10-K 1 dlno20130610_10k.htm FORM 10-K dlno20130605_10k10q.htm

United States

Securities and Exchange Commission

Washington, D.C. 20549

 

FORM 10-K

 

[X]

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended March 31, 2013

 

[ ]

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _________ to __________

 

Commission File Number: 0-52517

 

DELANCO BANCORP, INC.

(Name of small business issuer in its charter)

 

United States

(State or other jurisdiction of

incorporation or organization)

36-4519533

(I.R.S. Employer Identification No.)

615 Burlington Avenue,

Delanco, New Jersey 

(Address of principal executive offices)

 

08075

(Zip Code)

Issuer’s telephone number: (856) 461-0611

Securities registered under Section 12(b) of the Exchange Act: None

Securities registered under Section 12(g) of the Exchange Act:

 

 

Common Stock, par value $0.01 per share

 

 

(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 X

 

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 X

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 X 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 X   No ___

 

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

 

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

 

Large accelerated filer

[     ]

Accelerated filer

[     ]

Non-accelerated filer

[     ] (Do not check if a smaller reporting company)

Smaller reporting company

[ X ]

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Act).
Yes ____ No X

 

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of September 30, 2012 was approximately $6.5 million.

 

The number of shares outstanding of the registrant’s common stock as of June 11, 2013 was 1,634,725.

 

 
 

 

 


INDEX


 

Part I

Page

Item 1.

Business

1

Item 1A.

Risk Factors

13

Item 1B.

Unresolved Staff Comments

18

Item 2.

Properties

18

Item 3.

Legal Proceedings

18

Item 4.

Mine Safety Disclosures

18
     

Part II

 
     

Item 5.

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

18

Item 6.

Selected Financial Data

18

Item 7.

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

20

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

22

Item 8.

Financial Statements and Supplementary Data

37

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

37

Item 9A.

Controls and Procedures

37

Item 9B.

Other Information

38
     

Part III

 
     

Item 10.

Directors, Executive Officers and Corporate Governance

39

Item 11.

Executive Compensation

41

Item 12.

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

42

Item 13.

Certain Relationships and Related Transactions, and Director Independence

43

Item 14.

Principal Accounting Fees and Services

44
     

Part IV

 
     

Item 15.

Exhibits and Financial Statement Schedules

44
     

SIGNATURES

46

 

 
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This report contains certain “forward-looking statements” within the meaning of the federal securities laws that are based on assumptions and may describe future plans, strategies and expectations of Delanco Bancorp, Inc. (“Delanco Bancorp” or the “Company”), Delanco MHC and Delanco Federal Savings Bank (“Delanco Federal” or the “Bank”). These forward-looking statements are generally identified by terms such as “expects,” “believes,” “anticipates,” “intends,” “estimates,” “projects” and similar expressions.

 

Management’s ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of Delanco Bancorp and its subsidiaries include, but are not limited to, the following: interest rate trends; the general economic climate in the market area in which we operate, as well as nationwide; our ability to control costs and expenses; competitive products and pricing; loan delinquency rates and changes in federal and state legislation and regulation. Additional factors that may affect our results are discussed in this Annual Report on Form 10-K under “Item 1A—Risk Factors.” These risks and uncertainties should be considered in evaluating the forward-looking statements and undue reliance should not be placed on such statements. We assume no obligation to update any forward-looking statements.

 

PART I

 

ITEM 1.

BUSINESS

 

General


We are headquartered in Delanco Township, New Jersey and operate as a community-oriented financial institution dedicated to serving the financial services needs of consumers and businesses within our market areas. Delanco Federal is engaged primarily in the business of attracting deposits from the general public and using such funds to originate one- to four-family real estate loans and to a much lesser extent, multi-family and nonresidential real estate loans, home equity and consumer loans which we primarily hold for investment. Delanco Federal also maintains an investment portfolio. Delanco Federal’s primary federal regulator is the Office of the Comptroller of the Currency (the “OCC”). The FDIC, through the Deposit Insurance Fund, insures Delanco Federal’s deposit accounts up to the applicable legal limits. Delanco Federal is a member of the Federal Home Loan Bank (“FHLB”) of New York.

 

Delanco Bancorp, Inc. was organized in 2002 as a federal corporation at the direction of Delanco Federal, in connection with the reorganization of the Bank from the mutual form of organization to the mutual holding company form of organization. On March 30, 2007, Delanco Bancorp completed a minority stock offering.

 

Delanco Bancorp’s business activity is the ownership of the outstanding capital stock of Delanco Federal. Delanco Bancorp does not own or lease any property but instead uses the premises, equipment and other property of Delanco Federal with the payment of appropriate rental fees, as required by applicable law and regulations, under the terms of an expense allocation agreement. In the future, Delanco Bancorp may acquire or organize other operating subsidiaries; however, there are no current plans, arrangements, agreements or understandings, written or oral, to do so.

 

Delanco Federal operates as a community-oriented financial institution offering traditional financial services to consumers and businesses in our market area. We attract deposits from the general public and use those funds to originate a variety of consumer and business loans.

 

Our website address is www.delancofsb.com. Information on our website should not be considered a part of this report.

 

Market Area

 

We are headquartered in Delanco Township, New Jersey. In addition to our main office, we operate a full-service branch office in Cinnaminson, New Jersey. Delanco and Cinnaminson are in western Burlington County, New Jersey, across the Delaware River from northeastern Philadelphia. We consider Burlington County to be our primary market area.

 

 
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Competition


We face significant competition for the attraction of deposits and origination of loans. Our most direct competition for deposits has historically come from the many financial institutions operating in our market area and, to a lesser extent, from other financial service companies such as brokerage firms, credit unions and insurance companies. Several large banks operate in our market area, including Bank of America, Wells Fargo & Company (formerly known as Wachovia), TD Bank and PNC Bank. These institutions are significantly larger than us and, therefore, have significantly greater resources. We also face competition for customers’ funds from money market funds, mutual funds and other corporate and government securities. At June 30, 2012, which is the most recent date for which data is available from the FDIC, we held 1.44% of the deposits in Burlington County, New Jersey.

 

Our competition for loans comes primarily from financial institutions in our market area and, to a lesser extent, from other financial service providers, such as mortgage companies and mortgage brokers. Competition for loans also comes from non-depository financial service companies, such as insurance companies, securities companies and specialty finance companies.

 

We expect competition to remain intense in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Federal law permits affiliation among banks, securities firms and insurance companies, which promotes a competitive environment in the financial services industry. Competition for deposits and the origination of loans could limit our growth in the future.

 

Lending Activities 

 

One- to Four-Family Residential Loans. We offer three types of residential mortgage loans: fixed-rate loans, balloon loans and adjustable-rate loans. We offer fixed-rate mortgage loans with terms of 15, 20 or 30 years and balloon mortgage loans with terms of five, ten or 15 years. We offer adjustable-rate mortgage loans with interest rates and payments that adjust annually after an initial fixed period of one or three years. Interest rates and payments on our adjustable-rate loans generally are adjusted to a rate equal to a percentage above the one year U.S. Treasury index. The maximum amount by which the interest rate may be increased or decreased is generally 2% per adjustment period and the lifetime interest rate cap is generally 6.0% over the initial interest rate of the loan. We generally retain all of the mortgage loans that we originate, although from time to time we have sold some of the 30-year, fixed-rate mortgage loans that we originated. If we choose to sell any mortgages in the future, it would be with the servicing of the loans retained by the Bank.

 

Borrower demand for adjustable-rate or balloon loans compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to the interest rates and loan fees for adjustable-rate or balloon loans. The relative amount of fixed-rate, balloon and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. We have seen little demand for adjustable-rate loans in the low interest rate environment that has prevailed in recent years. The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.

 

While one- to four-family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. We do not offer loans with negative amortization and generally do not offer interest only loans.

 

We will make loans with loan-to-value ratios up to 95%; however, we require private mortgage insurance for loans with a loan-to-value ratio over 80%. We require all properties securing mortgage loans to be appraised by a board-approved independent appraiser. We generally require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.

 

 
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Commercial and Multi-Family Real Estate Loans. We have traditionally offer fixed- and adjustable-rate mortgage loans secured by a variety of commercial and multi-family real estate, such as small office buildings, warehouses, retail properties and small apartment buildings. We originate a variety of fixed- and adjustable-rate commercial real estate and multi-family real estate loans generally for terms up to five to seven years and payments based on an amortization schedule of up to 25 years. Adjustable-rate loans are typically based on the Prime Rate and the Constant Maturity Treasury rate. Loans are secured by first mortgages, and amounts generally do not exceed 80% of the property’s appraised value.

 

During 2006 and 2007, we expanded our lending area to all of Pennsylvania and New Jersey, with a focus on Philadelphia and southwestern New Jersey. As a result of the economic downturn we experienced a significant increase in non-performing assets, particularly in our commercial real estate portfolio. Following a change in our senior management in 2009, we restricted our out-of-market commercial lending. We were restricted from making new commercial loans under the Cease and Desist Order issued by the Office of Thrift Supervision on March 17, 2010 and, as a result, we have made few commercial and multi-family real estate loans in recent years. The written agreement with the OCC dated November 21, 2012 eliminated this lending restriction.

