UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2018

OR

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

For the transition period from _______________ to ______________________

Commission File No. 001-37912

Bancorp 34, Inc.

(Exact name of registrant as specified in its charter)

Maryland	74-2819148
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification Number)
500 East 10th Street, Alamogordo, New Mexico	88310
(Address of Principal Executive Offices)	(Zip Code)

(575) 437-9334

(Registrant’s telephone number)

                                         N/A                                         

(Former name or former address, if changed since last report)

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 requirements for the past 90 days.

YES  X   NO      .

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).

YES  X    NO     .

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

Large accelerated filer       ___	Accelerated filer	___
Non-accelerated filer         ___
	Smaller reporting company	X
	Emerging growth company	X

Page 1 of 40

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES         NO   X  

Shares of the Registrant’s common stock, par value $0.01 per share, issued and outstanding as of October 28, 2018 were 3,397,565.

Page 2 of 40

Bancorp 34, Inc.
FORM 10-Q

Index 

		Page
	Part I. Financial Information
Item 1.	Financial Statements
	Consolidated Balance Sheets as of September 30, 2018 (unaudited) and December 31, 2017	4
	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017 (unaudited)	5
	Consolidated Statements of Changes in Stockholders’ Equity for the Nine Months ended September 30, 2018 (unaudited) and Year Ended December 31, 2017	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September  30, 2018 and 2017 (unaudited)	7
	Notes to Consolidated Financial Statements (unaudited)	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	28
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	39
Item 4.	Controls and Procedures	39
	Part II. Other Information
Item 1.	Legal Proceedings	39
Item 1A.	Risk Factors	39
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3.	Defaults upon Senior Securities	39
Item 4.	Mine Safety Disclosures	39
Item 5.	Other Information	39
Item 6.	Exhibits	39
Signatures		40

Page 3 of 40

Item 1. Financial Statements 

BANCORP 34, INC.

CONSOLIDATED BALANCE SHEETS - UNAUDITED

	September 30, 2018			December 31, 2017
ASSETS
Cash and due from banks	$	6,194,715		$	4,988,178
Interest-bearing deposits with banks		9,205,000			4,885,000
Total cash and cash equivalents		15,399,715			9,873,178
Available-for-sale securities, at fair value		27,930,267			24,399,881
Loans held for sale		20,219,237			15,423,670
Loans held for investment		283,463,733			261,012,786
Allowance for loan losses		(3,233,813	)		(3,117,190	)
Loans held for investment, net		280,229,920			257,895,596
Premises and equipment, net		9,776,173			10,120,904
Stock in financial institutions, restricted, at cost		3,884,461			3,825,861
Accrued interest receivable		919,952			838,960
Deferred income taxes, net		2,421,790			2,191,526
Bank owned life insurance		10,502,550			10,135,672
Core deposit intangible, net		182,323			220,664
Prepaid and other assets		1,800,280			1,294,606
TOTAL ASSETS	$	373,266,668		$	336,220,518
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities
Deposits
Demand deposits	$	46,109,707		$	37,502,593
Savings and NOW deposits		131,536,102			135,009,406
Time deposits		73,867,604			63,049,334
Total deposits		251,513,413			235,561,333
Federal Home Loan Bank advances		70,000,000			45,000,000
Escrows		442,200			296,847
Accrued interest and other liabilities		5,148,046			4,391,649
Total liabilities		327,103,659			285,249,829
Commitments and contingencies (note 4)		-			-
Stockholders’ equity
Preferred stock, $0.01 par value, 50,000,000 authorized, 0 issued and outstanding		-			-
Common stock, $0.01 par value, 100,000,000 authorized, 3,404,065 and 3,490,672 issued and outstanding.		34,041			34,907
Additional paid-in capital		25,772,013			26,849,822
Retained earnings		22,791,914			26,060,598
Accumulated other comprehensive loss, net of tax		(776,480	)		(274,266	)
Unearned employee stock ownership plan (ESOP) shares		(1,658,479	)		(1,700,372	)
Total stockholders’ equity		46,163,009			50,970,689
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	373,266,668		$	336,220,518

The accompanying notes are an integral part of these consolidated financial statements.

Page 4 of 40

BANCORP 34, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME - UNAUDITED

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Interest income
Interest and fees on loans	$	4,344,337		$	3,972,449		$	12,219,260		$	11,224,945
Interest on securities		172,342			128,649			468,330			403,962
Interest on other interest-earning assets		103,818			42,151			245,394			142,507
Total interest income		4,620,497			4,143,249			12,932,984			11,771,414
Interest expense
Interest on deposits		635,340			423,373			1,642,042			1,190,324
Interest on borrowings		380,571			187,060			804,007			432,941
Total interest expense		1,015,911			610,433			2,446,049			1,623,265
Net interest income		3,604,586			3,532,816			10,486,935			10,148,149
Provision for loan losses		-			150,000			93,000			550,000
Net interest income after provision for loan losses		3,604,586			3,382,816			10,393,935			9,598,149
Noninterest income
Gain on sale of loans		3,409,098			3,557,724			10,822,238			8,066,795
Service charges and fees		94,581			102,657			273,545			277,833
Bank owned life insurance income		93,214			43,642			272,960			129,818
Other		6,449			18,992			33,390			42,589
Total noninterest income		3,603,342			3,723,015			11,402,133			8,517,035
Noninterest expense
Salaries and benefits		4,660,722			3,702,578			13,750,104			10,552,327
Occupancy		547,203			538,956			1,577,865			1,449,574
Data processing fees		757,576			574,578			2,216,407			1,765,943
FDIC and other insurance expense		48,941			50,809			150,806			140,116
Professional fees		303,679			311,201			890,734			992,630
Advertising		135,825			107,089			412,599			350,444
Net other real estate expenses		-			-						80
Other		587,300			521,683			1,666,244			1,420,700
Total noninterest expense		7,041,246			5,806,894			20,664,759			16,671,814
Income before provision for income taxes		166,682			1,298,937			1,131,309			1,443,370
Provision for income taxes		24,440			487,209			238,879			491,293
NET INCOME		142,242			811,728			892,430			952,077
Other comprehensive income
Unrealized (loss) gain on available-for-sale securities		(183,705	)		52,944			(674,063	)		123,744
Tax effect of unrealized (loss) gain on available-for-sale securities		46,753			(20,134	)		171,849			(46,832	)
Unrealized (loss) gain on available-for-sale securities, net of tax		(136,952	)		32,810			(502,214	)		76,912
COMPREHENSIVE INCOME	$	5,290		$	844,538		$	390,216		$	1,028,989
Earnings per common share:
Basic	$	0.04		$	0.25		$	0.28		$	0.29
Diluted	$	0.04		$	0.25		$	0.27		$	0.29

The accompanying notes are an integral part of these consolidated financial statements. 

Page 5 of 40

BANCORP 34, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

													Accumulated
													Other
							Additional						Comprehensive			Unearned			Total
	Common			Common			Paid-In			Retained			Income			ESOP			Stockholders'
	Shares			Stock			Capital			Earnings			(Loss)			Shares			Equity
BALANCE, DECEMBER 31, 2016		3,438,190		$	34,382		$	27,161,856		$	25,700,007		$	(363,437	)	$	(1,756,231	)	$	50,776,577
Net income		-			-			-			360,591			-			-			360,591
Unrealized gain on available-for-sale securities, net		-			-			-			-			89,171			-			89,171
Stock option exercise		5,732			57			55,257			-			-			-			55,314
Restricted stock awards		74,750			748			(748	)		-			-			-			-
Amortization of equity awards		-			-			47,577			-			-			55,859			103,436
Share repurchase		(28,000	)		(280	)		(414,120	)		-			-			-			(414,400	)
BALANCE, DECEMBER 31, 2017		3,490,672		$	34,907		$	26,849,822		$	26,060,598		$	(274,266	)	$	(1,700,372	)	$	50,970,689
Net income		-		$	-		$	-		$	892,430		$	-		$	-		$	892,430
Unrealized loss on available-for-sale securities, net		-			-			-			-			(502,214	)		-			(502,214	)
Stock option exercise		15,464			155			149,073			-			-			-			149,228
Restricted stock awards		429			4			(4	)		-			-			-			-
Amortization of equity awards					-			344,147			-			-			41,893			386,040
Share repurchase		(102,500	)		(1,025	)		(1,571,025	)		-			-			-			(1,572,050	)
Dividend paid - $1.25 per share		-			-			-			(4,161,114	)		-			-			(4,161,114	)
BALANCE SEPTEMBER 30, 2018		3,404,065		$	34,041		$	25,772,013		$	22,791,914		$	(776,480	)	$	(1,658,479	)	$	46,163,009

The accompanying notes are an integral part of these consolidated financial statements.

Page 6 of 40

BANCORP 34, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED

	Nine Months Ended September 30,
	2018			2017
Cash flows from operating activities
Net income	$	892,430		$	952,077
Adjustments to reconcile net income to net cash from operating activities:
Depreciation and amortization		533,643			504,538
Stock dividend on financial institution stock		(58,600	)		(36,600	)
Amortization of premiums and discounts on securities, net		207,696			317,530
Amortization of ESOP awards		41,893			57,832
Amortization of stock-based compensation		344,147			-
Amortization of core deposit intangible		38,341			49,167
Gain on sale of loans		(10,822,238	)		(8,066,795	)
Proceeds from sale of loans held for sale		245,523,027			199,313,427
Funding of loans held for sale		(238,052,849	)		(184,451,594	)
Provision for loan losses		93,000			550,000
Net appreciation on bank-owned life insurance		(211,878	)		(91,946	)
Deferred income tax (benefit) expense		(147,095	)		529,855
Changes in operating assets and liabilities:
Accrued interest receivable		(80,992	)		(44,802	)
Prepaid and other assets		(416,994	)		(56,323	)
Accrued interest and other liabilities		756,395			493,954
Net cash from operating activities		(1,360,074	)		10,020,320
Cash flows from investing activities
Proceeds from principal payments on available-for-sale securities		4,874,620			4,589,838
Purchases of available-for-sale securities		(9,286,764	)		-
Purchase of bank-owned life insurance		(155,000	)		-
Net change in loans held for investment		(23,870,830	)		(28,260,678	)
Purchases of premises and equipment		(188,912	)		(415,613	)
Purchase of stock in financial institutions		-			(197,200	)
Net cash from investing activities		(28,626,886	)		(24,283,653	)
Cash flows from financing activities
Net change in deposits		15,952,080			15,616,303
Net change in escrows		145,353			76,335
Net change in Federal Home Loan Bank advances		25,000,000			17,000,000
Exercise of stock options		149,228			55,314
Dividends paid		(4,161,114	)		-
Common stock repurchases		(1,572,050	)		-
Net cash from financing activities		35,513,497			32,747,952
Net increase in cash and cash equivalents		5,526,537			18,484,619
Cash and cash equivalents, beginning of period		9,873,178			16,411,344
Cash and cash equivalents, end of period	$	15,399,715		$	34,895,963
Supplemental disclosures:
Interest on deposits and advances paid	$	2,253,176		$	1,587,771
Income taxes paid	$	187,600		$	48,200
Loans transferred to loans held for sale	$	1,443,506		$	2,928,646

 The accompanying notes are an integral part of these consolidated financial statements.

