10-K 1 essa-10k_20160930.htm 10-K essa-10k_20160930.htm

 

SECURITIES AND EXCHANGE COMMISSION

100 F Street NE

Washington, D.C. 20549

 

FORM 10-K

 

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

For the Fiscal Year Ended September 30, 2016

or

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

For the transition period from                      to                      

Commission File No. 001-33384

 

ESSA Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

Pennsylvania

 

20-8023072

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

 

 

 

200 Palmer Street, Stroudsburg, Pennsylvania

 

18360

(Address of Principal Executive Offices)

 

(Zip Code)

(570) 421-0531

(Registrant’s telephone number)

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

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.01 par value

 

The NASDAQ Stock Market, LLC

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

 

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

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

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

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

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

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

 

Large accelerated filer

 

Accelerated filer

 

 

 

 

 

Non-accelerated filer

 

Smaller reporting company

 

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

As of December 1, 2016, there were 18,133,095 shares issued and 11,407,934 shares outstanding of the Registrant’s Common Stock.

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the last sale price on March 31, 2016, was $136,657,518.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Proxy Statement for the 2017 Annual Meeting of Stockholders of the Registrant (Part III).

 

 

 

 

 


TABLE OF CONTENTS

 

PART I

 

 

Item 1.

 

Business

 

2

Item 1A.

 

Risk Factors

 

26

Item 1B.

 

Unresolved Staff Comments

 

31

Item 2.

 

Properties

 

32

Item 3.

 

Legal Proceedings

 

33

Item 4.

 

Mine Safety Disclosures

 

33

PART II

 

 

Item 5.

 

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

 

34

Item 6.

 

Selected Financial Data

 

36

Item 7.

 

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

 

38

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

48

Item 8.

 

Financial Statements and Supplementary Data

 

48

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

48

Item 9A.

 

Controls and Procedures

 

48

Item 9B.

 

Other Information

 

49

PART III

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

50

Item 11.

 

Executive Compensation

 

50

Item 12.

 

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

 

50

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

50

Item 14.

 

Principal Accounting Fees and Services

 

50

PART IV

 

 

Item 15.

 

Exhibits and Financial Statement Schedules

 

51

 

 

 

i


Forward Looking Statements

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

 

 

1


PART I

 

 

Item  1.

Business

ESSA Bancorp, Inc.

ESSA Bancorp, Inc. (“ESSA Bancorp” or the “Company”) is a Pennsylvania-chartered holding company for ESSA Bank & Trust (the “Bank”). ESSA Bancorp owns 100% of the outstanding shares of common stock of the Bank. Since being formed in 2006, ESSA Bancorp has engaged primarily in the business of holding the common stock of the Bank. Our executive offices are located at 200 Palmer Street, Stroudsburg, Pennsylvania 18360. Our telephone number at this address is (570) 421-0531. ESSA Bancorp is subject to comprehensive regulation and examination by the Federal Reserve Board of Governors. On July 31, 2012, ESSA Bancorp completed its acquisition of First Star Bancorp, Inc. and its wholly-owned subsidiary, First Star Bank (“First Star”). The total value of the consideration for the acquisition was $24.6 million, 50% of which was paid in cash and the remainder paid in the form of ESSA Bancorp common stock. On April 4, 2014, ESSA Bancorp completed its acquisition of Franklin Security Bancorp, Inc. and its wholly owned subsidiary, Franklin Security Bank (“Franklin Security”). The total value of the consideration for the acquisition was $15.7 million which was paid in cash. On December 4, 2015, ESSA Bancorp completed its acquisition of Eagle National Bancorp, Inc. (“ENB”), whereby ESSA Bancorp acquired ENB and its wholly owned subsidiary, Eagle National Bank in an all cash transaction. Under the terms of the agreement, ENB stockholders received approximately $24.7 million, or $5.80 per share as of the December 4, 2015 closing date. Effective November 14, 2014, ESSA Bancorp converted its holding company status from a savings and loan holding company to a bank holding company, and it elected the financial holding company designation as a bank holding company. At September 30, 2016, ESSA Bancorp had consolidated assets of $1.8 billion, consolidated deposits of $1.2 billion and consolidated stockholders’ equity of $176.3 million. Consolidated net income for the fiscal year ended September 30, 2016 was $7.7 million.

