PART I

Item 1. Business

General

Prudential Bancorp is a Pennsylvania corporation that was incorporated in June 2013. It is the successor corporation to Prudential Bancorp, Inc. of Pennsylvania (“Old Prudential Bancorp”), the former stock holding company for Prudential Bank (the “Bank” or “Company” and formally knowknown as “Prudential Savings Bank”), a Pennsylvania-chartered, FDIC-insured savings bank, after the completion in October 2013 of the mutual-to-stock conversion of Prudential Mutual Holding Company (the “MHC”), the former mutual holding company for the Bank.

The mutual-to-stock conversion was completed on October 9, 2013. In connection with the conversion, Prudential Bancorp sold 7,141,602 shares of common stock at $10.00 per share in a public offering. In addition, 2,403,207 shares were issued in exchange for the outstanding shares of common stock of Old Prudential Bancorp held by shareholders other than the MHC. Each share of Old Prudential Bancorp’s common stock owned by the public was exchanged for 0.9442 shares of Prudential Bancorp common stock. Gross proceeds from the conversion and offering were approximately $71.4 million. Upon completion of the offering and the exchange, 9,544,809 shares of common stock of Prudential Bancorp were issued and outstanding.

As of January 1, 2017, the Company completed its acquisition of Polonia Bancorp, Inc. (“Polonia Bancorp”) and Polonia Bank, Polonia’s wholly owned subsidiary. Polonia Bancorp and Polonia Bank were merged with and into the Company and the Bank, respectively. Under the terms of the Merger Agreement, shareholders of Polonia had the option to receive $11.09 per share in cash or 0.7460 of a share of Prudential common stock for each share of Polonia common stock, subject to allocation provisions to assure that, in the aggregate, Polonia shareholders received total merger consideration that consists of 50% stock and 50% cash. As a result of Polonia shareholder stock and cash elections and the related proration provisions of the Merger Agreement,merger agreement, Prudential Bancorp issued approximately 1,274,197 shares of its common stock and approximately $18.9 million in the merger.

Financial information as of and for the year ended September 30, 2013 presented in this annual report is derived from the consolidated financial statements of Old Prudential Bancorp.

Prudential Bancorp’s business activity primarily consists of the ownership of the Bank’s common stock. Prudential Bancorp does not own or lease any property. Instead, it uses the premises, equipment and other property of the Bank. Accordingly, the information set forth in this annual report, including the consolidated financial statements and related financial data, relates primarily to the Bank. As a bank holding company, Prudential Bancorp is subject to the regulation of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”).

The Company’s results of operations are primarily dependent on the results of the Bank. As of September 30, 2017,2020, the Company, on a consolidated basis, had total assets of approximately $899.5 million,$1.2 billion, total deposits of approximately $636.0$770.9 million, and total stockholders’ equity of approximately $136.2$129.1 million.

The Bank is a community-oriented savings bank headquartered in South Philadelphia which was originally organized in 1886 as a Pennsylvania-chartered building and loan association known as “The South Philadelphia Building and Loan Association No. 2.” The Bank grew through a number of mergers with other mutual institutions with the last merger being with Polonia Bank completed in January 2017. The Bank converted to a Pennsylvania-chartered savings bank in August 2004. The banking office network currently consists of the headquarters and main office and 10nine additional full-service branch offices. EightSeven of the banking offices are located in Philadelphia (Philadelphia County), one is in Drexel Hill, Delaware County and one is in Huntingdon Valley, Montgomery County, Pennsylvania. The Bank maintains ATMs at all of the banking offices. WeThe Bank also provideprovides on-line and mobile banking services.

We are primarily engaged in attracting deposits from the general public and using those funds to invest in loans and securities. The Company’s principal sources of funds are deposits, repayments of loans and mortgage-backed securities, maturities and calls of investment securities and interest-bearing deposits, funds provided from operations and funds borrowed from the Federal Home Loan BankBank(”FHLB”) of Pittsburgh. These funds are primarily used for the origination of various loan types including single-family residential mortgage loans, construction and land development loans, non-residential or commercial real estate mortgage loans, home equity loans and lines of credit, commercial business loans and consumer loans. Traditionally, the Bank focused on originating long-term, single-family residential mortgage loans for portfolio, althoughportfolio. However, in recent years the focus has shifted in recent years to emphasisemphasizing commercial real estate and construction and land development lending. Construction and land development loans increased from $11.4$21.8 million or 3.7%6.2% of the total

loan portfolio at September 30, 2016 to $260.6 million or 38.0% of the total loan portfolio at September 30, 2013 to $145.52020. The Company also increased, on a dollar basis, its commercial real estate loans from $79.9 million or 22.3%22.7% of the total loan portfolio at September 30, 2017. The Company also increased its commercial real estate loans from $19.52016 to $139.9 million or 6.3%20.4% of the total loan portfolio at September 30, 2013 to $127.6 million or 19.6% of the total loan portfolio at September 30, 2017.2020. See “-AssetLending Activities” and “-Asset Quality”and “-Lending Activities”.