 

Construction Loans. We originate loans to individuals to finance the construction of residential dwellings. We also make construction loans for small commercial development projects. Our construction loans generally provide for the payment of interest only during the construction phase, which is usually nine months for residential properties and 12 months for commercial properties. Upon completion of the construction phase, the loan typically converts to a permanent mortgage loan and is reclassified as such. Loans generally can be made with a maximum loan to value ratio of 90% on residential construction and 80% on commercial construction, based on appraised value as if complete. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also will require an inspection of the property before disbursement of funds during the term of the construction loan.

 

Commercial Loans. We offer commercial business loans to professionals, sole proprietorships and small businesses in our market area. We offer installment loans for capital improvements, equipment acquisition and long-term working capital. These loans are secured by business assets other than real estate, such as business equipment and inventory, or are backed by the personal guarantee of the borrower. We originate lines of credit to finance the working capital needs of businesses to be repaid by seasonal cash flows or to provide a period of time during which the business can borrow funds for planned equipment purchases. We also offer accounts receivable lines of credit.

 

When making commercial business loans, we consider the financial statements of the borrower, the borrower’s payment history of both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the customer operates and the value of the collateral.

 

Consumer Loans. Our consumer loans consist primarily of home equity loans and lines of credit. We occasionally make loans secured by passbook or certificate accounts and automobile loans.

 

We offer home equity loans with a maximum combined loan to value ratio of 80% or less. Home equity lines of credit have adjustable rates of interest that are indexed to the Prime Rate as published by The Wall Street Journal. Home equity loans have fixed interest rates and terms that typically range from five to 15 years. Some of our home equity loans are originated as five-year balloon loans with monthly payments based on a 20- to 30-year amortization schedule.

 

The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.

 

Loan Originations, Purchases and Sales. Loan originations come from a number of sources. The primary sources of loan originations are existing customers, walk-in traffic, advertising and referrals from customers.

 

 
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From time to time, we have purchased participations in loans from the Thrift Institutions Community Investment Corporation of New Jersey to supplement our lending portfolio. Loan participations totaled $144 thousand at March 31, 2013. Loan participations are also subject to the same credit analysis and loan approvals as loans we originate. We are permitted to review all of the documentation relating to any loan in which we participate. However, in a purchased participation loan, we do not service the loan and thus are subject to the policies and practices of the lead lender with regard to monitoring delinquencies, pursuing collections and instituting foreclosure proceedings.

 

In the past, we have sold some of the 30-year fixed rate loans that we originated to the Federal Home Loan Bank of New York for interest risk management purposes. In recent periods we have retained all of the loans that we have originated. We may sell loans from time to time in the future to help manage our asset/liability mix and limit our interest rate risk. We intend to retain the servicing on any loans sold.

 

Loan Approval Procedures and Authority. Our lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by our board of directors and management. The board of directors has granted loan approval authority to our President and Chief Executive Officer and Vice President – Lending up to prescribed limits, based on the officer’s experience and tenure. All loans over $500,000 with respect to residential mortgage loans and smaller amounts with respect to other types of loans must be approved by the loan committee of the board of directors or the full board.

 

Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities is limited, by regulation, to generally 15% of our stated capital and reserves. At March 31, 2013, our regulatory limit on loans to one borrower was $1.8 million. At that date, our largest lending relationship was $1.1 million and was secured by residential real estate. This loan was performing in accordance with it terms at March 31, 2013.

 

Loan Commitments. We issue commitments for fixed- and adjustable-rate mortgage loans conditioned upon the occurrence of certain events. Commitments to originate mortgage loans are legally binding agreements to lend to our customers. Generally, our loan commitments expire after 60 days.

 

Loan Underwriting Risks.

 

Adjustable-Rate Loans. While we anticipate that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate mortgages, an increased monthly mortgage payment required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a high interest rate environment. In addition, although adjustable-rate mortgage loans make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.

 

Construction Loans. 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 Multi-Family Real Estate Loans. Loans secured by commercial and multi-family real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential mortgage loans. Of primary concern in commercial and multi-family real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, we require borrowers and loan guarantors, if any, to provide annual financial statements on commercial and multi-family real estate loans. In reaching a decision on whether to make a commercial or multi-family real estate loan, we consider and review a global cash flow analysis of the borrower and consider the net operating income of the property, the borrower’s expertise, credit history and profitability and the value of the underlying property. We have generally required that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.25x. An environmental survey or environmental risk insurance is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.

 

 
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Commercial Loans. 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 whose value 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. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

 

Consumer Loans. 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 depreciate rapidly, such as motor vehicles. In the latter case, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.


Investment Activities

 

We have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies and of state and municipal governments, mortgage-backed securities and certificates of deposit of federally insured institutions. Within certain regulatory limits, we also may invest a portion of our assets in corporate securities and mutual funds. We also are required to maintain an investment in Federal Home Loan Bank of New York and Atlantic Central Bankers Bank stock.

 

At March 31, 2013, our investment portfolio totaled $22.3 million, or 17.3% of total assets, and consisted primarily of mortgage-backed securities and debt securities of government sponsored enterprises.

 

Our investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of low-risk investments when demand for loans is weak and to generate a favorable return. Our board of directors has the overall responsibility for the investment portfolio, including approval of our investment policy. The Asset/Liability Committee is responsible for implementation of the investment policy and monitoring our investment performance. Our board of directors reviews the status of our investment portfolio on a monthly basis, or more frequently if warranted.

 

Deposit Activities and Other Sources of Funds

 

General. Deposits, borrowings and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.

 

Deposit Accounts. Substantially all of our depositors are residents of New Jersey. Deposits are attracted from within our market area through the offering of a broad selection of deposit instruments, including non-interest-bearing demand deposits (such as checking accounts), interest-bearing demand accounts (such as NOW and money market accounts), savings accounts and certificates of deposit. In addition to accounts for individuals, we also offer commercial checking accounts designed for the businesses operating in our market area. We do not have any brokered deposits. From time to time we promote various accounts in an effort to increase deposits.

 

 
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Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our liquidity needs, profitability to us, and customer preferences and concerns. We generally review our deposit mix and pricing bi-weekly. Our deposit pricing strategy has generally been to offer competitive rates and to be towards the top of the local market for rates on all types of deposit products.

 

Borrowings. We have the ability to utilize advances from the Federal Home Loan Bank of New York, Atlantic Central Bankers Bank and the Federal Reserve Bank of Philadelphia to supplement our investable funds. The Federal Home Loan Bank functions as a central reserve bank providing credit for member financial institutions. As a member, we are required to own capital stock in the Federal Home Loan Bank and are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution’s net worth or on the Federal Home Loan Bank’s assessment of the institution’s creditworthiness. Atlantic Central Bankers Bank provides correspondent banking services, both credit and non-credit, to financial institutions in the Mid-Atlantic region. As a member, we are required to own capital stock in Atlantic Central Bankers Bank and are authorized to apply for advances under an unsecured line of credit. The Federal Reserve Bank of Philadelphia functions as a central reserve bank providing credit for member financial institutions. We are authorized to apply for advances on the security of such stock and certain of our mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. At March 31, 2013, we had arrangements to borrow up to $11.4 million from the Federal Home Loan Bank of New York and $1.0 million from the Atlantic Central Bankers Bank.

 

Personnel

 

As of March 31, 2013, we had 23 full-time equivalent employees, none of whom is represented by a collective bargaining unit. We believe our relationship with our employees is good.

 

Subsidiaries

 

The only subsidiary of Delanco Bancorp is Delanco Federal. Delanco Federal has one active subsidiary, DFSB Properties, LLC, which is the title holder for repossessed real estate.

 

Regulation and Supervision

 

General

 

Delanco Federal, as a federal savings association, is currently subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and by the FDIC as the insurer of its deposits. Delanco Federal is a member of the Federal Home Loan Bank System and its deposit accounts are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. Delanco Federal must file reports with the OCC concerning its activities and financial condition in addition to obtaining regulatory approvals before entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OCC to evaluate Delanco Federal’s safety and soundness and compliance with various regulatory requirements. This regulatory structure is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of an adequate allowance for loan losses for regulatory purposes. Any change in such policies, whether by the OCC, the FDIC or Congress, could have a material adverse impact on Delanco Bancorp and Delanco Federal and their operations.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) made extensive changes to the regulation of Delanco Federal. Under the Dodd-Frank Act, the Office of Thrift Supervision was eliminated and responsibility for the supervision and regulation of federal savings associations such as Delanco Federal was transferred to the OCC on July 21, 2011. The OCC is the agency that is primarily responsible for the regulation and supervision of national banks. Additionally, the Dodd-Frank Act created a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve Board. The Consumer Financial Protection Bureau assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. However, institutions of less than $10 billion in assets, such as Delanco Federal, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the enforcement authority of, their prudential regulators.

