FSB Bancorp 10-Q 2018 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2018

OR

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

For the transition period from _______ to _______

FSB BANCORP, INC.

(Exact Name of Company as Specified in its Charter)

Maryland	001-37831	81-2509654
(State of Other Jurisdiction of Incorporation)	(Commission File No.)	(I.R.S. Employer Identification No.)

45 South Main Street, Fairport, NY 14450

(Address of Principal Executive Office) (Zip Code)

(585) 381-4040

(Issuer's Telephone Number including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YESx      NO¨

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this Chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

YESx      NO¨

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

Large accelerated filer        ¨	Accelerated filer        ¨
Non-accelerated filer          x	Smaller reporting company        x
	Emerging growth company        x

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

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

As of November 12, 2018, there were 1,943,253 shares issued and outstanding of the registrant’s common stock.

FSB BANCORP, INC.

INDEX

		PAGE NO.
PART I - FINANCIAL INFORMATION
Item 1.	Consolidated Financial Statements (Unaudited)
	Consolidated Balance Sheets	3
	Consolidated Statements of Operations/Income	4-5
	Consolidated Statements of Comprehensive Income (Loss)	6-7
	Consolidated Statements of Stockholders’ Equity	8
	Consolidated Statements of Cash Flows	9
	Notes to Consolidated Financial Statements	10-30
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	31-47
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	47
Item 4.	Controls and Procedures	47-48
PART II - OTHER INFORMATION		48-49
Item 1.	Legal Proceedings	48
Item 1A.	Risk Factors	48
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	48
Item 3.	Defaults upon Senior Securities	48
Item 4.	Mine Safety Disclosures	48
Item 5.	Other information	48
Item 6.	Exhibits	49
SIGNATURES		50

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PART I - FINANCIAL INFORMATION

Item 1 – Consolidated Financial Statements

FSB Bancorp, Inc.

Consolidated Balance Sheets

(Unaudited)

	September 30,			December 31,
(In thousands, except share and per share data)	2018			2017
ASSETS:
Cash and due from banks	$	1,648		$	1,672
Interest earning demand deposits		4,317			8,725
Total cash and cash equivalents		5,965			10,397
Available-for-sale securities, at fair value		17,027			18,313
Held-to-maturity securities, at amortized cost (fair value of $6,265 and $6,588, respectively)		6,335			6,575
Investment in restricted stock, at cost		3,725			3,270
Loans held for sale		4,662			2,770
Loans		280,551			263,972
Less: Allowance for loan losses		(1,486	)		(1,261	)
Loans receivable, net		279,065			262,711
Bank owned life insurance		3,804			3,758
Accrued interest receivable		936			824
Premises and equipment, net		2,853			3,064
Other assets		2,771			2,700
Total assets	$	327,143		$	314,382
LIABILITIES AND STOCKHOLDERS' EQUITY:
Deposits:
Non-interest bearing	$	10,657		$	8,385
Interest bearing		208,727			208,306
Total deposits		219,384			216,691
Short-term borrowings		14,550			13,000
Long-term borrowings		59,246			51,447
Official bank checks		1,274			929
Other liabilities		1,371			1,259
Total liabilities		295,825			283,326
Stockholders' equity:
Preferred stock – par value $0.01; 25,000,000 shares authorized, no shares issued and outstanding		-			-
Common stock, par value $0.01; 50,000,000 authorized shares; 1,943,253 and 1,934,853 shares issued and outstanding, respectively		19			19
Paid-in capital		15,702			15,441
Retained earnings		16,169			16,077
Accumulated other comprehensive loss		(282	)		(165	)
Unearned ESOP shares, at cost		(290	)		(316	)
Total stockholders’ equity		31,318			31,056
Total liabilities and stockholders' equity	$	327,143		$	314,382

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

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FSB Bancorp, Inc.

Consolidated Statements of Operations

(Unaudited)

	For the three			For the three
	months ended			months ended
(In thousands, except per share data)	September 30, 2018			September 30, 2017
Interest and dividend income:
Loans, including fees	$	3,023		$	2,621
Securities:
Taxable		105			80
Tax-exempt		26			27
Mortgage-backed securities		28			26
Other		14			11
Total interest and dividend income		3,196			2,765
Interest expense:
Interest on deposits		689			482
Interest on short-term borrowings		43			23
Interest on long-term borrowings		328			218
Total interest expense		1,060			723
Net interest income		2,136			2,042
Provision for loan losses		75			84
Net interest income after provision for loan losses		2,061			1,958
Other income:
Service fees		38			43
Fee income		36			34
Increase in cash surrender value of bank owned life insurance		16			16
Realized gain on sale of loans		461			650
Mortgage fee income		218			244
Other		47			44
Total other income		816			1,031
Other expense:
Salaries and employee benefits		1,711			1,712
Occupancy		268			273
Data processing costs		119			80
Advertising		24			28
Equipment		129			135
Electronic banking		26			29
Directors’ fees		46			65
Mortgage fees and taxes		229			78
FDIC premium expense		31			25
Audits and tax services		70			44
Other		283			243
Total other expenses		2,936			2,712
Income (loss) before income taxes		(59	)		277
Provision (benefit) for income taxes		(9	)		98
Net income (loss)	$	(50	)	$	179
Earnings (loss) per common share – basic and diluted	$	(0.03	)	$	0.09

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

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FSB Bancorp, Inc.

Consolidated Statements of Income

(Unaudited)

	For the nine		For the nine
	months ended		months ended
(In thousands, except per share data)	September 30, 2018		September 30, 2017
Interest and dividend income:
Loans, including fees	$	8,736	$	7,429
Securities:
Taxable		296		219
Tax-exempt		78		84
Mortgage-backed securities		103		80
Other		35		35
Total interest and dividend income		9,248		7,847
Interest expense:
Interest on deposits		1,855		1,282
Interest on short-term borrowings		127		64
Interest on long-term borrowings		841		631
Total interest expense		2,823		1,977
Net interest income		6,425		5,870
Provision for loan losses		225		196
Net interest income after provision for loan losses		6,200		5,674
Other income:
Service fees		107		121
Fee income		109		137
Increase in cash surrender value of bank owned life insurance		46		47
Realized gain on sale of loans		1,098		1,667
Mortgage fee income		588		613
Other		151		134
Total other income		2,099		2,719
Other expense:
Salaries and employee benefits		4,903		4,825
Occupancy		822		801
Data processing costs		323		250
Advertising		116		122
Equipment		412		418
Electronic banking		84		64
Directors’ fees		151		195
Mortgage fees and taxes		344		198
FDIC premium expense		81		77
Audits and tax services		165		137
Other		782		763
Total other expenses		8,183		7,850
Income before income taxes		116		543
Provision for income taxes		24		145
Net income	$	92	$	398
Earnings per common share – basic and diluted	$	0.05	$	0.21

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

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Consolidated Statements of Comprehensive Income (Loss)

(Unaudited)

	For the three months ended
(In thousands)	September 30,  2018			September 30,  2017
Net Income (Loss)	$	(50	)	$	179
Other Comprehensive Income (Loss)
Unrealized holding losses on available-for-sale securities
Unrealized holding losses arising during the period		(25	)		(8	)
Net unrealized loss on available for sale securities		(25	)		(8	)
Other comprehensive loss, before tax		(25	)		(8	)
Tax effect		(5	)		(3	)
Other comprehensive loss, net of tax		(20	)		(5	)
Comprehensive income (loss)	$	(70	)	$	174
Tax Effect Allocated to Each Component of Other Comprehensive Income (Loss)
Unrealized holding losses arising during the period	$	(5	)	$	(3	)
Income tax effect related to other comprehensive loss	$	(5	)	$	(3	)

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

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Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
	For the nine months ended
(In thousands)	September 30,  2018			September 30,  2017
Net Income	$	92		$	398
Other Comprehensive Income (Loss)
Unrealized holding gains (losses) on available-for-sale securities
Unrealized holding gains (losses) arising during the period		(148	)		21
Net unrealized gain (loss) on available for sale securities		(148	)		21
Other comprehensive income (loss), before tax		(148	)		21
Tax effect		(31	)		7
Other comprehensive income (loss), net of tax		(117	)		14
Comprehensive income (loss)	$	(25	)	$	412
Tax Effect Allocated to Each Component of Other Comprehensive Income (Loss)
Unrealized holding gains (losses) arising during the period	$	(31	)	$	7
Income tax effect related to other comprehensive income (loss)	$	(31	)	$	7

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

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FSB Bancorp, Inc.

Consolidated Statements of Stockholders’ Equity

(Unaudited)

										Accumulated Other
	Common			Paid in			Retained			Comprehensive			Unearned
(In thousands, except share and per share data)	Stock			Capital			Earnings			Loss			ESOP			Total
Balance, January 1, 2018	$	19		$	15,441		$	16,077		$	(165	)	$	(316	)	$	31,056
Net income		-			-			92			-			-			92
Other comprehensive loss, net of tax		-			-			-			(117	)		-			(117	)
ESOP shares committed to be released		-			30			-			-			26			56
Stock based compensation		-			231			-			-			-			231
Balance, September 30, 2018	$	19		$	15,702		$	16,169	��	$	(282	)	$	(290	)	$	31,318
Balance, January 1, 2017	$	19		$	16,352		$	15,839		$	(85	)	$	(350	)	$	31,775
Net income		-			-			398			-			-			398
Other comprehensive income, net of tax		-			-			-			14			-			14
ESOP shares committed to be released		-			13			-			-			26			39
Effect of stock repurchase plan		(1	)		(1,051	)		-			-			-			(1,052	)
Balance, September 30, 2017	$	18		$	15,314		$	16,237		$	(71	)	$	(324	)	$	31,174

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

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FSB Bancorp, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

	For the Nine Months Ended September 30,
(In thousands)	2018			2017
OPERATING ACTIVITIES
Net income	$	92		$	398
Adjustments to reconcile net income to net cash flows from operating activities:
Net amortization of premiums and accretion of discounts on investments		68			105
Gain on sale of loans		(1,098	)		(1,667	)
Proceeds from loans sold		46,229			54,668
Loans originated for sale		(47,023	)		(55,122	)
Amortization of net deferred loan origination costs		369			339
Depreciation and amortization		338			334
Provision for loan losses		225			196
Expense related to ESOP		56			39
Stock based compensation		231			-
Deferred income tax benefit		(12	)		(98	)
Earnings on investment in bank owned life insurance		(46	)		(47	)
Increase in accrued interest receivable		(112	)		(146	)
Increase in other assets		(71	)		(594	)
Increase (Decrease) in other liabilities		156			(214	)
Net cash flows from operating activities		(598	)		(1,809	)
INVESTING ACTIVITIES
Purchases of securities available-for-sale		(500	)		(7,533	)
Proceeds from maturities and calls of securities available-for-sale		-			3,500
Proceeds from principal paydowns on securities available-for-sale		1,591			2,667
Purchases of securities held-to-maturity		(415	)		(335	)
Proceeds from maturities and calls of securities held-to-maturity		460			715
Proceeds from principal paydowns on securities held-to-maturity		173			96
Net increase in loans		(16,948	)		(27,448	)
Purchase of restricted stock, net		(455	)		(612	)
Purchase of premises and equipment		(127	)		(331	)
Net cash flows from investing activities		(16,221	)		(29,281	)
FINANCING ACTIVITIES
Net increase in deposits		2,693			16,619
Proceeds from long-term borrowings		25,500			16,500
Repayments on long-term borrowings		(17,701	)		(12,290	)
Proceeds on short-term borrowings, net		1,550			8,500
Net increase in official bank checks		345			2,357
Effect of stock repurchase plan		-			(1,052	)
Net cash flows from financing activities		12,387			30,634
Change in cash and cash equivalents		(4,432	)		(456	)
Cash and cash equivalents at beginning of period		10,397			7,407
Cash and cash equivalents at end of period	$	5,965		$	6,951
CASH PAID DURING THE PERIOD FOR:
Interest	$	2,761		$	1,962
Income taxes	$	262		$	49

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

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Notes to Consolidated Financial Statements (Unaudited)

Note 1:   Basis of Presentation

The accompanying unaudited consolidated financial statements of FSB Bancorp, Inc. (“FSB Bancorp”), Fairport Savings Bank (the “Bank”), and its other wholly owned subsidiary, Fairport Wealth Management (collectively, the “Company”), have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions for Form 10-Q and Article 8 of Regulation S-X. Accordingly, they do not include all of the information and footnotes necessary for a complete presentation of consolidated financial condition, results of operations and cash flows in conformity with generally accepted accounting principles. In the opinion of management, all adjustments, consisting of normal recurring accruals considered necessary for a fair presentation, have been included. The results are not necessarily indicative of the results that may be expected for the year ending December 31, 2018 or for any future period.

The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available. When third party information is not available, valuation adjustments are estimated in good faith by management.

Note 2:   Change in Accounting Estimate

In conjunction with the filing of the 2017 New York State income tax return and based on challenges encountered with respect to the ongoing mortgage recording tax examinations, the Company believes at this time that it is important to record a valuation percentage lower than 0.25% against all mortgage loans eligible for the special additional mortgage recording tax credit and believes that it is appropriate to adjust the outstanding balance of previously recorded special additional mortgage recording tax credits. The Company made this election on September 30, 2018 and its impact was as follows:

Income from continuing operations $(159,000)

Net Income $(126,000)

Net income per share for the three months ended September 30, 2018 $(0.07)

Net income per share for the nine months ended September 30, 2018 $(0.06)

Note 3:   New Accounting Pronouncements

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606) and subsequent updates. This ASU clarifies the principles for recognizing revenue and develops a common standard for U.S. GAAP and International Financial Reporting Standards. The ASU establishes a core principle that requires an entity to identify the contract(s) with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the entity satisfies a performance obligation. The ASU provides for improved disclosure requirements that require entities to disclose sufficient financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The Company adopted the guidance effective January 1, 2018 using the modified retrospective method. The Company’s revenue is the sum of net interest income and non-interest income. The scope of the guidance excludes nearly all net interest income as well as many other revenues for financial assets and liabilities including loans, leases, securities, and derivatives. The Company completed its review and determined that the majority of non-interest income revenue streams are within the scope of the new standard. Non-interest income streams that are out of scope of the new standard include BOLI, sales of investment securities, mortgage banking activities, and certain items within service charges and other income. Management reviewed contracts related to service charges on deposits, investment advisory commissions and fee income, insurance commission and fee income, and certain items within other service charges and other income. The Company evaluated the impact of this ASU on the Company’s various revenue streams and, upon adoption on January 1, 2018 and going forward, does not anticipate a material impact to the consolidated financial statements. The Company has included applicable disclosures regarding revenue recognition within Note 10 of these consolidated financial statements.