The investment and mortgage-backed securities portfolio increaseddecreased by $61.0$138.2 million to $239.7$443.2 million at September 30, 20172020 from $178.7$581.5 million at September 30, 2016.2019. This increasedecrease was primarily due to the acquisitionsales and paydowns  of the investment securities portfolio of Polonia Bank on January 1, 2017. The securities were liquidated and replaced by other mortgage backed securities and corporate debt securities at no gain or loss to the Bank.guaranteed mortgage-backed securities. The Company recorded approximately $235,000$6.0 million in gains from theon sale of investment and mortgage-backed securities during fiscal 2017.2020. At September 30, 2017,2020, the investment and mortgage-backed securities available for sale had an aggregate net unrealized lossgain of $1.7$13.4 million compared with thean aggregate net unrealized gain of $1.5$10.3 million as of September 30, 2016,2019, which was primarily due to recent increasesdecreases in the yield on longer term U.S. Treasury bond yields which resulted in a decreasean increase in the fair value of our available-for-sale securities.

At September 30, 2017,2020, the Company’s non-performing assets totaled $15.6$13.0 million or 1.7%1.1% of total assets as compared to $16.5$14.3 million or 2.9%1.1% of total assets at September 30, 2016.2019. Non-performing assets at September 30, 20172020 included five construction loans aggregating $8.7$8.5 million, 3328 one-to-four family residential loans aggregating $3.7 million, one single-family residential investment property loan in the amount $1.4$3.1 million and fivefour commercial real estate loans aggregating $1.6$1.4 million. Non-performing assets also included atThere was no real estate acquired through foreclosure or deed-in-lieu as of September 30, 2017 one real estate owned property consisting of a single-family residential property with a carrying value of $192,000.2020.  At September 30, 2017,2020, the Company had ninefour loans aggregating $6.0totaling $5.0 million that were classified as troubled debt restructurings (“TDRs”). Three of such loans aggregating $4.9 million were designated non-performing as of September 30, 2017 andOne TDR is on non-accrual status; oneand consists of such loans in the amount of $1.4 million has continued to make paymentsa $415,000 loan secured by a single-family residential property and is performing in accordance with the restructured loan terms, but management continues to have concerns over the borrower’s ability to make future payments and as a result has determined to not return the loan to performing status.terms. The three remaining two TDRs classified non-accrual totaling $3.5$4.6 million are aalso classified as non-accrual and are part of a troubled borrowinglending relationship totaling $10.7$10.4 million (after taking into account the previously disclosed $1.9 million write-down recognized during the quarter ending March 31, 2017 related to this borrowing relationship).The primary project of the borrower (the development of a 169-unit townhouse project in Bristol Borough, Pennsylvania) is the subject of litigation between the Bank and the borrower and as a result, the project currently is not proceeding. Subsequentborrower. As previously disclosed, subsequent to the commencement of the litigation, the borrower filed for bankruptcy under Chapter 11 (Reorganization) of the federal bankruptcy code in June 2017. The Bank has moved the underlying litigation noted above with the borrower and the Bank from state court to the federal bankruptcy court in which the bankruptcy proceeding is being heard. The remaining six TDRs have performed in accordance withstate litigation is stayed pending the termsresolution of their revised agreements andthe bankruptcy proceedings. Nine units have been placed on accruing status. sold in the project and a portion of the proceeds have been applied against the outstanding debt.As of September 30, 2017,2020, the Company had reviewed $19.7$13.0 million of loans for possible impairment of which $15.0$13.0 million was classified substandard compared to $19.4$15.5 million reviewed for possible impairment and $14.6$13.9 million of which was classified substandard as of September 30, 2016.2019. The allowance for loan losses totaled $4.5$8.3 million, or 0.8%1.4% of total loans and 29.0%63.7% of total non-performing loans (which included loans acquired from Polonia Bank at their fair value) at September 30, 2017.2020. See “-Asset Quality”.

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The main office is located at 1834 West Oregon Avenue, Philadelphia, Pennsylvania and the Company’s telephone number is (215) 755-1500.

