PART I

 

ITEM 1.          Business

 

Forward Looking Statements

 

This Report contains certain “forward-looking statements” which may be identified by the use of words such as “believe,” “project,” “intend,” “plans,” “seek,” “will,” “would,” “may,” “expect,” “anticipate,” “should,” “planned,” “estimated” and “potential.” These forward-looking statements include, but are not limited to:

 

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statements of our goals, intentions and expectations;

 

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

 

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

 

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estimates of our risks and future costs and benefits.

 

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

 

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

 

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

	●	severe weather, natural disasters and other external events such as tsunamis, hurricanes, fires and earthquakes;
	●	competition among depository and other financial institutions;

 

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

 

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adverse changes in the securities or secondary mortgage markets;

 

	●	changes in laws or government regulations or policies affecting financial institutions, as well as the impact of laws and regulations, including changes in regulatory fees and capital requirements;
	●	changes in monetary or fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board;
	●	our ability to manage operations in current economic conditions;

 

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our ability to manage market risk, credit risk, liquidity and operational risk;

 

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

 

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our ability to implement changes in our business strategies;

 

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

 

 

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changes in consumer demand, borrowing and savings habits;

 

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our ability to access cost-effective funding;

 

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

 

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changes in the level of government support for housing finance;

 

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

 

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

 

	●	demand for loans and deposits in our market area;
	●	cyber-attacks, computer viruses and other technological risks that may breach the security of our websites or other systems to obtain unauthorized access to confidential information and destroy data or disable our systems;
	●	technological changes that may be more difficult or expensive than expected;

 

	●	the ability of third-party providers to perform their obligations to us;
	●	the ability of the U.S. Government to manage federal debt limits;

 

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our ability to attract and retain key employees;

 

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changes in our organization, compensation and benefit plans; and

 

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

 

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

 

 

Bancorp 34, Inc.

 

Bancorp 34, Inc. (the “Company”), a Maryland corporation that was organized in 2016, is a savings and loan holding company headquartered in Alamogordo, New Mexico. Bancorp 34, Inc.’s common stock is quoted on NASDAQ under the symbol “BCTF.” Bancorp 34, Inc. conducts its operations primarily through its wholly owned subsidiary, Bank 34, a federally chartered savings association. Bancorp 34, Inc. manages its operations as one unit, and thus does not have separate operating segments. At December 31, 2017, Bancorp 34, Inc. had total assets of $336.2 million, loans held for investment of $261.0 million, available-for-sale securities of $24.4 million, deposits of $235.6 million, and stockholders’ equity of $51.0 million.

 

The Company was formed to be the successor to Alamogordo Financial Corp. upon completion of the second step mutual-to-stock conversion (the “Conversion”) of AF Mutual Holding Company (the “MHC”), the top tier mutual holding company of Alamogordo Financial Corp. Alamogordo Financial Corp. was the former mid-tier holding company for Bank 34. Prior to completion of the Conversion, approximately 54.7% of the shares of common stock of Alamogordo Financial Corp. were owned by the MHC. In conjunction with the Conversion, the MHC and Alamogordo Financial Corp. merged into the Company. The Conversion was completed on October 11, 2016. The Company sold a total of 1,879,484 shares of common stock at $10.00 per share in the second-step offering. Concurrent with the completion of the stock offering, each share of Alamogordo Financial Corp. stock owned by public stockholders (stockholders other than the MHC) was exchanged for 2.0473 shares of Company common stock. The Conversion was accounted for as a capital raising transaction by entities under common control. The historical financial results of the MHC are immaterial to the results of the Company and therefore the net assets of the MHC have been reflected as an increase to stockholders’ equity.

 

As a result of the Conversion, all share and per share information for periods prior to October 11, 2016 has been revised to reflect the 2.0473-to-one exchange ratio. Such revised financial information presented in this Form 10-K is derived from the consolidated financial statements of Alamogordo Financial Corp. and its subsidiaries.

 

The executive offices of Bancorp 34, Inc. are located at 500 East 10th Street, Alamogordo, New Mexico 88310, and its telephone number is (575) 437-9334. Bancorp 34, Inc. is subject to comprehensive regulation and examination by the Board of Governors of the Federal Reserve System.

 

Bank 34

 

Bank 34 operates four full-service banking centers, one each in Otero and Dona Ana counties in New Mexico and two in Maricopa County, Arizona. Bank 34’s New Mexico offices include the main office and corporate headquarters located in Alamogordo and a branch office in Las Cruces. The Bank’s Arizona branch offices include the regional headquarters located in Scottsdale and a branch office in Peoria. Bank 34 also operates ten residential mortgage loan production offices, one each in El Paso, Texas, Phoenix, Arizona, Yuma, Arizona, Albuquerque, New Mexico, Rio Rancho, New Mexico, Tubac, Arizona, Medford, Oregon, West Linn, Oregon, Puyallup, Washington, and Lynnwood, Washington.

 

Bank 34’s business model focuses on two primary areas. The commercial focus is on the credit, deposit and treasury management needs of small businesses and real estate professionals and investors. Bank 34 originates conventional, SBA and USDA loans within its primary market areas. Commercial loan types offered include: owner and non-owner occupied real estate (including construction loans), multi-family loans, and commercial and industrial loans. The consumer focus is on residential construction and mortgage loan needs together with deposit, online banking and ancillary financial service needs of families and businesses served by Bank 34. While most of Bank 34’s one- to four-family residential real estate loans are secured by properties in the counties served by its branch offices and its loan production offices, it does actively seek one- to four-family residential real estate loans in other areas of the Southwest and Western United States.

 

Bank 34 originates deposits from its business and consumer customers predominantly from the areas where its branch offices are located. While Bank 34’s savings and loan origins still reflect a relatively high percentage of certificate of deposit balances to total deposits, the recent emphasis on business operating accounts and checking and money market accounts of consumers is consistent with Bank 34’s ongoing migration to a bank business model. 

 

Bank 34 is subject to comprehensive regulation and examination by the Office of the Comptroller of the Currency. Bank 34 is a member of the Federal Home Loan Bank system. Our website address is www.Bank34.com.   Information on our website is not considered a part of this report.

 

 

Business Strategy

 

Our goal is to enhance long-term stockholder and franchise value by executing a safe and sound growth strategy that produces increasing earnings. We have sought to accomplish this objective by implementing a business strategy designed to grow our loan portfolio while maintaining a strong capital position and solid asset quality.

 

Our current business strategy consists of the following:

 

Continued commercial loan growth. Our expansion to the Arizona market with our acquisition of Bank 1440 in August 2014 continues to provide a significant source of new commercial clients to supplement the New Mexico region of our franchise. Our Arizona market has experienced strong population and job growth, contributing to favorable economic conditions for generating new commercial loans. Our commercial real estate loans are generally secured by properties used for business purposes such as hotels, office buildings and industrial and retail facilities. In all of our markets, we seek commercial loan customers (both commercial real estate and commercial and industrial) with whom we can establish multiple lending relationships and provide other services, such as business checking accounts. We target new commercial real estate loan originations to experienced, growing small- and mid-size owners and investors in our market area. In addition to commercial real estate loans, we originate multi-family real estate loans to experienced, growing small- and mid-size owners and investors in our market areas. Our multi-family real estate loans are generally secured by properties consisting of five to 40 rental units.

 

We grew commercial real estate loans (including multi-family real estate loans) and commercial and industrial loans 11% in 2017 and 31% in 2016. Commercial loan growth in the Arizona region has outpaced New Mexico and represented 61% and 100% of growth in 2017 and 2016, respectively. Commercial loans in our Arizona region represented 69% and 70% of our total commercial loans outstanding as of December 31, 2017 and 2016, respectively. Commercial real estate and commercial and industrial loans totaled 86.7% of our loan portfolio at December 31, 2017 compared to 84.0% at December 31, 2016.

 

In addition, we continue to seek and originate SBA credits and we are actively pursuing other government-sponsored loan programs, such as those offered through the USDA, as a way to generate government-guaranteed loans with the opportunity to sell the guaranteed portion of the loan at a premium and retain the non- guaranteed portion as well as the servicing rights. We sold $11.7 million and $10.6 million SBA and USDA loans in the secondary market during the years ended December 31, 2017 and 2016, respectively, recognizing gains of $1.0 million and $839,000 directly into income during those periods. We also intend to build on our experience of selectively pursuing construction lending to established builders with proven track records.

 

Continued expansion of our mortgage banking footprint and corresponding areas of operational strength.  We sold $252.8 million of mortgage loans during the year ended December 31, 2017, generating $10.4 million in noninterest income and sold $259.4 million of mortgage loans during the year ended December 31, 2016, generating $9.8 million in noninterest income. We continue to add experienced mortgage lending personnel, consistent with recent and future growth opportunities, to further leverage our overall scalable business model. In February 2016, we expanded our physical mortgage origination footprint to Lynnwood and Puyallup, Washington, Medford, Oregon and Tucson, Arizona (subsequently moved to Tubac, Arizona), with loan production offices and established mortgage origination teams in each market area. We conducted similar expansion to West Linn, Oregon, Rio Rancho, New Mexico, and Yuma, Arizona in 2017. Subject to market conditions, and particularly changes in the interest rate environment, we intend to continue to grow our mortgage banking business. Such growth may occur through regional expansion, online origination, or both. We seek experienced lending teams in attractive market areas. We believe we have managed our mortgage banking operations to provide cost-management flexibility in the event of unfavorable economic conditions or increases in market interest rates.

 

 

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Disciplined expansion through organic growth and opportunistic bank or branch acquisitions. We completed our acquisition of Bank 1440 in August 2014. While we expect organic growth will be our primary strategic focus, we will also consider acquisition opportunities that we believe would enhance the value of our franchise and yield potential financial benefits for our stockholders. We may also open additional loan production offices that focus on mortgage banking and/or commercial lending, which would add to our existing loan production offices in the states of Arizona, New Mexico, Oregon, Texas and Washington.

 

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Manage credit risk to maintain a low level of nonperforming assets. We believe strong asset quality is a key to our long-term financial success, and we have maintained this focus through our acquisition of Bank 1440 and our subsequent increase in commercial lending during 2015, 2016 and 2017. Our strategy for credit risk management focuses on having a very experienced team of credit professionals, well-defined policies and procedures, appropriate loan underwriting criteria and active credit monitoring. Our nonperforming assets to total assets ratio was 1.62% as of December 31, 2017, 1.81% as of December 31, 2016 and 0.79% as of December 31, 2015. Over 50% of our nonperforming assets as of December 31, 2017 are covered by government guarantees.

 

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Increase core deposits, with emphasis on low cost commercial demand deposits. We seek core deposits to provide a stable source of funds for loan growth, at costs consistent with improving our interest rate spread and profitability. Core deposits also help us maintain loan-to-deposit ratios at levels consistent with regulatory expectations. We consider our core deposits to include demand deposits, negotiable orders of withdrawal (NOW) and automatic transfer service accounts, money market deposit accounts, other savings deposits, and certificates of deposit under $250,000, excluding wholesale and brokered deposits. As part of our focus on commercial loan growth, our lenders are expected to source business checking accounts from our borrowers. Noninterest bearing deposits increased to $37.5 million at December 31, 2017, or 15.9% of deposits, compared to $36.4 million at December 31, 2016, or 16.2% of deposits.

  

Competition

 

We face significant competition in originating loans and attracting deposits. Our primary market area and other areas in which we operate have a high concentration of financial institutions, many of which are significantly larger institutions that have greater financial resources than we have, and many of which are our competitors to varying degrees. Our competition for loans and leases comes principally from commercial banks, savings banks, mortgage banking companies, the U.S. Government, credit unions, leasing companies, insurance companies, real estate conduits and other companies that provide financial services to businesses and individuals. Our most direct competition for deposits has historically come from commercial banks, savings banks and credit unions. We face additional competition for deposits from online financial institutions and non-depository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies.

 

We seek to meet this competition by emphasizing personalized service and efficient decision-making tailored to individual needs. In addition, we reward long-standing relationships with preferred rates and terms on deposit products based on existing and prospective lending business. We do not rely on any individual, group or entity for a material portion of our loans or deposits.

 

 

As of June 30, 2017 (the latest date for which information is available), Bank 34’s deposit market share was 13.86% of total deposits in Otero County, New Mexico, representing the third largest market share of ten institutions in Otero County; 1.89% of total deposits in Dona Ana County, New Mexico, representing the 13th largest market share of 18 institutions in Dona Ana County; and 0.13% of total deposits in Maricopa County, Arizona, representing the 38th largest market share of 59 institutions in Maricopa County.

 

Market Area 

 

Bank 34 operates four full-service banking centers, one each in Otero and Dona Ana counties in New Mexico and two in Maricopa County, Arizona. Bank 34 also operates ten residential mortgage and commercial loan production offices, one each in El Paso, Texas, Phoenix, Arizona, Yuma, Arizona, Albuquerque, New Mexico, Rio Rancho, New Mexico, Tubac, Arizona, Medford, Oregon, West Linn, Oregon, Puyallup, Washington, and Lynnwood, Washington.

 

Arizona. Arizona’s real GDP growth from the second quarter of 2016 to the second quarter of 2017 was 3.0%. The economy has diversified from a population driven model and has attracted higher value-added industries since the end of the Great Recession. The Phoenix MSA is now one of the nation’s fastest growing metropolitan areas. The combination of new residents and an aging baby boomer cohort is pushing demand for health care, construction, restaurants, and retailing. Tourism is robust as there was a 3.6% gain in leisure and hospitality employment in 2016. It is anticipated that Arizona’s economy will continue with solid growth and driven by a mix of new and long established drivers. In February 2017, Intel announced it intends to invest $7 billion in its Chandler, Arizona facility with expected employment of 2,000 workers. Arizona remains one of the faster growth states in the nation. The cities of Gilbert, Scottsdale, and Chandler are considered to be top retirement destinations. Home sales have increased 35% since the recession of 2008 and in 2016 existing home sales increased 3.5% and new home sales improved 16%. Arizona’s home prices, in comparison to other western states, are still considered very affordable.

 

New Mexico. Southern New Mexico’s unemployment as of September 2017 was 6.5% as compared to 6.2% for the State. Employment growth was stable but flat due to the impact of government spending decreases. Dona Ana County’s home sales increased 1.3% in the third quarter of 2017 and the median home price is up 4.7% from the previous year. The Santa Teresa port of entry has had a major positive impact as total trade now exceeds $12 billion per month. Commodity prices for oil, potash, and copper have risen and has helped stabilize the Southern New Mexico economy. New Mexico’s total population has only grown by 45,000 people since the 2010 census. The University of New Mexico estimates that the State has had heavy migration out coupled with an aging population and fewer births. The migration out has been in the younger and educated cohort as they seek opportunities elsewhere. Increases in population, however, have been in Bernalillo, Dona Ana, and Otero counties where the Bank has its presence. 

 

 

Lending Activities  

 

At December 31, 2017, our gross loans held for investment consisted of $214.9 million, or 82.0%, commercial real estate loans (including multi-family); $29.1 million, or 11.1%, one- to four-family residential real estate loans; $12.3 million, or 4.7%, commercial and industrial loans, and $5.7 million, or 2.2%, consumer and other loans. At December 31, 2017, commercial real estate and multi-family loans included construction loans of $14.7 million. We currently sell a significant majority of our originated residential mortgage loans in the secondary market. Our residential mortgage loans held for sale portfolio totaled $15.4 million at December 31, 2017.

 

Commercial Real Estate Loans. At December 31, 2017, commercial real estate loans were $214.9 million, or 82.0%, of our total gross loans held for investment. This amount includes $41.6 million of multi-family residential real estate loans which are described below. Our commercial real estate loans are generally secured by properties used for business purposes such as office buildings, industrial and retail facilities. At December 31, 2017, $39.8 million of our commercial real estate portfolio was owner occupied commercial real estate, and $175.0 million was secured by income producing, or non-owner occupied commercial real estate. We currently target new commercial real estate loan originations to experienced, growing small- and mid-size owners and investors in our market area. The average outstanding loan in our commercial real estate portfolio was $614,000 as of December 31, 2017, although we originate commercial real estate loans with balances significantly larger than this average. At December 31, 2017, our ten largest commercial real estate loans had an average balance of $3.5 million.

 

We focus our commercial real estate lending on properties within our primary market areas, but we will originate commercial real estate loans on properties located outside this area based on an established relationship with a strong borrower. We intend to continue to grow our commercial real estate loan portfolio while maintaining prudent underwriting standards.