 

 
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Certain of the regulatory requirements that are applicable to Delanco Federal and Delanco Bancorp are described below. This description of statutes and regulations is not intended to be a complete explanation of such statutes and regulations and their effects on Delanco Federal and Delanco Bancorp.

 

Federal Banking Regulation

 

Business Activities. The activities of federal savings banks, such as Delanco Federal, are governed by federal laws and regulations. Those laws and regulations delineate the nature and extent of the business activities in which federal savings banks may engage. In particular, certain lending authority for federal savings banks, e.g., commercial, non-residential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.

 

Capital Requirements. The applicable capital regulations require savings associations to meet three minimum capital standards: a 1.5% tangible capital to total assets ratio, a 4% Tier 1 capital to total assets leverage ratio (3% for institutions receiving the highest rating on the CAMELS examination rating system) and an 8% risk-based capital ratio. In addition, the prompt corrective action standards discussed below also establish, in effect, a minimum 2% tangible capital standard, a 4% leverage ratio (3% for institutions receiving the highest rating on the CAMELS system) and, together with the risk-based capital standard itself, a 4% Tier 1 risk-based capital standard. The regulations also require that, in meeting the tangible, leverage and risk-based capital standards, institutions must generally deduct investments in and loans to subsidiaries engaged in activities as principal that are not permissible for a national bank.

 

The risk-based capital standard for savings associations requires the maintenance of Tier 1 (core) and total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments) to risk-weighted assets of at least 4% and 8%, respectively. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor assigned by the capital regulation based on the risks believed inherent in the type of asset. Tier 1 (core) capital is generally defined as common stockholders’ equity (including retained earnings), certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries, less intangibles other than certain mortgage servicing rights and credit card relationships. The components of supplementary capital (Tier 2 capital) include cumulative preferred stock, long-term perpetual preferred stock, mandatory convertible debt securities, subordinated debt and intermediate preferred stock, the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and up to 45% of unrealized gains on available-for-sale equity securities with readily determinable fair market values. Overall, the amount of supplementary capital included as part of total capital cannot exceed 100% of core capital.

 

The OCC also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of the particular risks or circumstances. See “—Regulatory Agreement” below for information on the individual minimum capital requirements currently applicable to Delanco Federal.

 

Savings and loan holding companies are not currently subject to specific regulatory capital requirements. The Dodd-Frank Act, however, requires the Federal Reserve Board to promulgate consolidated capital requirements for depository institution holding companies, including savings and loan holding companies, that are no less stringent, both quantitatively and in terms of components of capital, than those applicable to institutions themselves. On August 30, 2012, the federal banking agencies issued proposed rules that would implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

 

 
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The proposed rules include new risk-based capital and leverage ratios, which would be phased in from 2013 to 2019, and would revise the definition of what constitutes “capital” for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to Delanco Bancorp and Delanco Federal under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would eliminate the inclusion of certain instruments, such as trust preferred securities, from Tier 1 capital. Instruments issued prior to May 19, 2010 will be grandfathered for companies with consolidated assets of $15 billion or less and phased out over a period of 10 years ending in 2022. The proposed rules would also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

Prompt Corrective Regulatory Action. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept broker deposits. The OCC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OCC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and critically undercapitalized institutions are subject to additional mandatory and discretionary measures.

 

Insurance of Deposit Accounts. Delanco Federal’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. Deposit insurance per account owner is currently $250,000. Under the FDIC’s risk-based assessment system, insured institutions are assigned a risk category based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by FDIC regulations. Institutions deemed less risky pay lower assessments. The FDIC may adjust the scale uniformly, except that no adjustment can deviate more than two basis points from the base scale without notice and comment. No institution may pay a dividend if in default of the federal deposit insurance assessment.

 

The Dodd-Frank Act required the FDIC to revise its procedures to base its assessments upon each insured institution’s total assets less tangible equity instead of deposits. The FDIC finalized a rule, effective April 1, 2011, that set the assessment range at 2.5 to 45 basis points of total assets less tangible equity.

 

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of Delanco Federal. Management cannot predict what insurance assessment rates will be in the future.

 

Loans to One Borrower. Federal law provides that savings associations are generally subject to the limits on loans to one borrower applicable to national banks. Generally, subject to certain exceptions, a savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of its unimpaired capital and surplus. An additional amount may be lent, equal to 10% of unimpaired capital and surplus, if secured by specified readily-marketable collateral.

 

Qualified Thrift Lender Test. Federal law requires savings associations to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities but also including education, credit card and small business loans) in at least nine months out of each 12-month period.

 

A savings association that fails the qualified thrift lender test is subject to certain operating restrictions and the Dodd-Frank Act also specifies that failing the qualified thrift lender test is a violation of law that could result in an enforcement action and dividend limitations. As of March 31, 2013, Delanco Federal maintained 87.6 % of its portfolio assets in qualified thrift investments and, therefore, met the qualified thrift lender test.

 

 
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Limitation on Capital Distributions. Federal regulations impose limitations upon all capital distributions by a savings association, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, an application to and the prior approval of the OCC is required before any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under OCC regulations (i.e., generally, examination and Community Reinvestment Act ratings in the two top categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the OCC. If an application is not required, the institution must still provide 30 days prior written notice to, and receive the nonobjection of, the Federal Reserve Board of the capital distribution if, like Delanco Federal, it is a subsidiary of a holding company, as well as an informational notice filing to the OCC. If Delanco Federal’s capital ever fell below its regulatory requirements or the OCC notified it that it was in need of increased supervision, its ability to make capital distributions could be restricted. In addition, the OCC could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the OCC determines that such distribution would constitute an unsafe or unsound practice.  

 

Community Reinvestment Act. All federal savings associations have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income neighborhoods. An institution’s failure to satisfactorily comply with the provisions of the Community Reinvestment Act could result in denials of regulatory applications. Responsibility for administering the Community Reinvestment Act, unlike other fair lending laws, is not being transferred to the Consumer Financial Protection Bureau. Delanco Federal received an “outstanding” Community Reinvestment Act rating in its most recently completed examination.

 

Transactions with Related Parties. Federal law limits Delanco Federal’s authority to engage in transactions with “affiliates” (e.g., any entity that controls or is under common control with Delanco Federal, including Delanco Bancorp and Delanco MHC and their other subsidiaries). The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings association. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings association’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. Transactions with affiliates must generally be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings associations are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings association may purchase the securities of any affiliate other than a subsidiary.

 

The Sarbanes-Oxley Act of 2002 generally prohibits loans by Delanco Bancorp to its executive officers and directors. However, the law contains a specific exception for loans by a depository institution to its executive officers and directors in compliance with federal banking laws. Under such laws, Delanco Federal’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities such persons control, is limited. The laws limit both the individual and aggregate amount of loans that Delanco Federal may make to insiders based, in part, on Delanco Federal’s capital level and requires that certain board approval procedures be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved.

 

Enforcement. The OCC currently has primary enforcement responsibility over savings associations and has authority to bring actions against the institution and all institution-affiliated parties, including shareholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can amount to $25,000 per day, or even $1.0 million per day in especially egregious cases. The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings association. If action is not taken by the OCC, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

 

 
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Federal Home Loan Bank System. Delanco Federal is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Delanco Federal, as a member of the Federal Home Loan Bank of New York, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. Delanco Federal was in compliance with this requirement with an investment in Federal Home Loan Bank stock at March 31, 2013 of $203 thousand.

 

Federal Reserve Board System. The Federal Reserve Board regulations require savings associations to maintain non-interest earning reserves against their transaction accounts (primarily Negotiable Order of Withdrawal (NOW) and regular checking accounts). For 2013, the regulations provided that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $71.0 million; a 10% reserve ratio is applied above $71.0 million. The first $11.5 million of otherwise reservable balances (subject to adjustments by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually and, for 2013, require a 3% ratio for up to $79.5 million and an exemption of $12.4 million. Delanco Federal complies with the foregoing requirements. In October 2008, the Federal Reserve Board began paying interest on certain reserve balances.

 

Other Regulations

 

Delanco Federal’s operations are also subject to federal laws applicable to credit transactions, including the:

 

 

Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

 

Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

 

Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

 

 

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

 

 

rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

The operations of Delanco Federal also are subject to laws such as the:

 

 

Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

 

Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and

 

 

Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check.

 

 
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Holding Company Regulation

 

General. As a savings and loan holding company, Delanco Bancorp is subject to Federal Reserve Board regulations, examinations, supervision, reporting requirements and regulations regarding its activities. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to Delanco Federal.

 

Pursuant to federal law and regulations and policy, a savings and loan holding company such as Delanco Bancorp may generally engage in the activities permitted for financial holding companies under Section 4(k) of the Bank Holding Company Act and certain other activities that have been authorized for savings and loan holding companies by regulation.

