SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

For the quarterly period ended September 30, 2020

OR

For the transition period from _______________ to _______________

Commission File No.    001-38985    

 

 

First Seacoast Bancorp

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

(603) 742-4680

(Registrant’s Telephone Number, Including Area Code)

 

 

Not Applicable

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

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

 

 

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 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 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, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

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

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

6,083,500 shares of the Registrant’s common stock, par value $0.01 per share, were issued and outstanding as of November 13, 2020, of which 3,345,925 shares were owned by First Seacoast Bancorp, MHC.

 

 

 

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Table of Contents

 

 

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

FIRST SEACOAST BANCORP AND SUBSIDIARIES

CONSOLIDATED Balance Sheets

 

 

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

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FIRST SEACOAST BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (LOSS) (UNAUDITED)

 

 

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

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FIRST SEACOAST BANCORP AND SUBSIDIARIES

CONSOLIDATED Statements of COMPREHENSIVE INCOME (loss) (UNAUDITED)

 

 

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

 

 

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FIRST SEACOAST BANCORP AND SUBSIDIARIES

CONSOLIDATED Statements of Changes in STOCKHOLDERS’ EQUITY (UNAUDITED)

 

 

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

 

 

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FIRST SEACOAST BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

 

 

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

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FIRST SEACOAST BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Basis of Presentation

The accompanying unaudited consolidated financial statements of First Seacoast Bancorp (the “Company”) were prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”) for interim consolidated financial information, general practices within the banking industry and with instructions for Form 10-Q and Regulation S-X.  Accordingly, these interim financial statements do not include all the information or footnotes required by GAAP for annual financial statements. However, in the opinion of management, all adjustments (consisting solely of normal recurring adjustments) necessary for a fair presentation of these consolidated financial statements have been included. The results of operations for the interim periods disclosed herein are not necessarily indicative of the results which may be expected for the entire year. These statements should be read in conjunction with the audited consolidated financial statements and notes thereto  contained in the Annual Report on Form 10-K for the fiscal year ended December 31, 2019, as filed with the U.S. Securities and Exchange Commission (“SEC”) on March 27, 2020.

The accompanying consolidated financial statements include the accounts of the Company, its wholly owned subsidiary, First Seacoast Bank (the “Bank”), and the Bank’s wholly owned subsidiary, FSB Service Corporation, Inc. All significant intercompany balances and transactions have been eliminated in consolidation.

Corporate Structure

The Company is the holding company for the Bank (formerly named Federal Savings Bank). Effective July 16, 2019, pursuant to a Plan of Reorganization from Mutual Savings Bank to Mutual Holding Company and Stock Issuance Plan (the “Plan of Reorganization”), the Bank reorganized into the mutual holding company structure and the Company completed a concurrent stock offering (collectively, the “Reorganization”).  In the stock offering, the Company sold a total of 2,676,740 shares of common stock, which included 238,473 shares sold to the First Seacoast Bank Employee Stock Ownership Plan (the “ESOP”), at a price of $10.00 per share. In addition, as part of the Reorganization, the Company issued 3,345,925 shares of common stock to First Seacoast Bancorp, MHC (the “MHC”), the Bank’s parent mutual holding company, and 60,835 shares of common stock and $150,000 in cash to First Seacoast Community Foundation, Inc. (the “Foundation”), a charitable foundation formed in connection with the reorganization and dedicated to supporting charitable organizations operating in the Bank’s local community. The Company’s common stock began trading on the NASDAQ Capital Market under the symbol “FSEA” on July 17, 2019. Pursuant to the Plan of Reorganization, the Bank adopted an employee stock ownership plan (“ESOP”), which purchased 238,473 shares of common stock in the stock offering with the proceeds of a loan from the Company. As a result of the Reorganization, a total of 6,083,500 shares of common stock of the Company are issued and outstanding, of which 55% are issued to the MHC, 44% were sold to the Bank’s eligible members, the ESOP, and certain other persons in the stock offering, and 1% were contributed to the Foundation.  Expenses incurred related to the offering were $1.6 million and were deducted from the stock offering proceeds.

The Bank focuses on four core services that center around customer needs. The core services include residential lending, commercial banking, personal banking, and wealth management. The Bank offers a full range of commercial and consumer banking services through its network of five full-service branch locations. Banking services, the Company’s only reportable operating segment, is managed as a single strategic unit.

The Bank is engaged principally in the business of attracting deposits from the public and investing those funds in various types of loans, including residential and commercial real estate and a variety of commercial and consumer loans. The Bank also invests its deposits and borrowed funds in investment securities. Deposits at the Bank are insured by the Federal Deposit and Insurance Corporation (“FDIC”) for the maximum amount permitted by FDIC regulations.

Our wealth management group, FSB Wealth Management, assists individuals and families in building and preserving their wealth by providing investment services. The investment management group manages portfolios utilizing a variety of investment products. This group also provides a full-service brokerage offering equities, mutual funds, life insurance and annuity products.  Investment management services are offered at the Company’s full-service wealth management office in Dover, New Hampshire. The assets held for wealth management customers are not assets of the Company and, accordingly, are not reflected in the accompanying balance sheets. Assets under management totaled approximately $51.3 million and $49.3 million at September 30, 2020 and December 31, 2019, respectively.

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Recently Adopted Accounting Standards

As an “emerging growth company,” as defined in Title 1 of Jumpstart Our Business Startups (JOBS) Act, the Company has elected to use the extended transition period to delay adoption of new or reissued accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. As a result, the Company’s consolidated financial statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards without an extended transition period. As of September 30, 2020, there was no significant difference in the comparability of the Company’s consolidated financial statements as a result of this extended transition period except for the accounting treatment for measuring and recording the Company’s allowance for loan losses. The Company measures and records an allowance for loan losses based upon the incurred loss model while other public companies may be required to calculate their allowance for loan losses based upon the current expected credit loss (“CECL”) model. The CECL approach requires an estimate of the loan loss expected over the life of the loan while the incurred loss approach delays the recognition of a loan loss until it is probable a loss event has incurred. The Company’s status as an “emerging growth company” will end on the earlier of: (i) the last day of the fiscal year of the Company during which it had total annual gross revenues of $1.07 billion (as adjusted for inflation) or more; (ii) the last day of the fiscal year of the Company following the fifth anniversary of the effective date of the Company’s initial public offering; (iii) the date on which the Company has, during the previous three-year period, issued more than $1.0 billion in non-convertible debt; or (iv) the date on which the Company is deemed to be a “large accelerated filer” under Securities and Exchange Commission regulations (generally, at least $700 million of voting and non-voting equity held by non-affiliates).

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement.” The purpose of this ASU is to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by GAAP that is most important to users of each entity’s financial statements. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2019. The amendments removed 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. Additionally, the amendments modified the disclosure requirements for investments in certain entities that calculate net asset value and measurement uncertainty. Finally, the amendments added 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. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

Recent Accounting Pronouncements

The Company considers the applicability and impact of all ASUs. ASUs not listed below were assessed and determined to be either not applicable or are expected to have an immaterial impact on the Company’s consolidated financial statements.

In June 2020, the FASB issued ASU No. 2020-05, “Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842): Effective Dates for Certain Entities,” as a limited deferral of the effective dates, for one year, of ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” and ASU No. 2016-02, “Leases (Topic 842),” to provide immediate, near-term relief for certain entities for whom these ASU’s are either currently or imminently effective as a result of COVID-19. The Company adopted ASU No. 2014-09, “Revenue from Contracts with Customers (Topic 606),” as of January 1, 2019.  The Company does not expect the adoption of ASU No. 2016-02, “Leases (Topic 842),” to have a material impact on the Company’s consolidated financial statements.

In March 2020, the FASB issued ASU No. 2020-04, “Reference Rate Reform (Topic 848),” which provides optional guidance to ease the potential burden in accounting due to reference rate reform. The guidance in this update provides optional expedients and exceptions for applying GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain criteria are met. The amendments apply only to contracts and hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. These amendments are effective immediately and may be applied prospectively to contract modifications made, and hedging relationships entered into, on or before December 31, 2022. The Company is currently evaluating its contracts and the optional expedients provided by the new standard.

In February 2020, the FASB issued ASU 2020-2, “Financial Instruments – Credit Losses (Topic 326) and Leases (Topic 842) - Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842).”  This ASU adds an SEC paragraph pursuant to the issuance of SEC SAB Topic No. 119 to the FASB Codification Topic 326 and updates the SEC section of the Codification for the change in the effective dates of Topic 842.  This ASU primarily details guidance on what SEC staff would

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expect a registrant to perform and document when measuring and recording its allowance for credit losses for financial assets recorded at amortized cost.

