Item 1. Business
General
Riverview Bancorp, Inc., a Washington corporation, is the savings and loan holding company of Riverview Community Bank (the "Bank"). At March 31, 2017, the Company had total assets of $1.1 billion, total deposits of $980.1 million and shareholders' equity of $111.3 million. The Company's executive offices are located in Vancouver, Washington.
The Company is subject to regulation by the Board of Governors of the Federal Reserve Systems ("Federal Reserve"). Substantially all of the Company's business is conducted through the Bank which is regulated by the Office of the Comptroller of the Currency ("OCC"), its primary regulator, and by the Federal Deposit Insurance Corporation ("FDIC"), the insurer of its deposits. The Bank's deposits are insured by the FDIC up to applicable legal limits under the Deposit Insurance Fund ("DIF"). The Bank has been a member of the Federal Home Loan Bank System of Des Moines ("FHLB") which is one of the 11 regional banks in the Federal Home Loan Bank System ("FHLB System").
As a progressive, community-oriented financial services company, the Company emphasizes local, personal service to residents of its primary market area. The Company considers Clark, Cowlitz, Klickitat and Skamania counties of Washington, and Multnomah, Washington and Marion counties of Oregon as its primary market area. The Company is engaged predominantly in the business of attracting deposits from the general public and using such funds in its primary market area to originate commercial business, commercial real estate, multi-family real estate, land, real estate construction, residential real estate and other consumer loans. The Company's loan portfolio totaled $768.9 million at March 31, 2017 compared to $614.9 million a year ago.
The Bank's subsidiary, Riverview Trust Company (the "Trust Company"), formerly known as Riverview Asset Management Corp., is a trust and financial services company located in downtown Vancouver, Washington, and provides full-service brokerage activities, trust and asset management services. In April 2017, the Trust Company opened a second office in Lake Oswego, Oregon.
On May 24, 2016, Riverview Asset Management Corp. changed its name to Riverview Trust Company.
The Company's strategic plan includes targeting the commercial banking customer base in its primary market area for loan originations and deposit growth, specifically small and medium size businesses, professionals and wealth building individuals. In pursuit of these goals, the Company will seek to increase the loan portfolio consistent with its strategic plan and asset/liability and regulatory capital objectives, which includes maintaining a significant amount of commercial business and commercial real estate loans in its loan portfolio. Significant portions of our new loan originations – which are mainly concentrated in commercial real estate and real estate construction loans – carry adjustable rates, higher yields or shorter terms and higher credit risk than traditional fixed-rate consumer real estate one-to-four family mortgages.
Our strategic plan also stresses increased emphasis on non-interest income, including increased fees for asset management through the Trust Company and deposit service charges. The strategic plan is designed to enhance earnings, reduce interest rate risk and provide a more complete range of financial services to customers and the local communities the Company serves. We believe we are well positioned to attract new customers and to increase our market share through our 19 branches, including ten in Clark County, four in the Portland metropolitan area and three lending centers.
On February 17, 2017, the Company completed the purchase and assumption transaction in which the Company purchased certain assets and assumed certain liabilities of MBank, the wholly-owned subsidiary of Merchants Bancorp, including $115.3 million in loans and $130.6 million of deposits (the "MBank transaction"). In addition, as part of the MBank transaction, Riverview Bancorp, Inc. assumed the obligations of Merchant Bancorp's trust preferred securities.
Market Area
The Company conducts operations from its home office in Vancouver Washington and 19 branch offices located in Camas, Washougal, Stevenson, White Salmon, Battle Ground, Goldendale, Vancouver (seven branch offices) and Longview, Washington and Portland (two branch offices), Gresham, Tualatin and Aumsville, Oregon.
We believe we are well positioned to attract new customers and to increase our market share through our branch network.
The Trust Company has two locations, one in downtown Vancouver, Washington and one in Lake Oswego, Oregon, and provides full-service brokerage activities, trust and asset management services. Riverview Mortgage, a mortgage broker division of the Bank, originates mortgage loans for various mortgage companies predominantly in the Vancouver/Portland metropolitan areas, as well as for the Bank. The Bank's Business and Professional Banking Division, with two lending offices located in Vancouver and one in Portland, offers commercial and business banking services. The Bank also operates a lending office for mortgage banking activities in Vancouver.
Vancouver is located in Clark County, Washington, which is just north of Portland, Oregon. Many businesses are located in the Vancouver area because of the favorable tax structure and lower energy costs in Washington as compared to Oregon. Companies located in the Vancouver area include Sharp Microelectronics, Hewlett Packard, Georgia Pacific, Underwriters Laboratory, Wafer Tech, Nautilus, Barrett Business Services, PeaceHealth, Fisher Investments and Banfield Pet Hospitals, as well as several support industries. In addition to this industry base, the Columbia River Gorge Scenic Area and the Portland metropolitan area are sources of tourism, which has helped to transform the area from its past dependence on the timber industry.
Economic conditions in the Company's market areas have improved from the recent recessionary downturn and over the last year. According to the Washington State Employment Security Department, unemployment in Clark County decreased to 5.5% at March 31, 2017 compared to 6.3% at March 31, 2016. According to the Oregon Employment Department, unemployment in Portland decreased to 3.2% at March 31, 2017 compared to 3.9% at March 31, 2016. According to the Regional Multiple Listing Services ("RMLS"), residential home inventory levels in Portland, Oregon have remained at 1.3 months at both March 31, 2017 and March 31, 2016. Residential home inventory levels in Clark County have decreased to 1.6 months at March 31, 2017 compared to 1.7 months at March 31, 2016. According to the RMLS, closed home sales in March 2017 in Clark County decreased 8.2% compared to March 2016. Closed home sales during March 2017 in Portland decreased 2.8% compared to March 2016. The Company has also seen an increase in sales activity for building lots during the past twelve months. Commercial real estate leasing activity and the residential real estate market in the Portland/Vancouver area have been thriving and the vacancy rates in the Portland/Vancouver area have been relatively low.
Lending Activities
General
. At March 31, 2017, the Company's net loans receivable totaled $768.9 million, or 67.8% of total assets at that date. The principal lending activity of the Company is the origination of loans collateralized by commercial properties and commercial business loans. A substantial portion of the Company's loan portfolio is secured by real estate, either as primary or secondary collateral, located in its primary market area. The Company's lending activities are subject to the written, non-discriminatory, underwriting standards and loan origination procedures established by the Bank's Board of Directors ("Board") and management. The customary sources of loan originations are realtors, walk-in customers, referrals and existing customers. The Bank also uses commissioned loan brokers and print advertising to market its products and services.
Loans are approved at various levels of management, depending upon the amount of the loan.
Loan Portfolio Analysis
. The following table sets forth the composition of the Company's loan portfolio, excluding loans held for sale, by type of loan at the dates indicated (dollars in thousands):
|
|
At March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2013
|
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
Amount
|
|
|
Percent
|
|
|
|
|
|
Commercial and construction:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
107,371
|
|
|
|
13.78
|
%
|
|
$
|
69,397
|
|
|
|
11.11
|
%
|
|
$
|
77,186
|
|
|
|
13.31
|
%
|
|
$
|
71,632
|
|
|
|
13.43
|
%
|
|
$
|
71,935
|
|
|
|
13.42
|
%
|
Other real estate mortgage
(1)
|
|
|
506,661
|
|
|
|
65.00
|
|
|
|
399,527
|
|
|
|
63.94
|
|
|
|
345,506
|
|
|
|
59.60
|
|
|
|
324,881
|
|
|
|
60.90
|
|
|
|
355,397
|
|
|
|
66.30
|
|
Real estate construction
|
|
|
46,157
|
|
|
|
5.92
|
|
|
|
26,731
|
|
|
|
4.28
|
|
|
|
30,498
|
|
|
|
5.26
|
|
|
|
19,482
|
|
|
|
3.65
|
|
|
|
9,675
|
|
|
|
1.81
|
|
Total commercial and
construction
|
|
|
660,189
|
|
|
|
84.70
|
|
|
|
495,655
|
|
|
|
79.33
|
|
|
|
453,190
|
|
|
|
78.17
|
|
|
|
415,995
|
|
|
|
77.98
|
|
|
|
437,007
|
|
|
|
81.53
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
92,865
|
|
|
|
11.91
|
|
|
|
88,780
|
|
|
|
14.21
|
|
|
|
89,801
|
|
|
|
15.49
|
|
|
|
93,007
|
|
|
|
17.43
|
|
|
|
97,140
|
|
|
|
18.12
|
|
Other installment
|
|
|
26,378
|
|
|
|
3.39
|
|
|
|
40,384
|
|
|
|
6.46
|
|
|
|
36,781
|
|
|
|
6.34
|
|
|
|
24,486
|
|
|
|
4.59
|
|
|
|
1,865
|
|
|
|
0.35
|
|
Total consumer
|
|
|
119,243
|
|
|
|
15.30
|
|
|
|
129,164
|
|
|
|
20.67
|
|
|
|
126,582
|
|
|
|
21.83
|
|
|
|
117,493
|
|
|
|
22.02
|
|
|
|
99,005
|
|
|
|
18.47
|
|
Total loans
|
|
|
779,432
|
|
|
|
100.00
|
%
|
|
|
624,819
|
|
|
|
100.00
|
%
|
|
|
579,772
|
|
|
|
100.00
|
%
|
|
|
533,488
|
|
|
|
100.00
|
%
|
|
|
536,012
|
|
|
|
100.00
|
%
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses
|
|
|
10,528
|
|
|
|
|
|
|
|
9,885
|
|
|
|
|
|
|
|
10,762
|
|
|
|
|
|
|
|
12,551
|
|
|
|
|
|
|
|
15,643
|
|
|
|
|
|
Total loans receivable, net
|
|
$
|
768,904
|
|
|
|
|
|
|
$
|
614,934
|
|
|
|
|
|
|
$
|
569,010
|
|
|
|
|
|
|
$
|
520,937
|
|
|
|
|
|
|
$
|
520,369
|
|
|
|
|
|
|
|
(1)
Other real estate mortgage consists of commercial real estate, land and multi-family loans.
|
|
Loan Portfolio Composition.
The following tables set forth the composition of the Company's commercial and construction loan portfolio based on loan purpose at the dates indicated (in thousands):
|
|
Commercial
|
|
|
Other
Real Estate
Mortgage
|
|
|
Real Estate
Construction
|
|
|
Commercial &
Construction
Total
|
|
March 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
107,371
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
107,371
|
|
Commercial construction
|
|
|
-
|
|
|
|
-
|
|
|
|
27,050
|
|
|
|
27,050
|
|
Office buildings
|
|
|
-
|
|
|
|
121,983
|
|
|
|
-
|
|
|
|
121,983
|
|
Warehouse/industrial
|
|
|
-
|
|
|
|
74,671
|
|
|
|
-
|
|
|
|
74,671
|
|
Retail/shopping centers/strip malls
|
|
|
-
|
|
|
|
78,757
|
|
|
|
-
|
|
|
|
78,757
|
|
Assisted living facilities
|
|
|
-
|
|
|
|
3,686
|
|
|
|
-
|
|
|
|
3,686
|
|
Single purpose facilities
|
|
|
-
|
|
|
|
167,974
|
|
|
|
-
|
|
|
|
167,974
|
|
Land
|
|
|
-
|
|
|
|
15,875
|
|
|
|
-
|
|
|
|
15,875
|
|
Multi-family
|
|
|
-
|
|
|
|
43,715
|
|
|
|
-
|
|
|
|
43,715
|
|
One-to-four family construction
|
|
|
-
|
|
|
|
-
|
|
|
|
19,107
|
|
|
|
19,107
|
|
Total
|
|
$
|
107,371
|
|
|
$
|
506,661
|
|
|
$
|
46,157
|
|
|
$
|
660,189
|
|
March 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
69,397
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
69,397
|
|
Commercial construction
|
|
|
-
|
|
|
|
-
|
|
|
|
16,716
|
|
|
|
16,716
|
|
Office buildings
|
|
|
-
|
|
|
|
107,986
|
|
|
|
-
|
|
|
|
107,986
|
|
Warehouse/industrial
|
|
|
-
|
|
|
|
55,830
|
|
|
|
-
|
|
|
|
55,830
|
|
Retail/shopping centers/strip malls
|
|
|
-
|
|
|
|
61,600
|
|
|
|
-
|
|
|
|
61,600
|
|
Assisted living facilities
|
|
|
-
|
|
|
|
1,809
|
|
|
|
-
|
|
|
|
1,809
|
|
Single purpose facilities
|
|
|
-
|
|
|
|
126,524
|
|
|
|
-
|
|
|
|
126,524
|
|
Land
|
|
|
-
|
|
|
|
12,045
|
|
|
|
-
|
|
|
|
12,045
|
|
Multi-family
|
|
|
-
|
|
|
|
33,733
|
|
|
|
-
|
|
|
|
33,733
|
|
One-to-four family construction
|
|
|
-
|
|
|
|
-
|
|
|
|
10,015
|
|
|
|
10,015
|
|
Total
|
|
$
|
69,397
|
|
|
$
|
399,527
|
|
|
$
|
26,731
|
|
|
$
|
495,655
|
|
Commercial Business Lending.
At March 31, 2017, the commercial business loan portfolio totaled $107.4 million, or 13.8% of total loans, including $32.8 million of loans acquired from MBank. Commercial business loans are typically secured by business equipment, accounts receivable, inventory or other property. The Company's commercial business loans may be structured as term loans or as lines of credit. Commercial term loans are generally made to finance the purchase of assets and usually have maturities of five years or less. Commercial lines of credit are typically made for the purpose of providing working capital and usually have a term of one year or less. Lines of credit are made at variable rates of interest equal to a negotiated margin above an index rate and term loans are at either a variable or fixed-rate. The Company also generally obtains personal guarantees from financially capable parties based on a review of personal financial statements.
Commercial lending involves risks that are different from those associated with residential and commercial real estate lending. Although commercial business loans are often collateralized by equipment, inventory, accounts receivable or other business assets, the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectible and inventories may be obsolete or of limited use, among other things. Accordingly, the repayment of commercial business loans depends primarily on the cash flow and credit-worthiness of the borrower and secondarily on the underlying collateral provided by the borrower. Additionally, the borrower's cash flow may be unpredictable and collateral securing these loans may fluctuate in value.
Other Real Estate Mortgage Lending.
At March 31, 2017, the other real estate lending portfolio totaled $506.7 million, or 65.0% of total loans, including $66.2 million of loans acquired from MBank. The Company originates other real estate loans including office buildings, warehouse/industrial, retail, assisted living facilities and single-purpose facilities (collectively "commercial real estate loans"); as well as land and multi-family loans primarily located in its market area. At March 31, 2017, owner occupied properties accounted for 37.6% and non-owner occupied properties accounted for 62.4% of the Company's commercial real estate portfolio.
Commercial real estate and multi-family loans typically have higher loan balances, are more difficult to evaluate and monitor, and involve a higher degree of risk than one-to-four family residential loans. As a result, commercial real estate and multi-family loans are generally priced at a higher rate of interest than residential one-to-four family loans. Often payments on loans secured by commercial properties are dependent on the successful operation and management of the property securing the loan or business conducted on the property securing the loan; therefore, repayment of these loans may be affected by adverse conditions in the real estate market or the economy. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. The Company seeks to minimize these risks by generally limiting the maximum loan-to-value ratio to 80% and strictly scrutinizing the financial condition of the borrower, the quality of the collateral and the management of the property securing the loan. Loans are secured by first mortgages and often require specified debt service coverage ("DSC") ratios depending on the characteristics of the collateral. The Company generally imposes a minimum DSC ratio of 1.20 for loans secured by income producing properties. Rates and other terms on such loans generally depend on our assessment of credit risk after considering such factors as the borrower's financial condition and credit history, loan-to-value ratio, DSC ratio and other factors.
The Company actively pursues commercial real estate loans. Loan demand within the Company's market area was competitive in fiscal year 2017 as economic conditions improved and competition for strong credit-worthy borrowers remained high. At March 31, 2017, the Company had two commercial real estate loans totaling $1.3 million on non-accrual status compared to two commercial real estate loans totaling $1.6 million at March 31, 2016. For more information concerning risks related to commercial real estate loans, see Item 1A. "Risk Factors – Our emphasis on commercial real estate lending may expose us to increased lending risks."
Land acquisition and development loans are included in the other real estate mortgage portfolio balance and represent loans made to developers for the purpose of acquiring raw land and/or for the subsequent development and sale of residential lots. Such loans typically finance land purchases and infrastructure development of properties (i.e. roads, utilities, etc.) with the aim of making improved lots ready for subsequent sales to consumers or builders for ultimate construction of residential units. The primary source of repayment is generally the cash flow from developer sale of lots or improved parcels of land, secondary sources and personal guarantees, which may provide an additional measure of security for such loans. During fiscal year 2017, statistics reflect an increase in demand and sales of building lots in the Company's primary market area resulting in an increase in the number of closed sales for land and building lots as compared to previous years. At March 31, 2017, land acquisition and development loans totaled $15.9 million, or 2.04% of total loans compared to $12.0 million, or 1.93% of total loans at March 31, 2016. The largest land acquisition and development loan had an outstanding balance at March 31, 2017 of $3.6 million and was performing according to its original payment terms. At March 31, 2017, all of the land acquisition and development loans were secured by properties located in Washington and Oregon. At both March 31, 2017 and 2016, the Company had one land acquisition and development loan totaling $801,000 on non-accrual status.
Real Estate Construction.
The Company originates three types of residential construction loans: (i) speculative construction loans, (ii) custom/presold construction loans and (iii) construction/permanent loans. The Company also originates construction loans for the development of business properties and multi-family dwellings. All of the Company's real estate construction loans were made on properties located in Washington and Oregon.