ESSA Bank & Trust

General

The Bank was organized in 1916. The Bank is a Pennsylvania chartered full-service, community-oriented savings bank. We provide financial services to individuals, families and businesses through our 26 full-service banking offices, located in Monroe, Northampton, Lehigh, Lackawanna, Luzerne, Chester, Delaware and Montgomery Counties, Pennsylvania. The Bank is subject to comprehensive regulation and examination by the Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation. In March 2014, the Bank converted its charter from a Pennsylvania savings and loan association to a Pennsylvania savings bank. The charter change did not have a material effect on the operations of the Bank.

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

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

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

Market Area

At September 30, 2016, our 26 full-service banking offices consisted of 11 offices in Monroe County, 4 offices in Lehigh County, 5 offices in Northampton County, 1 office in Lackawanna County, 1 office in Luzerne County, 1 office in Chester County, 2 offices in Delaware County and 1 office in Montgomery County, Pennsylvania. Our primary market for deposits is currently concentrated around the areas where our full-service banking offices are located. Our primary lending area consists of the counties where our branch offices are located, and to a lesser extent, the contiguous counties in the Commonwealth of Pennsylvania.

2


Monroe County is located in eastern Pennsylvania, situated 90 miles north of Philadelphia, 75 miles west of New York and 116 miles northeast of Harrisburg. Monroe County is comprised of 611 square miles of mostly rural terrain. Major industries include tourism, construction and educational facilities. Northampton County is located south of Monroe County and directly borders New Jersey. Lehigh County is located southwest of Monroe County. Luzerne and Lackawanna Counties are located north of Monroe County. Chester and Montgomery Counties are located south and Delaware County southwest of Monroe County. As of September 30, 2016, we had a deposit market share of approximately 29.8% in Monroe County, which represented the largest deposit market share in Monroe County, 2.4% in Northampton County, 1.4% in Lehigh County, 0.1% in Lackawanna County, 0.9% in Luzerne County, 0.1% in Chester County, 0.1% in Montgomery County and 1.3% in Delaware County.

Lending Activities

Historically, our principal lending activity has been the origination of first mortgage loans for the purchase, construction or refinancing of one- to four-family residential real estate property. In recent years, we have increased our originations of commercial loans, commercial real estate loans and indirect auto loans in an effort to increase interest income, diversify our loan portfolio, and better serve the community. Commercial real estate loans have increased from $160.2 million or 16.7% of our total loan portfolio at September 30, 2012 to $288.4 million, or 23.5%, of our total loan portfolio at September 30, 2016. One- to four-family residential real estate mortgage loans represented $596.6 million, or 48.6%, of our loan portfolio at September 30, 2016. Home equity loans and lines of credit totaled $48.2 million, or 3.9%, of our loan portfolio at September 30, 2016. Commercial loans totaled $40.0 million, or 3.3%, of our loan portfolio at September 30, 2016 and construction first mortgage loans totaled $1.7 million, or 0.1%, of the total loan portfolio at September 30, 2016. Obligations of states and political subdivisions totaled $56.9 million, or 4.6%, of our loan portfolio at September 30, 2016. Auto loans totaled $193.1 million or 15.7% of the total loan portfolio at September 30, 2016. We originate other consumer loans on a limited basis.

