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EX-23.1 - EXHIBIT 23.1 - CONSENT OF BDO USA LLP - MSB FINANCIAL CORP.ex23-1.htm
EX-10.3 - EXHIBIT 10.3 - EMPLOYMENT AGREEMENT WITH NANCY SCHMITZ - MSB FINANCIAL CORP.ex10-3.htm
EX-32 - EXHIBIT 32 - CERTIFICATION PURSUANT TO SECTION 906 - MSB FINANCIAL CORP.ex32.htm
EX-21 - EXHIBIT 21 - SUBSIDIARIES OF THE REGISTRANT - MSB FINANCIAL CORP.ex21.htm
EX-10.2 - EXHIBIT 10.2 - EMPLOYMENT AGREEMENT WITH JEFFREY SMITH - MSB FINANCIAL CORP.ex10-2.htm
EX-31.1 - EXHIBIT 31.1 - CERTIFICATION OF CEO - MSB FINANCIAL CORP.ex31-1.htm
EX-31.2 - EXHIBIT 31.2 - CERTIFICATION OF CFO - MSB FINANCIAL CORP.ex31-2.htm
EXCEL - IDEA: XBRL DOCUMENT - MSB FINANCIAL CORP.Financial_Report.xls
EX-10.1 - EXHIBIT 10.1 - EMPLOYMENT AGREEMENT WITH MICHAEL SHRINER - MSB FINANCIAL CORP.ex10-1.htm
 

  UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

ANNUAL REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: June 30, 2014 or
[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________ to ____________

Commission File No. 001-33246

 
MSB FINANCIAL CORP.
 
 
(Exact name of Registrant as specified in its Charter)
 

 
United States
 
34-1981437
 
 
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 

 
1902 Long Hill Road, Millington, New Jersey
 
07946-0417
 
 
(Address of Principal Executive Offices)
 
(Zip Code)
 

Registrant’s telephone number, including area code: 908-647-4000
 
Securities registered pursuant to Section 12(b) of the Act:
 

 
Title of Each Class
 
Name of Each Exchange on Which Registered
 
 
Common Stock, $0.10 par value
 
The Nasdaq Stock Market LLC
 

 
Securities registered pursuant to Section 12(g) of the Act:  None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES [  ] NO [X]
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES [  ] NO [X]
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.YES [X] NO [  ]
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  [X] YES [  ] NO
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 
Large accelerated filer    o
 
Accelerated filer    o
 
Non-accelerated filer    o
(Do not check if a smaller reporting company)
 
Smaller reporting company    x

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). YES [  ] NO [X]
 
The aggregate market value of the voting stock held by non-affiliates of the Registrant, based on the closing price of the Registrant’s common stock as quoted on the Nasdaq Stock Market LLC on December 31, 2013, was approximately $15.3 million.
 
As of September 16, 2014 there were 5,010,437 shares outstanding of the Registrant’s common stock.
 
DOCUMENTS INCORPORATED BY REFERENCE
 
1.
Portions of the Proxy Statement for the 2014 Annual Meeting of Shareholders. (Parts II and III)

 
 

 


MSB FINANCIAL CORP.

FORM 10-K

FOR THE FISCAL YEAR ENDED JUNE 30, 2014

INDEX

 
PART 1
     
Page
Item 1.
 
Business
 
1
Item 1A.
 
Risk Factors
 
30
Item 1B.
 
Unresolved Staff Comments
 
30
Item 2.
 
Properties
 
30
Item 3.
 
Legal Proceedings
 
30
Item 4.
 
Mine Safety Disclosures
 
30
         
PART II
       
Item 5.
 
Market for Registrant’s Common Equity, Related Stockholder Matters
   and Issuer Purchases of Equity Securities
 
 
31
Item 6.
 
Selected Financial Data
 
32
Item 7.
 
Management’s Discussion and Analysis of Financial Condition
   and Results of Operations
 
 
32
Item 7A.
 
Quantitative and Qualitative Disclosures about Market Risk
 
43
Item 8.
 
Financial Statements and Supplementary Data
 
44
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and
   Financial Disclosure
 
 
44
Item 9A.
 
Controls and Procedures
 
45
Item 9B.
 
Other Information
 
46
         
PART III
       
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
46
Item 11.
 
Executive Compensation
 
46
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and
   Related Stockholder Matters
 
 
46
Item 13.
 
Certain Relationships and Related Transactions, and Director
   Independence
 
 
47
Item 14.
 
Principal Accounting Fees and Services
 
47
         
PART IV
       
Item 15.
 
Exhibits, Financial Statement Schedules
 
47
         
SIGNATURES
       



 

 


PART I

Forward-Looking Statements

MSB Financial Corp. (the “Company”) may from time to time make written or oral “forward-looking statements,” including statements contained in the Company’s filings with the Securities and Exchange Commission (including this Annual Report on Form 10-K and the exhibits thereto), in its reports to stockholders and in other communications by the Company, which are made in good faith by the Company pursuant to the “safe harbor” provisions of the private securities litigation reform act of 1995.

These forward-looking statements involve risks and uncertainties, such as statements of the Company’s plans, objectives, expectations, estimates and intentions, that are subject to change based on various important factors (some of which are beyond the Company’s control). The following factors, among others, could cause the Company’s financial performance to differ materially from the plans, objectives, expectations, estimates and intentions expressed in such forward-looking statements: The strength of the United States economy in general and the strength of the local economies in which the Company conducts operations; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the board of governors of the federal reserve system, inflation, interest rate, market and monetary fluctuations; the timely development of and acceptance of new products and services of the Company and the perceived overall value of these products and services by users, including the features, pricing and quality compared to competitors’ products and services; the willingness of users to substitute competitors’ products and services for the Company’s products and services; the success of the Company in gaining regulatory approval of its products and services, when required; the impact of changes in financial services’ laws and regulations (including laws concerning taxes, banking, securities and insurance); technological changes, acquisitions; market volatility; changes in consumer spending and saving habits; and the success of the Company at managing the risks involved in the foregoing.

The Company cautions that the foregoing list of important factors is not exclusive. The Company does not undertake to update any forward-looking statement, whether written or oral, that may be made from time to time by or on behalf of the Company.

Item 1. Business

General

The Company is a federally chartered corporation organized in 2004 for the purpose of acquiring all of the capital stock that Millington Savings Bank (the “Bank”) issued in its mutual holding company reorganization. During the fiscal year ended June 30, 2007, the Company conducted its initial public offering and sold 2,529,281 shares including 202,342 shares acquired by the Employee Stock Ownership Plan for net proceeds of approximately $24.5 million. The Company’s principal executive offices are located at 1902 Long Hill Road, Millington, New Jersey 07946-0417 and its telephone number at that address is (908) 647-4000.

MSB Financial, MHC (the “MHC”) is a federally chartered mutual holding company that was formed in 2004 in connection with the mutual holding company reorganization. The MHC has not engaged in any significant business since its formation. So long as the MHC is in existence, it will at all times own a majority of the outstanding stock of the Company.
 
 
1

 

 
The Bank is a New Jersey-chartered stock savings bank and its deposits are insured by the Federal Deposit Insurance Corporation. As of June 30, 2014, the Bank had 53 full time equivalent employees.  The Bank maintains a website at www.millingtonsb.com.  Information on the Bank’s website should not be treated as part of this Annual Report on Form 10-K.

The Bank is regulated by the New Jersey Department of Banking and Insurance and the Federal Deposit Insurance Corporation.  The MHC and the Company are regulated as savings and loan holding companies by the Board of Governors of the Federal Reserve System (“FRB”), as successor to the Office of Thrift Supervision (“OTS”) under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”).

Throughout this document, references to “we,” “us,” or “our” refer to the Bank or Company, or both, as the context indicates.

Competition

We operate in a market area with a high concentration of banking and other financial institutions, and we face substantial competition in attracting deposits and in originating loans. A number of our competitors are significantly larger institutions with greater financial and managerial resources and lending limits. Our ability to compete successfully is a significant factor affecting our growth potential and profitability.

Our competition for deposits and loans historically has come from other insured financial institutions such as local and regional commercial banks, savings institutions, and credit unions located in our primary market area. We also compete with mortgage banking and finance companies for real estate loans and with commercial banks and savings institutions for consumer loans, and we face competition for funds from investment products such as mutual funds, short-term money funds and corporate and government securities. There are large competitors operating throughout our total market area, and we also face strong competition from other community-based financial institutions.

Lending Activities

We have traditionally and currently focused on the origination of one- to four-family loans and home equity loans and lines of credit, which together comprise a substantial portion of the total loan portfolio. We also provide financing for commercial real estate, including multi-family dwellings/apartment buildings, service/retail and mixed-use properties, churches and non-profit properties, medical and dental facilities and other commercial real estate. We also originate residential and commercial construction loans and commercial and industrial loans. Our consumer loans are comprised of auto loans, personal loans and account loans and overdraft lines of credit.


 

 

Loan Portfolio Composition. The following tables analyze the composition of the Company’s loan portfolio by loan category at the dates indicated.  Except as set forth below, there were no concentrations of loans exceeding 10% of total loans.
 
 
 
At June 30,
  2014   2013   2012   2011   2010  
 
Amount
  Percent
 
Amount
 
Percent
 
Amount
  Percent
 
Amount
 
Percent
 
Amount
 
Percent
 
   
(Dollars in thousands)
 
Type of Loans:
                                                   
One- to four-family real estate
$
143,283
 
60.50
%
$
136,704
 
59.79
%
$
141,927
 
57.65
%
$
149,399
 
57.66
%
 
$
155,241
 
56.94
%
Commercial real estate
 
32,036
 
13.53
   
32,171
 
14.07
   
32,181
 
13.07
   
32,559
 
12.57
     
33,776
 
12.39
 
Construction
 
12,517
 
5.29
   
8,895
 
3.89
   
11,669
 
4.74
   
16,633
 
6.42
     
16,639
 
6.10
 
Home equity
 
38,484
 
16.25
   
40,682
 
17.79
   
49,224
 
19.99
   
50,240
 
19.39
     
56,862
 
20.86
 
Commercial and industrial
 
9,666
 
4.08
   
9,267
 
4.05
   
10,092
 
4.10
   
9,325
 
3.60
     
9,190
 
3.37
 
Consumer
 
832
 
0.35
   
929
 
0.41
   
1,107
 
0.45
   
941
 
0.36
     
918
 
0.34
 
                                                     
Total loans receivable
 
236,818
 
100.00
%
 
228,648
 
100.00
%
 
246,200
 
100.00
%
 
259,097
 
100.00
%
   
272,626
 
100.00
%
                                                     
Less:
                                                   
Construction loans in process
 
(2,491
)
     
(745
)
     
(2,261
)
     
(3,452
)
       
(4,027
)
   
Allowance for loan losses
 
(3,686
)
     
(4,270
)
     
(3,065
)
     
(2,170
)
       
(2,588
)
   
Deferred loan fees
 
(366
)
     
(377
)
     
(354
)
     
(224
)
       
(197
)
   
                                                     
Total loans receivable, net
$
230,275
     
$
223,256
     
$
240,520
     
$
253,251
       
$
265,814
     



 

 

Loan Maturity Schedule. The following table sets forth the maturity of the Company’s loan portfolio at June 30, 2014. Demand loans, loans having no stated maturity, and overdrafts are presented as due in one year or less. The construction loans presented in the table as of June 30, 2014 are net of $2,491,000 of undistributed amounts. The table presents contractual maturities and does not reflect repricing or the effect of prepayments. Actual maturities may differ.

   
At June 30, 2014
 
   
One- to Four-
Family
Real Estate
   
Commercial
Real Estate
   
 
Construction
   
 
Consumer
   
 
Home Equity
   
Commercial and Industrial
   
 
Total
 
   
(In thousands)
 
Amounts Due:
                                                       
Within 1 Year
 
$
6,267
   
$
1,068
   
$
8,033
   
$
199
   
$
1,699
   
$
2,226
   
$
19,492
 
                                                         
After 1 year:
                                                       
1 to 5 years
   
14,119
     
14,674
     
1,993
     
69
     
11,254
     
5,922
     
48,031
 
5 to 10 years
   
8,808
     
2,336
     
-
     
-
     
10,190
     
385
     
21,719
 
After 10 years
   
114,089
     
13,958
     
-
     
564
     
15,341
     
1,133
     
145,085
 
 Total due after one year
   
137,016
     
30,968
     
1,993
     
633
     
36.785
     
7,440
     
214,835
 
                                                         
 Total
 
$
143,283
   
$
32,036
   
$
10,026
   
$
832
   
$
38,484
   
$
9,666
   
$
234,327
 



 

 

The following table sets forth the dollar amount of all loans at June 30, 2014 due after June 30, 2015, which have fixed interest rates and which have floating or adjustable interest rates.