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In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Liabilities. The amendments in this update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments in this update require all equity investments to be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under equity method of accounting or those that result in consolidation of the investee). The amendments in this update also require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, the amendments in this update also simplify the impairment assessment of equity investments without readily determinable fair values by requiring assessment for impairment qualitatively at each reporting period. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods with those fiscal years. The adoption had no impact on the consolidated financial statements and only impacted fair value measurement disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This new guidance supersedes the lease requirements in Topic 840, Leases and is based on the principle that a lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The accounting applied by a lessor is largely unchanged from that applied under the previous guidance. In addition, the guidance requires an entity to separate the lease components from the nonlease components in a contract. The ASU requires disclosures about the amount, timing, and judgments related to a reporting entity's accounting for leases and related cash flows. The standard is required to be applied to all leases in existence as of the date of adoption using a modified retrospective transition approach. This guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted for all companies in any interim or annual period. The Company occupies certain offices and uses certain equipment under non-cancelable operating lease agreements, which currently are not reflected in its consolidated statement of condition. The Company expects to recognize lease liabilities and right of use assets associated with these lease agreements; however, the extent of the impact on the Company's consolidated financial statements is currently under evaluation.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326). This new guidance significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This ASU will replace the "incurred loss" model under existing guidance with an "expected loss" model for instruments measured at amortized cost, and require entities to record allowances for available-for-sale debt securities rather than reduce the carrying amount, as they do today under the other-than-temporary impairment model. This ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. This guidance requires adoption through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is adopted. This ASU is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for all companies as of fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact the guidance will have on the Company's consolidated financial statements, and expects an increase in the allowance for credit losses resulting from the change to expected losses for the estimated life of the financial asset, including an allowance for debt securities. The amount of the increase in the allowance for credit losses resulting from the new guidance will be impacted by the portfolio composition and asset quality at the adoption date, as well as economic conditions and forecasts at the time of adoption.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230). The amendments provide guidance on the following eight specific cash flow issues: 1) debt prepayment or debt extinguishment costs; 2) settlement of zero-coupon debt instruments or other debt instruments with coupon interest rates that are insignificant in relation to the effective interest rate of the borrowing; 3) contingent consideration payments made after a business combination; 4) proceeds from the settlement of insurance claims; 5) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; 6) distributions received from equity method investees; 7) beneficial interests in securitization transactions; and 8) separately identifiable cash flows and application of the predominance principle. This ASU is effective for fiscal years beginning after December 31, 2017, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. The Company adopted the amendment in this update during the three months ended March 31, 2018 and noted no material impact to the consolidated financial statements.

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In March 2017, the FASB issued an Update (ASU 2017-08) to its guidance on “Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20) related to premium amortization on purchased callable debt securities. The amendments in this Update shorten the amortization period for certain callable debt securities held at a premium.  Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.  For public business entities, the amendments in this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  Early adoption is permitted, including adoption in an interim period.  If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period.  An entity should apply the amendments in this Update on a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption.  Additionally, in the period of adoption, an entity should provide disclosure about a change in accounting principle.  The adoption of this guidance is not expected to have a material impact on our consolidated results of operations or financial position.

In May 2018, the FASB issued ASU No. 2018-06,Codification Improvements to Topic 942, Financial Services - Depository and Lending. This update superseded outdated guidance related to the Office of the Comptroller of the Currency’s Banking Circular 202, Accounting for Net Deferred Tax Charges. The Company does not expect the new guidance to have a material impact on the consolidated financial statements.

In June 2018, the FASB issued ASU No. 2018-07,Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. This update expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. As a result, nonemployee share-based payment awards will be measured at the grant-date fair value of the equity instruments that an entity is obligated to issue when the service has been rendered, subject to the probability of satisfying performance conditions when applicable. For public entities, this update is effective for fiscal years beginning after December 15, 2018. The Company does not expect the new guidance to have a material impact on the consolidated financial statements.

In June 2018, the FASB issued ASU No. 2018-08,Not for Profit Entities (Topic 958): Clarifying the Scope and the Accounting Guidance for Contributions Received and Contributions Made. This update clarifies the guidance about whether a transfer of assets (or the reduction, settlement or cancellation of liabilities) is a contribution or an exchange transaction. In addition, the guidance clarifies the determination of whether a transaction is conditional. For public entities, this update is effective for contributions made in fiscal years beginning after December 15, 2018. The Company does not expect the new guidance to have a material impact on the consolidated financial statements.

In July 2018, the FASB issued ASU No. 2018-09,Codification Improvements to address stakeholder suggestions for minor corrections and clarifications within the codification. The transition and effective date guidance is based on the facts and circumstances of each amendment. Some of the amendments in this update do not require transition guidance and will be effective upon issuance of this update. However, many of the amendments in this update do have transition guidance with effective dates for annual periods beginning after December 15, 2018, for public business entities. The Company does not expect the new guidance to have a material impact on the consolidated financial statements.

In July 2018, the FASB issued ASU No. 2018-10,Codification Improvements to Topic 842. Leases to address certain narrow aspects of the guidance issued in ASU No. 2016-02. This guidance did not change the Company’s assessment of the impact of ASU No. 2016-02 on the consolidated financial statements as described above.

In July 2018, the FASB issued ASU No. 2018-11,Leases (Topic 842): Targeted Improvements, which amends FASB Accounting Standards Codification (ASC) Topic 842,Leases, to (1) add an optional transition method that would permit entities to apply the new requirements by recognizing a cumulative-effect adjustment to the opening balance of retained earnings in the year of adoption, and (2) provide a practical expedient for lessors regarding the separation of the lease and non-lease components of a contract. This guidance did not change the Company’s assessment of the impact of ASU No. 2016-02 on the consolidated financial statements as described above.

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In August 2018, the FASB has issued Accounting Standards Update (ASU) No. 2018-15, Intangibles—Goodwill and Other—Internal Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, a consensus of the FASB Emerging Issues Task Force, which amends the FASB Accounting Standards Codification (ASC) to provide guidance on accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. In April 2015, the FASB issued ASU No. 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Fees Paid in a Cloud Computing Arrangement, which provided guidance to customers concerning whether a cloud computing arrangement (e.g., software, platform, or infrastructure offered as a service) includes a software license. Pursuant to that guidance, (1) if a cloud computing arrangement includes a software license, the software license element of the arrangement should be accounted for in a manner consistent with the acquisition of other software licenses, or (2) if the arrangement does not include a software license, then the arrangement should be accounted for as a service contract, with the fees associated with the hosting element (service) of the arrangement expensed as they are incurred.

Following the issuance of ASU No. 2015-05, constituents requested that the FASB provide additional guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. Accordingly, because United States generally accepted accounting principles (U.S. GAAP) do not contain explicit guidance on accounting for such costs, and to address the resulting diversity in practice, the FASB has issued ASU No. 2018-15 to align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). Note that the guidance on accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in ASU No. 2018-15.

For Public Business Entities, the amended guidance is effective for fiscal years beginning after December 15, 2019 (i.e., calendar-year 2020), and for interim periods within those fiscal years.

In October 2018, the FASB issued Accounting Standards Update (ASU) No. 2018-16 , Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes , which adds the SOFR OIS as a benchmark rate that businesses can use to designate hedges of interest rate risk. This update adds to U.S. GAAP a new interest rate from the market for U.S. Treasury repurchase contracts to the list of accepted benchmark rates for hedge accounting. The SOFR is calculated by the Fed based on the interest rates banks charge one another in the overnight market for loans they make to one another, typically called repurchase agreements. In introducing the new rate, the Fed said that because it is based on transactions in the open market, it is more reflective of market conditions than LIBOR, which relies more on judgment. Adding the SOFR OIS as an acceptable hedge accounting benchmark for U.S. GAAP is considered a critical step in helping it gain more acceptance in the market. FASB ASC 815 provides guidance on the risks associated with financial assets or liabilities that are allowed to be hedged. Among those risks is the risk of changes in fair values or cash flows of existing or forecasted issuances or purchases of fixed-rate financial assets or liabilities attributable to a designated benchmark interest rate. U.S. GAAP considers a benchmark rate as a rate that is widely recognized, commonly referenced, and quoted in an active financial market. FASB ASC 815 lists three rates as benchmarks: the rate on direct Treasury obligations of the U.S. government, the Fed Funds Effective Swap Rate (Overnight Index Swap Rate), and the LIBOR swap rate. In 2017, the FASB added a fourth rate, the Securities Industry and Financial Markets Association (SIFMA) Municipal Swap Rate when it published ASU No. 2017-12 , Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, which made several other changes to simplify hedge accounting and expand its use. The FASB wants businesses and organizations to adopt the amendments in ASU No. 2018-16 at the same time they adopt the changes in ASU No. 2017-12 . For public companies that have adopted ASU No. 2017-12, the new amendments are effective for fiscal years beginning after December 15 and interim periods within those fiscal years. For other companies and organizations that already have adopted ASU No. 2017-12 , the new amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted in any interim period as long as the company or organization already has adopted the broader 2017 hedge accounting update.

- 13 - 

Note 4:   Earnings per Common Share

Basic earnings per share is calculated by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Net income available to common stockholders is net income to FSB Bancorp, Inc. Diluted earnings per share is calculated in a manner similar to that of basic earnings per share except that the weighted average number of common shares outstanding is increased to include the number of incremental common shares that would have been outstanding under the treasury stock method if all potentially dilutive common shares (such as stock options) issued became vested during the period. There is no impact on earnings per share because no stock options have vested as of September 30, 2018. On September 27, 2017, the Board of Directors of the Company approved restricted stock and stock option grants to senior management and the directors of the Company, pursuant to the terms of the 2017 Equity Incentive Plan (the “Plan”). The Plan was approved previously by the Company’s stockholders on August 29, 2017. An aggregate of 20,000 stock options and 8,400 shares of restricted stock were granted to senior management during the nine months ended September 30, 2018. The grants to senior management vest over a five year period in equal annual installments, with the first installment vesting on the first anniversary date of the grant and succeeding installments on each anniversary thereafter, through 2023. The Company did not grant any restricted stock awards or stock options during the nine months ended September 30, 2017. Unallocated common shares held by the ESOP are not included in the weighted average number of common shares outstanding for purposes of calculating earnings per common share until they are committed to be released.

The following tables set forth the calculation of basic and diluted earnings per share.

	Three months ended
	September 30,
(In thousands, except per share data)	2018			2017
Basic and Diluted Earnings (Loss) Per Common Share
Net income (loss) available to common stockholders	$	(50	)	$	179
Weighted average common shares outstanding		1,911			1,889
Earnings (Loss) per common share – basic and diluted	$	(0.03	)	$	0.09

	Nine months ended
	September 30,
(In thousands, except per share data)	2018		2017
Basic and Diluted Earnings Per Common Share
Net income available to common stockholders	$	92	$	398
Weighted average common shares outstanding		1,909		1,900
Earnings per common share – basic and diluted	$	0.05	$	0.21

- 14 - 

Note 5:   Investment Securities

The amortized cost and estimated fair value of investment securities are summarized as follows:

	September 30, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In thousands)	Cost		Gains		Losses			Value
Available-for-Sale Portfolio
U.S. Government and agency obligations	$	11,111	$	7	$	(263	)	$	10,855
Mortgage-backed securities – residential		6,273		28		(129	)		6,172
Total available-for-sale	$	17,384	$	35	$	(392	)	$	17,027
Held-to-Maturity Portfolio
Mortgage-backed securities – residential	$	462	$	6	$	-		$	468
State and municipal securities		5,873		12		(88	)		5,797
Total held-to-maturity	$	6,335	$	18	$	(88	)	$	6,265

	December 31, 2017
			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
(In thousands)	Cost		Gains		Losses			Value
Available-for-Sale Portfolio
U.S. Government and agency obligations	$	10,612	$	-	$	(142	)	$	10,470
Mortgage-backed securities – residential		7,909		19		(85	)		7,843
Total available-for-sale	$	18,521	$	19	$	(227	)	$	18,313
Held-to-Maturity Portfolio
Mortgage-backed securities – residential	$	637	$	9	$	-		$	646
State and municipal securities		5,938		41		(37	)		5,942
Total held-to-maturity	$	6,575	$	50	$	(37	)	$	6,588

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The amortized cost and estimated fair value of debt investments at September 30, 2018 by contractual maturity are shown below. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties.

	Available-for-Sale				Held-to-Maturity
	Amortized		Fair		Amortized		Fair
(In thousands)	Cost		Value		Cost		Value
Due in one year or less	$	-	$	-	$	375	$	375
Due after one year through five years		9,611		9,392		3,941		3,880
Due after five years through ten years		500		497		1,557		1,542
Due after ten years		1,000		966		-		-
Sub-total	$	11,111	$	10,855	$	5,873	$	5,797
Mortgage-backed securities – residential		6,273		6,172		462		468
Totals	$	17,384	$	17,027	$	6,335	$	6,265

The Company’s investment securities’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, are as follows:

	September 30, 2018
	Less than Twelve Months						Twelve Months or More						Total
	Number of						Number of						Number of
	Individual		Unrealized		Fair		Individual		Unrealized		Fair		Individual		Unrealized		Fair
(Dollars in thousands)	Securities		Losses		Value		Securities		Losses		Value		Securities		Losses		Value
Available-for-Sale
U.S. Government and agency obligations		1	$	3	$	497		8	$	260	$	9,346		9	$	263	$	9,843
Mortgage-backed securities - residential		-		-		-		4		129		3,834		4		129		3,834
Totals		1	$	3	$	497		12	$	389	$	13,180		13	$	392	$	13,677
Held-to-Maturity
Mortgage-backed securities – residential(1)		-	$	-	$	-		1	$	-	$	166		1	$	-	$	166
State and municipal securities		9		35		2,748		12		53		1,860		21		88		4,608
Totals		9	$	35	$	2,748		13	$	53	$	2,026		22	$	88	$	4,774

	December 31, 2017
	Less than Twelve Months						Twelve Months or More						Total
	Number of						Number of						Number of
	Individual		Unrealized		Fair		Individual		Unrealized		Fair		Individual		Unrealized		Fair
(Dollars in thousands)	Securities		Losses		Value		Securities		Losses		Value		Securities		Losses		Value
Available-for-Sale
U.S. Government and agency obligations		4	$	34	$	4,472		5	$	108	$	5,999		9	$	142	$	10,471
Mortgage-backed securities - residential		4		23		2,459		4		62		3,435		8		85		5,894
Totals		8	$	57	$	6,931		9	$	170	$	9,434		17	$	227	$	16,365
Held-to-Maturity
Mortgage-backed securities – residential(1)		-	$	-	$	-		1	$	-	$	171		1	$	-	$	171
State and municipal securities		10		16		1,574		5		21		1,331		15		37		2,905
Totals		10	$	16	$	1,574		6	$	21	$	1,502		16	$	37	$	3,076

⁽¹⁾Aggregate unrealized loss position of these securities is less than $500.

