ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements Are Subject to Change
We make certain statements in this document as to what we expect may happen in the future. These statements usually contain the words "believe," "estimate," "project," "expect," "anticipate," "intend" or similar expressions. Because these statements look to the future, they are based on our current expectations and beliefs. Actual results or events may differ materially from those reflected in the forward-looking statements. You should be aware that our current expectations and beliefs as to future events are subject to change at any time, and we can give you no assurances that the future events will actually occur.
General
The Company was formed in connection with the Bank's conversion to a stock savings bank completed on July 3, 2007. The Company's results of operations are dependent primarily on the results of the Bank, which is a wholly owned subsidiary of the Company. The Bank's results of operations depend, to a large extent, on net interest income, which is the difference between the income earned on its loan and investment portfolios and the cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by provisions for loan losses, fee income and other non-interest income and non-interest expense. Non-interest expense principally consists of compensation, directors' fees and expenses, office occupancy and equipment expense, data processing expense, professional fees, advertising expense, FDIC deposit insurance assessment, and other expenses. Our results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact our financial condition and results of operations.
At June 30, 2018, the Bank has five wholly-owned subsidiaries, Quaint Oak Mortgage, LLC, Quaint Oak Real Estate, LLC, Quaint Oak Abstract, LLC, QOB Properties, LLC, and Quaint Oak Insurance Agency, LLC, each a Pennsylvania limited liability company. The mortgage, real estate and abstract companies offer mortgage banking, real estate sales and title abstract services, respectively, in the Lehigh Valley region of Pennsylvania, and began operation in July 2009. QOB Properties, LLC began operations in July 2012 and holds Bank properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. Quaint Oak Insurance Agency, LLC began operations in August 2016 and provides a broad range of personal and commercial insurance coverage solutions.
Critical Accounting Policies
The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the consolidated financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. The following accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the period or in future periods.
Allowance for Loan Losses. The allowance for loan losses represents management's estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans receivable. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are designated as impaired. For loans that are designated as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are reevaluated quarterly to ensure their relevance in the current economic environment. Residential owner occupied mortgage lending generally entails a lower risk of default than other types of lending. Consumer loans and commercial real estate loans generally involve more risk of collectability because of the type and nature of the collateral and, in certain cases, the absence of collateral. It is the Company's policy to establish a specific reserve for loss on any delinquent loan when it determines that a loss is probable. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company's impaired loans are measured based on the estimated fair value of the loan's collateral.
A loan is identified as a troubled debt restructuring ("TDR") if the Company, for economic or legal reasons related to a debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. Concessions granted under a TDR typically involve a temporary or permanent reduction in payments or interest rate or an extension of a loan's stated maturity date at less than a current market rate of interest. Loans identified as TDRs are designated as impaired.
For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower's overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for all loans (except one-to-four family residential owner-occupied loans) where the total amount outstanding to any borrower or group of borrowers exceeds $500,000, or when credit deficiencies arise, such as delinquent loan payments. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans criticized special mention have potential weaknesses that deserve management's close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management's comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.
Income Taxes. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various assets and liabilities and net operating loss carryforwards and gives current recognition to changes in tax rates and laws. The realization of our deferred tax assets principally depends upon our achieving projected future taxable income. We may change our judgments regarding future profitability due to future market conditions and other factors. We may adjust our deferred tax asset balances if our judgments change.
Comparison of Financial Condition at June 30, 2018 and December 31, 2017
General. The Company's total assets at June 30, 2018 were $255.9 million, an increase of $16.3 million, or 6.8%, from $239.6 million at December 31, 2017. This growth in total assets was primarily due to a $10.3 million, or 130.3% increase in cash and cash equivalents, a $6.5 million, or 3.2%, increase in loans receivable, net, and a $1.7 million increase in other real estate owned, net, partially offset by a $1.8 million, or 25.8%, decrease in loans held for sale and a $575,000, or 7.3% decrease in investment securities available for sales. Asset growth was funded primarily by deposits which increased $15.8 million, or 8.5%, to $202.0 million at June 30, 2018 from $186.2 million at December 31, 2017.
Cash and Cash Equivalents. Cash and cash equivalents increased $10.3 million, or 130.3%, from $7.9 million at December 31, 2017 to $18.2 million at June 30, 2018 with the expectation that excess liquidity will be used to fund loans.
Investment Securities Available for Sale. Investment securities available for sale decreased $575,000, or 7.3%, from $7.9 million at December 31, 2017 to $7.3 million at June 30, 2018, due primarily to the principal repayments on these securities during the six months ended June 30, 2018.