   
 
Fixed Rates
   
Floating or
Adjustable
Rates
   
 
Total
 
   
(In thousands)
 
                         
One-to four-family real estate
 
$
127,336
   
$
9,680
   
$
137,016
 
Commercial real estate
   
30,968
     
-
     
30,968
 
Construction
   
1,993
     
-
     
1,993
 
Consumer
   
633
     
-
     
633
 
Home equity
   
14,206
     
22,579
     
36,785
 
Commercial and industrial
   
3,309
     
4,131
     
7,440
 
Total
 
$
178,445
   
$
36,390
   
$
214,835
 


One- to Four-Family Real Estate Mortgages. Our primary lending activity consists of the origination of one- to four-family first mortgage loans. Fixed rate, conventional mortgage loans are offered by the Company with terms from 5 to 30 years.

We originate adjustable rate mortgages, or ARMs, with up to 30 year terms at rates based upon the U.S. Treasury One Year Constant Maturity as an index. Our ARMs currently reset on an annual basis, beginning with the first year, and have a 200 basis point annual increase cap and a 600 basis point lifetime adjustment cap.  We do not originate “teaser” rate or negative amortization loans.

We are also offering a two-step loan program whereby we offer an initial rate for a fixed period of time, normally 7 to 10 years, and thereafter there is one preset interest rate adjustment based on competitive rates.

Substantially all residential mortgages include “due on sale” clauses, which are provisions giving us the right to declare a loan immediately payable if the borrower sells or otherwise transfers an interest in the property to a third party. Property appraisals on real estate securing one-to four-family residential loans are made by state certified or licensed independent appraisers and are performed in accordance with applicable regulations and policies. We require title insurance policies on all first lien one-to four-family residential loans and all home equity loans over $250,000.  Homeowners, liability, fire and, if applicable, flood insurance policies are also required.

We provide financing on residential investment properties with 5 to 30 year fixed duration mortgages. Our investment property lending product is available to individuals or proprietorships, partnerships, limited liability corporations, and corporations with personal guarantees. All investment property is underwritten on its ability substantially to carry itself, unless the property is a two-family residence with the mortgagor living in one of the units. Preference is given to those loans where rental income covers all operating expenses, including but not limited to principal and interest, real estate taxes, hazard insurance, utilities, maintenance, and reserve. The cash coverage ratio to cover operating expenses must be at least 1.25 times.  Any negative cash flow will be included in borrower’s total debt ratio.

We generally originate one-to four-family first mortgage loans for primary residences with loan-to-value ratios ranging from 65% up to 80% depending on the collateral value and investment properties with loan-to-value ratios ranging from 65% up to 75%.
 
 
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Commercial Real Estate Mortgages. Our commercial real estate lending includes multi-family dwellings/apartment buildings, service/retail and mixed-use properties, churches and non-profit properties, medical and dental facilities and other commercial real estate. Our commercial real estate mortgage loans are either 3 to 10 year balloon mortgages (with a maximum amortization period of 25 years) or 15 year fixed duration mortgages. This type of lending is made available to proprietorships, partnerships, limited liability companies and corporations with personal guarantees. All commercial property is underwritten on its ability substantially to provide satisfactory cash flows.  A cash flow and lease analysis is performed for each property. Preference is given to those loans where rental income covers all operating expenses, including but not limited to principal and interest, real estate tax, hazard insurance, utilities, maintenance, and reserve. The cash coverage ratio to cover operating expenses must be at least 1.25 times.  Any negative cash flow will be included in the limit on the borrower’s total debt ratio. Cash from other assets of the borrower, who may own multiple properties and generate a surplus, can be made available to cover debt-service shortages of the financed property. The loan-to-value ratio on commercial real estate loans ranges from 65% to 75%.

The management skills of the borrower are judged on the basis of his/her professional experience and must be documented to meet the Company’s satisfaction in relation to the desired project. The assets of the borrower must indicate his/her ability to support the proposed investment, both in terms of liquidity and net worth, and tangible history of the borrower’s capability and experience must be evident.

Unlike single-family residential mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment and other income, and which are secured by real property the value of which tends to be more easily ascertainable, multi-family and commercial real estate loans typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business or rental income. As a result, the availability of funds for the repayment of commercial real estate and multi-family loans may be substantially dependent on the success of the business itself and the general economic environment. Commercial real estate and multi-family loans, therefore, have greater credit risk than one-to four-family residential mortgages or consumer loans. In addition, commercial real estate and multi-family loans generally result in larger balances to single borrowers, or related groups of borrowers and also generally require substantially greater evaluation and oversight efforts.

Construction Loans. We originate construction loans for an owner-occupied residence or to a builder with a valid contract of sale. With prior Board of Director approval, we also provide financing for speculative residential or commercial construction and development. Individual consideration is given to builders based on their past performance, workmanship, and financial worth. Our construction lending includes loans for construction or major renovations or improvements of owner-occupied residences.  The portfolio is virtually divided equally between owner-occupied properties and real estate developers.

Construction loans are mortgages up to 18 months in duration. Funds are disbursed periodically upon inspections made by our inspectors on the percentage of work completed, as per the approved budget. Funds disbursed may not exceed 50% of the loan-to-value of land and up to 80% of the loan-to-value of improvements any time during construction.  Interest rates on disbursed funds are based on the rates and terms set at the time of closing.  The majority of our construction loans are variable rate loans with rates tied to the prime rate published in The Wall Street Journal, plus a premium. The Bank also has established a floor rate on all new transactions.  A minimum of interest-only payments on disbursed funds must be made on a monthly basis.

Construction lending is generally considered to involve a higher degree of credit risk than residential mortgage lending. If the estimate of construction cost proves to be inaccurate, we may be compelled to advance additional funds to complete the construction with repayment dependent, in part, on
 
 
6

 
 
the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan. If we are forced to foreclose on a project prior to completion, there is no assurance that we will be able to recover the entire unpaid portion of the loan. In addition, we may be required to fund additional amounts to complete a project and may have to hold the property for an indeterminate period of time.

Consumer Loans. Our consumer lending products consist of new and used auto loans, secured and unsecured personal loans, account loans and overdraft lines of credit. The maximum term for a loan on a new or used automobile is six years and four years, respectively. We will lend up to 80% of retail value or dealer invoice on a car loan. We offer a reduction on the interest rate for car loans if payments are automatically deducted from a Millington Savings Bank checking or statement savings account.

Our personal loans have terms of up to four years with a minimum and maximum balance of $1,000 and $5,000, respectively. A reduction to the interest rate is offered for loans with automatic debit repayment from a Millington Savings Bank checking or statement savings account. Our account loans permit a depositor to borrow up to 90% of his or her funds on deposit with us in certificate of deposit accounts. The interest rate is the current rate paid to the depositor, plus a premium. A minimum payment of interest only is required. We offer an overdraft line of credit with a minimum of $500 and up to a maximum of $5,000 and an interest rate tied to the prime rate published in The Wall Street Journal, plus a premium.

Consumer lending is generally considered to involve a higher degree of credit risk than residential mortgage lending. Consumer loan repayment is dependent on the borrower’s continuing financial stability and can be adversely affected by job loss, divorce, illness, personal bankruptcy and other factors. The application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on consumer loans in the event of a default. Account loans are fully secured.

Home Equity Loans and Lines of Credit. We offer fixed rate home equity loans and variable rate home equity lines of credit with a minimum credit limit of $5,000. Collateral valuation is established through a variety of methods, including an on-line appraisal valuation estimator, drive by appraisals, recent assessed tax value, purchase price or consideration value as evidenced by a deed or property search report or a report of real estate comparables from a licensed realtor. Loan requests over $100,000, however, require full appraisals, and requests over $500,000 require Loan Committee approval. Loan requests over $3.0 million require Board approval.  The loan-to-value limit on home equity lending varies depending on the collateral value and ranges from 65% up to 80% on owner occupied property and from 65% up to 75% on investment property. The variable rate on home equity lines of credit is adjusted monthly and is currently set at prime for owner occupied properties and prime plus a premium for investment properties. The fixed rate loans on investment property are also higher than fixed rate owner occupied home equity loans. We generally provide home equity financing only for a first or second lien position.

Our fixed rate home equity loans have terms of 5 to 30 years. Our variable rate home equity lines of credit have terms of 15 years, and we also offer an interest only home equity line of credit based on a 10 year term. The loan-to-value limit on interest only home equity financing is 70% on owner-occupied property and 60% on investment property. We also offer bridge loans with a variable rate and a 70% loan-to-value limit on owner-occupied property and 60% on investment property.

Commercial and Industrial Loans. We offer revolving lines of credit to businesses to finance short-term working capital needs like accounts receivable and inventory. These lines of credit may be unsecured or secured by accounts receivable and inventory or real estate. We generally provide such financing for no more than a 3 year term and with a variable rate.
 
 
7

 

 
We also originate commercial term loans to fund longer-term borrowing needs such as purchasing equipment, property improvements or other fixed asset needs. These loans are secured by new and used machinery, equipment, fixtures, furniture or other long-term fixed assets and have terms of 1 to 15 years. We originate commercial term loans for other general long-term business purposes, and these loans are secured by real estate. Principal and interest on commercial term loans is payable monthly.

The normal minimum amount for our commercial term loans and lines of credit is $5,000. The maximum amount is based on the Loan to Value limits set in our policy.  We typically do not provide working capital loans to businesses outside our normal market area or to new businesses where repayment is dependent solely on future profitable operation of the business. We avoid originating loans for which the primary source of repayment could be liquidation of the collateral securing the loan in light of poor repayment prospects. We typically require personal guarantees on all commercial loans, regardless of other collateral securing the loan.

The loan-to-value limits on commercial lending vary according to the collateral. Loans secured by real estate may be originated for up to 80% loan-to-value. Other limits are as follows: Savings accounts-90% of the deposit amount; new equipment-75% of purchase price; and used equipment-lesser of 75% of purchase price or 75% of current market value.

Loans to One Borrower. The Bank’s regulatory limit on total loans to any borrower or attributed to any one borrower is 15% of unimpaired capital and surplus. Accordingly, as of June 30, 2014, our loans to one borrower legal limit was approximately $5.6 million.

The Bank’s lending policies require Board approval before any borrower’s existing and/or committed borrowings from the Bank may exceed $4.5 million in the aggregate. Any single loan in excess of $3.0 million also requires prior Board approval.

At June 30, 2014, the Bank’s largest lending relationship with a single borrower totaled $5.2 million, consisting of a $4.1 million loan, a $932,000 loan and a $170,000 loan.  Two of the loans were secured by commercial properties and the other loan was secured by a single family residence and all were performing according to their terms.

Loan Originations, Purchases, Sales, Solicitation and Processing. Our customary sources of loan applications include repeat customers, referrals from realtors and other professionals and “walk-in” customers. Our residential loan originations are driven by the Bank’s reputation, as opposed to being advertising driven.

We normally do not sell loans into the secondary mortgage market and did not sell any loans in the five year period ended June 30, 2014.  It is our policy to retain the loans we originate in our portfolio. We have not uniformly originated our real estate mortgage loans to meet the documentation standards to sell loans in the secondary mortgage market. We may do so, however, in the future if we find it desirable in connection with interest rate risk management to sell longer term fixed rate mortgages into the secondary mortgage market.

We did not purchase any whole loans in the five-year period ended June 30, 2014. We did, however, purchase insignificant participation interests in loans originated by other banks during this period.

 Loan Approval Procedures and Authority. Lending policies and loan approval limits are approved and adopted by the Board of Directors. Lending authority is vested primarily in President and
 
 
8

 
 
Chief Executive Officer and Vice President and Chief Lending Officer. Each of these officers may approve loans within the following limits: first mortgage real estate and construction loans up to $500,000; home equity loans up to $500,000; consumer loans up to $500,000; and commercial loans up to $500,000.  Loans in excess of $500,000 but under $3.0 million require the approval of the Loan Committee.  Prior Board approval is required for all loan products in excess of $3.0 million. The Board also must give prior approval for any aggregation of existing and/or committed loans to one borrower that exceeds $4.5 million. Certain other Bank employees also have limited lending authority.

Asset Quality

Loan Delinquencies and Collection Procedures. The Company’s procedures for delinquent loans are as follows:

 
15 days delinquent:
late charge added, first delinquent notice mailed
 
30 days delinquent:
second delinquent notice mailed
 
45 days delinquent:
additional late charge, third delinquent notice mailed, telephone contact made
 
60 days delinquent:
telephone contact made, separate letter mailed
 
90 days delinquent:
decision made to refer to attorney to send demand letter
  120 days delinquent: attorney to file complaint to begin legal action

When a loan is 90 days delinquent, the Vice President - Lending or the President may determine to refer it to an attorney to send demand letter.  After 120 days, attorney is able to start the foreclosure proceedings by filing a complaint with the court.  All reasonable attempts are made to collect from borrowers prior to referral to an attorney for collection. In certain instances, we may modify the loan or grant a limited moratorium on loan payments to enable the borrower to reorganize his or her financial affairs, and we attempt to work with the borrower to establish a repayment schedule to cure the delinquency.