The Company files with the Securities and Exchange Commission (“SEC”) and makes available, free of charge, through its website, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements on Schedule 14A, and all amendments to those reports as soon as reasonably practicable after the reports are electronically filed with the SEC. These reports can be obtained on the Company’s website at https://www.psbanker.com by following the link, “About Us,” followed by “Investor Relations.” The information contained on or connected to our website is not incorporated by reference into this Annual Report on Form 10-K.

Market Area and Competition

Most of Prudential Bancorp’s business activities are conducted within a few hours’ drive from Philadelphia and include eastern Pennsylvania, New Jersey, eastern Pennsylvania, Delaware and southern New York.

We face substantial competition from other financial institutions in our service area, especially from many local community banks, as well as many local credit unions. Competition among financial institutions is based upon a number of factors, including the quality of services rendered, interest rates offered on deposit accounts, interest rates charged on loans and other credit services, service charges, the convenience of banking facilities, locations and hours of operation

sources, including existing customers as well as new customers obtained from referrals and local advertising and promotional efforts. Consumer loan applications are taken at any of our offices while loan applications for all other types of loans, including home equity and home equity linelines of credits,credit, are taken only at our main office. All loan applications are processed and underwritten centrally at our executive office in Huntingdon Valley, PA.

Pennsylvania.

Single-family residential mortgage loans are generally written on standardized documents used by the Federal Home Loan Mortgage Corporation (“FHLMC” or “Freddie Mac”) and Federal National Mortgage Association (“FNMA” or “Fannie Mae”). Property valuations of loans secured by real estate are undertaken by independent third-party appraisers approved by the board of directors and are reviewed internally before acceptance. At both September 30, 20172020 and September 30, 2016,2019, the Company had no residential real estate loans in portfolio that would be considered subprime loans, which we define as mortgage loans advanced to borrowers who do not qualify for loans bearing market interest rates because of problems with their credit history.  The Bank does not originate and has not in the past originated subprime loans.

We also purchase participation interests in larger balance loans, typically commercial real estate and construction and land development loans, from other financial institutions in our market area. Such participations are reviewed for compliance, are underwritten independently in accordance with our underwriting criteria and are approved before they are purchased by the Management Loan Committee and one of the following: the President’s Committee, the Executive Committee or the full board, basedBoard, depending upon the dollar amount of the participation interest being purchased. Generally, loan purchases have been without any recourse to the seller.seller, but on occasion we have obtained such provisions. However, we actively monitor the performance of such loans through the receipt of regular updates, including inspection reports, from the lead lender regarding the loan’s performance, discussing the loan with the lead lender on a regular basis and receiving copies of updated financial statements of the borrower from the lead lender. These loans are subjected to regular internal reviews in accordance with our loan policy.

The Bank typically holds a 100% interest in construction and land development loans. The Bank has in the past and currently reserves the option to sell participation interests. We generally have sold participation interests in loans only when a loan would exceed the Bank’s internal and/or legal loans to one borrower limits. With respect to the sale of participation interests in such loans, we have typically received commitments to purchase suchthe participation interests offered prior to the time the loan is closed. See “-Lending Activities - Construction and Land Development Lending.”

As part of the Bank’s loan policy, we are permitted, to make loans to one borrower and related entities in an aggregate amount of up to 15% of the capital accounts of the Bank which consist of the aggregate of its capital, surplus, undivided profits, capital securities and allowance for loan losses. At September 30, 2017,2020, the Bank’s internal “guidance” limit is $12.5$15.0 million to one borrower or borrowing relationship as a threshold. The Bank is permitted to exceed such limit in certain situations subject to the (i) approval of the Board of Directors and (ii) subject to the overall legal/regulatory lending limit which was calculated to be $18.0$19.8 million at September 30, 2017.2020. At September 30, 2017,2020, our three largest loans to one borrower and related entities amounted to $14.8$18.5 million, $12.6$16.0 million and $12.0$15.0 million. The largest relationship consist ofis with a participation interestreal estate developer in four construction and land development loans to construct a 212 unit apartment building in Plainfield,northern New Jersey and to construct 24 townhouses in Hanover Township, New Jersey.consists of a multi-family residential housing construction project, two commercial real estate loans and a personal line of credit. The second largest relationship consists of foura participation interest in a $16.0 million commercial line of credit secured by commercial real estate loans to finance retail space in the Philadelphia suburbs.central and northern New Jersey. The third largest relationship consists of a participation interest in a commercial real estateconstruction loan to purchaseconstruct a 316-unit30 story, 102 unit mixed-use luxury apartment complexbuilding in East Rutherford,Manhattan, New Jersey.York. The three relationships are all performing in accordance with contractual terms. For more information regarding these loans, see“-Lending Activities - Construction and Land Development Lending.”

the contractual right to deem the loan immediately due and payable in the event the borrower transfers ownership of the property.