 

We originate a variety of fixed and adjustable rate commercial real estate loans with terms and amortization periods generally up to 25 years, although our commercial real estate loans generally have balloon terms. Interest rates and payments on our adjustable rate loans generally adjust daily and generally are indexed to the prime rate as published in The Wall Street Journal, plus a margin. We generally include pre-payment penalties on commercial real estate loans we originate. Commercial real estate loan amounts generally do not exceed 75% to 80% of the property’s appraised value at the time the loan is originated. Aggregate debt service ratios, including the guarantor’s cash flow and the borrower’s other projects, have a guideline minimum income to debt service ratio of 1.30x. For commercial real estate loans in excess of $250,000, we require independent appraisals from an approved appraisers list. For such loans below $250,000, we require formal evaluations but do not require an independent appraisal. We require commercial real estate loan borrowers with loan relationships in excess of $100,000 to submit annual financial statements and/or rent rolls on the subject property. We may request such information for smaller loans on a case-by-case basis. Commercial real estate properties may also be subject to annual inspections with pictures as evidence appropriate maintenance is being performed by the owner/borrower. The loan and its borrowers and/or guarantors are subject to an annual loan review verifying the loan is properly risk rated based upon covenant compliance and other terms as provided for in the loan agreements. While this process does not prevent loans from becoming delinquent, it provides us with the opportunity to better identify problem loans in a timely manner and to work with the borrower.

 

Our three largest commercial real estate loans at December 31, 2017 included a $4.7 million Montessori school loan originated May 2016 and increased April 2017, a $4.4 million retail strip center and restaurant building loan originated March 2017 and a $3.6 million hotel loan originated in May 2014. The collateral securing these loans is all located in our primary lending areas. At December 31, 2017, all of these loans were performing in accordance with their terms.

 

 

Multi-Family Real Estate Loans. At December 31, 2017, multi-family real estate loans were $41.6 million, or 15.9%, of our total loan portfolio. We originate individual multi-family real estate loans to experienced, growing small- and mid-size owners and investors in our market areas. Our multi-family real estate loans are generally secured by properties consisting of five to 40 rental units. The average outstanding loan size in our multi-family real estate portfolio was $831,000 as of December 31, 2017. We generally do not make multi-family real estate loans outside our primary market areas.

 

We originate a variety of fixed and adjustable rate multi-family real estate loans with balloon and amortization terms up to 30 years. Interest rates and payments on our adjustable rate loans generally adjust daily and generally are indexed to the prime rate as published in The Wall Street Journal, plus a margin. We generally include pre-payment penalties on these types of loans. Multi-family real estate loan amounts generally do not exceed 65% to 70% of the property’s appraised value at the time the loan is originated. Aggregate debt service ratios, including the guarantor’s cash flow and the borrower’s other projects, have a guideline minimum income to debt service ratio of 1.30x. We require multi-family real estate loan borrowers with loan relationships in excess of $100,000 to submit annual financial statements and/or rent rolls on the subject property. We may request such information for smaller loans on a case-by-case basis. These properties may also be subject to annual inspections with pictures as evidence appropriate maintenance is being performed.

 

Our largest multi-family real estate loan at December 31, 2017 totaled $3.2 million, was originated in October 2016 and is secured by 59 units out of an 84-unit complex. At December 31, 2017, this loan was performing in accordance with its terms.

 

Commercial and Industrial Loans. We make commercial and industrial loans, primarily in our market area, to a variety of professionals, sole proprietorships and small businesses. These loans are generally secured by business assets, and we may support this collateral with junior liens on real property. At December 31, 2017, commercial and industrial loans were $12.3 million, or 4.7% of our total loan portfolio. As part of our relationship driven focus, we encourage our commercial borrowers to maintain their primary deposit accounts with us, which enhances our interest rate spread and profitability.

 

Commercial lending products include term loans and revolving lines of credit. Commercial loans and lines of credit are made with either adjustable or fixed rates of interest. Adjustable rates and fixed rates are based on the prime rate as published in The Wall Street Journal, plus a margin. We are focusing our efforts on experienced, growing small- to medium-sized, privately-held companies with solid historical and projected cash flow that operate in our market areas.

 

When making commercial and industrial loans, we consider the financial statements of the borrower, our lending history with the borrower, the debt service capabilities and global cash flows of the borrower and other guarantors, the projected cash flows of the business and the value of the collateral, accounts receivable, inventory and equipment. Depending on the collateral used to secure the loans, commercial and industrial loans are made in amounts of up to 80% of the value of the collateral securing the loan. All of these loans are secured by assets of the respective borrowers.

 

A portion of our commercial and industrial loans are guaranteed by the SBA through the SBA 7(a) loan program. The SBA 7(a) loan program supports, through a U.S. Government guarantee, some portion of the traditional commercial loan underwriting that might not be fully covered absent the guarantee. A typical example would be a business acquiring another business, where the value purchased is an enterprise value (as opposed to tangible assets), which results in a collateral shortfall under traditional loan underwriting requirements. In addition, SBA 7(a) loans, through term loans, can provide a good source of permanent working capital for growing companies.

 

Our largest commercial and industrial loan at December 31, 2017 was a $5.0 million revolving line of credit originated in May 2015 with a $2.3 million outstanding balance. This loan is to an election printing-solutions company and is secured by a first lien on all business assets held by the company.

 

 

Construction and Land Development Loans. At December 31, 2017, construction and land development loans were $20.9 million, or 8.0% of our total loan portfolio, consisting of $14.7 million of commercial and multi-family real estate loans, $4.5 million of residential land or development loans and $1.7 million of consumer one- to four-family residential loans. At December 31, 2017, none of our consumer one- to four-family residential construction loans and $11.9 million of our commercial and multi-family real estate construction loans are expected to convert to permanent loans upon completion of the construction phase. The majority of the balance of these loans is secured by properties located in our primary lending area.

 

We primarily make construction loans for commercial development projects, including hotels, small industrial, retail, office and apartment buildings. Most of our construction loans are interest-only loans that provide for the payment of interest during the construction phase, which is usually up to 12 to 24 months. At the end of the construction phase, the loan may convert to a permanent mortgage loan or the loan may be paid in full. Construction loans generally can be made with a maximum loan-to-value ratio of 80% of the estimated appraised market value upon completion of the project. Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser for loans in excess of $250,000. We also generally require inspections of the property before disbursements of funds during the term of the construction loan.

 

We also originate construction and land development loans to contractors and builders to finance the construction of single-family homes and subdivisions. While we may originate these loans whether or not the collateral property underlying the loan is under contract for sale, we consider each project carefully in light of current residential real estate market conditions. We actively monitor the number of unsold homes in our construction loan portfolio and local housing markets to attempt to maintain an appropriate balance between home sales and new loan originations.  We generally will limit the maximum number of speculative units (units that are not pre-sold) approved for each builder. We have attempted to diversify the risk associated with speculative construction lending by doing business with experienced small and mid-sized builders within our market area.

 

Our largest construction loan at December 31, 2017 totaled $2.5 million, was originated in June 2017 and is secured by a hotel located in our primary market area. At December 31, 2017, this loan was performing in accordance with its terms.

 

One- to Four-Family Residential Real Estate Loans. Our one- to four-family residential real estate loan portfolio consists of mortgage loans that enable borrowers to purchase or refinance existing homes, most of which serve as the primary residence of the owner. At December 31, 2017, $29.1 million, or 11.1% of our loan portfolio, consisted of one- to four-family residential real estate loans.

 

One- to four-family residential real estate loans are generally originated with the intention of sale. By selling a large majority of the one- to four-family residential real estate loans originated through its mortgage banking operations for the past several years, the Company has been reducing the balance of those loans on the balance sheet and the percentage of residential real estate loans to total loans. This has helped diversify the portfolio and increase the relative share of shorter term fixed rate and adjustable rate commercial and commercial real estate loans.

 

Generally, one- to four-family residential real estate loans are originated in amounts up to 80% of the lesser of the appraised value or purchase price of the property, with private mortgage insurance required on loans with a loan-to-value ratio in excess of 80%. We will not make loans with a loan-to-value ratio in excess of 100% for loans secured by single family homes. Fixed rate one- to four-family residential real estate loans generally are originated for terms of 10 to 30 years. Generally, all fixed rate one- to four-family residential real estate loans are underwritten according to Freddie Mac, FHA, VA, USDA and correspondent investors policies and procedures.

 

In an effort to provide financing for moderate income home buyers, we offer VA, FHA and bond loans specific to the states where we conduct business. These programs offer one- to four-family residential real estate loans to qualified individuals. These loans are offered with fixed rates of interest and terms of up to 30 years, and are secured by one- to four-family residential properties. All of these loans are originated using agency underwriting guidelines.

 

 

We also offer adjustable rate mortgage loans for one- to four-family properties, with an interest rate based on the one-year Constant Maturity Treasury Bill Index, which adjusts annually from the outset of the loan or which adjusts annually after a three-, five-, seven-, or ten-year initial fixed rate period. We originated $8.3 million of adjustable rate one-to four-family residential loans during the year ended December 31, 2017, of which $6.2 million was sold in the secondary market. Our adjustable rate mortgage loans generally provide for maximum rate adjustments of 2% per adjustment, with a lifetime maximum adjustment up to 6% above the initial rate, regardless of the initial rate. Our adjustable rate one- to four-family residential real estate loans amortize over terms of up to 30 years.

 

Regulations limit the amount that an institution may lend relative to the appraised value of the real estate securing the loan, as determined by an appraisal of the property at the time the loan is originated. All borrowers are required to obtain title insurance. We also require homeowner’s insurance and fire and casualty insurance and, where circumstances warrant, flood insurance, on properties securing real estate loans. At December 31, 2017, our largest one- to four-family residential real estate loan had a principal balance of $547,000 and was secured by a residence located in New Mexico. At December 31, 2017, this loan was performing in accordance with its original terms.

 

Consumer and Other Loans. We offer a limited range of consumer and other loans, principally to customers with other relationships residing in our primary market area with acceptable credit ratings. Our consumer and other loans generally consist of home equity loans or lines of credit, loans secured by deposit accounts, loans on new and used automobiles and unsecured personal loans. At December 31, 2017, consumer loans were $5.7 million, or 2.2% of total loans. The underwriting standards utilized for home equity lines of credit include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan. The loan-to-value ratio for a home equity line of credit is generally limited to 75%. The procedures for underwriting other consumer loans include an assessment of the applicant’s payment history on other debts and ability to meet existing obligations plus payments on the proposed loan.

 

Loan Underwriting Risks

 

Commercial and Multi-Family Real Estate Loans. Loans secured by commercial and multi-family real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential real estate loans. Of primary concern in commercial and multi-family real estate lending is the borrower’s creditworthiness and the feasibility and cash flow potential 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 residential real estate loans, to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, we require borrowers and loan guarantors to provide annual financial statements on commercial and multi-family real estate loans. In reaching a decision on whether to make a commercial or multi-family real estate loan, we consider and review a global cash flow analysis of the borrower and consider the net operating income of the property, 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 an aggregate debt service ratio, including the guarantor’s cash flow and the borrower’s other projects, of at least 1.30x. An environmental phase one report is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.

 

If we foreclose on a commercial real estate or multi-family loan, the marketing and liquidation period to convert the real estate asset to cash can be lengthy with substantial holding costs. In addition, vacancies, deferred maintenance, repairs and market stigma can result in prospective buyers expecting sale price concessions to offset their real or perceived economic losses for the time it takes them to return the property to profitability. Depending on the individual circumstances, initial charge-offs and subsequent losses on commercial real estate loans can be unpredictable and substantial.

 

 

Construction and Land Development Loans. Our construction loans are based upon estimates of costs and values associated with the completed project. Underwriting is focused on the borrowers’ financial strength, credit history and demonstrated ability to produce a quality product and effectively market and manage their operations.  

 

Construction lending involves additional risks when compared with permanent lending because funds are advanced upon the security of the project, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. In addition, generally during the term of a construction loan, interest may be funded by the borrower or disbursed from an interest reserve set aside from the construction loan budget. These loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If the appraised value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss.

 

Commercial and Industrial Loans. Unlike residential real estate loans, which generally are made on the basis of the borrower’s ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial and industrial loans are of higher 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 and the collateral securing these loans may fluctuate in value. Our commercial and industrial loans are originated primarily based on the identified cash flow of the borrower and secondarily on the underlying collateral provided by the borrower. Most often, this collateral consists of real estate, accounts receivable, inventory or equipment. Credit support provided by the borrower for most of these loans and the probability of repayment is based on the liquidation of the pledged collateral and enforcement of a personal guarantee, if any. As a result, the availability of funds for the repayment of commercial and industrial 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.

 

Adjustable Rate Loans. While we anticipate that adjustable rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate loans, an increased monthly payment required of adjustable rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. In a high interest rate environment, the marketability of the underlying collateral may be adversely affected as the value of the underlying collateral decreases. For our adjustable rate one- to four-family real estate loans, upward adjustment of the contractual interest rate is also limited by the maximum periodic and lifetime interest rate adjustments permitted by our loan documents and, therefore, the effectiveness of adjustable rate real estate loans may be limited during periods of rapidly rising interest rates.

 

 

Consumer and Other Loans. Consumer loans may entail greater risk than residential real estate loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly, such as motor vehicles. Repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and a small remaining deficiency often does not warrant further substantial collection efforts against the borrower. Consumer loan collections depend on the borrower’s continuing financial stability, and therefore are likely to be adversely affected by various factors, including job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.

 

Loan Originations, Purchases and Sales

 

Lending activities are conducted primarily by our loan personnel operating at our four full-service banking offices and eight loan origination centers. All loans originated by us are underwritten pursuant to our policies and procedures. We originate both adjustable-rate and fixed-rate loans. Our ability to originate fixed or adjustable-rate loans is dependent upon competition for such loans and the relative customer demand for such loans, which is affected by current and expected future levels of market interest rates.

 

We sell the majority of the one- to four-family residential real estate loans we originate in the secondary market. The mortgage loans that we currently originate for sale include mortgage loans which conform to the underwriting standards specified by Freddie Mac, FHA, VA, USDA and correspondent investors. During the years ended December 31, 2017 and 2016, we originated $254.2 million and $267.1 million of one- to four-family loans and sold $252.8 million and $259.4 million, respectively. We recognize, at the time of sale, the cash gain or loss on the sale of the loans based on the difference between the net cash proceeds received and the carrying value of the loans sold.

 

We participate out interests in commercial real estate loans to other financial institutions, including the guaranteed portions of SBA or USDA loans, the portion of other loans exceeding our borrowing limits and periodically other loans when portfolio growth surges and the balances exceeds target portfolio loan levels. At December 31, 2017, we were servicing $49.6 million of commercial real estate loans where we had participated out an interest to other financial institutions. For the years ended December 31, 2017 and 2016, we participated out loan participations of $20.8 million and $10.6 million, respectively.

 

Loan Approval Procedures and Authority

 

Our lending activities follow written, non-discriminatory, underwriting standards and loan origination procedures established by management and approved by the Board of Directors. The Board of Directors has granted loan approval authority to certain officers up to prescribed limits, depending on the officer’s experience, the type of loan and whether the loan is secured or unsecured. Loans to relationships of $2.0 million and below require approval by members of senior management. Loans to relationships greater than $2.0 million require approval by the Director’s Loan Committee. Loans that involve exceptions to loan policy must be authorized by senior management. Loan policy exceptions are fully disclosed to the approving authority, either an individual officer or the appropriate management or Director’s Loan Committee prior to commitment. Exceptions are reported to the Board of Directors monthly.

 

Loans-to-One Borrower Limit

 

The maximum amount that we may lend to one borrower and the borrower’s related entities is generally limited, by regulation, to 15% of our unimpaired capital and surplus. At December 31, 2017, our regulatory limit on loans-to-one borrower was $6.7 million. At that date, the largest aggregate amount loaned to one borrower was $5.5 million, consisting of various commercial retail and office properties, an operating line of credit and a home equity line of credit. The loans comprising this lending relationship were performing in accordance with their original repayment terms at December 31, 2017.

 

 

Investment Activities

 

Bank 34 has an Asset/Liability Committee which is responsible, among other duties, for implementing the Bank’s Investment Policy. The Investment Policy is reviewed annually and any changes to the policy are recommended to, and subject to the approval of, our board of directors. While general investment strategies are developed and authorized by the Asset/Liability Committee, the execution of specific actions rests with the Chief Financial Officer, who is Bank 34’s designated Investment Officer. In the absence of the Chief Financial Officer, the Chief Executive Officer will be the designated Investment Officer. The Investment Officer is responsible for ensuring that the guidelines and requirements included in the Investment Policy are followed and that all securities are considered prudent for investment. The Investment Officer is authorized to execute investment transactions (purchases and sales) without the prior approval of the Asset/Liability Committee and within the scope of the established investment policy; however, all transactions shall be reviewed and ratified by the Asset/Liability Committee and Board of Directors.

 

Bank 34 utilizes the services of an independent investment advisor to assist in managing the investment portfolio. The investment advisor is responsible for maintaining current information regarding securities dealers with whom they are conducting business on our behalf. A list of appropriate dealers is provided annually to the board of directors for approval and authorization prior to execution of trades. The investment advisor, through its assigned portfolio manager, must contact our designated Investment Officer to review all investment recommendations and transactions and receive approval from the designated Investment Officer prior to execution of any transaction that might be executed on our behalf. Upon receipt of approval, the independent investment advisor, or its assigned portfolio manager, is authorized to conduct all investment business on our behalf.