As to mortgage loans, if a foreclosure action is taken and the loan is not reinstated, paid in full or refinanced, the property is sold at judicial sale at which we may be the buyer if there are no adequate offers to satisfy the debt. Any property acquired as the result of foreclosure or by deed in lieu of foreclosure is classified as real estate owned until it is sold or otherwise disposed of. When real estate owned is acquired, it is recorded at the lower of cost or its fair market value less estimated selling costs. The initial write-down of the property is charged to the allowance for loan losses. Adjustments to the carrying value of the property that result from subsequent declines in value are charged to operations in the period in which the declines occur. At June 30, 2014, we had $409,000 in other real estate owned.

As to commercial loans, the Company requests updated financial statements when the loan becomes 90 days delinquent. As to account loans, the outstanding balance is collected from the related account along with accrued interest when the loan is 180 days delinquent.

Loans are reviewed on a regular basis, and all delinquencies of 60 days or more are reported to the Board of Directors. Loans are placed on non-accrual status when they are more than 90 days delinquent, except for such loans which are “well secured” and “in the process of collection.”  In addition a loan may be placed on non-accrual status at any time if, in the opinion of management, the collection of the loan in full is doubtful. An asset is “well secured” if it is secured (1) by collateral in the form of liens on or pledges of real or personal property, including securities, that have a realizable value sufficient to discharge the debt (including accrued interest) in full, or (2) by the guarantee of a financially responsible party.  An asset is “in process of collection” if collection of the asset is proceeding in due course either (1) through legal action, including judgment enforcement procedures, or (2) in appropriate circumstances,
 
 
9

 
 
through collection efforts not involving legal action which are reasonably expected to result in repayment of the debt or its restoration to a current status in the near future.

Loans with interest accrued and unpaid during the year placed on non-accrual status and are charged against interest income.  Interest accrued and unpaid in prior years is charged against the allowance for loan losses.  Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectability of the loan. At June 30, 2014, we had approximately $8.0 million of loans that were held on a non-accrual basis, all of which were classified as impaired with $137,000 subject to specific loss allowances totaling $73,000.

Non-Performing Assets. The following table provides information regarding our non-performing loans and other non-performing assets as of the dates indicated.

    
At June 30,
 
    2014     2013   2012     2011   2010  
    (Dollars in thousands)  
Loans accounted for on a non-accrual basis:
                                   
One-to four-family real estate
 
$
4,346
   
$
7,955
 
$
9,003
   
$
8,317
 
$
6,764
 
Commercial real estate
   
1,248
     
2,587
   
2,337
     
3,132
   
3,465
 
Construction
   
137
     
601
   
1,258
     
1,027
   
864
 
Consumer
   
-
     
802
   
     
2
   
9
 
Home equity
   
1,586
     
1,502
   
923
     
950
   
2,281
 
Commercial and industrial
   
635
     
   
1,064
     
642
   
514
 
Total
   
7,952
     
13,447
   
14,585
     
14,070
   
13,897
 
Accruing loans contractually past due
                                   
90 days or more:
                                   
One-to four-family real estate
   
310
     
501
   
1,263
     
1,369
   
1,439
 
Commercial real estate
   
     
   
     
   
 
Construction
   
     
   
     
   
 
Consumer
   
     
   
1
     
   
2
 
Home equity
   
51
     
146
   
906
     
934
   
321
 
Commercial and industrial
   
     
   
     
   
 
Total
   
361
     
647
   
2,170
     
2,303
   
1,762
 
Total non-performing loans
 
$
8,313
   
$
14,094
 
$
16,755
   
$
16,373
 
$
15,659
 
Total non-performing assets (1)
 
$
8,722
   
$
14,624
 
$
16,755
   
$
17,234
 
$
16,726
 
                                     
Accruing loans modified in troubled debt restructuring
 
$
13,439
   
$
11,848
 
$
7,061
   
$
543
 
$
6,555
 
                                     
Total non-performing loans to total loans
   
3.51
%
   
6.16
%
 
6.81
%
   
6.32
   
5.74
%
Total non-performing loans to total assets
   
2.41
%
   
4.00
%
 
4.82
%
   
4.69
   
4.36
%
Total non-performing assets to total assets
   
2.53
%
   
4.15
%
 
4.82
%
   
4.93
   
4.66
%
2014
__________________
(1)
Total non-performing assets consist of total non-performing loans and other real estate owned of $409, $530, $-, $861 and $1,067 at June 30, 2014, 2013, 2012, 2011 and 2010, respectively.

At June 30, 2014, there were no loans not disclosed in the table above where known information about possible credit problems of borrowers causes management to have serious doubts as to the ability of such borrowers to comply with present loan repayment terms and which may result in disclosure of such loans in the future.
 
 
10

 

During the year ended June 30, 2014, gross interest income of $400,000 would have been recorded on loans accounted for on a non-accrual basis and $533,000 would have been recorded on troubled debt restructurings if those loans had been current in accordance with their original terms, and $275,000 and $585,000, respectively, of interest collected on such loans was included in income.   

Classified Assets. The Company in compliance with the Uniform Credit Classification and Account Management Policy adopted by the Federal Deposit Insurance Corporation, and the Company has an internal loan review program, whereby non-performing loans are classified as special mention, substandard, doubtful or loss. It is our policy to review the loan portfolio, in accordance with regulatory classification procedures, on at least a quarterly basis. When a loan is classified as substandard or doubtful, management is required to evaluate the loan for impairment. When management classifies a portion of a loan as loss, a reserve equal to 100% of the loss amount is required to be established or the loan is to be charged-off, if a conforming loss event has occurred.

An asset that does not currently expose the Company to a sufficient degree of risk to warrant an adverse classification, but which possesses credit deficiencies or potential weaknesses that deserve management’s close attention is classified as “special mention.”

An asset classified as “substandard” is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. Assets so classified have well-defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected.

An asset classified as “doubtful” has all the weaknesses inherent in a “substandard” asset with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of a loss on a doubtful asset is high.

That portion of an asset classified as “loss” is considered uncollectible and of such little value that its continuance as an asset, without charge-off, is not warranted. This classification does not necessarily mean that an asset has absolutely no recovery or salvage value; but rather, it is not practical or desirable to defer writing off a basically worthless asset even though partial recovery may be affected in the future.

Management’s classification of assets is reviewed by the Board on a regular basis and by the regulatory agencies as part of their examination process.

The following table discloses the Company’s classification of assets as of June 30, 2014.

     
At June 30, 2014
 
     
(In thousands)
 
         
 
Special Mention
  $ 3,612  
 
Substandard
    4,170  
 
Doubtful
    -  
 
Loss
    73  
 
Total
  $ 7,855  

At June 30, 2014, 13 out of the 23 loans adversely classified totaling $2.0 million are included as non-performing loans in the non-performing assets table.
 
 
11

 
 
Allowance for Credit Losses. The allowance for credit losses consists of the allowance for loan losses and the reserve for unfunded credit commitments.  The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the Statement of Financial Condition date and is recorded as a reduction to loans. The reserve for unfunded credit commitments represents management’s estimate of losses inherent in its unfunded loan commitments and is recorded in other liabilities on the consolidated Statement of Financial Condition. The allowance for credit losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. All, or part, of the principal balance of loans receivable that are deemed uncollectible are charged against the allowance when management determines that the repayment of that amount is highly unlikely.    Any subsequent recoveries are credited to the allowance.  Non-residential consumer loans are generally charged off no later than 120 days past due on a contractual basis, earlier in the event of bankruptcy, or if there is an amount deemed uncollectible.  

Management, in determining the allowance for loan losses, considers the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available. The allowance consists of specific, general and unallocated components. The specific component relates to loans that are classified as impaired. For loans that are classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price of the impaired loan) is lower than the carrying value of that loan. The general component covers pools of loans by loan class.  These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these classes of loans, adjusted for qualitative factors.  Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation.  The unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
 
The allowance calculation methodology includes segregation of the total loan portfolio into segments. The Company’s loans receivable portfolio is comprised of the following segments: residential mortgage, commercial real estate, construction, consumer and commercial and industrial. Some segments of the Company’s loan receivable portfolio are further disaggregated into classes which allows management to better monitor risk and performance.
 
The residential mortgage loan segment is disaggregated into two classes: one-to four-family loans, which are primarily first liens, and home equity loans, which consist of first and second liens.  The commercial real estate loan segment consists of both owner and non-owner occupied loans which have medium risk due to historical activity on these type loans.  The construction loan segment is further disaggregated into two classes: one-to four-family owner occupied, which includes land loans, whereby the owner is known and there is less risk, and other, whereby the property is generally under development and tends to have more risk than the one-to four-family owner occupied loans.  The commercial and industrial loan segment consists of loans made for the purpose of financing the activities of commercial customers. The majority of commercial and industrial loans are secured by real estate and thus carry a lower risk than traditional commercial and industrial loans.  The consumer loan segment consists primarily of installment loans and overdraft lines of credit connected with customer deposit accounts.  

Management evaluates individual loans in all of the loan segments (including loans in residential mortgage and consumer segments) for possible impairment if the recorded investment in the loan is
 
 
12

 
 
 
greater than $200,000 and if the loan is either in nonaccrual status or risk rated Substandard or worse or has been modified in a troubled debt restructuring.  A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.
 
Loans whose terms are modified are classified as troubled debt restructurings if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty.  Concessions granted under a troubled debt restructuring generally involve a reduction in interest rate, a below market interest rate based on risk, or an extension of a loan’s stated maturity date. Nonaccrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification.   Loans classified as troubled debt restructurings are designated as impaired.
 
The evaluation of the need and amount of the allowance for impaired loans and whether a loan can be removed from impairment status is made on a quarterly basis.  The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

In addition, the New Jersey Department of Banking and Insurance and the Federal Deposit Insurance Corporation, as an integral part of their examination processes, periodically review our loan and real estate owned portfolios and the related allowance for loan losses and valuation allowance for real estate owned. They may require the allowance for loan losses or the valuation allowance for real estate owned to be increased based on their review of information available at the time of the examination, which would negatively affect our earnings.

 
13 

 

The following table sets forth information with respect to the Company’s allowance for loan losses for the periods indicated:

   
Year Ended June 30,
 
   
2014
 
2013
 
2012
 
2011
 
2010
   
(Dollars in thousands)
 
                               
Allowance balance at beginning of period
 
$
4,270
   
$
3,065
   
$
2,170
   
$
2,588
   
$
1,808
 
Provision for loan losses
   
600
     
4,044
     
2,217
     
1,686
     
1,600
 
Charge-offs:
                                       
One-to four-family real estate
   
522
     
1,574
     
857
     
1,134
     
6
 
Commercial real estate
   
340
     
348
     
5
     
155
     
166
 
Construction
   
119
     
333
     
     
34
     
487
 
Consumer
   
9
     
5
     
17
     
8
     
14
 
Home equity
   
15
     
293
     
443
     
759
     
148
 
Commercial and industrial
   
236
     
342
     
2
     
14
     
 
Total charge-offs
   
1,241
     
2,895
     
1,324
     
2,104
     
821
 
                                         
Recoveries:
                                       
Consumer
   
57
     
56
     
2
     
     
1
 
Net charge-offs
 
$
1,184
   
$
2,839
   
$
1,322
   
$
2,104
   
$
820
 
Allowance balance at end of period
 
$
3,686
   
$
4,270
   
$
3,065
   
$
2,170
   
$
2,588
 
Total loans outstanding at end of period
 
$
236,818
   
$
228,648
   
$
246,200
   
$
259,097
   
$
272,626
 
Average loans outstanding during period
 
$
232,148
   
$
237,776
   
$
248,124
   
$
264,476
   
$
277,379
 
Allowance for loan losses as a
     percentage of non-performing loans
   
44.34
%
   
30.30
%
   
18.29
%
   
13.25
%
   
16.53
%
Allowance for loan losses as a
     percentage of total loans
   
1.56
%
   
1.87
%
   
1.24
%
   
0.84
%
   
0.95
%
Net loans charged-off as a
     percentage of average loans
   
0.51
%
   
1.19
%
   
0.53
%
   
0.80
%
   
0.30
%



 
14 

 


Allocation of Allowance for Loan Losses. The following table sets forth the allocation of the Company’s allowance for loan losses by loan category and the percent of loans in each category to total loans receivable at the dates indicated. The portion of the loan loss allowance allocated to each loan category does not represent the total available for future losses that may occur within the loan category since the total loan loss allowance is a valuation allocation applicable to the entire loan portfolio.