Our single-family residential mortgage loans also include home equity loans and lines of credit, which amounted to $6.5$3.3 million and $14.1$7.8 million, respectively, at September 30, 2017.2020. The unused portion of home equity lines was $6.1$5.9 million at such date. Our home equity loans are fully amortizing and have terms to maturity of up to 20 years. While home equity loans also are secured by the borrower’s residence, we generally obtain a second mortgage position on these loans. Our lending policy providesrequires that our home equity loans have loan-to-value ratios, when combined with any first mortgage, of a maximum 80% or less at time of origination, although the preponderance of our home equity loans have combined loan-to-value ratios of 75% or less at time of origination. We also offer home equity revolving lines of credit with interest tied to theWall Street Journal prime rate plus a stipulated margin. Generally, we have a second mortgage on the borrower’s residence as collateral on our home equity lines. In addition, our home equity lines generally have loan-to-value ratios (combined with any loan secured by a first mortgage) of 75% or less at time of origination. Our customers may apply for home equity lines as well as home equity loans at any banking office. While there has been decline in some collateral values due to the continued weak real estate market, we believe our conservative underwriting guidelines have minimized our exposure in thatthis regard.

Construction and Land Development Lending. We have maintained our emphasis on construction and land development loansloan originations because construction loans have shorter terms to maturity, provide an attractive yield and generally have either higher fixed interest rates or adjustable interest rates..rates. At September 30, 2017,2020, our construction and loan development loans amounted to $145.5$260.6 million, or 22.3%38.0% of our total loan portfolio. This amount includes $73.9$86.9 million of undisbursed loans in process. The average size of our construction and land development loans, excluding loans to our largest lending relationship, was approximately $3.3$2.3 million at September 30, 2017.2020. Our construction loan portfolio has increased substantially since September 30, 20132016 when construction loans amounted to $11.4$21.8 million or 3.7%6.2% of our total loan portfolio as compared to $145.5 million or 22.3% ofportfolio.

Other than our total loan portfolio at September 30, 2017.

Loansparticipations, loans to finance the construction of condominium projects or single-family homes and subdivisions are generally offered to experienced builders in our primary market area with whom we have an established relationship. Residential construction and development loans are offered with terms of up to 36 months although typically the terms are 12 to 24 months. The maximum loan-to-value limit applicable to these loans is 75% of the appraised post construction value and the policy does not require amortization of the principal during the term of the loan. We often establish interest reserves and obtain personal and corporate guarantees as additional security on the construction loans. Interest reserves are used to pay the monthly interest payments during the development phase of the loan and are treated as an addition to the loan balance. Interest reserves pose an additional risk to the Company if it does not become aware of deterioration in the borrower’s financial condition before the interest reserve is fully utilized. In order to help monitor the risk, financial statements and tax returns are obtained from borrowers on an annual basis. Additionally, construction loans are reviewed at least annually pursuant to a third partythird-party loan review. Construction loan proceeds are disbursed periodically in increments as construction progresses and as inspection by approved appraisers or loan inspectorsinspector warrants. Construction loans are negotiated on an individual basis but typically have floating rates of interest based upon theWall Street Journal prime rate plus a stipulated margin. Additional fees may be charged as funds are disbursed. In addition to interest payments during the term of the construction loan, we typically require that payments to reduce the principal outstanding be made as units are completed and released. Generally, such principal payments must be equal to 110% of the amount attributable to the acquisition and development of the lot plus 100% of the amount attributable to construction of the individual home. We typically permit a pre-determined limited number of model homes to be constructed on an unsold or “speculative” basis. All other units must be pre-sold before we will disburse funds for construction. Construction loans also include loans to acquire land and loans to develop the basic infrastructure, such as roads and sewers. The majority of the construction loans are secured by properties located in our primary lending area.

Set forth below is a brief description of the five largest construction loanloans or loan relationships.

The largest construction loan is in the amount of $14.9 million of which $13.6 million had been disbursed as of September 30, 2020. This loan was originated in January 2018 and is a participation interest in a $73.0 million loan participated from another financial institution. The proceeds were used to construct a 30 story, 102-unit mixed use luxury

apartment building in Manhattan, New York. The project was approximately 78% complete as of September 30, 2020. The loan is performing in accordance with its contractual terms.