Page 7 of 40

BANCORP 34, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED

NOTE 1 – NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING AND REPORTING POLICIES

Bancorp 34, Inc. (“Bancorp 34” or the “Company”) is a Maryland corporation and savings and loan holding company which owns 100% of the common stock of Bank 34 (the “Bank”).

The Bank provides a variety of banking services to individuals and businesses through its full-service branches in Alamogordo and Las Cruces, New Mexico, and Scottsdale and Peoria, Arizona. The Bank also operates ten mortgage loan production offices in El Paso, Texas, Scottsdale, Arizona, Gilbert, Arizona, Yuma, Arizona, Tubac, Arizona, Albuquerque, New Mexico, Lynnwood, Washington, Puyallup, Washington, West Linn, Oregon and Medford, Oregon.

A large portion of the Bank’s New Mexico loans are secured by real estate in Otero and Dona Ana Counties. The economy for these counties is heavily dependent on two U.S. Government military installations located in those counties. Accordingly, the ultimate collectability of the Bank’s New Mexico loans is susceptible to changes in U.S. Government military operations in southern New Mexico.

The primary deposit products are demand deposits, time deposits, NOW, savings and money market accounts. The primary lending products are real estate mortgage loans and commercial loans. The Bank is subject to competition from other financial institutions and regulated and non-regulated financial services providers, regulation by certain federal agencies and undergoes periodic examinations by regulatory authorities.

Rising and falling interest rate environments can have various impacts on the Bank’s net interest income, depending on the short-term interest rate gap that the Bank maintains. The Bank’s net interest income is also affected by prepayments of loans and early withdrawals of deposits.

Basis of Presentation – The accompanying unaudited consolidated financial statements have been prepared on the accrual basis of accounting in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In the opinion of management, the accompanying consolidated financial statements include all adjustments, consisting of only normal recurring adjustments, necessary for a fair presentation of the financial condition, cash flows and results of operations at the dates and for the periods presented. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results of operations for the full fiscal year or for any other period. This information should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Basis of Consolidation – The consolidated financial statements include the accounts of Bancorp 34 and the Bank. All significant intercompany accounts and transactions have been eliminated.

Reclassifications – Certain reclassifications have been made to prior period’s financial information to conform to the current period presentation.

Use of Estimates – The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Significant estimates include, but are not limited to, allowance for loan losses, other-than-temporary impairment of securities, useful lives used in depreciation and amortization, deferred income taxes, valuation of other real estate and core deposit intangibles.

Subsequent Events – Subsequent events have been evaluated through the date the unaudited consolidated financial statements were issued.

Page 8 of 40

Summary of Recent Accounting Pronouncements:

Bancorp 34 is an emerging growth company and has elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. The Company expects to lose its status as an emerging growth company on August 29, 2019, five years after the completion of the acquisition of Bank 1440.

Revenue Recognition - In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers (Topic 606).” ASU 2014-09 implements a comprehensive new revenue recognition standard that will supersede substantially all existing revenue recognition guidance. The new standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. To achieve that core principle, an entity should apply the following steps: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract and (v) recognize revenue when (or as) the entity satisfies a performance obligation. ASU 2015-4 “Revenue from Contracts with Customers – Deferral of the Effective Date” deferred the effective date of ASU 2014-09 by one year. The Company’s revenue is comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and non-interest income. The Company does not expect adoption of ASU 2014-09 will have a material impact on our consolidated financial statements and disclosures. We plan to adopt the revenue recognition guidance in the first quarter of 2019 with a cumulative effect adjustment to opening retained earnings, if management deems such adjustment significant. Our revenue is mainly comprised of interest income on financial instruments, which is explicitly excluded from the scope of ASU 2014-09. We have identified applicable sources of non-interest income and are gathering and reviewing related contracts and evaluating their potential impact to our revenue recognition under the new standards. While the recognition of certain components of our non-interest income may be affected by the ASU, we do not expect it to have a material impact on our financial condition and results of operations.

Financial Instruments – In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (Subtopic 825-10). The amendment has a number of provisions including the requirements that public business entities use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, a separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (i.e. securities or loans receivables), and eliminating the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost. The amendment is effective for the Company in the first quarter of 2019 and is not expected to have a significant impact on the consolidated financial statements.

Leases – In February 2016, the FASB issued ASU 2016-02 “Leases (Topic 842).” This standard requires entities that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. The standard is effective for the Company in the first quarter of 2020. The guidance is required to be applied by the modified retrospective transition approach. Early adoption is permitted. We are currently assessing the impact of the adoption of this authoritative guidance on our consolidated financial statements. We do not expect ASU 2016-02 will have a material impact on our capital ratios or return on average assets when adopted and we are currently evaluating the effect that the ASU will have on other components of our financial condition and results of operations.

Credit Losses - In June 2016, the FASB issued ASU 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this update replace the incurred loss impairment methodology with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to create credit loss estimates. The new guidance is effective for the Company in the first quarter of 2020. The guidance is required to be applied by the modified retrospective approach. Early adoption is permitted as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We are currently assessing the impact of the adoption of this authoritative guidance on our consolidated financial statements. We have formed an internal Current Expected Credit Loss ("CECL") committee and are working with our third party vendor to determine the appropriate methodologies and resources to utilize in preparation for transition to CECL. The impact of this ASU on our financial condition and results of operations is not known at this time.

Premium on Callable Debt - In March 2017, the FASB issued ASU 2017-08, “Receivables–Nonrefundable Fees and Other Costs (Subtopic 310-20)” to shorten the amortization period for certain purchased callable debt securities held at a premium to the earliest call date. Currently, entities generally amortize the premium as a yield adjustment over the contractual life of the security. The guidance does not change the accounting for callable debt securities held at a discount. For public business entities, the guidance is effective for the Company in the first quarter of 2020. Early adoption is permitted, including in an interim period. ASU 2017-08 is not expected to have a significant impact on our consolidated financial statements.

Page 9 of 40

Share-Based Payment Modification - In May 2017, the FASB issued ASU 2017-09, “Compensation - Stock Compensation (Subtopic 718): Scope of Modification Accounting.” ASU 2017-09 clarifies when changes to terms or conditions of a share-based payment award must be accounted for as a modification. Under the new guidance, an entity will not apply modification accounting to a share-based payment award if all of the following are the same immediately before and after the change: (i) the fair value of the award, (ii) the vesting conditions of the award, and (iii) the classification of the award as either an equity or liability instrument. ASU 2017-09 was effective for the Company in the quarter ended March 31, 2018. The guidance requires companies to apply the requirements prospectively to awards modified on or after the adoption date. The adoption of ASU 2017-09 did not have a significant impact on our consolidated financial statements.

Reporting Tax Effects of Tax Cuts and Jobs Act - In February 2018, the FASB issued ASU 2018-02, “Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” that helps organizations address certain stranded income tax effects in accumulated other comprehensive income ("AOCI") resulting from the 2017 Tax Cuts and Jobs Act. The ASU provides financial statement preparers with an option to reclassify stranded tax effects within AOCI to retained earnings in each period in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act (or portion thereof) is recorded. The ASU requires financial statement preparers to disclose a description of the accounting policy for releasing income tax effects from AOCI, whether they elect to reclassify the stranded income tax effects from the Tax Cuts and Jobs Act, and information about the other income tax effects that are reclassified. The amendments are effective for the Company in the first quarter of 2019. Early adoption is permitted. Organizations should apply the proposed amendments either in the period of adoption or retrospectively to each period (or periods) in which the effect of the change in the U.S. federal corporate income tax rate in the Tax Cuts and Jobs Act is recognized. ASU 2018-02 is not expected to have a significant impact on our consolidated financial statements.

NOTE 2 – AVAILABLE-FOR-SALE SECURITIES

Available-for-sale securities have been classified in the consolidated balance sheets according to management’s intent at September 30, 2018 and December 31, 2017. The amortized cost of such securities and their approximate fair values were as follows:

	Gross		Gross		Gross
	Amortized		Unrealized		Unrealized
	Cost		Gains		Losses			Fair Value
September 30, 2018
Available-for-sale securities
Mortgage-backed securities	$	24,235,628	$	1,777	$	(877,175	)	$	23,360,230
U.S. Government agencies		1,582,801		-		(75,287	)		1,507,514
Municipal obligations		3,093,877		-		(31,354	)		3,062,523
Total	$	28,912,306	$	1,777	$	(983,816	)	$	27,930,267
December 31, 2017
Available-for-sale securities
Mortgage-backed securities	$	21,028,794	$	12,757	$	(272,959	)	$	20,768,592
U.S. Government agencies		2,006,786		44		(49,047	)		1,957,783
Municipal obligations		1,672,277		2,584		(1,355	)		1,673,506
Total	$	24,707,857	$	15,385	$	(323,361	)	$	24,399,881

There were no sales of available-for-sale securities during the nine months ended September 30, 2018 or 2017.

Amortized cost and fair value of securities by contractual maturity as of September 30, 2018 and December 31, 2017 are shown below. For purposes of the maturity table, mortgage-backed securities, which are not due at a single maturity date, have been allocated over maturity groupings based on the actual contractual maturities of underlying collateral. Expected maturities may differ from contractual maturities because borrowers may call or prepay obligations.

Page 10 of 40

The scheduled maturities of available-for-sale securities at September 30, 2018 and December 31, 2017 were as follows:

	September 30, 2018				December 31, 2017
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Due in one year or less	$	407,252	$	406,076	$	1,254,321	$	1,256,906
Due after one to five years		23,242,101		22,394,531		21,574,631		21,306,086
Due after five to ten years		5,262,953		5,129,660		1,878,905		1,836,889
Due after ten years		-		-		-		-
Totals	$	28,912,306	$	27,930,267	$	24,707,857	$	24,399,881

At September 30, 2018 and December 31, 2017, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

At September 30, 2018 and December 31, 2017, mortgage-backed securities included collateralized mortgage obligations of $11.2 million and $10.0 million, respectively, which are backed by single-family mortgage loans. The Company does not hold any securities backed by commercial real estate loans.

Gross Unrealized Losses and Fair Value – The following tables show the gross unrealized losses and fair values of securities by length of time that individual securities in each category have been in a continuous loss position.

	September 30, 2018
	Less Than 12 Months					12 Months or More					Total
			Gross					Gross					Gross
Description of			Unrealized					Unrealized					Unrealized
Securities	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Available-for-sale securities:
Mortgage-backed securities	$	12,084,132	$	(335,937	)	$	11,120,301	$	(541,238	)	$	23,204,433	$	(877,175	)
U.S. Government agencies		297,270		(6,389	)		1,210,244		(68,898	)		1,507,514		(75,287	)
Municipal obligations		3,062,523		(31,354	)		-		-			3,062,523		(31,354	)
Total temporarily impaired securities	$	15,443,925	$	(373,680	)	$	12,330,545	$	(610,136	)	$	27,774,470	$	(983,816	)

	December 31, 2017
	Less Than 12 Months					12 Months or More					Total
			Gross					Gross					Gross
Description of			Unrealized					Unrealized					Unrealized
Securities	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Available-for-sale securities:
Mortgage-backed securities	$	3,468,607	$	(39,099	)	$	9,763,879	$	(233,860	)	$	13,232,486	$	(272,959	)
U.S. Government agencies		-		-			1,548,481		(49,047	)		1,548,481		(49,047	)
Municipal obligations		416,600		(1,355	)		-					416,600		(1,355	)
Total temporarily impaired securities	$	3,885,207	$	(40,454	)	$	11,312,360	$	(282,907	)	$	15,197,567	$	(323,361	)

Page 11 of 40

At September 30, 2018 and December 31, 2017, all of the government agencies and mortgage-backed securities held by the Company were issued by U.S. Government-sponsored entities and agencies, primarily Fannie Mae and Freddie Mac, institutions which the government has affirmed its commitment to support. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because the Company does not have the intent to sell these securities and it is likely that it will not be required to sell the securities before their anticipated recovery, the Company does not consider these securities to be other-than-temporarily impaired at September 30, 2018.

