UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

 

Commission File Number: 001-37780

 

Randolph Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

(781) 963-2100

(Registrant's telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

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

 

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

 

 

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

 

Emerging growth company ☒

 

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

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

As of November 2, 2018 there were 5,952,919 shares of the registrant’s common stock outstanding.

 

 

 

 

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Table of Contents

 

 

 

 

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PART I—FINANCIAL INFORMATION

Item 1.  Financial Statements

RANDOLPH BANCORP, INC. AND SUBSIDIARY

Consolidated Balance Sheets (Unaudited)

(In thousands except for share data)

 

 

See accompanying notes to consolidated financial statements.

 

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RANDOLPH BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Operations (Unaudited)

(Dollars in thousands except per share amounts)

 

 

See accompanying notes to consolidated financial statements.

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RANDOLPH BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

(In thousands)

 

 

 

See accompanying notes to consolidated financial statements.

 

 

 

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RANDOLPH BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Changes in Stockholders’ Equity (Unaudited)

Nine months ended September 30, 2018 and 2017

 

 

See accompanying notes to consolidated financial statements.

 

 

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RANDOLPH BANCORP, INC. AND SUBSIDIARY

Consolidated Statements of Cash Flows (Unaudited)

(In thousands)

 

 

See accompanying notes to consolidated financial statements.

 

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RANDOLPH BANCORP, INC. AND SUBSIDIARY

Notes to Unaudited Consolidated Financial Statements

September 30, 2018 and 2017

 

The consolidated financial statements include the accounts of Randolph Bancorp, Inc. (“Bancorp”) and its wholly-owned subsidiary, Envision Bank (the “Bank”, together with Bancorp, the “Company”). The Bank has subsidiaries involved in owning investment securities and foreclosed real estate properties and a subsidiary which provides loan closing services. All intercompany accounts and transactions have been eliminated in consolidation.

These financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim financial reporting and with the instructions to Form 10-Q and Article 10 of Regulation S-X issued by the Securities and Exchange Commission (“SEC”). Accordingly, the accompanying interim financial statements do not include all information required under GAAP for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation of the financial statements, primarily consisting of normal recurring adjustments, have been included. The operating results for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018 or any other interim period.

Prior to 2018, the Company’s operations were managed, and financial performance was evaluated, by the chief operating decision-maker on a company-wide basis. As a result, management had determined there to be a single business segment for financial reporting purposes through December 31, 2017. Due to the significance of the Company’s mortgage banking operations and the strategic focus on this business, management prepared its 2018 operating budget by breaking-out its mortgage banking activities, including residential loan origination and loan servicing. As a result, effective January 1, 2018, the Company is reporting two business segments, namely, “Envision Bank” and “Envision Mortgage”. As part of this process, management analyzed costs incurred by departments providing services to both segments (indirect costs), such as IT, Marketing, Accounting and Administration, to determine the allocation of indirect costs to each business segment in order to fully measure each segment’s results of operations. See Note 15 for disclosure of the Company’s segment information.

For further information, refer to the consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the SEC.

 

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers. This Update provides a revenue recognition framework for any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of non-financial assets unless those contracts are within the scope of other accounting standards. This ASU, as amended by ASU 2015-14, is effective for emerging growth companies in fiscal years beginning after December 15, 2018, including interim periods therein with early adoption permitted. The timing of the Company’s revenue recognition is not expected to materially change. The Company's revenue relates principally to financial instruments, which are explicitly excluded from the scope of the new guidance. Management continues to evaluate the potential impact of this ASU on the Company’s consolidated financial statements but does not anticipate, at this time, that adoption of this standard will have a significant impact.

In January 2016, FASB issued ASU 2016-01, Financial Instruments. This ASU revises the accounting related to the classification and measurement of investments in equity securities, and the presentation of certain fair value changes for financial liabilities measured at fair value. It also amends certain disclosure requirements associated with the fair value of financial instruments. This ASU is effective for emerging growth companies for annual periods beginning after December 31, 2018, including interim periods therein. The Company is currently assessing the impact of this ASU on the consolidated financial statements.

In February 2016, FASB issued ASU 2016-02, Leases. This ASU requires lessees to put most leases on their balance sheets but recognize expenses on their income statements in a manner similar to current accounting requirements. For lessors, this ASU modifies the classification criteria and the accounting for sales-type and direct financing leases. This ASU is effective for emerging growth companies in fiscal years beginning after December 15, 2019, including interim periods therein. Earlier adoption is permitted. The Company is currently assessing the impact of the adoption of this ASU on its consolidated balance sheet.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses. The ASU sets forth a “current expected credit loss” (“CECL”) model which requires the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable and supportable forecasts. This replaces the existing probable incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and

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applies to some off-balance sheet credit exposures. This ASU requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgements used in determining the allowance for loan losses, as well as the credit quality and underwriting standards of an organization’s loan portfolio. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. This ASU is effective for emerging growth companies in fiscal years beginning after December 15, 2020, including interim periods therein. Early adoption is permitted in fiscal years beginning after December 31, 2018. The Company is currently assessing its data and system needs and is evaluating the impact of the adoption of this ASU on the consolidated financial statements.

In April 2017, the FASB issued ASU 2017-08 Receivables – Non-refundable Fees and Other Costs, which shortens the period of amortization of the premium on certain callable debt securities to the earliest call date. Currently, generally accepted accounting principles (“GAAP”) excludes certain callable debt securities from consideration of early repayment of principal even if the holder is certain that the call will be exercised. As a result, upon the exercise of a call on a callable debt security held at a premium, the unamortized premium is recorded as a loss in earnings. This ASU requires that premiums on certain callable debt securities be amortized to the shortest call date. Securities within the scope of this paragraph are those that have explicit, noncontingent call features that are callable at fixed prices and on preset dates. This ASU is effective for emerging growth companies for annual periods beginning after December 15, 2019, including interim periods therein. Early adoption is permitted, including adoption in an interim period. The impact of adopting this ASU is dependent on the materiality of callable debt securities at the time of adoption.

In August 2018, the FASB issued ASU 2018-13 Fair Value Measurement – Changes to the Disclosure Requirements for Fair Value Measurement, which removes the disclosure requirements for transfers between Levels 1 and 2 of the fair value hierarchy, the policy for timing of transfers between levels of the fair value hierarchy and the valuation processes for Level 3 fair value measurements. This ASU also adds disclosure requirements for the changes in unrealized gains and losses included in other comprehensive income for recurring Level 3 fair value measurements and the range and weighted average of significant unobservable inputs used to develop Level 3 measurements. This ASU is effective for emerging growth companies for annual periods beginning after December 15, 2019, including interim periods therein. Early adoption is permitted, including adoption in an interim period. The Company is currently assessing the impact of this ASU on the consolidated financial statements.

 

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net loss. Although certain changes in assets and liabilities are reported as a separate component of stockholders’ equity, such items, along with net loss, are components of comprehensive loss.

The components of accumulated other comprehensive loss, included in total stockholders’ equity, are as follows:

 

 

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The amortized cost and fair value of securities available for sale, including gross unrealized gains and losses, are as follows:

 

 

For the nine months ended September 30, 2018, proceeds from sales of available-for-sale securities amounted to $9.0 million with gross realized gains of $49,000 and no gross realized losses.

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The amortized cost and fair value of debt securities by contractual maturity at September 30, 2018 are presented below.  Expected maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

Information pertaining to securities with gross unrealized losses, aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:

 

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At September 30, 2018, 41 debt securities have unrealized losses with aggregate depreciation of 4.64% from the Company’s amortized cost basis. The unrealized losses at September 30, 2018, which related primarily to securities issued by U.S. government-sponsored enterprises, were primarily caused by interest rate increases. The Company currently does not believe it is probable that it will be unable to collect all amounts due according to the contractual terms of these investments. Therefore, it is expected that the securities would not be settled at a price less than the par value of the investment. Because the Company does not intend to sell any debt securities and it is more likely than not that the Company will not be required to sell any debt securities before recovery of its amortized cost basis, it does not consider these investments to be other-than-temporarily impaired at September 30, 2018.