The second largest construction loan is in the amount of $19.4 million of which $3.9 million had been disbursed as of September 30, 2020. This loan was originated in August 2019 and a participation interest of $7.4 million was sold to another financial institution, reducing our position to $12.0 million. The proceeds are being used to construct 90 apartments and 21 townhomes in Philadelphia, Pennsylvania. The project was approximately 7.0% complete as of September 30, 2020. The loan is performing in accordance with its contractual terms.

The third largest construction loan is in the amount of $10.0 million of which $10.0$9.9 million hashad been disbursed as of September 30, 2017. This loan was originated March 2017 and is a participation interest in a $35.1 million loan purchased from another financial institution. The proceeds were used to acquire land and construct a 312 unit garden apartment complex in Winslow Township, New Jersey. The project was substantially complete as of September 30, 2017. The loan is performing in accordance with contractual terms.

The second largest construction loan is in the amount of $10.0 million of which $1.4 million has been disbursed as of September 30, 2017.2020. This loan was originated in January of 2017. The proceeds will beare being used to construct 66 residential units and 9,000 square feet of retail space in Jersey City, New Jersey. The project was 14.3%approximately 99.0% complete as of September 30, 2017.2020. The loan is performing in accordance with its contractual terms.

The thirdfourth largest construction loan is also in the amount of $10.0 million of which $3.4$8.8 million hashad been disbursed as of September 30, 2017.2020. The loan was originated in March of 2017February 2019 and is a participation interest in a $24.0$30.0 million loan purchased from another financial institution. The proceeds are being used to construct a six story building with 150214 apartment units and 3,500 square feet of retail space.in Dover, New Jersey. The project was 34.3%approximately 98.0% complete as of September 30, 2017.2020. The loan is performing in accordance with its contractual terms.

The fourthfifth largest construction loan is in the amount of $10.0 million of which $624,000 has$8.8 million had been disbursed as of September 30, 2017. The2020. This loan was originated in April 2017February 2019 and is a participation interest in a $35.0$28.0 million loan purchasedparticipated from another financial institution. The proceeds are beingwere used to construct a 212198 unit residential apartment complex in Plainfield,Warren County, New Jersey. The project was 6.3%approximately 59.0% complete as of September 30, 2017.The loan is performing in accordance with contractual terms.

The fifth largest construction loan is in the amount of $8.4 million of which $6.1 million has been disbursed as of September 30, 2017. The loan was originated July of 2017 and is a participation interest in a $16.8 million loan purchased from another financial institution. The proceeds are being used to construct a 200 unit apartment complex in Aberdeen Township, New Jersey. The project was 72.8% complete as of September 30, 2017.2020. The loan is performing in accordance with its contractual terms.

Construction financing is generally considered to involve a higher degree of credit risk than long-term financing on improved, owner-occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction compared to the estimated costs, including interest, of construction and other assumptions. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the completed project loan-to-value ratio. Additionally, if the estimate of value proves to be inaccurate, we may be confronted with a project, when completed, having a value less than the loan amount. Furthermore, because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and costly to monitor.

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Multi-Family Residential and Commercial Real Estate Loans. At September 30, 2017,2020, multi-family residential and commercial real estate loans amounted in the aggregate to $149.2$171.0 million or 22.9%25.0% of the total loan portfolio.

The commercial real estate and multi-family residential real estate loan portfolio consists primarily of loans secured by small office buildings, strip shopping centers, small apartment buildings and other properties used for commercial and multi-family purposes located in the Company’s market area. At September 30, 2017,2020, the average commercial and multi-family real estate loan size was approximately $932,000. The$1.2 million. At September 30, 2020, the largest multi-family residential orrelationship consists of a participation interest in a $16.0 million commercial real estate loan at September 30, 2017 was a $11.9 million fixed-rate loan secured by 38-unit luxury condominiuma 70 unit residential building located in Brooklyn,Westfield, New York with retail space on the first floor.Jersey. The second largest multi-family residential or commercial real estate loan at September 30, 20172020 was a $6.8$11.5 million fixed-rate loan used to developsecured by a nine316 unit apartment building for student housingcomplex located in Philadelphia, PA.East Rutherford, New Jersey with retail space on the first floor. Substantially all of the properties securing the multi-family residential and commercial real estate loans are located in the Company’s primary lending area.

