Attached files

file filename
EX-10.25 - CHANGE IN CONTROL SEVERANCE AGREEMENT BETWEEN UNITED COMMUNITY BANK AND DAVID Z. - United Community Bancorpf10k2017ex10-25_united.htm
EX-32 - CERTIFICATION - United Community Bancorpf10k2017ex32_unitedcommun.htm
EX-31.2 - CERTIFICATION - United Community Bancorpf10k2017ex31-2_unitedcommun.htm
EX-31.1 - CERTIFICATION - United Community Bancorpf10k2017ex31-1_unitedcommun.htm
EX-23 - CONSENT OF CLARK, SCHAEFER, HACKETT & CO. - United Community Bancorpf10k2017ex23_united.htm
EX-21 - SUBSIDIARIES - United Community Bancorpf10k2017ex21_unitedcomm.htm
EX-10.24 - UNITED COMMUNITY BANK SUPPLEMENTAL LIFE INSURANCE PLAN - United Community Bancorpf10k2017ex10-24_unitedcomm.htm
EX-10.23 - THIRD AMENDMENT TO EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN UN - United Community Bancorpf10k2017ex10-23_unitedcomm.htm
EX-10.22 - SECOND AMENDMENT TO EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN U - United Community Bancorpf10k2017ex10-22_unitedcomm.htm
EX-10.21 - FIRST AMENDMENT TO EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN UN - United Community Bancorpf10k2017ex10-21_unitedcomm.htm
EX-10.20 - EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN UNITED COMMUNITY BANK - United Community Bancorpf10k2017ex10-20_unitedcomm.htm
EX-10.19 - THIRD AMENDMENT TO EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN UN - United Community Bancorpf10k2017ex10-19_unitedcomm.htm
EX-10.18 - THIRD AMENDMENT TO EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN UN - United Community Bancorpf10k2017ex10-18_unitedcomm.htm
EX-10.17 - SECOND AMENDMENT TO EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN U - United Community Bancorpf10k2017ex10-17_unitedcomm.htm
EX-10.16 - SECOND AMENDMENT TO EXECUTIVE SUPPLEMENTAL RETIREMENT INCOME AGREEMENT BETWEEN U - United Community Bancorpf10k2017ex10-16_unitedcomm.htm

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-K

 

(Mark One)

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

 

For the fiscal year ended June 30, 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: 000-54876

 

UNITED COMMUNITY BANCORP

(Exact Name of Registrant as Specified in Its Charter)

 

Indiana   80-0694246

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

     
92 Walnut Street, Lawrenceburg, Indiana   47025
(Address of Principal Executive Offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (812) 537-4822

 

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

 

Common Stock, par value $0.01 per share   The NASDAQ Stock Market LLC
Title of Class   Name of each exchange on which registered

 

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

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES ☐    NO ☒

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ☐    NO ☒

 

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

 

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

 

Large accelerated filer ☐  Accelerated filer  
Non-Accelerated filer ☐   (Do not check if a smaller reporting company) Smaller 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 complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    ☐

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates as of December 31, 2016 was $58.1 million. The number of shares outstanding of the registrant’s common stock as of September 26, 2017 was 4,201,113.

 

 

 

 

INDEX

 

  Page
   
PART I  
Item 1. Business 1
Item 1A. Risk Factors 18
Item 1B. Unresolved Staff Comments 25
Item 3. Legal Proceedings 25
Item 4. Mine Safety Disclosures 25
   
PART II  
   
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 26
Item 6. Selected Financial Data 28
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 30
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 68
Item 8. Financial Statements and Supplementary Data 68
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 112
Item 9A. Controls and Procedures 112
Item 9B. Other Information 112
   
PART III  
   
Item 10. Directors, Executive Officers and Corporate Governance 112
Item 11. Executive Compensation 113
Item 12. Security Ownership of Certain Beneficial Owners and Management Related Stockholder Matters 113
Item 13. Certain Relationships and Related Transactions, and Director Independence 113
Item 14. Principal Accountant Fees and Services 113
   
PART IV  
   
Item 15. Exhibits and Financial Statement Schedules 114

Item 16. Form 10-K Summary

115
   
SIGNATURES 116

 

 i 

 

 

Note on Forward-Looking Statements

 

This report, like many written and oral communications presented by United Community Bancorp and our authorized officers, may contain certain forward-looking statements regarding our prospective performance and strategies within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, and are including this statement for purposes of said safe harbor provisions.

 

Forward-looking statements, which are based on certain assumptions and describe future plans, strategies, and expectations of the Company, are generally identified by use of the words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “plan,” “project,” “seek,” “strive,” “try,” or future or conditional verbs such as “will,” “would,” “should,” “could,” “may,” or similar expressions. Our ability to predict results or the actual effects of our plans or strategies is inherently uncertain. Accordingly, actual results may differ materially from anticipated results.

 

There are a number of factors, many of which are beyond our control, that could cause actual conditions, events, or results to differ significantly from those described in our forward-looking statements. These factors include, but are not limited to:

 

general economic conditions, either nationally or in some or all of the areas in which we and our customers conduct our respective businesses;

 

conditions in the securities markets and real estate markets or the banking industry;

 

changes in interest rates, which may affect our net interest income, net income, and other future cash flows, or the market value of our assets and liabilities;

 

changes in deposit flows and wholesale borrowing facilities;

 

changes in the demand for deposit, loan, and investment products and other financial services in the markets we serve;

 

changes in our credit ratings or in our ability to access the capital markets;

 

changes in our customer base or in the financial or operating performance of our customers’ businesses;

 

changes in real estate values, which could impact the quality of the assets securing the loans in our portfolio;

 

changes in the quality or composition of our loan or securities portfolios;

 

changes in competitive pressures among financial institutions or from non-financial institutions;

 

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

 

our ability to retain key members of management;

 

our timely development of new lines of business and competitive products or services in a changing environment, and the acceptance of such products or services by our customers;

 

any interruption or breach of security resulting in failures or disruptions in customer account management, general ledger, deposit, loan, or other systems;

 

any interruption in customer service due to circumstances beyond our control;

 

potential exposure to unknown or contingent liabilities of companies we have acquired or target for acquisition;

 

 ii 

 

 

the outcome of pending or threatened litigation, or of other matters before regulatory agencies, whether currently existing or commencing in the future;

 

environmental conditions that exist or may exist on properties owned by, leased by, or mortgaged to the Company;

 

operational issues stemming from, and/or capital spending necessitated by, the potential need to adapt to industry changes in information technology systems, on which we are highly dependent;

 

changes in our estimates of future reserves based upon the periodic review thereof under relevant regulatory and accounting requirements;

 

changes in our capital management policies, including those regarding business combinations, dividends, and share repurchases, among others;

 

changes in legislation, regulation, policies, or administrative practices, whether by judicial, governmental, or legislative action, including, but not limited to, the impact of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and other changes pertaining to banking, securities, taxation, rent regulation and housing, environmental protection, and insurance; and the ability to comply with such changes in a timely manner;

 

additional FDIC special assessments or required assessment prepayments;

 

changes in accounting principles, policies, practices or guidelines;

 

the ability to keep pace with, and implement on a timely basis, technological changes;

 

changes in the monetary and fiscal policies of the U.S. Government, including policies of the U.S. Department of the Treasury and the Board of Governors of the Federal Reserve System;

 

war or terrorist activities; and

 

other economic, competitive, governmental, regulatory, and geopolitical factors affecting our operations, pricing, and services.

 

Additional factors that may affect our results are discussed in this Annual Report on Form 10-K under “Item 1A. Risk Factors.” The Company wishes to caution readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The Company wishes to advise readers that the factors listed above could affect the Company’s financial performance and could cause the Company’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

 

The Company does not undertake the responsibility, and specifically disclaims any obligation, to publicly release the result of any revisions, which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.

 

 iii 

 

 

PART I 

 

Item 1. Business

 

United Community Bancorp. United Community Bancorp, Inc. is an Indiana corporation (“United Community Bancorp” or the “Company”) that was incorporated in March 2011 to be the successor corporation to old United Community Bancorp (“Old United Community Bancorp”), the former stock holding company for United Community Bank (the “Bank”), upon completion of the mutual-to-stock conversion of United Community MHC, the former mutual holding company for United Community Bancorp. The mutual-to-stock conversion was completed on January 9, 2013. As part of the conversion, all outstanding shares of Old United Community Bancorp common stock (other than those owned by United Community MHC) were converted into the right to receive 0.6573 of a share of United Community Bancorp common stock resulting in 2,089,939 shares issued in the exchange without giving effect to cash distributed for fractional shares. In addition, a total of 3,060,058 shares of common stock were sold in the subscription and community offerings at the price of $8.00 per share, including 194,007 shares of common stock purchased by the United Community Bancorp Employee Stock Ownership Plan (the “ESOP”). As of June 30, 2017, United Community Bancorp had 4,205,980 shares outstanding. As a savings and loan holding company, United Community Bancorp is subject to the regulation of the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).

 

United Community Bancorp’s business activities consist of the ownership of the Bank’s capital stock and the management of the offering proceeds it retained. It does not own or lease any property. Instead, it uses the premises, equipment and other property of United Community Bank. Accordingly, the information set forth in this Annual Report on Form 10-K, including the consolidated financial statements and related financial data, relates primarily to the Bank.

 

Financial information presented in this Annual Report on Form 10-K is derived in part from the consolidated financial statements of United Community Bancorp and subsidiaries on and after January 9, 2013 and from the consolidated financial statements of Old United Community Bancorp and subsidiaries prior to January 9, 2013.

 

United Community Bank. United Community Bank is a federally chartered savings bank and was created on April 12, 1999 through the merger of Perpetual Federal Savings and Loan Association and Progressive Federal Savings Bank, both located in Lawrenceburg, Indiana. On June 4, 2010, United Community Bank acquired three branches from Integra Bank National Association all of which are located in Ripley County, Indiana. At June 30, 2017, we had approximately $536.9 million in assets and $453.7 million in deposits. We operate as a community-oriented financial institution offering a wide menu of banking services and products to consumers and businesses in our market areas. Recent years have seen the expansion of services we offer from a traditional savings and loan product mix to those of a full-service financial institution servicing the needs of consumer and commercial customers. United Community Bank attracts deposits from the general public and local municipalities and uses those funds to originate one- to four-family real estate, multi-family real estate and nonresidential real estate, construction, commercial and consumer loans. Generally, fixed-rate one- to four-family residential conforming loans with terms of more than ten years that we originate are sold in the secondary market with the servicing retained. Such sales generate mortgage banking income. The remainder of our loan portfolio is originated for investment. United Community Bank also maintains an investment portfolio. United Community Bank is regulated by the Office of the Comptroller of the Currency (the “OCC”) and its deposits are insured up to applicable legal limits by the Federal Deposit Insurance Corporation, referred to as the FDIC. United Community Bank is also a member of the Federal Home Loan Bank of Indianapolis.

 

UCB Real Estate Management Holdings, LLC. UCB Real Estate Management Holdings, LLC is a wholly-owned subsidiary of United Community Bank. The entity was formed for the purpose of holding real estate assets that are acquired by the Bank through, or in lieu of, foreclosure. Real estate assets held totaled $93,000 as of June 30, 2017.

 

UCB Financial Services, Inc. UCB Financial Services, Inc., a wholly owned subsidiary of the Bank, owns and manages a portion of the Bank’s municipal bond portfolio, and is used for the collection of commissions from a wealth management partner.

 

Market Areas

 

We are headquartered in Lawrenceburg, Indiana, which is in the eastern part of Dearborn County, Indiana, along the Ohio River and part of the Greater Cincinnati MSA. We currently have five branches located in Dearborn County and three branches located in adjacent Ripley County. Dearborn and Ripley Counties represent our primary deposit markets. The primary sources of loan originations are existing customers, walk-in traffic, advertising, referrals from customers and other sources, and business development efforts. We advertise on television and radio and in newspapers that are widely circulated in Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. Accordingly, as our loan rates are competitive, we attract loans from throughout these counties. The economy of the region in which our current offices are located has historically been a mixture of light industrial enterprises and services. Since the mid-1990s, the economy in Lawrenceburg has been strengthened by the riverboat casino in Lawrenceburg whose presence has supported the development of retail centers and job growth as well as an increase in housing development. Located 20 miles from Cincinnati, Ohio, Dearborn and Ripley Counties have also benefited from the growth in and around Cincinnati and Northern Kentucky, as many residents commute to these areas for employment.

 

 1 

 

 

Dearborn and Ripley Counties’ road system includes eight state highways and three U.S. highways. The counties have two rail lines and port facilities due to the proximity of the Ohio River.

 

Competition

 

We face significant competition for the attraction of deposits and the origination of loans. Our most direct competition for deposits has historically come from the several financial institutions operating in our market areas and, to a lesser extent, from other financial service companies such as brokerage firms, credit unions and insurance companies. We also face competition for investors’ funds from money market funds, mutual funds and other corporate and government securities. As the use of the internet has grown, we also face significant competition from financial institutions and other financial service companies across the nation and around the world with internet banking platforms. At June 30, 2016, which is the most recent date for which data is available from the Federal Deposit Insurance Corporation (“FDIC”), we held approximately 40.8% of the deposits held by FDIC-insured institutions in Dearborn County, which was the largest market share out of the eight financial institutions with offices in Dearborn County, and 10.9% of the deposits in Ripley County, which was the fifth largest market share out of the nine financial institutions with offices in Ripley County. In addition, banks owned by large out-of-state bank holding companies such as Fifth Third Bancorp, PNC Bank and U.S. Bancorp also operate in our market areas.

 

Our competition for loans comes primarily from financial institutions in our market areas, and, to a lesser extent, from other financial service providers such as mortgage companies and mortgage brokers. Competition for loans also comes from non-depository financial service companies which have entered the mortgage market such as insurance companies, securities companies and specialty finance companies.

 

We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered the barriers to market entry, allowed banks and other lenders to expand their geographic reach by providing services over the Internet and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Competition for deposits and the origination of loans could limit our future growth. Nevertheless, total deposits increased $14.8 million from June 30, 2016 to June 30, 2017. The deposit growth during the year is comprised of $7.8 million in retail growth and $7.0 million in municipal deposit growth.

 

Lending Activities

 

General. We originate loans primarily for investment purposes. Historically, our primary lending activity has been the origination of one- to four-family mortgage loans secured by homes in our local market area, particularly in Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. A significant portion of this historical lending activity has been the origination for retention in our portfolio of adjustable-rate mortgage (“ARM”) loans collateralized by one- to four-family residential real estate located within our primary market area. The low interest rate environment that has persisted over the last few years has required that we augment adjustable rate originations with select 10-year fixed rate loan originations as well as select 15-year fixed loan originations. Mortgage loans with a fixed term of more than 15 years are generally sold to the secondary market with servicing retained. In order to further complement our traditional emphasis of one- to four-family residential real estate lending, significant segments of our loan portfolio consist of nonresidential real estate and land loans, multi-family real estate loans, commercial loans, agricultural loans, and consumer loans. Between 2006 and 2010, we increased and diversified our lending efforts in the metropolitan Cincinnati market area and, to a lesser extent, in Northern Kentucky and the Indiana counties outside of our local market area, particularly with respect to nonresidential and multi-family real estate lending. In June 2010, we implemented a strategy to deemphasize the origination of nonresidential real estate and multi-family real estate loans, particularly outside of Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. The strategy was implemented to address the fact that multi-family and nonresidential real estate loans, particularly those originated outside of the Bank’s traditional southeastern Indiana market area, experienced the most financial difficulty during the recent economic downturn, in turn causing the Bank to incur losses and devote an inordinate amount of management oversight to these relationships. Consequently, between June 2010 and the quarter ended December 31, 2013, our multifamily and nonresidential real estate lending origination activity outside, and to a lesser extent inside, of Dearborn, Ripley, Franklin, Ohio and Switzerland Counties in Indiana had been limited to the renewal, refinancing and restructuring of these types of loans. During the quarter ended December 31, 2013 we reviewed the economic environment in our lending markets and implemented a controlled growth strategy to prudently increase commercial and commercial real estate lending, including in the Cincinnati and Northern Kentucky markets. Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate loan portfolios.

 

 2 

 

 

For additional information regarding our strategy to deemphasize the origination of multi-family and nonresidential real estate loans, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Our Operating Strategy – Improving our asset quality,” “– Implementing a controlled growth strategy to originate multi-family and nonresidential real estate loans to improve interest income” and “– Risk Management – Analysis of Nonperforming and Classified Assets.”

 

One- to Four-Family Residential Real Estate Loans. We offer mortgage loans to enable borrowers to purchase or refinance existing homes, most of which serve as the primary residence of the owner. We offer fixed-rate and adjustable-rate loans with terms up to 30 years. Borrower demand for adjustable-rate loans versus fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans and the initial period interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate mortgage loans and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions. Most of our loan originations result from relationships with existing or past customers, members of our local community and referrals from realtors, attorneys and builders.

 

While one- to four-family residential real estate loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans. As a result of the continued low interest rate environment during the past several years, a greater percentage of our one- to four-family loan originations consisted of fixed-rate one- to four-family mortgage loans. Our practice in recent years has generally been to (i) sell in the secondary market newly originated conforming fixed-rate 15-, 20- and 30-year one- to four-family residential real estate loans on a servicing retained basis, without recourse to United Community Bank, and (ii) to hold in our portfolio fixed-rate loans with 10-year terms or less and adjustable-rate loans. At times, we have also placed select loans with a 15-year fixed term on the balance sheet. Beginning in the quarter ended June 30, 2017, after modeling the impact to our Asset/Liability profile, we began placing select mortgage loans with a 15-year fixed term on the balance sheet. This practice may change at any time, but the impact of the strategy will be monitored in conjunction with our Asset/Liability Committee meetings. In the past, we have occasionally purchased loans and purchased participation interests in loans originated by other institutions to supplement our origination efforts. At June 30, 2017, loans serviced by United Community Bank for others totaled $81.4 million, resulting in $190,000 in servicing fee income during the year ended June 30, 2017. At June 30, 2016, loans serviced by United Community Bank for others totaled $68.9 million, resulting in $164,000 in servicing fee income during the year ended June 30, 2016. During the years ended June 30, 2017 and 2016, we sold $23.7 million and $11.3 million, respectively, of fixed-rate one- to four-family loans. As of June 30, 2017, and 2016, we had $1.0 million and $783,000, respectively, of mortgage loans held for sale recorded at the lower of cost or fair value.

 

Interest rates and payments on our adjustable-rate mortgage loans generally adjust annually after an initial fixed period that ranges from one to ten years. Interest rates and payments on these adjustable-rate loans generally are based on the one-year constant maturity U.S. Treasury index (three-year constant maturity U.S. Treasury index in the case of three-year adjustable-rate loans) as published by the Federal Reserve Board in Statistical Release H.15. The maximum amount by which the interest rate may be increased is generally two percentage points per adjustment period and the lifetime interest rate cap ranges from five to six percentage points over the initial interest rate of the loan. Our adjustable-rate one- to four-family mortgage loans generally do not provide for a decrease in the rate paid below the initial contract rate. The inability of our residential real estate loans to adjust downward below the initial contract rate can contribute to increased income in periods of declining interest rates, and also assists us in our efforts to limit the risks to earnings and equity value resulting from changes in interest rates, subject to the risk that borrowers may refinance these loans during periods of declining interest rates.

 

 3 

 

 

ARM loans decrease the risk associated with increases in market interest rates by periodically repricing, but involve other risks. As interest rates increase, the required periodic payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time, the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustment permitted by the terms of the ARM loans, and therefore, is potentially limited in effectiveness during periods of rapidly rising interest rates. Decreasing interest rates could result in a downward adjustment of the contractual interest rates, subject to interest rate floor, resulting in lower interest income. At June 30, 2017, 35.7% of our loan portfolio consisted of one- to four-family residential loans with adjustable interest rates.

 

We generally do not make conventional one-to-four family real estate loans with loan-to-value ratios exceeding 80% without requiring private mortgage insurance. We require all properties securing mortgage loans to be appraised by a board-approved independent appraiser. We generally require title insurance on all first mortgage loans. Borrowers must obtain hazard insurance and flood insurance for loans on properties located in a flood zone before closing the loan.

 

We do not offer, and have not previously offered, subprime, Alt-A, low-doc, no-doc loans or loans with negative amortization and generally do not offer interest-only loans.

 

At June 30, 2017, we had $144.3 million in One-to four-family real estate loans outstanding, or 50.5% of total loans.

 

Multi-Family Real Estate Loans. We offer adjustable-rate mortgage loans secured by multi-family real estate. Our multi-family real estate loans are generally secured by apartment buildings within and outside our primary market area. At June 30, 2017, approximately 56.1% of our multi-family real estate loans were secured by properties located outside of Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana, 100% of which were in the Cincinnati and Northern Kentucky markets. In June 2010, we implemented a strategy to deemphasize the origination of nonresidential real estate and multi-family real estate loans, particularly outside of Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. The strategy was implemented to address the fact that multi-family and nonresidential real estate loans, particularly those originated outside of the Bank’s traditional southeastern Indiana market area, experienced significant financial difficulties during the recent economic downturn, which resulted in the Bank incurring losses and being required to devote a significant amount of management’s time and energy to overseeing these relationships. Consequently, between June 2010 and the quarter ended December 31, 2013, our multi-family and nonresidential real estate lending origination activity outside of, and to a lesser extent within, Dearborn, Ripley, Franklin, Ohio and Switzerland Counties in Indiana was limited to the renewal, refinancing and restructuring of these types of loans. As part of the strategy, we amended our loan policy to reduce our concentration limits for multi-family real estate loans to 75% of the sum of tier 1 risk-based capital plus our allowance for loan losses. During the quarter ended December 31, 2013 we reviewed the economic environment in our lending markets and implemented a controlled growth strategy to prudently increase multi-family and nonresidential real estate lending, including in the Cincinnati and Northern Kentucky markets. Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate loan portfolios. At June 30, 2017, none of the nonperforming assets were multi-family residential real estate loans. For additional information regarding our troubled debt restructurings, controlled growth strategy and our multi-family residential lending, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Our Operating Strategy – Improving our asset quality,” “–Implementing a controlled growth strategy to originate multi-family and nonresidential real estate loans to improve interest income” and “ – Risk Management – Analysis of Nonperforming Assets.”

 

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These loans are typically repaid or the term is extended before maturity, in which case a new rate is negotiated to meet market conditions and an extension of the loan is executed for a new term with a new amortization schedule. Our portfolio primarily includes adjustable-rate multi-family real estate loans with terms up to 30 years. Amortization periods for loans originated since 2014 typically do not exceed 25 years. Interest rates and payments on most of these loans typically adjust annually after an initial fixed term of one to seven years, with the adjustable-rate generally being based on the prime interest rate as published in The Wall Street Journal, plus a spread, or the one, three, or five-year US Treasury index as published by the Federal Reserve Board in Statistical Release H.15, plus a spread. The maximum amount by which the interest rate may be increased is generally two percentage points per adjustment period and the lifetime interest rate cap is generally six percentage points over the initial interest rate of the loan. Our adjustable-rate multi-family loans generally do not provide for a decrease in the rate paid below the initial contract rate. Loans are secured by first mortgages that generally do not exceed 80% of the lesser of the property’s appraised value or the purchase price, the maximum amount of which is limited by our in-house loans to one borrower limit, which currently is $6.4 million. When the borrower is a corporation, partnership or other entity, we generally require that significant equity holders serve as co-borrowers or guarantors on the loan. Environmental reports are generally required for all multi-family loans.