In January 2020, the FASB issued ASU 2020-1, “Investments – Equity Securities (Topic 321), Investments - Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions Between Topic 321, Topic 323, and T 815 (A Consensus of the Emerging Issues Task Force),” which clarifies the interaction among the accounting standards for equity securities, equity method investments and certain derivatives.  This ASU becomes effective for public entities for fiscal years beginning after December 15, 2020 and all other entities for fiscal years beginning after December 15, 2021. Early adoption is permitted. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes.” This ASU simplifies accounting for income taxes by removing specific technical exceptions. The guidance removes the need for companies to analyze whether (1) the exception to the incremental approach for intra-period tax allocation, (2) exceptions to accounting for basis differences when there are ownership changes in foreign investments and (3) the exception in interim period income tax accounting for year-to-date losses that exceed anticipated losses apply in a given period. The amendments in this ASU are effective for smaller reporting companies for fiscal years beginning after December 15, 2021. Early adoption is permitted. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

In November 2019, the FASB issued ASU 2019-11, “Codification Improvements to Topic 326, Financial Instruments – Credit Losses,” to increase stakeholder awareness of the improvements made to the various amendments to Topic 326 and to clarify certain areas of guidance as companies transition to the new standard. Also during November 2019, the FASB issued ASU 2019-10, “Financial Instruments – Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842):  Effective Dates,” finalizing various effective date deferrals for private companies, not-for-profit organizations and certain smaller reporting companies applying the credit losses (CECL), leases and hedging standards.  The effective date for ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” is deferred to years beginning after December 15, 2022.  The effective dates for ASU 2016-02, “Leases (Topic 842)” and ASU 2017-12, “Targeted Improvements to Accounting for Hedging Activities,” are deferred to fiscal years beginning after December 15, 2020.

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” Under the new guidance, lessees are required to recognize lease assets and lease liabilities on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement. Initially the FASB approved a proposal to delay the implementation of this standard by one year for smaller reporting companies to years beginning after December 15, 2020. On June 30, 2020, the FASB further delayed the implementation of this standard by one year for smaller reporting companies to years beginning after December 15, 2021. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. In July 2018, the FASB issued ASU 2018-10, “Codification Improvements to Topic 842, Leases,” which seeks to clarify ASU 2016-02 with respect to certain aspects of the update and ASU 2018-11, “Leases (Topic 842) – Targeted Improvements,” which provides transition relief on comparative reporting upon adoption of the ASU. The Company currently has no leases with terms longer than 12 months. The Company does not expect these ASUs to have a material impact on the Company’s consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” which creates a new credit impairment standard for financial assets measured at amortized cost and available-for-sale debt securities. The ASU requires financial assets measured at amortized cost (including loans and held-to-maturity debt securities) to be presented at the net amount expected to be collected, through an allowance for credit losses that are expected to occur over the remaining life of the asset, rather than incurred losses. The ASU requires that credit losses on available-for-sale debt securities be presented as an allowance rather than as a direct write-down. The measurement of credit losses for newly recognized financial assets (other than certain purchased assets) and subsequent changes in the allowance for credit losses are recorded in the statement of income as the amounts expected to be collected change. The ASU was originally to be effective for fiscal years beginning after December 15, 2020 and interim periods within fiscal years beginning after December 15, 2021. In November 2018, the FASB issued ASU 2018-19, “Codification Improvements to Topic 326, Financial Instruments-Credit Losses,” extending the implementation date by one year for smaller reporting companies and clarifying that operating lease receivables are outside the scope of Accounting Standards Codification Topic 326. In April 2019, the FASB issued ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments,” to increase stakeholders’ awareness of the amendments and to expedite improvements to the Codification.  In May 2019, the FASB issued ASU 2019-05, “Financial Instruments—Credit

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Losses, Topic 326.” This ASU addresses certain stakeholders’ concerns by providing an option to irrevocably elect the fair value option for certain financial assets previously measured at amortized cost basis. For those entities, the targeted transition relief will increase comparability of financial statement information by providing an option to align measurement methodologies for similar financial assets. Furthermore, the targeted transition relief also may reduce the costs for some entities to comply with the amendments in Update 2016-13, while still providing financial statement users with decision-useful information. On October 16, 2019, the FASB approved a proposal to delay the implementation of this standard for smaller reporting companies to years beginning after December 15, 2022.  Early adoption is permitted.  Upon adoption, however, the Company will apply the standard’s provisions as a cumulative effect adjustment to equity capital as of the first reporting period in which the guidance is effective. Upon adoption, the Company expects a change in the processes and procedures to calculate the allowance for loan losses, including changes in the assumptions and estimates to consider expected credit losses over the life of the loan versus the current accounting practice that utilizes the incurred loss model. The Company is reviewing the requirements of ASU 2016-13 and is developing and implementing processes and procedures to ensure it is fully compliant with the amendments at the adoption date. At this time, the Company anticipates the allowance for loan losses will increase as a result of the implementation of this ASU; however, until its evaluation is complete, the magnitude of the increase will be unknown.

In August 2018, the FASB issued ASU 2018-14, “Compensation—Retirement Benefits – Defined Benefit Plans – General (Subtopic 715-20).” The purpose of this ASU is to improve the effectiveness of disclosures in the notes to financial statements by facilitating clear communication of the information required by GAAP that is most important to users of each entity’s financial statements. The amendments in this ASU are effective for non-public business entities for fiscal years ending after December 15, 2021. Early adoption is permitted. The amendments modified the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. The amendments in this ASU should be applied retrospectively to all periods presented. The adoption of this ASU is not expected to have a material impact on the Company’s consolidated financial statements.

At September 30, 2020 and December 31, 2019, cash and due from banks totaled $27.3 million and $4.0 million, respectively. The Company pledged cash collateral to derivative counterparties totaling $525,000 and $-0- at September 30, 2020 and December 31, 2019, respectively. See Note 11 for a discussion of the Company’s derivative and hedging activities.

The amortized cost and fair value of securities available-for-sale, and the corresponding amounts of gross unrealized gains and losses, are as follows as of September 30, 2020 and December 31, 2019:

 

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The amortized cost and fair values of available-for-sale securities at September 30, 2020 by contractual maturity are shown below. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

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The following is a summary of gross unrealized losses and fair value for those investments with unrealized losses, aggregated by investment category and length of time the individual securities have been in a continuous unrealized loss position, at September 30, 2020 and December 31, 2019:

 

 

In evaluating whether an investment has suffered an other-than-temporary decline, management evaluated the amount of the decline compared to cost, the length of time and extent to which fair value has been less than cost, the underlying creditworthiness of the issuer, the fair values exhibited during the year and estimated future fair values. In general, management concluded the declines are due to coupon rates compared to market rates and current economic conditions. The Company does not intend to sell investments with unrealized losses, and it is more likely than not that the Company will not be required to sell these investments before recovery of their amortized cost basis. Based on evaluations of the underlying issuers’ financial condition, current trends and economic conditions, management does not believe any securities suffered an other-than-temporary decline in value as of September 30, 2020 or December 31, 2019.

Proceeds from sales, maturities, and gross realized gains and losses on available-for-sale securities were as follows for the three and nine months ended September 30, 2020 and 2019:

 

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As of September 30, 2020 and December 31, 2019, there were no holdings at either date that were issued by a single state or political subdivision which comprised more than 10% of the total fair value of the Company’s available-for-sale securities.

The Bank’s lending activities are primarily conducted in and around Dover, New Hampshire, and in the areas surrounding its branches. The Bank grants commercial real estate loans, multifamily 5+ dwelling unit loans, commercial and industrial loans, acquisition, development, and land loans, 1–4 family residential loans, home equity line of credit loans and consumer loans. Most loans are collateralized by real estate. The ability and willingness of real estate, commercial and construction loan borrowers to honor their repayment commitments is generally dependent on the health of the real estate sector in the borrowers’ geographic area and the general economy.

On March 27, 2020, the Small Business Administration (“SBA”) established a loan program in response to the COVID-19 pandemic, the Paycheck Protection Program (“PPP”), which was added to the SBA’s 7(a) loan program by of the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) (such loans, “PPP Loans”).  The CARES Act provides that PPP Loans are fully guaranteed as to principal and interest by the SBA. As of September 30, 2020, the Bank originated 286 PPP Loans with aggregate outstanding principal balances of $33.0 million and are included in the commercial and industrial loans category (C+I).

Loans consisted of the following at September 30, 2020 and December 31, 2019:

 

 

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Changes in the allowance for loan losses (“ALL”) for the three and nine months ended September 30, 2020 and 2019, by portfolio segment, are summarized as follows:

 

 

As of September 30, 2020 and December 31, 2019, information about loans and the ALL, by portfolio segment, are summarized below:

 

 

The following is an aging analysis of past due loans by portfolio segment as of September 30, 2020: 

 

 

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The following is an aging analysis of past due loans by portfolio segment as of December 31, 2019:

 

 

Foreclosure Proceedings

As of September 30, 2020, a loan collateralized by residential real estate property amounting to $65,000, was in process of foreclosure. Subsequent to September 30, 2020, the foreclosure process was terminated due to the borrower remitting all past due loan payments and expenses. As of December 31, 2019, there were no loans collateralized by residential real estate property in the process of foreclosure.

The following table provides information on impaired loans as of September 30, 2020 and December 31, 2019:

 

 

Credit Quality Information

The Bank utilizes a ten-grade internal loan rating system for its commercial real estate, multifamily, commercial and industrial and acquisition, development, and land loans. Residential real estate, home equity line of credit and consumer loans are considered “pass” rated loans until they become delinquent. Once delinquent, loans can be rated an 8, 9 or 10 as applicable.