A summary of loans held for investment at the dates indicated is as follows:

 

 

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The following table summarizes the changes in the allowance for loan losses by portfolio segment for the three and nine months ended September 30, 2018 and 2017:

 

 

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Additional information pertaining to the allowance for loan losses at September 30, 2018 and December 31, 2017 is as follows:

 

 

The following is a summary of past due and non-accrual loans at September 30, 2018 and December 31, 2017:

 

 

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The following is a summary of impaired loans at September 30, 2018 and December 31, 2017:

 

 

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Additional information pertaining to impaired loans follows:

 

 

No additional funds are committed to be advanced in connection with impaired loans.

Troubled Debt Restructurings

The Company periodically grants concessions to borrowers experiencing financial difficulties. The Company’s troubled debt restructurings consist primarily of interest rate concessions for periods of three months to thirty years for residential real estate loans, and for periods up to one year for commercial real estate loans.

At September 30, 2018, the Company had seventeen residential real estate loans and one commercial real estate loan aggregating $3,721,000 and $54,000, respectively, which were subject to troubled debt restructuring agreements.

At September 30, 2017, the Company had twenty residential real estate loans and two commercial real estate loan aggregating $4,382,000 and $185,000, respectively, which were subject to troubled debt restructuring agreements.

As of September 30, 2018 and 2017, $3,530,000 and $4,567,000, respectively, in troubled debt restructurings were performing in accordance with the terms of the modified loan agreements.  Included in such amounts are $369,000 and $1,139,000, respectively, that are being accounted for as non-accrual loans.

For the nine months ended September 30, 2018 the Company entered into one loan modification meeting the criteria of a troubled debt restructuring in which a loan term concession was granted to a borrower. For the nine months ended 2017, the Company did not enter into any loan modifications meeting the criteria of a troubled debt restructuring.

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Management performs a discounted cash flow calculation to determine the amount of valuation reserve required on each of the troubled debt restructurings.  Any reserve required is recorded as part of the allowance for loan losses. During the three and nine months ended September 30, 2018 and 2017, there were no material changes to the allowance for loan losses as a result of loan modifications made which were considered a troubled debt restructuring.

During the three and nine months ended September 30, 2018 and 2017, there were no troubled debt restructurings that defaulted (over 30 days past due) within twelve months of the restructure date.

Credit Quality Information

The Company utilizes an eight-grade internal loan rating system for commercial real estate, construction and commercial loans, as follows:

Loans rated 1 – 3B are considered “pass” rated loans with low to average risk.

Loans rated 4 are considered “special mention.”  These loans are starting to show signs of potential weakness and are being closely monitored by management.

Loans rated 5 are considered “substandard” and are inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged.  There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.

Loans rated 6 are considered “doubtful” and have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.

Loans rated 7 are considered uncollectible (“loss”) and of such little value that their continuance as loans is not warranted.

On an annual basis, or more often if needed, the Company formally reviews the ratings on all commercial real estate, construction and commercial and industrial loans.  Annually, the Company engages an independent third party to review a significant portion of loans within these segments.  Management uses the results of these reviews as part of its annual review process.

The following table presents the Company’s loans by risk rating at the dates indicated:

 

 

Residential mortgages, home equity loans and lines of credit, and consumer loans are monitored for credit quality based primarily on their payment status. When one of these loans becomes more than 90 days delinquent, it is assigned an internal loan rating.  At September 30, 2018, $51,000 in consumer loans were rated as doubtful, $699,000 in residential mortgages were rated as substandard, and $2,551,000 in residential mortgages and $243,000 in home equity loans were rated as special mention. At December 31, 2017, $712,000 in residential mortgages were rated as substandard, and $2,512,000 in residential mortgages and $247,000 in home equity loans were rated as special mention.  

 

Mortgage loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of residential mortgage loans serviced for others were $873,933,000 and $771,407,000 at September 30, 2018 and December 31, 2017, respectively.

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The following table summarizes the activity relating to mortgage servicing rights for the nine months ended September 30, 2018 and 2017 (in thousands):

 

 

 

 

During the nine months ended September 30, 2018 and 2017, the Company decreased the valuation allowance for its mortgage servicing rights by $84,000 and $134,000, respectively, due primarily to an increase in fair value caused by lower expected loan prepayments.

 

During the nine months ended September 30, 2018 and 2017, the Company recorded a deferred income tax benefit of $0 and $151,000, respectively, and current state tax expense of $14,000 and $3,000, respectively. The deferred income tax benefit for the 2017 period resulted from, and was limited to, an offsetting tax provision attributable to other comprehensive income, specifically, appreciation in the fair value of available-for-sale securities.

A deferred tax provision of $129,000 was recognized for the three months ended September 30, 2017, while no deferred tax provision or benefit was recognized for the three months ended September 30, 2018. The tax provision for the 2017 period resulted from a limitation in the year-to-date tax benefit included in the results of operations. This provision was fully offset by a tax benefit included in other comprehensive income.

Since 2014, the Company has maintained a valuation allowance for all of its net deferred tax assets based on a determination that it was more likely than not that such assets would not be realized. This determination was based on the Company’s net operating loss (“NOL”) carryforward position, its current period operating results exclusive of non-recurring items and its expectations for the upcoming year. In performing subsequent assessments, management has concluded that no significant changes in the key factors affecting the realizability of the deferred tax asset has occurred and that a valuation allowance for its net deferred tax assets should be maintained. The Company’s NOL carryforward at September 30, 2018 was $13.4 million. The tax valuation allowance at such date totaled $3.2 million.

 

Derivative Loan Commitments

Mortgage loan commitments qualify as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding.  The Company enters into commitments to fund residential mortgage loans at specified rates and times in the future, with the intention that these loans will subsequently be sold in the secondary market.

Outstanding derivative loan commitments expose the Company to the risk that the price of the loans arising from exercise of the loan commitment might decline from inception of the rate lock to funding of the loan due to an increase in mortgage interest rates.  If interest rates increase, the value of these loan commitments decreases.  Conversely, if interest rates decrease, the value of these loan commitments increases.  The notional amount of derivative loan commitments was $34,476,000 and $24,222,000 at September 30, 2018 and December 31, 2017, respectively.  The fair value of certain of these commitments was an asset of $419,000 and $363,000 as of September 30, 2018 and December 31, 2017, respectively, and is included in other assets in the consolidated balance sheets while

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the fair value of the other commitments was a liability of $10,000 at September 30, 2018 and is included in other liabilities in the consolidated balance sheet.

Forward Loan Sale Commitments

The Company utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments.

With a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date.  If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay a “pair-off” fee, based on then-current market prices, to the investor to compensate the investor for the shortfall.

With a “best efforts” contract, the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. Generally, the price the investor will pay the seller for an individual loan is specified prior to the loan being funded (e.g. on the same day the lender commits to lend funds to a potential borrower).

 

The Company expects that these forward loan sale commitments will experience inverse changes in fair value to the change in fair value of derivative loan commitments. The notional amount of forward loan sale commitments was $34,034,000 and $29,613,000 at September 30, 2018 and December 31, 2017, respectively. The fair value of certain of these commitments was an asset of $74,000 and $4,000 at September 30, 2018 and December 31, 2017, respectively, and is included in other assets in the consolidated balance sheets while the fair value of other such commitments was a liability of $62,000 and $19,000 at September 30, 2018 and December 31, 2017, respectively, and is included in other liabilities in the consolidated balance sheets.

