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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended March 31, 2017

OR

 

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

For the transition period from                      to                     

Commission File Number: 001-38065

 

 

PCSB Financial Corporation

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Maryland		81-4710738
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
2651 Strang Blvd, Suite 100 Yorktown Heights, NY		10598
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (914) 248-7272

 

 

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  ☐    No  ☒

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

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

 

Large accelerated filer		☐		Accelerated filer		☐
Non-accelerated filer		☒  (Do not check if a small reporting company)		Small reporting company		☐
				Emerging growth company		☒

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

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

18,165,110 shares of the Registrant’s common stock, par value $0.01 per share, were issued and outstanding as of May 12, 2017.

 

 

 

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Table of Contents

 

				Page
PART I.		FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)			2
		Consolidated Balance Sheets			2
		Consolidated Statements of Operations			3
		Consolidated Statements of Comprehensive Income			4
		Consolidated Statements of Changes in Equity			5
		Consolidated Statements of Cash Flows			6
		Notes to Unaudited Consolidated Financial Statements			8
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			31
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			41
Item 4.		Controls and Procedures			42
PART II.		OTHER INFORMATION
Item 1.		Legal Proceedings			42
Item 1A.		Risk Factors			42
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			42
Item 3.		Defaults Upon Senior Securities			42
Item 4.		Mine Safety Disclosures			42
Item 5.		Other Information			42
Item 6.		Exhibits			43
Signatures					44

 

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EXPLANATORY NOTE

Effective April 20, 2017, PCSB Financial Corporation (the “Company,” “we” or “our”) became the bank holding company for PCSB Bank upon the conversion of PCSB Bank from a New York-chartered mutual savings bank to a New York-chartered capital stock savings bank. As of March 31, 2017, the conversion had not been completed. As of March 31, 2017, the Company had no assets or liabilities and had not conducted any business activities other than organizational activities. Accordingly, the unaudited consolidated financial statements and the other financial information contained in this quarterly report on Form 10-Q relate solely to PCSB Bank and subsidiaries.

The unaudited consolidated financial statements and other financial information contained in this quarterly report on Form 10-Q should be read in conjunction with the audited consolidated financial statements of PCSB Bank and subsidiaries at and for the fiscal year ended June 30, 2016 contained in the Company’s definitive prospectus dated February 10, 2017 (the “Prospectus”) as filed with the Securities and Exchange Commission pursuant to Securities Act Rule 424(b)(3) on February 17, 2017.

 

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

PCSB Bank

Consolidated Balance Sheets (unaudited)

(amounts in thousands)

 

		March 31, 2017				June 30, 2016
ASSETS
Cash and due from banks		$	177,022			$	36,258
Federal funds sold			1,387				5,320
Cash and cash equivalents			178,409				41,578
Held to maturity investment securities, at amortized cost (fair value of $290,363 and $273,317, respectively)			292,073				270,679
Available for sale investment securities, at fair value			99,286				112,351
Total investment securities			391,359				383,030
Loans receivable, net of allowance for loan losses of $4,830 at March 31, 2017 and $4,042 at June 30, 2016			776,756				782,336
Accrued interest receivable			3,464				3,361
Federal Home Loan Bank stock, at cost			2,243				2,047
Bank premises and equipment, net			12,200				10,774
Deferred tax assets, net			4,301				6,164
Foreclosed real estate			1,742				905
Bank-owned life insurance			23,031				22,557
Goodwill			6,106				6,106
Other intangible assets, net			593				702
Other assets			7,117				2,511
Total assets		$	1,407,321			$	1,262,071
LIABILITIES
Interest bearing deposits		$	978,898			$	990,032
Non-interest bearing deposits			135,571				122,663
Total deposits			1,114,469				1,112,695
Mortgage escrow funds			6,732				7,023
Advances from Federal Home Loan Bank			24,446				20,081
Stock offering subscription funds			136,252				—
Other liabilities			8,152				12,323
Total liabilities			1,290,051				1,152,122
Commitments and Contingencies
EQUITY
Retained earnings			122,938				117,919
Accumulated other comprehensive loss			(5,668	)			(7,970	)
Total equity			117,270				109,949
Total liabilities and equity		$	1,407,321			$	1,262,071

See accompanying notes to the consolidated financial statements (unaudited)

 

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PCSB Bank

Consolidated Statements of Operations (unaudited)

(amounts in thousands)

 

		Three months ended March 31,								Nine months ended March 31,
		2017				2016				2017				2016
Interest and dividend income
Loans		$	8,493			$	8,337			$	25,256			$	24,537
Investment securities			1,633				1,425				4,643				4,322
Fed funds and other			150				106				336				230
Total interest and dividend income			10,276				9,868				30,235				29,089
Interest expense
Deposits			1,242				1,136				3,788				3,382
Mortgage escrow funds			12				11				42				38
FHLB advances			55				45				136				138
Stock offering subscription rights			9				—				9				—
Total interest expense			1,318				1,192				3,975				3,558
Net interest income			8,958				8,676				26,260				25,531
Provision for loan losses			235				103				823				500
Net interest income after provision for loan losses			8,723				8,573				25,437				25,031
Noninterest income
Fees and service charges			353				269				955				816
Bank-owned life insurance			146				154				474				300
Settlement on acquired loan			—				—				1,615				—
Other			127				95				393				300
Total noninterest income			626				518				3,437				1,416
Noninterest expense
Salaries and employee benefits			3,495				4,325				12,189				12,594
Occupancy and equipment			1,362				1,284				4,497				3,567
FDIC assessment			160				230				481				673
Professional fees			273				442				858				1,249
Postage, printing, stationary and supplies			140				157				404				513
Advertising			135				143				364				261
Merger and acquisition related expenses			—				—				—				161
Amortization of intangible assets			36				40				109				121
Other operating expenses			979				903				2,670				2,912
Total noninterest expense			6,580				7,524				21,572				22,051
Net income before income tax expense			2,769				1,567				7,302				4,396
Income tax expense			878				468				2,283				1,314
Net income		$	1,891			$	1,099			$	5,019			$	3,082

See accompanying notes to the consolidated financial statements (unaudited)

 

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PCSB Bank

Consolidated Statements of Comprehensive Income (unaudited)

(amounts in thousands)

 

		Three months ended March 31,								Nine months ended March 31,
		2017				2016				2017				2016
Net income		$	1,891			$	1,099			$	5,019			$	3,082
Other comprehensive income (loss), net of tax:
Change in fair value of available for sale securities			210				313				(522	)			197
Changes in funded status of defined benefit plan and other post-retirement benefit plans			2,412				—				2,824				—
Other comprehensive income			2,622				313				2,302				197
Total comprehensive income		$	4,513			$	1,412			$	7,321			$	3,279

See accompanying notes to the consolidated financial statements (unaudited)

 

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PCSB Bank

Consolidated Statements of Changes in Equity (unaudited)

(amounts in thousands)

 

		Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Total Equity
Balance at July 1, 2016		$	117,919			$	(7,970	)		$	109,949
Net income			5,019				—				5,019
Other comprehensive income			—				2,302				2,302
Balance at March 31, 2017		$	122,938			$	(5,668	)		$	117,270
Balance at July 1, 2015		$	114,993			$	(4,722	)		$	110,271
Net income			3,082				—				3,082
Other comprehensive income			—				197				197
Balance at March 31, 2016		$	118,075			$	(4,525	)		$	113,550

See accompanying notes to the consolidated financial statements (unaudited)

 

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PCSB Bank

Consolidated Statements of Cash Flows (unaudited)

(amounts in thousands)

 

		Nine months ended March 31,
		2017				2016
OPERATING ACTIVITIES
Net income		$	5,019			$	3,082
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan loss			823				500
Depreciation and amortization			1,065				922
Amortization of net premiums on securities and net deferred loan origination costs			681				887
Deferred income tax expense, net of valuation reserves			677				974
Net decrease in accrued interest receivable			(103	)			(32	)
Net loss on sale of foreclosed real estate			5				1
Write-downs on foreclosed real estate			—				30
Earnings from cash surrender value of BOLI			(474	)			(300	)
Net accretion of purchase account adjustments			(651	)			(1,252	)
Other adjustments, principally net changes in other assets and liabilities			(4,518	)			543
Net cash provided by operating activities			2,524				5,355
INVESTING ACTIVITIES
Purchases of investment securities:
Held to maturity			(78,589	)			(59,221	)
Available for sale			(18,222	)			(48,291	)
Proceeds from maturities and calls of securities held to maturity			56,808				79,363
Proceeds from maturities, calls and sales of securities available for sale			30,295				20,251
Disbursement for loan originations, net of principal repayments			15,507				(12,091	)
Purchase of loans			(12,069	)			(14,087	)
Net purchase of FHLB stock			(196	)			(455	)
Purchase of bank premises and equipment			(2,382	)			(2,955	)
Purchase of BOLI			—				(10,000	)
Proceeds from sale of foreclosed real estate			939				284
Net cash used in investing activities			(7,909	)			(47,202	)
FINANCING ACTIVITIES
Net increase in deposits			1,890				25,931
Net change in short-term FHLB advances			20,454				(1,000	)
Proceeds from long-term FHLB advances			—				20,100
Repayment of long-term FHLB advances			(16,089	)			(9,000	)
Net decrease in mortgage escrow funds			(291	)			(563	)
Stock offering subscription funds			136,252				—
Net cash provided by financing activities			142,216				35,468
Net increase (decrease) in cash and cash equivalents			136,831				(6,379	)
Cash and cash equivalents:
Cash and cash equivalents at beginning of period			41,578				77,761
Cash and cash equivalents at end of period		$	178,409			$	71,382

 

See accompanying notes to the consolidated financial statements (unaudited)

 

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PCSB Bank

Consolidated Statements of Cash Flows (unaudited) - (Continued)

(amounts in thousands)

 

		Nine months ended March 31,
		2017				2016
Supplemental information:
Cash paid for:
Interest		$	3,974			$	3,552
Income taxes (net of refunds)			223				(31	)
Loans transferred to foreclosed real estate and other assets			1,762				1,015

See accompanying notes to the consolidated financial statements (unaudited)

 

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PCSB Bank

Notes to Unaudited Consolidated Financial Statements (unaudited)

Note 1. Basis of Presentation

PCSB Bank (the “Bank”) is a community-oriented financial institution that provides financial services to individuals and businesses within its market area of Putnam, Southern Dutchess, Rockland and Westchester Counties in New York. The Bank is a state-chartered mutual savings bank and its deposits are insured up to applicable limits by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”). The Bank’s primary regulators are the FDIC and the New York State Department of Financial Services.