Loans and securities with a carrying value of approximately $150.8 million at September 30, 2018 were pledged to secure Federal Home Loan Bank (“FHLB”) advances. In addition, securities with a carrying value of approximately 4.0 million at September 30, 2018 were pledged to secure public deposits.

NOTE 3 – LOANS HELD FOR INVESTMENT, NET

The components of loans held for investment, net in the consolidated balance sheets were as follows:

	September 30, 2018						December 31, 2017
	Amount			Percent			Amount			Percent
Loans held for investment, net:
Commercial real estate	$	231,303,130			81.3	%	$	214,871,788			82.0	%
One- to four-family residential real estate		30,138,258			10.6			29,114,060			11.1
Commercial and industrial		16,560,992			5.8			12,296,308			4.7
Consumer and other		6,555,384			2.3			5,740,352			2.2
Total gross loans		284,557,764			100.0	%		262,022,508			100.0	%
Unamortized loan fees		(1,094,031	)					(1,009,722	)
Loans held for investment		283,463,733						261,012,786
Allowance for loan losses		(3,233,813	)					(3,117,190	)
Loans held for investment, net	$	280,229,920					$	257,895,596

At September 30, 2018 and December 31, 2017, loans held for investment includes construction loans of $18.5 million and $16.4 million, respectively.  Commercial real estate construction loans were $15.0 million and $13.4 million at September 30, 2018 and December 31, 2017, respectively.   One- to four-family residential real estate construction loans (builder/speculative) were $1.9 million and $1.3 million at September 30, 2018 and December 31, 2017, respectively. Consumer construction loans (owner/borrower) were $1.6 million and $1.7 million at September 30, 2018 and December 31, 2017, respectively.

Page 12 of 40

Allowance for Loan Losses and Recorded Investment in Loans – The following is a summary of the allowance for loan losses and recorded investment in loans as of September 30, 2018 and December 31, 2017:

	As of September 30, 2018
	Commercial Real Estate		One- to Four- Family Residential Real Estate		Commercial and Industrial		Other		Total
Allowance for loan losses
Ending balance: individually evaluated for impairment	$	215,000	$	-	$	-	$	-	$	215,000
Ending balance: collectively evaluated for impairment		2,036,429		380,114		559,494		42,776		3,018,813
Total	$	2,251,429	$	380,114	$	559,494	$	42,776	$	3,233,813
Gross loans
Ending balance: individually evaluated for impairment	$	3,571,208	$	663,580	$	1,109,689	$	-	$	5,344,477
Ending balance: collectively evaluated for impairment		227,731,922		29,474,678		15,451,303		6,555,384		279,213,287
Ending balance: loans acquired with deteriorated credit quality		-		-		-		-		-
Total	$	231,303,130	$	30,138,258	$	16,560,992	$	6,555,384	$	284,557,764

	As of December 31, 2017
	Commercial Real Estate		One- to Four- Family Residential Real Estate		Commercial and Industrial		Other		Total
Allowance for loan losses
Ending balance: individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-
Ending balance: collectively evaluated for impairment		2,055,911		567,290		462,406		31,583		3,117,190
Total	$	2,055,911	$	567,290	$	462,406	$	31,583	$	3,117,190
Gross loans
Ending balance: individually evaluated for impairment	$	3,483,078	$	679,184	$	1,274,710	$	-	$	5,436,972
Ending balance: collectively evaluated for impairment		211,388,710		28,434,876		11,021,598		5,740,352		256,585,536
Ending balance: loans acquired with deteriorated credit quality		-		-		-		-		-
Total	$	214,871,788	$	29,114,060	$	12,296,308	$	5,740,352	$	262,022,508

Page 13 of 40

The following tables summarize activities for the allowance for loan losses for the nine months ended September 30, 2018 and 2017 by quarter:

	Commercial Real Estate		One- to Four- Family Residential Real Estate			Commercial and Industrial		Consumer and Other		Total
Balance December 31, 2017	$	2,055,911	$	567,290		$	462,406	$	31,583	$	3,117,190
Provision for loan losses		10,374		(46,975	)		51,901		6,700		22,000
Charge-offs		-		(23,269	)		-		-		(23,269	)
Recoveries		-		6,249			-		-		6,249
Net charge-offs		-		(17,020	)		-		-		(17,020	)
Balance March 31, 2018	$	2,066,285	$	503,295		$	514,307	$	38,283	$	3,122,170
Provision for loan losses	$	77,026	$	(22,165	)	$	13,138	$	3,001	$	71,000
Charge-offs		-		-			-		-		-
Recoveries		-		6,250			-		-		6,250
Net recoveries		-		6,250			-		-		6,250
Balance June 30, 2018	$	2,143,311	$	487,380		$	527,445	$	41,284	$	3,199,420
			4
Provision for loan losses	$	108,118	$	(94,439)		$	(15,171)	$	1,492	$	-
Charge-offs		-		(12,827	)		-		-		(12,827	)
Recoveries		-		-			47,220		-		47,220
Net recoveries		-		(12,827	)		47,220		-		34,393
Balance September 30, 2018	$	2,251,429	$	380,114		$	559,494	$	42,776	$	3,233,813

Page 14 of 40

	Commercial Real Estate		One- to Four- Family Residential Real Estate			Commercial and Industrial		Consumer and Other			Total
Balance December 31, 2016	$	1,688,448	$	617,912		$	147,371	$	52,302		$	2,506,033
Provision for loan losses		120,158		3,488			152,397		(26,043	)		250,000
Charge-offs		-		-			-		-			-
Recoveries		1,200		6,250			-		-			7,450
Net recoveries		1,200		6,250			-		-			7,450
Balance March 31, 2017	$	1,809,806	$	627,650		$	299,768	$	26,259		$	2,763,483
Provision for loan losses	$	74,443	$	(34,305	)	$	109,100	$	762		$	150,000
Charge-offs		-		-			-		-			-
Recoveries		-		6,250			-		-			6,250
Net recoveries		-		6,250			-		-			6,250
Balance June 30, 2017	$	1,884,249	$	599,595		$	408,868	$	27,021		$	2,919,733
Provision for loan losses	$	40,533	$	(41,718	)	$	151,058	$	127		$	150,000
Charge-offs		-		(8,850	)		-		-			(8,850	)
Recoveries		-		6,250			-		-			6,250
Net recoveries		-		(2,600	)		-		-			(2,600	)
Balance September 30, 2017	$	1,924,782	$	555,277		$	559,926	$	27,148		$	3,067,133

Nonperforming Assets – The following tables present an aging analysis of the recorded investment of past due loans as of September 30, 2018 and December 31, 2017. Payment activity is reviewed by management on a monthly basis to determine the performance of each loan. Per Company policy, loans past due 90 days or more no longer accrue interest.

	Past Due										Total
					90 Days						Financing
	30 - 59 Days		60 - 89 Days		or More		Total		Current		Receivables
September 30, 2018
Commercial real estate	$	-	$	-	$	550,000	$	550,000	$	230,753,130	$	231,303,130
One- to four-family residential real estate		7,000		50,314		427,524		484,838		29,653,420		30,138,258
Commercial and industrial		-		-		1,109,689		1,109,689		15,451,303		16,560,992
Consumer and other		-		-		-		-		6,555,384		6,555,384
Totals	$	7,000	$	50,314	$	2,087,213	$	2,144,527	$	282,413,237	$	284,557,764

Page 15 of 40

	Past Due										Total
					90 Days						Financing
	30 - 59 Days		60 - 89 Days		or More		Total		Current		Receivables
December 31, 2017
Commercial real estate	$	246,154	$	-	$	550,000	$	796,154	$	214,075,634	$	214,871,788
One- to four-family residential real estate		235,561		116,977		525,532		878,070		28,235,990		29,114,060
Commercial and industrial		-		-		1,274,710		1,274,710		11,021,598		12,296,308
Consumer and other		-		-		-		-		5,740,352		5,740,352
Totals	$	481,715	$	116,977	$	2,350,242	$	2,948,934	$	259,073,574	$	262,022,508

The following table sets forth nonaccrual loans and other real estate at September 30, 2018 and December 31, 2017:

	September 30,		December 31,
	2018		2017
Nonaccrual loans
Commercial real estate	$	3,571,208	$	3,483,078
One- to four-family residential real estate		663,580		679,184
Commercial and industrial		1,109,689		1,274,710
Consumer and other		-		-
Total nonaccrual loans		5,344,477		5,436,972
Other real estate (ORE)		-		-
Total nonperforming assets	$	5,344,477	$	5,436,972
Nonperforming assets to gross loans held for investment and ORE		1.88%		2.08%
Nonperforming assets to total assets		1.43%		1.62%

Two large loan relationships partially secured by real estate comprise $4.4 million, or 82.8%, of the $5.3 million in nonaccrual loans at September 30, 2018.  $3.4 million, or 64.0% of the total September 30, 2018 nonaccrual loan balance, is guaranteed by the SBA.

Page 16 of 40

Credit Quality Indicators – The following table represents the credit exposure by internally assigned grades at September 30, 2018 and December 31, 2017. This grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements in accordance with the loan terms. The Bank’s internal credit risk grading system is based on management’s experiences with similarly graded loans. Credit risk grades are reassessed each quarter based on any recent developments potentially impacting the creditworthiness of the borrower, as well as other external statistics and factors, which may affect the risk characteristics of the respective loan.

	As of September 30, 2018
	Commercial Real Estate		One- to Four- Family Residential Real Estate		Commercial and Industrial		Consumer and Other		Total
Grade
Pass	$	224,370,286	$	28,519,214	$	15,012,206	$	6,399,444	$	274,301,150
Special mention		1,845,517		-		-		-		1,845,517
Substandard		4,537,327		1,619,044		1,548,786		155,940		7,861,097
Doubtful		550,000		-		-		-		550,000
Loss		-		-		-		-		-
Totals	$	231,303,130	$	30,138,258	$	16,560,992	$	6,555,384	$	284,557,764

	As of December 31, 2017
	Commercial Real Estate		One- to Four- Family Residential Real Estate		Commercial and Industrial		Consumer and Other		Total
Grade
Pass	$	208,395,458	$	27,400,698	$	10,624,210	$	5,568,633	$	251,988,999
Special mention		911,571		43,382		-		-		954,953
Substandard		5,014,759		1,669,980		1,672,098		171,719		8,528,556
Doubtful		550,000		-		-		-		550,000
Loss		-		-		-		-		-
Totals	$	214,871,788	$	29,114,060	$	12,296,308	$	5,740,352	$	262,022,508

The Bank’s internally assigned grades are as follows:

Pass – Strong credit with no existing or known potential weaknesses deserving of management’s close attention.