 

The Company maintains an Employee Stock Ownership Plan (“ESOP”), which is a tax-qualified retirement plan providing eligible employees the opportunity to own Bancorp stock. Bancorp made a loan to the ESOP for the purchase of 469,498 shares of its common stock at $10.00 per share. The loan is payable annually over 25 years with interest at the prime rate to be reset each January 1st. The loan is secured by the shares which have not yet been allocated to participants. Loan payments are funded by cash contributions from the Bank. Such contributions are allocated to eligible participants based on their compensation, subject to federal tax limits.

Shares are committed to be released on a monthly basis and allocated as of December 31st of each year. The number of shares to be allocated annually is 18,780 through the year 2040. For the three and nine months ended September 30, 2018, the Company recognized compensation expense for the ESOP of $79,000 and $229,000, respectively, while for the three and nine months ended September 30, 2017, the Company recognized compensation expense for the ESOP of $69,000 and $214,000, respectively. The fair value of the 417,853 unallocated ESOP shares at September 30, 2018 was $6,907,000.

 

In September 2017, the Company’s Board of Directors adopted a share repurchase program under which the Company may repurchase up to 10%, or 586,854 shares of its then outstanding common shares. Repurchases under the program may be made in open market or in privately negotiated transactions and pursuant to any trading plan that may be adopted in accordance with Rule 10b5-1 of the SEC. Any repurchased shares will be held by the Company as authorized but unissued shares. The repurchase program may be suspended or terminated at any time without prior notice, and is currently set to expire on September 14, 2019. As of September 30, 2018, the Company had repurchased 47,500 shares at a cost of $748,000 in connection with this program.

 

Basic earnings (loss) per share represents net income (loss) divided by the weighted average of common shares outstanding during the period. Unvested restricted shares of common stock having dividend rights are treated as “participating securities” and, accordingly, are considered outstanding in computing basic earnings (loss) per share. Unallocated ESOP shares are not considered to be outstanding for purposes of computing earnings per share. None of the Company’s 325,707 outstanding stock options were included in the computation of diluted earnings (loss) per share for the three and nine months ended September 30, 2018. Due to the net loss for these periods, inclusion of the stock options in the computation would have been anti-dilutive.

 

 

 

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The following table sets forth the calculation of the average number of shares outstanding used to calculate the basic and diluted earnings (loss) per share for the periods indicated:

 

Under the Randolph Bancorp, Inc. 2017 Stock Option and Incentive Plan (the “Equity Plan”), the Company may grant options, restricted stock, restricted units or performance awards to its directors, officers and employees. Both incentive stock options and nonqualified stock options may be granted under the Equity Plan with 586,872 shares reserved for options. The exercise price of each option equals the market price of the Company’s stock on the date of the grant and the maximum term of each options is 10 years. The total number of shares reserved for restricted stock is 234,749. Options and awards generally vest ratably over five years. The fair value of shares awarded is based on the market price at the date of grant.

Stock Options

The fair value of each option grant is estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions:

During the nine months ended September 30, 2018, the Company granted options to purchase 27,000 shares of common stock and used the following assumptions in measuring the fair value of such grants:

 

 

A summary of stock option activity for the nine months ended September 30, 2018 is presented in the table below:

 

 

For the three and nine months ended September 30, 2018, stock-based compensation expense applicable to stock options was $81,000 and $226,000, respectively.

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Restricted Stock

Shares issued upon vesting may be either authorized but unissued shares or reacquired shares held by the Company. Any shares not issued because vesting requirements are not met will again be available for issuance under the Equity Plan. The fair market value of shares awarded, based on the market price at the date of grant, is recorded as unearned compensation and amortized over the applicable vesting period. Restricted stock awarded in 2017 was at no cost to the awardee. The following table presents the activity in restricted stock awards under the Equity Plan for the nine months ended September 30, 2018:

 

 

For the three and nine months ended September 30, 2018, stock-based compensation expense applicable to restricted stock was $129,000 and $371,000, respectively.

 

Determination of fair value

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures.  Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  Fair value is best determined based upon quoted market prices.  However, in many instances, there are no quoted market prices for the Company’s various assets and liabilities.  In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques.  Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows.  Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability.

The following methods and assumptions were used by the Company in estimating fair value disclosures:

Cash and cash equivalents – The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.

Certificates of deposit – Certificates of deposit are carried at cost. These assets are measured at fair value in level 2 based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.

Securities – All fair value measurements are obtained from a third-party pricing service and are not adjusted by management.  The securities measured at fair value in Level 1 (none at September 30, 2018 and December 31, 2017) are based on quoted market prices in an active exchange market.  Securities measured at fair value in Level 2 are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.

Federal Home Loan Bank of Boston (“FHLBB”) stock – It is not practical to determine the fair value of FHLBB stock due to restrictions on its transferability.

Loans held for sale – Fair values are based on commitments in effect from investors or prevailing market prices and include the servicing value of the loans.

Loans – For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values.  Fair values for other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.  Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable. Included in loans are certain loans which were transferred from loans held for sale. These loans, which are accounted for using the fair value option, continue to be accounted for subsequent to transfer at fair value.

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Mortgage servicing rights – Fair value is based on a valuation model that calculates the present value of estimated future net servicing income, using various assumptions related to fees, discount rates and prepayment speeds.

Deposit liabilities – The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts).  Fair values for fixed-rate term certificates are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities.

FHLBB advances - The fair values of the Company’s FHLBB advances are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.

Accrued interest - The carrying amounts of accrued interest approximate fair value.

On-balance-sheet derivatives - Fair values of forward loan sale commitments and derivative loan commitments are based on fair values of the underlying mortgage loans based on current market prices for similar assets in the secondary market. For derivative loan commitments, fair values also include the value of servicing, deferred origination fees/costs and the probability of such commitments being exercised.

Off-balance sheet credit-related instruments - Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing.  The fair values of these instruments are not material.

Assets and liabilities measured at fair value on a recurring basis

Assets and liabilities measured at fair value on a recurring basis are summarized below.

 

 

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Assets measured at fair value on a non-recurring basis

The Company may also be required, from time to time, to measure certain other assets at fair value on a non-recurring basis in accordance with U.S. generally accepted accounting principles.  These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets.  The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related assets as of September 30, 2018 and December 31, 2017.

 

 

The Company recorded a partial reversal of the valuation allowance for its mortgage servicing rights of $84,000 during the nine months ended September 30, 2018, due to increases in fair value caused by lower expected loan prepayments.

 

During the nine months ended September 30, 2018, the Company sold properties which had been occupied by its former North Randolph and Stoughton branch offices and which had been classified with assets held for sale. The North Randolph sale was completed at the carrying value of this property and, accordingly, no gain or loss was recognized.  The Stoughton sale was completed for above carrying value and a gain of $230,000 was recognized.

 

During the three months ended September 30, 2018, the Company transferred its Boston branch office having a carrying value of $2,897,000 to assets held for sale. In October 2018, the Company entered into an agreement to sell this building.  See Note 16 for additional information.

There were no liabilities measured at fair value on a non-recurring basis at September 30, 2018 and December 31, 2017.

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Summary of fair values of financial instruments

The estimated fair values, and related carrying amounts, of the Company’s financial instruments are presented below.  Certain financial instruments and all non-financial instruments are exempt from disclosure requirements.  Accordingly, the aggregate fair value amounts presented herein do not represent the underlying fair value of the Company. This table excludes financial instruments for which the carrying amount approximates fair value. Financial assets for which the fair value approximates carrying value include cash and cash equivalents, and accrued interest receivable. Financial liabilities for which the fair value approximates carrying value include mortgagors’ escrow accounts and accrued interest payable.

 

 

 

Loan commitments

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit. These instruments involve, to varying degrees, elements of market, credit and interest rate risk which are not recognized in the consolidated financial statements.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.

The following financial instruments were outstanding, at the dates indicated, whose contract amounts represent credit risk:

 

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Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The majority of these financial instruments are collateralized by real estate.

Other contingencies

The Company is not currently a party to any pending legal proceedings that it believes would have a material adverse effect on its financial condition, results of operations or cash flows.