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The Company conducts a formal review of investment securities on a quarterly basis for the presence of other-than-temporary impairment (“OTTI”). The Company assesses whether OTTI is present when the fair value of a debt security is less than its amortized cost basis at the statement of condition date. Under these circumstances, OTTI is considered to have occurred (1) if we intend to sell the security; (2) if it is “more likely than not” we will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not anticipated to be sufficient to recover the entire amortized cost basis. The guidance requires that credit-related OTTI is recognized in earnings while non-credit-related OTTI on securities not expected to be sold is recognized in other comprehensive income (“OCI”). Non-credit-related OTTI is based on other factors, including illiquidity and changes in the general interest rate environment. Presentation of OTTI is made in the consolidated statement of income on a gross basis, including both the portion recognized in earnings as well as the portion recorded in OCI. The gross OTTI would then be offset by the amount of non-credit-related OTTI, showing the net as the impact on earnings.

There were 35 securities in an unrealized loss position at September 30, 2018, of which 25 have been in loss positions for a period greater than twelve months and 10 have been in loss positions for a period less than twelve months. This compares to 33 securities in an unrealized loss position at December 31, 2017, of which 15 had been in loss positions for a period greater than twelve months and 18 had been in loss positions for a period less than twelve months. These issuing entities are currently rated Aaa by Moody’s Investor Services and AA+ by Standard and Poors. Among the 25 securities in loss positions for a period greater than twelve months at September 30, 2018, 13 were either direct issuances of, or mortgage-backed securities or collateralized mortgage obligations issued by, the following entities sponsored and guaranteed by the United States Government: GNMA, FNMA, and FHLMC. The remaining 12 securities that have been in a loss position for a period greater than twelve months were issued by a state or political subdivision, primarily local municipalities. The unrealized losses reflected are primarily attributable to changes in interest rates since the securities were acquired.

Among the 10 securities in an unrealized loss position at September 30, 2018 for less than twelve months, one was a direct issuance of FHLB and guaranteed by the United States Government. The remaining nine securities were issued by a state or political subdivision, primarily local municipalities. The unrealized losses reflected are primarily attributable to changes in interest rates since the securities were acquired. The Company does not intend to sell these securities, nor is it more likely than not, that the Company will be required to sell these securities prior to recovery of the amortized cost. The state and municipal securities are general obligation (G.O.) bonds backed by the full faith and credit of local municipalities. There has never been a default of a New York G.O. in the history of the state. Historical performance does not guarantee future performance, but it does indicate that the risk of loss on default of a G.O. municipal bond for the Company is relatively low. All are paying in accordance with their terms with no deferrals of interest or defaults. As such, management does not believe any individual unrealized loss as of September 30, 2018 represents OTTI.

There were no realized gains or losses on sales of securities for the three or nine months ended September 30, 2018 and September 30, 2017.

As of September 30, 2018 and December 31, 2017, no securities were pledged to secure public deposits or for any other purpose required or permitted by law.

Management has reviewed its loan and mortgage-backed securities portfolios and determined that, to the best of its knowledge, little or no exposure exists to sub-prime or other high-risk residential mortgages. The Company is not in the practice of investing in, or originating, these types of investments or loans.

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Note 6:   Loans

Major classifications of loans at the indicated dates are as follows:

	September 30,			December 31,
(In thousands)	2018			2017
Real estate loans:
Secured by one-to-four family residences	$	219,841		$	206,894
Secured by multi-family residences		10,337			10,650
Construction		6,277			10,750
Commercial real estate		21,650			14,803
Home equity lines of credit		17,012			17,127
Total real estate loans		275,117			260,224
Commercial and industrial loans		5,399			3,679
Other loans		56			70
Total loans		280,572			263,973
Net deferred loan origination fees		(21	)		(1	)
Less allowance for loan losses		(1,486	)		(1,261	)
Loans receivable, net	$	279,065		$	262,711

The Company originates residential mortgage, commercial, and consumer loans largely to customers throughout Monroe county and the surrounding western New York counties of Erie, Livingston, Ontario, Orleans, Jefferson, Niagara, and Wayne. Although the Company has a diversified loan portfolio, a substantial portion of its borrowers’ abilities to honor their loan contracts is dependent upon the counties’ employment and economic conditions.

As of September 30, 2018 and December 31, 2017, residential mortgage loans with a carrying value of $194.9 million and $190.4 million, respectively, have been pledged by the Company to the Federal Home Loan Bank of New York (“FHLBNY”) under a blanket collateral agreement to secure the Company’s line of credit and term borrowings. The Company retains the servicing on conventional fixed-rate mortgage loans sold to Freddie Mac (“FHLMC”) and receives a fee based on the principal balance outstanding. Loans serviced for others totaled $126.5 million and $132.4 million at September 30, 2018 and December 31, 2017, respectively. Loan servicing rights are recorded at fair value when loans are sold with servicing rights retained. The fair value of the mortgage servicing rights (“MSRs”) is determined using a method which utilizes servicing income, discount rates, and prepayment speeds relative to the Bank’s portfolio for MSRs and are amortized over the life of the loan. MSRs amounted to $848,000 and $892,000 at September 30, 2018 and December 31, 2017, respectively, and are included in other assets on the consolidated balance sheets.

Loan Origination / Risk Management

The Company’s lending policies and procedures are presented in Note 4 to the consolidated financial statements included in FSB Bancorp’s Amendment No. 1 to the Annual Report on Form 10-K/A filed with the Securities and Exchange Commission on August 13, 2018 and have not changed.

To develop and document a systematic methodology for determining the allowance for loan losses, the Company has divided the loan portfolio into two portfolio segments, each with different risk characteristics but with similar methodologies for assessing risk.  Each portfolio segment is broken down into loan classes where appropriate.  Loan classes contain unique measurement attributes, risk characteristics, and methods for monitoring and assessing risk that are necessary to develop the allowance for loan losses. Unique characteristics such as borrower type, loan type, collateral type, and risk characteristics define each class. 

- 18 - 

The following table illustrates the portfolio segments and classes for the Company’s loan portfolio:

Portfolio Segment	Class
Real Estate Loans	Secured by one-to-four family residences
	Secured by multi-family residences
	Construction
	Commercial real estate
	Home equity lines of credit
Other Loans	Commercial and industrial
	Other loans

The following tables present the classes of the loan portfolio, not including net deferred loan fees, summarized by the aggregate pass rating and the classified ratings of special mention, substandard and doubtful within the Company's internal risk rating system as of the dates indicated:

	As of September 30, 2018
			Special
(In thousands)	Pass		Mention		Substandard		Doubtful		Total
Real estate loans:
Secured by one-to-four family residences	$	216,176	$	500	$	3,165	$	-	$	219,841
Secured by multi-family residences		10,337		-		-		-		10,337
Construction		6,277		-		-		-		6,277
Commercial real estate		20,462		1,188		-		-		21,650
Home equity lines of credit		16,808		-		204		-		17,012
Total real estate loans		270,060		1,688		3,369		-		275,117
Commercial & industrial loans		5,354		-		45		-		5,399
Other loans		56		-		-		-		56
Total loans	$	275,470	$	1,688	$	3,414	$	-	$	280,572

	As of December 31, 2017
			Special
(In thousands)	Pass		Mention		Substandard		Doubtful		Total
Real estate loans:
Secured by one-to-four family residences	$	203,815	$	116	$	2,963	$	-	$	206,894
Secured by multi-family residences		10,650		-		-		-		10,650
Construction		10,750		-		-		-		10,750
Commercial real estate		14,803		-		-		-		14,803
Home equity lines of credit		16,897		-		230		-		17,127
Total real estate loans		256,915		116		3,193		-		260,224
Commercial & industrial loans		3,679		-		-		-		3,679
Other loans		70		-		-		-		70
Total loans	$	260,664	$	116	$	3,193	$	-	$	263,973

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Real estate loans secured by one-to four family residences rated substandard increased $202,000, or 6.8%, to $3.2 million at September 30, 2018 from $3.0 million at December 31, 2017 due to the addition of 10 residential mortgage loans newly categorized as substandard at September 30, 2018, partially offset by the upgrades of six residential mortgage loans now paying as agreed and three mortgage loan payoffs. Real estate loans secured by one-to four family residences rated special mention increased $384,000, or 330.2%, to $500,000 at September 30, 2018 from $116,000 at December 31, 2017 due to the addition of one residential mortgage loan newly categorized as special mention at September 30, 2018, partially offset by one loan now being paid as agreed which was classified as special mention at December 31, 2017. Commercial real estate loans rated special mention increased $1.2 million to $1.2 million from the $0 balance at December 31, 2017 due to the addition of three loans newly categorized as special mention after annual financial statement reviews of these borrowers were performed during the nine months ended September 30, 2018. Commercial and industrial loans rated substandard increased $45,000 to $45,000 from the $0 balance at December 31, 2017 due to the addition of one loan newly categorized as substandard during the nine months ended September 30, 2018.

Management has reviewed its loan portfolio and determined that, to the best of its knowledge, no exposure exists to sub-prime or other high-risk residential mortgages. The Company is not in the practice of originating these types of loans.

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Nonaccrual and Past Due Loans

Loans are placed on nonaccrual when the contractual payment of principal and interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan may be currently performing.

Loans are considered past due if the required principal and interest payments have not been received within thirty days of the payment due date. An age analysis of past due loans, segregated by portfolio segment and class of loans, as of September 30, 2018 and December 31, 2017, are detailed in the following tables:

	As of September 30, 2018
	30-59 Days		60-89 Days
	Past Due		Past Due		90 Days		Total				Total Loans
(In thousands)	And Accruing		And Accruing		and Over		Past Due		Current		Receivable
Real estate loans:
Secured by one-to-four family residences	$	1,150	$	-	$	55	$	1,205	$	218,636	$	219,841
Secured by multi-family residences		-		-		-		-		10,337		10,337
Construction		-		-		-		-		6,277		6,277
Commercial		-		-		-		-		21,650		21,650
Home equity lines of credit		5		-		-		5		17,007		17,012
Total real estate loans		1,155		-		55		1,210		273,907		275,117
Commercial & industrial loans		-		-		45		45		5,354		5,399
Other loans		-		-		-		-		56		56
Total loans	$	1,155	$	-	$	100	$	1,255	$	279,317	$	280,572

	As of December 31, 2017
	30-59 Days		60-89 Days
	Past Due		Past Due		90 Days		Total				Total Loans
(In thousands)	And Accruing		And Accruing		and Over		Past Due		Current		Receivable
Real estate loans:
Secured by one-to-four family residences	$	699	$	-	$	153	$	852	$	206,042	$	206,894
Secured by multi-family residences		-		-		-		-		10,650		10,650
Construction		-		-		-		-		10,750		10,750
Commercial		-		-		-		-		14,803		14,803
Home equity lines of credit		-		-		-		-		17,127		17,127
Total real estate loans		699		-		153		852		259,372		260,224
Commercial & industrial loans		-		-		-		-		3,679		3,679
Other loans		-		-		-		-		70		70
Total loans	$	699	$	-	$	153	$	852	$	263,121	$	263,973

Real estate loans secured by one-to four family residences 30-59 days past due and accruing increased $451,000, or 64.5%, to $1.2 million at September 30, 2018 from $699,000 at December 31, 2017 due to the delinquency of three additional mortgage loans during the nine months ended September 30, 2018, partially offset by two mortgage loan payoffs.

- 21 - 

At September 30, 2018, the Company had one nonaccrual residential mortgage loan for $55,000 and one nonaccrual commercial and industrial loan for $45,000. At December 31, 2017, the Company had two nonaccrual residential mortgage loans for $153,000.

There were no loans that were past due 90 days or more and still accruing interest at September 30, 2018 and December 31, 2017. At September 30, 2018 and December 31, 2017, there were no loans considered to be impaired and no troubled debt restructurings.

Note 7: Allowance for Loan Losses and Foreclosed Real Estate

Summarized in the tables below are changes in the allowance for loan losses for the indicated periods and information pertaining to the allocation of the allowance for loan losses, balances of the allowance for loan losses, loans receivable based on individual, and collective impairment evaluation by loan portfolio class. An allocation of a portion of the allowance to a given portfolio class does not limit the Company’s ability to absorb losses in another portfolio class.