   
At June 30,
 
   
2014
   
2013
   
2012
   
2011
   
2010
 
   
 
 
Amount
   
Percent
of Loans
to Total
Loans
   
 
 
Amount
   
Percent
of Loans
to Total
Loans
   
 
 
Amount
   
Percent
of Loans
to Total
Loans
   
 
 
Amount
   
Percent
of Loans
to Total
Loans
   
 
 
Amount
   
Percent
of Loans
to Total
Loans
 
   
(Dollars in thousands)
 
                                                             
One-to-four family real estate
  $ 1,851       60.50 %   $ 2,488       59.79 %   $ 1,251       57.65 %   $ 733       57.66 %   $ 969       56.94 %
Commercial real estate
    860       13.53       706       14.07       445       13.07       303       12.57       507       12.39  
Construction
    379       5.29       238       3.89       527       4.74       514       6.42       272       6.10  
Home equity
    332       16.25       548       17.79       557       19.99       397       19.39       665       20.86  
Commercial  and industrial
    256       4.08       276       4.05       272       4.10       211       3.60       164       3.37  
Consumer
    8       0.35       11       0.41       13       0.45       12       0.36       11       0.34  
Unallocated
    -       -       3       -       -       -       -       -       -       -  
Total allowance
  $ 3,686       100.00 %   $ 4,270       100.00 %   $ 3,065       100.00 %   $ 2,170       100.00 %   $ 2,588       100.00 %



 
15 

 


Securities Portfolio

Our investment policy is designed to manage cash flows and foster earnings within prudent interest rate risk and credit risk guidelines. The portfolio mix is governed by our short term and long term liquidity needs. Rate-of-return, cash flow, rating and guarantor-backing are also considered when making investment decisions. The purchase of principal only and stripped coupon interest only security instruments is specifically not authorized by our investment policy. Furthermore, other than government related securities which may not be rated, we only purchase securities with a rating of AAA or AA. We invest primarily in mortgage-backed securities, U.S. Government obligations, U.S. Government agency issued securities and to a lesser extent in Corporate Bonds and Certificates of Deposits.

Mortgage-backed securities represent a participation interest in a pool of mortgages issued by U.S. government agencies or government-sponsored enterprises, such as Federal Home Loan Mortgage Corporation (“Freddie Mac”), the Government National Mortgage Association (“Ginnie Mae”), and the Federal National Mortgage Association (“Fannie Mae”), as well as non-government, private corporate issuers. Mortgage-backed securities are pass-through securities and generally yield less than the mortgage loans underlying the securities. The characteristics of the underlying pool of mortgages, i.e., fixed-rate or adjustable-rate, as well as prepayment risk, are passed on to the certificate holder.

Mortgage-backed securities issued or sponsored by U.S. government agencies and government-sponsored entities are guaranteed as to the payment of principal and interest to investors.

Corporate bonds often pay higher rates than government or municipal bonds, because they tend to be riskier.  The bond holder receives interest payments (yield) and principal and is repaid on a fixed maturity date.  Corporate bonds can mature anywhere between 1 to 30 years and changes in interest rates are generally reflected in the bond prices.  Corporate bonds carry no claims to ownership and do not pay a dividend, but are considered to be less risky than stocks, since the company has to pay off all of its debts (including bonds) before it handles its obligations to stockholders.  Corporate bonds have a wide range of ratings and yields because the financial health of the issuers can vary widely,

Accounting standards require that securities be categorized as “held to maturity,” “trading securities” or “available for sale,” based on management’s intent as to the ultimate disposition of each security. These standards allow debt securities to be classified as “held to maturity” and reported in financial statements at amortized cost if the reporting entity has the positive intent and ability to hold these securities to maturity. Securities that might be sold in response to changes in market interest rates, changes in the security’s prepayment risk, increases in loan demand, or other similar factors cannot be classified as “held to maturity.”

At June 30, 2014, our entire securities portfolio was classified as held to maturity.  All securities are purchased with the intent to hold each security until maturity.  Securities not classified as “held to maturity” or as “trading securities” are classified as “available for sale” and are reported at fair value with unrealized gains and losses on the securities impacting equity.  The Company held  no available for sale or trading securities during or as of years ending June 30, 2014 and 2013.

Individual securities are considered impaired when their fair values are less than their amortized cost. Management evaluates all securities with unrealized losses quarterly to determine if such impairments are “temporary” or “other-than-temporary” in accordance with applicable accounting guidance.  Accordingly, the Company accounts for temporary impairments based upon security classification as either trading, available for sale or held to maturity.  Temporary impairments on “available for sale” securities would be recognized, on a tax-effected basis, through other comprehensive
 
 
16

 
 
income with offsetting entries adjusting the carrying value of the security and the balance of deferred taxes.  Temporary impairments of “held to maturity” securities are not recognized in the consolidated financial statements; however, information concerning the amount and duration of impairments on held to maturity securities is disclosed in the notes to the consolidated financial statements.  The carrying value of securities held in a trading portfolio would be adjusted to fair value through earnings on a quarterly basis.

Other-than-temporary impairments on securities that the Company has decided to sell or will more likely than not be required to sell prior to the full recovery of their fair value to a level equal to or exceeding amortized cost are recognized in earnings.  Otherwise, the other-than-temporary impairment is bifurcated into credit-related and noncredit-related components.  The credit-related impairment generally represents the amount by which the present value of the cash flows expected to be collected on a debt security falls below its amortized cost.  The noncredit-related component represents the remaining portion of the impairment not otherwise designated as credit-related. Credit-related other-than-temporary impairments are recognized in earnings while noncredit-related other-than-temporary impairments are recognized, net of deferred taxes, in other comprehensive income.

At June 30, 2014, our securities portfolio did not contain securities of any issuer, other than the U.S. Government agencies and government-sponsored enterprises, having an aggregate book value in excess of 10% of stockholders’ equity.  We do not currently participate in hedging programs, interest rate caps, floors or swaps, or other activities involving the use of off-balance sheet derivative financial instruments, however, we may in the future utilize such instruments if we believe it would be beneficial for managing our interest rate risk.

 
17 

 

The following table sets forth certain information regarding the carrying values, weighted average yields and maturities of our held to maturity securities portfolio at June 30, 2014. Our held to maturity securities portfolio is carried at amortized cost.  This table shows contractual maturities and does not reflect repricing or the effect of prepayments. Actual maturities of the securities held by us may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without prepayment penalties. Callable securities pose reinvestment risk because we may not be able to reinvest the proceeds from called securities at an equivalent or higher interest rate.

 
At June 30, 2014
 
 
One Year or Less
 
One to Five Years
 
Five to Ten Years
 
More than Ten Years
 
Total Investment Securities
 
 
Carrying
Value
 
Average
Yield
 
Carrying
Value
 
Average
Yield
 
Carrying
Value
 
Average
Yield
 
Carrying
Value
 
Average
Yield
 
Carrying
Value
 
Average
Yield
 
Market
Value
 
 
(Dollars in thousands)
 
                                                                   
U.S. Government Agency Obligations
$
-
 
-
%
 
$
23,000
 
1.37
%
 
$
12,177
 
2.41
%
 
$
14,000
 
3.31
%
 
$
49,177
 
2.18
%
 
$
47,675
 
                                                                   
Mortgage-Backed Securities:
                                                                 
Government National
      Mortgage Association
 
-
 
-
     
1
 
9.21
     
13
 
1.97
     
-
 
-
     
14
 
2.69
     
14
 
Federal Home Loan
      Mortgage Corporation
 
-
 
-
     
56
 
2.22
     
16
 
3.57
     
2,854
 
1.92
     
2,926
 
1.93
     
2,892
 
Federal National Mortgage
      Association
 
-
 
-
     
1,008
 
1.21
     
19,631
 
2.61
     
2,510
 
2.13
     
23,149
 
2.50
     
23,309
 
Corporate bonds
 
-
 
-
     
4,630
 
1.62
     
-
 
-
     
-
 
-
     
4,630
 
1.62
     
4,681
 
Certificate of deposits
 
1,425
 
0.82
     
3,611
 
1.08
     
-
 
-
     
-
 
-
     
5,036
 
1.01
     
5,065
 
Total
$
1,425
 
0.82
%
 
$
32,306
 
1.37
%
 
$
31,837
 
2.54
%
 
$
19,364
 
2.95
%
 
$
84,932
 
2.16
%
 
$
83,636
 


 
18 

 

The following table sets forth the carrying value of our held to maturity securities portfolio at the dates indicated. Securities classified as held to maturity are shown at our amortized cost.

   
At June 30
 
   
2014
   
2013
   
2012
 
   
(In thousands)
 
                   
U.S. Government Agency Obligations
 
$
49,177
   
$
46,194
   
$
37,018
 
Government National Mortgage Association
   
14
     
17
     
20
 
Federal Home Loan Mortgage Corporation
   
2,926
     
3,397
     
325
 
Federal National Mortgage Association
   
23,149
     
21,354
     
9,775
 
Corporate bonds
   
4,630
     
4,669
     
2,143
 
Certificates of deposits
   
5,036
     
5,281
     
1,425
 
Total securities held to maturity
 
$
84,932
   
$
80,912
   
$
50,706
 
 
Sources of Funds

General. Deposits are our major source of funds for lending and other investment purposes. To the extent that our loan originations may exceed the funding available from deposits, we have borrowed funds from the Federal Home Loan Bank to supplement the amount of funds for lending and funding daily operations.

In addition, we derive funds from loan and mortgage-backed securities principal repayments, interest, and proceeds from the maturity and call of investment securities. Loan and securities payments are a relatively stable source of funds, while deposit inflows and outflows are significantly influenced by pricing strategies and money market conditions.

Deposits. Our current deposit products include checking and savings accounts, certificates of deposit and fixed or variable rate individual retirement accounts (IRAs). Deposit account terms vary, primarily as to the required minimum balance amount, the amount of time, if any, that the funds must remain on deposit and the applicable interest rate. Our savings account menu includes regular passbook, statement, money market and club accounts. We also offer a six-level tiered savings account. Our certificates of deposit currently range in terms from 6 months to 10 years. Our IRAs are available with the same maturities as certificates of deposit accounts, with the exception of the 30 month term. We offer a two year certificate of deposit that permits the depositor to increase the interest rate to the current two year rate once during the term.

Deposits are obtained primarily from within New Jersey. The Bank also utilizes brokered deposits as a funding source.  As of June 30, 2014 the Bank did not have any brokered deposits.  Premiums or incentives for opening accounts are sometimes offered. We periodically select particular certificate of deposit maturities for promotion in connection with asset/liability management and interest rate risk concerns.

The determination of deposit and certificate interest rates is based upon a number of factors, including: (1) need for funds based on loan demand, current maturities of deposits and other cash flow needs; (2) a current survey of a selected group of competitors’ rates for similar products; (3) economic conditions; and (4) business plan projections.

A large percentage of our deposits are in certificates of deposit. The inflow of certificates of deposit and the retention of such deposits upon maturity are significantly influenced by general interest rates and money market conditions, making certificates of deposit traditionally a more volatile source of funding than core deposits. Our liquidity could be reduced if a significant amount of certificates of deposit maturing within a short period of time were not renewed. To the extent that such deposits do not remain with us, they may need to be replaced with borrowings which could increase our cost of funds and negatively impact our net interest rate spread and our financial condition.

 
19 

 


The following table sets forth the distribution of average deposits for the periods indicated and the weighted average nominal interest rates for each period on each category of deposits presented.

   
For the Year Ended June 30,
 
   
2014
 
2013
 
2012
   
 
Average
Balance
   
Percent
of Total
Deposits
 
Weighted
Average
Nominal
Rate
 
 
Average
Balance
   
Percent
of Total
Deposits
 
Weighted
Average
Nominal
Rate
 
 
Average
Balance
   
Percent
of Total
Deposits
 
 
Weighted
Average
Nominal
Rate
   
(Dollars in thousands)
                                                 
Non-interest-bearing demand
 
$
21,598
 
7.98
%
%
 
$
18,691
 
6.64
%
%
 
$
16,094
 
5.65
%
%
Interest-bearing demand
   
39,356
 
14.54
 
0.13
     
36,918
 
13.12
 
0.14
     
34,012
 
11.94
 
0.18
 
Savings and club
   
107,960
 
39.88
 
0.22
     
110,916
 
39.42
 
0.23
     
112,901
 
39.63
 
0.37
 
Certificates of deposit
   
101,801
 
37.60
 
1.35
     
114,876
 
40.82
 
1.48
     
121,858
 
42.78
 
1.78
 
                                                 
Total deposits
 
$
270,715
 
100.00
%
0.66
%
 
281,401
 
100.00
%
0.76
%
 
284,865
 
100.00
%
0.93
 



 
20 

 

The following table sets forth certificates of deposit classified by interest rate categories as of the dates indicated.