Merger with CMS Bancorp: On April 28, 2015, CMS Bancorp and CMS Bank merged with and into the Bank.

Basis of Presentation: The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, and include the accounts of the Bank and its three subsidiaries – PCSB Funding Corp., PCSB Commercial Bank and PCSB Realty Ltd. PCSB Funding Corp. is a real estate investment trust that holds certain mortgage assets. PCSB Commercial Bank is a state-chartered commercial bank authorized to accept the deposits of local governments in New York State. PCSB Realty Ltd. is a corporation that holds certain properties foreclosed upon by the Bank. All significant intercompany transactions and balances have been eliminated in consolidation.

The unaudited consolidated financial statements at March 31, 2017 and for the three and nine months ended March 31, 2017 and 2016 reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods presented. The annualized results of operations for the three and nine months ended March 31, 2017 are not necessarily indicative of the results of operations that may be expected for the entire fiscal year. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission.

Use of Estimates: To prepare financial statements in conformity with accounting principles generally accepted in the United States of America, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the financial statements and the disclosures provided, and actual results could differ.

Note 2. Recent Accounting Pronouncements

The pronouncements discussed below are not intended to be an all-inclusive list, but rather only those pronouncements that could potentially have an impact on our financial position, results of operations or disclosures.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 “Revenue from Contracts with Customers.” The amendments in ASU 2014-09 provide a comprehensive framework for addressing revenue recognition issues that can be applied to all contracts with customers. While the guidance in ASU 2014-09 supersedes most existing industry-specific revenue recognition accounting guidance, much of PCSB Bank’s revenue comes from financial instruments such as debt securities and loans that are outside the scope of the guidance. The amendments in ASU 2014-09 also include improved disclosures to enable users of financial statements to better understand the nature, amount, timing and uncertainty of revenue that is recognized. For public entities, ASU 2014-09, as amended, is effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is permitted for interim and annual reporting periods beginning after December 15, 2016. ASU 2014-09 is not expected to have a material impact on the Bank’s consolidated financial position, results of operations or disclosures.

In January 2016, the FASB issued ASU 2016-01 “Financial Instruments – Overall.” The amendments in ASU 2016-01 are intended to improve the recognition, measurement, presentation and disclosure of financial assets and liabilities to provide users of financial statements with information that is more useful for decision-making purposes. Among other changes, ASU 2016-01 would require equity securities to be measured at fair value with changes in fair value recognized through net income, but would allow equity securities that do not have readily determinable fair values to be re-measured at fair value either upon the occurrence of an observable price change or upon identification of an impairment. The amendments would simplify the impairment assessment of such equity

 

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securities and would require enhanced disclosure about these investments. ASU 2016-01 would also require separate presentation of financial assets and liabilities by measurement category and type of instrument, such as securities or loans, on the balance sheet or in the notes, and would eliminate certain other disclosures relating to the methods and assumptions used to estimate fair value. For public entities, the amendments in ASU 2016-01 are effective for interim and annual reporting periods beginning after December 15, 2017. Early adoption is not permitted. ASU 2016-01 is not expected to have a material impact on the Bank’s consolidated financial position, results of operations or disclosures.

In February 2016, the FASB issued ASU 2016-02 “Leases.” ASU 2016-02 affects any entity that enters into a lease and is intended to increase the transparency and comparability of financial statements among organizations. The ASU requires, among other changes, a lessee to recognize on its balance sheet a lease asset and a lease liability for those leases previously classified as operating leases. The lease asset would represent the right to use the underlying asset for the lease term and the lease liability would represent the discounted value of the required lease payments to the lessor. The ASU would also require entities to disclose key information about leasing arrangements. ASU 2016-02 is effective for interim and annual reporting periods beginning after December 15, 2018. Early adoption is permitted. Management is currently evaluating the impact that ASU 2016-02 will have on the Bank’s consolidated financial position, results of operations and disclosures.

In June 2016, the FASB issued ASU 2016-13 “Measurement of Credit Losses on Financial Instruments.” ASU 2016-13 affects entities holding financial assets that are not accounted for at fair value through net income, including loans, debt securities, and other financial assets. The ASU requires financial assets measured at amortized cost basis to be presented at the net amount expected to be collected by recording an allowance for current expected credit losses. ASU 2016-13 is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years. Management is currently evaluating the impact that ASU 2016-13 will have on the Bank’s consolidated financial position, results of operations and disclosures.

In March 2017, the FASB issued ASU 2017-08 “Receivables - Non-Refundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.” The ASU requires premiums on callable debt securities to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity. ASU 2017-08 is effective for interim and annual reporting periods beginning after December 15, 2019. Early adoption is permitted beginning after December 15, 2018, including interim periods within those fiscal years. ASU 2017-08 is not expected to have a material impact on the Bank’s consolidated financial position, results of operations or disclosures.

 

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Note 3. Investment Securities

The amortized cost, gross unrealized/unrecognized gains and losses and fair value of available for sale and held to maturity securities at March 31, 2017 and June 30, 2016 were as follows:

 

		March 31, 2017
		Amortized				Gross Unrealized/Unrecognized								Fair
		Cost				Gains				Losses				Value
						(in thousands)
Available for sale
U.S. Government and agency obligations		$	53,654			$	23			$	(265	)		$	53,412
Corporate and other debt securities			8,473				65				(19	)			8,519
Mortgage-backed securities – residential			37,125				414				(216	)			37,323
Equity securities			32				—				—				32
Total available for sale		$	99,284			$	502			$	(500	)		$	99,286
Held to maturity
U.S. Government and agency obligations		$	129,992			$	41			$	(766	)		$	129,267
Corporate and other debt securities			1,002				—				(1	)			1,001
Mortgage-backed securities – residential			100,330				332				(1,065	)			99,597
Mortgage-backed securities – collateralized mortgage obligations			38,156				50				(304	)			37,902
Mortgage-backed securities – commercial			22,593				213				(210	)			22,596
Total held to maturity		$	292,073			$	636			$	(2,346	)		$	290,363
		June 30, 2016
		Amortized				Gross Unrealized/Unrecognized								Fair
		Cost				Gains				Losses				Value
						(in thousands)
Available for sale
U.S. Government and agency obligations		$	65,953			$	204			$	(25	)		$	66,132
Corporate and other debt securities			8,514				132				—				8,646
Mortgage-backed securities – residential			37,043				542				(61	)			37,524
Equity securities			49				—				—				49
Total available for sale		$	111,559			$	878			$	(86	)		$	112,351
Held to maturity
U.S. Government and agency obligations		$	145,896			$	357			$	(51	)		$	146,202
Mortgage-backed securities – residential			72,842				1,342				(45	)			74,139
Mortgage-backed securities – collateralized mortgage obligations			30,268				350				(38	)			30,580
Mortgage-backed securities – commercial			21,673				723				—				22,396
Total held to maturity		$	270,679			$	2,772			$	(134	)		$	273,317

There were no sales of or realized gains or losses on investment securities for the three or nine months ended March 31, 2017 or 2016.

 

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The following table presents the fair value and carrying amount of debt securities at March 31, 2017, by contractual maturity. Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay obligations with or without call or prepayment penalties. Securities not due at a single maturity date, primarily mortgage-backed securities, are shown separately.

 

		Held to maturity								Available for sale
		Carrying Amount				Fair Value				Amortized Cost				Fair Value
		(in thousands)
March 31, 2017
1 year or less		$	42,483			$	42,468			$	14,001			$	13,990
1 to 5 years			88,511				87,800				46,126				45,888
5 to 10 years			—				—				2,000				2,052
Mortgage-backed securities			161,079				160,095				37,125				37,324
Total		$	292,073			$	290,363			$	99,252			$	99,254

Securities pledged had carrying amounts of $88.4 million and $93.1 million at March 31, 2017 and June 30, 2016, respectively, and were pledged principally to secure FHLB advances and public deposits.

The following table provides information regarding investment securities with unrealized/unrecognized losses, aggregated by investment category and length of time that individual securities had been in a continuous unrealized loss position at March 31, 2017 and June 30, 2016:

 

		March 31, 2017
		Less than 12 months								Greater than 12 months								Total
		Fair Value				Unrealized/ Unrecognized Loss				Fair Value				Unrealized/ Unrecognized Loss				Fair Value				Unrealized/ Unrecognized Loss
		(in thousands)
Available for sale
U.S. Government and agency obligations		$	40,960			$	(262	)		$	1,997			$	(3	)		$	42,957			$	(265	)
Corporate and other debt securities			4,429				(19	)			—				—				4,429				(19	)
Mortgage-backed securities – residential			17,700				(196	)			2,144				(20	)			19,844				(216	)
Total		$	63,089			$	(477	)		$	4,141			$	(23	)		$	67,230			$	(500	)
Held to maturity
U.S. Government and agency obligations		$	94,257			$	(762	)		$	1,995			$	(4	)		$	96,252			$	(766	)
Corporate and other debt securities			1,001				(1	)			—				—				1,001				(1	)
Mortgage-backed securities – residential			71,542				(1,065	)			274				—				71,816				(1,065	)
Mortgage-backed securities – collateralized mortgage obligations			24,397				(224	)			3,086				(80	)			27,483				(304	)
Mortgage-backed securities – commercial			9,264				(210	)			—				—				9,264				(210	)
Total		$	200,461			$	(2,262	)		$	5,355			$	(84	)		$	205,816			$	(2,346	)

 

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		June 30, 2016
		Less than 12 months								Greater than 12 months								Total
		Fair Value				Unrealized/ Unrecognized Loss				Fair Value				Unrealized/ Unrecognized Loss				Fair Value				Unrealized/ Unrecognized Loss
		(in thousands)
Available for sale
U.S. Government and agency obligations		$	19,462			$	(22	)		$	1,007			$	(3	)		$	20,469			$	(25	)
Mortgage-backed securities – residential			11,912				(52	)			676				(9	)			12,588				(61	)
Total		$	31,374			$	(74	)		$	1,683			$	(12	)		$	33,057			$	(86	)
Held to maturity
U.S. Government and agency obligations		$	22,000			$	(44	)		$	7,993			$	(7	)		$	29,993			$	(51	)
Mortgage-backed securities – residential			6,886				(19	)			4,895				(26	)			11,781				(45	)
Mortgage-backed securities – collateralized mortgage obligation			4,420				(20	)			1,333				(18	)			5,753				(38	)
Total		$	33,306			$	(83	)		$	14,221			$	(51	)		$	47,527			$	(134	)

As of March 31, 2017, the Bank’s security portfolio consisted of $391.4 million in securities, of which 167 securities with a fair value of $273.0 million were in an unrealized loss position. The majority of unrealized losses are related to the Bank’s U.S. Government and agency obligations and mortgage-backed securities.