	For the three months ended September 30, 2018
	Secured by		Secured by
	one-to-four		multi-family							Home equity
	family residences		residences		Construction			Commercial		lines of credit		Commercial		Other/
(In thousands)	real estate loans		real estate loans		real estate loans			real estate loans		real estate loans		& industrial		Unallocated			Total
Allowance for loan losses:
Beginning Balance	$	803	$	78	$	33		$	211	$	103	$	54	$	129		$	1,411
Charge-offs		-		-		-			-		-		-		-			-
Recoveries		-		-		-			-		-		-		-			-
Provisions		85		-		(2	)		53		1		19		(81	)		75
Ending balance	$	888	$	78	$	31		$	264	$	104	$	73	$	48		$	1,486

	For the three months ended September 30, 2017
	Secured by		Secured by
	one-to-four		multi-family						Home equity
	family residences		residences		Construction		Commercial		lines of credit		Commercial		Other/
(In thousands)	real estate loans		real estate loans		real estate loans		real estate loans		real estate loans		& industrial		Unallocated			Total
Allowance for loan losses:
Beginning Balance	$	690	$	47	$	49	$	106	$	109	$	38	$	63		$	1,102
Charge-offs		-		-		-		-		-		-		-			-
Recoveries		-		-		-		-		-		-		-			-
Provisions		93		18		2		21		2		9		(61	)		84
Ending balance	$	783	$	65	$	51	$	127	$	111	$	47	$	2		$	1,186

	For the nine months ended September 30, 2018
	Secured by		Secured by
	one-to-four		multi-family								Home equity
	family residences		residences			Construction			Commercial		lines of credit			Commercial		Other/
(In thousands)	real estate loans		real estate loans			real estate loans			real estate loans		real estate loans			& industrial		Unallocated		Total
Allowance for loan losses:
Beginning Balance	$	816	$	80		$	54		$	148	$	107		$	47	$	9	$	1,261
Charge-offs		-		-			-			-		-			-		-		-
Recoveries		-		-			-			-		-			-		-		-
Provisions		72		(2	)		(23	)		116		(3	)		26		39		225
Ending balance	$	888	$	78		$	31		$	264	$	104		$	73	$	48	$	1,486

- 22 - 

	For the nine months ended September 30, 2017
	Secured by		Secured by
	one-to-four		multi-family						Home equity
	family residences		residences		Construction		Commercial		lines of credit			Commercial		Other/
(In thousands)	real estate loans		real estate loans		real estate loans		real estate loans		real estate loans			& industrial		Unallocated			Total
Allowance for loan losses:
Beginning Balance	$	584	$	38	$	31	$	84	$	112		$	28	$	113		$	990
Charge-offs		-		-		-		-		-			-		-			-
Recoveries		-		-		-		-		-			-		-			-
Provisions		199		27		20		43		(1	)		19		(111	)		196
Ending balance	$	783	$	65	$	51	$	127	$	111		$	47	$	2		$	1,186

The Company had no foreclosed real estate at September 30, 2018 or December 31, 2017.

At September 30, 2018, the Company had one residential real estate loan for $55,000 in the process of foreclosure and at December 31, 2017, the Company had one residential real estate loan for $37,000 in the process of foreclosure.

- 23 - 

Note 8: Fair Value Measurements

Accounting guidance related to fair value measurements and disclosures specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. These two types of inputs have created the following fair value hierarchy:

Level 1 – Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 – Quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.

Level 3 – Model-derived valuations in which one or more significant inputs or significant value drivers are unobservable.

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

In determining fair value, the Company utilizes valuation techniques that maximize the use of observable inputs, minimize the use of unobservable inputs, to the extent possible, and considers counterparty credit risk in its assessment of fair value.

The following tables summarize assets measured at fair value on a recurring basis as of the indicated dates, segregated by the level of valuation inputs within the hierarchy utilized to measure fair value:

	September 30, 2018
(In thousands)	Level 1		Level 2		Level 3		Total Fair Value
Available-for-sale portfolio
U.S. Government and agency obligations	$	-	$	10,855	$	-	$	10,855
Mortgage-backed securities – residential		-		6,172		-		6,172
Total available-for-sale securities	$	-	$	17,027	$	-	$	17,027

	December 31, 2017
(In thousands)	Level 1		Level 2		Level 3		Total Fair Value
Available-for-sale portfolio
U.S. Government and agency obligations	$	-	$	10,470	$	-	$	10,470
Mortgage-backed securities – residential		-		7,843		-		7,843
Total available-for-sale securities	$	-	$	18,313	$	-	$	18,313

There have been no transfers of assets into or out of any fair value measurement level during the nine months ended September 30, 2018.

Required disclosures include fair value information of financial instruments, whether or not recognized in the consolidated statement of condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument.

- 24 - 

The Company has various processes and controls in place to ensure that fair value is reasonably estimated. The Company performs due diligence procedures over third-party pricing service providers in order to support their use in the valuation process. 

While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of their respective period-ends, and have not been re-evaluated or updated for purposes of these financial statements subsequent to those respective dates. As such, the estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported at each period-end. FASB ASC Topic 820 for Fair Value Measurements and Disclosures, the financial assets and liabilities were valued at a price that represents the Company’s exit price or the price at which these instruments would be sold or transferred.

The following information should not be interpreted as an estimate of the fair value of the entire Company since a fair value calculation is only provided for a limited portion of the Company’s assets and liabilities. Due to a wide range of valuation techniques and the degree of subjectivity used in making the estimates, comparisons between the Company’s disclosures and those of other companies may not be meaningful. The Company, in estimating its fair value disclosures for financial instruments, used the following methods and assumptions:

Cash, Due from Banks, and Interest Earning Demand Deposits

The carrying amounts of these assets approximate their fair values.

Investment Securities

The fair value of securities available for sale (carried at fair value) and held to maturity (carried at amortized cost) are determined by matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities but rather relying on the securities’ relationship to other benchmark quoted prices and is considered to be a Level 2 measurement.

Investment in Restricted Stock

The carrying value of restricted stock, which consists of Federal Home Loan Bank and Atlantic Community Bankers Bank, approximates its fair value based on the redemption provisions of the restricted stock, resulting in a Level 2 classification.

Loans

The fair values of loans held in portfolio are estimated using discounted cash flow analyses, using market rates at the balance sheet date that reflect the credit and interest rate-risk inherent in the loans, resulting in a Level 3 classification. Projected future cash flows are calculated based upon contractual maturity or call dates, projected repayments and prepayments of principal. Generally, for variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.

Loans held for sale in the secondary market are carried at the lower of cost or fair value, resulting in a Level 2 classification. Separate determinations of fair value for residential and commercial loans are made on an aggregate basis. Fair value is determined based solely on the effect of changes in secondary market interest rates and yield requirements from the commitment date to the date of the financial statements.

- 25 - 

Accrued Interest Receivable and Payable

The carrying amount of accrued interest receivable and payable approximates fair value.

Deposits

The fair values disclosed for demand deposits (e.g., NOW accounts, non-interest checking, regular savings and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts), resulting in a Level 1 classification. The carrying amounts for variable-rate certificates of deposit approximate their fair values at the reporting date, resulting in a Level 1 classification. Fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits, resulting in a Level 2 classification.

Borrowings

The fair values of FHLB long-term borrowings are estimated using discounted cash flow analyses, based on the quoted rates for new FHLB advances with similar credit risk characteristics, terms and remaining maturity, resulting in a Level 2 classification.

The carrying amounts and fair values of the Company’s financial instruments as of the indicated dates are presented in the following table:

			September 30, 2018				December 31, 2017
	Fair Value		Carrying		Estimated		Carrying		Estimated
(In thousands)	Hierarchy		Amounts		Fair Values		Amounts		Fair Values
Financial assets:
Cash and due from banks		1	$	1,648	$	1,648	$	1,672	$	1,672
Interest earning demand deposits		1		4,317		4,317		8,725		8,725
Securities - available-for-sale		2		17,027		17,027		18,313		18,313
Securities - held-to-maturity		2		6,335		6,265		6,575		6,588
Investment in restricted stock		2		3,725		3,725		3,270		3,270
Loans held for sale		2		4,662		4,662		2,770		2,770
Loans, net		3		279,065		274,943		262,711		261,588
Accrued interest receivable		1		936		936		824		824
Financial liabilities:
Demand Deposits, Savings, NOW and MMDA		1		102,730		102,730		103,377		103,377
Time Deposits		2		116,654		116,657		113,314		113,501
Borrowings		2		73,796		74,348		64,447		64,502
Accrued interest payable		1		156		156		94		94

- 26 - 

Note 9:   Accumulated Other Comprehensive Income (Loss)

Changes in the components of accumulated other comprehensive income (loss) (“AOCI”), net of tax, for the periods indicated are summarized in the table below.

	For the three months ended September 30, 2018
(In thousands)	Unrealized Losses on Available-for-Sale Securities			Total
Beginning balance	$	(262	)	$	(262	)
Other comprehensive loss		(20	)		(20	)
Ending balance	$	(282	)	$	(282	)

	For the three months ended September 30, 2017
(In thousands)	Unrealized Losses on Available-for-Sale Securities			Total
Beginning balance	$	(66	)	$	(66	)
Other comprehensive loss		(5	)		(5	)
Ending balance	$	(71	)	$	(71	)

	For the nine months ended September 30, 2018
(In thousands)	Unrealized Losses on Available-for-Sale Securities			Total
Beginning balance	$	(165	)	$	(165	)
Other comprehensive loss		(117	)		(117	)
Ending balance	$	(282	)	$	(282	)

	For the nine months ended September 30, 2017
(In thousands)	Unrealized Gains and Losses on Available-for-Sale Securities			Total
Beginning balance	$	(85	)	$	(85	)
Other comprehensive income		14			14
Ending balance	$	(71	)	$	(71	)

- 27 - 

Note 10:   Non-Interest Income

The Company has included the following tables regarding the Company’s non-interest income for the periods presented.

	For the three		For the three
	months ended		months ended
(In thousands)	September 30, 2018		September 30, 2017
Service fees
Deposit related fees		18		20
Insufficient funds fee		20		23
Total service fees		38		43
Fee income
Securities commission income		9		23
Insurance commission income		27		11
Total insurance and securities commission income		36		34
Card income
Debit card interchange fee income		37		36
ATM fees		9		8
Total card income		46		44
Mortgage fee income and realized gain on sales of loans
Residential mortgage loan origination fees		94		144
Commercial loan fees		49		21
Loan servicing income		75		79
Realized gain on sales of residential mortgage loans		461		650
Total mortgage fee income and realized gain on sales of loans		679		894
Bank owned life insurance		16		16
Other miscellaneous income		1		-
Total non-interest income	$	816	$	1,031

- 28 - 

	For the nine		For the nine
	months ended		months ended
(In thousands)	September 30, 2018		September 30, 2017
Service fees
Deposit related fees		45		57
Insufficient funds fee		62		64
Total service fees		107		121
Fee income
Securities commission income		36		46
Insurance commission income		73		91
Total insurance and securities commission income		109		137
Card income
Debit card interchange fee income		108		101
ATM fees		24		23
Total card income		132		124
Mortgage fee income and realized gain on sales of loans
Residential mortgage loan origination fees		262		340
Commercial loan fees		81		40
Loan servicing income		245		233
Realized gain on sales of residential mortgage loans		1,051		1,667
Realized gain on sale of SBA loan		47		-
Total mortgage fee income and realized gain on sales of loans		1,686		2,280
Bank owned life insurance		46		47
Other miscellaneous income		19		10
Total non-interest income	$	2,099	$	2,719

The Company recognizes revenue as it is earned and noted no impact to its revenue recognition policies as a result of the adoption of ASU 2014-09. The following is a discussion of key revenues within the scope of the new revenue guidance:

· Service fees –Revenue from fees on deposit accounts is earned through the presentation of an individual item for processing for insufficient funds fees or customer initiated activities or passage of time for deposit related fees.

· Fee income –Fee income is earned through commissions on insurance and securities sales and earned at a point in time.

· Card income – Card income consists of interchange fees from consumer debit card networks and other card related services. Interchange rates are set by the card networks. Interchange fees are based on purchase volumes and other factors and are recognized as transactions occur.

· Mortgage fee income and realized gain on sales of loans –Revenue from mortgage fee income and realized gain on sales of loans is earned through the origination of residential and commercial mortgage loans and the sales of one-to-four family residential mortgage loans and government guaranteed portions of SBA loans and is recognized as transactions occur.

- 29 - 

Note 11:   Stock-Based Compensation

On January 5, 2018, a total of 6,400 restricted stock awards were granted to four executive officers of the Company. On July 2, 2018, a total of 2,000 restricted stock awards were granted to one executive officer of the Company. The awards will vest ratably over five years (20% per year for each year of the participant’s service with the Company).

The Company has a stock-based compensation plan which allows the Company to issue up to 194,168 stock options. On January 5, 2018, the Board of Directors granted a combined total of 15,000 options to three executive officers to buy stock under the plan at an exercise price of $17.52, the fair value of the stock as of January 5, 2018. On July 2, 2018, the Board of Directors granted a total of 5,000 options to one executive officer to buy stock under the plan at an exercise price of $17.75, the fair value of the stock as of July 2, 2018. These options have a 10-year term and are vested over a five year period (20% per year for each year of the participant’s service with the Company).

A summary of the Company’s stock option activity and related information for its option plans for the three and nine months ended September 30, 2018 is as follows:

	For the three months ended September 30, 2018				For the nine months ended September 30, 2018
	Options		Weighted Average Exercise Price Per Share		Options		Weighted Average Exercise Price Per Share
Outstanding at beginning of period		167,080	$	16.79		152,080	$	16.72
Grants		5,000		17.75		20,000		17.58
Exercised		-		-		-		-
Outstanding at quarter end		172,080	$	16.82		172,080	$	16.82
Exercisable at quarter end		-	$	-		-	$	-

The Company did not grant any stock options for the three and nine months ended September 30, 2017.

The grants to senior management and directors vest over a five year period in equal annual installments, with the first installment vesting on the first anniversary date of the grant and succeeding installments on each anniversary thereafter, through 2023.

The compensation expense of the awards is based on the fair value of the instruments on the date of grant. The Company recorded compensation expense in the amount of $79,000 for the three months ended September 30, 2018 and $231,000 for the nine months ended September 30, 2018. The Company did not record any compensation expense for the three and nine months ended September 30, 2017.

- 30 - 

Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

Statement Regarding Forward-Looking Statements

Certain statements contained herein are “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are generally identified by use of the words "believe," "expect," "intend," "anticipate," "estimate," "project" or similar expressions. The Company's ability to predict results or the actual effect of future plans or strategies is inherently uncertain. Factors which could have a material adverse effect on the operations of the Company and its subsidiaries include, but are not limited to:

· Credit quality and the effect of credit quality on the adequacy of our allowance for loan losses;

· Deterioration in financial markets that may result in impairment charges relating to our securities portfolio;

· Competition in our primary market areas;

· Changes in interest rates and national or regional economic conditions;

· Changes in monetary and fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board;

· Significant government regulations, legislation and potential changes thereto;

· A reduction in our ability to generate or originate revenue-producing assets as a result of compliance with heightened capital standards;

· Increased cost of operations due to greater regulatory oversight, supervision and examination of banks andbank holding companies, and higher deposit insurance premiums;

· Limitations on our ability to expand consumer product and service offerings due to potential stricter consumer protection laws and regulations; and

· Other risks described herein and in the other reports and statements we file with the Securities and Exchange Commission (the “SEC”).

