared to the prior year. The average yield on our interest earning assets decreased by 3 basis points to 4.15% for the year ended December 31, 2016 from 4.18% for the prior year.

Interest and fees on loans increased by $3.0 million, or 9.2%, to $35.8 million for the year ended December 31, 2017 compared to $32.8 million for the same period in 2016. Of the $3.0 million increase in interest and fees on loans, $3.1 million was attributable to volume-related increases, which were partially offset by $128,000 of rate-related decreases. The average balance of the loan portfolio for the year ended December 31, 2017 increased by $69.2 million, or 9.5%, to $793.7 million from $724.5 million for the same period in 2016. The average annualized yield on the loan portfolio decreased to 4.51% for the year ended December 31, 2017, from 4.53% for the same period in 2016. The average balance of non-accrual loans was $2.1 million and $1.9 million for the years ended December 31, 2017 and 2016, respectively, which impacted the Company’s loan yield for both periods presented.
 
Interest and fees on loans increased by $2.2 million, or 7.1%, to $32.8 million for the year ended December 31, 2016 compared to $30.6 million for the same period in 2015. Of the $2.2 million increase in interest and fees on loans, $2.9 million was attributable to volume-related increases, which were partially offset by $727,000 of rate-related decreases. The average balance of the loan portfolio for the year ended December 31, 2016 increased by $62.7 million, or 9.5%, to $724.5 million from $661.8 million for the same period in 2015. The average annualized yield on the loan portfolio decreased to 4.53% for the year ended December 31, 2016, from 4.63% for the same period in 2015. The average balance of non-accrual loans was $1.9 million and $4.1 million for the years ended December 31, 2016 and 2015, respectively, which impacted the Company’s loan yield for both periods presented.

Interest income on interest-bearing deposits was $350,000 for the year ended December 31, 2017, representing an increase of $217,000, or 163.2%, from $133,000 for the same period in 2016. For the year ended December 31, 2017, interest-bearing deposits had an average balance of $33.3 million and an average annualized yield of 1.05% as compared to $26.2 million and an average annualized yield of 0.51% for the 2016 period.
 

33



Interest income on interest bearing deposits was $133,000 for the year ended December 31, 2016, representing an increase of $59,000, or 79.7%, from $74,000 for the same period in 2015. For the year ended December 31, 2016, interest bearing deposits had an average balance of $26.2 million and an average annualized yield of 0.51% as compared to $28.6 million and an average annualized yield of 0.26% for the 2015 period.

Interest income on investment securities totaled $2.1 million for the year ended December 31, 2017, representing an increase of $396,000, or 23.4%, over the year ended December 31, 2016. For the year ended December 31, 2017, investment securities had an average balance of $94.1 million with an average annualized yield of 2.22%, compared to an average balance of $84.2 million with an average annualized yield of 2.01% for the year ended December 31, 2016.
 
Interest income on investment securities totaled $1.7 million for the year ended December 31, 2016, representing an increase of $288,000, or 20.5%, over the year ended December 31, 2015. For the year ended December 31, 2016, investment securities had an average balance of $84.2 million with an average annualized yield of 2.01%, compared to an average balance of $77.5 million with an average annualized yield of 1.81% for the year ended December 31, 2015.

Total interest expense amounted to $5.7 million for the year ended December 31, 2017, compared to $5.2 million for the corresponding period in 2016, an increase of $543,000, or 10.5%. Of this increase in interest expense, $307,000 was due to volume-related increases resulting from deposit growth and by $236,000 in rate-related increases.
 
Total interest expense amounted to $5.2 million for the year ended December 31, 2016, compared to $3.9 million for the corresponding period in 2015, an increase of $1.3 million, or 33.7%. Of this increase in interest expense, $1.1 million was due to volume-related increases resulting from deposit growth and by $165,000 in rate-related increases.

The average balance of interest-bearing liabilities increased to $714.6 million for the year ended December 31, 2017, from $647.9 million for the same period last year, an increase of $66.7 million, or 10.3%. The average balance in NOW deposits during 2017 increased $50.1 million from $151.4 million with an average annualized yield of 0.43% for the year ended December 31, 2016, to $201.5 million with an average annualized yield of 0.48% for the same period in 2017. Additionally, during 2017, average demand deposits reached $163.7 million, an increase of $13.2 million, or 8.8%, over the same period last year. Average time deposits increased by $1.5 million, or 1.1%, to $135.3 million with an average annualized yield of 1.45% for the year ended December 31, 2017, from $133.8 million with an average annualized yield of 1.42% for the year ended December 31, 2016. Average savings deposits increased by $22.7 million, or 9.7%, to $256.2 million with an average annualized yield of 0.52% for the year ended December 31, 2017, from $233.5 million with an average annualized yield of 0.50% for the year ended December 31, 2016. Average money market deposits decreased by $9.6 million, or 13.2%, to $63.1 million with an average annualized yield of 0.17% for the year ended December 31, 2017, from $72.7 million with an average annualized yield of 0.16% for the 2016 period. For both the years ended December 31, 2017 and 2016, the average yield on our interest-bearing liabilities was 0.80%.

