UNITED STATES OF AMERICA

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

________________________

 

FORM 10-Q

 _______________________

 

  (Mark One)
     
 

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

 

For the Quarterly Period Ended March 31, 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 Number:  000-54835

__________________________

 

MALVERN BANCORP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 ___________________________

 

Pennsylvania 45-5307782

(State or Other Jurisdiction of

Incorporation or Organization)

(IRS Employer

Identification No.)

 

42 E. Lancaster Avenue, Paoli, Pennsylvania 19301

(Address of Principal Executive Offices) (Zip Code)

 

(610) 644-9400

(Registrant’s Telephone Number, Including Area Code)

 

 Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

 

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

 

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

 

 Large accelerated filer  ☐ Accelerated filer  ☒

Non-accelerated filer  ☐ 

(Do not check if smaller reporting company)

Smaller reporting company  ☐

Emerging growth company ☐

 

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

 

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

 

 Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 Common Stock, par value $0.01: 6,572,684 shares
(Title of Class) (Outstanding as of May 10, 2018)

 

 

 

Table of Contents

 

      Page
       
PART I – FINANCIAL INFORMATION   3
       
Item  1. Financial Statements    
  Consolidated Statements of Financial Condition at March 31, 2018 (unaudited) and September 30, 2017   4
  Consolidated Statements of Operations for the three- and six- month periods ended March 31, 2018 and 2017 (unaudited)   5
  Consolidated Statements of Comprehensive Income for the three- and six- month periods ended March 31, 2018 and 2017 (unaudited)   6
  Consolidated Statements of Changes in Shareholders’ Equity for the six- month periods ended March 31, 2018 and 2017 (unaudited)   7
  Consolidated Statements of Cash Flows for the six- month periods ended March 31, 2018 and 2017 (unaudited)   8
  Notes to unaudited Consolidated Financial Statements   9
     
Item  2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   39
       
Item  3. Qualitative and Quantitative Disclosures about Market Risks   56
       
Item  4. Controls and Procedures   56
       
PART II – OTHER INFORMATION    
       
Item  1. Legal Proceedings   57
       
Item  1A. Risk Factors   57
       
Item  2. Unregistered Sales of Equity Securities and Use of Proceeds   57
       
Item  3. Default Upon Senior Securities   57
       
Item  4. Mine Safety Disclosure   57
       
Item  5. Other Information   57
       
Item  6. Exhibits   57
       
SIGNATURES     58

 

-2-

 

 

PART I – FINANCIAL INFORMATION

 

The following unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and, accordingly, do not include all of the information and footnotes required by U.S. generally accepted accounting principles for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and six months ended March 31, 2018 are not necessarily indicative of the results that may be expected for the full year ending September 30, 2018, or for any other interim period. The Malvern Bancorp, Inc. 2017 Annual Report on Form 10-K should be read in conjunction with these financial statements.

 

-3-

 

 

Item 1. Financial Statements

 

MALVERN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

 

   March 31,
2018
   September 30,
2017
 
   (Dollars in thousands, except per share data) 
Assets        
  Cash and due from depository institutions  $1,566   $1,615 
  Interest bearing deposits in depository institutions   120,144    115,521 
     Cash and Cash Equivalents   121,710    117,136 
Investment securities available for sale, at fair value (amortized cost of $44.8 million and $14.9 million at March 31, 2018 and September 30, 2017, respectively)   44,341    14,587 
Investment securities held to maturity, at cost (fair value of $32.1 million and $34.6 million at March 31, 2018 and September 30, 2017, respectively)   33,052    34,915 
  Restricted stock, at cost   8,583    5,559 
Loans receivable, net of allowance for loan losses of $8.5 million and $8.4 million, respectively   837,314    834,331 
  Accrued interest receivable   3,583    3,139 
  Property and equipment, net   7,357    7,507 
  Deferred income taxes, net   3,713    6,671 
  Bank-owned life insurance   19,163    18,923 
  Other assets   4,500    3,244 
      Total Assets  $1,083,316   $1,046,012 
           
Liabilities and Shareholders’ Equity          
           
Liabilities          
  Deposits:          
    Deposits-noninterest-bearing  $38,444   $42,121 
    Deposits-interest-bearing   787,125    748,275 
      Total Deposits   825,569    790,396 
  FHLB advances   118,000    118,000 
  Other short-term borrowings   2,500    5,000 
  Subordinated debt   24,382    24,303 
  Advances from borrowers for taxes and insurance   2,463    1,553 
  Accrued interest payable   713    694 
  Other liabilities   4,327    3,546 
      Total Liabilities   977,954    943,492 
           
Commitments and Contingencies        
           
Shareholders’ Equity          
  Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued        
Common stock, $0.01 par value, 50,000,000 shares authorized, issued and outstanding: 6,572,684 shares at March 31, 2018 and September 30, 2017
   66    66 
  Additional paid-in-capital   60,886    60,736 
  Retained earnings   45,536    43,139 
  Unearned Employee Stock Ownership Plan (ESOP) shares   (1,411)   (1,483)
  Accumulated other comprehensive income   285    62 
      Total Shareholders’ Equity   105,362    102,520 
      Total Liabilities and Shareholders’ Equity  $1,083,316   $1,046,012 

 

See accompanying notes to unaudited consolidated financial statements.

 

-4-

 

 

MALVERN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

   Three Months Ended March 31,   Six Months Ended March 31, 
(Dollars in thousands, except for per share data)  2018   2017   2018   2017 
                 
Interest and Dividend Income                    
Loans, including fees  $8,740   $7,367   $17,441   $13,680 
Investment securities, taxable   302    470    532    942 
Investment securities, tax-exempt   65    159    130    322 
Dividends, restricted stock   134    64    203    128 
Interest-bearing cash accounts   463    115    909    208 
       Total Interest and Dividend Income   9,704    8,175    19,215    15,280 
Interest Expense                    
Deposits   2,182    1,424    4,337    2,748 
Short-term borrowings   22    11    41    11 
Long-term borrowings   546    528    1,109    1,070 
Subordinated debt   386    221    778    221 
Total Interest Expense   3,136    2,184    6,265    4,050 
Net interest income   6,568    5,991    12,950    11,230 
Provision for Loan Losses   240    997    240    1,657 

Net Interest Income after Provision for Loan Losses 

   6,328    4,994    12,710    9,573 
Other Income                    
Service charges and other fees   237    274    508    497 
Rental income-other   67    55    133    110 
Net gains on sales of investments       58        58 
Net gains on sale of real estate           1,186     
Net gains on sale of loans   26    30    93    75 
Earnings on bank-owned life insurance   119    125    240    255 
Total Other Income   449    542    2,160    995 
Other Expense                    
Salaries and employee benefits   2,001    1,804    3,991    3,516 
Occupancy expense   586    514    1,148    1,008 
Federal deposit insurance premium   75    91    151    95 
Advertising   38    73    92    124 
Data processing   267    301    545    603 
Professional fees   450    399    1,238    800 
Other operating expenses   688    596    1,411    1,202 
Total Other Expense   4,105    3,778    8,576    7,348 
Income before income tax expense   2,672    1,758    6,294    3,220 
Income tax expense   654    588    3,873    1,077 
Net Income  $2,018   $1,170   $2,421   $2,143 
                     
Earnings Per Common Share:                    
  Basic  $0.31   $0.18   $0.38   $0.33 
  Diluted  $0.31   $0.18   $0.38   $0.33 

Weighted Average Common Shares Outstanding:

                    
  Basic   6,448,691    6,427,309    6,446,959    6,422,899 
  Diluted   6,452,246    6,427,932    6,451,205    6,423,269 
                     
Dividends Declared Per Share  $   $   $   $ 

 

See accompanying notes to unaudited consolidated financial statements.

 

-5-

 

 

MALVERN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

 

   Three Months Ended March 31,   Six Months Ended March 31, 
(Dollars in thousands)  2018   2017   2018   2017 
                 
Net Income  $2,018   $1,170   $2,421   $2,143 
Other Comprehensive Income, Net of Tax:                    
Unrealized holding gains (losses) on available-for-sale securities   (136)   352    (219)   (745)
Tax effect   3    (120)   28    253 
      Net of tax amount   (133)   232    (191)   (492)

Reclassification adjustment for net gains arising during the period(1)

       (58)       (58)
Tax effect       20        20 
      Net of tax amount       (38)       (38)

Accretion of unrealized holding losses on securities transferred from available-for-sale to held-to-maturity(2)

   4    2    6    6 
Tax effect   (1)   (1)   (2)   (2)
   Net of tax amount   3    1    4    4 
Fair value adjustments on derivatives   253    74    495    1,019 
Tax effect   (86)   (26)   (109)   (347)
    Net of tax amount   167    48    386    672 
Total other comprehensive income   37    243    199    146 
Total comprehensive income  $2,055   $1,413   $2,620   $2,289 

 

 

(1)  Amounts are included in net gains on sales of investments, net on the Consolidated Statements of Operations in total other income.
(2)  Amounts are included in interest and dividends on investment securities on the Consolidated Statements of Operations.

 

See accompanying notes to unaudited consolidated financial statements.

 

-6-

 

 

MALVERN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

                         
   Common Stock   Additional
Paid-In
Capital
   Retained Earnings   Unearned ESOP Shares  

Accumulated Other Comprehensive

Income (Loss)

   Total
Shareholders’ Equity
 
   (Dollars in thousands, except share data) 
Balance, October 1, 2016  $66   $60,461   $37,322   $(1,629)  $(63)  $96,157 
Net Income           2,143            2,143 
Other comprehensive income                   146    146 
Committed to be released ESOP shares (7,200 shares)       71        73        144 
Stock based compensation       4                4 
Balance, March 31, 2017  $66   $60,536   $39,465   $(1,556)  $83   $98,594 
                               
Balance, October 1, 2017  $66   $60,736   $43,139   $(1,483)  $62   $102,520 
Net Income           2,421            2,421 
Impact of adoption of new accounting standard (1)           (24)       24     
Other comprehensive income                   199    199 
Committed to be released ESOP shares (7,200 shares)       112        72        184 
Stock based compensation       38                38 
Balance, March 31, 2018  $66   $60,886   $45,536   $(1,411)  $285   $105,362 

 

 

(1) Represents the impact of adopting ASU 2018-02. See Note 2 to the consolidated financial statements for more information.

 

See accompanying notes to unaudited consolidated financial statements.

 

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MALVERN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

   Six Months Ended March 31, 
(Dollars in thousands)  2018   2017 
Cash Flows from Operating Activities          
Net income  $2,421   $2,143 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation expense   377    361 
Provision for loan losses   240    1,657 
Deferred income taxes expense   2,898    871 
ESOP expense   184    144 
Stock based compensation   38    4 
Amortization of premiums and discounts on investment securities, net   166    480 
Accretion of loan origination fees and costs   (122)   (876)
Amortization of mortgage service rights   24    31 
Net gain on sale of investment securities available-for-sale       (58)
Net gain on sale of real estate   (1,186)    
Net gain on sale of secondary market loans   (93)   (75)
Proceeds on sale of secondary market loans   8,037    3,892 
Originations of secondary market loans   (7,944)   (3,817)
Earnings on bank-owned life insurance   (240)   (255)
Increase in accrued interest receivable   (444)   (619)
Increase in accrued interest payable   19    222 
Increase (decrease) in other liabilities   781    (907)
Increase in other assets   (808)   (510)
Amortization of subordinated debt   79     
Net Cash Provided by Operating Activities   4,427    2,688 
Cash Flows from Investing Activities          
Investment securities available-for-sale:          
Purchases   (30,140)    
Sales       3,903 
Maturities, calls and principal repayments   123    151 
Investment securities held-to-maturity:          
Maturities, calls and principal repayments   1,747    3,379 
(Loan originations) and principal collections, net   (3,101)   (179,329)
Net decrease (increase) in restricted stock   (3,024)   27 
Proceeds from sale of property and equipment   1,315     
Purchases of property and equipment   (356)   (620)
Net Cash Used in Investing Activities   (33,436)   (172,489)
Cash Flows from Financing Activities          
Net increase in deposits   35,173    102,226 
Net increase in short-term borrowings       10,000 
Proceeds from long-term borrowings   70,000    70,000 
Repayment of long-term borrowings   (70,000)   (70,000)
Repayment of other borrowed money   (2,500)    
Increase in advances from borrowers for taxes and insurance   910    1,565 
Proceeds from issuance of subordinated debt       25,000 
Net Cash Provided by Financing Activities   33,583    138,791 
Net Increase (Decrease) in Cash and Cash Equivalents   4,574    (31,010)
Cash and Cash Equivalent–Beginning   117,136    96,762 
Cash and Cash Equivalent–Ending  $121,710   $65,752 
Supplementary Cash Flows Information          
Interest paid  $6,246   $3,828 
Income taxes paid  $254   $ 

 

See accompanying notes to unaudited consolidated financial statements.

 

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 1 – The Company

 

Malvern Bancorp, Inc. (the “Company” or “Malvern Bancorp”) is the holding company for Malvern Bank, National Association (the “Bank”), a national bank that was originally organized in 1887 as a federally-chartered savings bank. Malvern Bank, National Association now serves as one of the oldest banks headquartered on the Philadelphia Main Line. For more than a century, the Bank has been committed to helping people build prosperous communities as a trusted financial partner, forging lasting relationships through teamwork, respect and integrity.

 

 The Bank conducts business from its headquarters in Paoli, Pennsylvania, a suburb of Philadelphia and through its nine other banking locations in Chester, Delaware and Bucks counties, Pennsylvania and Morristown, New Jersey, its New Jersey regional headquarters. The Bank also maintains new representative offices in Palm Beach, Florida and Montchanin, Delaware. The Bank’s wholly-owned subsidiary, Malvern Insurance Associates, LLC (“Malvern Insurance”) offers a full line of business and personal insurance products.

 

Note 2 – Summary of Significant Accounting Policies

 

Basis of financial statement presentation. The unaudited condensed consolidated financial statements of the Company include the accounts of the Company and its wholly-owned subsidiary, Malvern Bank, National Association and the Bank’s wholly-owned subsidiary, Malvern Insurance. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

The accompanying unaudited condensed consolidated financial statements present the Company’s financial position at March 31, 2018 and the results of operations for the three-and six-month periods ended March 31, 2018 and 2017, and cash flows for the six-month periods ended March 31, 2018 and 2017. In Management’s opinion, the unaudited Condensed Consolidated Financial Statements contain all adjustments, which include normal and recurring adjustments, necessary for a fair presentation of the financial position and results of operations for the interim periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and note disclosures included in the Company’s Form 10-K filed with the Securities and Exchange Commission (“SEC”) on December 29, 2017. The consolidated results of operations for the three-and six -month periods ended March 31, 2018 and the consolidated statements of cash flows for the six-month periods ended March 31, 2018 are not necessarily indicative of the results of operations or cash flows for the full year ending September 30, 2018 or any other period.

 

There have been no significant changes to our Critical Accounting Policies as described in our 2017 Annual Report on Form 10-K.

 

Recently Issued Accounting Standards

 

Income Taxes. In March 2018, the Financial Accounting Standards Board (“FASB”) issued ASU 2018- 05, Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 to update the income tax accounting in U.S. generally accepted accounting principles (“GAAP”) to reflect the Securities and Exchange Commission (“SEC”) interpretive guidance released on Dec. 22, 2017, when the Tax Cuts and Jobs Act was signed into law. The adoption of this new requirement is not expected to have a material impact on the consolidated earnings, financial position or cash flows of the Company.

 

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NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Investments and Regulated Operations. In March 2018, the FASB issued ASU 2018-04, Investments—Debt Securities (Topic 320) and Regulated Operations (Topic 980): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 117 and SEC Release No. 33-9273, to delete ASC 320-10-S99-1, which had codified SAB Topic 5.M which provided the SEC guidance determining when a decline in fair value below cost for an available-for-sale equity security is OTTI. ASU 2018-04 also removes from the ASC special requirements in SEC Regulation S-X Rule 3A-05 for public utility holding companies. The changes were effective when issued. The adoption of this new requirement is not expected to have a material impact on the consolidated earnings, financial position or cash flows of the Company.