 

Effective January 1, 2018, management began reporting its activities in one of two business segments, namely Envision Bank (“EB”) and Envision Mortgage (“EM”). Comparative information for the 2017 period has been prepared on a basis consistent with the methodology used in 2018. Envision Bank operations primarily consist of accepting deposits from customers within the communities surrounding the Bank’s six full service branch offices and investing those funds in residential and commercial real estate loans, home equity lines of credit, construction loans, commercial and industrial loans, and consumer loans. Envision Mortgage’s operations primarily consist of the origination and sale of residential mortgage loans and the servicing of loans sold to government-sponsored entities. A portion of the loans originated by Envision Mortgage are held in the loan portfolio of Envision Bank.

Segment information as of and for the three and nine months ended September 30, 2018, follows:

 

 

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The information above was derived from the internal management reporting system used by management to measure performance of the segments.

The Company’s internal transfer pricing arrangements determined by management primarily consist of the following:

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Segment information as of and for the three and nine months ended September 30, 2017 follows:

 

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The information above was derived from the internal management reporting system used by management to measure performance of the segments.

The Company’s internal transfer pricing arrangements determined by management primarily consist of the following:

 

 

 

 

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Pending Sale of Boston Branch

 

During the third quarter of 2018, the Company began to actively market for sale its branch office in Boston and on October 23, 2018 entered into a purchase and sale agreement to sell the property for $5,000,000. Consummation of this transaction is subject to an inspection review by the buyer, removal of asbestos in accordance with an environmental engineering report and certain other customary closing conditions, including receipt of regulatory approval to close the branch. This transaction is expected to close in the fourth quarter of 2018.

 

The Company reclassified the net book value of this property totaling $2,897,000 from premises and equipment to assets held for sale (included in other assets in the accompanying balance sheet) as of September 30, 2018.

 

In August 2018, this property experienced significant water damage from a leaking pipe which resulted in the temporary closure of the branch. The property has undergone a clean-up of the damage, including the removal of the building contents and asbestos on the affected floors. The Company has recognized an insurance recovery of $90,000 for personal property which was damaged but has not yet reached a settlement with the insurer on its claim for real property damage. Settlement of the claim is expected to occur in the fourth quarter of 2018.

 

While the property has undergone a clean-up from the water damage, re-construction of the affected areas is not being undertaken by the Company due to the pending sale of the property. Additional insurance proceeds received will be used to reduce the carrying value of the property. Based on a range of likely insurance settlements, management estimates that the Company would recognize a gain of from $2,000,000 to $2,150,000 on the sale of this building based on the selling price set forth in the pending purchase and sale agreement.

 

Consolidation of Mortgage Banking Operations

 

In October 2018, the Company’s Board of Directors approved a plan to consolidate mortgage banking operations in the Company’s North Attleboro loan operations center. As a result, the Company eliminated fifteen administrative positions supporting the origination of residential mortgages in its Andover loan operations center and will add eight similar positions in its North Attleboro location. Approximately twenty-five employees, including loan originators, remain in the Andover location.

 

Terminated employees were given a severance package based on their length of service with the Company. In addition, retention bonuses were offered to certain employees. The estimated total cost is $235,000 and is expected to be paid in 2018.

 

As previously disclosed, the Company entered into a sublease agreement in July 2018 for 27% of the space in its Andover location. This sublease commenced on October 1, 2018 and runs co-terminus with the Company’s lease which expires in March 2023. At September 30, 2018, the Company’s remaining minimum lease obligation, net of sublease payments, amounted to $1,223,000.

 

The Company intends to vacate all but approximately 3,000 square feet of its remaining leased space in the Andover location in 2018 and is currently attempting to sublease this space. Management expects to complete its analysis of the expected future cash flows for this property and to record a liability at fair value once the Company ceases the use of all or a portion of its remaining leased space.

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

This section is intended to help investors understand the financial performance of Randolph Bancorp, Inc. and its subsidiary through a discussion of the factors affecting its financial condition at September 30, 2018 and December 31, 2017, and its results of operations for the three and nine month periods ended September 30, 2018 and 2017. This section should be read in conjunction with the consolidated financial statements of Randolph Bancorp, Inc. and notes thereto that appear elsewhere in this Quarterly Report. For the purpose of this Quarterly Report, the terms the “Company” “we,” “our,” and “us” refer to Randolph Bancorp, Inc. and its subsidiary unless the context indicates another meaning.

Cautionary Statement Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q contains statements that may be considered forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements, which are based on certain current assumptions and describe our future plans, strategies and expectations, can generally be identified by the use of the words “may,” “will,” “should,” “could,” “would,” “plan,” “potential,” “estimate,” “project,” “believe,” “intend,” “anticipate,” “expect,” “target” and similar expressions. These statements include, among others, statements regarding our strategy, goals and expectations; evaluations of future interest rate trends and liquidity; expectations as to growth in assets, deposits and results of operations, future operations, market position and financial position; and prospects, plans and objectives of management. You should not place undue reliance on our forward-looking statements. You should exercise caution in interpreting and relying on forward-looking statements because they are subject to significant risks, uncertainties and other factors which are, in some cases, beyond our control.

Forward-looking statements are based on the current assumptions and beliefs of management and are only expectations of future results. Our actual results could differ materially from those projected in the forward-looking statements as a result of, among others, factors referenced herein under the section captioned “Risk Factors”; adverse conditions in the capital and debt markets and the impact of such conditions on our business activities; changes in interest rates; competitive pressures from other financial institutions; the effects of weakness in general economic conditions on a national basis or in the local markets in which we operate, including changes that adversely affect borrowers’ ability to service and repay our loans; changes in the value of securities in our investment portfolio; changes in loan default and charge-off rates; fluctuations in real estate values; the adequacy of loan loss reserves; decreases in deposit levels necessitating increased borrowing to fund loans and investments; operational risks including, but not limited to, cybersecurity and natural disasters; changes in government regulation; changes in accounting standards and practices; the risk that intangible assets recorded in our financial statements will become impaired; demand for loans in our market area; our ability to attract and maintain deposits; risks related to the implementation of acquisitions, dispositions, and restructurings; the risk that we may not be successful in the implementation of our business strategy; and changes in assumptions used in making such forward-looking statements. Forward-looking statements speak only as of the date on which they are made. We do not undertake any obligation to update any forward-looking statement to reflect circumstances or events that occur after the date the forward-looking statements are made.

Overview

Our results of operations depend primarily on net interest income and net gains on loan origination and sale activities. Net interest income is the difference between the interest income we earn on our interest-earning assets and the interest we pay on interest-bearing liabilities. Our interest-earning assets consist primarily of residential mortgage loans, commercial real estate loans, commercial and industrial loans, home equity loans and lines of credit, construction loans, consumer loans and investment securities. Interest-bearing liabilities consist primarily of deposit accounts and borrowings from the Federal Home Loan Bank of Boston (“FHLBB”). Net gains on loan origination and sale activities result from the origination and sale of such loans to investors including Fannie Mae, Freddie Mac and other financial institutions. The amount of these gains is dependent on the volume of our loan originations, profit margins earned upon sale and the prevailing fair value of mortgage servicing rights.

Critical Accounting Policies

Certain of our accounting policies are important to the presentation of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Our significant accounting policies are discussed in Note 2 to the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, as filed with the Securities and Exchange Commission.

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The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an “emerging growth company” we have 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 consolidated financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards.

Comparison of Financial Condition at September 30, 2018 and December 31, 2017

Total Assets. Total assets increased $57.8 million, or 10.9%, to $589.7 million at September 30, 2018 from $531.9 million at December 31, 2017. Growth was concentrated in loans held in portfolio, which increased $68.6 million. This increase was partially offset by a decrease of $7.2 million in securities available for sale. Asset growth was funded by an increase in deposits of $60.3 million, including $45.6 million in brokered deposits.