     
At June 30,
     
2014
 
2013
 
2012
     
Amount
     
Percent
of Total
 
Amount
     
Percent
of Total
 
Amount
     
Percent
of Total
     
(Dollars in thousands)
 
Interest Rate:
                                                 
Under - 1.00%
   
$
57,698
     
58.56
%
 
$
54,101
     
49.21
%
 
$
46,094
     
38.52
%
1.00% - 1.99%      
19,758
     
20.05
     
31,737
     
28.86
     
44,694
     
37.35
 
2.00% - 2.99%      
7,618
     
7.73
     
9,575
     
8.71
     
10,728
     
8.97
 
3.00% - 3.99%      
6,055
     
6.15
     
6,774
     
6.16
     
7,225
     
6.04
 
4.00% - 4.99%      
1,188
     
1.21
     
1,414
     
1.29
     
3,177
     
2.65
 
5.00% - 5.99%      
6,211
     
6.30
     
6,347
     
5.77
     
7,712
     
6.45
 
6.00%+          
-
     
-
     
-
     
-
     
26
     
0.02
 
Total
   
$
98,528
     
100.00
%
 
$
109,948
     
100.00
%
 
$
119,656
     
100.00
%


The following table sets forth the amount and maturities of certificates of deposit at June 30, 2014.

     
Amount Due
 
     
Year Ended June 30,
 
     
2015
   
2016
   
2017
   
2018
   
2019
   
After
June 30,
2019
   
Total
 
     
(Dollars in thousands)
 
Interest Rate:
                                           
Under - 1.00%
    $ 48,655     $ 8,506     $ 536     $ -     $ -     $ 1     $ 57,698  
1.00% - 1.99%       7,195       2,964       5,764       1,872       1,323       640       19,758  
2.00% - 2.99%       878       4,089       1,478       -       -       1,173       7,618  
3.00% - 3.99%       3,302       2,071       -       82       282       318       6,055  
4.00% - 4.99%     204       90       -       727       167       -       1,188  
5.00% - 5.99%       1,908       1,338       1,376       834       755       -       6,211  
6.00%+         -       -       -       -       -       -       -  
Total
    $ 62,142     $ 19,058     $ 9,154     $ 3,515     $ 2,527     $ 2,132     $ 98,528  



 
21 

 

The following table shows the amount of the Company’s certificates of deposit of $100,000 or more by time remaining until maturity as of June 30, 2014.

     
Certificates
of Deposit
 
     
(In thousands)
 
 
Remaining Time Until Maturity:
       
 
  Within three months
 
$
5,910
 
 
  Three through six months
   
19,826
 
 
  Six through twelve months
   
12,529
 
 
  Over twelve months
   
3,510
 
 
       Total
 
$
41,775
 

Borrowings. To supplement our deposits as a source of funds for lending or investment, we have borrowed funds in the form of advances from the Federal Home Loan Bank of New York.  At June 30, 2014, our collateralized borrowing limit with the Federal Home Loan Bank was $69.5 million and our outstanding borrowings with the Federal Home Loan Bank totaled $30.0 million. Information regarding our total borrowings as of June 30, 2014 is set forth in the following table.

    
At June 30, 2014
   
Balance
 
Rate
 
Maturity
 
(Dollars in thousands)
     
Total Borrowings:
             
Three year fixed rate  advance
 
$
5,000
 
0.780%
 
February 2016
Three year fixed rate  advance
 
$
5,000
 
0.780%
 
March 2016
Ten year fixed rate convertible advance
 
$
10,000
 
3.272%
 
November 2017
Ten year fixed rate convertible advance
 
$
10,000
 
3.460%
 
March 2018

In addition, the Bank had an $8.0 million overnight advance with the Federal Home Loan Bank of New York as of June 30, 2014 and did not have any overnight borrowings with the Federal Home Loan Bank as of June 30, 2013.

Advances from the Federal Home Loan Bank of New York are typically secured by the Federal Home Loan Bank stock and a portion of our residential mortgage loans and by other assets, mainly securities which are obligations of or guaranteed by the U.S. government. Additional information regarding our borrowings is included under Note 9 to our consolidated financial statements beginning on page F-1.

Subsidiary Activity

The Company has no direct subsidiaries other than the Bank. The Bank has one wholly owned subsidiary, Millington Savings Service Corp., formed in 1984. The service corporation is currently inactive.

Regulation and Supervision

The Bank and the Company operate in a highly regulated industry. This regulation establishes a comprehensive framework of activities in which they may engage and is intended primarily for the protection of the Deposit Insurance Fund and depositors. Set forth below is a brief description of certain
 
 
22

 
 
 
laws that relate to the regulation of the Bank and the Company. The description does not purport to be complete and is qualified in its entirety by reference to applicable laws and regulations.

Regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on operations, the classification of assets and the adequacy of the allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, including changes in the regulations governing mutual holding companies, could have a material adverse impact on the Company and the Bank. The adoption of regulations or the enactment of laws that restrict the operations of the Bank and/or the Company or impose burdensome requirements upon one or both of them could reduce their profitability and could impair the value of the Bank’s franchise, resulting in negative effects on the trading price of the Company’s common stock.

Holding Company Regulation

General.  The Company is a savings and loan holding company within the meaning of Section 10 of the HOLA.  As a result of the Dodd-Frank Act, it is now required to file reports with the Federal Reserve and is subject to regulation and examination by the Federal Reserve, as successor to the OTS.  The Company must also obtain regulatory approval from the Federal Reserve before engaging in certain transactions, such as mergers with or acquisitions of other financial institutions.  In addition, the Federal Reserve has enforcement authority over the Company and any non-savings institution subsidiaries.  This permits the Federal Reserve to restrict or prohibit activities that it determines to be a serious risk to the Bank.  This regulation is intended primarily for the protection of the depositors and not for the benefit of stockholders of the Company.

The Federal Reserve has indicated that, to the greatest extent possible taking into account any unique characteristics of savings and loan holding companies and the requirements of the HOLA, it intends to apply its current supervisory approach to the supervision of bank holding companies to savings and loan holding companies.  The stated objective of the Federal Reserve is to ensure the savings and loan holding company and its non-depository subsidiaries are effectively supervised and can serve as a source of strength for, and do not threaten the safety and soundness of the subsidiary depository institutions.  The Federal Reserve has generally adopted the substantive provisions of former OTS regulations governing savings and loan holding companies on an with certain modifications as discussed below.

Activities Restrictions.  As a savings and loan holding company and as a subsidiary holding company of a mutual holding company, the Company is subject to statutory and regulatory restrictions on its business activities.  The non-banking activities of the Company and its non-savings institution subsidiaries are restricted to certain activities specified by the Federal Reserve regulation, which include performing services and holding properties used by a savings institution subsidiary, activities authorized for savings and loan holding companies as of March 5, 1987 and non-banking activities permissible for bank holding companies pursuant to the Bank Holding Company Act of 1956, as amended, or authorized for financial holding companies pursuant to the Gramm-Leach-Bliley Act.  Before engaging in any non-banking activity or acquiring a company engaged in any such activities, the Company must file with the Federal Reserve either a prior notice or (in the case of non-banking activities permissible for bank holding companies) an application regarding its planned activity or acquisition.  Under the Dodd-Frank Act, a savings and loan holding company may only engage in activities authorized for financial holding companies if they meet all of the criteria to qualify as a financial holding company. Accordingly, the Federal Reserve will require savings and loan holding companies to elect to be treated as financial holding companies in order to engage in financial holding company activities.  In order to make such an election, the savings and loan holding company and its depository institution subsidiaries must be well capitalized and well managed.
 
 
23

 

 
Mergers and Acquisitions.  The Company must obtain approval from the Federal Reserve before acquiring, directly or indirectly, 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.  Federal law also prohibits a savings and loan holding company from acquiring more than 5% of a company engaged in activities other than those authorized for savings and loan holding companies by federal law; or acquiring or retaining control of a depository institution that is not insured by the FDIC.  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 insurance funds, the convenience and the needs of the community and competitive factors.

Waivers of Dividends by MSB Financial MHC.  OTS policies had permitted mutual holding companies to waive the receipt of dividends and, when permitted, the MHC had waived the receipt of dividends from the Company.  However, under current Federal Reserve regulations, any notice of waiver of dividends must include a board resolution together with any supporting materials relied upon by the MHC board to conclude that the dividend waiver is consistent with the board’s fiduciary duties.  The resolution must include; (i) a description of the conflict of interest that exists because of a MHC director’s ownership of stock in the subsidiary declaring the dividend and any actions taken to eliminate the conflict of interest, such as a waiver by the directors of their right to receive dividends; (ii) a finding by the MHC that the waiver is consistent with its fiduciary duties despite any conflict of interest; (iii) an affirmation that the MHC is able to meet the terms of any loan agreement for which the stock of the subsidiary is pledged or to which the MHC is subject; and (iv) any affirmation that  a majority of the MHC’s members have approved a waiver of dividends within the past 12 months and that the proxy statement used for such vote included certain disclosures.  The MHC did not waive any dividends during the year ended June 30, 2014.

 Conversion of the MHC to Stock Form.  Federal regulations permit the MHC to convert from the mutual form of organization to the capital stock form of organization, commonly referred to as a second step conversion.  In a second step conversion a new holding company would be formed as a successor to the Company, the MHC’s corporate existence would end and certain depositors of the Bank would receive the right to subscribe for shares of the new holding company.  In a second step conversion, each share of common stock held by stockholders other than the MHC would be automatically converted into a number of shares of common stock of the new holding company determined pursuant to an exchange ratio that ensures that the Company’s stockholders own the same percentage of common stock in the new holding company as they owned in the Company immediately prior to the second step conversion.   The total number of shares held by the Company’s stockholders after a second step conversion also would be increased by any purchases by the Company’s stockholders in the stock offering of the new holding company conducted as part of the second step conversion.

Under the Dodd-Frank Act, waived dividends must be taken into account in determining the appropriate exchange ratio for a second-step conversion of a mutual holding company unless the mutual holding company has waived dividends prior to December 1, 2009.

Acquisition of Control.  Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve if any person (including a company), or group acting in concert, seeks to acquire “control” of a savings and loan holding company.  An acquisition of “control” can occur upon the acquisition of 10% or more of the voting stock of a savings and loan holding company or as otherwise defined by the Federal Reserve.  Under the Change in Bank Control Act, the Federal Reserve has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial
 
 
24

 
 
 
and managerial resources of the acquirer and the anti-trust effects of the acquisition.  Any company that so acquires control is then subject to regulation as a savings and loan holding company.

Regulation of the Bank

General. As a New Jersey chartered, FDIC-insured bank, the Bank is regulated by the New Jersey Department of Banking and Insurance and the FDIC. The Bank’s operations are subject to extensive regulation, including restrictions or requirements with respect to loans to one borrower, the percentage of non-mortgage loans or investments to total assets, capital distributions, permissible investments and lending activities, liquidity, transactions with affiliates and community reinvestment. The Bank must file regulatory reports concerning its activities and financial condition, and must obtain regulatory approvals prior to entering into certain transactions, such as mergers with or acquisitions of other financial institutions. The New Jersey Department of Banking and Insurance and the Federal Deposit Insurance Corporation regularly examine the Bank and prepare reports to the Bank’s Board of Directors on deficiencies, if any, found in its operations. The regulatory authorities have substantial discretion to impose enforcement action on an institution that fails to comply with applicable regulatory requirements, particularly with respect to its capital requirements.

Federal Deposit Insurance. The Bank’s deposits are insured to applicable limits by the FDIC.  The maximum deposit insurance amount is $250,000.  The FDIC has adopted a risk-based premium system that provides for quarterly assessments based on an insured institution’s ranking in one of four risk categories based on their examination ratings and capital ratios.  The assessment base is the institution’s average consolidated assets less average tangible equity.  Insured banks with more than $1.0 billion in assets must calculate quarterly average assets based on daily balances while smaller banks and newly chartered banks may use weekly averages.  In the case of a merger, the average assets of the surviving bank for the quarter must include the average assets of the merged institution for the period in the quarter prior to the merger. Average assets would be reduced by goodwill and other intangibles.  Average tangible equity equals Tier 1 capital. For institutions with more than $1.0 billion in assets average tangible equity must be calculated on a weekly basis while smaller institutions may use the quarter-end balance.  The base assessment rate for insured institutions in Risk Category I range from 5 to 9 basis points and for institutions in Risk Categories II, III, and IV, the base assessment rate is 14, 23 and 35 basis points, respectively.  An institution’s assessment rate is reduced based on the amount of its outstanding unsecured long-term debt and for institutions in Risk Categories II, III and IV may be increased based on their brokered deposits.

In addition, all FDIC-insured institutions are required to pay assessments to the FDIC to fund interest payments on bonds issued by the Financing Corporation (“FICO”), an agency of the Federal government established to recapitalize the Federal Savings and Loan Insurance Corporation.  The FICO assessment rates, which are determined quarterly, averaged 0.62 basis points of insured deposits on an annualized basis in fiscal year 2014.  These assessments will continue until the FICO bonds mature in 2017.