Loans Held for Sale. Loans held for sale decreased $1.8 million, or 25.8%, from $7.0 million at December 31, 2017 to $5.2 million at June 30, 2018 as the Bank's mortgage banking subsidiary, Quaint Oak Mortgage, LLC, originated $43.4 million of one-to-four family residential loans during the six months ended June 30, 2018 and sold $45.1 million of loans in the secondary market during this same period. In addition, the Bank originated $1.5 million of equipment loans held for sale during the six months ended June 30, 2018 and sold $1.6 million of equipment loans during this same period.
Loans Receivable, Net. Loans receivable, net, increased $6.5 million, or 3.2%, to $208.2 million at June 30, 2018 from $201.7 million December 31, 2017. This increase was funded primarily from deposits and proceeds from the sale of loans held for sale. Increases within the portfolio occurred in commercial real estate loans which increased $4.8 million, or 5.2%, commercial business loans which increased $5.8 million, or 48.8%, multi-family residential loans which increased $1.9 million, or 9.0%, and one-to-four family residential owner occupied loans which increased $1.3 million, or 22.6%. These increases were partially offset by a $3.9 million, or 7.5%, decrease in one-to-four family residential non-owner occupied loans, a $2.6 million, or 16.5%, decrease in construction loans an $816,000, or 15.9%, decrease in home equity loans, and a $13,000, or 9.4%, decrease in other consumer loans. The Company continues its strategy of diversifying its loan portfolio with higher yielding and shorter-term loan products and selling substantially all of its newly originated one-to-four family owner-occupied loans into the secondary market.
Other Real Estate Owned. Other real estate owned (OREO) amounted to $1.7 million at June 30, 2018, consisting of one property. There were no properties in other real estate owned at December 31, 2017. During the quarter, collateral for a non-performing construction loan with an aggregate outstanding balance of $1.8 million at the time of foreclosure, was transferred into OREO. In conjunction with this transfer, $100,000 of the outstanding loan balance was charged-off through the allowance for loan losses. Non-performing assets amounted to $2.5 million, or 0.96% of total assets at June 30, 2018 compared to $3.1 million, or 1.28% of total assets at December 31, 2017.
Deposits. Total deposits increased $15.8 million, or 8.5%, to $202.0 million at June 30, 2018 from $186.2 million at December 31, 2017. This increase in deposits was primarily attributable to increases of $12.0 million, or 8.3%, in certificates of deposit, $3.9 million, or 49.2% in non-interest bearing checking accounts, and $444,000, or 1.5%, in money market accounts, partially offset by a $441,000, or 18.7% decrease in savings accounts and a $160,000, or 34.6% decrease in passbook accounts.
Stockholders' Equity. Total stockholders' equity increased $747,000, or 3.4%, to $22.9 million at June 30, 2018 from $22.2 million at December 31, 2017. Contributing to the increase was net income for the six months ended June 30, 2018 of $823,000, the reissuance of treasury stock for exercised stock options of $534,000, common stock earned by participants in the employee stock ownership plan of $96,000, amortization of stock awards and options under our stock compensation plans of $61,000, the reissuance of treasury stock under the Bank's 401(k) Plan of $40,000, and other comprehensive income, net of $11,000. These increases were partially offset by the purchase of treasury stock of $586,000 and by dividends paid of $232,000.
Comparison of Operating Results for the Three Months Ended June 30, 2018 and 2017
General. Net income amounted to $535,000 for the three months ended June 30, 2018, an increase of $11,000, or 2.1%, compared to net income of $524,000 for three months ended June 30, 2017. The increase in net income on a comparative quarterly basis was primarily the result of an increase in net interest income of $171,000, a decrease in the provision for income taxes of $104,000, and an increase in non-interest income of $59,000, partially offset by an increase in non-interest expense of $293,000 and an increase in the provision for loan losses of $30,000.
Net Interest Income. Net interest income increased $171,000, or 9.1%, to $2.1 million for the three months ended June 30, 2018 from $1.9 million for the three months ended June 30, 2017. The increase was driven by a $395,000, or 15.2%, increase in interest income, partially offset by a $224,000, or 31.3%, increase in interest expense.
Interest Income. Interest income increased $395,000, or 15.2%, to $3.0 million for the three months ended June 30, 2018 from $2.6 million for the three months ended June 30, 2017. The increase in interest income was primarily due to a $25.7 million increase in average loans receivable, net, including loans held for sale, which increased from an average balance of $187.9 million for the three months ended June 30, 2017 to an average balance of $213.6 million for the three months ended June 30, 2018, and had the effect of increasing interest income $345,000. The increase in interest income was also due to a $10.4 million increase in average cash and cash equivalents due from banks, interest bearing, which increased from an average balance of $6.7 million for the three months ended June 30, 2017 to an average balance of $17.1 million for the three months ended June 30, 2018, and had the effect of increasing interest income $27,000. Also contributing to this increase was a 64 basis point increase in the yield on average cash and cash equivalents due from banks, interest bearing, which increased from 1.02% for the three months ended June 30, 2017 to 1.66% for the three months ended June 30, 2018, which had the effect of increasing interest income $27,000.