 

Leases. In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The update requires lessees to recognize, as of the lease commencement date, assets and liabilities for all such leases with lease terms of more than 12 months, which is a change from the current GAAP requirement to recognize only capital leases on the balance sheet. Pursuant to the new standard, the liability initially recognized for the lease obligation is equal to the present value of the lease payments not yet made, discounted over the lease term at the implicit interest rate of the lease, if available, or otherwise at the lessee’s incremental borrowing rate. The lessee is also required to recognize an asset for its right to use the underlying asset for the lease term, based on the liability subject to certain adjustments, such as for initial direct costs. Leases are required to be classified as either operating or finance, with expense on operating leases recorded as a single lease cost on a straight-line basis. For finance leases, interest expense on the lease liability is required to be recognized separately from the straight-line amortization of the right-of-use asset. Quantitative disclosures are required for certain items, including the cost of leases, the weighted-average remaining lease term, the weighted-average discount rate and a maturity analysis of lease liabilities. Additional qualitative disclosures are also required regarding the nature of the leases, such as basis, terms and conditions of: (i) variable interest payments; (ii) extension and termination options; and (iii) residual value guarantees. For lessors, the standard modifies classification criteria and accounting for sales-type and direct financing leases and requires a lessor to derecognize the carrying value of the leased asset that is considered to have been transferred to a lessee and record a lease receivable and residual asset (“receivable and residual” approach). This Update is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect to early adopt this standard. The new standard must be adopted by applying the new guidance as of the beginning of the earliest comparative period presented, using a modified retrospective transition approach with certain optional practical expedients. The Company is still evaluating the impact of this new guidance.

 

Revenue Recognition. In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The ASU’s core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this ASU specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for revenue recognition. This ASU is effective, as a result of ASU 2015-14, for annual reporting periods beginning after December 15, 2017, including interim periods within that reporting period. The Company expects to adopt the revenue recognition guidance on October 1, 2018 using the modified retrospective approach. A significant amount of the Company’s revenues is derived from net interest income on financial assets and liabilities, which are excluded from the scope of the amended guidance. With respect to other income, the Company is in the process of identifying and evaluating the revenue streams and underlying revenue contracts within the scope of the guidance. The Company is expecting to develop processes and procedures during the fiscal third quarter of 2018 to ensure it is fully compliant with these amendments. To date, the Company has not yet identified any significant changes in the timing of revenue recognition when considering the amended accounting guidance; however, the Company’s implementation efforts are ongoing and such assessments may change prior to the October 1, 2018 implementation date.

 

Recently Adopted Accounting Standards

 

Income Statement. 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. The amendments in this Update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act (the “TCJA”). Consequently, the amendments eliminate the stranded tax effects resulting from the TCJA and will improve the usefulness of information reported to financial statement users. All entities may adopt the amendments in this Update for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The amendments in this Update should be applied 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 TCJA is recognized. We have elected to early adopt the ASU as of January 1, 2018. The adoption of the guidance resulted in a reclassification of an insignificant amount stranded in accumulated other comprehensive income to retained earnings in the fiscal second quarter of 2018.

 

Note 3 – Earnings Per Share

 

Basic earnings per common share is computed based on the weighted average number of shares outstanding reduced by unearned ESOP shares. Diluted earnings per share is computed based on the weighted average number of shares outstanding and common stock equivalents (“CSEs”) that would arise from the exercise of dilutive securities reduced by unearned ESOP shares. The Company did not grant any stock options to purchase common stock and restricted shares during the three months ended March 31, 2018. During the six months ended March 31, 2018, the Company granted stock options to purchase 4,664 shares of common stock and 4,768 restricted shares. During the three and six months ended March 31, 2017, the Company granted stock options to purchase 7,000 shares of common stock and 12,552 restricted shares.

 

-10-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table sets forth the composition of the weighted average shares (denominator) used in the earnings per share computations.

 

   Three Months Ended March 31,   Six Months Ended March 31, 
(Dollars in thousands, except for share data)  2018   2017   2018   2017 
                 
Net Income  $2,018   $1,170   $2,421   $2,143 
                     
Weighted average shares outstanding   6,572,443    6,565,461    6,572,525    6,562,865 
Average unearned ESOP shares   (123,752)   (138,152)   (125,566)   (139,966)
Basic weighted average shares outstanding   6,448,691    6,427,309    6,446,959    6,422,899 
                     
Plus: effect of dilutive options   3,555    623    4,246    370 
Diluted weighted average common shares outstanding   6,452,246    6,427,932    6,451,205    6,423,269 
                     
Earnings per share:                    
  Basic  $0.31   $0.18   $0.38   $0.33 
  Diluted  $0.31   $0.18   $0.38   $0.33 

 

Note 4 – Employee Stock Ownership Plan

 

The Company established an ESOP for substantially all of its full-time employees. The current ESOP trustee is Pentegra. Shares of the Company’s common stock purchased by the ESOP are held until released for allocation to participants. Shares released are allocated to each eligible participant based on the ratio of each such participant’s base compensation to the total base compensation of all eligible plan participants. As the unearned shares are committed to be released and allocated among participants, the Company recognizes compensation expense equal to the fair value of the ESOP shares during the periods in which they become committed to be released. To the extent that the fair value of the ESOP shares released differs from the cost of such shares, the difference is charged or credited to additional paid-in capital. During the period from May 20, 2008 to September 30, 2008, the ESOP purchased 241,178 shares of common stock for approximately $2.6 million, an average price of $10.86 per share, which was funded by a loan from Malvern Federal Bancorp, Inc. (the Company’s predecessor). The ESOP loan is being repaid principally from the Bank’s contributions to the ESOP. The loan, which bears an interest rate of 5%, is being repaid in quarterly installments through 2026. Shares are released to participants proportionately as the loan is repaid. During the three and six months ended March 31, 2018 and 2017 there were 3,600 and 7,200 shares, respectively, committed to be released. At March 31, 2018, there were 121,965 unallocated shares and 137,253 allocated shares held by the ESOP which had an aggregate fair value of approximately $3.2 million.

 

Note 5 - Investment Securities

 

The Company’s investment securities are classified as available-for-sale or held-to-maturity at March 31, 2018 and at September 30, 2017. Investment securities available-for-sale are reported at fair value with unrealized gains or losses included in equity, net of tax. Accordingly, the carrying value of such securities reflects their fair value at the balance sheet date. Fair value is based upon either quoted market prices, or in certain cases where there is limited activity in the market for a particular instrument, assumptions are made to determine their fair value.

 

-11-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Transfers of debt securities from the available-for-sale category to the held-to-maturity category are made at fair value at the date of transfer. The unrealized holding gain or loss at the date of transfer remains in accumulated other comprehensive income and in the carrying value of the held-to-maturity investment security. Premiums or discounts on investment securities are amortized or accreted using the effective interest method over the life of the security as an adjustment of yield. Unrealized holding gains or losses that remain in accumulated other comprehensive income are amortized or accreted over the remaining life of the security as an adjustment of yield, offsetting the related amortization of the premium or accretion of the discount.

 

The following tables present information related to the Company’s investment securities at March 31, 2018 and September 30, 2017.

 

   March 31, 2018 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair
Value
 
   (Dollars in thousands) 
Investment Securities Available-for-Sale:                    
U.S. treasury notes  $29,999   $   $(57)  $29,942 
State and municipal obligations   6,972    1    (32)   6,941 
Single issuer trust preferred security   1,000        (82)   918 
Corporate debt securities   6,616        (326)   6,290 
Mutual fund   250            250 
Total   44,837    1    (497)   44,341 
Investment Securities Held-to-Maturity:                    
U.S. government agencies  $1,999   $   $(24)  $1,975 
State and municipal obligations   9,447    5    (40)   9,412 
Corporate debt securities   3,767        (45)   3,722 
Mortgage-backed securities:                    
Collateralized mortgage obligations, fixed-rate   17,839        (854)   16,985 
Total  $33,052   $5   $(963)  $32,094 
Total investment securities  $77,889   $6   $(1,460)  $76,435 

 

   September 30, 2017 
   Amortized
Cost
   Gross
Unrealized
Gains
   Gross
Unrealized
Losses
   Fair
Value
 
   (Dollars in thousands) 
Investment Securities Available-for-Sale:                    
State and municipal obligations  $6,992   $39   $(2)  $7,029 
Single issuer trust preferred security   1,000        (66)   934 
Corporate debt securities   6,627        (253)   6,374 
Mutual fund   250            250 
Total   14,869    39    (321)   14,587 
Investment Securities Held-to-Maturity:                    
U.S. government agencies  $1,999   $   $(8)  $1,991 
State and municipal obligations   9,574    89        9,663 
Corporate debt securities   3,818    26        3,844 
Mortgage-backed securities:                    
Collateralized mortgage obligations, fixed-rate   19,524    1    (457)   19,068 
Total  $34,915   $116   $(465)  $34,566 
Total investment securities  $49,784   $155   $(786)  $49,153 

 

-12-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

For the three and six months ended March 31, 2018, no available-for-sale investment securities were sold. For the three and six months ended March 31, 2017, proceeds of investment securities sold amounted to approximately $3.9 million and gross realized gains on investment securities sold amounted to approximately $0.1 million.

 

The following tables indicate gross unrealized losses not recognized in income and fair value, aggregated by investment category and the length of time individual securities have been in a continuous unrealized loss position at March 31, 2018 and September 30, 2017:

 

   March 31, 2018 
   Less than 12 Months   More than 12 Months   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
value
   Unrealized
Losses
 
   (Dollars in thousands) 
Investment Securities Available-for-Sale:                              
U.S. treasury notes  $29,942   $(57)  $   $   $29,942   $(57)
State and municipal obligations   5,382    (26)   495    (6)   5,877    (32)
Single issuer trust preferred security           918    (82)   918    (82)
Corporate debt securities           6,290    (326)   6,290    (326)
Total  $35,324   $(83)  $7,703   $(414)  $43,027   $(497)
Investment Securities Held-to-Maturity:                              
U.S. government agencies           1,975    (24)   1,975    (24)
State and municipal obligations   8,229    (40)           8,229    (40)
Corporate securities   3,722    (45)           3,722    (45)
Mortgage-backed securities:                              
CMO, fixed-rate   797    (23)   16,188    (831)   16,985    (854)
Total   12,748    (108)   18,163    (855)   30,911    (963)
Total investment securities  $48,072   $(191)  $25,866   $(1,269)  $73,938   $(1,460)

 

   September 30, 2017 
   Less than 12 Months   12 Months or longer   Total 
   Fair
Value
   Unrealized
Losses
   Fair
Value
   Unrealized
Losses
   Fair
value
   Unrealized
Losses
 
   (Dollars in thousands) 
Investment Securities Available-for-Sale:                              
State and municipal obligations  $   $   $500   $(2)  $500   $(2)
Single issuer trust preferred security           934    (66)   934    (66)
Corporate debt securities           6,375    (253)   6,375    (253)
Total  $   $   $7,809   $(321)  $7,809   $(321)
Investment Securities Held-to-Maturity:                              
U.S. government agencies  $   $   $1,991   $(8)  $1,991   $(8)
State and municipal obligations                        
Mortgage-backed securities:                              
CMO, fixed-rate           18,902    (457)   18,902    (457)
Total           20,893    (465)   20,893    (465)
Total investment securities  $   $   $28,702   $(786)  $28,702   $(786)

 

-13-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

As of March 31, 2018, the estimated fair value of the securities disclosed above was primarily dependent upon the movement in market interest rates, particularly given the negligible inherent credit risk associated with these securities. These investment securities are comprised of securities that are rated investment grade by at least one bond credit rating service. Although the fair value will fluctuate as market interest rates move, management believes that these fair values will recover as the underlying portfolios mature and are reinvested in market rate yielding investments. As of March 31, 2018, the Company held three U.S. government treasury notes, two U.S. government agency securities, sixteen municipal bonds, four corporate securities, thirty-seven mortgage-backed securities and one single issuer trust preferred security which were in an unrealized loss position. The Company does not intend to sell and expects that it is not more likely than not that it will be required to sell these securities until such time as the value recovers or the securities mature. Management does not believe any individual unrealized loss as of March 31, 2018 represents other-than-temporary impairment.

 

Investment securities having a carrying value of approximately $42.1 million and $9.6 million at March 31, 2018 and September 30, 2017, respectively, were pledged to secure public deposits.

 

 The following table presents information for investment securities at March 31, 2018, based on scheduled maturities. Actual maturities can be expected to differ from scheduled maturities due to prepayment or early call options of the issuer.

 

   March 31, 2018 
   Amortized Cost   Fair Value 
   (Dollars in thousands) 
Investment Securities Available-for-Sale:          
Due in one year or less  $29,999   $29,942 
Due after one year through five years   7,556    7,435 
Due after five years through ten years   5,827    5,591 
Due after ten years   1,455    1,373 
Total  $44,837   $44,341 
Investment Securities Held-to-Maturity:          
Due after one year through five years  $1,999   $1,975 
Due after five years through ten years   6,170    6,092 
Due after ten years   24,883    24,027 
Total  $33,052   $32,094 
           
Total investment securities  $77,889   $76,435 

 

-14-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 6 - Loans Receivable and Related Allowance for Loan Losses

 

Loans receivable in the Company’s portfolio consisted of the following at the dates indicated below:

 

   March 31,   September 30, 
   2018   2017 
   (Dollars in thousands) 
Residential mortgage  $184,318   $192,500 
Construction and Development:          
Residential and commercial   35,213    35,622 
Land   21,727    18,377 
Total Construction and Development   56,940    53,999 
Commercial:          
Commercial real estate   445,995    437,760 
Farmland   12,069    1,723 
Multi-family   32,608    39,768 
Other   75,368    74,837 
Total Commercial   566,040    554,088 
Consumer:          
Home equity lines of credit   15,538    16,509 
Second mortgages   19,960    22,480 
Other   2,404    2,570 
Total Consumer   37,902    41,559 
Total loans   845,200    842,146 
Deferred loan fees and cost, net   579    590 
Allowance for loan losses   (8,465)   (8,405)
Total loans receivable, net  $837,314   $834,331 

 

-15-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following tables summarize the primary classes of the allowance for loan losses (“ALLL”), segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of March 31, 2018 and September 30, 2017.  Activity in the allowance is presented for the three and six months ended March 31, 2018 and 2017 and the year ended September 30, 2017, respectively.

 

   Three Months Ended March 31, 2018 
       Construction and Development   Commercial   Consumer         
                                                 
   Residential Mortgage   Residential and Commercial   Land  

Commercial Real

Estate

   Farmland   Multi- family   Other   Home Equity Lines of Credit   Second
Mortgages
   Other   Unallocated   Total 
       (Dollars in thousands) 
Allowance for loan losses:                                                            

Beginning balance

  $1,029   $532   $130   $4,260   $12   $200   $449   $94   $463   $30   $1,238   $8,437 
Charge-offs   (6)           (221)                   (54)           (281)
Recoveries   56            1            1        9    2        69 
Provisions   (92)   (135)   28    6    70    (5)   40    (7)   (11)   (5)   351    240 
Ending Balance  $987   $397   $158   $4,046   $82   $195   $490   $87   $407   $27   $1,589   $8,465 

 

   Three Months Ended March 31, 2017 
       Construction and Development   Commercial   Consumer         
                                             
   Residential Mortgage   Residential and Commercial   Land  

Commercial Real

Estate

   Multi- family   Other   Home
Equity
Lines of Credit
   Second Mortgages   Other   Unallocated   Total 
   (Dollars in thousands) 
Allowance for loan losses:                                                       
Beginning
balance
  $1,162   $874   $90   $2,215   $106   $208   $111   $408   $28   $975   $6,177 
Charge-offs                               (50)           (50)
Recoveries               26        1    1    25    4        57 
Provision (Credit)   (120)   469    38    238    (39)   160    (5)   32    (12)   236    997 
Ending Balance  $1,042   $1,343   $128   $2,479   $67   $369   $107   $415   $20   $1,211   $7,181 

 

-16-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENT

 

   Six Months Ended March 31, 2018 
       Construction and Development   Commercial   Consumer         
                                                 
   Residential Mortgage   Residential and Commercial   Land  

Commercial Real

Estate

   Farmland   Multi- family   Other   Home Equity Lines of Credit   Second Mortgages   Other   Unallocated   Total 
       (Dollars in thousands) 
Allowance for loan losses:                                                            
Beginning
balance
  $1,004   $523   $132   $3,581   $9   $224   $541   $90   $402   $27   $1,872   $8,405 
Charge-offs   (6)           (221)                   (54)   (2)       (283)
Recoveries   58            10            2    1    28    4        103 
Provisions   (69)   (126)   26    676    73    (29)   (53)   (4)   31    (2)   (283)   240 
Ending Balance  $987   $397   $158   $4,046   $82   $195   $490   $87   $407   $27   $1,589   $8,465 
Ending balance:
individually
evaluated
for impairment
  $   $   $   $243   $   $   $45   $   $132   $1   $   $421 
Ending balance:
collectively
evaluated for
impairment
  $987   $397   $158   $3,803   $82   $195   $445   $87   $275   $26   $1,589   $8,044 
                                                             
Loans receivable:                                                            
Ending balance  $184,318   $35,213   $21,727   $445,995   $12,069   $32,608   $75,368   $15,538   $19,960   $2,404        $845,200 
Ending balance:
individually
evaluated for
impairment
  $2,420   $   $85   $17,535   $   $   $45   $34   $675   $1        $20,795 
Ending balance:
collectively
evaluated for
impairment
  $181,898   $35,213   $21,642   $428,460   $12,069   $32,608   $75,323   $15,504   $19,285   $2,403        $824,405 