Regulatory Capital Requirements.  Federal Deposit Insurance Corporation capital regulations require savings institutions to meet three minimum capital standards: (1) tangible capital equal to 1.5% of total adjusted assets, (2) “Tier 1” or “core” capital equal to at least 4% (3% if the institution has received the highest possible rating on its most recent examination) of total adjusted assets, and (3) risk-based capital equal to 8% of total risk-weighted assets. At June 30, 2014, the Bank was in compliance with the minimum capital standards and qualified as “well capitalized.”  For the Bank’s compliance with these regulatory capital standards, see Note 14 to the consolidated financial statements. In assessing an institution’s capital adequacy, the Federal Deposit Insurance Corporation takes into consideration not
 
 
25

 
 
only these numeric factors but also qualitative factors, and has the authority to establish higher capital requirements for individual institutions where necessary.
 
The Federal Deposit Insurance Corporation may require any savings institution that has a risk-based capital ratio of less than 8%, a ratio of Tier 1 capital to risk-weighted assets of less than 4% or a ratio of Tier 1 capital to total adjusted assets of less than 4% (3% if the institution has received the highest rating on its most recent examination) to take certain action to increase its capital ratios. If the savings institution’s capital is significantly below the minimum required levels of capital or if it is unsuccessful in increasing its capital ratios, the institution’s activities may be restricted.

For purposes of the capital regulations, tangible capital is defined as core capital less all intangible assets except for certain mortgage servicing rights. Tier 1 or core capital is defined as common stockholders’ equity, non-cumulative perpetual preferred stock and related surplus, minority interests in the equity accounts of consolidated subsidiaries, and certain non-withdrawable accounts and pledged deposits of mutual Banks. The Bank does not have any non-withdrawable accounts or pledged deposits. Tier 1 and core capital are reduced by an institution’s intangible assets, with limited exceptions for certain mortgage and non-mortgage servicing rights and purchased credit card relationships. Both core and tangible capital are further reduced by an amount equal to the savings institution’s debt and equity investments in “non-includable” subsidiaries engaged in activities not permissible for national banks other than subsidiaries engaged in activities undertaken as agent for customers or in mortgage banking activities and subsidiary depository institutions or their holding companies.

The risk-based capital standard for savings institutions requires the maintenance of total capital of 8% of risk-weighted assets. Total capital equals the sum of core and supplementary capital. The components of supplementary capital include, among other items, cumulative perpetual preferred stock, perpetual subordinated debt, mandatory convertible subordinated debt, intermediate-term preferred stock, the portion of the allowance for loan losses not designated for specific loan losses and up to 45% of unrealized gains on equity securities. The portion of the allowance for loan and lease losses includable in supplementary capital is limited to a maximum of 1.25% of risk-weighted assets. Overall, supplementary capital is limited to 100% of core capital. For purposes of determining total capital, a savings institution’s assets are reduced by the amount of capital instruments held by other depository institutions pursuant to reciprocal arrangements and by the amount of the institution’s equity investments (other than those deducted from core and tangible capital) and its high loan-to-value ratio land loans and non-residential construction loans.

A savings institution’s risk-based capital requirement is measured against risk-weighted assets, which equal the sum of each on-balance-sheet asset and the credit-equivalent amount of each off-balance-sheet item after being multiplied by an assigned risk weight. These risk weights range from 0% for cash to 100% for delinquent loans, property acquired through foreclosure, commercial loans, and certain other assets.

Qualified Thrift Lender Test. Savings institutions must meet a qualified thrift lender test or they become subject to the business activity restrictions and branching rules applicable to national banks. To qualify as a qualified thrift lender, a savings institution must either (i) be deemed a “domestic building and loan association” under the Internal Revenue Code by maintaining at least 60% of its total assets in specified types of assets, including cash, certain government securities, loans secured by and other assets related to residential real property, educational loans and investments in premises of the institution or (ii) satisfy the statutory qualified thrift lender test set forth in the Home Owners’ Loan Act by maintaining at least 65% of its portfolio assets in qualified thrift investments (defined to include residential mortgages and related equity investments, certain mortgage-related securities, small business loans, student loans and credit card loans). For purposes of the statutory qualified thrift lender test, portfolio assets are defined
 
 
26

 
 
 
as total assets minus goodwill and other intangible assets, the value of property used by the institution in conducting its business, and specified liquid assets up to 20% of total assets. A savings institution must maintain its status as a qualified thrift lender on a monthly basis in at least nine out of every twelve months. The Bank met the qualified thrift lender test as of June 30, 2014 and in each of the last twelve months and, therefore, qualifies as a qualified thrift lender.
 
A bank that fails the qualified thrift lender test and does not convert to a bank charter generally will be prohibited from:  (1) engaging in any new activity not permissible for a national bank, (2) paying dividends not permissible under national bank regulations, and (3) establishing any new branch office in a location not permissible for a national bank in the institution’s home state. In addition, if the institution does not requalify under the qualified thrift lender test within three years after failing the test, the institution would be prohibited from engaging in any activity not permissible for a national bank and would have to repay any outstanding advances from the Federal Home Loan Bank as promptly as possible.

Community Reinvestment Act. Under the Community Reinvestment Act, every insured depository institution, including the Bank, has a continuing and affirmative obligation consistent with its safe and sound operation to help meet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act 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. The Community Reinvestment Act requires the depository institution’s record of meeting the credit needs of its community to be assessed and taken into account in the evaluation of certain applications by such institution, such as a merger or the establishment of a branch office by the Bank. An unsatisfactory Community Reinvestment Act examination rating may be used as the basis for the denial of an application. The Bank received a “satisfactory” rating in its most recent Community Reinvestment Act examination.
 
Federal Home Loan Bank System. The Bank is a member of the Federal Home Loan Bank of New York, which is one of twelve regional federal home loan banks. Each Federal Home Loan Bank serves as a reserve or central bank for its members within its assigned region. It is funded primarily from funds deposited by financial institutions and proceeds derived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes loans to members pursuant to policies and procedures established by its board of directors.

As a member, the Bank is required to purchase and maintain stock in the Federal Home Loan Bank of New York in an amount equal to the greater of 1% of its aggregate unpaid residential mortgage loans, home purchase contracts or similar obligations at the beginning of each year or 5% of its outstanding Federal Home Loan Bank advances.   The FHLB imposes various limitations on advances such as limiting the amount of certain types of real estate related collateral to 30% of a member’s capital and limiting total advances to a member.

The Federal Home Loan Banks are required to provide funds for the resolution of troubled savings institutions and to contribute to affordable 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 Federal Home Loan Bank dividends paid and could continue to do so in the future. In addition, these requirements could result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members.

 
27

 


Changes to Regulatory Capital Requirements

In July 2013, the federal banking agencies approved amendments to their regulatory capital rules to conform them with the international regulatory standards agreed to by the Basel Committee on Banking Supervision in the accord often referred to as “Basel III”.  The revisions establish new higher capital ratio requirements, tighten the definitions of capital, impose new operating restrictions on banking organizations with insufficient capital buffers and increase the risk weighting of certain assets including residential mortgages. The new capital requirements apply to all banks and savings associations, bank holding companies with more than $500 million in assets and all savings and loan holding companies regardless of asset size. The rules became effective for institutions with over $250 billion in assets and internationally active institutions starting in January 2014 and will become effective for all other institutions beginning in January 2015.  The following discussion summarizes the changes that are most likely to affect the Company and the Bank.

New and Higher Capital Requirements.  The regulations establish a new capital measure called “Common Equity Tier 1 Capital” which will consist of common stock instruments and related surplus (net of treasury stock), retained earnings, accumulated other comprehensive income and, subject to certain adjustments, minority common equity interests in subsidiaries.  Unlike the current rules which exclude unrealized gains and losses on available-for-sale debt securities from regulatory capital, the rules would generally require accumulated other comprehensive income to flow through to regulatory capital.  Depository institutions and their holding companies would be required to maintain Common Equity Tier 1 Capital equal to 4.5% of risk-weighted assets by 2015.

The regulations increase the required ratio of Tier 1 Capital to risk-weighted assets from the current 4% to 6% by 2015. Tier 1 Capital would consist of Common Equity Tier 1 Capital plus Additional Tier 1 Capital elements which would include non-cumulative perpetual preferred stock.  Cumulative preferred stock (other than cumulative preferred stock issued to the U.S. Treasury under the TARP Capital Purchase Program or the Small Business Lending Fund) will no longer qualify as Additional Tier 1 Capital.  Trust preferred securities and other non-qualifying capital instruments issued prior to May 19, 2010 by bank and savings and loan holding companies with less than $15 billion in assets as of December 31, 2009, or by mutual holding companies may continue to be included in Tier 1 Capital but will be phased out over 10 years beginning in 2016 for all other banking organizations.  These elements, however, could be included in Tier 2 Capital which could also include qualifying subordinated debt.  The regulations also require a minimum Tier 1 leverage ratio of 4% for all institutions eliminating the 3% option for institutions with the highest supervisory ratings.  The minimum required ratio of total capital to risk-weighted assets would remain at 8%.

Capital Buffer Requirement. In addition to higher capital requirements, depository institutions and their holding companies will be required to maintain a capital buffer of at least 2.5% of risk-weighted assets over and above the minimum risk-based capital requirements.  Institutions that do not maintain the required capital buffer will become subject to progressively more stringent limitations on the percentage of earnings that can be paid out in dividends or used for stock repurchases and on the payment of discretionary bonuses to senior executive management.  The capital buffer requirement will be phased in over four years beginning in 2016.  The capital buffer requirement effectively raises the minimum required risk-based capital ratios to 7% Common Equity Tier 1 Capital, 8.5% Tier 1 Capital and 10.5% Total Capital on a fully phased-in basis.

Changes to Prompt Corrective Action Capital Categories.  The Prompt Corrective Action rules have been amended to incorporate a Common Equity Tier 1 Capital requirement and to raise the capital requirements for certain capital categories.  In order to be adequately capitalized for purposes of the prompt corrective action rules, a banking organization will be required to have at least an 8% Total Risk-
 
 
28

 
 
 
Based Capital Ratio, a 6% Tier 1 Risk-Based Capital Ratio, a 4.5% Common Equity Tier 1 Risk Based Capital Ratio and a 4% Tier 1 Leverage Ratio.  To be well capitalized, a banking organization will be required to have at least a 10% Total Risk-Based Capital Ratio, an 8% Tier 1 Risk-Based Capital Ratio, a 6.5% Common Equity Tier 1 Risk Based Capital Ratio and a 5% Tier 1 Leverage Ratio.

Additional Deductions from Capital. Banking organizations will be required to deduct goodwill and other intangible assets (other than certain mortgage servicing assets), net of associated deferred tax liabilities, from Common Equity Tier 1 Capital.  Deferred tax assets arising from temporary timing differences that could not be realized through net operating loss carrybacks would continue to be deducted but deferred tax assets that could be realized through NOL carrybacks would not be deducted but would be subject to 100% risk weighting.  Defined benefit pension fund assets, net of any associated deferred tax liability, will be deducted from Common Equity Tier 1 Capital unless the banking organization has unrestricted and unfettered access to such assets.  Reciprocal cross-holdings of capital instruments in any other financial institutions will now be deducted from capital, not just holdings in other depository institutions.  For this purpose, financial institutions are broadly defined to include securities and commodities firms, hedge and private equity funds and non-depository lenders.  Banking organizations will also be required to deduct non-significant investments (less than 10% of outstanding stock) in other financial institutions to the extent these exceed 10% of Common Equity Tier 1 Capital subject to a 15% of Common Equity Tier 1 Capital cap.  Greater than 10% investments must be deducted if they exceed 10% of Common Equity Tier 1 Capital.  If the aggregate amount of certain items excluded from capital deduction due to a 10% threshold exceeds 17.65% of Common Equity Tier 1 Capital, the excess must be deducted.  Savings associations will continue to be required to deduct investments in subsidiaries engaged in activities not permitted for national banks.

Changes in Risk-Weightings.  The federal banking agencies did not adopt a proposed regulation that would have significantly changed the risk-weighting for residential mortgages.  However, the regulations do apply a 250% risk-weighting to mortgage servicing rights, deferred tax assets that cannot be realized through NOL carrybacks and significant (greater than 10%) investments in other financial institutions. The regulations also create a new 150% risk-weighting category for “high volatility commercial real estate loans” which are credit facilities for the acquisition, construction or development of real property other than one- to four-family residential properties or commercial real projects where: (i) the loan-to-value ratio is not in excess of interagency real estate lending standards; and (ii) the borrower has contributed capital equal to not less than 15% of the real estate’s “as completed” value before the loan was made.


 
29

 

Item 1A. Risk Factors

Not applicable as the Company is a “smaller reporting company.”

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

At June 30, 2014, our investment in property and equipment, net of depreciation and amortization, totaled $8.5 million, including leasehold improvements and construction in progress. The following table lists our offices.