Loans Held for Sale. We are actively involved in the secondary mortgage market and designate a significant majority of our residential first mortgage loan production for sale. At September 30, 2018, loans held for sale, which consist of closed residential first mortgage loans which we intend to sell to investors, totaled $24.1 million compared to $25.4 million at December 31, 2017. This decrease occurred despite an increase of 13% in residential mortgage production during the first nine months of 2018 compared to the prior year period as a higher percentage of production in 2018 was invested in the loan portfolio. The Company added to its loan origination capabilities with the addition of ten experienced loan originators in 2018, which caused the increase in production despite a slowdown in loan refinancing activity resulting from increasing mortgage interest rates.

Net Loans. Net loans increased $68.6 million, or 17.1%, to $468.9 million at September 30, 2018 from $400.4 million at December 31, 2017. This net growth occurred entirely in real estate secured loans led by residential mortgage loan growth of $55.8 million, or 28.1%, and commercial mortgage loan growth of $7.1 million, or 6.9%, in both cases due to organic growth. Residential loan growth resulted primarily from the placement in portfolio of a higher proportion of loan originations in 2018 as compared to recent years as the Company originated more jumbo mortgages in 2018. These loans are not readily saleable in the secondary mortgage market. The growth in commercial real estate lending reflects continuing strong market conditions in our lending area aided by the favorable interest rate environment that prevailed throughout the period.  Consumer loans and commercial and industrial loans, which consist primarily of loan participations and purchased loans, decreased, in aggregate, by $1.1 million during the first nine months of 2018 as loan repayments exceeded loan purchases during the period.

Investment Securities. Investment securities, all of which are classified as available for sale, decreased $7.2 million to $54.4 million at September 30, 2018 from $61.6 million at December 31, 2017 due primarily to principal payments on mortgage-backed securities and, to a lesser extent, a decline in market values attributable to the rise in interest rates during 2018. At September 30, 2018, investment securities represented 9.2% of total assets compared to 11.6% at December 31, 2017. This decrease continues a trend in recent years and is a consequence of our strategic shift to investing a higher proportion of interest-earning assets in loans.

Mortgage Servicing Rights. Mortgage servicing rights (“MSRs”) increased $919,000 to $7.3 million at September 30, 2018 from $6.4 million at December 31, 2017. This increase was due to the MSR value of loans sold to Fannie Mae and Freddie Mac on a servicing retained basis, net of amortization, of $835,000 during the first nine months of 2018 and an $84,000 partial reversal of the valuation allowance. This reversal resulted from an increase in the fair value of MSRs due primarily to slower projected loan prepayment speeds. We serviced $873.9 million in loans for others at September 30, 2018. The fair value of the related MSRs was $8.0 million.

Deposits. Deposits increased $60.3 million, or 16.4%, to $427.2 million at September 30, 2018 from $366.8 million at December 31, 2017. Included in this increase was $45.6 million in brokered deposits and $14.7 million in non-brokered deposits. Management considers brokered deposits to be a source of wholesale funding and an alternative to FHLBB advances. Because of the lower interest rates available on brokered deposits compared to FHLBB advances across all maturity levels, the Company has increased its utilization of this funding source in 2018. The increase in non-brokered deposits during the first nine months of 2018 is primarily due to increases in money market accounts and term certificates, both product types where rates paid to depositors have been increased to meet competition.

FHLBB Advances. FHLBB advances, which consist primarily of overnight advances, increased $1.5 million to $77.4 million at September 30, 2018 from $76.0 million at December 31, 2017. This increase was limited by the greater utilization of brokered deposits as a wholesale funding source during the first nine months of 2018.

Stockholders’ Equity. Stockholders’ equity was $78.1 million at September 30, 2018 compared to $81.5 million at December 31, 2017. The decrease of $3.4 million during the first nine months of 2018 was due to the net loss from operations of $1.9 million, a reduction in the fair value of available-for sale securities of $1.7 million and stock purchases of $631,000. These items were partially offset by equity adjustments of $826,000 related to the stock benefit plan and the employee stock ownership plan.

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Comparison of Operating Results for the Three Months Ended September 30, 2018 and 2017

General. The Company recorded a net loss of $142,000, or $0.03 per share, for the three months ended September 30, 2018 compared to a net income of $49,000, or $0.01 per share, for the three months ended September 30, 2017. Included in the 2018 net loss were gains of $320,000 from the sale of a former branch office and an insurance recovery. Excluding these non-recurring gains, the net loss would have been $462,000, or $0.08 per share, for the three months ended September 30, 2018. These non-core items and their financial impact are summarized in the table presented on page 37 under the caption “Non- GAAP Measures.”

The decline in operating results between periods was attributable to the Envision Mortgage business segment which experienced lower revenues in 2018 due principally to a reduction in the profit margin realized upon the sale of mortgage loans and higher expenses associated with an increase in loan production and the hiring of ten loan originators.

Analysis of Net Interest Income

Net interest income represents the difference between income we earn on our interest-earning assets and the expense we pay on interest-bearing liabilities. Net interest income depends on the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned on such assets and paid on such liabilities.

Average Balances and Yields. The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. The yields set forth below include the effect of acquisition accounting adjustments as well as deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

 

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Rate/Volume Analysis. The following table presents the effects of changing rates and volumes on our net interest income, presented on a tax equivalent basis, for the periods 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). The net column represents the sum of the prior columns. 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.

 

 

Interest and Dividend Income. Interest and dividend income, inclusive of tax equivalent adjustments on municipal securities, increased $1,038,000, or 23.4%, to $5,473,000 for the three months ended September 30, 2018 compared to $4,435,000 for the three months ended September 30, 2017. This increase was due to an increase in average interest-earning assets between periods of $68.9 million, or 14.4%, as the Company continued to leverage the capital raised in its 2016 initial public offering. This increase all occurred in loans. The yield on interest-earning assets increased 29 basis points to 4.01% in the 2018 quarter from 3.72% in the same quarter of the prior year due principally to the higher proportion of loans to total interest-earning assets and a 23 basis points increase in the yield on loans.

Interest Expense. Interest expense increased $635,000, or 110.8%, to $1,208,000 for the three months ended September 30, 2018 compared to $573,000 for the three months ended September 30, 2017. This increase was due to an increase in average interest-bearing liabilities of $72.8 million combined with a 49 basis points increase in the cost of funds to 1.14%. The increase in cost of funds was due to a 42 basis point increase in the cost of interest-bearing deposits caused by a growth in higher yielding money market accounts and term certificates, including brokered deposits, and an 85 basis points increase in the cost of FHLBB advances. These increases are attributable to the increase in the federal funds rate from 1.25% to 2.25% during the past fifteen months. The cost of deposits has risen at a slower rate than the cost of FHLBB advances as the interest rates paid on certain core deposit products such as savings and NOW accounts have largely remained unchanged between periods.

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Net Interest Income. Net interest income increased $403,000, or 10.5%, to $4,266,000 for the three months ended September 30, 2018 compared to $3,862,000 for the three months ended September 30, 2017. This improvement resulted principally from loan growth. The net interest margin decreased 11 basis points from 3.24% in the third quarter of 2017 to 3.13% in the third quarter of 2018 due to a decrease in the ratio of interest-earning assets to interest-bearing liabilities from 135.4% in the 2017 quarter to 128.5% in the 2018 quarter. In addition, the net interest margin was adversely affected by an increase in the federal funds rate from 1.25% to 2.25% over the past fifteen months and a flattening yield curve wherein short-term rates have increased more than long-term rates.

Provision for Loan Losses. Based on the application of our loan loss methodology, we recorded a provision for loan losses of $178,000 for the three months ended September 30, 2018 while no provision was recorded for the three months ended September 30, 2017. The provision in 2018 was directly attributable to growth in the residential loan portfolio. Classified and nonaccrual loan balances were stable during the third quarter. Regional and local economic data, including housing prices, continued their positive trend of the past several years. The allowance for loan losses was 0.82% of total loans at September 30, 2018 compared to 0.92% at December 31, 2017, and was 193.7% of non-performing loans at September 30, 2018 compared to 165.9% at December 31, 2017.