 

-17-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

   Six Months Ended March 31, 2017 
       Construction and Development   Commercial   Consumer         
                                             
   Residential Mortgage   Residential and Commercial   Land  

Commercial Real

Estate

   Multi- family   Other   Home Equity Lines of Credit   Second Mortgages   Other   Unallocated   Total 
   (Dollars in thousands) 
Allowance for loan losses:                                                       
Beginning
balance
  $1,201   $199   $97   $1,874   $109   $158   $116   $467   $34   $1,179   $5,434 
Charge-offs                               (121)   (5)       (126)
Recoveries       90        30        6    2    82    6        216 
Provisions   (159)   1,054    31    575    (42)   205    (11)   (13)   (15)   32    1,657 
Ending Balance  $1,042   $1,343   $128   $2,479   $67   $369   $107   $415   $20   $1,211   $7,181 
Ending balance:
individually
evaluated
for impairment
  $   $   $   $   $   $116   $   $99   $   $   $215 
Ending balance:
collectively
evaluated for
impairment
  $1,042   $1,343   $128   $2,479   $67   $253   $107   $316   $20   $1,211   $6,966 
                                                        
Loans receivable:                                                       
Ending balance  $192,775   $46,721   $14,322   $383,170   $12,838   $63,551   $19,214   $25,103   $1,512        $759,206 
Ending balance:
individually
evaluated for
impairment
  $2,094   $109   $   $752   $   $249   $60   $174   $        $3,438 
Ending balance:
collectively
evaluated for
impairment
  $190,681   $46,612   $14,322   $382,418   $12,838   $63,302   $19,154   $24,929   $1,512        $755,768 

 

-18-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

   Year Ended September 30, 2017 
       Construction and Development   Commercial   Consumer         
                                                 
   Residential Mortgage   Residential and Commercial   Land  

Commercial Real

Estate

   Farmland   Multi- family   Other   Home Equity Lines of Credit   Second Mortgages   Other   Unallocated   Total 
       (Dollars in thousands) 
Allowance for loan losses:                                                            
Beginning
balance
  $1,201   $199   $97   $1,874   $   $109   $158   $116   $467   $34   $1,179   $5,434 
Charge-offs                                   (218)   (5)       (223)
Recoveries   2    90        40            9    18    232    12        403 
Provisions   (199)   234    35    1,667    9    115    374    (44)   (79)   (14)   693    2,791 
Ending Balance  $1,004   $523   $132   $3,581   $9   $224   $541   $90   $402   $27   $1,872   $8,405 
Ending balance:
individually
evaluated
for impairment
  $   $   $   $   $   $   $109   $   $128   $   $   $237 
Ending balance:
collectively
evaluated for
impairment
  $1,004   $523   $132   $3,581   $9   $224   $432   $90   $274   $27   $1,872   $8,168 
                                                             
Loans receivable:                                                            
Ending balance  $192,500   $35,622   $18,377   $437,760   $1,723   $39,768   $74,837   $16,509   $22,480   $2,570        $842,146 
Ending balance:
individually
evaluated for
impairment
  $2,262   $   $94   $555   $   $   $243   $10   $356   $        $3,520 
Ending balance:
collectively
evaluated for
impairment
  $190,238   $35,622   $18,283   $437,205   $1,723   $39,768   $74,594   $16,499   $22,124   $2,570        $838,626 

 

In assessing the adequacy of the ALLL, it is recognized that the process, methodology and underlying assumptions require a significant degree of judgment. The estimation of credit losses is not precise; the range of factors considered is wide and is significantly dependent upon management’s judgment, including the outlook and potential changes in the economic environment.  At present, components of the commercial loan segments of the portfolio are new originations and the associated volumes continue to see increased growth.  At the same time, historical loss levels have decreased as factors in assessing the portfolio.   The combination of these factors has given rise to an increase in the unallocated level within the allowance.  Any unallocated portion of the allowance in conjunction with the quarterly review and changes to the qualitative factors to adjust for the risk due to current economic conditions, reflects management’s estimate of probable inherent but undetected losses within the portfolio due to uncertainties in economic conditions, delays in obtaining information, including unfavorable information about a borrower’s financial condition, the difficulty in identifying triggering events that correlate perfectly to subsequent loss rates, and risk factors that have not yet manifested themselves in loss allocation factors.

 

-19-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents impaired loans in portfolio by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary as of March 31, 2018 and September 30, 2017.

 

   Impaired Loans With
Specific Allowance
   Impaired
Loans
With No
Specific
Allowance
   Total Impaired Loans 
   Recorded
Investment
   Related
Allowance
   Recorded
Investment
   Recorded
Investment
   Unpaid
Principal
Balance
 
   (Dollars in thousands) 
March 31, 2018:                    
Residential mortgage  $   $   $2,420   $2,420   $2,537 
Construction and Development:                         
Land           85    85    85 
Commercial:                         
Commercial real estate   9,970    243    7,565    17,535    17,756 
Other   45    45        45    45 
Consumer:                         
Home equity lines of credit           34    34    34 
Second mortgages   159    132    516    675    771 
Other   1    1        1    1 
Total impaired loans  $10,175   $421   $10,620   $20,795   $21,229 
September 30, 2017:                         
Residential mortgage  $   $   $2,262   $2,262   $2,379 
Construction and Development:                         
Land           94    94    94 
Commercial:                         
Commercial real estate           555    555    555 
Other   243    109        243    243 
Consumer:                         
Home equity lines of credit           10    10    11 
Second mortgages   131    128    225    356    385 
Total impaired loans  $374   $237   $3,146   $3,520   $3,667 

 

-20-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the average recorded investment in impaired loans in portfolio and related interest income recognized for three and six months ended March 31, 2018 and 2017.

 

   Three Months Ended March 31, 2018   Six Months Ended March 31, 2018 
(Dollars in thousands)  Average Impaired Loans   Interest Income Recognized on Impaired Loans   Average Impaired Loans   Interest Income Recognized on Impaired Loans 
                 
Residential mortgage  $2,425   $2   $2,408   $13 
Construction and Development:                    
Land   86    1    88    2 
Commercial:                    
Commercial real estate   6,998    14    4,011    14 
Other   185        214     
Consumer:                    
Home equity lines of credit   12        11     
Second mortgages   655    1    574    4 
Other   1        1      
Total  $10,362   $18   $7,307   $33 

 

   Three Months Ended March 31, 2017   Six Months Ended March 31, 2017 
(Dollars in thousands)  Average Impaired Loans   Interest Income Recognized on Impaired Loans   Average Impaired Loans   Interest Income Recognized on Impaired Loans 
                 
Residential mortgage  $2,178   $13   $2,099   $33 
Construction and Development:                    
Residential and commercial   109    1    109    2 
Commercial:                    
   Commercial real estate   755    5    1,187    9 
   Other   86    2    43    2 
Consumer:                    
Home equity lines of credit   60        65     
Second mortgages   139        184    1 
Total  $3,327   $21   $3,687   $47 

 

-21-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents the classes of the loan portfolio summarized by loans considered to be rated as pass and the categories of special mention, substandard and doubtful within the Company’s internal risk rating system as of March 31, 2018 and September 30, 2017.

 

   March 31, 2018 
   Pass   Special
Mention
   Substandard   Doubtful   Total 
   (Dollars in thousands) 
Residential mortgage  $181,589   $   $2,729   $   $184,318 
Construction and Development:                         
Residential and commercial   35,213                35,213 
Land   17,273        4,454        21,727 
Commercial:                         
Commercial real estate   424,881    2,201    18,913        445,995 
Farmland   12,069                12,069 
Multi-family   32,261    347            32,608 
Other   75,156        212        75,368 
Consumer:                         
Home equity lines of credit   15,403        135        15,538 
Second mortgages   18,883    107    970        19,960 
Other   2,399    4    1        2,404 
Total  $815,127   $2,659   $27,414   $   $845,200 

 

   September 30, 2017 
   Pass   Special
Mention
   Substandard   Doubtful   Total 
   (Dollars in thousands) 
Residential mortgage  $189,925   $114   $2,461   $   $192,500 
Construction and Development:                         
Residential and commercial   35,622                35,622 
Land   13,207        5,170        18,377 
Commercial:                         
Commercial real estate   431,336    4,456    1,968        437,760 
Farmland   1,723                1,723 
Multi-family   39,410    358            39,768 
Other   73,935        902        74,837 
Consumer:                         
Home equity lines of credit   16,399        110        16,509 
Second mortgages   21,611    112    757        22,480 
Other   2,563    6    1        2,570 
Total  $825,731   $5,046   $11,369   $   $842,146 

 

-22-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents loans that are no longer accruing interest by portfolio class.

 

   March 31,   September 30, 
   2018   2017 
   (Dollars in thousands) 
Residential mortgage  $1,130   $826 
Commercial:          
Commercial real estate   575     
Other   45     
Consumer:          
Home equity lines of credit   34    10 
Second  mortgages   344    202 
Other   1     
Total non-accrual loans  $2,129   $1,038 

 

Under the Bank’s loan policy, once a loan has been placed on non-accrual status, we do not resume interest accruals until the loan has been brought current and has maintained a current payment status for not less than six consecutive months. Interest income that would have been recognized on nonaccrual loans had they been current in accordance with their original terms was less than $0.1 million for each of the three months ended March 31, 2018 and 2017 and was less than $0.1 million for each of the six months ended March 31, 2018 and 2017.

 

Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by whether a loan payment is “current,” that is, it is received from a borrower by the scheduled due date, or the length of time a scheduled payment is past due. The following table presents the classes of the loan portfolio summarized by the aging categories as of March 31, 2018 and September 30, 2017.

 

   Current   30-59
Days Past
Due
   60-89
Days Past
Due
   90
Days or More Past
Due
   Total Past Due   Total Loans Receivable   Accruing 90
Days or More Past
Due
 
   (Dollars in thousands) 
March 31, 2018:                            
Residential mortgage  $180,164   $2,597   $   $1,557   $4,154   $184,318   $427 
Construction and Development:                                   
Residential and commercial   34,446    767            767    35,213     
 Land   21,727                    21,727     
Commercial:                                   
 Commercial real estate   444,969    156    295    575    1,026    445,995     
 Farmland   12,069                    12,069     
 Multi-family   32,608                        32,608      
 Other   75,323            45    45    75,368     
Consumer:                                   
Home equity lines of credit   15,095    409        34    443    15,538     
 Second  mortgages   18,989    691    31    249    971    19,960    47 
 Other   2,386    17        1    18    2,404    1 
Total  $837,776   $4,637   $326   $2,461   $7,424   $845,200   $475 

 

-23-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

   Current   30-
59
Days
Past
Due
   60-
89
Days
Past
Due
   90
Days
or
More
Past
Due
   Total
Past
Due
   Total Loans Receivable   Accruing
90
Days or
More
Past
Due
 
   (Dollars in thousands) 
September 30, 2017:                            
Residential mortgage  $189,272   $1,442   $1,145   $641   $3,228   $192,500   $31 
Construction and Development:                                   

Residential and commercial

   35,622                    35,622     
Land   18,377                    18,377     
Commercial:                                   
Commercial real estate   436,804    160    796        956    437,760     
Farmland   1,723                    1,723     
Multi-family   39,768                    39,768     
Other   74,837                    74,837     
Consumer:                                   

Home equity lines of credit

   16,122    350    37        387    16,509     
Second mortgages   21,183    844    182    271    1,297    22,480    141 
Other   2,561    7    1    1    9    2,570    1 
Total  $836,269   $2,803   $2,161   $913   $5,877   $842,146   $173 

 

Restructured loans deemed to be troubled debt restructurings (“TDRs”) are typically the result of extension of the loan maturity date or a reduction of the interest rate of the loan to a rate that is below market, a combination of rate and maturity extension, or by other means including covenant modifications, forbearance and other concessions. However, the Company generally only restructures loans by modifying the payment structure to require payments of interest only for a specified period or by reducing the actual interest rate. Once a loan becomes a TDR, it will continue to be reported as a TDR during the term of the restructure.

 

  The Company had fifteen loans classified as TDRs with an aggregate outstanding balance of $18.8 million at March 31, 2018. The Company had twelve loans classified as TDRs at September 30, 2017 with an aggregate outstanding balance of $2.3 million. At March 31, 2018, these loans were also classified as impaired. Thirteen of the TDR loans continue to perform under the restructured terms through March 31, 2018 and we continued to accrue interest on such loans through such date. The increase in TDRs at March 31, 2018 compared to September 30, 2017 was primarily due to two commercial real estate loans with an aggregate outstanding balance of approximately $16.4 million.

 

All such loans have been classified as TDRs since we modified the payment terms and in some cases interest rate from the original agreements and allowed the borrowers, who were experiencing financial difficulty, to make interest only payments for a period of time in order to relieve some of their overall cash flow burden. Some loan modifications classified as TDRs may not ultimately result in the full collection of principal and interest, as modified, and result in potential incremental losses. These potential incremental losses have been factored into our overall estimate of the allowance for loan losses. The level of any defaults will likely be affected by future economic conditions. A default on a troubled debt restructured loan for purposes of this disclosure occurs when the borrower is 90 days past due or a foreclosure or repossession of the applicable collateral has occurred.

 

TDRs may arise in which, due to financial difficulties experienced by the borrower, the Company obtains through physical possession one or more collateral assets in satisfaction of all or part of an existing credit. Once possession is obtained, the Company reclassifies the appropriate portion of the remaining balance of the credit from loans to OREO, which is included within other assets in the Consolidated Statements of Condition. For any residential real estate property collateralizing a consumer mortgage loan, the Company is considered to possess the related collateral only if legal title is obtained upon completion of foreclosure, or the borrower conveys all interest in the residential real estate property to the Company through completion of a deed in lieu of foreclosure or similar legal agreement. Excluding OREO, the Company had $0.2 million and $0.3 million of residential real estate properties in the process of foreclosure at March 31, 2018 and September 30, 2017, respectively.

 

-24-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table presents our TDR loans as of March 31, 2018 and September 30, 2017.

 

   Total Troubled Debt
Restructurings
   Troubled Debt Restructured
Loans That Have Defaulted on
Modified Terms Within The Past
12 Months
 
   Number of
Loans
   Recorded
Investment
   Number of
Loans
   Recorded
Investment
 
   (Dollars in thousands) 
At March 31, 2018:                
Residential mortgage   7   $1,650    1   $153 
Construction and Development:                    
Land   1    85         
Commercial:                    
Commercial real estate   4    16,960         
    Consumer                    
Second mortgages   3    143    1    19 
Total   15   $18,838    2   $172 
At September 30, 2017:                    
Residential mortgage   6   $1,464       $ 
Construction and Development:                    
Land   1    94         
Commercial:                    
Commercial real estate   2    554         
    Consumer                    
Second mortgages   3    148    1    22 
Total   12   $2,260    1   $22 

 

The following table reports the performing status all of TDR loans. The performing status is determined by the loans’ compliance with the modified terms.

 

   March 31, 2018   September 30, 2017 
   Performing   Non-
Performing
   Performing   Non-
Performing
 
   (Dollars in thousands) 
Residential mortgage  $1,497   $153   $1,464   $ 
Construction and Development:                    
  Land   85        94     
Commercial:                    
  Commercial real estate   16,960        554     
Consumer                    
  Second mortgages   124    19    126    22 
Total  $18,666   $172   $2,238   $22 

 

-25-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table shows the activity in loans which were first deemed to be TDRs during the three and six months ended March 31, 2018 and 2017.

 

   For the Three Months Ended March 31, 
   2018   2017 
   Restructured During Period 
   Number
of
Loans
   Pre-
Modifications Outstanding Recorded Investments
   Post-
Modifications Outstanding Recorded Investments
   Number
of
Loans
   Pre-
Modifications Outstanding Recorded Investments
   Post-
Modifications Outstanding Recorded Investments
 
   (In thousands) 

Troubled Debt
Restructurings:
 

                              
Residential mortgage   1   $203   $203    1   $234   $234 
Commercial:                              

Commercial real estate

   2    16,417    16,414    1    193    193 
Consumer:                              
Second mortgages               2    81    81 
Total   3   $16,620   $16,617    4   $508   $508 

 

   For the Six Months Ended March 31, 
   2018   2017 
   Restructured During Period 
   Number
of
Loans
   Pre-
Modifications Outstanding Recorded Investments
   Post-
Modifications Outstanding Recorded Investments
   Number
of
Loans
   Pre-
Modifications Outstanding Recorded Investments
   Post-
Modifications Outstanding Recorded Investments
 
   (In thousands) 

Troubled Debt Restructurings:

                              
Residential mortgage   1   $203   $203    3   $889   $889 
Commercial:                              

Commercial real estate

   2    16,417    16,414    1    193    193 
Consumer:                              
Second mortgages               2    81    81 
Total   3   $16,620   $16,617    6   $1,163   $1,163 

 

Note 7 - Regulatory Matters

 

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional 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 that involve 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 classifications are also subject to qualitative judgments by the regulators about components, risk-weightings and other factors.