Interest Expense. Interest expense increased $224,000, or 31.3%, to $939,000 for the three months ended June 30, 2018 from $715,000 for the three months ended June 30, 2017. The increase in interest expense was primarily attributable to a $28.2 million increase in average interest-bearing liabilities, which increased from an average balance of $189.0 million for the three months ended June 30, 2017 to an average balance of $217.2 million for the three months ended June 30, 2018, and had the effect of increasing interest expense $122,000. This increase in average interest-bearing liabilities was primarily attributable to an $18.7 million increase in average certificate of deposit accounts which increased from an average balance of $136.2 million for the three months ended June 30, 2017 to an average balance of $154.9 million for the three months ended June 30, 2018, and had the effect of increasing interest expense $81,000, and an $11.1 million increase in average Federal Home Loan Bank borrowings which increased from an average balance of $16.9 million for the three months ended June 30, 2017 to an average balance of $28.0 million for the three months ended June 30, 2018, and had the effect of increasing interest expense $45,000. Also contributing to this increase was a 22 basis point increase in the average rate on interest-bearing liabilities, from 1.51% for the three months ended June 30, 2017 to 1.73% for the three months ended June 30, 2018, which had the effect of increasing interest expense by $102,000. This increase in rate was primarily attributable to an 18 basis point increase in rate on average certificate of deposit accounts, which increased from 1.72% for the three months ended June 30, 2017 to 1.90% for the three months ended June 30, 2018, and had the effect of increasing interest expense by $68,000, and a 55 basis point increase in rate on average Federal Home Loan Bank borrowings, which increased from 1.44% for the three months ended June 30, 2017 to 1.99% for the three months ended June 30, 2018, which had the effect of increasing interest expense by $34,000.
Average Balances, Net Interest Income, 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. All average balances are based on daily balances.
| | Three Months Ended June 30, | |
| | 2018 | | | 2017 | |
| | | Average Balance | | | Interest | | | Average Yield/ Rate | | | Average Balance | | | Interest | | | Average Yield/ Rate | |
| | | (Dollars in thousands) | |
| Interest-earning assets: | | | |
| Due from banks, interest-bearing | | $ | 17,070 | | | $ | 71 | | | | 1.66 | % | | $ | 6,697 | | | $ | 17 | | | | 1.02 | % |
| Investment in interest-earning time deposits | | | 4,920 | | | | 22 | | | | 1.79 | | | | 5,361 | | | | 20 | | | | 1.49 | |
| Investment securities available for sale | | | 7,554 | | | | 37 | | | | 1.96 | | | | 9,102 | | | | 36 | | | | 1.58 | |
| Loans receivable, net (1) (2) (3) | | | 213,555 | | | | 2,849 | | | | 5.34 | | | | 187,863 | | | | 2,523 | | | | 5.37 | |
| Investment in FHLB stock | | | 1,246 | | | | 20 | | | | 6.42 | | | | 797 | | | | 8 | | | | 4.02 | |
| Total interest-earning assets | | | 244,345 | | | | 2,999 | | | | 4.91 | % | | | 209,820 | | | | 2,604 | | | | 4.96 | % |
| Non-interest-earning assets | | | 8,812 | | | | | | | | | | | | 9,034 | | | | | | | | | |
| Total assets | | $ | 253,157 | | | | | | | | | | | $ | 218,854 | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Passbook accounts | | $ | 329 | | | $ | * | | | | * | % | | $ | 721 | | | $ | * | | | | * | % |
| Savings accounts | | | 1,968 | | | | 1 | | | | 0.20 | | | | 1,437 | | | | 1 | | | | 0.28 | |
| Money market accounts | | | 31,948 | | | | 64 | | | | 0.80 | | | | 33,718 | | | | 67 | | | | 0.79 | |
| Certificate of deposit accounts | | | 154,925 | | | | 735 | | | | 1.90 | | | | 136,170 | | | | 586 | | | | 1.72 | |
| Total deposits | | | 189,170 | | | | 800 | | | | 1.69 | | | | 172,046 | | | | 654 | | | | 1.52 | |
| FHLB short-term borrowings | | | 10,000 | | | | 48 | | | | 1.92 | | | | 7,750 | | | | 21 | | | | 1.08 | |
| FHLB long-term borrowings | | | 18,000 | | | | 91 | | | | 2.02 | | | | 9,179 | | | | 40 | | | | 1.74 | |
| Total interest-bearing liabilities | | | 217,170 | | | | 939 | | | | 1.73 | % | | | 188,975 | | | | 715 | | | | 1.51 | % |
| Non-interest-bearing liabilities | | | 13,299 | | | | | | | | | | | | 8,406 | | | | | | | | | |