As of June 30, 2016, the Bank’s security portfolio consisted of $383.0 million in securities, of which 52 securities with a fair value of $80.6 million were in an unrealized loss position. The majority of unrealized losses are related to the Bank’s U.S. Government and agency obligations and mortgage-backed securities.

There were no securities for which the Bank believes it is not probable that it will collect all amounts due according to the contractual terms of the security as of March 31, 2017 and June 30, 2016. Management believes the unrealized losses are primarily a result of changing interest rates. The Bank has determined that it does not intend to sell, or it is not more likely than not that it will be required to sell, its securities that are in an unrealized loss position prior to the recovery of its amortized cost basis. Therefore, the Bank did not consider any securities to be other-than-temporarily impaired as of March 31, 2017 and June 30, 2016.

 

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Note 4. Loans

Loans receivable are summarized as follows (in thousands):

 

		March 31, 2017				June 30, 2016
Mortgage loans:
Residential		$	219,797			$	226,073
Commercial			394,738				385,827
Construction			28,518				25,050
Net deferred loan origination costs			472				319
Total mortgages			643,525				637,269
Commercial and consumer loans:
Commercial loans			35,420				40,607
Other loans secured			46,874				49,993
Home equity lines of credit			40,323				41,180
Consumer and installment loans			14,659				16,476
Net deferred loan origination costs			785				853
Total commercial and consumer loans			138,061				149,109
Total loans receivable			781,586				786,378
Allowance for loan losses			(4,830	)			(4,042	)
Loans receivable, net		$	776,756			$	782,336

 

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The following tables present the activity in the allowance for loan losses by portfolio segment for the three and nine months ended March 31, 2017 and 2016 (in thousands):

 

		For three months ended March 31, 2017
		Beginning Allowance				Provision (credit)				Charge-offs				Recoveries				Ending Allowance
Originated:
Residential		$	238			$	158			$	(15	)		$	—			$	381
Commercial			3,031				(621	)			—				—				2,410
Construction			336				552				—				—				888
Commercial loans			501				48				—				—				549
Other loans secured			339				31				—				—				370
Home equity lines of credit			70				3				—				—				73
Consumer and installment loans			113				61				(19	)			4				159
Acquired:
Residential			—				—				—				—				—
Commercial loans			—				—				—				—				—
Consumer and installment loans			—				3				(3	)			—				—
Total		$	4,628			$	235			$	(37	)		$	4			$	4,830
		For three months ended March 31, 2016
		Beginning Allowance				Provision (credit)				Charge-offs				Recoveries				Ending Allowance
Originated:
Residential		$	201			$	104			$	(73	)		$	—			$	232
Commercial			1,924				(24	)			—				171				2,071
Construction			147				11				—				—				158
Commercial loans			1,177				(3	)			(369	)			—				805
Other loans secured			403				2				—				—				405
Home equity lines of credit			129				(57	)			—				—				72
Consumer and installment loans			163				2				(9	)			—				156
Acquired:
Residential			—				—				—				—				—
Commercial loans			—				5				—				(5	)			—
Consumer and installment loans			—				63				—				(63	)			—
Total		$	4,144			$	103			$	(451	)		$	103			$	3,899
		For nine months ended March 31, 2017
		Beginning Allowance				Provision (credit)				Charge-offs				Recoveries				Ending Allowance
Originated:
Residential		$	237			$	89			$	(15	)		$	70			$	381
Commercial			2,149				242				—				19				2,410
Construction			269				619				—				—				888
Commercial loans			604				(628	)			—				573				549
Other loans secured			397				199				(324	)			98				370
Home equity lines of credit			73				—				—				—				73
Consumer and installment loans			313				259				(417	)			4				159
Acquired:
Residential			—				38				(38	)			—				—
Commercial loans			—				2				(2	)			—				—
Consumer and installment loans			—				3				(3	)			—				—
Total		$	4,042			$	823			$	(799	)		$	764			$	4,830

 

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		For nine months ended March 31, 2016
		Beginning Allowance				Provision (credit)				Charge-offs				Recoveries				Ending Allowance
Originated:
Residential		$	193			$	314			$	(275	)		$	—			$	232
Commercial			1,766				134				—				171				2,071
Construction			100				(134	)			—				192				158
Commercial loans			1,266				101				(562	)			—				805
Other loans secured			416				(11	)			—				—				405
Home equity lines of credit			69				21				(18	)			—				72
Consumer and installment loans			111				75				(30	)			—				156
Acquired:
Residential			—				—				—				—				—
Commercial loans			—				—				—				—				—
Consumer and installment loans			—				—				—				—				—
Total		$	3,921			$	500			$	(885	)		$	363			$	3,899

 

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The following tables present the balance in the allowance for loan losses and the recorded investment in loans, excluding net deferred fees and accrued interest, by portfolio segment, and based on impairment method as of March 31, 2017 and June 30, 2016 (in thousands):

 

		March 31, 2017
		Loans																Allowance for Loan Losses
		Individually Evaluated for Impairment				Collectively Evaluated for Impairment				Acquired With Deteriorated Credit Quality				Total				Individually Evaluated for Impairment				Collectively Evaluated for Impairment				Acquired With Deteriorated Credit Quality				Total
Residential		$	3,589			$	214,895			$	1,313			$	219,797			$	146			$	235			$	—			$	381
Commercial			2,279				390,634				1,825				394,738				—				2,410				—				2,410
Construction			3,388				25,130				—				28,518				700				188				—				888
Commercial loans			89				35,331				—				35,420				—				549				—				549
Other loans secured			5,906				40,968				—				46,874				16				354				—				370
Home equity lines of credit			610				39,535				178				40,323				5				68				—				73
Consumer and installment loans			—				14,606				53				14,659				—				159				—				159
		$	15,861			$	761,099			$	3,369			$	780,329			$	867			$	3,963			$	—			$	4,830
		June 30, 2016
		Loans																Allowance for Loan Losses
		Individually Evaluated for Impairment				Collectively Evaluated for Impairment				Acquired With Deteriorated Credit Quality				Total				Individually Evaluated for Impairment				Collectively Evaluated for Impairment				Acquired With Deteriorated Credit Quality				Total
Residential		$	5,483			$	219,310			$	1,280			$	226,073			$	—			$	237			$	—			$	237
Commercial			9,277				374,772				1,778				385,827				—				2,149				—				2,149
Construction			144				24,906				—				25,050				83				186				—				269
Commercial loans			2,494				38,113				—				40,607				—				604				—				604
Other loans secured			6,465				43,528				—				49,993				2				395				—				397
Home equity lines of credit			417				40,583				180				41,180				—				73				—				73
Consumer and installment loans			585				15,807				84				16,476				175				138				—				313
		$	24,865			$	757,019			$	3,322			$	785,206			$	260			$	3,782			$	—			$	4,042

 

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The following tables present information related to loans individually evaluated for impairment (excluding loans acquired with deteriorated credit quality) by class of loans as of March 31, 2017 and June 30, 2016 (in thousands):

 

		March 31, 2017												Three months ended March 31, 2017								Nine months ended March 31, 2017
		Unpaid Principal Balance				Recorded Investment				Allowance for Loan Losses				Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Residential		$	3,132			$	3,042			$	—			$	3,048			$	—			$	3,078			$	—
Commercial			2,724				2,279				—				2,287				32				2,303				95
Commercial loans			89				89				—				89				1				91				3
Other loans secured			5,933				4,783				—				4,804				53				4,846				172
Home equity lines of credit			599				599				—				599				—				599				(2	)
With an allowance recorded:
Residential			487				547				146				517				4				513				14
Construction			4,580				3,388				700				3,388				—				3,073				71
Other loans secured			1,123				1,123				16				1,129				14				1,141				43
Home equity lines of credit			11				11				5				11				—				11				—
Total		$	18,678			$	15,861			$	867			$	15,872			$	104			$	15,655			$	396
		June 30, 2016												Three months ended March 31, 2016								Nine months ended March 31, 2016
		Unpaid Principal Balance				Recorded Investment				Allowance for Loan Losses				Average Recorded Investment				Interest Income Recognized				Average Recorded Investment				Interest Income Recognized
With no related allowance recorded:
Residential		$	5,683			$	5,483			$	—			$	5,577			$	6			$	5,705			$	23
Commercial			9,947				9,277				—				9,324				88				9,114				327
Construction			12				12				—				13				—				32				—
Commercial loans			5,250				2,494				—				3,971				2				4,423				4
Other loans secured			7,762				6,408				—				6,549				69				6,667				212
Home equity lines of credit			445				417				—				430				—				430				—
Consumer and installment loans			314				236				—				235				—				259				—
With an allowance recorded:
Construction			1,324				132				83				132				—				132				—
Other loans secured			57				57				2				62				1				31				1
Consumer and installment			353				349				175				360				11				329				21
Total		$	31,147			$	24,865			$	260			$	26,653			$	177			$	27,122			$	588

 

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The following table presents the recorded investment in nonaccrual loans and in loans past due over 90 days still on accrual status, by class of loans as of March 31, 2017 and June 30, 2016 (in thousands):

 

		Nonaccrual								Loans Past Due Over 90 Days and Still Accruing
		March 31, 2017				June 30, 2016				March 31, 2017				June 30, 2016
Originated:
Residential		$	2,607			$	4,717			$	—			$	—
Commercial			314				300				—				—
Construction			3,792				144				—				—
Commercial loans			—				1,615				—				—
Other loans secured			3,029				3,433				—				—
Home equity lines of credit			302				405				—				—
Consumer and installment loans			—				584				6				4
Acquired:
Residential			1,274				1,164				—				—
Home equity lines of credit			296				197				—				—
Consumer and installment loans			1				—				—				—
Total		$	11,615			$	12,559			$	6			$	4

Nonperforming loans include both smaller-balance homogeneous loans that are collectively evaluated for impairment and individually classified impaired loans. The table above excludes acquired loans that are accounted for as purchased credit impaired loans totaling $2.7 million and $3.3 million as of March 31, 2017 and June 30, 2016, respectively. Such loans are excluded because the loans are in pools that are considered performing. The discounts arising from recording these loans at fair value upon acquisition were due in part to credit quality and the accretable yield is being recognized as interest income over the life of the loans based on expected cash flows.

