UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K/A

AMENDMENT NO. 1

 

x

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

 

For the fiscal year ended December 31, 2016

 

OR

 

¨

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

 

For the transition period from                      to                     

 

Commission File Number: 001-37504

 

PROVIDENT BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Massachusetts		45-3231576
(State or other jurisdiction of incorporation or organization)		I.R.S. Employer Identification No.)
5 Market Street, Amesbury, Massachusetts		01913
(Address of principal executive offices)		(Zip Code)

 

(978) 834-8555

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Common Stock, no par value

(Title of Class)

 

The NASDAQ Stock Market LLC

(Name of exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

 

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

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

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

 

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

 

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

 

The aggregate market value of the voting and non-voting common stock held by non-affiliates of the registrant, computed by reference to the last sale price as of June 30, 2016, as reported by the Nasdaq Capital Market, was approximately $59 million.

 

The number of shares outstanding of the registrant’s common stock as of March 8, 2017 was 9,652,448.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Certain portions of the registrant’s Definitive Proxy Statement for the 2017 Annual Meeting of the Stockholders are incorporated by reference in Part III.

 

 

 

Explanatory Note

 

Provident Bancorp, Inc. (the “Company”) is filing this Amendment No. 1 on Form 10-K/A to its Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission on March 16, 2017. The Company is re-filing Item 7 of Part II of the Form 10-K to correct the percentage changes for economic value of equity in Management of Market Risk, and is correcting the cover page to indicate the incorporation by reference of items from the Company’s Proxy Statement for its 2017 Annual Meeting of Stockholders.

 

 

INDEX

 

	Part II
Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	3
	Part III
Item 10.	Directors, Executive Officers and Corporate Governance	26
Item 11.	Executive Compensation	27
Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholders Matters	27
Item 13.	Certain Relationships and Related Transactions, and Director Independence	27
Item 14.	Principal Accounting Fees and Services	27
	Part IV
Item 15.	Exhibits and Financial Statement Schedules	27

 

 

PART II

 

ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. You should read the information in this section in conjunction with the business and financial information regarding Provident Bancorp, Inc. and the financial statements provided in this Annual Report.

 

Overview

 

On July 15, 2015, the Company closed its stock offering and issued 4,274,425 shares of common stock to the public at $10.00 per share, including 357,152 shares purchased by The Provident Bank Employee Stock Ownership Plan. In addition, the Company issued 5,034,323 shares to Provident Bancorp, the Company’s mutual holding company, and 189,974 shares to The Provident Community Charitable Organization, Inc., a charitable foundation that was formed in connection with the stock offering and is dedicated to supporting charitable organizations operating in the Bank’s local community. A total of 9,498,722 shares of common stock are outstanding following the completion of the stock offering. Expenses incurred related to the offering were $1.5 million, and have been recorded against offering proceeds.

 

Upon the completion of the stock offering, a special “liquidation account” was established for the benefit of certain depositors of the Bank in an amount equal to the percentage ownership interest in the equity of the Company to be held by persons other than the MHC as of the date of the latest balance sheet contained in the stock offering prospectus. Following the completion of the offering, the Company is not permitted to pay dividends on its capital stock if the Company’s shareholders’ equity is reduced below the amount of the liquidation account. The liquidation account is reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible account holder’s interest in the liquidation account.

 

On December 21, 2015 the Company redeemed the 17,145 shares of Series A Preferred Stock issued to the U.S. Treasury under the SBLF preferred stock program. The redemption was completed with a payment to the U.S. Treasury of $17,145,000 plus accrued dividends.

 

On November 17, 2016, the Company granted a total of 384,268 stock options and 153,726 restricted stock awards under the Provident Bancorp, Inc. 2016 Equity Incentive Plan (the “Plan”) to officers, employees and directors of the Company and The Provident Bank. Each award granted under the Plan is evidenced by an award agreement signed by the grantee. The Incentive Stock Option Award Agreement and the Non-Statutory Stock Option Award Agreement provide the terms of individual option grants, including the number of options granted, the exercise price per share, the date of grant, the vesting schedule, restrictions on transfer, the effect of termination under certain conditions, and the term and expiration date of the options. The Restricted Stock Award Agreement provides the terms of individual restricted stock awards, including the number of shares awarded, the vesting schedule, restrictions on transfer, grantee rights prior to vesting of awards, and the effect of termination under certain conditions.

 

On January 26, 2017, Company announced that its Board of Directors has adopted a stock repurchase program. Under the repurchase program, the Company may repurchase up to 625,015 shares of its common stock, or approximately 6.6% of the current outstanding shares.

 

Our profitability is highly dependent on our net interest and dividend income, which is the difference between our interest income on interest-earning assets, such as loans and securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowed funds.

 

 

Our net income increased $2.5 million, or 65.8%, to $6.3 million for the year ended December 31, 2016 from $3.8 million for the year ended December 31, 2015. The increase was primarily due to the charitable foundation expense in connection with our offering of $2.2 million in 2015 that did not recur in 2016 and an increase of $2.8 million, or 12.2%, in net interest and dividend income, offset by an increase in salaries and employee benefits of $1.1 million, or 9.0%.

 

Our provision for loan losses was $703,000 for the year ended December 31, 2016 compared to $805,000 for the year ended December 31, 2015. Decreases within our provisions year over year are primarily a result of our improvements in asset quality. For further information related to changes in the provision and allowance for loan losses, refer to “—Asset Quality—Allowance for Loan Losses.”

 

Noninterest expense decreased $616,000, or 2.9%, to $20.5 million for the year ended December 31, 2016 from $21.1 million for year ended December 31, 2015. The largest decrease was related to the $2.2 million funding of the Bank’s new charitable foundation in 2015 that did not recur in 2016. Salaries and employee benefits expense increased $1.1 million, or 9.0%, to $12.9 million for the year ended December 31, 2016 from $11.8 million for the year ended December 31, 2015, due primarily to changes in staffing, increased expense for the Bank’s Employee Stock Ownership Plan (“ESOP”) and the expense related to the Bank’s equity plan.

 

Critical Accounting Policies

 

A summary of our accounting policies is described in Note 2 to the Consolidated Financial Statements included in this annual report. Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Management believes that the most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:

 

Allowance for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, size and composition of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

A loan is considered impaired when, based on current information and events, it is probable that we 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 for commercial, commercial real estate and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, 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, we do not separately identify individual consumer and residential loans for impairment disclosures.

 

 

The allowance consists of a general component, a specific component, and an unallocated component. The general component of the allowance for loan losses is based on historical loss experience adjusted for qualitative factors stratified by the following loan segments: residential real estate, commercial real estate, construction and land development, commercial and consumer. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment. This historical loss factor is adjusted for the following qualitative factors: levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no changes in our policies or methodology pertaining to the general component of the allowance for loan losses during 2016.

 

The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:

 

Residential real estate: We generally do not originate loans with a loan-to-value ratio greater than 80% and do not originate subprime loans. Loans with loan to value ratios greater than 80% require the purchase of private mortgage insurance. All loans in this segment are collateralized by owner-occupied residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, will have an effect on the credit quality in this segment.