The Company disclaims any obligation to revise or update any forward-looking statements contained in this quarterly report on Form 10-Q to reflect future events or developments.

Overview

The following discussion reviews the Company's financial condition at September 30, 2018 and at December 31, 2017 and the results of operations for the three and nine month periods ended September 30, 2018 and 2017. Operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results that may be expected for the year ending December 31, 2018 or for any other period.

Our business has traditionally focused on originating one- to four-family residential real estate mortgage loans, home equity lines of credit, and offering retail deposit accounts. In recent years, we have expanded our mortgage origination footprint and opened new mortgage offices in Cheektowaga and Lewiston, New York. Our primary market area now consists of Monroe County and the surrounding western New York counties of Erie, Livingston, Ontario, Orleans, Jefferson, Niagara, and Wayne. Management has made the decision to deploy available funds from deposit and borrowings growth into higher-yielding assets, primarily commercial loan products and adjustable rate one- to four-family mortgage and construction loans in 2018. More recently, we shifted attention to expand our commercial loan department in an effort to improve our interest rate risk exposure with shorter duration commercial loan products, as well as higher yielding assets.

Our results of operations depend primarily on our net interest income and, to a lesser extent, other income. Net interest income is the difference between the interest income we earn on our interest-earning assets, consisting primarily of loans, investment securities and other interest-earning assets (primarily cash and cash equivalents), and the interest we pay on our interest-bearing liabilities, consisting primarily of savings accounts, NOW accounts, money market accounts, time deposits and borrowings. Other income consists primarily of realized gains on sale of loans, mortgage fee income, fees and service charges from deposit products, fee income from our financial services subsidiary, earnings on bank owned life insurance and miscellaneous other income. Our results of operations also are affected by our provision for loan losses and other expenses. Other expenses consist primarily of salaries and employee benefits, occupancy, equipment, electronic banking, data processing costs, mortgage fees and taxes, advertising, directors’ fees, FDIC deposit insurance premium expense, audit and tax services, and other miscellaneous expenses. Our results of operations also may be affected significantly by general and local economic and competitive conditions, changes in market interest rates, government policies and actions of regulatory authorities.

- 31 - 

Critical Accounting Policies

Critical accounting policies are defined as those that involve significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. The most significant accounting policies followed by the Company are presented in FSB Bancorp's Amendment No. 1 to the Annual Report on Form 10-K/A filed with the SEC on August 13, 2018. These policies, along with the disclosures presented in the other financial statement notes filed with the SEC and in this discussion, provide information on how significant assets and liabilities are valued in the consolidated financial statements and how those values are determined. We believe that the most critical accounting policies upon which our financial condition and results of operations depend, involve the most complex subjective decisions or assessments including our policies with respect to our allowance for loan losses, deferred tax assets and the estimation of fair values for accounting and disclosure purposes. These areas could be the most subject to revision as new information becomes available. There have been no significant changes in application of critical accounting policies during the nine months ended September 30, 2018.

Allowance for Loan Losses.The allowance for loan losses is the amount estimated by management as necessary to absorb credit losses incurred in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. The amount of the allowance is based on significant estimates, and the ultimate losses may vary from such estimates as more information becomes available or conditions change. The methodology for determining the allowance for loan losses is considered a critical accounting policy by management due to the high degree of judgment involved, the subjectivity of the assumptions used and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses.

As a substantial percentage of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans are critical in determining the amount of the allowance required for specific loans. Assumptions are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property securing a loan and the related allowance determined. Management carefully reviews the assumptions supporting such appraisals to determine that the resulting values reasonably reflect amounts realizable on the related loans.

Management performs an evaluation of the adequacy of the allowance for loan losses at least quarterly. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change based on changes in economic and real estate market conditions.

The evaluation has specific, general, and unallocated components. The specific component relates to loans that are deemed to be impaired and classified as special mention, substandard, doubtful, or loss. For such loans that are also classified as impaired, an allowance is generally established when the collateral value of the impaired loan is lower than the carrying value of that loan. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. 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 known and inherent losses in the portfolio.

Actual loan losses may be significantly more than the allowance we have established which could have a material negative effect on our financial results.

Deferred Tax Assets. The deferred tax assets and liabilities represent the future tax return consequences of the temporary differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Deferred tax assets and liabilities are reflected at income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

- 32 - 

Estimation of Fair Values. Fair values for securities available-for-sale are obtained from an independent third party pricing service. Where available, fair values are based on quoted prices on a nationally recognized securities exchange. If quoted prices are not available, fair values are measured using quoted market prices for similar benchmark securities. Management generally makes no adjustments to the fair value quotes provided by the pricing source. The fair values of foreclosed real estate and the underlying collateral value of impaired loans are typically determined based on evaluations by third parties, less estimated costs to sell. When necessary, appraisals are updated to reflect changes in market conditions.

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

Total Assets.Total assets increased $12.8 million to $327.1 million at September 30, 2018 from $314.4 million at December 31, 2017, primarily due to increases in net loans receivable, restricted stock, accrued interest receivable, and other assets, partially offset by decreases in cash and cash equivalents, securities available-for-sale, securities held-to-maturity, and premises and equipment.

Net loans receivable increased $16.4 million, or 6.2%, to $279.1 million at September 30, 2018 from $262.7 million at December 31, 2017. The Bank continues to focus on loan production as we continue to primarily grow our residential mortgage and commercial loan portfolios at a measured pace while still maintaining our strong credit quality and strict underwriting standards. One-to four-family residential mortgage loans increased $12.9 million, or 6.3%, to $219.8 million at September 30, 2018 from $206.9 million at December 31, 2017. Commercial real estate loans increased $6.8 million, or 46.3%, to $21.7 million at September 30, 2018 from $14.8 million at December 31, 2017. Commercial and industrial loans increased $1.7 million, or 46.8%, to $5.4 million at September 30, 2018 from $3.7 million at December 31, 2017. We anticipate continued growth in loan production throughout the remainder of the year due to the existing pipeline at September 30, 2018. The Bank originated $70.7 million of residential mortgage loans and sold $44.4 million of such loans in the secondary market as a balance sheet management strategy during the first nine months of 2018 to reduce interest rate risk. The Bank sold these loans at a gain of $1.1 million which was recorded in other income. At September 30, 2018, the Bank was servicing $126.5 million in residential mortgage loans and $748,000 in commercial real estate loans sold to third parties and will realize servicing income on these loans as long as they remain outstanding. At September 30, 2018, the Bank had $4.7 million in loans held for sale, comprised of one- to four-family residential fixed rate conventional, FHA, VA, and USDA mortgage loans originated and closed by the Bank in the third quarter of 2018 that have been committed for sale in the secondary market, and will be delivered and sold in the fourth quarter of 2018. Mortgage servicing rights decreased $44,000, or 4.9%, to $848,000 at September 30, 2018 compared to $892,000 at December 31, 2017, and are included in other assets on the consolidated balance sheets due to lower volume of loans sold with servicing retained.

Investment in restricted stock increased by $455,000, or 14.3%, to $3.7 million at September 30, 2018 from $3.3 million at December 31, 2017 due to increased borrowings from the Federal Home Loan Bank of New York.

Accrued interest receivable increased by $112,000, or 13.6%, to $936,000 at September 30, 2018 from $824,000 at December 31, 2017 due to increased residential mortgage and commercial loan originations.

Other assets primarily comprised of prepaid and deferred charges, mortgage servicing rights, and accounts receivable, increased by $71,000, or 2.6%, to $2.8 million at September 30, 2018 from $2.7 million at December 31, 2017, primarily due to increased mortgage loan originations.

Cash and cash equivalents, primarily interest-earning demand deposits at the Federal Reserve Bank and the Federal Home Loan Bank, decreased by $4.4 million, or 42.6%, to $6.0 million at September 30, 2018 from $10.4 million at December 31, 2017, in order to fund loans.

Securities available-for-sale decreased by $1.3 million, or 7.0%, to $17.0 million at September 30, 2018 from $18.3 million at December 31, 2017. The decrease was due to principal repayments of $1.6 million, a decrease in the fair market value of available-for-sale securities of $149,000 due to the increase in market interest rates, and amortization of $46,000, partially offset by purchases of $500,000 in new securities of U.S. Government and agency obligations during the first nine months of 2018.

- 33 - 

Securities held-to-maturity decreased $240,000, or 3.7%, to $6.3 million at September 30, 2018 from $6.6 million at December 31, 2017 due to maturities and principal repayments of $633,000 and amortization of $22,000, partially offset by purchases of $415,000 during the first nine months of 2018.

Premises and equipment decreased by $211,000, or 6.9%, to $2.9 million at September 30, 2018 from $3.1 million at December 31, 2017, primarily due to disposals and depreciation of fixed assets.

Deposits and Borrowings. Total deposits increased $2.7 million, or 1.2%, to $219.4 million at September 30, 2018 from $216.7 million at December 31, 2017. Transaction accounts decreased $647,000, or 0.6%, to $102.7 million at September 30, 2018 from $103.4 million at December 31, 2017. Certificates of deposit (including individual retirement accounts) increased $3.3 million, or 3.2%, to $116.7 million at September 30, 2018 from $113.3 million at December 31, 2017. Total borrowings from the Federal Home Loan Bank of New York increased $9.3 million, or 14.5%, to $73.8 million at September 30, 2018 from $64.4 million at December 31, 2017. Long-term borrowings increased $7.8 million, or 15.2%, to $59.2 million at September 30, 2018 from $51.4 million at December 31, 2017 due to $25.5 million in new advances partially offset by $17.7 million in principal repayments on our amortizing advances and maturities. The Company increased its short-term borrowings by $1.6 million, or 11.9%, to $14.6 million at September 30, 2018 compared to $13.0 million at December 31, 2017. The increase in borrowings from the Federal Home Loan Bank of New York was used to fund the additional loan growth in the portfolio.

Stockholders’ Equity. Stockholders’ equity increased $262,000, or 0.8%, to $31.3 million at September 30, 2018 from $31.1 million at December 31, 2017. The increase was primarily due to $92,000 in net income, a $231,000 increase in additional paid in capital as a result of stock based compensation, and an increase of $56,000 resulting from the release of ESOP shares from the suspense account, partially offset by an increase of $117,000 in accumulated other comprehensive loss during the nine months ended September 30, 2018.

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

General.Net income decreased $229,000, or 127.9%, to a net loss of $50,000 for the quarter ended September 30, 2018 from $179,000 for the quarter ended September 30, 2017. The quarter over quarter decrease was attributable to an increase in other expense of $224,000 and a decrease in other income of $215,000, partially offset by an increase in net interest income of $94,000 and decreases in provision for income taxes of $107,000 and provision for loan losses of $9,000.

Interest and Dividend Income.Total interest and dividend income increased $431,000, or 15.6%, to $3.2 million for the quarter ended September 30, 2018 from $2.8 million for the quarter ended September 30, 2017. The increase resulted from a $26.9 million increase quarter over quarter in average interest-earning assets, primarily residential mortgage and commercial real estate loans, and a 20 basis point increase in the average yield earned on interest-earning assets from 3.90% for the three months ended September 30, 2017 to 4.10% for the three months ended September 30, 2018 due to rising interest rates.

Interest income on loans increased $402,000, or 15.3%, to $3.0 million for the quarter ended September 30, 2018 from $2.6 million for the quarter ended September 30, 2017, reflecting a $28.6 million increase in the average balance of loans to $281.5 million for the three months ended September 30, 2018 from $252.9 million for the three months ended September 30, 2017, in addition to a 16 basis point increase in the average yield earned on loans for the three months ended September 30, 2018 as compared to the same period in 2017. The increase in the average balance of loans was due to our focus on increasing our residential mortgage and commercial loan portfolios during the three months ended September 30, 2018 as compared to the same period in 2017. The average yield on loans increased to 4.30% for the three months ended September 30, 2018 from 4.14% for the three months ended September 30, 2017, reflecting increases in market interest rates on new loan products, primarily commercial mortgages, commercial and industrial loans, and home equity lines of credit, in addition to upward repricing for adjustable rate loans in a rising interest rate environment.

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Interest income on taxable investment securities increased $25,000, or 31.3%, to $105,000 for the three months ended September 30, 2018 from $80,000 for the three months ended September 30, 2017. The average balance of taxable investment securities increased $1.1 million, or 8.0%, to $14.2 million for the three months ended September 30, 2018 from $13.1 million for the three months ended September 30, 2017. The average yield on taxable investment securities increased 53 basis points to 2.96% during the quarter ended September 30, 2018 as compared to 2.43% for the quarter ended September 30, 2017 due to new purchases of modestly higher yielding investment securities replacing calls of slightly lower yielding investment securities. Interest income on mortgage-backed securities increased $2,000, or 7.7%, to $28,000 for the three months ended September 30, 2018, from $26,000 for the three months ended September 30, 2017 reflecting an increase in the average yield on mortgage-backed securities of 42 basis points to 1.59% for the three months ended September 30, 2018 from 1.17% for the three months ended September 30, 2017, partially offset by a decrease in the average balance of mortgage-backed securities of $1.8 million, or 19.8%, to $7.1 million for the three months ended September 30, 2018 from $8.9 million for the three months ended September 30, 2017. The increase in average yield on mortgage-backed securities was primarily attributable to slower prepayment speeds and upward repricing on the pools of mortgage-backed securities held in portfolio during the three months ended September 30, 2018 compared to the three months ended September 30, 2017. A portion of the cash flow from these investment and mortgage-backed securities was redeployed to fund loan growth. Interest income on tax-exempt state and municipal securities decreased $1,000, or 3.7%, to $26,000 for the three months ended September 30, 2018, from $27,000 for the three months ended September 30, 2017. The average balance of state and municipal securities decreased by $285,000, or 4.6%, from $6.2 million for the three months ended September 30, 2017 to $5.9 million for the three months ended September 30, 2018. The average tax equivalent yield on state and municipal securities decreased 28 basis points to 2.28% for the three months ended September 30, 2018 from 2.56% for the three months ended September 30, 2017,as a result of the enactment of the Tax Cuts and Jobs Act that took effect on January 1, 2018 which reduced the corporate federal income tax rate from 34% to 21%. Interest income on Fed Funds sold increased $3,000, or 27.3%, to $14,000 for the three months ended September 30, 2018 from $11,000 for the three months ended September 30, 2017. The increase in Fed Funds sold was attributable to an increase in the average yield on Fed Funds sold of 47 basis points to 1.59% during the quarter ended September 30, 2018 as compared to 1.12% for the quarter ended September 30, 2017 due to the Federal Reserve’s increase of the fed funds rate, partially offset by a decrease in the average balance of Fed Funds sold of $624,000, or 15.2%, to $3.5 million for the three months ended September 30, 2018 from $4.1 million for the three months ended September 30, 2017.