 

Loans secured by multi-family real estate generally have larger balances and involve a greater degree of inherent risk than one- to four-family residential mortgage loans. A primary concern in multi-family real estate lending is the borrower’s creditworthiness and the feasibility and cash flow expectations of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than one- to four-family residential real estate loans to adverse conditions in the real estate market or the economy. To monitor project and global cash flows on multi-family real estate loans, we typically require borrowers, co-borrowers, and guarantors to provide annual financial statements and/or tax returns. In reaching a decision on whether to make a multi-family real estate loan, we consider the net operating income of the property, the borrower’s character and expertise, credit history and profitability and the value of the underlying property. We have generally required that the properties securing these real estate loans have debt service coverage ratios (cash available to service debt divided by required debt service) of at least 1.20x.

 

At June 30, 2017, we had $15.4 million in multi-family real estate loans outstanding, or 5.4% of total loans. The largest outstanding multi-family real estate loan at such date had an outstanding balance of $6.5 million and is secured by multiple apartment buildings. This loan was performing in accordance with its original contractual terms at June 30, 2017. The total outstanding is a Board approved exception to our in-house limit, which was $6.4 million as of June 30, 2017.

 

Nonresidential Real Estate and Land Loans. We offer adjustable-rate mortgage loans secured by owner-occupied and non-owner occupied nonresidential real estate. Our nonresidential real estate loans are generally secured by commercial buildings. These loans are typically repaid or the term is extended before maturity, in which case a new rate is negotiated to meet market conditions and an extension of the loan is executed for a new term with a new amortization schedule. We originate adjustable-rate nonresidential real estate loans with terms up to 30 years. Amortization periods for loans originated since 2014 typically do not exceed 20 years. Interest rates and payments on most of these loans typically adjust annually after an initial fixed term of one to seven years, with the adjustable-rate generally being based on the prime interest rate as published in The Wall Street Journal, plus a spread, or the one, three, or five-year US Treasury index as published by the Federal Reserve Board in Statistical Release H.15, plus a spread. The maximum amount by which the interest rate may be increased is generally two percentage points per adjustment period and the lifetime interest rate cap is generally six percentage points over the initial interest rate of the loan. Loans are secured by first mortgages that generally do not exceed 80% of the property’s appraised value or the purchase price (70% for improved land only loans and 50% for unimproved land only loans), the maximum amount of which is limited by our in-house loans to one borrower limit, which currently is $6.4 million. When the borrower is a corporation, partnership or other entity, we may require that significant equity holders serve as co-borrowers or as personal guarantors of the loan. As of June 30, 2017, approximately $1.1 million, or 37.7%, of our nonperforming assets were nonresidential real estate loans.

 

In June 2010, we implemented a strategy to control the growth of our nonresidential real estate and multi-family real estate loan portfolios, particularly outside of Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. The strategy was implemented to address the fact that multi-family and nonresidential real estate loans, particularly those originated outside of the Bank’s traditional southeastern Indiana market area, experienced the most financial difficulty during the recent economic downturn, in turn causing the Bank to incur losses and devote an inordinate amount of management oversight to these relationships. Consequently, between June 2010 and the quarter ended December 31, 2013, our multi-family and nonresidential real estate lending origination activity outside of, and to a lesser extent within, Dearborn, Ripley, Franklin, Ohio and Switzerland Counties in Indiana was limited to the renewal, refinancing and restructuring of these types of loans. As part of the strategy, we amended our loan policy to reduce our concentration limits for nonresidential real estate loans to 100% of the sum of tier 1 risk-based capital plus our allowance for loan losses. During the quarter ended December 31, 2013 we reviewed the economic environment in our lending markets and implemented a controlled growth strategy to prudently increase multi-family and nonresidential real estate lending, including in the Cincinnati and Northern Kentucky markets. Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate loan portfolios. For additional information regarding our troubled debt restructurings, controlled growth strategy and our nonresidential real estate and land loans, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Our Operating Strategy – Improving our asset quality”, “ – Implementing a controlled growth strategy to originate multi-family and nonresidential real estate loans to improve interest income” and “ – Risk Management – Analysis of Nonperforming and Classified Assets.”

 

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Loans secured by nonresidential real estate generally have larger balances and involve a greater degree of inherent risk than one- to four-family residential mortgage loans. Our primary concern in nonresidential real estate lending is the borrower’s creditworthiness and the feasibility and cash flow expectations of the project or business. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than one- to four-family residential real estate loans to adverse conditions in the real estate market or the economy. To monitor project, business and global cash flows on nonresidential real estate loans, we typically require borrowers, co-borrowers and loan guarantors to provide annual financial statements and/or tax returns. In reaching a decision on whether to make a nonresidential real estate loan, we consider the net operating income of the property, the borrower’s expertise and character, credit history and profitability and the value of the underlying property. In addition, with respect to rental properties, we will also consider the term of the leases and the credit quality of the tenants. We may require that the properties securing these real estate loans have debt service coverage ratios (cash available to service debt divided by required debt service) of at least 1.20x. Environmental reports are generally required for nonresidential real estate loans.

 

We also originate loans secured by unimproved property, including lots for single-family homes and for mobile homes, raw land, commercial property and agricultural property. The interest rates charged on our land loans are typically higher the interest rates charged on our nonresidential and multi-family real estate loans due to the higher level of inherent risk. Loans secured by undeveloped land or improved lots generally involve greater risks than one- to four-family residential mortgage lending because land loans are more complex, more difficult to evaluate and require more extensive monitoring. If the estimate of value proves to be inaccurate or changes over time, in the event of default and foreclosure, we may be confronted with a property with a value that is insufficient to assure full repayment. Loan amounts generally do not exceed 70% and 50% of the lesser of the appraised value or the purchase price for improved and unimproved land loans, respectively.

 

At June 30, 2017, we had $74.8 million in nonresidential real estate loans outstanding, or 26.2% of total loans, and $3.0 million in land loans outstanding, or 1.1% of total loans. At June 30, 2017, the largest outstanding nonresidential real estate loan had an outstanding balance of $5.6 million and was performing in accordance with its original contractual terms at that date. At June 30, 2017, our largest land loan, which was performing in accordance with its original terms at that date, had an outstanding balance of $586,000 and was secured by a commercial land development.

 

Construction Loans. We originate adjustable-rate loans to individuals and, to a lesser extent, builders to finance the construction of residential dwellings. We also make construction loans for commercial development projects, including apartment buildings and nonresidential properties (owner occupied and non-owner occupied). Our construction loans generally provide for the payment of interest only during the construction phase, which is typically nine months for residential properties and 12 months for commercial properties. At the end of the construction phase, the loan generally converts to a permanent mortgage loan. Loans generally can be made with a maximum loan to value ratio not to exceed 80% without private mortgage insurance on residential construction and 80% on commercial construction at the time the loan is originated. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also typically require an inspection and title update of the property before disbursement of funds during the term of the construction loan.

 

At June 30, 2017, we had $5.2 million of construction loans, or 1.8% of total loans.

 

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At June 30, 2017, our largest residential construction loan was for $441,000, of which the entire balance was outstanding. At June 30, 2017, our largest commercial construction loan relationship was for $1.7 million, of which the entire balance was outstanding.

 

Commercial Loans. We make commercial business loans to professionals, sole proprietorships, partnerships and other small businesses primarily in our market area. We extend commercial business loans on an unsecured basis and secured basis, the maximum amount of which is limited by our in-house loans to one borrower limit.

 

We also originate secured and unsecured commercial lines of credit to finance the working capital needs of businesses to be repaid by seasonal cash flows. Commercial lines of credit are typically secured by business assets or nonresidential real estate and are typically adjustable-rate loans whose rates are based on the prime interest rate as published in The Wall Street Journal, plus a spread, and adjust monthly. Commercial lines of credit have maximum terms of one to five years, depending on the collateral. We also originate commercial lines of credit secured by marketable securities and unsecured lines of credit. Our commercial lines of credit typically require interest only payments to be paid on a monthly or quarterly basis.

 

We also originate secured and unsecured commercial loans. Secured commercial loans are generally collateralized by business assets, including accounts receivable, inventory, industrial/commercial machinery, equipment, furniture and fixtures and marketable securities. We originate both fixed-rate and adjustable-rate commercial loans with terms up to seven years for secured loans and up to three years for unsecured loans unless there is an adequate credit enhancement to the loans such as an SBA guarantee. Term limits for larger machinery and equipment may be extended to ten years. Terms assigned to a specific loan generally will not exceed the useful life of the collateral. Adjustable-rate loans are typically based on the prime interest rate as published in The Wall Street Journal, plus a spread, and adjust either monthly or annually. Where the borrower is a corporation, partnership or other entity, we generally require significant equity holders to be co-borrowers or guarantors on the loan.

 

When making commercial business loans, we consider the financial statements and/or tax returns of the borrower, the borrower’s payment history of both corporate and personal debt, the debt service capabilities of the borrower, the projected cash flows of the business, the viability of the industry in which the customer operates and the value of the collateral.

 

At June 30, 2017, we had $5.4 million of commercial loans outstanding, or 1.9% of total loans.

 

At June 30, 2017, our largest commercial loan was a $712,000 loan which was secured primarily by personal aircraft. This loan was performing in accordance with its original contractual terms at June 30, 2017.

 

Consumer Loans. We offer a variety of consumer loans, primarily home equity loans and lines of credit, and, to a much lesser extent, loans secured by savings accounts or certificates of deposit, new farm and garden equipment, new and used automobiles, recreational vehicle loans and secured and unsecured personal loans.

 

The procedures for underwriting consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant’s creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.

 

We generally offer home equity loans and lines of credit with a maximum combined loan to value ratio of 90%. Our lowest interest rates are generally offered to customers with a maximum combined loan to value ratio of 80% or less. Home equity lines of credit have adjustable-rates of interest that are typically based on the prime interest rate as published in The Wall Street Journal, plus a spread. Home equity lines of credit have terms up to 25 years and generally require that only interest be paid on a monthly basis during the 10-year draw period then converting to principal and interest payments over the remaining 15 years of the loan. Interest rates on these loans typically adjust monthly. We offer fixed-rate and adjustable-rate home equity loans. Home equity loans with fixed-rates have terms up to 10 years. Home equity loans with adjustable-rates have terms up to 30 years. Interest rates on these loans are based on the prime interest rate as published in The Wall Street Journal, plus a spread. We hold a first mortgage position on the majority of the homes that secure our home equity loans and home equity lines of credit.

 

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We offer loans secured by new and used vehicles. These loans have fixed interest rates and generally have terms up to 72 months.

 

We offer loans secured by new and used boats, motor homes, campers and motorcycles. We offer fixed and adjustable-rate loans for new motor homes and boats with terms up to 10 years for adjustable-rate loans and up to 10 years for fixed-rate loans. We offer fixed-rate loans for all other new and used recreational vehicles with terms up to 10 years for campers and five years for motorcycles.

 

We offer secured consumer loans with fixed interest rates and terms up to 10 years and secured lines of credit with adjustable-rates typically based on the prime interest rate as published in The Wall Street Journal with terms up to 25 years. We also offer fixed-rate unsecured consumer loans with terms up to five years. For more information on our loan commitments, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations–Risk Management–Liquidity Management.” At June 30, 2017, we had $33.6 million of consumer loans outstanding, or 11.8% of total loans.

 

Agricultural Loans. Originally, our agricultural loans were acquired in connection with our acquisition of the Ripley County branch offices in 2010. However, we continue to devote efforts to growing the agricultural segment of our loan portfolio due to the opportunities in our markets. Our agricultural loans generally consist of short and medium-term loans and lines of credit that are primarily used for crops, livestock, equipment and general operations. Agricultural loans are ordinarily secured by assets such as livestock, crops, equipment, or real estate and are repaid from the operations of the farm. Agricultural lines of credit generally have maturities of three years or less. At June 30, 2017, we had $3.9 million of agricultural loans outstanding, or 1.3% of total loans.

 

At June 30, 2017, our largest outstanding agricultural loan balance was $934,000, and is secured by real estate and a UCC filing on all business assets. This loan was performing in accordance with its original contractual terms at June 30, 2017.

 

Loan Underwriting Risks

 

Adjustable-Rate Loans. While it is expected that adjustable-rate mortgage loans will better offset the adverse effects of a potential increase in interest rates when compared to fixed-rate mortgage loans, the increased mortgage payments required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying property also may be adversely affected in a higher interest rate environment. In addition, although adjustable-rate mortgage loans help make our loan portfolio more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits. We stress test adjustable-rate mortgage loans and home equity lines of credit during underwriting in order to assess the borrower’s ability to repay under higher interest rate scenarios.

 

Multi-Family and Nonresidential Real Estate and Land Loans. Loans secured by multi-family and nonresidential real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential mortgage loans. Of primary concern in multi-family and nonresidential real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential of the project or business. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to a greater extent than residential real estate loans to adverse conditions in the real estate market or the economy. To monitor project, business and global cash flows on multi-family and nonresidential real estate loans, we typically require borrowers, co-borrowers and loan guarantors to provide annual financial statements and/or tax returns. In reaching a decision on whether to make a multi-family and nonresidential real estate loan, we consider the net operating income of the property or the repayment capacity of the business, the borrower’s expertise, credit history and profitability and the value of the underlying property. We have generally required that the properties securing these real estate loans have debt service coverage ratios (cash available to service debt divided by required debt service) of at least 1.20x. Environmental reports are generally required for all multi-family and nonresidential real estate loans. There is also a risk present for any adjustable-rate multi-family and nonresidential real estate and land loans in the event of rising interest rates. We stress test these loans at origination in order to assess the borrower’s ability to repay under higher interest rate scenarios.

 

We underwrite all purchased loan participations to our own underwriting standards and will not participate in a loan unless each participant has at least a 10% interest in the loan. In addition, we also consider the financial strength and reputation of the lead lender. To monitor cash flows on commercial loan participations, we require the lead lender to provide us with annual financial statements from the borrower. Generally, we also conduct an annual internal loan review for purchased loan participations.

 

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Construction Loans. Construction financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property’s value at completion of construction and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the building. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a property that does not have sufficient value to assure full repayment. If we are forced to foreclose on a building before or at completion due to a default, there can be no assurance that we will be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.

 

Commercial Loans. Unlike one- to four-family mortgage loans, which generally are made on the basis of the borrower’s ability to make repayment from employment or other income, and which are secured by real property the value of which tends to be more easily ascertainable, commercial loans are of higher inherent risk and typically are made on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.

 

Consumer Loans. Consumer loans may entail greater risk than do one- to four-family mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that may depreciate rapidly in value. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.

 

Agricultural Loans. Payments on agricultural loans are typically dependent on the profitable operation or management of the related farm property. The success of the farm may be affected by many factors outside our control and outside the control of the borrower, including adverse weather conditions that prevent the planting of a crop or limit crop yields, declines in market prices for agricultural products and the impact of government regulations. In addition, many farms are dependent on a limited number of key individuals whose injury or death may significantly affect the successful operation of the farm. If the cash flow from a farming operation is diminished, the borrower’s ability to repay the loan may be impaired. For loan relationships greater than $250,000, crop insurance is required at a minimum of 70% of the loan amount when the crops are the Bank’s primary collateral.

 

Loan Originations, Purchases and Sales. Loan originations come from a number of sources. The primary sources of loan originations are existing customers, walk-in traffic, advertising, referrals from customers and other sources, and business development efforts. We advertise on television and on radio and in newspapers that are widely circulated in Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. Accordingly, when our rates are competitive, we attract loans from throughout Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. We occasionally purchase loans and participation interests in loans to supplement our origination efforts. The networks of our lenders have also allowed us to obtain new loan business in the Cincinnati and Northern Kentucky markets in recent years. The Cincinnati and Northern Kentucky markets represent many opportunities for the Bank to continue to grow the loan portfolio.

 

We generally originate loans for our portfolio, but our current practice is to sell to the secondary market almost all newly originated conforming fixed-rate 20-, 25- and 30-year one-to four-family mortgage loans and to hold in our portfolio fixed-rate loans with 15-year terms or less and adjustable-rate loans. Our decision to sell loans is based on prevailing market interest rate conditions and interest rate risk management considerations. Loans are sold to either Freddie Mac or Federal Home Loan Bank of Indianapolis with servicing retained.

 

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Loan Approval Procedures and Authority. Our lending activities follow written, non-discriminatory underwriting standards and loan origination procedures established by our Board of Directors and management.

 

The Board has granted individual and aggregate loan approval authority to the Management Loan Committee, consisting of the President, the Executive Vice President, the Senior Vice President of Lending and the Chief Credit Officer. The Board Loan Committee, consisting of the President and three to four Board members, may approve loans secured by either real estate or non-real estate assets up to $3.0 million and unsecured loans up to $1.5 million. The Management Loan Committee may approve loans secured by either real estate or non-real estate assets up to $1.5 million and unsecured loans up to $500,000. Through the Management Loan Committee, the Board has also granted authority to approve consumer loans to certain employees up to prescribed limits, depending on the officer’s experience and tenure.

 

All loans in excess of these limits must be approved by the full Board of Directors.

 

Loans to One Borrower. The maximum amount that we may lend to one borrower and the borrower’s related entities generally is limited, by regulation, to 15% of tier 1 risk-based capital plus our allowance for loan losses. At June 30, 2017, our general regulatory limit on loans to one borrower was $9.6 million. On June 30, 2017, our largest lending relationship was a $6.5 million multi-family real estate loan relationship. The loan that comprises this relationship was performing according to the terms of the loan at June 30, 2017. In 2014, to reduce the risk of loss to any one borrower, the Board established a loans to one borrower limit of 10% of tier 1 risk-based capital plus our allowance for loan losses. At June 30, 2017, this limit was $6.4 million. Any relationship in excess of 10% at the time of implementation of our in-house limit was grandfathered.

 

Loan Commitments. We issue commitments for fixed- and adjustable-rate mortgage, consumer, and commercial loans conditioned upon the occurrence of certain events. Commitments to originate mortgage, consumer, and commercial loans are legally binding agreements to lend to our customers. Generally, our loan commitments expire after 30 days.

 

Investment Activities

 

We have legal authority to invest in various types of liquid assets, including U.S. Treasury obligations, securities of various federal agencies, state and municipal governments, deposits at the Federal Reserve, the Federal Home Loan Bank of Indianapolis and other financial institutions and certificates of deposit of federally insured institutions. We also are required to maintain an investment in Federal Home Loan Bank of Indianapolis stock. While we have the authority under applicable law to invest in derivative securities, our investment policy does not permit such investments at this time. We had no investments in derivative securities at June 30, 2017.

 

At June 30, 2017, our investment portfolio totaled $189.5 million and consisted primarily of municipal bonds, agency backed mortgage-backed securities and guaranteed portions of Small Business Administration (SBA) pools.

 

At June 30, 2017, the investment portfolio contained approximately $66.2 million of callable municipal bonds. The securities generally contain a one-time call option or may be called at any time following the initial call date. Reinvestment risk is present with callable securities, particularly during periods of declining market interest rates when issuers have economic incentive to call the debt and reissue at a lower rate. The risk for the investor is needing to reinvest the proceeds from called securities into securities with lower rates.

 

Our investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide an alternate source of income when demand for deposits exceeds demand for loans and to generate a favorable return. The Investment Committee, comprised of board members, is responsible for the implementation of the investment policy. The Management Investment Committee, comprised of the Chief Executive Officer, the Chief Operating Officer, the Chief Financial Officer, the Senior VP of Lending, and the Chief Credit Officer is responsible for monitoring our investment performance. Portfolio composition and performance are reviewed by our board of directors quarterly.

 

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Deposit Activities and Other Sources of Funds

 

General. Deposits, borrowings, loan repayments and maturities and investment repayments and maturities are the major sources of our funds for lending and other investment purposes. Loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and market conditions.

 

Deposit Accounts. Substantially all of our depositors are residents of the States of Indiana, Ohio and Kentucky. We attract deposits in our market area from existing customers and referrals from existing customers, through advertising and through our website. We offer a broad selection of deposit products, including noninterest-bearing demand accounts (such as checking accounts), interest-bearing accounts (such as interest-bearing checking and money market accounts), regular savings accounts and certificates of deposit. Municipal deposits comprise a substantial portion of our total deposits. At June 30, 2017, $107.2 million, or 23.6% of our total deposits, were municipal deposits compared to 43.7% of total deposits at June 30, 2007. While we expect municipal deposits to continue to remain an important source of funding, we expect to continue to improve our funding mix by marketing lower cost core retail deposits, with the goal to reduce the portion of our deposit portfolio comprised of municipal deposits. Municipal deposits increased $7.0 million from June 30, 2016 to June 30, 2017. During that same period core deposits increased $15.5 million. At June 30, 2017, we did not utilize brokered deposits. Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the desired interest rate spread, our liquidity needs, customer preferences and rates offered by our competition. We generally review our deposit mix and pricing as needed.

 

Borrowings. We may utilize advances from the Federal Home Loan Bank of Indianapolis to supplement our liquidity from deposits or to manage interest rate risk. The Federal Home Loan Bank functions as a central reserve bank providing credit for its member financial institutions. As a member, we are required to own capital stock in the Federal Home Loan Bank of Indianapolis and are authorized to apply for advances on the security of such stock and certain of our whole first mortgage loans and other assets (primarily securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the dollar balance of advances are based on the amount of FHLB stock owned by the institution, the amount of collateral that is acceptable for pledging, or by a resolution of our board. At June 30, 2017, $8.8 million was advanced from the Federal Home Loan Bank at an average interest rate of 2.19%, and we had the ability to draw up to an additional $64.5 million from the Federal Home Loan Bank.

 

Personnel

 

As of June 30, 2017, we had 96 full-time employees and 21 part-time employees, none of which are represented by a collective bargaining unit. We believe our relationship with our employees is good.

 

Subsidiaries

 

United Community Bank has two wholly-owned subsidiaries, which are United Community Bank Financial Services, Inc. and UCB Real Estate Management Holdings, LLC. United Community Bank Financial Services, Inc. manages a portion of the Bank’s municipal bond portfolio and collects commissions from a wealth management partner. UCB Real Estate Management Holdings, LLC primarily manages the Bank’s real estate acquired through foreclosure.