 

In July of 2013, the respective U.S. federal banking agencies issued final rules implementing Basel III and the Dodd-Frank Act capital requirements to be fully phased in on a global basis on January 1, 2019. The new regulations establish a new tangible common equity capital requirement, increase the minimum requirement for the current Tier 1 risk-weighted asset (“RWA”) ratio, phase out certain kinds of intangibles treated as capital and certain types of instruments and change the risk weightings of certain assets used to determine required capital ratios. The new common equity Tier 1 capital component requires capital of the highest quality – predominantly composed of retained earnings and common stock instruments. For community banks such as Malvern Bank, National Association, a common equity Tier 1 capital ratio of 4.5% became effective on January 1, 2015. The new capital rules also increased the minimum Tier 1 capital ratio from 4.0% to 6.0% beginning on January 1, 2015. The rules also establish a capital conservation buffer of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (1) a common equity Tier 1 capital ratio of 7.0%, (2) a Tier 1 capital ratio of 8.5%, and (3) a total capital ratio of 10.5%. The new capital conservation buffer requirement was phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution is also subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

-26-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of tangible and core capital (as defined in the regulations) to total adjusted tangible assets (as defined) and of risk-based capital (as defined) to risk-weighted assets (as defined).

 

As of March 31, 2018, the Company’s and the Bank’s current capital levels exceed the required capital amounts to be considered “well capitalized” and we believe they also meet the fully-phased in minimum capital requirements, including the related capital conservation buffers, as required by the Basel III capital rules.

 

The following table summarizes the Company’s compliance with applicable regulatory capital requirements as of March 31, 2018 and September 30, 2017:

                        
   Actual   For Capital
Adequacy Purposes
   To Be Well
Capitalized
Under Prompt
Corrective
Action Provisions
(Dollars in thousands)  Capital
Amount
   Ratio   Capital
Amount
   Ratio   Capital
Amount
  Ratio 
As of March 31, 2018:                       
Tier 1 Leverage (Core) Capital (to average assets)  $105,077    9.97%  $42,166    4.00%  n/a   n/a 
Common Equity Tier 1 Capital (to risk weighted assets)   105,077    12.67%   37,320    4.50%  n/a   n/a 
Tier 1 Capital (to risk weighted assets)   105,077    12.67%   49,760    6.00%  n/a   n/a 
Total Risk Based Capital (to risk weighted assets)   137,986    16.64%   66,347    8.00%  n/a   n/a 
                             
As of September 30, 2017:                            
Tier 1 Leverage (Core) Capital (to average assets)  $100,779    10.00%  $40,315    4.00%  n/a   n/a 
Common Equity Tier 1 Capital (to risk weighted assets)   100,779    12.28%   36,945    4.50%  n/a   n/a 
Tier 1 Capital (to risk weighted assets)   100,779    12.28%   49,260    6.00%  n/a   n/a 
Total Risk Based Capital (to risk weighted assets)   133,549    16.27%   65,679    8.00%  n/a   n/a 

 

-27-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The following table summarizes the Bank’s compliance with applicable regulatory capital requirements as of March 31, 2018 and September 30, 2017:

                         
   Actual   For Capital
Adequacy Purposes
   To Be Well
Capitalized
Under Prompt
Corrective
Action Provisions
 
(Dollars in thousands)  Capital
Amount
   Ratio   Capital
Amount
   Ratio   Capital
Amount
   Ratio 
As of March 31, 2018:                        
Tier 1 Leverage (to average assets)  $125,936    11.96%  $42,132    4.00%  $52,664    5.00%
Common Equity Tier 1 Capital (to risk weighted assets)   125,936    15.20%   37,276    4.50%   53,842    6.50%
Tier 1 Capital (to risk weighted assets)   125,936    15.20%   49,701    6.00%   66,268    8.00%
Total Risk Based Capital (to risk weighted assets)   134,463    16.23%   66,268    8.00%   82,834    10.00%
As of September 30, 2017:                              
Tier 1 Leverage (to average assets)  $120,902    12.02%  $40,234    4.00%  $50,292    5.00%
Common Equity Tier 1 Capital (to risk weighted assets)   120,902    14.75%   36,894    4.50%   53,292    6.50%
Tier 1 Capital (to risk weighted assets)   120,902    14.75%   49,192    6.00%   65,590    8.00%
Total Risk Based Capital (to risk weighted assets)   129,369    15.78%   65,590    8.00%   81,987    10.00%

 

Note 8 – Derivatives and Hedging Activities

 

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its debt funding and the use of derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future uncertain cash amounts, the value of which are determined by interest rates.

 

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish this objective, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. 

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in Accumulated Other Comprehensive Income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. At March 31, 2018, such derivatives were used to hedge the variable cash flows associated with FHLB advances. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. The Company’s derivatives did not have any hedge ineffectiveness recognized in earnings during the three and six months ended March 31, 2018 and 2017.

 

Amounts reported in accumulated other comprehensive income related to derivatives will be reclassified to interest expense as interest payments are made on the Company’s variable-rate debt. During the next twelve months, the Company estimates approximately $0.2 million to be reclassified to earnings in interest expense. The Company is hedging its exposure to the variability in future cash flows for forecasted transactions over a maximum period of twenty months (excluding forecasted transactions related to the payment of variable interest on existing financial instruments).

 

-28-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheet as of March 31, 2018 and September 30, 2017:

 

   March 31, 2018
   Notional
Amount
   Fair
Value
   Balance Sheet
Location
  Expiration Date
   (Dollars in thousand)
Derivatives designated as hedging instruments                
Interest rate swaps by effective date:                
      August 3, 2015  $15,000   $261   Other assets  August 3, 2020
      February 5, 2016   20,000    714   Other assets  February 1, 2021
       October 22, 2018   30,000    103   Other liabilities  October 22, 2021

 

   September 30, 2017
   Notional
Amount
   Fair Value   Balance Sheet Location  Expiration Date
   (Dollars in thousand)
Derivatives designated as hedging instruments                
Interest rate swaps by effective date:                
      August 3, 2015  $15,000   $9   Other assets  August 3, 2020
      February 5, 2016   20,000    367   Other assets  February 1, 2021

 

The tables below present the net gains (losses) recorded in accumulated other comprehensive income (loss) and the Consolidated Statements of Operations relating to the cash flow derivative instruments for the three and six months ended March 31, 2018 and 2017.

 

    For the Three Months Ended March 31, 2018 
    Amount of Gain
(Loss) Recognized
in OCI (Effective
Portion)
   Amount of Gain
(Loss) Reclassified
from OCI to
Interest Expense
   Amount of Gain (Loss)
Recognized in Other
Non-Interest Income
(Ineffective Portion)
 
    (Dollars in thousand) 
                 
August 3, 2015   $140   $(5)  $ 
February 5, 2016    229    18     
October 22, 2018    (103)        

 

    For the Six Months Ended March 31, 2018 
    Amount of Gain
(Loss) Recognized
in OCI (Effective
Portion)
   Amount of Gain
(Loss) Reclassified
from OCI to
Interest Expense
  

Amount of Gain (Loss)
Recognized in Oter

Non-Interest Income
(Ineffective Portion)

 
    (Dollars in thousand) 
August 3, 2015   $231   $(21)  $ 
February 5, 2016    368    21     
October 22, 2018    (103)        

 

-29-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

    For the Three Months Ended March 31, 2017 
    Amount of Gain
(Loss) Recognized
in OCI (Effective
Portion)
   Amount of Gain
(Loss) Reclassified
from OCI to
Interest Expense
   Amount of Gain (Loss)
Recognized in Other
Non-Interest Income
(Ineffective Portion)
 
    (Dollars in thousand) 
August 3, 2015   $13   $(30)  $ 
February 5, 2016    16    (16)    

 

    For the Six Months Ended March 31, 2017 
    Amount of Gain
(Loss) Recognized
in OCI (Effective
Portion)
   Amount of Gain
(Loss) Reclassified
from OCI to
Interest Expense
   Amount of Gain (Loss)
Recognized in Other
Non-Interest Income
(Ineffective Portion)
 
    (Dollars in thousand) 
August 3, 2015   $351   $(66)  $ 
February 5, 2016    564    (39)    

 

The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then the Company could also be declared in default on its derivative obligations.

 

At March 31, 2018 and September 30, 2017, the fair value of derivatives was in a net asset position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was zero for both periods. At March 31, 2018 and September 30, 2017, the Company has minimum collateral posting thresholds with certain of its derivative counterparties and has posted collateral of zero for both periods, respectively, against its obligations under these agreements. If the Company had breached any of these provisions at March 31, 2018, it could have been required to settle its obligations under the agreements at the termination value and would have been required to pay any additional amounts due in excess of amounts previously posted as collateral with the respective counterparty.

 

Note 9 - Fair Value Measurements

 

The Company follows FASB ASC Topic 820 “Fair Value Measurement,” to record fair value adjustments to certain assets and to determine fair value disclosures for the Company’s financial instruments. Investment and mortgage-backed securities available for sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets on a nonrecurring basis, such as impaired loans, real estate owned and certain other assets. These nonrecurring fair value adjustments typically involve application of lower-of-cost-or-market accounting or write-downs of individual assets.

 

The Company groups its assets at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

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

 

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

 

Level 3—Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect the Company’s own estimates of assumptions that market participants would use in pricing the asset.

 

The Company bases its fair values on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. It is our policy to maximize the use of observable inputs and minimize the use of unobservable inputs when developing fair value measurements, in accordance with the fair value hierarchy.

 

-30-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Fair value measurements for assets where there exists limited or no observable market data and, therefore, are based primarily upon the Company’s or other third-party’s estimates, are often calculated based on the characteristics of the asset, the economic and competitive environment and other factors. Therefore, the results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset. Additionally, there may be inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future valuations.

 

FASB ASC Topic 825 “Financial Instruments” provides an option to elect fair value as an alternative measurement for selected financial assets and financial liabilities not previously recorded at fair value. The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation.

 

The Company monitors and evaluates available data to perform fair value measurements on an ongoing basis and recognizes transfers among the levels of the fair value hierarchy as of the date event or a change in circumstances that affects the valuation method chosen. There were no changes in valuation technique or transfers between levels at March 31, 2018 or September 30, 2017.

 

The tables below present the balances of assets measured at fair value on a recurring basis at March 31, 2018 and September 30, 2017:

 

   March 31, 2018 
   Total   Level 1   Level 2   Level 3 
   (Dollars in thousands) 
Assets:                
Investment securities available-for-sale:                    
Debt securities:                    
U.S. treasury notes  $29,942   $29,942   $   $ 
State and municipal obligations   6,941        6,941     
Single issuer trust preferred security   918        918     
Corporate debt securities   6,290        6,290     
Mutual funds   250            250 
Total investment securities available-for-sale   44,341    29,942    14,149    250 
                     
Derivative instruments  $975   $   $975   $ 
Liabilities:                    
Derivative instruments  $103   $   $103   $ 

 

-31-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

   September 30, 2017 
   Total   Level 1   Level 2   Level 3 
   (Dollars in thousands) 
Assets:                
Investment securities available-for-sale:                    
Debt securities:                    
State and municipal obligations  $7,029   $   $7,029   $ 
Single issuer trust preferred security   934        934     
Corporate debt securities   6,374        6,374     
Mutual funds   250            250 
Total investment securities available-for-sale   14,587        14,337    250 
                     
Derivative instruments  $376   $   $376   $ 

 

For assets measured at fair value on a nonrecurring basis that were still held at the end of the period, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at March 31, 2018 and September 30, 2017:

 

    March 31, 2018 
    Total   Level 1   Level 2   Level 3 
    (Dollars in thousands) 
Impaired loans(1)   $9,870   $   $   $9,870 
Total   $9,870   $   $   $9,870 

 

    March 31, 2018 
    Fair Value at
March 31, 2018
   Valuation Technique  Unobservable Input  Range/(Weighted
Average)
 
    (Dollars in thousands) 
Impaired loans(1)   $9,870   Appraisal of collateral(2)    Collateral discounts(3)     9.5%-21.4%%/(12.2%) 
Total   $9,870            

 

 

(1) At March 31, 2018, consisted of nine loans with an aggregate balance of $10.2 million and with $0.4 million in specific loan loss allowance. 

(2) Fair value is generally determined through independent appraisals of the underlying collateral primarily using comparable sales.

(3) Appraisals may be adjusted by management for qualitative factors such as time, changes in economic conditions and estimated liquidation expense.

 

    September 30, 2017 
    Total   Level 1   Level 2   Level 3 
    (Dollars in thousands) 
Impaired loans(1)   $137   $   $   $137 
Total   $137   $   $   $137 

 

-32-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

  
    September 30, 2017 
    Fair Value at
September 30, 2017
   Valuation Technique  Unobservable Input  Range/(Weighted
Average)
 
    (dollars in thousands) 
Impaired loans(1)   $137   Appraisal of collateral(2)    Collateral discounts(3)     0%/(0%) 
Total   $137            

 

 

(1) At September 30, 2017, consisted of five loans with an aggregate balance of $0.4 million and with $0.2 million in specific loan loss allowance.
(2) Fair value is generally determined through independent appraisals of the underlying collateral primarily using comparable sales.

(3) Appraisals may be adjusted by management for qualitative factors such as time, changes in economic conditions and estimated liquidation expense. 

                                   

At March 31, 2018 and September 30, 2017, the Company did not have any additions to our mortgage servicing assets. At March 31, 2018 and September 30, 2017, the Company only sold loans with servicing released.

 

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of FASB ASC 825. The estimated fair value amounts have been determined by the Company using available market information and appropriate valuation methods. However, considerable judgment is necessarily required to interpret market data to develop the estimates of fair value. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company would realize in a current market exchange. The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts. FASB ASC 825 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

 

The fair value estimates presented herein are based on pertinent information available to management as of March 31, 2018 and September 30, 2017. Although management is not aware of any factors that would significantly affect the estimated fair value amounts, such amounts have not been comprehensively revalued for purposes of these financial statements since March 31, 2018 and September 30, 2017 and, therefore, current estimates of fair value may differ significantly from the amounts presented herein.

 

The following assumptions were used to estimate the fair value of the Company’s financial instruments:

 

Cash and Cash Equivalents—These assets are carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

 

Investment Securities— Investment and mortgage-backed securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are measured at fair value on a recurring basis. Fair value measurements for these securities are typically obtained from independent pricing services that we have engaged for this purpose. When available, we, or our independent pricing service, use quoted market prices to measure fair value. If market prices are not available, fair value measurement is based upon models that incorporate available trade, bid and other market information and for structured securities, cash flow and, when available, loan performance data. Because many fixed income securities do not trade on a daily basis, our independent pricing service’s applications apply available information through processes such as benchmark curves, benchmarking of like securities, sector groupings and matrix pricing to prepare evaluations. For each asset class, pricing applications and models are based on information from market sources and integrate relevant credit information. All of our securities available for sale are valued using either of the foregoing methodologies to determine fair value adjustments recorded to our financial statements. The fair value of the Level 1 securities was $30.0 million as of March 31, 2018. The Company had no Level 1 securities as of September 30, 2017. The fair value of the Level 3 security was $0.3 million both as of March 31, 2018 and as of September 30, 2017.

 

-33-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Loans Receivable—We do not record loans at fair value on a recurring basis. As such, valuation techniques discussed herein for loans are primarily for estimating fair value for FASB ASC 825 disclosure purposes. However, from time to time, we record nonrecurring fair value adjustments to loans to reflect partial write-downs for impairment or the full charge-off of the loan carrying value. The valuation of impaired loans is discussed below. The fair value estimate for FASB ASC 825 purposes differentiates loans based on their financial characteristics, such as product classification, loan category, pricing features and remaining maturity. Prepayment and credit loss estimates are evaluated by loan type and rate. The fair value of loans is estimated by discounting contractual cash flows using discount rates based on current industry pricing, adjusted for prepayment and credit loss estimates.

 

Impaired Loans— Impaired loans are valued utilizing independent appraisals that rely upon quoted market prices for similar assets in active markets. These appraisals include adjustments to comparable assets based on the appraisers’ market knowledge and experience. The appraisals are adjusted downward by management, as necessary, for changes in relevant valuation factors subsequent to the appraisal date and are considered level 3 inputs.

 

Accrued Interest Receivable—This asset is carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

 

Restricted Stock—Although restricted stock is an equity interest in the FHLB, it is carried at cost because it does not have a readily determinable fair value as its ownership is restricted and it lacks a market. The estimated fair value approximates the carrying amount.