Special Mention – Potential weaknesses that deserve management’s close attention. Borrower and guarantor’s capacity to meet all financial obligations is marginally adequate or deteriorating.

Substandard – Inadequately protected by the paying capacity of the Borrower and/or collateral pledged. The borrower or guarantor is unwilling or unable to meet loan terms or loan covenants for the foreseeable future.

Doubtful – All the weakness inherent in one classified as substandard with the added characteristic that those weaknesses in place make the collection or liquidation in full, on the basis of current conditions, highly questionable and improbable.

Loss – Considered uncollectible or no longer a bankable asset. This classification does not mean that the asset has absolutely no recoverable value. In fact, a certain salvage value is inherent in these loans. Nevertheless, it is not practical or desirable to defer writing off a portion or whole of a perceived asset even though partial recovery may be collected in the future.

Page 17 of 40

Impaired Loans – The following tables include the recorded investment and unpaid principal balances, net of charge-offs for impaired loans with the associated allowance amount, if applicable. Management determined the allocated allowance based on the present value of expected future cash flows, discounted at the loan’s effective interest rate, except when the remaining source of repayment for the loan is the operation or liquidation of the collateral. In those cases, the current fair value of the collateral, less selling costs was used to determine the allocated allowance recorded.

	As of September 30, 2018
			Principal				Average
	Recorded		Net of		Related		Recorded
	Investment		Charge-offs		Allowance		Investment
With no related allowance recorded:
Commercial real estate	$	3,021,208	$	3,021,208	$	-	$	3,054,043
One- to four-family residential real estate		663,580		663,580		-		680,907
Commercial and industrial		1,109,689		1,109,689		-		1,129,837
Consumer and other		-		-		-		-
	$	4,794,477	$	4,794,477	$	-	$	4,864,787
With an allowance recorded:
Commercial real estate	$	550,000	$	550,000	$	215,000	$	550,000
Total:
Commercial real estate	$	3,571,208	$	3,571,208	$	215,000	$	3,604,043
One- to four-family residential real estate		663,580		663,580		-		680,907
Commercial and industrial		1,109,689		1,109,689		-		1,129,837
Consumer and other		-		-		-		-
	$	5,344,477	$	5,344,477	$	215,000	$	5,414,787

	As of December 31, 2017
			Principal				Average
	Recorded		Net of		Related		Recorded
	Investment		Charge-offs		Allowance		Investment
With no related allowance recorded:
Commercial real estate	$	3,483,078	$	3,483,078	$	-	$	3,521,421
One- to four-family residential real estate		679,184		679,184		-		684,632
Commercial and industrial		1,274,710		1,274,710		-		1,297,740
Consumer and other		-		-		-		-
	$	5,436,972	$	5,436,972	$	-	$	5,503,793
With an allowance recorded:	$	-	$	-	$	-	$	-
Total:
Commercial real estate	$	3,483,078	$	3,483,078	$	-	$	3,521,421
One- to four-family residential real estate		679,184		679,184		-		684,632
Commercial and industrial		1,274,710		1,274,710		-		1,297,740
Consumer and other		-		-		-		-
	$	5,436,972	$	5,436,972	$	-	$	5,503,793

During the nine months ended September 30, 2018 and 2017, $4,000 and $2,700 of interest income, respectively, was recognized on nonaccrual loans.

Page 18 of 40

Certain loans within the Company’s loan and ORE portfolios are guaranteed by the Veterans Administration (VA). In the event of default by the borrower, the VA can elect to pay the guaranteed amount or take possession of the property. If the VA takes possession of the property, the Company is entitled to be reimbursed for the outstanding principal balance, accrued interest and certain other expenses. There were no commitments from the VA to take title to foreclosed VA properties at September 30, 2018 and December 31, 2017.

Troubled Debt Restructurings – Restructured loans are considered “troubled debt restructurings” if due to the borrower’s financial difficulties, the Bank has granted a concession that they would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, rates, or a combination of the two. All troubled debt restructurings placed on nonaccrual status must show no less than six consecutive months of repayment performance by the borrower in accordance with contractual terms to return to accrual status. Once a loan has been identified as a troubled debt restructuring, it will continue to be reported as such until the loan is paid in full.

There were no troubled debt restructurings as of September 30, 2018 or December 31, 2017.

In the normal course of business, the Company may modify a loan for a credit-worthy borrower where the modified loan is not considered a troubled debt restructuring. In these cases, the modified terms are consistent with loan terms available to credit-worthy borrowers and within normal loan pricing. The modifications to such loans are done according to existing underwriting standards which include review of historical financial statements, including current interim information if available, an analysis of the causes of the borrower’s decline in performance, and projections intended to assess repayment ability going forward.

NOTE 4 – FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK

In the normal course of business, the Bank has outstanding commitments to extend credit and standby letters of credit, which are not included in the accompanying consolidated financial statements. The Bank’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual or notional amount of those instruments. The Bank uses the same credit policies in making commitments as it does for instruments that are included in the consolidated balance sheets.

Financial instruments whose contract amounts represent off-balance-sheet credit risk are as follows as of September 30, 2018 and December 31, 2017:

	September 30, 2018		December 31, 2017
Commitments to originate and sell mortgage loans	$	35,579,786	$	27,440,793
Commitments to extend credit		33,319,808		23,425,182
Unused lines of credit		14,768,265		13,576,993
Standby letters of credit		-		125,000
Totals	$	83,667,859	$	64,567,968

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation. Collateral held varies by and may include accounts receivable, inventory, property and equipment, and income-producing commercial properties.

Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third-party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Bank’s policy for obtaining collateral, and the nature of such collateral, is essentially the same as that involved in making commitments to extend credit.

Page 19 of 40

NOTE 5 – REGULATORY MATTERS

Bank 34 is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and discretionary actions by regulators that if undertaken, could have a direct material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines involving quantitative measures of the Bank’s assets, liabilities and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors.

The Basel III regulatory capital framework (the "Basel III Capital Rules") adopted by U.S. federal regulatory authorities, among other things, (i) establish the capital measure called "Common Equity Tier 1" ("CET1"), (ii) specify that Tier 1 capital consist of CET1 and "Additional Tier 1 Capital" instruments meeting stated requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) set forth the acceptable scope of deductions/adjustments to the specified capital measures. The Basel III Capital Rules became effective for us on January 1, 2015 with certain transition provisions fully phased in on January 1, 2019.

Additionally, the Basel III Capital Rules require that we maintain a capital conservation buffer with respect to each of the CET1, Tier 1 and total capital to risk-weighted assets, which provides for capital levels that exceed the minimum risk-based capital adequacy requirements. The capital conservation buffer is subject to a three-year phase-in period that began on January 1, 2016 and will be fully phased in on January 1, 2019 at 2.5%. The required phase-in capital conservation buffer during 2018 is 1.875% and was 1.25% during 2017. A financial institution with a conservation buffer of less than the required amount is subject to limitations on capital distributions, including dividend payments and stock repurchases, and certain discretionary bonus payments to executive officers.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of total risk-based capital and Tier 1 capital to risk-weighted assets, and Tier 1 capital to adjusted total assets. Management believes, as of September 30, 2018 and December 31, 2017, the Bank meets all capital adequacy requirements to which it is subject.

Banks and bank holding companies are also subject to certain restrictions on the amount of dividends that they may declare without prior regulatory non-objection.

As a result of the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies are required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion.  A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes.  The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement. The federal banking agencies must set the minimum capital for the new Community Bank Leverage Ratio at not less than 8% and not more than 10%.  A financial institution can elect to be subject to this new definition.

As of September 30, 2018, the Bank was categorized as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the Bank has to maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as disclosed in the table below. There are no conditions or events that management believes have changed the Bank’s prompt corrective action category.

Page 20 of 40

The Bank’s actual and required capital amounts and ratios are as follows:

											To be Well
											Capitalized Under
						For Capital					Prompt Corrective
	Actual					Adequacy Purposes					Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars in thousands)
As of September 30, 2018:
Total Capital
(to Risk-Weighted Assets)	$	46,757		16.54	%	$	22,619		>8.00	%	$	28,274		>10.00	%
Tier I Capital
(to Risk-Weighted Assets)	$	43,246		15.30	%	$	16,964		>6.00	%	$	22,619		>8.00	%
Common Equity Tier 1 Capital
(to Risk-Weighted Assets)	$	43,246		15.30	%	$	12,723		>4.50	%	$	18,378		>6.50	%
Tier I Capital
(to Average Assets)	$	43,246		11.66	%	$	14,833		>4.00	%	$	18,541		>5.00	%
As of December 31, 2017:
Total Capital
(to Risk-Weighted Assets)	$	45,076		17.21	%	$	20,950		>8.00	%	$	26,187		>10.00	%
Tier I Capital
(to Risk-Weighted Assets)	$	41,800		15.96	%	$	15,712		>6.00	%	$	20,950		>8.00	%
Common Equity Tier 1 Capital
(to Risk-Weighted Assets)	$	41,800		15.96	%	$	11,784		>4.50	%	$	17,022		>6.50	%
Tier I Capital
(to Average Assets)	$	41,800		11.96	%	$	14,011		>4.00	%	$	17,514		>5.00	%

NOTE 6 – EQUITY-BASED COMPENSATION

The Company has fully vested stock options outstanding under the 2001 Stock Option Plan and unvested stock options and restricted stock awards under the 2017 Equity Incentive Plan.

Page 21 of 40

A summary of stock option activity during the nine months ended September 30, 2018 and 2017 is presented below:

	For the Nine Months Ended September 30, 2018
					Average
			Weighted-		Remaining
			Average		Contractual
	Shares		Exercise Price		Term (years)
Outstanding, December 31, 2017		207,108	$	14.18		6.2
Granted		5,000		15.48		-
Exercised		(15,464)		9.65		-
Forfeited or expired		(7,734)		11.08		-
Outstanding, September 30, 2018		188,910	$	14.71		6.0
Exercisable, September 30, 2018		7,260	$	9.65		0.8

	For the Nine Months Ended September 30, 2017
					Average
			Weighted-		Remaining
			Average		Contractual
	Shares		Exercise Price		Term (years)
Outstanding, December 31, 2016		34,190	$	9.65		2.3
Granted		-		-		-
Exercised		-		-		-
Forfeited or expired		-		-		-
Outstanding, September 30, 2017		34,190	$	9.65		1.8
Exercisable, September 30, 2017		34,190	$	9.65		1.8

The exercise price of outstanding stock options at September 30, 2018 range from $9.65 to $15.48 per share. The grant date fair value of stock options awarded in the nine months ended September 30, 2018 was $4.04 using the Black-Scholes-Merton options pricing model with the following inputs and assumptions:

Grant date stock price	$	15.48
Dividend yield		0.00	%
Expected volatility		19.55	%
Risk-free interest rate		2.75	%
Expected life in years		6

The intrinsic value of the 15,464 stock options exercised in the first nine months of 2018 was $89,000.

The Company had 75,179 restricted stock awards outstanding at September 30, 2018 including 429 granted in the nine months ended September 30, 2018. There were 74,750 restricted stock awards outstanding at December 31, 2017.

Page 22 of 40

Equity-based expense for the nine months ended September 30, 2018 was $413,000 of which $306,000 was charged to compensation expense and $107,000 was charged to other noninterest expense. There was no stock-based expense for the nine months ended September 30, 2017.  