The average balance of interest-bearing liabilities increased to $647.9 million for the year ended December 31, 2016, from $584.6 million for the year ended December 31, 2015, an increase of $63.3 million, or 10.8%. The average balance in NOW deposits during 2016 increased $20.7 million from $130.7 million with an average annualized yield of 0.42% for the year ended December 31, 2015, to $151.4 million with an average annualized yield of 0.43% for the same period in 2016. Additionally, during 2016, average demand deposits reached $150.5 million, an increase of $5.5 million, or 3.8%, over 2015. Average time deposits increased by $30.5 million, or 29.5%, to $133.8 million with an average annualized yield of 1.42% for the year ended December 31, 2016, from $103.3 million with an average annualized yield of 1.32% for the year ended December 31, 2015. Average savings deposits increased by $4.8 million, or 2.1%, to $233.5 million with an average annualized yield of 0.50% for the year ended December 31, 2016, from $228.7 million with an average annualized yield of 0.48% for the year ended December 31, 2015. Average money market deposits increased by $392,000, or 0.5%, to $72.7 million with an average annualized yield of 0.16% for the year ended December 31, 2016, from $72.3 million with the same average annualized yield for the 2015 period. For the year ended December 31, 2016, the average yield on our interest-bearing liabilities was 0.80%, compared to 0.66% for the year ended December 31, 2015, primarily due to the interest expense associated with the Company’s issuance of subordinated debentures discussed below, which effected our cost of interest-bearing liabilities by approximately 9 basis points.

Our strategies for increasing and retaining core relationship deposits, managing loan originations within our acceptable credit criteria and loan category concentrations, and our branch network strategy have combined to meet our liquidity needs. The Company also offers agreements to repurchase securities, commonly known as repurchase agreements, to its customers as an alternative to other insured deposits. Average balances of repurchase agreements for the year ended December 31, 2017 amounted to $22.1 million, with an average interest rate of 0.30%, compared to $19.3 million, with an average interest rate of 0.32%, for the 2016, and $22.1 million, with an average interest rate of 0.31% for 2015.
 

34



The Company also utilizes Federal Home Loan Bank of New York ("FHLB") term borrowings as an additional funding source. Average FHLB term borrowings amounted to $26.5 million, $27.3 million, and $27.1 million for the years ended December 31, 2017, 2016 and 2015, respectively, with an average yield of 2.34%, 2.26% and 2.30% for the years ended December 31, 2017, 2016 and 2015, respectively.
 
In December 2015, the Company completed a private placement of $10 million in aggregate principal amount of fixed to floating rate subordinated debentures to certain institutional accredited investors. The subordinated debentures have a maturity date of December 31, 2025 and bear interest, payable quarterly, at the rate of 6.25% per annum until January 1, 2021 when the rate adjusts. The subordinated debentures have been structured to qualify as Tier 2 capital for regulatory purposes. Subordinated debentures totaled $9.9 million at both December 31, 2017 and 2016, and $9.8 million at December 31, 2015, which included $112,000, $145,000, and $176,000, respectively, of remaining unamortized debt issuance costs. The debt issuance costs are being amortized over the expected life of the issue. The effective interest rate of the subordinated debt is 6.67%.
 
The net cash proceeds of the subordinated debenture offering were used to redeem the Company’s Senior Non-Cumulative Perpetual Preferred Stock issued to the United States Treasury in connection with the Company’s participation in the Small Business Lending Fund program. The balance of such net proceeds are being used for general corporate purposes and to support future growth.


35



The following table reflects, for the periods presented, the components of our net interest income, setting forth: (1) average assets, liabilities, and shareholders’ equity, (2) interest income earned on interest-earning assets and interest expense paid on interest-bearing liabilities, (3) average yields earned on interest-earning assets and average rates paid on interest-bearing liabilities, (4) our net interest spread (i.e., the average yield on interest-earning assets less the average rate on interest-bearing liabilities), and (5) our yield on interest-earning assets. There have been no tax equivalent adjustments made to yields.
 