 

Deposits—Deposit liabilities are carried at cost. As such, valuation techniques discussed herein for deposits are primarily for estimating fair value for FASB ASC 825 disclosure purposes. The fair value of deposits is discounted based on rates available for borrowings of similar maturities. A decay rate is estimated for non-time deposits. The discount rate for non-time deposits is adjusted for servicing costs based on industry estimates.

 

Borrowings—Advances from the FHLB are carried at amortized cost. However, we are required to estimate the fair value of long-term debt under FASB ASC 825. The fair value is based on the contractual cash flows discounted using rates currently offered for new notes with similar remaining maturities.

 

Derivatives— The fair value of derivatives are based on valuation models using observable market data as of the measurement date (level 2). Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rate, and volatility factors to value the position. The majority of market inputs is actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

 

Accrued Interest Payable—This liability is carried at historical cost. The carrying amount is a reasonable estimate of fair value because of the relatively short time between the origination of the instrument and its expected realization.

 

Commitments to Extend Credit and Letters of Credit—The majority of the Company’s commitments to extend credit and letters of credit carry current market interest rates if converted to loans. Because commitments to extend credit and letters of credit are generally unassignable by either the Bank or the borrower, they only have value to the Company and the borrower. The estimated fair value approximates the recorded deferred fee amounts, which are not significant.

 

Mortgage Servicing Rights—The fair value of mortgage servicing rights is based on observable market prices when available or the present value of expected future cash flows when not available. Assumptions, such as loan default rates, costs to service, and prepayment speeds significantly affect the estimate of future cash flows. Mortgage servicing rights are carried at the lower of cost or fair value.

 

-34-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The carrying amount and estimated fair value of the Company’s financial instruments as of March 31, 2018 and September 30, 2017 are presented below:

 

   Carrying
Amount
   Fair Value   Level 1   Level 2   Level 3 
   (Dollars in thousands) 
March 31,2018:                    
Financial assets:                         
Cash and cash equivalents  $121,710   $121,710   $121,710   $   $ 
Investment securities available-for-sale   44,341    44,341    29,942    14,149    250 
Investment securities held-to-maturity   33,052    32,094        32,094     
Loans receivable, net (including impaired loans)   837,314    830,576            830,576 
Accrued interest receivable   3,583    3,583        3,583     
Restricted stock   8,583    8,583        8,583     

Mortgage servicing rights (included in Other Assets) 

   244    285        285     

Derivatives (included in Other Assets) 

   975    975        975     
Financial liabilities:                         
Savings accounts   44,716    44,716        44,716     
Checking and NOW accounts   229,046    229,046        229,046     
Money market accounts   293,813    293,813        293,813     
Certificates of deposit   257,994    259,949        259,949     
Borrowings(excluding sub debt)   120,500    120,362        120,362     
Subordinated debt   24,382    24,382        24,382     

Derivatives (included in Other Liabilities) 

   103    103        103     
Accrued interest payable   713    713        713     
                          
September 30, 2017:                         
Financial assets:                         
Cash and cash equivalents  $117,136   $117,136   $117,136   $   $ 
Investment securities available-for-sale   14,587    14,587        14,337    250 
Investment securities held-to-maturity   34,915    34,566        34,566     
Loans receivable, net (including impaired loans)   834,331    839,242            839,242 
Accrued interest receivable   3,139    3,139        3,139     
Restricted stock   5,559    5,559        5,559     

Mortgage servicing rights (included in Other) 

   268    271        271     
    Derivatives   376    376        376     
Financial liabilities:                         
Savings accounts   44,526    44,526        44,526     
Checking and NOW accounts   197,700    197,700        197,700     
Money market accounts   276,404    276,404        276,404     
Certificates of deposit   271,766    273,723        273,723     
Borrowings(excluding sub debt)   123,000    123,658        123,658     
Subordinated debt   24,303    24,303        24,303     
Accrued interest payable   694    694        694     

 

-35-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Note 10 – Income Taxes

 

In the first quarter of fiscal 2018, the Company revised its estimated annual effective rate to reflect a change in the federal statutory rate from 35% to 21%, resulting from legislation that was enacted on December 22, 2017. The rate change is administratively effective at the beginning of our calendar year, using a blended rate for the annual period. As a result, the blended statutory tax rate for the year is 24.5%. However, we are still analyzing certain aspects of the Tax Cuts and Jobs Act of 2017 and refining our calculations, which could potentially affect the measurement of these balances or potentially give rise to new deferred tax amounts. The provisional amount recorded in the first quarter of fiscal 2018 related to the re-measurement of our deferred tax asset was $2.3 million, and no further adjustments were made during the three months ended March 31, 2018.

 

Note 11 – Comprehensive Income

 

The components of accumulated other comprehensive income (loss) included in shareholders’ equity are as follows:

 

   March 31,   September 30, 
   2018   2017 
   (Dollars in thousands) 
Net unrealized holding (losses) gains on available-for-sale securities  $(495)  $(282)
Tax effect   121    96 
   Net of tax amount   (374)   (186)
Fair value adjustments on derivatives   872    376 
Tax effect   (213)   (128)
   Net of tax amount   659    248 
           
Total accumulated other comprehensive income  $285   $62 

 

-36-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

Other comprehensive income and related tax effects are presented in the following table:

 

   Three Months Ended March 31,   Six Months Ended March 31, 
(Dollars in thousands)  2018   2017   2018   2017 

Net unrealized holding gains (losses) on available-for-sale securities

  $(136)  $352   $(219)  $(745)
                     

Net realized gains on securities available-for-sale

       (58)       (58)
                     

Amortization (accretion) of unrealized holding losses on securities available-for-sale transferred to held-to-maturity

   4    2    6    6 
                     
Fair value adjustments on derivatives   253    74    495    1,019 
                     
Other comprehensive income before taxes   121    370    282    222 
   Tax effect   (84)   (127)   (83)   (76)
      Total comprehensive income  $37   $243   $199   $146 

 

Note 12 – Equity Based Incentive Compensation Plan

 

The Company maintains the Malvern Bancorp, Inc. 2014 Long-Term Incentive Compensation Plan (the “2014 Plan”), which permits the grant of long-term incentive and other stock and cash awards. The purpose of the 2014 Plan is to promote the success of the Company and the Bank by providing incentives to officers, employees and directors of the Company and the Bank that will link their personal interests to the financial success of the Company and to growth in shareholder value. The maximum total number of shares of the Company’s common stock available for grants under the 2014 Plan is 400,000. As of March 31, 2018, there were 365,357 remaining shares available for future grants.

 

Restricted stock and option awards granted vest in 20% increments beginning on the one year anniversary of the grant date, and accelerate upon a change in control of the Company. The options generally expire ten years from the date of grant. All issuances are subject to forfeiture if the recipient leaves or is terminated prior to the award’s vesting. Shares of restricted stock have the same dividend and voting rights as common stock while options do not.

 

All awards are issued at fair value of the underlying shares at the grant date. The Company expenses the cost of the awards, which is determined to be the fair market value of the awards at the date of grant. The Company did not grant any stock options to purchase common stock and restricted shares during the three months ended March 31, 2018.

 

The Company did not grant any stock options to purchase common stock during the three months ended March 31, 2018. During the six months ended March 31, 2018, stock options covering a total of 4,664 shares of common stock were granted. During the three and six months ended March 31, 2017, stock options covering a total of 7,000 shares of common stock were granted. Total compensation expense related to stock options granted under the 2014 Plan was $5,000 and $9,000 for the three and six months ended March 31, 2018, respectively.

 

-37-

 

 

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

 

The Company did not award any restricted shares during the three months ended March 31, 2018. During the six months ended March 31, 2018, a total of 4,768 restricted shares were awarded. During the three and six months ended March 31, 2017, a total of 12,522 restricted shares were awarded. The compensation expense related to restricted stock awards for three and six months ended March 31, 2018 was $18,000 and $29,000.

 

Stock-based compensation expense for the cost of the awards granted is based on the grant-date fair value. For stock option awards, the fair value is estimated at the date of grant using the Black-Scholes option-pricing model. This model requires the input of highly subjective assumptions, changes to which can materially affect the fair value estimate. Additionally, there may be other factors that would otherwise have a significant effect on the value of employee stock options that have been granted, but are not considered by the model. Accordingly, while management believes that the Black-Scholes option-pricing model provides a reasonable estimate of fair value, the model does not necessarily provide the best single measure of fair value for the Company’s employee stock options.

 

The following is a summary of stock option activity for the six months ended March 31, 2018:

 

   Shares   Weighted Average Exercise
Price
  

Weighted

Average Remaining Contractual Term

(In Years)

  

Aggregate 

Intrinsic
Value

 
Outstanding, beginning of fiscal year   11,000   $19.19        $83,170 
Granted   4,664    26.20          
Exercised                 
Forfeited/cancelled/expired                 
Outstanding, at March 31, 2018   15,664   $21.28    8.963   $74,920 
Exercisable at March 31, 2018   3,000   $18.34    8.463   $22,968 
Nonvested at March 31, 2018   12,664   $21.97    8.963   $51,952 

 

The table below summarizes the activity for the Company’s restricted stock outstanding during the six months ended at March 31, 2018:

 

    Shares   Weighted
Average
Fair Value
 
Nonvested at September 30, 2017    10,711   $20.36 
Granted    4,768    26.20 
Vested    (2,211)   20.27 
Forfeited/cancelled/expired         
Nonvested at March 31, 2018    13,268   $22.47 

 

As of March 31, 2018, there was $287,000 of total unrecognized compensation cost related to non-vested shares of restricted stock granted under the Plan. The cost is expected to be recognized over a weighted average period of 4.19 years. As of March 31, 2018, there was $86,000 of total unrecognized compensation cost related to non-vested options under the Plan. The cost is expected to be recognized over a weighted average period of 4.15 years.

 

-38-

 

 

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

 

The purpose of this analysis is to provide the reader with information relevant to understanding and assessing the Company’s results of operations for the periods presented herein and financial condition as of March 31, 2018 and September 30, 2017. In order to fully understand this analysis, the reader is encouraged to review the consolidated financial statements and accompanying notes thereto appearing elsewhere in this report.

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains certain forward looking statements (as defined in the Securities Exchange Act of 1934, as amended, and the regulations thereunder). Forward looking statements are not historical facts but instead represent only the beliefs, expectations or opinions of Malvern Bancorp, Inc. and its management regarding future events, many of which, by their nature, are inherently uncertain. Forward looking statements may be identified by the use of such words as: ‘‘believes,’’ ‘‘expects,’’ ‘‘anticipates,’’ ‘‘plans,’’ ‘‘trend,’’ ‘‘objective,’’ ‘‘continue,’’ ‘‘remain,’’ ‘‘pattern,’’ or words of similar meaning, or future or conditional terms such as ‘‘will,’’ ‘‘would,’’ ‘‘should,’’ ‘‘could,’’ ‘‘might,’’ ‘‘can,’’ or ‘‘may.’’ Forward looking statements include, but are not limited to, financial projections and estimates and their underlying assumptions; statements regarding plans, objectives and expectations with respect to future operations, products and services; and statements regarding future performance. Such statements are subject to certain risks, uncertainties and assumptions, many of which are difficult to predict and generally are beyond the control of Malvern Bancorp, Inc. and its management, that could cause actual results to differ materially from those expressed in, or implied or projected by, forward looking statements. The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward looking statements: (1) competitive pressures among depository institutions may increase significantly; (2) changes in the interest rate environment may reduce interest margins; (3) prepayment speeds, loan origination and sale volumes, charge-offs and loan loss provisions may vary substantially from period to period; (4) general economic conditions may be less favorable than expected; (5) political developments, wars or other hostilities may disrupt or increase volatility in securities markets or other economic conditions; (6) legislative or regulatory changes or actions may adversely affect the businesses in which Malvern Bancorp, Inc. is engaged; (7) changes and trends in the securities markets may adversely impact Malvern Bancorp, Inc.; (8) a delayed or incomplete resolution of regulatory issues could adversely impact our planning; (9) difficulties in integrating any businesses that we may acquire, which may increase our expenses and delay the achievement of any benefits that we may expect from such acquisitions; (10) the impact of reputation risk created by the developments discussed above on such matters as business generation and retention, funding and liquidity could be significant; and (11) the outcome of any regulatory and legal investigations and proceedings may not be anticipated.

 

As used in this report, unless the context otherwise requires, the terms “we,” “our,” “us,” or the “Company” refer to Malvern Bancorp, Inc., a Pennsylvania corporation, and the term the “Bank” refers to Malvern Bank, National Association, a national bank and wholly owned subsidiary of the Company. In addition, unless the context otherwise requires, references to the operations of the Company include the operations of the Bank.

 

This report contains certain financial information determined by methods other than in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These measures include net interest income on a fully tax equivalent basis and net interest margin on a fully tax equivalent basis, including the efficiency ratio. Our management uses these non-GAAP measures, together with the related GAAP measures, in its analysis of our performance and in making business decisions. Management also uses these measures for peer comparisons. The tax equivalent adjustment to net interest income recognizes the income tax savings when comparing taxable and tax-exempt assets and assumes a blended statutory rate of 24.5% for the current period and 34% for each of the prior periods presented. Management believes that it is standard practice in the banking industry to present net interest income and net interest margin on a fully tax equivalent basis, and accordingly believes that providing these measures may be useful for peer comparison purposes. These disclosures should not be viewed as substitutes for the results determined to be in accordance with GAAP, nor are they necessarily comparable to non-GAAP performance measures that may be represented by other companies. Reconciliations of net interest income on a fully tax equivalent basis to net interest income and net interest margin on a fully tax equivalent basis to net interest margin are contained in the tables under “Earnings-Net Interest Income and Margin.”

 

-39

 

 

Critical Accounting Policies

 

The accounting and reporting policies followed by Malvern Bancorp, Inc. and its subsidiaries (the “Company”) conform, in all material respects, to U.S. generally accepted accounting principles. In preparing the consolidated financial statements, management has made estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of condition and for the periods indicated in the statements of operations. Actual results could differ significantly from those estimates.

 

The Company’s accounting policies are fundamental to understanding Management’s Discussion and Analysis (“MD&A”) of financial condition and results of operations. The Company has identified the determination of the allowance for loan losses, other real estate owned, fair value measurements, deferred tax assets, the other-than-temporary impairment evaluation of securities and the valuation of our derivative positions to be critical because management must make subjective and/or complex judgments about matters that are inherently uncertain and could be most subject to revision as new information becomes available. Additional information on these policies can be found in our 2017 Annual Report on Form 10-K. There have been no significant changes to our Critical Accounting Policies as described in our 2017 Annual Report on Form 10-K.

 

Earnings

 

Net income available to common shareholders for the three months ended March 31, 2018 amounted to $2.0 million, or $0.31 per fully diluted common share, an increase of $0.8 million, or 72.5 percent, as compared with net income of $1.2 million, or $0.18 per common share, for the quarter ended March 31, 2017. The annualized return on average assets was 0.77 percent for the three months ended March 31, 2018, compared to annualized return on average assets of 0.51 percent for three months ended March 31, 2017. The annualized return on average shareholders’ equity was 7.71 percent for the three-month period ended March 31, 2018, compared to 4.77 percent in annualized return on average shareholders’ equity for the three months ended March 31, 2017.

 

Net income available to common shareholders for the six months ended March 31, 2018 amounted to $2.4 million, or $0.38 per fully diluted common share, an increase of $0.3 million, or 13.0 percent, as compared with net income of $2.1 million, or $0.33 per common share, for the six months ended March 31, 2017. The annualized return on average assets was 0.46 percent for the six months ended March 31, 2018, compared to annualized return on average assets of 0.49 percent for the six months ended March 31, 2017. The annualized return on average shareholders’ equity was 4.65 percent for the six-month period ended March 31, 2018, compared to 4.40 percent in annualized return on average shareholders’ equity for the six months ended March 31, 2017.

 

Net Interest Income and Margin on a Fully Tax-Equivalent Basis, Non-GAAP Financial Measure

 

Net interest income is the difference between the interest earned on the portfolio of earning assets (principally loans and investments) and the interest paid for deposits and borrowings, which support these assets. Net interest income is presented on a fully tax-equivalent basis by adjusting tax-exempt income (primarily interest earned on obligations of state and political subdivisions) by the amount of income tax which would have been paid had the assets been invested in taxable issues. We believe this to be the preferred measurement of net interest income as it provides a relevant comparison between taxable and non-taxable amounts.

 

The following table shows the Company’s calculation of this non-GAAP financial measure.

                 
   Three Months Ended March 31,   Six Months Ended March 31, 
(Dollars in thousands)  2018   2017   2018   2017 
                 
Net interest income  $6,568   $5,991   $12,950   $11,230 
Tax-equivalent adjustment, investment income (1)   19    50    29    101 
Tax-equivalent adjustment, loan interest (1)   10    2    11    4 
Net interest income on a fully tax-equivalent basis   6,597    6,043    12,990    11,335 

(1)Computed using a federal income tax rate of 24.5 percent for the three and six months ended March 31, 2018 and 34 percent for the three and six months ended March 31, 2017.