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

 

 

 

At September 30,

 

 

 

2016

 

 

2015

 

 

2014

 

 

 

 

 

 

2013

 

 

 

 

 

 

2012

 

 

 

 

 

 

 

Amount

 

 

Percent

 

 

Amount

 

 

Percent

 

 

Amount

 

 

Percent

 

 

Amount

 

 

Percent

 

 

Amount

 

 

Percent

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential first mortgage

   loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family

 

$

596,645

 

 

 

48.6

%

 

$

610,582

 

 

 

55.0

%

 

$

654,152

 

 

 

61.3

%

 

$

686,651

 

 

 

73.3

%

 

$

696,696

 

 

 

72.8

%

Construction

 

 

1,733

 

 

 

0.1

 

 

 

878

 

 

 

0.1

 

 

 

1,367

 

 

 

0.1

 

 

 

2,288

 

 

 

0.2

 

 

 

3,805

 

 

 

0.4

 

Commercial

 

 

39,978

 

 

 

3.3

 

 

 

34,314

 

 

 

3.1

 

 

 

25,807

 

 

 

2.4

 

 

 

10,125

 

 

 

1.1

 

 

 

12,818

 

 

 

1.3

 

Commercial real estate

 

 

288,447

 

 

 

23.5

 

 

 

200,004

 

 

 

18.0

 

 

 

190,536

 

 

 

17.9

 

 

 

159,469

 

 

 

17.0

 

 

 

160,192

 

 

 

16.7

 

Obligations of states and

   political subdivisions

 

 

56,923

 

 

 

4.6

 

 

 

59,820

 

 

 

5.4

 

 

 

49,177

 

 

 

4.6

 

 

 

33,445

 

 

 

3.6

 

 

 

33,736

 

 

 

3.5

 

Home equity loans and

   lines of credit

 

 

48,163

 

 

 

3.9

 

 

 

39,903

 

 

 

3.6

 

 

 

41,387

 

 

 

3.9

 

 

 

41,923

 

 

 

4.5

 

 

 

47,925

 

 

 

5.0

 

Auto loans

 

 

193,078

 

 

 

15.7

 

 

 

162,193

 

 

 

14.5

 

 

 

100,571

 

 

 

9.4

 

 

 

61

 

 

 

 

 

 

165

 

 

 

 

Other

 

 

3,302

 

 

 

0.3

 

 

 

3,343

 

 

 

0.3

 

 

 

3,904

 

 

 

0.4

 

 

 

2,332

 

 

 

0.3

 

 

 

2,320

 

 

 

0.3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans receivable

 

$

1,228,269

 

 

 

100.0

%

 

$

1,111,037

 

 

 

100.0

%

 

$

1,066,901

 

 

 

100.0

%

 

$

936,294

 

 

 

100.0

%

 

$

957,657

 

 

 

100.0

%

Allowance for loan losses

 

 

(9,056

)

 

 

 

 

 

 

(8,919

)

 

 

 

 

 

 

(8,634

)

 

 

 

 

 

 

(8,064

)

 

 

 

 

 

 

(7,302

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans receivable, net

 

$

1,219,213

 

 

 

 

 

 

$

1,102,118

 

 

 

 

 

 

$

1,058,267

 

 

 

 

 

 

$

928,230

 

 

 

 

 

 

$

950,355

 

 

 

 

 

 

3


Loan Portfolio Maturities. The following table summarizes the scheduled repayments of our loan portfolio at September 30, 2016. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less.

 

 

 

One-to-four-

family

 

 

Construction

 

 

Commercial

 

 

Commercial

Real Estate

 

 

 

(Dollars in thousands)

 

Due During the Years Ending September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2017

 

$

581

 

 

$

 

 

$

5,812

 

 

$

34,223

 

2018

 

 

3,646

 

 

 

 

 

 

3,544

 

 

 

25,834

 

2019

 

 

3,922

 

 

 

 

 

 

5,294

 

 

 

24,792

 

2020 to 2021

 

 

11,043

 

 

 

 

 

 

4,439

 

 

 

41,520

 

2022 to 2026

 

 

113,133

 

 

 

 

 

 

12,337

 

 

 

53,060

 

2027 to 2031

 

 

156,282

 

 

 

 

 

 

688

 

 

 

29,536

 

2031 and beyond

 

 

308,038

 

 

 

1,733

 

 

 

7,864

 

 

 

79,482

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

596,645

 

 

$

1,733

 

 

$

39,978

 

 

$

288,447

 

 

 

 

Obligations of States and

Political subdivisions

 

 