The composition of the Company's construction loan portfolio including undisbursed funds was as follows at the dates indicated (dollars in thousands):
|
|
At March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
Amount
(1)
|
|
|
Percent
|
|
|
Amount
(1)
|
|
|
Percent
|
|
|
|
|
|
Speculative construction
|
|
$
|
7,915
|
|
|
|
8.47
|
%
|
|
$
|
6,089
|
|
|
|
8.76
|
%
|
Commercial/multi-family construction
|
|
|
59,599
|
|
|
|
63.80
|
|
|
|
50,174
|
|
|
|
72.22
|
|
Custom/presold construction
|
|
|
20,697
|
|
|
|
22.16
|
|
|
|
10,529
|
|
|
|
15.16
|
|
Construction/permanent
|
|
|
5,202
|
|
|
|
5.57
|
|
|
|
2,681
|
|
|
|
3.86
|
|
Total
|
|
$
|
93,413
|
|
|
|
100.00
|
%
|
|
$
|
69,473
|
|
|
|
100.00
|
%
|
(1)
Includes undisbursed funds of $47.3 million and $42.7 million at March 31, 2017 and 2016, respectively.
At March 31, 2017, the balance of the Company's construction loan portfolio, including undisbursed funds, was $93.4 million compared to $69.5 million at March 31, 2016. The $23.9 million increase was primarily due to a $9.4 million increase in commercial/multi-family construction loans and a $10.2 million increase in custom/presold construction loans. The Company plans to continue to proactively manage and control the growth in its construction loan portfolio in fiscal year 2018 but will continue to originate new construction loans to selected customers.
Speculative construction loans are made to home builders and are termed "speculative" because the home builder does not have, at the time of loan origination, a signed contract with a home buyer who has a commitment for permanent financing with either the Company or another lender for the finished home. The home buyer may be identified either during or after the construction period, with the risk that the builder will have to service the speculative construction loan and finance real estate taxes and other carrying costs of the completed home for a significant time after the completion of construction until a home buyer is identified. The largest speculative construction loan at March 31, 2017 was a loan to finance the construction of a single family home totaling $513,000. The average balance of loans in the speculative construction portfolio at March 31, 2017 was $173,000. This loan is to a single borrower that is secured by a property located in the Company's market area. At March 31, 2017 and 2016, the Company had no speculative construction loans on non-accrual status.
The composition of speculative construction and land acquisition and development loans by geographical area is as follows at the dates indicated (in thousands):
|
|
Northwest
Oregon
|
|
|
Other
Oregon
|
|
|
Southwest
Washington
|
|
|
Total
|
|
March 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land development
|
|
$
|
223
|
|
|
$
|
2,523
|
|
|
$
|
13,129
|
|
|
$
|
15,875
|
|
Speculative construction
|
|
|
945
|
|
|
|
3
|
|
|
|
14,492
|
|
|
|
15,440
|
|
Total land development and speculative construction
|
|
$
|
1,168
|
|
|
$
|
2,526
|
|
|
$
|
27,621
|
|
|
$
|
31,315
|
|
March 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Land development
|
|
$
|
97
|
|
|
$
|
2,766
|
|
|
$
|
9,182
|
|
|
$
|
12,045
|
|
Speculative construction
|
|
|
400
|
|
|
|
-
|
|
|
|
7,711
|
|
|
|
8,111
|
|
Total land development and speculative construction
|
|
$
|
497
|
|
|
$
|
2,766
|
|
|
$
|
16,893
|
|
|
$
|
20,156
|
|
Unlike speculative construction loans, presold construction loans are made for homes that have buyers. Presold construction loans are made to homebuilders who, at the time of construction, have a signed contract with a home buyer who has a commitment for permanent financing for the finished home from the Company or another lender. Presold construction loans are generally originated for a term of 12 months. At March 31, 2017 and 2016, presold construction loans totaled $11.4 million and $5.0 million, respectively.
Unlike speculative and presold construction loans, custom construction loans are made directly to the homeowner. At March 31, 2017 and 2016, the Company had no custom construction loans. Construction/permanent loans are originated to the homeowner rather than the homebuilder along with a commitment by the Company to originate a permanent loan to the homeowner to repay the construction loan at the completion of construction. The construction phase of a construction/permanent loan generally lasts six to nine months. At the completion of construction, the Company may either originate a fixed-rate mortgage loan or an adjustable rate mortgage ("ARM") loan or use its mortgage brokerage capabilities to obtain permanent financing for the customer with another lender. At completion of construction, the interest rate of the Company-originated fixed-rate permanent loan is set at a market rate. For adjustable rate loans, the interest rates adjust on their first adjustment date. See "—Mortgage Brokerage" and "—Mortgage Loan Servicing." At March 31, 2017, construction/permanent loans totaled $3.7 million, the largest of which had an outstanding balance of $1.0 million and was performing according to its original repayment terms. The average balance of loans in the construction/permanent portfolio at March 31, 2017 was $333,000.
The Company provides construction financing for non-residential business properties and multi-family dwellings. At March 31, 2017, such loans totaled $
27.1
million, or
58.60
% of total real estate construction loans and 3.47% of total loans. Borrowers may be the business owner/occupier of the building who intends to operate their business from the property upon construction, or non-owner developers. The expected source of repayment of these loans is typically the sale or refinancing of the project upon completion of the construction phase. In certain circumstances, the Company may provide or commit to take-out financing upon construction. Take-out financing is subject to the project meeting specific underwriting guidelines. No assurance can be given that such take-out financing will be available upon project completion. These loans are secured by office buildings, retail rental space, mini storage facilities, assisted living facilities and multi-family dwellings located in the Company's market area. At March 31, 2017, the largest commercial construction loan had a balance of $
3.6
million and was performing according to its original repayment terms.
The average balance of loans in the commercial construction portfolio at March 31, 2017 was $1.5 million
. At March 31, 2017 and 2016, the Company had no commercial construction loans on non-accrual status.
The Company has originated construction and land acquisition and development loans where a component of the cost of the project was the interest required to service the debt during the construction period of the loan, sometimes known as interest reserves. The Company allows disbursements of this interest component as long as the project is progressing as originally projected and if there has been no deterioration in the financial standing of the borrower or the underlying project. If the Company makes a determination that there is such deterioration, or if the loan becomes nonperforming, the Company halts any disbursement of those funds identified for use in paying interest. In some cases, additional interest reserves may be taken by use of deposited funds or through credit lines secured by separate and additional collateral. For additional information concerning the risks related to construction lending, see Item 1A. "Risk Factors – Our real estate construction and land acquisition or development loans expose us to risk."
Consumer Lending.
Consumer loans totaled $
119.2
million at March 31, 2017, and were comprised of $
70.7
million of one-to-four family mortgage loans, $
19.7
million of home equity lines of credit, $
2.5
million of land loans to consumers for the future construction of one-to-four family homes and $
26.4
million of other secured and unsecured consumer loans, which primarily consisted of purchased automobile loans.
One-to-four family residences located in the Company's primary market area secure the majority of the residential loans. Underwriting standards require that one-to-four family portfolio loans generally be owner occupied and that loan amounts not exceed 80% (95% with private mortgage insurance) of the lesser of current appraised value or cost of the underlying collateral. Terms typically range from 15 to 30 years. The Company also offers balloon mortgage loans with terms of either five or seven years and originates both fixed-rate mortgages and ARMs with repricing based on the one-year constant maturity U.S. Treasury index or other index. At March 31, 2017, the Company had three residential real estate loans totaling $
170,000
on non-accrual status compared to three loans totaling $251,000 at March 31, 2016. All of these loans were secured by properties located in Oregon and Washington.
The Company also purchases, from time to time, pools of automobile loans from another financial institution as a way to further diversify its loan portfolio and to earn a higher yield than on its cash or short-term investments. These indirect automobile loans are originated through a single dealership group located outside the Company's primary market area. The collateral for these loans is comprised of a mix of used automobiles. These loans are purchased with servicing retained by the seller. The Company did not purchase any automobile loans during fiscal year 2017. The Company purchased $15.6 million of automobile loans during fiscal year 2016. At March 31, 2017, thirteen of the purchased automobile loans were on non-accrual status totaling $108,000. At March 31, 2016, eight of the purchased automobile loans were on non-accrual status totaling $83,000. For more information concerning risks related to automobile loans, see Item 1A. "Risk Factors – Our consumer loan portfolio has increased risk due to the substantial amount of indirect automobile loans."
The Company originates a variety of installment loans, including loans for debt consolidation and other purposes, automobile loans, boat loans and savings account loans. These consumer loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as mobile homes, automobiles, boats and recreational vehicles. At March 31, 2017 and 2016, excluding the purchased automobile loans noted above, the Company had no installment loans on non-accrual status.
Loan Maturity.
The following table sets forth certain information at March 31, 2017 regarding the dollar amount of loans maturing in the Company's total loan portfolio based on their contractual terms to maturity but does not include potential prepayments. Demand loans, loans having no stated schedule of repayments or stated maturity and overdrafts are reported as due in one year or less. Loan balances are reported net of deferred fees (in thousands):
|
|
Within 1
Year
|
|
|
1 – 3 Years
|
|
|
After 3 – 5
Years
|
|
|
After 5 – 10
Years
|
|
|
Beyond 10
Years
|
|
|
Total
|
|
Commercial and construction:
|
|
|
|
Commercial business
|
|
$
|
20,810
|
|
|
$
|
15,279
|
|
|
$
|
11,626
|
|
|
$
|
50,363
|
|
|
$
|
9,293
|
|
|
$
|
107,371
|
|
Other real estate mortgage
|
|
|
54,622
|
|
|
|
35,047
|
|
|
|
16,981
|
|
|
|
301,614
|
|
|
|
98,397
|
|
|
|
506,661
|
|
Real estate construction
|
|
|
18,090
|
|
|
|
778
|
|
|
|
2,047
|
|
|
|
18,024
|
|
|
|
7,218
|
|
|
|
46,157
|
|
Total commercial and construction
|
|
|
93,522
|
|
|
|
51,104
|
|
|
|
30,654
|
|
|
|
370,001
|
|
|
|
114,908
|
|
|
|
660,189
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
415
|
|
|
|
1,970
|
|
|
|
1,676
|
|
|
|
5,586
|
|
|
|
83,218
|
|
|
|
92,865
|
|
Other installment
|
|
|
249
|
|
|
|
8,277
|
|
|
|
17,569
|
|
|
|
223
|
|
|
|
60
|
|
|
|
26,378
|
|
Total consumer
|
|
|
664
|
|
|
|
10,247
|
|
|
|
19,245
|
|
|
|
5,809
|
|
|
|
83,278
|
|
|
|
119,243
|
|
Total loans
|
|
$
|
94,186
|
|
|
$
|
61,351
|
|
|
$
|
49,899
|
|
|
$
|
375,810
|
|
|
$
|
198,186
|
|
|
$
|
779,432
|
|
The following table sets forth the dollar amount of loans due after one year from March 31, 2017, which have fixed and adjustable interest rates (in thousands)
:
|
|
Fixed
Rate
|
|
|
Adjustable
Rate
|
|
|
Total
|
|
|
|
|
|
Commercial and construction:
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
34,254
|
|
|
$
|
52,307
|
|
|
$
|
86,561
|
|
Other real estate mortgage
|
|
|
127,468
|
|
|
|
324,571
|
|
|
|
452,039
|
|
Real estate construction
|
|
|
12,010
|
|
|
|
16,057
|
|
|
|
28,067
|
|
Total commercial and construction
|
|
|
173,732
|
|
|
|
392,935
|
|
|
|
566,667
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
66,306
|
|
|
|
26,144
|
|
|
|
92,450
|
|
Other installment
|
|
|
25,172
|
|
|
|
957
|
|
|
|
26,129
|
|
Total consumer
|
|
|
91,478
|
|
|
|
27,101
|
|
|
|
118,579
|
|
Total loans
|
|
$
|
265,210
|
|
|
$
|
420,036
|
|
|
$
|
685,246
|
|
Loan Commitments
. The Company issues commitments to originate commercial loans, other real estate mortgage loans, construction loans, residential mortgage loans and other installment loans conditioned upon the occurrence of certain events. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments. Commitments to originate loans are conditional and are honored for up to 45 days subject to the Company's usual terms and conditions. Collateral is not required to support commitments. At March 31, 2017, the Company had outstanding commitments to originate loans of $45.3 million compared to $41.9 million at March 31, 2016.
Mortgage Brokerage.
In addition to originating mortgage loans for retention in its portfolio, the Company employs commissioned brokers who originate mortgage loans (including construction loans) for various mortgage companies, as well as for the Company. The loans brokered to mortgage companies are closed in the name of, and funded by, the purchasing mortgage company and are not originated as an asset of the Company. In return, the Company receives a fee ranging from 1.5% to 2.0% of the loan amount that it shares with the commissioned broker. Loans brokered to the Company are closed on the Company's books and the commissioned broker receives a portion of the origination fee. During the year ended March 31, 2017, brokered loans totaled $47.3 million (including $42.3 million brokered to the Company) compared to $43.3 million (including $39.1 million brokered to the Company) of brokered loans in fiscal year 2016. Gross fees of $757,000, which includes brokered loan fees and fees for loans sold to the Federal Home Loan Mortgage Company ("FHLMC"), were earned for the year ended March 31, 2017. The interest rate environment has a strong influence on the loan volume and amount of fees generated from the mortgage broker activity. In general, during periods of rising interest rates, the volume of loans and the amount of loan fees generally decrease as a result of slower mortgage loan demand. Conversely, during periods of falling interest rates, the volume of loans and the amount of loan fees generally increase as a result of the increased mortgage loan demand.
Mortgage Loan Servicing.
The Company is a qualified servicer for the FHLMC. The Company generally sells fixed-rate residential one-to-four family mortgage loans that it originates with maturities of 15 years or more and balloon mortgages to the FHLMC as part of its asset liability strategy. Mortgage loans are sold to the FHLMC on a non-recourse basis whereby foreclosure losses are the responsibility of the FHLMC and not the Company. The Company's general policy is to close its residential loans on FHLMC modified loan documents to facilitate future sales to the FHLMC. Upon sale, the Company continues to collect payments on the loans, supervise foreclosure proceedings, and otherwise service the loans. At March 31, 2017, total loans serviced for others were $138.1 million, of which $117.2 million were serviced for the FHLMC.
Nonperforming Assets.
Nonperforming assets were $3.0 million or 0.27% of total assets at March 31, 2017 compared with $3.3 million or 0.36% of total assets at March 31, 2016. The Company also had net loan recoveries totaling $643,000 during fiscal 2017 compared to $273,000 during fiscal 2016. Credit quality challenges continued to lessen in the past fiscal year and the real estate market in our primary market area has improved steadily. Although it appears the economic conditions have stabilized, a prolonged weak economy in our market area could result in increases in nonperforming assets, increases in the provision for loan losses and charge-offs in the future.
Loans are reviewed regularly and it is the Company's general policy that when a loan is 90 days delinquent or when collection of principal or interest appears doubtful, it is placed on non-accrual status, at which time the accrual of interest ceases and a reserve for any unrecoverable accrued interest is established and charged against operations. In general, payments received on non-accrual loans are applied to reduce the outstanding principal balance on a cash-basis method.
The Company continues to focus on managing the residential construction and land acquisition and development portfolios. At March 31, 2017, the Company's residential construction and land acquisition and development loan portfolios were $19.1 million and $15.9 million, respectively as compared to $10.0 million and $12.0 million, respectively, at March 31, 2016. At March 31, 2017 and 2016, there were no nonperforming loans in the residential construction loan portfolio. At March 31, 2017 and 2016, the percentage of nonperforming loans in the land acquisition and development portfolios was 5.05% and 6.65%, respectively. For the year ended March 31, 2017, the charge-off (recovery) ratio for the residential construction and land development portfolios was 0.00% and (3.29)%, respectively, compared to (0.09)% and (2.41)%, respectively, for the year ended March 31, 2016.
The following table sets forth information regarding the Company's nonperforming loans at the dates indicated (dollars in thousands):
|
|
March 31, 2017
|
|
|
March 31, 2016
|
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
2
|
|
|
$
|
294
|
|
|
|
-
|
|
|
$
|
-
|
|
Commercial real estate
|
|
|
2
|
|
|
|
1,342
|
|
|
|
2
|
|
|
|
1,559
|
|
Land
|
|
|
1
|
|
|
|
801
|
|
|
|
1
|
|
|
|
801
|
|
Consumer
|
|
|
19
|
|
|
|
312
|
|
|
|
12
|
|
|
|
354
|
|
Total
|
|
|
24
|
|
|
$
|
2,749
|
|
|
|
15
|
|
|
$
|
2,714
|
|
Nonperforming loans remained similar to prior year. However, the Company is continuing its efforts to work out problem loans, seek full repayment or pursue foreclosure proceedings. All of these loans are to borrowers with properties located in Oregon and Washington, with the exception of sixteen automobile loans totaling $142,000 (thirteen nonaccrual automobile loans totaling $108,000 and three accruing automobile loan contractually 90 days past due totaling $34,000). At March 31, 2017, 88.66% of the Company's nonperforming loans, totaling $2.4 million, were measured for impairment. These loans have been charged down to the estimated fair market value of the collateral less selling costs or carry a specific reserve to reduce the net carrying value. There were no reserves associated with these nonperforming loans that were measured for impairment at March 31, 2017. At March 31, 2017, the largest single nonperforming loan was a commercial real estate loan totaling $1.1 million. This loan was measured for impairment during fiscal year 2017 and management determined that a specific reserve was not required.
The balance of nonperforming assets included $298,000 in real estate owned ("REO") at March 31, 2017. The $298,000 balance of REO is comprised of a one-to-four family real estate property located in Washington. Total REO sales were $267,000 during fiscal year 2017. During fiscal year 2017, write-downs on existing properties were $30,000 and maintenance and operating expenses for these properties totaled $24,000. The orderly resolution of nonperforming loans and REO properties remains a priority for management. Because of the uncertain nature of the real estate market, no assurance can be given as to the timing of ultimate disposition of such assets or that the selling price will be at or above the carrying value. Declines in real estate values in our area could lead to additional valuation adjustments, which would have an adverse effect on our results of operations.