 

Regulation and Supervision

 

General

 

United Community Bancorp, as a savings and loan holding company, is subject to reporting to and regulation by the Federal Reserve Board. United Community Bank is subject to extensive regulation, examination and supervision by the OCC, as its primary federal regulator, and the FDIC, as the deposit insurer. United Community Bank is a member of the Federal Home Loan Bank System and, with respect to deposit insurance, of the Deposit Insurance Fund managed by the FDIC. United Community Bank must file reports with the OCC and the FDIC concerning its activities and financial condition in addition to obtaining regulatory approvals prior to entering into certain transactions such as mergers with, or acquisitions of, other savings institutions. The OCC and/or the FDIC conduct periodic examinations to test United Community Bank’s safety and soundness and compliance with various regulatory requirements.

 

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This regulation and supervision establishes a comprehensive framework of activities in which an institution can engage and is intended primarily for the protection of the insurance fund and depositors. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies with respect to the classification of assets and the establishment of adequate allowance for loan losses for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Federal Reserve Board, the OCC, the FDIC or Congress, could have a material adverse impact on United Community Bancorp and United Community Bank and their operations.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) made extensive changes in the regulation of federal savings banks such as United Community Bank and their holding companies. Under the Dodd-Frank Act, the Office of Thrift Supervision was eliminated and responsibility for the supervision and regulation of federal savings banks was transferred on July 21, 2011 to the OCC, the agency that is also primarily responsible for the regulation and supervision of national banks. Additionally, on that date, responsibility for the regulation and supervision of savings and loan holding companies was transferred to the Federal Reserve Board, which also supervises bank holding companies. The Dodd-Frank Act also created a new Consumer Financial Protection Bureau as an independent bureau of the Federal Reserve System. The Consumer Financial Protection Bureau assumed responsibility for the implementation of the federal financial consumer protection and fair lending laws and regulations and has authority to impose new requirements. However, institutions of less than $10 billion in assets, such as United Community Bank, will continue to be examined for compliance with consumer protection and fair lending laws and regulations by, and be subject to the enforcement authority of, their primary regulators.

 

United Community Bank completed its conversion from the mutual holding company form of organization to the stock holding company structure in January 2013. Applicable regulations provided, among other things, that for a period of three years following the date of the completion of the conversion, no person, acting singly or together with associates in a group of persons acting in concert, could directly or indirectly offer to acquire or acquire the beneficial ownership of more than 10% of a class of United Community Bancorp's equity securities without the prior written approval of the appropriate federal banking agency. Further, as part of the approval of the conversion, the OCC required United Community Bank to maintain a charter that subjects United Community Bank to the OCC’s jurisdiction for three years following the completion of the conversion.

 

Certain regulatory requirements currently applicable to United Community Bancorp and United Community Bank are referred to below or elsewhere herein. The description of statutory provisions and regulations applicable to savings institutions and their holding companies set forth below and elsewhere in this document does not purport to be a complete description of such statutes and regulations and their effects on United Community Bancorp and United Community Bank and is qualified in its entirety by reference to the actual statutes and regulations.

 

Holding Company Regulation

 

General. As a savings and loan holding company, United Community Bancorp is subject to Federal Reserve Board regulations, examinations, supervision, reporting requirements and regulations concerning its activities. In addition, the Federal Reserve Board has enforcement authority over United Community Bancorp and its non-savings institution subsidiaries. Among other things, this authority permits the Federal Reserve Board to restrict or prohibit activities that are determined to be a serious risk to United Community Bank, and therefore to United Community Bancorp as its owner.

 

Pursuant to federal law and regulations and policy, a savings and loan holding company, such as United Community Bancorp, may engage in activities permitted for financial holding companies under Section 4(k) of the Bank Holding Company Act and certain other activities that have been authorized for savings and loan holding companies by regulation.

 

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Federal law prohibits a savings and loan holding company from, directly or indirectly or through one or more subsidiaries, acquiring more than 5% of the voting stock of another savings association or savings and loan holding company, without prior written approval of the Federal Reserve Board or from acquiring or retaining, with certain exceptions, more than 5% of a non-subsidiary holding company or savings association. A savings and loan holding company is also prohibited from acquiring more than 5% of a company engaged in activities other than those authorized by federal law or acquiring or retaining control of a depository institution that is not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings associations, the Federal Reserve Board must consider, among other things, factors such as the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on the risk to the deposit insurance fund, the convenience and needs of the community and competitive factors.

 

The Federal Reserve Board is prohibited from approving any acquisition that would result in a multiple savings and loan holding company controlling savings associations in more than one state, except: (1) the approval of interstate supervisory acquisitions by savings and loan holding companies; and (2) the acquisition of a savings association in another state if the laws of the state of the target savings association specifically permit such acquisitions. The states vary in the extent to which they permit interstate savings and loan holding company acquisitions.

 

Capital Requirements. Savings and loan holding companies historically have not been subject to consolidated regulatory capital requirements. However, in July 2013, the Federal Reserve Board approved a new rule that implements the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The final rule established consolidated capital requirements for many savings and loan holding companies, including United Community Bancorp. See “— Federal Savings Institution Regulation—Capital Requirements.”

 

Source of Strength. The Dodd-Frank Act also extends the “source of strength” doctrine to savings and loan holding companies. The regulatory agencies must issue regulations implementing the "source of strength" policy that holding companies act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

 

Acquisition of Control. Under the Federal Change in Bank Control Act, a notice must be submitted to the Federal Reserve Board if any person (including a company), or group acting in concert, seeks to acquire direct or indirect "control" of a savings and loan holding company or savings association. Under certain circumstances, a change in control may occur, and prior notice is required, upon the acquisition of 10% or more of the outstanding voting stock of the company or institution, unless the Federal Reserve Board has found the acquisition will not result in a change in control. Under the Change in Control Act, the Federal Reserve Board has 60 days from the filing of a complete notice to act, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the anti-trust effects of the acquisition. Any company that so acquires control would then be subject to regulation as a savings and loan holding company.

 

Dividends. The Federal Reserve Board has the power to prohibit dividends by savings and loan holding companies if their actions constitute unsafe or unsound practices. The Federal Reserve Board has issued a policy statement on the payment of cash dividends by bank holding companies, which also applies to savings and loan holding companies and which expresses the Federal Reserve Board’s view that a holding company should pay cash dividends only to the extent that the company’s net income for the past year is sufficient to cover both the cash dividends and a rate of earnings retention that is consistent with the company’s capital needs, asset quality and overall financial condition. The Federal Reserve Board also indicated that it would be inappropriate for a holding company experiencing serious financial problems to borrow funds to pay dividends. Under the prompt corrective action regulations, the Federal Reserve Board may prohibit a bank holding company from paying any dividends if the holding company’s bank subsidiary is classified as “undercapitalized.”

 

Federal Savings Institution Regulation

 

Business Activities. The activities of federal savings banks, such as United Community Bank, are governed by federal law and regulations. These laws and regulations delineate the nature and extent of the business activities in which federal savings banks may engage. In particular, certain lending authority for federal savings institutions, e.g., commercial, nonresidential real property loans and consumer loans, is limited to a specified percentage of the institution’s capital or assets.

 

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Capital Requirements. The minimum capital level requirements applicable to the United Community Bank are: (i) a common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6%; (iii) a total capital ratio of 8%; and (iv) a Tier 1 leverage ratio of 4%. The capital adequacy rules also establish a “capital conservation buffer” of 2.5% above the regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and will result in the following minimum ratios: (1) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The capital conservation buffer requirement is being phased in beginning in January      , 2016, at 0.625% of risk-weighted assets, and will increase by that amount each year until fully implemented in January     , 2019. An institution is subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

The Office of the Comptroller of the Currency also has authority to establish individual minimum capital requirements in appropriate cases upon a determination that an institution’s capital level is or may become inadequate in light of particular risks or circumstances.

 

Prompt Corrective Regulatory Action. Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept broker deposits. The OCC is required to take certain supervisory actions against undercapitalized institutions, the severity of which depends upon the institution’s degree of undercapitalization. In addition, numerous mandatory supervisory actions become immediately applicable to an undercapitalized institution, including, but not limited to, increased monitoring by regulators and restrictions on growth, capital distributions and expansion. The OCC could also take any one of a number of discretionary supervisory actions, including the issuance of a capital directive and the replacement of senior executive officers and directors. Significantly and undercapitalized institutions are subject to additional mandatory and discretionary measures.

 

Insurance of Deposit Accounts. United Community Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund of the FDIC. Deposit insurance per account owner is currently $250,000. Under the FDIC’s risk-based assessment system, insured institutions are assigned a risk category based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned, and certain adjustments specified by FDIC regulations. Assessment rates range from 1.5 to 30 basis points of total assets less tangible equity.

 

The FDIC has authority to increase insurance assessments. A significant increase in insurance premiums would likely have an adverse effect on the operating expenses and results of operations of United Community Bank cannot predict what insurance assessment rates will be in the future.

 

Loans to One Borrower. Federal law provides that savings institutions are generally subject to the limits on loans to one borrower applicable to national banks. Generally, subject to certain exceptions, a savings institution may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of tier 1 risk-based capital plus the allowance for loan losses. An additional amount may be lent, equal to 10% of tier 1 risk-based capital plus the allowance for loan losses, if secured by specified readily-marketable collateral.

 

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QTL Test. Federal law requires savings institutions to meet a qualified thrift lender test. Under the test, a savings association is required to either qualify as a “domestic building and loan association” under the Internal Revenue Code or maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangibles, including goodwill; and (iii) the value of property used to conduct business) in certain “qualified thrift investments” (primarily residential mortgages and related investments, including certain mortgage-backed securities but also including education loans, credit card loans and small business loans) in at least 9 months out of each 12-month period.

 

A savings institution that fails the qualified thrift lender test is subject to certain operating restrictions. The Dodd-Frank Act also specifies that failing the qualified thrift lender test is a violation of law that could result in possible enforcement action for violation of law and imposes dividend limitations.

 

As of June 30, 2017, United Community Bank met the qualified thrift lender test.

 

Limitation on Capital Distributions. Federal Reserve Board and OCC regulations impose limitations upon all capital distributions by a savings institution, including cash dividends, payments to repurchase its shares and payments to shareholders of another institution in a cash-out merger. Under the regulations, a notice must be filed with the Federal Reserve Board 30 days prior to declaring a dividend, with a notice to the OCC. The Federal Reserve Board may disapprove a dividend notice if the proposed dividend raises safety and soundness concerns, the institution would be undercapitalized following the distribution or the distribution would otherwise be contrary to a statute, regulation or agreement with the OCC. In the event United Community Bank’s capital fell below its regulatory requirements or the OCC notified it that it was in need of increased supervision, United Community Bank’s ability to make capital distributions could be restricted. In addition, the Federal Reserve Board could prohibit a proposed capital distribution by any institution, which would otherwise be permitted by the regulation, if the Federal Reserve Board determines that such distribution would constitute an unsafe or unsound practice. Federal law further provides that no insured depository institution may pay a dividend that causes it to fall below any applicable regulatory capital requirement or if it is in default of its FDIC deposit insurance assessment.

 

Transactions with Related Parties. United Community Bank’s authority to engage in transactions with “affiliates” (e.g., any entity that controls or is under common control with an institution, including United Community Bancorp and any non-savings institution subsidiaries) is limited by federal law. The aggregate amount of covered transactions with any individual affiliate is limited to 10% of the capital and surplus of the savings institution. The aggregate amount of covered transactions with all affiliates is limited to 20% of the savings institution’s capital and surplus. Certain transactions with affiliates are required to be secured by collateral in an amount and of a type specified by federal law. The purchase of low quality assets from affiliates is generally prohibited. The transactions with affiliates must be on terms and under circumstances that are at least as favorable to the institution as those prevailing at the time for comparable transactions with non-affiliated companies. In addition, savings institutions are prohibited from lending to any affiliate that is engaged in activities that are not permissible for bank holding companies and no savings institution may purchase the securities of any affiliate other than a subsidiary.

 

The Sarbanes-Oxley Act of 2002 generally prohibits loans by a company to its executive officers and directors. However, the law contains a specific exception for loans by institutions such as United Community Bank to its executive officers and directors as long as the loans are in compliance with federal banking laws. Under such laws, United Community Bank’s authority to extend credit to executive officers, directors and 10% shareholders (“insiders”), as well as entities under their control, is limited. The law limits both the individual and aggregate amount of loans United Community Bank may make to insiders based, in part, on United Community Bank’s capital position and requires certain board approval procedures to be followed. Such loans are required to be made on terms substantially the same as those offered to unaffiliated individuals and not involve more than the normal risk of repayment. There is an exception for loans made pursuant to a benefit or compensation program that is widely available to all employees of the institution and does not give preference to insiders over other employees. Loans to executive officers are subject to additional limitations based on the type of loan involved.

 

Enforcement. The OCC has primary enforcement responsibility over savings institutions and has the authority to bring actions against the institution and all institution-affiliated parties, including stockholders, and any attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful actions likely to have an adverse effect on an insured institution. Formal enforcement action may range from civil penalties, the issuance of a capital directive or cease and desist, order to remove officers and/or directors to institution of receivership, conservatorship or termination of deposit insurance. The FDIC has the authority to recommend to the Director of the OCC that enforcement action be taken with respect to a particular savings institution. If action is not taken by the Director, the FDIC has authority to take such action under certain circumstances. Federal law also establishes criminal penalties for certain violations.

 

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Federal Home Loan Bank System

 

United Community Bank is a member of the Federal Home Loan Bank System, which consists of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. United Community Bank, as a member of the Federal Home Loan Bank, is required to acquire and hold shares of capital stock in that Federal Home Loan Bank. United Community Bank was in compliance with this requirement with an investment in Federal Home Loan Bank stock at June 30, 2017 of $3.5 million.

 

The Federal Home Loan Banks are required to provide funds for the resolution of insolvent savings institutions and to contribute funds for affordable housing programs. These requirements, and general adverse operating results, could reduce the level of dividends that the Federal Home Loan Banks pay to their members and could also result in the Federal Home Loan Banks imposing a higher rate of interest on advances to their members. If dividends were reduced, or interest on future Federal Home Loan Bank advances increased, United Community Bank’s net interest income may also be adversely impacted.

 

Federal Reserve System

 

The Federal Reserve Board regulations require savings institutions to maintain reserves against their transaction accounts (primarily Negotiable Order of Withdrawal (NOW) and regular checking accounts). The regulations generally provide that reserves be maintained against aggregate transaction accounts as follows: a 3% reserve ratio is assessed on net transaction accounts up to and including $115.1 million; a 10% reserve ratio is applied above $115.1 million. The first $15.5 million of otherwise reservable balances (subject to adjustment by the Federal Reserve Board) are exempted from the reserve requirements. The amounts are adjusted annually. United Community Bank complies with the foregoing requirements.

 

Other Regulations

 

United Community Bank’s operations are also subject to federal laws applicable to credit transactions, such as the:

 

  Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

  Real Estate Settlement Procedures Act, requiring that borrowers for mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;

 

  Truth in Savings Act; requiring certain disclosures to inform consumers about fees, annual percentage yield, interest rate, and other terms for deposit accounts. The regulation also includes requirements on the payment of interest, the methods of calculating the balance on which interest is paid, the calculation of the annual-percentage yield, and advertising.

 

  Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

  Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;

 

  Fair Credit Reporting Act of 1978, governing the use and provision of information to credit reporting agencies;

 

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  Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and

 

  Rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.

 

The operations of United Community Bank also are subject to the:

 

  Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

  Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services;

 

  Check Clearing for the 21st Century Act (also known as “Check 21”), which gives “substitute checks,” such as digital check images and copies made from that image, the same legal standing as the original paper check;

 

  The USA PATRIOT Act, which requires banks and savings institutions to, among other things, establish broadened anti-money laundering compliance programs and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement pre-existing compliance requirements that apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and

 

  The Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties and requires all financial institutions offering products or services to retail customers to provide such customers with the financial institution’s privacy policy and allow such customers the opportunity to “opt out” of the sharing of certain personal financial information with unaffiliated third parties.

 

Federal and State Taxation

 

Federal Income Taxation

 

General. United Community Bank reports its income on a fiscal year basis using the accrual method of accounting. The federal income tax laws apply to United Community Bank in the same manner as to other corporations with some exceptions, including the reserve for bad debts discussed below. The following discussion of tax matters is intended only as a summary and does not purport to be a comprehensive description of the tax rules applicable to United Community Bank. United Community Bank’s federal income tax returns have been either audited or closed under the statute of limitations through June 30, 2012. For its tax year ended June 30, 2017, United Community Bank’s maximum federal income tax rate was 34%.

 

Bad Debt Reserves. For fiscal years beginning before June 30, 1996, thrift institutions that qualified under certain definitional tests and other conditions of the Internal Revenue Code were permitted to use certain favorable provisions to calculate their deductions from taxable income for annual additions to their bad debt reserve. A reserve could be established for bad debts on qualifying real property loans, generally secured by interests in real property improved or to be improved, under the percentage of taxable income method or the experience method. The reserve for nonqualifying loans was computed using the experience method. Federal legislation enacted in 1996 repealed the reserve method of accounting for bad debts and the percentage of taxable income method for tax years beginning after 1995 and require savings institutions to recapture or take into income certain portions of their accumulated bad debt reserves. Approximately $749,000 of United Community Bank’s accumulated bad debt reserves would not be recaptured into taxable income unless United Community Bank makes a “non-dividend distribution” to United Community Bancorp as described below.

 

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Distributions. If United Community Bank makes “non-dividend distributions” to United Community Bancorp, the distributions will be considered to have been made from United Community Bank’s unrecaptured tax bad debt reserves, including the balance of its reserves as of December 31, 1987, to the extent of the “non-dividend distributions,” and then from United Community Bank’s supplemental reserve for losses on loans, to the extent of those reserves, and an amount based on the amount distributed, but not more than the amount of those reserves, will be included in United Community Bank’s taxable income. Non-dividend distributions include distributions in excess of United Community Bank’s current and accumulated earnings and profits, as calculated for federal income tax purposes, distributions in redemption of stock and distributions in partial or complete liquidation. Dividends paid out of United Community Bank’s current or accumulated earnings and profits will not be so included in United Community Bank’s taxable income.

 

The amount of additional taxable income triggered by a non-dividend is an amount that, when reduced by the tax attributable to the income, is equal to the amount of the distribution. Therefore, if United Community Bank makes a non-dividend distribution to United Community Bancorp, approximately one and one-half times the amount of the distribution not in excess of the amount of the reserves would be includable in income for federal income tax purposes, assuming a 34% federal corporate income tax rate. United Community Bank does not intend to pay dividends that would result in a recapture of any portion of its bad debt reserves.

 

State Taxation

 

Indiana Taxation. Prior to the fiscal year ended June 30, 2015 for the Company, Indiana imposed an 8.5% franchise tax based on a financial institution’s adjusted gross income as defined by statute. Starting in the fiscal year ended June 30, 2015, this tax rate was reduced 0.5% per year until reaching 6.5% in the fiscal year ending June 30, 2018. In computing adjusted gross income, deductions for municipal interest, U.S. Government interest, the bad debt deduction computed using the reserve method and pre-1990 net operating losses are disallowed.

 

Item 1A. Risk Factors

 

An investment in shares of our common stock involves various risks. Before deciding to invest in our common stock, you should carefully consider the risks described below in conjunction with the other information in this Annual Report on Form 10-K, including the items included as exhibits. Our business, financial condition and results of operations could be harmed by any of the following risks or by other risks that have not been identified or that we may believe are immaterial or unlikely. The value or market price of our common stock could decline due to any of these risks. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements.

 

Our nonperforming assets expose us to increased risk of loss.

 

Our nonperforming assets totaled $3.0 million, or 0.56% of total assets at June 30, 2017 and were comprised of $2.9 million of nonperforming loans and $93,000 of other real estate owned. This total represents an increase of $61,000 from the June 30, 2016 total of $3.0 million. The increase in nonperforming assets in fiscal year 2017 was primarily the result of the additions of new nonperforming loans in the current year partially offset by reductions due to loan payoffs, foreclosures, payments and movements of such loans to accruing status. Troubled debt restructurings are considered to be impaired loans. Our troubled debt restructurings decreased from $3.7 million at June 30, 2016 to $2.6 million at June 30, 2017, $1.3 million of which were on nonaccrual status and included in nonperforming loans. At June 30, 2016, $1.4 million of troubled debt restructurings were on nonaccrual status and included in nonperforming loans.

 

Our nonperforming assets adversely affect our net income in various ways. We do not accrue interest income on non-accrual loans and no interest income is recognized until the loan is performing for an established period of time and the value of the underlying collateral supports recording interest income. We must reserve for probable losses, which are established through a current period charge to income in the provision for loan losses, and from time to time, write down the value of properties in our other real estate owned portfolio to reflect changing market values. Write-downs to other real estate owned are typically charged directly to the income statement, which would have a negative impact on net income. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our other real estate owned. Further, the resolution of nonperforming assets requires the active involvement of senior management, which can result in more time being devoted to resolution and less time devoted to overall supervision of operations and other income-producing activities of including new business opportunities. Finally, if our estimate of the allowance for loan losses is insufficient, we will have to increase the allowance accordingly through earnings. At June 30, 2017, our allowance for loan losses was $4.3 million, or 1.5% of total loans and 146.8% of nonperforming loans, compared to $4.9 million, or 1.8% of total loans and 169.2% of nonperforming loans at June 30, 2016.

 

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Our multi-family and nonresidential real estate loans expose us to increased credit risks.

 

At June 30, 2017, our nonresidential real estate and multi-family real estate loans totaled $74.8 million and $15.4 million, respectively, or 26.2% and 5.4%, respectively, of our total loans outstanding. Nonresidential and multi-family real estate loans represented 37.7% and 0%, respectively, of our total nonperforming assets of $3.0 million at June 30, 2017. Our current strategy is to continue to execute on our controlled growth strategy by prudently growing multi-family residential and nonresidential real estate loans as well as other loan categories. We plan to continue to limit our exposure to loans involving properties outside of our local market area. These types of loans generally expose a lender to greater risk of non-payment and loss than one- to four-family mortgage loans because repayment of the loans often depends on the successful operation of the property and the income stream of the borrowers. Such loans typically involve larger loan balances to single borrowers or groups of related borrowers compared to one- to four-family mortgage loans. Also, some of our multi-family and nonresidential real estate and land borrowers have more than one loan outstanding with us. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to a significantly greater risk of loss compared to an adverse development with respect to a one- to four-family mortgage loan. During the year ended June 30, 2017, we experienced no charge-offs on multi-family real estate loans and $17,000 in recoveries resulting in a net recovery of $17,000. During the year ended June 30, 2017, we experienced charge offs of $600,000 on nonresidential real estate loans, offset by $248,000 of recoveries resulting in net charge-offs of $352,000.

 

We implemented a controlled loan growth strategy starting in 2014.