 

Federal law prohibits a savings and loan holding company from, directly or indirectly or through one or more subsidiaries, acquiring more than 5% of the voting stock of another savings association, or savings and loan holding company thereof, without prior written approval of the Federal Reserve Board or from acquiring or retaining, with certain exceptions, more than 5% of a non-subsidiary holding company or savings association. A savings and loan holding company is also prohibited from acquiring more than 5% of a company engaged in activities other than those authorized by federal law or acquiring or retaining control of a depository institution that is not insured by the FDIC. In evaluating applications by holding companies to acquire savings associations, the Federal Reserve Board must consider the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the insurance funds, the convenience and needs of the community and competitive factors.

 

The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, except: (i) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (ii) the acquisition of a savings association in another state if the laws of the state of the target savings association specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

 

Source of Strength. The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must promulgate regulations implementing the “source of strength” policy that holding companies act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

 

Dividends. The Federal Reserve Board has the power to prohibit dividends by savings and loan holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which also applies to savings and loan holding companies and which expresses the Federal Reserve Board’s view that a holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends. Under the prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

 

Acquisition of Delanco Bancorp. Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect “control” of a savings and loan holding company or savings association. Under certain circumstances, a change of control may occur, and prior notice is required, upon the acquisition of 10% or more of the outstanding voting stock of the company or institution, unless the Federal Reserve Board has found that the acquisition will not result in a change of control. Under the Change in Control Act, the Federal Reserve Board generally has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that acquires control would then be subject to regulation as a savings and loan holding company.

 

 
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Regulatory Agreement

 

Delanco Federal is a party to a formal written agreement with the OCC dated November 21, 2012. The written agreement supersedes and terminates the Order to Cease and Desist issued by the Office of Thrift Supervision on March 17, 2010.

 

The written agreement requires Delanco Federal to take the following actions:

 

 

prepare a three-year strategic plan that establishes objectives for Delanco Federal’s overall risk profile, earnings performance, growth, balance sheet mix, liability structure, reduction in the volume of nonperforming assets, and product line development;

 

 

prepare a capital plan that includes specific proposals related to the maintenance of adequate capital, identifies strategies to strengthen capital if necessary and includes detailed quarterly financial projections. If the OCC determines that Delanco Federal has failed to submit an acceptable capital plan or fails to implement or adhere to its capital plan, then the OCC may require Delanco Federal to develop a contingency capital plan detailing Delanco Federal’s proposal to sell, merge or liquidate Delanco Federal;

 

 

prepare a criticized asset plan that will include strategies, targets and timeframes to reduce Delanco Federal’s level of criticized assets;

 

 

implement a plan to improve Delanco Federal’s credit risk management and credit administration practices;

 

 

implement programs and policies related to Delanco Federal’s allowance for loan and lease losses, liquidity risk management, independent loan review and other real estate owned;

 

 

review the capabilities of Delanco Federal’s management to perform present and anticipated duties and to recommend and implement any changes based on such assessment;

 

 

not pay any dividends or make any other capital distributions without the prior written approval of the OCC;

 

 

not make any severance or indemnification payments without complying with regulatory requirements regarding such payments; and

 

 

comply with prior regulatory notification requirements for any changes in directors or senior executive officers.

 

The written agreement will remain in effect until terminated, modified, or suspended in writing by the OCC.


We have submitted strategic and capital plans to the OCC and have developed the other plans and policies required by the written agreement. The written agreement will remain in effect until terminated, modified, or suspended in writing by the OCC.


The written agreement does not require Delanco Federal to maintain any specific minimum regulatory capital ratios. However, by letter dated January 2, 2013, the OCC established higher individual minimum capital requirements for Delanco Federal. Specifically, Delanco Federal must maintain Tier 1 capital at least equal to 8% of adjusted total assets, Tier 1 capital at least equal to 12% of risk-weighted assets, and total capital at least equal to 13% of risk-weighted assets. At March 31, 2013, Delanco Federal’s Tier 1 leverage capital ratio, Tier 1 risk-based capital ratio and total risk based-capital ratio were 7.79%, 13.41% and 14.67%, respectively.

 

 
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ITEM 1A.

RISK FACTORS


We have experienced net losses in each of the last two fiscal years and we may not return to profitability in the near future.


We have experienced net losses of $324 thousand and $494 thousand for the years ended March 31, 2013 and 2012, respectively. Our profitability has suffered due to lower net interest income resulting from the prolonged low interest rate environment, as well as heightened provisions for loan losses, expenses for and losses on the sale of real estate owned and other problem loan expenses. For the year ended March 31, 2013, we incurred provision expenses of $640 thousand, real estate owned expenses and losses of $340 thousand, and other problem loan expenses of $448 thousand. For the year ended March 31, 2012, we incurred provision expenses of $1.6 million, real estate owned expenses and losses of $197 thousand, and other problem loan expenses of $203 thousand. At March 31, 2013, non-performing assets and troubled debt restructurings totaled $8.8 million, or 6.8% of total assets. As we work through our problem assets, we may incur additional expenses and losses on real estate owned and other problem loan expenses, while continued high levels of problem assets may result in additional provisions for loan losses, all of which would impede our return to profitability. In addition, our earnings have been adversely affected by a shrinking net interest margin caused by the protracted low interest rate environment and its impact on earning asset yields. Our net interest margin was 3.35% for the year ended March 31, 2013, as compared to 3.60% for the year ended March 31, 2012. Our average yield on earning assets declined to 4.22% for the year ended March 31, 2013, from 4.76% for the year ended March 31, 2012 as higher yielding loans were paid off or refinanced at lower market rates and higher yielding securities were called by the issuer and replaced with lower yielding investments. Continued low market interest rates could cause further declines in our net interest margin, as our ability to reduce our cost of funds to offset further reductions in asset yields is limited.


We are a party to a formal written agreement with the OCC and our failure to comply with that agreement may result in further regulatory enforcement actions, including restrictions on our operations.


Delanco Federal is a party to a formal written agreement with the OCC dated November 21, 2012. The written agreement supersedes and terminates the Order to Cease and Desist issued by the Office of Thrift Supervision on March 17, 2010. The written agreement requires Delanco Federal to take certain actions and implement certain policies and procedures aimed at improving Delanco Federal’s capital, earnings and asset quality. The written agreement does not require Delanco Federal to maintain any specific minimum regulatory capital ratios. However, by letter dated January 2, 2013, the OCC established higher individual minimum capital requirements for Delanco Federal. Specifically, Delanco Federal must maintain Tier 1 capital at least equal to 8% of adjusted total assets, Tier 1 capital at least equal to 12% of risk-weighted assets, and total capital at least equal to 13% of risk-weighted assets. At March 31, 2013, Delanco Federal’s Tier 1 leverage capital ratio, Tier 1 risk-based capital ratio and total risk based-capital ratio were 7.79%, 13.41% and 14.67%, respectively.

 

The written agreement will remain in effect until terminated, modified, or suspended in writing by the OCC. A failure to comply with the written agreement could result in the initiation of further enforcement actions by the OCC, including the imposition of civil monetary penalties. The written agreement has resulted in additional regulatory compliance expense for the Company. A detailed description of the written agreement can be found at “Regulation and Supervision—Regulatory Agreement.”


A return of recessionary conditions could result in increases in our level of non-performing loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.


Although the U.S. economy has emerged from the severe recession that occurred in 2008 and 2009, economic growth has been slow and uneven, and unemployment levels remain high. Recovery by many businesses has been impaired by lower consumer spending. A return to prolonged deteriorating economic conditions could significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and continued elevated unemployment levels may result in higher than expected loan delinquencies, increases in our non-performing and criticized classified assets and a decline in demand for our products and services. These events may cause us to incur losses and may adversely affect our financial condition and results of operations. As a result of the economic downturn, our non-performing assets and troubled debt restructurings jumped from $1.8 million at March 31, 2008 to $9.0 million at March 31, 2009 and then to $10.3 million at March 31, 2010. Since that time, the amount of non-performing assets and troubled debt restructurings has declined to $8.8 million at March 31, 2013. Reduction in problem assets has been slow, and the process has been exacerbated by the condition of some of the properties securing non-performing loans, the lengthy foreclosure process in New Jersey, and extended workout plans with certain borrowers. As we work through the resolution of these assets, the continued economic problems that exist in the financial markets could have a negative impact on the Company.

 

 
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A return of recessionary conditions and/or continued negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Further declines in real estate values and sales volumes and continued high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.


Adverse conditions in the local economy or real estate market could hurt our profits.


Our success depends to a large degree on the general economic conditions in Burlington County, New Jersey and the surrounding areas that comprise our market. Our market has experienced a significant downturn in which we have seen falling home prices, rising foreclosures and an increased level of commercial and consumer delinquencies. At March 31, 2013, 56.7% of our loan portfolio consisted of loans secured by real estate in Burlington County. We have relatively few loans outside of our market area, and, as a result, we have a greater risk of loan defaults and losses in the event of a further economic downturn in our market area, as adverse economic conditions may have a negative effect on the ability of our borrowers to make timely payments of their loans. Further significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished.


Our local economy may affect our future growth possibilities and operations in our primary market area. Our future growth opportunities depend on the growth and stability of our regional economy and our ability to expand in our market area. Continued adverse conditions in our local economy may limit funds available for deposit and may negatively affect demand for loans, both of which could have an impact on our profitability.