As of September 30, 2018, there was $486,000 and $775,000 of total unrecognized equity-based expense related to unvested stock options and restricted stock awards granted under the 2017 Equity Incentive Plan, respectively, that is expected to be recognized over the next 4.2 years.

NOTE 7 – FAIR VALUES OF FINANCIAL INSTRUMENTS

The following is a description of the valuation methodologies used for assets measured at fair value. There have been no changes in the methodologies used at September 30, 2018 and December 31, 2017.

Available-for-sale Securities – Where quoted market prices are available in an active market, securities are classified within Level 1 of the valuation hierarchy. Level 1 securities include highly-liquid government bonds, mortgage products and exchange-traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 securities include certain collateralized mortgage and debt obligations and certain municipal securities. In certain cases, where Level 1 or Level 2 inputs are not available, securities are classified within Level 3 of the hierarchy and include certain residual municipal securities and other less liquid securities.

Loans Held for Sale – The fair value of loans held for sale is based on quoted market prices from the Federal Home Loan Mortgage Corporation ("FHLMC"). FHLMC quotes are updated daily and represent prices at which loans are exchanged in high volumes and in a liquid market.

Other Real Estate – Other real estate is fair valued under Level 3 based on property appraisals less estimated disposition costs, which include both observable and unobservable inputs, at the time of transfer and as appropriate thereafter.

Derivative Financial Instruments - The fair value of mortgage derivatives is estimated based upon changes in mortgage interest rates from the date the interest rate on the loan is locked. The fair value of interest rate lock commitments is based upon the expected sales price using market prices of similar loans less estimated costs still to be incurred adjusted for projected fall out.  Forward commitment values are received from national broker counterparties.

Impaired Loans – Periodically, the Bank records nonrecurring adjustments to the carrying value of loans held for investment based on fair value measurements for loans subject to impairment. The fair value of impaired loans is typically determined using a combination of observable inputs, such as interest rates, contract terms, appraisals of collateral supporting the loan and recent comparable sales of similar properties, and unobservable inputs such as creditworthiness, disposition costs and underlying cash flows associated with the loan. Since the estimates of fair value utilized for loans also involve unobservable inputs, valuations of impaired loans have been classified as Level 3.

Page 23 of 40

The following table sets forth by level, within the fair value hierarchy, the Company’s assets at fair value:

	Fair Value Measurements Using
	Quoted Prices		Significant
	in Active		Other			Significant
	Markets for		Observable			Unobservable
	Identical Assets		Inputs			Inputs
	Level 1		Level 2			Level 3		Fair Value
September 30, 2018:
Recurring basis
Mortgage-backed securities	$	-	$	23,360,230		$	-	$	23,360,230
U.S. Government agencies		-		1,507,514			-		1,507,514
Municipal obligations		-		3,062,523			-		3,062,523
Loans held for sale		-		20,219,237			-		20,219,237
Derivative IRLC's		-					336,041		336,041
Derivative forward commitments		-		44,141			-		44,141
Nonrecurring basis
Impaired loans		-		-			5,344,477		5,344,477
Totals	$	-	$	48,193,645		$	5,680,518	$	53,874,163
December 31, 2017:
Recurring basis
Mortgage-backed securities	$	-	$	20,768,592		$	-	$	20,768,592
U.S. Government agencies		-		1,957,783			-		1,957,783
Municipal obligations		-		1,673,506			-		1,673,506
Loans held for sale		-		15,423,670			-		15,423,670
Derivative IRLC's		-					183,087		183,087
Derivative forward commitments		-		(15,820	)		-		(15,820	)
Nonrecurring basis
Impaired loans		-		-			5,436,972		5,436,972
Totals	$	-	$	39,807,731		$	5,620,059	$	45,427,790

The fair values of certain of these instruments were calculated by discounting expected cash flows, which involves significant judgments by management and uncertainties. Fair value is the estimated amount at which financial assets or liabilities could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. Because no market exists for certain of these financial instruments and because management does not intend to sell these financial instruments, the Bank does not know whether the fair values shown represent values at which the respective financial instruments could be sold individually or in the aggregate.

Page 24 of 40

The following table presents the significant unobservable inputs used in the fair value measurements for Level 3 financial assets measured on a non-recurring basis:

	Fair Value		Valuation Methodologies	Valuation Model	Unobservable Input Valuation
At September 30, 2018
Impaired loans
Commercial real estate	$	3,571,208	Appraisal	Appraisal discount and estimated selling costs	17	-	18%
One- to four-family residential real estate		663,580	Appraisal	Appraisal discount and estimated selling costs	17	-	18%
Commercial and industrial		1,109,689	Appraisal	Appraisal discount and estimated selling costs	17	-	18%
Total Impaired Loans	$	5,344,477
Derivative IRLC's	$	336,041	Internal pricing model	Pull-through rate	81%
At December 31, 2017
Impaired loans
Commercial real estate	$	3,483,078	Appraisal	Appraisal discount and estimated selling costs	17	-	18%
One- to four-family residential real estate		679,184	Appraisal	Appraisal discount and estimated selling costs	17	-	18%
Commercial and industrial		1,274,710	Appraisal	Appraisal discount and estimated selling costs	17	-	18%
	$	5,436,972

In addition, derivative Interest Rate Lock Commitment ("IRLC") fair values are derived using internal pricing models. Such models use pull-through rates (which are considered significant unobservable inputs), the weighted average of which was 81% and 77% as of September 30, 2018 and December 31, 2017, respectively.

Page 25 of 40

The following tables present estimated fair values of the Company’s financial instruments at September 30, 2018 and December 31, 2017.

					Quoted Prices		Significant
					in Active		Other		Significant
					Markets for		Observable		Unobservable
	Carrying				Identical Assets		Inputs		Inputs
	Amount		Fair Value		Level 1		Level 2		Level 3
	(Dollars in thousands)
At September 30, 2018:
Financial assets:
Cash and due from banks	$	6,195	$	6,195	$	6,195	$	-	$	-
Interest-bearing deposits with banks		9,205		9,205		9,205		-		-
Available-for-sale securities		27,930		27,930		-		27,930		-
Loans held for sale		20,219		20,219		-		20,219		-
Loans held for investment, net		280,230		280,940		-		-		280,940
Derivative IRLC's		336		336		-		-		336
Derivative forward commitments		44		44		-		44		-
Stock in financial institutions		3,884		3,884		-		3,884		-
Financial liabilities:
Demand deposits, savings and NOW deposits		177,646		162,325		162,325		-		-
Time deposits		73,868		73,830		-		73,830		-
Federal Home Loan Bank advances		70,000		69,462		-		69,462		-
At December 31, 2017
Financial assets:
Cash and due from banks	$	4,988	$	4,988	$	4,988	$	-	$	-
Interest-bearing deposits with banks		4,885		4,885		4,885		-		-
Available-for-sale securities		24,400		24,400		-		24,400		-
Loans held for sale		15,424		15,424		-		15,424		-
Loans held for investment, net		257,896		257,937		-		-		257,937
Stock in financial institutions		3,826		3,826		-		3,826		-
Financial liabilities:
Demand deposits, savings and NOW deposits		172,512		168,080		168,080		-		-
Time deposits		63,049		63,076		-		63,076		-
Federal Home Loan Bank advances		45,000		45,176		-		45,176		-

The following methods and assumptions were used to estimate the fair value of the additional classes of financial instruments shown:

Cash and Due from Banks, Interest-Bearing Deposits with Banks and Stock in Financial Institutions – The carrying amount approximates fair value.

Deposits and FHLB Advances – Deposits include demand deposits, savings accounts, NOW accounts and money market deposits. The carrying amount approximates fair value. The fair value of fixed-maturity time deposits and FHLB advances is estimated using a discounted cash flow calculation that applies the rates currently offered for deposits and advances of similar remaining maturities.

Page 26 of 40

NOTE 8 – EARNINGS PER SHARE

The two-class method is used in the calculation of basic and diluted earnings per share. Under the two-class method, earnings available to common shareholders for the period are allocated between common shareholders and participating securities according to dividends declared (or accumulated) and participation rights in undistributed earnings. The factors used in the earnings per share computation follow:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
Basic:
Net income	$	142,242		$	811,728		$	892,430		$	952,077
Less: Earnings allocated to participating securities		(3,313	)		-			(21,681	)		-
Net income allocated to common shareholders	$	138,929		$	811,728		$	870,749		$	952,077
Weighted-average common shares outstanding including participating securities		3,404,065			3,438,190			3,416,900			3,438,190
Less: Average participating securities		(75,179	)		-			(75,083	)		-
Less: Average unallocated ESOP Shares		(176,102	)		(181,887	)		(176,102	)		(181,887	)
Average shares		3,152,784			3,256,303			3,165,715			3,256,303
Basic earnings per common share	$	0.04		$	0.25		$	0.28		$	0.29
Diluted:
Net income allocated to common shareholders	$	138,929		$	811,728		$	870,749		$	952,077
Weighted-average common shares outstanding for basic earnings per common share		3,152,784			3,256,303			3,165,715			3,256,303
Add: Dilutive effects of assumed exercises of stock options		13,362			9,218			9,480			8,729
Weighted average shares and dilutive potential common shares		3,166,146			3,265,521			3,175,195			3,265,032
Diluted earnings per common share	$	0.04		$	0.25		$	0.27		$	0.29

Our restricted stock awards are participating securities since they participate in common stock dividends.

For the three and nine months ended September 30, 2018 and 2017 there were no stock options considered antidilutive. 

Page 27 of 40

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s discussion and analysis of financial condition at September 30, 2018 and December 31, 2017 and results of operations for the three and nine months ended September 30, 2018 and 2017 is intended to assist in understanding the financial condition and results of operations of the Company. The information contained in this section should be read in conjunction with the Unaudited Consolidated Financial Statements and the notes thereto, appearing in Part 1, Item 1 of this report.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Certain statements contained in this document that are not historical facts may constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (referred to as the Securities Act), and Section 21E of the Securities Exchange Act of 1934, as amended (referred to as the Securities Exchange Act), and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. You can identify these statements from the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” “tend,” “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions.

These forward-looking statements are subject to significant risks, assumptions and uncertainties, including among other things, changes in general economic and business conditions. Because of these and other uncertainties, Bancorp 34’s actual results, performance or achievements, or industry results, may be materially different from the results indicated by these forward-looking statements. You should not place undue reliance on any forward-looking statements, which speak only as of the dates on which they were made. Bancorp 34 is not undertaking an obligation to update these forward-looking statements, even though its situation may change in the future, except as required under federal securities law. Bancorp 34 qualifies all of its forward-looking statements by these cautionary statements.                          

Critical Accounting Policies

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, the evaluation of other-than-temporary impairment of investment securities, the valuation of and our ability to realize deferred tax assets and the measurement of fair values of financial instruments.

Allowance for Loan Losses. The allowance for loan losses is calculated with the objective of maintaining an allowance necessary to absorb credit losses inherent in the loan portfolio. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the loss content for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral.

We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish an allowance for loan losses. The allowance for loan losses is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of the probable losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date. Our evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

The allowance for loan losses consists primarily of specific allocations and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral, including adjustments for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting and payment history. We also analyze delinquency trends, general economic conditions, trends in historical loss experience, and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance. The principal assumption used in calculating the allowance for loan losses is the estimate of loss for each risk rating. Actual loan losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results.