| Total liabilities | | | 230,469 | | | | | | | | | | | | 197,381 | | | | | | | | | |
| Stockholders' Equity | | | 22,688 | | | | | | | | | | | | 21,473 | | | | | | | | | |
| Total liabilities and Stockholders' Equity | | $ | 253,157 | | | | | | | | | | | $ | 218,854 | | | | | | | | | |
| Net interest-earning assets | | $ | 27,175 | | | | | | | | | | | $ | 20,845 | | | | | | | | | |
| Net interest income; average interest rate spread | | | | | | $ | 2,060 | | | | 3.18 | % | | | | | | $ | 1,889 | | | | 3.45 | % |
| Net interest margin (4) | | | | | | | | | | | 3.37 | % | | | | | | | | | | | 3.60 | % |
| Average interest-earning assets to average interest-bearing liabilities | | | | | | | | | | | 112.51 | % | | | | | | | | | | | 111.03 | % |
_______________
| (1) | Includes loans held for sale. |
| (2) | Includes non-accrual loans during the respective periods. Calculated net of deferred fees and discounts, loans in process and allowance for loan losses. |
| (3) | Includes tax free municipal leases with an aggregate average balance of $20,000 and an average yield of 3.63% for the three months ended June 30, 2018 and an aggregate average balance of $73,000 and an average yield of 4.04% for the three months ended June 30, 2017. The tax-exempt income from such loans has not been calculated on a tax equivalent basis. |
| (4) | Equals net interest income divided by average interest-earning assets. |
Provision for Loan Losses. The provision for loan losses increased $30,000, or 46.9%, from $64,000 for the three months ended June 30, 2017 to $94,000 for the three months ended June 30, 2018. The increase was based on an evaluation of the allowance relative to such factors as volume of the loan portfolio, concentrations of credit risk, prevailing economic conditions, prior loan loss experience and amount of non-performing loans at June 30, 2018.
Non-performing loans amounted to $785,000, or 0.38% of net loans receivable at June 30, 2018, consisting of five loans, three of which are on non-accrual status and two of which are 90 days or more past due and accruing interest. Comparably, non-performing loans amounted to $3.1 million, or 1.52% of net loans receivable at December 31, 2017, consisting of eleven loans, three of which were on non-accrual status and eight of which were 90 days or more past due and accruing interest. The non-performing loans at June 30, 2018 include three one-to-four family owner occupied residential loans, one construction loan, and one commercial real estate loan, and all are generally well-collateralized or adequately reserved for. During the quarter ended June 30, 2018, no new loans were placed on non-accrual status and one loan was transferred to other real estate owned. The allowance for loan losses as a percent of total loans receivable was 0.87% at June 30, 2018 and 0.89% at December 31, 2017.
Other real estate owned (OREO) amounted to $1.7 million at June 30, 2018, consisting of one property. There were no properties in other real estate owned at December 31, 2017. During the quarter, collateral for a non-performing construction loan with an aggregate outstanding balance of $1.8 million at the time of foreclosure, was transferred into OREO. In conjunction with this transfer, $100,000 of the outstanding loan balance was charged-off through the allowance for loan losses. Non-performing assets amounted to $2.5 million, or 0.96% of total assets at June 30, 2018 compared to $3.1 million, or 1.28% of total assets at December 31, 2017.
Non-Interest Income. Non-interest income increased $59,000, or 6.1%, from $961,000 for the three months ended June 30, 2017 to $1.0 million for the three months ended June 30, 2018 due primarily to a $70,000, or 47.6%, increase in mortgage banking and title abstract fees, a $67,000 decrease in loss on sales and write-downs on other real estate owned, a $30,000, or 150.0%, increase in other non-interest income, a $26,000, or 144.4%, increase in other fees and service charges, and a $14,000, or 15.7%, increase in insurance commissions earned by Quaint Oak Insurance Agency, a wholly owned insurance subsidiary of Quaint Oak Bank. These increases were partially offset by a $131,000, or 18.3%, decrease in net gain on loans held for sale, a $16,000 decrease in gain on the sale of SBA loans, and a $1,000, or 4.5%, decrease in income from bank-owned life insurance.