Loans rated 1 through 6: Loans in these categories are considered “pass” rated loans with low to average risk.

Loans rated 7: Loans in this category are considered “special mention.” These loans are starting to show signs of potential weakness and are being closely monitored by management.

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Loans rated 8: Loans in this category are considered “substandard.” Generally, a loan is considered substandard if it is 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 Bank will sustain some loss if the weakness is not corrected.

Loans rated 9: Loans in this category are considered “doubtful.” Loans classified as doubtful 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 10: Loans in this category are considered uncollectible (“loss”) and of such little value that their continuance as loans is not warranted and should be charged off.

On an annual basis, or more often if needed, the Bank formally reviews the ratings on its commercial and industrial, commercial real estate and multifamily loans. On a periodic basis, the Bank engages an independent third party to review a significant portion of loans within these segments and to assess the credit risk management practices of its commercial lending department. Management uses the results of these reviews as part of its annual review process and overall credit risk administration.

On a quarterly basis, the Bank formally reviews the ratings on its applicable residential real estate and home equity loans if they have become classified as non-accrual. Criteria used to determine ratings consist of loan-to-value ratios and days delinquent.

The following presents the internal risk rating of loans by portfolio segment as of September 30, 2020:

 

 

The following presents the internal risk rating of loans by portfolio segment as of December 31, 2019:

 

 

In December 2019, a novel strain of coronavirus (“COVID-19”) was reported. In response to COVID-19, the Bank has implemented a short-term loan modification program to provide temporary payment relief to certain of our borrowers who meet the program's qualifications. In April 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency, issued an interagency statement titled Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus, that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, Receivables – Troubled Debt Restructurings by Creditors (ASC 310-40), a restructuring of debt constitutes a troubled debt restructuring, or TDR, if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider.  The regulatory agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief, are not to

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be considered TDRs. These include short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.

Additionally, Section 4013 of the CARES Act that passed on March 27, 2020 further provides banks with the option to elect either or both of the following, from March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates:

If a bank elects a suspension noted above, the suspension (i) will be effective for the term of the loan modification, but solely with respect to any modification, including a forbearance arrangement, an interest rate modification, a repayment plan, and any other similar arrangement that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019; and (ii) will not apply to any adverse impact on the credit of a borrower that is not related to the COVID–19 pandemic. The Company has applied this guidance to qualifying loan modifications.

The program has been offered to both retail and commercial borrowers. The majority of short-term loan modifications for retail loan borrowers consist of deferred payments (which may include principal, interest and escrow), which are capitalized to the loan balance and recovered through the re-amortization of the monthly payment at the end of the deferral period. For commercial loan borrowers, the majority of short-term modifications consist of allowing the borrower to make interest-only payments with the deferred principal to be due at maturity or repaid as the monthly payment is re-amortized at the next interest reset date as is applicable to the individual loan structure.  Alternatively, commercial loan borrowers may defer their full monthly payment similar to the retail loan program outlined above. All loans modified under these programs are maintained on full accrual status during the deferral period.

As of September 30, 2020, the Bank had provided temporary payment relief for 6 loans with aggregate outstanding principal balances of $5.8 million. As of September 30, 2020, temporary modifications consisted of 1 commercial loan with aggregate outstanding principal balances of $4.1 million and 5 residential loans with aggregate outstanding principal balances of $1.7 million.

 

Certain directors and executive officers of the Company and companies in which they have significant ownership interests are customers of the Bank. Loans outstanding to these persons and entities at September 30, 2020 and December 31, 2019 were $5.3 million and $5.2 million, respectively.

Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of such loans were $49.3 million and $49.3 million at September 30, 2020 and December 31, 2019, respectively. Substantially all of these loans were originated by the Bank and sold to third parties on a non-recourse basis with servicing rights retained. These retained servicing rights are recorded as a servicing asset and are initially recorded at fair value (see Note 13, Fair Value of Assets and Liabilities, for more information). Changes to the balance of mortgage servicing rights are recorded in loan servicing fee income (loss) in the Company’s consolidated statements of income.

The Bank’s mortgage servicing activities include collecting principal, interest and escrow payments from borrowers; making tax and insurance payments on behalf of borrowers; monitoring delinquencies and executing foreclosure proceedings; and accounting for and remitting principal and interest payments to investors. Loan servicing fee income (loss), including late and ancillary fees, was $12,000 and $0 for the three months ended September 30, 2020 and 2019, respectively, and $5,000 and $(25,000) for the nine months ended September 30, 2020 and 2019, respectively. The Bank’s residential mortgage investor loan servicing portfolio is primarily comprised of fixed rate loans concentrated in the Bank’s market areas.

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The following summarizes activity in mortgage servicing rights for the three and nine months ended September 30, 2020 and 2019:

 

      

Deposits consisted of the following at September 30, 2020 and December 31, 2019:

 

 

At September 30, 2020, the scheduled maturities of time deposits were as follows:

 

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There were no brokered deposits included in time deposits at September 30, 2020 or December 31, 2019.

Federal Home Loan Bank (“FHLB”)

A summary of borrowings from the FHLB is as follows:

 

 

 

All borrowings from the FHLB are secured by a blanket security agreement on qualified collateral, principally residential mortgage loans and certain U.S. government sponsored mortgage-backed securities, in an aggregate amount equal to outstanding advances. The Bank’s unused remaining available borrowing capacity at the FHLB was approximately $95.0 million and $81.7 million at September 30, 2020 and December 31, 2019, respectively. At September 30, 2020 and December 31, 2019, the Bank had sufficient collateral at the FHLB to support its obligations and was in compliance with the FHLB’s collateral pledging program.

 

Federal Reserve Bank of Boston (“FRB”)

The Bank has established a Paycheck Protection Program Liquidity Facility (“PPPLF”). The PPPLF allows us to request advances from the FRB. Under the PPPLF, advances must be secured by pledges of PPP Loans. The interest rate applicable to any advance made under the PPPLF is 35 basis points. As of September 30, 2020, $25.7 million of PPPLF advances are outstanding and collateralized by 156 PPP Loans. Maturities of PPPLF advances are tied to the maturity of the underlying PPP loan and will be accelerated if the PPP loan is sold or forgiven.

The Bank has an overnight line of credit with the FHLB that may be drawn up to $3.0 million. Additionally, the Bank has a total of $5.0 million of unsecured Fed Funds borrowing lines of credit with two correspondent banks. The entire balance of all these credit facilities was available at September 30, 2020.

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Employee Stock Ownership Plan

As part of the stock offering in 2019, the Company established the First Seacoast Bank Employee Stock Ownership Plan (“ESOP”) to provide eligible employees of the Company the opportunity to own Company stock.  The ESOP is a tax-qualified retirement plan for the benefit of Company employees.  Contributions are allocated to eligible participants on the basis of compensation, subject to federal limits.  The number of shares committed to be released per year through 2038 is 11,924.

The ESOP funded its purchase of 238,473 shares through a loan from the Company equal to 100% of the aggregate purchase price of the common stock.  The ESOP trustee will repay the loan principally through the Bank’s contributions to the ESOP over the remaining loan term that matures on December 31, 2038.  At September 30, 2020, the remaining principal balance on the ESOP debt was $2.3 million.  

Under applicable accounting requirements, the Company records compensation expense for the ESOP equal to fair market value of shares when they are committed to be released from the suspense account to participants’ accounts under the plan.  Total compensation expense recognized in connection with the ESOP for the three and nine months ended September 30, 2020 was $18,000 and $63,000, respectively.  

 

 

The fair value of unallocated shares was approximately $1.7 million at September 30, 2020.

401(k) Plan

The Company sponsors a 401(k) defined contribution plan for substantially all employees pursuant to which employees of the Company could elect to make contributions to the plan subject to Internal Revenue Service limits. The Company makes matching and profit-sharing contributions to eligible participants in accordance with plan provisions. The Company’s contributions for the three months ended September 30, 2020 and 2019 were $56,000 and $44,000, respectively, and $150,000 and $123,000 for the nine months ended September 30, 2020 and 2019, respectively.

Pension Plan

The Company participates in the Pentegra Defined Benefit Plan for Financial Institutions (The Pentegra DB Plan), a tax-qualified defined benefit pension plan. The Pentegra DB Plan operates as a multi-employer plan for accounting purposes and as a multiple-employer plan under the Employee Retirement Income Security Act of 1974 and the Internal Revenue Code. There are no collective bargaining agreements in place that require contributions to the Pentegra DB Plan. The Pentegra DB Plan is a single plan under Internal Revenue Code Section 413 (c) and, as a result, all of the assets stand behind all of the liabilities. Accordingly, under the Pentegra DB Plan, contributions made by a participating employer may be used to provide benefits to participants of other participating employers.

The funded status (fair value of plan assets divided by funding target) as of July 1, 2020 is as follows:

 

 

Based upon the funded status of the Pentegra DB Plan as of July 1, 2020, no funding improvement plan or rehabilitation plan has been implemented or is pending as of September 30, 2020.

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Total pension plan expense for the three months ended September 30, 2020 and 2019  was $90,000 and $87,000, respectively, and $279,000 and $260,000 for the nine months ended September 30, 2020 and 2019, respectively, and is included in salaries and employee benefits expense in the accompanying consolidated statements of income. The Company did not pay a surcharge to the Pentegra DB Plan during the three or nine months ended September 30, 2020.