 

Commercial real estate: Loans in this segment are primarily income-producing properties throughout Massachusetts and New Hampshire. The underlying cash flows generated by the properties are adversely impacted by a downturn in the economy as evidenced by increased vacancy rates, which in turn, will have an effect on the credit quality in this segment. Management periodically obtains rent rolls and continually monitors the cash flows of these loans.

 

Construction and land development: Loans in this segment primarily include speculative and pre-sold real estate development loans for which payment is derived from sale of the property and construction to permanent loans for which payment is derived from cash flows of the property. Credit risk is affected by cost overruns, time to sell at an adequate price, and market conditions.

 

Commercial: Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer spending, will have an effect on the credit quality in this segment.

 

Consumer: Loans in this segment are generally unsecured and repayment is dependent on the credit quality of the individual borrower.

 

The allocated component relates to loans that are classified as impaired. Impairment is measured on a loan by loan basis for commercial, commercial real estate and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is collateral dependent. An allowance is established when the discounted cash flows (or collateral value) of the impaired loan is lower than the carrying value of that loan.

 

We periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. All troubled debt restructurings are initially classified as impaired.

 

An unallocated component can be 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 allocated and general reserves in the portfolio.

 

 

Stock-based Compensation Plans. The Company measures and recognizes compensation cost relating to stock-based payment transactions based on the grant-date fair value of the equity instruments issued. Stock-based compensation is recognized over the period the employee is required to provide services for the award. The Company uses the Black-Scholes option-pricing model to determine the fair value of stock options granted. The fair value of restricted stock is recorded based on the grant date value of the equity instrument issued.

 

Income Taxes. We recognize income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of our assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled.

 

The Company reduces the deferred tax asset by a valuation allowance if, based on the weight of the available evidence, it is not “more likely than not” that some portion or all of the deferred tax assets will be realized. The Company assesses the realizability of its deferred tax assets by assessing the likelihood of the Company generating federal and state income tax, as applicable, in future periods in amounts sufficient to offset the deferred tax charges in the periods they are expected to reverse. Based on this assessment, management concluded that a valuation allowance was not required as of December 31, 2016 and 2015.

 

We examine our significant income tax positions annually to determine whether a tax benefit is more likely than not to be sustained upon examination by tax authorities.

 

Comparison of Financial Condition at December 31, 2016 and December 31, 2015

 

Assets. Our total assets increased $52.1 million, or 7.0%, to $795.5 million at December 31, 2016 from $743.4 million at December 31, 2015. The increase resulted primarily from an increase in loans.

 

Cash and Cash Equivalents. Cash and cash equivalents decreased $9.8 million, or 47.7%, to $10.7 million at December 31, 2016 from $20.5 million at December 31, 2015. The decrease resulted from paying off borrowings as we used cash generated from an increase in deposits to fund our operations.

 

 Loan Portfolio Analysis. At December 31, 2016, net loans were $624.4 million, or 78.5% of total assets, compared to $554.9 million, or 74.6% of total assets at December 31, 2015. The increase in loans during the year was caused by increases in commercial real estate loans and commercial business loans. The increase was partially offset by a $23.4 million, or 32.7%, decrease in construction and land development loans. The decrease in construction and land development loans and part of the increase in commercial real estate loans was related to loans moving from the construction phase to permanent financing. During the year ended December 31, 2014, we discontinued single-family residential real estate lending, with the exception of home equity lines of credit. We believe that new federal regulations governing the origination of single-family residential real estate loans would increase our costs and expand the risks associated with this type of lending beyond the benefits that we could realize from originating these loans. We have instead focused our lending activities on commercial loans.

 

 

The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated, excluding loans held for sale.

 

		At December 31,
		2016								2015								2014								2013								2012
		Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent
		(Dollars in thousands)
Real estate:
Residential (1)		$	76,850				12.13	%		$	92,392				16.40	%		$	104,568				20.84	%		$	111,244				24.93	%		$	109,725				28.69	%
Commercial (2)			336,102				53.07				285,356				50.67				249,691				49.76				223,642				50.12				189,031				49.42
Construction and land development			48,161				7.60				71,535				12.70				47,079				9.38				20,588				4.61				12,520				3.27
Commercial			166,157				26.23				112,073				19.90				97,589				19.45				87,405				19.59				67,528				17.66
Consumer			6,172				0.97				1,855				0.33				2,863				0.57				3,329				0.75				3,666				0.96
Total loans			633,442				100.00	%			563,211				100.00	%			501,790				100.00	%			446,208				100.00	%			382,470				100.00	%
Deferred loan fees, net			(427	)							(377	)							(383	)							(419	)							(339	)
Allowance for loan losses			(8,590	)							(7,905	)							(7,224	)							(6,077	)							(5,013	)
Loans, net		$	624,425							$	554,929							$	494,183							$	439,712							$	377,118

 

(1)        Includes home equity loans and lines of credit

(2)        Includes multi-family real estate loans

 

 Loan Maturity. The following table sets forth certain information at December 31, 2016 regarding the contractual maturity of our loan portfolio. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. The table does not include any estimate of prepayments that could significantly shorten the average life of all loans and may cause our actual repayment experience to differ from that shown below.

 

		Residential				Commercial				Construction and												Total
		Real Estate				Real Estate				Land Development				Commercial				Consumer				Loans
										(In thousands)
Amounts due in:
One year or less		$	22			$	16,696			$	8,438			$	29,987			$	5,299			$	60,442
More than one year to five years			3,799				34,652				10,429				69,814				873				119,567
More than five years through ten years			13,830				29,917				64				50,536				-				94,347
More than ten years			59,199				254,837				29,230				15,820				-				359,086
Total		$	76,850			$	336,102			$	48,161			$	166,157			$	6,172			$	633,442

 

The following table sets forth our fixed and adjustable-rate loans at December 31, 2016 that are contractually due after December 31, 2017.

 

						Floating or
		Fixed				Adjustable
		Rates				Rates				Total
						(In thousands)
Real estate:
Residential		$	51,510			$	25,318			$	76,828
Commercial			7,218				312,188				319,406
Construction and land development			5,604				34,119				39,723
Commercial			57,580				78,590				136,170
Consumer			873				-				873
Total loans		$	122,785			$	450,215			$	573,000

 

 

Asset Quality

 

Credit Risk Management. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. Management of asset quality is accomplished by internal controls, monitoring and reporting of key risk indicators, and both internal and independent third-party loan reviews. The primary objective of our loan review process is to measure borrower performance and assess risk for the purpose of identifying loan weakness in order to minimize loan loss exposure. From the time of loan origination through final repayment, commercial real estate, construction and land development and commercial business loans are assigned a risk rating based on pre-determined criteria and levels of risk. The risk rating is monitored annually for most loans; however, it may change during the life of the loan as appropriate.