Net Gain on Loan Origination and Sale Activities. The net gain on loan origination and sale activities decreased $749,000, or 27.7%, to $1,956,000 for the three months ended September 30, 2018 compared to $2,705,000 for the three months ended September 30, 2017, while the volume of loan sales was essentially flat between periods at approximately $110 million.   Net gains on loan sales in 2018 were adversely affected by a declining profit margin caused by competitive pressures as banks and other lenders competed based on rate to maintain market share, lower demand for FHA loans which historically have had a higher profit margin than conforming conventional mortgage loans and a softening in pricing for mortgage-backed securities used to package conventional mortgages sold in the secondary market.  

Other Non-interest Income. Non-interest income, excluding the net gain on loan origination and sale activities, increased $386,000 to $1,252,000 during the three months ended September 30, 2018 compared to $866,000 during the three months ended September 30, 2017. Included in non-interest income in the 2018 period were non-recurring gains totaling $320,000 due to the sale of of a former branch office and an insurance recovery. Excluding these non-recurring gains, other non-interest income would have increased by $66,000. This improvement was due to an increase in net mortgage servicing fee income of $111,000 attributable primarily to growth in the balance of loans serviced for others.  

Non-interest Expenses. Non-interest expenses increased $218,000, or 3.0%, from $7,209,000 for the three months ended September 30, 2017 to $7,427,000 for the three months ended September 30, 2018.   

Salaries and employee benefits increased $120,000, or 2.6%, from $4,668,000 in the third quarter of 2017 to $4,788,000 in the third quarter of 2018 despite a reduction in full-time equivalent employees from 201 at June 30, 2017 to 183 at September 30, 2018. This decrease in headcount occurred within the Company’s Envision Mortgage business segment. The increase in salaries and employee benefits is primarily due to stock-based compensation of $128,000, transition payments to new loan originators of $77,000, increased commissions of $66,000 due to a 23% increase in residential mortgage loan originations, and salary increases averaging 2.5%, or $65,000.  

Occupancy and equipment expenses increased $46,000, or 6.7%, from $682,000 in the third quarter of 2017 to $728,000 in the third quarter of 2018. This increase is due to additional rent expense and depreciation associated with the lease of the Andover loan operations center, as well as the relocation of two existing branches to new locations (Stoughton in September 2017 and Braintree in April 2018).

Professional fees decreased $96,000, or 27.6%, from $348,000 in the third quarter of 2017 to $252,000 in the third quarter of 2018. This decrease reflected lower spending for legal, consulting and auditing services.

Marketing expenses decreased $72,000, or 26.0%, from $277,000 in the third quarter of 2017 to $205,000 in the third quarter of 2018. Spending on marketing had been higher in the first half of 2018 due primarily to advertising costs associated with the re-branding to Envision Bank but has since been reduced.

Other non-interest expenses increased $204,000, or 19.8%, from $1,030,000 in the third quarter of 2017 to $1,234,000 in the third quarter of 2018. This increase is due to additional mortgage banking related operating costs of $145,000 associated with the 23% increase in production volume, higher software maintenance costs of $40,000 and director stock-based compensation costs of $80,000.

Income Tax Expense. No federal tax benefit was recognized for the three months ended September 30, 2018, while a federal tax provision of $129,000 was recognized for the three months ended September 30, 2017. The 2017 tax provision resulted from, and

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was limited to, an offsetting tax benefit included in other comprehensive income caused by appreciation in the far value of available for sale securities during 2017. The Company has a net operating loss (“NOL”) carryforward at September 30, 2018 of $13.4 million. Since 2014, the NOL carryforward as well as other net deferred tax assets have been subject to a full valuation allowance, which totaled $3.2 million at September 30, 2018. Management evaluates this position on a quarterly basis and has concluded, based on recent operating results, to maintain the full valuation allowance.

Comparison of Operating Results for the Nine Months Ended September 30, 2018 and 2017

General. The Company incurred a net loss of $1,859,000, or $0.33 per share, for the nine months ended September 30, 2018 compared to a net loss of $548,000, or $0.10 per share, for the nine months ended September 30, 2017. The net loss in the 2018 period included gains of $320,000 from the sale of a former branch office and an insurance recovery. Excluding these non-recurring items, the net loss in the 2018 period would have been $2,179,000, or $0.39 per share. The net loss in the 2017 period included merger and integration costs related to the July 2016 acquisition of First Eastern Bankshares Corporation (“First Eastern”), which amounted to $531,000. Excluding this non-recurring item and the related tax effect, the net loss in the 2017 period would have been $101,000, or $0.02 per share.   These non-core items and their financial impact are summarized in the table presented on page 37 under the caption “Non- GAAP Measures.”

The increase in the net loss between periods was attributable to the Envision Mortgage business segment which experienced lower revenues in 2018 due principally to a reduction in the profit margin realized upon the sale of mortgage loans and higher expenses associated with an increase in loan production.

Analysis of Net Interest Income

Net interest income represents the difference between income we earn on our interest-earning assets and the expense we pay on interest-bearing liabilities. Net interest income depends on the volume of interest-earning assets and interest-bearing liabilities and the interest rates earned on such assets and paid on such liabilities.

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Average Balances and Yields. The following tables set forth average balance sheets, average yields and costs, and certain other information for the periods indicated. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.

 

 

 

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Rate/Volume Analysis. The following table presents the effects of changing rates and volumes on our net interest income, presented on a tax equivalent basis, for the periods 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). The net column represents the sum of the prior columns. 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.

 

 

Interest and Dividend Income. Interest and dividend income, inclusive of tax equivalent adjustments on municipal securities, increased $2,678,000, or 21.3%, to $15,262,000 for the nine months ended September 30, 2018 compared to $12,584,000 for the nine months ended September 30, 2017. This increase was due to an increase in average interest-earning assets between periods of $62.7 million, or 13.7%, as the Company continued to leverage the capital raised in its 2016 initial public offering. This increase all occurred in loans. The yield on interest-earning assets increased 25 basis points to 3.91% in the first nine months of 2018 from 3.66% in the first nine months of 2017 due principally to the higher proportion of loans to total interest-earning assets and a 21 basis points increase in the yield on loans.

Interest Expense. Interest expense increased $1,500,000, or 102.9%, to $2,958,000 for the nine months ended September 30, 2018 compared to $1,458,000 for the nine months ended September 30, 2017. This increase principally reflects growth in the average balance of interest-bearing liabilities of $68.0 million and a 40 basis points increase to 0.98% in the cost of funds. The increase in cost of funds was due to a 30 basis points increase in the cost of interest-bearing deposits caused by a growth in higher yielding money market accounts and term certificates, including brokered deposits, and a 73 basis points increase in the cost of FHLBB advances. These increases are attributable to the increase in the federal funds rate from 1.25% to 2.25% during the past fifteen months. The cost of deposits has risen at a slower rate than the cost of FHLBB advances as the interest rates paid on certain core deposit products such as savings and NOW accounts have largely remained unchanged between periods.

Net Interest Income. Net interest income increased $1,178,000, or 10.6%, to $12,304,000 for the nine months ended September 30, 2018 compared to $11,126,000 for the nine months ended September 30, 2017. This improvement resulted principally from loan growth. The net interest margin in the first nine months of 2018 decreased 9 basis points from 3.24% in 2017 to 3.15% in 2018 due to a decrease in the ratio of interest-earning assets to interest-bearing liabilities from 136.9% in the first nine months of 2017 to 129.3% in the first nine months of 2018. In addition, the net interest margin was adversely affected by the increase in the federal funds rate from 1.25% to 2.25% over the past fifteen months and a flattening yield curve wherein short-term rates have increased more than long-term rates.