Total Interest Expense. Total interest expense increased $337,000, or 46.6%, to $1.1 million for the quarter ended September 30, 2018 from $723,000 for the quarter ended September 30, 2017. Total interest expense reflected an increase in interest expense on deposits of $207,000 and an increase in interest expense on borrowings of $130,000 when comparing the quarters ended September 30, 2018 and 2017. The total interest expense reflected an increase in the average cost of interest-bearing liabilities of 38 basis points from 1.15% for the three months ended September 30, 2017 to 1.53% for the three months ended September 30, 2018, in addition to an increase of $26.0 million in average interest-bearing liabilities.

Interest expense on deposits increased $207,000, or 43.0%, to $689,000 for the three months ended September 30, 2018 from $482,000 for the three months ended September 30, 2017. The average cost of deposits increased to 1.31% for the three months ended September 30, 2018 from 0.99% for the three months ended September 30, 2017, primarily reflecting higher average balances on higher rate promotional savings and certificates of deposit accounts offered during the third quarter of 2018. The average balance of deposits increased $17.4 million, or 9.0%, from $193.6 million for the three months ended September 30, 2017 to $211.1 million for the three months ended September 30, 2018 also primarily due to higher rate promotional certificates of deposit and savings accounts offered in the third quarter of 2018. The average cost of certificates of deposit (including individual retirement accounts) increased to 1.77% for the three months ended September 30, 2018 from 1.39% for the three months ended September 30, 2017, in addition to an increase in the average balance of these accounts by $17.3 million to $117.2 million for the three months ended September 30, 2018 from $99.8 million for the three months ended September 30, 2017. The average balance of transaction accounts, our core non-time deposit accounts, increased by $1.2 million to $104.3 million for the three months ended September 30, 2018 from $103.1 million for the three months ended September 30, 2017, along with an increase in the average cost of transaction accounts of 14 basis points to 0.66% for the three months ended September 30, 2018 from 0.52% for the three months ended September 30, 2017 primarily due to promotional savings and money market accounts.

At September 30, 2018, we had $11.5 million of certificates of deposit, including individual retirement accounts, scheduled to mature throughout the remainder of 2018. Based on current market interest rates, we expect that the cost of these deposits upon renewal will be at a moderately higher cost to us than their current contractual rates.

Interest expense on borrowings increased $130,000 from $241,000 for the quarter ended September 30, 2017 to $371,000 for the quarter ended September 30, 2018, due to an $8.6 million increase in our average balance of borrowings with the Federal Home Loan Bank from $58.4 million for the three months ended September 30, 2017 to $67.0 million for the three months ended September 30, 2018 in order to fund loans, along with an increase in the average cost of these funds from 1.65% for the three months ended September 30, 2017 to 2.22% for the three months ended September 30, 2018 as a result of an increase in market interest rates.

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Net Interest Income. Net interest income increased $94,000, or 4.6%, to $2.1 million for the quarter ended September 30, 2018 as compared to $2.0 million for the quarter ended September 30, 2017. Net interest income increased primarily due to continued efforts to change the interest-earning asset mix to increase the balances of higher yielding residential and commercial loans when comparing the quarter ended September 30, 2018 to the same period in 2017. Our net interest rate spread decreased 18 basis points to 2.58% for the quarter ended September 30, 2018 from 2.76% for the quarter ended September 30, 2017. There was a 38 basis point increase in the average cost of our interest-bearing liabilities from 1.15% for the three months ended September 30, 2017 to 1.53% for the three months ended September 30, 2018, partially offset by a 20 basis point increase in the average yield on our interest-earning assets to 4.10% for the three months ended September 30, 2018 from 3.90% for the three months ended September 30, 2017. Our net interest margin decreased 15 basis points to 2.74% during the three months ended September 30, 2018 from 2.89% during the three months ended September 30, 2017.

Provision for Loan Losses. We establish provisions for loan losses which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses inherent in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan, and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses on at least a quarterly basis and make provisions for loan losses in order to maintain the allowance.

Based on our evaluation of the above factors, we recorded a $75,000 provision for loan losses for the quarter ended September 30, 2018, compared to an $84,000 provision for loan losses recorded for the quarter ended September 30, 2017. The lower provision for loan losses for the three months ended September 30, 2018 was the result of adding additional loan loss reserves needed for the quarter ended September 30, 2017 due to an increase in loans newly classified as substandard in the third quarter of 2017, partially offset by additional provisioning on classified loans and general provisions deemed necessary to support an increased balance of loans receivable, primarily one- to four-family residential real estate, commercial real estate, and, commercial and industrial loans when comparing the three months ended September 30, 2018 and September 30, 2017. The increase in the classified loan provision was due to an increase in loans rated special mention and substandard which were classified as such during the three months ended September 30, 2018. The allowance for loan losses was $1.5 million, or 0.53% of net loans outstanding at September 30, 2018 compared to $1.2 million, or 0.47% of net loans outstanding, at September 30, 2017. The allowance for loan losses was $1.3 million, or 0.48% of net loans outstanding at December 31, 2017.

Other Income. Other income decreased by $215,000, or 20.9%, to $816,000 for the three months ended September 30, 2018 compared to $1.0 million for the three months ended September 30, 2017. The decrease in other income was primarily attributable to decreases in realized gains on sales of loans and mortgage fee income. Realized gains on sales of loans decreased $189,000, or 29.1%, to $461,000 for the three months ended September 30, 2018 from $650,000 for the three months ended September 30, 2017. The decrease in realized gains on sales of loans was primarily due to lower volume of mortgage loans sold in addition to lower premiums received on government and conventional mortgage loans sold in the third quarter of 2018 compared to the third quarter of 2017. Mortgage fee income decreased by $26,000, or 10.7%, to $218,000 for the three months ended September 30, 2018 compared to $244,000 for the three months ended September 30, 2017 due to lower volume of residential mortgage loans originated in the third quarter of 2018 compared to the third quarter of 2017, partially offset by an increase in commercial loan fees.

Other Expense.Other expense increased $224,000, or 8.3%, to $2.9 million for the three months ended September 30, 2018 from $2.7 million for the three months ended September 30, 2017. The increase in other expense was primarily attributable to increases in mortgage fees and taxes of $151,000, other miscellaneous expense of $40,000, data processing costs of $39,000, and audit and tax services of $26,000, partially offset by a decrease in directors’ fees of $19,000. Mortgage fees and taxes increased $151,000, or 193.6%, to $229,000 for the three months ended September 30, 2018 from $78,000 for the three months ended September 30, 2017 due to a $159,000 change in accounting estimate. Other miscellaneous expense increased $40,000, or 16.5%, to $283,000 for the three months ended September 30, 2018 from $243,000 for the three months ended September 30, 2017 as a result of increases in professional services and legal expenses associated with the Company’s restatement of its 2017 audited financial statements and its first quarter 2018 unaudited financial statements as a result of the Company incorrectly claiming a tax credit for residential mortgages on properties located in Erie County. Data processing costs increased $39,000, or 48.8%, to $119,000 for the three months ended September 30, 2018 from $80,000 for the three months ended September 30, 2017 primarily due to the end of first year promotional pricing associated with the conversion of our core processing system from in-house hosting to data center hosting. Audits and tax services increased $26,000, or 59.1%, to $70,000 for the three months ended September 30, 2018 from $44,000 for the three months ended September 30, 2017 as a result of increased expenses related to the Company’s restatement of its 2017 audited financial statements and its first quarter 2018 unaudited financial statements. Directors’ fees decreased $19,000, or 29.2%, to $46,000 for the three months ended September 30, 2018 from $65,000 for the three months ended September 30, 2017 due to the retirement of four directors as of December 31, 2017.

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Income Taxes. Income tax expense decreased $107,000, or 109.2%, to a benefit of $9,000 for the three months ended September 30, 2018 from $98,000 for the three months ended September 30, 2017. The decrease in income tax expense for the three months ended September 30, 2018 as compared to the same period in 2017 was due to lower income before income taxes and the reduction in the corporate federal income tax rate from 34% to 21% as a result of the enactment of the Tax Cuts and Jobs Act that took effect on January 1, 2018. The effective tax rate was (15.3)% for the three months ended September 30, 2018 compared to 35.4% for the three months ended September 30, 2017.

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

General.Net income decreased $306,000, or 76.9%, to $92,000 for the nine months ended September 30, 2018 from $398,000 for the nine months ended September 30, 2017. The year over year nine month decrease was attributable to increases in other expense of $333,000 and the provision for loan losses of $29,000, and a decrease in other income of $620,000, partially offset by an increase in net interest income of $555,000 and a decrease in provision for income taxes of $121,000.

Interest and Dividend Income.Total interest and dividend income increased $1.4 million, or 17.9%, to $9.2 million for the nine months ended September 30, 2018 from $7.8 million for the nine months ended September 30, 2017. The increase resulted from a $29.3 million year over year nine month increase in average interest-earning assets, primarily residential mortgage and commercial real estate loans, and a 24 basis point increase in the average yield earned on interest-earning assets from 3.81% for the nine months ended September 30, 2017 to 4.05% for the nine months ended September 30, 2018.

Interest income on loans increased $1.3 million, or 17.6%, to $8.7 million for the nine months ended September 30, 2018 from $7.4 million for the nine months ended September 30, 2017, reflecting a $31.9 million increase in the average balance of loans to $274.6 million for the nine months ended September 30, 2018 from $242.7 million for the nine months ended September 30, 2017, in addition to a 16 basis point increase in the average yield earned on loans for the nine months ended September 30, 2018 as compared to the same period in 2017. The increase in the average balance of loans was due to our focus on increasing our residential mortgage and commercial loan portfolios during the nine months ended September 30, 2018 as compared to the same period in 2017. The average yield on loans increased to 4.24% for the nine months ended September 30, 2018 from 4.08% for the nine months ended September 30, 2017, reflecting increases in market interest rates on loan products, primarily commercial mortgages, commercial and industrial loans, and home equity lines of credit, in addition to upward repricing for adjustable rate loans in a rising interest rate environment.

Interest income on taxable investment securities increased $77,000, or 35.2%, to $296,000 for nine months ended September 30, 2018 from $219,000 for the nine months ended September 30, 2017. The average balance of taxable investment securities increased $1.6 million, or 13.4%, to $13.8 million for the nine months ended September 30, 2018 from $12.2 million for the nine months ended September 30, 2017. The average yield on taxable investment securities increased 45 basis points to 2.85% during the nine months ended September 30, 2018 as compared to 2.40% for the nine months ended September 30, 2017 due to new purchases of modestly higher yielding investment securities replacing calls of slightly lower yielding investment securities. Interest income on mortgage-backed securities increased $23,000, or 28.8%, to $103,000 for the nine months ended September 30, 2018, from $80,000 for the nine months ended September 30, 2017 reflecting an increase in the average yield on mortgage-backed securities of 63 basis points to 1.77% for the nine months ended September 30, 2018 from 1.14% for the nine months ended September 30, 2017, partially offset by a decrease in the average balance of mortgage-backed securities of $1.6 million, or 17.5%, to $7.7 million for the nine months ended September 30, 2018 from $9.4 million for the nine months ended September 30, 2017. The increase in average yield on mortgage-backed securities was primarily attributable to slower prepayment speeds and upward repricing on the pools of mortgage-backed securities held in portfolio during the nine months ended September 30, 2018 compared to the same period in 2017. A portion of the cash flow from these investment and mortgage-backed securities was redeployed to fund loan growth. Interest income on tax-exempt state and municipal securities decreased $6,000, or 7.1%, to $78,000 for the nine months ended September 30, 2018, from $84,000 for the nine months ended September 30, 2017. The average balance of state and municipal securities decreased by $519,000, or 8.0%, from $6.5 million for the nine months ended September 30, 2017 to $5.9 million for the nine months ended September 30, 2018. The average tax equivalent yield on state and municipal securities decreased 38 basis points to 2.23% for the nine months ended September 30, 2018 from 2.61% for the nine months ended September 30, 2017, as a result of the enactment of the Tax Cuts and Jobs Act that took effect on January 1, 2018 which reduced the corporate federal income tax rate from 34% to 21%. Interest income on Fed Funds remained flat at $35,000 for the nine months ended September 30, 2018 and 2017. The average balance of Fed Funds sold decreased $2.1 million, or 35.6%, to $3.3 million for the nine months ended September 30, 2018 from $5.4 million for the nine months ended September 30, 2017, offset by an increase in the average yield on Fed Funds sold of 56 basis points to 1.43% during the nine months ended September 30, 2018 as compared to 0.87% for the nine months ended September 30, 2017 due to four rate increases from the Federal Reserve beginning in December 2017 which increased the fed funds rate from 1.25% to 2.25%.

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Total Interest Expense. Total interest expense increased $846,000, or 42.8%, to $2.8 million for the nine months ended September 30, 2018 from $2.0 million for the nine months ended September 30, 2017. Total interest expense reflected an increase in interest expense on deposits of $573,000 and an increase in interest expense on borrowings of $273,000 when comparing the nine months ended September 30, 2018 and 2017. The total interest expense reflected an increase in the average cost of interest-bearing liabilities of 30 basis points from 1.08% for the nine months ended September 30, 2017 to 1.38% for the nine months ended September 30, 2018, in addition to an increase of $29.2 million in average interest-bearing liabilities.