 

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The following tables present the aging of the recorded investment in past due loans by class of loans as of March 31, 2017 and June 30, 2016 (in thousands):

 

		March 31, 2017
		30-59 Days Past Due				60-89 Days Past Due				90 Days or More Past Due				Total Past Due				Current				Total
Originated:
Residential		$	692			$	443			$	1,211			$	2,346			$	153,945			$	156,291
Commercial			—				—				314				314				309,389				309,703
Construction			3,257				404				131				3,792				24,410				28,202
Commercial loans			—				—				—				—				33,858				33,858
Other loans secured			500				—				81				581				43,553				44,134
Home equity lines of credit			150				—				103				253				33,723				33,976
Consumer and installment loans			10				—				6				16				14,282				14,298
Total originated			4,609				847				1,846				7,302				613,160				620,462
Acquired:
Residential			—				316				950				1,266				62,240				63,506
Commercial			—				—				554				554				84,481				85,035
Construction			—				—				—				—				316				316
Commercial loans			—				—				—				—				1,562				1,562
Other loans secured			—				—				—				—				2,740				2,740
Home equity lines of credit			80				—				296				376				5,971				6,347
Consumer and installment loans			—				—				—				—				361				361
Total acquired			80				316				1,800				2,196				157,671				159,867
Total		$	4,689			$	1,163			$	3,646			$	9,498			$	770,831			$	780,329

 

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		June 30, 2016
		30-59 Days Past Due				60-89 Days Past Due				90 Days or More Past Due				Total Past Due				Current				Total
Originated:
Residential		$	430			$	573			$	2,232			$	3,235			$	150,010			$	153,245
Commercial			—				—				300				300				291,044				291,344
Construction			—				—				144				144				24,590				24,734
Commercial loans			—				760				1,615				2,375				35,621				37,996
Other loans secured			—				—				100				100				47,175				47,275
Home equity lines of credit			—				—				113				113				34,340				34,453
Consumer and installment loans			5				—				589				594				15,280				15,874
Total originated			435				1,333				5,093				6,861				598,060				604,921
Acquired:
Residential			732				—				1,073				1,805				71,023				72,828
Commercial			—				—				520				520				93,963				94,483
Construction			—				—				—				—				316				316
Commercial loans			—				—				—				—				2,611				2,611
Other loans secured			—				—				—				—				2,718				2,718
Home equity lines of credit			296				—				197				493				6,234				6,727
Consumer and installment loans			—				—				—				—				602				602
Total acquired			1,028				—				1,790				2,818				177,467				180,285
Total		$	1,463			$	1,333			$	6,883			$	9,679			$	775,527			$	785,206

Troubled Debt Restructurings

The terms of certain loans were modified as troubled debt restructurings. The modification of the terms of such loans included one or a combination of the following: a reduction of the stated interest rate of the loan; an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk; or a permanent reduction of the recorded investment in the loan.

As of March 31, 2017 and June 30, 2016, the Bank had 21 and 26 loans classified as troubled debt restructurings totaling $9.9 million and $18.6 million, respectively, of which $5.5 million and $13.3 million are performing in accordance with their modified terms. The Bank has allocated $167,000 and $2,000, respectively, of specific reserves to customers whose loan terms have been modified in troubled debt restructurings as of March 31, 2017 and June 30, 2016, and has not committed to lend additional amounts to customers with outstanding loans that are classified as troubled debt restructurings.

The Bank modified one loan as troubled debt restructuring during the three and nine months ended March 31, 2017. The modification involved a rate reduction and an increase in outstanding principal from $165,000 to $210,000.

The Bank had two troubled debt restructurings for which there was a payment default in the three and nine months ended March 31, 2017 that were modified in the twelve months prior to default. There was one such default in the three and nine months ended March 31, 2016.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed under the Bank’s internal underwriting policy.

Certain loans may have been modified during the periods presented which did not meet the definition of a troubled debt restructuring as the modification was a delay in a payment, ranging from thirty days to six months, which was considered to be insignificant.

 

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Credit Quality Indicators

The Bank categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Bank analyzes loans individually by classifying the loans as to credit risk. This analysis includes non-homogeneous loans, such as commercial and commercial real estate loans. This analysis is performed on a monthly basis. The Bank utilized the same grading process for acquired loans as it does for originated loans. The Bank uses the following definitions for risk ratings:

Special Mention – Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, 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.

Loans not meeting the criteria above that are analyzed individually as part of the above-described process and loans in groups of homogenous loans are considered to be pass rated loans. These loans are monitored based on delinquency and performance. Based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):

 

		March 31, 2017
		Pass				Special Mention				Substandard				Doubtful				Total
Originated:
Residential		$	153,777			$	—			$	2,514			$	—			$	156,291
Commercial			306,286				129				3,288				—				309,703
Construction			24,410				—				3,792				—				28,202
Commercial loans			30,265				1,169				2,424				—				33,858
Other loans secured			37,146				—				6,988				—				44,134
Home equity lines of credit			33,674				58				244				—				33,976
Consumer and installment loans			14,226				—				72				—				14,298
Total originated			599,784				1,356				19,322				—				620,462
Acquired:
Residential			61,049				—				2,457				—				63,506
Commercial			83,210				—				1,825				—				85,035
Construction			316				—				—				—				316
Commercial loans			1,562				—				—				—				1,562
Other loans secured			2,740				—				—				—				2,740
Home equity lines of credit			5,874				—				473				—				6,347
Consumer and installment loans			361				—				—				—				361
Total acquired			155,112				—				4,755				—				159,867
Total		$	754,896			$	1,356			$	24,077			$	—			$	780,329

 

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		June 30, 2016
		Pass				Special Mention				Substandard				Doubtful				Total
Originated:
Residential		$	147,944			$	181			$	5,120			$	—			$	153,245
Commercial			278,491				2,101				10,752				—				291,344
Construction			24,590				—				144				—				24,734
Commercial loans			30,916				2,004				5,076				—				37,996
Other loans secured			38,382				109				8,784				—				47,275
Home equity lines of credit			34,047				—				406				—				34,453
Consumer and installment loans			15,069				24				432				349				15,874
Total originated			569,439				4,419				30,714				349				604,921
Acquired:
Residential			70,629				—				2,199				—				72,828
Commercial			91,380				949				2,154				—				94,483
Construction			316				—				—				—				316
Commercial loans			2,611				—				—				—				2,611
Other loans secured			2,718				—				—				—				2,718
Home equity lines of credit			6,529				—				198				—				6,727
Consumer and installment loans			602				—				—				—				602
Total acquired			174,785				949				4,551				—				180,285
Total		$	744,224			$	5,368			$	35,265			$	349			$	785,206

Purchased Credit Impaired Loans

The Bank has acquired loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of those loans as of March 31, 2017 and June 30, 2016 is as follows (in thousands):

 

		March 31, 2017				June 30, 2016
Residential		$	1,313			$	1,280
Commercial			1,825				1,778
Home equity lines of credit			178				180
Consumer and installment loans			53				84
Carrying amount, net of allowance of $0		$	3,369			$	3,322

For those purchased credit impaired loans disclosed in the preceding table, the Bank did not increase or reverse the allowance for loan losses during any period presented.

 

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Accretable yield, or income expected to be collected, for acquired loans is as follows (in thousands):

 

		Three months ended March 31,								Nine months ended March 31,
		2017				2016				2017				2016
Beginning balance		$	486			$	529			$	578			$	713
New loans acquired			—				—				—				—
Accretion income			(47	)			(41	)			(139	)			(143	)
Reclassification from non-accretable difference			—				—				—				—
Disposals			—				—				—				(82	)
Ending balance		$	439			$	488			$	439			$	488

Note 5. Other Comprehensive Income (Loss)

The following is a summary of the accumulated other comprehensive income (loss) balances, net of tax (in thousands):

 

		Net unrealized gain (loss) on available for sale securities				Unrealized loss on pension benefits				Unrealized loss on SERP benefits				Total
Balance at January 1, 2017		$	(209	)		$	(7,302	)		$	(779	)		$	(8,290	)
Other comprehensive income before reclassifications			319				4,357				—				4,676
Reclassification adjustment for expense included in salaries and benefits			—				(727	)			24				(704	)
Less tax effect			109				1,233				9				1,350
Net other comprehensive income			210				2,397				15				2,622
Balance at March 31, 2017		$	1			$	(4,905	)		$	(764	)		$	(5,668	)

 

		Net unrealized gain (loss) on available for sale securities				Unrealized loss on pension benefits				Unrealized loss on SERP benefits				Total
Balance at January 1, 2016		$	207			$	(4,311	)		$	(734	)		$	(4,838	)
Other comprehensive income before reclassifications			444				—				—				444
Reclassification adjustment for expense included in salaries and benefits			—				—				—				—
Less tax effect			131				—				—				131
Net other comprehensive income			313				—				—				313
Balance at March 31, 2016		$	520			$	(4,311	)		$	(734	)		$	(4,525	)