Years ended December 31,
 
2017
 
2016
 
2015
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands, except for percentages)
ASSETS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-Earning Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits in banks
$
33,255

 
$
350

 
1.05
%
 
$
26,241

 
$
133

 
0.51
%
 
$
28,633

 
$
74

 
0.26
%
Investment securities
94,052

 
2,089

 
2.22
%
 
84,227

 
1,693

 
2.01
%
 
77,525

 
1,405

 
1.81
%
Loans, net of unearned fees (1) (2)
793,671

 
35,801

 
4.51
%
 
724,511

 
32,798

 
4.53
%
 
661,817

 
30,624

 
4.63
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Interest-Earning Assets
920,978

 
38,240

 
4.15
%
 
834,979

 
34,624

 
4.15
%
 
767,975

 
32,103

 
4.18
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-Interest-Earning Assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan loss
(9,933
)
 
 

 
 

 
(9,275
)
 
 

 
 

 
(8,311
)
 
 

 
 

Other assets
79,850

 
 

 
 

 
77,181

 
 

 
 

 
72,744

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Assets
$
990,895

 
 
 
 
 
$
902,885

 
 
 
 
 
$
832,408

 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
LIABILITIES & SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest-Bearing Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NOW deposits
$
201,490

 
958

 
0.48
%
 
$
151,360

 
649

 
0.43
%
 
$
130,658

 
551

 
0.42
%
Savings deposits
256,222

 
1,330

 
0.52
%
 
233,514

 
1,165

 
0.50
%
 
228,707

 
1,106

 
0.48
%
Money market deposits
63,093

 
107

 
0.17
%
 
72,721

 
119

 
0.16
%
 
72,329

 
116

 
0.16
%
Time deposits
135,326

 
1,968

 
1.45
%
 
133,842

 
1,896

 
1.42
%
 
103,324

 
1,368

 
1.32
%
Securities sold under agreements to repurchase
22,066

 
66

 
0.30
%
 
19,309

 
61

 
0.32
%
 
22,071

 
68

 
0.31
%
FHLB and other borrowings
26,544

 
620

 
2.34
%
 
27,304

 
618

 
2.26
%
 
27,051

 
621

 
2.30
%
Subordinated debt
9,872

 
658

 
6.67
%
 
9,840

 
656

 
6.67
%
 
494

 
33

 
6.68
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Interest-Bearing Liabilities
714,613

 
5,707

 
0.80
%
 
647,890

 
5,164

 
0.80
%
 
584,634

 
3,863

 
0.66
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-Interest-Bearing Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Demand deposits
163,707

 
 

 
 

 
150,495

 
 

 
 

 
144,980

 
 

 
 

Other liabilities
8,003

 
 

 
 

 
7,919

 
 

 
 

 
6,509

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Non-Interest-Bearing Liabilities
171,710

 
 

 
 

 
158,414

 
 

 
 

 
151,489

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Shareholders’ Equity
104,572

 
 

 
 

 
96,581

 
 

 
 

 
96,285

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total Liabilities and Shareholders’ Equity
$
990,895

 
 

 
 

 
$
902,885

 
 

 
 

 
$
832,408

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NET INTEREST INCOME
 

 
$
32,533

 
 

 
 

 
$
29,460

 
 

 
 

 
$
28,240

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NET INTEREST SPREAD (3)
 

 
 

 
3.35
%
 
 

 
 

 
3.35
%
 
 

 
 

 
3.52
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NET INTEREST MARGIN (4)
 

 
 

 
3.53
%
 
 

 
 

 
3.53
%
 
 

 
 

 
3.68
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(1)
Included in interest income on loans are loan fees.
(2)
Includes non-performing loans.
(3)
The interest rate spread is the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.
(4)
The interest rate margin is calculated by dividing net interest income by average interest-earning assets.


36



Analysis of Changes in Net Interest Income
 
The following table sets forth for the periods indicated the amounts of the total change in net interest income that can be attributed to changes in the volume of interest-earning assets and interest-bearing liabilities and the amount of the change that can be attributed to changes in interest rates.
 