Non-Interest Expense. Non-interest expense increased $293,000, or 14.8%, from $2.0 million for the three months ended June 30, 2017 to $2.3 million for the three months ended June 30, 2018. Salaries and employee benefits expense accounted for $268,000 of the change as this expense increased 19.8%, from $1.4 million for the three months ended June 30, 2017 to $1.6 million for the three months ended June 30, 2018 due primarily to increased staff related to the continued expansion of the Company's mortgage banking and lending operations, and the expansion of our real estate agency subsidiary through the acquisition of a local real estate agency in August 2017. Also contributing to the increase was a $29,000, or 30.9%, increase in professional fees, a $15,000, or 38.5%, increase in advertising expense, a $7,000, or 8.1%, increase in data processing expense, a $3,000, or 7.0%, increase in FDIC insurance assessment, a $1,000, or 0.7%, increase in occupancy and equipment expense, and a $1,000, or 100.0%, increase in other real estate owned expense. These increases were partially offset by a $21,000, or 12.7%, decrease in other non-interest expense and a $10,000, or 20.0%, decrease in directors' fees and expenses.
Provision for Income Tax. The provision for income tax decreased $104,000, or 38.0%, from $274,000 for the three months ended June 30, 2017 to $170,000 for the three months ended June 30, 2018 as our effective tax rate decreased from 34.3% for the three months ended June 30, 2017 to 24.1% for the three months ended June 30, 2018 primarily due to the decrease in the Company's federal income tax rate from 34% in 2017 to 21% in 2018 as a result of the Tax Cuts and Jobs Act which was signed into law on December 22, 2017.
Comparison of Operating Results for the Six Months Ended June 30, 2018 and 2017
General. Net income amounted to $823,000 for the six months ended June 30, 2018, an increase of $128,000, or 18.4%, compared to net income of $695,000 for six months ended June 30, 2017. The increase in net income was primarily the result of increases in non-interest income of $444,000 and net interest income of $329,000, and a decrease in the provision for income taxes of $123,000, partially offset by an increase in non-interest expense of $709,000 and an increase in the provision for loan losses of $59,000.
Net Interest Income. Net interest income increased $329,000, or 8.9%, to $4.0 million for the six months ended June 30, 2018 from $3.7 million for the six months ended June 30, 2017 due primarily to a $715,000, or 14.0%, increase in interest income, partially offset by a $386,000, or 27.4%, increase in interest expense.
Interest Income. Interest income increased $715,000, or 14.0%, to $5.8 million for the six months ended June 30, 2018 from $5.1 million for the six months ended June 30, 2017. The increase in interest income was primarily due to a $25.9 million increase in average loans receivable, net, including loans held for sale, which increased from an average balance of $184.8 million for the six months ended June 30, 2017 to an average balance of $210.7 million for the six months ended June 30, 2018, and had the effect of increasing interest income $694,000. Partially offsetting this increase was an eight basis point decline in the yield on loans receivable, net, including loans held for sale, from 5.36% for the six months ended June 30, 2017 to 5.28% for the six months ended June 30, 2018, which had the effect of decreasing interest income by $89,000. The increase in interest income was also due to a $6.3 million increase in average cash and cash equivalents due from banks, interest bearing, which increased from an average balance of $8.4 million for the six months ended June 30, 2017 to an average balance of $14.7 million for the six months ended June 30, 2018, and had the effect of increasing interest income $30,000. Also contributing to this increase was a 69 basis point increase in the yield on average cash and cash equivalents due from banks, interest bearing, which increased from 0.95% for the six months ended June 30, 2017 to 1.64% for the six months ended June 30, 2018, which had the effect of increasing interest income by $51,000.
Interest Expense. Interest expense increased $386,000, or 27.4%, to $1.8 million for the six months ended June 30, 2018 from $1.4 million for the six months ended June 30, 2017. The increase in interest expense was primarily attributable to a $25.0 million increase in average interest-bearing liabilities, which increased from an average balance of $188.6 million for the six months ended June 30, 2017 to an average balance of $213.6 million for the six months ended June 30, 2018, and had the effect of increasing interest expense $210,000. This increase in average interest-bearing liabilities was primarily attributable to a $14.8 million increase in average certificate of deposit accounts which increased from an average balance of $137.0 million for the six months ended June 30, 2017 to an average balance of $151.8 million for the six months ended June 30, 2018, and had the effect of increasing interest expense $127,000, and an $11.8 million increase in average Federal Home Loan Bank borrowings which increased from an average balance of $16.2 million for the six months ended June 30, 2017 to an average balance of $28.0 million for the six months ended June 30, 2018, and had the effect of increasing interest expense $89,000. Also contributing to this increase was a 19 basis point increase in the average rate on interest-bearing liabilities, from 1.49% for the six months ended June 30, 2017 to 1.68% for the six months ended June 30, 2018, which had the effect of increasing interest expense by $176,000. This increase in rate was primarily attributable to a 14 basis point increase in rate on average certificate of deposit accounts, which increased from 1.71% for the six months ended June 30, 2017 to 1.85% for the six months ended June 30, 2018, and had the effect of increasing interest expense by $106,000, and a 58 basis point increase in rate on average Federal Home Loan Bank borrowings, which increased from 1.32% for the six months ended June 30, 2017 to 1.90% for the six months ended June 30, 2018, which had the effect of increasing interest expense by $70,000.