Although terms for commercial real estate and multi-family residential loans vary, our underwriting standards generally allow for terms up to 15 years with loan-to-value ratios of not more than 75%. Most of the loans are structured with balloon payments of 10 years or less and amortization periods of up to 25 years. Interest rates are either fixed or adjustable, based upon designated market indices such as theWall Street Journal prime rate plus a stipulated margin or,

with respect to our multi-family residential loans, the Average Contract Interest Rate for previously occupied houses as reported by the Federal Housing Finance Board. In addition, fees are charged to the borrower at the origination of the loan.

Commercial real estate and multi-family residential real estate lending involves different risks than single-family residential lending. These risks include larger loans to individual borrowers and loan payments that are dependent upon the successful operation of the project or the borrower’s business. These risks can be affected by supply and demand conditions in the project’s market area offor rental housing units, office and retail space and other commercial space. We attempt to minimize these risks by limiting loans to proven businesses, only considering properties with existing operating performance which can be analyzed, using conservative debt coverage ratios in our underwriting, and periodically monitoring the operation of the business or project and the physical condition of the property.

Various aspects of commercial and multi-family loan transactions are evaluated in an effort to mitigate the additional risk in these types of loans. In our underwriting procedures, consideration is given to the stability of the property’s cash flow history, future operating projections, current and projected occupancy levels, location and physical condition. Generally, we impose a debt service ratio (the ratio of net cash flows from operations before the payment of debt service to debt service) of not less than 120%. We also evaluate the credit and financial condition of the borrower, and if applicable, the guarantor. With respect to loan participation interests we purchase, we underwrite the loans as if we were the originating lender. Appraisal reports prepared by independent appraisers are reviewed by us prior to the closing of the loan.

During the past year,In recent years, the Company has shifted its emphasis to originate for portfolio more multi-family residential and commercial real estate loans, due to their higher yieldyields and shorter duration. Although some delinquencies have existedoccured with respect to these types of loans in our portfolio, no losses have been incurred over the past several years.

Consumer Lending Activities. We offer various types of consumer loans such as loans secured by deposit accounts and unsecured personal loans. Consumer loans are originated primarily through existing and walk-in customers and direct advertising. At September 30, 2017, $1.9 million, or 0.3% of the total loan portfolio consisted of consumer loans.

Consumer loans generally have higher interest rates and shorter terms than residential loans. However, consumer loans have additional credit risk due to the type of collateral securing the loan or in some cases the absence of collateral.

Commercial Business Loans. At September 30, 2017, commercial business consisted of one loan that amounted to $488,000. The Bank anticipates being able to originate2020, commercial business loans during fiscal year 2018.

amounted to $12.9 million, or 1.9% of our loan portfolio.

Commercial business loans are made to small to mid-sized businesses in our market area primarily to provide working capital. Small business loans may have adjustable or fixed rates of interest and generally have terms of three years or less but may be as long as 15 years. Our commercial business loans have historically been underwritten based on the creditworthiness of the borrower and generally require a debt service coverage ratio of at least 120%. In addition, we generally obtain personal guarantees from the principals of the borrower with respect to commercial business loans and frequently obtain real estate as additional collateral.

Consumer Lending Activities. We offer various types of consumer loans such as loans secured by deposit accounts and unsecured personal loans. Consumer loans are originated primarily through existing and walk-in customers and direct advertising. At September 30, 2020, $604,000, or 0.1% of the total loan portfolio consisted of consumer loans.

Consumer loans generally have higher interest rates and shorter terms than residential loans. However, consumer loans have additional credit risk due to the type of collateral securing the loan or in some cases the absence of collateral.

Loans to Financial Institutions. At September 30, 2020, we had one loan in the amount of $6.0 million to a financial institution.

Leases. The Company purchases small business equipment leases through a relationship with a local lender specializing in originating such loans. These leases are purchased based on the remaining cash flow’s present value on an agreed upon yield. This lender provides the servicing for the leases purchased.

Loan Approval Procedures and Authority. Our Board of Directors establishes the Bank’s lending policies and procedures. Our various lending policies are reviewed at least annually by our management team and the Board in order to consider modifications as a result of market conditions, regulatory changes and other factors.

The Company maintains separate loan approval committees with tiered levels of approvals.approval authority. The Management Loan Committee, comprised of the Chief Operating Officer (“COO”), the Chief Lending Officer (“CLO”),

the Chief Credit Officer (“CCO”), the Chief Financial Officer (“CFO”), the Compliance Risk Officer (“CRO”) and the Controller has lending approval authority of up to $3.0 million. The next tier in the approval process, with an approval range of $3.0 million to $5.0$7.5 million, is the President’s Loan committee, comprised of the Chief Executive Officer (”(“CEO”) and the COO. All loans in excess of $5.0$7.5 million must be presented to the full boardBoard of directorsDirectors for approval. All loans submitted to the top two tiers of approval must be recommended for approval by the Management Loan Committee. For single-familySingle-family residential loans originated for sale into the secondary market are processed through underwriting software and are reviewed for approval by two senior officers in the credit department

department.