Interest expense on deposits increased $573,000, or 44.7%, to $1.9 million for the nine months ended September 30, 2018 from $1.3 million for the nine months ended September 30, 2017. The average cost of deposits increased to 1.18% for the nine months ended September 30, 2018 from 0.93% for the nine months ended September 30, 2017, primarily reflecting higher average balances on higher rate promotional money market, and certificates of deposit accounts offered during the first nine months of 2018. The average balance of deposits increased $24.4 million, or 13.2%, from $184.5 million for the nine months ended September 30, 2017 to $208.9 million for the nine months ended September 30, 2018 also primarily due to higher rate promotional certificates of deposit and money market accounts offered in the first nine months of 2018. The average cost of certificates of deposit (including individual retirement accounts) increased to 1.64% for the nine months ended September 30, 2018 from 1.31% for the nine months ended September 30, 2017, in addition to an increase in the average balance of these accounts by $20.9 million to $115.7 million for the nine months ended September 30, 2018 from $94.7 million for the nine months ended September 30, 2017. The average balance of transaction accounts, our core non-time deposit accounts, increased by $3.9 million to $102.4 million for the nine months ended September 30, 2018 from $98.4 million for the nine months ended September 30, 2017, along with an increase in the average cost of transaction accounts of nine basis points to 0.56% for the nine months ended September 30, 2018 from 0.47% for the nine months ended September 30, 2017 primarily due to promotional savings and money market accounts.

Interest expense on borrowings increased $273,000, or 39.3%, from $695,000 for the nine months ended September 30, 2017 to $968,000 for the nine months ended September 30, 2018, due to a $4.9 million increase in our average balance of borrowings with the Federal Home Loan Bank from $59.3 million for the nine months ended September 30, 2017 to $64.2 million for the nine months ended September 30, 2018 in order to fund loans, along with an increase in the average cost of these funds from 1.56% for the nine months ended September 30, 2017 to 2.01% for the nine months ended September 30, 2018 as a result of an increase in market interest rates.

Net Interest Income. Net interest income increased $555,000, or 9.5%, to $6.4 million for the nine months ended September 30, 2018 as compared to $5.9 million for the nine months ended September 30, 2017. Net interest income increased primarily due to continued efforts to change the interest-earning asset mix to increase the balances of higher yielding residential and commercial loans when comparing the nine months ended September 30, 2018 to the same period in 2017. Our net interest rate spread decreased six basis points to 2.67% for the nine months ended September 30, 2018 from 2.73% for the nine months ended September 30, 2017. There was an increase in the average cost of our interest-bearing liabilities of 30 basis points from 1.08% for the nine months ended September 30, 2017 to 1.38% for the nine months ended September 30, 2018, partially offset by a 24 basis point increase in the average yield on our interest-earning assets to 4.05% for the nine months ended September 30, 2018 from 3.81% for the nine months ended September 30, 2017. Our net interest margin decreased four basis points to 2.82% for the nine months ended September 30, 2018 from 2.86% for the nine months ended September 30, 2017.

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Provision for Loan Losses. We establish provisions for loan losses which are charged to operations in order to maintain the allowance for loan losses at a level we consider necessary to absorb credit losses inherent in the loan portfolio that are both probable and reasonably estimable at the balance sheet date. In determining the level of the allowance for loan losses, we consider past and current loss experience, evaluations of real estate collateral, current economic conditions, volume and type of lending, adverse situations that may affect a borrower’s ability to repay a loan, and the levels of non-performing and other classified loans. The amount of the allowance is based on estimates and the ultimate losses may vary from such estimates as more information becomes available or conditions change. We assess the allowance for loan losses on at least a quarterly basis and make provisions for loan losses in order to maintain the allowance.

Based on our evaluation of the above factors, we recorded a $225,000 provision for loan losses for the nine months ended September 30, 2018, compared to a $196,000 provision for loan losses recorded for the nine months ended September 30, 2017. The increase in the provision for loan losses for the nine months ended September 30, 2018 was the result of additional provisioning on classified loans and general provisions deemed necessary to support an increased balance of loans receivable, primarily one- to four-family residential real estate, commercial real estate, and commercial and industrial loans when comparing the nine months ended September 30, 2018 and September 30, 2017. The increase in the provision on classified loans was due to an increase in loans rated special mention and substandard which were classified as such during the nine months ended September 30, 2018. The allowance for loan losses was $1.5 million, or 0.53% of net loans outstanding at September 30, 2018 compared to $1.2 million, or 0.47% of net loans outstanding, at September 30, 2017. The allowance for loan losses was $1.3 million, or 0.48% of net loans outstanding at December 31, 2017.

Other Income. Other income decreased by $620,000, or 22.8%, to $2.1 million for the nine months ended September 30, 2018 compared to $2.7 million for the nine months ended September 30, 2017. The decrease in other income was primarily attributable to decreases in realized gains on sales of loans, fee income, and mortgage fee income. Realized gains on sales of loans decreased $569,000, or 34.1%, to $1.1 million for the nine months ended September 30, 2018 from $1.7 million for the nine months ended September 30, 2017. The decrease in realized gains on sales of loans was primarily due to lower volume of mortgage loans sold in addition to lower premiums received on government and conventional mortgage loans sold during the first nine months of 2018 compared to the first nine months of 2017. Fee income from Fairport Wealth Management decreased by $28,000, or 20.4%, to $109,000 for the nine months ended September 30, 2018 compared to $137,000 for the nine months ended September 30, 2017 due to a decrease in non-deposit investment product sales. Mortgage fee income decreased by $25,000, or 4.1%, to $588,000 for the nine months ended September 30, 2018 compared to $613,000 for the nine months ended September 30, 2017 due to lower volume of residential mortgage loans originated in the first nine months of 2018 compared to the same period in 2017, partially offset by an increase in commercial loan fees.

Other Expense. Other expense increased $333,000, or 4.2%, to $8.2 million for the nine months ended September 30, 2018 from $7.9 million for the nine months ended September 30, 2017. The increase in other expense was primarily attributable to increases in mortgage fees and taxes of $146,000, salaries and employee benefits of $78,000, data processing costs of $73,000, audits and tax services of $28,000, occupancy expense of $21,000, electronic banking of $20,000, and other miscellaneous expense of $19,000, partially offset by a decrease in directors’ fees of $44,000. Mortgage fees and taxes increased $146,000, or 73.4%, to $344,000 for the nine months ended September 30, 2018 from $198,000 for the nine months ended September 30, 2017 due to a $159,000 change in accounting estimate. Salaries and employee benefits increased $78,000, or 1.6%, to $4.9 million for the nine months ended September 30, 2018 from $4.8 million for the nine months ended September 30, 2017 primarily due to annual merit increases for existing staff, the addition of a Chief Lending Officer in October 2017, and the expense related to the issuance of restricted stock awards and stock options to senior management and the Board of Directors in the fourth quarter of 2017 and the first and third quarters of 2018, partially offset by a decrease in commission expense due to lower mortgage and commercial loan origination volume and annual incentive expense. Data processing costs increased $73,000, or 29.2%, to $323,000 for the nine months ended September 30, 2018 from $250,000 for the nine months ended September 30, 2017 primarily due to the end of first year promotional pricing associated with the conversion of our core processing system from in-house hosting to data center hosting. Audits and tax services increased $28,000, or 20.4%, to $165,000 for the nine months ended September 30, 2018 from $137,000 for the nine months ended September 30, 2017 as a result of increased expenses related to the Company’s restatement of its 2017 audited financial statements and its first quarter 2018 unaudited financial statements. Occupancy expense increased $21,000, or 2.6%, to $822,000 for the nine months ended September 30, 2018 from $801,000 for the nine months ended September 30, 2017 primarily due to additional rent expense related to the addition of our Lewiston mortgage origination office, additional office space in our Cheektowaga mortgage origination office in November 2017, and increases in building repairs and maintenance for our branches. Electronic banking increased $20,000, or 31.3%, to $84,000 for the nine months ended September 30, 2018 from $64,000 for the nine months ended September 30, 2017 primarily due to the end of first year promotional pricing associated with the conversion of our core processing system from in-house hosting to data center hosting. Other miscellaneous expense increased $19,000, or 2.5%, to $782,000 for the nine months ended September 30, 2018 from $763,000 for the nine months ended September 30, 2017 as a result of increases in professional services and legal expenses associated with the Company’s restatement of its 2017 audited financial statements and its first quarter 2018 unaudited financial statements. Directors’ fees decreased $44,000, or 22.6%, to $151,000 for the nine months ended September 30, 2018 from $195,000 for the nine months ended September 30, 2017 due to the retirement of four directors as of December 31, 2017.

Income Taxes. Income tax expense decreased $121,000, or 83.5%, to $24,000 for the nine months ended September 30, 2018 from $145,000 for the nine months ended September 30, 2017. The decrease in income tax expense for the nine months ended September 30, 2018 as compared to the same period in 2017 was due to lower income before income taxes and the reduction in the corporate federal income tax rate from 34% to 21% as a result of the enactment of the Tax Cuts and Jobs Act that took effect on January 1, 2018. The effective tax rate was 20.7% for the nine months ended September 30, 2018 compared to 26.7% for the nine months ended September 30, 2017.

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Average balances and yields. The following tables set forth average balance sheets, average yields and costs and certain other information for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are accreted or amortized to interest income or interest expense. 

	For the three months September 30,
	2018									2017
							Average									Average
	Average						Yield /			Average						Yield /
(Dollars in thousands)	Balance			Interest			Cost(5)			Balance			Interest			Cost(5)
Interest-earning assets:
Loans	$	281,491		$	3,023			4.30	%	$	252,932		$	2,621			4.14	%
Federal funds sold		3,476			14			1.59			4,100			11			1.12
Taxable investment securities		14,196			105			2.96			13,145			80			2.43
Mortgage-backed securities		7,144			28			1.59			8,904			26			1.17
State and municipal securities(1)		5,877			33			2.28			6,162			40			2.56
Total interest-earning assets	$	312,184		$	3,203			4.10	%	$	285,243		$	2,778			3.90	%
Noninterest-earning assets:
Other assets	$	10,159								$	10,838
Total assets	$	322,343								$	296,081
Interest-bearing liabilities:
NOW accounts	$	30,456		$	23			0.30	%	$	31,092		$	24			0.30	%
Passbook savings		29,850			51			0.68			27,436			35			0.50
Money market savings		33,576			98			1.17			35,258			75			0.85
Individual retirement accounts		6,684			21			1.27			7,096			20			1.11
Certificates of deposit		110,489			496			1.80			92,740			328			1.42
Federal Home Loan Bank advances		67,042			371			2.22			58,430			241			1.65
Total interest-bearing liabilities	$	278,097		$	1,060			1.53	%	$	252,052		$	723			1.15	%
Noninterest-bearing liabilities:
Demand deposits	$	10,413								$	9,353
Other liabilities		2,545									2,824
Total liabilities	$	291,055								$	264,229
Stockholders' equity	$	31,288								$	31,852
Total liabilities & stockholders' equity	$	322,343								$	296,081
Net interest income				$	2,143								$	2,055
Interest rate spread(2)								2.57	%								2.75	%
Net interest-earning assets(3)	$	34,087								$	33,191
Net interest margin(4)					2.74	%								2.89	%
Ratio of average interest-earning assets to average interest-bearing liabilities		112.26	%								113.17	%

(1)	Tax-exempt interest income is presented on a tax equivalent basis using a 21% federal tax rate for the quarter ended September 30, 2018 and a 34% federal tax rate for the quarter ended September 30, 2017. The unadjusted average yield on tax-exempt securities was 1.80% and 1.69% for the quarters ended September 30, 2018 and 2017, respectively.  The unadjusted interest income on tax-exempt securities was $26,000 and $27,000 for the quarters ended September 30, 2018 and 2017, respectively.
(2)	Interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3)	Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(4)	Net interest margin represents net interest income divided by total interest-earning assets.
(5)	Annualized.

- 40 - 

	For the nine months September 30,
	2018									2017
							Average									Average
	Average						Yield /			Average						Yield /
(Dollars in thousands)	Balance			Interest			Cost(5)			Balance			Interest			Cost(5)
Interest-earning assets:
Loans	$	274,580		$	8,736			4.24	%	$	242,668		$	7,429			4.08	%
Federal funds sold		3,254			35			1.43			5,385			35			0.87
Taxable investment securities		13,813			296			2.85			12,177			219			2.40
Mortgage-backed securities		7,731			103			1.77			9,366			80			1.14
State and municipal securities(1)		5,936			99			2.23			6,455			126			2.61
Total interest-earning assets	$	305,314		$	9,269			4.05	%	$	276,051		$	7,889			3.81	%
Noninterest-earning assets:
Other assets	$	10,540								$	10,783
Total assets	$	315,854								$	286,834
Interest-bearing liabilities:
NOW accounts	$	30,350		$	70			0.31	%	$	29,457		$	65			0.30	%
Passbook savings		27,780			111			0.53			26,947			80			0.40
Money market savings		35,121			248			0.94			33,414			205			0.82
Individual retirement accounts		6,858			63			1.22			7,063			54			1.02
Certificates of deposit		108,803			1,363			1.67			87,657			878			1.34
Federal Home Loan Bank advances		64,200			968			2.01			59,341			695			1.56
Total interest-bearing liabilities	$	273,112		$	2,823			1.38	%	$	243,879		$	1,977			1.08	%
Noninterest-bearing liabilities:
Demand deposits	$	9,105								$	8,626
Other liabilities		2,290									2,119
Total liabilities	$	284,507								$	254,624
Stockholders' equity	$	31,347								$	32,210
Total liabilities & stockholders' equity	$	315,854								$	286,834
Net interest income				$	6,446								$	5,912
Interest rate spread(2)								2.67	%								2.73	%
Net interest-earning assets(3)	$	32,202								$	32,172
Net interest margin(4)					2.82	%								2.86	%
Ratio of average interest-earning assets to average interest-bearing liabilities		111.79	%								113.19	%

(1)	Tax-exempt interest income is presented on a tax equivalent basis using a 21% federal tax rate for the nine months ended September 30, 2018 and a 34% federal tax rate for the nine months ended September 30, 2017. The unadjusted average yield on tax-exempt securities was 1.76% for the nine months ended September 30, 2018 and 1.72% for the nine months ended September 30, 2018 and 2017.  The unadjusted interest income on tax-exempt securities was $78,000 and $84,000 for the nine months ended September 30, 2018 and 2017, respectively.
(2)	Interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities.
(3)	Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(4)	Net interest margin represents net interest income divided by total interest-earning assets.
(5)	Annualized.