The Company enacted a “hard freeze” for the Pentegra DB Plan as of December 31, 2018, eliminating all future service-related accruals for participants. Prior to this enactment the Company maintained a “soft freeze” status that continued service-related accruals for its active participants with no new participants permitted into the Pentegra DB Plan. The Company estimates a contribution amount of approximately $360,000 for the fiscal year ending December 31, 2020.

Supplemental Executive Retirement Plans

Salary Continuation Plan

The Company maintains a nonqualified supplemental retirement plan for its current President and its former President. The plan provides supplemental retirement benefits payable in installments over a period of years upon retirement or death. The recorded liability at September 30, 2020 and December 31, 2019 relating to this supplemental retirement plan was $567,000 and $590,000, respectively. The discount rate used to determine the Company’s obligation was 5.00%. The projected rate of salary increase for its current President was 5%. The expense of this salary retirement plan was $16,000 and $22,000 for the three months ended September 30, 2020 and 2019, respectively, and $66,000 and $68,000 for the nine months ended September 30, 2020 and 2019, respectively.

Executive Supplemental Retirement Plan

The recorded liability at September 30, 2020 and December 31, 2019 relating to the supplemental retirement plan for the Bank’s former President was $171,000. The discount rate used to determine the Company’s obligation was 6.25% at September 30, 2020 and December 31, 2019.  

Endorsement Method Split Dollar Plan

The Company has an endorsement method split dollar plan for a former President. The recorded liability at September 30, 2020 and December 31, 2019 relating to this supplemental executive benefit agreement was $33,000. The expense (benefit) of this supplemental plan was $-0- and $(6,000) for the three months ended September 30, 2020 and 2019, respectively and $-0- and $(19,000) for the nine months ended September 30, 2020 and 2019, respectively.

Directors Deferred Supplemental Retirement Plan

The Company has a supplemental retirement plan for eligible directors that provides for monthly benefits based upon years of service to the Company, subject to certain limitations as set forth in the agreements. The present value of these future payments is being accrued over the estimated period of service. The estimated liability at September 30, 2020 and December 31, 2019 relating to this plan was $559,000 and $581,000, respectively. The discount rate used to determine the Company’s obligation was 6.25% at September 30, 2020 and December 31, 2019. Total supplemental retirement plan expense amounted to $18,000 and $20,000 for the three months ended September 30, 2020 and 2019, respectively, and $46,000 and $71,000 for the nine months ended September 30, 2020 and 2019, respectively.

Additionally, the Company has a deferred director’s fee plan, which allows members of the board of directors to defer the receipt of fees that otherwise would be paid to them in cash. At September 30, 2020 and December 31, 2019, the total deferred director’s fees amounted to $283,000 and $233,000, respectively.

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The Company reports certain items as “other comprehensive income (loss)” and reflects total comprehensive income (loss) in the consolidated financial statements for all periods containing elements of other comprehensive income (loss). The following table presents a reconciliation of the changes in the components of other comprehensive income (loss) for the dates indicated, including the amount of income tax expense (benefit) allocated to each component of other comprehensive income (loss):

 

 

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The following tables present the changes in each component of AOCI for the periods indicated:

 

 

 

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Regulatory Capital

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below). Management believes that, as of September 30, 2020 and December 31, 2019, the Bank met all capital adequacy requirements to which it was subject, including the capital conservation buffer, at those dates.

As fully phased in on January 1, 2019, the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (“Basel III Capital Rules”) require the Bank to maintain (i) a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum ratio of Common Equity Tier 1 capital to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%), (iii) a minimum ratio of Total capital (that is, Tier 1 plus Tier 2) to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average quarterly assets. The capital conservation buffer is designed to absorb losses during periods of economic stress and effectively increases the minimum required risk-weighted capital ratios. Banking institutions with a ratio of Common Equity Tier 1 capital to risk-weighted assets below the effective minimum will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

The following table presents actual and required capital ratios as of September 30, 2020 and December 31, 2019 for the Bank under the Basel III Capital Rules. The minimum required capital amounts presented include the minimum required capital levels as of September 30, 2020 and December 31, 2019 based on the phase-in provisions of the Basel III Capital Rules and the minimum required capital levels as of January 1, 2019, when the Basel III Capital Rules were fully phased-in. Capital levels required to be considered well capitalized are based upon prompt corrective action regulations, as amended to reflect the changes under the Basel III Capital Rules.

 

 

 

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On September 23, 2020, the board of directors of the Company authorized a stock repurchase program pursuant to which the Company may purchase up to 136,879 shares of the Company’s common stock, equal to 2.3% of the Company’s outstanding common stock at the time and approximately 5.0% of the currently outstanding shares owned by stockholders other than the MHC. The program allows the Company to repurchase common stock at various prices in the open market or through private transactions. The actual amount and timing of future repurchases, if any, will depend on market conditions, applicable SEC rules and various other factors.

The Company did not repurchase any shares of common stock during the nine months ended September 30, 2020.

 

Derivatives are recognized as either assets or liabilities on the balance sheet and are measured at fair value.  The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and resulting designation. The Company utilizes interest rate swap agreements as part of its asset liability management strategy. Interest rate swaps involve the exchange of interest payments at specified intervals between two parties without the exchange of any underlying principal. These derivative instruments are designated as cash flow hedges with the effective portion of changes in the fair value of the derivative recorded in accumulated other comprehensive income and recognized in earnings when the hedged transaction affects earnings.  The ineffective portion of changes in the fair value of the cash flow hedge is recognized directly in earnings. For the three and nine months ended September 30, 2020 the Company did not record any ineffectiveness related to these cash flow hedges.

 

During April 2020, the Company entered into two $5 million notional interest rate swaps that have been designated as cash flow hedges on 90-day advances from FHLB. One agreement is currently active and the other is a forward swap with a start date of April 13, 2021. The purpose of these cash flow hedges is to reduce potential interest rate risk by swapping a variable rate borrowing to a fixed rate. Management deemed it prudent to limit the variability of these interest payments by entering into these interest rate swap agreements. These agreements provide for the Company to receive payments at a variable rate determined by a specific index (three-month LIBOR) in exchange for making payments at a fixed rate. Publication of LIBOR is expected to cease at the end of 2021. The swap agreements allow for substitution of an alternative reference rate such as the secured overnight financing rate (“SOFR”) at that time.

 

The effective portion of changes in the fair value of interest rate swaps are reported in other comprehensive income and are subsequently reclassified into earnings in the period that the hedged transactions affect earnings. For the three months ended September 30, 2020, the change in fair value for these derivative instruments was $-0-. At September 30, 2020, the fair value of interest rate swap derivatives resulted in a liability of $164,000 and is recorded in other liabilities.

 

The following table summarizes the Company’s derivatives associated with its interest rate risk management activities:

 

 

The credit risk associated with these interest rate swaps is the risk of default by the counterparty. To minimize this risk, the Company only enters into interest rate swaps agreements with highly rated counterparties that management believes to be creditworthy. The notional amounts of these agreements do not represent amounts exchanged by the parties and, therefore, are not a measure of the potential loss exposure. Risk management results for the three and nine months ended September 30, 2020, related to the balance sheet hedging of $5.0 million of 90 day FHLB advances, included in borrowings, indicate that the hedge was 100% effective and there was no component of the derivative instruments’ unrealized loss which was excluded from the assessment of hedge effectiveness. The Company’s arrangement with its counterparty requires it to post cash or other assets as collateral for its interest rate swap contracts in a net liability position based on their aggregate fair value and the Company’s

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credit rating. At September 30, 2020, the Company posted $525,000 of cash to the counterparty as collateral on its interest rate swap contracts which was presented within cash and due from banks on the consolidated balance sheets.

Determination of Fair Value

The fair value of an asset or liability 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. The Company uses prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from one level to another. 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 of cash flows 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 instrument.

The Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded, and the observability and reliability of the assumptions used to determine fair value.

Level 1 - Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 - Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Level 3 - Level 3 inputs are unobservable inputs for the asset or liability.

For assets and liabilities, fair value is based upon the lowest level of observable input that is significant to the fair value measurement.

In general, fair value is based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon models that primarily use, as inputs, observable market-based parameters. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Furthermore, the reported fair value amounts have not been comprehensively revalued since the presentation dates, and, therefore, estimates of fair value after the balance sheet date may differ significantly from the amounts presented therein. A more detailed description of the valuation methodologies used for assets and liabilities measured at fair value is set forth below. A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below. These valuation methodologies were applied to all the Company’s financial assets and financial liabilities carried at fair value at September 30, 2020 and December 31, 2019. There were no significant transfers between levels of the fair value hierarchy during the three or nine months ended September 30, 2020 and 2019.  

Financial Assets and Financial Liabilities: Financial assets and financial liabilities measured at fair value on a recurring basis include the following:

Securities Available-for-Sale: The Company’s investment in U.S. Government-sponsored entities bonds, U.S Government agency small business administration pools guaranteed by the SBA, collateralized mortgage obligations issued by the FHLMC, residential mortgage-backed securities and other municipal bonds is generally classified within Level 2 of the fair value hierarchy. For these securities, the Company obtains fair value measurements from independent pricing services. The fair value measurements consider observable data that may include reported trades, dealer quotes, market spreads, cash flows, the U.S. treasury yield curve, trading levels, market consensus prepayment speeds, credit information and the instrument’s terms and conditions.