The following table sets forth information regarding the Company's nonperforming assets at the dates indicated (in thousands):
|
|
At March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
Loans accounted for on a non-accrual basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
294
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
452
|
|
|
$
|
1,349
|
|
Other real estate mortgage
|
|
|
2,143
|
|
|
|
2,360
|
|
|
|
4,092
|
|
|
|
10,881
|
|
|
|
16,550
|
|
Real estate construction
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
175
|
|
Consumer
|
|
|
278
|
|
|
|
334
|
|
|
|
1,226
|
|
|
|
2,729
|
|
|
|
3,059
|
|
Total
|
|
|
2,715
|
|
|
|
2,694
|
|
|
|
5,318
|
|
|
|
14,062
|
|
|
|
21,133
|
|
Accruing loans which are contractually
past due 90 days or more
|
|
|
34
|
|
|
|
20
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Total nonperforming loans
|
|
|
2,749
|
|
|
|
2,714
|
|
|
|
5,318
|
|
|
|
14,062
|
|
|
|
21,133
|
|
REO
|
|
|
298
|
|
|
|
595
|
|
|
|
1,603
|
|
|
|
7,703
|
|
|
|
15,638
|
|
Total nonperforming assets
|
|
$
|
3,047
|
|
|
$
|
3,309
|
|
|
$
|
6,921
|
|
|
$
|
21,765
|
|
|
$
|
36,771
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Foregone interest on non-accrual loans
|
|
$
|
81
|
|
|
$
|
112
|
|
|
$
|
433
|
|
|
$
|
949
|
|
|
$
|
1,420
|
|
The following table sets forth information regarding the Company's nonperforming assets by loan type and geographical area at the dates indicated (in thousands):
|
|
Northwest
Oregon
|
|
|
Other
Oregon
|
|
|
Southwest
Washington
|
|
|
Other
Washington
|
|
|
Other
|
|
|
Total
|
|
March 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
294
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
294
|
|
Commercial real estate
|
|
|
-
|
|
|
|
1,128
|
|
|
|
214
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,342
|
|
Land
|
|
|
-
|
|
|
|
801
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
801
|
|
Consumer
|
|
|
-
|
|
|
|
-
|
|
|
|
170
|
|
|
|
-
|
|
|
|
142
|
|
|
|
312
|
|
Total nonperforming loans
|
|
|
-
|
|
|
|
1,929
|
|
|
|
678
|
|
|
|
-
|
|
|
|
142
|
|
|
|
2,749
|
|
REO
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
298
|
|
|
|
-
|
|
|
|
298
|
|
Total nonperforming assets
|
|
$
|
-
|
|
|
$
|
1,929
|
|
|
$
|
678
|
|
|
$
|
298
|
|
|
$
|
142
|
|
|
$
|
3,047
|
|
March 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial real estate
|
|
$
|
269
|
|
|
$
|
1,290
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
1,559
|
|
Land
|
|
|
-
|
|
|
|
801
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
801
|
|
Consumer
|
|
|
112
|
|
|
|
-
|
|
|
|
139
|
|
|
|
-
|
|
|
|
103
|
|
|
|
354
|
|
Total nonperforming loans
|
|
|
381
|
|
|
|
2,091
|
|
|
|
139
|
|
|
|
-
|
|
|
|
103
|
|
|
|
2,714
|
|
REO
|
|
|
271
|
|
|
|
-
|
|
|
|
26
|
|
|
|
298
|
|
|
|
-
|
|
|
|
595
|
|
Total nonperforming assets
|
|
$
|
652
|
|
|
$
|
2,091
|
|
|
$
|
165
|
|
|
$
|
298
|
|
|
$
|
103
|
|
|
$
|
3,309
|
|
Other loans of concern, which are classified as substandard loans and are not presently included in the non-accrual category, consist of loans where the borrowers have cash flow problems, or the collateral securing the respective loans may be inadequate. In either or both of these situations, the borrowers may be unable to comply with the present loan repayment terms, and the loans may subsequently be included in the non-accrual category. Management considers the allowance for loan losses to be adequate to cover the probable losses inherent in these and other loans.
The following table sets forth information regarding the Company's other loans of concern at the dates indicated (dollars in thousands):
|
|
March 31, 2017
|
|
|
March 31, 2016
|
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
Number
of Loans
|
|
|
Balance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
6
|
|
|
$
|
2,901
|
|
|
|
5
|
|
|
$
|
363
|
|
Commercial real estate
|
|
|
3
|
|
|
|
4,380
|
|
|
|
4
|
|
|
|
1,225
|
|
Multi-family
|
|
|
1
|
|
|
|
12
|
|
|
|
1
|
|
|
|
12
|
|
Total
|
|
|
10
|
|
|
$
|
7,293
|
|
|
|
10
|
|
|
$
|
1,600
|
|
At March 31, 2017, loans delinquent 30 – 89 days were 0.03% of total loans compared to 0.10% at March 31, 2016. There were no delinquent loans 30 – 89 days past due in our commercial real estate ("CRE") portfolio at March 31, 2017 or 2016. At March 31, 2017, the 30 – 89 days delinquency rate in our commercial business portfolio was 0.01% of commercial business loans. There were no loans 30-89 days past due in our commercial business portfolio at March 31, 2016. CRE loans represent the largest portion of our loan portfolio at 57.36% of total loans and the commercial business loans represent 13.78% of total loans.
Troubled debt restructurings ("TDRs") are loans for which the Company, for economic or legal reasons related to the borrower's financial condition, has granted a concession to the borrower that it would otherwise not consider. A TDR typically involves a modification of terms such as a reduction of the stated interest rate or face amount of the loan, a reduction of accrued interest, or an extension of the maturity date(s) at a stated interest rate lower than the current market rate for a new loan with similar risk.
TDRs are considered impaired loans and as such, when a loan is deemed to be impaired, the amount of the impairment is measured using discounted cash flows using the original note rate, except when the loan is collateral dependent. In these cases, the estimated fair value of the collateral (less any selling costs, if applicable) is used. Impairment is recognized as a specific component within the allowance for loan losses if the estimated value of the impaired loan is less than the recorded investment in the loan. When the amount of the impairment represents a confirmed loss, it is charged off against the allowance for loan losses. At March 31, 2017, the Company had TDRs totaling $11.9 million of which $9.4 million were on accrual status. The $2.4 million of TDRs accounted for on a non-accrual basis at March 31, 2017, are included as nonperforming loans in the nonperforming asset table above. However, all of the Company's TDRs were paying as agreed at
March 31, 2017 except for two TDR commercial business loans totaling $294,000 and two TDR commercial real estate loans totaling $1.3 million that have defaulted since the loans were modified. The related amount of interest income recognized on these TDR loans was $502,000 for the year ended March 31, 2017.
The Company has determined that, in certain circumstances, it is appropriate to split a loan into multiple notes. This typically includes a nonperforming charged-off loan that is not supported by the cash flow of the relationship and a performing loan that is supported by the cash flow. These may also be split into multiple notes to align portions of the loan balance with the various sources of repayment when more than one exists. Generally the new loans are restructured based on customary underwriting standards. In situations where they were not, the policy exception qualifies as a concession, and if the borrower is experiencing financial difficulties, the loans are accounted for as TDRs.
The accrual status of a loan may change after it has been classified as a TDR. The Company's general policy related to TDRs is to perform a credit evaluation of the borrower's financial condition and prospects for repayment under the revised terms. This evaluation includes consideration of the borrower's sustained historical repayment performance for a reasonable period of time. A sustained period of repayment performance generally would be a minimum of six months and may include repayments made prior to the restructuring date. If repayment of principal and interest appears doubtful, it is placed on non-accrual status.
In accordance with the Company's policy guidelines, unsecured loans are generally charged-off when no payments have been received for three consecutive months unless an alternative action plan is in effect. Consumer installment loans delinquent six months or more that have not received at least 75% of their required monthly payment in the last 90 days are charged-off. In addition, loans discharged in bankruptcy proceedings are charged-off. Loans under bankruptcy protection with no payments received for four consecutive months will be charged-off. The outstanding balance of a secured loan that is in excess of the net realizable value is generally charged-off if no payments are received for four to five consecutive months. However, charge-offs are postponed if alternative proposals to restructure, obtain additional guarantors, obtain additional assets as collateral or a potential sale would result in full repayment of the outstanding loan balance. Once any of these or other potential sources of repayment are exhausted, the impaired portion of the loan is charged-off, unless an updated valuation of the collateral reveals no impairment. Regardless of whether a loan is unsecured or collateralized, once an amount is determined to be a confirmed loan loss it is promptly charged off.
Asset Classification.
The OCC has adopted various regulations regarding problem assets of savings institutions. The regulations require that each insured institution review and classify its assets on a regular basis. In addition, in connection with examinations of insured institutions, OCC examiners have authority to identify problem assets and, if appropriate, require them to be classified. There are three classifications for problem assets: substandard, doubtful and loss (collectively "classified loans"). Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset of the institution is not warranted.
When the Company classifies problem assets as either substandard or doubtful, we may establish a specific allowance in an amount we deem prudent to address the risk specifically or we may allow the loss to be addressed in the general allowance. General allowances represent loss allowances which have been established to recognize the inherent risk associated with lending activities, but which, unlike specific allowances, have not been specifically allocated to particular problem assets. When a problem asset is classified by us as a loss, we are required to charge off the asset in the period in which it is deemed uncollectible.
The aggregate amount of the Company's classified loans (comprised entirely of substandard loans), general loss allowances, specific loss allowances and net recoveries were as follows at the dates indicated (in thousands):
|
|
At or For the Year
|
|
|
|
Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
|
|
|
Classified loans
|
|
$
|
10,008
|
|
|
$
|
4,294
|
|
|
|
|
|
|
|
|
|
|
General loss allowances
|
|
|
10,440
|
|
|
|
9,775
|
|
Specific loss allowances
|
|
|
88
|
|
|
|
110
|
|
Net recoveries
|
|
|
(643
|
)
|
|
|
(273
|
)
|
All of the loans on non-accrual status as of March 31, 2017 were categorized as classified loans. Classified loans at March 31, 2017 were comprised of eight commercial business loans totaling $3.2 million, five commercial real estate loans totaling $5.7 million (the largest of which was $3.3 million), one multi-family loan totaling $12,000, one land development loan totaling $801,000, three one-to-four family real estate loans totaling $170,000 and thirteen purchased automobile loans totaling $108,000.
Allowance for Loan Losses.
The Company maintains an allowance for loan losses to provide for probable losses inherent in the loan portfolio consistent with U.S. generally accepted accounting principles ("GAAP") guidelines. The adequacy of the allowance is evaluated monthly to maintain the allowance at levels sufficient to provide for inherent losses existing at the balance sheet date. The key components to the evaluation are the Company's internal loan review function by its credit administration, which reviews and monitors the risk and quality of the loan portfolio; as well as the Company's external loan reviews and its loan classification systems. Credit officers are expected to monitor their portfolios and make recommendations to change loan grades whenever changes are warranted. Credit administration approves any changes to loan grades and monitors loan grades.
For additional discussion of the Company's methodology for assessing the appropriate level of the allowance for loan losses see
Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies."
In accordance with acquisition accounting, loans acquired from MBank were recorded at their estimated fair value, which resulted in a net discount to the loans' contractual amounts, of which a portion reflects a discount for possible credit losses. Credit discounts are included in the determination of fair value and as a result no allowance for loan losses is recorded for acquired loans at the acquisition date. Although the discount recorded on the acquired loans is not reflected in the allowance for loan losses or related allowance coverage ratios, we believe the ratio of the allowance for loan losses to total loans, including the remaining discount on acquired loans, a non-GAAP financial measure, should be considered by investors when comparing the Company's allowance for loan losses to total loans in periods prior to the MBank transaction.
The Company did not record a provision for loan losses for the year ended March 31, 2017 compared to recording a recapture of loan losses of $1.2 million for the year ended March 31, 2016. At March 31, 2017, the Company had an allowance for loan losses of $10.5 million, or 1.35% of total loans, compared to $9.9 million, or 1.58% at March 31, 2016. If the allowance for loan losses and loans were grossed up to include the remaining acquisition loan discount as of March 31, 2017, the adjusted allowance for loan losses to adjusted loans would have been 1.73%. The increase in the balance of the allowance for loan losses at March 31, 2017 reflects the $50.6 million increase in loan balances (excluding $104.0 million at March 31, 2017 of loans acquired from MBank in the MBank transaction) from March 31, 2016 compared to March 31, 2017. The Company is continuing to experience stabilizing real estate values in our market areas as reflected by an increase in recoveries compared to the prior fiscal year. Nonperforming loans remained constant at $2.7 million and 30-89 day delinquent loans decreased $370,000 during the year ended March 31, 2017. Classified loans were $10.0 million at March 31, 2017 compared to $4.3 million at March 31, 2016. The $5.7 million increase is primarily attributed to two commercial business loans totaling $2.4 million and one commercial real estate loan totaling $3.3 million. The increase also included three classified loans acquired through the MBank transaction totaling $1.4 million. These increases were partially offset by payoffs on existing classified loans during the year totaling $1.1 million. The coverage ratio of allowance for loan losses to nonperforming loans was 382.98% at March 31, 2017 compared to 364.22% at March 31, 2016. The Company's general valuation allowance to non-impaired loans was 1.36% and 1.60% at March 31, 2017 and 2016, respectively.
Set forth below is a reconciliation to GAAP of the allowance for loan losses to total loans and the allowance for loan losses as adjusted to include acquired loans at the dates indicated (dollars in thousands):
|
|
March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
|
|
|
|
|
|
Loans receivable (GAAP)
|
|
$
|
779,432
|
|
|
$
|
624,819
|
|
|
$
|
579,772
|
|
Net loan discount on acquired loans
|
|
|
3,010
|
|
|
|
-
|
|
|
|
-
|
|
Adjusted loans (non-GAAP)
|
|
$
|
782,442
|
|
|
$
|
624,819
|
|
|
$
|
579,772
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses (GAAP)
|
|
$
|
10,528
|
|
|
$
|
9,885
|
|
|
$
|
10,762
|
|
Net loan discount on acquired loans
|
|
|
3,010
|
|
|
|
-
|
|
|
|
-
|
|
Adjusted allowance for loan losses (non-GAAP)
|
|
$
|
13,538
|
|
|
$
|
9,885
|
|
|
$
|
10,762
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Allowance for loan losses/Total loans (GAAP)
|
|
|
1.35
|
%
|
|
|
1.58
|
%
|
|
|
1.86
|
%
|
Adjusted allowance for loan losses/Adjusted total loans (non-GAAP)
|
|
|
1.73
|
%
|
|
|
1.58
|
%
|
|
|
1.86
|
%
|
Management considers the allowance for loan losses to be adequate at March 31, 2017 to cover probable losses inherent in the loan portfolio based on the assessment of various factors affecting the loan portfolio, and the Company believes it has established its existing allowance for loan losses in accordance with GAAP. However, a decline in local economic conditions, results of examinations by the Company's regulators, or other factors could result in a material increase in the allowance for loan losses and may adversely affect the Company's future financial condition and results of operations. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses will be adequate or that substantial increases will not be necessary should the quality of any loans deteriorate or should collateral values decline as a result of the factors discussed elsewhere in this document.