 

Internal and independent third-party loan reviews vary by loan type. Depending on the size and complexity of the loan, some loans may warrant detailed individual review, while other loans may have less risk based upon size, or be of a homogeneous nature reducing the need for detailed individual analysis. Assets with these characteristics, such as consumer loans and loans secured by residential real estate, may be reviewed on the basis of risk indicators such as delinquency or credit rating. In cases of significant concern, a total re-evaluation of the loan and associated risks are documented by completing a loan risk assessment and action plan. Some loans may be re-evaluated in terms of their fair market value or net realizable value in order to determine the likelihood of potential loss exposure and, consequently, the adequacy of specific and general loan loss reserves.

 

When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status, including contacting the borrower by letter and phone at regular intervals. When the borrower is in default, we may commence collection proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. Management informs the board of directors monthly of the amount of loans delinquent more than 30 days. Management provides detailed information to the board of directors quarterly on loans 60 or more days past due and all loans in foreclosure and repossessed property that we own.

 

 

Delinquent Loans. The following tables set forth our loan delinquencies by type and amount at the dates indicated.

 

		At December 31,
		2016												2015												2014
		30-59				60-89				90 Days				30-59				60-89				90 Days				30-59				60-89				90 Days
		Days				Days				or more				Days				Days				or more				Days				Days				or more
		Past Due				Past Due				Past Due				Past Due				Past Due				Past Due				Past Due				Past Due				Past Due
		(In thousands)
Real Estate:
Residential		$	-			$	-			$	-			$	130			$	173			$	365			$	-			$	404			$	423
Commercial			-				-				346				-				-				-				110				132				363
Construction and land development			-				-				-				-				-				-				-				-				-
Commercial			29				-				-				-				-				-				149				108				350
Consumer			-				-				-				1				1				-				9				-				-
Total		$	29			$	-			$	346			$	131			$	174			$	365			$	268			$	644			$	1,136

 

 

		At December 31,
		2013												2012
		30-59				60-89				90 Days				30-59				60-89				90 Days
		Days				Days				or more				Days				Days				or more
		Past Due				Past Due				Past Due				Past Due				Past Due				Past Due
		(In thousands)
Real Estate:
Residential		$	427			$	345			$	937			$	1,112			$	-			$	112
Commercial			366				141				464				425				-				150
Construction and land development			50				-				-				-				-				-
Commercial			238				24				31				1,081				118				50
Consumer			4				-				-				11				-				-
Total		$	1,085			$	510			$	1,432			$	2,629			$	118			$	312

 

Non-performing Assets. Non-performing assets include loans that are 90 or more days past due or on non-accrual status, including troubled debt restructurings on non-accrual status, and real estate and other loan collateral acquired through foreclosure and repossession. Troubled debt restructurings include loans for which either a portion of interest or principal has been forgiven, loans modified at interest rates materially less than current market rates, or the borrower is experiencing financial difficulty. Loans 90 days or greater past due may remain on an accrual basis if adequately collateralized and in the process of collection. At December 31, 2016, we did not have any accruing loans past due 90 days or greater. For non-accrual loans, interest previously accrued but not collected is reversed and charged against income at the time a loan is placed on non-accrual status. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as foreclosed real estate until it is sold. When property is acquired, it is initially recorded at the fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Holding costs and declines in fair value after acquisition of the property result in charges against income.

 

  

The following table sets forth information regarding our non-performing assets at the dates indicated.

 

		At December 31,
		2016				2015				2014				2013				2012
		(Dollars in thousands)
Non-accrual loans:
Real estate:
Residential		$	303			$	1,031			$	1,564			$	1,608			$	1,348
Commercial			346				106				3,002				1,049				920
Construction and land development			-				-				-				185				206
Commercial			933				1,147				516				474				317
Consumer			-				-				-				2				-
Total non-accrual loans			1,582				2,284				5,082				3,318				2,791
Accruing loans past due 90 days or more			-				-				-				-				-
Real estate owned			-				-				-				-				-
Total non-performing assets			1,582				2,284				5,082				3,318				2,791
Total loans (1)		$	633,015			$	562,834			$	501,407			$	445,789			$	382,131
Total assets		$	795,543			$	743,397			$	658,606			$	624,659			$	576,460
Total nonperforming loans to total loans (1)			0.25	%			0.41	%			1.01	%			0.74	%			0.73	%
Total nonperforming assets to total assets			0.20	%			0.31	%			0.77	%			0.53	%			0.48	%

 

(1) Loans are presented before allowance for loan losses, but include deferred loan costs/fees.

 

The decrease in non-accrual loans in 2016 was primarily due to borrowers proving the ability to repay their loans, such that the loans were returned to accrual status. The decrease in non-accruing commercial real estate loans in 2015 was primarily due to a $2.2 million loan secured by multiple investment properties that was placed on non-accrual in 2014.

 

Interest income that would have been recorded for the year ended December 31, 2016 had non-accruing loans been current according to their original terms amounted to $117,000. We recognized $13,000 of interest income for these loans for the year ended December 31, 2016.

 

The following table sets forth the accruing and non-accruing status of troubled debt restructurings at the dates indicated.

 

		At December 31,
		2016								2015								2014								2013								2012
		Non-								Non-								Non-								Non-								Non-
		Accruing				Accruing				Accruing				Accruing				Accruing				Accruing				Accruing				Accruing				Accruing				Accruing
		(In thousands)
Troubled Debt Restructurings:
Real estate:
Residential		$	-			$	422			$	-			$	436			$	-			$	221			$	185			$	227			$	206			$	363
Commercial			346				1,610				106				3,167				1,490				1,385				729				1,438				768				1,495
Construction and land development			-				-				-				-				-				-				-				-				-				-
Commercial			919				727				1,147				565				202				196				266				139				38				154
Consumer			-				-				-				-				-				-				-				-				-				-
Total		$	1,265			$	2,759			$	1,253			$	4,168			$	1,692			$	1,802			$	1,180			$	1,804			$	1,012			$	2,012

 

 

Total troubled debt restructurings decreased in 2016 primarily due to a payoff of a $1.2 million troubled debt restructure. During 2016 there was one loan totaling $58,000 that was modified under a troubled debt restructure. The loan that was modified in 2016 is paying in accordance with its modified terms.

 

Interest income that would have been recorded for the year ended December 31, 2016 had troubled debt restructurings been current according to their original terms amounted to $180,000. We recognized $143,000 of interest income for these loans for the year ended December 31, 2016.

 

Potential Problem Loans. We classify certain commercial real estate, construction and land development, and commercial loans as “special mention”, “substandard”, or “doubtful”, based on criteria consistent with guidelines provided by our banking regulators. Certain potential problem loans represent loans that are currently performing, but for which known information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the present loan repayment terms and which may result in such loans becoming nonperforming at some time in the future. Potential problem loans also include non-accrual or restructured loans presented above. We expect the levels of non-performing assets and potential problem loans to fluctuate in response to changing economic and market conditions, and the relative sizes of the respective loan portfolios, along with our degree of success in resolving problem assets.

 

Other potential problem loans are those loans that are currently performing, but where known information about possible credit problems of the borrowers causes us to have concerns as to the ability of such borrowers to comply with contractual loan repayment terms. At December 31, 2016, other potential problem loans totaled $2.8 million, consisting of 19 troubled debt restructured loans that were accruing interest in accordance with their modified terms.