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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. The valuation model utilizes interest rate, prepayment speed and default rate assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data (see Note 5, Loan Servicing, for more information). These assumptions are inherently sensitive to change as these unobservable inputs are not based on quoted prices in active markets or otherwise observable.

Derivative Instruments and Hedges: The valuation of these instruments is determined using the discounted cash flow method on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.

The following table summarizes financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

 

 

 

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For the nine months ended September 30, 2020 and 2019, the changes in Level 3 assets and liabilities measured at fair value on a recurring basis were as follows:

 

 

 

For Level 3 assets measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019, the significant unobservable inputs used in the fair value measurements were as follows:

 

 

 

The significant unobservable inputs used in the fair value measurement of the Company’s mortgage servicing rights are the weighted-average prepayment rate, weighted-average discount rate, weighted average delinquency rate and weighted-average default rate. Significant increases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement.  Although the prepayment rate and the discount rate are not directly interrelated, they generally move in opposite directions of each other.

 

The Company estimates the fair value of mortgage servicing rights by using a discounted cash flow model to calculate the present value of estimated future net servicing income. Observable and unobservable inputs are entered into this model as prescribed by an independent third party to arrive at an estimated fair value. 

 

See Note 5, Loan Servicing, for a rollforward of our Level 3 item and related inputs and assumptions used to determine fair value at September 30, 2020.

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Certain financial assets and financial liabilities are measured at fair value on a non-recurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). Financial assets measured at fair value on a non-recurring basis during the reported periods may include certain impaired loans reported at the fair value of the underlying collateral. Fair value is measured using appraised values of collateral and adjusted as necessary by management based on unobservable inputs for specific properties. However, the choice of observable data is subject to significant judgment, and there are often adjustments based on judgment in order to make observable data comparable and to consider the impact of time, the condition of properties, interest rates and other market factors on current values. Additionally, commercial real estate appraisals frequently involve discounting of projected cash flows, which relies inherently on unobservable data. Therefore, real estate collateral related nonrecurring fair value measurement adjustments have generally been classified as Level 3. Estimates of fair value used for other collateral supporting commercial loans generally are based on assumptions not observable in the marketplace and therefore such valuations have been classified as Level 3. Financial assets measured at fair value on a non-recurring basis during the reported periods also include loans held for sale. Residential mortgage loans held for sale are recorded at the lower of cost or fair value and are therefore measured at fair value on a non-recurring basis. The fair values for loans held for sale are estimated based on commitments in effect from investors or prevailing market prices for loans with similar terms to borrowers of similar credit quality and are included in Level 3. At September 30, 2020, the Company’s only asset measured at fair value on a nonrecurring basis was a loan identified as impaired for which a partial write-off has been recorded. This impaired loan was reported at the fair value of the underlying collateral, less estimated selling costs. The Company classifies impaired loans as Level 3 in the fair value hierarchy. Collateral values are estimated using Level 2 inputs based upon appraisals of similar properties obtained from a third party, but can be adjusted, and therefore classified as Level 3.

The following summarizes assets measured at fair value on a nonrecurring basis at September 30, 2020 and December 31, 2019:

 

 

The following is a summary of the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a nonrecurring basis at September 30, 2020 and December 31, 2019:

  

 

Non-Financial Assets and Non-Financial Liabilities: The Company has no non-financial assets or non-financial liabilities measured at fair value on a recurring basis. Non-financial assets measured at fair value on a non-recurring basis generally include certain foreclosed assets which, upon initial recognition, were remeasured and reported at fair value through a charge-off to the allowance for loan losses and certain foreclosed assets which, subsequent to their initial recognition, are remeasured at fair value through a write-down included in other non-interest expense. There were no foreclosed assets at September 30, 2020 or December 31, 2019.

ASC Topic 825, “Financial Instruments,” requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above.

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Summary of Fair Values of Financial Instruments not Carried at Fair Value

The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments at September 30, 2020 and December 31, 2019 are as follows:

 

 

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General

Management’s discussion and analysis of financial condition and results of operations is intended to assist in understanding the Company’s consolidated financial condition at September 30, 2020 and consolidated results of operations for the three and nine months ended September 30, 2020 and 2019. It should be read in conjunction with our unaudited consolidated financial statements and accompanying notes presented elsewhere in this report and with the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed on March 27, 2020 with the Securities and Exchange Commission. Certain prior year amounts have been reclassified to conform to the current year presentation.

Overview

Our business consists primarily of taking deposits from the general public and investing those deposits, together with funds generated from operations and borrowings from the FHLB, in one- to four-family residential real estate loans, commercial real estate and multi-family loans, acquisition, development and land loans, commercial and industrial loans, home equity loans and lines of credit and consumer loans.  In recent years, we have increased our focus, consistent with what we believe to be conservative underwriting standards, on originating higher yielding commercial real estate and commercial and industrial loans.

We conduct our operations from four full-service banking offices in Strafford County, New Hampshire and one full-service banking office in Rockingham County, New Hampshire. We consider our primary lending market area to be Strafford and Rockingham Counties in New Hampshire and York County in Southern Maine.

COVID-19 Pandemic

In March 2020, the outbreak of the COVID-19 was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has created a global public health crisis that has resulted in unprecedented uncertainty, volatility, and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve. Governmental responses to the pandemic have included orders closing businesses not deemed essential and directing individuals to restrict their movements, observe social distancing and shelter in place. These actions, together with responses to the pandemic by businesses and individuals, have resulted in rapid decreases in commercial and consumer activity, temporary closures of many businesses that have led to a loss of revenues and a rapid increase in unemployment, material decreases in oil and gas prices and in business valuations, disrupted global supply chains, market downturns and volatility, changes in consumer behavior related to pandemic fears, related emergency response legislation and an expectation that Federal Reserve policy will maintain a low interest rate environment for the foreseeable future.

We have taken deliberate actions to ensure that we have the balance sheet strength to serve our customers and communities, including increases in liquidity and reserves supported by a strong capital position. Our business and consumer customers are experiencing varying degrees of financial distress, which is expected to increase in the coming months. In order to protect the health of our customers and employees, and to comply with applicable government directives, we have modified our business practices, including restricting employee travel, directing employees to work from home insofar as is possible and implementing our business continuity plans and protocols to the extent necessary.

On March 27, 2020, the CARES Act was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The CARES Act includes the PPP, a nearly $350 billion program designed to aid small- and medium-sized businesses through federally guaranteed SBA loans distributed through banks. These loans are intended to guarantee eight weeks of payroll and other costs to help those businesses remain viable and allow their workers to pay their bills. As of September 30, 2020, the Bank originated 286 PPP Loans with aggregate outstanding principal balances of $33.0 million.

In response to the COVID-19 pandemic, we have also implemented a short-term loan modification program to provide temporary payment relief to certain borrowers who meet the program's qualifications. In April 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve System and the Office of the Comptroller of the Currency, issued an interagency statement titled Interagency Statement on Loan Modifications and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus, that encourages financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations due to the effects of the COVID-19 pandemic. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification 310-40, Receivables – Troubled Debt Restructurings by Creditors (ASC 310-40), a restructuring of debt constitutes a troubled debt restructuring, or TDR, if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider.  The regulatory agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to the COVID-19 pandemic to borrowers who were current prior to any relief, are not to be considered TDRs. These include short-term modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant.

Additionally, Section 4013 of the CARES Act that passed on March 27, 2020 further provides banks with the option to elect either or both of the following, from March 1, 2020 until the earlier of December 31, 2020 or the date that is 60 days after the date on

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which the national emergency concerning the COVID-19 pandemic declared by the President of the United States under the National Emergencies Act (50 U.S.C. 1601 et seq.) terminates:

If a bank elects a suspension noted above, the suspension (i) will be effective for the term of the loan modification, but solely with respect to any modification, including a forbearance arrangement, an interest rate modification, a repayment plan, and any other similar arrangement that defers or delays the payment of principal or interest, that occurs during the applicable period for a loan that was not more than 30 days past due as of December 31, 2019; and (ii) will not apply to any adverse impact on the credit of a borrower that is not related to the COVID–19 pandemic. The Company has applied this guidance to qualifying loan modifications.

The program has been offered to both retail and commercial borrowers. The majority of short-term loan modifications for retail loan borrowers consist of deferred payments (which may include principal, interest and escrow), which are capitalized to the loan balance and recovered through the re-amortization of the monthly payment at the end of the deferral period. For commercial loan borrowers, the majority of short-term modifications consist of allowing the borrower to make interest-only payments with the deferred principal to be due at maturity or repaid as the monthly payment is re-amortized at the next interest reset date as is applicable to the individual loan structure.  Alternatively, commercial loan borrowers may defer their full monthly payment similar to the retail loan program outlined above. All loans modified under these programs are maintained on full accrual status during the deferral period.