The following table sets forth an analysis of the Company's allowance for loan losses for the periods indicated (dollars in thousands):
|
|
Year Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2013
|
|
|
|
|
|
Balance at beginning of year
|
|
$
|
9,885
|
|
|
$
|
10,762
|
|
|
$
|
12,551
|
|
|
$
|
15,643
|
|
|
$
|
19,921
|
|
Provision for (recapture of) loan losses
|
|
|
-
|
|
|
|
(1,150
|
)
|
|
|
(1,800
|
)
|
|
|
(3,700
|
)
|
|
|
900
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial and construction
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
492
|
|
|
|
30
|
|
|
|
34
|
|
|
|
526
|
|
|
|
118
|
|
Other real estate mortgage
|
|
|
463
|
|
|
|
331
|
|
|
|
271
|
|
|
|
873
|
|
|
|
1,263
|
|
Real estate construction
|
|
|
-
|
|
|
|
6
|
|
|
|
-
|
|
|
|
4
|
|
|
|
228
|
|
Total commercial and construction
|
|
|
955
|
|
|
|
367
|
|
|
|
305
|
|
|
|
1,403
|
|
|
|
1,609
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
89
|
|
|
|
153
|
|
|
|
158
|
|
|
|
304
|
|
|
|
138
|
|
Other installment
|
|
|
57
|
|
|
|
27
|
|
|
|
12
|
|
|
|
7
|
|
|
|
1
|
|
Total consumer
|
|
|
146
|
|
|
|
180
|
|
|
|
170
|
|
|
|
311
|
|
|
|
139
|
|
Total recoveries
|
|
|
1,101
|
|
|
|
547
|
|
|
|
475
|
|
|
|
1,714
|
|
|
|
1,748
|
|
Charge-offs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial and construction
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
|
1
|
|
|
|
-
|
|
|
|
120
|
|
|
|
340
|
|
|
|
1,606
|
|
Other real estate mortgage
|
|
|
117
|
|
|
|
-
|
|
|
|
233
|
|
|
|
406
|
|
|
|
3,869
|
|
Real estate construction
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
11
|
|
|
|
141
|
|
Total commercial and construction
|
|
|
118
|
|
|
|
-
|
|
|
|
353
|
|
|
|
757
|
|
|
|
5,616
|
|
Consumer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
-
|
|
|
|
8
|
|
|
|
53
|
|
|
|
346
|
|
|
|
1,238
|
|
Other installment
|
|
|
340
|
|
|
|
266
|
|
|
|
58
|
|
|
|
3
|
|
|
|
72
|
|
Total consumer
|
|
|
340
|
|
|
|
274
|
|
|
|
111
|
|
|
|
349
|
|
|
|
1,310
|
|
Total charge-offs
|
|
|
458
|
|
|
|
274
|
|
|
|
464
|
|
|
|
1,106
|
|
|
|
6,926
|
|
Net charge-offs (recoveries)
|
|
|
(643
|
)
|
|
|
(273
|
)
|
|
|
(11
|
)
|
|
|
(608
|
)
|
|
|
5,178
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance at end of year
|
|
$
|
10,528
|
|
|
$
|
9,885
|
|
|
$
|
10,762
|
|
|
$
|
12,551
|
|
|
$
|
15,643
|
|
Ratio of allowance to total loans
outstanding at end of year
|
|
|
1.35
|
%
|
|
|
1.58
|
%
|
|
|
1.86
|
%
|
|
|
2.35
|
%
|
|
|
2.92
|
%
|
Ratio of net charge-offs (recoveries) to average net
loans outstanding during year
|
|
|
(0.10
|
)
|
|
|
(0.05
|
)
|
|
|
0.00
|
|
|
|
(0.12
|
)
|
|
|
0.86
|
|
Ratio of allowance to total nonperforming loans
|
|
|
382.98
|
|
|
|
364.22
|
|
|
|
202.37
|
|
|
|
89.25
|
|
|
|
74.02
|
|
The following table sets forth the breakdown of the allowance for loan losses by loan category as of the dates indicated (dollars in thousands):
|
|
At March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
|
2013
|
|
|
|
Amount
|
|
|
Loan
Category
as a
Percent
of Total
Loans
|
|
|
Amount
|
|
|
Loan
Category
as a
Percent of
Total
Loans
|
|
|
Amount
|
|
|
Loan
Category
as a
Percent of
Total
Loans
|
|
|
Amount
|
|
|
Loan
Category
as a
Percent
of Total
Loans
|
|
|
Amount
|
|
|
Loan
Category
as a
Percent
of Total
Loans
|
|
|
|
|
|
Commercial and construction:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial business
|
|
$
|
1,418
|
|
|
|
13.78
|
%
|
|
$
|
1,048
|
|
|
|
11.11
|
%
|
|
$
|
1,263
|
|
|
|
13.31
|
%
|
|
$
|
2,409
|
|
|
|
13.43
|
%
|
|
$
|
2,128
|
|
|
|
13.42
|
%
|
Other real estate mortgage
|
|
|
5,609
|
|
|
|
65.00
|
|
|
|
5,310
|
|
|
|
63.94
|
|
|
|
5,155
|
|
|
|
59.60
|
|
|
|
5,812
|
|
|
|
60.90
|
|
|
|
8,539
|
|
|
|
66.30
|
|
Real estate construction
|
|
|
714
|
|
|
|
5.92
|
|
|
|
416
|
|
|
|
4.28
|
|
|
|
769
|
|
|
|
5.26
|
|
|
|
387
|
|
|
|
3.65
|
|
|
|
221
|
|
|
|
1.81
|
|
Consumer:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Real estate one-to-four family
|
|
|
1,525
|
|
|
|
11.91
|
|
|
|
1,652
|
|
|
|
14.21
|
|
|
|
1,881
|
|
|
|
15.49
|
|
|
|
2,190
|
|
|
|
17.43
|
|
|
|
2,868
|
|
|
|
18.12
|
|
Other installment
|
|
|
574
|
|
|
|
3.39
|
|
|
|
751
|
|
|
|
6.46
|
|
|
|
667
|
|
|
|
6.34
|
|
|
|
463
|
|
|
|
4.59
|
|
|
|
81
|
|
|
|
0.35
|
|
Unallocated
|
|
|
688
|
|
|
|
-
|
|
|
|
708
|
|
|
|
-
|
|
|
|
1,027
|
|
|
|
-
|
|
|
|
1,290
|
|
|
|
-
|
|
|
|
1,806
|
|
|
|
-
|
|
Total allowance for loan losses
|
|
$
|
10,528
|
|
|
|
100.00
|
%
|
|
$
|
9,885
|
|
|
|
100.00
|
%
|
|
$
|
10,762
|
|
|
|
100.00
|
%
|
|
$
|
12,551
|
|
|
|
100.00
|
%
|
|
$
|
15,643
|
|
|
|
100.00
|
%
|
Investment Activities
The Board sets the investment policy of the Company. The Company's investment objectives are: to provide and maintain liquidity within regulatory guidelines; to maintain a balance of high quality, diversified investments to minimize risk; to provide collateral for pledging requirements; to serve as a balance to earnings; and to optimize returns. The policy permits investment in various types of liquid assets permissible under OCC regulation, which includes U.S. Treasury obligations, securities of various federal agencies, "bank qualified" municipal bonds, certain certificates of deposit of insured banks, repurchase agreements, federal funds and mortgage-backed securities ("MBS"), but does not permit investment in non-investment grade bonds. The policy also dictates the criteria for classifying securities into one of three categories: held to maturity, available for sale or trading. At March 31, 2017, no investment securities were held for trading purposes.
See
Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies."
The Company primarily purchases agency securities with maturities of five years or less and purchases a combination of MBS backed by government agencies (FHLMC, Fannie Mae ("FNMA"), U.S. Small Business Administration ("SBA") or Ginnie Mae ("GNMA")). FHLMC and FNMA securities are not backed by the full faith and credit of the United States government while SBA and GNMA securities are backed by the full faith and credit of the United States government. At March 31, 2017, the Company owned no privately issued MBS. Our real estate mortgage investment conduits ("REMICS") consist of FHLMC and FNMA securities and our CRE mortgage-backed securities consist of FNMA securities. The Company does not believe that it has any exposure to sub-prime lending in its investment securities portfolio. See Note 4 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K for additional information.
The following table sets forth the investment securities portfolio and carrying values at the dates indicated (dollars in thousands).
|
|
At March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
Carrying
Value
|
|
|
Percent of
Portfolio
|
|
|
Carrying
Value
|
|
|
Percent of
Portfolio
|
|
|
Carrying
Value
|
|
|
Percent of
Portfolio
|
|
|
|
|
|
Available for sale (at estimated fair value):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Municipal securities
|
|
$
|
2,819
|
|
|
|
1.41
|
%
|
|
$
|
-
|
|
|
|
-
|
%
|
|
$
|
-
|
|
|
|
-
|
%
|
Trust preferred securities
|
|
|
-
|
|
|
|
-
|
|
|
|
1,808
|
|
|
|
1.20
|
|
|
|
1,812
|
|
|
|
1.61
|
|
Agency securities
|
|
|
16,808
|
|
|
|
8.39
|
|
|
|
19,569
|
|
|
|
12.98
|
|
|
|
13,939
|
|
|
|
12.38
|
|
REMICs
|
|
|
43,160
|
|
|
|
21.55
|
|
|
|
43,924
|
|
|
|
29.14
|
|
|
|
22,709
|
|
|
|
20.18
|
|
MBS
|
|
|
96,611
|
|
|
|
48.24
|
|
|
|
76,353
|
|
|
|
50.64
|
|
|
|
68,514
|
|
|
|
60.87
|
|
Other MBS
|
|
|
40,816
|
|
|
|
20.38
|
|
|
|
9,036
|
|
|
|
5.99
|
|
|
|
5,489
|
|
|
|
4.88
|
|
|
|
|
200,214
|
|
|
|
99.97
|
|
|
|
150,690
|
|
|
|
99.95
|
|
|
|
112,463
|
|
|
|
99.92
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Held to maturity (at amortized cost):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
MBS
|
|
|
64
|
|
|
|
0.03
|
|
|
|
75
|
|
|
|
0.05
|
|
|
|
86
|
|
|
|
0.08
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment securities
|
|
$
|
200,278
|
|
|
|
100.00
|
%
|
|
$
|
150,765
|
|
|
|
100.00
|
%
|
|
$
|
112,549
|
|
|
|
100.00
|
%
|
The following table sets forth the maturities and weighted average yields in the securities portfolio at March 31, 2017 (dollars in thousands):
|
|
One to Five Years
|
|
|
More Than Five to Ten Years
|
|
|
More Than
Ten Years
|
|
|
|
Amount
|
|
|
Weighted
Average
Yield
(1)
|
|
|
Amount
|
|
|
Weighted
Average
Yield
(1)
|
|
|
Amount
|
|
|
Weighted
Average
Yield
(1)
|
|
|
|
|
|
Municipal securities
|
|
$
|
-
|
|
|
|
-
|
%
|
|
$
|
2,154
|
|
|
|
1.70
|
%
|
|
$
|
665
|
|
|
|
2.60
|
%
|
Agency securities
|
|
|
13,956
|
|
|
|
1.20
|
|
|
|
2,852
|
|
|
|
1.75
|
|
|
|
-
|
|
|
|
-
|
|
REMICs
|
|
|
2,499
|
|
|
|
2.14
|
|
|
|
4,944
|
|
|
|
2.33
|
|
|
|
35,717
|
|
|
|
2.21
|
|
MBS
|
|
|
-
|
|
|
|
-
|
|
|
|
13,910
|
|
|
|
1.93
|
|
|
|
82,765
|
|
|
|
2.34
|
|
Other MBS
|
|
|
-
|
|
|
|
-
|
|
|
|
11,548
|
|
|
|
2.11
|
|
|
|
29,268
|
|
|
|
2.11
|
|
Total
|
|
$
|
16,455
|
|
|
|
1.34
|
%
|
|
$
|
35,408
|
|
|
|
2.01
|
%
|
|
$
|
148,415
|
|
|
|
2.26
|
%
|
(1)
For available for sale securities carried at estimated fair value, the weighted average yield is computed using amortized cost without a tax equivalent
adjustment for tax-exempt obligations.
Management reviews investment securities quarterly for the presence of other than temporary impairment ("OTTI"), taking into consideration current market conditions, the extent and nature of changes in estimated fair value, issuer rating changes and trends, financial condition of the underlying issuers, current analysts' evaluations, the Company's ability and intent to hold investments until a recovery of estimated fair value, which may be maturity, as well as other factors. The Company's trust preferred securities investment consisted of a single collateralized debt obligation ("CDO") secured by a pool of trust preferred securities issued by other bank holding companies which during the year ended March 31, 2017, was liquidated and the Company received $1.8 million in proceeds from the liquidation. During the year ended March 31, 2017, the Company recognized a $240,000 OTTI charge related to this CDO. There was no impairment charge for this security for the years ended March 31, 2016 or 2015. For additional information related to this security, see Note 4 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.
For additional information related to our Level 3 estimated fair value measurements see
Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations – Comparison of Financial Condition at March 31, 2017 and 2016" and "Estimated Fair Value of Level 3 Assets," and Note 17 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.
Deposit Activities and Other Sources of Funds
General.
Deposits, loan repayments and loan sales are the major sources of the Company's funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions. Borrowings may be used on a short-term basis to compensate for reductions in the availability of funds from other sources. They may also be used on a longer-term basis for general business purposes.
Deposit Accounts.
The Company attracts deposits from within its primary market area by offering a broad selection of deposit instruments, including demand deposits, negotiable order of withdrawal ("NOW") accounts, money market accounts, regular savings accounts, certificates of deposit and retirement savings plans. The Company has focused on building customer relationship deposits which include both business and consumer depositors. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of its deposit accounts, the Company considers the rates offered by its competition, profitability to the Company, matching deposit and loan products and customer preferences and concerns.
The following table sets forth the average balances of deposit accounts held by the Company at the dates indicated (dollars in thousands):
|
|
Year Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
Average
Balance
|
|
|
Average
Rate
|
|
|
Average
Balance
|
|
|
Average
Rate
|
|
|
Average
Balance
|
|
|
Average
Rate
|
|
|
|
|
|
Non-interest-bearing demand
|
|
$
|
202,376
|
|
|
|
0.00
|
%
|
|
$
|
170,612
|
|
|
|
0.00
|
%
|
|
$
|
140,949
|
|
|
|
0.00
|
%
|
Interest checking
|
|
|
151,801
|
|
|
|
0.06
|
|
|
|
127,161
|
|
|
|
0.08
|
|
|
|
104,719
|
|
|
|
0.08
|
|
Regular savings accounts
|
|
|
106,324
|
|
|
|
0.10
|
|
|
|
84,485
|
|
|
|
0.10
|
|
|
|
71,202
|
|
|
|
0.10
|
|
Money market accounts
|
|
|
252,040
|
|
|
|
0.12
|
|
|
|
231,873
|
|
|
|
0.12
|
|
|
|
229,840
|
|
|
|
0.12
|
|
Certificates of deposit
|
|
|
118,769
|
|
|
|
0.53
|
|
|
|
129,427
|
|
|
|
0.55
|
|
|
|
148,573
|
|
|
|
0.61
|
|
Total
|
|
$
|
831,310
|
|
|
|
0.14
|
%
|
|
$
|
743,558
|
|
|
|
0.16
|
%
|
|
$
|
695,283
|
|
|
|
0.19
|
%
|
Deposit accounts totaled $980.1 million at March 31, 2017 compared to $779.8 million at March 31, 2016. The Company did not have any wholesale-brokered deposits at March 31, 2017 and 2016. The Company continues to focus on core deposits and growth generated by customer relationships as opposed to obtaining deposits through the wholesale markets. The Company has continued to experience increased competition for customer deposits within its market area. Customer branch deposits increased $209.8 million since March 31, 2016 including $125.7 million assumed in the MBank transaction. At March 31, 2017, the Company had $24.3 million, or 2.5% of total deposits, in Certificate of Deposit Account Registry Service ("CDARS") and Insured Cash Sweep ("ICS") deposits, which were gathered from customers within the Company's primary market-area. CDARS and ICS deposits allow customers access to FDIC insurance on deposits exceeding the $250,000 FDIC insurance limit.
There were no deposits from the Trust Company at March 31, 2017. At March 31, 2016, deposits from the Trust Company totaled $4.9 million. These deposits were included in interest-bearing accounts and represent assets under management by the Trust Company. At March 31, 2017 and 2016, the Company also had $3.5 million and $15.5 million, respectively in deposits from public entities located in the States of Washington and Oregon, all of which were fully covered by FDIC insurance or secured by pledged collateral.
The Company is enrolled in an internet deposit listing service. Under this listing service, the Company may post certificates of deposit rates on an internet site where institutional investors have the ability to deposit funds with the Company. At March 31, 2017, the Company had $7.0 million of deposits through this listing service which were assumed in the MBank transaction. At March 31, 2016, the Company did not have any deposits through this listing service as the Company chose not to utilize these internet based deposits. Although the Company did not originate any internet based deposits during the year ended March 31, 2017, the Company may do so in the future consistent with its asset/liability objectives.
Deposit growth remains a key strategic focus for the Company and our ability to achieve deposit growth, particularly growth in core deposits, is subject to many risk factors including the effects of competitive pricing pressures, changing customer deposit behavior, and increasing or decreasing interest rate environments. Adverse developments with respect to any of these risk factors could limit the Company's ability to attract and retain deposits and could have a material negative impact on the Company's financial condition, results of operations and cash flows.
The following table presents the amount and weighted average rate of certificates of deposit equal to or greater than $100,000 at March 31, 2017 (dollars in thousands):
Maturity Period
|
|
Amount
|
|
|
Weighted
Average Rate
|
|
|
|
|
|
Three months or less
|
|
$
|
15,110
|
|
|
|
0.48
|
%
|
Over three through six months
|
|
|
14,269
|
|
|
|
0.66
|
|
Over six through 12 months
|
|
|
25,743
|
|
|
|
0.62
|
|
Over 12 months
|
|
|
26,164
|
|
|
|
1.06
|
|
Total
|
|
$
|
81,286
|
|
|
|
0.74
|
%
|
Borrowings.
The Company relies upon advances from the FHLB and borrowings from the Federal Reserve Bank of San Francisco ("FRB") to supplement its supply of lendable funds and to meet deposit withdrawal requirements. Advances from the FHLB and borrowings from the FRB are typically secured by the Bank's commercial loans, commercial real estate loans, first mortgage loans and investment securities. At March 31, 2017, 2016 and 2015, the Bank did not have any FHLB advances or FRB borrowings.
The FHLB functions as a central reserve bank providing credit for member financial institutions. As a member, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances on the security of such stock and certain of its mortgage loans and other assets (primarily securities which are obligations of, or guaranteed by, the United States) provided certain standards related to credit-worthiness have been met. The FHLB determines specific lines of credit for each member institution and the Bank has a line of credit with the FHLB equal to 35% of its total assets to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. At March 31, 2017, the Bank had an available credit capacity of $344.4 million, subject to sufficient collateral and stock investment.
The Bank also has a borrowing arrangement with the FRB with an available credit facility of $57.4 million, subject to pledged collateral, as of March 31, 2017. The following table sets forth certain information concerning the Company's borrowings for the periods indicated (dollars in thousands):
|
|
Year Ended March 31,
|
|
|
|
2017
|
|
|
2016
|
|
|
2015
|
|
|
|
|
|
Maximum amounts of FHLB advances outstanding at any month end
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
2,100
|
|
Average FHLB advances outstanding
|
|
|
239
|
|
|
|
5
|
|
|
|
285
|
|
Weighted average rate on FHLB advances
|
|
|
0.80
|
%
|
|
|
0.31
|
%
|
|
|
0.33
|
%
|
Maximum amounts of FRB borrowings outstanding at any month end
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
Average FRB borrowings outstanding
|
|
|
-
|
|
|
|
5
|
|
|
|
3
|
|
Weighted average rate on FRB borrowings
|
|
|
-
|
|
|
|
0.88
|
%
|
|
|
0.75
|
%
|
At March 31, 2017, the Company had three wholly-owned subsidiary grantor trusts totaling $27.8 million that were established for the purpose of issuing trust preferred securities and common securities including a $5.2 million trust acquired in the MBank transaction. The trust preferred securities accrue and pay distributions periodically at specified annual rates as provided in each trust agreement. The trusts used the net proceeds from each of the offerings to purchase a like amount of junior subordinated debentures (the "Debentures") of the Company. The Debentures are the sole assets of the trusts. The Company's obligations under the Debentures and related documents, taken together, constitute a full and unconditional guarantee by the Company of the obligations of the trusts. The trust preferred securities are mandatorily redeemable upon maturity of the Debentures or upon earlier redemption as provided in the indentures. The Company has the right to redeem the Debentures in whole or in part on or after specific dates, at a redemption price specified in the indentures governing the Debentures plus any accrued but unpaid interest to the redemption date. The Company also has the right to defer the payment of interest on each of the Debentures for a period not to exceed 20 consecutive quarters, provided that the deferral period does not extend beyond the stated maturity. During such deferral period, distributions on the corresponding trust preferred securities will also be deferred and the Company may not pay cash dividends to the holders of shares of the Company's common stock. The common securities issued by the grantor trusts are held by the Company, and the Company's investment in the common securities of $836,000 and $681,000 at March 31, 2017 and 2016, respectively, is included in prepaid expenses and other assets in the Consolidated Balance Sheets included in the Consolidated Financial Statements contained in Item 8 of this Form 10-K. For more information, see also Note 11 of the Notes to the Consolidated Financial Statements contained in Item 8 of this Form 10-K.