Page 28 of 40

Other-Than-Temporary Impairment. Securities are evaluated on at least a quarterly basis, to determine whether a decline in their value is other-than-temporary. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether or not we intend to sell or expect that it is more likely than not that we will be required to sell the investment security prior to an anticipated recovery in fair value. Once a decline in value for a debt security is determined to be other than temporary, the other-than-temporary impairment is separated in (a) the amount of total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to credit loss is recognized in operations. The amount of other-than-temporary impairment related to other factors is recognized in other comprehensive income (loss).

Valuation of Deferred Tax Assets. As a result of the reduction in the Federal corporate tax rate effective in 2018 under the Tax Cuts and Jobs Act signed into law in December 2017, income tax expense for 2017 includes a $1.2 million deferred tax asset re-measurement adjustment. Effective December 31, 2016, we reversed 100% of our net deferred tax asset valuation allowances and recognized an income tax benefit based upon our assessment of net deferred tax assets that are more-likely-than-not to be realized. The net deferred tax asset had been offset by an equal valuation allowance from September 2012 through November 2016. In evaluating our ability to realize deferred tax assets, management considers all positive and negative information, including our past operating results and our forecast of future taxable income. In determining future taxable income, management utilizes a budget process that makes business assumptions and the implementation of feasible and prudent tax planning strategies, if any. These assumptions require us to make judgments about our future taxable income that are consistent with the plans and estimates we use to manage our business. Any change in estimated future taxable income or effective tax rates may result in changes to the carrying balance of our net deferred tax assets which would result in an income tax benefit or expense in the same period.

Fair Value Measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.  A three-level of fair value hierarchy prioritizes the inputs used to measure fair value:

● Level 1 – Quoted prices in active markets for identical assets or liabilities; includes certain U.S. Treasury and other U.S. Government agency debt that is highly liquid and actively traded in over-the-counter markets.

● Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

● Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

The asset or liability’s fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. 

Page 29 of 40

Average Balance Sheets

The following tables set forth average balances, average yields and costs, and certain other information for the periods indicated. Tax-equivalent yield adjustments have not been made for tax-exempt securities, as the effect thereof was not material. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income.

	Three Months Ended September 30,
	2018								2017
	Average								Average
	Outstanding					Yield/			Outstanding					Yield/
	Balance			Interest		Rate (1)			Balance			Interest		Rate (1)
	(Dollars in thousands)
Interest-earning assets:
Loans	$	299,538		$	4,344		5.75	%	$	285,425		$	3,972		5.52	%
Securities		29,492			172		2.31	%		27,943			129		1.83	%
Other interest earning assets		19,041			104		2.17	%		11,444			42		1.46	%
Total interest-earning assets		348,071			4,620		5.27	%		324,812			4,143		5.06	%
Noninterest-earning assets		24,012								23,568
Total assets	$	372,083							$	348,380
Interest-bearing liabilities:
Checking, money market and savings accounts	$	130,941			325		0.99	%	$	129,785			270		0.83	%
Certificates of deposit		72,948			309		1.68	%		63,061			153		0.96	%
Total deposits		203,888			634		1.23	%		192,846			423		0.87	%
Advances from FHLB of Dallas		73,204			381		2.06	%		63,554			187		1.16	%
Total interest-bearing liabilities		277,093			1,015		1.45	%		256,400			610		0.94	%
Non-interest bearing deposits		43,253								36,209
Non-interest bearing liabilities		4,912								3,747
Total liabilities		325,258								296,356
Stockholders' equity		46,824								52,024
Total liabilities and stockholders' equity	$	372,083							$	348,380
Net interest income				$	3,605							$	3,533
Net interest rate spread (2)							3.82	%							4.12	%
Net interest-earning assets (3)	$	70,978							$	68,412
Net interest margin (4)							4.11	%							4.32	%
Average interest-earning assets to average interest- bearing liabilities		125.62	%							126.68	%

(1)	Yield/Rate for the three-month periods have been annualized.
(2)	Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.
(3)	Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(4)	Net interest margin represents net interest income as a percentage of average total interest-earning assets.

Page 30 of 40

	Nine Months Ended September 30,
	2018								2017
	Average								Average
	Outstanding					Yield/			Outstanding					Yield/
	Balance			Interest		Rate (1)			Balance			Interest		Rate (1)
	(Dollars in thousands)
Interest-earning assets:
Loans	$	285,713		$	12,219		5.72	%	$	270,560		$	11,224		5.55	%
Securities		27,719			468		2.26	%		29,523			404		1.83	%
Other interest earning assets		17,024			246		1.93	%		15,256			143		1.25	%
Total interest-earning assets		330,456			12,933		5.23	%		315,339			11,771		4.99	%
Noninterest-earning assets		23,713								22,333
Total assets	$	354,169							$	337,672
Interest-bearing liabilities:
Checking, money market and savings accounts	$	130,131			902		0.93	%	$	127,217			760		0.80	%
Certificates of deposit		68,118			740		1.45	%		62,212			430		0.92	%
Total deposits		198,248			1,642		1.11	%		189,429			1,190		0.84	%
Advances from FHLB of Dallas		59,596			804		1.80	%		56,564			433		1.02	%
Total interest-bearing liabilities		257,845			2,446		1.27	%		245,993			1,623		0.88	%
Non-interest bearing deposits		43,156								36,758
Non-interest bearing liabilities		4,997								3,358
Total liabilities		305,997								286,109
Stockholders' equity		48,171								51,563
Total liabilities and stockholders' equity	$	354,169							$	337,672
Net interest income				$	10,487							$	10,148
Net interest rate spread (2)							3.96	%							4.11	%
Net interest-earning assets (3)	$	72,611							$	69,346
Net interest margin (4)							4.24	%							4.30	%
Average interest-earning assets to average interest- bearing liabilities		128.16	%							128.19	%

(1)	Yield/Rate for the nine-month periods have been annualized.
(2)	Net interest rate spread represents the difference between the weighted average yield on interest-earning assets and the weighted average rate of interest-bearing liabilities.
(3)	Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(4)	Net interest margin represents net interest income as a percentage of average total interest-earning assets.

Page 31 of 40

Comparison of Financial Condition at September 30, 2018 and December 31, 2017

Cash and cash equivalents increased $5.5 million, or 56.0%, to $15.4 million at September 30, 2018 from $9.9 million at December 31, 2017. Daily cash and cash equivalent balances vary between our target level of approximately $7.0 million to $20.0 million primarily due to the timing of large commercial loan fundings, large deposits and FHLB advance maturities.

Available-for-sale securities increased $3.5 million, or 14.5%, during the nine months ended September 30, 2018 to $27.9 million as we took advantage of higher interest rates to replace some of our regular monthly mortgage-backed securities principal reductions.

Loans held for sale at September 30, 2018 totaled $20.2 million, consisting entirely of residential mortgage loans. We currently sell a significant majority of our residential mortgage loans in the secondary market. At December 31, 2017, loans held for sale totaled $15.4 million. The balances at any date vary based upon the timing and volume of current loan originations and sales.

Loans held for investment increased $22.5 million, or 8.6%, to $283.5 million at September 30, 2018 from $261.0 million at December 31, 2017, due to organic growth. In the nine months ended September 30, 2018, commercial real estate loans increased $16.4 million to $231.3 million and represented 81.3% of the gross loan portfolio at September 30, 2018, down from 82.0% at September 30, 2017.

Total deposits increased $16.0 million, or 6.8%, to $251.5 million at September 30, 2018 from $235.6 million at December 31, 2017. The increase included a $8.6 million, or 23.0%, increase in non-interest-bearing demand deposits and a $10.9 million, or 17.2% increase in time deposits, partially offset by a $3.5 million, or 2.6%, decrease in savings and NOW deposits. The $10.9 million increase in time deposits included a $15.0 million increase in brokered deposits, partially offset by a decrease of $3.5 million in internet time deposits.

Borrowings, consisting solely of Federal Home Loan Bank advances, increased $25.0 million, or 55.6%, to $70.0 million at September 30, 2018 from $45.0 million at December 31, 2017. We utilize short-term borrowings to fund loans held for sale, and long-term borrowings and some short-term borrowings to fund net growth in loans held for investment.

Total stockholders’ equity decreased $4.8 million, or 9.4%, to $46.2 million at September 30, 2018 from $51.0 million at December 31, 2017. The decrease was primarily due to a $4.2 million special dividend paid in the second quarter of 2018 and $1.6 million used to repurchase common stock in the first quarter of 2018, partially offset by $892,000 of net income during the nine-month period.

Comparison of Operating Results for the Three Months Ended September 30, 2018 and 2017

General. We had net income of $142,000 for the three months ended September 30, 2018, compared to $812,000 for the three months ended September 30, 2017. Pre-tax income was $1.1 million, or 87.2%, lower in the three months ended September 30, 2018 at $167,000 compared to $1.3 million for the three months ended September 30, 2017. Gain on sale of loans for the three months ended September 30, 2018 was $149,000 lower than the three months ended September 30, 2017 primarily due to the implementation of a mandatory delivery mortgage loan sales program in 2017 that added $668,000 to the gain on sale of loans for the three months ended September 30, 2017. The three months ended September 30, 2018 included separation settlement costs and equity plan expenses totaling $382,000 not incurred in 2017.        

Interest Income. Interest income increased $477,000, or 11.5%, to $4.6 million for the three months ended September 30, 2018 from $4.1 million for the three months ended September 30, 2017. The increase was due to a $23.3 million, or 7.2%, increase in average interest-earning assets and a 21 basis point increase in average yields, partially offset by a change in asset mix as loans, our highest yielding assets, decreased to 86.1% of average interest-earning assets from 87.9% of average interest-earning assets. Loan and securities interest rates increased in 2018 compared to 2017 due to the higher interest rate environment. The yield on average interest-earning assets increased 21 basis points to 5.27% for the three months ended September 30, 2018, from 5.06% for the three months ended September 30, 2017, due primarily to a 48 basis point increase in securities yield from 1.83% for the three months ended September 30, 2017, to 2.31% for the three months ended September 30, 2018. Interest income on loans increased due primarily to a $14.1 million, or 4.9%, increase in average loan balances due to organic growth and a 23 basis point increase in yield. Interest on securities increased $44,000, or 34.0%, for the three months ended September 30, 2018 compared to the three months ended September 30, 2017. The average balance of securities increased $1.4 million, or 5.5%, to $29.5 million for the three months ended September 30, 2018, compared to $27.9 million for the three months ended September 30, 2017.

Interest Expense. Interest expense increased $405,000, or 66.4%, to $1.0 million for the three months ended September 30, 2018 from $610,000 for the three months ended September 30, 2017. The increase was the result of increases of $194,000, or 103.4%, in interest expense on borrowings and $212,000, or 50.1%, in interest expense on deposits. The average balance of borrowings increased $9.7 million, or 15.2%, from the quarter ended September 30, 2017 to the quarter ended September 30, 2018 and the average rate paid increased 90 basis points from 1.16% for the three months ended September 30, 2017 to 2.06% for the three months ended September 30, 2018.

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Interest paid on checking, money market and savings accounts increased $55,000, or 20.4%, to $325,000 for the three months ended September 30, 2018 from $270,000 for the three months ended September 30, 2017. The average rate we paid on such deposit accounts increased 16 basis points to 0.99% for the three months ended September 30, 2018 from 0.83% for the three months ended September 30, 2017 and the average balance increased $1.2 million, or 0.9%, to $130.9 million for the three months ended September 30, 2018 from $129.8 million for the three months ended September 30, 2017. The average rates we pay on deposits is considerably higher in the Arizona market.