 

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The following table presents the components of net interest income on a fully tax-equivalent basis, a non-GAAP measure, for the periods indicated, together with a reconciliation of net interest income as reported under GAAP.

  

Net Interest Income (tax-equivalent basis)

    Three Months Ended March 31,     Six Months Ended March 31,  
(dollars in thousands)   2018     2017     Increase
(Decrease)
    Percent
Change
    2018     2017     Increase
(Decrease)
    Percent
Change
 
Interest income:                                                                
Loans, including fees   $ 8,750     $ 7,369     $ 1,381       18.74 %   $ 17,452     $ 13,684     $ 3,768       27.54 %
Investment securities     386       679       (293)       (43.15)       691       1,365       (674)       (49.38)  
Dividends, restricted stock     134       64       70       110.94       203       128       75       58.59  
Interest-bearing cash accounts     463       115       348       302.61       909       208       701       337.02  
Total interest income     9,733       8,227       1,506       18.32       19,255       15,385       3,870       25.15  
Interest expense:                                                                
Deposits     2,182       1,424       758       53.23       4,337       2,748       1,589       57.82  
Short-term borrowings     22       11       11       100.00       41       11       30       272.72  
Long-term borrowings     546       528       18       3.40       1,109       1,070       39       3.64  
Subordinated debt     386       221       165       74.66       778       221       557       252.04  
Total interest expense     3,136       2,184       952       43.59       6,265       4,050       2,215       54.69  
Net interest income on a fully tax-equivalent basis     6,597       6,043       554       9.17       12,990       11,335       1,655       14.60  
Tax-equivalent adjustment (1)     (29)       (52)       23       44.23       (40)       (105)       65       61.90  
Net interest income, as reported under GAAP   $ 6,568     $ 5,991     $ 577       9.63 %   $ 12,950     $ 11,230     $ 1,720       15.32 %

 

 

 

(1) Computed using a federal income tax rate of 24.5 percent for the three and six months ended March 31, 2018 and 34 percent for the three and six months ended March 31, 2017.

 

Net interest income on a fully tax-equivalent basis, a non-GAAP measure, increased $0.6 million, or 9.17 percent, to $6.6 million for the three months ended March 31, 2018 as compared to the same period in fiscal 2017. For the three months ended March 31, 2018, the net interest margin (which is defined as net interest income as a percentage of total average interest-earnings assets) on a fully tax-equivalent basis, a non-GAAP measure, decreased 17 basis points to 2.58 percent from 2.75 percent during the three months ended March 31, 2017. For the three months ended March 31, 2018, an increase in the average yield on interest-earning assets of 6 basis points together with an increase of 26 basis points in the average cost of interest-bearing liabilities resulted in a decrease in the Company’s net interest spread of 20 basis points for the period.

Net interest income on a fully tax-equivalent basis, a non-GAAP measure, increased $1.7 million, or 14.6 percent, to $13.0 million for the six months ended March 31, 2018 as compared to the six months ended March 31, 2017. For the six months ended March 31, 2018, the net interest margin on a fully tax-equivalent basis decreased 18 basis points to 2.52 percent from 2.70 percent during the six months ended March 31, 2017. For the six months ended March 31, 2018, an increase in the average yield on interest-earning assets of 8 basis points and an increase in the average cost of interest-bearing liabilities of 28 basis points, resulted in a decrease in the Company’s net interest spread of 20 basis points for the period.

For the three-month period ended March 31, 2018, total interest income on a tax-equivalent basis, a non-GAAP measure, increased by $1.5 million, or 18.32 percent, to $9.7 million, compared to the same three-month period in fiscal 2017. This increase in interest income was due primarily to an increase in the average volume of interest-earning assets, due primarily to an increase in the average balances of the loan portfolio. The average balance of the loan portfolio increased by $110.1 million, to $827.5 million, from an average of $717.4 million in the three months ended March 31, 2017, primarily reflecting net increases in construction loans and commercial loans. Average loans represented approximately 80.8 percent of average interest-earning assets during the second quarter of fiscal 2018 compared to 81.5 percent in the same quarter in fiscal 2017. The average balance of investment securities decreased during the quarter ended March 31, 2018 by $24.1 million, to $78.0 million, compared to the second quarter of fiscal 2017.

For the six-month period ended March 31, 2018, interest income on a tax-equivalent basis, a non-GAAP measure, increased by $3.9 million, or 25.1 percent, to $19.3 million, compared to the six months ended March 31, 2017. This increase in interest income was due primarily to a volume increase in loans. The average balance of the loan portfolio increased by $160.9 million, to $825.2 million during the first six months of fiscal 2018, from an average of $664.3 million in the six months ended March 31, 2017, reflecting net increases in construction loans and commercial loans in the loan portfolio. Average loans represented approximately 80.1 percent of average interest-earning assets during the six months ended March 31, 2018 compared to 79.0 percent in the six months ended March 31, 2017. The average balance of investment securities decreased during the six months ended March 31, 2018 by $34.8 million, to $68.6 million, compared to the six months ended March 31, 2017.

 

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For the three months ended March 31, 2018, interest expense increased $1.0 million, or 43.6 percent, to $3.1 million, compared to the same three-month period in fiscal 2017. The average rate of total interest-bearing liabilities increased 26 basis points to 1.39 percent for the three months ended March 31, 2018, from 1.13 percent for the three months ended March 31, 2017. At the same time, the average balance of total interest-bearing liabilities increased by $129.8 million. This increase primarily reflects an increase in the average balance of deposits of $120.6 million, an increase in the average balance of subordinated debt of $9.6 million offset by a decrease in the average balance of other short-term borrowings of $0.4 million.  The increase in the average balance of deposits consisted primarily of a $48.8 million increase in the average balance of money market accounts, a $0.7 million increase in the average balance of savings deposit accounts and a $76.7 million increase in the average balance of other interest-bearing deposit accounts offset by a $5.6 million decrease in the average balance of certificates of deposit accounts. For the three months ended March 31, 2018, the Company’s net interest spread on a tax-equivalent basis, a non-GAAP measure, decreased to 2.41 percent, from 2.61 percent for the three months ended March 31, 2017.

For the six months ended March 31, 2018, interest expense increased $2.2, or 54.7 percent, to $6.3 million, compared to the same six-month period in fiscal 2017. The average rate of total interest-bearing liabilities increased 28 basis points to 1.38 percent for the six months ended March 31, 2018, from 1.10 percent for the six months ended March 31, 2017. At the same time, the average balance of total interest-bearing liabilities increased by $172.2 million. This increase primarily reflects an increase in the average balance of deposits of $152.8 million, an increase in the average balance of other short-term borrowings of $2.3 million and an increase in the average balance of subordinated debt of $17.1 million.  The increase in the average balance of deposits consisted primarily of a $78.6 million increase in the average balance of money market accounts, a $5.5 million increase in the average balance of certificates of deposit accounts and a $68.8 million increase in the average balance of other interest-bearing deposit accounts. For the six months ended March 31, 2018, the Company’s net interest spread on a tax-equivalent basis decreased to 2.36 percent, from 2.56 percent for the three months ended March 31, 2017.

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The following table quantifies the impact on net interest income on a tax-equivalent basis, a non-GAAP measure, resulting from changes in average balances and average rates during the periods presented. Any change in interest income or expense attributable to both changes in volume and changes in rate has been allocated in proportion to the relationship of the absolute dollar amount of change in each category. 

Analysis of Variance in Net Interest Income Due to Changes in Volume and Rates

 

   

Three Months Ended 

March 31, 2018 and 2017

Increase (Decrease) Due to Change in:

   

Six Months Ended 

March 31, 2018 and 2017

Increase (Decrease) Due to Change in:

 
(tax-equivalent basis, dollars in thousands)  

Average

Volume

   

Average

Rate

   

Net 

Change

   

Average

Volume

   

Average

Rate

   

Net 

Change

 
Interest-earning assets:                                    
Loans, including fees   $ 1,131     $ 250     $ 1,381     $ 3,314     $ 454     $ 3,768  
Investment securities     (160)       (133)       (293)       (460)       (214)       (674)  
Interest-bearing cash accounts     117       231       348       193       508       701  
Dividends, restricted stock     20       51       71       24       51       75  
Total interest-earning assets     1,108       399       1,507       3,071       799       3,870  
Interest-bearing liabilities:                                                
Money market deposits     93       308       401       287       620       907  
Savings deposits           1       1             1       1  
Certificates of deposit     (20)       121       101       39       169       208  
Other interest-bearing deposits     42       213       255       72       401       473  
Total interest-bearing deposits     115       643       758       398       1,191       1,589  
Borrowings     51       143       194       198       428       626  
Total interest-bearing liabilities     166       786       952       596       1,619       2,215  
Change in net interest income   $ 942     $ (387)     $ 555     $ 2,475     $ (820)     $ 1,655  

 

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Average Balances, Net Interest Income, and Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin (net interest income as a percentage of average interest-earning assets). Tax-exempt income and yields have been adjusted to a tax-equivalent basis, a non-GAAP measure. All average balances are based on monthly balances. Management does not believe that the monthly averages differ significantly from what the daily averages would be.

    Three Months Ended March 31,  
    2018       2017  
(tax-equivalent basis)  

Average

Balance

   

Interest

Income/

Expense

   

Average

Yield/

Rate

 

   

Average

Balance

   

Interest

Income/

Expense

   

Average

Yield/

Rate

 
    (dollars in thousands)  
Assets                                    
Interest-earning assets:                                    
Loans, including fees(1)   $ 827,483     $ 8,750       4.23 %   $ 717,376     $ 7,369       4.11 %
Investment securities     77,961       386       1.98       102,090       679       2.66  
Interest-bearing cash accounts     111,793       463       1.66       55,643       115       0.83  
Dividends, restricted stock     7,072       134       7.58       5,406       64       4.74  
Total interest-earning assets     1,024,309       9,733       3.80       880,515       8,227       3.74  
Non interest-earning assets:                                                
Cash and due from banks     1,392                       1,298                  
Bank-owned life insurance     19,115                       18,624                  
Other assets     17,754                       20,833                  
Allowance for loan losses     (8,426 )                     (6,489 )                
Total non interest-earning assets     29,835                       34,266                  
Total assets   $ 1,054,144                     $ 914,781                  
Liabilities and Shareholders’ Equity                                                
Interest-bearing liabilities:                                                
Money market deposits   $ 278,167       839       1.21 %   $ 229,328     $ 438       0.76 %
Savings deposits     43,524       9       0.08       42,861       8       0.07  
Certificates of deposit     256,019       1,025       1.60       261,582       924       1.41  
Other interest-bearing deposits     177,110       309       0.70       100,443       54       0.22  
Total interest-bearing deposits     754,820       2,182       1.16       634,214       1,424       0.90  
Borrowings     118,000       546       1.85       118,000       528       1.79  
Short-term borrowings     4,945       22       1.78       5,389       11       0.82  
Subordinated debt     24,360       386       6.34       14,722       221       6.00  
Total interest-bearing liabilities     902,125       3,136       1.39       772,325       2,184       1.13  
Non interest-bearing liabilities:                                                
Demand deposits     40,034                       38,565                  
Other liabilities     7,283                       5,778                  
Total non interest-bearing liabilities     47,317                       44,343                  
Shareholders’ equity     104,702                       98,113                  
Total liabilities and shareholders’ equity   $ 1,054,144                     $ 914,781                  

Net interest income (tax equivalent basis)

            6,597                       6,043          
Net interest spread                     2.41 %                     2.61 %

Net interest margin (tax equivalent basis)

                    2.58 %                     2.75 %
Tax equivalent effect                     0.01 %                     0.03 %
Net interest margin on a GAAP basis                     2.57 %                     2.72 %
Tax-equivalent adjustment (2)             (29 )                     (52 )        
Net interest income           $ 6,568                     $ 5,991          
                                                     

 

(1)Includes non-accrual loans during the respective periods. Calculated net of deferred loan fees and loan discounts.
(2)Computed using a federal income tax rate of 24.5 percent and 34 percent, respectively, for the periods ended March 31, 2018 and March 21, 2017.

 

-44

 

    Six Months Ended March 31,  
    2018       2017  
(tax-equivalent basis)  

Average

Balance

   

Interest

Income/

Expense

   

Average

Yield/

Rate

 

   

Average

Balance

   

Interest

Income/

Expense

   

Average

Yield/

Rate

 
    (dollars in thousands)  
Assets                                    
Interest-earning assets:                                    
Loans, including fees(1)   $     825,187     $ 17,452       4.23 %   $ 664,305     $ 13,684       4.12 %
Investment securities     68,605       691       2.01       103,416       1,365       2.64  
Interest-bearing cash accounts     129,889       909       1.40       67,483       208       0.62  
Dividends, restricted stock     6,420       203       6.32       5,413       128       4.73  
Total interest-earning assets     1,030,101       19,255       3.74       840,617       15,385       3.66  
Non interest-earning assets:                                                
Cash and due from banks     1,463                       1,316                  
Bank-owned life insurance     19,054                       18,553                  
Other assets     18,948                       20,256                  
Allowance for loan losses     (8,422 )                     (6,065 )                
Total non interest-earning assets     31,043                       34,060                  
Total assets   $ 1,061,144                     $ 874,677                  
Liabilities and Shareholders’ Equity                                                
Interest-bearing liabilities:                                                
Money market deposits   $ 283,564     $ 1,660       1.17 %   $ 204,948     $ 753       0.73 %
Savings deposits     43,594       19       0.09       43,662       18       0.08  
Certificates of deposit     265,505       2,079       1.57       260,026       1,871       1.44  
Other interest-bearing deposits     167,861       579       0.69       99,102       106       0.21  
Total interest-bearing deposits     760,524       4,337       1.14       607,738       2,748       0.90  
Borrowings     118,000       1,109       1.88       118,000       1,070       1.81  
Short-term borrowings     4,973       41       1.65       2,665       11       0.83  
Subordinated debt     24,341       778       6.39       7,280       221       6.07  
Total interest-bearing liabilities     907,838       6,265       1.38       735,683       4,050       1.10  
Non interest-bearing liabilities:                                                
Demand deposits     41,412                       35,919                  
Other liabilities     7,689                       5,754                  
Total non interest-bearing liabilities     49,101                       41,673                  
Shareholders’ equity     104,205                       97,321                  
Total liabilities and shareholders’ equity   $ 1,061,144                     $ 874,677                  

Net interest income (tax equivalent basis)

            12,990                       11,335          
Net interest spread                     2.36 %                     2.56 %

Net interest margin (tax equivalent basis)

                    2.52 %                     2.70 %
Tax equivalent effect                     0.01 %                     0.03 %
Net interest margin on a GAAP basis                     2.51 %                     2.67 %
Tax-equivalent adjustment (2)             (40 )                     (105 )        
Net interest income           $ 12,950                     $ 11,230          
                                                     

 

(1)Includes non-accrual loans during the respective periods. Calculated net of deferred loan fees and loan discounts.
(2)Computed using a federal income tax rate of 24.5 percent and 34 percent, respectively, for the periods ended March 31, 2018 and March 31, 2017.

 

Investment Portfolio

  During the three-month period ended March 31, 2018, the average volume of investment securities decreased by $24.1 million to approximately $78.0 million or 7.6 percent of average earning assets, from $102.1 million on average, or 11.6 percent of average earning assets, for the comparable period in fiscal 2017.

 

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During the three-month period ended March 31, 2018, the volume-related factors decreased investment revenue by approximately $0.2 million, while rate-related factors decreased investment revenue by approximately $0.1 million from the same period in fiscal 2017. The tax-equivalent yield, a non-GAAP measure, on investments decreased by 68 basis points to 1.98 percent for the three-month period ended March 31, 2018 as compared to the three-month period ended March 31, 2017 at 2.66 percent. The decrease in the yield on the portfolio in the three-month period ended March 31, 2018 compared to the same period in fiscal 2017 is due primarily to lower average volume of investment securities.

 

During the six-month period ended March 31, 2018, the average volume of investment securities decreased by $34.8 million to approximately $68.6 million or 6.7 percent of average earning assets, from $103.4 million on average, or 12.3 percent of average earning assets, for the comparable period in fiscal 2017.

 

During the six-month period ended March 31, 2018, the volume-related factors decreased investment revenue by approximately $0.5 million, while rate-related factors decreased investment revenue by approximately $0.2 million from the same period in fiscal 2017. The tax-equivalent yield, a non-GAAP measure, on investments decreased by 63 basis points to 2.01 percent for the three-month period ended March 31, 2018 as compared to the three-month period ended March 31, 2017 at 2.64 percent. The decrease in the yield on the portfolio in the six-month period ended March 31, 2018 compared to the same period in fiscal 2017 is due primarily to lower average volume of investment securities.