Taxation
For details regarding the Company's taxes, see Item 8 – "Financial Statements and Supplementary Data - Note 12 of the Notes to the Consolidated Financial Statements."
Personnel
As of March 31, 2017, the Company had 260 full‑time equivalent employees, none of whom are represented by a collective bargaining unit. The Company believes its relationship with its employees is good.
Corporate Information
The Company's principal executive offices are located at 900 Washington Street, Vancouver, Washington 98660. Its telephone number is (360) 693-6650. The Company maintains a website with the address
www.riverviewbank.com
. The information contained on the Company's website is not included as a part of, or incorporated by reference into, this Annual Report on Form 10-K. Other than an investor's own internet access charges, the Company makes available free of charge through its website the Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after it has electronically filed such material with, or furnished such material to, the Securities and Exchange Commission ("SEC").
Subsidiary Activities
Under OCC regulations, the Bank is authorized to invest up to 3% of its assets in subsidiary corporations, with amounts in excess of 2% only if primarily for community purposes. At March 31, 2017, the Bank's investments in its wholly owned subsidiaries of $1.2 million in Riverview Services, Inc. ("Riverview Services") and $4.4 million in the Trust Company were within these limitations.
Riverview Services acts as a trustee for deeds of trust on mortgage loans granted by the Bank, and receives a reconveyance fee for each deed of trust. Riverview Services had net income of $25,000 for the fiscal year ended March 31, 2017 and total assets of $1.2 million at March 31, 2017. Riverview Services' operations are included in the Consolidated Financial Statements of the Company contained in Item 8 of this Form 10-K.
The Trust Company is an asset management company providing trust, estate planning and investment management services. The Trust Company had net income of $86,000 for the fiscal year ended March 31, 2017 and total assets of $4.8 million at that date. The Trust Company earns fees on the management of assets held in fiduciary or agency capacity. At March 31, 2017, total assets under management were $425.9 million. The Trust Company's operations are included in the Consolidated Financial Statements of the Company contained in Item 8 of this Form 10-K.
Executive Officers
. The following table sets forth certain information regarding the executive officers of the Company and its subsidiaries:
Name
|
Age
(1
)
|
Position
|
Patrick Sheaffer
|
77
|
Chairman of the Board and Chief Executive Officer
|
Ronald A. Wysaske
|
64
|
President and Chief Operating Officer
|
Kevin J. Lycklama
|
39
|
Executive Vice President and Chief Financial Officer
|
Daniel D. Cox
|
39
|
Executive Vice President and Chief Credit Officer
|
Richard S. Michalek
|
72
|
Executive Vice President and Chief Lending Officer
|
Christopher P. Cline
|
56
|
President and Chief Executive Officer of Riverview Trust Company
|
Kim J. Capeloto
|
55
|
Executive Vice President and Chief Retail Banking Officer
|
(1)
At March 31, 2017
Patrick Sheaffer
is
Chairman of the Board and Chief Executive Officer
of the Company and Chief Executive Officer of the Bank, positions he has held since February 2004. Prior to February 2004, Mr. Sheaffer served as Chairman of the Board, President and Chief Executive Officer of the Company since its inception in 1997. He became Chairman of the Board of the Bank in 1993. Mr. Sheaffer joined the Bank in 1963. He is responsible for leadership and management of the Company. Mr. Sheaffer is active in numerous professional and civic organizations.
Ronald A. Wysaske
is President and Chief Operating Officer of the Bank, positions he has held since February 2004. Prior to February 2004, Mr. Wysaske served as Executive Vice President, Treasurer and Chief Financial Officer of the Bank from 1981 to 2004 and of the Company since its inception in 1997. He joined the Bank in 1976. Mr. Wysaske is responsible for daily operations and management of the Bank. He holds an M.B.A. from Washington State University and is active in numerous professional, educational and civic organizations.
Kevin J. Lycklama
is Executive Vice President and Chief Financial Officer of the Company, positions he has held since February 2008. Prior to February 2008, Mr. Lycklama served as Vice President and Controller of the Bank since 2006. Prior to joining Riverview, Mr. Lycklama spent five years with a local public accounting firm advancing to the level of audit manager. He is responsible for accounting, SEC reporting and treasury functions for the Bank and the Company. He holds a Bachelor of Arts degree from Washington State University, is a graduate of the Pacific Coast Banking School and is a certified public accountant.
Daniel D. Cox
is Executive Vice President and Chief Credit Officer and is responsible for credit administration related to the Bank's commercial, mortgage and consumer loan activities. Mr. Cox joined Riverview in August 2002 and spent five years as a commercial lender and progressed through the credit administration function, most recently serving as Senior Vice President of Credit Administration. He holds a Bachelor of Arts degree from Washington State University and was an Honor Roll graduate of the Pacific Coast Banking School. Mr. Cox is an active mentor in the local schools and was the Past Treasurer and Endowment Chair for the Washougal Schools Foundation and Past Board Member of Camas-Washougal Chamber of Commerce.
Richard S. Michalek
is Executive Vice President and Chief Lending Officer of the Company, a position he has held since June 2012. Mr. Michalek is responsible for the Bank's commercial lending division. Prior to joining Riverview in 2001, Mr. Michalek spent seven years at Northwest National Bank where he was a commercial loan officer and later managed the retail banking loan center. Mr. Michalek also spent 19 years at Seattle First National Bank/Bank of America in various capacities. Mr. Michalek holds a Bachelor of Arts degree and an M.B.A. from Seattle University and is a graduate of the Pacific Coast Banking School.
Christopher P. Cline
is President and Chief Executive Officer of the Trust Company, a wholly-owned subsidiary of the Bank. Mr. Cline joined the Trust Company in 2016, after having spent eight years managing the trust department of Wells Fargo's Private Bank in Oregon and Southwest Washington. Prior to that, Mr. Cline was an estate planning attorney for 17 years, most recently as a partner at Holland & Knight. Mr. Cline has managed all aspects of the trust business, is a Fellow of the American College of Trust and Estate Counsel and is a nationally recognized speaker and author, having written books on estate planning and trust administration. Mr. Cline holds a Bachelor of Arts degree from San Francisco State University and a Juris Doctor degree from Hastings College of the Law in San Francisco.
Kim J. Capeloto
is Executive Vice President and Chief Retail Banking Officer. Mr. Capeloto has been employed by the Bank since September 2010. Mr. Capeloto has over 30 years of banking experience serving as regional manager for Union Bank of California and Wells Fargo Bank directing small business and personal banking activities. Prior to joining the Bank, Mr. Capeloto held the position of President and Chief Executive Officer of the Greater Vancouver Chamber of Commerce. Mr. Capeloto is active in numerous professional and civic organizations.
REGULATION
The following is a brief description of certain laws and regulations which are applicable to the Company and the Bank. The description of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, does not purport to be complete and is qualified in its entirety by reference to the applicable laws and regulations.
Legislation is introduced from time to time in the United States Congress ("Congress") that may affect the Company's and Bank's operations. In addition, the regulations governing the Company and the Bank may be amended from time to time by the OCC, the FDIC, the Federal Reserve Board or the SEC, as appropriate. Any such legislation or regulatory changes in the future could have an adverse effect
on our operations and financial condition. We cannot predict whether any such changes may occur.
General
As a federally chartered savings bank, the Bank is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the FDIC, as the insurer of its deposits. Additionally, the Company is subject to extensive regulation, examination and supervision by the Federal Reserve Board as its primary federal regulator. The Bank is a member of the FHLB System and its deposits are insured up to applicable limits by the DIF, which is administered by the FDIC. The Bank must file reports with the OCC and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other financial institutions. There are periodic examinations by the OCC, the Federal Reserve and under certain circumstances, the FDIC, to evaluate the Bank's safety and soundness and compliance with various regulatory requirements. This regulatory structure establishes a comprehensive framework of activities in which the Bank may engage and is intended primarily for the protection of the DIF and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate loan loss reserves for regulatory purposes. Any change in such policies, whether by the OCC, the Federal Reserve, the FDIC or Congress, could have a material adverse impact on the Company and the Bank and their operations.
In connection with the enactment of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the "Dodd-Frank Act"), the laws and regulations affecting depository institutions and their holding companies have changed the bank regulatory structure and are affecting the lending, investment, trading and operating activities of depository institutions and their holding companies. Among other changes, the Dodd-Frank Act eliminated the Office of Thrift Supervision, the Bank's previous primary federal regulator, as of July 21, 2011 and established the Consumer Financial Protection Bureau ("CFPB") as an independent bureau of the Federal Reserve Board. The CFPB assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. The Bank is subject to consumer protection regulations issued by the CFPB, but as a smaller financial institution, the Bank is generally subject to supervision and enforcement by the FDIC and the OCC with respect to its compliance with consumer financial protection laws and CFPB regulations.
Many aspects of the Dodd-Frank Act are subject to delayed effective dates and/or rulemaking by the federal banking agencies. Their impact on operations cannot yet fully be assessed. The Dodd-Frank Act has resulted in, and may continue to result in, increased regulatory burden and increased compliance costs and interest expense for the Bank, the Company and the financial services industry in general. However, in February 2017, the President issued an executive order that a policy of his administration would be making regulation efficient, effective, and appropriately tailored, and directed certain regulatory agencies to review and identify laws and regulations that inhibit federal regulation of the U.S. financial system in a manner consistent with the policies stated in the executive order. Any changes in laws or regulation as a result of this review could result in a repeal, amendment to or delayed implementation of the Dodd-Frank Act.
Federal Regulation of Savings Institutions
Office of the Comptroller of the Currency.
The OCC has extensive authority over the operations of savings institutions. As part of this authority, the Bank is required to file periodic reports with the OCC and is subject to periodic examinations by the OCC. The OCC also has extensive enforcement authority over all savings institutions, including the Bank. This enforcement authority includes, among other things, the ability to assess civil money penalties, issue cease-and-desist or removal orders and initiate prompt corrective action orders. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with the OCC. Except under certain circumstances, public disclosure of final enforcement actions by the OCC is required by law.
All savings institutions are required to pay assessments to the OCC to fund the agency's operations. The general assessments, paid on a semi-annual basis, are determined based on the savings institution's total assets, including consolidated subsidiaries. The Bank's OCC assessment for the fiscal year ended March 31, 2017 was $232,000.
The Bank's general permissible lending limit for loans-to-one-borrower is equal to the greater of $500,000 or 15% of unimpaired capital and surplus (except for loans fully secured by certain readily marketable collateral, in which case this limit is increased to 25% of unimpaired capital and surplus). At March 31, 2017, the Bank's lending limit under this restriction was $
16.9
million and, at that date, the Bank's largest lending relationship with one borrower was $
14.0
million, which consisted of one commercial real estate loan which was performing according to its original payment terms.
The OCC's oversight of the Bank includes reviewing its compliance with the customer privacy requirements imposed by the Gramm-Leach-Bliley Act of 1999 ("GLBA") and the anti-money laundering provisions of the USA Patriot Act. The GLBA privacy requirements place limitations on the sharing of consumer financial information with unaffiliated third parties. They also require each financial institution offering financial products or services to retail customers to provide such customers with its privacy policy and with the opportunity to "opt out" of the sharing of their personal information with unaffiliated third parties. The USA Patriot Act significantly expands the responsibilities of financial institutions in preventing the use of the United States' financial system to fund terrorist activities. Its anti-money laundering provisions require financial institutions operating in the United States to develop anti-money laundering compliance programs and due diligence policies and controls to ensure the detection and reporting of money laundering. These compliance programs are intended to supplement existing compliance requirements under the Bank Secrecy Act and the Office of Foreign Assets Control Regulations.
The OCC, as well as the other federal banking agencies, has adopted guidelines establishing safety and soundness standards on such matters as loan underwriting and documentation, asset quality, earnings standards, internal controls and audit systems, interest rate risk exposure and compensation and other employee benefits. Any institution that fails to comply with these standards must submit a compliance plan.
Capital Requirements.
Federally insured savings institutions, such as the Bank, are required by the OCC to maintain minimum levels of regulatory capital including, a common equity Tier 1 ("CET1") capital to risk-based assets ratio, a Tier 1 capital to risk-based assets ratio, a total capital to risk-based assets ratio and a Tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final rule implementing the regulatory capital reforms required by the Dodd Frank Act and the "Basel III" requirements.
The capital standards require the maintenance of (i) a CET1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The Bank must also maintain additional levels of Tier 1 common equity over the minimum risk-based capital levels before it may pay dividends, repurchase shares or pay discretionary bonuses.
There are a number of changes in what constitutes regulatory capital, which are subject to transition periods. These changes include the phasing-out of certain instruments as qualifying capital. The Bank does not have any of these instruments. Mortgage servicing rights and certain deferred tax assets over designated percentages of CET1 are deducted from capital subject to a transition period ending December 31, 2017. In addition, Tier 1 capital includes accumulated other comprehensive income (loss), which includes all unrealized gains and losses on available for sale debt and equity securities, subject to a transition period ending December 31, 2017. Because of the Bank's asset size, the bank elected to take a one-time option to permanently opt-out of the inclusion of unrealized gains and losses on available for sale debt and equity securities in its capital calculations.
The risk-weightings of assets for the calculation of risk-based capital ratios also were changed to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and for non-residential mortgage loans that are 90 days past due or otherwise in non-accrual status; a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable; and a 250% risk weight (up from 100%) for mortgage servicing and deferred tax assets that are not deducted from capital.
The Bank also must maintain a capital conservation buffer consisting of additional CET1 capital greater than 2.5% of risk-weighted assets above the required minimum levels in order to avoid limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses based on percentages of eligible retained income that could be utilized for such actions. The capital conservation buffer requirement was subject to a phase in period, which began in January 2016 at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019.
In order to be considered well-capitalized under the prompt corrective action regulation, the Bank must maintain a CET1 risk-based ratio of 6.5%, a Tier 1 risk-based ratio of 8%, a total risk-based capital ratio of 10% and a leverage ratio of 5%.
As of March 31, 2017, the most recent notification from the OCC categorized the Bank as "well capitalized" under the regulatory framework for prompt corrective action. For additional information, see Note 15 of the Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
Prompt Corrective Action.
The OCC is required to take certain supervisory actions against undercapitalized savings institutions, the severity of which depends upon the institution's degree of undercapitalization. Subject to a narrow exception, the OCC is required to appoint a receiver or conservator for a savings institution that is "critically undercapitalized." OCC regulations also require that a capital restoration plan be filed with the OCC within 45 days of the date a savings institution receives notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. "Significantly undercapitalized" and "critically undercapitalized" institutions are subject to more extensive mandatory regulatory actions. The OCC also could take a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. At March 31, 2017, the Bank's capital ratios met the regulatory capital requirements described above under "Capital Requirements" to be considered as "well capitalized".
Federal Home Loan Bank System.
The Bank is a member of the FHLB of Des Moines which is one of 11 regional FHLBs that administer the home financing credit function of savings institutions. Each FHLB serves as a reserve or central bank for its members within its assigned region. It is funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. It makes loans or advances to members in accordance with policies and procedures, established by the Board of Directors of the FHLB, which are subject to the oversight of the Federal Housing Finance Board. All advances from the FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. In addition, all long-term advances are required to provide funds for residential home financing. See Business – "Deposit Activities and Other Sources of Funds – Borrowings." As a member, the Bank is required to purchase and maintain stock in the FHLB of Des Moines. At March 31, 2017, the Bank held $1.2 million in FHLB stock, which was in compliance with this requirement. During the year ended March 31, 2017, the Bank purchased $121,000 of FHLB stock, at par.
The FHLBs continue to contribute to low- and moderately-priced housing programs through direct loans or interest subsidies on advances targeted for community investment and low- and moderate-income housing projects. These contributions have adversely affected the level of FHLB dividends paid and could continue to do so in the future. These contributions could also have an adverse effect on the value of FHLB stock in the future. A reduction in value of the Bank's FHLB stock may result in a decrease in net income and possibly capital.
Federal Deposit Insurance Corporation
. The DIF of the FDIC insures deposits in the Bank up to $250,000 per separately insured depositor. As insurer, the FDIC imposes deposit insurance premiums and is authorized to conduct examinations of and to require reporting by FDIC-insured institutions. The Bank's deposit insurance premiums for the fiscal year ended March 31, 2017 were $
356,000
.
Prior to July 1, 2016, the FDIC assessed deposit insurance premiums on each FDIC-insured institution quarterly based on annualized rates for one of four risk categories, applied to its assessment rate. An institution's assessment base is equal to average consolidated total assets minus its average tangible equity (defined as Tier 1 capital). An institution with assets reported in its Call Report that have not exceeded $10 billion for at least four consecutive quarters and has been federally insured for at least five years is considered an established small institution and is assigned to one of four risk categories based on its capital, supervisory ratings, and other factors. The Bank is considered an established small institution. Well-capitalized institutions that were financially sound with only a few minor weaknesses were assigned to Risk Category I. Risk Categories II, III and IV present progressively greater risks to the DIF. A range of initial base assessment rates applied to each Risk Category, adjusted downward based on unsecured debt issued by the institution and, except for an institution in Risk Category I, adjusted upward if the institution's brokered deposits exceed 10% of its domestic deposits, to produce total base assessment rates. Total base assessment rates ranged from 2.5 to 9 basis points for Risk Category I, 9 to 24 basis points for Risk Category II, 18 to 33 basis points for Risk Category III, and 30 to 45 basis points for Risk Category IV, all subject to further adjustment upward if the institution held more than a de minimis amount of unsecured debt issued by another FDIC-insured institution.