Home Equity Loans

and Lines of Credit

 

 

Auto Loans

 

 

Other

 

 

Total

 

 

 

(Dollars in thousands)

 

Due During the Years Ending September 30,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2017

 

$

470

 

 

$

1,360

 

 

$

1,255

 

 

$

189

 

 

$

43,890

 

2018

 

 

1,367

 

 

 

1,173

 

 

 

4,900

 

 

 

312

 

 

 

40,776

 

2019

 

 

123

 

 

 

1,959

 

 

 

14,904

 

 

 

391

 

 

 

51,385

 

2020 to 2021

 

 

841

 

 

 

6,303

 

 

 

114,441

 

 

 

1,290

 

 

 

179,877

 

2022 to 2026

 

 

17,803

 

 

 

13,027

 

 

 

57,578

 

 

 

108

 

 

 

267,046

 

2027 to 2031

 

 

25,930

 

 

 

10,744

 

 

 

 

 

 

543

 

 

 

223,723

 

2031 and beyond

 

 

10,389

 

 

 

13,597

 

 

 

 

 

 

469

 

 

 

421,572

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

56,923

 

 

$

48,163

 

 

$

193,078

 

 

$

3,302

 

 

$

1,228,269

 

 

The following table sets forth the scheduled repayments of fixed- and adjustable-rate loans at September 30, 2016 that are contractually due after September 30, 2017.

 

 

 

Due After September 30, 2017

 

 

 

Fixed

 

 

Adjustable

 

 

Total

 

 

 

(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential first mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family

 

$

554,947

 

 

$

41,117

 

 

$

596,064

 

Construction

 

 

1,733

 

 

 

 

 

 

1,733

 

Commercial

 

 

26,410

 

 

 

7,756

 

 

 

34,166

 

Commercial real estate

 

 

58,740

 

 

 

195,484

 

 

 

254,224

 

Obligations of states and political subdivisions

 

 

26,707

 

 

 

29,746

 

 

 

56,453

 

Home equity loans and lines of credit

 

 

16,382

 

 

 

30,421

 

 

 

46,803

 

Auto loans

 

 

191,823

 

 

 

 

 

 

191,823

 

Other

 

 

2,889

 

 

 

224

 

 

 

3,113

 

Total

 

$

879,631

 

 

$

304,748

 

 

$

1,184,379

 

 

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

One- to four-family Residential Loans. Historically, our principal lending activity has consisted of the origination of one- to four-family residential mortgage loans secured primarily by properties located in Monroe, Northampton, Lackawanna, Luzerne, Lehigh, Chester, Delaware, and Montgomery Counties, Pennsylvania. At September 30, 2016, $596.6 million, or 48.6%, of our loan

4


portfolio, consisted of one- to four-family residential loans. Our origination of one- to four-family loans increased in fiscal year 2016 compared to fiscal year 2015 and fiscal year 2014. Generally, one- to four-family residential mortgage loans are originated in amounts up to 80% of the lesser of the appraised value or purchase price of the property, although loans may be made with higher loan-to-value ratios if private mortgage insurance is specified to compensate for the risk. Fixed-rate loans are originated for terms of 10, 15, 20 and 30 years. At September 30, 2016, our largest loan secured by one- to four-family real estate had a principal balance of approximately $1.9 million and was secured by a single family house. This loan was performing in accordance with its repayment terms.

We also offer adjustable-rate mortgage loans which have initial fixed terms of one, three, five or seven-years before converting to an annual adjustment schedule based on changes in a designated United States Treasury index. We originated $5.0 million of adjustable rate one- to four-family residential loans during the year ended September 30, 2016 and $2.2 million during the year ended September 30, 2015. Our adjustable rate mortgage loans provide for maximum rate adjustments of 200 basis points per adjustment, with a lifetime maximum adjustment of 500 basis points. Our adjustable rate mortgage loans amortize over terms of up to 30 years.