 

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		Net unrealized gain (loss) on available for sale securities				Unrealized loss on pension benefits				Unrealized loss on SERP benefits				Total
Balance at July 1, 2016		$	523			$	(7,683	)		$	(810	)		$	(7,970	)
Other comprehensive income (loss) before reclassifications			(790	)			4,357				—				3,567
Reclassification adjustment for expense included in salaries and benefits			—				(149	)			70				(79	)
Less tax effect			(268	)			1,430				24				1,186
Net other comprehensive (loss) income			(522	)			2,778				46				2,302
Balance at March 31, 2017		$	1			$	(4,905	)		$	(764	)		$	(5,668	)

 

		Net unrealized gain (loss) on available for sale securities				Unrealized loss on pension benefits				Unrealized loss on SERP benefits				Total
Balance at July 1, 2015		$	323			$	(4,311	)		$	(734	)		$	(4,722	)
Other comprehensive income before reclassifications			250				—				—				250
Reclassification adjustment for expense included in salaries and benefits			—				—				—				—
Less tax effect			53				—				—				53
Net other comprehensive income			197				—				—				197
Balance at March 31, 2016		$	520			$	(4,311	)		$	(734	)		$	(4,525	)

Note 6. Post-Retirement Benefits

Employee Pension Plan: The Bank maintains a non-contributory defined benefit pension plan that covers employees meeting specific requirements as to age and length of service. The Bank’s contributions to this qualified plan are determined on the basis of (i) the maximum amount that can be deducted for federal income tax purposes, and (ii) the amount determined by a consulting actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974 (ERISA). Contributions are intended to provide not only for benefits attributed to service to date, but also those expected to be earned in the future. On February 15, 2017, the Board of Trustees approved the freezing and termination of the defined benefit pension plan effective May 1, 2017. As a result, as of March 31, 2017 the Bank recorded a $919,000 curtailment gain, which is included in earnings as a reduction to salaries and employee benefits expense. Plan settlement will occur upon receiving necessary IRS approvals, however the timing and financial impact of the settlement has not yet been determined.

Supplemental Retirement Plans: The Bank also maintains unfunded and non-qualified supplemental retirement plans (“SERP”) to provide pension benefits in addition to those provided under the qualified pension plan.

 

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Net periodic benefit cost and other amounts recognized in other comprehensive income for the three and nine months ended March 31, 2017 and 2016 (in thousands):

 

		Three months ended March 31, 2017								Three months ended March 31, 2016
		Defined benefit plan				Supplemental retirement plan				Defined benefit plan				Supplemental retirement plan
Service cost		$	150			$	100			$	156			$	81
Interest cost			250				32				272				34
Expected return on plan assets			(462	)			—				(451	)			—
Amortization of prior net loss			300				23				214				22
Amortization of prior service cost			(48	)			—				(72	)			—
Gain on curtailment			(919	)			—				—				—
New past service liability			—				—				—				—
Net periodic cost		$	(729	)		$	155			$	119			$	137

 

		Nine months ended March 31, 2017								Nine months ended March 31, 2016
		Defined benefit plan				Supplemental retirement plan				Defined benefit plan				Supplemental retirement plan
Service cost		$	519			$	261			$	469			$	241
Interest cost			757				91				816				99
Expected return on plan assets			(1,424	)			—				(1,349	)			—
Amortization of prior net loss			1,021				70				641				63
Amortization of prior service cost			(192	)			—				(216	)			—
Gain on curtailment			(919	)			—				—				—
New past service liability			—				—				—				—
Net periodic cost		$	(238	)		$	422			$	361			$	403

The Bank contributed $3.0 million to the defined benefit plan during the nine months ended March 31, 2017 and expects to make no additional contributions to the plan year ended June 30, 2017.

Note 7. Fair Value of Financial Instruments

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

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

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

A description of the valuation methodologies used for assets and liabilities measured at fair value, as well as general classification of such instruments pursuant to the valuation hierarchy, is set forth below. While management believes the Bank’s valuation methodologies are appropriate and consistent with other financial institutions, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.

 

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Investment Securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs), or a broker’s opinion of value (Level 3 inputs).

Impaired Loans: The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. Appraisals are generally obtained annually and may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Management performs a review of all appraisals, including any such adjustments.

Foreclosed Real Estate: Assets acquired through or instead of loan foreclosure are initially recorded at fair value, less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower cost or fair value, less estimated costs to sell. Fair value is commonly based on recent real estate appraisals which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value.

Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Appraisals for both collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Bank. Once received, a member of the Credit Department, as well as a third-party specialist, where deemed appropriate, reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. Once appraisals are considered appropriate, management discounts the appraised value for estimated selling costs, such as legal, broker, and property maintenance and insurance costs. The most recent analysis performed indicated discount rates ranging between 10% and 20% should be applied to properties with appraisals performed.

 

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Assets and liabilities measured at fair value are summarized below (in thousands):

 

		Fair Value Measurements
		Level 1				Level 2				Level 3				Total
March 31, 2017:
Measured on a recurring basis:
Available for sale securities:
U.S. Government and agency obligations		$	—			$	53,412			$	—			$	53,412
Corporate and other debt securities			—				8,519				—				8,519
Mortgage-backed securities – residential			—				37,323				—				37,323
Equity securities			—				32				—				32
Total assets at fair value		$	—			$	99,286			$	—			$	99,286
Measured on a non-recurring basis:
Impaired loans:
Residential mortgages		$	—			$	—			$	721			$	721
Construction			—				—				2,688				2,688
Other loans secured			—				—				1,608				1,608
Home equity lines of credit			—				—				6				6
Foreclosed real estate			—				—				230				230
Total assets at fair value		$	—			$	—			$	5,253			$	5,253

 

		Fair Value Measurements
		Level 1				Level 2				Level 3				Total
June 30, 2016:
Measured on a recurring basis:
Available for sale securities:
U.S. Government and agency obligations		$	—			$	66,132			$	—			$	66,132
Corporate and other debt securities			—				8,646				—				8,646
Mortgage-backed securities – residential			—				37,524				—				37,524
Equity securities			—				49				—				49
Total assets at fair value		$	—			$	112,351			$	—			$	112,351
Measured on a non-recurring basis:
Impaired loans:
Residential mortgages		$	—			$	—			$	913			$	913
Construction			—				—				49				49
Commercial loans			—				—				54				54
Consumer and installment loans			—				—				175				175
Foreclosed real estate			—				—				905				905
Total assets at fair value		$	—			$	—			$	2,096			$	2,096

Impaired loans in the table above had a carrying amount of $5.9 million, a remaining valuation allowance of $867,000 at March 31, 2017, incurred $38,000 of net charge-offs during the nine months ended March 31, 2017, and resulted in an additional provision for loan losses of $824,000. Impaired loans as of June 30, 2016 in the table above had a carrying amount of $1.5 million, a remaining valuation allowance of $259,000 at June 30, 2016, and incurred no net charge-offs during the year ended June 30, 2016, which resulted in an additional provision for loan losses of $175,000 for the year.

 

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The following tables present quantitative information about Level 3 fair value measurements for selected financial instruments measured at fair value on a non-recurring basis at March 31, 2017 and June 30, 2016 (in thousands):

 

		Fair Value				Valuation Technique(s)		Unobservable Input(s)		Range or Rate Used
March 31, 2017:
Impaired loans - residential mortgages		$	721			Sales comparison		Adjustments for differences in sales comparables		-2.2% to 7.8%
						Discounted cash flow		Discount rate		5.4% to 6.3%
Impaired loans - construction			2,688			Discounted cash flow		Discount rate		1.0% to 10.5%
Impaired loans - other loans secured			1,608			Discounted cash flow		Discount rate		6.0% to 10.5%
Impaired loans - home equity lines of credit			6			Discounted cash flow		Discount rate		6.3%
Foreclosed real estate			230			Sales comparison		Adjustments for differences in sales comparables		8.2%
June 30, 2016:
Impaired loans - residential mortgages		$	913			Sales comparison		Adjustments for differences in sales comparables		-2.0% to 13.3%
Impaired loans - construction			49			Discounted cash flow		Discount rate		1.0%
Impaired loans - other loans secured			54			Discounted cash flow		Discount rate		4.5%
Impaired loans - consumer and installment loans			175			Discounted cash flow		Discount rate		4.3%
Foreclosed real estate			905			Sales comparison		Adjustments for differences in sales comparables		-14.3% to 7.5%

 

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The following is a summary of the carrying amounts and estimated fair values of the Bank’s financial assets and liabilities (in thousands) (none of which are held for trading purposes):

 

		Carrying Amount				Fair Value Measurements
						Level 1				Level 2				Level 3				Total
March 31, 2017:
Financial assets:
Cash and cash equivalents		$	178,409			$	178,409			$	—			$	—			$	178,409
Investment securities held to maturity			292,073				—				290,089				274				290,363
Investment securities available for sale			99,286				—				99,286				—				99,286
Loans receivable, net			776,756				—				—				782,480				782,480
Accrued interest receivable			3,464				—				1,094				2,370				3,464
Federal Home Loan Bank stock			2,243				N/A				N/A				N/A				N/A
Financial liabilities:
Demand, NOW, money market deposits and savings accounts		$	806,555			$	806,555			$	—			$	—			$	806,555
Time certificate deposits			307,914				—				311,264				—				311,264
Mortgage escrow funds			6,732				6,732				—				—				6,732
FHLB advances			24,446				—				24,354				—				24,354
Stock order subscription rights			136,252				136,252				—				—				136,252
June 30, 2016:
Financial assets:
Cash and cash equivalents		$	41,578			$	41,578			$	—			$	—			$	41,578
Investment securities held to maturity			270,679				—				273,032				285				273,317
Investment securities available for sale			112,351				—				112,351				—				112,351
Loans receivable, net			782,336				—				—				799,242				799,242
Accrued interest receivable			3,361				—				958				2,403				3,361
Federal Home Loan Bank stock			2,047				N/A				N/A				N/A				N/A
Financial liabilities:
Demand, NOW, money market deposits and savings accounts		$	781,638			$	781,638			$	—			$	—			$	781,638
Time certificate deposits			331,057				—				334,290				—				334,290
Mortgage escrow funds			7,023				7,023				—				—				7,023
FHLB advances			20,081				—				20,171				—				20,171

The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

Cash and Cash Equivalents: The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

Loans Receivable, Net: For valuation purposes, the loan portfolio was segregated into its significant categories such as one-to-four family residential mortgage loans, other mortgage loans, consumer loans and commercial loans. These categories were further analyzed, where appropriate, into components based on significant financial characteristics such as type of interest rate (adjustable or fixed). For adjustable rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for other loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans do not necessarily represent an exit price. The fair value of loans is considered Level 3.