 

We have legal authority to invest in various types of investment securities and liquid assets, including U.S. Treasury obligations, securities of various government-sponsored enterprises, residential mortgage-backed securities and municipal governments, deposits at the Federal Home Loan Bank of Dallas, certificates of deposit of federally insured institutions, investment grade corporate bonds and investment grade marketable equity securities, including common stock and money market mutual funds. Our equity securities generally pay dividends. We also are required to maintain an investment in Federal Home Loan Bank of Dallas stock, which investment is based on the level of our Federal Home Loan Bank borrowings. We have the authority under applicable law to invest in derivative securities. At December 31, 2017 the Company had $183,000 in fair value of mortgage interest rate lock commitment (“IRLC”) assets and a $16,000 liability to national investment brokers representing the net fair value of forward trade commitments utilized to hedge loans in our mortgage banking pipeline with a notional value of $13.5 million. We had no investments in derivative securities at December 31, 2016.

 

Our investment objectives are to provide and maintain liquidity, to establish an acceptable level of interest rate and credit risk, to provide a use of funds when demand for loans is weak and to generate a favorable return.

 

At December 31, 2017 our investment security portfolio had a fair value of $24.4 million, and consisted primarily of mortgage-backed securities, securities of U.S. Government Agencies and municipal bonds. All investment securities as of December 31, 2017 were classified as available-for-sale. Bonds secured by adjustable rate loans were 8.4% of the total portfolio.

 

Each reporting period, we evaluate all securities with a decline in fair value below the amortized cost to determine whether or not the impairment is deemed to be other-than-temporary. Other-than-temporary impairment is required to be recognized if (1) we intend to sell the security; (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. At December 31, 2017 our investment securities had a fair value of $24.4 million and a net unrealized loss of $308,000. The decline in fair value is attributable to changes in interest rates and liquidity and not credit quality. The Bank does not have the intent to sell these securities before maturity and it is unlikely that it will be required to sell them before their anticipated recovery. Therefore, the Bank does not consider the decline to be other than temporary. No other-than-temporary impairment was recognized for any periods from 2012 through December 31, 2017.

 

 

Mortgage-Backed Securities. We purchase mortgage-backed securities insured or guaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. We invest in mortgage-backed securities to achieve positive interest rate spreads with minimal administrative expense, and lower our credit risk as a result of the guarantees provided by Freddie Mac, Fannie Mae and Ginnie Mae.

 

Mortgage-backed securities are created by the pooling of mortgages and the issuance of a security with an interest rate that is less than the interest rates on the underlying mortgages. Mortgage-backed securities typically represent a participation interest in a pool of single-family or multi-family mortgages, although we focus our investments on mortgage-backed securities backed by one- to four-family mortgages. The issuers of such securities (generally U.S. Government agencies and government-sponsored enterprises, including Fannie Mae, Freddie Mac and Ginnie Mae) pool and resell the participation interests in the form of securities to investors and guarantee the payment of principal and interest to investors. Mortgage-backed securities generally yield less than the loans that underlie such securities because of the cost of payment guarantees and credit enhancements. However, mortgage-backed securities are usually more liquid than individual mortgage loans and may be used to collateralize our specific liabilities and obligations.

 

At December 31, 2017 mortgage-backed securities totaled $20.8 million, or 85.1% of total securities, of which, 10% were backed by adjustable rate mortgage loans and 90% were backed by fixed rate mortgage loans. The mortgage-backed securities portfolio had a weighted average yield of 2.21% at December 31, 2017.

 

Investments in mortgage-backed securities involve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments thereby changing the net yield on such securities. There is also reinvestment risk associated with the cash flows from such securities or if such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected by changes in interest rates.

 

U.S. Government and Government-Sponsored Securities. At December 31, 2017, our U.S. Government and government-sponsored securities portfolio totaled $2.0 million, or 8.0% of total securities. While U.S. Government and government-sponsored securities generally provide lower yields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes, as collateral for borrowings and prepayment protection.

 

Municipal Obligations. At December 31, 2017 our investment in municipal obligations totaled $1.7 million or 6.9% of total securities and 0.5% of total assets. The Bank’s investment in municipal bonds may not exceed 3% of total assets. Municipal obligations generally carry a higher interest rate than U.S. Government obligations but also carry a higher credit risk.

 

Deposit Activities 

 

Our deposit accounts consist principally of certificates of deposit, savings accounts, checking accounts and money market accounts. We provide commercial checking accounts and related services, such as online cash management. We also provide low-cost checking account services.

 

Our deposits are generated mainly from residents and businesses within our primary deposit market area. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and the interest rate.

 

Interest rates, maturity terms, service fees and withdrawal penalties are established on a periodic basis, supported by third party reporting of competitive deposit rates by market. Deposit rates and terms are based primarily on current operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. Personalized customer service and long-standing relationships with customers are relied upon to attract and retain deposits.

 

 

The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates and competition. The variety of deposit accounts offered allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based on experience, we believe that our deposits are relatively stable. However, the ability to attract and maintain deposits and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions which may be significantly impacted by what appears to be an increasing rate environment and associated impact on deposit pricing.

 

At December 31, 2017, our deposits totaled $235.6 million. Interest-bearing deposits totaled $198.1 million and noninterest-bearing deposits totaled $37.5 million. Savings, money market and checking deposits totaled $135.0 million, and certificates of deposit totaled $63.0 million, of which $31.9 million had maturities of one year or less.

 

Subsidiary Activities

 

Bancorp 34, Inc. has no subsidiaries other than Bank 34.

 

Personnel

 

At December 31, 2017, Bank 34 had 144 full-time employees and one part-time employee, none of whom was party to a collective bargaining agreement. Bank 34 believes it has a good working relationship with its employees.

  

TAXATION

 

Bancorp 34 and Bank 34 are subject to federal and state income taxation in the same general manner as other corporations, with some exceptions discussed below. The following discussion of federal and state taxation is intended only to summarize certain pertinent tax matters and is not a comprehensive description of the tax rules applicable to Bancorp 34 or Bank 34.

 

Federal Taxation

 

Federal Tax Reform. On December 22, 2017, President Trump signed into law H.R. 1, commonly known as the Tax Cuts and Jobs Act of 2017 (the “Act”). The Act includes a number of changes in existing tax law impacting businesses including, among other things, a reduction of the federal corporate income tax rate from 34% to 21% effective January 1, 2018. As a result, we were required to re-measure, through income tax expense, our deferred tax assets and liabilities using the enacted rate at which we expect them to be recovered or settled. The re-measurement of our net deferred tax asset resulted in additional income tax expense of $1. 2 million in 2017.

 

Method of Accounting. For federal income tax purposes, Bancorp 34 and Bank 34 currently report their income and expenses on the accrual method of accounting and use a tax year ending December 31 for filing their federal income tax returns.

 

Taxable Distributions and Recapture. Prior to the 1996 Act, bad debt reserves created prior to January 1, 1988 were subject to recapture into taxable income if Bank 34 failed to meet certain thrift asset and definitional tests. Federal legislation has eliminated these thrift-related recapture rules. At December 31, 2017, our total federal pre-1988 base year reserve was approximately $2.7 million, or $689,000 tax-effected. However, under current law, pre-1988 base year reserves remain subject to recapture if Bank 34 makes certain non-dividend distributions, repurchases any of its stock, pays dividends in excess of tax earnings and profits, or ceases to maintain a bank charter.

 

 

Alternative Minimum Tax. Prior to January 1, 2018, the Internal Revenue Code imposed an alternative minimum tax (“AMT”) at a rate of 20% on a base of regular taxable income plus certain tax preferences, which we refer to as “alternative minimum taxable income.” The AMT is payable to the extent such alternative minimum taxable income is in excess of an exemption amount and the AMT exceeded the regular income tax. Net operating losses could offset no more than 90% of alternative minimum taxable income. Certain AMT payments may be used as credits against regular tax liabilities in future years Effective January 1, 2018, the corporate AMT is repealed. At December 31, 2017, the Company had $141,000 of AMT payments available to carry forward to future periods.

 

Net Operating Loss Carryovers. Prior to January 1, 2018, subject to certain limitations, a company could carry back net operating losses to the preceding two taxable years and forward to the succeeding 20 taxable years. For net operating losses generated beginning January 1, 2018, there are no carry backs allowed and an unlimited carry forward period. At December 31, 2017, Bancorp 34 had $4.6 million in net operating loss carry forwards for federal income tax purposes.

 

Corporate Dividends-Received Deduction. Bancorp 34 may exclude from its taxable income 100% of dividends received from Bank 34 as a member of the same affiliated group of corporations. Through December 31, 2017, the corporate dividends-received deduction was 80% in the case of dividends received from a corporation in which a corporate recipient owns at least 20% of its stock, and corporations that owned less than 20% of the stock of a corporation distributing a dividend could deduct only 70% of dividends received or accrued on their behalf. Effective January 1, 2018, the dividends received deduction decreases from 80% to 65% and 70% to 50% for corporate recipients owning at least 20% or less than 20%, respectively, of a corporation’s stock.

 

State Taxation 

 

Bank 34’s full service branches in New Mexico and Arizona, and loan production offices in New Mexico, Arizona, Oregon, Texas and Washington subject Bank 34 to taxation in those states. As a Maryland business corporation, Bancorp 34 is required to file an annual report with and pay franchise taxes to the state of Maryland.

 

 

SUPERVISION AND REGULATION

 

General

 

As a federal savings association, Bank 34 is subject to examination and regulation by the Office of the Comptroller of the Currency, and is also subject to examination by the Federal Deposit Insurance Corporation. The federal system of regulation and supervision establishes a comprehensive framework of activities in which Bank 34 may engage and is intended primarily for the protection of depositors and the Federal Deposit Insurance Corporation’s Deposit Insurance Fund. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engage and is intended primarily for the protection of the Federal Deposit Insurance Corporation’s deposit insurance fund and depositors, and not for the protection of security holders. Bank 34 also is a member of and owns stock in the Federal Home Loan Bank of Dallas, which is one of the 11 regional banks in the Federal Home Loan Bank System.

 

Under this system of regulation, the regulatory authorities have extensive discretion in connection with their supervisory, enforcement, rulemaking and examination activities and policies, including rules or policies that: establish minimum capital levels; restrict the timing and amount of dividend payments; govern the classification of assets; determine the adequacy of loan loss reserves for regulatory purposes; and establish the timing and amounts of assessments and fees. Moreover, as part of their examination authority, the banking regulators assign numerical ratings to banks and savings institutions relating to capital, asset quality, management, liquidity, earnings and other factors. These ratings are inherently subjective and the receipt of a less than satisfactory rating in one or more categories may result in enforcement action by the banking regulators against a financial institution. A less than satisfactory rating may also prevent a financial institution, such as Bank 34 or its holding company, from obtaining necessary regulatory approvals to access the capital markets, pay dividends, acquire other financial institutions or establish new branches.

 

 

In addition, we must comply with significant anti-money laundering and anti-terrorism laws and regulations, Community Reinvestment Act laws and regulations, and fair lending laws and regulations. Government agencies have the authority to impose monetary penalties and other sanctions on institutions that fail to comply with these laws and regulations, which could significantly affect our business activities, including our ability to acquire other financial institutions or expand our branch network.

 

As a savings and loan holding company, Bancorp 34 is required to comply with the rules and regulations of the Federal Reserve Board. It is required to file certain reports with the Federal Reserve Board and is subject to examination by and the enforcement authority of the Federal Reserve Board. Bancorp 34 is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.

 

Any change in applicable laws or regulations, whether by the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Federal Reserve Board, the Securities and Exchange Commission or Congress, could have a material adverse impact on the operations and financial performance of Bancorp 34 and Bank 34.

 

Set forth below is a brief description of material regulatory requirements that are or will be applicable to Bank 34 and Bancorp 34. The description is limited to certain material aspects of the statutes and regulations addressed, and is not intended to be a complete description of such statutes and regulations and their effects on Bank 34 and Bancorp 34.

 

Federal Banking Regulation

 

Business Activities. A federal savings association derives its lending and investment powers from the Home Owners’ Loan Act, as amended, and applicable federal regulations. Under these laws and regulations, Bank 34 may invest in mortgage loans secured by residential and commercial real estate, commercial business and consumer loans, certain types of debt securities and certain other assets, subject to applicable limits. Bank 34 may also establish subsidiaries that may engage in certain activities not otherwise permissible for Bank 34, including real estate investment and securities and insurance brokerage.

 

Capital Requirements. Federal regulations require federally insured depository institutions to meet several minimum capital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-based assets ratio of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. These capital requirements were effective January 1, 2015 and are the result of a final rule implementing recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act.

 

In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets (e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believed inherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. Common equity Tier 1 capital is generally defined as common stockholders’ equity and retained earnings. Tier 1 capital is generally defined as common equity Tier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests in equity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2 capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetual preferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan and lease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that made such an election regarding the treatment of Accumulated Other Comprehensive Income, up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair values. Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations. In assessing an institution’s capital adequacy, the Office of the Comptroller of the Currency takes into consideration not only these numeric factors, but qualitative factors as well, and has the authority to establish higher capital requirements for individual institutions where deemed necessary.

 

 

In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus payments to management if the institution does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital to risk-weighted asset above the amount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at 0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% of risk-weighted assets on January 1, 2019.

 

At December 31, 2017, Bank 34’s capital exceeded all applicable requirements.

 

Loans-to-One Borrower. Generally, a federal savings association may not make a loan or extend credit to a single or related group of borrowers in excess of 15% of unimpaired capital and surplus. An additional amount may be loaned, equal to 10% of unimpaired capital and surplus, if the loan is secured by readily marketable collateral, which generally does not include real estate. As of December 31, 2017, Bank 34 was in compliance with the loans-to-one borrower limitations.

 

Qualified Thrift Lender Test. As a federal savings association, Bank 34 must satisfy the qualified thrift lender, or “QTL,” test. Under the QTL test, Bank 34 must maintain at least 65% of its “portfolio assets” in “qualified thrift investments” (primarily residential mortgages and related investments, including mortgage-backed securities) in at least nine months of every 12-month period. “Portfolio assets” generally means total assets of a savings association, less the sum of specified liquid assets up to 20% of total assets, goodwill and other intangible assets, and the value of property used in the conduct of the savings association’s business.

 

Bank 34 also may satisfy the QTL test by qualifying as a “domestic building and loan association” as defined in the Internal Revenue Code of 1986, as amended. This test generally requires a savings association to have at least 75% of its deposits held by the public and earn at least 25% of its income from loans and U.S. Government obligations. Alternatively, a savings association can satisfy this test by maintaining at least 60% of its assets in cash, real estate loans and U.S. Government or state obligations.

 

A savings association that fails the qualified thrift lender test must operate under specified restrictions set forth in the Home Owners’ Loan Act. The Dodd-Frank Act made noncompliance with the QTL test subject to agency enforcement action for a violation of law. At December 31, 2017, Bank 34 satisfied the QTL test.

 

Capital Distributions. Federal regulations govern capital distributions by a federal savings association, which include cash dividends, stock repurchases and other transactions charged to the savings association’s capital account. A federal savings association must file an application with the Office of the Comptroller of the Currency for approval of a capital distribution if:

 

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the total capital distributions for the applicable calendar year exceed the sum of the savings association’s net income for that year to date plus the savings association’s retained net income for the preceding two years;

 

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the savings association would not be at least adequately capitalized following the distribution;

 

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the distribution would violate any applicable statute, regulation, agreement or regulatory condition; or

 

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the savings association is not eligible for expedited treatment of its filings, generally due to an unsatisfactory CAMELS rating or being subject to a cease and desist order or formal written agreement that requires action to improve the institution’s financial condition.

 

 

Even if an application is not otherwise required, every savings association that is a subsidiary of a savings and loan holding company, such as Bank 34, must still file a notice with the Federal Reserve Board at least 30 days before the board of directors declares a dividend or approves a capital distribution.

 

A notice or application related to a capital distribution may be disapproved if:

 

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the federal savings association would be undercapitalized following the distribution;

 

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the proposed capital distribution raises safety and soundness concerns; or

 

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the capital distribution would violate a prohibition contained in any statute, regulation or agreement.

 

In addition, the Federal Deposit Insurance Act provides that an insured depository institution may not make any capital distribution if, after making such distribution, the institution would fail to meet any applicable regulatory capital requirement. A federal savings association also may not make a capital distribution that would reduce its regulatory capital below the amount required for the liquidation account established in connection with its conversion to stock form.

 

Community Reinvestment Act and Fair Lending Laws. All federal savings associations have a responsibility under the Community Reinvestment Act and related regulations to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a federal savings association, the Office of the Comptroller of the Currency is required to assess the federal savings association’s record of compliance with the Community Reinvestment Act. A savings association’s failure to comply with the provisions of the Community Reinvestment Act could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the Office of the Comptroller of the Currency, as well as other federal regulatory agencies and the Department of Justice.

 

The Community Reinvestment Act requires all institutions insured by the Federal Deposit Insurance Corporation to publicly disclose their rating. Bank 34 received a “satisfactory” Community Reinvestment Act rating in its most recent federal examination.