 
Years ended December 31,
 
2017 vs. 2016
 
2016 vs. 2015
 
Increase (decrease) due to change in
 
Average
volume
 
Average
rate
 
Net
 
Average
volume
 
Average
rate
 
Net
 
 
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Interest Earned On:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits in banks
$
36

 
$
181

 
$
217

 
$
(6
)
 
$
65

 
$
59

Investment securities
197

 
199

 
396

 
121

 
167

 
288

Loans, net of unearned fees
3,131

 
(128
)
 
3,003

 
2,901

 
(727
)
 
2,174

 
 
 
 
 
 
 
 
 
 
 
 
Total Interest Income
3,364

 
252

 
3,616

 
3,016

 
(495
)
 
2,521

 
 
 
 
 
 
 
 
 
 
 
 
Interest Paid On:
 
 
 
 
 
 
 
 
 
 
 
NOW deposits
215

 
94

 
309

 
87

 
11

 
98

Savings deposits
113

 
52

 
165

 
23

 
36

 
59

Money market deposits
(16
)
 
4

 
(12
)
 
1

 
2

 
3

Time deposits
1

 
71

 
72

 
404

 
124

 
528

Securities sold under agreements to repurchase
8

 
(3
)
 
5

 
(9
)
 
2

 
(7
)
FHLB and other borrowings
(16
)
 
18

 
2

 
6

 
(9
)
 
(3
)
Subordinated debt
2

 

 
2

 
624

 
(1
)
 
623

 
 
 
 
 
 
 
 
 
 
 
 
Total Interest Expense
307

 
236

 
543

 
1,136

 
165

 
1,301

 
 
 
 
 
 
 
 
 
 
 
 
Net Interest Income
$
3,057

 
$
16

 
$
3,073

 
$
1,880

 
$
(660
)
 
$
1,220

 
The change in interest due to both volume and rate has been allocated proportionally to both, based on their relative absolute values.
 
Provision for Loan Losses
 
Our provision for loan losses for the year ended December 31, 2017 was $1.5 million, as compared to $515,000 for the year ended December 31, 2016. The increase in our provision was primarily due to an increase in loan activity. The $1.5 million provision for 2017 was driven by a number of factors, including the level of charge-offs and recoveries, our assessment of the current state of the economy, allowances related to impaired loans and loan activity. The provision for the comparable 2016 period considered the same factors. The provision for loan losses is determined by an allocation process whereby an estimated allowance is allocated to the specific allowance for impaired loans and the general allowance for pools of loans. The allocation reflects management’s assessment of economic conditions, credit quality and other risk factors inherent in the loan portfolio. The allowance for loan losses totaled $10.7 million, or 1.25% of total loans at December 31, 2017, compared to $9.6 million, or 1.27% of total loans at December 31, 2016.

Our provision for loan losses for the year ended December 31, 2016 was $515,000, as compared to $490,000 for the year ended December 31, 2015. The increase in our provision was primarily due to an increase in loan activity. The $515,000 provision for 2016 was driven by a number of factors, including the level of charge-offs and recoveries, our assessment of the current state of the economy, allowances related to impaired loans and loan activity. The provision for the comparable 2015 period considered the same factors. The provision for loan losses is determined by an allocation process whereby an estimated allowance

37



is allocated to the specific allowance for impaired loans and the general allowance for pools of loans. The allocation reflects management’s assessment of economic conditions, credit quality and other risk factors inherent in the loan portfolio. The allowance for loan losses totaled $9.6 million, or 1.27% of total loans at December 31, 2016, compared to $8.7 million, or 1.26% of total loans at December 31, 2015.

Non-Interest Income
 
Non-interest income amounted to $5.5 million for both the years ended December 31, 2017 and 2016. Excluding the tax-free BOLI death benefit of $862,000 in 2016, non-interest income increased $832,000, or 18.0%. Mortgage banking revenue increased by $421,000, or 36.2%, while gains on the sale of SBA loans increased $184,000, or 21.2%. Both of these increases were the result of a higher volume of originated salable loans. Additionally, service fees on deposit accounts increased by $185,000, or 31.5%, mainly due to the realignment of fees on various products.

Non-interest income amounted to $5.5 million for the year ended December 31, 2016, compared to $3.5 million for the year ended December 31, 2015. This increase of $2.0 million, or 55.2%, included the receipt of a tax-free BOLI death benefit of $862,000. Additionally, the Company reported higher gains on the sale of SBA loans of $307,000 and an increase in other loan fees of $396,000 due to higher loan prepayment fees. Residential mortgage banking revenue increased by $379,000, or 48.4%, while other income increased by $140,000, or 19.7%, due primarily to higher fees related to our title agency joint venture as well as other fees. These increases were partially offset by a decrease of $208,000 resulting from the gain on sale of a branch property in 2015.
 