Average Balances, Net Interest Income, 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. All average balances are based on daily balances.
| | Six Months Ended June 30, | |
| | 2018 | | | 2017 | |
| | | Average Balance | | | Interest | | | Average Yield/ Rate | | | Average Balance | | | Interest | | | Average Yield/ Rate | |
| | | (Dollars in thousands) | |
| Interest-earning assets: | | | |
| Due from banks, interest-bearing | | $ | 14,754 | | | $ | 121 | | | | 1.64 | % | | $ | 8,453 | | | $ | 40 | | | | 0.95 | % |
| Investment in interest-earning time deposits | | | 4,903 | | | | 45 | | | | 1.84 | | | | 5,712 | | | | 46 | | | | 1.61 | |
| Investment securities available for sale | | | 7,681 | | | | 72 | | | | 1.87 | | | | 9,254 | | | | 65 | | | | 1.40 | |
| Loans receivable, net (1) (2) (3) | | | 210,708 | | | | 5,558 | | | | 5.28 | | | | 184,824 | | | | 4,953 | | | | 5.36 | |
| Investment in FHLB stock | | | 1,240 | | | | 38 | | | | 6.13 | | | | 755 | | | | 15 | | | | 3.97 | |
| Total interest-earning assets | | | 239,286 | | | | 5,834 | | | | 4.88 | % | | | 208,998 | | | | 5,119 | | | | 4.90 | % |
| Non-interest-earning assets | | | 8,741 | | | | | | | | | | | | 9,135 | | | | | | | | | |
| Total assets | | $ | 248,027 | | | | | | | | | | | $ | 218,133 | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Passbook accounts | | $ | 362 | | | $ | * | | | | * | % | | $ | 817 | | | $ | 1 | | | | 0.24 | % |
| Savings accounts | | | 1,986 | | | | 2 | | | | 0.20 | | | | 1,608 | | | | 2 | | | | 0.25 | |
| Money market accounts | | | 31,509 | | | | 125 | | | | 0.79 | | | | 33,000 | | | | 131 | | | | 0.79 | |
| Certificate of deposit accounts | | | 151,785 | | | | 1,402 | | | | 1.85 | | | | 136,961 | | | | 1,168 | | | | 1.71 | |
| Total deposits | | | 185,642 | | | | 1,529 | | | | 1.65 | | | | 172,386 | | | | 1,302 | | | | 1.51 | |
| FHLB short-term borrowings | | | 10,000 | | | | 84 | | | | 1.68 | | | | 7,429 | | | | 33 | | | | 0.89 | |
| FHLB long-term borrowings | | | 18,000 | | | | 182 | | | | 2.02 | | | | 8,789 | | | | 74 | | | | 1.68 | |
| Total interest-bearing liabilities | | | 213,642 | | | | 1,795 | | | | 1.68 | % | | | 188,604 | | | | 1,409 | | | | 1.49 | % |
| Non-interest-bearing liabilities | | | 11,858 | | | | | | | | | | | | 8,261 | | | | | | | | | |
| Total liabilities | | | 225,500 | | | | | | | | | | | | 196,865 | | | | | | | | | |
| Stockholders' Equity | | | 22,527 | | | | | | | | | | | | 21,268 | | | | | | | | | |
| Total liabilities and Stockholders' Equity | | $ | 248,027 | | | | | | | | | | | $ | 218,133 | | | | | | | | | |
| Net interest-earning assets | | $ | 25,644 | | | | | | | | | | | $ | 20,394 | | | | | | | | | |
| Net interest income; average interest rate spread | | | | | | $ | 4,039 | | | | 3.20 | % | | | | | | $ | 3,710 | | | | 3.41 | % |
| Net interest margin (4) | | | | | | | | | | | 3.38 | % | | | | | | | | | | | 3.55 | % |
| Average interest-earning assets to average interest-bearing liabilities | | | | | | | | | | | 112.00 | % | | | | | | | | | | | 110.81 | % |
_______________________
| (1) | Includes loans held for sale. |
| (2) | Includes non-accrual loans during the respective periods. Calculated net of deferred fees and discounts, loans in process and allowance for loan losses. |
| (3) | Includes tax free municipal leases with an aggregate average balance of $27,000 and an average yield of 4.23% for the six months ended June 30, 2018 and an aggregate average balance of $79,000 and an average yield of 4.03% for the six months ended June 30, 2017. The tax-exempt income from such loans has not been calculated on a tax equivalent basis. |
| (4) | Equals net interest income divided by average interest-earning assets. |
Provision for Loan Losses. The Company increased its provision for loan losses by $59,000, or 55.7%, from $106,000 for the six months ended June 30, 2017 to $165,000 for the six months ended June 30, 2018. As was the case for the quarter, the increase was based on an evaluation of the allowance relative to such factors as volume of the loan portfolio, concentrations of credit risk, prevailing economic conditions, prior loan loss experience and amount of non-performing loans. See additional discussion under "Comparison of Operating Results for the Three Months Ended June 30, 2018 and 2017-Provision for Loan Losses."