Adjustable rate mortgage loans decrease the risk associated with changes in market interest rates by periodically repricing, but involve other risks. As interest rates increase, the principal and interest payments on the loan increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Adjustment of the contractual interest rate is limited by the periodic and lifetime interest rate adjustments specified by our loan documents and therefore, is potentially limited in effectiveness during periods of rapidly rising interest rates. At September 30, 2016, $41.1 million, or 6.9%, of our one- to four-family residential loans had adjustable rates of interest.

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

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

Home Equity Loans and Lines of Credit. Home equity loans and lines of credit are generated by our loan originators. Eligible properties include primary and vacation homes in northeastern Pennsylvania, with the majority of loans being originated in Monroe, Northampton and Lehigh Counties. As of September 30, 2016, home equity loans and lines totaled about $48.2 million, or 3.9%, of our loan portfolio.

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

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

Commercial Real Estate Loans. At September 30, 2016, $288.4 million, or 23.5%, of our total loan portfolio consisted of commercial real estate loans. Commercial real estate loans are secured by office buildings, mixed-use properties and other commercial properties. We generally originate adjustable rate commercial real estate loans with an initial term of five years and a repricing option, and a maximum term of up to 25 years. The maximum loan-to-value ratio for most commercial real estate loans is 75% to 80% and 85% for select loans with faster amortizations. At September 30, 2016, our largest commercial real estate relationship balance was $13.6 million, which was performing in accordance with its terms.

We consider a number of factors in originating commercial real estate loans. We evaluate the qualifications and financial condition of the borrower, including credit history, profitability and expertise, as well as the value and condition of the mortgaged property securing the loan. When evaluating the qualifications of the borrower, we consider the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with us and other financial institutions. In evaluating the property securing the loan, the factors we consider include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the

5


debt service coverage ratio (the ratio of net operating income to debt service) to ensure that it is at least 120% of the monthly debt service. All commercial real estate loans in excess of $250,000 are appraised by outside independent appraisers approved by the Board of Directors. Personal guarantees are obtained from commercial real estate borrowers although we may occasionally waive this requirement given very strong loan to value and debt service coverage ratios. All purchase money and most asset refinance borrowers are required to obtain title insurance. We also require fire and casualty insurance and, where circumstances warrant, flood insurance.

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

First Mortgage Construction Loans. At September 30, 2016, $1.7 million, or 0.1%, of our total loan portfolio consisted of first mortgage construction loans. Our first mortgage construction loans are for the construction of residential properties. We currently offer fixed and adjustable-rate residential first mortgage construction loans. First mortgage construction loans are generally structured for permanent mortgage financing once the construction is completed. At September 30, 2016, our largest first mortgage construction loan balance was $321,000. The loan was performing in accordance with its terms. First mortgage construction loans will generally be made in amounts of up to 80% of the appraised value of the completed property, or the actual cost of the improvements. First mortgage construction loans require only the payment of interest during the construction period. Once converted to permanent financing, they generally repay over a 30 year period. Funds are disbursed based on our inspections in accordance with a schedule reflecting the completion of portions of the project.

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

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

Commercial Loans. At September 30, 2016, approximately $40.0 million, or 3.3%, of our loan portfolio, consisted of commercial loans. We generally offer commercial loans to individuals and businesses located in our primary market area. The commercial loan portfolio includes lines of credit, equipment loans, vehicle loans, improvement loans and term loans. These loans are primarily secured by vehicles, machinery and equipment, inventory, accounts receivable, marketable securities, deposit accounts and real estate.

Obligations of States and Political Subdivisions. At September 30, 2016, $56.9 million, or 4.6%, of our total loan portfolio consisted of loan transactions including tax and revenue anticipation notes, general obligation notes, and authority general revenue notes. The financial strength of the state or political subdivision, type of transaction, relationship efforts, and profitability of return are considered when pricing and structuring each transaction.

Auto Loans. At September 30, 2016, $193.1 million, or 15.7% of our total loan portfolio consisted of auto loans. Franklin Security specialized in indirect automobile lending. After the acquisition of Franklin Security, the Bank retained a number of their experienced employees. Although collateralized, these loans require stringent underwriting standards and procedures. Each loan decision is based primarily on the credit history of the individual(s) and their ability to repay the loan. Collision and comprehensive insurance is required and the Bank must be listed as the loss payee.