On April 26, 2016, the FDIC adopted a final rule that, effective July 1, 2016, changed the method of calculating assessments for established small institutions effective the quarter following the DIF reserve ratio reaching 1.15%, which occurred on June 30, 2016. Under the final rule, the FDIC established assessment rates for established small institutions based on an institution's weighted average CAMELS component ratings and certain financial ratios. The four risk categories noted above were eliminated. Total base assessment rates range from 1.5 to 16 basis points for institutions with CAMELS composite ratings of 1 or 2, 3 to 30 basis points for those with a CAMELS composite score of 3, and 11 to 30 basis points for those with CAMELS composite scores of 4 or 5, subject to certain adjustments. Assessment rates are expected to decrease in the future as the reserve ratio increases in specified increments to the 1.35% ratio required by the Dodd-Frank Act. Formerly, the required reserve ratio was 1.15%.
An institution that has reported on its Call Reports total assets of $10 billion or more for at least four consecutive quarters is considered a large institution and is assessed under a complex scorecard method employing many factors, including weighted average CAMELS ratings; a performance score; leverage ratio; ability to withstand asset-related stress; certain measures of concentration, core earnings, core deposits, credit quality, and liquidity; and a loss severity score and loss severity measure. Total base assessment rates for these institutions currently range from 1.5 to 40 basis points, subject to certain adjustments, and are expected to decrease in the future as the reserve ratio increases in specified increments.
The Dodd-Frank Act directs the FDIC to offset the effects of higher assessments due to the increase in the reserve ratio on established small institutions by charging higher assessments to large institutions. To implement this mandate, large and highly complex institutions must pay an annual surcharge of 4.5 basis points on their assessment base beginning July 1, 2016. If the DIF reserve ratio has not reached 1.35% by December 31, 2018, the FDIC plans to impose a shortfall assessment on large institutions on March 31, 2019. The FDIC may increase or decrease its rates by 2 basis points without further rule-making. In an emergency, the FDIC may also impose a special assessment.
Since established small institutions will be contributing to the DIF while the reserve ratio remains between 1.15% and 1.35% and the large institutions are paying a surcharge, the FDIC will provide assessment credits to the established small institutions for the portion of their assessments that contribute to the increase. When the reserve ratio reaches 1.35%, the FDIC will automatically apply an established small institution's assessment credits to reduce its regular deposit insurance assessments.
In addition to the FDIC assessments, the Financing Corporation is authorized to impose and collect, through the FDIC, assessments for anticipated payments, issuance costs and custodial fees on bonds issued in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the Financing Corporation are due to mature in 2017 through 2019.
The FDIC conducts examinations of and requires reporting by state non-member banks, such as the Bank. The FDIC also may prohibit any insured institution from engaging in any activity determined by regulation or order to pose a serious risk to the DIF. The FDIC may terminate the deposit insurance of any insured depository institution, including the Bank, if it determines after a hearing that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed by an agreement with the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If insurance of accounts is terminated, the accounts at the institution at the time of the termination, less subsequent withdrawals, shall continue to be insured for a period of six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances which would result in termination of the deposit insurance of the Bank.
Qualified Thrift Lender Test.
All savings institutions, including the Bank, are required to meet a qualified thrift lender ("QTL") test to avoid certain restrictions on their operations. This test requires a savings institution to have at least 65% of its total assets, as defined by regulation, in qualified thrift investments on a monthly average for nine out of every 12 months on a rolling basis. As an alternative, the savings institution may maintain 60% of its assets in those assets specified in Section 7701(a) (19) of the Internal Revenue Code ("Code"). Under either test, such assets primarily consist of residential housing related loans and investments.
Any institution that fails to meet the QTL test is subject to certain operating restrictions and may be required to convert to a national bank charter. As of March 31, 2017, the Bank maintained 91.34% of its portfolio assets in qualified thrift investments and therefore met the QTL test.
Limitations on Capital Distributions.
OCC regulations impose various restrictions on savings institutions with respect to their ability to make distributions of capital, which include dividends, stock redemptions or repurchases, cash-out mergers
and other transactions charged to the capital account. Generally, savings institutions, such as the Bank, that before and after the proposed distribution are well-capitalized, may make capital distributions during any calendar year equal to up to 100% of net income for the year-to-date plus retained net income for the two preceding years. However, an institution deemed to be in need of more than normal supervision by the OCC may have its dividend authority restricted by the OCC. If the Bank, however, proposes to make a capital distribution when it does not meet its capital requirements (or will not following the proposed capital distribution) or that will exceed these net income-based limitations, it must obtain the OCC's approval prior to making such distribution. In addition, the Bank must file a prior written notice of a dividend with the Federal Reserve. The Federal Reserve or the OCC may object to a capital distribution based on safety and soundness concerns. Additional restrictions on Bank dividends may apply if the Bank fails the QTL test. In addition, as noted above, if the Bank does not have the required capital conservation buffer, its ability to pay dividends to the Company would be limited, which may limit the ability of the Company to pay dividends to its stockholders.
Activities of Associations and their Subsidiaries.
When a savings institution establishes or acquires a subsidiary or elects to conduct any new activity through a subsidiary that the savings institution controls, the savings institution must file a notice or application with the FDIC and the OCC at least 30 days in advance and receive regulatory approval or non-objection. Savings institutions also must conduct the activities of subsidiaries in accordance with existing regulations and orders.
The OCC may determine that the continuation by a savings institution of its ownership control of, or its relationship to, the subsidiary constitutes a serious risk to the safety, soundness or stability of the savings institution or is inconsistent with sound banking practices or with the purposes of the FDIC. Based upon that determination, the FDIC or the OCC has the authority to order the savings institution to divest itself of control of the subsidiary. The FDIC also may determine by regulation or order that any specific activity poses a serious threat to the DIF. If so, it may require that no FDIC insured institution engage in that activity directly.
Transactions with Affiliates.
The Bank's authority to engage in transactions with "affiliates" is limited by Sections 23A and 23B of the Federal Reserve Act as implemented by the Federal Reserve's Regulation W. The term "affiliates" for these purposes generally means any company that controls or is under common control with an institution. The Company and its non-savings institution subsidiaries are affiliates of the Bank. In general, transactions with affiliates must be on terms that are as favorable to the institution as comparable transactions with non-affiliates. In addition, certain types of transactions are restricted to an aggregate percentage of the institution's capital. Collateral in specified amounts must be provided by affiliates in order to receive loans from an institution. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary. Federally insured savings institutions are subject, with certain exceptions, to certain restrictions on extensions of credit to their parent holding companies or other affiliates, on investments in the stock or other securities of affiliates and on the taking of such stock or securities as collateral from any borrower. In addition, these institutions are prohibited from engaging in certain tying arrangements in connection with any extension of credit or the providing of any property or service.
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley Act") generally prohibits a company that makes filings with the SEC from making loans to its executive officers and directors. That act, however, contains a specific exception for loans by a depository institution to its executive officers and directors, if the lending is in compliance with federal banking laws. Under such laws, the Bank's authority to extend credit to executive officers, directors and 10% stockholders ("insiders"), as well as entities which such persons control, is limited. The law restricts both the individual and aggregate amount of loans the Bank may make to insiders based, in part, on the Bank's capital position and requires certain Board approval procedures to be followed. Such loans must be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. There are additional restrictions applicable to loans to executive officers.
Community Reinvestment Act and Consumer Protection Laws.
Under the Community Reinvestment Act of 1977 ("CRA"), every FDIC-insured institution has a continuing and affirmative obligation consistent with safe and sound banking practices to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA requires the OCC, in connection with the examination of the Bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its evaluation of certain applications, such as a merger or the establishment of a branch, by the Bank. The OCC may use an unsatisfactory rating as the basis for
the denial of an application. Due to the heightened attention being given to the CRA in the past few years, the Bank may be required to devote additional funds for investment and lending in its local community. In connection with its deposit-taking, lending and other activities, the Bank is subject to a number of federal laws designed to protect consumers and promote lending to various sectors of the economy and population. The CFPB issues regulations and standards under these federal consumer protection laws, which include the Equal Credit Opportunity Act, the Truth-in-Lending Act, the Home Mortgage Disclosure Act and the Real Estate Settlement Procedures Act. Through its rulemaking authority, the CFPB has promulgated several proposed and final regulations under these laws that will affect our consumer businesses. Among these regulatory initiatives, are final regulations setting "ability to repay" and "qualified mortgage" standards for residential mortgage loans and establishing new mortgage loan servicing and loan originator compensation standards. The Bank is evaluating these recent CFPB regulations and proposals and devotes substantial compliance, legal and operational business resources to ensure compliance with these consumer protection standards. In addition, the OCC has enacted customer privacy regulations that limit the ability of the Bank to disclose nonpublic consumer information to non-affiliated third parties. The regulations require disclosure of privacy policies and allow consumers to prevent certain personal information from being shared with non-affiliated parties.
Enforcement.
The OCC has primary enforcement responsibility over savings institutions and has the authority to bring action against all "institution-affiliated parties," including shareholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an insured institution. Formal enforcement action may range from the issuance of a capital directive or cease and desist order to removal of officers or directors, receivership, conservatorship or termination of deposit insurance. Civil penalties cover a wide range of violations and can range from $25,000 to $1.1 million per day. The FDIC has the authority to recommend to the OCC that enforcement action be taken with respect to a particular savings institution. If action is not taken by the OCC, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.
Standards for Safety and Soundness.
As required by statute, the federal banking agencies have adopted Interagency Guidelines prescribing Standards for Safety and Soundness. The guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the OCC determines that a savings institution fails to meet any standard prescribed by the guidelines, the OCC may require the institution to submit an acceptable plan to achieve compliance with the standard.
Federal Reserve System.
The Federal Reserve Board requires that all depository institutions maintain reserves on transaction accounts or non-personal time deposits. These reserves may be in the form of cash or non-interest-bearing deposits with the regional Federal Reserve Bank. Interest-bearing checking accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, as are any non-personal time deposits at a bank. At March 31, 2017, the Bank was in compliance with these reserve requirements. The balances maintained to meet the reserve requirements imposed by the Federal Reserve Board may be used to satisfy any liquidity requirements that may be imposed by the OCC.
Commercial Real Estate Lending Concentrations
. The federal banking agencies have issued guidance on sound risk management practices for concentrations in commercial real estate lending. The particular focus is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be sensitive to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is not to limit a bank's commercial real estate lending but to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance directs the FDIC and other bank regulatory agencies to focus their supervisory resources on institutions that may have significant commercial real estate loan concentration risk. A bank that has experienced rapid growth in commercial real estate lending, has notable exposure to a specific type of commercial real estate loan, or is approaching or exceeding the following supervisory criteria may be identified for further supervisory analysis with respect to real estate concentration risk:
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Total reported loans for construction, land development and other land represent 100% or more of the bank's capital; or
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Total commercial real estate loans (as defined in the guidance) represent 300% or more of the bank's total capital or the outstanding balance of the bank's commercial real estate loan portfolio has increased 50% or more during the prior 36 months.
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The guidance provides that the strength of an institution's lending and risk management practices with respect to such concentrations will be taken into account in supervisory guidance on evaluation of capital adequacy.
Environmental Issues Associated with Real Estate Lending.
The Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), is a federal statute that generally imposes strict liability on all prior and present "owners and operators" of sites containing hazardous waste. However, Congress acted to protect secured creditors by providing that the term "owner and operator" excludes a person whose ownership is limited to protecting its security interest in the site. Since the enactment of the CERCLA, this "secured creditor exemption" has been the subject of judicial interpretations which have left open the possibility that lenders could be liable for cleanup costs on contaminated property that they hold as collateral for a loan. To the extent that legal uncertainty exists in this area, all creditors, including the Bank, that have made loans secured by properties with potential hazardous waste contamination (such as petroleum contamination) could be subject to liability for cleanup costs, which could substantially exceed the value of the collateral property.
Bank Secrecy Act/Anti-Money Laundering Laws.
The Bank is subject to the Bank Secrecy Act and other anti-money laundering laws and regulations, including the USA Patriot Act of 2001. These laws and regulations require the Bank to implement policies, procedures, and controls to detect, prevent, and report money laundering and terrorist financing and to verify the identity of their customers. Violations of these requirements can result in substantial civil and criminal sanctions. In addition, provisions of the USA Patriot Act require the federal financial institution regulatory agencies to consider the effectiveness of a financial institution's anti-money laundering activities when reviewing mergers and acquisitions.
Other Consumer Protection Laws and Regulations.
The Dodd-Frank Act established the CFPB and empowered it to exercise broad regulatory, supervisory and enforcement authority with respect to both new and existing consumer financial protection laws. The Bank is subject to consumer protection regulations issued by the CFPB, but as a financial institution with assets of less than $10 billion, the Bank is generally subject to supervision and enforcement by the FDIC and the OCC with respect to our compliance with consumer financial protection laws and CFPB regulations.
The Bank is subject to a broad array of federal and state consumer protection laws and regulations that govern almost every aspect of its business relationships with consumers. While the list set forth below is not exhaustive, these include the Truth-in-Lending Act, the Truth in Savings Act, the Electronic Fund Transfers Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Right to Financial Privacy Act, the Home Ownership and Equity Protection Act, the Fair Credit Billing Act, the Homeowners Protection Act, the Check Clearing for the 21st Century Act, laws governing flood insurance, laws governing consumer protections in connection with the sale of insurance, federal and state laws prohibiting unfair and deceptive business practices, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans, and providing other services. Failure to comply with these laws and regulations can subject the Bank to various penalties, including but not limited to, enforcement actions, injunctions, fines, civil liability, criminal penalties, punitive damages, and the loss of certain contractual rights.
Savings and Loan Holding Company Regulations
General.
The Company is a unitary savings and loan holding company subject to regulatory oversight of the Federal Reserve. Accordingly, the Company is required to register and file reports with the Federal Reserve and is subject to regulation and examination by the Federal Reserve. In addition, the Federal Reserve has enforcement authority over the Company and its non-savings institution subsidiaries, which also permits the Federal Reserve to restrict or prohibit activities that are determined to present a serious risk to the subsidiary savings institution. In accordance with the Dodd-Frank Act, the federal banking regulators must require any company that controls an FDIC-insured depository institution to serve as a source of strength for the institution, with the ability to provide financial assistance if the institution suffers financial distress. These and other Federal Reserve policies may restrict the Company's ability to pay dividends.
Capital Requirements.
For a savings and loan holding company, such as the Company, the capital guidelines apply on a bank only basis. The Federal Reserve expects the holding company's subsidiary banks to be well capitalized under the prompt corrective action regulations. If the Company was subject to regulatory guidelines for bank holding companies at March 31, 2017, the Company would have exceeded all regulatory capital requirements. See "-Federal Regulation of Savings Institutions-- Capital Requirements" above.
Activities Restrictions.
The GLBA provides that no company may acquire control of a savings association after May 4, 1999 unless it engages only in the financial activities permitted for financial holding companies under the law or for multiple savings and loan holding companies as described below. Further, the GLBA specifies that, subject to a grandfather provision, existing savings and loan holding companies may only engage in such activities. The Company qualifies for the grandfathering and is therefore not restricted in terms of its activities. Upon any non-supervisory acquisition by the Company of another savings association as a separate subsidiary, the Company would become a multiple savings and loan holding company and would be limited to activities permitted by Federal Reserve regulation. The Federal Reserve has issued an interpretation concluding that multiple savings holding companies may also engage in activities permitted for financial holding companies, including lending, trust services, insurance activities and underwriting, investment banking and real estate investments.
Mergers and Acquisitions.
The Company must obtain approval from the Federal Reserve before acquiring more than 5% of the voting stock of another savings institution or savings and loan holding company or acquiring such an institution or holding company by merger, consolidation or purchase of its assets. In evaluating an application for the Company to acquire control of a savings institution, the Federal Reserve would consider the financial and managerial resources and future prospects of the Company and the target institution, the effect of the acquisition on the risk to the DIF, the convenience and the needs of the community and competitive factors.
The Federal Reserve may not approve any acquisition that would result in a multiple savings and loan holding company controlling savings institutions in more than one state, subject to two exceptions; (i) the approval of interstate supervisory acquisitions by savings and loan holding companies and (ii) the acquisition of a savings institution in another state if the laws of the state of the target savings institution specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.
Acquisition of the Company.
Any company, except a bank holding company, that acquires control of a savings association or savings and loan holding company becomes a "savings and loan holding company" subject to registration, examination and regulation by the Federal Reserve and must obtain the prior approval of the Federal Reserve under the Savings and Loan Holding Company Act before obtaining control of a savings association or savings and loan holding company. A bank holding company must obtain the prior approval of the Federal Reserve under the Bank Holding Company Act before obtaining control of a savings association or savings and loan holding company and remains subject to regulation under the Bank Holding Company Act. The term "company" includes corporations, partnerships, associations, and certain trusts and other entities. "Control" of a savings association or savings and loan holding company is deemed to exist if a company has voting control, directly or indirectly, of more than 25% of any class of the savings association's voting stock or controls in any manner the election of a majority of the directors of the savings association or savings and loan holding company, and may be presumed under other circumstances, including, but not limited to, holding 10% or more of a class of voting securities if the institution has a class of registered securities, as the Company has. Control may be direct or indirect and may occur through acting in concert with one or more other persons. In addition, a savings and loan holding company must obtain Federal Reserve approval prior to acquiring voting control of more than 5% of any class of voting stock of another savings association or another savings association holding company. A similar provision limiting the acquisition by a bank holding company of 5% or more of a class of voting stock of any company is included in the Bank Holding Company Act.
Accordingly, the prior approval of the Federal Reserve Board would be required:
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before any savings and loan holding company or bank holding company could acquire 5% or more of the common stock of the Company; and
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before any other company could acquire 25% or more of the common stock of the Company and may be required for an acquisition of as little as 10% of such stock.
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In addition, persons that are not companies are subject to the same or similar definitions of control with respect to savings and loan holding companies and savings associations and requirements for prior regulatory approval by the Federal Reserve in the case of control of a savings and loan holding company or by the OCC in the case of control of a savings association not obtained through control of a holding company of such savings association.
Dividends and Stock Repurchases.