 

Transactions with Related Parties. A federal savings association’s authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and federal regulation. An affiliate is generally a company that controls, or is under common control with, an insured depository institution such as Bank 34. Bancorp 34 is an affiliate of Bank 34 because of its control of Bank 34. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative limits and collateral requirements. In addition, federal regulations prohibit a savings association from lending to any of its affiliates that are engaged in activities that are not permissible for bank holding companies and from purchasing the securities of any affiliate, other than a subsidiary. Finally, transactions with affiliates must be consistent with safe and sound banking practices, not involve the purchase of low-quality assets and be on terms that are as favorable to the institution as comparable transactions with non-affiliates.

 

Bank 34’s authority to extend credit to its directors, executive officers and 10% stockholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions generally require that extensions of credit to insiders:

 

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be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and

 

 

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not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of Bank 34’s capital.

 

In addition, extensions of credit in excess of certain limits must be approved by Bank 34’s board of directors. Extensions of credit to executive officers are subject to additional limits based on the type of extension involved.

 

Enforcement. The Office of the Comptroller of the Currency has primary enforcement responsibility over federal savings associations and has authority to bring enforcement action against all “institution-affiliated parties,” including directors, officers, stockholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on a federal savings association. Formal enforcement action by the Office of the Comptroller of the Currency may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The Federal Deposit Insurance Corporation also has the authority to terminate deposit insurance or recommend to the Office of the Comptroller of the Currency that enforcement action be taken with respect to a particular savings association. If such action is not taken, the Federal Deposit Insurance Corporation has authority to take the action under specified circumstances.

 

Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.

 

Interstate Banking and Branching. Federal law permits well capitalized and well managed holding companies to acquire banks in any state, subject to Federal Reserve Board approval, certain concentration limits and other specified conditions. Interstate mergers of banks are also authorized, subject to regulatory approval and other specified conditions. In addition, among other things, recent amendments made by the Dodd-Frank Act permit banks to establish de novo branches on an interstate basis provided that branching is authorized by the law of the host state for the banks chartered by that state.

 

Prompt Corrective Action. Federal law requires, among other things, that federal bank regulators take “prompt corrective action” with respect to institutions that do not meet minimum capital requirements. For this purpose, the law establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. The applicable Office of the Comptroller of the Currency regulations were amended to incorporate the previously mentioned increased regulatory capital standards that were effective January 1, 2015. Under the amended regulations, an institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based capital ratio of 8.0% or greater, a leverage ratio of 5.0% or greater and a common equity Tier 1 ratio of 6.5% or greater. An institution is “adequately capitalized” if it has a total risk-based capital ratio of 8.0% or greater, a Tier 1 risk-based capital ratio of 6.0% or greater, a leverage ratio of 4.0% or greater and a common equity Tier 1 ratio of 4.5% or greater. An institution is “undercapitalized” if it has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a leverage ratio of less than 4.0% or a common equity Tier 1 ratio of less than 4.5%. An institution is deemed to be “significantly undercapitalized” if it has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a leverage ratio of less than 3.0% or a common equity Tier 1 ratio of less than 3.0%. An institution is considered to be “critically undercapitalized” if it has a ratio of tangible equity (as defined in the regulations) to total assets that is equal to or less than 2.0%.

 

 

At each successive lower capital category, an insured depository institution is subject to more restrictions and prohibitions, including restrictions on growth, restrictions on interest rates paid on deposits, restrictions or prohibitions on payment of dividends, and restrictions on the acceptance of brokered deposits. Furthermore, if an insured depository institution is classified in one of the undercapitalized categories, it is required to submit a capital restoration plan to the appropriate federal banking agency, and the holding company must guarantee the performance of that plan. Based upon its capital levels, a bank that is classified as well-capitalized, adequately capitalized, or undercapitalized may be treated as though it were in the next lower capital category if the appropriate federal banking agency, after notice and opportunity for hearing, determines that an unsafe or unsound condition, or an unsafe or unsound practice, warrants such treatment. An undercapitalized bank’s compliance with a capital restoration plan is required to be guaranteed by any company that controls the undercapitalized institution in an amount equal to the lesser of 5.0% of the institution’s total assets when deemed undercapitalized or the amount necessary to achieve the status of adequately capitalized. If an “undercapitalized” bank fails to submit an acceptable plan, it is treated as if it is “significantly undercapitalized.” “Significantly undercapitalized” banks must comply with one or more of a number of additional restrictions, including but not limited to a regulatory order to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, ceasing receipt of deposits from correspondent banks, dismissal of directors or officers, and restrictions on interest rates paid on deposits, compensation of executive officers and capital distributions by the parent holding company. “Critically undercapitalized” institutions are subject to additional measures including, subject to a narrow exception, the appointment of a receiver or conservator within 270 days after it obtains such status.

 

At December 31, 2017, Bank 34 met the criteria for being considered “well capitalized.”

 

Insurance of Deposit Accounts. The Deposit Insurance Fund of the Federal Deposit Insurance Corporation insures deposits at Federal Deposit Insurance Corporation insured financial institutions such as Bank 34. Deposit accounts in Bank 34 are insured by the Federal Deposit Insurance Corporation generally up to a maximum of $250,000 per separately insured depositor. The Federal Deposit Insurance Corporation charges insured depository institutions premiums to maintain the Deposit Insurance Fund.

 

Under the Federal Deposit Insurance Corporation’s risk-based assessment system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other risk factors. Rates are based on each institution’s risk category and certain specified risk adjustments. Institutions deemed to be less risky pay lower rates while institutions deemed riskier pay higher rates. Assessment rates (inclusive of possible adjustments) currently range from 2.5 to 45 basis points of each institution’s total assets less tangible capital.

 

Effective July 1, 2016, the Federal Deposit Insurance Corporation adopted changes that eliminated the risk categories. Assessments for most institutions are now based on financial measures and supervisory ratings derived from statistical modeling estimating the probability of failure within three years. In conjunction with the Deposit Insurance Fund reserve ratio achieving 1.5%, the assessment range (inclusive of possible adjustments) was reduced for most banks and savings associations to 1.5 basis points to 30 basis points.

 

The Federal Deposit Insurance Corporation has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of Bank 34. We cannot predict what assessment rates will be in the future.

 

Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the Federal Deposit Insurance Corporation. We do not know of any practice, condition or violation that may lead to termination of our deposit insurance.

 

 

In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (“FICO”) is authorized to impose and collect, with the approval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the 1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For the quarter ended December 31, 2016, the annualized FICO assessment was equal to 0.56 basis points of total assets less tangible capital.

 

Privacy Regulations. Federal regulations generally require that Bank 34 disclose its privacy policy, including identifying with whom it shares a customer’s “non-public personal information,” to customers at the time of establishing the customer relationship and annually thereafter. In addition, Bank 34 is required to provide its customers with the ability to “opt-out” of having their personal information shared with unaffiliated third parties and not to disclose account numbers or access codes to non-affiliated third parties for marketing purposes. Bank 34 currently has a privacy protection policy in place and believes that such policy is in compliance with the regulations.

 

USA PATRIOT Act. Bank 34 is subject to the USA PATRIOT Act, which gives federal agencies additional powers to address terrorist threats through enhanced domestic security measures, expanded surveillance powers, increased information sharing, and broadened anti-money laundering requirements. The USA PATRIOT Act contains provisions intended to encourage information sharing among bank regulatory agencies and law enforcement bodies and imposes affirmative obligations on financial institutions, such as enhanced recordkeeping and customer identification requirements.

 

Prohibitions Against Tying Arrangements. Federal savings associations are prohibited, subject to some exceptions, from extending credit to or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.

 

Other Regulations

 

Interest and other charges collected or contracted for by Bank 34 are subject to state usury laws and federal laws concerning interest rates. Loan operations are also subject to state and federal laws applicable to credit transactions, such as the:

 

●

Home Mortgage Disclosure Act, 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, governing the use and provision of information to credit reporting agencies; and

 

●

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

 

The deposit operations of Bank 34 also are subject to, among others, 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;

 

 

●

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; and

 

●

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.

 

Federal Reserve System

 

The Federal Reserve Board regulations require depository institutions to maintain noninterest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Federal Reserve Board regulations generally require that reserves be maintained against aggregate transaction accounts as follows: for that portion of transaction accounts aggregating $110.2 million or less (which may be adjusted by the Federal Reserve Board) the reserve requirement is 3.0% and the amounts greater than $110.2 million require a 10.0% reserve (which may be adjusted annually by the Federal Reserve Board between 8.0% and 14.0%). The first $15.2 million of otherwise reservable balances (which may be adjusted by the Federal Reserve Board) are exempted from the reserve requirements. Bank 34 was in compliance with these requirements at December 31, 2017.

 

Federal Home Loan Bank System

 

Bank 34 is a member of the Federal Home Loan Bank System, which consists of 11 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a central credit facility primarily for member institutions. Members of the Federal Home Loan Bank are required to acquire and hold shares of capital stock in the Federal Home Loan Bank. Bank 34 was in compliance with this requirement at December 31, 2017. Based on redemption provisions of the Federal Home Loan Bank of Dallas, the stock has no quoted market value and is carried at cost. Bank 34 reviews for impairment, based on the ultimate recoverability, the cost basis of the Federal Home Loan Bank of Dallas stock. As of December 31, 2017, no impairment had been recognized.

 

Holding Company Regulation

 

Bancorp 34 is a unitary savings and loan holding company subject to regulation and supervision by the Federal Reserve Board. The Federal Reserve Board has enforcement authority over Bancorp 34 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 risk to Bank 34.

 

As a savings and loan holding company, Bancorp 34’s activities are limited to those activities permissible by law for financial holding companies (if Bancorp 34 makes an election to be treated as a financial holding company and meets the other requirements to be a financial holding company) or multiple savings and loan holding companies. A financial holding company may engage in activities that are financial in nature, incidental to financial activities or complementary to a financial activity. Such activities include lending and other activities permitted for bank holding companies under Section 4(c) (8) of the Bank Holding Company Act, insurance and underwriting equity securities. Multiple savings and loan holding companies are authorized to engage in activities specified by federal regulation, including activities permitted for bank holding companies under Section 4(c)(8) of the Bank Holding Company Act.

 

Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of another savings institution or savings and loan holding company without prior written approval of the Federal Reserve Board, and from acquiring or retaining control of any depository institution not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, the Federal Reserve Board must consider such things as the financial and managerial resources and future prospects of the company and institution involved, the effect of the acquisition on and the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors. A savings and loan holding company may not acquire a savings institution in another state and hold the target institution as a separate subsidiary unless it is a supervisory acquisition or the law of the state in which the target is located authorizes such acquisitions by out-of-state companies.

 

 

Savings and loan holding companies historically have not been subject to consolidated regulatory capital requirements. The Dodd-Frank Act requires the Federal Reserve Board to establish minimum consolidated capital requirements for all depository institution holding companies that are as stringent as those required for the insured depository subsidiaries. However, legislation was enacted in December 2014 that required the Federal Reserve Board to amend its “Small Bank Holding Company” exemption from consolidated holding company capital requirements to generally extend its applicability to bank and savings and loan holding companies of up to $1 billion in assets. Regulations implementing this amendment were effective May 15, 2015. Consequently, savings and loan holding companies of under $1 billion in consolidated assets remain exempt from consolidated regulatory capital requirements, unless the Federal Reserve determines otherwise in particular cases.

 

The Dodd-Frank Act extended the “source of strength” doctrine to savings and loan holding companies. The Federal Reserve Board has promulgated regulations implementing the “source of strength” doctrine that require holding companies to act as a source of strength to their subsidiary depository institutions by providing capital, liquidity and other support in times of financial stress.

 

The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies and savings and loan holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization’s capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company’s net income for the past four quarters, net of capital distributions previously paid over that period, is insufficient to fully fund the dividend or the company’s overall rate of earnings retention is inconsistent with the company’s capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if a subsidiary bank becomes undercapitalized. The policy statement also states that a holding company should inform the Federal Reserve Board supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect the ability of Bancorp 34 to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions.

 

In order for Bancorp 34 to be regulated as savings and loan holding company by the Federal Reserve Board, rather than as a bank holding company, Bank 34 must qualify as a “qualified thrift lender” under federal regulations or satisfy the “domestic building and loan association” test under the Internal Revenue Code. Under the qualified thrift lender test, a savings institution is required to maintain at least 65% of its “portfolio assets” (total assets less: (i) specified liquid assets up to 20% of total assets; (ii) intangible assets, 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 and related securities) in at least nine out of each 12 month period. At December 31, 2017, Bank 34 satisfied the qualified thrift lender requirement.

 

Federal Securities Laws

 

Bancorp 34 common stock is registered with the Securities and Exchange Commission. Bancorp 34 is subject to the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.

 

The registration under the Securities Act of 1933 of shares of common stock issued in Bancorp 34’s public offering does not cover the resale of those shares. Shares of common stock purchased by persons who are not affiliates of Bancorp 34 may be resold without registration. Shares purchased by an affiliate of Bancorp 34 are subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If Bancorp 34 meets the current public information requirements of Rule 144 under the Securities Act of 1933, each affiliate of Bancorp 34 that complies with the other conditions of Rule 144, including those that require the affiliate’s sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a number of shares not to exceed, in any three-month period, the greater of 1% of the outstanding shares of Bancorp 34, or the average weekly volume of trading in the shares during the preceding four calendar weeks. In the future, Bancorp 34 may permit affiliates to have their shares registered for sale under the Securities Act of 1933.

 

 

Sarbanes-Oxley Act of 2002

 

The Sarbanes-Oxley Act of 2002 is intended to improve corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. We have policies, procedures and systems designed to comply with these regulations, and we review and document such policies, procedures and systems to ensure continued compliance with these regulations.

 

Change in Control Regulations

 

Under the Change in Bank Control Act, no person may acquire control of a savings and loan holding company, such as Bancorp 34, unless the Federal Reserve Board has been given 60 days’ prior written notice and has not issued a notice disapproving the proposed acquisition, taking into consideration certain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Control, as defined under federal law, means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of a majority of the institution’s directors, or a determination by the regulator that the acquirer has the power, directly or indirectly, to exercise a controlling influence over the management or policies of the institution. Acquisition of more than 10% of any class of a savings and loan holding company’s voting stock constitutes a rebuttable determination of control under the regulations under certain circumstances including where, as is the case with Bancorp 34, the issuer has registered securities under Section 12 of the Securities Exchange Act of 1934.

 

In addition, federal regulations provide that no company may acquire control of a savings and loan holding company without the prior approval of the Federal Reserve Board. Any company that acquires such control becomes a “savings and loan holding company” subject to registration, examination and regulation by the Federal Reserve Board.

 

Emerging Growth Company Status

 

Bancorp 34 is an emerging growth company under the JOBS Act. We will cease to be an emerging growth company upon the earliest of: (i) the end of the fiscal year following the fifth anniversary of the completion of our acquisition of Bank 1440, (ii) the first fiscal year after our annual gross revenues are $1.0 billion or more, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities or (iv) the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year. The Company expects to lose its status as an emerging growth company on August 29, 2019, five years after the Bank 1440 acquisition.

 

An “emerging growth company” may choose not to hold stockholder votes to approve annual executive compensation (more frequently referred to as “say-on-pay” votes) or executive compensation payable in connection with a merger (more frequently referred to as “say-on-golden parachute” votes). An emerging growth company also is not subject to the requirement that its auditors attest to the effectiveness of the company’s internal control over financial reporting, and can provide scaled disclosure regarding executive compensation; however, Bancorp 34 will also not be subject to the auditor attestation requirement or additional executive compensation disclosure so long as it remains a “smaller reporting company” under Securities and Exchange Commission regulations (generally less than $75 million of voting and non-voting equity held by non-affiliates). Finally, an emerging growth company may elect to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies, but must make such election when the company is first required to file a registration statement. Such an election is irrevocable during the period a company is an emerging growth company. Bancorp 34 has elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards.

 

 

ITEM 1A.           Risk Factors

 

Not applicable, as Bancorp 34, Inc. is a “Smaller Reporting Company.”

 

ITEM 1B.           Unresolved Staff Comments

 

None.

 

ITEM 2.          Properties

 

We conduct business through our main office in Alamogordo, New Mexico and three branch offices located in Las Cruces, New Mexico and Peoria and Scottsdale, Arizona. We also operate loan production offices in El Paso, Texas (El Paso County), Albuquerque, New Mexico (Bernalillo County), Rio Rancho, New Mexico (Sandoval County), Scottsdale, Arizona (Maricopa County), Tubac, Arizona (Santa Cruz County), Lynnwood, Washington (Snohomish County), Puyallup, Washington (Pierce County), Medford, Oregon (Jackson County), West Linn, Oregon (Clackamas County) and Yuma, Arizona (Yuma County). At December 31, 2017, the total net book value of our premises, land and equipment was $10.1 million.

 

ITEM 3.          Legal Proceedings

 

Periodically, we are involved in claims and lawsuits, such as claims to enforce liens, condemnation proceedings on properties in which we hold security interests, claims involving the making and servicing of real property loans and other issues incident to our business. We are not a 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.