An inability to maintain our regulatory capital position could require us to raise additional capital, which may not be available on favorable terms or at all.


At March 31, 2013, Delanco Federal’s Tier 1 leverage ratio was 7.79%, which was not in compliance with the individual minimum capital requirement imposed by the OCC that requires Delanco Federal to maintain a Tier 1 leverage ratio of at least 8%. If we are unable to remain in compliance with the individual minimum capital requirement imposed by the OCC, we may be required to raise additional capital. The need to raise substantial additional funds may force our management to spend more time in managerial and financing related activities than in operational activities. We may not be able to secure the required funding or it may not be available on favorable terms. Additional offerings of our common stock will dilute the ownership interest and possibly the book value per share of our current shareholders.


Our allowance for loan losses may be inadequate, which could hurt our earnings.


When borrowers default and do not repay the loans that we make to them, we may lose money. The allowance for loan losses is the amount estimated by management as necessary to cover probable losses in the loan portfolio at the statement of financial condition date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. If our estimates and judgments regarding such matters prove to be incorrect, our allowance for loan losses might not be sufficient, and additional loan loss provisions might need to be made. Depending on the amount of such loan loss provisions, the adverse impact on our earnings could be material. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in our charging off more loans and increasing our allowance. In addition, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with high combined loan-to-value ratios.

 

 
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The economic downturn that began in 2007 has required us to make significant additions to our allowance for loan losses. For the year ended March 31, 2008 through the year ended March 31, 2013, provisions for loan losses totaled $6.4 million. During this same period, we had net charge-offs of $5.9 million. For our most recent fiscal year ended March 31, 2013, provisions for loan losses totaled $640 thousand and net charge-offs totaled $768 thousand. At March 31, 2013, the allowance for loan losses was $1.0 million, which represented 1.2% of total loans and 16.3% of non-performing loans. A large loss could deplete the allowance and require substantial provisions to replenish the allowance, which would negatively affect earnings.


In addition, bank regulators may require us to make a provision for loan losses or otherwise recognize further loan charge-offs following their periodic review of our loan portfolio, our underwriting procedures, and our loan loss allowance. Any increase in our allowance for loan losses or loan charge-offs as required by such regulatory authorities could have a material adverse effect on our financial condition and results of operations. Please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies – Allowance for Loan Losses” for a discussion of the procedures we follow in establishing our loan loss allowance.


Our previous emphasis on commercial lending may expose us to increased lending risks.


At March 31, 2013, $13.6 million, or 15.2%, of our loan portfolio consisted of commercial and multi-family real estate loans and commercial business loans, down from $18.6 million at March 31, 2012 and $32.2 million at March 31, 2008. Of these loans, $3.3 million were non-performing at March 31, 2013. These types of loans generally expose a lender to greater risk of non-payment and loss than one- to four-family residential mortgage loans because repayment of the loans often depends on the successful operation of the property or a business. These types of loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family residential mortgage loans. Commercial business loans expose us to additional risks since they typically are made on the basis of the borrower’s ability to make repayments from the cash flow of the borrower’s business and are secured by non-real estate collateral that may depreciate over time. In addition, since such loans generally entail greater risk than one- to four-family residential mortgage loans, we may need to increase our allowance for loan losses in the future to account for potential losses. We were restricted from making new commercial loans under the cease and desist order issued by the Office of Thrift Supervision on March 17, 2010. The written agreement with the OCC dated November 21, 2012 eliminated this lending restriction.


If our foreclosed real estate is not properly valued or if our reserves are insufficient, our earnings could be reduced.


We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property taken in as foreclosed real estate and at certain other times during the holding period of the asset. Our net book value in the loan at the time of foreclosure and thereafter is compared to the updated fair value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset’s net book value over its fair value less estimated selling costs. If our valuation process is incorrect, or if property values decline, the fair value of our foreclosed real estate may not be sufficient to recover our carrying value in such assets, resulting in the need for additional charge-offs. In addition, bank regulators periodically review our foreclosed real estate and may require us to recognize further charge-offs. Significant charge-offs to our foreclosed real estate could have a material adverse effect on our financial condition and results of operations.


Historically low interest rates may adversely affect our net interest income and profitability.


In recent years it has been the policy of the Federal Reserve Board to maintain interest rates at historically low levels through its targeted federal funds rate and the purchase of mortgage-backed securities. As a result, market rates on the loans we have originated and the yields on securities we have purchased have been at lower levels than available prior to 2008. This has been a significant factor in the decrease in the amount of our net interest income to $4.0 million for the year ended March 31, 2013 from $4.5 million for the year ended March 31, 2012 and $4.8 million for the year ended March 31, 2011. Our ability to lower our interest expense to offset declines in asset yields is limited at current interest rate levels. The Federal Reserve Board has indicated its intention to maintain low interest rates in the near future. Accordingly, our net interest income (the difference between interest income earned on assets and interest expense paid on liabilities) may continue to decrease, which would have an adverse effect on our profitability.

 

 
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Changes in interest rates may hurt our earnings and asset value.


Our net interest income is the interest we earn on loans and investment less the interest we pay on our deposits and borrowings. Our net interest margin is the difference between the yield we earn on our assets and the interest rate we pay for deposits and our other sources of funding. Changes in interest rates—up or down—could adversely affect our net interest margin and, as a result, our net interest income. Although the yield we earn on our assets and our funding costs tend to move in the same direction in response to changes in interest rates, one can rise or fall faster than the other, causing our net interest margin to expand or contract. Our liabilities tend to be shorter in duration than our assets, so they may adjust faster in response to changes in interest rates. As a result, when interest rates rise, our funding costs may rise faster than the yield we earn on our assets, causing our net interest margin to contract until the yield catches up. Changes in the slope of the “yield curve”—or the spread between short-term and long-term interest rates—could also reduce our net interest margin. Normally, the yield curve is upward sloping, meaning short-term rates are lower than long-term rates. Because our liabilities tend to be shorter in duration than our assets, when the yield curve flattens or even inverts, we could experience pressure on our net interest margin as our cost of funds increases relative to the yield we can earn on our assets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Risk Management—Interest Rate Risk Management.”


If we conclude that the decline in value of any of our investment securities is other than temporary, we are required to write down the value of that security through a charge to earnings.


We review our investment securities portfolio at each quarter-end reporting period to determine whether the fair value is below the current carrying value. When the fair value of any of our investment securities has declined below its carrying value, we are required to assess whether the decline is other than temporary. If we conclude that the decline is other than temporary, we are required to write down the value of that security through a charge to earnings. As of March 31, 2013, our investment portfolio included securities with an amortized cost of $22.4 million and an estimated fair value of $22.5 million. Changes in the expected cash flows of these securities and/or prolonged price declines may result in our concluding in future periods that the impairment of these securities is other than temporary, which would require a charge to earnings to write down these securities to their fair value. Any charges for other-than-temporary impairment would not impact cash flow, tangible capital or liquidity.


Impairment of our deferred tax assets could require charges to earnings, which could result in a negative impact on our results of operations.


As a result of losses in prior years, we maintain a deferred tax asset (that is an asset recognized to reflect an expected benefit to be realized in the future) that may be used to reduce the amount of tax that we would otherwise be required to pay in future periods. Deferred tax assets are only recognized to the extent it is more likely than not they will be realized. Should our management determine it is not more likely than not that the deferred tax assets will be realized, a valuation allowance with a charge to earnings would be reflected in the period. At March 31, 2013, our net deferred tax asset was $1.2 million, which does not include a valuation allowance, and of which $1.1 million was disallowed for regulatory capital purposes. If we are required in the future to take a valuation allowance with respect to our deferred tax asset, our financial condition and results of operations would be negatively affected.


Strong competition within our market area could hurt our profits and slow growth.


We face intense competition in making loans, attracting deposits and hiring and retaining experienced employees. This competition has made it more difficult for us to make new loans and attract deposits. Price competition for loans and deposits sometimes results in us charging lower interest rates on our loans and paying higher interest rates on our deposits, which reduces our net interest income. Competition also makes it more difficult and costly to attract and retain qualified employees. At June 30, 2012, which is the most recent date for which data is available from the FDIC, we held 1.44% of the deposits in Burlington County, New Jersey. Many of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market area.


We are dependent upon the services of key executives and we could be harmed by the loss of their services.


We rely heavily on our President and Chief Executive Officer, James E. Igo, and on our Chief Financial Officer, Eva Modi. The loss of Mr. Igo or Ms. Modi could have a material adverse impact on our operations because, as a small company, we have fewer management-level personnel that have the experience and expertise to readily replace these individuals. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition, and results of operations. We do not have employment agreements with our executive officers. See “Directors, Executive Officers and Corporate Governance.

 

 
16

 


 

If we do not rent the excess office space in our Cinnaminson branch building, it will negatively impact earnings.