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Rate/Volume Analysis

The following tables present the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of these tables, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately, based on the changes due to rate and the changes due to volume. 

	Three months ended September 30,
	2018 vs. 2017
	Increase/(Decrease) Due to
							Total
							Increase
(In thousands)	Volume			Rate			(Decrease)
Interest and dividend income:
Loans	$	299		$	103		$	402
Federal funds sold		(2	)		5			3
Taxable investment securities		7			18			25
Mortgage-backed securities		(2	)		4			2
State and municipal securities(1)		(2	)		(5	)		(7	)
Total interest and dividend income		300			125			425
Interest expense:
NOW accounts		(1	)		-			(1	)
Passbook savings		3			13			16
Money market savings		(3	)		26			23
Individual retirement accounts		(1	)		2			1
Certificates of deposit		70			98			168
Federal home loan bank advances		39			91			130
Total interest expense		107			230			337
Net change in net interest income	$	193		$	(105	)	$	88

(1) Tax-exempt interest income is presented on a tax equivalent basis using a 21% federal tax rate for the quarter ended September 30, 2018 and a 34% federal tax rate for the quarter ended September 30, 2017.

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	Nine months ended September 30,
	2018 vs. 2017
	Increase/(Decrease) Due to
							Total
							Increase
(In thousands)	Volume			Rate			(Decrease)
Interest and dividend income:
Loans	$	1,007		$	300		$	1,307
Federal funds sold		-			-			-
Taxable investment securities		32			45			77
Mortgage-backed securities		(11	)		34			23
State and municipal securities(1)		(10	)		(17	)		(27	)
Total interest and dividend income		1,018			362			1,380
Interest expense:
NOW accounts		2			3			5
Passbook savings		3			28			31
Money market savings		11			32			43
Individual retirement accounts		(2	)		11			9
Certificates of deposit		240			245			485
Federal home loan bank advances		60			213			273
Total interest expense		314			532			846
Net change in net interest income	$	704		$	(170	)	$	534

(1) Tax-exempt interest income is presented on a tax equivalent basis using a 21% federal tax rate for the nine months ended September 30, 2018 and a 34% federal tax rate for the nine months ended September 30, 2017.

Loan and Asset Quality and Allowance for Loan Losses

The following table represents information concerning the aggregate amount of nonperforming assets at the indicated dates:

	September 30,			December 31,			September 30,
(Dollars In thousands)	2018			2017			2017
Nonaccrual loans:
Residential mortgage loans	$	55		$	153		$	37
Commercial and industrial loans		45			-			-
Total nonaccrual loans		100			153			37
Total nonperforming loans		100			153			37
Total nonperforming assets	$	100		$	153		$	37
Nonperforming loans to total loans		0.05	%		0.06	%		0.01	%
Nonperforming assets to total assets		0.03	%		0.05	%		0.01	%

Nonperforming assets include nonaccrual loans, non-accruing TDRs, and foreclosed real estate. The Company generally places a loan on nonaccrual status and ceases accruing interest when loan payment performance is deemed unsatisfactory and the loan is past due 90 days or more. At September 30, 2018 there were no loans that were past due 90 days or more and still accruing interest. Loans are considered modified in a TDR when, due to a borrower’s financial difficulties, the Company makes a concession(s) to the borrower that it would not otherwise consider. These modifications may include, among others, an extension of the term of the loan, and granting a period when interest-only payments can be made, with the principal payments made over the remaining term of the loan or at maturity. At the dates indicated above, the Company had no TDRs outstanding.

- 43 - 

As indicated in the table above, nonperforming assets at September 30, 2018 were $100,000, a decrease of $53,000, or 34.6%, from $153,000 at December 31, 2017. At September 30, 2018, the Company had one non-performing residential mortgage loan for $55,000 and one non-performing commercial and industrial loan for $45,000 and at December 31, 2017, the Company had two non-performing residential mortgage loans for $153,000. At September 30, 2017, the Company had one non-performing residential mortgage loan for $37,000. At the dates indicated above, the Company had no foreclosed real estate.

The allowance for loan losses represents management’s estimate of the probable losses inherent in the loan portfolio as of the date of the balance sheet. The allowance for loan losses was $1.5 million at September 30, 2018 and $1.3 million at December 31, 2017. The Company reported an increase in the ratio of the allowance for loan losses to gross loans to 0.53% at September 30, 2018 as compared to 0.48% at December 31, 2017. Management performs a quarterly evaluation of the allowance for loan losses based on quantitative and qualitative factors and has determined that the current level of the allowance for loan losses is adequate to absorb the losses in the loan portfolio as of September 30, 2018.

A loan is considered impaired when, based on current information and events, it is probable that the Bank 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 classified as 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.

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures unless subject to a troubled debt restructuring.

At September 30, 2018 and December 31, 2017, the Company did not have loans which were deemed to be impaired.

Management has identified potential credit problems which may result in the borrowers not being able to comply with the current loan repayment terms and which may result in it being included in future impaired loan reporting. Management has identified potential problem loans totaling $5.1 million as of September 30, 2018 as compared to $3.3 million at December 31, 2017. These loans have been internally classified as special mention, substandard, or doubtful, yet are not currently considered impaired. Total potential problem loans increased between these two dates, as the Company reported an increase of $1.6 million in loans rated special mention and an increase of $221,000 in loans rated substandard. The increase in loans classified as special mention was due to one residential mortgage loan and three commercial real estate loans which were newly categorized as such during the nine months ended September 30, 2018, partially offset by one residential mortgage loan now paying as agreed. These loans were not criticized as of December 31, 2017. The increase in loans classified as substandard was due to the additions of one commercial and industrial loan and 10 residential mortgage loans newly categorized as substandard during the nine months ended September 30, 2018, partially offset by the upgrades of six residential mortgage loans now paying as agreed and three residential mortgage loan payoffs. Based on current information available at September 30, 2018, these loans were re-evaluated for their range of potential losses and reclassified accordingly.

- 44 - 

Liquidity and Capital Resources

Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our cash flows are derived from operating activities, investing activities and financing activities as reported in our consolidated statements of cash flows included in our consolidated financial statements.

Our primary sources of funds consist of deposit inflows, loan repayments, borrowings from the Federal Home Loan Bank of New York, maturities and principal repayments of securities, and loan and securities sales. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our asset/liability management committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs and deposit withdrawals of our customers as well as unanticipated contingencies. We seek to maintain a liquidity ratio of 20.0% or greater. For the quarter ended September 30, 2018, our liquidity ratio averaged 27.2%. We believe that we have enough sources of liquidity to satisfy our short and long-term liquidity needs as of September 30, 2018.

We regularly adjust our investments in liquid assets based upon our assessment of:

(i)       expected loan demand;

(ii)      expected deposit flows;

(iii)     yields available on interest-earning deposits and securities; and

(iv)     the objectives of our asset/liability management program.

Excess liquid assets are invested generally in interest-earning deposits, short and intermediate-term securities and federal funds sold. Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2018, cash and cash equivalents totaled $6.0 million.

At September 30, 2018, we had $11.6 million in loan commitments outstanding. In addition to commitments to originate loans, we had $19.9 million in unused lines of credit outstanding to borrowers. Certificates of deposit (including individual retirement accounts comprised solely of certificates of deposit), due within one year of September 30, 2018 totaled $61.4 million, or 52.7% of our certificates of deposit (including individual retirement accounts) and 28.0% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including loan sales, other deposit products, and Federal Home Loan Bank borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the existing certificates of deposit due on or before September 30, 2019. We believe, however, based on past experience that a significant portion of such deposits will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of New York, which provides an additional source of funds. Federal Home Loan Bank borrowings increased by $9.3 million, to $73.8 million at September 30, 2018, from $64.4 million at December 31, 2017. At September 30, 2018, we had the ability to borrow approximately $165.7 million from the Federal Home Loan Bank of New York, of which $73.8 million had been advanced.

We also have a repurchase agreement with Raymond James providing an additional $10.0 million in liquidity. Funds obtained under the repurchase agreement are secured by the Company’s U.S. Government and agency obligations.  There were no advances outstanding under the repurchase agreement at September 30, 2018 and December 31, 2017. In addition to the repurchase agreement with Raymond James, we also have an unsecured line of credit through Atlantic Community Bankers Bank which would provide an additional $5.0 million in liquidity. There were no draws or outstanding balances from the line of credit at September 30, 2018 and December 31, 2017.

- 45 - 

Capital

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

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a "capital conservation buffer" consisting of 2.5% of common equity Tier 1 capital to risk-weighted assets above the amount necessary to meet its minimum risk-based capital requirements.  The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019. For 2018, the capital conservation buffer requirement is 1.875% of risk-weighted assets.

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

Fairport Savings Bank’s capital amounts and ratios as of the indicated dates are presented in the following table.

Minimum

To Be "Well-

Minimum

Capitalized"

Well-Capitalized

For Capital

Under Prompt

With Buffer, Fully

Actual

Adequacy Purposes

Corrective Provisions

Phased in for 2019

(Dollars in thousands)

Amount

Ratio

Amount

Ratio

Amount

Ratio

Amount

Ratio

As of September 30, 2018

Total Core Capital (to Risk-Weighted Assets)

$

30,767

15.62

%

³$15,762

³8.0

%

³$19,703

³10.0

%

³$20,688

³10.5

%

Tier 1 Capital (to Risk-Weighted Assets)

29,281

14.86

³11,822

³6.0

³15,762

³8.0

³16,747

³8.5

Tier 1 Common Equity (to Risk-Weighted Assets)

29,281

14.86

³8,866

³4.5

³12,807

³6.5

³13,792

³7.0

Tier 1 Capital (to Assets)

29,281

9.14

³12,813

³4.0

³16,016

³5.0

³16,016

³5.0

As of December 31, 2017:

Total Core Capital (to Risk-Weighted Assets)

$

30,067

16.11

%

³$14,927

³8.0

%

³$18,658

³10.0

%

³$19,591

³10.5

%

Tier 1 Capital (to Risk-Weighted Assets)

28,806

15.44

³11,195

³6.0

³14,927

³8.0

³15,860

³8.5

Tier 1 Common Equity (to Risk-Weighted Assets)

28,806

15.44

³8,396

³4.5

³12,128

³6.5

³13,061

³7.0

Tier 1 Capital (to Assets)

28,806

9.47

³12,173

³4.0

³15,216

³5.0

³15,216

³5.0

- 46 - 

Off-Balance Sheet Arrangements

In the ordinary course of business, Fairport Savings Bank is a party to credit-related financial instruments with off-balance sheet risk to meet the financing needs of our customers. These financial instruments include commitments to extend credit. We follow the same credit policies in making commitments as we do for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by us, is based on our credit evaluation of the customer.

At September 30, 2018 and December 31, 2017, we had $7.7 million and $12.4 million, respectively, of commitments to grant loans, $3.9 million and $5.9 million, respectively, of unadvanced portions of construction loans, and $19.9 million and $17.5 million, respectively, of unfunded commitments under lines of credit. We had three commercial letters of credit for $249,000 at September 30, 2018 and two commercial letters of credit for $414,000 at December 31, 2017.

Impact of Inflation and Changing Prices

Our consolidated financial statements and related notes have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

A smaller reporting company is not required to provide the information relating to this item.

Item 4 – Controls and Procedures

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities and Exchange Act of 1934, as amended (the “Exchange Act”) is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

The Company maintains controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission. As of September 30, 2018, the Company’s management, including the Company’s Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Accounting Officer), has evaluated the effectiveness of the Company’s disclosure controls and procedures as defined in Rules 13a-15 and 15d-15(e) under the Exchange Act. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this report, the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures must necessarily reflect the fact that there are resource constraints and that management is required to apply its judgement in evaluating the benefits of possible controls and procedures relative to their costs.

- 47 - 

There has been no change in the Company’s internal control over financial reporting during the third quarter of the fiscal year ended December 31, 2018 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1 – Legal Proceedings

As of September 30, 2018, the Company is not currently a named party in a legal proceeding, the outcome of which would have a material effect on the financial condition or results of operations of the Company.

Item 1A – Risk Factors

A smaller reporting company is not required to provide the information relating to this item.

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

The following table provides certain information with regard to shares repurchased by the Company in the third quarter of 2018.

Period	(a) Total Number of Shares Purchased		(b) Average Price Paid per Share		(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1)		(d) Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs(1)
July 1 — July 31, 2018		-	$	-		-		27,549
August 1 — August 31, 2018		-	$	-		-		27,549
September 1 — September 30, 2018		-	$	-		-		27,549
Total		-	$			-

(1) The Company’s Board of Directors authorized its first stock repurchase program on July 27, 2017 to acquire up to 97,084 shares, or 5.0% of the Company’s then outstanding common stock.  Repurchases will be made from time to time depending on market conditions and other factors, and will be conducted through open market or private transactions, through block trades, and pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the Securities and Exchange Commission.  There is no guarantee as to the exact number of shares to be repurchased by the Company.

Item 3 – Defaults Upon Senior Securities

None

Item 4 – Mine Safety Disclosures

Not applicable

Item 5 – Other Information

None

- 48 - 

Item 6 – Exhibits

Exhibit No.	Description
31.1	Rule 13a-14(a) / 15d-14(a) Certification of the Chief Executive Officer
31.2	Rule 13a-14(a) / 15d-14(a) Certification of the Chief Financial Officer
32	Section 1350 Certification of the Chief Executive Officer and Chief Financial Officer
101	The following materials from FSB Bancorp, Inc. Form 10-Q for the quarter ended September 30, 2018, formatted in Extensible Business Reporting Language (XBRL): (i) the Consolidated Statements of Income, (ii) the Consolidated Statements of Financial Condition, (iii) Consolidated Statements of Cash Flows, and (iv) related notes

- 49 - 

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.

	FSB BANCORP, INC. (registrant)
November 13, 2018	/s/ Kevin D. Maroney
	Kevin D. Maroney
	President & Chief Executive Officer

November 13, 2018	/s/ Angela M. Krezmer
	Angela M. Krezmer
	Chief Financial Officer

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