 

PART II

 

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

 

Our common stock is listed on the NASDAQ Capital Market under the symbol “BCTF.” As of March 13, 2018, we had 342 stockholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms), and 3,388,601 shares of common stock outstanding. The following table sets forth market price information for our common stock. Information for stock prices prior to the conversion on October 12, 2016 have been restated to reflect the 2.0473-to-one exchange ratio. We did not declare a dividend for any of the periods listed.

 

Quarter Ended		High				Low
December 31, 2017		$	14.91			$	14.00
September 30, 2017		$	14.40			$	13.24
June 30, 2017		$	14.30			$	12.56
March 31, 2017		$	12.90			$	12.50
December 31, 2016		$	13.45			$	11.96
September 30, 2016		$	11.60			$	10.36
June 30, 2016		$	11.23			$	10.26
March 31, 2016		$	11.23			$	7.91

 

 

 

The Company’s board of directors has the authority to declare dividends on our shares of common stock, subject to our capital requirements, our financial condition and results of operations, tax considerations, statutory and regulatory limitations, and general economic conditions. We cannot assure you that we will pay dividends in the future, or that any such dividends will not be reduced or eliminated in the future.

 

The Company will not be permitted to pay dividends on its common stock if its stockholders’ equity would be reduced below the amount of the liquidation account established by the Company in connection with the conversion. The source of dividends will depend on the net proceeds retained by the Company and earnings thereon, and dividends from Bank 34. In addition, the Company is subject to state law limitations and federal bank regulatory policy on the payment of dividends. Maryland law generally limits dividends if the corporation would not be able to pay its debts in the usual course of business after giving effect to the dividend or if the corporation’s total assets would be less than the corporation’s total liabilities plus the amount needed to satisfy the preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution.

 

There were no sales of unregistered securities during the quarter ended December 31, 2017.

 

The Company’s repurchases of common stock for the three months ended December 31, 2017 were as follows:

 

										Total Number of				Maximum Number
		Total								Shares Purchased as				of Shares that May
		Number of				Average Price				Part of Publicly				Be Purchased Yet
		Shares				Paid				Announced Plans or				Under the Plans
Period		Purchased				per Share				Programs				or Programs (1)
October 1, 2017 through October 31, 2017			-				-				-				171,910
November 1, 2017 through November 30, 2017		-				-				-					171,910
December 1, 2017 through December 31, 2017			28,000			$	14.75				28,000				143,910
			28,000								28,000

 

(1) On October 24, 2017, the Company adopted a repurchase program under which it would repurchase up to 171,910 shares of its common stock, or approximately 5% of the Company’s outstanding shares. The repurchase program would continue until it is completed or terminated by the Company’s Board of Directors.

 

 

ITEM 6.          Selected Financial Data

 

You should read the following summary financial information in connection with our historical financial information, which appears elsewhere in this annual report. The selected historical financial data at December 31, 2017 and 2016 and for the years ended December 31, 2017 and 2016 is derived in part from the audited consolidated financial statements that appear in this report. The information at December 31, 2015 and June 30, 2014, 2013, and 2012 and for the years then ended is derived in part from audited consolidated financial statements that do not appear in this report. The information for the year ended December 31, 2014 and the six months ended December 31, 2013 is unaudited.

 

		At December 31,																At June 30,
		2017				2016				2015				2014				2014				2013
		(Dollars in thousands)
Selected Financial Condition:
Total assets		$	336,221			$	328,867			$	270,984			$	246,954			$	167,785			$	174,310
Cash and cash equivalents			9,873				16,411				19,825				14,824				9,946				4,216
Available-for-sale securities			24,400				31,499				28,631				29,018				38,959				55,340
Loans held for investment, net			257,896				241,399				192,137				173,990				90,998				89,390
Loans held for sale			15,424				14,221				11,381				9,429				10,279				6,295
Deposits			235,561				224,522				225,700				201,939				134,673				135,517
Federal Home Loan Bank advances			45,000				50,000				13,000				12,500				8,810				13,327
Stockholders' equity			50,971				50,777				29,644				29,336				22,184				23,597

 

 

		Years Ended																Six Months Ended								Years Ended
		December 31,																December 31,								June 30,
		2017				2016				2015				2014				2014				2013				2014				2013
														(unaudited)								(unaudited)
		(In thousands, except per share data)
Selected Operating Data:
Interest income		$	15,965			$	13,502			$	12,224			$	8,367			$	4,894			$	3,467			$	6,940			$	7,503
Interest expense			2,272				1,684				1,434				1,394				767				736				1,363				1,831
Net interest income			13,693				11,818				10,790				6,973				4,127				2,731				5,577				5,672
Provision (credit) for loan losses			575				1,019				694				50				50				-				-				(121	)
Net interest income after provision (credit) for loan losses			13,118				10,799				10,096				6,923				4,077				2,731				5,577				5,793
Non-interest income (1)			11,906				11,213				4,903				6,243				4,473				1,314				3,083				3,596
Non-interest expense (2)			22,695				20,888				14,658				12,766				7,528				4,656				9,895				9,486
Income (loss) before income taxes			2,329				1,124				341				399				1,023				(611	)			(1,235	)			(97	)
Income taxes (3)			1,968				(4,171	)			20				74				74				-				-				36
Net income		$	361			$	5,295			$	321			$	326			$	949			$	(611	)		$	(1,235	)		$	(133	)
Income (loss) per share - basic (4)		$	0.11			$	1.57			$	0.09			$	0.11			$	0.30			$	(0.23	)		$	(0.46	)		$	(0.05	)
Income (loss) per share - diluted (4)		$	0.11			$	1.57			$	0.09			$	0.11			$	0.30			$	(0.23	)		$	(0.46	)		$	(0.05	)

 

______________

(1)	Non-interest income for the year ended December 31, 2014 and the six months ended December 31, 2014 includes a bargain purchase gain of $2.9 million in connection with the acquisition of Bank 1440.
(2)	Non-interest expense for the years ended December 31, 2015 and 2014, the six months ended December 31, 2014 and 2013 and the years ended June 30, 2014, 2013 and 2012 includes merger-related expenses of $100,000, $1.4 million, $801,000, $344,000, $920,000, $234,000, and $0, respectively.
(3)	As a result of the reduction in the Federal corporate tax rate effective in 2018 under the Tax Cuts and Jobs Act signed into law in December 2017, income tax expense for 2017 includes a $1.2 million deferred tax adjustment. A $4.2 million net income tax benefit was recognized in 2016 primarily due to the reversal of all valuation reserves on net deferred tax assets.
(4)	Basic and diluted income (loss) per share amounts in the above table for all periods prior to October 2016 have been restated at the second-step conversion exchange rate of 2.0473 to one.

 

 

 

		At or For the
		Years Ended																Six Months Ended								Years Ended
		December 31,																December 31, (4)								June 30,
		2017				2016				2015				2014				2014				2013				2014				2013
Performance Ratios:
Return on average assets (ratio of net income (loss) to average total assets)			0.11	%			1.78	%			0.12	%			0.17	%			0.84	%			(0.71	)%			(0.73	)%			(0.07	)%
Return on average equity (ratio of net income (loss) to average stockholders' equity)			0.69	%			16.31	%			1.08	%			1.29	%			6.77	%			(5.36	)%			(5.46	)%			(0.55	)%
Net interest rate spread (1)			4.19	%			4.11	%			4.36	%			3.77	%			3.84	%			3.39	%			3.52	%			3.34	%
Net interest margin (2)			4.38	%			4.26	%			4.47	%			3.89	%			3.96	%			3.52	%			3.66	%			3.50	%
Noninterest expense to average assets			6.66	%			7.52	%			5.64	%			6.51	%			6.68	%			5.39	%			5.84	%			5.29	%
Dividend payout ratio			-	%			-	%			-	%			-	%			-	%			-	%			-	%			-	%
Efficiency ratio (3)			88.05	%			90.70	%			93.41	%			96.60	%			87.53	%			115.10	%			114.26	%			102.34	%
Average interest-earning assets to average interest- bearing liabilities			125.95	%			123.69	%			118.80	%			116.20	%			116.27	%			113.73	%			114.88	%			114.50	%
Capital Ratios:
Total capital to risk-weighted assets (Bank only)			17.21	%			18.14	%			16.93	%			17.09	%			17.09	%			24.66	%			23.89	%			25.77	%
Tier 1 capital to risk-weighted assets (Bank only)			15.96	%			17.03	%			15.91	%			16.13	%			16.13	%			23.41	%			22.64	%			24.51	%
Tier 1 capital to average assets (Bank only)			11.96	%			11.91	%			11.06	%			11.68	%			11.68	%			13.89	%			13.36	%			13.63	%
Average stockholders' equity to average total assets			15.22	%			10.91	%			11.46	%			12.88	%			12.44	%			13.20	%			13.34	%			13.41	%
Asset Quality Ratios:
Allowance for loan losses to total gross loans			1.19	%			1.03	%			0.97	%			0.97	%			0.97	%			1.85	%			1.77	%			2.00	%
Allowance for loan losses to total gross loans less acquired loans			1.29	%			1.19	%			1.28	%			1.50	%			1.50	%			1.85	%			1.77	%			2.00	%
Allowance for loan losses to nonperforming loans			57.33	%			41.99	%			102.71	%			209.50	%			209.50	%			288.83	%			371.33	%			242.23	%
Net (charge-offs) recoveries to average loans			0.01	%			(0.20	)%			(0.25	)%			(0.06	)%			0.02	%			(0.19	)%			(0.18	)%			(0.45	)%
Nonperforming loans to total gross loans			2.08	%			2.44	%			0.95	%			0.46	%			0.46	%			0.64	%			0.48	%			0.82	%
Nonperforming loans to total assets			1.62	%			1.81	%			0.68	%			0.33	%			0.33	%			0.36	%			0.26	%			0.43	%
Nonperforming assets and accruing troubled debt restructurings to total assets			1.62	%			1.81	%			0.79	%			0.86	%			0.86	%			1.43	%			1.05	%			1.52	%
Other Data:
Number of full service offices			4				4				4				4				4				2				2				2
Full time equivalent employees			145				138				98				75				75				60				65				66

 

 

---

 

(1)

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

(2)

Net interest margin represents net interest income as a percentage of average interest-earning assets.

(3)

Efficiency ratio represents noninterest expense divided by the sum of net interest income and noninterest income.

(4)

Ratios for six-month periods have been annualized.

 

 

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

 

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data, and is intended to enhance your understanding of our financial condition and results of operations. The information in this section as of and for the years ended December 31, 2017 and 2016, has been derived from the consolidated financial statements that appear elsewhere in this annual report. You should read the information in this section in conjunction with the business and financial information regarding Bancorp 34, Inc. and the financial statements provided in Part II, Item 8 of this annual report.

 

Critical Accounting Policies

 

Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets. Our critical accounting policies are those related to our allowance for loan losses, the evaluation of other-than-temporary impairment of securities, the valuation of and our ability to realize deferred tax assets and the measurement of fair values of financial instruments.

 

Allowance for Loan Losses. The allowance for loan losses is calculated with the objective of maintaining an allowance necessary to absorb probable credit losses inherent in the loan portfolio. Management’s determination of the adequacy of the allowance is based on periodic evaluations of the loan portfolio and other relevant factors. However, this evaluation is inherently subjective, as it requires an estimate of the losses for each risk rating and for each impaired loan, an estimate of the amounts and timing of expected future cash flows, and an estimate of the value of collateral.

 

We have established a systematic method of periodically reviewing the credit quality of the loan portfolio in order to establish an allowance for loan losses. The allowance for loan losses is based on our current judgments about the credit quality of individual loans and segments of the loan portfolio. The allowance for loan losses is established through a provision for loan losses based on our evaluation of the probable losses inherent in the loan portfolio, and considers all known internal and external factors that affect loan collectability as of the reporting date. Our evaluation, which includes a review of loans on which full collectability may not be reasonably assured, considers among other matters, the estimated net realizable value or the fair value of the underlying collateral, economic conditions, historical loan loss experience, our knowledge of inherent losses in the portfolio that are probable and reasonably estimable and other factors that warrant recognition in providing an appropriate loan loss allowance. Management believes this is a critical accounting policy because this evaluation involves a high degree of complexity and requires us to make subjective judgments that often require assumptions or estimates about various matters.

 

The allowance for loan losses consists primarily of specific allocations and general allocations. Specific allocations are made for loans that are determined to be impaired. Impairment is measured by determining the present value of expected future cash flows or, for collateral-dependent loans, the fair value of the collateral, including adjustments for market conditions and selling expenses. The general allocation is determined by segregating the remaining loans by type of loan, risk weighting and payment history. We also analyze delinquency trends, general economic conditions, trends in historical loss experience and geographic and industry concentrations. This analysis establishes factors that are applied to the loan groups to determine the amount of the general allowance. The principal assumption used in calculating the allowance for loan losses is the estimate of loss for each risk rating. Actual loan losses may be significantly more than the allowance we have established, which could have a material negative effect on our financial results.

 

Other-Than-Temporary Impairment. Securities are evaluated on at least a quarterly basis, to determine whether a decline in their value is other-than-temporary. In estimating other-than-temporary impairment losses, management considers (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) whether or not we intend to sell or expect that it is more likely than not that we will be required to sell the investment security prior to an anticipated recovery in fair value. Once a decline in value for a debt security is determined to be other-than-temporary, the other-than-temporary impairment is separated in (a) the amount of total other-than-temporary impairment related to a decrease in cash flows expected to be collected from the debt security (the credit loss) and (b) the amount of other-than-temporary impairment related to all other factors. The amount of the total other-than-temporary impairment related to credit loss is recognized in operations. The amount of other-than-temporary impairment related to other factors is recognized in other comprehensive loss.

 

 

Valuation of Deferred Tax Assets. As a result of the reduction in the Federal corporate tax rate effective in 2018 under the Tax Cuts and Jobs Act signed into law in December 2017, income tax expense for 2017 includes a $1.2 million deferred tax asset re-measurement adjustment. Effective December 31, 2016, we reversed 100% of our net deferred tax asset valuation allowances and recognized an income tax benefit based upon our assessment of net deferred tax assets that are more-likely-than-not to be realized. The net deferred tax asset had been offset by an equal valuation allowance from June 2012 through November 2016. In evaluating our ability to realize deferred tax assets, management considers all positive and negative information, including our past operating results and our forecast of future taxable income. In determining future taxable income, management utilizes a budget process that makes business assumptions and the implementation of feasible and prudent tax planning strategies, if any. These assumptions require us to make judgments about our future taxable income that are consistent with the plans and estimates we use to manage our business. Any change in estimated future taxable income or effective tax rates may result in changes to the carrying balance of our net deferred tax assets which would result in an income tax benefit or expense in the same period.

 

Fair Value Measurements. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.  A three-level of fair value hierarchy prioritizes the inputs used to measure fair value:

 

●

Level 1 – Quoted prices in active markets for identical assets or liabilities; includes certain U.S. Treasury and other U.S. Government agency debt that is highly liquid and actively traded in over-the-counter markets.

 

●

Level 2 – Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

●

Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.  Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

The asset or liability fair value measurement level within the fair value hierarchy is based on the lowest level of any input that is significant to the fair value measurement. 

 

 

Average Balance Sheet

 

The following tables set forth average balances, average yields and costs, and certain other information for the years indicated. Tax-equivalent yield adjustments have not been made for tax-exempt securities, as the effect thereof was not material. All average balances are daily average balances. Nonaccrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income. 

 

		For the Years Ended December 31,
						2017												2016								2015
		Average												Average												Average
		Outstanding								Yield/				Outstanding								Yield/				Outstanding								Yield/
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
		(Dollars in thousands)
Interest-earning assets:
Loans		$	270,038			$	15,221				5.64	%		$	228,662			$	12,924				5.65	%		$	198,999			$	11,644				5.87	%
Interest-earning deposits			10,181				144				1.41	%			16,155				81				0.50	%			8,010				19				0.24	%
Securities			28,744				529				1.84	%			30,546				473				1.55	%			32,635				506				1.55	%
Federal Home Loan Bank stock			3,302				54				1.64	%			1,973				16				0.79	%			1,114				42				3.81	%
Other			383				17				4.44	%			383				8				2.09	%			506				13				2.55	%
Total interest-earning assets			312,648				15,965				5.11	%			277,719				13,502				4.86	%			241,264				12,224				5.07	%
Noninterest-earning assets			28,347												19,959												18,691
Total assets		$	340,995											$	297,678											$	259,955
Interest-bearing liabilities:
Checking, money market and savings accounts		$	128,835			$	1,049				0.81	%		$	124,540			$	912				0.73	%		$	104,798			$	719				0.69	%
Certificates of deposit			63,415				624				0.98	%			67,096				564				0.84	%			78,091				653				0.84	%
Total deposits			192,250				1,673				0.87	%			191,636				1,476				0.77	%			182,889				1,372				0.75	%
Advances from FHLB of Dallas			55,984				599				1.07	%			32,894				208				0.63	%			20,196				62				0.31	%
Total interest-bearing liabilities			248,234				2,272				0.92	%			224,530				1,684				0.75	%			203,085				1,434				0.71	%
Non-interest bearing deposits			37,361												37,200												24,570
Non-interest bearing liabilities			3,493												3,476												2,503
Total liabilities			289,088												265,206												230,158
Stockholders' equity			51,907												32,472												29,797
Total liabilities and stockholders' equity		$	340,995											$	297,678											$	259,955
Net interest income						$	13,693											$	11,818											$	10,790
Net interest rate spread (1)											4.19	%											4.11	%											4.36	%
Net interest-earning assets (2)		$	64,414											$	53,189											$	38,179
Net interest margin (3)											4.38	%											4.26	%											4.47	%
Average interest-earning assets to average interest-bearing liabilities			125.95	%											123.69	%											118.80	%

 

 _________________

(1)

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

(2)

Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(3)

Net interest margin represents net interest income as a percentage of average total interest-earning assets.