Asset Quality

General. One of our key objectives has been, and continues to be, maintaining a high level of asset quality. In addition to maintaining credit standards for new originations which we believe are prudent, we are proactive in our loan monitoring, collection and workout processes in dealing with delinquent or problem loans. We have also retained an independent, third party to undertake periodic reviews of the credit quality of a random sample of new loans as well as all of our major loans on at least an annual basis.

Reports listing all delinquent accounts are generated and reviewed by management on a monthly basis. These reports include information regarding all loans 30 days or more delinquent as to principal and/or interest and all real estate owned properties and are provided to the Board of Directors. The procedures we take with respect to delinquencies vary depending on the nature of the loan, period and cause of delinquency and whether the borrower is habitually delinquent. When a borrower fails to make a required payment on a loan, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status. We generally send the borrower a written notice of non-payment after the loan is first past due. Our guidelines provide that telephone, written correspondence and/or face-to-face contact will be attempted to ascertain the reasons for delinquency and the prospects of repayment. When contact is made with the borrower at any time prior to foreclosure, we will attempt to obtain full payment, work out a repayment schedule with the borrower to avoid foreclosure or, in some instances, accept a deed in lieu of foreclosure. In the event payment is not then received or the loan is not otherwise satisfied, additional letters and telephone calls generally are made. If the loan is still not brought current or satisfied and it becomes necessary for us to take legal action, which typically occurs after a loan is 90 days or more delinquent, we will commence foreclosure proceedings against any real property that secures the loan. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before foreclosure sale, the property securing the loan generally is sold at foreclosure and, if purchased by us, becomes real estate owned. Since there has not been a significant increase in recent years in the one-to-four family residential loans that are 90 days past due, the Company was not adversely impacted by any recent government programs related to the foreclosure process.

On loans where the collection of principal or interest payments is doubtful, the accrual of interest income ceases (“non-accrual” loans). On loans 90 days or more past due as to principal and/or interest payments, our policy is to discontinue accruing additional interest and reverse any interest previously accrued. On occasion, this action may be taken earlier if the financial condition of the borrower raises significant concern with regard to his/her ability to service the debt in accordance with the terms of the loan agreement. Interest income is not accrued on these loans until the borrower’s financial condition and payment record demonstrate an ability to service the debt.

Property acquired by the Bank through foreclosure is initially recorded at the lower of cost, which is the carrying value of the loan, or fair value at the date of acquisition, which is fair value of the related assets at the date of foreclosure, less estimated costs to sell. Thereafter, if there is a further deterioration in value, we charge earnings for the diminution in value. The Bank’s policy is to obtain an appraisal on real estate subject to foreclosure proceedings prior to the time of foreclosure if the property is located outside the Company’s market area or consists of other than single-family residential property. We obtain re-appraisals on a periodic basis, generally on at least an annual basis, on foreclosed properties. We also conduct inspections on foreclosed properties.

We account for our impaired loans in accordance with generally accepted accounting principles. An impaired loan generally is one for which it is more likely than not, based on current information, that the lender will not collect all the amounts due under the contractual terms of the loan. Large groups of smaller balance, homogeneous loans are collectively evaluated for impairment. Loans collectively evaluated for impairment include smaller balance commercial real estate loans, residential real estate loans and consumer loans. These loans are evaluated as a group because they have

similar characteristics and performance experience. Larger commercial real estate, construction and land development and commercial business loans are individually evaluated for impairment on at least a quarterly basis by management. All loans classified as substandard as part of the loan review process or due to delinquency status are evaluated for potential impairment. There were $19.7$13.0 million of loans evaluated for impairment as of September 30, 20172020 (of which $10.7$10.5 million is related to one relationship), consisting of $8.7$8.5 million of construction and land development loans, $8.3$3.1 million of one-to-four family residential loans $2.3and $1.4 million of commercial real estate loans, $317,000 of multi-family residential loans and $10,000 of consumer loans. Although no specific allocations were applied to these loans, there were partial charge-offs totaling $2.0 million$144,000 incured during fiscal 2017.2020. As of September 30, 2017,2020, there were ninetwenty-one loans totaling $3.1$11.4 million designated as special mention loans consisting of eight non-residential real estate loans aggregating $10.0 million and thirteen single-family residential loans aggregating $1.4 million. As of September 30, 2019, there were twenty-one loans totaling $5.5 million designated as special mention loans, consisting of six non-residential real estate loans aggregating $1.5 million, one residential investment property aggregating $1.4$3.7 million and twofifteen single-family residential loans aggregating $275,000. As of September 30, 2016 there were five loans totaling $2.6 million designated as special mention loans, consisting of five single-family residential loans aggregating $1.7 million, two commercial real estate loans aggregating $943,000.