Non-Interest Expenses
  
Non-interest expenses for year ended December 31, 2017 increased $2.5 million, or 11.5%, compared to the year ended December 31, 2016. This increase was primarily the result of an increase of $1.2 million, or 9.4%, in salaries and employee benefits, which was due primarily to both annual merit increases and commissions from higher residential mortgage banking business. Occupancy and equipment expenses increased $124,000, or 3.0%, due primarily to increased expenses associated with computer and technology upgrades. Professional fees increased $299,000, or 25.0%, primarily due to higher consulting and audit fees. Advertising expenses increased $35,000, or 8.4%, due to increased advertising related to the Company’s branding, awareness and products and services. Loan workout expenses increased $160,000 or 219.2% primarily due to the recapture of $144,000 of expenses in 2016 related to previously charged off credit. OREO expenses, impairments and sales, net, increased by $322,000, or 117.5%, from 2016 primarily due to a $250,000 recovery of settlement expenses from an OREO property in 2016.

Non-interest expenses for year ended December 31, 2016 increased $120,000, or 0.6%, compared to the year ended December 31, 2015. This increase was primarily the result of an increase of $358,000, or 2.9%, in salaries and employee benefits, which was due primarily to both annual merit increases and commissions from higher residential mortgage banking volume. Occupancy and equipment expenses increased $175,000, or 4.4%, due primarily to increased expenses associated with computer and technology upgrades. Professional fees increased $216,000, or 22.0%, primarily due to higher consulting and legal fees. Data processing fees increased $79,000, or 16.6%, due primarily to computer and technology upgrades. These increases were partially offset by a decrease of $358,000, or 83.1%, in loan workout expenses primarily due to the decrease in impaired loans to which such expenses relate, in addition to the recapture of $144,000 of expenses related to a previously charged off credit. OREO expenses, impairments and sales, net, declined by $204,000, or 291.4%, from 2015 primarily due to a lower level of OREO assets and, as such, lower associated costs. Amortization of intangible assets, which was the result of The Town Bank acquisition in 2006, amounted to $9,000 during 2016 as compared to $48,000 during 2015.

Income Tax Expense

The Company recorded $6.0 million and $4.3 million in income tax expense for the years ended December 31, 2017 and 2016, respectively. The effective tax rate for 2017 increased to 48.1% from 33.4% in 2016 primarily due to the previously mentioned $1.8 million charge related to the re-valuation of our net deferred tax asset as a result of the Tax Act. Additionally the tax-free BOLI death benefit had the effect of lowering our effective tax rate in 2016.

The Company recorded $4.3 million and $3.6 million in income tax expense for the years ended December 31, 2016 and 2015, respectively. The effective tax rate for 2016 decreased to 33.4% from 36.1% in 2015 due to a lower level of taxable income during the current period due primarily to the tax-free BOLI death benefit and a higher level of tax-exempt municipal securities.


38




Financial Condition
December 31, 2017 Compared to December 31, 2016
 
Assets
 
At December 31, 2017, total assets were $1.04 billion, an increase of $99.6 million, or 10.6%, compared to $940.2 million at December 31, 2016. At December 31, 2017, total loans were $850.9 million, an increase of $97.8 million, or 13.0%, from the $753.1 million reported at December 31, 2016. Investment securities, including restricted stock, were $94.6 million at December 31, 2017 as compared to $97.1 million at December 31, 2016, a decrease of $2.5 million, or 2.6%. At December 31, 2017, cash and cash equivalents totaled $48.2 million compared to $42.1 million at December 31, 2016, a increase of $6.1 million, or 14.6%. Our liquidity position is described below under “Liquidity.” Goodwill totaled $18.1 million at both December 31, 2017 and 2016.

Liabilities
 
Total liabilities increased $93.7 million, or 11.2%, to $933.2 million at December 31, 2017, from $839.5 million at December 31, 2016. Total deposits increased $85.0 million, or 10.9%, to $861.6 million at December 31, 2017, from $776.6 million at December 31, 2016. FHLB and other borrowings increased $500,000 to $25.8 million at December 31, 2017, from $25.3 million at December 31, 2016, and the Company issued $9.8 million of subordinated debentures in December 2015.
 