 

 

Rate/Volume Analysis

 

The following table presents the effects of changing rates and volumes on our net interest income for the years indicated. 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). For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume.

 

		Years Ended December 31,
		2017 vs. 2016													2016 vs. 2015
		Increase (Decrease)									Total				Increase (Decrease)								Total
		Due to									Increase				Due to								Increase
		Volume				Rate					(Decrease)				Volume				Rate				(Decrease)
Interest-earning assets:		(Dollars in thousands)
Loans		$	2,781			$	(484	)			$	2,297			$	1,706			$	(426	)		$	1,280
Interest-earning deposits			(100	)			163					63				34				28				62
Securities			(24	)			80					56				(28	)			(5	)			(33	)
Federal Home Loan Bank of Dallas stock			38				-					38				33				(60	)			(27	)
Other			-				9					9				(4	)			-				(4	)
Total interest-earning assets			2,695				(232	)				2,463				1,741				(463	)			1,278
Interest-bearing liabilities:
Checking, money-market and savings accounts			65				72					137				201				(8	)			13
Certificates of deposit			(16	)			76					60				(85	)			(4	)			(89	)
Total deposits			49				148					197				116				(12	)			104
Advances from FHLB of Dallas			194				197					391				56				90				146
Total interest-bearing liabilities			243				345					588				172				78				250
Change in net interest income		$	2,452			$	(577	)			$	1,875			$	1,569			$	(541	)		$	1,028

 

 

Comparison of Financial Condition at December 31, 2017 and December 31, 2016

 

Cash and cash equivalents decreased $6.5 million to $9.9 million at December 31, 2017 from $16.4 million at December 31, 2016. The decrease is primarily the result of funding the increase in portfolio loans.

 

Loans held for investment increased $17.1 million, or 7.0%, to $261.0 million at December 31, 2017 from $243.9 million at December 31, 2016. The increase was primarily due to a $19.1 million, or 9.7%, increase in commercial real estate loans. Most of the growth was in our Arizona market.    

 

Loans held for sale increased $1.2 million to $15.4 million at December 31, 2017 from $14.2 million at December 31, 2016. We currently sell a significant majority of the one- to four-family residential real estate loans we originate in the secondary market. The balances at any month end may vary based upon the timing and volume of current loan originations and sales.

 

Available for sale securities decreased $7.1 million, or 22.5%, to $24.4 million at December 31, 2017 from $31.5 million at December 31, 2016 as our emphasis was on growing loans in 2017 to enhance earning asset yield.  Underwater securities were sold in December 2017 taking a loss of $176,000 to take advantage of higher tax rates in 2017 and were replaced with similar securities with higher yields in December 2017 and January 2018.

 

The core deposit intangible recorded in connection with the acquisition of Bank 1440 decreased $62,000 to $221,000 at December 31, 2017 from $283,000 at December 31, 2016, reflecting normal amortization.

 

Total deposits increased $11.1 million, or 4.9%, to $235.6 million at December 31, 2017 from $224.5 million at December 31, 2016. The increase includes a $10.5 million, or 8.4% increase in savings and NOW accounts and a $1.1 million increase in non-interest bearing demand deposits, partially offset by a $511,000, or 0.8% decrease in time deposits.  At December 31, 2017 time deposits included $10.0 million of brokered certificates of deposit originated in September 2017 with $5.0 million at a rate of 1.75% maturing in 18 months and $5.0 million at a rate of 1.90% maturing in 30 months.  

 

 

Borrowings, consisting solely of Federal Home Loan Bank advances, decreased $5.0 million to $45.0 million at December 31, 2017 from $50.0 million at December 31, 2016. We utilized short-term borrowings during the course of the year to fund loans held for sale and loans held for investment.

 

Total stockholders’ equity increased $194,000 to $51.0 million at December 31, 2017 from $50.8 million at December 31, 2016. The growth was primarily from net income for the year of $361,000.

 

Comparison of Operating Results for the Years Ended December 31, 2017 and December 31, 2016

 

General. We had net income of $361,000 for the year ended December 31, 2017, compared to net income of $5.3 million for the year ended December 31, 2016. Income before income taxes increased $1.2 million or 107.3% to $2.3 million from $1.1 million in 2016; however, we incurred a $2.0 million provision for income taxes in 2017 including $1.2 million from a deferred tax asset adjustment created by the tax law change. In 2016 we recognized a $4.2 million income tax benefit including $4.1 million due to the reversal of all net deferred tax asset valuation reserves.

 

Interest Income. Interest income increased $2.5 million, or 18.2%, to $16.0 million for the year ended December 31, 2017 from $13.5 million for the year ended December 31, 2016. The increase was primarily due to a $34.9 million, or 12.6%, increase in average interest-earning assets. The yield on average interest-earning assets increased 25 basis points to 5.11% for the year ended December 31, 2017 from 4.86% for the year ended December 31, 2016. Interest and fees on loans increased $2.3 million, or 17.8%, to $15.2 million for the year ended December 31, 2017, from $12.9 million for the year ended December 31, 2016. Interest income on loans increased due primarily to a $41.4 million, or 18.1%, increase in average loan balances from organic growth. The average balance of securities decreased $1.8 million, or 5.9%, to $28.7 million for the year ended December 31, 2017, compared to $30.5 million for the year ended December 31, 2016, and the average yield increased to 1.84% in 2017 from 1.55% for 2016.

 

Interest Expense. Interest expense increased $588,000 or 34.9%, to $2.3 million for the year ended December 31, 2017 from $1.7 million for the year ended December 31, 2016. The increase was partially the result of an increase in interest expense on borrowings, which increased $391,000, or 188.0%, to $599,000 for the year ended December 31, 2017 from $208,000 for the year ended December 31, 2016 due to a 70% increase in average borrowings and a 44 basis point or 70% increase in average borrowing rates. Average interest-bearing deposits for the year ended December 31, 2017 were $192.2 million, representing a $614,000, or 3.2%, increase compared to average interest-bearing deposits of $191.6 million for the year ended December 31, 2016. The average rate paid on interest-bearing deposits was 0.87% compared to 0.77% for 2016.

 

Interest expense on checking, money market and savings accounts increased $137,000, or 15.0%, to $1.0 million for the year ended December 31, 2017 from $912,000 for the year ended December 31, 2016. The average rate we paid on such deposit accounts increased eight basis points to 0.81% for the year ended December 31, 2017 from 0.73% for the year ended December 31, 2016 and the average balance increased $4.3 million, or 3.48%, to $128.8 million for the year ended December 31, 2017 from $124.5 million for the year ended December 31, 2016. The average rates we pay on these accounts is considerably higher in the Arizona market.

 

Interest expense on certificates of deposits decreased $60,000, or 10.6%, to $624,000 for the year ended December 31, 2017 from $564,000 for the year ended December 31, 2016. The average balance of certificates of deposit decreased $3.7 million, or 5.5%, to $63.4 million for the year ended December 31, 2017 from $67.1 million for the year ended December 31, 2016. The average rate paid on certificates of deposit was 0.98% for the year ended December 31, 2017 and 0.84% for the year ended December 31, 2016.

 

 

Net Interest Income. Net interest income increased $1.9 million, or 15.9%, to $13.7 million for the year ended December 31, 2017 from $11.8 million for the year ended December 31, 2016, as a result of a higher balance of net interest-earning assets. Our average interest-earning assets increased by $34.9 million, or 12.6%, to $312.6 million for the year ended December 31, 2017 from $277.7 million for the year ended December 31, 2016, due primarily to organic growth. Our net interest rate spread increased by eight basis points to 4.19% for the year ended December 31, 2017 from 4.11% for the year ended December 31, 2016. Our cost of borrowings increased to 1.07% for the year ended December 31, 2017 from 0.63% for the year ended December 31, 2016 due to the increase in short-term interest rates.

 

Provision for Loan Losses. Provisions for loan losses are charged to operations to establish an allowance for loan losses at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. If the allowance for loan losses is larger than necessary, we post a negative provision as a benefit to earnings. In evaluating the level of the allowance for loan losses, management analyzes several qualitative loan portfolio risk factors including but not limited to, charge-off history over a relevant period, changes in management or underwriting policies, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower and results of internal and external loan reviews.

 

See “Asset Quality - Allowance for Loan Losses” for additional information.

 

After an evaluation of these factors, we recorded a provision for loan losses of $575,000 for the year ended December 31, 2017, compared to $1.0 million for the year ended December 31, 2016. In the year ended December 31, 2017, the allowance for loan losses grew $611,000 or 24.4%, due primarily to the $17.1 million, or 7.0% growth in gross loans held for investment. Recoveries in 2017 exceeded charge-offs by $36,000.

 

To the best of our knowledge, at December 31, 2017 we have recorded all loan losses that are both probable and reasonable to estimate as of December 31, 2017.  However, future changes in the factors described above, including, but not limited to, actual loss experience with respect to our loan portfolio, could result in material increases in our provision for loan losses. In addition, the Office of the Comptroller of the Currency, as an integral part of its examination process, will periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on its judgments about the recoverability of our loan balances based upon information available to it at the time of its examination.

 

Noninterest Income. Noninterest income increased $693,000, or 6.2%, to $11.9 million for the year ended December 31, 2017 from $11.2 million for the year ended December 31, 2016 due to a higher volume of loan sales and related gains.

 

Gain on sale of loans increased $763,000, or 7.1%, to $11.5 million for the year ended December 31, 2017 from $10.7 million for the year ended December 31, 2016. During the year ended December 31, 2017, we sold $252.8 million of mortgage loans for a gain of $10.4 million and $11.8 million of SBA and USDA loans for gains of $1.0 million, compared to $259.4 million of mortgage loan sales and $10.6 million of SBA and USDA loan sales during the year ended December 31, 2016 for gains of $9.8 million and $839,000, respectively. We realized a 3.8% average premium (gain on sale/sold loans) on the sales of mortgage loans for the year ended December 31, 2017 and 3.8% for the year ended December 31, 2016. Premiums vary from period to period based upon the mix of government Federal Housing Administration (FHA) and Veterans Administration (VA) loans to conventional loans, geographic markets and market interest rates, specifically 10-year U.S. Treasury rates.

 

Noninterest Expense. Noninterest expense increased $1.8 million, or 8.6%, to $22.7 million for the year ended December 31, 2017 from $20.9 million for the year ended December 31, 2016, due primarily to higher salaries and benefits, data processing fees, advertising and occupancy costs. The increases were primarily related to the expansion of our mortgage banking operations.

 

 

Provision for Income Tax. There was a $2.0 million income tax expense recorded for the year ended December 31, 2017 compared to a $4.2 million income tax benefit recorded for the year ended December 31, 2016. Effective December 31, 2017 we recognized a $1.2 million one-time reduction in our deferred tax assets as a result of the reduction in corporate tax rates beginning in 2018 included in the 2017 Tax Cuts and Jobs Act. Effective December 31, 2016, we reversed net deferred tax asset valuation allowances and recognized an income tax benefit based upon our assessment of net deferred tax assets that are more-likely-than-not to be realized. The net deferred tax asset had been offset by an equal valuation allowance from June 2012 through November 2016. In evaluating our ability to realize deferred tax assets, management considered all positive and negative information, including our past operating results and our forecast of future taxable income. In determining future taxable income, management utilizes a budget and forecasting process based upon market and reasonable business assumptions. These assumptions require us to make judgments about our future taxable income that are consistent with the plans and estimates we use to manage our business.

 

Loans Held for Investment

 

We originate residential real estate loans, as well as commercial real estate loans, including multi-family residential real estate loans, construction loans, commercial and industrial loans and consumer and other loans. The following tables set forth the composition of our loans held for investment by type at the dates indicated.

 

		At December 31,																																At June 30,
		2017								2016								2015								2014								2014								2013
		Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent				Amount				Percent
		(Dollars in thousands)
Commercial real estate (1)		$	214,872				82.0	%		$	195,814				80.0	%		$	146,644				75.3	%		$	129,949				73.7	%		$	55,103				59.3	%		$	48,081				52.6	%
One- to four-family residential real estate			29,114				11.1	%			29,977				12.2	%			31,412				16.1	%			32,959				18.7	%			34,015				36.6	%			38,432				42.1	%
Commercial and industrial			12,296				4.7	%			9,876				4.0	%			10,235				5.3	%			8,594				4.9	%			2,787				3.0	%			3,346				3.7	%
Consumer and other			5,740				2.2	%			9,191				3.8	%			6,429				3.3	%			4,816				2.7	%			1,007				1.1	%			1,487				1.6	%
Total gross loans			262,022				100.0	%			244,858				100.0	%			194,720				100.0	%			176,318				100.0	%			92,912				100.0	%			91,346				100.0	%
Less:
Unamortized loan fees			(1,010	)							(953	)							(689	)							(621	)							(269	)							(132	)
Allowance for loan losses			(3,117	)							(2,506	)							(1,894	)							(1,707	)							(1,645	)							(1,824	)
Loans held for investment, net		$	257,895							$	241,399							$	192,137							$	173,990							$	90,998							$	89,390

 

__________________

(1)	Includes multi-family real estate loans.

 

 

The following table sets forth the contractual maturities of our loans held for investment at December 31, 2017. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. The table presents contractual maturities and does not reflect repricing or the effect of prepayments. Actual maturities may differ.

 

										One- to four-family
		Commercial real estate								residential real estate
		Amount				Weighted Average Rate				Amount				Weighted Average Rate
Due during the years ending December 31,		(Dollars in thousands)
2018		$	24,939				5.43	%		$	494				5.56	%
2019 to 2022			96,350				5.16	%			2,289				5.19	%
2023 and beyond			93,583				5.21	%			26,331				5.27	%
		$	214,872				5.21	%		$	29,114				5.27	%

 

 

		Commercial and industrial								Consumer and other								Total
		Amount				Weighted Average Rate				Amount				Weighted Average Rate				Amount				Weighted Average Rate
Due during the years ending December 31,		(Dollars in thousands)
2018		$	5,482				5.88	%		$	2,553				5.60	%		$	33,468				5.51	%
2019 to 2022			5,959				5.36	%			3,154				5.87	%			107,752				5.19	%
2023 and beyond			855				5.45	%			33				7.06	%			120,802				5.23	%
		$	12,296				5.60	%		$	5,740				5.76	%		$	262,022				5.25	%

 

The following table sets forth our fixed and adjustable-rate loans at December 31, 2017 that are contractually due after December 31, 2018.

 

		Due after December 31, 2018
		Fixed				Adjustable				Total
		(Dollars in thousands)
Commercial real estate		$	88,942			$	100,991			$	189,933
One- to four-family residential real estate			25,736				2,884				28,620
Commercial and industrial			4,194				2,620				6,814
Consumer and other			200				2,987				3,187
		$	119,072			$	109,482			$	228,554

 

Asset Quality

 

We review loans on a regular basis, and place loans on nonaccrual status when either principal or interest is 90 days or more past due, or earlier if we do not expect to receive full payment of interest or principal. Interest accrued and unpaid at the time a loan is placed on nonaccrual status is reversed from interest income. Once a loan is placed on nonaccrual status, the borrower must generally demonstrate at least six months of payment performance before the loan is eligible to return to accrual status.

 

 

Nonperforming Assets. The following table sets forth information regarding our nonperforming assets.

 

		At December 31,																At June 30,
		2017				2016				2015				2014				2014				2013
Nonaccrual loans		(Dollars in thousands)
Real estate loans:
One- to four-family residential real estate		$	679			$	649			$	1,490			$	181			$	99			$	120
Commercial real estate			3,483				3,719				-				617				327				633
Commercial and industrial loans			1,275				1,600				354				17				17				-
Consumer and other loans			-				-				-				-				-				-
Total nonaccrual loans			5,437				5,968				1,844				815				443				753
Accruing loans past due 90 days or more:
Total accruing loans past due 90 days or more			-				-				-				-				-				-
Total nonaccrual loans and accruing loans past due 90 days or more			5,437				5,968				1,844				815				443				753
Other real estate (ORE)
One- to four-family residential real estate			-				-				-				-				17				297
Commercial real estate			-				-				306				820				820				1,095
Total other real estate			-				-				306				820				837				1,392
Other nonperforming assets			-				-				-				-				-				-
Total nonperforming assets		$	5,437			$	5,968			$	2,150			$	1,635			$	1,280			$	2,145
Ratios:
Nonperforming loans to gross loans held for investment			2.08	%			2.44	%			0.95	%			0.46	%			0.48	%			0.82	%
Nonperforming assets to total assets			1.62	%			1.81	%			0.79	%			0.66	%			0.76	%			1.23	%
Nonperforming assets to gross loans held for investment and ORE			2.08	%			2.44	%			1.10	%			0.92	%			1.37	%			2.31	%

 

 

Two large loan relationships partially secured by real estate comprise $4.6 million, or 84.5%, of the $5.4 million in nonaccrual loans at December 31, 2017, and $3.6 million, or 66%, of the total December 31, 2017 nonaccrual loan balance, is guaranteed by the SBA.