 

Prior to the quarter ended December 31, 2013, we deemphasized the origination of nonresidential and multi-family real estate loans as a strategic focus, particularly outside of Dearborn and Ripley Counties in Indiana. From June 30, 2006 through June 30, 2010, we experienced asset growth in excess of 38% in large part due to a determination to increase the size of our nonresidential and multi-family real estate portfolios and expand our lending efforts to southwestern Ohio and Northern Kentucky. While these lending areas are geographically proximate to the southeastern Indiana marketplace, the southwestern Ohio and Northern Kentucky real estate markets were more negatively impacted by the economic downturn. As a result, our loan relationships in these markets experienced disproportionate loan losses and required an extraordinary investment of managerial time to monitor in order to mitigate losses on these credits. In response, management elected to deemphasize multi-family and nonresidential lending in all markets until the economies in each of these markets materially improved and the level of our nonperforming assets in these segments of our loan portfolio materially declined. This strategy caused our one- to four-family residential mortgage loan portfolio and our investment securities portfolio to increase as a percentage of our interest-earning assets. At June 30, 2017, our nonresidential real estate and multi-family real estate loan portfolios totaled $90.2 million, or 16.8% of total assets, compared to $74.9 million, or 14.2% of total assets at June 30, 2016, and $124.3 million, or 25.3% of total assets, at June 30, 2010.

 

We reviewed the economic environment in our lending markets, including those in southwestern Ohio and Northern Kentucky, and the level of our nonperforming assets, and beginning in December 2013, we implemented a controlled growth strategy to prudently increase nonresidential real estate and multi-family real estate loan portfolios to generate more interest income. Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate portfolios.

 

A significant amount of our troubled debt restructurings are subject to balloon payments due in the next three years.

 

At June 30, 2017, troubled debt restructurings totaling $1.2 million were subject to balloon payments that must be repaid within the next three years. If the financial position of the borrowers of these loans is not sufficient to enable the borrowers to satisfy their balloon payments, we may have to further restructure the loans or foreclose and liquidate the collateral, which could result in an increase in non-accrual loans and/or additional provisions for loan losses.

 

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Higher loan losses could require us to increase our allowance for loan losses through a charge to earnings.

 

When we extend credit, we incur the risk that our borrowers will not repay their loans according to the contractual terms. We reserve for loan losses by establishing an allowance through a charge to earnings. The amount of this allowance is based on our assessment of loan losses inherent in our loan portfolio. The process for determining the amount of the allowance is critical to our financial results and condition. It requires subjective and complex judgments about the future, including forecasts of economic or market conditions that might impair the ability of our borrowers to repay their loans. We might underestimate the loan losses inherent in our loan portfolio and have loan losses in excess of the amount reserved. We might increase the allowance because of changing economic conditions. For example, in a rising interest rate environment, borrowers with adjustable-rate loans could see their payments increase. There may be a significant increase in the number of borrowers who are unable or unwilling to repay their loans, resulting in an elevated level of charge-offs, which could require an increase to the allowance. In addition, when real estate values decline, the potential severity of loss on a real estate-secured loan can increase significantly, especially in the case of loans with higher loan-to-value ratios. The decline in the national economy and the local economies of the areas in which our loans are concentrated could result in an increase in loan delinquencies, foreclosures or repossessions, resulting in elevated charge-off levels and the need for additional loan loss provisions in future periods. In addition, our determination as to the amount of our allowance for loan losses is subject to review by our primary regulator, the Office of the Comptroller of the Currency referred to as the OCC, as part of its examination process, which may result in the establishment of an additional allowance based upon the judgment of the OCC after a review of the information available at the time of its examination. Our allowance for loan losses amounted to 1.50% of total loans and 146.8% of nonperforming loans at June 30, 2017.

 

Our emphasis on one- to four-family mortgage loans exposes us to credit risks.

 

At June 30, 2017, $144.3 million, or 50.5%, of our loan portfolio consisted of one- to four-family mortgage loans, and $30.7 million, or 10.75%, of our loan portfolio consisted of home equity loans and second mortgage loans. Recent economic conditions have resulted in a stabilization in real estate values in our market areas. If real estate values in our market area decline, real estate values could cause some of our mortgage and home equity loans to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by foreclosure and liquidation of the real estate collateral.

 

Our primary market area depends substantially on the gaming industry and a decline in that industry could hurt our business and our prospects.

 

Our business is concentrated in the Lawrenceburg, Indiana area. Since the mid-1990s, the economy in Lawrenceburg has been strengthened by the riverboat casinos in Lawrenceburg and nearby Rising Sun whose presence has supported the development of retail centers and job growth as well as an increase in housing development. Any event that negatively and materially impacts the gaming and tourism industry will adversely impact the Lawrenceburg economy.

 

Gaming revenue is vulnerable to fluctuations in the local and national economies. There has been a slow and steady recovery in the national economy since 2009. The impact from the last recession on Lawrenceburg and its gaming industry was not as significant as in other parts of the country. However, tax revenue from the gaming industry has decreased in recent years due to increased competition from the nearby Ohio markets.

 

A continued deterioration in economic conditions generally, and a slowdown in gaming and tourism activities in particular, could result in the following consequences, any of which could adversely affect our business, financial condition, results of operations and prospects and expose us to a greater risk of loss:

 

  Loan delinquencies may increase;

 

  Problem assets and foreclosures may increase;

 

  Demand for our products and services may decline; and

 

  Collateral for loans made by us may decline in value, reducing the amount of money that our customers may borrow against the collateral, and reducing the value of assets and collateral associated with our loans.

 

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The expansion of permissible gaming activities in other states, particularly in Ohio and/or Kentucky, has led to a decline, and may lead to further declines in gaming revenue in Lawrenceburg, Indiana, which could hurt our business and our prospects.

 

Lawrenceburg, Indiana competes with other areas of the country for gaming revenue. The expansion of gaming operations in other states, as a result of changes in laws or otherwise, has reduced gaming revenue in the Lawrenceburg area. In 2009, a vote in the State of Ohio approved casino gaming in several cities in the state, including one in downtown Cincinnati, Ohio which opened in March 2013. Casino gaming in Cincinnati and other areas has adversely affected, and could have a substantial adverse effect on, gaming revenue in Lawrenceburg, which would adversely affect the Lawrenceburg economy and could adversely affect our business.

 

Changes in interest rates could adversely affect our results of operations and financial condition.

 

Our primary source of income is net interest income, which is the difference between the interest income generated by our interest-earning assets (consisting primarily of loans and, to a lesser extent, investment securities) and the interest expense generated by our interest-bearing liabilities (consisting primarily of deposits and, to a lesser extent, wholesale borrowings).

 

The level of net interest income is a function of the average balance of our interest-earning assets, the average balance of our interest-bearing liabilities, the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. These factors are influenced by both the pricing and mix of our interest-earning assets and our interest-bearing liabilities which, in turn, are affected by such external factors as the local economy, competition for loans and deposits, the monetary policy of the Federal Open Market Committee of the Federal Reserve Board (FOMC) and market interest rates across the treasury curve.

 

The cost of our deposits and short-term wholesale borrowings is largely based on short-term interest rates, the level of which is heavily influenced by the FOMC. However, the yields on our loans and securities are typically based on intermediate-term or long-term interest rates, which are set by the market and generally, vary daily. The level of net interest income is therefore influenced by movements in interest rates and the pace at which such movements occur. If the interest rates on our interest-bearing liabilities increase at a faster pace than the interest rates on our interest-earning assets, the result could be a reduction in net interest income and a reduction in our earnings. Our net interest income and earnings would be similarly impacted were the interest rates on our interest-earning assets to decline more quickly than the interest rates on our interest-bearing liabilities.

 

In addition, such changes in interest rates could affect our ability to originate loans and attract and retain deposits at the preferred pricing levels, the fair value of our financial assets and liabilities, and the duration of our loan and securities portfolios.

 

Changes in interest rates could also have an effect on the slope of the yield curve. A flat or inverted yield curve could cause our net interest income to decline, which could have a material adverse effect on our net income and cash flows and the value of our assets.

 

Changes in interest rates particularly affect the value of our securities portfolio. Generally, the value of fixed-rate securities fluctuates inversely with changes in market interest rates. Unrealized gains and losses on securities available-for-sale are reported as a separate component of equity, net of tax. Decreases in the fair value of securities available-for-sale resulting from increases in interest rates could have an adverse effect on stockholders’ equity. In addition, we invest in callable securities that expose us to reinvestment risk, particularly during periods of falling market interest rates when issuers of callable securities have an economic incentive to call their securities and reissue at a lower rate. In this scenario, we may have to reinvest the proceeds from called securities at lower rates of return than the rates earned on the called securities, which could have an adverse impact on our earnings.

 

A majority of our real estate loans held for investment are adjustable-rate loans. Any rise in market interest rates may result in increased payments for borrowers who have adjustable-rate mortgage loans, increasing the possibility of default. In addition, although adjustable-rate mortgage loans help make our loan portfolio more responsive to upward changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits. At June 30, 2017, approximately 35.7% of our one-to-four family real estate loans had adjustable rates of interest.

 

 21 

 

 

Municipal deposits are an important source of funds for us and a reduced level of those deposits may hurt our profits. Securities we may pledge as collateral for our municipal deposits may be subject to risk of loss.

 

Historically, municipal deposits, the source of which was primarily tax revenues from the local casino operations, have been a significant source of funds for our lending and investment activities. At June 30, 2017, $107.2 million, or 23.6% of our total deposits, consisted of municipal deposits. If our municipal deposits decrease to a level where we would need to resort to other sources of funds to support our lending and investment activities, such as borrowings from the Federal Home Loan Bank of Indianapolis, the interest expense associated with these other funding sources may be higher than the rates we pay on the municipal deposits, which would adversely affect our earnings. Since October 2011, the Indiana Board of Depositories required certain institutions holding municipal deposits to pledge up to 100% of the municipal deposits maintained. The requirement to pledge collateral, and the percentage that may be required to be pledged will periodically vary based on a number of financial factors. This collateral is used to insure the municipal deposits of all institutions who receive deposits from Indiana municipalities, and, therefore, is subject to risk of loss if other such institutions fail and there are insufficient Federal Deposit Insurance funds available to cover the liabilities of such institutions. For the years ending June 30, 2017 and 2016, respectively, no pledge was required.

 

We are dependent upon the services of key executives.

 

We rely heavily on our President and Chief Executive Officer, Elmer G. McLaughlin, and on our Executive Vice President and Chief Operating Officer, W. Michael McLaughlin. The loss of either could have a material adverse impact on our operations because, as a small company, we have fewer management-level personnel that have the experience and expertise to readily replace these individuals. Changes in key personnel and their responsibilities may be disruptive to our business and could have a material adverse effect on our business, financial condition, and results of operations. We have employment agreements with Messrs. Elmer G. and W. Michael McLaughlin.

 

Strong competition within our market areas could hurt our profits and slow growth.

 

We face intense competition both in making loans and attracting deposits. Price competition for loans and deposits could result in lower yields on loans and higher costs for deposits, which would reduce net interest income. As of June 30, 2016, the most recent date for which information is available, we held 40.8% of the deposits in Dearborn County and 10.9% of the deposits in Ripley County. Competition also makes it more difficult to hire and retain experienced employees. Some of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Our profitability depends upon our continued ability to compete successfully in our market areas.

 

Our asset valuations may include methodologies, estimations and assumptions that are subject to differing interpretations and could result in changes to asset valuations that may materially adversely affect our results of operations or financial condition.

 

We must use estimates, assumptions, and judgments when financial assets and liabilities are measured and reported at fair value. Assets and liabilities carried at fair value inherently result in a higher degree of financial statement volatility. Fair values and the information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices and/or other observable inputs provided by independent third-party sources, when available. When such third-party information is not available, we estimate fair value primarily by using discounted cash flow analysis and other financial modeling techniques utilizing assumptions such as credit quality, liquidity, interest rates and other relevant inputs. Changes in underlying factors, assumptions, or estimates in any of these areas could materially impact our future financial condition and results of operations.

 

During periods of market disruption, including periods of significantly rising or falling interest rates, rapidly widening credit spreads or illiquidity, it may be difficult to value certain assets and liabilities if trading becomes less frequent and/or market data becomes less observable. There may be certain asset classes that were in active markets with significant observable data that become illiquid due to the new financial environment. In such cases, certain asset valuations may require more subjectivity and management judgment. As such, valuations may include inputs and assumptions that are less observable or require greater estimation. Further, rapidly changing and unprecedented credit and equity market conditions could materially impact the valuation of assets as reported within our consolidated financial statements, and the period-to-period changes in value could vary significantly. Decreases in value may have a material adverse effect on our results of operations or financial condition.

 

 22 

 

 

New capital rules generally require insured depository institutions and their holding companies to hold more capital.

 

In July 2013, the Federal Reserve and the OCC adopted a final rule for the Basel III capital framework. These rules substantially amend the regulatory risk-based capital rules applicable to us. The rules phase in over time beginning in 2015 and will become fully effective in 2019. The rules currently apply to the Bank. Beginning in 2015, our minimum capital requirements are (i) a common Tier 1 equity ratio of 4.5%, (ii) a Tier 1 capital (common Tier 1 capital plus Additional Tier 1 capital) of 6% and (iii) a total capital ratio of 8%. Our leverage ratio requirement remains at the 4% level. Beginning in 2016, a capital conservation buffer phases in over three years, ultimately resulting in a requirement of 2.5% on top of the common Tier 1, Tier 1 and total capital requirements, resulting in a required common Tier 1 equity ratio of 7%, a Tier 1 ratio of 8.5%, and a total capital ratio of 10.5%. Failure to satisfy any of these three capital requirements will result in limits on paying dividends, engaging in share repurchases and paying discretionary bonuses. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

Regulation of the financial services industry is undergoing major changes, and future legislation could increase our cost of doing business or harm our competitive position.

  

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) enacted in 2010 has created a significant shift in the way financial institutions operate. The Dodd-Frank Act restructured the regulation of depository institutions by merging the Office of Thrift Supervision, which previously regulated the Bank, into the Office of the Comptroller of the Currency, and assigning the regulation of savings and loan holding companies, including the Company, to the Board of Governors of the Federal Reserve System.

 

The Dodd-Frank Act also created the Consumer Financial Protection Bureau which has broad powers to supervise and enforce consumer protection laws. The Consumer Financial Protection Bureau has broad rule-making authority for a wide range of consumer protection laws that apply to all banks and savings institutions including the authority to prohibit “unfair, deceptive or abusive” acts and practices. The Consumer Financial Protection Bureau has examination and enforcement authority over all banks and savings institutions with more than $10.0 billion in assets. Banks and savings institutions with $10.0 billion or less in assets continue to be examined by their applicable bank regulators.

 

As required by the Dodd-Frank Act, the federal banking regulators have adopted new consolidated capital requirements that will limit our ability to borrow at the holding company level and invest the proceeds from such borrowings as capital in the Bank that could be leveraged to support additional growth. The Dodd-Frank Act contains various other provisions designed to enhance the regulation of depository institutions and prevent the recurrence of a financial crisis such as occurred in 2008-2009. The full impact of the Dodd-Frank Act on our business and operations will not be known for years until regulations implementing the statute are written and adopted. The Dodd-Frank Act may have a material impact on our operations, particularly through increased regulatory burden and compliance costs.

 

Any future legislative changes could have a material impact on our profitability, the value of assets held for investment or collateral for loans. Future legislative changes could require changes to business practices or force us to discontinue businesses and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.

 

We are dependent on our information technology and telecommunications systems and third-party servicers; systems failures, interruptions or breaches of security could have a material adverse effect on us.

 

Our business is dependent on the successful and uninterrupted functioning of our information technology and telecommunications systems and third-party servicers. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations. Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and/or subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

 

 23 

 

 

Our third-party service providers may be vulnerable to unauthorized access, computer viruses, phishing schemes and other security breaches. We may be required to expend significant additional resources to protect against the threat of such security breaches and computer viruses, or to alleviate problems caused by such security breaches or viruses. To the extent that the activities of our third-party service providers or the activities of our customers involve the storage and transmission of confidential information, security breaches and viruses could expose us to claims, regulatory scrutiny, litigation and other possible liabilities. 

 

Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.

 

In the ordinary course of our business, we collect and store sensitive data, including our proprietary business information and that of our customers, suppliers and business partners; and personally identifiable information of our customers and employees. The secure processing, maintenance and transmission of this information is critical to our operations and business strategy. We, our customers, and other financial institutions with which we interact, are subject to ongoing, continuous attempts to penetrate key systems by individual hackers, organized criminals, and in some cases, state-sponsored organizations. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such unauthorized access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties; disrupt our operations and the services we provide to customers; damage our reputation; and cause a loss of confidence in our products and services, all of which could adversely affect our business, revenues and competitive position. We may be required to spend significant capital and other resources to protect against the threat of security breaches and computer viruses, or to alleviate problems caused by security breaches or viruses.

 

The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce risk and costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations.

 

We face a risk of noncompliance and enforcement action with the Bank Secrecy Act and other anti-money laundering statutes and regulations.

 

The federal Bank Secrecy Act, the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “PATRIOT Act”) and other laws and regulations require financial institutions, among other duties, to institute and maintain effective anti-money laundering programs and file suspicious activity and currency transaction reports as appropriate. The federal Financial Crimes Enforcement Network, established by the U.S. Treasury Department to administer the Bank Secrecy Act, is authorized to impose significant civil money penalties for violations of those requirements and has recently engaged in coordinated enforcement efforts with the individual federal banking regulators, as well as the U.S. Department of Justice, Drug Enforcement Administration and Internal Revenue Service. Federal and state bank regulators also have begun to focus on compliance with Bank Secrecy Act and anti-money laundering regulations. If our policies, procedures and systems are deemed deficient or the policies, procedures and systems of the financial institutions that we may acquire in the future are deficient, we would be subject to liability, including fines and regulatory actions such as restrictions on our ability to pay dividends and the necessity to obtain regulatory approvals to proceed with certain aspects of our business plan, including our acquisition plans, which would negatively impact our business, financial condition and results of operations. Failure to maintain and implement adequate programs to combat money laundering and terrorist financing could also have serious reputational consequences for us.

 

We are subject to a variety of operational, environmental, legal and compliance risks, which may adversely affect our business and results of operations.

 

We are exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, and unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems. Negative public opinion can result from our actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect our ability to attract and keep customers and can expose us to litigation and regulatory action. Actual or alleged conduct by the Bank can also result in negative public opinion about our business.

 

 24 

 

 

Item 1B. Unresolved Staff Comments

 

Not applicable.

 

Item 2. Properties

 

The following table sets forth the location of the Company’s office facilities at June 30, 2017, and certain other information relating to these properties at that date.

 

Location  Year
Opened
  Owned/
Leased
  Net Book
Value
as of
June 30,
2017
 
           

Full-Service Branch and Main Office:

92 Walnut Street 

Lawrenceburg, Indiana 47025

  2004  Owned  $1,105 
            

Full-Service Branches:

215 W. Eads Parkway

Lawrenceburg, Indiana 47025

  1914  Owned   426 
            
19710 Stateline Road
Lawrenceburg, Indiana 47025
  2000  Owned   687 
            
500 Green Blvd
Aurora, Indiana 47001
  2006  Owned   1,157 
            
7600 Frey Road
West Harrison, Indiana 47060
  2007  Owned   1,089 
            
106 Mill Street
Milan, Indiana 47031
  1990(1)  Owned   367 
            
510 South Buckeye
Osgood, Indiana 47037
  1977(1)  Owned   784 
            
111 East U.S. 50
Versailles, Indiana 47042
  1983(1)  Owned   394 
            

Other Properties:

Corner of State Route 350 & State Route 101

Milan, Indiana 47031

  Lot  Owned(2)   77 
            

Corner of 4th and Main Street

Lawrenceburg, Indiana 47025

  Lot  Owned(2)   135 

 

 

(1) Acquired from Integra Bank National Association on June 4, 2010. “Year Opened” for these branches reflects the date the branch was originally opened (prior to being acquired by United Community Bank).

 

(2) Land only.

  

Item 3. Legal Proceedings

 

Periodically, there have been various claims and lawsuits against us, such as claims to enforce liens and contracts, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not party to any pending legal proceedings that we believe would have a material adverse effect on our financial condition, results of operations or cash flows.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

 25 

 

 

PART II 

 

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

 

The Company’s common stock, par value $0.01 per share, is traded on the Nasdaq Global Market under the symbol “UCBA.” On June 30, 2017, there were 643 holders of record of the Company’s common stock. The Company began paying quarterly dividends during the fourth quarter of fiscal year 2006. The Company’s ability to pay dividends is dependent on dividends received from the Bank. See “Business—Regulation and Supervision—Limitation on Capital Distributions” for a discussion of the restrictions on the payment of cash dividends by the Company.

 

The following table sets forth the high and low sales prices for the common stock as reported on the Nasdaq Global Market and the cash dividends declared on the common stock.

 

Fiscal Year 2017:

  High   Low   Dividends
Declared
 
Fourth Quarter  $19.20   $17.65   $0.09 
Third Quarter   17.70    16.20    0.06 
Second Quarter   16.95    14.70    0.06 
First Quarter   15.75    14.25    0.06 

 

Fiscal Year 2016:  High   Low   Dividends
Declared
 
Fourth Quarter  $14.62   $13.65   $0.06 
Third Quarter   15.00    13.05    0.06 
Second Quarter   15.27    14.55    0.06 
First Quarter   14.95    13.60    0.06 

 

 26 

 

 

Purchases of Equity Securities

 

Repurchases of the Company’s common stock were as follows:

 

Fiscal Year 2017  Total number of shares purchased   Average price paid per share   Total number of shares purchased as part of publicly announced plans or programs   Maximum number of shares that may yet be purchased under the plans or programs 
                 
Fourth Quarter   1,988   $17.784    -    195,215 
Third Quarter   2,700    16.576    2,700    195,215 
Second Quarter   11,992    16.073    11,992    197,915 
First Quarter   -    -    -    - 
Total   16,680   $16.358    14,692      

 

Fiscal Year 2016  Total number of shares purchased   Average price paid per share   Total number of shares purchased as part of publicly announced plans or programs   Maximum number of shares that may yet be purchased under the plans or programs 
                 
Fourth Quarter   3,183   $14.420    -    - 
Third Quarter   -    -    -    - 
Second Quarter   329,156    14.990    130,614    - 
First Quarter   80,357    14.015    80,357    130,614 
Total   412,696   $14.796    210,971      

 

 27 

 

 

Item 6. Selected Financial Data

 

   At June 30, 
  

2017

  

2016

  

2015

  

2014

  

2013

 
   (In thousands) 
Financial Condition Data:                    
Total assets  $536,931   $526,089   $521,185   $530,465   $512,631 
Cash and cash equivalents   26,885    28,980    18,522    24,970    16,787 
Securities held-to-maturity   41,954    40,763    40,653    337    417 
Securities available-for-sale   79,188    77,725    60,873    39,965    32,013 
Mortgage-backed securities available-for-sale   68,374    74,727    109,138    179,017    170,117 
Loans receivable, net   282,477    267,138    253,828    244,384    254,578 
Deposits   453,655    438,885    432,537    439,636    421,243 
Advances from Federal Home Loan Bank   8,833    12,000    13,000    15,000    15,000 
Stockholders’ equity   71,291    70,454    71,437    72,930    73,543 

 

   For the Years Ended June 30, 
  

2017

  

2016

  

2015

  

2014

  

2013

 
    (Dollars in thousands)
Operating Data:                         
Interest income  $16,180   $15,698   $15,232   $14,958   $15,887 
Interest expense   2,269    2,201    2,375    2,656    3,351 
Net interest income   13,911    13,497    12,857    12,302    12,536 
Provision for (recovery of) loan losses   55    187    (348)   (132)   (66)
Net interest income after provision for loan losses   13,856    13,310    13,205    12,434    12,602 
Other income   4,796    4,639    3,374    3,697    4,489 
Other expense   14,252    13,980    13,618    13,192    13,595 
Income before income taxes   4,400    3,969    2,961    2,939    3,496 
Provision for income taxes   953    541    425    659    929 
Net income  $3,447   $3,428   $2,536   $2,280   $2,567 
                          
Per Share Data:                         
Earnings per share basic  $0.85   $0.83   $0.57   $0.47   $0.52 
Earnings per share diluted(1)  $0.84   $0.82   $0.57   $0.47   $0.52 

 

 

(1) Earnings per share amounts for periods prior to January 9, 2013 have been restated retroactively to reflect the second step conversion at a conversion rate of 0.6573 to 1.