FHLB Stock: It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

 

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Accrued Interest Receivable/Payable: The carrying amount of accrued interest approximates fair value.

Deposits and stock order subscription rights: The fair values disclosed for demand deposits (e.g., non-interest bearing demand, NOW, money market, savings deposits and escrow accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) and are considered Level 1. Fair values for time certificates of deposit are estimated using a discounted cash flows calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits, resulting in a Level 2 classification.

FHLB Advances: Fair value of the advances is estimated using a discounted cash flow calculation that applies current FHLB interest rates for advances of similar maturity to the Bank’s current advances maturities schedule, resulting in a Level 2 classification.

Note 8. Regulatory Capital

The following is a summary of the Bank’s actual capital amounts and ratios as of March 31, 2017 and June 30, 2016, compared to the required ratios for minimum capital adequacy and for classification as well capitalized (dollars in thousands):

 

										FDIC Required Ratios
		Bank Actual								Adequacy								Well Capitalized
		Amount				Ratio				Amount				Ratio				Amount				Ratio
March 31, 2017
Leverage (Tier 1)		$	116,357				9.1	%		$	51,258				4.0	%		$	64,073				5.0	%
Risk-based:
Common Tier 1			116,357				14.0				37,426				4.5				54,059				6.5
Tier 1			116,357				14.0				49,901				6.0				66,535				8.0
Total			121,187				14.6				66,535				8.0				83,168				10.0
June 30, 2016
Leverage (Tier 1)		$	110,888				8.9	%		$	49,748				4.0	%		$	62,185				5.0	%
Risk-based:
Common Tier 1			110,888				13.5				37,036				4.5				53,497				6.5
Tier 1			110,888				13.5				49,382				6.0				65,842				8.0
Total			114,930				14.0				65,842				8.0				82,303				10.0

In addition to the ratios above, the Basel III Capital Rules established that community banking institutions must maintain a capital conservation buffer of common equity Tier 1 capital in an amount greater than 2.5% of total risk-weighted assets to avoid being subject to limitations on capital distributions and discretionary bonus payments to executive officers. The implementation of the capital conservation buffer began on January 1, 2016 at the 0.625% level and will be phased in over a four-year period (increasing by that amount on each subsequent January 1, until it reaches 2.5% on January 1, 2019).

Management believes that as of March 31, 2017 and June 30, 2016, the Bank met all capital adequacy requirements to which it was subject, including the capital conservation buffer of 1.250% as of March 31, 2017 and 0.625% as of June 30, 2016. Further, the most recent FDIC notification categorized the Bank as a well-capitalized institution under the prompt corrective action regulations. There have been no conditions or events since that notification that management believes have changed the Bank’s capital classification.

 

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Note 9. Plan of Conversion

On December 7, 2016, the Board of Trustees of the Bank adopted a plan of conversion (“Plan”). The Plan received the approval of the FDIC, New York State Department of Financial Services, and the Board of Governors of the Federal Reserve System, and was approved by the depositors of the Bank at a special meeting held on March 31, 2017. Effective April 20, 2017, and pursuant to the Plan, the Bank converted to a stock savings bank, with PCSB Financial Corporation (the “Company”) becoming the bank holding company parent of the Bank. In connection with the conversion, the Bank issued all of its outstanding common stock to the Company.

The conversion stock offering by the Company, which commenced on February 10, 2017 and was completed on April 20, 2017, resulted in gross proceeds of $178.3 million, through the sale of 17,826,408 shares, including 1,453,209 shares sold to the PCSB Bank Employee Stock Ownership Plan (ESOP), at the offering price of $10.00 per share. In addition, the Company also contributed 338,702 shares of its common stock and $1.6 million in cash to the PCSB Community Foundation. Expenses related to the offering were approximately $3.6 million, which resulted in net proceeds of approximately $174.7 million prior to the contribution to PCSB Community Foundation. The Company lent approximately $14.5 million to the ESOP and retained approximately $87.3 million of the net proceeds of the offering prior to the contribution to PCSB Community Foundation. The remainder of the net proceeds was contributed to the Bank.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

General

Management’s discussion and analysis of financial condition and results of operations at March 31, 2017 and June 30, 2016, and for the three and nine months ended March 31, 2017 and 2016 is intended to assist in understanding the financial condition and results of operations of the Bank. The information contained in this section should be read in conjunction with the unaudited financial statements and the notes thereto appearing in Part I, Item 1, of this quarterly report on Form 10-Q.

Cautionary Note Regarding Forward-Looking Statements

This quarterly report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect,” “will,” “may” and words of similar meaning. These forward-looking statements include, but are not limited to:

 

•

statements of our goals, intentions and expectations;

 

•

statements regarding our business plans, prospects, growth and operating strategies;

 

•

statements regarding the quality of our loan and investment portfolios; and

 

•

estimates of our risks and future costs and benefits.

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

 

•

general economic conditions, either nationally or in our market areas, that are worse than expected;

 

•

changes in the level and direction of loan delinquencies and charge-offs and changes in estimates of the adequacy of the allowance for loan losses;

 

•

our ability to access cost-effective funding;

 

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•

fluctuations in real estate values and both residential and commercial real estate market conditions;

 

•

demand for loans and deposits in our market area;

 

•

our ability to continue to implement our business strategies;

 

•

competition among depository and other financial institutions;

 

•

inflation and changes in the interest rate environment that reduce our margins and yields, reduce the fair value of financial instruments or reduce the origination levels in our lending business, or increase the level of defaults, losses and prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;

 

•

adverse changes in the securities markets;

 

•

changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements, including as a result of Basel III;

 

•

our ability to manage market risk, credit risk and operational risk in the current economic conditions;

 

•

our ability to enter new markets successfully and capitalize on growth opportunities;

 

•

our ability to successfully integrate any assets, liabilities, customers, systems and management personnel we may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto;

 

•

changes in consumer spending, borrowing and savings habits;

 

•

changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board;

 

•

our ability to retain key employees;

 

•

our compensation expense associated with equity allocated or awarded to our employees; and

 

•

changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

Additional factors that may affect our results are discussed in the Prospectus under the heading “Risk Factors.”

Because of these and other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.

Critical Accounting Policies

Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Management believes that the most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:

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

 

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

Goodwill. Goodwill resulting from business combination transactions is generally determined as the excess of the fair value of the consideration transferred, plus the fair value of any non-controlling interests in the acquire, over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. We recognized goodwill in connection with our acquisition of CMS Bancorp, Inc. and CMS Bank.

Comparison of Financial Condition at March 31, 2017 and June 30, 2016

Total Assets. Total assets increased $145.3 million, or 11.5%, to $1.4 billion at March 31, 2017 from $1.3 billion at June 30, 2016. The increase is primarily the result of increases of $136.8 million in cash and cash equivalents and $21.4 million in HTM securities, partially offset by decreases of $13.1 million in AFS securities, $5.6 million in net loans and $1.9 million in deferred tax asset.

Cash and Cash Equivalents. Cash and cash equivalents increased $136.8 million, or 329.1%, to $178.4 million at March 31, 2017 from $41.6 million at June 30, 2016. The increase is due primarily to the receipt of $136.3 million of investors’ subscriptions funds being held pending the completion of stock offering.

Securities Held-to-Maturity. Total securities held to maturity increased $21.4 million, or 7.9%, to $292.1 million at March 31, 2017 from $270.7 million at June 30, 2016. This increase was primarily caused by $24.0 million of net purchases of mortgage-backed securities and $1.0 million of net purchases of municipal securities, partially offset by $3.6 million of net maturities and calls of U.S. government and agency obligations.

Securities Available for Sale. Total securities available for sale decreased $13.1 million, or 11.6%, to $99.3 million at March 31, 2017 from $112.4 million at June 30, 2016. This decline was primarily due to $9.6 million of net maturities and calls of U.S. government and agency obligations, $2.3 million of net maturities of mortgage backed securities and a $790,000 decrease in unrealized gain/loss.

Net Loans. Net loans decreased $5.6 million, or 0.7%, to $776.8 million at March 31, 2017 from $782.3 million at June 30, 2016. The decrease is primarily due to net repayments of $8.3 million in commercial loans, $6.3 million in residential mortgages, $1.8 million in consumer and installment loans and $857,000 in home equity lines of credit, partially offset by net originations of $8.9 million in commercial mortgages and by net originations of $3.5 million in construction loans.

Deposits. Total deposits increased $1.8 million, or 0.2%, to $1.1 billion at March 31, 2017 from $1.1 billion at June 30, 2016. This increase primarily reflects a $12.9 million increase in demand accounts and $12.1 million in savings accounts, partially offset by $23.2 million decrease in certificates of deposit, which reflects our focus on increasing low cost core deposits.

Federal Home Loan Bank Advances. Federal Home Loan Bank advances increased $4.4 million, or 21.7%, to $24.4 million at March 31, 2017 from $20.1 million at June 30, 2016. The increase was due to a $20.5 million increase in short-term advances offset by $16.1 million of maturities on long-term advances.

Total Equity. Total equity increased $7.3 million, or 6.7%, to $117.3 million at March 31, 2017 from $109.9 million at June 30, 2016 as a result of net income of $5.0 million and increase in accumulated other comprehensive income of $2.3 million.