 

At March 31, 2018, the total investment portfolio amounted to $77.4 million, an increase of $27.9 million, or 56.3 percent, from September 30, 2017. The increase in the investment portfolio was primarily due to the purchase of U.S. treasury notes during the first quarter of fiscal 2018. At March 31, 2018, the principal components of the investment portfolio were government treasury notes, government agency obligations, Federal agency obligations including mortgage-backed securities, obligations of U.S. states and political subdivision, corporate bonds and notes, and equity securities.

 

Loan Portfolio

 

Lending is one of the Company’s primary business activities. The Company’s loan portfolio consists of residential, construction and development, commercial and consumer loans, serving the diverse customer base in its market area. The composition of the Company’s portfolio continues to change due to the local economy. Factors such as the economic climate, interest rates, real estate values and employment all contribute to these changes. Growth is generated through business development efforts, repeat customer requests for new financings, penetration into existing markets and entry into new markets.

 

The Company seeks to create growth in commercial lending by offering customer-focused products and competitive pricing and by capitalizing on the positive trends in its market area. Products offered are designed to meet the financial requirements of the Company’s customers. It is the objective of the Company’s credit policies to diversify the commercial loan portfolio to limit concentrations in any single industry. 

 

At March 31, 2018, total gross loans amounted to $845.2 million, an increase of $3.1 million, or 0.36 percent, as compared to September 30, 2017. For the six-month period ended March 31, 2018, there was an increase of $12.0 million in commercial loans, an increase of $2.9 million in construction and development loans, an $8.2 million decrease in residential mortgage loans and a $3.7 million decrease in total consumer loans. Total gross loans recorded in the six months ended March 31, 2018 included new loan volume of $111.3 million, which was offset by loan payoffs of $59.8 million, and prepayments and maturities totaling $35.0 million. Even though the Company continues to be challenged by the competition for lending relationships that exists within its market, growth in volume has been achieved through successful lending sales efforts to build on continued customer relationships.

 

At March 31, 2018, the Company had $122.7 million in overall undisbursed loan commitments, which consisted primarily of unused commercial lines of credit, home equity lines of credit and available usage from active construction facilities. The Company’s current “Approved, Accepted but Unfunded” pipeline, includes approximately $54.0 million in commercial and construction loans and $15.7 million in residential mortgage loans expected to fund over the next 90 days.

 

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The average balance of our total loans increased $110.1 million, or 15.4 percent, for the three months ended March 31, 2018 as compared to the same period in fiscal 2017, while the average yield on loans increased 12 basis points for the three months ended March 31, 2018 compared with the same period in fiscal 2017. During the second quarter of fiscal 2018 compared to the same period fiscal 2017, the volume-related factors during the period contributed to an increase of interest income on loans of $1.1 million, while the rate-related changes increased interest income by $0.3 million. Total average loan volume increased $160.9 million or 24.2 percent for the six months ended March 31, 2018, while the portfolio yield increased by 11 basis points compared to the same period in fiscal 2017. The volume-related factors during the period contributed increased revenue of $3.3 million, while the average rate- related changes increased revenue by $0.5 million. The increase in average total loan volume was due primarily to the volume of new loan originations.

 

Allowance for Loan Losses and Related Provision

 

The purpose of the allowance for loan losses (the “allowance”) is to absorb the impact of losses inherent in the loan portfolio. Additions to the allowance are made through provisions charged against current operations and through recoveries made on loans previously charged-off. The allowance for loan losses is maintained at an amount considered adequate by management to provide for probable credit losses inherent in the loan portfolio based upon a periodic evaluation of the portfolio’s risk characteristics. In establishing an appropriate allowance, an assessment of the individual borrowers, a determination of the value of the underlying collateral, a review of historical loss experience and an analysis of the levels and trends of loan categories, delinquencies and problem loans are considered. Such factors as the level and trend of interest rates and current economic conditions and peer group statistics are also reviewed. Given the extraordinary economic volatility impacting national, regional and local markets, the Company’s analysis of its allowance for loan losses takes into consideration the potential impact that current trends may have on the Company’s borrower base.

 

 Although management uses the best information available, the level of the allowance for loan losses remains an estimate, which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to increase the allowance based on their analysis of information available to them at the time of their examination. Furthermore, the majority of the Company’s loans are secured by real estate in the State of Pennsylvania. Future adjustments to the allowance may be necessary due to economic factors impacting Pennsylvania real estate and the economy in general, as well as operating, regulatory and other conditions beyond the Company’s control.

 

At March 31, 2018, the allowance for loan losses amounted to approximately $8.5 million, or 1.00 percent of total loans, compared to $8.4 million, or 1.00 percent of total loans, at September 30, 2017. We recorded $0.2 million in provision for loan losses during the quarter ended March 31, 2018 compared to $1.0 million for the quarter ended March 31, 2017. For the six months ended March 31, 2018 we recorded $0.2 million in provision for loan losses compared to $1.7 million for the six months ended March 31, 2017. Provision expense was lower during fiscal 2018 due to a decrease in loan footings from extraordinary payoffs and paydowns during the first fiscal quarter of 2018. The net charge-offs were $0.2 million for each of the three and six months ended March 31, 2018 compared to less than $0.1 million and $0.1 million in recoveries for the three and six months ended March 31, 2017.

 

The level of the allowance for the respective periods of fiscal 2018 and fiscal 2017 reflects the credit quality within the loan portfolio, the loan volume recorded during the periods, the changing composition of the commercial and residential real estate loan portfolios and other related factors. In management’s view, the level of the allowance at March 31, 2018 was adequate to cover losses inherent in the loan portfolio. Actual results could differ materially from management’s analysis, based principally upon the factors considered by management in establishing the allowance.

 

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Changes in the allowance for loan losses are presented in the following table for the periods indicated.

 

   Six Months Ended March 31, 
   2018   2017 
   (Dollars in thousands) 
Average loans outstanding   825,187    664,305 
Total gross loans at end of period   845,200    759,206 
           
Analysis of the Allowance of Loan Losses:          
Balance at beginning of period  $8,405   $5,434 
           
Charge-offs:          
Residential mortgage   6     
    Commercial:          
Commercial real estate   221     
    Consumer:          
Second mortgages   54    121 
Other   2    5 
Total charge-offs   283    126 
Recoveries:          
Residential mortgage   58     
Construction and Development:          
Residential and commercial       90 
Commercial:          
Commercial real estate   10    30 
Other   2    6 
Consumer:          
Home equity lines of credit   1    2 
Second mortgages   28    82 
Other   4    6 
Total recoveries   103    216 
Net (recoveries) charge-offs   180    (90)
Provisions for loan loss   240    1,657 
Balance at end of period  $8,465   $7,181 
Ratios:          
Ratio of allowance for loan losses to non-performing loans   325.08%   425.41%

Ratio of net charge-offs to average loans outstanding in portfolio(1)

   0.04%   (0.03)%
Ratio of net charge-offs to total allowance for loan losses(1)   4.25%   (2.51)%

 

 

(1)Annualized                

 

Asset Quality

 

 The Company manages asset quality and credit risk by maintaining diversification in its loan portfolio and through review processes that include analysis of credit requests and ongoing examination of outstanding loans, delinquencies, and potential problem loans, with particular attention to portfolio dynamics and mix. The Company strives to identify loans experiencing difficulty early enough to correct the problems, to record charge-offs promptly based on realistic assessments of current collateral values and cash flows, and to maintain an adequate allowance for loan losses at all times.

 

It is generally the Company’s policy to discontinue interest accruals once a loan is past due as to interest or principal payments for a period of ninety days. When a loan is placed on non-accrual status, interest accruals cease and uncollected accrued interest is reversed and charged against current income. Payments received on non-accrual loans are applied against principal. A loan may be restored to an accruing basis when it again becomes well-secured, all past due amounts have been collected and the borrower continues to make payments for the next six months on a timely basis. Accruing loans past due 90 days or more are generally well-secured and in the process of collection. For additional information regarding loans, see Note 6 of the Notes to the Unaudited Consolidated Financial Statements.

 

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 Non-Performing Assets and Troubled Debt Restructured Loans

 

 Non-performing loans include non-accrual loans and accruing loans which are contractually past due 90 days or more. Non-accrual loans represent loans on which interest accruals have been suspended. In general, it is the policy of management to consider the charge-off of loans at the point they become past due in excess of 90 days, with the exception of loans that are both well-secured and in the process of collection. Non-performing assets include non-performing loans and other real estate owned. Troubled debt restructured loans represent loans to borrowers experiencing financial difficulties on which a concession was granted, such as a reduction in interest rate which is lower than the current market rate for new debt with similar risks, or modified repayment terms, and are performing under the restructured terms. Such loans, as long as they are performing in accordance with their restructured terms, are not included within the Company’s non-performing loans. For additional information regarding loans, see Note 6 of the Notes to the Unaudited Consolidated Financial Statements.

 

 The following table sets forth, as of the dates indicated, the amount of the Company’s non-accrual loans, accruing loans past due 90 days or more, other real estate owned and troubled debt restructured loans.

 

  

March 31,

2018

  

September 30,

2017

 
   (Dollars in thousands) 
Non-accrual loans  $2,129   $1,038 
Accruing loans past due 90 days or more   475    173 
Total non-performing loans   2,604    1,211 
Other real estate owned        
Total non-performing assets  $2,604   $1,211 
           
Troubled debt restructured loans — performing  $18,666   $2,238 

 

Non-accrual loans were $2.1 million at March 31, 2018, as compared to $1.0 million at September 30, 2017 and $1.6 million at March 31, 2017. Other real estate owned (“OREO”) was zero at March 31, 2018, September 30, 2017, and March 31, 2017, respectively. Total performing troubled debt restructured loans were $18.7 million at March 31, 2018, $2.2 million at September 30, 2017 and $1.6 million at March 31, 2017, respectively. The increase in performing troubled debt restructured loans at March 31, 2018 compared to September 30, 2017 was primarily due to two commercial loans with an aggregate outstanding balance of approximately $16.4 million.  

 

At March 31, 2018, non-performing assets totaled $2.6 million, or 0.24 percent of total assets, as compared with $1.2 million, or 0.12 percent, at September 30, 2017 and $1.7 million, or 0.18 percent, at March 31, 2017. Non-performing assets increased by $1.4 million at March 31, 2018 from September 30, 2017. The increase in non-performing assets at March 31, 2018 compared to September 30, 2017, was primarily attributable to the addition of four single residential loans with an aggregate outstanding balance of $0.4 million, two commercial loans with an outstanding balance of $0.6 million and eight consumer loans with an aggregate outstanding balance of $0.2 million moving into non-accrual status.

 

Overall credit quality in the Bank’s loan portfolio at March 31, 2018 remained relatively strong. Credit quality risk ratings include categories of “pass,” “special mention,” “substandard” and “doubtful.” Assets classified as “pass” are those protected by the current net worth and paying capacity of the obligor or by the value of the underlying collateral. Assets which do not currently expose the insured institution to sufficient risk to warrant classification as substandard or doubtful but possess certain identified weaknesses are required to be designated “special mention.” If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all the weaknesses inherent in those classified “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.”

 

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At March 31, 2018, special mention loans were $2.7 million compared to $5.0 million at September 30, 2017. The decrease of approximately $2.4 million in special mention loans was attributable to one commercial real estate loan designated as a special mention loan with an outstanding balance of $0.4 million at September 30, 2017 being classified as a pass loan during the first quarter of fiscal 2018 and one commercial real estate loan with an outstanding balance of $0.8 million at September 30, 2017 being classified as a substandard loan from classification as a special mention loan during the first quarter of fiscal 2018. In addition, two commercial real estate loans with an aggregate outstanding balance of $1.0 million and one residential real estate loan with an outstanding balance of $0.1 million were paid off during the second quarter of fiscal 2018.

 

Substandard loans were $27.4 million and $11.4 million at March 31, 2018 and September 30, 2017, respectively. The increase of approximately $16.0 million from September 30, 2017 to March 31, 2018, was attributable to the addition of two commercial real estate loans with an aggregate outstanding balance of $16.4 million classified as substandard. Our loans which have been identified as specially mention or substandard are considered potential problem loans due to a variety of changing conditions affecting the credits, including general economic conditions and/or conditions applicable to the specific borrowers. The Company has no foreign loans.

 

At March 31, 2018, other than the loans set forth above, the Company is not aware of any loans which present serious doubts as to the ability of its borrowers to comply with present loan repayment terms and which are expected to fall into one of the categories set forth in the tables or descriptions above.

 

 

Other Income

 

 The following table presents the principal categories of other income for the periods indicated.

 

   Three Months Ended March 31,   Six Months Ended March 31, 
(dollars in thousands)  2018   2017   Increase
(Decrease)
   Percent
Change
   2018   2017   Increase
(Decrease)
   Percent Change 
Service charges and other fees  $237   $274   $(37)   (13.50)%  $508   $497   $11    2.21%
Rental income-other   67    55    12    21.82    133    110    23    20.90 
Gain on sale of investments, net       58    (58)   (100.00)       58    (58)   (100.00)
Gain on sale of real estate, net                   1,186        1,186    100.00 
Gain on sale of loans, net   26    30    (4)   (13.33)   93    75    18    24.00 
Earnings on bank-owned life insurance   119    125    (6)   (4.80)   240    255    (15)   (5.88)
Total other income  $449   $542   $(93)   (17.16)%  $2,160   $995   $1,165    (117.09)%

 

For the three months ended March 31, 2018, total other income amounted to $0.4 million, compared to total other income of $0.5 million for the three months ended March 31, 2017. The decrease of $0.1 million was primarily due to a decrease of $37,000 in service charges and other fees, a $58,000 decrease in net gains on sales of investment securities, a $4,000 decrease in net gains on sale of loans, and a $6,000 decrease in earnings on bank-owned insurance offset by an $12,000 increase in rental income. The Company did not have any net investment securities gains, a non-GAAP measure, for the three months ended March 31, 2018. Excluding net investment securities gains, a non-GAAP measure, the Company recorded total other income of $0.5 million for the three months ended March 31, 2017. 

 

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For the six months ended March 31, 2018, total other income amounted to $2.2 million, compared to total other income of $1.0 million for the six months ended March 31, 2017. The increase of $1.2 million for the six months ended March 31, 2018 was primarily due to a $1.2 million net gain on the sale of real estate, an increase of $11,000 in service charges, a $23,000 increase in rental income, and an $18,000 increase in net gains on sale of loans offset by a $58,000 decrease in net gains on sales of investment securities and a $15,000 decrease in earnings on bank-owned insurance. Excluding net securities gains and losses and net gains on sale of real estate, non-GAAP measures, the Company recorded other income of $1.0 million for the six months ended March 31, 2018 compared to $0.9 million for the comparable period in fiscal 2017, an increase of $0.1 million, or 3.9 percent.

 

Other Expense

 

 The following table presents the principal categories of other expense for the periods indicated.

 

   Three Months Ended March 31,   Six Months Ended March 31, 
(dollars in thousands)  2018   2017   Increase
(Decrease)
   Percent
Change
   2018   2017   Increase
(Decrease)
   Percent Change 
Salaries and employee benefits  $2,001   $1,804   $197    10.92%  $3,991   $3,516   $475    13.51%
Occupancy expense   586    514    72    14.01    1,148    1,008    140    13.89 
Federal deposit insurance premium   75    91    (16)   (17.58)   151    95    56    58.95 
Advertising   38    73    (35)   (47.95)   92    124    (32)   (25.81)
Data processing   267    301    (34)   (11.29)   545    603    (58)   (9.62)
Professional fees   450    399    51    12.78    1,238    800    438    54.75 
Other operating expense   688    596    92    15.44    1,411    1,202    209    17.39 
Total other expense  $4,105   $3,778   $327    8.66%  $8,576   $7,348   $1,228    16.71%

 

For the three months ended March 31, 2018, total other expense increased $0.3 million, or 8.7 percent, from the comparable three months ended March 31, 2017. For the six months ended March 31, 2018, total other expense increased $1.2 million, or 16.7 percent, from the comparable six months ended March 31, 2017.

 

Salaries and employee benefits expense for the three months ended March 31, 2018 increased $0.2 million, or 10.9 percent, compared to the three months ended March 31, 2017 due to added staff to support overall franchise growth.

 

For the six months ended March 31, 2018, salaries and employee benefits expense increased $0.5 million, or 13.5 percent, compared to the six months ended March 31, 2017. The increase in salaries and employee benefits primarily reflects higher compensation and related costs due to added staff to support overall franchise growth. Full-time equivalent staffing levels were 86 at March 31, 2018 and 81 at March 31, 2017. Professional fee expense for the six months ended March 31, 2018 increased $0.4 million, or 54.8 percent, compared to the six months ended March 31, 2017 primarily due to an increase of $0.3 million related to increased legal and accounting fees. Other operating expense for the six months ended March 31, 2018 increased $0.2 million, or 17.4 percent, compared to the six months ended March 31, 2017 primarily due to amortization of subordinated debt costs of $0.1 million.