 28 

 

 

   At or for the Years Ended June 30, 
   2017   2016   2015   2014   2013 
Performance Ratios:                    
Return on average assets   0.65%   0.66%   0.49%   0.43%   0.50%
Return on average equity   4.91    4.91    3.54    3.09    4.04 
Interest rate spread (1)   2.77    2.77    2.65    2.50    2.58 
Net interest margin (2)   2.80    2.81    2.68    2.55    2.64 
Noninterest expense to average assets   2.67    2.70    2.62    2.53    2.66 
Efficiency ratio (3)   76.19    77.08    83.92    82.46    79.85 
Average interest-earning assets to average interest-bearing liabilities   107.78    108.28    107.71    108.42    107.23 
Average equity to average assets   13.15    13.48    13.75    14.16    12.41 
Dividend payout ratio (4)   31.68    28.62    44.83    48.86    91.78 
                          
United Community Bank Capital Ratios:                         
Tangible capital   11.13    11.60    11.47    11.88    12.07 
Core capital   11.13    11.60    11.47    11.88    12.07 
Total risk-based capital    21.90    22.70    23.80    26.89    26.72 
                          
Asset Quality Ratios:                         
Nonperforming loans as a percent of total loans   1.02    1.07    2.52    4.00    4.91 
Nonperforming loans as a percent of total assets   0.54    0.55    1.25    1.88    2.48 
Nonperforming assets as a percent of total assets   0.56    0.56    1.30    1.99    2.60 
Allowance for loan losses as a percent of total loans   1.50    1.80    1.99    2.19    2.10 
Allowance for loan losses as a percent of nonperforming loans   146.80    169.21    78.96    54.88    42.83 
Net charge-offs (recoveries) to average outstanding loans during the period   0.23    0.16    (0.01)   (0.06)   0.04 
                          
Other Data:                         
Number of:                         
Real estate loans outstanding   2,552    2,726    2,727    2,466    2,491 
Deposit accounts   34,893    34,390    33,886    33,090    32,526 
Full-service offices   8    8    8    8    8 

 

 

(1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of average interest-bearing liabilities.

(2) Represents net interest income as a percent of average interest-earning assets.

(3) Represents other expense divided by the sum of net interest income and other income.

(4) Represents dividends declared (excluding waived dividends) divided by net income. A summary of the dividends declared and waived (and thus not paid) dividends is set forth below:

 

   For the Year Ended June 30, 
  

2017

  

2016

  

2015

  

201

  

2013 

 
   (In thousands) 
Dividends:                    
Paid to minority stockholders  $1,092   $981   $1,080   $1,114   $1,844 
Waived by United Community MHC   -    -    -    -    - 
Paid to United Community MHC   -    -    -    -    512 
Total dividend  $1,092   $981   $1,080   $1,114   $2,356 

 

 29 

 

 

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

 

Overview

 

Income. Our primary source of pre-tax income is net interest income. Net interest income is the difference between interest income, which is the income that we earn on our interest-earning assets (primarily loans and securities), and interest expense, which is the interest that we pay on our interest-bearing liabilities (primarily deposits and advances from the Federal Home Loan Bank of Indianapolis (“FHLB”). Other significant sources of pre-tax income are service charges on deposit accounts, income from bank-owned life insurance, and gain on the sale of loans, among others. We also recognize income or losses from the sale of investments in fiscal years that we have such sales.

 

Allowance for Loan Losses. The allowance for loan losses is a valuation allowance for credit losses that are known and those inherent in the loan portfolio. The allowance is established through the provision for loan losses, which is charged to income. Management estimates the balance required using historical loss experience, specific borrower information including estimates of any collateral shortfalls, and environmental factors including local and national economic factors, trends in delinquencies and problem loan balances, and other factors.

 

Expenses. The noninterest expenses we incur in operating our business consist primarily of compensation and employee benefits, premises and occupancy expense, deposit insurance premiums, advertising, data processing, professional fees and various other miscellaneous expenses.

 

Compensation and employee benefits consist primarily of salaries and wages paid to our employees, payroll taxes and expenses for health insurance and other employee benefits, and stock-based compensation.

 

Premises and occupancy expenses consist primarily of depreciation charges, furniture and equipment expenses, maintenance, real estate taxes, insurance and utilities. Depreciation of premises and equipment is computed using the straight-line method based on the useful lives of the related assets, which range from three to 40 years.

 

Deposit insurance premiums are paid to the FDIC for our account holders to receive FDIC insurance up to the maximum allowable.

 

Advertising expense includes print, radio and television advertisements, promotions and third-party marketing services.

 

Data processing expense represents the costs incurred to operate the Bank’s core data processing system as well as ancillary products that allow the Bank to offer the products and services that are demanded in our marketplace.

 

Professional fees are paid primarily to the Company’s and Bank’s outside attorneys and registered independent public accounting firm, among others.

 

Other expenses include expenses for supplies, telephone and postage, expenses related to other real estate owned by the Bank, director and committee fees, insurance and surety bond premiums and other fees and expenses.

 

Critical Accounting Policies

 

We consider accounting policies involving significant judgments and assumptions by management that have, or could have, a material impact on the carrying value of certain assets or on income to be critical accounting policies. We consider the following to be our critical accounting policies: allowance for loan losses, deferred income taxes, mortgage servicing rights, and fair value measurements.

 

 30 

 

 

Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover probable credit losses in the loan portfolio at the statement of financial condition date. The allowance is established through the provision for loan losses, which is charged to income. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: loss exposure at default; the amount and timing of future cash flows on affected loans; and the value of collateral. Inherent loss factors based upon economic and other environmental factors are then applied to the remaining loan portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the evaluation. In addition, the OCC, as an integral part of its examination process, periodically reviews our allowance for loan losses. Such agency may require us to recognize adjustments to the allowance based on its judgments about information available to it at the time of its examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would negatively affect earnings. For additional discussion, see notes 1 and 4 of the Notes to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.

 

Deferred Income Taxes. We use the asset and liability method of accounting for income taxes as prescribed in Accounting Standards Codification (“ASC”) 740-10-50. Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. We exercise significant judgment in evaluating the amount and timing of recognition of the resulting tax liabilities and assets. These judgments require us to make projections of future taxable income. The judgments and estimates we make in determining our deferred tax assets, which are inherently subjective, are reviewed on a continual basis as regulatory and business factors change. Any reduction in estimated future taxable income may require us to record a valuation allowance against our deferred tax assets. A valuation allowance would result in additional income tax expense in the period, which would adversely affect earnings. United Community Bancorp (the “Company”), accounts for income taxes under the provisions of ASC 275-10-50-8 to account for uncertainty in income taxes. The Company had no unrecognized tax benefits as of June 30, 2017 and 2016. The Company recognized no interest and penalties on the underpayment of income taxes during fiscal years June 30, 2017 and 2016, and had no accrued interest and penalties on the balance sheet as of June 30, 2017 and 2016. The Company has no tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will significantly increase with the next fiscal year. The Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for tax years ending on or before June 30, 2013.

 

Fair Value Measurements. ASC 820, Fair Value Measurements and Disclosures, requires disclosure of the fair value of financial instruments, both assets and liabilities, whether or not recognized in the consolidated balance sheet for which it is practicable to estimate the value. For financial instruments where quoted market prices are not available, fair values are estimated using present value or other valuation methods.

 

The following methods and assumptions are used in estimating the fair values of financial instruments:

 

Cash and Cash Equivalents. The carrying values presented in the Consolidated Statements of Financial Condition approximate fair value.

 

Investments and Mortgage-Backed Securities. For investment securities (debt instruments) and mortgage-backed securities, fair values are based on quoted market prices, where available. If a quoted market price is not available, fair value is estimated using quoted market prices of comparable instruments.

 

Loans receivable. The fair value of the loan portfolio is estimated by evaluating homogeneous categories of loans with similar financial characteristics. Loans are segmented by type, such as residential mortgage, nonresidential real estate, and consumer. Each loan category is further segmented into fixed and adjustable-rate interest, terms, and by performing and non-performing categories. The fair value of performing loans, except residential mortgage loans, is calculated by discounting contractual cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loan. For performing residential mortgage loans, fair value is estimated by discounting contractual cash flows adjusted for prepayment estimates using discount rates based on secondary market sources. The fair value for significant non-performing loans is based on recent internal or external appraisals. Assumptions regarding credit risk, cash flow, and discount rates are judgmentally determined by using available market information.

 

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Federal Home Loan Bank Stock. The Bank is a member of the Federal Home Loan Bank system and is required to maintain an investment based upon a pre-determined formula. The carrying values presented in the consolidated statements of financial condition approximate fair value.

 

Deposits. The fair values of passbook accounts, interest bearing checking accounts, and money market savings and demand deposits approximate their carrying values. The fair values of fixed maturity certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently offered for deposits of similar maturities.

 

Advances from Federal Home Loan Bank. The fair value is calculated using rates available to the Company on advances with similar terms and remaining maturities.

 

Off-Balance Sheet Items. Carrying value is a reasonable estimate of fair value. These instruments are generally variable rate or short-term in nature, with minimal fees charged.

 

Operating Strategy

 

Our mission is to operate a profitable, independent community-oriented financial institution serving retail customers and small businesses in our market areas. We are focused on prudently increasing profitability and enhancing stockholder value. The following are key elements of our current business strategy:

 

Improving our asset quality

 

We recognize that high asset quality is a key to long-term financial success. We have sought to grow and diversify our loan portfolio, while maintaining a high level of asset quality and moderate credit risk, using underwriting standards that we believe are prudent. We also believe that we have implemented diligent monitoring and collection efforts. Historically we have not had significant losses in our lending operations. Beginning in the year ended June 30, 2008, we began to experience the adverse effects of the national recession and declining real estate values, negatively impacting both the ability of some of our borrowers to repay their loans and the value of the collateral securing those loans. The impact was particularly pronounced in our multi-family and nonresidential real estate loan portfolios, as multi-family and commercial properties suffered increases in vacancies and slowdowns in revenues, resulting in reduced cash flows as well as decreases in the market values of the underlying properties.

 

Our initial approach to resolving nonperforming loans focused on foreclosure and liquidations. This manner of troubled asset resolution proved lengthy and costly as a result of legal and other operating costs, as well as the depressed values of the collateral securing the loan. As a result, beginning in the latter part of the year ended June 30, 2009, management initiated a restructuring process with respect to certain nonperforming loans that provided for either restructuring the loan to the borrower in recognition of the lower available cash flows from the collateral properties or identification of stronger borrowers to purchase the property and refinance the loan. In evaluating whether to restructure a loan, we consider the borrower’s payment status and history, the borrower’s ability to pay upon a rate reset on an adjustable-rate mortgage as supported by a current cash flow analysis, size of any payment increase upon a rate reset, period of time remaining before the rate reset, and other relevant factors in determining whether a borrower is experiencing financial difficulty. Through these troubled debt restructurings, management believes they have provided the necessary valuation allowances or charge-offs to reflect the loans’ carrying amounts at fair value.

 

During the quarter ended March 31, 2011, management undertook an “A/B split note” strategy for certain nonperforming loans, restructuring them into a Note A/B format. While no amount of the original indebtedness of the borrower is forgiven when the loans are restructured in the Note A/B format, the full amount of Note B is charged-off at the time the loan is restructured. Note A is treated as any other troubled debt restructuring, and generally may return to accrual status after performing in accordance with the restructured terms for at least six consecutive months. The intended benefit of this strategy is that the restructuring and subsequent charge-off reduces the carrying value of the loan to an “as is” fair value, which enables the Company to liquidate delinquent loan balances without recording significant additional losses if the restructured loans experience further delinquency. Management believes that the loans that needed to be restructured in this manner represented a distinct identifiable pool of loans.

 

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As a result of these efforts, total nonperforming loans have declined from $20.7 million at June 30, 2011 to $2.9 million and $3.0 million for the periods ending June 30, 2017 and 2016, respectively. Troubled debt restructurings on nonaccrual status totaled $1.3 million at June 30, 2017 compared to $1.4 million at June 30, 2016. The slight decrease in nonperforming restructured loans was the result of payments made in accordance with restructured terms, two mortgage loans moving to accruing status, and an additional charge off on one nonresidential property offset by a nonresidential and a mortgage loan moving to nonperforming status. Total accruing restructured loans decreased from $2.3 million at June 30, 2016 to $1.3 million at June 30, 2017. The decrease in performing restructured loans was primarily the result of a nonresidential loan and a 1-4 family loan moving from performing to nonperforming and two 1-4 family loans becoming eligible for removal from troubled debt status offset by two 1-4 family loans moving from nonperforming to performing. At June 30, 2017 and 2016, respectively, there were no nonresidential and multi-family loans 60-89 days delinquent.

 

In 2010 and 2011, we also implemented more stringent underwriting standards for our lending programs and enhanced our document requirements and document review process. Residential real estate mortgage applicants are required to have a higher credit score than previously required. We have reduced the maximum loan-to-value ratio for real estate secured consumer loans from 100% to 90%. Commercial and nonresidential real estate loan customers are required to provide us with rent rolls and financial statements for evaluation on a more frequent basis, and members of our loan department are in more frequent contact with these customers. In addition, our internal loan review policy requires us to perform an annual review of all commercial loan relationships having an aggregate exposure of at least $750,000 and all loan relationships with an aggregate exposure of at least $1.5 million are also reviewed annually by an independent third-party loan review auditor. As discussed below, we have implemented a strategy to control the growth of our nonresidential real estate and multi-family real estate loan portfolios. For additional information on this strategy, see “—Implementing a controlled growth strategy to originate multi-family and nonresidential real estate loans to improve interest income.”

 

Improving our funding mix by attracting lower cost core retail and business deposits

 

We consider all deposit types other than certificates of deposit and municipal deposits to be core. These core deposits are our least costly source of funds and represents our best opportunity to develop customer relationships that enable us to cross sell our full complement of products and services. Core deposits also contribute noninterest income from account-related fees and services and are generally less sensitive to withdrawal when interest rates fluctuate. At June 30, 2017, core deposits represented 51.7% of our total deposits compared to 49.9% at June 30, 2016, and 45.9% at June 30, 2015. A significant portion of the municipal deposit balances are from tax revenue and other revenues from the gaming industry. However, in recent years, we have gathered additional municipal accounts in an effort to diversify our funding efforts and to reduce the expected impact of any one particular municipal account holder closing their accounts. We have also implemented strategies to increase the balance of core deposits through marketing and promotional efforts. Because of the growth of the core deposits, we have steadily reduced our reliance on municipal deposits as a percentage of total deposits. At June 30, 2017, municipal deposits represented 23.6% of total deposits, compared to 47.9% of total deposits at June 30, 2006. Municipal deposits increased by $7.0 million from June 30, 2016 to June 30, 2017. In the same period, retail and business deposits increased by $7.8 million. While we expect municipal deposits to continue to remain an important source of funding, we expect to continue our efforts to improve our funding mix by marketing lower cost core retail and business deposits.

 

We aggressively market core deposits through concentrated advertising and public relations efforts. In recent years, we have significantly expanded and improved the products and services we offer our retail and business deposit customers who maintain core deposit accounts and have improved our infrastructure for critical electronic banking services, including online banking, bill pay, eStatements, merchant capture, and business online cash management tools that include ACH origination, direct deposit, payroll, federal tax payment, wire transfer capabilities. The deposit infrastructure we have established can accommodate significant increases in retail and business deposit accounts without additional capital expenditure.

 

Implementing a controlled growth strategy to originate multi-family and nonresidential real estate loans to improve interest income

 

Our primary lending activities are the origination of one- to four-family mortgage loans secured by homes in our local market area of Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana and the origination of multi-family and nonresidential real estate loans. Between 2006 and 2010, we expanded and diversified our lending activities by originating multi-family and nonresidential real estate loans secured by properties in the metropolitan Cincinnati market area and, to a lesser extent, in Northern Kentucky and the Indiana counties outside of our local market area. From June 30, 2006 until June 30, 2010, our multi-family real estate loans grew from $20.3 million, or 8.2% of the total loan portfolio, to $46.8 million, or 14.8% of our total loans outstanding. During the same period, our nonresidential real estate loans grew from $65.6 million, or 26.5% of total loans outstanding, to $77.6 million, or 24.6% of total loans outstanding. In the Cincinnati and Northern Kentucky markets, our multi-family loans grew from $15.5 million to $32.8 million and our nonresidential real estate loans increased from $21.7 million to $35.8 million.

 

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As a result of the credit quality issues arising in our multi-family and nonresidential real estate loan portfolios as discussed under “Improving our asset quality” above, in June 2010, we implemented a strategy to de-emphasize the origination of our nonresidential real estate and multi-family real estate loans, particularly outside of five-county local market area. As part of this strategy, beginning in June 2010, we restricted the origination of new multi-family and nonresidential real estate loans to our local market area, and limited our multi-family and nonresidential real estate lending origination activity outside of our local market area to the renewal, refinancing and restructuring of existing loans. We also amended our loan policy to reduce our concentration limits for nonresidential real estate, multi-family real estate, construction and land loans, which limits were further reduced in August 2011. At June 30, 2017, we met each of these concentration limits.

 

Due to our prior strategy to deemphasize the origination of multi-family and nonresidential real estate loans, our multi-family and nonresidential loan portfolios declined from $46.3 million and $65.2 million at June 30, 2011, to $32.3 million and $51.9 million at June 30, 2013, respectively. We have reviewed the economic environment in our lending markets, including those in southwestern Ohio and Northern Kentucky, and the level of our nonperforming assets, and beginning in December 2013, we have implemented a controlled growth strategy to prudently increase nonresidential real estate and multi-family real estate loan portfolios to generate more interest income. Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate loan portfolio. At June 30, 2017, our multi-family loans totaled $15.4 million, or 5.4% of our total loans outstanding and our nonresidential real estate loans totaled $74.8 million, or 26.2% of our total loans outstanding. At June 30, 2016, our multi-family loans were $16.0 million, or 5.9% of our total loans outstanding and our nonresidential real estate loans totaled $58.9 million, or 21.7% of our total loans outstanding.

 

We believe our existing infrastructure will enable us to replace existing loans as they are repaid and prudently grow our loan portfolio in accordance with this strategy and as economic conditions permit.

 

Continuing to increase noninterest income

 

Our earnings rely heavily on the spread between the interest earned on loans and securities and interest paid on deposits and other borrowings. Because of our prior strategy to de-emphasize the origination of nonresidential real estate and multi-family loan portfolios, we expect that our weighted average yield on interest-earning assets may decrease in future periods because of the low interest rate environment. As discussed above in Implementing a controlled growth strategy to originate multi-family and nonresidential real estate loans to improve interest income” we have determined to implement a controlled grown strategy to prudently increase nonresidential real estate and multi-family loans to generate more interest income. Additionally, in order to decrease our reliance on interest rate spread income, we have pursued initiatives to increase noninterest income. Our primary recurring sources of noninterest income are service charges on deposit products and other services and income from bank-owned life insurance. We have also implemented, and realize fee income from, an overdraft protection program and from customer use of debit cards. We also have a significant secondary mortgage operation, including loan servicing, and we continue to invest in personnel and systems in order to increase our ability to sell one- to four-family mortgages in the secondary market to increase fee income and reduce interest rate risk through the sale of conforming fixed-rate one- to four-family residential mortgage loans. To date, all loans have been sold without recourse but with servicing retained. The volume of loans sold totaled $23.7 million and $11.3 million for the years ended June 30, 2017 and 2016, respectively. For the years ended June 30, 2017 and 2016, we recognized gains of $644,000 and $342,000, respectively, on the sale of loans. We intend to continue to originate loans for sale in the secondary market to grow our servicing portfolio and generate additional noninterest income. We continue to review programs to further enhance our service fee structure within the new regulatory environment.

 

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Expanding our geographic footprint

 

We consider our primary deposit and lending market area to be Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. Since 2005, we have grown our community banking franchise organically through the addition of de novo branches in St. Leon and Aurora, Indiana, and through the strategic acquisition of three branch offices in Ripley County, Indiana. As a result, we have increased our branch network from four to eight offices. We plan to continue to seek opportunities to grow our business through loan production offices, de novo branches and complementary acquisitions in our existing market and contiguous markets. We will consider acquisition opportunities that expand our geographic reach in banking, insurance or other complementary financial service businesses, although we do not currently have any agreements or understandings regarding any specific acquisition.

 

Continuing our community-oriented focus

 

As a community-oriented financial institution, we emphasize providing exceptional customer service as a means to attract and retain customers. We deliver personalized service and respond with flexibility to customer needs. Our ability to succeed in our communities is enhanced by the stability of our senior management, who have an average tenure with the Bank of over 33 years. We believe that our community orientation is attractive to our customers and distinguishes us from the larger banks that operate in our market area. At June 30, 2016, which is the most recent date for which data is available from the FDIC, we held 40.8% of the total deposits held by FDIC-insured institutions in Dearborn County, which was the largest market share out of the eight financial institutions with offices in Dearborn County, and 10.9% of the deposits in Ripley County, which was the fifth largest market share out of the nine financial institutions with offices in Ripley County.

 

Balance Sheet Analysis

 

Total assets were $536.9 million at June 30, 2017, compared to $526.1 million at June 30, 2016. Total assets increased during the year primarily as a result of a $15.3 million increase in net loans. This increase was partially offset by a $3.7 million decrease in investment securities and a $2.1 million decrease in cash and cash equivalents.