Net Interest Income. Net interest income increased $72,000, or 2.0%, to $3.6 million for the three months ended September 30, 2018 from $3.5 million for the three months ended September 30, 2017, primarily due to a 7.2% increase in average interest earning assets partially offset by a 30 basis point decrease in net interest rate spread from 4.12% for the three months ended September 30, 2017 to 3.82% for the three months ended September 30, 2018. Average interest bearing liability rates increased 51 basis points compared to a 21 basis point increase in the average interest earning assets yield. Our average net interest-earning assets increased by $2.6 million, or 3.8%, to $71.0 million for the three months ended September 30, 2018 from $68.4 million for the three months ended September 30, 2017 due primarily to higher growth in interest-bearing liabilities than interest-earning assets. Loan yield was 5.75% of average loans for the three months ended September 30, 2018, compared to 5.52% in the comparable quarter in 2017. Our cost of borrowings increased 90 basis points to 2.06% for the quarter ended September 30, 2018 from 1.16% for the quarter ended September 30, 2017 due to the increase in short-term market interest rates. The target Federal Funds rate has increased 125 basis points from 0.75% at December 31, 2016 to 2.00% at September 30, 2018 with three 25 basis point increases in 2017 and two in 2018.

Provision for Loan Losses. Provisions for loan losses are charged to operations to establish an allowance for loan losses at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. If allowance for loan losses is larger than necessary, we post a negative provision as a benefit to earnings. In evaluating the level of the allowance for loan losses, management analyzes several qualitative loan portfolio risk factors including but not limited to, charge-off history over a relevant period, changes in management or underwriting policies, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower and results of internal and external loan reviews.

See “Asset Quality - Allowance for Loan Losses” for additional information.

After an evaluation of these factors, no provision for loan losses was recorded for the three months ended September 30, 2018, compared to $150,000 for the three months ended September 30, 2017. In the quarter ended September 30, 2018, gross loans held for investment grew $3.7 million, or 1.3%. Net recoveries were $34,000 in the three months ended September 30, 2018 compared to $3,000 in net charge-offs in the three months ended September 30, 2017.

To the best of our knowledge, we have recorded all loan losses that are both probable and reasonable to estimate at September 30, 2018.  However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for loan losses. In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, will periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on its judgments about the recoverability of our loan balances based upon information available to it at the time of its examination.

Noninterest Income. Noninterest income decreased $120,000, or 3.2%, to $3.6 million for the three months ended September 30, 2018 from $3.7 million for the three months ended September 30, 2017 due primarily to reduced loan sales gains.

The gain on sale of loans decreased $149,000, or 4.2%, to $3.4 million for the three months ended September 30, 2018 from $3.6 million for the three months ended September 30, 2017 despite a 19.1% increase in mortgage loan sales. During the three months ended September 30, 2018, we sold $84.0 million of mortgage loans for a gain of $3.4 million, compared to $72.7 million of mortgage loan sales during the three months ended September 30, 2017 for a gain of $3.5 million. There were no SBA loans sold during the three months ended September 30, 2018 and no sales gains recognized directly into income compared to $491,000 SBA loan sales in the quarter ended September 30, 2017 with gains of $31,000. We realized a 4.5% average premium (gain on sale/sold loans) on the sales of mortgage loans for the three months ended September 30, 2018 and 3.9% for the three months ended September 30, 2017. We began selling mortgage loans under mandatory delivery contracts as opposed to on a best efforts basis in September 2017, and sales gain percentages tend to be larger under mandatory delivery contracts. Premiums also vary from period to period based upon the mix of government Federal Housing Administration (FHA) and VA loans to conventional loans, geographic markets and market interest rates, specifically 10-year Treasury rates. The implementation of mandatory delivery represented $668,000 of the gain on sale of loans for the three months ended September 30, 2017 compared to $0 in the three months ended September 30, 2018.

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Noninterest Expense. Noninterest expense increased $1.2 million, or 21.3%, to $7.0 million for the three months ended September 30, 2018 from $5.8 million for the three months ended September 30, 2017 due primarily to higher salaries and benefits, data processing fees and occupancy expense. The increases were primarily related to growth in our mortgage banking area and $295,000 in expenses accrued related to a settlement agreement reached with our outgoing president who resigned effective October 2, 2018. Our mortgage banking area sold 19.1% more loans in the three months ended September 30, 2018 compared to the three months ended September 30, 2017. The increase in salaries and benefits also included $146,000 of equity-based expense in 2018, compared to $0 in the three months ended September 30, 2017. Average assets for the quarter ended September 30, 2018 were 6.8% larger than for the quarter ended September 30, 2017.

Provision for Income Tax. Provision for income tax expense was $24,000 for the three months ended September 30, 2018, representing an effective tax rate of 14.7% on pre-tax income. Although there are numerous differences between pre-tax income and actual taxable income that have an effect on the effective income tax rate for any given period, it is notable that the tax rate assumption used to compute income tax expense in 2018 is lower than previous years due to the reduction in the Federal corporate income tax rate to 21% from the Tax Cuts and Jobs Act enacted in December 2017. A 34% Federal tax rate was applied to earnings in 2017 and previous years. We recognized an income tax expense of $487,000 for the three months ended September 30, 2017 representing 37.5% of the $1.3 million income before income taxes.

Comparison of Operating Results for the Nine Months Ended September 30, 2018 and 2017

General. We had net income of $892,000 for the nine months ended September 30, 2018, compared to net income of $952,000 for the nine months ended September 30, 2017. Pre-tax income was $312,000, or 21.6%, lower in the nine months ended September 30, 2018 at $1.1 million compared to $1.4 million for the nine months ended September 30, 2017. Results in the first nine months of 2018 reflected a $457,000 lower provision for loan losses due to improving credit quality and more rapid loan growth in 2017 and a $339,000, or 3.3%, increase in net interest income, mostly due to a 4.8% increase in average interest-earning assets. Gain on sale of loans for the nine months ended September 30, 2018 was $2.8 million larger than the nine months ended September 30, 2017 despite the implementation of a mandatory delivery mortgage loan sales program in 2017 that added $668,000 to the gain on sale of loans for the nine months ended September 30, 2017.  The nine months ended September 30, 2018 included separation settlement costs and equity plan expenses totaling $649,000 not incurred in 2017.

Interest Income. Interest income increased $1.2 million, or 9.9%, to $12.9 million for the nine months ended September 30, 2018 from $11.8 million for the nine months ended September 30, 2017. The increase was due to a 4.8% increase in average interest-earning assets and a 24 basis point increase in yield. Loans, our highest yielding asset, increased from 85.8% to 86.5% of average interest-earning assets. Interest and fees on loans increased $994,000, or 8.9%, to $12.2 million for the nine months ended September 30, 2018, from $11.2 million for the nine months ended September 30, 2017. Interest income on loans increased due to a $15.2 million, or 5.6%, increase in average loan balances due to organic growth and a 17 basis point increase in average yields. Interest income on securities increased $64,000 or 15.9% to $468,000 in 2018 from $404,000 in 2017. The average balance of securities decreased $1.8 million, or 6.1%, to $27.7 million for the nine months ended September 30, 2018, compared to $29.5 million for the nine months ended September 30, 2017 and the average yield increased 43 basis points.

The 24 basis point increase in yield on interest-earning assets from the nine months ended September 30, 2017 to the nine months ended September 30, 2018 was primarily due to a 17 basis point increase in loan yields and a 43 basis point increase in securities yields due to market interest rate increases.

Interest Expense. Interest expense increased $823,000, or 50.7%, to $2.4 million for the nine months ended September 30, 2018 from $1.6 million for the nine months ended September 30, 2017. The increase included a $452,000, or 37.9%, increase in interest expense on deposits and a $371,000, or 85.7%, increase in interest expense on borrowings. Our funding cost increases were facilitated by increases in market interest rates as the target Federal Funds rate increased 125 basis points from 0.75% at December 31, 2016 to 2.00% at September 30, 2018 with three 25 basis point increases in 2017 and two in 2018.

Average interest-bearing deposits for the nine months ended September 30, 2018 were $198.2 million, representing a $2.9 million, or 2.3%, increase compared to average interest-bearing deposits of $189.4 million for the nine months ended September 30, 2017. The average rate paid on interest-bearing deposits was 31 basis points higher at 1.11% for the nine months ended September 30, 2018 compared to 0.84% for the 2017 period.

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The $371,000 increase in interest expense on borrowings was due to an 88 basis point increase in average rates paid and a $3.0 million, or 5.4%, increase in average balances outstanding. We primarily utilize short term FHLB advances to support mortgage loans held for sale and other shorter-term funding needs, and longer term FHLB advances to supplement deposits in funding loans held for investment and securities. At September 30, 2018 we held $40.0 million in FHLB advances due within one year with an average rate of 2.19% and $30.0 million in longer term advances maturing between January and October 2020 with an average rate of 2.12%. Longer term FHLB advances and brokered CD maturities are generally designed to fill gaps within a funding maturities ladder in order to smooth out maturities to mitigate interest rate risk as market rates move.

Interest paid on interest bearing checking, money market and savings accounts increased $142,000, or 18.7%, to $902,000 for the nine months ended September 30, 2018 from $760,000 for the nine months ended September 30, 2017. The average rate we paid on such deposit accounts increased 13 basis points to 0.93% for the nine months ended September 30, 2018 from 0.80% for the nine months ended September 30, 2017 and the average balance increased $2.9 million, or 2.3%, to $130.1 million for the nine months ended September 30, 2018 from $127.2 million for the nine months ended September 30, 2017. The increase in checking, savings and money market deposit rates is primarily due to increases in market interest rates. The average rates we pay on these accounts is considerably higher in the Arizona market.

Net Interest Income. Net interest income increased $339,000, or 3.3%, to $10.5 million for the nine months ended September 30, 2018 from $10.1 million for the nine months ended September 30, 2017, as a result of a higher balance of net interest-earning assets and a higher net interest rate spread. Our average net interest-earning assets increased by $3.3 million, or 4.7%, to $72.6 million for the nine months ended September 30, 2018 from $69.3 million for the nine months ended September 30, 2017 due primarily to organic growth. Our net interest rate spread declined by 15 basis points to 3.96% for the nine months ended September 30, 2018 from 4.11% for the nine months ended September 30, 2017. We carried 86.5% of our average interest-earning assets in loans, our highest yielding asset, for the nine months ended September 30, 2018 compared to 85.8% in loans for the comparable period in 2017.

Provision for Loan Losses. We recorded a provision for loan losses of $93,000 for the nine months ended September 30, 2018, compared to $550,000 for the nine months ended September 30, 2017. Due to improving credit quality, in the nine months ended September 30, 2018, the allowance for loan losses decreased $117,000, or 3.7%, compared to a $22.5 million or 8.6% increase in gross loans held for investment. Net recoveries were $24,000 in the nine months ended September 30, 2018 and $11,000 for the comparable 2017 period.

Noninterest Income. Noninterest income increased $2.9 million, or 33.9%, to $11.4 million for the nine months ended September 30, 2018 from $8.5 million for the nine months ended September 30, 2017 primarily due to a higher volume of loan sales and larger average mortgage loan sales premiums.