Our Cinnaminson branch was designed and built to have rental units for third party tenants. Our inability to rent all of those units will necessitate that Delanco Federal cover some or all of the operating expenses for the building without the rental income to offset those expenses, thus having a negative impact on our earnings. Currently, two of the three rental units are occupied by third party tenants. The third office suite was formerly occupied by our employees and is currently available for rent.


Regulation of the financial services industry is undergoing major changes, and future legislation could increase our cost of doing business or harm our competitive position.


In 2010 and 2011, in response to the financial crisis and recession that began in 2008, significant regulatory and legislative changes resulted in broad reform and increased regulation impacting financial institutions. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) has created a significant shift in the way financial institutions operate. The Dodd-Frank Act restructured the regulation of depository institutions by merging the Office of Thrift Supervision, which previously regulated Delanco Federal, into the OCC, and assigning the regulation of savings and loan holding companies, including Delanco Bancorp, to the Federal Reserve Board. The Dodd-Frank Act also created the Consumer Financial Protection Bureau to administer consumer protection and fair lending laws, a function that was formerly performed by the depository institution regulators. As required by the Dodd-Frank Act, the federal banking regulators have proposed new consolidated capital requirements that will limit our ability to borrow at the holding company level and invest the proceeds from such borrowings as capital in Delanco Federal that could be leveraged to support additional growth. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs. Any future legislative changes could have a material impact on our profitability, the value of assets held for investment or collateral for loans. Future legislative changes could require changes to business practices or force us to discontinue businesses and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.


We operate in a highly regulated environment and we may be adversely affected by changes in laws and regulations.


We are subject to extensive regulation, supervision and examination by the Federal Reserve Board and the OCC, our primary federal regulators, and by the FDIC, as insurer of our deposits. Such regulation and supervision governs the activities in which an institution and its holding company may engage and are intended primarily for the protection of the insurance fund and the depositors and borrowers of Delanco Federal rather than for holders of Delanco Bancorp common stock. Regulatory authorities have extensive discretion in their supervisory and enforcement activities, including the imposition of restrictions on our operations, the classification of our assets and determination of the level of our allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, legislation or supervisory action, may have a material impact on our operations.


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 or operational integrity 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, we cannot assure you 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.

 

 
17

 

 

ITEM 1B.

UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2.

PROPERTIES

 

We conduct our business through our main office in Delanco, New Jersey and our branch office in Cinnaminson, New Jersey, both of which we own. The net book value of our land, buildings, furniture, fixtures and equipment was $6.9 million as of March 31, 2013.

 

ITEM 3.

LEGAL PROCEEDINGS

 

Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

 

ITEM 4.

MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

The common stock of Delanco Bancorp is quoted on the OTC Bulletin Board under the symbol “DLNO.” The following table sets forth the high and low sales prices of the common stock, as reported by the OTC Bulletin Board, during each quarter of fiscal 2013 and 2012. As of June 1, 2013 there were approximately 290 holders of record of the Company’s common stock.

 

For the Year Ended

March 31, 2013

High

Low

                 

First Quarter

  $ 5.00   $ 4.12

Second Quarter

    4.50     3.60

Third Quarter

    4.00     3.25

Fourth Quarter

    5.50     3.10

For the Year Ended

March 31, 2012

High

Low

                 

First Quarter

  $ 6.30   $ 5.05

Second Quarter

    6.25     4.96

Third Quarter

    5.75     4.77

Fourth Quarter

    5.00     4.77

 

 
18

 

 

 

Delanco Bancorp has never declared or paid a cash dividend on its common stock. We currently intend to retain any future earnings for use in the operation of our business and do not intend to declare or pay any cash dividends in the forseeable future. Any determination to pay dividends on our common stock will depend on our financial condition, results of operations, capital requirements, general business conditions, and other factors that our board of directors considers relevant.

 

The Company’s ability to pay dividends may depend, in part, on its receipt of dividends from Delanco Federal. The OCC and Federal Reserve Board regulations limit dividends and other distributions from Delanco Federal to us. No insured depository institution may make a capital distribution if, after making the distribution, the institution would be undercapitalized or if the proposed distribution raises safety and soundness concerns. In addition, any payment of dividends by Delanco Federal to Delanco Bancorp that would be deemed to be drawn out of Delanco Federal’s bad debt reserves would require the payment of federal income taxes by Delanco Federal at the then current income tax rate on the amount deemed distributed. See note 14 of the notes to consolidated financial statements included herein. Delanco Bancorp does not contemplate any distribution by Delanco Federal that would result in this type of tax liability.

 

Under OCC regulations, an application to and the prior approval of the OCC is required prior to any capital distribution if the institution does not meet the criteria for “expedited treatment” of applications under applicable regulations (i.e., generally examination ratings in the top two categories), the total capital distributions for the calendar year exceed net income for that year plus the amount of retained net income for the preceding two years, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the OCC. If an application is not required, an institution must still provide prior notice to the Federal Reserve Board of the capital contribution if it is a subsidiary of a holding company. In such circumstances, notice must also be provided to the OCC. Under the terms of its written agreement with the OCC, Delanco Federal is not permitted to pay dividends without prior regulatory approval. In addition, at the request of the Federal Reserve Board, Delanco Bancorp has adopted resolutions that prohibit it from declaring or paying any dividends or taking any dividends or other distributions that would reduce the capital of Delanco Federal without the prior written consent of the Federal Reserve Board.

 

 
19

 

 

ITEM 6.

SELECTED FINANCIAL DATA

 

 

Years Ended March 31,

(Dollars in thousands, except per share data)

 

2013

   

2012

   

2011

Financial Condition Data:

                       

Total assets

  $ 129,415   $ 134,308   $ 136,172

Investment securities

    22,345     17,699     15,944

Loans receivable, net

    88,419     99,432     103,867

Deposits

    117,034     121,589     120,842

Borrowings

    -     -     2,100

Total stockholders’ equity

    11,395     11,743     12,213
                         
                         

Operating Data:

                       

Interest income

    5,101     5,891     6,693

Interest expense

    1,057     1,431     1,890

Net interest income

    4,044     4,460     4,803

Provision for loan losses

    640     1,602     440

Net interest income after provision for loan losses

    3,404     2,858     4,363

Noninterest income

    49     150     134

Noninterest expenses

    3,987     3,751     3,740

Income before taxes

    (534 )     (743 )     757

Income tax benefit

    (210 )     (249 )     289

Net income (loss)

  $ (324 )   $ (494 )   $ 468

Per Share Data:

                       

Earnings (loss) per share, basic

  $ (0.20 )   $ (0.31 )   $ 0.30

Earnings (loss) per share, diluted

    (0.20 )     (0.31 )     0.30

Weighted average shares – basic

    1,589,868     1,586,664     1,583,460

Weighted average shares – diluted

    1,589,868     1,586,664     1,583,460

 

 
20

 

 

 

Years Ended March 31,

 

2013

2012

2011

Performance Ratios:

                       

Return on average assets

    (0.25 )%     (0.37 )%     0.34 %

Return on average equity

    (2.80 )     (4.04 )     3.89

Interest rate spread (1)

    3.30     3.53     3.75

Net interest margin (2)

    3.35     3.60     3.82

Noninterest expense to average assets

    3.02     2.79     2.73

Efficiency ratio (3)

    97.41     81.37     75.75

Average interest-earning assets to average interest-bearing liabilities

    105.56     106.57     104.80

Average equity to average assets

    8.77     9.10     8.76

Equity to assets at period end

    8.80     8.74     8.97
                         

Capital Ratios (4):

                       

Tangible capital

    7.79     7.93     8.67

Core capital

    7.79     7.93     8.67

Total risk-based capital

    14.67     14.13     14.52
                         

Asset Quality Ratios:

                       

Allowance for loan losses as a percent of total loans

    1.15     1.15     1.22

Allowance for loan losses as a percent of nonperforming loans

    16.28     16.13     23.80

Net charge-offs to average outstanding loans during the period

    0.81     1.68     0.15

Non-performing loans as a percent of total loans

    7.08     8.57     5.14

Non-performing assets to total assets

    6.81     7.06     6.33

 


(1)

Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.

(2)

Represents net interest income as a percent of average interest-earning assets.

(3)

Represents noninterest expense divided by the sum of net interest income and noninterest income.

(4)

Capital ratios are for Delanco Federal.

 

 
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ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION

 

The objective of this section is to help potential investors understand our views on our results of operations and financial condition. You should read this discussion in conjunction with the financial statements and notes to the financial statements that appear at the end of this report.

 

Overview

 

Our principal business is to acquire deposits from individuals and businesses in the communities surrounding our offices and to use these deposits to fund loans. We focus on providing our products and services to two segments of customers: individuals and small businesses.

 

We have experienced net losses of $324 thousand and $494 thousand for the years ended March 31, 2013 and 2012, respectively. Our profitability has suffered due to lower net interest income resulting from the prolonged low interest rate invironment, as well as heightened provisions for loan losses, expenses for real estate owned and other problem loan expenses. For the year ended March 31, 2013, we had net interest income of $4.0 million and incurred provision expenses of $640 thousand, real estate owned expenses and losses of $340 thousand, and other problem loan expenses of $448 thousand. For the year ended March 31, 2012, we had net interest income of $4.5 million and incurred provision expenses of $1.6 million, real estate owned expenses and losses of $197 thousand, and other problem loan expenses of $203 thousand. At March 31, 2013, non-performing assets and troubled debt restructurings totaled $8.8 million, or 6.8% of total assets.