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

Other Loans. We offer a variety of loans that are either unsecured or secured by property other than real estate. These loans include loans secured by deposits and personal unsecured loans. At September 30, 2016, these other loans totaled $3.3 million, or 0.3%, of the total loan portfolio.

Loan Approval Procedures and Authority. The loan approval process is intended to assess the borrower’s ability to repay the loan, the viability of the loan, and the adequacy of the value of the property that will secure the loan. To assess the borrower’s

6


ability to repay, we review each borrower’s employment and credit history and information on the historical and projected income and expenses of mortgagors. For all loans the Board has granted lending authority to prescribed loan committees. Larger and more complex loan requests require the involvement of senior management or the Board.

Non-Performing Loans and Problem Assets

Performance of the loan portfolio is reviewed on a regular basis by Bank Management. A number of factors regarding the borrower, such as overall financial strength, collateral values and repayment ability, are considered in deciding what actions should be taken when determining the collectability of interest for accrual purposes.

When a loan, including a loan that is impaired, is classified as nonaccrual, the accrual of interest on such a loan is discontinued. A loan is typically classified as nonaccrual when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about the further collectability of principal or interest, even though the loan is currently performing. A loan may remain on accrual status if it is in the process of collection and is either guaranteed or well secured. When a loan is placed on nonaccrual status, unpaid accrued interest is fully reversed. Interest payments received on nonaccrual loans are either applied against principal or reported as interest income, according to management’s judgment as to the collectability of principal.

Loans are usually restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Non-performing Loans. At September 30, 2016, $19.3 million, or 1.57% of our total loans, were non-performing loans. The majority of these loans were commercial real estate loans and residential mortgage loans. Non-performing commercial real estate loans totaled $8.1 million at September 30, 2016. Residential first mortgage loans that were 90 days or more past due or classified as non-performing troubled debt restructured loans totaled $9.0 million at September 30, 2016. In connection with the ENB acquisition, the Company acquired loans with deteriorated credit quality totaling $3.5 million. These loans were carried at $1.8 million at September 30, 2016. The Company acquired no loans with deteriorated credit quality in connection with the acquisition of Franklin Security Bank in April 2014, and acquired no non-performing assets from First National Community Bank in January 2014.

Real Estate Owned. At September 30, 2016, the Company had $2.7 million of real estate owned consisting of 34 properties. These properties are being carried on the Company’s books at fair value less estimated costs to sell. All these properties are being actively marketed and additional losses may occur.

7


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

 

 

 

At September 30,

 

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

 

(Dollars in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-accrual loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential first mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family

 

$

8,972

 

 

$

9,772

 

 

$

9,778

 

 

$

10,945

 

 

$

10,536

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

874

 

 

 

416

 

 

 

1,243

 

 

 

1,177

 

 

 

1,870

 

Commercial real estate

 

 

8,144

 

 

 

8,840

 

 

 

10,612

 

 

 

10,818

 

 

 

10,909

 

Home equity loans and lines of credit

 

 

950

 

 

 

690

 

 

 

259

 

 

 

339

 

 

 

373

 

Auto loans

 

 

344

 

 

 

366

 

 

 

 

 

 

 

 

 

 

Other

 

 

31

 

 

 

21

 

 

 

20

 

 

 

 

 

 

19

 

Total

 

 

19,315

 

 

 

20,105

 

 

 

21,912

 

 

 

23,279

 

 

 

23,707

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Accruing loans 90 days or more past due:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential first mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial real estate

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Home equity loans and lines of credit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Auto Loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total loans 90 days or more past due

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-performing troubled debt restructurings

 

 

 

 

 

 

 

 

238

 

 

 

585

 

 

 

533

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-performing loans

 

 

19,315

 

 

 

20,105

 

 

 

22,150

 

 

 

23,864

 

 

 

24,240

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Real estate owned

 

 

2,659

 