 

Allowance for Loan Losses. The allowance for loan losses is maintained at levels considered adequate by management to provide for probable loan losses inherent in the loan portfolio as of the consolidated balance sheet reporting dates. The allowance for loan losses is based on management’s assessment of various factors affecting the loan portfolio, including portfolio composition, delinquent and non-accrual loans, national and local business conditions and loss experience and an overall evaluation of the quality of the underlying collateral.

 

 

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

 

		Year Ended December 31,
		2016				2015				2014				2013				2012
		(Dollars in thousands)
Allowance at beginning of year		$	7,905			$	7,224			$	6,077			$	5,013			$	4,507
Provision for loan losses			703				805				1,452				1,175				681
Charge offs:
Real estate:
Residential			-				-				30				50				65
Commercial			-				-				243				148				245
Construction and land development			-				-				-				-				-
Commercial			-				96				-				19				16
Consumer			44				65				91				85				76
Total charge-offs			44				161				364				302				402
Recoveries:
Real estate:
Residential			12				6				24				37				16
Commercial			-				-				24				55				12
Construction and land development			-				-				-				-				-
Commercial			1				20				5				5				11
Consumer			13				11				6				1				48
Total recoveries			26				37				59				98				87
Net charge-offs			18				124				305				204				315
Allowance at end of year		$	8,590			$	7,905			$	7,224			$	5,984			$	4,873
Non-performing loans at end of year		$	1,582			$	2,284			$	5,082			$	3,318			$	2,791
Total loans outstanding at end of year (1)		$	633,015			$	562,834			$	501,407			$	445,789			$	382,131
Average loans outstanding during the year (1)		$	583,156			$	516,405			$	471,650			$	419,084			$	360,543
Allowance to non-performing loans			542.98	%			346.10	%			142.15	%			180.35	%			174.60	%
Allowance to total loans outstanding at end of the year			1.36	%			1.40	%			1.44	%			1.34	%			1.28	%
Net chargeoffs to average loans outstanding during the year			0.00	%			0.02	%			0.06	%			0.05	%			0.09	%

 

(1) Loans are presented before the allowance for loan losses but include deferred fees/costs

 

 

Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

 

		At December 31,
		2016								2015								2014
		Allowance				% of Loans				Allowance				% of Loans				Allowance				% of Loans
		for Loan				in Category				for Loan				in Category				for Loan				in Category
		Losses				to Total Loans				Losses				to Total Loans				Losses				to Total Loans
		(Dollars in thousands)
Real estate:
Residential		$	328				12.13	%		$	412				16.40	%		$	560				20.84	%
Commercial			4,503				53.07				3,827				50.67				3,500				49.76
Construction and land development			882				7.60				1,236				12.70				872				9.38
Commercial			2,513				26.23				2,138				19.90				1,751				19.45
Consumer			279				0.97				119				0.33				184				0.57
Total allocated allowance for loan losses			8,505				100.00	%			7,732				100.00	%			6,867				100.00	%
Unallocated			85								173								357
Total		$	8,590							$	7,905							$	7,224

 

		At December 31,
		2013								2012
		Allowance				% of Loans				Allowance				% of Loans
		for Loan				in Category				for Loan				in Category
		Losses				to Total Loans				Losses				to Total Loans
		(Dollars in thousands)
Real estate:
Residential		$	725				24.93	%		$	1,038				28.69	%
Commercial			3,207				50.12				2,499				49.42
Construction and land development			363				4.61				192				3.27
Commercial			1,331				19.59				795				17.66
Consumer			206				0.75				155				0.96
Total allocated allowance for loan losses			5,832				100.00	%			4,679				100.00	%
Unallocated			245								334
Total		$	6,077							$	5,013

 

 

The allowance consists of general, specific, and unallocated components. The general component relates to pools of non-impaired loans and is based on historical loss experience adjusted for qualitative factors. The allocated component relates to loans that are classified as impaired, whereby an allowance is established when the discounted cash flows, collateral value or observable market price of the impaired loan is lower than the carrying value of that loan.

 

An unallocated component can be 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 allocated and general reserves in the portfolio.

 

We had impaired loans totaling $4.0 million and $5.5 million as of December 31, 2016 and 2015, respectively. At December 31, 2016, impaired loans totaling $861,000 had a valuation allowance of $46,000. Impaired loans totaling $1.1 million had a valuation allowance of $488,000 at December 31, 2015. Our average investment in impaired loans was $4.9 million and $5.6 million for the years ended December 31, 2016 and 2015, respectively.

 

A loan is considered impaired when, based on current information and events, it is probable that we 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 for commercial, commercial real estate and construction and land development loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. 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, the loan’s obtainable market price, 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 based on payment status. Accordingly, we do not separately identify individual one- to four-family residential and consumer loans for impairment disclosures, unless such loans are subject to a troubled debt restructuring. We periodically agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a troubled debt restructuring. All troubled debt restructurings are initially classified as impaired.

 

We review residential and commercial loans for impairment based on the fair value of collateral, if collateral-dependent, or the present value of expected cash flows. Management has reviewed the collateral value for all impaired and non-accrual loans that were collateral dependent as of December 31, 2016 and considered any probable loss in determining the allowance for loan losses.

 

Loans that are partially charged off generally remain on non-accrual status until foreclosure or such time that they are performing in accordance with the terms of the loan and have a sustained payment history of at least six months. The accrual of interest is generally discontinued when the contractual payment of principal or interest has become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. Loan losses are charged against the allowance when we believe the uncollectability of a loan balance is confirmed; for collateral-dependent loans, generally when appraised values (as adjusted values, if applicable) less estimated costs to sell, are less than our carrying values.

 

 

Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with generally accepted accounting principles in the United States of America, our regulators, in reviewing our loan portfolio, may require us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, the existing allowance for loan losses may not be adequate or increases may be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.

 

Securities Portfolio

 

During 2016, we transferred all of our investments classified as held-to-maturity to available-for-sale. The following table sets forth the amortized cost and estimated fair value of our available-for-sale securities portfolio at the dates indicated.

 

		At December 31,
		2016								2015								2014
		Amortized				Fair				Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value				Cost				Value
		(In thousands)
Securities available-for-sale:
U.S. Government and federal agency		$	-			$	-			$	1,996			$	2,033			$	1,991			$	2,084
State and municipal			49,367				50,580				3,373				3,682				3,479				3,901
Corporate debt			1,000				1,031				1,000				1,071				1,000				1,114
Asset-backed securities			8,747				8,678				9,656				9,624				2,733				2,645
Government mortgage-backed securities			41,818				41,914				52,515				52,812				54,063				54,853
Trust preferred securities			1,368				968				1,368				1,116				1,502				1,122
Marketable equity securities			11,363				14,696				8,341				10,646				7,349				10,313
Total		$	113,663			$	117,867			$	78,249			$	80,984			$	72,117			$	76,032

 

The following table sets forth the amortized cost and estimated fair value of our held-to-maturity securities portfolio at the dates indicated.