 

In addition to the loan growth achieved during the year ended June 30, 2017, the Company had approximately $8.3 million in undisbursed construction loans as of June 30, 2017. While these were not on the Company’s balance sheet as of June 30, 2017 and there can be no assurance of disbursement in the future, the loans have closed and management expects the majority of these committed funds to be disbursed.

 

Total liabilities were $465.6 million at June 30, 2017, compared to $455.6 million at June 30, 2016. Total liabilities increased during the year primarily due to a $14.8 million increase in deposits during the current year, partially offset by a $3.2 million decrease in FHLB advances.

 

Stockholders’ equity totaled $71.3 million as of June 30, 2017, which represented an increase of $837,000 when compared to June 30, 2016. The increase was primarily due to net income of $3.4 million and $255,000 in proceeds received related to the exercise of stock options, partially offset by $1.1 million in dividends declared during the year, stock repurchases totaling $273,000, and a $2.2 million decrease in accumulated other comprehensive income reflecting declines in the market value of available-for-sale securities. The decrease in accumulated other comprehensive income is the result of increasing market interest rates during the year. In connection with the preparation of the financial statements for the year ended June 30, 2017, management evaluated the credit quality of the investment portfolio and believes all unrealized losses to be temporary. Management has the intent and ability to hold these securities until the value recovers or until maturity.

 

Loans. Our primary lending activity is the origination of loans secured by real estate. We originate one- to four-family residential loans, multi-family and nonresidential real estate loans and construction loans. To a lesser extent, we originate commercial and consumer loans. From time to time, as part of our loss mitigation process, loans may be renegotiated in a troubled debt restructuring when we determine that greater economic value will ultimately be recovered under the new terms than through foreclosure, liquidation, or bankruptcy. In determining whether a borrower is experiencing financial difficulty, we may consider the borrower’s payment status and history, the borrower’s ability to pay upon a rate reset on an adjustable-rate mortgage, the size of the payment increase upon a rate reset, the period of time remaining prior to the rate reset, and other relevant factors. We do not offer, and have not previously offered, subprime, Alt-A, low-doc, no-doc loans or loans with negative amortization and generally do not offer interest-only loans.

 

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The largest segment of our loan portfolio is one- to four-family residential loans. At June 30, 2017, these loans totaled $144.3 million, or 50.5% of total gross loans, compared to $143.0 million, or 52.8% of total gross loans, at June 30, 2016.

 

Multi-family and nonresidential real estate loans totaled $90.2 million and represented 31.6% of total loans at June 30, 2017, compared to $74.9 million, or 27.6% of total loans, at June 30, 2016. The growth in these segments is the result of the previously discussed controlled growth strategy. As further discussed in “Operating Strategy – Implementing a controlled growth strategy to originate multi-family and nonresidential real estate loans to improve interest income,” we have reviewed the economic environment in our lending markets, including those in southwestern Ohio and Northern Kentucky, and the level of our nonperforming assets, and beginning in December 2013, we implemented a controlled growth strategy to prudently increase nonresidential real estate and multi-family real estate loan portfolios. Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate loan portfolios.

 

Construction loans totaled $5.2 million, or 1.8% of total loans, at June 30, 2017, compared to $5.4 million, or 2.0% of total loans, at June 30, 2016.

 

Commercial business loans totaled $5.4 million, or 1.9% of total loans, at June 30, 2017, compared to $4.5 million, or 1.7% of total loans, at June 30, 2016.

 

Consumer loans totaled $33.6 million, or 11.8% of total loans, at June 30, 2017, compared to $35.0 million, or 12.9% of total loans, at June 30, 2016.

 

Agricultural loans totaled $3.9 million, or 1.3% of total loans, at June 30, 2017, compared to $6.0 million or 2.2% of total loans, at June 30, 2016.

 

The following table sets forth the composition of our loan portfolio at the dates indicated.

 

   At June 30, 
   2017   2016   2015   2014   2013 
   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent   Amount   Percent 
   (Dollars in thousands) 
Residential real estate:                                        
One- to four-family  $144,334    50.5%  $143,043    52.8%  $141,052    54.7%  $129,484    52.1%  $128,059    49.4%
Multi-family   15,401    5.4    16,032    5.9    19,296    7.5    23,645    9.5    32,306    12.5 
Construction   5,145    1.8    5,373    2.0    2,425    0.9    797    0.3    2,200    0.2 
Nonresidential real estate   74,791    26.2    58,851    21.7    47,929    18.6    48,769    19.6    51,902    20.0 
Land   3,026    1.1    2,151    0.8    2,985    1.2    3,391    1.4    3,435    1.3 
Commercial business   5,383    1.9    4,476    1.7    4,038    1.6    4,514    1.8    3,556    1.4 
Agricultural   3,874    1.3    5,966    2.2    5,161    2.0    3,456    1.4    3,559    1.4 
Consumer:                                                  
Home equity   28,992    10.2    30,558    11.3    30,600    11.9    30,804    12.4    31,411    12.1 
Auto   2,208    0.8    2,249    0.8    2,008    0.8    1,516    0.6    1,468    0.6 
Share loans   945    0.3    932    0.3    893    0.3    1,088    0.4    1,625    0.6 
Other   1,488    0.5    1,279    0.5    1,379    0.5    1,261    0.5    1,195    0.5 
Total consumer loans   33,633    11.8    35,018    12.9    34,880    13.5    34,699    13.9   $128,059    13.8%
Total loans   285,587    100.0%   270,910    100.0%   257,766    100.0%   248,725    100.0%   258,996    100.0%
Less (plus):                                                  
Deferred loan costs, net   (1,184)        (1,113)        (1,186)        (1,118)        (1,025)     
Allowance for loan losses   4,294         4,885         5,124         5,459         5,443      
Loans, net  $282,477        $267,138        $253,828        $244,384        $254,578      

 

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Loan Maturity

 

The following table sets forth certain information at June 30, 2017 regarding the dollar amount of loan principal repayments becoming due during the periods indicated. The table does not include any estimate of prepayments, which significantly shorten the average life of all loans and may cause our actual repayment experience to differ from the contractual requirements shown below. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less.

 

   Less Than
One Year
   More Than
One Year to
Five Years
   More Than
Five Years
   Total
Loans
 
   (In thousands) 
                 
One- to four-family residential real estate  $8,681   $32,962   $102,691   $144,334 
Multi-family real estate   557    3,483    11,361    15,401 
Construction   934    165    4,046    5,145 
Nonresidential real estate   7,221    18,054    49,516    74,791 
Land   793    1,399    834    3,026 
Commercial   1,187    2,625    1,571    5,383 
Agricultural   834    2,020    1,020    3,874 
Consumer   1,848    3,651    28,134    33,633 
Total  $22,055   $64,359   $199,173   $285,587 

 

The following table sets forth the dollar amount of all loans at June 30, 2017 due after June 30, 2018 that have either fixed interest rates or adjustable interest rates. The amounts shown below exclude unearned interest on consumer loans and deferred loan fees.

 

  

Fixed

Rates

  

Floating or

Adjustable Rates

   Total 
   (In thousands) 
             
One- to four-family residential real estate  $36,998   $98,655   $135,653 
Multi-family real estate   7,284    7,560    14,844 
Construction   903    3,308    4,211 
Nonresidential real estate   17,563    50,007    67,570 
Land   81    2,152    2,233 
Commercial   2,563    1,633    4,196 
Agricultural   1,854    1,186    3,040 
Consumer   2,340    29,445    31,785 
Total  $69,586   $193,946   $263,532 

 

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Loans Originated

 

The following table shows loan origination, participation, purchase and sale activity during the periods indicated.

 

   Year Ended June 30, 
   2017   2016 
   (In thousands) 
Total loans at beginning of period  $270,910   $257,766 
Loans originated (1):          
One- to four-family residential real estate   50,504    34,450 
Multi-family residential real estate   8,645    977 
Construction   1,449    10,103 
Nonresidential real estate   23,778    20,194 
Land   1,768    391 
Commercial business   2,049    4,854 
Consumer   9,778    7,597 
Total loans originated   97,971    78,566 
Deduct:          
Loan principal repayments   59,591    54,074 
Loans disbursed for sale   23,703    11,348 
Net loan activity   14,677    13,144 
Total loans at end of period  $285,587   $270,910 

 

 

(1) Includes loan renewals, loan refinancing’s and restructured loans.

 

After review of the economic environment in our lending markets during the quarter ended December 31, 2013, the Bank has implemented a controlled growth strategy to prudently increase nonresidential real estate and multi-family real estate portfolios to generate more interest income. Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate loan portfolios. Additionally, an emphasis was placed on business development efforts bank-wide in order to increase the overall loan portfolio. As a result, loan originations increased 25% from fiscal year ending June 30, 2016 to fiscal year ending June 30, 2017.

 

Securities. The securities portfolio consists primarily of municipal bonds, agency backed mortgage-backed securities and collateralized mortgage obligations, and guaranteed portions of Small Business Administration (SBA) pools. As of June 30, 2017, the investment securities portfolio totaled $189.5 million, a decrease of $3.7 million from the June 30, 2016 total of $193.2 million. The decrease was caused by routine principal repayments as well as investment sales, partially offset by purchases during the fiscal year.

 

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The following table sets forth the amortized cost and fair values of our securities portfolio at the dates indicated.

 

   At June 30, 
   2017   2016 
  

Amortized
Cost

  

Fair
Value

  

Amortized
Cost

  

Fair
Value

 
   (In thousands) 
Securities available-for-sale:                
Mortgage-backed securities  $69,335   $68,374   $74,198   $74,727 
Municipal Bonds   36,990    36,941    33,512    34,790 
U.S. Government Agency Bonds   -    -    -    - 
Small Business Admin   9,799    9,743    7,651    7,872 
Collateralized Mortgage Obligations   29,664    29,305    31,650    31,832 
Certificates of Deposit   2,971    3,000    2,971    3,064 
Other Equity Securities   210    199    210    167 
Total  $148,969   $147,562   $150,192   $152,452 
Securities held-to-maturity:                    
Municipal bonds  $41,954   $42,711   $40,763   $43,201 

 

At June 30, 2017 and 2016, we had no investments in a single company or entity (other than U.S. Government-sponsored agency securities) that had an aggregate book value in excess of 10% of our stockholders’ equity.

 

The following table sets forth the stated maturities and weighted average yields of investment securities at June 30, 2017. Weighted average yields on tax-exempt securities are not presented on a tax equivalent basis. Our callable securities consist primarily of municipal bonds which contain either a one-time call option or may be callable any time after the first call date.

 

    One Year
or Less 
    More than
One Year to
Five Years
    More than
Five Years to
Ten Years
    More than
Ten Years
    Total  
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
    Carrying
Value
    Weighted
Average
Yield
 
    (Dollars in thousands)  
Securities available-for-sale:                                                            
Mortgage-backed securities   $ -       - %   $ 47,011       1.83 %   $ 21,363       2.17 %   $ -       - %   $ 68,374       1.94 %
Municipal Bonds     595       3.17 %     8,967       2.49 %     7,585       3.45 %     19,794       3.04 %     36,941       2.99 %
Small Business Admin     -       - %     -       - %     9,743       2.58 %     -       - %     9,743       2.58 %
Collateralized Mtg Oblig     1,342       1.22 %     19,549       1.78 %     8,414       2.36 %     -       - %     29,305       1.92 %
Certificates of Deposit     248       1.45 %     2,502       2.19 %     250       2.50 %     -       - %     3,000       2.15 %
Total   $ 2,185             $ 78,029             $ 47,355             $ 19,794             $ 147,363          
Securities held-to-maturity:                                                                                
Municipal bonds   $ 65       4.97 %   $ 3,507       2.39 %   $ 4,451       2.85 %   $ 33,931       3.47 %   $ 41,954       3.32 %

 

Mortgage-backed securities and collateralized mortgage obligations represent a participation interest in a pool of one- to four-family or multi-family real estate mortgages. The mortgage originators use intermediaries (generally U.S. Government agencies and government-sponsored enterprises) to pool and repackage the participation interests in the form of securities, with investors receiving the principal and interest payments on the mortgages. Such U.S. Government agencies and government-sponsored enterprises guarantee the payment of principal and interest to investors.

 

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The mortgage-backed securities in the portfolio are all backed by an implied principal and interest guarantee from the U.S. government through its agencies (typically Federal Home Loan Bank, Government National Mortgage Association, or the Federal Home Loan Mortgage Corporation). Neither United Community Bancorp nor United Community Bank has invested in subprime mortgage-backed securities or any private label mortgage-backed securities, which carry credit risk beyond that of the implied guarantee of the U.S. government agencies.

 

Mortgage-backed securities generally yield less than the loans which underlie such securities because of their payment guarantees or credit enhancements which offer nominal credit risk. In addition, mortgage-backed securities are more liquid than individual mortgage loans and may be used to collateralize our borrowings or other obligations. Mortgage-backed securities generally increase the quality of our assets by virtue of the insurance or guarantees that back them. At June 30, 2017, approximately $29.9 million of our mortgage-backed and investment securities were pledged to secure various obligations of United Community Bank.

 

The average life of a mortgage-backed security is typically far less than its stated maturity due to prepayments of the underlying mortgages as well as the typical monthly return of a portion of principal. During periods of declining interest rates, prepayments tend to increase, which could result in the return of our principal faster than we anticipated. Prepayments that are faster than anticipated may shorten the life of the security and increase or decrease its yield if the security was purchased at a discount or premium, respectively. The yield is based upon the coupon interest payments and the amortization of any premium or accretion of any discount related to the security. In accordance with accounting principles generally accepted in the United States of America, premiums and discounts are amortized over the estimated lives of the underlying loans. The prepayment assumptions used to determine the amortization period for premiums and discounts can significantly affect the yield of the mortgage-backed security and these assumptions are reviewed periodically to reflect actual prepayments. Although prepayments of underlying mortgages depend on many factors, including the type of mortgages, the coupon rate, the age of mortgages, the location of the underlying real estate collateralizing the mortgages and general levels of market interest rates, the difference between the interest rates on the underlying mortgages and the prevailing mortgage interest rates generally is the most significant determinant of the rate of prepayments. During periods of falling mortgage interest rates, if the coupon rate of the underlying mortgages exceeds the prevailing market interest rates offered for mortgage loans, refinancing generally increases and accelerates the prepayment of the underlying mortgages and the related security. Under such circumstances, United Community Bank may be subject to reinvestment risk because to the extent that the mortgage-backed securities amortize or prepay faster than anticipated, United Community Bank may not be able to reinvest the proceeds of such repayments and prepayments at a comparable yield. During periods of rising interest rates, prepayment rates of the underlying mortgages generally slow down when the coupon rate of such mortgages is less than the prevailing market rate.

 

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. The evaluation is based upon factors such as the creditworthiness of the issuers/guarantors, the underlying collateral, if applicable, and the continuing performance of the securities. Management also evaluates other facts and circumstances that may be indicative of an other-than-temporary impairment condition. This includes, but is not limited to, an evaluation of the type of security, length of time and extent to which the fair value has been less than cost and near-term prospects of the issuers.

 

Marketable equity securities are evaluated for other-than-temporary impairments based on the severity and duration of the impairment and, if deemed to be other-than-temporary, the declines in fair value are reflected in earnings as realized losses. For debt securities, other-than-temporary impairment is required to be recognized (1) if we intend to sell the security; (2) if it is “more likely than not” that we will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis.

 

Deposits. Our primary source of funds is our deposit accounts, which are comprised of noninterest-bearing accounts, interest-bearing checking accounts, money market accounts, passbook accounts and certificates of deposit. These deposits are provided primarily by individuals within our market areas. During the year ended June 30, 2017, our deposits increased $14.8 million primarily due to an increase in core deposits resulting from marketing initiatives to increase core deposits. During the year ended June 30, 2016, our deposits increased $6.3 million primarily due to an increase in core deposits resulting from marketing initiatives to increase core deposits.

 

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The following table sets forth the balances of our deposit products at the dates indicated.

 

   At June 30, 
   2017   2016 
   (In thousands) 
Noninterest-bearing checking accounts  $37,421   $35,981 
Interest-bearing checking accounts   137,605    119,881 
Passbook accounts   124,102    117,102 
Money market deposit accounts   28,927    23,204 
Certificates of deposit   125,600    142,717 
Total  $453,655(1)  $438,885(2)

 

 
(1) Includes $107.2 million in municipal deposits at June 30, 2017.

(2) Includes $100.2 million in municipal deposits at June 30, 2016.

 

The following table indicates the amount of jumbo certificates of deposit by time remaining until maturity as of June 30, 2017. Jumbo certificates of deposit require minimum deposits of $100,000. We did not have any brokered deposits as of June 30, 2017 and 2016.

 

Maturity Period  Certificates
of Deposit
 
   (In thousands) 
Three months or less  $8,424 
Over three through six months   8,060 
Over six through twelve months   14,313 
Over twelve months   29,644 
Total  $60,441 

 

The following table sets forth time deposits classified by rate at the dates indicated.

 

   At June 30, 
   2017   2016 
   (In thousands) 
0.00 - 1.00%  $79,285   $96,170 
1.01 - 2.00   42,596    35,788 
2.01 - 3.00   3,535    10,340 
3.01 - 4.00   175    410 
4.01 - 5.00   9    9 
Total  $125,600   $142,717 

 

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The following table sets forth the amount and maturities of time deposits classified by rates at June 30, 2017.

 

   Amount Due         
   Less Than
One Year
   More Than
One Year to
Two Years
   More Than
Two Years to
Three Years
   More Than
Three Years
to Four
Years
   More Than
Four Years
   Total   Percent of
Total
Certificate
of Deposit
Accounts
 
   (Dollars in thousands) 
0.00 – 1.00%  $55,141   $18,263   $5,877   $4   $-   $79,285    63.2%
1.01 – 2.00   10,499    12,694    8,961    3,155    7,287    42,596    33.9 
2.01 – 3.00   678    616    1,698    473    70    3,535    2.8 
3.01 – 4.00   -    -    -    175    -    175    0.1 
4.01 – 5.00   9    -    -    -    -    9    0.0 
Total  $66,327   $31,573   $16,536   $3,807   $7,357   $125,600    100.0%

 

The following table sets forth deposit activity for the periods indicated.

 

   Year Ended June 30, 
   2017   2016 
   (In thousands) 
Beginning balance  $438,885   $432,537 
Increase (decrease) before interest credited   12,712    4,382 
Interest credited   2,058    1,966 
Net increase (decrease) in deposits   14,770    6,348 
Ending balance  $453,655   $438,885 

 

Borrowings. We utilize borrowings from the FHLB to supplement our supply of funds for loans and investments. Borrowings were $8.8 million and $12.0 million at June 30, 2017 and 2016, respectively.

 

   Year Ended June 30, 
   2017   2016 
   (Dollars in thousands) 
Maximum amount of advances outstanding at any month end during the period:        
FHLB advances  $12,000   $13,000 
Average advances outstanding during the period:          
FHLB advances  $10,154   $12,764 
Weighted average interest rate during the period:          
FHLB advances   2.08%   1.84%
Balance outstanding at end of period:          
FHLB advances  $8,833   $12,000 
Weighted average interest rate at end of period:          
FHLB advances   2.19%   1.87%

 

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Results of Operations for the Years Ended June 30, 2017 and 2016

 

Overview.

 

   2017   2016   %
Change
2017/2016
 
Net income  $3,447   $3,428    0.6%
Return on average assets   0.65%   0.66%   (1.5)
Return on average equity   4.91%   4.91%   - 
Average equity to average assets   13.15%   13.48%   (2.4)

 

Net income totaled $3.4 million for the year ended June 30, 2017, which represented an increase of $19,000, or 0.6%, when compared to the year ended June 30, 2016. The increase in net income was primarily the result of an increase in net interest income, an increase in non-interest income and a decrease in the provision for loan losses, partially offset by an increase in non-interest expense and an increase in the provision for income taxes.

 

Net Interest Income.

 

Net interest income totaled $13.9 million for the year ended June 30, 2017, which represented an increase of $414,000, or 3.1%, when compared to the year ended June 30, 2016. The growth in net interest income, the Company’s core business, was the result of an increase in interest income, which was partially offset by an increase in interest expense. Interest income increased by $482,000 primarily due to a $12.2 million increase in the average balance of loans and an increase in the average rate earned on investment securities from 2.13% in the prior year to 2.22% in the current year. The increase in loan balances is primarily the result of the continued execution of our controlled growth strategy in mortgage and commercial lending. The increases were partially offset by a $2.2 million decrease in the average balance of investment securities and a decrease in the average rate earned on loans from 4.40% in the prior year to 4.29% in the current year. Interest expense increased $68,000 for the year primarily due to a $19.1 million increase in the average balance of deposits. The average rate paid on deposits was 0.46% for both the year ended June 30, 2017 and the year ended June 30, 2016.

 

Average Balances and Yields. The following table presents 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. For purposes of this table, average balances have been calculated using month-end balances, and nonaccrual loans are included in average balances only. Management does not believe that the use of month-end balances instead of daily average balances has caused any material differences in the information presented. Loan fees are included in interest income on loans. Yields are not presented on a tax-equivalent basis.

 

   Year Ended June 30, 
   2017   2016 
   (Dollars in thousands) 
   Average
Balance
   Interest
and
Dividends
   Yield/
Cost
   Average
Balance
   Interest
and
Dividends
   Yield/
Cost
 
Assets:                        
Interest-earning assets:                        
Loans  $275,588   $11,816    4.29%  $263,435   $11,595    4.40%
Investment securities   188,242    4,179    2.22    190,423    4,065    2.13 
Other interest-earning assets   32,110    185    0.58    26,587    38    0.14 
Total interest-earning assets   495,940    16,180    3.26    480,445    15,698    3.27 
Noninterest-earning assets   37,883              37,146           
Total assets  $533,823             $517,591           

 

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   Year Ended June 30, 
   2017   2016 
   (Dollars in thousands) 
   Average
Balance
   Interest
and
Dividends
   Yield/
Cost
   Average
Balance
   Interest
and
Dividends
   Yield/
Cost
 
Liabilities and equity:                        
Interest-bearing liabilities:                        
NOW and money market deposit accounts  $194,508    446    0.23   $171,981    262    0.15 
Passbook accounts   120,126    318    0.26    111,252    290    0.26 
Certificates of deposit   135,365    1,294    0.96    147,698    1,414    0.96 
Total interest-bearing deposits   449,999    2,058    0.46    430,931    1,966    0.46 
FHLB advances   10,154    211    2.08    12,764    235    1.84 
Total interest-bearing liabilities   460,153    2,269    0.49    443,695    2,201    0.50 
Noninterest-bearing liabilities   3,447              4,119           
Total liabilities   463,600              447,814           
Total stockholders’ equity   70,223              69,777           
Total liabilities and stockholders’ equity  $533,823             $517,591           
Net interest income       $13,911             $13,497      
Interest rate spread             2.77%             2.77%
Net interest margin             2.80%             2.81%
Average interest-earning assets to average interest-bearing liabilities             107.78%             108.28%

 

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

 

   Year Ended
June 30,
2017 Compared to 2016
 
   Increase (Decrease)
Due to
     
  

Volume

   Rate   Net 
   (In thousands) 
Interest and dividend income:            
Loans  $529   $(308)  $221 
Investment securities   (47)   161    114 
Other interest-earning assets   8    139    147 
Total interest-earning assets   490    (8)   482 
Interest expense:               
Deposits   79    13    92 
FHLB advances   (48)   24    (24)
Total interest-bearing liabilities   31    37    68 
Net change in net interest income  $459   $(45)  $414 

 

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Provision for Loan Losses.