 

The largest nonaccrual relationship, with a $2.9 million outstanding balance, is a loan to an operating commercial entity that has filed for Chapter 11 bankruptcy protection. The loan is 75% SBA guaranteed and the outstanding balance is collateralized by the real estate and all business assets.

 

The second largest nonaccrual loan relationship includes two loans to a commercial enterprise that ceased operation in late 2016, with a total $1.7 million book balance as of December 31, 2017. One loan with a contractual balance of $1.1 million is 75% SBA guaranteed. The loans are personally guaranteed by the principal, who has filed for personal protection under Chapter 7 of the bankruptcy code, and his living trust. Collateral includes two operating commercial entities in Arizona, residential condominiums in Arizona and a single family residence in Arizona.

 

Due to the decrease in nonaccrual loans, the nonperforming asset ratios decreased from December 31, 2016 to December 31, 2017.

 

Interest income that would have been recorded for the year ended December 31, 2017, had nonaccruing loans been current according to their original terms amounted to $320,000. We recognized $8,000 in interest income on these loans for the year ended December 31, 2017. Of such amounts, $0 was related to troubled debt restructurings for the year ended December 31, 2017.

 

 

In addition to nonperforming assets, as of December 31, 2017, 2016, 2015 and 2014, and June 30, 2014 and 2013 we had $0, $0, $0, $483,000, $489,000 and $505,000 accruing troubled debt restructurings, respectively.

 

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

 

		30 to 59				60 to 89				90 Days
		Days				Days				or more
		Past Due				Past Due				Past-Due
		(In thousands)
At December 31, 2017
Commercial real estate		$	246			$	-			$	550
One- to four-family residential real estate			236				117				525
Commercial and industrial			-				-				1,275
Consumer and other			-				-				-
		$	482			$	117			$	2,350
At December 31, 2016
Commercial real estate		$	550			$	-			$	-
One- to four-family residential real estate			108				501				69
Commercial and industrial			1,140				-				461
Consumer and other			-				-				-
		$	1,798			$	501			$	530
At December 31, 2015
Commercial real estate		$	-			$	-			$	-
One- to four-family residential real estate			315				173				788
Commercial and industrial			-				-				-
Consumer and other			-				-				-
		$	315			$	173			$	788
At December 31, 2014
Commercial real estate		$	-			$	894			$	-
One- to four-family residential real estate			945				150				113
Commercial and industrial			-				-				-
Consumer and other			-				-				-
		$	945			$	1,044			$	113
At June 30, 2014
Commercial real estate		$	162			$	-			$	-
One- to four-family residential real estate			-				43				-
Commercial and industrial			-				-				-
Consumer and other			-				-				-
		$	162			$	43			$	-
At June 30, 2013
Commercial real estate		$	-			$	-			$	137
One- to four-family residential real estate			-				45				65
Commercial and industrial			-				-				-
Consumer and other			-				-				-
		$	-			$	45			$	202

 

 

Classified Assets. Federal regulations require loans and other assets of lesser quality be classified as “substandard”, “doubtful” or “loss” assets. An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that we will sustain “some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. We designate an asset as “special mention” if the asset has a potential weakness that warrants management’s close attention.

 

The following table sets forth our amounts of classified assets and assets designated as special mention as of December 31, 2017, 2016 and 2015.  The classified assets total at December 31, 2017 includes $5.4 million of nonperforming loans. Three large loan relationships partially secured by real estate comprise $5.8 million of classified loans at December 31, 2017, and $4.3 million of those, representing 47% of total classified loans, are guaranteed by the SBA.

 

		At December 31,
		2017				2016				2015
		(In thousands)
Classified assets:
Substandard loans		$	8,529			$	11,709			$	4,052
Substandard ORE			-				-				306
Substandard assets			8,529				11,709				4,358
Doubtful			550				296				354
Loss			-				-				-
Total classified assets		$	9,079			$	12,005			$	4,712
Special mention		$	955			$	856			$	2,105

 

 

Allowance for Loan Losses. The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of probable credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by full and partial charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management’s periodic evaluation of the adequacy of the allowance is based on the current level of net loan losses, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, and current economic conditions.

 

 

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

 

 

	Years Ended								Six Months Ended				Years Ended
	December 31,								December 31, (1)				June 30,
	2017		2016		2015		2014		2014		2013		2014		2013
	(Dollars in thousands)
Balance at beginning of period	$               2,506		$               1,894		$               1,707		$               1,733		$               1,645		$               1,824		$               1,824		$               2,437
Provision for (credit to) loan losses	575		1,019		694		50		50		-		-		(121)
Charge-offs:
One- to four-family residential real   estate loans	(21)		(141)		(339)		(101)		(14)		-		(86)		(111)
Commercial real estate loans	-		-		-		-		-		(76)		(76)		(383)
Commercial and industrial loans	-		(384)		(359)		-		-		-		-		-
Consumer and other loans	-		-		-		(33)		(1)		(16)		(48)		(187)
Total charge-offs	(21)		(525)		(698)		(134)		(15)		(92)		(210)		(681)
Recoveries:
One- to four-family residential real   estate loans	25		2		3		26		26		-		-		46
Commercial real estate loans	1		116		183		30		-		-		30		66
Commercial and industrial loans	31		-		-		-		-		-		-		-
Consumer and other loans	-		-		-		2		1		1		1		77
Total recoveries	57		118		186		58		27		1		31		189
Net (charge-offs) recoveries	36		(407)		(512)		(76)		12		(91)		(179)		(492)
Balance at end of period	$               3,117		$               2,506		$               1,889		$               1,707		$               1,707		$               1,733		$               1,645		$               1,824
Allowance for loan losses to
nonperforming loans	57.33%		41.99%		102.71%		209.50%		209.50%		288.83%		371.33%		242.23%
Allowance for loan losses to
total loans	1.19%		1.03%		0.97%		0.97%		0.97%		1.85%		1.77%		2.00%
Allowance for loan losses to
total loans less acquired loans	1.29%		1.19%		1.28%		1.50%		1.50%		1.85%		1.77%		2.00%
Net (charge-offs) recoveries to
average loans outstanding
during the period	0.01%		(0.20)%		(0.25)%		(0.06)%		0.02%		(0.19)%		(0.18)%		(0.45)%

 

 

 

______________________

(1)

Ratios for the six month periods have been annualized.

 

The ratio of our allowance for loan losses to nonperforming loans increased in the year ended December 31, 2017 due to the 24.4% increase in the allowance for loan losses and the 8.9% decrease in nonperforming loans, and decreased during the year ended December 31, 2016 due primarily to the increase in nonperforming loans.

 

 

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

 

		At December 31,
		2017								2016								2015								2014
		Allowance for Loan Losses				Percent of Loans in Each Category to Total Loans				Allowance for Loan Losses				Percent of Loans in Each Category to Total Loans				Allowance for Loan Losses				Percent of Loans in Each Category to Total Loans				Allowance for Loan Losses				Percent of Loans in Each Category to Total Loans
										(Dollars in thousands)
One- to four-family residential real estate loans		$	567				11.1	%		$	618				12.2	%		$	656				16.1	%		$	388				18.7	%
Commercial real estate loans			2,056				82.0	%			1,689				80.0	%			1,136				75.3	%			1,125				73.7	%
Commercial and industrial loans			462				4.7	%			147				4.0	%			64				5.3	%			178				4.9	%
Consumer and other loans			32				2.2	%			52				3.8	%			38				3.3	%			16				2.7	%
Total allocated allowance		$	3,117				100.0	%		$	2,506				100.0	%		$	1,894				100.0	%		$	1,707				100.0	%

 

 

		At June 30,
		2014								2013
		Allowance for Loan Losses				Percent of Loans in Each Category to Total Loans				Allowance for Loan Losses				Percent of Loans in Each Category to Total Loans
		(Dollars in thousands)
One- to four-family residential real estate loans		$	375				36.6	%		$	196				42.1	%
Commercial real estate loans			1,126				59.3	%			1,568				52.6	%
Commercial and industrial loans			129				3.0	%			55				3.7	%
Consumer and other loans			15				1.1	%			5				1.6	%
Total allocated allowance		$	1,645				100.0	%		$	1,824				100.0	%

 

Investments

 

Our investment policy is established by our Board of Directors. The policy emphasizes safety of the investment, liquidity requirements, potential returns, cash flow targets, and consistency with our interest rate risk management strategy.

 

 

The following table sets forth the amortized cost and estimated fair value of our available-for-sale securities portfolio at the dates indicated.

 

		At December 31,
		2017								2016								2015
		Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value				Amortized Cost				Estimated Fair Value
		(Dollars in thousands)
Mortgage-backed securities (1)		$	21,029			$	20,769			$	27,525			$	27,128			$	23,450			$	23,271
Agency securities			2,007				1,958				2,589				2,526				3,498				3,459
Municipal obligations			1,672				1,673				1,837				1,845				1,899				1,901
Total		$	24,708			$	24,400			$	31,951			$	31,499			$	28,847			$	28,631

 

______________________

(1)

Includes Freddie Mac, Ginnie Mae and Fannie Mae.

 

 

At December 31, 2017, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies, in an amount greater than 10% of stockholders’ equity.

  

Portfolio Maturities and Yields. The composition and maturities of the securities portfolio at December 31, 2017, are summarized in the following table. Maturities are based on the final contractual payment dates, and do not reflect the effect of scheduled principal repayments, prepayments, or early redemptions that may occur. Tax-equivalent yield adjustments have not been made for tax-exempt securities, as the effect thereof was not material.

 

 

		One Year or Less								More than One Year Through Five Years								More than Five Years Through Ten Years								More Than Ten Years								Total
		Amortized Cost				Weighted Average Yield				Amortized Cost				Weighted Average Yield				Amortized Cost				Weighted Average Yield				Amortized Cost				Weighted Average Yield				Amortized Cost				Estimated Fair Value				Weighted Average Yield
		(Dollars in thousands)
Mortgage-backed securities (1)		$	-				-	%		$	19,150				2.10	%		$	1,879				2.16	%		$	-				-	%		$	21,029			$	20,769				2.10	%
Agency securities			-				-	%			2,007				2.08	%			-				-	%			-				-	%			2,007				1,958				2.08	%
Municipal obligations			1,254				2.63	%			418				2.33	%			-				-	%			-				-	%			1,672				1,673				2.56	%
		$	1,254				2.63	%		$	21,575				2.10	%		$	1,879				2.16	%		$	-				-	%		$	24,708			$	24,400				2.13	%

 

__________________

(1) Includes Freddie Mac, Ginnie Mae and Fannie Mae.

 

 

 

Sources of Funds

 

General. Deposits traditionally have been our primary source of funds for use in lending and investment activities. We also use Federal Home Loan Bank of Dallas advances to supplement cash flow needs, lengthen the maturities of liabilities, for interest rate risk purposes and to manage the cost of funds. Funds are also derived from scheduled loan payments, securities maturities, loan prepayments, loan sales, and income on earning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widely and are influenced by prevailing interest rates, market conditions and levels of competition.

 

 

Deposits. The following tables set forth the distribution of average total deposits by type, for the periods indicated.

 

		For the Years Ended December 31,
		2017												2016												2015
		Average Balance				Percent				Weighted Average Rate				Average Balance				Percent				Weighted Average Rate				Average Balance				Percent				Weighted Average Rate
		(Dollars in thousands)
Deposit Type:
Non-interest bearing		$	44,285				18.7	%			-	%		$	37,200				16.3	%			-	%		$	24,570				11.8	%			-	%
Checking			26,521				11.2	%			0.49	%			31,275				13.7	%			0.43	%			30,080				14.5	%			0.50	%
Money market			96,751				40.9	%			0.94	%			87,387				38.2	%			0.88	%			63,298				30.5	%			0.84	%
Savings			5,545				2.4	%			0.15	%			5,878				2.6	%			0.12	%			11,420				5.5	%			0.34	%
Certificates of deposit			63,406				26.8	%			1.07	%			67,097				29.2	%			0.84	%			78,091				37.7	%			0.84	%
Total deposits		$	236,508				100.0	%			0.78	%		$	228,837				100.0	%			0.77	%		$	207,459				100.0	%			0.50	%

 

 

As of December 31, 2017, the aggregate amount of all our certificates of deposit in amounts greater than or equal to $250,000 was $12.5 million. The $12.5 million excludes $10.0 million of brokered certificates of deposit as an individual investor only invests in $1,000 increments up to the $250,000 insured limit. The following table sets forth the maturity of these certificates of deposit as of December 31, 2017:

 

		At December 31, 2017
		(In thousands)
Three months or less		$	2,000
Over three through six months			4,633
Over six through twelve months			3,681
Over twelve months			2,216
Total		$	12,530

 

 

Borrowings. As of December 31, 2017, 2016 and 2015 our borrowings consisted solely of Federal Home Loan Bank of Dallas advances. The following table sets forth information concerning balances and interest rates on our Federal Home Loan Bank advances at the dates and for the periods indicated.

 

		At or For the Years Ended
		December 31,
		2017				2016				2015
		(Dollars in thousands)
Average amount outstanding during the period		$	55,984			$	32,894			$	20,196
Highest amount outstanding at any month end during the period		$	67,000			$	75,000			$	30,000
Weighted average interest rate during the period			1.07	%			0.68	%			0.31	%
Balance outstanding at end of period		$	45,000			$	50,000			$	13,000
Weighted average interest rate at end of period			1.26	%			0.79	%			0.41	%

 

Management of Market Risk

 

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our board of directors has established an Asset/Liability Management Committee, which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Senior management monitors the level of interest rate risk on a regular basis and the Asset/Liability Management Committee reviews our asset/liability policies and position and the implementation of interest rate risk strategies.

 

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk:

 

	●	forward commitments are used to mitigate our exposure to interest rate risk associated with interest rate lock commitments and mortgage loans held for sale in our mortgage banking operation;
	●	offering a variety of adjustable rate loan products;

 

●

using alternate funding sources, such as advances from the Federal Home Loan Bank of Dallas and brokered deposits;

 

●

maintaining pricing strategies that encourage “core” deposits; and

 

●

selling longer-term, fixed rate loans into the secondary market.

 

 By following these strategies, we believe that we are better positioned to react to increases in market interest rates.

 

Economic Value of Equity. We monitor interest rate risk through the use of a simulation model that estimates the amounts by which the fair value of our assets and liabilities (our economic value of equity or “EVE”) would change in the event of a range of assumed changes in market interest rates. The quarterly reports developed in the simulation model assist us in identifying, measuring, monitoring and controlling interest rate risk to ensure compliance within our policy guidelines.

 

 

The tables below set forth, as of December 31, 2017 and 2016, the estimated changes in our EVE that would result from the designated instantaneous changes in market interest rates. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.

 

 

December 31, 2017													December 31, 2016
Change in													Change in
Interest						Estimated Increase							Interest						Estimated Increase
Rates		Estimated				(Decrease) in EVE							Rates		Estimated				(Decrease) in EVE
(basis points)(1)		EVE (2)				Amount				Percent			(basis points)(1)		EVE (2)				Amount				Percent
(Dollars in thousands)
+300		$	50,707			$	(5,656	)			-10.03	%	+300		$	38,165			$	(3,895	)			-9.26	%
+ 200			53,206				(3,157	)			-5.60	%	+ 200			40,073				(1,987	)			-4.72	%
+ 100			55,071				(1,292	)			-2.29	%	+ 100			41,328				(732	)			-1.74	%
-			56,363										-			42,060				-				-
-100			55,563				(800	)			-1.42	%	-100			40,838				(1,222	)			-2.91	%

 

______________________

 

(1)

Assumes an instantaneous uniform change in interest rates at all maturities.

(2)

EVE is the discounted present value of expected cash flows from assets, liabilities and off-balance sheet contracts.

 

The table above indicates that at December 31, 2017, in the event of a 100 basis point decrease in interest rates, we would experience a 1.42% decrease in EVE. In the event of a 200 basis point increase in interest rates at December 31, 2017, we would experience a 5.60% decrease in EVE. At December 31, 2016, in the event of a 100 basis point decrease in interest rates, we would have experienced a 2.91% decrease in EVE. In the event of a 200 basis point increase in interest rates at December 31, 2016, we would have experienced 4.72% increase in EVE.

 

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

 

EVE calculations also may not reflect the fair values of financial instruments. For example, decreases in market interest rates can increase the fair values of our loans, deposits and borrowings.