Securities Portfolio
 
Investment securities, including restricted investments, totaled $94.6 million at December 31, 2017 compared to $97.1 million at December 31, 2016, a decrease of $2.5 million, or 2.6%. For 2017 and 2016, investment securities purchases amounted to $18.0 million and $33.2 million, respectively, while repayments, calls and maturities amounted to $20.4 million and $15.9 million, respectively. In 2017, there were no investment securities sales as compared to sales totaling $1.0 million resulting in a net gain on sale of $72,000 during 2016.
 
The Company maintains an investment portfolio to fund increased loans and liquidity needs (resulting from decreased deposits or otherwise) and to provide an additional source of interest income. The portfolio is composed of obligations of the U.S. Government agencies and U.S. Government-sponsored entities, municipal securities, a limited amount of corporate debt securities and an investment in a Community Reinvestment Act (“CRA”) mutual fund. U.S. Government agencies are considered to have the lowest risk due to the “full faith and credit” guarantee by the U.S. Government. All of our mortgage-backed investment securities are collateralized by pools of mortgage obligations that are guaranteed by privately managed, U.S. Government-sponsored enterprises (“GSE”), such as Fannie Mae, Freddie Mac and the Government National Mortgage Association. Due to these GSE guarantees, these investment securities are susceptible to less risk of non-performance and default than other corporate securities which are collateralized by private pools of mortgages. At December 31, 2017, the Company maintained $15.6 million of GSE residential mortgage-backed securities in the investment portfolio and $9.7 million of collateralized residential mortgage obligations, all of which are current as to payment of principal and interest and are performing to the terms set forth in their respective prospectuses. Municipal securities are evaluated by a review of the credit ratings of the underlying issuer, any changes in such ratings that have occurred, and adverse conditions relating to the security or its issuer, as well as other factors.
 
Included within the Company’s investment portfolio are trust preferred securities, which consists of four single issue securities issued by large financial institutions with Moody’s ratings from Baa1 to Baa3. These securities have an amortized cost value of $2.8 million and a fair value of $2.6 million at December 31, 2017. The unrealized loss on these securities is related to general market conditions and the widening of interest rate spreads.
 
Management evaluates all securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic and market concerns warrant such evaluations. As of December 31, 2017, all of these securities are current with their scheduled interest payments. Future deterioration in the cash flow of these investments or the credit quality of the financial institution issuers could result in impairment charges in the future.
 
The Company accounts for its investment securities as available for sale or held to maturity. Management determines the appropriate classification at the time of purchase. Based on an evaluation of the probability of the occurrence of future events, we determine if we have the ability and intent to hold the investment securities to maturity, in which case we classify them as held to maturity. All other investments are classified as available for sale.

Securities classified as available for sale must be reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders’ equity, net of taxes. Gains or losses on the sales of securities available for sale are recognized upon realization utilizing the specific identification method. The net effect of unrealized gains or losses, caused by marking our available for sale portfolio to fair value, could cause fluctuations in the level of shareholders’ equity and equity-related financial ratios as changes in market interest rates cause the fair value of fixed-rate securities to fluctuate.
 
Securities classified as held to maturity are carried at cost, adjusted for amortization of premium and accretion of discount over the terms of the maturity in a manner that approximates the interest method.

39



 
The following table sets forth the carrying value of the securities portfolio as of December 31, 2017, 2016 and 2015 (in thousands).
 
 
December 31,
 
2017
 
2016
 
2015
Securities available for sale at fair value:
 
 
 
 
 
U.S. Government agency securities
$
10,057

 
$
8,413

 
$
1,238

Municipal securities
495

 
503

 
517

U.S. Government-sponsored enterprises (“GSE”) - residential mortgage-backed securities
8,219

 
11,255

 
14,449

U.S. Government collateralized residential mortgage obligations
7,482

 
9,537

 
12,627

Corporate debt securities, primarily financial institutions
2,431

 
2,359

 
2,317

Community Reinvestment Act (“CRA”) mutual fund
2,448

 
2,397

 
2,382

 
 
 
 
 
 
Total securities available for sale
$
31,132

 
$
34,464

 
$
33,530

 
 
 
 
 
 
Securities held to maturity at amortized cost:
 
 
 
 
 
Municipal securities
$
46,614

 
$
47,806

 
$
33,956

GSE - residential mortgage-backed securities
7,339

 
5,414

 
3,789

U.S. Government collateralized residential mortgage obligations
2,224

 
2,801

 
3,602

Corporate debt securities, primarily financial institutions
1,825

 
1,822

 
1,820

 
 
 
 
 
 
Total securities held to maturity
$
58,002

 
$
57,843

 
$
43,167



40