 

The net provision for loan losses was $55,000 for the year ended June 30, 2017 compared to $187,000 for the year ended June 30, 2016.

 

Reflective of continued improvement in our asset quality, nonperforming loans as a percentage of total loans decreased from 1.07% at June 30, 2016 to 1.02% at June 30, 2017, and nonperforming loans as a percentage of total assets was 0.56% at June 30, 2017 which is consistent with the percentage at June 30, 2016.

 

All of the troubled debt restructurings in fiscal 2017 and 2016 represented loan relationships with long-time borrowers of the Company. In measuring impairment, management considered the results of independent property appraisals, together with estimated selling expenses, and/or detailed cash flow analyses. A detailed discussion of our most significant nonaccrual loans at June 30, 2017 and June 30, 2016 is set forth in the section below entitled “—Analysis of Nonperforming and Classified Assets.”

 

Noninterest Income. The following table shows the components of other income for the years ended June 30, 2017 and 2016.

 

   2017   2016   %
Change
2017/2016
 
   (Dollars in thousands)     
Service charges  $3,106   $2,968    4.6%
Gain on sale of loans   644    342    88.3 
Gain on sale of investments   79    145    (45.5)
Gain (loss) on sale of other real estate owned   (13)   27    (148.1)
Provision for loss on real estate owned   -    (60)   (100.0)
Income from bank-owned life insurance   622    773    (19.5)
Other   358    444    (19.4)
Total  $4,796   $4,639    3.4 

 

Noninterest income totaled $4.8 million for the year ended June 30, 2017, which represented an increase of $157,000, or 3.4%, compared to the prior year. The increase was primarily due to a $302,000 increase in gain on the sale of mortgage loans due to higher sales volume, and a $138,000 increase in service charge income on deposit accounts due to an increase in the number of transaction accounts. These increases were partially offset by a $151,000 decrease in income from Bank-Owned Life Insurance primarily due to one Director and one former Director passing away during the year ended June 30, 2017 resulting in gains totaling $149,000 compared to one Director and one former Director also passing away in the prior year, which resulted in gains totaling $298,000.

 

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 Noninterest Expense. The following table shows the components of noninterest expense for the years ended June 30, 2017 and 2016.

 

   2017   2016   %
Change
2017/2016
 
    (Dollars in thousands)      
Compensation and employee benefits  $8,585   $8,347    2.9%
Premises and occupancy expense   1,191    1,139    4.6 
Deposit insurance premium   166    301    (44.9)
Advertising expense   401    365    9.9 
Data processing expense   1,820    1,410    29.1 
Intangible amortization   117    117    0.0 
Professional fees   703    748    (6.0)
Other operating expenses   1,269    1,553    (18.3)
Total  $14,252   $13,980    1.9 

 

Noninterest expense totaled $14.3 million for the year ended June 30, 2017, which represented an increase of $272,000, or 1.9%, compared to the year ended June 30, 2016. The increase in noninterest expense was primarily the result of an increase of $410,000 in data processing expense and an increase of $238,000 in compensation expense. The increase in data processing expense was the result of the expiration of temporary monthly credits and an increase in fraud prevention services, which serve to protect the Bank and its customers. The increase in compensation expense was primarily due to the $196,000 separation payment made in the current year in connection with the departure of the Company’s former Chief Financial Officer, and a two-month medical insurance holiday in the prior year, which saved the Company $114,000, as compared to a one-month holiday in the current year, which only saved the Company $60,000. These increases were partially offset by a $135,000 decrease in deposit insurance due to a favorable change to the FDIC assessment rate, and a $284,000 decrease in other non-interest expenses. Other non-interest expenses decreased primarily as a result of a $271,000 decrease in loan closing costs associated with a closing cost promotion. Prior to July 1, 2016, the Company charged certain loan closing costs immediately to expense. Pursuant to ASC 310-20, the Company is deferring a portion of these closing costs associated with new loans and amortizing those costs over the life of the loan.

 

Income Taxes.

 

Income tax expense increased by $412,000 to $953,000 for the year ended June 30, 2017, compared to $541,000 for the year ended June 30, 2016. The effective tax rates for the years ended June 30, 2017 and 2016 were beneficially affected by tax exempt municipal bond interest and income on bank-owned life insurance.

 

Risk Management

 

Overview. Managing risk is an essential part of successfully managing a financial institution. Our most prominent risk exposures are credit risk, interest rate risk and market risk. Credit risk is the risk of not collecting the interest and/or the principal balance of a loan or investment when it is due. Interest rate risk is the potential reduction of net interest income as a result of changes in interest rates. Market risk arises from fluctuations in interest rates that may result in changes in the values of financial instruments, such as available-for-sale securities, that are accounted for on a mark-to-market basis. Other risks that we face are operational risks, liquidity risks and reputation risk. Operational risks include risks related to fraud, regulatory compliance, processing errors, technology and disaster recovery. Liquidity risk is the possible inability to fund obligations to depositors, lenders or borrowers. Reputation risk is the risk that negative publicity or press, whether true or not, could cause a decline in our customer base or revenue.

 

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Credit Risk Management. Our strategy for credit risk management focuses on having well-defined credit policies and uniform underwriting criteria and providing prompt attention to potential problem loans. In June 2010, we implemented a strategy to deemphasize the origination of multi-family and nonresidential real estate loans, restricting the new origination of nonresidential and multi-family residential loans to the southeastern Indiana Counties of Dearborn, Ripley, Franklin, Ohio and Switzerland. The intent of this strategy was to control the growth of our nonresidential real estate and multi-family real estate loan portfolios, particularly with respect to loans located outside of Dearborn, Ripley, Franklin, Ohio and Switzerland Counties, Indiana. This strategy also emphasized the origination of one- to four-family mortgage loans, which typically have lower default rates than other types of loans and are secured by collateral that had generally tended to appreciate in value. In March 2014, we amended our loan policies to reduce our concentration limits for multi-family and nonresidential real estate loans to 75% and 100%, respectively, of the sum of tier 1 risk-based capital plus our allowance for loan losses. The limits were reduced because United Community Bank identified multi-family and nonresidential real estate loans, especially those located outside our normal southeastern Indiana market area, as the loan types that had experienced the most financial difficulties, which resulted in United Community Bank incurring losses and management being required to devote an extraordinary amount of time to overseeing these relationships. As of June 30, 2017, these loans represented 24.0% and 116.5%, respectively, of the sum of tier 1 risk-based capital plus our allowance for loan losses. We have reviewed the economic environment in our lending markets, including those in southwestern Ohio and Northern Kentucky, and the level of our nonperforming assets, and beginning in December 2013, we have implemented a controlled growth strategy to prudently increase nonresidential real estate and multi-family real estate loan portfolios to generate more interest income Starting in 2014, we hired experienced commercial lenders and credit staff to enhance our capacity to implement this strategy of prudently growing the commercial and commercial real estate loan portfolios.

 

When a borrower fails to make a required loan payment, we take a number of steps to attempt to have the borrower cure the delinquency and restore the loan to current status. When the loan becomes 15 days past due, a late charge notice is generated and sent to the borrower and efforts are made to contact the borrower by the collections department or the relationship manager. If payment is not then received by the 30th day of delinquency, a further notification is sent to the borrower. If no successful workout can be achieved, after a loan becomes 120 days delinquent, we may commence foreclosure or other legal proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan generally is sold at foreclosure. We may consider loan workout arrangements with certain borrowers under certain circumstances in the form of a short sale or troubled debt restructuring.

 

Management reports to the Board of Directors monthly regarding the amount of loans delinquent more than 30 days and all foreclosed and repossessed property that we own.

 

Analysis of Nonperforming and Classified Assets. We consider foreclosed real estate, repossessed assets, nonaccrual loans, and troubled debt restructurings that are delinquent or have not been performing in accordance with their restructured terms for a reasonable amount of time to be nonperforming assets. Loans are generally placed on nonaccrual status when the collection of principal or interest is in doubt, or at the latest, when a loan becomes 90 days delinquent. When a loan is placed on nonaccrual status, the accrual of interest ceases and an allowance for any uncollectible accrued interest is established and charged against operations. All commercial loans that are placed on nonaccrual status are evaluated for impairment at the time the loans are placed on nonaccrual status and quarterly thereafter. Payments received on a nonaccrual loan are applied to the outstanding principal and interest on a cash basis only when United Community Bank has determined that all principal and interest will be collected. If there is doubt about future collection, United Community Bank records the entire payment against principal pursuant to the OCC regulations.

 

Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as a nonperforming asset until it is sold. When property is acquired, it is initially recorded at the lower of the outstanding balance of the loan or market value of the property, less estimate selling expenses. Holding costs and declines in fair value after acquisition of the property result in charges against income.

 

Prior to the recession, we had not incurred significant losses in our lending operations. Beginning in the year ended June 30, 2008, we began to experience the adverse effects of a significant national decline in real estate values. The consequences of this decline were generally evident in all portfolio types, but were more pronounced in multi-family and nonresidential real estate loans, particularly in markets outside of Dearborn and Ripley Counties. Our approach to resolving nonperforming loans focused on foreclosure and liquidations in the year ended June 30, 2008 and the greater part of the year ended June 30, 2009. This manner of troubled asset resolution proved lengthy and costly as a result of legal and other operating costs, as well as the depressed values of the collateral securing the loan.

 

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As a result, beginning in the latter part of the year ended June 30, 2009, management initiated a restructuring process with respect to certain nonperforming loans that provided for either restructuring the loan to the borrower in recognition of the lower available cash flows from the collateral properties or identification of stronger borrowers to purchase the property and refinance the loan. In evaluating whether to restructure a loan, we consider the borrower’s payment status and history, the borrower’s ability to pay upon a rate reset on an adjustable-rate mortgage as supported by a current cash flow analysis, size of the payment increase upon a rate reset, period of time remaining before the rate reset, and other relevant factors in determining whether a borrower is experiencing financial difficulty. Through these troubled debt restructurings, management believes they have provided the necessary valuation allowances or charge-offs to reflect the loans’ carrying amounts at fair value.

 

Loan workouts and modifications are handled by the President and Chief Executive Officer, the Executive Vice President and Chief Operating Officer, the Senior Vice President of Lending, and the Chief Credit Officer. Management ascertains the value of the underlying collateral, depending on whether the loan is “collateral dependent” or “cash-flow” dependent. If a loan is determined to be “collateral dependent,” the value of the underlying collateral is determined through an independent appraisal. If the loan is determined to be “cash-flow dependent,” the value of the underlying collateral is determined through an in-house cash flow analysis of the property with the cash flows discounted at the loan’s original effective interest rate. Once the value of collateral is established, management will either establish a specific allocation to reduce the loan’s carrying value to its fair value measured using the present value of cash flows or a charge-off for collateral dependent loans in an amount equal to the shortfall between the collateral value and the outstanding principal loan balance. Management will then develop and pursue a workout plan. Once a workout plan is established and implemented, management will, at a minimum, monitor the monthly performance of the loan until it is removed from nonaccrual status. On at least an annual basis, management will conduct property inspections and review financial information of the borrowers and any guarantors. In situations where a collateral shortfall (i.e., the value of the underlying collateral of the loan is less than the outstanding principal balance of the loan) is discovered, typically through an updated independent appraisal, evaluation, or collateral inspection, management will seek to obtain additional collateral and/or a personal guaranty at that time. If no additional collateral is available, management will work with the borrower on a suitable workout arrangement that may include a troubled debt restructuring, or management may determine to foreclose on the property. To determine the best outcome for United Community Bank, management reviews the financial condition of the borrower, the cash flow of the property and the value of the loan’s collateral.

 

If United Community Bank obtains an additional guaranty during the workout process, the strength and value of the guaranty is measured by the Bank prior to the loan closing and is re-evaluated at least annually. The strength of each guaranty is determined by evaluating the guarantor’s net worth, liquid net worth, debt-to-income ratio and credit score. In certain circumstances, the Bank may deem it appropriate not to enforce a guaranty, such as when we determine enforcing a guaranty could be detrimental to the overall banking relationship.

 

After the restructuring is completed, if the borrower continues to experience payment difficulties, or if there is an additional decline in the collateral value identified in the annual property inspection or updated appraisal, management may impair the loan further, restructure the loan again, or foreclose on the collateral property. At this point, management considers all of the same factors it did when the initial restructuring occurred, and attempts to resolve the situation so as to achieve the best outcome for the Bank.

 

Troubled debt restructurings are considered to be impaired and are initially treated as nonperforming. Troubled debt restructurings that are originally restructured at a market rate of interest and have a history of performance (generally a minimum of 12 consecutive months of performance at a market rate of interest) may be excluded from being reported as TDRs in periods subsequent to meeting this requirement. At June 30, 2017, 19 loans were considered to be troubled debt restructurings (with an aggregate balance of $2.6 million) of which 6 loans (with an aggregate balance of $1.3 million) were included in nonperforming assets. At June 30, 2016, 22 loans were considered to be troubled debt restructurings (with an aggregate balance of $3.7 million) of which 6 loans (with an aggregate balance of $1.4 million) were included in nonperforming assets.

 

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The following table provides information with respect to our nonperforming assets at the dates indicated.

 

   At June 30, 
   2017   2016   2015   2014   2013 
   (Dollars in thousands) 
Nonaccrual loans:                         
One- to four-family residential real estate  $612   $1,011   $1,721   $1,788   $1,876 
Multi-family real estate   -    -    -    -    1,861 
Nonresidential real estate and land   594    88    926    3,136    918 
Commercial   -    -    -    -    - 
Consumer   370    398    458    633    535 
Total nonaccrual loans   1,576    1,497    3,105    5,557    5,190 
Nonaccrual restructured loans:                         
One- to four-family residential real estate   213    324    948    1,552    2,554 
Multi-family real estate   -    -    -    1,200    2,263 
Nonresidential real estate and land   1,136    1,066    2,437    1,639    2,701 
Total nonaccrual restructured loans   1,349    1,390    3,385    4,391    7,518 
Total nonperforming loans   2,925    2,887    6,490    9,948    12,708 
Real estate owned   93    70    286    598    618 
Total nonperforming assets  $3,018   $2,957   $6,776   $10,546   $13,326 
Accruing restructured loans   1,297    2,330    4,589    5,618    11,543 
Accruing restructured loans and nonperforming assets  $4,315   $5,287   $11,365   $16,164   $24,869 
Total nonperforming loans to total loans   1.02%   1.07%   2.52%   4.00%   4.91%
Total nonperforming loans to total assets   0.54    0.55    1.25    1.88    2.48 
Total nonperforming assets to total assets   0.56    0.56    1.30    1.99    2.60 

 

Interest income that would have been recorded for the years ended June 30, 2017 and 2016 had nonaccruing loans been current according to their original terms was $295,000 and $368,000, respectively. Interest recognized on the cash basis with regard to nonaccrual restructured loans was $9,000 and $18,000 for the years ended June 30, 2017 and 2016, respectively.

 

Nonperforming assets as a percentage of total assets were 0.56% at June 30, 2017 and June 30, 2016, and decreased slightly from 0.57% at March 31, 2017. Nonperforming loans as a percentage of total loans decreased from 1.07% at June 30, 2016 to 1.02% at June 30, 2017, and decreased from 1.09% at March 31, 2017. The Company remains focused on improving asset quality and continues to review all available options to decrease nonperforming assets. Beginning with the disclosure in the Company’s Form 10-Q for the quarter ended March 31, 2011, the Company included “Loan Relationship” narratives regarding its five largest nonaccrual (nonperforming) loans and loans having the five largest charge-offs, all of which were commercial real estate loans. As of March 31, 2011, the amount of all nonaccrual (nonperforming) loans totaled $19.5 million, and the amount of all accruing TDR loans totaled $7.0 million. As of June 30, 2017, the amount of all nonaccrual (nonperforming) loans decreased to $2.9 million and the amount of all accruing TDR loans decreased to $1.3 million.

 

Because of the decrease in the aggregate amount of nonaccrual (nonperforming) loans and the aggregate amount of accruing TDR loans over the last six years, the Loan Relationship narratives since December 31, 2015 have focused on commercial Loan Relationships with the following loans:

 

  The largest nonaccruing commercial real estate loans (including nonaccrual TDRs) having a carrying value of at least $250,000, plus any related commercial or retail loans;

 

  The largest commercial real estate loan charge-offs having a charge-off of at least $250,000 that are related to commercial real estate loans in a Loan Relationship, whether accruing or not, plus any related commercial or retail loans; and

 

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  The largest accruing TDR commercial loans having a carrying value of at least $250,000 plus any related commercial or retail loans.

 

If a commercial loan falls into one of the three categories listed above, then a narrative is composed for that commercial loan and any related commercial or retail loans.

 

At June 30, 2017:

 

  The largest commercial real estate nonaccrual loans having a carrying value of at least $250,000 are related to loans in Loan Relationships M, O and R. There are a total of five loans in these three Loan Relationships.

 

  The largest commercial real estate loan charge-offs of at least $250,000 are related to loans in Loan Relationships F, H, M, O and R. There are a total of 10 loans in these five Loan Relationships.

 

  There are no accruing TDRs having a carrying value of at least $250,000.

 

As discussed below, some of the Loan Relationships include loans that were restructured using the “Note A/B split note” strategy for which the amount of the Note B loan has been charged-off, with the borrower remaining responsible for that charged-off amount unless otherwise agreed to by the Bank. For purposes of the narratives, loans that have a carrying value are identified by a Loan number within each Loan Relationship, such as “Loan A-1” and “Loan A-2”. However, the Note B loans are identified as a “Note B loan” because these loans have no carrying value because they have been charged-off.

 

Management monitors the performance of all of these loans and reviews all options available to keep the loans current, including further restructuring of the loans. If restructuring efforts ultimately are not successful, management will initiate foreclosure proceedings. 

 

  Loan Relationship F. At June 30, 2017 and June 30, 2016, Loan Relationship F was comprised of two loans, a Note A loan (Loan F-1) and a Note B loan, having an aggregate carrying value of $402,000 and $414,000, respectively. These loans are secured by a multi-family residential real estate property and a single-family real estate property. The borrower is a corporate entity, with three principals, each of whom is a co-borrower of the loan. Loan F-1 is not included in any nonaccrual table because in the September 30, 2011 quarter, Loan F-1 was put on accrual because of sufficient payment history. At June 30, 2017 and June 30, 2016, Loan F-1 was classified as “Multi-family real estate, Watch” in the “Credit Risk Profile by Internally Assigned Grade” table. As of June 30, 2014, Loan F-1 was no longer reported as a TDR, or classified as substandard, because the loan was current and there were more than 12 consecutive monthly payments made on time. Additionally, recent appraisals obtained for the properties securing the loan indicated that the loan to value ratio of the loan complied with the Bank’s underwriting standards, and the cash flow analysis performed on the loan from updated financial information indicated that the debt service coverage ratio complied with the Bank’s underwriting standards. The annual cash flow analysis performed from the 2015 tax returns on this property, showed that the debt service coverage ratio was 1.00x. Loan F-1 was performing in accordance with its terms at June 30, 2017. A more detailed history of Loan Relationship F follows.

 

The original loan was initially restructured using the Note A/B split note strategy in June 2010 based on an 80% loan-to-value ratio derived from an April 2010 independent appraisal. The first loan (Note A loan) had a balance of $631,000 with a market interest rate of 5.50%, for a 25-year term, based on a 3/1 ARM. This loan was put on nonaccrual and classified as substandard. The second loan (a Note B loan) had a balance of $216,800 and there was a specific reserve established for the entire amount of the loan. The borrower was a corporate entity, with two principals, each of whom individually was a co-borrower of the loans. At December 31, 2010, the first loan was 160 days delinquent. The delinquency was a result of personal problems between the borrowers affecting their ability to manage the multi-family residential real estate and the single-family real estate. The personal problems between the borrowers also resulted in the borrowers’ inability to make the required personal cash infusions. In the latter part of 2010 and into early 2011, one of the borrowers effectively took control of the multi-family residential real estate and the single-family real estate, and brought the business current with respect to property taxes, deposit refunds to former tenants, and made required monthly loan payments in January and February 2011. Other than the January and February 2011 loan payments, the borrowers were unable to make payments to bring the loan current. Based upon those developments, management completed a detailed analysis of the total lending relationship with the borrowers. As a result of this analysis, these loans were again restructured, using the Note A/B split note strategy in March 2011. The terms of the first loan (a Note A loan) were calculated using the borrowers’ then current financial information to yield a payment having a debt service coverage ratio of approximately 1.5x, which was more stringent than the Bank’s normal underwriting standards. A restructuring fee of $7,000 was charged and included in the second loan (a Note B loan) at March 31, 2011. After the restructuring in March 2011, the Note A loan had a balance of $475,000, was put on nonaccrual, classified as substandard and reported as a TDR. The Note B loan had a balance of $405,000. The full amount of the Note B loan was charged-off in the quarter ended March 31, 2011, inclusive of the previous specific reserve of $216,800 from December 31, 2010.

 

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A two-year balloon payment was due in March 31, 2013 on the loans unless the borrower refinanced the loans to a market rate loan at that time. During the quarter ended December 31, 2012, as a result of the continued personal problems of the co-borrowers, the two loans were modified with one of the borrowers who had taken control of the two properties in early 2011. The other borrower relinquished all of its interest in the two properties. However, in addition to the one borrower retained on the loan, two other borrowers were added to the loans to provide managerial strength to the relationship and increase the property’s income potential. The Bank had been reviewing the cash flow of the property on a monthly basis and determined that the cash flows had improved due to the borrowers’ enhanced managerial ability. An independent appraisal was ordered to provide the “as is” value of the properties. The Bank obtained the appraisal in December 2012, and the appraised value of the properties had decreased to $730,000 from $774,000 in February 2011. During the quarter ended December 31, 2012, the two loans were modified, again using the Note A/B split note strategy, with both loans having three year balloon payments. The Note A loan was modified to a market interest rate of 5.50%, with no increase in the principal balance ($453,000). The term of the loan was also reduced to 324 months from the remaining term of 339 months. Even with the higher market interest rate and the shorter term of the loan, the debt service coverage ratio was above 1.20x, which complied with the Bank’s current loan underwriting standards. This loan remained on accrual (because of its sufficient payment history since the September 30, 2011 quarter), classified as substandard, and reported as a TDR. There was no increase in the principal balance ($405,000) of the Note B loan from that loan’s prior restructuring in March 2011, and therefore, the charge-off amount ($405,000) remained the same as in March 2011. However, the interest rate was reduced to 0% as the loan had been charged-off.