Gain on sale of loans increased $2.8 million, or 34.2%, to $10.8 million for the nine months ended September 30, 2018 from $8.1 million for the nine months ended September 30, 2017 due to expansion in our secondary mortgage loan operation in 2017 and early 2018. During the nine months ended September 30, 2018, we sold $243.3 million of mortgage loans for a gain of $10.7 million and $1.4 million of SBA loans for a gain of $123,000, compared to $188.2 million of mortgage loan sales and $2.9 million of SBA loan sales during the nine months ended September 30, 2017 for gains of $7.8 million and $273,000, respectively. The average premium (gain on sale/sold loans) for the 2018 period was 4.1% compared to 3.9% for the 2017 period. Sales premiums have improved since we began using mandatory delivery and hedging in September 2017, and also vary from period to period based upon the mix of government FHA, VA and jumbo loans to conventional loans, geographic markets and market interest rates, specifically 10-year Treasury rates. The implementation of mandatory delivery and hedging represented $668,000 of the gain on sale of loans for the nine months ended September 30, 2017 compared to $0 in the nine months ended September 30, 2018.

Noninterest Expense. Noninterest expense increased $4.0 million, or 24.0%, to $20.7 million for the nine months ended September 30, 2018 from $16.7 million for the nine months ended September 30, 2017 due primarily to higher salaries and benefits and data processing fees, partially offset by lower professional fees. The increase in salaries and benefits expense resulted primarily from the expansion of our mortgage banking program, $413,000 from equity-based expense in 2018 from December 2017 grants and $295,000 in expenses accrued related to a settlement agreement reached with our outgoing president who resigned effective October 2, 2018. Average assets for the nine months ended September 30, 2018 were 4.9% larger than the nine months ended September 30, 2017.

Provision for Income Tax. Provision for income tax expense was $239,000 for the nine months ended September 30, 2018, representing an effective tax rate of 21.1% on pre-tax income. Although there are numerous differences between pre-tax income and actual taxable income that have an effect on the effective income tax rate for any given period, it is notable that the tax rate assumption used to compute income tax expense in 2018 is 13% lower than 2017 due to the permanent reduction in the Federal corporate income tax rate to 21% from the Tax Cuts and Jobs Act enacted in December 2017. We recognized income tax expense of $491,000 for the nine months ended September 30, 2017, representing 34% of the $1.4 million income before income taxes.

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Asset Quality

We review loans on a regular basis, and place loans on nonaccrual status when either principal or interest is 90 days or more past due or earlier if we do not expect to receive full payment of interest or principal. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is reversed from interest income. Once a loan is placed on nonaccrual status, the borrower must generally demonstrate at least nine consecutive months of payment performance before the loan is eligible to return to accrual status.

Non-Performing Loans and Non-Performing Assets. The following table sets forth information regarding our non-performing assets. As of September 30, 2018 and December 31, 2017, we had no accruing troubled debt restructurings. Troubled debt restructurings include loans for which either a portion of interest or principal has been forgiven, or for loans modified at interest rates materially less than current market rates.

	At September 30,			At December 31,
	2018			2017
Nonaccrual loans	(Dollars in thousands)
Real estate loans:
One- to four-family residential real estate	$	663		$	679
Commercial real estate		3,571			3,483
Commercial and industrial loans		1,110			1,275
Consumer and other loans		-			-
Total nonaccrual loans		5,344			5,437
Accruing loans past due 90 days or more		-			-
Total nonaccrual loans and accruing loans past due 90 days or more		5,344			5,437
Other real estate (ORE)		-			-
Total nonperforming assets	$	5,344		$	5,437
Ratios:
Nonperforming loans to gross loans held for investment		1.88	%		2.08	%
Nonperforming assets to total assets		1.43	%		1.62	%
Nonperforming assets to gross loans held for investment and ORE		1.88	%		2.08	%

Two large loan relationships partially secured by real estate comprise $4.4 million, or 82.8%, of the $5.3 million in nonaccrual loans at September 30, 2018.  $3.4 million, or 64.0% of the total September 30, 2018 nonaccrual loan balance, is guaranteed by the SBA.

The nonperforming asset ratios decreased due to an increase in loans held for investment and assets and a minor decrease in nonaccrual loans.

Interest income that would have been recorded for the nine months ended September 30, 2018, had nonaccruing loans been current according to their original terms amounted to $260,000. We recognized $4,000 of interest income on nonaccrual loans for the nine months ended September 30, 2018.

At September 30, 2018, we had no loans that were not currently classified as nonaccrual, 90 days past due or troubled debt restructurings where known information about possible credit problems of borrowers caused management to have serious concerns as to the ability of the borrowers to comply with existing loan repayment terms and that could result in disclosure as non-accrual, 90 days past due or troubled debt restructurings.

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Allowance for Loan Losses. The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by full and partial charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management’s periodic evaluation of the adequacy of the allowance is based on the current level of net loan losses, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions.

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2018			2017			2018			2017
	(Dollars in thousands)
Balance at beginning of period	$	3,199		$	2,920		$	3,117		$	2,506
Provision for loan losses		-			150			93			550
Charge-offs:
One- to four-family residential real estate loans		(13	)		(9	)		(36	)		(9	)
Commercial real estate loans		-			-			-			-
Commercial and industrial loans		-			-			-			-
Consumer and other loans		-			-			-			-
Total charge-offs		(13	)		(9	)		(36	)		(9	)
Recoveries:
One- to four-family residential real estate loans		-			6			12			19
Commercial real estate loans		-			-			-			1
Commercial and industrial loans		48			-			48			-
Consumer and other loans		-			-			-			-
Total recoveries		48			6			60			20
Net (charge-offs) recoveries		35			(3	)		24			11
Balance at end of period	$	3,234		$	3,067		$	3,234		$	3,067
ALLL to nonperforming loans		60.52	%		52.86	%		60.52	%		52.86	%
ALLL to total gross loans		1.14	%		1.13	%		1.14	%		1.13	%
ALLL to total gross loans less acquired loans		1.17	%		1.26	%		1.17	%		1.26	%
Net (charge-offs) recoveries to average loans outstanding during the period		0.01	%		(0.00	)%		0.01	%		0.01	%

The ratio of our allowance for loan losses to nonperforming loans increased due to a 5.4% increase in the allowance for loan losses and a 7.9% decrease in nonperforming loans. The allowance for loan losses to total loans ratios increased because the 5.4% increase in allowance for loan losses was larger than the 5.3% increase in total gross loans.

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Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, FHLB borrowings, loan repayments and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition.

We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits with other banks and short- and intermediate-term securities.

We believe that we have enough sources of liquidity to satisfy our short-term liquidity needs as of September 30, 2018.

Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2018, cash and cash equivalents totaled $15.4 million. Available-for-sale securities, which provide additional sources of liquidity, totaled $27.9 million at September 30, 2018. In addition, at September 30, 2018, we had $70.0 million of advances outstanding from the Federal Home Loan Bank of Dallas and the ability to borrow an additional $79.1 million from the FHLB, $9.8 million from the Independent Bankers Bank (TIB), and $6.0 million from the Pacific Coast Bankers Bank (PCBB).

At September 30, 2018, we had $33.3 million in loan commitments outstanding, and $35.6 million in commitments to originate and sell mortgage loans. In addition, we had $14.8 million in unused lines of credit and $0 in commitments issued under standby letters of credit. Time deposits due within one year as of September 30, 2018 totaled $31.0 million, or 12.0% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other time deposits and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before September 30, 2019. We believe, however, based on past experience that a significant portion of our time deposits will remain with us, either as time deposits or as other deposit products. We have the ability to attract and retain deposits by adjusting the interest rates offered.

We have no material commitments or demands that are likely to affect our liquidity other than set forth above. In the event loan demand were to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we would access our borrowing capacity with the Federal Home Loan Bank of Dallas or the other financial institutions, or increase our deposits by offering higher interest rates.

Our primary investing activities are the origination of loans and the purchase of securities. During the nine months ended September 30, 2018, we originated $90.3 million of loans held for investment and $238.1 million of mortgage loans held for sale, compared to $51.1 million of loans held for investment and $112.7 million of mortgage loans held for sale during the nine months ended September 30, 2017. In the nine months ended September 30, 2018 and 2017 we purchased $8.0 million and $0 in securities, respectively. We have not purchased any whole loans in recent periods.

Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances. We experienced net increases of $16.0 million and $11.0 million in total deposits for the nine months ended September 30, 2018 and 2017, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits so that we are competitive in our market area.

We had $70.0 million in Federal Home Loan Bank advances at September 30, 2018 and $45.0 million at December 31, 2017. The increase was primarily due to increases of $22.3 million in loans held for investment, net, $4.8 million in loans held for sale and $3.5 million in securities.

Bancorp 34, Inc. is a separate legal entity from the Bank and must provide for its own liquidity to pay any dividends to stockholders, to repurchase its common stock, and for other corporate purposes. Bancorp 34, Inc.’s primary source of liquidity is dividend payments it may receive from the Bank. At September 30, 2018, Bancorp 34, Inc. (on an unconsolidated basis) had liquid assets of $595,000.

The Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At September 30, 2018 and December 31, 2017, Bank 34 exceeded all regulatory capital requirements. Bank 34 is considered “well-capitalized” under regulatory guidelines.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Not applicable, as the Registrant is a smaller reporting company.

Item 4. Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended) as of September 30, 2018. Based on that evaluation, the Company’s management, including the President and Chief Executive Officer and the Executive Vice President and Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

During the quarter ended September 30, 2018, there have been no changes in the Company’s internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

Part II – Other Information

Item 1. Legal Proceedings 

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

Item 1A. Risk Factors

Not applicable, as the Registrant is a smaller reporting company.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 

(a) Not applicable.

(b) Not applicable.

(c) On October 24, 2017, the Company adopted a repurchase program under which it may repurchase up to 171,910 shares of its common stock, or approximately 5.0% of the Company’s outstanding shares. The repurchase program will continue until it is completed or terminated by the Company’s Board of Directors. In December 2017, 28,000 shares were repurchased and in the first quarter of 2018 another 102,500 shares were repurchased under this program. No shares were repurchased during the quarters ended June 30, 2018 or September 30, 2018. 41,410 shares remain available for repurchase under this program.  

Item 3. Defaults Upon Senior Securities 

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

3.1 Articles of Incorporation of Bancorp 34, Inc. (1)

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3.2	Bylaws of Bancorp 34, Inc. (1)
10.2	Confidential Separation and Settlement Agreement and Release with William P. Kauper dated October 2, 2018

31.1	Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2	Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1	Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101	The following financial statements from the Bancorp 34, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2018, formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Comprehensive Income; (iii) Consolidated Statements of Stockholders’ Equity; (iv) Consolidated Statements of Cash Flows; and (v) Notes to Consolidated Financial Statements.

(1) Incorporated by reference to the Registration Statement on Form S-1 of Bancorp 34, Inc. (File No. 333-21182), originally filed with the Securities and Exchange Commission on September 3, 2016.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	BANCORP 34, INC.
Date:     October 29, 2018	/s/ Jill Gutierrez
	Jill Gutierrez
	President and Chief Executive Officer
Date:     October 29, 2018	/s/ Jan R. Thiry
	Jan R. Thiry
	Executive Vice President and Chief Financial Officer

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