Non-Interest Income. Non-interest income increased $444,000, or 33.7%, for the six months ended June 30, 2018 over the comparable period in 2017 primarily due to a $126,000 net increase in gain on sales and write-downs on other real estate owned, an $82,000, or 10.0%, increase in net gain on loans held for sale, a $74,000, or 168.2%, increase in other fees and services charges, a $73,000, or 251.7%, increase in other non-interest income, a $69,000, or 26.7%, increase in mortgage banking and title abstract fees, a $16,000, or 9.6%, increase in insurance commissions earned by Quaint Oak Insurance Agency, a wholly owned insurance subsidiary of Quaint Oak Bank, and a $7,000, or 43.8%, increase in gain on sale of SBA loans. These increases were partially offset by a $3,000, or 6.8%, decrease in income from bank-owned life insurance.
Non-Interest Expense. Non-interest expense increased $709,000, or 18.3%, from $3.9 million for the six months ended June 30, 2017 to $4.6 million for the six months ended June 30, 2018. Salaries and employee benefits expense accounted for $619,000 of the change as this expense increased 23.2%, from $2.7 million for the six months ended June 30, 2017 to $3.3 million for the six months ended June 30, 2018 due primarily to increased staff related to the continued expansion of the Company's mortgage banking and lending operations, and the expansion of our real estate agency subsidiary through the acquisition of a local real estate agency in August 2017. Also contributing to the increase was a $46,000, or 34.6%, increase in data processing expense, a $30,000, or 38.5%, increase in advertising expense, a $17,000, or 5.6%, increase in other non-interest expense, a $6,000, or 2.1%, increase in occupancy and equipment expense, and a $6,000, or 6.9%, increase in FDIC insurance assessment. These increases were partially offset by an $8,000, or 7.8%, decrease in directors' fees and expenses, a $6,000, or 75.0%, decrease in other real estate owned expense, and a $1,000, or 0.5%, decrease in professional fees.
Provision for Income Tax. The provision for income tax decreased $123,000, or 35.3%, from $348,000 for the six months ended June 30, 2017 to $225,000 for the six months ended June 30, 2018 as our effective tax rate decreased from 33.4% for the six months ended June 30, 2017 to 21.5% for the six months ended June 30, 2018 primarily due to the decrease in the Company's federal income tax rate from 34% in 2017 to 21% in 2018 as a result of the Tax Cuts and Jobs Act, and an increase in a tax deduction taken related to the exercise of non-qualified stock options during this same period.
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, amortization and prepayment of loans and to a lesser extent, loan sales and other funds provided from operations. While scheduled principal and interest payments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company sets the interest rates on its deposits to maintain a desired level of total deposits. In addition, the Company invests excess funds in short-term interest-earning assets that provide additional liquidity. At June 30, 2018, the Company's cash and cash equivalents amounted to $18.2 million. At such date, the Company also had $1.6 million invested in interest-earning time deposits maturing in one year or less.
The Company uses its liquidity to fund existing and future loan commitments, to fund deposit outflows, to invest in other interest-earning assets and to meet operating expenses. At June 30, 2018, Quaint Oak Bank had outstanding commitments to originate loans of $12.8 million and commitments under unused lines of credit of $13.3 million.
At June 30, 2018, certificates of deposit scheduled to mature in less than one year totaled $47.7 million. Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case.