 

Liquidity and Capital Resources

 

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

 

We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits with other banks and short- and intermediate-term securities.

 

 

We believe that we have enough sources of liquidity to satisfy our short- and long-term liquidity needs as of December 31, 2017.

 

Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2017, cash and cash equivalents totaled $9.9 million. Available-for-sale securities, which provide additional sources of liquidity, totaled $24.4 million at December 31, 2017. In addition, at December 31, 2017, we had $45.0 million of advances outstanding from the Federal Home Loan Bank of Dallas and the ability to borrow an additional $92.3 million from the FHLB, $9.8 million from The Independent BankersBank (TIB) and $6.0 million from the Pacific Coast Bankers Bank (PCBB).

 

At December 31, 2017, we had $64.6 million in loan commitments outstanding, of which $13.9 million is for construction loans, and $27.4 million is commitments to originate and sell loans held for sale. In addition to commitments to originate loans, we had $13.6 million in unused lines of credit.

 

Time deposits due within one year of December 31, 2017 totaled $31.9 million, or 50.6% of total time deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and Federal Home Loan Bank advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2017. We believe, however, based on past experience that a significant portion of our certificates of deposit will remain with us, either as certificates of deposit or as other deposit products. We expect that we will be able to attract and retain deposits by adjusting the interest rates offered.

 

We have no material commitments or demands that are likely to affect our liquidity other than set forth above. In the event loan demand were to increase at a pace greater than expected, or any unforeseen demand or commitment were to occur, we would access our borrowing capacity with the Federal Home Loan Bank of Dallas.

 

During the year ended December 31, 2017 net cash provided by operating activities was $15.4 million representing net income adjusted for non-cash items. The largest outgoing cash flow was $254.3 million in funding of loans held for sale and the largest cash inflow was the $276.3 million in proceeds from sales of loans held for sale.

 

Our primary investing activities are the origination of loans and the purchase of securities. In the years ended December 31, 2017 and 2016, we originated $373.7 million and $391.5 million of loans and purchased $6.1 million and $10.4 million of securities, respectively. We have not purchased any whole loans in recent periods.

 

Financing activities consist primarily of activity in deposit accounts and Federal Home Loan Bank advances. We experienced a net increase in total deposits of $11.0 million during the year ended December 31, 2017 due primarily to the increase in savings and NOW deposits.  Federal Home Loan Bank advances decreased $5.0 million during the year ended December 31, 2017.

 

Bank 34 is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning balance sheet assets and off-balance sheet items to broad risk categories. At December 31, 2017, Bank 34 exceeded all regulatory capital requirements. Bank 34 is categorized as “well-capitalized” under regulatory guidelines.

 

The $15.9 million net proceeds from the October 2016 stock offering significantly increased our liquidity and capital resources.  Over time, the initial level of liquidity has been reduced as net proceeds from the stock offering have been for general corporate purposes, including funding loans.  Our financial condition and results of operations have been enhanced by the net proceeds from the stock offering through higher net interest-earning assets and net interest income.  However, due to the increase in equity resulting from the net proceeds raised in the stock offering, as well as other factors associated with the stock offering, our return on equity has been adversely affected by the stock offering.

 

 

Off-Balance Sheet Arrangements and Contractual Obligations

 

Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. In addition, we enter into commitments to sell mortgage loans. For additional information, see Note 11 of the Notes to the Consolidated Financial Statements.

 

Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment, agreements with respect to borrowings and deposits and agreements with respect to securities.

 

Derivative Financial Instrument. We use forward commitments to mitigate our exposure to interest rate risk associated with interest rate lock commitments and mortgage loans held for sale in our mortgage banking operation.

 

 

Recent Accounting Pronouncements

 

For recent accounting pronouncements see Note 1 of the Notes to the Consolidated Financial Statements.

 

Impact of Inflation and Changing Prices

 

The consolidated financial statements and related notes of Bancorp 34, Inc. have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). U.S. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.

 

ITEM 7A.

Quantitative and Qualitative Disclosures About Market Risk

 

For information regarding market risk, see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”.

 

 

ITEM 8.

Financial Statements and Supplementary Data

 

 

CONTENTS

 

		Page
Management's Report on Internal Control over Financial Reporting		51
Reports of Independent Registered Public Accounting Firms		52
Consolidated Balance Sheets		54
Consolidated Statements of Comprehensive Income (Loss)		55
Consolidated Statements of Changes in Stockholders’ Equity		56
Consolidated Statements of Cash Flows		57
Notes to Consolidated Financial Statements		58

 

 

Management’s Report on Internal Control over Financial Reporting

 

Management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Securities Exchange Act of 1934.

 

Management, including the principal executive officer and principal financial officer, has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2017.  In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal control — Integrated Framework (2013).  Based on such assessment, management concluded that, as of December 31, 2017, the Company’s internal control over financial reporting is effective based upon those criteria.

 

Because the Company is a smaller reporting company, it is not required to receive, and has not received, a report with respect to the effectiveness of internal control over financial reporting from an independent registered public accounting firm.

 

/s/ Jill Gutierrez		/s/ Jan R. Thiry
Jill Gutierrez		Jan R. Thiry
Chief Executive Officer		Executive Vice President, Chief Financial Officer & Treasurer

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

 

To the Stockholders and the Board of Directors of

Bancorp 34, Inc.

 

Opinion on the Financial Statements

 

We have audited the accompanying consolidated balance sheet of Bancorp 34, Inc. (the “Company”) as of December 31, 2017, the related consolidated statements of comprehensive income, changes in stockholders’ equity, and cash flows for the year then ended, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2017, and the consolidated results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

 

Basis for Opinion

 

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audit. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

 

We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

 

Our audit included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures to respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audit provides a reasonable basis for our opinion.

 

 

/s/ Moss Adams LLP

Scottsdale, Arizona

March 14, 2018

 

We have served as the Company’s auditor since 2017.

 

 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

 

 

 

 

 

To the Board of Directors and Stockholders of

Bancorp 34, Inc.

Alamogordo, New Mexico

 

 

We have audited the accompanying consolidated balance sheet of Bancorp 34, Inc. (the “Company”) as of December 31, 2016, and the related consolidated statement of comprehensive income, stockholders’ equity, and cash flows for the year then ended. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 31, 2016, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

 

 

 

/s/ Briggs & Veselka Co.

Houston, Texas

 

March 22, 2017

 

 

 

BANCORP 34, INC.

CONSOLIDATED BALANCE SHEETS

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

BANCORP 34, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

BANCORP 34, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

 

 

The accompanying notes are an integral part of these consolidated financial statements.

 

 

 

BANCORP 34, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

The accompanying notes are an integral part of these consolidated financial statements. 

 

 

Bancorp 34, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

---

 

ITEM 9.

Changes In and Disagreements With Accountants on Accounting and Financial Disclosure

 

None.

 

ITEM 9A.

Controls and Procedures

 

Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, the principal executive officer and principal financial officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.   There were no changes made in our internal controls during the quarter ended December 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.   See Management’s Report On Internal Control Over Financial Reporting - filed herewith under Part II, Item 8, “Financial Statements and Supplementary Data.”

 

 

 

ITEM 9B.

Other Information

 

None.

 

PART III

 

ITEM 10.

Directors, Executive Officers and Corporate Governance

 

Bancorp 34, Inc. has adopted a Code of Ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. A copy of the Code is available on Bancorp 34, Inc.’s website at www.Bank34.com under “About Bank 34 – Investor Relations.”

 

The information contained under the sections captioned “Proposal I – Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive Proxy Statement for the 2018 Annual Meeting of Stockholders (The “Proxy Statement”) is incorporated herein by reference or will be filed by amendment to this Annual Report on Form 10-K.

 

ITEM 11.

Executive Compensation

 

The information contained under the section captioned “Executive Compensation” in the definitive Proxy Statement is incorporated herein by reference or will be filed by amendment to this Annual Report on Form 10-K.

 

 

ITEM 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

(a)

Securities Authorized for issuance under Stock-Based Compensation Plans

 

Set forth below is information as of December 31, 2017 with respect to compensation plans (other than our employee stock ownership plan) under which equity securities of the Registrant are authorized for issuance. Other than our Employee Stock Ownership Plan, we do not have any equity compensation plans that were not approved by our stockholders. Equity compensation plans approved by stockholders consist of our 2001 Stock Option Plan and our 2017 Equity Incentive Plan.

 

Equity Compensation Plan Information
		Number of securities to be issued upon exercise of outstanding options, warrants and rights				Weighted-average exercise price of outstanding options, warrants and rights				Number of securities remaining available for future issuance under stock-based compensation plans (excluding securities reflected in first column)
Equity compensation plans approved by security holders			207,108			$	14.18				9,727
Equity compensation plans not approved by security holders			N/A				N/A				N/A
Total			207,108			$	14.18				9,727

 

 

(b)

Security Ownership of Certain Beneficial Owners

 

The information required by this item is incorporated herein by reference to the section captioned “Voting Securities and Principal Holders” in the Proxy Statement or will be filed by amendment to this Annual Report on Form 10-K.

 

(c)

Security Ownership of Management

 

The information required by this item is incorporated herein by reference to the section captioned “Proposal I – Election of Directors” in the Proxy Statement or will be filed by amendment to this Annual Report on Form 10-K.

 

(d)

Changes in Control

 

Management of the Company know of no arrangements, including any pledge by any person of securities of the Company, the operation of which may at a subsequent date result in a change in control of the registrant.

 

ITEM 13.

Certain Relationships and Related Transactions, and Director Independence

 

The information required by this item is incorporated herein by reference to the section captioned “Proposal I – Election of Directors – Certain Relationships and Related Transactions” of the Proxy Statement or will be filed by amendment to this Annual Report on Form 10-K.

 

ITEM 14.

Principal Accountant Fees and Services

 

The information required by this item is incorporated herein by reference to the section captioned “Proposal II – Ratification of Appointment of Independent Registered Public Accounting Firm” of the Proxy Statement or will be filed by amendment to this Annual Report on Form 10-K.

 

 

PART IV

 

ITEM 15.

Exhibits and Financial Statement Schedules

 

3.1	Articles of Incorporation of Bancorp 34, Inc. (1)

3.2	Bylaws of Bancorp 34, Inc. (1)

4	Form of Common Stock Certificate of Bancorp 34, Inc. (1)

10.1	Amended and Restated Employee Stock Ownership Plan, including amendments (2) †

10.2	Deferred Compensation Agreement with Jill Gutierrez (3) †

10.3	Deferred Compensation Plan Agreement with Jan R. Thiry (3) †

10.4	Deferred Compensation Plan Agreement with William P. Kauper (3) †

10.5	Split Dollar Life Insurance Agreement with Jill Gutierrez (3) †

10.6	Form of Director Retirement Agreement, as amended (3) †

10.7	Form of Director Split Dollar Life Insurance Agreement (3) †

10.8	Alamogordo Financial Corp. 2001 Stock Option Plan (4) †

10.9	Alamogordo Financial Corp. 2001 Recognition and Retention Plan (4) †

10.10

Form of Amendment to Deferred Compensation Plan Agreement with Jill Gutierrez, Jan R. Thiry and William P. Kauper (5) †

10.11

Director Deferred Fee Plan (6) †

10.12

Retention Bonus Agreement with Jan R. Thiry (7) †

10.13

Employment Agreement By and Between Bancorp 34, Inc. and Jill Gutierrez (8) †

10.14

Employment Agreement By and Between Bancorp 34, Inc. and William P. Kauper (9) †

10.15

Employment Agreement By and Between Bancorp 34, Inc. and Jan R. Thiry (10) †

10.16

Employment Agreement By and Between Bank 34 and Jill Gutierrez (11) †

10.17

Employment Agreement By and Between Bank 34 and William P. Kauper (12) †

10.18

Employment Agreement By and Between Bank 34 and Jan R. Thiry (13) †

10.19

Bancorp 34, Inc. 2017 Equity Incentive Plan (14) †

10.20

Form of Incentive Stock Option Award Agreement (15) †

10.21

Form of Non-Qualified Stock Option Award Agreement (16) †

10.22

Form of Restricted Stock Award Agreement (17) †

21	Subsidiaries of Registrant

23.1	Consent of Moss Adams LLP

23.2	Consent of Briggs & Veselka Co.

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

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

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

101

The following materials from the Company’s Annual Report on Form 10-K, formatted in XBRL:  (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Comprehensive Income (Loss), (iii) the Consolidated Statements of Changes in Stockholders’ Equity, (iv) the Consolidated Statements of Cash Flows and (v) the Notes to the Consolidated Financial Statements

_______________________________

†	Management contract or compensation plan or arrangement.

(1)	Incorporated by reference to the Registration Statement on Form S-1 of Bancorp 34, Inc. (File No. 333-21182), initially filed with the Securities and Exchange Commission on June 3, 2016.

(2)	Incorporated by reference to Exhibit 10.1 to Alamogordo Financial Corp.’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 000-29655) as filed with the Securities and Exchange Commission on March 28, 2016.

(3)	Incorporated by reference to the Registration Statement on Form S-4 of Alamogordo Financial Corp. (File No. 333-192233), originally filed with the Securities and Exchange Commission on November 8, 2013, as amended.

 

 

(4)	Incorporated by reference to the exhibits to Alamogordo Financial Corp.’s Definitive Proxy Statement for the Special Meeting of Stockholders (File No. 000-29655) as filed with the Securities and Exchange Commission on May 29, 2001.

(5)	Incorporated by reference to Exhibit 10.1 to Alamogordo Financial Corp.’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2015 (File No. 000-29655) as filed with the Securities and Exchange Commission on July 30, 2015.

(6)	Incorporated by reference to Exhibit 10.11 to Alamogordo Financial Corp.’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 000-29655) as filed with the Securities and Exchange Commission on March 28, 2016.

(7)	Incorporated by reference to Exhibit 10.12 to Alamogordo Financial Corp.’s Annual Report on Form 10-K for the year ended December 31, 2015 (File No. 000-29655) as filed with the Securities and Exchange Commission on March 28, 2016.

(8)	Incorporated by reference to Exhibit 10.13 to Bancorp 34, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016 (File No. 001-37912) as filed with the Securities and Exchange Commission on March 23, 2017.

(9)	Incorporated by reference to Exhibit 10.14 to Bancorp 34, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016 (File No. 001-37912) as filed with the Securities and Exchange Commission on March 23, 2017.

(10)	Incorporated by reference to Exhibit 10.15 to Bancorp 34, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016 (File No. 001-37912) as filed with the Securities and Exchange Commission on March 23, 2017.

(11)	Incorporated by reference to Exhibit 10.16 to Bancorp 34, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016 (File No. 001-37912) as filed with the Securities and Exchange Commission on March 23, 2017.

(12)	Incorporated by reference to Exhibit 10.17 to Bancorp 34, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016 (File No. 001-37912) as filed with the Securities and Exchange Commission on March 23, 2017.

(13)	Incorporated by reference to Exhibit 10.18 to Bancorp 34, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2016 (File No. 001-37912) as filed with the Securities and Exchange Commission on March 23, 2017.

(14)	Incorporated by reference to Appendix A to Bancorp 34, Inc.’s definitive proxy statement for the Annual Meeting of Stockholders (File No. 001-37912) as filed with the Securities and Exchange Commission on October 13, 2017.

(15)	Incorporated by reference to Exhibit 10.1 to Bancorp 34, Inc.’s Current Report on Form 8-K (File No. 001-37912) as filed with the Securities and Exchange Commission on December 8, 2017.

(16)	Incorporated by reference to Exhibit 10.2 to Bancorp 34, Inc.’s Current Report on Form 8-K (File No. 001-37912) as filed with the Securities and Exchange Commission on December 8, 2017.

(17)	Incorporated by reference to Exhibit 10.3 to Bancorp 34, Inc.’s Current Report on Form 8-K (File No. 001-37912) as filed with the Securities and Exchange Commission on December 8, 2017.

 

ITEM 16.          Form 10-K Summary

 

Not applicable

 

 

SIGNATURES

 

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

 

			BANCORP 34, INC.
Date: March 14, 2018		By:	/s/ Jill Gutierrez
			Jill Gutierrez
			Chief Executive Officer and Director
			(Duly Authorized Representative)

 

Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

 

Signatures		Title		Date
/s/ Jill Gutierrez		Chief Executive Officer		March 14, 2018
Jill Gutierrez		and Director (Principal Executive
		Officer)
/s/ Jan R. Thiry		Executive Vice President, Chief		March 14, 2018
Jan R. Thiry		Financial Officer and Treasurer
		(Principal Financial and
		Accounting Officer)
/s/ William F. Burt		Vice Chairman		March 14, 2018
William F. Burt
/s/ Wortham A. (Pete) Cook		Director		March 14, 2018
Wortham A. (Pete) Cook
/s/ James D. Harris		Director		March 14, 2018
James D. Harris
/s/ Randal L. Rabon		Chairman		March 14, 2018
Randal L. Rabon
/s/ Elaine E. Ralls		Director		March 14, 2018
Elaine E. Ralls

 

/s/ Don P. Van Winkle		Director		March 14, 2018
Don P. Van Winkle

 

98