Comparison of Operating Results for the Three Months Ended March 31, 2017 and 2016

General. Net income increased $792,000, or 72.1%, to $1.9 million for the three months ended March 31, 2017 compared to $1.1 million for the three months ended March 31, 2016. The increase was primarily due to a $282,000 increase in net interest income, a $108,000 increase in non-interest income, and a $944,000 decrease in non-interest expenses, partially offset by increases of $410,000 in income tax expense and $132,000 in the provision for loan losses.

 

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Net Interest Income. Net interest income increased $282,000, or 3.3%, to $9.0 million for the three months ended March 31, 2017 compared to $8.7 million for the three months ended March 31, 2016. The increase primarily reflects a $912,000 increase in net interest-earning assets, partially offset by a 4 basis point decrease in the net interest margin to 2.96% for the three months ended March 31, 2017 from 3.00% for the same period last year.

Interest and Dividend Income. Interest and dividend income increased $408,000, or 4.1%, to $10.3 million at March 31, 2017 compared to $9.9 million at March 31, 2016. The increase primarily reflects a $54.3 million increase in total interest-earning assets, partially offset by a 3 basis point decrease in the yield on total interest-earning assets.

Interest income on loans increased $156,000 primarily due to a $26.9 million increase in the average balance to $773.0 million for the three months ended March 31, 2017 from $746.2 million for the three months ended March 31, 2016, partially offset by an 8 basis point decrease in the average yield on loans to 4.40% for the three months ended March 31, 2017 from 4.48% for the same period last year.

Interest income on securities increased $208,000, or 14.6%, primarily due to a $18.8 million increase in the average balance of securities to $379.4 million for the three months ended March 31, 2017 from $360.5 million for the three months ended March 31, 2016 and a 14 basis point increase in the average yield on securities to 1.72% for the current-year period.

Interest income on other interest-earning assets increased $44,000, or 41.5%, primarily due to an $8.6 million increase in the average balance on other interest-earning assets and an 18 basis point increase in the average yield on other interest-earning assets to 1.02% for the three months ended March 31, 2017 from 0.84% for the same period last year. The increase in the yield on other interest-earning assets was due primarily to an increase in market interest rates.

Interest Expense. Interest expense increased $126,000, or 10.6%, to $1.3 million for the three months ended March 31, 2017 compared to $1.2 million for the three months ended March 31, 2016. The increase primarily reflects a $53.4 million increase in the average balance on interest-bearing liabilities and a 2 basis point increase in the average cost to 0.52% for the three months ended March 31, 2017 from 0.50% for the same period last year.

Interest expense on interest-bearing deposits and mortgage escrow funds increased $107,000 primarily due to a $28.2 million increase in the average balance to $974.6 million for the three months ended March 31, 2017 from $946.4 million for the three months ended March 31, 2016 and a 3 basis point increase in the average cost to 0.52% for the three months ended March 31, 2017 from 0.49% for the same period last year. The increase in the average rate paid on interest-bearing deposits was caused by growth in medium-term and long-term certificates of deposit which caused a 22 basis point increase in the average rate paid on certificates of deposit.

Interest expense on Federal Home Loan Bank advances increased $10,000, or 22.2%, primarily due to a 51 basis point increase in the average cost to 1.38% for the three months ended March 31, 2017 from 0.87% for the same period last year, primarily due to a longer average maturity in the current year compare to the same period last year.

Provision for Loan Losses. The provision for loan losses increased by $132,000 to $235,000 for the three months ended March 31, 2017, compared to $103,000 for the three months ended March 31, 2016 primarily as a result of a net increase in specific reserves on impaired loans.

Non-Interest Income. Non-interest income increased $108,000 to $626,000 for the three months ended March 31, 2017 compared to $518,000 for the three months ended March 31, 2016. The increase was caused primarily by the increase in fees and service charges.

Non-Interest Expense. Non-interest expense decreased $944,000, or 12.5%, to $6.6 million for the three months ended March 31, 2017 compared to $7.5 million for the three months ended March 31, 2016. The decrease was caused primarily by decreases of $830,000 in salaries and benefits, primarily due to a $919,000 curtailment gain related to the Bank’s defined benefit plan, $169,000 in professional fees and $70,000 in FDIC assessment, partially offset by a $78,000 increase in occupancy expense.

Income Tax Expense. Income tax expense increased $410,000, or 87.6%, to $878,000 for the three months ended March 31, 2017 from $468,000 for the three months ended March 31, 2016. The increase was caused primarily by a $1.2 million, or 76.7%, increase in pre-tax income. The effective tax rate was 31.7% and 29.9% for the three months ended March 31, 2017 and 2016, respectively.

 

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Comparison of Operating Results for the Nine Months Ended March 31, 2017 and 2016

General. Net income increased $1.9 million, or 62.8%, to $5.0 million for the nine months ended March 31, 2017 compared to $3.1 million for the nine months ended March 31, 2016. The increase was primarily due to a $729,000 increase in net interest income, a $2.0 million increase in non-interest income and a $479,000 decrease in non-interest expenses, partially offset by a $969,000 increase in income tax expense and a $323,000 increase in the provision for loan losses.

Net Interest Income. Net interest income increased $729,000, or 2.9%, to $26.3 million for the nine months ended March 31, 2017 from $25.5 million for the nine months ended March 31, 2016. The increase primarily reflects a $1.1 million increase in interest and dividend income, partially offset by a $417,000 increase in interest expense.

Interest and Dividend Income. Interest and dividend income increased $1.1 million, or 3.9%, to $30.2 million for the nine months ended March 31, 2017 from $29.1 million for the nine months ended March 31, 2016. The increase primarily reflects a $39.0 million increase in the average balance on interest-earning assets and a 2 basis point increase in the average yield to 3.35% for the nine months ended March 31, 2017 from 3.33% for the same period last year.

Interest income on loans increased $719,000, or 2.9%, primarily due to a $31.7 million increase in the average balance to $770.6 million for the nine months ended March 31, 2017 from $738.9 million for the nine months ended March 31, 2016, partially offset by a 6 basis point decrease in the average yield to 4.37% for the nine months ended March 31, 2017 from 4.43% for the same period last year.

Interest income on securities increased $321,000, or 7.4%, primarily due to a $7.8 million increase in the average balance of securities to $372.4 million for the nine months ended March 31, 2017 from $364.6 million for the nine months ended March 31, 2016 and an 8 basis point increase in the average yield on securities to 1.66% for the current year period primarily due to an increase in market interest rates.

Interest income on other interest-earning assets increased $106,000, or 46.1%, primarily due to a 24 basis point increase in the average yield to 0.75% for the nine months ended March 31, 2017 from 0.51% for the nine months ended March 31, 2016, partially offset by a $507,000 decrease in the average balance. The increase in the yield on other interest-earning assets was primarily due to an increase in market interest rates.

Interest Expense. Interest expense increased $417,000, or 11.7%, to $4.0 million for the nine months ended March 31, 2017 from $3.6 million for the nine months ended March 31, 2016. The increase primarily reflects a $39.6 million increase in the average balance on interest-bearing liabilities and a 3 basis point increase in the average cost to 0.52% for the nine months ended March 31, 2017 from 0.49% for the same period last year.

Interest expense on interest-bearing deposits and mortgage escrow funds increased $410,000 primarily due to a $41.5 million increase in the average balance to $984.7 million for the nine months ended March 31, 2017 from $943.2 million for the nine months ended March 31, 2016 and a 4 basis point increase in the average cost to 0.52% from 0.48% for the nine months ended March 31, 2016. The increase in the average rate paid on deposits was caused by growth in the medium-term and long-term certificates of deposit, which caused a 23 basis point increase in the rate paid on certificates of deposit.

Interest expense on Federal Home Loan Bank advances decreased $2,000 primarily due to a $12.1 million decrease in the average balance to $12.6 million for the nine months ended March 31, 2017 from $24.7 million for the nine months ended March 31, 2016, partially offset by a 68 basis point increase in the average cost to 1.43% for the nine months ended March 31, 2017 from 0.75% for the same period last year.

Provision for Loan Losses. We recorded a provision for loan losses of $823,000 and $500,000 for the nine months ended March 31, 2017 and 2016, respectively. The increase was caused primarily by a net increase in specific reserves on impaired loans in the current year period.

 

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Non-Interest Income. Non-interest income increased $2.0 million to $3.4 million for the nine months ended March 31, 2017 compared to $1.4 million for the nine months ended March 31, 2016. The increase was caused primarily by the receipt of $1.6 million in settlement on a loan charged-off by CMS Bank before the 2015 merger.

Non-Interest Expense. Non-interest expense decreased $479,000, or 2.2%, to $21.6 million for the nine months ended March 31, 2017 compared to $22.1 million for the nine months ended March 31, 2016. The decrease was caused primarily by a $405,000 decrease in salaries and benefits expense and a $1.0 million decrease in other non-interest expenses, partially offset by a $930,000 increase in occupancy expense. The decrease in salaries and benefits expense was primarily due to a $919,000 curtailment gain related to the Bank’s defined benefit plan while the decrease in other non-interest expenses primarily reflects decreases in professional fees, merger and acquisition related expenses and FDIC assessment. The increase in occupancy expense was primarily due to a non-recurring impairment charge on an operating lease of $521,000.

Income Tax Expense. Income tax expense increased $969,000, or 73.7%, to $2.3 million for the nine months ended March 31, 2017 from $1.3 million for the nine months ended March 31, 2016. The increase was caused primarily by a $2.9 million, or 66.1%, increase in pre-tax income. The effective tax rate was 31.3% and 29.9% for the nine months ended March 31, 2017 and 2016, respectively.

 

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Net Interest Income

Average Balance Sheet and Interest Rates. The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Nonaccrual loans are included in average balances only. Amortization of loan fees is included in interest income on loans.