$1.8 million.

Federal regulations and our policies require that we utilize an internal asset classification system as a means of reporting problem and potential problem assets. We have incorporated an internal asset classification system, consistent with Federal banking regulations, as a part of our credit monitoring system. We currently classify problem and potential problem assets as “special mention”, “substandard,” “doubtful” or “loss” assets. 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 of 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.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are required to be designated “special mention.”

When an insured institution classifies one or more assets, or portions thereof, as “substandard” or “doubtful,” it is required that a general valuation allowance for loan losses be established for loan losses in accordance with established methodology. General valuation allowances represent loss allowances which have been established to recognize the inherent losses associated with lending activities, but which, unlike specific allocations, have not been allocated to particular problem assets. When an insured institution classifies one or more assets, or portions thereof, as “loss,” it is required to charge off such amount.

Our allowance for loan losses includes a portion which is allocated by type of loan, based primarily upon our periodic reviews of the risk elements within the various categories of loans. The specific components relate to certain impaired loans. The general components cover non-classified loans and are based on historical loss experience adjusted for qualitative factors in response to changes in risk and market conditions. Our management believes that, based on information currently available, the allowance for loan losses is maintained at a level which covers all known and inherent losses that are both probable and reasonably estimable at each reporting date. However, actual losses are dependent upon future events and, as such, further additions to the level of the allowance for loan losses may become necessary.

We review and classify assets on no less frequently than a quarterly basis and the Board of Directors is provided with reports on our classified and criticized assets. We classify assets in accordance with the management guidelines described above. At September 30, 20172020 and 2016,2019, we had no assets classified as “doubtful” or “loss” and $12.7$13.0 million and $14.6$15.5 million, respectively, of assets classified as “substandard.” In addition, there were $3.1$11.4 million and $2.6$5.5 million of loans designated as “special mention” as of September 30, 20172020 and 2016,2019, respectively. There was one loan totaling $1.4 million classified as non-performing included

In response to the current situation surrounding the COVID-19 pandemic, the Company is providing assistance to its customers in a variety of ways.   The Company  participated in the Paycheck Protection Program offered under the CARES Act as a Small Business Administration (“SBA”) lender. During the quarter ended June 30, 2020, we had originated 63 requests for Paycheck Protection Program (“PPP”) loans classified “special mention”totaling approximately $5.1 million. These loans were sold during the quarter ended September 30, 2020 at a net gain of $111,000.  We are working closely with our loan

customers to effectively manage our portfolio through the ongoing uncertainty surrounding the duration, impact and government response to the crisis.

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The CARES Act provided guidance around the modification of loans as a result of the COVID-19 pandemic, which outlined, among other criteria, that short-term modifications made on a good faith basis to borrowers who were current as defined under the CARES Act prior to any relief, are not TDRs. This includes short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers are considered current under the CARES Act and related regulatory guidance if they are less than 30 days past due on their contractual payments at the time a modification program is implemented. During the year ended September 30, 2020, the Company made COVID-19 pandemic related modifications on 160 loans aggregating to $149.7 million. All of these borrowers had resumed making payments as of September 30, 2016. See –“Construction2020. Loan modifications in accordance with the CARES Act and Land Development Lending”. See also -“Non-Performing Loansrelated regulatory guidance are still subject to an evaluation in regard to determining whether or not a loan is deemed to be impaired. Two participation interests in commercial real estate loans aggregating $10.0 million, or 1.5% of total loans, each entered into a subsequent deferral period during October 2020.  With respect to one of the two loan participations on deferral in the amount of $3.0 million, the Company was granted a put option as an integral part of the purchase of the participation from the lead lender. The Company has notified the lead lender that it is exercising the put option. These deferments were not considered to be TDRs as of September 30, 2020 as all applicable borrowers were current as of December 31, 2019 and Real Estate Owned.”the request for the deferments were related to the current economic conditions caused by the COVID-19 pandemic, and not by underlying weaknesses within the respective loans.

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Delinquent Loans. The following table shows the delinquencies in the loan portfolio as of the dates indicated.

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