 

		At December 31,
		2016								2015								2014
		Amortized				Fair				Amortized				Fair				Amortized				Fair
		Cost				Value				Cost				Value				Cost				Value
		(In thousands)
Securities held-to-maturity
State and municipal		$	-			$	-			$	44,623			$	46,474			$	45,559			$	47,435
Total		$	-			$	-			$	44,623			$	46,474			$	45,559			$	47,435

 

At December 31, 2016, we had no investments in a single company or entity, other than government and government agency securities, that had an aggregate book value in excess of 10% of our equity.

 

 

Portfolio Maturities and Yields. The composition and maturities of the investment securities portfolio at December 31, 2016, are summarized in the following table. The table excludes marketable equity securities with an amortized cost of $11.4 million and a fair value of $14.7 million at December 31, 2016, as such securities do not have a maturity date or stated yield. Certain mortgage-backed securities have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below. No tax-equivalent yield adjustments have been made, as the amount of tax free interest-earning assets is immaterial.

 

										More than								More than								More than
		One Year or Less								One Year to Five Years								Five Years to Ten Years								Ten Years								Total
		Amortized Cost				Weighted Average Yield				Amortized Cost				Weighted Average Yield				Amortized Cost				Weighted Average Yield				Amortized Cost				Weighted Average Yield				Amortized Cost				Fair Value				Weighted Average Yield
		(Dollars in thousands)
Securities available-for-sale:
State and municipal		$	782				1.43	%		$	2,280				2.89	%		$	7,637				3.11	%		$	38,668				3.33	%		$	49,367			$	50,580				3.25	%
Corporate debt			1,000				6.38	%			-				-	%			-				-	%			-				-	%			1,000				1,031				6.38	%
Asset-backed securities			80				1.73	%			583				1.90	%			1,284				1.97	%			6,800				2.73	%			8,747				8,678				2.55	%
Government mortgage-			-				-	%			3,592				1.50	%			2,524				2.41	%			35,702				2.15	%			41,818				41,914				2.11	%
backed securities
Trust Preferred Securities			-				-	%			-				-	%			-				-	%			1,368				3.47	%			1,368				968				3.47	%
Total		$	1,862				4.10	%		$	6,455				2.02	%		$	11,445				2.83	%		$	82,538				2.77	%		$	102,300			$	103,171				2.76	%

 

Each reporting period, we evaluate all securities with a decline in fair value below the amortized cost of the investment to determine whether or not the impairment is deemed to be other-than-temporary. Other-than-temporary impairment (“OTTI”) is required to be recognized if (1) we intend to sell the security; (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. Marketable equity securities are evaluated for OTTI based on the severity and duration of the impairment and, if deemed to be other than temporary, the declines in fair value are reflected in earnings as realized losses. For impaired debt securities that we intend to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI, resulting in a realized loss that is a charged to earnings through a reduction in our non-interest income. For all other impaired debt securities, credit-related OTTI is recognized through earnings and non-credit related OTTI is recognized in other comprehensive income/loss, net of applicable taxes. We did not recognize any OTTI during the years ended December 31, 2016 or 2015.

 

 

Deposits

 

Total deposits increased $50.7 million, or 8.8%, to $628.0 million at December 31, 2016 from $577.2 million at December 31, 2015. Our continuing focus on the acquisition and expansion of core deposit relationships, which we define as all deposits except for certificates of deposit, resulted in net growth in these deposits of $84.1 million, or 18.6%, to $537.1 million at December 31, 2016, or 85.5% of total deposits at that date. The growth in core deposits was offset by a $33.3 million, or 26.2%, decrease in certificates of deposit.

 

The following tables set forth the distribution of total deposits by account type at the dates indicated.

 

		At December 31,
		2016								2015								2014
		Amount				Percent				Amount				Percent				Amount				Percent
		(Dollars in thousands)
Noninterest bearing		$	158,075				25.17	%		$	153,093				26.52	%		$	128,157				23.88	%
Negotiable order of withdrawal (NOW)			122,698				19.54	%			85,369				14.79	%			83,521				15.56	%
Savings accounts			111,016				17.68	%			106,208				18.40	%			90,389				16.84	%
Money market deposit accounts			145,321				23.14	%			108,377				18.78	%			110,468				20.58	%
Certificates of deposit			90,872				14.47	%			124,188				21.51	%			124,149				23.13	%
Total		$	627,982				100.00	%		$	577,235				100.00	%		$	536,684				100.00	%

 

As of December 31, 2016, our certificates of deposit included $49.3 million of brokered certificates of deposit and $10.4 million of QwickRate certificates of deposit, where we gather certificates of deposit nationwide by posting rates we will pay on these deposits.

 

As of December 31, 2016, the aggregate amount of all our certificates of deposit in amounts greater than or equal to $100,000, which excludes all brokered certificates, was approximately $20.2 million. The following table sets forth the maturity of these certificates as of December 31, 2016.

 

		At
		December 31, 2016
		(In thousands)
Maturity Period
Three months or less		$	6,338
Over three through six months			3,190
Over six through twelve months			5,565
Over twelve months			5,134
Total		$	20,227

 

 

Borrowings

 

Our borrowings at December 31, 2016 consisted of Federal Home Loan Bank advances. The following table sets forth information concerning balances and interest rates on Federal Home Loan Bank advances at the dates and for the years indicated.

 

		At or For the Year Ended December 31,
		2016				2015				2014
		(Dollars in thousands)
Balance outstanding at end of year		$	49,858			$	57,423			$	39,237
Weighted average interest rate at end of year			1.36	%			1.07	%			1.43	%
Maximum amount of borrowings outstanding at any month end during the year		$	50,025			$	57,637			$	55,988
Average balance outstanding during the year		$	36,672			$	31,246			$	42,360
Weighted average interest rate during the year			1.70	%			1.74	%			1.34	%

 

We had no securities sold under agreements to repurchase during the years ended December 31, 2016, 2015 and 2014.

 

Shareholders’ Equity

 

Total shareholders’ equity increased $7.7 million, or 7.6%, to $109.1 million at December 31, 2016, from $101.4 million at December 31, 2015. The increase was due primarily to net income of $6.3 million and an increase in accumulated other comprehensive income of $932,000.

 

 

Average Balance Sheets and Related Yields and Rates

 

The following tables set forth average balance sheets, average yields and costs, and certain other information for the years indicated. No tax-equivalent yield adjustments have been made, as we consider the amount of tax free interest-earning assets is immaterial. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances. The yields set forth below include the effect of deferred fees, discounts, and premiums that are amortized or accreted to interest income or interest expense.