 

Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our loans and investments, and interest expense, which is the interest that we pay on our deposits and borrowings. Changes in levels of interest rates affect our net interest income.

 

Our earnings have been adversely affected by a shrinking net interest margin caused by the protracted low interest rate environment and its impact on earning asset yields. Our net interest margin was 3.35% for the year ended March 31, 2013, as compared to 3.60% for the year ended March 31, 2012. Our average yield on earning assets declined to 4.22% for the year ended March 31, 2013, from 4.76% for the year ended March 31, 2012 as higher yielding loans were paid off or refinanced at lower market rates and higher yielding securities were called by the issuer and replaced with lower yielding investments.

 

A secondary source of income is non-interest income, which is revenue that we receive from providing products and services. The majority of our non-interest income generally comes from service charges (mostly from service charges on deposit accounts). In some years, we recognize income from the sale of loans and securities. Our facility in Cinnaminson includes space that we will rent to other businesses. Currently, two of the rental units are occupied.

 

Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for probable losses inherent in the loan portfolio. We evaluate the need to establish allowances against losses on loans on a quarterly basis. When additional allowances are necessary, a provision for loan losses is charged to earnings.

 

Expenses. The noninterest expenses we incur in operating our business consist of salaries and employee benefits expenses, occupancy expenses, loan expenses, data processing expenses and other miscellaneous expenses, such as office supplies, telephone, postage, advertising and professional services.

 

Our largest noninterest expense is salaries and employee benefits, which consist primarily of salaries and wages paid to our employees, payroll taxes, and expenses for health insurance, retirement plans and other employee benefits. We have incurred additional noninterest expenses as a result of operating as a public company. These additional expenses consist primarily of legal and accounting fees and expenses of shareholder communications and meetings. In the future, we may recognize additional annual employee compensation expenses stemming from share-based compensation. We cannot determine the actual amount of this expense at this time because applicable accounting practices require that they be based on the fair market value of the shares of common stock at specific points in the future.

 

 
22

 

 

Occupancy expenses, which are the fixed and variable costs of buildings and equipment, consist primarily of depreciation charges, furniture and equipment expenses, maintenance, real estate taxes and costs of utilities.

 

Critical Accounting Policies

 

In the preparation of our consolidated financial statements, we have adopted various accounting policies that govern the application of accounting principles generally accepted in the United States. Our significant accounting policies are described in the notes to our financial statements.

 

Certain accounting policies involve significant judgments and assumptions by us that have a material impact on the carrying value of certain assets and liabilities. We consider these accounting policies to be critical accounting policies. The judgments and assumptions we use are based on historical experience and other factors, which we believe to be reasonable under the circumstances. Actual results could differ from these judgments and estimates under different conditions, resulting in a change that could have a material impact on the carrying values of our assets and liabilities and our results of operations.

 

Allowance for Loan Losses. We consider the allowance for loan losses to be a critical accounting policy. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on impacted loans; value of collateral; and determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the OCC, as an integral part of its examination process, periodically reviews our allowance for loan losses. Such agency may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See note 2 of the notes to the financial statements included in this report.

 

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change.

 

The calculation of deferred taxes for GAAP capital differs from the calculation of deferred taxes for regulatory capital. For regulatory capital, deferred tax assets that are dependent upon future taxable income for realization are limited to the lesser of either the amount of deferred tax assets that the institution expects to realize within one year of the calendar quarter-end date, or 10% of Delanco Federal’s Tier I capital. As a result of this variance, our Tier I regulatory capital ratio is lower than our GAAP capital ratio by 77 basis points.

 

Balance Sheet Analysis

 

Overview. Total assets at March 31, 2013 were $129.4 million, a decrease of $4.9 million, or 3.6%, from total assets of $134.3 million at March 31, 2012. The change in the asset composition primarily reflected decreases in outstanding loans offset by an increase in investments. Total liabilities were $118.0 million, a decrease of $4.6 million, or 3.8%, from total liabilities of $122.6 million at March 31, 2012. The change in liabilities primarily reflected a decrease in higher yielding certificates of deposit as we concentrated on increasing our core deposits and chose not to match competitors’ rates on certificates of deposit. Total stockholders’ equity decreased by $349 thousand, reflecting the net loss for the year.

 

 
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Loans. At March 31, 2013, total loans, net, were $88.4 million, or 68.3% of total assets. During the year ended March 31, 2013, loans decreased by $11.0 million due primarily to payoffs of residential and commercial real estate loans and the transfer of loan assets to other real estate owned. Commercial and multi-family real estate loans decreased by $4.7 million, commercial loans decreased by $314 thousand and residential loans decreased by $3.6 million. Net loans have decreased $18.8 million since March 31, 2010 as we have curtailed our lending activities to focus on working out our problem assets and managing our asset size in order to maintain our capital ratios.

 

Table 1: Loan Portfolio Analysis

                                               
 

2013

2012

2011

March 31, (Dollars in thousands)

Amount

Percent

Amount

Percent

Amount

Percent

Real estate loans:

                                               

Residential

  $ 66,597     74.4 %   $ 70,192     69.7 %   $ 70,310     66.8 %

Commercial and multi-family

    12,403     13.8     17,130     17.0     21,866     20.8

Construction

    83     0.1     839     0.8     374     0.4

Total real estate loans

    79,083     88.3     88,611     87.6     92,550     88.0

Commercial loans

    1,166     1.3     1,480     1.5     1,736     1.6

Consumer loans:

                                               

Home equity

    8,361     9.3     9,987     9.9     9,912     9.4

Other

    960     1.1     1,047     1.1     1,026     1.0

Total consumer loans

    9,321     10.4     11,034     11.0     10,938     10.4

Total loans

    89,570     100.0 %     100,675     100.0 %     105,224     100.0 %

Net deferred loan fees

    (118 )             (82 )             (71 )        

Allowance for losses

    (1,033 )             (1,161 )             (1,286 )        

Loans, net

  $ 88,419           $ 99,432           $ 103,867        

 

The following table sets forth certain information at March 31, 2013 regarding the dollar amount of loan principal repayments becoming due during the periods indicated. The table does not include any estimate of prepayments which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.     The amounts shown below exclude applicable loans in process, unearned interest in consumer loans and net deferred loan costs. Our adjustable-rate mortgage loans generally do not provide for downward adjustments below the initial discounted contract rate. When market interest rates rise, the interest rates on these loans may increase based on the contract rate (the index plus the margin) exceeding the initial interest rate floor.

 

Table 2: Contractual Maturities and Interest Rate Sensitivity

March 31, 2013 (Dollars in thousands)

Real Estate

Loans

Commercial Loans

Consumer

Loans

Total

Loans

Amounts due in:

                               

One year or less

  $ 7,999   $ 1,112   $ 2,456   $ 11,567

More than one to five years

    3,812     54     3,959     7,825

More than five years

    67,179     -     3,041     70,220

Total

  $ 78,990   $ 1,166   $ 9,456   $ 89,612
                                 

Interest rate terms on amounts due after one year:

                               

Fixed-rate loans

  $ 68,567   $ 54   $ 2,407   $ 71,028

Adjustable-rate loans

    2,424     -     4,593     7,017

Total

  $ 70,991   $ 54   $ 7,000   $ 78,045

 

Securities. The investment securities portfolio was $22.3 million, or 17.3% of total assets, at March 31, 2013. At that date, 9.1% of the investment portfolio was invested in mortgage-backed securities, while the remainder was invested primarily in U.S. Government agency and other debt securities. The portfolio increased $4.6 million in the year ended March 31, 2013 due to the purchase of U.S. Government agency securities.

 

 
24

 

 

Table 3: Investment Securities

 

2013

2012

2011

March 31, (Dollars in thousands)

Amortized

Cost

Fair

Value

Amortized

Cost

Fair

Value

Amortized

Cost

Fair

Value

Securities available for sale:

                                               

Government sponsored enterprise securities

  $ 2,000   $ 1,985     -     -     -     -

Mutual funds

    217     222   $ 237   $ 242   $ 249   $ 248

Total available for sale

    2,217     2,207     237     242     249     248
                                                 

Securities held to maturity:

                                               

Government sponsored enterprise securities

    18,035     18,044     14,441     14,401     8,746     8,506

Municipal securities

    64     64     104     104     144     144

Mortgage-backed securities

    2,039     2,178     2,912     3,101     6,806     7,031

Total held to maturity

    20,138     20,286     17,457     17,606     15,696     15,681

Total

  $ 22,355   $ 22,493   $ 17,694   $ 17,848   $ 15,945   $ 15,929

 

The following table sets forth the stated maturities and weighted average yields of our investment securities at March 31, 2013. Approximately $703 thousand of mortgage-backed securities have adjustable interest rates and will reprice annually within the various maturity ranges. These re-pricing schedules are not reflected in the table below.