 

During the December 2015 quarter, the balloon payment from the December 2012 renewal became due. Due to the upcoming balloon payment, the Bank ordered new appraisals on the two properties. The Bank received the appraisals in October 2015, and the appraised value of the properties increased to $775,000 from $730,000 in December 2012. The Bank also reviewed the cash flow from updated financials of the borrowers and co-borrowers. After this review and based on the increase in value of the properties, the Bank extended the two loans, again using the Note A/B split note strategy, with both loans having three year balloon payments. The Note A Loan was renewed at the market interest rate of 5.50%, with no increase in the principal balance ($421,000). The term of the loan was renewed at 288 months, the remaining term of the loan. This loan remained on accrual (because of its sufficient payment history) and classified as watch. There was no increase in the principal balance ($405,000) of the Note B loan from that loan’s prior restructuring in December 2012, and therefore, the charge-off amount ($405,000) remained the same as in December 2012. The interest rate remained at 0% as the loan had been charged-off.

 

  Loan Relationship H. At June 30, 2017 and June 30, 2016, Loan Relationship H was comprised of three loans having an aggregate carrying value of $860,000 and $901,000, respectively. At June 30, 2017 and June 30, 2016, two of the loans, a Note A loan (Loan H-1) and a Note B loan, had an aggregate carrying value of $681,000 and $696,000, respectively. Loan H-1 is secured by a first lien on an 18-unit apartment complex, a single-family rental dwelling, a 6.3 acre tract of land, and a second lien on a single-family owner occupied dwelling on 11.36 acres. The borrower is a limited liability company and the two co-borrowers are the principals of the limited liability company. Loan H-1 is not included in any nonaccrual table because in the June 30, 2013 quarter, Loan H-1 was put on accrual because of sufficient payment history. At June 30, 2017 and June 30, 2016, Loan H-1 was classified as “Multi-family residential real estate, Watch” in the “Credit Risk Profile by Internally Assigned Grade” table. As of June 30, 2014, Loan H-1 was no longer reported as a TDR loan because the loan was current and there were more than 12 consecutive market rate monthly payments made on time. Also, recent appraisals indicated that the loan to value was adequate and the cash flows from updated financial information of the properties securing the loan indicated that the debt service coverage ratio was adequate. The annual cash flow analysis from the 2016 tax returns on the rental properties, showed that the debt service coverage ratio was 1.13x.

 

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During the quarter ended June 30, 2013, the Bank refinanced the principal residence of the co-borrowers (the single-family owner occupied dwelling on 11.36 acres mentioned above). This loan, Loan H-2, had an original balance of $280,000 at a market rate of interest for a ten year term. At June 30, 2017 and June 30, 2016, the balance of Loan H-2 was $179,000 and $206,000, respectively. Loan H-2 is secured by a first lien on the single-family owner occupied dwelling on 11.36 acres mentioned above. The borrowers are a husband and wife who are the principals in the limited liability company mentioned above. At June 30, 2017 and June 30, 2016, Loan H-2 was classified as “One- to Four-Family Owner-Occupied Mortgage, Watch” in the “Credit Risk Profile by Internally Assigned Grade” table.

 

At June 30, 2017, Loan H-1 and Loan H-2 were performing in accordance with their terms. A more detailed history of the Note A loan (Loan H-1) and the Note B loan follows.

 

During the quarter ended December 31, 2008, the Note A loan (Loan H-1) and the Note B loan were comprised of one loan with a carrying value of $1.3 million and classified as special mention. In the quarter ended June 30, 2009, the co-borrowers approached the Bank and advised that the only co-borrower who was employed had experienced a substantial salary reduction. The borrowers requested an interest rate reduction to 3% and interest only payments for three years. Independent appraisals were ordered and received and reflected that the properties on which the Bank had a first lien position had an aggregate value of $1.0 million. The loan was classified as substandard, placed on nonaccrual, and reported as a TDR. Due to the reduced interest rate, a specific valuation of $123,000 was established for the loan through a charge-off to the general allowance. Under the loan’s modified terms, the interest rate was to reset to 5.75% on June 1, 2012. In June 2012, the co-borrowers approached the Bank and advised that the properties’ cash flow could not service the increase in interest rate. Independent appraisals were ordered and received in June 2012 and reflected that the properties on which the Bank had a first lien position had decreased to $978,000 from $1.0 million in June 2009. As a result, the Bank recorded a charge-off of $481,000, (inclusive of the $123,000 specific allocation established) to reflect the carrying value of the loan at $744,000. The one loan performed in accordance with its restructured terms until the September 30, 2012 quarter, when the co-borrowers again approached the Bank and advised that the properties’ cash flow could not service the loan. Therefore, the one loan was restructured using the Note A/B split note strategy. The Note A loan (Loan H-1) was for $748,000, with a market rate of interest of 5.00%, for a 30-year term and a three year balloon payment. The carrying value of this loan was placed on nonaccrual, classified as substandard, and reported as a TDR. The Note B loan was for $515,000 (inclusive of the $481,000 that was charged-off in the June 30, 2012 quarter) and was charged-off. The interest rate was reduced to 0% as the loan had been charged-off.

 

During the September 2015 quarter, the balloon payment from the September 2012 renewal became due. As a result of the upcoming balloon payment, the Bank ordered new appraisals on the 18-unit apartment complex and the single-family rental dwelling. The Bank received new appraisals on the 18 unit apartment complex and the single-family rental dwelling in September 2015. In addition, the Bank used the June 2014 value of the 6.3 acre tract of land. The total appraised value of the three properties increased to $1,048,000 as compared to the $978,000 total appraised value in June 2012. The Bank also reviewed the cash flow from updated financials of the borrower and co-borrowers. After this review and based on the increase in value of the properties, the Bank extended the two loans, again using the Note A/B split note strategy, with both loans having three year balloon payments. The Note A loan (Loan H-1) was renewed at the market interest rate of 5.00%, using a 1/1 ARM, with a 5% floor rate, and with no increase in the principal balance ($710,000). The term of the loan was renewed at 324 months. This loan was put on accrual (because of its sufficient payment history) and classified as watch. Also, as stated above, the loan was not reported as a TDR. There was no increase in the principal balance ($515,000) of the Note B loan from that loan’s prior restructuring in September 2012, and therefore, the charge-off amount ($515,000) remained the same as in September 2012. The interest rate remained at 0% as the loan had been charged-off.

 

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  Loan Relationship M. At June 30, 2017 and June 30, 2016, Loan Relationship M was comprised of two loans having an aggregate carrying value of $601,000 and $1.1 million, respectively. At June 30, 2017 and June 30, 2016, Loan M-1 had an aggregate carrying value of $176,000 and $571,000, respectively. At June 30, 2017 and June 30, 2016, Loan M-2 had an aggregate carrying value of $425,000 and $495,000, respectively. Originally Loans M-1 and M-2 were both secured by the two golf courses, including a club house on each, in the greater Cincinnati area, an approximately 25 acre tract of land, and a second mortgage on the principal residence of two of the individual co-borrowers. The borrower of Loans M-1 and M-2 is a corporate entity, each of whose principals, a husband and wife, has individually signed as a co-borrower, as had, originally, the father and stepmother of one of the co-borrowers. At June 30, 2017 and June 30, 2016, Loans M-1 and M-2 are included in the table in “Nonaccrual, Nonresidential Real Estate” and classified as “Nonresidential Real Estate, Substandard” in the “Credit Risk Profile by Internally Assigned Grade” table. During the June 30, 2015 quarter, the Bank entered into a forbearance agreement with the borrower and co-borrowers pursuant to which full principal, interest and escrow payments will be made for the months of May through October of each year beginning in 2015. The maturity date for these loans is now October 1, 2018. Also, subsequent to the June 30, 2016 quarter, the Bank entered into an amended forbearance agreement with the borrower and co-borrowers, reflecting the reduced principal balances for Loans M-1 and M-2. The maturity date for these loans remained at October 1, 2018. Loans M-1 and M-2 were not performing in accordance with their restructured terms at June 30, 2017. A more detailed history of Loan Relationship M follows.

 

Loan M-1 originated in December 2007 and Loan M-2 originated in July 2009, each with a 20 year term. Under each loan’s terms, payments were due from April through December of each year; no payments were required in January, February and March of each year. Due to reduced cash flows resulting from inclement weather, in December 2013 the co-borrowers advised the Bank that they would pay the amounts due for November and December 2013 in February and March 2014, respectively. Due to the continuation of the severe winter weather and resultant reduced cash flows, the borrowers were unable to make the November and December 2013 payments that the borrowers had stated would be paid in February and March 2014, and were unable to make the real estate tax payment due during the period ended March 31, 2014. As a result of the failure to make the November and December 2013 payments and the borrowers’ failure to pay real estate taxes, the Bank had both properties appraised. The appraisals were received in March 2014 and reflected an aggregate decrease in value of approximately $500,000 as compared to their March 2009 appraised value. Based on the new appraised value, there was no known loss to the Bank. The Bank also performed an impairment analysis on each loan in March 2014 resulting in an aggregate impairment of $41,000. In March 2014, the Bank and the co-borrowers agreed to a revised repayment plan to bring all payments then due, and real estate taxes due, but not paid during the period ended March 31, 2014, current by July 31, 2014. At June 30, 2014, an impairment analysis was performed. The impairment analysis showed that no further impairment was needed on either Loan M-1 or Loan M-2.

 

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At September 30, 2014, the borrowers had successfully complied with the revised payment plan agreement from March 31, 2014 and both loans were current. Additionally, the real estate taxes due during the March 31, 2014 quarter were paid. However, at September 30, 2014, the real estate taxes that were due in July 2014 had not been paid. At December 31, 2014, due to cash flow issues caused by inclement weather during the quarter, the real estate taxes that were due in July 2014 were still not paid, and the loan payments due for October, November, and December 2014 were not paid. The Bank met with the husband and wife co-borrowers during the December 31, 2014 quarter. The co-borrowers advised the Bank that they would not be able to make the past due payments and the past due real estate taxes because of the inclement weather during the quarter until the golf season opened in the spring of 2015. Because of these developments, the Bank performed another impairment analysis of these two loans. While the appraisals of the properties showed no need for an impairment, the Bank further analyzed the cash flow of the golf courses. After this analysis, the Bank determined that an additional impairment of $466,000 was needed for this loan relationship, and an additional charge-off of $233,000 was established for each of the two loans in this loan relationship, through a charge-off to the general allowance. During the quarter ended March 31, 2015, the Bank entered into further discussions with the co-borrowers about another revised payment plan. As stated above, during the June 30, 2015 quarter, the Bank entered into a forbearance agreement with the borrower and co-borrowers. An impairment analysis was performed for the quarter ended June 30, 2015. The impairment analysis showed that no further impairment was needed on either Loan M-1 or M-2. For the quarter ended December 31, 2015, because there was still the partial escrow payment due for the October 2015 escrow payment, the Bank performed another impairment analysis. Even though the partial escrow payment was paid subsequent to the December 31, 2015 quarter and the appraisals of the properties indicated no further impairment was needed, the Bank reviewed the observable market price of the properties and determined that an additional impairment of $250,000 was needed for this loan relationship, and an additional charge-off of $125,000 was established for each of the two loans in this loan relationship through a charge-off to the general allowance.

 

During the March 31, 2016 quarter, because there had not been an updated appraisal since the March 2014 quarter, the Bank ordered and received new appraisals on all of the collateral securing this Loan Relationship. The new appraisal on one of the golf courses decreased to $1.1 million from $1.2 million. The new appraisal on the other golf course decreased to $1.4 million from $1.6 million. The new appraisal on the approximately 25 acre tract of land increased to $100,000 from $95,000. The new appraisal for the principal residence of two of the individual co-borrowers increased to $165,000 from $150,000. Also during the March 2016 quarter, the husband and wife principals of the two corporate entities informed the Bank that they were not going to open the golf course that appraised for $1.1 million for the 2016 golf season and that they are going to attempt to sell the property as a land development project. Subsequent to the end of the March 2016 quarter, the Bank was informed that one of the co-borrowers had passed. She was the wife of one of the co-borrowers and the stepmother of one of the other co-borrowers who is one of the two principals of the corporate entities.

 

During the June 30, 2016 quarter, the borrowers entered into a purchase agreement to sell the golf course that was not opened. As part of this purchase, the Bank agreed to release the nonoperational golf course, the 25 acre tract of land, and the co-borrower who was the father of one of the principals. In connection with the transaction, the Bank secured the first mortgage, instead of a second mortgage, on the principal residence of two of the individual co-borrowers. However, based on this purchase agreement, the Bank determined that an additional impairment of $210,000 was needed for this loan relationship, and an additional charge-off of $105,000 was established for each of the two loans in the loan relationship through a charge-off to the general allowance. The nonoperational golf course was sold subsequent to the end of the June 30, 2016 quarter. After the sale and subsequent reduction of the principal balance of Loan M-1, the Bank determined that no further impairment was needed. Also, subsequent to the June 30, 2016 quarter, the Bank entered into an amended forbearance agreement with the borrower and co-borrowers, reflecting the reduced principal balances for Loans M-1 and M-2. The maturity date for these loans remained at October 1, 2018. The Bank will monitor the cash flow of the remaining golf course each quarter and determine if any further impairment is necessary. For the June 30, 2017 quarter, the impairment analysis showed that no further impairment is necessary.

 

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  Loan Relationship O. At June 30, 2017 and June 30, 2016, this Loan Relationship consisted of two loans and three loans, having an aggregate carrying value of $535,000 and $1.6 million, respectively. At June 30, 2017 and June 30, 2016, two of the loans, a Note A loan (Loan O-1) and a Note B loan, had an aggregate carrying value of $535,000 and $721,000, respectively. Loan O-1 is secured by a first lien on a nonresidential retail strip center. The borrower is a limited liability company and the two co-borrowers are the principals of the limited liability company. At June 30, 2017 and June 30, 2016, Loan O-1 is included in the table as “Nonaccrual, Nonresidential Real Estate” and “Accruing Restructured Loans”, respectively. At June 30, 2017 and June 30, 2016, Loan O-1 was classified as “Nonresidential Real Estate, Substandard” in the “Credit Risk Profile by Internally Assigned Grade” table. As of September 30, 2011, Loan O-1 was put on accrual because of its sufficient payment history, but was still considered a TDR and thus continued to be classified as substandard. However, after the December 31, 2016 quarterly impairment analysis was completed, it was determined that an impairment of $175,000 was needed, and an impairment in the amount of $175,000 was established through a charge-off to the general allowance. Therefore, this loan was put back on nonaccrual and remained classified as substandard and continued to be reported as a TDR. In the December 31, 2016 quarter the other loan in this relationship, Loan O-2, was paid in full with no loss experienced by the Bank. At June 30, 2017 and June 30, 2016, the balance of Loan O-2 was $0 and $890,000, respectively. When the balloon payment for Loan O-1 became due in the March 2017 quarter, the co-borrowers did not sell the property, nor did they refinance the loan with another lender. Therefore, subsequent to the end of the March 31, 2017 quarter, the Bank filed a complaint for foreclosure. The legal process continued through the June 30, 2017 quarter, and continues subsequent to the June 30, 2017 quarter. Also, subsequent to June 30, 2017, the borrower has made two payments. An impairment analysis was performed at June 30, 2017, and no further impairment was required. However, Loan O-1 was not performing in accordance with its terms at June 30, 2017. A more detailed history of the Note A loan (Loan O-1) and the Note B loan follows.

 

In June 2006, Loan O-1 was originated and comprised of one loan for $1.1 million. In the June 2010 quarter, the co-borrowers approached the Bank and advised that the anchor tenant was vacating the retail strip center. Independent appraisals were ordered and received, and reflected the value of the property had decreased to a value of $900,000 from the value of $1.4 million in June 2006. A specific valuation allowance was established for $360,000 to reduce the net carrying value down to $720,000, or 80% loan to value. In the March 2011 quarter, the co-borrowers again approached the Bank and advised that even though they had been able to replace the anchor tenant, the lease amount that they were receiving was 20% less than the previous tenant. A new appraisal was ordered and received in the March 2011 quarter, and reflected the value of the property had decreased to a value of $828,000 from the value of $900,000 in June 2010. The Bank reviewed the present value of future cash flow of this property and the one loan was restructured using the Note A/B split note strategy. Based on the present value of future cash flow of the property, the Note A loan (Loan O-1) was for $810,000, with a below market rate of interest of 2%, for a 30 year term, and a two year balloon payment. The carrying value of the Loan O-1 continued on nonaccrual and a classification of substandard, but was also reported as a TDR. The Note B loan was for $360,000 (inclusive of the $360,000 specific valuation allowance established in June 2010) and was charged-off. In September 2011, because there were six consecutive payments made and the cash flow of the property from updated financial information indicated that the debt service coverage ratio was adequate, the loan was placed on accrual. However, because of the below market interest rate, an impairment of $28,750 was established. During the March 2013 quarter, the balloon payment from the March 2011 loan became due. As a result of the upcoming balloon payment, the Bank ordered and received a new appraisal on the property. The new appraisal dated March 2013 showed a value of $825,000, a decrease of $3,000 from the value of $828,000 in the March 2011 quarter. The Bank reviewed the present value of the future cash flow of this property from updated financial information of the borrower and co-borrowers. After this review, the Bank extended the two loans, again using the Note A/B split note strategy, with both loans having three year balloon payments. The loan amount for the Note A loan (Loan O-1) was decreased to $761,000. The Note A loan (Loan O-1) was renewed at a market rate of interest of 5.5%, for a 30 year term, and a three year balloon payment. This loan was placed on accrual (because of its sufficient payment history). However, the classification remained substandard and the loan was still reported as a TDR. Also, because this loan now had a market rate of interest, the impairment amount of $28,750 was removed. The Note B loan was for $376,000 (inclusive of the $366,000 charge-off from March 2011) and was charged-off. During the March 31, 2016 quarter, the balloon payment from the March 2013 loan became due. As a result of the upcoming balloon payment, the Bank ordered and received a new appraisal on the property. The new appraisal dated February 2016 showed a value of $870,000, an increase of $45,000 from the value of $825,000 in the March 2013 quarter. The Bank reviewed the present value of the future cash flow of this property from updated financial information of the borrower and co-borrowers. After this review, the Bank extended the two loans, again using the Note A/B split note strategy, with both loans having a one year balloon payment. At this time, the Bank advised the co-borrowers that there would be no further renewal of the loan. The loan amount for the Note A loan (Loan O-1) had decreased to $723,000. The Note A loan (Loan O-1) was renewed at a market rate of interest of 5.5%, for a 27 year term, and a one year balloon payment. This loan was placed on accrual because of its sufficient payment history. However, the classification remained substandard and the loan was still reported as TDR. There was no increase in the principal balance ($376,000) of the Note B loan from that loan’s prior restructuring in March 2013, and therefore, the charge-off amount ($376,000) remained the same as in March 2013. The interest rate remained at 0%, as the loan had been charged-off.

 

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  Loan Relationship R. At June 30, 2017 and June 30, 2016, Loan Relationship R was comprised of one loan, having a carrying value of $586,000 and $890,000, respectively. This loan is, and has always been, an interest only loan. This loan is secured by 48.54 acres of land, of which 12.54 acres is in the right of way of an Ohio highway, and is located in southwestern Ohio. The borrower is a “subchapter S” Corporation. The co-borrowers, who were individually signed, were originally a husband and wife who were 100% owners of the corporation. The husband passed away in 2015; the wife is the only remaining borrower, still individually signed, and owns 100% of the corporation. At June 30, 2017, the Loan R carrying value is included in the table for “Nonaccrual, Land”, and at June 30, 2016, the carrying value of Loan R was not included in the table for “Nonaccrual, Land”. In the “Credit Risk Profile by Internally Assigned Grade” table, Loan R is classified as substandard at June 30, 2017, and as special mention at June 30, 2016. An impairment analysis was performed at June 30, 2017, and no further impairment was required.

 

Loan R is performing in accordance with its renewed terms at March 31, 2017. A more detailed history of Loan Relationship R follows.

 

The land was purchased by the co-borrowers in 1997 as an investment for future development. The Bank originated Loan R on the land in November 2003. Since the Bank made the original loan in 2003, this loan has been renewed three times. The loan was set to renew again in March 2017. The Bank ordered an appraisal during the March 2017 quarter. The Bank also analyzed the cash flow and the liquid assets of the remaining co-borrower. After this analysis, the Bank ordered an appraisal based on the market value and the liquidation value of the property. The market value of the property was $1,940,000 and the liquidation value of the property was $1,070,000. Because of the results of the financial analysis performed on the co-borrower, and the fact that the property had not been sold, the Bank completed an impairment analysis of the property using the liquidation value. After the impairment analysis was completed, it was determined that an impairment of $255,000 was needed. An impairment in the amount of $255,000 was established through a charge-off to the general allowance. The remaining balance of $601,000 was put on nonaccrual as stated above. This loan was renewed in March 2017, but only for one year (new maturity date is March 2018). The borrower has confirmed her intent to have the property sold by the date. If the property is not sold by this date, the Bank will review all of the options available to it, including foreclosure action.

 

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The following table summarizes all Note A/B format loans at June 30, 2017 and 2016:

 

At June 30, 2017

 

Loan Balances

  

Number of Loans

 
  

Note A

  

Note B

  

Total

  

Note A

  

Note B

 
   (Dollars in thousands) 
Non-Residential real estate  $886   $482   $1,368    2    2 
Multi-family residential real estate   1,083    920    2,003    2    2 
One- to four-family residential real estate   84    20    104    1    1 
                          
Total (1)  $2,053   $1,422   $3,475    5    5 

 

At June 30, 2016

 

Loan Balances

  

Number of Loans

 
  

Note A

  

Note B

  

Total

  

Note A

  

Note B

 
   (Dollars in thousands) 
Non-Residential real estate  $1,078   $482   $1,560    2    2 
Multi-family residential real estate   1,109    920    2,029    2    2 
One- to four-family residential real estate   89    20    109    1    1 
                          
Total  $2,276   $1,422   $3,698    5    5 

 

(1) Included in this total are an aggregate of $1.6 million comprised of Note As and $1.3 million comprised of Note Bs that are included in the discussion of Loan Relationships F, H, and O.

 

Primarily based on an assessment of our loans receivable greater than 30 days past due and accruing in the multi-family residential real estate and nonresidential real estate portfolios of $0 at June 30, 2017, management does not believe there are any other large concentrations of credit risk that are not performing under the original terms or modified terms, as applicable.

 

The following tables provide information with respect to all of our loans that are classified as troubled debt restructurings. Troubled debt restructurings are considered to be impaired, except for those that have established a sufficient performance history under the terms for the restructured loan. For additional information regarding troubled debt restructurings on nonaccrual status, see the table of nonperforming assets above.

 

   At June 30, 2017 
   Loan Status   Total Unpaid
Principal
   Related   Recorded 
   Accrual