 
Office Location
 
Year Facility
Opened
 
Leased or
Owned
         
Millington Main Office
1902 Long Hill Road
Millington, NJ
 
1994
(1)
 
Owned
Dewy Meadow Branch Office
415 King George Road
Basking Ridge, NJ
 
2002
   
Leased
RiverWalk Branch Office
675 Martinsville Road
Basking Ridge, NJ
 
2005
(2)
 
Leased
Martinsville Branch Office
1924 Washington Valley Road
Martinsville, NJ
 
2006
   
Leased
Bernardsville Branch Office
122 Morristown Road
Bernardsville, NJ
 
2008
   
Owned

__________________
(1)
The Bank’s main office opened in 1911 in Millington, New Jersey. The Bank moved into its current main office in 1994.
(2)
The Bank’s first branch office opened in 1998 in Liberty Corner, New Jersey. This office was relocated in 2005.


Item 3. Legal Proceedings

The Bank, from time to time, is a party to routine litigation which arises in the normal course of business, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans, and other issues incident to our business. There were no lawsuits pending or known to be contemplated against the Company or the Bank at June 30, 2014 that would have a material effect on operations or income.


Item 4. Mine Safety Disclosures

Not applicable.

 
30

 
 
 
PART II

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Purchases of Equity Securities

(a)           Market Information. The Company’s common stock trades on the NASDAQ Stock Market under the symbol “MSBF”. The table below shows the reported high and low closing prices of common stock reported by NASDAQ and dividends declared during the periods indicated.

   
High
   
Low
   
Dividends
 
                   
2013
                 
 Quarter ended September 30, 2012
  $ 6.09     $ 5.25     $ -  
 Quarter ended December 31, 2012
  $ 7.34     $ 4.26     $ -  
 Quarter ended March 31, 2013
  $ 7.72     $ 6.50     $ -  
 Quarter ended June 30, 2013
  $ 7.88     $ 6.06     $ -  
                         
2014
                       
 Quarter ended September 30, 2013
  $ 7.86     $ 7.01     $ -  
 Quarter ended December 31, 2013
  $ 8.82     $ 7.01     $ -  
 Quarter ended March 31, 2014
  $ 9.10     $ 7.00     $ -  
 Quarter ended June 30, 2014
  $ 8.30     $ 7.87     $ -  


Dividends. Declarations of dividends by the Board of Directors depend on a number of factors, including investment opportunities, growth objectives, financial condition, profitability, tax considerations, minimum capital requirements, regulatory limitations, and general economic as well as stock market conditions. The timing, frequency and amount of dividends are determined by the Board of Directors.

Stockholders. As of September 19, 2014, there were approximately 528 shareholders of record of the Company’s common stock. This number does not include brokerage firms, banks and registered clearing agents acting as nominees for an indeterminate number of beneficial (“street name”) owners.
 

(b)
Use of Proceeds.
 
 
Not applicable.

(c)  
Issuer Purchases of Equity Securities.


 
31 

 

Treasury stock repurchases during the fourth quarter of fiscal year 2014 for the Company were as follows:

           
Total number of shares
 
Maximum number of
           
Purchased as part of
 
Shares that may be
   
Total number of
 
Average price
 
Publicly announced
 
Purchased under the
Period
 
shares purchased
 
paid per share
 
plans or programs
 
plans or programs
April, 2014
 
-
 
$
-
 
-
 
59,837
May, 2014
 
-
   
-
 
-
 
59,837
June, 2014
 
-
   
-
 
-
 
59,837
         
-
       
Total
 
-
 
$
-
 
-
   

Item 6. Selected Financial Data

Not applicable as the Company is a smaller reporting company.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis reflects the Company’s consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. You should read the information in this section in conjunction with the Company’s consolidated financial statements and accompanying notes thereto beginning on page F-1 following Item 15 of this Form 10-K.

Overview

Our primary business is attracting retail deposits from the general public and using those deposits, together with funds generated from operations, principal repayments on securities and loans and borrowed funds, for our lending and investing activities. Our loan portfolio consists of one-to-four-family residential real estate mortgages, commercial real estate mortgages, construction loans, commercial and industrial loans, home equity loans and lines of credit, and other consumer loans. We also invest in U.S. Government obligations and mortgage-backed securities and, to a lesser extent, corporate bonds.

We reported net income of $988,000 for the fiscal year ended June 30, 2014 as compared to a net loss of $1.4 million for fiscal 2013.

Net interest income for fiscal 2014 was up approximately $259,000 or 2.8% as compared to fiscal 2013.   Non-interest expense decreased by $131,000 or 1.6%, while non-interest income increased by $74,000 or 11.4% for the same comparative period.  The net interest rate spread decreased in fiscal 2014 to 2.86%, compared to 2.90% for fiscal 2013, mainly as a result of a lower interest rate environment.  For the year ended June 30, 2014, interest income decreased by $40,000 or 0.3% while interest expense decreased by $299,000 or 11.0% as compared to fiscal 2013.

Total assets were $345.2 million at June 30, 2014, a 2.1% decrease compared to $352.6 million at June 30, 2013. The decrease in assets occurred primarily as the result of a $17.4 million decrease in cash and cash equivalent balances, offset in part by a $7.0 million increase in loans receivable, net and a $4.0 million increase in securities held to maturity.  Deposits were $263.4 million at June 30, 2014, compared to $280.5 million at June 30, 2013.  FHLB advances were $38.0 million at June 30, 2014 compared to $30.0 million at June 30, 2013.
 
 
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Stockholders’ equity at June 30, 2014 was $40.8 million compared to our stockholders’ equity at the prior fiscal year-end of $39.5 million. The Company had net income of $988,000 for the fiscal year ended June 30, 2014.   The increase in paid in capital of $143,000 was related primarily to the recognition of stock based compensation expense, while the unallocated common stock held by ESOP decreased by $168,000.  The accumulated other comprehensive loss balance increased by $2,000 for the year ended June 30, 2014, while treasury stock remained unchanged for both  comparative fiscal year end dates.  Our return on average equity for fiscal 2014 was 2.46% compared to (3.45%) for fiscal 2013.

The Company experienced a reduction in deposits during the year ended June 30, 2014, primarily due to an extended low interest rate environment.  Cash and cash equivalents decreased by $17.4 million or 70.5% and deposits decreased by $17.1 million or 6.1%, while loans receivable, net, and investment securities held to maturity increased by $7.0 million or 3.1% and $4.0 million or 5.0%, respectively.  The Company’s borrowings increased by $8.0 million or 26.7% as of June 30, 2014 compared to June 30, 2013.

Critical Accounting Policies

Our accounting policies are integral to understanding the results reported and are described in Note 2 to our consolidated financial statements beginning on page F-1. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the dates of the consolidated statements of financial condition and revenues and expenses for the periods then ended. Actual results could differ significantly from those estimates. A material estimate that is particularly susceptible to significant change relates to the determination of the allowance for loan losses.

The allowance for loan losses is established through provisions for loan losses charged against income. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance.

The allowance for loan losses is maintained at a level by management which represents the evaluation of known and inherent risks in the loan portfolio at the consolidated balance sheet date that are both probable and reasonable to estimate. Management’s periodic evaluation of the adequacy of the allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions, and other relevant factors. This evaluation is inherently subjective, as it requires material estimates that may be susceptible to significant change, including the amounts and timing of future cash flows expected to be received on impaired loans.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses based on their judgments about information available to them at the time of their examinations.

The allowance calculation methodology includes segregation of the total loan portfolio into segments. The Company’s loans receivable portfolio is comprised of the following segments: residential mortgage, commercial real estate, construction, consumer and, commercial and industrial. Some segments of the Company’s loan receivable portfolio are further disaggregated into classes which allows management to better monitor risk and performance.
 
 
33

 
 
The residential mortgage loan segment is disaggregated into two classes: one-to four-family loans, which are primarily first liens, and home equity loans, which consist of first and second liens.  The commercial real estate loan segment consists of both owner and non-owner occupied loans which have medium risk due to historical activity on these type loans.  The construction loan segment is further disaggregated into two classes: one-to four-family owner occupied, which includes land loans, whereby the owner is known and there is less risk, and other, whereby the property is generally under development and tends to have more risk than the one-to four-family owner occupied loans.  The commercial and industrial loan segment consists of loans made for the purpose of financing the activities of commercial customers. The majority of commercial and industrial loans are secured by real estate and thus carry a lower risk than traditional commercial and industrial loans.  The consumer loan segment consists primarily of installment loans (direct and indirect) and overdraft lines of credit connected with customer deposit accounts.  

The allowance consists of specific, general and unallocated components. The specific component is related to loans that are classified as impaired.  For loans classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class and is based on historical loss experience adjusted for qualitative factors. These qualitative risk factors include:

 
1.
Lending policies and procedures, including underwriting standards and collection, charge-off, and recovery practices.
 
2.
National, regional, and local economic and business conditions as well as the condition of various market segments, including the value of underlying collateral for collateral dependent loans.
 
3.
Nature and volume of the portfolio and terms of loans.
 
4.
Experience, ability, and depth of lending management and staff.
 
5.
Volume and severity of past due, classified and nonaccrual loans as well as and other loan modifications.
 
6.
Quality of the Company’s loan review system, and the degree of oversight by the Company’s Board of Directors.
 
7.
Existence and effect of any concentrations of credit and changes in the level of such concentrations.
 
8.
Effect of external factors, such as competition and legal and regulatory requirements.
 
Each factor is assigned a value to reflect improving, stable or declining conditions based on management’s best judgment using relevant information available at the time of the evaluation.

The unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

Management evaluates individual loans in all of the loan segments (including loans in residential mortgage and consumer segments) for possible impairment if the loan is either in nonaccrual status or is risk rated Substandard or worse or has been modified in a troubled debt restructuring.  A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due.  Loans that experience insignificant payment delays and payment shortfalls generally
 
 
34

 
 
are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the principal and interest owed.
 
Loans the terms of which are modified are classified as troubled debt restructurings if the Company grants such borrowers concessions and it is deemed that those borrowers are experiencing financial difficulty.  Concessions granted under a troubled debt restructuring generally involve a reduction in interest rate below market rate given the associated credit risk, or an extension of a loan’s stated maturity date. Non-accrual troubled debt restructurings are restored to accrual status if principal and interest payments, under the modified terms, are current for six consecutive months after modification.   Loans classified as troubled debt restructurings are designated as impaired until they are ultimately repaid in full or foreclosed and sold.
 
Once the determination has been made that a loan is impaired, impairment is measured by comparing the recorded investment in the loan to one of the following:(a) present value of expected cash flows (discounted at the loan’s effective interest rate), (b) loan’s observable market price or (c) fair value of collateral adjusted for expected selling costs.  The method is selected on a loan by loan basis with management primarily utilizing the fair value of collateral method.
 
The estimated fair values of the real estate collateral are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.
 
The estimated fair values of the non-real estate collateral, such as accounts receivable, inventory and equipment, are determined based on the borrower’s financial statements, inventory reports, accounts receivable agings or equipment appraisals or invoices. Indications of value from these sources are generally discounted based on the age of the financial information or the quality of the assets.

The evaluation of the need and amount of the allowance for impaired loans and whether a loan can be removed from impairment status is made on a quarterly basis.  The Company’s policy for recognizing interest income on impaired loans does not differ from its overall policy for interest recognition.

Comparison of Financial Condition at June 30, 2014 and 2013

General. Total assets were $345.2 million at June 30, 2014, compared to $352.6 million at June 30, 2013.  The Company experienced a $17.4 million or 70.5% decrease in cash and cash equivalent balances and a $1.1 million or 25.5% decrease in other asset balances, while loans receivable, net, and securities held to maturity balances increased by $7.0 million and $4.0 million or 3.1% and 5.0%, respectively.  Deposits decreased $17.1 million or 6.1%, while advances from the Federal Home Loan Bank of New York increased by $8.0 million of 26.7%.  The decrease in cash and cash equivalent balances was primarily due to the decrease in deposit balances, while the increase in loans receivable, net and securities held to maturity balances was primarily achieved through  increases in borrowings from the Federal Home Loan Bank of New York during this period.
 
 
35

 
 
Total assets decreased by $7.3 million or 2.1% between years, as did total liabilities by $8.6 million or 2.8%, and the ratio of average interest-earning assets to average-interest bearing liabilities increased to 114.09% for fiscal 2014 as compared to 109.33% for fiscal 2013.  Stockholders’ equity increased $1.3 million or 3.3% to $40.8 million at June 30, 2014 compared to $39.5 million at June 30, 2013.