 

		For the Year Ended December 31,
		2016																2015												2014
						Interest												Interest												Interest
		Average				Earned/				Yield/				Average				Earned/				Yield/				Average				Earned/				Yield/
		Balance				Paid				Rate				Balance				Paid				Rate				Balance				Paid				Rate
		(Dollars in thousands)
Assets:
Interest-earning assets:
Loans		$	583,156			$	25,549				4.38	%		$	516,405			$	22,124				4.28	%		$	471,650			$	19,884				4.22	%
Interest-earning deposits			7,992				33				0.41	%			14,526				38				0.26	%			1,628				6				0.37	%
Investment securities			120,897				3,222				2.67	%			116,618				3,215				2.76	%			128,509				3,302				2.57	%
Federal Home Loan Bank Stock			2,599				90				3.46	%			3,260				75				2.30	%			4,541				74				1.63	%
Total interest-earning assets			714,644				28,894				4.04	%			650,809				25,452				3.91	%			606,328				23,266				3.84	%
Non-interest earning assets			39,845												34,552												33,134
Total assets		$	754,489											$	685,361											$	639,462
Interest-bearing liabilities:
Savings accounts		$	110,528				190				0.17	%		$	95,203				140				0.15	%		$	87,243				131				0.15	%
Money Market Accounts			115,857				334				0.29	%			111,412				296				0.27	%			111,217				284				0.26	%
Now Accounts			112,003				661				0.59	%			80,164				127				0.16	%			74,464				118				0.16	%
Certificates of deposit			109,175				978				0.90	%			120,668				1,067				0.88	%			124,890				1,191				0.95	%
Total interest-bearing deposits			447,563				2,163				0.48	%			407,447				1,630				0.40	%			397,814				1,724				0.43	%
Federal Home Loan Bank advances			36,672				622				1.70	%			31,246				544				1.74	%			42,360				567				1.34	%
Total interest-bearing liabilities			484,235				2,785				0.58	%			438,693				2,174				0.50	%			440,174				2,291				0.52	%
Noninterest-bearing liabilities:
Noninterest-bearing deposits			156,379												141,853												119,436
Other noninterest-bearing liabilities			7,813												10,824												5,608
Total liabilities			648,427												591,370												565,218
Total equity			106,062												93,991												74,244
Total liabilities and equity		$	754,489											$	685,361											$	639,462
Net interest income						$	26,109											$	23,278											$	20,975
Interest rate spread (1)											3.46	%											3.41	%											3.32	%
Net interest-earning assets (2)		$	230,409											$	212,116											$	166,154
Net interest margin (3)											3.65	%											3.58	%											3.46	%
Average interest-earning assets to interest-bearing liabilities			147.58	%											148.35	%											137.75	%

 

(1) Net interest rate spread represents the difference between the weighted average yield on interest-bearing assets and the weighted average rate of interest-bearing liabilities.

(2) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(3) Net interest margin represents net interest income divided by average total interest-earning assets

 

 

Rate/Volume Analysis

 

The following table sets forth the effects of changing rates and volumes on our net interest income. 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 this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

 

		Year Ended December 31, 2016 vs. 2015												Year Ended December 31,  2015 vs. 2014
		Increase (Decrease) Due to								Total				Increase (Decrease) Due to								Total
										Increase												Increase
		Rate				Volume				(Decrease)				Rate				Volume				(Decrease)
Interest-earning assets:
Loans		$	510			$	2,915			$	3,425			$	327			$	1,913			$	2,240
Interest-earning deposits			16				(21	)			(5	)			-				32				32
Investment securities			(109	)			116				7				231				(318	)			(87	)
Federal Home Loan Bank Stock			32				(17	)			15				26				(25	)			1
Total interest-earning assets			449				2,993				3,442				584				1,602				2,186
Interest-bearing liabilities:
Savings accounts			26				24				50				(3	)			11				9
Money market accounts			26				12				38				12				-				12
Now accounts			466				68				534				-				9				9
Certificates of deposit			14				(103	)			(89	)			(85	)			(39	)			(124	)
Total interest-bearing deposits			532				1				533				(76	)			(19	)			(94	)
Federal Home Loan Bank advances			(14	)			92				78				147				(170	)			(23	)
Total interest-bearing liabilities			518				93				611				71				(189	)			(117	)
Change in net interest and dividend income		$	(69	)		$	2,900			$	2,831			$	512			$	1,791			$	2,303

 

 Results of Operations for the Years Ended December 31, 2016 and 2015

 

General. Net income increased $2.5 million, or 65.8%, to $6.3 million for the year ended December 31, 2016 from $3.8 million for the year ended December 31, 2015. The increase was primarily due to the charitable foundation expense in connection with our offering of $2.2 million in 2015 that did not recur in 2016 and an increase of $2.9 million, or 13.1%, in net interest and dividend income after provision for loan losses, offset by an increase in salaries and employee benefits of $1.1 million, or 9.0%.

 

Interest and Dividend Income. Interest and dividend income increased $3.4 million, or 13.5%, to $28.9 million for the year ended December 31, 2016 from $25.5 million for the year ended December 31, 2015. This was caused by an increase in interest and fees on loans, which increased $3.4 million, or 15.5%, to $25.6 million for the year ended December 31, 2016 from $22.1 million for the year ended December 31, 2015.

 

The increase in interest income on loans was due to an increase in average balance of $66.8 million, or 12.9%, to $583.2 million for the year ended December 31, 2016 from $516.4 million for the year ended December 31, 2015 and an increase in yield on loans of 10 basis points, to 4.38% for the year ended December 31, 2016 from 4.28% for the year ended December 31, 2015 due to the shift to higher yielding commercial loans.

 

Interest on investment securities remained the same at $3.3 million for each of the years ended December 31, 2016 and 2015. The average balances of securities increased $4.3 million, or 3.7%, to $120.9 million as of December 31, 2016, but our yield decreased nine basis points to 2.76%.

 

 

Interest Expense. Interest expense increased $611,000, or 28.1%, to $2.8 million for the year ended December 31, 2016 from $2.2 million for the year ended December 31, 2015, due mainly to an increase in interest expense on deposits. Interest expense on deposits increased $533,000, or 32.7%, to $2.2 million for the year ended December 31, 2016 from $1.6 million for the year ended December 31, 2015, as our cost of funds on interest-bearing deposits increased eight basis points to 48 basis points for the year ended December 31, 2016 from 40 basis points for the year ended December 31, 2015. The increase in the cost of funds was primarily due to the increases in the average rate paid on NOW accounts. Our average balance of interest-bearing deposits increased $40.1 million, or 9.8%, to $447.6 million as of December 31, 2016 from $407.4 million as of December 31, 2015 and include a change in mix from higher cost certificates of deposits to lower cost core deposit accounts.

 

Interest expense on borrowings, which consists of advances from the Federal Home Loan Bank of Boston, increased $78,000, or 14.3%, to $622,000 for the year ended December 31, 2016 from $544,000 for the year ended December 31, 2015. The average balance of borrowings increased $5.4 million, or 17.4%, to $36.7 million for the year ended December 31, 2016 from $31.2 million for the year ended December 31, 2015. Our cost of borrowings decreased four basis points to 1.70% for the year ended December 31, 2016 compared to 1.74% for the year ended December 31, 2015.

 

Net Interest and Dividend Income. Net interest and dividend income increased $2.8 million, or 12.2%, to $26.1 million for the year ended December 31, 2016 from $23.3 million for the year ended December 31, 2015. Our net interest rate spread increased six basis points to 3.46% for the year ended December 31, 2016 from 3.41% for the year ended December 31, 2015, while our net interest margin increased seven basis points to 3.65% for the year ended December 31, 2016 from 3.58% for the year ended December 31, 2015. The average yield we earned on interest-earning assets increased more than the average rate we paid on interest-bearing liabilities.