 

Table 4: Investment Maturities Schedule

 

One Year or Less

More than One Year to Five Years

More than Five Years to Ten Years

More than Ten Years

Total

March 31, 2013

(Dollars in thousands)

Carrying Value

Weighted

Average

Yield

Carrying Value

Weighted

Average

Yield

Carrying Value

Weighted

Average

Yield

Carrying Value

Weighted

Average

Yield

Carrying Value

Weighted

Average

Yield

Securities available-for-sale:

                                                                               

Government sponsored enterprise securities

    -     -     -     -     -     -   $ 1,985     2.3 %   $ 1,985     2.3 %

Mutual funds

    -     -     -     -     -     -     -     -     222     -

Total available for sale

    -     -     -     -     -     -     1,985     2.3     2,207     -
                                                                                 

Securities held to maturity:

                                                                               

Government sponsored enterprise securities

    -     -   $ 1,000     1.3 %   $ 6,422     1.9 %     10,613     2.7     18,035     2.3

Municipal securities

  $ 64     2.5 %     -     -     -     -     -     -     64     2.5

Mortgage-backed securities

    -     -     5     10.4     -     -     2,034     3.8     2,039     3.9

Total held to maturity

    64     2.5     1,005     1.3     6,422     1.9     12,647     2.8     20,138     2.5

Total

  $ 64     2.5 %   $ 1,005     1.3 %   $ 6,422     1.9 %   $ 14,632     2.8 %   $ 22,345     -
 

Deposits. Our deposit base is comprised of demand deposits, money market and passbook accounts and time deposits. We consider demand deposits and money market and passbook accounts to be core deposits. At March 31, 2013, core deposits were 53.3% of total deposits, up from 47.4% at March 31, 2012. We do not have any brokered deposits. Total deposits decreased by $4.6 million in the year ended March 31, 2013 as core deposits increased by $4.7 million and certificates of deposit decreased by $9.3 million. During the year ended March 31, 2013, we chose not to match the highest time deposit rates in our market in an effort to reduce our funding costs.  

 

 
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Table 5: Deposits

 

2013

2012

2011

March 31, (Dollars in thousands)

Amount

Percent

Amount

Percent

Amount

Percent

Noninterest-bearing demand deposits

  $ 6,873     5.9 %   $ 4,673     3.8 %   $ 4,161     3.4 %

Interest-bearing demand deposits

    14,882     12.7     13,086     10.8     13,136     10.9

Savings and money market accounts

    40,596     34.7     39,877     32.8     39,550     32.7

Certificates of deposit

    54,683     46.7     63,953     52.6     63,995     53.0

Total

  $ 117,034     100.0 %   $ 121,589     100.0 %   $ 120,842     100.0 %

 

Table 6: Time Deposit Maturities of $100,000 or more

       

March 31, 2013 (Dollars in thousands)

Certificates

of Deposit

Maturity Period

       

Three months or less

  $ 2,700

Over three through six months

    2,003

Over six through twelve months

    4,690

Over twelve months

    6,920

Total

  $ 16,313

 

 

Table 7: Time deposits by rate

 

At March 31,

(Dollars in thousands)

2013

2012

2011

0.00 – 0.99%

  $ 25,623   $ 16,314   $ 5,360

1.00 – 1.99%

    19,220     33,312     34,758

2.00 – 2.99%

    8,035     9,821     13,226

3.00 – 3.99%

    1,560     1,899     10,646

4.00 – 4.99%

    245     2,607     5

Total

  $ 54,683   $ 63,953   $ 63,995

 


Table 8: Time deposits by rate and maturity

 

Amount Due

               

(Dollars in thousands)

Less Than

One Year

More Than

One Year to

Two Years

More Than

Two Years to

Three Years

More Than

Three Years

to Four Years

More Than

Four Years

Total at March 31, 2013

Percent of Total Certificate Accounts

0.00 – 0.99%

  $ 21,860   $ 3,487   $ 276   $ -   $ -   $ 25,623     46.9 %

1.00 – 1.99%

    9,554     4,838     1,044     1,040     2,744     19,220     35.1

2.00 – 2.99%

    1,355     1,991     2,076     2,613     -     8,035     14.7

3.00 – 3.99%

    1,390     170     -     -     -     1,560     2.9

4.00 – 4.99%

    243     -     -     -     2     245     0.4

Total

  $ 34,402   $ 10,486   $ 3,396   $ 3,653   $ 2,746   $ 54,683     100.0 %
 

 

Borrowings. We have borrowing arrangements with the FHLB and Atlantic Central Banker’s Bank to provide an additional source of liquidity. At March 31, 2013, we had no borrowings outstanding.

 

 
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Table 9: Borrowings

March 31, (Dollars in thousands)

2013

2012

2011

Maximum amount outstanding at any month end during the period:

                       

Advances

    -   $ 2,500   $ 2,100

Average amount outstanding during the period (1):

                       

Advances

    -     458     175

Weighted average interest rate during the period (1):

                       

Advances

    -     0.33 %     0.89 %

Balance outstanding at end of period:

                       

Advances

    -     -     2,100

Weighted average interest rate at end of period:

                       

Advances

    -     -     0.89 %


(1)

Averages are based on month-end balances.

 

Results of Operations for the Years Ended March 31, 2013 and 2012

 

Financial Highlights. Net loss for the year ended March 31, 2013 was $324 thousand compared to net loss of $494 thousand for the year ended March 31, 2012. Our profitability has suffered due to heightened provisions for loan losses, expenses for real estate owned and other problem loan expenses. In addition, our earnings have been adversely affected by a shrinking net interest margin caused by the protracted low interest rate environment and its impact on earning asset yields. Our net interest margin was 3.35% for the year ended March 31, 2013, as compared to 3.60% for the year ended March 31, 2012. Our average yield on earning assets declined to 4.22% for the year ended March 31, 2013, from 4.76% for the year ended March 31, 2012 as higher yielding loans were paid off or refinanced at lower market rates and higher yielding securities were called by the issuer and replaced with lower yielding investments.

 

Table 10: Summary Income Statements

                               

Year Ended March 31, (Dollars in thousands)

2013

2012

2013 v. 2012

% Change

Net interest income

  $ 4,045   $ 4,460   $ (415 )     (9.3 )

Provision for loan losses

    640     1,602     (962 )     (60.0 )

Noninterest income

    49     150     (101 )     (67.3 )

Noninterest expenses

    3,987     3,751     236     6.3

Net income (loss)

    (324 )     (494 )     170     34.4
                                 

Return on average equity

    (2.8 )%     (4.04 )%                

Return on average assets

    (0.25 )     (0.37 )                

 

Net Interest Income. Net interest income for the year ended March 31, 2013 was $4.0 million compared to $4.5 million for the year ended March 31, 2012, a decrease of 9.3%. The net interest margin decreased 25 basis points to 3.35% for the year ended March 31, 2013, as average interest-earning assets decreased $3.1 million while average interest-bearing liabilities decreased $2.2 million. Also contributing to the decrease in the net interest margin was a 54 basis point decrease in the average yield on interest-earning assets, which exceeded the 31 basis point decrease in the average cost of interest-bearing liabilities.

 

For the year ended March 31, 2013, interest income declined 13.41% compared to the prior year. Interest income on loans decreased $855 thousand as the average balance declined $97 million and the average yield declined 37 basis points. Partially offsetting lower interest income on loans, interest income on investment securities increased $65 thousand, as growth of the investment portfolio exceeded the impact of lower yields.

 

For the year ended March 31, 2013, interest expense declined 26.1% compared to the prior year, as the average balance of deposits decreased $1.8 million and the average rate paid decreased 31 basis points. The decrease in deposits was driven by a decrease 31 basis points. The decrease in deposits was driven by a decrease of $3.6 million in certificates of deposit, which was partially offset by increases in demand deposits and savings and money market accounts.

 

 
27

 

 

Table 11: Analysis of Net Interest Income

                               

Year Ended March 31, (Dollars in thousands)

2013

2012

2013 v. 2012

% Change

Components of net interest income

                               

Loans

  $ 4,483   $ 5,338   $ (855 )     (16.0 )%

Investment securities

    618     553     65     11.8

Total interest income

    5,101     5,891     (790 )     (13.4 )

Deposits

    1,057     1,431     (374 )     (26.1 )

Borrowings

    -     -     -     -

Total interest expense

    1,057     1,431     (374 )     (26.1 )

Net interest income

    4,044     4,460     (416 )     (9.3 )

Average yields and rates paid

                               

Interest-earning assets

    4.22 %     4.76 %

(54

)bp        

Interest-bearing liabilities

    0.92     1.23     (31 )        

Interest rate spread

    3.30     3.53     (23 )        

Net interest margin

    3.35     3.60     (25 )        

Average balances

                               

Loans

  $ 92,900   $ 102,606   $ (9,706 )     (9.5 )%

Investment securities

    22,392     16,717     5,675