Loans. Loans receivable, net, increased $7.0 million, or 3.1% from $223.3 million at June 30, 2013 to $230.3 million at June 30, 2014. As a percentage of assets, loans increased to 66.7% from 63.3%. The Company’s one-to-four family and construction loans grew by $6.6 million and $3.6 million or 4.8% and 40.7%, respectively, as did commercial and industrial and personal loans by $399,000 and $4,000, or 4.3% and 12.5%, respectively.  Correspondingly, home equity and commercial real estate loans decreased by $2.2 million and $135,000 or 5.4% and 0.4%, respectively, as did automobile, overdraft protection and deposit account loans decreased by $78,000, $14,000 and $9,000 or 70.3%, 8.0% and 1.5%, respectively, between June 30, 2013 and June 30, 2014.

Securities. Our portfolio of securities held to maturity was at $84.9 million at June 30, 2014 as compared to $80.9 million at June 30, 2013. Maturities, calls and principal repayments during the year totaled $4.3 million as compared to $41.6 million during the prior year. We purchased $8.4 million of new securities during the year ended June 30, 2014 compared to $71.8 million during the year ended June 30, 2013.

Deposits. Total deposits at June 30, 2014 were $263.4 million, a $17.1 million decrease as compared to $280.5 million at June 30, 2013. Demand deposits, in aggregate, increased by $4.5 million, and certificates of deposit accounts decreased by $11.4 million, while savings and club accounts decreased by $10.1 million.

Borrowings. Total borrowings were $38.0 million at June 30, 2014 compared to $30.0 million at June 30, 2013.  The Company borrowed $8.0 million in overnight funds at June 30, 2014 from the Federal Home Loan Bank of New York and did not have any short-term borrowings at June 30, 2013.  The Company did not repay any long term borrowings during the fiscal year ended June 30, 2014.

Equity. Stockholders’ equity was $40.8 million at June 30, 2014 compared to $39.5 million at June 30, 2013, an increase of $1.3 million or 3.3%. The Company had net income of $988,000 for the fiscal year ended June 30, 2014.  The increase in paid-in capital of $143,000 related primarily to recognition of stock based compensation expense, while the unallocated common stock held by ESOP decreased by $168,000.  The accumulated other comprehensive loss balance increased by $2,000 at  June 30, 2014 compared to  June 30, 2013, while treasury stock remained unchanged for the same comparative period end dates.

Comparison of Operating Results for the Two Years Ended June 30, 2014

General. Our results of operations depend primarily on our net interest income. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. It is a function of the average balances of loans and investments versus deposits and borrowed funds outstanding in any one period and the yields earned on those loans and investments and the cost of those deposits and borrowed funds. Our results of operations are also affected by our provision for loan losses, non-interest income and non-interest expense. Non-interest income includes service fees and charges, and income on bank owned life insurance. Non-interest expense includes salaries and employee benefits, occupancy and equipment expense and other general and administrative expenses such as service bureau fees and advertising costs.
 
 
36

 
 
The Company reported net income of $988,000 for the year ended June 30, 2014 compared to a net loss of $1.4 million for the year ended June 30, 2013, representing a $2.4 million or 171.3% increase.  This increase was primarily due to a decrease in the provision for loan losses, an increase in net interest income and non-interest income and, a decrease in non-interest expenses offset by an increase in income taxes for the year ended June 30, 2014, compared to the year ended June 30, 2013.
 
Net Interest Income. Net interest income for the year ended June 30, 2014 amounted to $9.6 million, 2.8% higher than net interest income for the year ended June 30, 2013 of $9.3 million. Interest income decreased by $40,000, or 0.3%, and interest expense decreased by $299,000 or 11.0% for the year ended June 30, 2014.

Average earning assets increased by $9.3 million or 3.0% for the year ended June 30, 2014, compared to the year ended June 30, 2013, while the average rate on earning assets decreased by 13 basis points to 3.72% for the year ended June 30, 2014, resulting in a decrease of $40,000 or 0.3% in total interest income compared to the year ended June 30, 2013. Interest income on loans decreased by $402,000 or 3.9% for the year ended June 30, 2014, compared to the year ended June 30, 2013, as a result of decreases in both the average yield on loans receivable and the average balance of loans outstanding.   The average yield decreased by 7 basis points to 4.32%. Average loans receivable balances decreased $5.6 million or 2.4% to $232.1 million for the year ended June 30, 2014, compared to $237.8 million for the year ended June 30, 2013. Interest income on securities held to maturity increased by $366,000 or 24.3% for the year ended June 30, 2014, compared to the year ended June 30, 2013. Average securities held to maturity balances increased $16.6 million or 24.0% for the year ended June 30, 2014, compared to the year ended June 30, 2013 and, the yield increased  1 basis point to 2.19% for the year ended June 30, 2014, compared to the year ended June 30, 2013. Interest income on other interest-earning assets decreased by $4,000 or 4.3% for the year ended June 30, 2014, compared to the year ended June 30, 2013 due to a $1.7 million or 28.3% decrease in average balance, offset by a 52 basis point increase in yield to 2.08%.

Total interest expense decreased $299,000 or 11.0% for the year ended June 30, 2014, compared to the year ended June 30, 2013. Average interest-bearing liabilities decreased $3.8 million or 1.3%, from $286.0 million for the year ended June 30, 2013, to $282.2 million for the year ended June 30, 2014, and the average rate on interest-bearing liabilities decreased by 9 basis points to 0.86 % for the year ended June 30, 2014, resulting in a decrease of $299,000 or 11.0% in total interest expense compared to the year ended June 30, 2013. Interest expense on deposits decreased $352,000 or 17.5% for the year ended June 30, 2014, compared to the year ended June 30, 2013, as a result of a 10 basis point reduction to 0.66% in the average rate on interest-bearing deposits, and a $13.6 million or 5.2% decrease in average balance of interest-bearing deposits. The average balance of NOW, super NOW and money market demand account balances increased $2.4 million or 6.6%, while the average balance of savings balances decreased $3.0 million or 2.7%, and the average balance of certificates of deposit decreased by $13.1 million or 11.4% for the year ended June 30, 2014 compared to the same period ended June 30, 2013. The average rate on savings and club deposits, NOW, super NOW and money market demand accounts and certificates of deposit decreased by 1 basis point, 1 basis point, and 13 basis points, respectively, for the year ended June 30, 2014 compared to the year ended June 30, 2013.  Total interest expense on FHLB advances was $767,000 for the year ended June 30, 2014 compared to $714,000 for the year ended June 30, 2013.  Average FHLB advances were $33.1 million for the year ended June 30, 2014 compared to $23.3 million for the year ended June 30, 2013, an increase of $9.8 million or 41.9%.  The average rate on FHLB advances decreased by 74 basis points to 2.32% for the year ended June 30, 2014 compared to the year ended June 30, 2013.

Our net interest rate spread was 2.86% for the year ended June 30, 2014 compared to 2.90% for the year ended June 30, 2013. The spread decreased during the year ended June 30, 2014 as our average
 
 
37

 
 
 
yield on interest-earning assets decreased by 13 basis points to 3.72% from 3.85%, offset in part by a decrease in the cost of interest-bearing liabilities of 9 basis points to 0.86% from 0.95%, compared to the same period ended June 30, 2013.

Provision for Loan Losses. The loan loss provision for the year ended June 30, 2014 was $600,000 compared to $4.0 million for the year ended June 30, 2013.  The provision for loan losses for the year ended June 30, 2013 included an additional provision of $2.0 million deemed necessary to support the Company’s planned asset disposition strategy approved by the Company’s Board of Directors during the quarter ended December 31, 2012, the goal of which was to rapidly reduce (through strategies such as short sales, cash for keys, deeds in lieu of foreclosure and/or bulk sales) the dollar amount of non-performing loans in the Company’s loan portfolio and thereby reduce the costs associated with the foreclosure process.  The Company’s management reviews the level of the allowance for loan losses on a quarterly basis based on a variety of factors including, but not limited to, (1) the risk characteristics of the loan portfolio, (2) current economic conditions, (3) actual losses previously experienced, (4) the Company’s level of loan growth and (5) the existing level of reserves for loan losses that are probable and estimable. This analysis resulted in a lower provision for loan loss being required for the year ended June 30, 2014.  The reduction in the level of provision for loan loss primarily reflects lower levels of specific reserves related to non-performing loans individually evaluated for impairment which continued to decrease as a result of various above mentioned disposition activities.  Also, there was a stabilization of the quantitative and qualitative factors during the twelve months ended June 30, 2014 compared to-upward-trending factors during the twelve period ended June 30, 2013, thus further reducing the need for additional provisions as of June 30, 2014.  The Company had $1.2 million in charge-offs and $57,000 in recoveries for the year ended June 30, 2014 compared to $2.9 million in charge-offs and $56,000 in recoveries for the year ended June 30, 2013.  The Company had $8.3 million in non-performing loans as of June 30, 2014, compared to $14.1 million as of June 30, 2013.  The allowance for loan losses as a percentage of total loans was 1.56% at June 30, 2014, compared to 1.87% at June 30, 2013, while the allowance for loan losses as a percentage of non-performing loans ratio increased from 30.30% at June 30, 2013 to 44.34% at June 30, 2014, due to decreases in total non-performing loans at June 30, 2014 compared to June 30, 2013.  Non-performing loans to total loans and net charge-offs to average loans outstanding ratios were 3.51% and 0.51%, respectively, at and for the year ended June, 30, 2014 compared to 6.16% and 1.19% at and for the year ended June 30, 2013.

Non-Interest Income. This category includes fees derived from checking accounts, ATM transactions, debit card use and mortgage related fees. It also includes increases in the cash-surrender value of our bank owned life insurance. Overall, non-interest income was $724,000 for the year ended June 30, 2014 compared to $650,000 for the year ended June 30, 2013, an increase of $74,000 or 11.4%.

Income from fees and service charges totaled $407,000 for the year ended June 30, 2014 compared to $329,000 for the year ended June 30, 2013, an increase of $78,000 or 23.7%.  The increase was due in part to an increase in certificate of deposit and demand deposit account services fees, an increase in ATM fees, and a $22,000 penalty fee received on the early prepayment of a mortgage-backed security that the Bank had held in its held to maturity investment portfolio.

The unrealized loss on the Bank’s trading security portfolio was $1,000 for the year ended June 30, 2013.  The Bank had liquidated its trading security portfolio during the year ended June 30, 2013.

Income on bank owned life insurance was $217,000  in each of the years ended June 30, 2014 and 2013.

Other non-interest income was $100,000 and $103,000 for the years ended June 30, 2014 and 2013, respectively.  The decrease was primarily attributable to a decrease in miscellaneous operating
 
 
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income, offset by an increase in income from late charges.
 
     Non-Interest Expenses. Total non-interest expenses decreased by $131,000 or 1.6% during the year ended June 30, 2014 and amounted to $8.2 million as compared to $8.3 million for the year ended June 30, 2013.

Other non-interest expense totaled $860,000 for the year ended June 30, 2014, compared to $983,000 for the year ended June 30, 2013, a decrease of $123,000 or 12.5%.  The decrease in other non-interest expense was primarily attributable to decreases in other real estate and non-operating expenses.  Salaries and employee benefits expense decreased by $75,000 or 1.9% to $3.8 million for the year ended June 30, 2014 compared to $3.9 million for the year ended June 30, 2013.  The decrease in salaries and employee benefits expense was primarily due a decrease in stock based compensation expense.  Occupancy and equipment expense decreased by $60,000 or 4.3% to $1.3 for the year ended June 30, 2014 compared to $1.4 million for the year ended June 30, 2013.  The decrease in occupancy and equipment expense was primarily due to a decrease in depreciation expense.  Directors’ compensation expense totaled $444,000 for the year ended June 30, 2014 compared to $495,000 for the year ended June 30, 2013, representing a reduction of $51,000 or 10.3%.  The decrease in directors’ compensation expense was primarily due a decrease in stock based compensation expense.  Advertising expense totaled $144,000 for the year ended June 30, 2014 compared to $162,000 for the year ended June 30, 2013, representing a reduction of $18,000 or 11.1%.  The decrease in advertising expense was attributable to a reduction in spending. FDIC assessment expense totaled $410,000 for the year ended June 30, 2014 compared to $291,000 for the year ended June 30, 2013, an increase of $119,000 or 40.9%.  The increase in FDIC assessment expense related to the increase in factors used in calculation of the assessment.  Service bureau fees increased by $73,000 or 13.2% to $626,000 for the year ended June 30, 2014 compared to $553,000 for the year ended June 30, 2013.  The increase in service bureau fees was related to the expansion of services.  Professional services expense increased slightly by $4,000 or 0.7% to $547,000 for the year ended June 30, 2014 compared to $543,000 for the year ended June 30, 2013.

Income Taxes. The income tax expense for the year ended June 30, 2014 was $548,000 or 35.7% of income before taxes as compared to a tax benefit of $987,000 or 41.6% of the reported loss before income taxes for the year ended June 30, 2013.

 
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Average Balance Sheet. The following tables set forth certain information for the years ended June 30, 2014, 2013 and 2012.  The average yields and costs are derived by dividing interest income and expense by the average daily balance of assets and liabilities, respectively, for the periods presented.