 

Provision for Loan Losses. Our provision for loan losses was $703,000 for the year ended December 31, 2016 compared to $805,000 for the year ended December 31, 2015. The provisions recorded resulted in an allowance for loan losses of $8.6 million, or 1.36% of total loans and 543.0% of non-performing loans at December 31, 2016, compared to $7.9 million, or 1.40% of total loans and 346.1% of non-performing loans at December 31, 2015. The increase in the allowance for loan losses resulted primarily from an increase in our loan portfolio as we apply historical loss ratios to newly originated loans, which, absent other factors, results in an increase in the allowance for loan losses as the loan portfolio increases. For further information related to changes in the provision and allowance for loan losses, refer to “—Asset Quality—Allowance for Loan Losses.”

 

Noninterest Income. Noninterest income information is as follows.

 

		Years Ended
		December 31,								Change
		2016				2015				Amount				Percent
		(Dollars in thousands)
Customer service fees on deposit accounts		$	1,274			$	1,222			$	52				4.3	%
Service charges and fees - other			1,777				1,754				23				1.3	%
Gain on sales, calls and donated securities, net			690				317				373				117.7	%
Other income			694				513				181				35.3	%
Total noninterest income		$	4,435			$	3,806			$	629				16.5	%

 

 

Customer service fees on deposit accounts increased $52,000, or 4.3%, primarily due to increased volume in transactional deposit accounts. Gains on sales, calls and donated securities, net, increased for the year ended December 31, 2016 from the year ended December 31, 2015. We sold $3.3 million of securities in 2016 compared to $739,000 during the year ended December 31, 2015. During the year ended December 31, 2016, we recognized $39,000 of non-interest income related to the contribution of appreciated securities to our charitable foundation, compared to $21,000 of such gains during the year ended December 31, 2015. Other income increased $181,000, or 35.3%, primarily due to an increase in bank owned life insurance income.

 

Noninterest Expense. Noninterest expense information is as follows.

 

		Years Ended
		December 31,								Change
		2016				2015				Amount				Percent
(Dollars in thousands)
Salaries and employee benefits		$	12,857			$	11,797			$	1,060				8.99	%
Occupancy expense			1,548				1,535				13				0.85	%
Equipment expense			631				528				103				19.51	%
FDIC assessment			323				378				(55	)			(14.55	)%
Data processing			662				568				94				16.55	%
Marketing expense			249				127				122				96.06	%
Professional fees			1,088				942				146				15.50	%
Charitable Foundation expense			-				2,150				(2,150	)			100.00	%
Other			3,119				3,068				51				1.66	%
Total noninterest expense		$	20,477			$	21,093			$	(616	)			(2.92	)%

 

Salaries and employee benefits expense increased for the year ended December 31, 2016 from the year ended December 31, 2015 due to changes in staffing, increased expense for the Bank’s ESOP and the expense related to the Bank’s equity plan. Marketing expense increased for the year ended December 31, 2016 from the year ended December 31, 2015 due to increased marketing efforts for the Company’s commercial services. Professional fees increased due to increased legal and accounting fees associated with being a public company as well as increased fees for professional development of our employees. Equipment expense increased for the year ended December 31, 2016 from the year ended December 31, 2015 due to replacing older equipment and the additional equipment expenses from the Bedford branch.

 

Income Tax Provision. We recorded a provision for income taxes of $3.0 million for the year ended December 31, 2016, reflecting an effective tax rate of 32.3%, compared to $1.3 million, or 26.3%, for the year ended December 31, 2015. The changes in the income tax provision were primarily due to changes in the components of pre-tax income. Our effective tax rates are below statutory federal and states rates due primarily to tax-exempt income related to investments in bank owned life insurance and municipal securities.

 

 

Management of Market Risk

 

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, we have established a management-level Asset/Liability Management Committee, which takes initial responsibility for developing an asset/liability management process and related procedures, establishing and monitoring reporting systems and developing asset/liability strategies. On at least a quarterly basis, the Asset/Liability Management Committee reviews asset/liability management with the Investment Asset/Liability Committee that has been established by the board of directors. This committee also reviews any changes in strategies as well as the performance of any specific asset/liability management actions that have been implemented previously. On a quarterly basis, an outside consulting firm provides us with detailed information and analysis as to asset/liability management, including our interest rate risk profile. Ultimate responsibility for effective asset/liability management rests with our board of directors.

 

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk: originating loans with adjustable interest rates; promoting core deposit products; and adjusting the interest rates and maturities of funding sources, as necessary. In addition, we no longer originate single-family residential real estate loans, which often have longer terms and fixed rates. By following these strategies, we believe that we are better positioned to react to changes in market interest rates.

 

 

Net Interest Income Simulation. We analyze our sensitivity to changes in interest rates through a net interest income simulation model. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. We estimate what our net interest income would be for a 12-month period in the current interest rate environment. We then calculate what the net interest income would be for the same period under the assumption that interest rates increase 200 basis points from current market rates and under the assumption that interest rates decrease 100 basis points from current market rates, with changes in interest rates representing immediate and permanent, parallel shifts in the yield curve.

 

The following table presents the estimated changes in net interest income of The Provident Bank, calculated on a bank-only basis, that would result from changes in market interest rates over twelve-month periods beginning December 31, 2016 and 2015.

 

			At December 31,
			2016								2015
Changes in			Estimated								Estimated
Interest Rates			12-Months Net								12-Months Net
(Basis Points)			Interest Income				Change				Interest Income				Change
			(Dollars in thousands)
200			$	30,866				0.71	%		$	26,747				2.15	%
0			$	30,650				-			$	26,184				-
-100			$	30,190				(1.50	)%		$	25,855				(1.26	)%

 

 

Economic Value of Equity Simulation. We also analyze our sensitivity to changes in interest rates through an economic value of equity (“EVE”) model. EVE represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities adjusted for the value of off-balance sheet contracts. The EVE ratio represents the dollar amount of our EVE divided by the present value of our total assets for a given interest rate scenario. EVE attempts to quantify our economic value using a discounted cash flow methodology while the EVE ratio reflects that value as a form of capital ratio. We estimate what our EVE would be as of a specific date. We then calculate what EVE would be as of the same date throughout a series of interest rate scenarios representing immediate and permanent, parallel shifts in the yield curve. We currently calculate EVE under the assumptions that interest rates increase 100, 200, 300 and 400 basis points from current market rates, and under the assumption that interest rates decrease 100 basis points from current market rates.

 

The following table presents the estimated changes in EVE of The Provident Bank, calculated on a bank-only basis, that would result from changes in market interest rates as of December 31, 2016 and 2015.