As of September 30, 2020, we provided temporary payment relief for 6 loans with aggregate outstanding principal balances of $5.8 million. As of September 30, 2020, temporary modifications consisted of 1 commercial loan with aggregate outstanding principal balances of $4.1 million and 5 residential loans with aggregate outstanding principal balances of $1.7 million. Under the applicable regulatory guidance, none of these loans were considered restructured as of September 30, 2020. We continue to monitor the impact of COVID-19 closely, as well as any effects that may result from the CARES Act; however, the extent to which the COVID-19 pandemic will impact our operations and financial results during the remainder of 2020 and beyond is highly uncertain.

Cautionary Note Regarding Forward-Looking Statements

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

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

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

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

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

Critical Accounting Policies

The discussion and analysis of the financial condition and results of operations are based on our consolidated financial statements, which are prepared in conformity with generally accepted accounting principles used in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions affecting the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of income and expenses. We consider the accounting policies discussed below to be critical accounting policies. The estimates and assumptions that we use are based on historical experience and various other factors and are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions, resulting in a change that could have a material impact on the carrying value of our assets and liabilities and our results of operations.

Our critical accounting policies involve the calculation of the allowance for loan losses and the measurement of the fair value of financial instruments. A detailed description of these critical accounting policies can be found in Note 2 of the Company’s consolidated financial statements contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

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Comparison of Financial Condition at September 30, 2020 (unaudited) and December 31, 2019

Total Assets. Total assets were $477.3 million as of September 30, 2020, an increase of $67.8 million, or 16.6%, compared to total assets of $409.5 million at December 31, 2019. The increase was due primarily to a $33.0 million increase in net loans and a $23.3 million increase in cash and due from banks.

Cash and Due From Banks. Cash and due from banks increased $23.3 million, or 581.4%, to $27.3 million at September 30, 2020 from $4.0 million at December 31, 2019. This increase primarily resulted from a $57.8 million increase in deposits and $25.7 million of borrowings from the FRB under the PPPLF, offset by a decrease in advances from the FHLB of $19.3 million and a $33.0 million increase in net loans for the nine months ended September 30, 2020.  

Available-for-Sale Securities. Available-for-sale securities increased by $12.1 million, or 27.1%, to $56.9 million at September 30, 2020 from $44.8 million at December 31, 2019. This increase was primarily due to investments purchased and market price appreciation during the nine months ended September 30, 2020.

Net Loans. Net loans increased $33.0 million, or 9.7%, to $375.0 million at September 30, 2020 from $342.0 million at December 31, 2019. During the nine months ended September 30, 2020, we originated $131.5 million of loans (including $33.0 million of PPP loans classified as commercial and industrial loans), including $60.7 million of one- to four-family residential mortgage loans, $3.1 million of commercial real estate mortgage loans, $18.8 million of acquisition, development and land loans, $40.1 million of commercial and industrial loans, $5.1 million of multi- family loans and $3.7 million of consumer and home equity loans and lines of credit. During the nine months ended September 30, 2020, we had $107.1 million in loan principal repayments. We also purchased $9.9 million of one- to four-family residential mortgage loans collateralized by properties located in the greater Boston market during the nine months ended September 30, 2020.

One- to four-family residential mortgage loans increased $3.9 million, or 1.8%, to $217.2 million at September 30, 2020 from $213.3 million at December 31, 2019. Commercial real estate mortgage loans decreased $3.4 million, or 4.9%, to $66.8 million from $70.2 million at December 31, 2019. Multi-family loans increased $1.4 million, or 27.9%, to $6.3 million from $4.9 million at December 31, 2019. Commercial and industrial loans increased $31.1 million, or 126.1%, to $55.8 million from $24.7 million at December 31, 2019. Acquisition, development, and land loans increased $1.5 million, or 7.7%, to $20.3 million from $18.8 million at December 31, 2019. Home equity loans and lines of credit decreased $563,000, or 5.6%, to $9.6 million from $10.1 million at December 31, 2019. Consumer loans increased $420,000, or 24.0%, to $2.2 million from $1.8 million at December 31, 2019. The largest increase in our loan portfolio was in the commercial and industrial loan portfolio due to the origination of $33.0 million of PPP loans as of September 30, 2020.

Our strategy to grow the balance sheet continues to be through originations of one- to four-family residential mortgage loans, while also diversifying into higher yielding commercial and industrial loans to improve net margins and manage interest rate risk. We also continue to sell selected, conforming 15-year and 30-year fixed rate mortgage loans to the secondary market on a servicing retained basis, providing us a recurring source of revenue from loan servicing income and gains on the sale of such loans.

Net deferred loan (fees) costs decreased $884,000 during the nine months ended September 30, 2020 primarily due to fees received from the SBA for processing PPP loans. Total SBA fees received were $1.4 million. SBA fee income recognized during the nine months ended September 30, 2020 was approximately $287,000 and is included in interest and fees on loans.

Our allowance for loan losses increased $371,000 to $3.2 million at September 30, 2020 from $2.9 million at December 31, 2019.  The Company measures and records its allowance for loan losses based upon an incurred loss model. Under this approach, loan loss is recognized when it is probable that a loss event was incurred.  This approach also considers qualitative adjustments to the quantitative baseline determined by the model. The Company considers the impact of current environmental factors at the reporting date that did not exist over the period from which historical experience was used. Relevant factors include, but are not limited to, concentrations of credit risk (geographic, large borrower and industry), economic trends and conditions, changes in underwriting standards, experience and depth of lending staff, trends in delinquencies and the level of criticized loans. Given the many economic uncertainties regarding COVID-19, the Company made relevant adjustments to its qualitative factors in the measurement of its allowance for loan losses at September 30, 2020 that balanced the need to recognize an allowance during this unprecedented economic situation while adhering to an incurred loss recognition and measurement principle which prohibits the recognition of future or lifetime losses.  

The Company has limited or no direct exposure to industries expected to be hardest hit by the COVID-19 pandemic, including oil and gas/energy, credit cards, airlines, cruise ships, arts/entertainment/recreation, casinos and shopping malls. Our exposure to the transportation and hospitality/restaurant industries amounted to less than 5% of our gross loan portfolio at September 30, 2020.   

Deposits. Our deposits are generated primarily from residents within our primary market area. We offer a selection of deposit accounts, including non-interest-bearing and interest-bearing checking accounts, savings accounts, money market accounts and certificates of deposit, for both individuals and businesses.

Deposits increased $57.8 million, or 20.5%, to $339.5 million at September 30, 2020 from $281.6 million at December 31, 2019 primarily as a result of an increase in commercial deposits due, in part, to the deposit of PPP loan proceeds. Core deposits (defined as

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deposits other than time deposits) increased $67.4 million, or 30.6%, to $288.0 million from $220.6 million at December 31, 2019. The increase was due to an increase in savings deposits of $8.2 million, an increase in money market deposits of $15.2 million and an increase in NOW and demand deposit accounts of $44.0 million. Time deposits decreased $9.6 million, or 15.7%, to $51.5 million from $61.0 million at December 31, 2019. There were no brokered deposits included in time deposits at September 30, 2020 or December 31, 2019.

Borrowings. Total borrowings increased $6.4 million, or 9.7%, to $72.6 million at September 30, 2020 from $66.2 million at December 31, 2019. Advances from FHLB decreased $19.3 million, or 29.2%, to $46.9 million at September 30, 2020 from $66.2 million at December 31, 2019 as a result of scheduled maturities. The decrease in advances from the FHLB was offset by a $25.7 million increase in advances from the FRB under the PPPLF program.

Total Stockholders’ Equity. Total stockholders’ equity increased $1.7 million, or 2.9%, to $58.7 million at September 30, 2020 from $57.1 million at December 31, 2019. This increase was due primarily to other comprehensive income of $438,000 related to net changes in unrealized holding gains in the available-for-sale securities portfolio and fair value of interest rate swap derivatives and net income of $1.2 million for the nine months ended September 30, 2020.

Nonperforming Assets. Non-performing assets include loans that are 90 or more days past due or on non-accrual status, including troubled debt restructurings on non-accrual status, and real estate and other loan collateral acquired through foreclosure and repossession. Troubled debt restructurings include loans for which either a portion of interest or principal has been forgiven or loans modified at interest rates materially less than current market rates.

Management determines that a loan is impaired or nonperforming when it is probable at least a portion of the loan will not be collected in accordance with the original terms due to a deterioration in the financial condition of the borrower or the value of the underlying collateral if the loan is collateral dependent. When a loan is determined to be impaired, the measurement of the loan in the allowance for loan losses is based on present value of expected future cash flows, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Non-accrual loans are loans for which collectability is questionable and, therefore, interest on such loans will no longer be recognized on an accrual basis. 

We generally cease accruing interest on our loans when contractual payments of principal or interest have become 90 days past due or management has serious doubts about further collectability of principal or interest, even though the loan is currently performing. Interest received on non-accrual loans generally is applied against principal or applied to interest on a cash basis. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for at least six consecutive months and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Nonperforming loans were $930,000 and $1.1 million, or 0.25% and 0.31% of total loans, at September 30, 2020 and December 31, 2019, respectively. Nonperforming loans consist primarily of an SBA-guaranteed commercial and industrial loan, which had an outstanding balance of $865,000 at September 30, 2020, and is secured by all business assets. The SBA-guarantee covers 75% of the loan balance. Although this loan was performing according to its original terms at September 30, 2020, it was considered nonperforming due to the financial condition and prospects of the borrower. At September 30, 2020 and December 31, 2019, we had no troubled debt restructurings or foreclosed assets.