 

		Three months ended March 31,
		2017												2016
		Average Balance				Interest/ Dividends				Average Rate				Average Balance				Interest/ Dividends				Average Rate
		(in thousands)
Assets:
Loans		$	773,022			$	8,493				4.40	%		$	746,171			$	8,337				4.48	%
Investment securities			379,364				1,633				1.72				360,533				1,425				1.58
Other interest-earning assets			59,915				150				1.02				51,287				106				0.84
Total interest-earning assets			1,212,301				10,276				3.39				1,157,991				9,868				3.42
Non-interest-earning assets			61,354												51,829
Total assets		$	1,273,655											$	1,209,820
Liabilities and equity:
NOW accounts		$	108,798			$	45				0.17			$	92,922			$	36				0.16
Money market accounts			31,689				21				0.26				32,405				22				0.27
Savings accounts			523,045				315				0.24				510,278				386				0.30
Certificates of deposit			311,092				873				1.14				310,815				703				0.92
Total interest-bearing deposits			974,624				1,254				0.52				946,420				1,147				0.49
Federal Home Loan Bank advances			15,920				55				1.38				21,234				45				0.87
Stock offering subscription funds			30,508				9				0.12				—				—				0.00
Total interest-bearing liabilities			1,021,052				1,318				0.52				967,654				1,192				0.50
Non-interest-bearing deposits			125,774												118,846
Other non-interest-bearing liabilities			12,617												9,984
Total liabilities			1,159,443												1,096,484
Total equity			114,212												113,336
Total liabilities and equity		$	1,273,655											$	1,209,820
Net interest income						$	8,958											$	8,676
Interest rate spread (1)											2.87												2.92
Net interest margin (2)											2.96												3.00
Average interest-earning assets to interest-bearing liabilities			118.73	%											119.67	%

 

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

(2)	Net interest margin represents annualized net interest income divided by average interest-earning assets.

 

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		Nine months ended March 31,
		2017												2016
		Average Balance				Interest/ Dividends				Average Rate				Average Balance				Interest/ Dividends				Average Rate
		(in thousands)
Assets:
Loans		$	770,567			$	25,256				4.37	%		$	738,870			$	24,537				4.43	%
Investment securities			372,358				4,643				1.66				364,568				4,322				1.58
Other interest-earning assets			59,838				336				0.75				60,345				230				0.51
Total interest-earning assets			1,202,763				30,235				3.35				1,163,783				29,089				3.33
Non-interest-earning assets			58,405												44,124
Total assets		$	1,261,168											$	1,207,907
Liabilities and equity:
NOW accounts		$	108,135			$	133				0.16			$	87,619			$	104				0.16
Money market accounts			31,658				63				0.26				33,206				68				0.27
Savings accounts			526,735				970				0.25				510,532				1,176				0.31
Certificates of deposit			318,214				2,664				1.12				311,865				2,072				0.89
Total interest-bearing deposits			984,742				3,830				0.52				943,222				3,420				0.48
Federal Home Loan Bank advances			12,583				136				1.43				24,703				138				0.75
Stock offering subscription funds			10,169				9				0.12				—				—				0.00
Total interest-bearing liabilities			1,007,494				3,975				0.52				967,925				3,558				0.49
Non-interest-bearing deposits			126,559												117,758
Other non-interest-bearing liabilities			14,468												9,719
Total liabilities			1,148,521												1,095,402
Total equity			112,647												112,505
Total liabilities and equity		$	1,261,168											$	1,207,907
Net interest income						$	26,260											$	25,531
Interest rate spread (1)											2.83												2.84
Net interest margin (2)											2.91												2.93
Average interest-earning assets to interest-bearing liabilities			119.38	%											120.23	%

 

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

(2)	Net interest margin represents annualized net interest income divided by average interest-earning assets.

 

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Rate/Volume Analysis. The following tables set forth the effects of changing rates and volumes on our net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. Changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume.

 

		Three months ended March 31, 2017 versus 2016
		Rate				Volume				Net
		(in thousands)
Interest income:
Loans		$	(182	)		$	338			$	156
Investment securities			72				136				208
Other interest-earning assets			18				26				44
Total interest income			(92	)			500				408
Interest expense:
NOW accounts			2				7				9
Money market accounts			(1	)			—				(1	)
Savings accounts			(83	)			12				(71	)
Certificates of deposit			169				1				170
Federal Home Loan Bank advances			23				(13	)			10
Stock offering subscription rights			—				9				9
Total interest expense			110				16				126
(Decrease) increase in net interest income		$	(202	)		$	484			$	282

 

		Nine months ended March 31, 2017 versus 2016
		Rate				Volume				Net
		(in thousands)
Interest income:
Loans		$	(484	)		$	1,203			$	719
Investment securities			91				230				321
Other interest-earning assets			107				(1	)			106
Total interest income			(286	)			1,432				1,146
Interest expense:
NOW accounts			4				25				29
Money market accounts			(2	)			(3	)			(5	)
Savings accounts			(247	)			41				(206	)
Certificates of deposit			549				43				592
Federal Home Loan Bank advances			88				(90	)			(2	)
Stock offering subscription rights			—				9				9
Total interest expense			392				25				417
(Decrease) increase in net interest income		$	(678	)		$	1,407			$	729

 

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Management of Market Risk

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

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. The net proceeds from the offering will increase our capital and provide management with greater flexibility to manage our interest rate risk. In particular, management intends to leverage the capital we receive to increase our interest-earning assets. We have implemented the following strategies to manage our interest rate risk: originating loans with adjustable interest rates; promoting core deposit products; and adjusting the interest rates and maturities of funding sources, as necessary. By following these strategies, we believe that we are better positioned to react to changes in market interest rates.

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

The following tables present the estimated changes in our EVE that would result from changes in market interest rates at March 31, 2017 and June 30, 2016. All estimated changes presented in the table are within our Board-approved policy limits.

 

		Economic Value of Equity (EVE)												EVE as a Percent of Portfolio Value of Assets
Basis Point Change in Interest Rates		(dollars in thousands)
		Dollar Amount				Dollar Change				Percent Change				EVE Ratio				Change (in bps)
March 31, 2017:
200			146,875				(19,964	)			(12.0	)			10.99				(90	)
100			159,761				(7,078	)			(4.2	)			11.66				(23	)
—			166,840				—				—				11.89				—
(100)			164,968				(1,871	)			(1.1	)			11.52				(37	)
June 30, 2016:
200			130,967				(25,380	)			(16.2	)			10.78				(141	)
100			147,104				(9,243	)			(5.9	)			11.78				(42	)
—			156,347				—				—				12.19				—
(100)			169,597				13,250				8.5				12.92				73

 

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Certain shortcomings are inherent in the methodologies used in the above interest rate risk measurements. Modeling changes requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. The above table assumes that the composition of our interest-sensitive assets and liabilities existing at the date indicated remains constant uniformly across the yield curve regardless of the duration or repricing of specific assets and liabilities. Accordingly, although the table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our NPV and will differ from actual results.

Liquidity and Capital Resources

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

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

Our most liquid assets are cash and cash equivalents. The levels of these assets depend on our operating, financing, lending and investing activities during any given period. At March 31, 2017, cash and cash equivalents totaled $178.4 million. Securities classified as available for sale, which provide an additional source of liquidity, totaled $99.3 million at March 31, 2017.

At March 31, 2017, we had the ability to borrow up to $259.3 million from the Federal Home Loan Bank of New York, $24.4 million of which was outstanding. At March 31, 2017, we also had an available line of credit with the Federal Reserve Bank of New York’s discount window program of $83.9 million, none of which was outstanding at that date.

We have no material commitments or demands that are likely to affect our liquidity other than as set forth below. If loan demand was to increase faster than expected, or any unforeseen demand or commitment was to occur, we could access our borrowing capacity with the Federal Home Loan Bank of New York or the Federal Reserve Bank of New York.

At March 31, 2017, we had $71.6 million of loan commitments outstanding and $22.8 million of approved, but unadvanced, funds to borrowers. We also had $0.7 million in outstanding letters of credit at March 31, 2017.

Certificates of deposit due within one year of March 31, 2017 totaled $112.7 million. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and Federal Home Loan Bank of New York advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit at March 31, 2017. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.

At March 31, 2017, the Company had no liquid assets because the conversion stock offering had not yet been completed.

Capital Resources. The Bank is subject to various regulatory capital requirements administered by the New York State Department of Financial Services and the Federal Deposit Insurance Corporation. At March 31, 2017, the Bank exceeded all applicable regulatory capital requirements, and was considered “well capitalized” under regulatory guidelines.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

The information required by this item is included in Part I, Item 2 of this report under “Management of Market Risk”.

 

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Item 4. Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of March 31, 2017. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Registrant’s disclosure controls and procedures were effective.

During the quarter ended March 31, 2017, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1. Legal Proceedings

We are not involved in any pending legal proceedings as a plaintiff or a defendant other than routine legal proceedings occurring in the ordinary course of business. At March 31, 2017, we were not involved in any legal proceedings the outcome of which we believe would be material to our financial condition or results of operations.

Item 1A. Risk Factors

In addition to the other information set forth in this quarterly report, you should carefully consider the factors discussed under the heading “Risk Factors” contained in the Prospectus. The Company’s evaluation of the risk factors applicable to it has not changed materially from those disclosed in the Prospectus.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds of Registered Securities

None

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

 

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Item 6. Exhibits

 

Exhibit Number		Description
3.1		Articles of Incorporation of PCSB Financial Corporation (1)
3.2		Bylaws of PCSB Financial Corporation (2)
31.1		Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32		Written Statement of Chief Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(3)
101.0		The following materials for the quarter ended March 31, 2017, formatted in XBRL (Extensible Business Reporting Language): (i) Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income (Loss), (iv) Consolidated Statements of Changes in Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Consolidated Financial Statements (3)

 

(1)	Incorporated by reference to Exhibit 3.1 to the Company’s Registration Statement on Form S-1, as amended (Commission File No. 333-215052).

(2)	Incorporated by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1, as amended (Commission File No. 333-215052).

(3)	Furnished, not filed.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

						PCSB FINANCIAL CORPORATION
Date: May 12, 2017						/s/  Joseph D. Roberto
						Joseph D. Roberto
						Chairman, President and Chief Executive Officer
Date: May 12, 2017						/s/  Scott D. Nogles
						Scott D. Nogles
						Executive Vice President and Chief Financial Officer

 

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