 

		At December 31,
		2016								2015
Changes in		Economic								Economic
Interest Rates		Value of								Value of
(Basis Points)		Equity				Change				Equity				Change
		(Dollars in thousands)
400		$	120,313				0.90	%		$	105,804				(5.70	)%
300		$	120,763				1.30	%		$	107,899				(3.90	)%
200		$	120,793				1.30	%		$	109,704				(2.30	)%
100		$	120,931				1.40	%		$	111,893				(0.30	)%
0		$	119,252				-			$	112,248				-
-100		$	108,715				(8.80	)%		$	105,875				(5.70	)%

 

Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the tables presented above assume that the composition of our interest-sensitive assets and liabilities existing at the beginning of a period remains constant over the period being measured and assume that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

 

Liquidity and Capital Resources

 

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

 

We regularly review the need to adjust our investments in liquid assets based upon our assessment of: (1) expected loan demand, (2) expected deposit flows, (3) yields available on interest-earning deposits and securities, and (4) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short- and intermediate-term securities.

 

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 December 31, 2016, cash and cash equivalents totaled $10.7 million. Securities classified as available-for-sale, which provide additional sources of liquidity, totaled $117.9 million at December 31, 2016.

 

 

At December 31, 2016, we had the ability to borrow a total of $137.4 million from the Federal Home Loan Bank of Boston. On that date, we had $49.9 million in advances outstanding. At December 31, 2016, we also had an available line of credit with the Federal Reserve Bank of Boston’s borrower-in-custody program of $118.8 million, none of which was outstanding as of that date.

 

We have no material commitments or demands that are likely to affect our liquidity other than as set forth below. In the event loan demand were to increase faster than expected, or any unforeseen demand or commitment were to occur, we could access our borrowing capacity with the Federal Home Loan Bank of Boston or obtain additional funds through brokered certificates of deposit.

 

At December 31, 2016 and 2015, we had $25.4 million and $15.6 million in loan commitments outstanding, respectively. In addition to commitments to originate loans, at December 31, 2016 and 2015, we had $202.0 million and $191.6 million in unadvanced funds to borrowers, respectively. We also had $5.2 million and $5.5 million in outstanding letters of credit at December 31, 2016 and 2015, respectively.

 

Certificates of deposit due within one year of December 31, 2016 totaled $69.8 million, or 76.8% of total certificates of deposit. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and Federal Home Loan Bank of Boston advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit at December 31, 2016. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

 

Our primary investing activities are the origination of loans and the purchase of securities. During the year ended December 31, 2016, we originated $206.8 million of loans, including $206.4 million of loans to be held in our portfolio, and we purchased $9.8 million of securities. During the year ended December 31, 2015, we originated $225.3 million of loans, including $218.8 million of loans to be held in our portfolio, and we purchased $17.8 million of securities.

 

Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances. We experienced net increases in total deposits of $50.7 million and $40.5 for the years ended December 31, 2016 and 2015, respectively. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors. We generally manage the pricing of our deposits to be competitive. Federal Home Loan Bank advances decreased $7.6 million in 2016 and increased $18.2 million during the year ended December 31, 2015. We have been able to use the cash generated from the increases in deposits to fund loan growth in recent periods.

 

The Provident Bank is subject to various regulatory capital requirements administered by Massachusetts Commissioner of Banks, and the Federal Deposit Insurance Corporation. At December 31, 2016, The Provident Bank exceeded all applicable regulatory capital requirements, and was considered “well capitalized” under regulatory guidelines. See Note 12 of the Notes to the Consolidated Financial Statements for additional information.

 

We paid $167,000 in dividends on our SBLF preferred stock during the year ended December 31, 2015. The per annum dividend rate on the SBLF preferred stock was 1.00%, but during the first quarter of 2016, the per annum dividend rate would have increased to a fixed rate of 9.0% if any SBLF preferred stock remained outstanding at that time. On December 21, 2015 the Company redeemed the 17,145 shares of Series A Preferred Stock issued to the U.S. Treasury under the SBLF preferred stock program. The redemption was completed with payment to the U.S. Treasury of $17.1 million plus accrued dividends.

 

 

Contractual Obligations and Off-Balance Sheet Arrangements

 

Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations.  Such obligations include operating leases for premises and equipment, agreements with respect to borrowed funds and deposit liabilities, agreements with respect to investments and employment agreements with certain of our executive officers. The following table presents our contractual obligations as of December 31, 2016.

 

						Payments Due by period
										More Than				More than Three				More
						One Year				One Year to				Years to				Than Five
Contractual Obligations		Total				or Less				Three Years				Five Years				Years
		(In thousands)
Long-term debt obligations		$	49,858			$	35,000			$	5,000			$	6,358			$	3,500
Operating lease obligations			3,504				302				595				497				2,110
Total		$	53,362			$	35,302			$	5,595			$	6,855			$	5,610

 

Off-Balance Sheet Arrangements. We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, which involve elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Our exposure to credit loss is represented by the contractual amount of the instruments. We use the same credit policies in making commitments as we do for on-balance sheet instruments.

 

For further information, see note 14 of the Notes to the Consolidated Financial Statements.

 

Recent Accounting Pronouncements

 

For information with respect to recent accounting pronouncements that are applicable to Provident Bancorp, Inc., see note 2 of the Notes to the Consolidated Financial Statements.

 

Effect of Inflation and Changing Prices

 

The consolidated financial statements and related financial data included in this annual report have been prepared in accordance with generally accepted accounting principles in the United States of America, which require the measurement of financial position and operating results in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, virtually all the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates generally have a more significant impact on a financial institution’s performance than do general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the prices of goods and services.

 

PART III

 

ITEM 10.

DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

 

The information in the Company’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders under the captions “Proposal 1—Election of Directors,” “Information About Executive Officers,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Corporate Governance—Code of Ethics for Senior Officers,” “Nominating and Corporate Governance Committee Procedures—Procedures to be Followed by Stockholders,” “Corporate Governance—Committees of the Board of Directors” and “—Audit Committee” is incorporated herein by reference.

 

 

A copy of the Code of Ethics is available to shareholders on the “Corporate Governance” portion of the Investor Relations’ section on the Company’s website at www.theproividentbank.com.

 

ITEM 11.

EXECUTIVE COMPENSATION

 

The information in the Company’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders under the caption “Executive Compensation,” “Director Compensation,” and “Corporate Governance—Committees of the Board of Directors—Compensation Committee” is incorporated herein by reference.

 

ITEM 12.

SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERS MATTERS

 

The information in the Company’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders under the caption “Stock Ownership” is incorporated herein by reference. 

 

Equity Compensation Plan Information

 

Information with respect to equity plan information is included in Item 5 of the Annual Report.

 

ITEM 13.

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

 

The information in the Company’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders under the captions “Transactions with Certain Related Persons” and “Proposal 1 — Election of Directors” is incorporated herein by reference.

 

ITEM 14.

PRINCIPAL ACCOUNTING FEES AND SERVICES

 

The information in the Company’s definitive Proxy Statement for the 2017 Annual Meeting of Stockholders under the captions “Proposal 2—Ratification of Independent Registered Public Accounting Firm—Audit Fees” and “—Pre-Approval of Services by the Independent Registered Public Accounting Firm” is incorporated herein by reference.

 

PART IV

 

ITEM 15.

EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

Exhibits

 

31.1

Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

		Provident Bancorp, Inc.
Date:  March 28, 2017	By:	/s/ David P. Mansfield
		David P. Mansfield
		President and Chief Executive Officer