The Federal Reserve's policy statement on the payment of cash dividends applicable to savings and loan holding companies, which expresses its view that although there are no specific regulations restricting dividend payments other than state corporate laws, a savings and loan holding company must maintain an adequate capital position and generally should not pay cash dividends unless the company's net income for the past year is sufficient to fully fund the cash dividends and that the prospective rate of earnings appears consistent with the company's capital needs, asset quality, and overall financial condition. The Federal Reserve policy statement also indicates that it would be inappropriate for a company experiencing serious financial problems to borrow funds to pay dividends. In addition, a savings and loan holding company is required to give the Federal Reserve prior written notice of any purchase or redemption of its outstanding equity securities if the gross consideration for the purchase or redemption, when combined with the net consideration paid for all such purchases or redemptions during the preceding twelve months, is equal to 10% or more of its consolidated net worth. The Federal Reserve may disapprove such a purchase or redemption if it determines that the proposal would constitute an unsafe or unsound practice or would violate any law, regulation, Federal Reserve order or any condition imposed by, or written agreement with, the Federal Reserve.
Sarbanes-Oxley Act of 2002.
The Sarbanes-Oxley Act was enacted in 2002 in response to public concerns regarding corporate accountability in connection with recent accounting scandals. The stated goals of the Sarbanes-Oxley Act are to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. The Sarbanes-Oxley Act generally applies to all companies, both U.S. and non-U.S., that file or are required to file periodic reports with the SEC under the Securities Exchange Act of 1934, including the Company.
The Sarbanes-Oxley Act includes very specific additional disclosure requirements and new corporate governance rules, and requires the SEC and securities exchanges to adopt extensive additional disclosure, corporate governance and related rules. The Sarbanes-Oxley Act represents significant federal involvement in matters traditionally left to state regulatory systems, such as the regulation of the accounting profession, and to state corporate law, such as the relationship between a board of directors and management and between a board of directors and its committees.
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.
On July 21, 2010, the Dodd-Frank Act was signed into law. The Dodd-Frank-Act imposes new restrictions and an expanded framework of regulatory oversight for financial institutions, including depository institutions and implements new capital regulations discussed above under "- Regulation and Supervision of the Bank - Capital Requirements." In addition, among other changes, the Dodd-Frank Act requires public companies, such as the Company, to (i) provide their shareholders with a non-binding vote (a) at least once every three years on the compensation paid to executive officers and (b) at least once every six years on whether they should have a "say on pay" vote every one, two or three years; (ii) have a separate, non-binding shareholder vote regarding golden parachutes for named executive officers when a shareholder vote takes place on mergers, acquisitions, dispositions or other transactions that would trigger the parachute payments; (iii) provide disclosure in annual proxy materials concerning the relationship between the executive compensation paid and the financial performance of the issuer; and (iv) amend Item 402 of Regulation S-K to require companies to disclose the ratio of the Chief Executive Officer's annual total compensation to the median annual total compensation of all other employees. For certain of these changes, the implementing regulations have not been promulgated, so the full impact of the Dodd-Frank Act on public companies cannot be determined at this time.
Item 1A. Risk Factors
An investment in our common stock is subject to risks inherent in our business. Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included in this report. In addition to the risks and uncertainties described below,
other
risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition and results of operations.
The value or market price of our common stock could decline due to any of these identified or other risks, and you could lose all or part of your investment. The risks below also include forward-looking statements. This report is qualified in its entirety by these risk factors.
Our business may be adversely affected by downturns in the national and the regional economies on which we depend.
Substantially all of our loans are to businesses and individuals in the states of Washington and Oregon. A decline in the economies of the seven counties in which we operate, including the Portland, Oregon metropolitan area, which we consider to be our primary market area, could have a material adverse effect on our business, financial condition, results of operations and prospects. Weakness in the global economy has adversely affected many businesses operating in our markets that are dependent upon international trade and it is not known how the recent withdrawal by the United States from the Trans-Pacific Partnership trade agreement may also affect these businesses.
While real estate values and unemployment rates have recently improved, a deterioration in economic conditions in the market areas we serve could result in the following consequences, any of which could have a materially adverse impact on our business, financial condition and results of operations:
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loan delinquencies, problem assets and foreclosures may increase;
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we may increase our allowance for loan losses;
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the slowing of sales of foreclosed assets;
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demand for our products and services may decline possibly resulting in a decrease in our total loans or assets;
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collateral for loans made may decline further in value, exposing us to increased risk loans, reducing customers' borrowing power, and reducing the value of assets and collateral associated with existing loans;
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the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us; and
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the amount of our low-cost or non-interest bearing deposits may decrease.
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A decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse. If we are required to liquidate a significant amount of collateral during a period of reduced real estate values, our financial condition and profitability could be adversely affected:
A return of recessionary conditions could result in increases in our level of nonperforming loans and/or reduce demand for our products and services, which could have an adverse effect on our results of operations.
A return of recessionary conditions and/or negative developments in the domestic and international credit markets may significantly affect the markets in which we do business, the value of our loans and investments, and our ongoing operations, costs and profitability. Declines in real estate values and sales volumes and high unemployment levels may result in higher than expected loan delinquencies and a decline in demand for our products and services. These negative events may cause us to incur losses and may adversely affect our capital, liquidity, and financial condition.
Our real estate construction and land acquisition or development loans expose us to risk.
We originate real estate construction loans to individuals and builders, primarily for the construction of residential properties. We originate these loans whether or not the collateral property underlying the loan is under contract for sale. At March 31, 2017, construction loans totaled $46.2 million, or 5.92% of our total loan portfolio, of which $19.1 million were for residential real estate projects. Undisbursed funds for construction projects totaled $47.3 million at March 31, 2017. Land loans, which are loans made with land as security, totaled $15.9 million, or 2.04% of our total loan portfolio at March 31, 2017. Land loans include raw land and land acquisition and development loans.
In general, construction and land lending involves additional risks because of the inherent difficulty in estimating a property's value both before and at completion of the project as well as the estimated cost of the project and the time needed to sell the property at completion. Construction costs may exceed original estimates as a result of increased materials, labor or other costs. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation on real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. Changes in the demand, such as for new housing and higher than anticipated building costs may cause actual results to vary significantly from those estimated. For these reasons, this type of lending also typically involves higher loan principal amounts and is often concentrated with a small number of builders. A downturn in housing, or the real estate market, could increase loan delinquencies, defaults and foreclosures, and significantly impair the value of our collateral and our ability to sell the collateral upon foreclosure. Some of our builders have more than one loan outstanding with us and also have residential mortgage loans for rental properties with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.
In addition, during the term of most of our construction loans, no payment from the borrower is required since the accumulated interest is added to the principal of the loan through an interest reserve. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or refinance the indebtedness, rather than the ability of the borrower or guarantor to repay principal and interest.
If the appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss. Because construction loans require active monitoring of the building process, including cost comparisons and on-site inspections, these loans are more difficult and costly to monitor. Increases in market rates of interest may have a more pronounced effect on construction loans by rapidly increasing the end-purchasers' borrowing costs, thereby reducing the overall demand for the project. Properties under construction are often difficult to sell and typically must be completed in order to be successfully sold which also complicates the process of working out problem construction loans. This may require us to advance additional funds and/or contract with another builder to complete construction. Further, in the case of speculative construction loans, there is the added risk associated with identifying an end-purchaser for the finished project, and thus pose a greater potential risk than construction loans to individuals on their personal residences. Loans on land under development or held for future construction as well as lot loans made to individuals for the future construction of a residence also pose additional risk because of the lack of income being produced by the property and the potential illiquid nature of the collateral. These risks can also be significantly impacted by supply and demand conditions.
At March 31, 2017, total committed construction and land loans totaled $109.3 million comprised mainly of $7.9 million of speculative construction loans, $15.9 million of land acquisition and development loans, $59.6 million of commercial/multi-family construction loans and $20.7 million of custom/presold construction loans.
Our emphasis on commercial real estate lending may expose us to increased lending risks.
Our current business strategy is focused on the expansion of commercial real estate lending. This type of lending activity, while potentially more profitable than single-family residential lending, is generally more sensitive to regional and local economic conditions, making loss levels more difficult to predict. Collateral evaluation and financial statement analysis in these types of loans requires a more detailed analysis at the time of loan underwriting and on an ongoing basis. Many of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss.
At March 31, 2017, we had $490.8 million of commercial and multi-family real estate mortgage loans, representing 62.97% of our total loan portfolio. These loans typically involve higher principal amounts than other types of loans and some of our commercial borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one-to-four family residential loan. Repayment on these loans is dependent upon income generated, or expected to be generated, by the property securing the loan in amounts sufficient to cover operating expenses and debt service, which may be adversely affected by changes in the economy or local market conditions. For example, if the cash flow from the borrower's project is reduced as a result of leases not being obtained or renewed, the borrower's ability to repay the loan may be impaired. Commercial and multi-family mortgage loans also expose a lender to greater credit risk than loans secured by one-to-four family residential real estate because the collateral securing these loans typically cannot be sold as easily as residential real estate. In addition, many of our commercial and multi-family real estate loans are not fully amortizing and contain large balloon payments upon maturity. Such balloon payments may require the borrower to either
sell or refinance the underlying property in order to make the payment, which may increase the risk of default or non-payment. A secondary market for most types of commercial real estate and multi-family loans is not readily liquid, so we have less opportunity to mitigate credit risk by selling part or all of our interest in these loans. As a result of these characteristics, if we foreclose on a commercial or multi-family real estate loan, our holding period for the collateral typically is longer than for one-to-four family residential mortgage loans because there are fewer potential purchasers of the collateral. Accordingly, charge-offs on commercial and multi-family real estate loans may be larger on a per loan basis than those incurred with our residential or consumer loan portfolios.
The level of our commercial real estate loan portfolio may subject us to additional regulatory scrutiny.
The FDIC, the Federal Reserve and the Office of the Comptroller of the Currency have promulgated joint guidance on sound risk management practices for financial institutions with concentrations in commercial real estate lending. Under this guidance, a financial institution that, like us, is actively involved in commercial real estate lending should perform a risk assessment to identify concentrations. A financial institution may have a concentration in commercial real estate lending if, among other factors (i) total reported loans for construction, land development, and other land represent 100% or more of total capital, or (ii) total reported loans secured by multi-family and non-farm residential properties, loans for construction, land development and other land, and loans otherwise sensitive to the general commercial real estate market, including loans to commercial real estate related entities, represent 300% or more of total capital. Based on these criteria, the Bank has a concentration in commercial real estate lending as total loans for multifamily, non-farm/non-residential, construction, land development and other land represented 349% of total risk-based capital at March 31, 2017. The particular focus of the guidance is on exposure to commercial real estate loans that are dependent on the cash flow from the real estate held as collateral and that are likely to be at greater risk to conditions in the commercial real estate market (as opposed to real estate collateral held as a secondary source of repayment or as an abundance of caution). The purpose of the guidance is to guide banks in developing risk management practices and capital levels commensurate with the level and nature of real estate concentrations. The guidance states that management should employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing.
Our business may be adversely affected by credit risk associated with residential property.
At March 31, 2017, $92.9 million, or 11.91% of our total loan portfolio, was secured by one-to-four family mortgage loans and home equity loans. This type of lending is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations, making loss levels difficult to predict. A decline in residential real estate values resulting from a downturn in the Washington and Oregon housing markets in which we operate may reduce the value of the real estate collateral securing these types of loans and increase our risk of loss if borrowers default on their loans. Declines in the volume of real estate sales and/or the sales prices coupled with elevated unemployment rates may result in higher than expected loan delinquencies or problem assets, and a decline in demand for our products and services. These potential negative events may cause us to incur losses, adversely affect our capital and liquidity and damage our financial condition and business operations.
Many of our one-to-four family loans and home equity lines of credit are secured by liens on mortgage properties. Residential loans with high combined loan-to-value ratios will be more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, they may be unable to repay their loans in full from the sale. Further, the majority of our home equity lines of credit consist of second mortgage loans. For those home equity lines secured by a second mortgage, it is unlikely that we will be successful in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property.
Repayment of our commercial business loans is often dependent on the cash flows of the borrower, which may be unpredictable, and the collateral securing these loans may fluctuate in value.
At March 31, 2017, we had $107.4 million, or 13.78% of total loans, in commercial business loans. Commercial lending involves risks that are different from those associated with residential and commercial real estate lending. Real estate lending is generally considered to be collateral based lending with loan amounts based on predetermined loan to collateral values and liquidation of the underlying real estate collateral being viewed as the primary source of repayment in the event of borrower default. Our commercial loans are primarily made based on the cash flow of the borrower and secondarily on
the underlying collateral provided by the borrower. The borrowers' cash flow may be unpredictable, and collateral securing these loans may fluctuate in value. This collateral may consist of equipment, inventory, accounts receivable, or other business assets. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers. Other collateral securing loans may depreciate over time, may be difficult to appraise, may be illiquid and may fluctuate in value based on the specific type of business and equipment. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself which, in turn, is often dependent in part upon general economic conditions and secondarily on the underlying collateral provided by the borrower.
Our allowance for loan losses may prove to be insufficient to absorb losses in our loan portfolio.
Lending money is a substantial part of our business and each loan carries a certain risk that it will not be repaid in accordance with its terms or that any underlying collateral will not be sufficient to assure repayment. This risk is affected by, among other things:
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the cash flow of the borrower and/or the project being financed;
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in the case of a collateralized loan, the changes and uncertainties as to the future value of the collateral;
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the duration of the loan;
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the credit history of a particular borrower; and
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changes in economic and industry conditions.
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We maintain an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, which we believe is appropriate to provide for probable losses in our loan portfolio. The amount of this allowance is determined by management through periodic reviews and consideration of several factors, including, but not limited to:
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our general reserve, based on our historical default and loss experience and certain macroeconomic factors based on management's expectations of future events;
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our specific reserve, based on our evaluation of nonperforming loans and their underlying collateral; and
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an unallocated reserve to provide for other credit losses inherent in our portfolio that may not have been contemplated in the other loss factors.
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The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for loan losses.
The Financial Accounting Standards Board has adopted a new accounting standard update ("ASU") that will be effective for our first fiscal year after December 15, 2019. This standard, referred to as "Current Expected Credit Loss", or "CECL", will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans and recognize the expected credit losses as allowances for credit losses at inception of the loan. This will change the current method of providing allowances for credit losses that are probable of having been incurred, which may require us to increase our allowance for loan losses, and may greatly increase the types of data we would need to collect and review to determine the appropriate level of the allowance for credit losses. For more on this ASU, see Note 1 of the Notes to Consolidated Financial Statements - Recently Issued Accounting Pronouncements contained in Item 8 of this report. In addition, bank regulatory agencies periodically review our allowance for loan losses and may require an increase in the provision for possible loan losses or the recognition of further loan charge-offs based on judgments different than those of management. If charge-offs in future periods exceed the allowance for loan losses, we may need additional provisions to replenish the allowance for loan losses. Any increases in the allowance for loan losses will result in a decrease in net income and, most likely, capital, and may have a material negative effect on our financial condition and results of operations.
Our consumer loan portfolio has increased risk due to the substantial amount of indirect automobile loans.
Our consumer loan portfolio includes a substantial number of indirect loans which are automobile loans purchased by us from another financial institution as well as other installment consumer loans. These indirect automobile loans were originated through a single dealership group located outside the Company's primary market area. Unlike a direct loan where
the borrower makes an application directly to the lender, in these loans the dealer, who has a direct financial interest in the loan transaction, assists the borrower in preparing the loan application. Indirect automobile loans we purchased are underwritten by us using substantially similar guidelines to our internal guidelines. However, because these loans are originated through a third party and not directly by us, we do not have direct contact with the borrower and therefore these loans may be more susceptible to a material misstatement on the loan application and present greater risks than other types of lending activities. The collateral for these loans is comprised of a mix of used automobiles. These loans are purchased with servicing retained by the seller. At March 31, 2017, our other installment consumer loans totaled $26.4 million, or 3.38% of our total loan portfolio, of which indirect automobile loans totaled $23.6 million, representing 89.4% of total consumer loans. At March 31, 2017, thirteen of the purchased automobile loans were on non-accrual status totaling $108,000.
The Company also originates a variety of installment loans, including loans for debt consolidation and other purposes, automobile loans, boat loans and savings account loans. At March 31, 2017 and 2016, excluding the purchased automobile loans noted above, the Company had no installment loans on non-accrual status.
Consumer loans generally entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as mobile homes, automobiles, boats and recreational vehicles. In these cases, we face the risk that any collateral for a defaulted loan may not provide an adequate source of repayment of the outstanding loan balance. Thus, the recovery and sale of such property could be insufficient to compensate us for the principal outstanding on these loans. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit our ability to recover on such loans. Finally, because indirect automobile loan applications are originated by automobile dealerships, we underwrite the loans and we assume the risks associated with unsatisfactory origination procedures, including compliance with federal, state and local laws. In addition, since a third party services these loans for us, any failure of our third party servicer to timely pursue repossession action may adversely affect our ability to limit our credit losses. As a result of these factors, it may become necessary to increase our provision for loan losses in the event our losses on these loans increase, which could negatively affect our results of operations.
If our investments in real estate are not properly valued or sufficiently reserved to cover actual losses, or if we are required to increase our valuation reserves, our earnings could be reduced.
We obtain updated valuations in the form of appraisals and broker price opinions when a loan has been foreclosed and the property is taken in as REO and at certain other times during the assets' holding periods. Our net book value ("NBV") in the loan at the time of foreclosure and thereafter is compared to the updated market value of the foreclosed property less estimated selling costs (fair value). A charge-off is recorded for any excess in the asset's NBV over its fair value. If our valuation process is incorrect, or if property values decline, the fair value of the investments in real estate may not be sufficient to recover our carrying value in such assets, resulting in the need for additional write-downs. Significant write-downs to our investments in real estate could have a material adverse effect on our financial condition, liquidity and results of operations.
In addition, bank regulators periodically review our REO and may require us to recognize further write-downs. Any increase in our write-downs, as required by the bank regulators, may have a material adverse effect on our financial condition, liquidity and results of operations.
Our securities portfolio may be negatively impacted by fluctuations in market value and interest rates.
Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income and/or earnings. Fluctuations in market value may be caused by changes in market interest rates, lower market prices for securities and limited investor demand. Our securities portfolio is evaluated for OTTI. If this evaluation shows impairment to the actual or projected cash flows associated with one or more securities, a potential loss to earnings may occur. Changes in interest rates can also have an adverse effect on our financial condition, as our available-for-sale securities are reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates. We increase or decrease our shareholders' equity by the amount of change in the estimated fair value of the available-for-sale securities, net of taxes. There can be no assurance that the declines in market value will not result in OTTI of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
Changes in interest rates may reduce our net interest income, and may result in higher defaults in a rising rate environment.
Our earnings and cash flows are largely dependent upon our net interest income, which is the difference, or spread, between the interest earned on loans, securities and other interest-earning assets and the interest paid on deposits, borrowings, and
other interest-bearing liabilities. Interest rates are highly sensitive to many factors that are beyond our control, including domestic and international economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve. In an attempt to help the overall economy, the Federal Reserve has kept interest rates low through its targeted Fed Funds rate. In December 2016 and March 2017, the Federal Reserve slightly increased the Fed Funds rate by 25 basis points at each date and intends further increases during 2017 subject to economic conditions. As the Federal Reserve increases the Fed Funds rate, overall interest rates will likely rise, which may negatively impact the housing markets and the U.S. economic recovery. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of collateral securing loans, which could negatively affect our financial performance.
We principally manage interest rate risk by managing our volume and mix of our earning assets and funding liabilities. Changes in monetary policy, including changes in interest rates, could influence not only the interest we receive on loans and investments and the amount of interest we pay on deposits and borrowings, but also can affect: (1) our ability to originate and/or sell loans; (2) the fair value of our financial assets and liabilities, which could negatively impact shareholders' equity, and our ability to realize gains from the sale of such assets; (3) our ability to obtain and retain deposits in competition with other available investment alternatives; (4) the ability of our borrowers to repay adjustable or variable rate loans; and (5) the average duration of our mortgage backed securities portfolio and other interest-earning assets.
If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, our net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. In a changing interest rate environment, we may not be able to manage this risk effectively. If we are unable to manage interest rate risk effectively, our business, financial condition and results of operations could be materially affected.
A sustained increase in market interest rates could adversely affect our earnings. A significant portion of our loans have fixed interest rates and longer terms than our deposits and borrowings. As a result of the relatively low interest rate environment, an increasing percentage of our deposits have been comprised of certificates of deposit and other deposits yielding no or a relatively low rate of interest having a shorter duration than our assets. At March 31, 2017, we had $99.9 million in certificates of deposit that mature within one year and $242.7 million in non-interest bearing demand deposits. We would incur a higher cost of funds to retain these deposits in a rising interest rate environment. Our net interest income could be adversely affected if the rates we pay on deposits and borrowings increase more rapidly than the rates we earn on loans. In addition, a substantial amount of our home equity lines of credit have adjustable interest rates. As a result, these loans may experience a higher rate of default in a rising interest rate environment.
Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected or prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our consolidated balance sheet or projected operating results. See Item 7A., "Quantitative and Qualitative Disclosures About Market Risk," of this Form 10-K.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, growth and prospects.
Liquidity is essential to our business; therefore, the inability to obtain adequate funding may negatively affect growth and, consequently, our earnings capability and capital levels. An inability to raise funds through deposits, borrowings, the sale of loans or investment securities, or other sources could have a substantial negative effect on our liquidity. Our access to funding sources in amounts adequate to finance our activities on terms that are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general. Factors that could detrimentally impact our access to liquidity sources include a decrease in the level of our business activity as a result of a downturn in the Washington or Oregon markets in which our loans are concentrated, negative operating results, or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry and the continued uncertainty in credit markets. In particular, our liquidity position could be significantly constrained if we are unable to access funds from the FHLB, the Federal Reserve Bank of San Francisco or other wholesale funding sources, or if adequate financing is not available at acceptable interest rates. Finally, if we are required to rely more heavily on more expensive funding sources, our revenues may not increase proportionately to cover our costs. In this case, our results of operations and financial condition would be negatively affected.
An increase in interest rates, change in the programs offered by governmental sponsored entities ("GSE") or our ability to qualify for such programs may reduce our mortgage revenues, which would negatively impact our non-interest income.
Our mortgage banking operations provide a significant portion of our non-interest income. We generate mortgage revenues primarily from gains on the sale of single-family mortgage loans pursuant to programs currently offered by FNMA, FHLMC,
GNMA and non-
GSE entities
. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any future changes in these programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations. Mortgage banking is generally considered a volatile source of income because it depends largely on the level of loan volume which, in turn, depends largely on prevailing market interest rates. In a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage banking revenues and a corresponding decrease in non-interest income. In addition, our results of operations are affected by the amount of non-interest expense associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in loan originations. In addition, although we sell loans into the secondary market without recourse, we are required to give customary representations and warranties about the loans to the buyers. If we breach those representations and warranties, the buyers may require us to repurchase the loans and we may incur a loss on the repurchase.
We may be adversely affected by risks associated with completed and potential acquisitions.
As part of our general growth strategy, we have recently expanded our business through the purchase and assumption transaction in which the Company purchased certain assets and assumed certain liabilities of MBank, the wholly owned subsidiary of Merchants Bancorp. Although our business strategy emphasizes organic expansion, we continue, from time to time in the ordinary course of business, to engage in preliminary discussions with potential acquisition targets. There can be no assurance that, in the future, we will successfully identify suitable acquisition candidates, complete acquisitions and successfully integrate acquired operations into our existing operations or expand into new markets. The consummation of any future acquisitions may dilute shareholder value or may have an adverse effect upon our operating results while the operations of the acquired business are being integrated into our operations. In addition, once integrated, acquired operations may not achieve levels of profitability comparable to those achieved by our existing operations, or otherwise perform as expected. Further, transaction-related expenses may adversely affect our earnings. These adverse effects on our earnings and results of operations may have a negative impact on the value of our common stock. Acquiring banks, bank branches or businesses involves risks commonly associated with acquisitions, including:
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We may be exposed to potential asset quality issues or unknown or contingent liabilities of the banks, businesses, assets, and liabilities we acquire. If these issues or liabilities exceed our estimates, our results of operations and financial condition may be materially negatively affected;
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Higher than expected deposit attrition;
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Our strategic efforts may divert resources or management's attention from ongoing business operations and may subject us to additional regulatory scrutiny;
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Prices at which acquisitions can be made may not be acceptable to us;
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The acquisition of other entities generally requires integration of systems, procedures and personnel of the acquired entity into our company to make the transaction economically successful. This integration process is complicated and time consuming and can also be disruptive to the customers of the acquired business. If the integration process is not conducted successfully and with minimal adverse effect on the acquired business and its customers, we may not realize the anticipated economic benefits of particular acquisitions within the expected time frame, and we may lose customers or employees of the acquired business. We may also experience greater than anticipated customer losses even if the integration process is successful;
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To the extent our costs of an acquisition exceed the fair value of the net assets acquired, the acquisition will generate goodwill. As discussed below, we are required to assess our goodwill for impairment at least annually, and any goodwill impairment charge could have a material adverse effect on our results of operations and financial condition;
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To finance an acquisition, we may borrow funds, thereby increasing our leverage and diminishing our liquidity, or raise additional capital, which could dilute the interests of our existing shareholders; and
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We expect our net income will increase following our acquisitions, however, we also expect our general and administrative expenses and consequently our efficiency rates will also increase. Ultimately, we would expect our efficiency ratio to improve; however, if we are not successful in our integration process, this may not occur, and our acquisitions or branching activities may not be accretive to earnings in the short or long-term.
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The required accounting treatment of loans we acquire through acquisitions could result in higher net interest margins and interest income in current periods and lower net interest margins and interest income in future periods.
Under GAAP, we are required to record loans acquired through acquisitions, including purchase credit-impaired loans, at fair value. Estimating the fair value of such loans requires management to make estimates based on available information and facts and circumstances on the acquisition date. Actual performance could differ from management's initial estimates. If these loans outperform our original fair value estimates, the difference between our original estimate and the actual performance of the loan (the "discount") is accreted into net interest income. Thus, our net interest margins may initially increase due to the discount accretion. We expect the yields on our loans to decline as our acquired loan portfolio pays down or matures and the discount decreases, and we expect downward pressure on our interest income to the extent that the runoff on our acquired loan portfolio is not replaced with comparable high-yielding loans. This could result in higher net interest margins and interest income in current periods and lower net interest rate margins and lower interest income in future periods.
A general decline in economic conditions may adversely affect the fees generated by our asset management company.
To the extent our asset management clients and their assets become adversely affected by weak economic and stock market conditions, they may choose to withdraw the amount of assets managed by us and the value of their assets may decline. Our asset management revenues are based on the value of the assets we manage. If our clients withdraw assets or the value of their assets decline, the revenues generated by the Trust Company will be adversely affected.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.
We are required by federal regulatory authorities to maintain adequate levels of capital to support our operations. Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we cannot make assurances that we will be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our ability to further expand our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, any additional capital we obtain may result in the dilution of the interests of existing holders of our common stock. Further, if we are unable to raise additional capital when required by our bank regulators, we may be subject to adverse regulatory action.
We may experience future goodwill impairment, which could reduce our earnings.
In accordance with GAAP, we record assets acquired and liabilities assumed in a business combination at their fair values with the excess of the purchase consideration over the net assets acquired resulting in the recognition of goodwill. As a result, business combinations typically result in recording goodwill. We perform a goodwill evaluation at least annually to test for goodwill impairment. We performed our annual goodwill impairment test during the quarter-ended December 31, 2016, but no impairment was identified. Our assessment of the fair value of goodwill is based on an evaluation of current purchase transactions, discounted cash flows from forecasted earnings, our current market capitalization, and a valuation of our assets. Our evaluation of the fair value of goodwill involves a substantial amount of judgment. If our judgment was incorrect and an impairment of goodwill was deemed to exist, we would be required to write down our goodwill resulting in a charge to earnings, which could adversely affect our results of operations, perhaps materially; however, it would have no impact on our liquidity, operations or regulatory capital. The recent MBank transaction has increased our goodwill.
We operate in a highly regulated environment and may be adversely affected by changes in federal and state laws and regulations that are expected to increase our costs of operations.
The financial services industry is extensively regulated. The Bank is subject to extensive examination, supervision and comprehensive regulation by the OCC and the FDIC, and Riverview is subject to examination, supervision and regulation by the Federal Reserve. Such regulation and supervision governs the activities in which an institution and its holding company may engage, and are intended primarily for the protection of the deposit insurance fund and consumers and not to benefit our shareholders. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the ability to impose restrictions on our operations, the classification of our assets, the determination of the level of our allowance for loan losses, and the level of deposit insurance premiums assessed. Additionally, actions by regulatory agencies or significant litigation against us could require us to devote significant time and resources to defend our business and may lead to penalties that materially affect us. These regulations, along with the currently existing tax, accounting, securities, insurance, and monetary laws, regulations, rules, standards, policies, and interpretations control the methods by which financial institutions conduct business, implement strategic initiatives and tax compliance, and govern financial reporting and disclosures. Because our business is highly regulated, the applicable laws, rules and regulations are subject to constant modification and change, and the laws, rules, and regulations adopted in the future could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition, or prospects. Further, changes in accounting standards can be both difficult to predict and involve judgment and discretion in their interpretation by us and our independent accounting firms. These changes could materially impact, potentially even retroactively, how we report our financial condition and results of our operations as could our interpretation of those changes.
As discussed under "Business-Regulation" in Item I of this form 10-K, the Dodd-Frank Act has significantly changed the bank regulatory structure and has affected the lending, deposit, investment, trading and operating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of new implementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies are given significant discretion in drafting and implementing rules and regulations, and consequently, many of the details and much of the impact of the Dodd-Frank Act may not be known for many months or years.
It is difficult at this time to predict when or how any new standards will ultimately be applied to us or what specific impact the Dodd-Frank Act and the yet to be written implementing rules and regulations will have on community banks. However, it is expected that at a minimum they will increase our operating and compliance costs and could increase our interest expense.
The CFPB, which was created under the Dodd-Frank Act, has issued a number of final regulations and changes to certain consumer protections under existing laws and continues to issue new rules. These final rules (including the qualified mortgage rule), generally prohibit creditors from extending mortgage loans without regard for the consumers' ability-to-repay and add restrictions and requirements to mortgage origination and servicing practices. In addition, these rules limit prepayment penalties and require creditors to retain evidence of compliance with the ability-to-repay requirement for three years. Compliance with these rules has increased our overall regulatory compliance costs and may require changes to our underwriting practices with respect to mortgage loans. This includes compliance with the Truth in Lending Act and the Real Estate Settlement Procedures Act Integrated Disclosure ("TRID") rule, which combines certain disclosures that consumers receive in connection with applying for and closing a mortgage loan. Moreover, these rules may adversely affect the volume of mortgage loans that we underwrite and may subject us to increased potential liabilities related to such residential loan origination activities. The CFPB has adopted a number of additional requirements and issued additional guidance, including with respect to appraisals, escrow accounts and servicing, each of which entails increased compliance costs. We will continue to monitor these developments and analyze the expected impacts on our business.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury's Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions and limit our ability to get regulatory approval of acquisitions. Recently several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, no assurance can be given that these policies and procedures will be effective in preventing violations of these laws and regulations.
Competition with other financial institutions could adversely affect our profitability.
Although we consider ourselves competitive in our market areas, we face intense competition in both making loans and attracting deposits. Price competition for loans and deposits might result in our earning less on our loans and paying more on our deposits, which reduces net interest income. Some of the institutions with which we compete have substantially greater resources than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability will depend upon our continued ability to compete successfully in our market areas.
We are subject to certain risks in connection with our use of technology.
Our security measures may not be sufficient to mitigate the risk of a cyber-attack
. Communications and information systems are essential to the conduct of our business, as we use such systems to manage our customer relationships, our general ledger and virtually all other aspects of our business. Our operations rely on the secure processing, storage, and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and endeavor to modify them as circumstances warrant, the security of our computer systems, software, and networks may be vulnerable to breaches, unauthorized access, misuse, computer viruses, or other malicious code and cyber-attacks that could have a security impact. If one or more of these events occur, this could jeopardize our or our customers' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our operations or the operations of our customers or counterparties. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us. We could also suffer significant reputational damage.
Security breaches in our internet banking activities could further expose us to possible liability and damage our reputation
. Any compromise of our security also could deter customers from using our internet banking services that involve the transmission of confidential information. We rely on standard internet security systems to provide the security and authentication necessary to effect secure transmission of data. These precautions may not protect our systems from compromises or breaches of our security measures, and could result in significant legal liability and significant damage to our reputation and our business.
Our security measures may not protect us from system failures or interruptions
. While we have established policies and procedures to prevent or limit the impact of systems failures and interruptions, there can be no assurance that such events will not occur or that they will be adequately addressed if they do. In addition, we outsource certain aspects of our data processing and other operational functions to certain third-party providers. If our third-party providers encounter difficulties, or if we have difficulty in communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely impacted. Replacing these third-party vendors could also entail significant delay and expense. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.
The occurrence of any failures or interruptions may require us to identify alternative sources of such services, and we cannot assure you that we could negotiate terms that are as favorable to us, or could obtain services with similar functionality as found in our existing systems without the need to expend substantial resources, if at all. Further, the occurrence of any systems failure or interruption could damage our reputation and result in a loss of customers and business, could subject us to additional regulatory scrutiny, or could expose us to legal liability. Any of these occurrences could have a material adverse effect on our financial condition and results of operations.
We are dependent on key personnel and the loss of one or more of those key personnel may materially and adversely affect our prospects.
Competition for qualified employees and personnel in the banking industry is intense and there are a limited number of qualified persons with knowledge of, and experience in, the community banking industry where the Bank conducts its business. The process of recruiting personnel with the combination of skills and attributes required to carry out our strategies is often lengthy. Our success depends to a significant degree upon our ability to attract and retain qualified management, loan origination, finance, administrative, marketing and technical personnel and upon the continued contributions of our management and personnel. In particular, our success has been and continues to be highly dependent upon the abilities of key executives, including our President, and certain other employees. In addition, our success has been and continues to be highly dependent upon the services of our directors, many of whom are at or nearing retirement age, and we may not be able to identify and attract suitable candidates to replace such directors.
Our exposure to operational risks may adversely affect us.
Similar to other financial institutions, we are exposed to many types of operational risk, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, the risk that sensitive customer or Company data is compromised, unauthorized transactions by employees or operational errors, including clerical or record-keeping errors. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur. If any of these risks occur, it could result in material adverse consequences for us.
Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of loss due to fraud and other financial crimes. Nationally, reported incidents of fraud and other financial crimes have increased. We have also experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, there can be no assurance that such losses will not occur.
Managing reputational risk is important to attracting and maintaining customers, investors and employees.
Threats to our reputation can come from many sources, including adverse sentiment about financial institutions generally, unethical practices, employee misconduct, failure to deliver minimum standards of service or quality or operational failures due to integration or conversion challenges as a result of acquisitions we undertake, compliance deficiencies, and questionable or fraudulent activities of our customers. We have policies and procedures in place to protect our reputation and promote ethical conduct, but these policies and procedures may not be fully effective. Negative publicity regarding our business, employees, or customers, with or without merit, may result in the loss of customers, investors and employees, costly litigation, a decline in revenues and increased governmental regulation.
We rely on dividends from the Bank for substantially all of our revenue at the holding company level.
We are an entity separate and distinct from our principal subsidiary, the Bank, and derive substantially all of our revenue at the holding company level in the form of dividends from that subsidiary. Accordingly, we are, and will be, dependent upon dividends from the Bank to pay the principal of and interest on our indebtedness, to satisfy our other cash needs and to pay dividends on our common stock. The Bank's ability to pay dividends is subject to its ability to earn net income and to meet certain regulatory requirements. In the event the Bank is unable to pay dividends to us, we may not be able to pay dividends on our common stock. Also, our right to participate in a distribution of assets upon a subsidiary's liquidation or reorganization is subject to the prior claims of the subsidiary's creditors.