 

 

2,480

 

 

 

2,759

 

 

 

2,111

 

 

 

2,998

 

Other repossessed assets

 

 

9

 

 

 

64

 

 

 

69

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-performing assets

 

$

21,983

 

 

$

22,649

 

 

$

24,978

 

 

$

25,975

 

 

$

27,238

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Troubled Debt Restructurings (1):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential first mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family

 

$

4,981

 

 

$

6,575

 

 

$

5,302

 

 

$

6,024

 

 

$

7,342

 

Construction

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial

 

 

 

 

 

 

 

 

 

 

 

18

 

 

 

227

 

Commercial real estate

 

 

2,625

 

 

 

800

 

 

 

1,381

 

 

 

1,582

 

 

 

5,344

 

Home equity loans and lines of credit

 

 

234

 

 

 

264

 

 

 

103

 

 

 

197

 

 

 

167

 

Auto loans

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

7,840

 

 

$

7,639

 

 

$

6,786

 

 

$

7,821

 

 

$

13,080

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Ratios:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total non-performing loans to total loans

 

 

1.57

%

 

 

1.81

%

 

 

2.08

%

 

 

2.55

%

 

 

2.53

%

Total non-performing loans to total assets

 

 

1.09

%

 

 

1.25

%

 

 

1.41

%

 

 

1.74

%

 

 

1.71

%

Total non-performing assets to total assets

 

 

1.24

%

 

 

1.41

%

 

 

1.58

%

 

 

1.89

%

 

 

1.92

%

 

1)

Non-performing troubled debt restructurings are included in total troubled debt restructurings as part of the non-performing assets table.

For the years ended September 30, 2016, 2015, 2014, 2013, and 2012, gross interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $779,000, $188,000, $660,000, $883,000 and $592,000, respectively.

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At September 30, 2016, the principal balance of troubled debt restructures was $7.8 million as compared to $7.6 million at September 30, 2015. Of the $7.8 million of troubled debt restructures at September 30, 2016, $433,000 are performing loans and $7.4 million are non-accrual loans.

Of the 57 loans that comprised our troubled debt restructures at September 30, 2016, no loans were granted a rate concession at a below market interest rate, 21 loans with balances totaling $3.0 million were granted market rate and terms concessions, 24 loans with balances totaling $4.1 million were granted terms concessions and 12 loans with balances totaling $722,000 were granted interest rate concessions.

Troubled debt restructured loans at September 30, 2016 were comprised of 46 residential loans totaling $5.0 million, 8 commercial real estate loans totaling $2.6, and 3 consumer loans (home equity loans, home equity lines of credit, and other) totaling $234,000.

For the year ended September 30, 2016, 18 loans totaling $2.5 million were removed from TDR status, 4 loans totaling $497,000 were transferred to foreclosed real estate, 10 loans for $1.5 million had completed timely payments, and 4 loan totaling $446,000 was paid off.

We have modified terms of performing loans that do not meet the definition of a TDR. The vast majority of such loans were simply rate modifications of residential first mortgage loans in lieu of refinancing. The non-TDR rate modifications were all performing loans when the rates were reset to current market rates. For the year ended September 30, 2016, we modified 29 loans totaling $3.9 million. With regard to commercial loans, including commercial real estate loans, various non-troubled loans were modified, either for the purpose of a rate reduction to reflect current market rates (in lieu of a refinance) or the extension of a loan’s maturity date. In total we modified 9 commercial loans with an aggregate balance of approximately $10.0 million for the year ended September 30, 2016.

9


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

 

 

 

Loans Delinquent For

 

 

 

 

 

 

 

 

 

 

 

60-89 Days

 

 

90 Days and Over

 

 

Total

 

 

 

Number

 

 

Amount

 

 

Number

 

 

Amount

 

 

Number

 

 

Amount

 

 

 

(Dollars in thousands)

 

At September 30, 2016

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Residential first mortgage loans:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

One- to four-family

 

$

6

 

 

$

660

 

 

$

92

 

 

$

8,972

 

 

$

98