Provision for Loan Losses. Based on the application of our loan loss methodology, we recorded a provision for loan losses of $183,000 for the nine months ended September 30, 2018 compared to a provision of $335,000 for the nine months ended September 30, 2017. The provision in both 2018 and 2017 was primarily attributable to growth in the loan portfolio. Based on the quarterly assessment of internal and external performance factors affecting credit risk in June 2018, reductions were made in the

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qualitative portion of the allowance for loan losses (“ALLL”) for both commercial real estate loans and home equity loans during the second quarter of 2018. The qualitative portion of the ALLL for consumer loans was increased slightly as part of this analysis. Together these changes reduced the amount that would have been provided based on loan growth by $265,000. Classified and nonaccrual loan balances were stable during the first nine months of 2018. Regional and local economic data, including housing prices, continuing their positive trend of the past several years.

Net Gain on Loan Origination and Sale Activities. The net gain on loan origination and sale activities decreased $1,907,000, or 26.3%, to $5,356,000 for the nine months ended September 30, 2018 compared to $7,263,000 for the nine months ended September 30, 2017. During the first nine months of 2017, we sold $308.2 million of residential mortgage loans compared to $278.7 million of such loans in the first nine months of 2018 despite an overall increase in residential loan originations of 13% principally due to an increase in the origination of jumbo mortgages that are not readily saleable. Also contributing to the decrease in the net gain on loan origination and sale activities in 2018 was a decrease in the profit margin experienced in the current year. The reduced profit margin was due to competitive pressures as banks and other lenders compete based on rate to maintain market share, lower demand for FHA loans which have a higher profit margin than conforming conventional loans and a softening in pricing for mortgage-backed securities used to package conventional mortgages sold in the secondary market.

Other Non-interest Income. Non-interest income, excluding the net gain on loan origination and sale activities, decreased $110,000 to $3,042,000 for the nine months ended September 30, 2018 from $3,152,000 during the same period of the prior year. Included in other non-interest income in 2018 were gains of $320,000 from the sale of a former branch office and an insurance recovery. Excluding these gains, other non-interest income would have decreased $430,000 between periods. This decrease was due to a decrease in net mortgage servicing fees of $214,000 and a gain in 2017 of $150,000 on the sale of MSRs. The decrease in net mortgage servicing fees is due to a reduction in the average balance of serviced loans in the 2018 period caused by the sale of servicing rights to $379.0 million in serviced loans during the third quarter of 2017, and by a reduction between periods of $50,000 in favorable adjustments to the valuation allowance for MSRs due to increases in their fair values attributable to slower expected loan prepayment speeds. Also contributing to the decrease in other non-interest income in 2018 was lower loan closing service revenue of $73,000 and a $46,000 reduction related to a state training grant.

Non-interest Expenses. Non-interest expenses increased $570,000 to $22,336,000 for the nine months ended September 30, 2018 compared to $21,766,000 for the nine months ended September 30, 2017. Included in the 2017 period were merger and integration costs of $531,000 associated with the First Eastern acquisition. Excluding this non-recurring item, non-interest expenses would have increased $1,101,000, or 5.2%, in the first nine months of 2018 compared to the 2017 period.  

Salaries and employee benefits increased $107,000, or 0.8%, to $14,166,000 for the nine months ended September 30, 2018 compared to $14,059,000 in the prior year period despite a reduction in full-time equivalent employees from 220 at December 31, 2016 to 183 at September 30, 2018.  The decrease in headcount occurred within the Company’s Envision Mortgage business segment. Offsetting the savings from the reduction in headcount were stock-based compensation of $380,000, transition payments to new loan originators of $304,000, increased commissions of $189,000 due to a 13% increase in residential mortgage loan originations, and salary increases averaging 2.5%, or $195,000.  

Occupancy and equipment expenses increased $200,000, or 10.2%, in the first nine months of 2018 compared to the same period in the prior year.  This increase is due to additional rent expense and depreciation associated with the new lease of the Andover loan operations center, as well as the relocation of two existing branches to new locations (Stoughton in September 2017 and Braintree in April 2018).  Also included in expenses in the first nine months of 2018 is an accrual of $93,000 associated with a sub-lease of approximately 27% of the space in the Andover facility.

Marketing expenses increased $243,000, or 38.9%, from $624,000 in the first nine months of 2017 to $867,000 in the first nine months of 2018 due primarily to advertising costs and other promotional materials associated with the re-branding to Envision Bank.

Professional fees decreased $195,000, or 14.8%, from $1,019,000 in the first nine months of 2017 compared to $824,000 in the first nine months of 2018 due to a reduction in spending for legal, consulting and audit services.

Other non-interest expenses increased $751,000, or 25.6%, in the first nine months of 2018 compared to the first nine months of 2017. This increase is primarily due to additional mortgage banking related operating costs of $282,000 associated with the increase in production volume, director stock-based compensation costs of $217,000 as well as smaller expense increases attributable to the re-branding to Envision Bank and higher interchange fees.

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Income Tax Expense (Benefit). A federal tax benefit of $151,000 was recognized for the nine months ended September 30, 2017 while no federal tax benefit was recognized for the nine months ended September 30, 2018. The 2017 tax benefit resulted from, and was limited to, an offsetting tax provision attributable to other comprehensive income relating to appreciation in the fair value of available for sale securities.

Non-GAAP Measures

Management assesses the Company’s financial performance for purposes of making day-to-day and strategic decisions, it does so based upon the performance of its core banking business which is derived from the combination of net interest income and non-interest income reduced by the provision for loan losses and non-interest expenses and the impact of income taxes, if any, all as adjusted for any non-core items. The Company’s financial reporting is determined in accordance with GAAP, which sometimes includes items that management believes are unrelated to its core banking business and are not expected to have a material financial impact on operating results in future periods, such as merger and integration costs and other items. Management computes the Company’s non-GAAP operating earnings, non-interest income as a percentage of total income and the efficiency ratio on an operating basis, which excludes these items, in order to measure the performance of the Company’s core banking business.

Non-GAAP measures should not be viewed as a substitute for operating results determined in accordance with GAAP. An item that management determines to be non-core and excludes when computing these non-core measures can be of substantial importance to the Company’s results for any particular reporting period. The Company’s non-GAAP performance measures are not necessarily comparable to such measures that may be used by other companies.

The following table summarizes the impact of non-core items recorded for the reporting periods indicated below and reconciles them in accordance with GAAP (in thousands):

 

 

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Asset Quality

Nonperforming Assets. The following table provides information with respect to our nonperforming assets, including troubled debt restructurings, at the dates indicated. We did not have any accruing loans past due 90 days or more at the dates presented.  

 

Interest income that would have been recorded for the three and nine months ended September 30, 2018 had nonaccruing loans been current according to their original terms amounted to $57,000 and $208,000, respectively. Income related to nonaccrual loans included in interest income for the three and nine months ended September 30, 2018 amounted to $27,000 and $91,000, respectively.

Classified Loans.  The following table shows the aggregate amounts of our regulatory classified loans at the dates indicated.

 

 

None of the special mention loans at September 30, 2018 and December 31, 2017 were on nonaccrual.

Other than as disclosed in the above tables, there are no other loans where management has information indicating that there is serious doubt about the ability of the borrowers to comply with the present loan repayment terms.

 

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Allowance for Loan Losses. The following table sets the breakdown for loan losses by loan category at the dates indicated.

 

 

The following table sets forth an analysis of the allowance for loan losses for the periods indicated.

 

 

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Liquidity and Capital Resources

At September 30, 2018, we had $77.4 million of FHLBB advances outstanding. At that date, we had the ability to borrow up to an additional $97.8 million from the FHLBB and $7.5 million under an unsecured line of credit with a correspondent bank.

Our most liquid assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2018, cash and cash equivalents totaled $5.9 million.  