In addition to cash flow from loan payments and prepayments and deposits, the Company has significant borrowing capacity available to fund liquidity needs. If the Company requires funds beyond its ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Pittsburgh (FHLB), which provide an additional source of funds. As of June 30, 2018, we had $28.0 million of borrowings from the FHLB and had $125.2 million in borrowing capacity. Under terms of the collateral agreement with the FHLB of Pittsburgh, we pledge residential mortgage loans as well as Quaint Oak Bank's FHLB stock as collateral for such advances. In addition, as of June 30, 2018 Quaint Oak Bank had $850,000 in borrowing capacity with the Federal Reserve Bank of Philadelphia. There were no borrowings under this facility at June 30, 2018.
Our stockholders' equity amounted to $22.9 million at June 30, 2018, an increase of $747,000 million, or 3.4%, from $22.2 million at December 31, 2017. Contributing to the increase was net income for the six months ended June 30, 2018 of $823,000, the reissuance of treasury stock for exercised stock options of $534,000, common stock earned by participants in the employee stock ownership plan of $96,000, amortization of stock awards and options under our stock compensation plans of $61,000, the reissuance of treasury stock under the Bank's 401(k) Plan of $40,000, and other comprehensive income, net of $11,000. These increases were partially offset by the purchase of treasury stock of $586,000 and by dividends paid of $232,000. For further discussion of the stock compensation plans, see Note 10 in the Notes to Unaudited Consolidated Financial Statements contained elsewhere herein.
Quaint Oak Bank is required to maintain regulatory capital sufficient to meet tier 1 leverage, common equity tier 1 capital, tier 1 risk-based and total risk-based capital ratios of at least 4.00%, 4.50%, 6.00%, and 8.00%, respectively. At June 30, 2018, Quaint Oak Bank exceeded each of its capital requirements with ratios of 8.17%, 11.14%, 11.14 and 12.15%, respectively. As a small savings and loan holding company eligible for exemption, the Company is not currently subject to any regulatory capital requirements.
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers' requests for funding and take the form of loan commitments and lines of credit. Our exposure to credit loss from non-performance by the other party to the above-mentioned financial instruments is represented by the contractual amount of those instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. In general, we do not require collateral or other security to support financial instruments with off–balance sheet credit risk.
Commitments. At June 30, 2018, we had unfunded commitments under lines of credit of $13.3 million and $12.8 million of commitments to originate loans. We had no commitments to advance additional amounts pursuant to outstanding lines of credit or undisbursed construction loans.
Impact of Inflation and Changing Prices
The consolidated financial statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America which generally require the measurement of financial position and operating results in terms of historical dollars, without considering changes in relative purchasing power over time due to inflation. Unlike most industrial companies, virtually all of the Company's assets and liabilities are monetary in nature. As a result, interest rates generally have a more significant impact on the Company's performance than does the effect of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the "Exchange Act")) as of June 30, 2018. Based on their evaluation of the Company's disclosure controls and procedures, the Company's Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and regulations are operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the second fiscal quarter of fiscal 2018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business, which involve amounts in the aggregate believed by management to be immaterial to the financial condition and operating results of the Company.
Not applicable.
| ITEM 2. | UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS |
(a) Not applicable.
(b) Not applicable.
(c) Purchases of Equity Securities
The Company's repurchases of its common stock made during the quarter ended June 30, 2018 are set forth in the table below:
| Period | | Total Number of Shares Purchased | | | Average Price Paid per Share | | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | | Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs (1) | |
| April 1, 2018 – April 30, 2018 | | | 5,000 | | | $ | 13.14 | | | | 5,000 | | | | 14,344 | |
| May 1, 2018 – May 31, 2018 | | | 19,210 | | | | 13.07 | | | | - | | | | 14,344 | |
| June 1, 2018 – June 30, 2018 | | | - | | | | - | | | | - | | | | 14,344 | |
| Total | | | 24,210 | | | $ | 13.08 | | | | 5,000 | | | | 14,344 | |
Notes to this table:
| (1) | On February 21, 2014, the Board of Directors of Quaint Oak Bancorp approved its fourth share repurchase program which provides for the repurchase of up to 69,432 shares (adjusted to reflect the two-for-one stock split), or approximately 2.5% of the Company's then issued and outstanding shares of common stock, and announced the fourth repurchase program on Form 8-K filed on February 26, 2014. The repurchase program does not have an expiration date. |
| ITEM 3. | DEFAULTS UPON SENIOR SECURITIES |
Not applicable.
| ITEM 4. | MINE SAFETY DISCLOSURES |
Not applicable.
Not applicable.
| No. | | Description |
| | |
| | |
| | | |
| 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. | |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Date: August 13, 2018 | By: | /s/Robert T. Strong |
| | | Robert T. Strong President and Chief Executive Officer |
| | | |
| | | |
| | | |
Date: August 13, 2018 | By: | /s/John J. Augustine |
| | | John J. Augustine Executive Vice President and Chief Financial Officer |