Comparison of Operating Results for the Three Months Ended September 30, 2020 and September 30, 2019

Net Income. Net income was $392,000 for the three months ended September 30, 2020, compared to a net loss of $613,000 for the three months ended September 30, 2019, an increase of $1.0 million, or 163.9%. The increase was primarily due to a $301,000 increase in net interest and dividend income after provision for loan losses and a decrease in noninterest expense of $985,000 due primarily to the absence in the current period of a $758,000 funding of the charitable foundation established during the three months ended September 30, 2019, offset by an increase of $302,000 in the provision for income taxes during the three months ended September 30, 2020.

Interest and Dividend Income. Interest and dividend income increased $24,000, or 0.6%, to $3.9 million for the three months ended September 30, 2020 from $3.9 million for the three months ended September 30, 2019. This increase was due to a $67,000 increase in interest and fees on loans, primarily due to an increase of $45.7 million in the average balance of the loan portfolio to $380.5 million for the three months ended September 30, 2020 from $334.8 million for the three months ended September 30, 2019, offset by a $43,000 decrease in interest and dividend income on investments, or 11.8%, to $321,000 for the three months ended September 30, 2020 from $364,000 for the three months ended September 30, 2019. The increase is also attributable to SBA interest and fee income earned related to the Bank’s participation in the PPP. The weighted average annualized yield for the loan portfolio decreased to 3.81% for the three months ended September 30, 2020 from 4.25% for the three months ended September 30, 2019 primarily as a result of a decrease in market interest rates. The weighted average annualized yield for the investment portfolio decreased to 2.21% for the three months ended September 30, 2020 from 2.78% for the three months ended September 30, 2019 due primarily to the reinvestment of proceeds from sales and maturities into lower yielding investments as a result of a decrease in market interest rates.

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Average interest-earning assets increased $70.3 million, to $458.0 million for the three months ended September 30, 2020 from $387.7 million for the three months ended September 30, 2019. The annualized yield on interest earning-assets decreased 60 basis points to 3.45% for the three months ended September 30, 2020 from 4.05% for the three months ended September 30, 2019 primarily as a result of a decrease in market interest rates.

Interest Expense. Total interest expense decreased $387,000, or 43.4%, to $504,000 for the three months ended September 30, 2020 from $891,000 for the three months ended September 30, 2019. Interest expense on deposits decreased $286,000, or 46.4% to $330,000 for the three months ended September 30, 2020 from $616,000 for the three months ended September 30, 2019 due to a decrease in deposit rates, offset by an increase in interest-bearing deposit balances. The weighted average annualized rate of interest-bearing deposits decreased to 0.48% for the three months ended September 30, 2020 from 1.01% for the three months ended September 30, 2019 primarily as a result of a decrease in market interest rates and low interest rate borrowings associated with PPPLF  advances. The average balance of interest-bearing deposits increased to $273.5 million for the three months ended September 30, 2020 from $243.6 million for the three months ended September 30, 2019, an increase of $30.0 million, or 12.3%, primarily as a result of an increase in the average balance of commercial deposits due, in part, to the deposit of PPP loan proceeds.

Interest expense on borrowed funds decreased $101,000, or 36.7% to $174,000 for the three months ended September 30, 2020 from $275,000 for the three months ended September 30, 2019, primarily due to a decrease in the borrowing rate, offset by an increase in the amount of funds borrowed. The weighted average annualized rate of borrowings decreased to 0.96% for the three months ended September 30, 2020 from 2.22% for the three months ended September 30, 2019. The average balance increased $22.7 million, or 45.8%, to $72.3 million for the three months ended September 30, 2020 from $49.6 million for the three months ended September 30, 2019. The increase in the average balance of borrowed funds was due primarily to funds borrowed from the FRB under the PPPLF program.

Net Interest Income. Net interest income increased $411,000, or 13.6%, to $3.4 million for the three months ended September 30, 2020 from $3.0 million for the three months ended September 30, 2019. This increase was due to a $70.3 million, or 18.1%, increase in the balance of average interest-earning assets offset by an increase of $52.7 million, or 17.9%, in interest-bearing liabilities during the three months ended September 30, 2020. The annualized net interest margin decreased to 3.01% for the three months ended September 30, 2020 from 3.13% for the three months ended September 30, 2019.

Provision for Loan Losses. Based on management’s analysis of the allowance for loan losses, a $110,000 provision for loan losses was recorded for the three months ended September 30, 2020, compared to no provision for loan losses for the three months ended September 30, 2019. The increase in the provision for the three months ended September 30, 2020 was primarily due to adjustments to qualitative factors reflecting economic uncertainties as a result of COVID-19.

Non-Interest Income. Non-interest income increased $21,000, or 4.7%, to $465,000 for the three months ended September 30, 2020 compared to $444,000 for the three months ended September 30, 2019. The increase in non-interest income during the three months ended September 30, 2020 was due primarily to a $44,000 increase in gain on sale of loans and a $21,000 increase in income from bank-owned life insurance, offset by a $42,000 decrease in securities gains, net, during the three months ended September 30, 2020.

Non-Interest Expense. Non-interest expense decreased $1.0 million, or 22.9%, to $3.3 million for the three months ended September 30, 2020 from $4.3 million for the three months ended September 30, 2019. The decrease was due primarily to the absence in the current period of a $758,000 funding of the charitable foundation during the three months ended September 30, 2019. Also contributing to the decrease in non-interest expense was a $438,000, or 81.7%, decrease in marketing expense, offset by increased salaries and employee benefits of $100,000, or 5.2%, an increase in data processing expense of $77,000, or 35.0%, and an increase in deposit insurance fees of $47,000, or 313.3% for the three months ended September 30, 2020. The increase in salaries and benefits during the three months ended September 30, 2020 was due to filling vacant positions, normal salary increases, employee bonus accruals and compensation expense recognized in connection with the ESOP.

Income Taxes. An income tax expense of $82,000 was recorded for the three months ended September 30, 2020 compared to an income tax benefit of $220,000 for the three months ended September 30, 2019. The effective tax rate was 17.3% for the three months ended September 30, 2020. The difference between the Company’s effective tax rate as compared to the statutory rate of 21% is due primarily to tax-exempt income related to municipal securities. The benefit recognized during the three months ended September 30, 2019 resulted primarily from the tax benefit of a $758,000 donation to the charitable foundation established during the period. The effective tax rate for the three months ended September 30, 2019 is less than statutory federal and state tax rates due primarily to tax-exempt income related to investments in bank owned life insurance and municipal securities, as well as the impact of a state tax credit and a state net operating loss carryforward.

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Average Balance Sheets

The following tables set forth average balance sheets, average yields and costs and certain other information at and for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial.  All average balances are daily average balances. Non-accrual loans are included in the computation of average balances only. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or interest expense.

 

 

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Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the years indicated.  The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume).  The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate).  The total 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.

 

 

Comparison of Operating Results for the Nine Months Ended September 30, 2020 and 2019

Net Income. Net income was $1.2 million for the nine months ended September 30, 2020, compared to a net loss of $222,000 for the nine months ended September 30, 2019, an increase of $1.4 million, or 631.5%. The increase was related primarily to an increase of $904,000 in net interest and dividend income after provision for loan losses, an increase in noninterest income of $460,000 and a decrease in noninterest expenses of $376,000, offset by an increase in income tax expense of $338,000 during the nine months ended September 30, 2020.

Interest and Dividend Income. Interest and dividend income increased $230,000, or 2.0%, to $11.8 million for the nine months ended September 30, 2020 from $11.6 million for the nine months ended September 30, 2019. This increase was due to a $417,000 increase in interest and fees on loans, primarily due to an increase of $36.9 million in the average balance of the loan portfolio to $367.0 million for the nine months ended September 30, 2020 from $330.1 million for the nine months ended September 30, 2019, offset by a $187,000, or 16.2%, decrease in interest and dividend income on investments, to $964,000 for the nine months ended September 30, 2020 from $1.2 million for the nine months ended September 30, 2019. The increase is also attributable to SBA interest and fee income earned related to the Bank’s participation in the PPP. The weighted average annualized yield for the loan portfolio decreased to 3.94% for the nine months ended September 30, 2020 from 4.21% for the nine months ended September 30, 2019 primarily as a result of a decrease in market interest rates. The weighted average annualized yield for the investment portfolio decreased to 2.39% for the nine months ended September 30, 2020 from 2.76% for the nine months ended September 30, 2019 due primarily to the reinvestment of proceeds from sales and maturities into lower yielding investments as a result of a decrease in market interest rates.

Average interest-earning assets increased $50.0 million, to $434.8 million for the nine months ended September 30, 2020 from $384.8 million for the nine months ended September 30, 2019. The annualized yield on interest earning-assets decreased to 3.62% for the nine months ended September 30, 2020 from 4.01% for the nine months ended September 30, 2019 primarily as a result of a decrease in market interest rates.