Financing activities consist primarily of activity in deposit accounts and borrowings. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors, and by other factors. We experienced a net increase in deposits of $60.3 million during the nine months ended September 30, 2018, including $45.6 million in brokered deposits. The greater utilization of brokered deposits as a wholesale funding source in 2018 is primarily due to the more favorable interest cost of such funding compared to FHLBB advances having a similar maturity. In addition, brokered deposits are unsecured and therefore serve to preserve our borrowing capacity at the FHLBB.

At September 30, 2018, we had $48.7 million in loan commitments outstanding, including $34.5 million related to loans to be sold in the secondary mortgage market and for which the Company had $25.6 million in forward loan sale commitments from investors. In addition to commitments to originate loans, we had $42.9 million in unused lines of credit to borrowers and letters of credit and $11.6 million in undisbursed construction loans. We anticipate that we will have sufficient funds available to meet our current loan origination commitments. Certificates of deposit that are scheduled to mature in less than one year from September 30, 2018 totaled $78.4 million. Management expects, based on historical experience, that a substantial portion of the maturing certificates of deposit will be renewed.

We are subject to various regulatory capital requirements, including a risk-based capital measure. At September 30, 2018, our Tier 1 capital to average assets ratio was 14.72%. We exceeded all regulatory capital requirements and were considered “well capitalized” under regulatory guidelines.

 

Item 3.  Quantitative and Qualitative Disclosures About Market Risk.

Net Interest Income Analysis. We analyze our sensitivity to changes in interest rates through our net interest income simulation model which is provided to us by an independent third party. Net interest income is the difference between the interest income we earn on our interest-earning assets, such as loans and securities, and the interest we pay on our interest-bearing liabilities, such as deposits and borrowings. We estimate what our net interest income would be over specified time horizons based on current interest rates. We then calculate what the net interest income would be for the same period under different interest rate assumptions. The comparative scenarios assume immediate parallel shifts in the yield curve in increments of 100 basis point (bp) rate movements. A basis point equals one-hundredth of one percent, and 100 basis points equals one percent. An increase in interest rates from 3.0% to 4.0% would mean, for example, a 100 basis point increase in the “Change in Interest Rates” column below. The following table shows the estimated impact on net interest income for the one-year period beginning September 30, 2018 resulting from potential changes in interest rates. The model is run quarterly and currently is showing shocks from +300bp to -200bp. These estimates require certain assumptions to be made, including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturities and decay rates. These assumptions are inherently uncertain. As a result, no simulation model can precisely predict the impact of changes in interest rates on our net interest income. Although the net interest income table below provides an indication of our interest rate risk exposure at a particular point in time, such estimates are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on our net interest income and will differ from actual results.

 

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Economic Value of Equity Analysis. In order to monitor and manage interest rate risk, we also use the net present value of equity at risk, or NPV, methodology. This methodology calculates the difference between the present value of expected cash flows from assets and liabilities and provides a longer-term view of the Company’s interest rate risk positions by estimating longer-term repricing risk embedded in the balance sheet. As with the net interest income analysis discussed above, the model is run at least quarterly showing shocks ranging from +300bp to -200bp.

The table below sets forth, as of September 30, 2018, the estimated changes in the Company’s net present value of equity that would result from the designated changes in the United States Treasury yield curve under an instantaneous parallel shift. 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.

 

 

(1)Assumes instantaneous parallel changes in interest rates.

The table above indicates that at September 30, 2018, in the event of an instantaneous parallel 200 basis points decrease in interest rates, we would experience a 12.1% decrease in the Economic Value of Equity at Risk. In the event of an instantaneous 300 basis point increase in interest rates, we would experience a 7.9% decrease in Economic Value of Equity at Risk. In all scenarios presented above, the calculated variances are within policy guidelines.

Certain shortcomings are inherent in the methodology used in the above interest rate risk measurement. Modeling changes in net portfolio value requires making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. In this regard, the 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. The table also does not measure the changes in credit and liquidity risk that may occur as a result of changes in general interest rates. Accordingly, although the table provides an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market interest rates on our economic value of equity and will differ from actual results.

 

Item 4.  Controls and Procedures.

An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2018. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.

During the quarter ended September 30, 2018, there have been no changes in the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

The Company is not involved in any material pending litigation.

Item 1A. Risk Factors.

 

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the Company’s Annual Report on Form 10-K as filed with the SEC under the heading “Risk Factors.” The Company’s evaluation of its risk factors has not changed materially since those discussed in the Annual Report on Form 10-K.

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

 

In September 2017, the Company’s Board of Directors adopted a stock repurchase program pursuant to which the Company would purchase up to 10%, or 586,854 shares, of its then outstanding common shares. This program may be suspended or terminated at any time without prior notice and it is currently set to expire on September 14, 2019. Repurchased shares are returned to the status of authorized but unissued shares. The following table sets forth information with respect to any purchases made by or on behalf of the Company during the indicated periods under the repurchase plan:

 

 

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

 

Pending Sale of Boston Branch

 

During the third quarter of 2018, the Company began to actively market for sale its branch office in Boston and on October 23, 2018 entered into a purchase and sale agreement to sell the property for $5,000,000. Consummation of this transaction is subject to an inspection review by the buyer, removal of asbestos in accordance with an environmental engineering report and certain other customary closing conditions, including receipt of regulatory approval to close the branch. This transaction is expected to close in the fourth quarter of 2018.

 

The Company reclassified the net book value of this property totaling $2,897,000 from premises and equipment to assets held for sale (included in other assets in the accompanying balance sheet) as of September 30, 2018.

 

In August 2018, this property experienced significant water damage from a leaking pipe which resulted in the temporary closure of the branch. The property has undergone a clean-up of the damage, including the removal of the building contents and asbestos on the affected floors. The Company has recognized an insurance recovery of $90,000 for personal property which was damaged but has not yet reached a settlement with the insurer on its claim for real property damage. Settlement of the claim is expected to occur in the fourth quarter of 2018.

 

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While the property has undergone a clean-up from the water damage, re-construction of the affected areas is not being undertaken by the Company due to the pending sale of the property. Additional insurance proceeds received will be used to reduce the carrying value of the property. Based on a range of likely insurance settlements, management estimates that the Company would recognize a gain of from $2,000,000 to $2,150,000 on the sale of this building based on the selling price set forth in the pending purchase and sale agreement.

 

Consolidation of Mortgage Banking Operations

 

In October 2018, the Company’s Board of Directors approved a plan to consolidate mortgage banking operations in the Company’s North Attleboro loan operations center. As a result, the Company eliminated fifteen administrative positions supporting the origination of residential mortgages in its Andover loan operations center and will add eight similar positions in its North Attleboro location. Approximately twenty-five employees, including loan originators, remain in the Andover location.

 

Terminated employees were given a severance package based on their length of service with the Company. In addition, retention bonuses were offered to certain employees. The estimated total cost is $235,000 and is expected to be paid in 2018.

 

As previously disclosed, the Company entered into a sublease agreement in July 2018 for 27% of the space in its Andover location. This sublease commenced on October 1, 2018 and runs co-terminus with the Company’s lease which expires in March 2023. At September 30, 2018, the Company’s remaining minimum lease obligation, net of sublease payments, amounted to $1,223,000.

 

The Company intends to vacate all but approximately 3,000 square feet of its remaining leased space in the Andover location in 2018 and is currently attempting to sublease this space. Management expects to complete its analysis of the expected future cash flows for this property and to record a liability at fair value once the Company ceases the use of all or a portion of its remaining leased space.

 

The annual savings in both employee and property related costs resulting from the consolidation of mortgage banking operations is estimated to be $360,000.

 

Item 6. Exhibits.

 

The exhibits listed in the Exhibit Index (following the signatures section of this report) are included in, or incorporated by reference into, this Quarterly Report on Form 10-Q.

 

 

 

 

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SIGNATURE

 

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

 

 

 

 

 

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