 

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The Company’s efficiency ratio, calculated on a GAAP basis without excluding net investment securities gains and without deducting non-core items from other expense, follows:

 

  

Three Months Ended

March 31,

  

Six Months Ended

March 31,

 
    2018    2017    2018    2017 
                     
Efficiency ratio on a GAAP Basis   58.5%   57.8%   56.8%   60.1%

 

The “efficiency ratio” is defined as other expense, excluding certain non-core items, as a percentage of net interest income on a tax equivalent basis, a non-GAAP financial measure, plus other income, excluding net securities gains, calculated as follows:

 

  

Three Months Ended

March 31,

  

Six Months Ended

March 31,

 
   2018   2017   2018   2017 
                 
Other expense  $4,105   $3,778   $8,576   $7,348 
Less: Non-core items(1)   43    29    115    58 
Other expense, excluding non-core items  $4,062   $3,749   $8,461   $7,290 
                     
Net interest income (tax equivalent basis)  $6,597   $6,043   $12,990   $11,335 
Other income, excluding net investment securities gains and gain on sale of real estate   449    484    974    937 
Total  $7,046   $6,527   $13,964   $12,272 
                     
Efficiency ratio   57.7%   57.4%   60.6%   59.4%

 

 

(1)Included in non-core items are costs which include expenses related to the Company’s corporate restructuring initiatives, such as professional fees, litigation and settlement costs, severance costs, and external payroll development costs related to such restructuring initiatives. The Company believes these adjustments are necessary to provide the most accurate measure of core operating results as a means to evaluated comparative results.

 

 The Company’s efficiency ratio, a non-GAAP financial measure, was 57.7 percent for the second quarter of fiscal 2018 on an annualized basis, compared to 57.4 percent in the second quarter of fiscal 2017. The Company’s efficiency ratio, a non-GAAP financial measure, was 60.6 percent for the six months ended March 31, 2018 on an annualized basis, compared to 59.4 percent in the six months ended March 31, 2017. The increase in the efficiency ratio reflects an increase in other expense, excluding non-core items, as well as an increase in total income.

 

 Provision for Income Taxes

 

 The Company recorded a provision for income taxes of $0.7 million and $3.9 million for the three and six months ended March 31, 2018, reflecting an effective tax rate of 24.5% and 61.5%, respectively. The Company recorded a provision for income taxes of $0.6 million and $1.1 million for the three and six months ended March 31, 2017, reflecting an effective tax rate of 33.4%, respectively. The changes in the income tax provision and effective tax rate were primarily due to the enactment of the Tax Cuts and Jobs Act of 2017 that required the Company to revalue its net deferred tax asset.

 

Recent Accounting Pronouncements

 

 Note 2 of the Notes to Unaudited Consolidated Financial Statements discusses the expected impact of accounting pronouncements recently issued or proposed but not yet required to be adopted.

 

 Asset and Liability Management

 

Asset and Liability management encompasses an analysis of market risk, the control of interest rate risk (interest sensitivity management) and the ongoing maintenance and planning of liquidity and capital. The composition of the Company’s statement of condition is planned and monitored by the Asset and Liability Committee (“ALCO”). In general, management’s objective is to optimize net interest income and minimize market risk and interest rate risk by monitoring the components of the statement of condition and the interaction of interest rates.

 

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 Short-term interest rate exposure analysis is supplemented with an interest sensitivity gap model. The Company utilizes interest sensitivity analysis to measure the responsiveness of net interest income to changes in interest rate levels. Interest rate risk arises when an earning asset matures or when its interest rate changes in a time period different than that of a supporting interest-bearing liability, or when an interest-bearing liability matures or when its interest rate changes in a time period different than that of an earning asset that it supports. While the Company matches only a small portion of specific assets and liabilities, total earning assets and interest-bearing liabilities are grouped to determine the overall interest rate risk within a number of specific time frames. The difference between interest-sensitive assets and interest-sensitive liabilities is referred to as the interest sensitivity gap. At any given point in time, the Company may be in an asset-sensitive position, whereby its interest-sensitive assets exceed its interest-sensitive liabilities, or in a liability-sensitive position, whereby its interest-sensitive liabilities exceed its interest-sensitive assets, depending in part on management’s judgment as to projected interest rate trends.

 

 The Company’s interest rate sensitivity position in each time frame may be expressed as assets less liabilities, as liabilities less assets, or as the ratio between rate sensitive assets (“RSA”) and rate sensitive liabilities (“RSL”). For example, a short-funded position (liabilities repricing before assets) would be expressed as a net negative position, when period gaps are computed by subtracting repricing liabilities from repricing assets. When using the ratio method, a RSA/RSL ratio of 1 indicates a balanced position, a ratio greater than 1 indicates an asset-sensitive position and a ratio less than 1 indicates a liability-sensitive position.

 

 A negative gap and/or a rate sensitivity ratio less than 1 tends to expand net interest margins in a falling rate environment and reduce net interest margins in a rising rate environment. Conversely, when a positive gap occurs, generally margins expand in a rising rate environment and contract in a falling rate environment. From time to time, the Company may elect to deliberately mismatch liabilities and assets in a strategic gap position.

 

 At March 31, 2018, the Company reflected a positive interest sensitivity gap with an interest sensitivity ratio of 1.58:1.00 at the cumulative one-year position. Based on management’s perception of interest rising through 2018, emphasis has been, and is expected to continue to be, placed on controlling liability costs while extending the maturities of liabilities in our efforts to insulate the net interest spread from rising interest rates in the future. However, no assurance can be given that this objective will be met.

 

Estimates of Fair Value

 

 The estimation of fair value is significant to a number of the Company’s assets, including investment securities available-for-sale. These are all recorded at either fair value or the lower of cost or fair value. Fair values are volatile and may be influenced by a number of factors. Circumstances that could cause estimates of the fair value of certain assets and liabilities to change include a change in prepayment speeds, discount rates, or market interest rates. Fair values for most available-for-sale investment securities are based on quoted market prices. If quoted market prices are not available, fair values are based on judgments regarding future expected loss experience, current economic condition risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature, involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

 

 Impact of Inflation and Changing Prices

 

The financial statements and notes thereto presented elsewhere herein have been prepared in accordance with generally accepted accounting principles, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations; unlike most industrial companies, nearly all of the Company’s assets and liabilities are monetary. As a result, interest rates have a greater impact on performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

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Liquidity

 

 The liquidity position of the Company is dependent primarily on successful management of the Bank’s assets and liabilities so as to meet the needs of both deposit and credit customers. Liquidity needs arise principally to accommodate possible deposit outflows and to meet customers’ requests for loans. Scheduled principal loan repayments, maturing investments, short-term liquid assets and deposit inflows, can satisfy such needs. The objective of liquidity management is to enable the Company to maintain sufficient liquidity to meet its obligations in a timely and cost-effective manner.

 

 Management monitors current and projected cash flows, and adjusts positions as necessary to maintain adequate levels of liquidity. Under its liquidity risk management program, the Company regularly monitors correspondent bank funding exposure and credit exposure in accordance with guidelines issued by the banking regulatory authorities. Management uses a variety of potential funding sources and staggering maturities to reduce the risk of potential funding pressure. Management also maintains a detailed contingency funding plan designed to respond adequately to situations which could lead to stresses on liquidity. Management believes that the Company has the funding capacity to meet the liquidity needs arising from potential events. The Company maintains borrowing capacity through the Federal Home Loan Bank of Pittsburgh secured with loans and marketable securities.

 

 The Company’s primary sources of short-term liquidity consist of cash and cash equivalents and investment securities available-for-sale.

 

 At March 31, 2018, the Company had $121.7 million in cash and cash equivalents compared to $117.1 million at September 30, 2017. In addition, our available for sale investment securities amounted to $44.3 million at March 31, 2018 and $14.6 million at September 30, 2017.

 

Deposits

 

Total deposits increased to $825.6 million at March 31, 2018 from $790.4 million at September 30, 2017. Deposit growth during the period is a result of business development efforts, expanded market, and the higher visibility of the Bank, which have resulted in increased deposits and a broadened depositor base. Total interest-bearing deposits increased from $748.3 million at September 30, 2017 to $787.1 million at March 31, 2018. Interest-bearing demand, savings and time deposits under $100,000 increased $50.6 million to a total of $608.3 million at March 31, 2018 as compared to $557.7 million at September 30, 2017. Time deposits $100,000 and over decreased $11.7 million as compared to September 30, 2017. Time deposits $100,000 and over represented 21.7 percent of total deposits at March 31, 2018 compared to 24.1 percent at September 30, 2017. We had brokered deposits totaling $113.8 million at March 31, 2018 compared to $103.7 million at September 30, 2017.

 

Core Deposits

 

 The Company derives a significant proportion of its liquidity from its core deposit base. Total demand deposits, savings and money market accounts of $567.6 million at March 31, 2018 increased by $48.9 million, or 9.4 percent, from September 30, 2017. Total demand deposits, savings and money market accounts were 68.8 percent of total deposits at March 31, 2018 and 65.6 percent at September 30, 2017. Alternatively, the Company uses a more stringent calculation for the management of its liquidity positions internally, which calculation consists of total demand, savings accounts and money market accounts (excluding money market accounts greater than $100,000 and time deposits) as a percentage of total deposits. This number increased by $28.8 million, or 8.5 percent, from $337.7 million at September 30, 2017 to $366.5 million at March 31, 2018 and represented 44.4 percent of total deposits at March 31, 2018 as compared with 42.7 percent at September 30, 2017.

 

 The Company continues to place the main focus of its deposit gathering efforts in the maintenance, development, and expansion of its core deposit base. Management believes that the emphasis on serving the needs of our communities will provide a long-term relationship base that will allow the Company to efficiently compete for business in its market. The success of this strategy is reflected in the growth of deposits during the first six-month period of fiscal 2018.

 

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The following table depicts the Company’s core deposit mix at March 31, 2018 and September 30, 2017 based on the Company’s alternative calculation:

 

   March 31, 2018   September 30, 2017   Dollar 
   Amount   Percentage   Amount   Percentage   Change 
   (Dollars in thousands) 
Non interest-bearing demand  $38,444    10.5%  $42,121    12.5%  $(3,677)
Interest-bearing demand   190,602    52.0    155,579    46.1    35,023 
Savings   44,716    12.2    44,526    13.2    190 
Money market deposits under $100,000   13,597    3.7    14,299    4.2    (702)
Certificates of deposits under $100,000   79,139    21.6    81,166    24.0    (2,027)
Total core deposits  $366,498    100.0%  $337,691    100.0%  $28,807 
                          
Total deposits  $825,569        $790,396        $35,173 
Core deposits to total deposits        44.4%        42.7%     

 

Borrowings

 

 Borrowings from the Federal Home Loan Bank (“FHLB”) of Pittsburgh are available to supplement the Company’s liquidity position and, to the extent that maturing deposits do not remain with the Company, management may replace such funds with advances. As of both March 31, 2018 and September 30, 2017, the Company’s outstanding balance of FHLB advances, totaled $118.0 million. Of the $118.0 million in advances, $28.0 million represent long-term, fixed-rate advances maturing in 2020 that have terms enabling the FHLB to call the borrowing at their option prior to maturity. The remaining balance of long-term, fixed rate advances totaled $55.0 million, representing five separate advances maturing during fiscal year 2019. At March 31, 2018, there were two short-term FHLB advances totaling $35.0 million of fixed-rate borrowing with rollover of 90 days.  

 

During fiscal 2017 the Company had purchased securities sold under agreements to repurchase as a short-term funding source. At March 31, 2018 and September 30, 2017, the Company had $2.5 million and $5.0 million, respectively, in securities sold under agreements to repurchase at a rate of 2.00%.

 

Payments Due Under Contractual Obligations

 

The following table presents information relating to the Company’s payments due under contractual obligations as of March 31, 2018.

 

   Payments Due by Period 
   Less than
One Year
   One to
Three Years
   Three to
Five Years
   More than
Five Years
   Total 
   (in thousands) 
Long-term debt obligations(1)  $35,206   $85,243   $   $   $120,449 
Certificates of deposit(1)   146,163    85,451    10,946    19,741    262,301 
Operating lease obligations   479    947    970    1,456    3,852 
Total contractual obligations  $181,848   $171,641   $11,916   $21,197   $386,602 

 

 

(1) Includes interest payments

 

We anticipate that we will continue to have sufficient funds and alternative funding sources to meet our current commitments.

 

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Cash Flows

 

The Consolidated Statements of Cash Flows present the changes in cash and cash equivalents resulting from the Company’s operating, investing and financing activities. During the six months ended March 31, 2018, cash and cash equivalents increased by $4.6 million over the balance at September 30, 2017. Net cash of $4.4 million was provided by operating activities. Net cash used by investing activities amounted to approximately $33.4 million and net cash of $33.6 million was provided by financing activities.

 

Shareholders’ Equity

 

 Total shareholders’ equity amounted to $105.4 million, or 9.7 percent of total assets, at March 31, 2018, compared to $102.5 million or 9.8 percent of total assets at September 30, 2017. Book value per common share was $16.03 at March 31, 2018, compared to $15.60 at September 30, 2017.

 

   March 31,   September 30, 
   2018   2017 
   (in thousands, except for share data) 
Shareholders’ equity  $105,362   $102,520 
           
Book value per common share  $16.03   $15.60 

 

Capital

 

At March 31, 2018, the Bank’s common equity tier 1 ratio was 15.20 percent, tier 1 leverage ratio was 11.96 percent, tier 1 risk-based capital ratio was 15.20 percent and the total risk-based capital ratio was 16.23 percent. At September 30, 2017, the Bank’s common equity tier 1 ratio was 14.75 percent, tier 1 leverage ratio was 12.02 percent, tier 1 risk-based capital ratio was 14.75 percent and the total risk-based capital ratio was 15.78 percent. At March 31, 2018, the Bank was in compliance with all applicable regulatory capital requirements.

 

Item 3 - Quantitative and Qualitative Disclosures About Market Risk

 

For a discussion of the Company’s asset and liability management policies as well as the methods used to manage its exposure to the risk of loss from adverse changes in market prices and rates market, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Asset and Liability Management” in the Company’s Annual Report on Form 10-K for the year ended September 30, 2017. There has been no material change in the Company’s asset and liability position since September 30, 2017.

 

Item 4. Controls and Procedures

 

Our management evaluated, with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and regulations and that such information is accumulated and communicated to management including the Chief Executive Officer and the Chief Financial Officer, to allow timely decisions regarding required disclosures. Based on such evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective as of March 31, 2018.

 

Item 9A of the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2017 (the “Fiscal 2017 10-K”) set forth management’s conclusion that because of the material weakness and related matters described in Item 9A of the Fiscal 2017 10-K, the Company’s internal control over financial reporting was not effective as of September 30, 2017. The matters described in Item 9A of the Fiscal 2017 10-K related to the Company’s income tax balances Management implemented a more formal review and documentation process around the accounting for income tax which management believes will strengthen the Company’s overall internal control over financial reporting. During the quarter ended March 31, 2018, the Company completed the remediation efforts described in Item 9A of its Annual Report on Form 10-K.

 

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Except as noted above, no change in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

PART II - OTHER INFORMATION

 

Item 1 - Legal Proceedings

 

Not applicable.

 

Item 1A - Risk Factors

 

See Item 1A, “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended September 30, 2017. There have been no material changes from the risk factors previously disclosed in the Company’s Annual Report on Form 10-K for the year ended September 30, 2017.

 

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

 

Not applicable.

 

Item 3 - Defaults Upon Senior Securities

 

There are no matters required to be reported under this item.

 

Item 4 - Mine Safety Disclosure

 

There are no matters required to be reported under this item.

Item 5 - Other Information

 

There are no matters required to be reported under this item.

 

Item 6 - Exhibits

 

31.1Rule 13a-14(a)/15d-14(a) Section 302 Certification
31.2Rule 13a-14(a)/15d-14(a) Section 302 Certification
32.0Section 1350 Certification

 

101.INS XBRL Instance Document.
101.SCH XBRL Taxonomy Extension Schema Document.
101.CAL XBRL Taxonomy Extension Calculation Linkbase Document.
101.LAB XBRL Taxonomy Extension Label Linkbase Document.
101.PRE XBRL Taxonomy Extension Presentation Linkbase Document.
101.DEF XBRL Taxonomy Extension Definitions Linkbase Document.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

  MALVERN BANCORP, INC.
     
May 10, 2018 By: /s/ Anthony C. Weagley
    Anthony C. Weagley
    President and Chief Executive Officer

     
May 10, 2018 By: /s/ Joseph D. Gangemi
    Joseph D. Gangemi
    Senior Vice President and Chief Financial Officer

 

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