Interest Expense. Total interest expense decreased $1.0 million, or 34.6%, to $2.0 million for the nine months ended September 30, 2020 from $3.0 million for the nine months ended September 30, 2019. Interest expense on borrowed funds decreased $606,000, or 46.8%, to $689,000 for the nine months ended September 30, 2020 from $1.3 million for the nine months ended September 30, 2019. The average balance of borrowings increased to $73.0 million for the nine months ended September 30, 2020 from $69.4 million for the nine months ended September 30, 2019, an increase of $3.5 million, or 5.1% due primarily to funds borrowed from the FRB under the PPPLF program offset by repayments of FHLB borrowings. The weighted average annualized rate paid on borrowings decreased to 1.26% for the nine months ended September 30, 2020 from 2.49% for the nine months ended

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September 30, 2019 primarily as a result of a decrease in market interest rates and low interest rate borrowings associated with PPPLF advances.

While deposit balances increased, the interest expense on deposits decreased $428,000 for the nine months ended September 30, 2020 compared to the nine months ended September 30, 2019. The average balance of interest-bearing deposits increased to $258.1 million for the nine months ended September 30, 2020 from $237.1 million for the nine months ended September 30, 2019, an increase of $20.9 million, or 8.8%, primarily as a result of an increase in the average balance of commercial deposits due, in part, to the deposit of PPP loan proceeds. The weighted average annualized rate on deposits decreased to 0.65% for the nine months ended September 30, 2020 from 0.95% for the nine months ended September 30, 2019 primarily as a result of a decrease in market interest rates.  

Net Interest Income. Net interest income increased $1.3 million, or 14.7%, to $9.9 million for the nine months ended September 30, 2020 from $8.6 million for the nine months ended September 30, 2019. This increase was due to a $50.0 million, or 13.0%, increase in the balance of average interest-earning assets offset by an increase of $24.5 million, or 7.9%, in interest-bearing liabilities during the nine months ended September 30, 2020. The annualized net interest margin increased to 3.02% for the nine months ended September 30, 2020 from 2.97% for the nine months ended September 30, 2019.

Provision for Loan Losses. Based on management’s analysis of the allowance for loan losses, a $385,000 provision for loan losses was recorded for the nine months ended September 30, 2020, compared to $25,000 for the nine months ended September 30, 2019. The increase in the provision for the nine months ended September 30, 2020 was primarily due to adjustments to qualitative factors reflecting economic uncertainties as a result of COVID-19.

Non-Interest Income. Non-interest income increased $460,000, or 41.6%, to $1.6 million for the nine months ended September 30, 2020 compared to $1.1 million for the nine months ended September 30, 2019. The increase in non-interest income during the nine months ended September 30, 2020 was due primarily to a $251,000 increase in securities gains, net, and a $227,000 increase in gain on sale of loans during the nine months ended September 30, 2020.

Non-Interest Expense. Non-interest expense decreased $376,000, or 3.7%, to $9.7 million for the nine months ended September 30, 2020 from $10.1 million for the nine months ended September 30, 2019. The decrease to non-interest expense was primarily due to decreased marketing expenses of $527,000, or 67.3%, decreased employee travel and education expenses of $102,000, or 56.4%, decreased charitable foundation expense of $758,000, or 100.0%, offset by increased salaries and employee benefits of $527,000, or 9.7%, increased data processing expense of $332,000, or 63.4%, and increased professional fees and assessments of $215,000, or 49.2%. The increase in salaries and benefits during the nine months ended September 30, 2020 was due to filling vacant positions, normal salary increases, employee bonus accruals and compensation expense recognized in connection with the ESOP. The increase in professional fees and assessments was due to expenses incurred to meet SEC reporting requirements. Data processing fees for the nine months ended September 30, 2019 were net of the receipt of proceeds from an insurance claim.

Income Taxes. An income tax expense of $128,000 was recorded for the nine months ended September 30, 2020 compared to an income tax benefit of $210,000 for the nine months ended September 30, 2019. The effective tax rate was 9.8% for the nine months ended September 30, 2020. The difference between the Company’s effective tax rate as compared to the statutory rate of 21% is due primarily to tax-exempt income related to municipal securities. The benefit recognized during the nine months ended September 30, 2019 resulted primarily from the tax benefit of a $758,000 donation to the charitable foundation established during the period. The effective tax rate for the period is less than statutory federal and state rates due primarily to tax-exempt income related to investments in bank owned life insurance and municipal securities, as well as the impact of a state tax credit and a state net operating loss carryforward.

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Average Balance Sheets

The following tables set forth average balance sheets, average yields and costs and certain other information at and for the periods indicated. No tax-equivalent yield adjustments have been made, as the effects would be immaterial. All average balances are daily average balances. Non-accrual loans are included in the computation of average balances only. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or interest expense.

 

 

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Rate/Volume Analysis

The following table presents the effects of changing rates and volumes on our net interest income for the years indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total 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.

 

 

Liquidity and Capital Resources

Liquidity describes our ability to meet the financial obligations that arise in the ordinary course of business. Liquidity is primarily needed to meet the borrowing and deposit withdrawal requirements of our customers and to fund current and planned expenditures. Our primary sources of funds are deposits, principal and interest payments on loans and securities, proceeds from the sale of loans and proceeds from maturities of securities. We also rely on borrowings from the FHLB and FRB as supplemental sources of funds. At September 30, 2020 and December 31, 2019, we had $46.9 million and $66.2 million outstanding in advances from the FHLB, respectively, and the ability to borrow an additional $95.0 million and $81.7 million, respectively. At September 30, 2020, we also had $25.7 million outstanding in PPPLF advances from FRB. Additionally, at September 30, 2020 and December 31, 2019, we had an overnight line of credit with the FHLB for up to $3.0 million and unsecured Fed Funds borrowing lines of credit with two correspondent banks for up to $5.0 million. At September 30, 2020 and December 31, 2019, there were no outstanding balances under any of these additional credit facilities.

While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions, and competition. Our most liquid assets are cash and cash equivalents and available-for-sale investment securities. The levels of these assets are dependent on our operating, financing, lending, and investing activities during any given period.

Our cash flows are comprised of three primary classifications: cash flows from operating activities, investing activities and financing activities. Net cash provided by operating activities was $3.0 million and $1.3 million for the nine months ended September 30, 2020 and 2019, respectively. Net cash used by investing activities, which consists primarily of disbursements for loan originations and purchases, net of principal collections, and the purchase of securities available for sale, offset by proceeds from the sale and maturity of securities available for sale, was $45.3 million and $11.4 million for the nine months ended September 30, 2020 and 2019, respectively. Net cash provided by financing activities, consisting of activity in deposit accounts and FHLB and FRB advances, was $65.5 million and $10.8 million for the nine months ended September 30, 2020 and 2019, respectively. Net cash provided by financing activities for the nine months ended September 30, 2019 included $25.1 million of net proceeds from the sale of the Company’s common stock.

We are committed to maintaining a strong liquidity position. We monitor our liquidity position daily. We anticipate that we will have sufficient funds to meet our current funding commitments based on our current strategy to increase core deposits and the continued use of FHLB advances, as well as brokered certificates of deposit as needed, to fund loan growth.

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COVID-19 has adversely impacted our business and that of many of our customers, and the ultimate impact will depend on future developments, which are highly uncertain, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic. We have performed an additional stress test that illustrates the impact of 35% of our loan portfolio payments being deferred for six months. This stress scenario was added to our base scenario which factored in our budgeted annual growth for 2020. The results indicated that our liquidity position would remain strong.

The net proceeds from the stock offering in 2019 significantly increased our liquidity and capital resources.  Over time, the initial level of liquidity is expected to be reduced as net proceeds from the stock offering are used for general corporate purposes, including the funding of loans.  However, due to the increase in equity resulting from the net proceeds raised in the stock offering, as well as other factors associated with the stock offering, our return on equity was adversely affected as a result of the stock offering and could continue to be adversely affected in the future.

First Seacoast Bancorp is a separate legal entity from First Seacoast Bank and must provide for its own liquidity to pay its operating expenses and other financial obligations. The Company’s primary source of income is dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company is governed by applicable bank regulations. At September 30, 2020, the Company (on an unconsolidated basis) had liquid assets of $10.0 million. On September 23, 2020, the board of directors of the Company authorized the repurchase of up to 136,879 shares of the Company’s outstanding common stock, which equals approximately 2.3% of all shares currently outstanding and approximately 5.0% of the currently outstanding shares owned by stockholders other than the MHC. See Note 11 of the unaudited consolidated financial statements appearing under Item 1 of this quarterly report.

At September 30, 2020 and December 31, 2019, the Bank exceeded all its regulatory capital requirements. See Note 10 of the unaudited consolidated financial statements appearing under Item 1 of this quarterly report.

 

Off-Balance Sheet Arrangements

As a financial services provider, we routinely are a party to various financial instruments with off-balance sheet risks, such as commitments to extend credit and unused lines of credit. While these contractual obligations represent our potential future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans we make. See Note 12 for a discussion of the Company’s derivative and hedging activities.

General.  Most of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage our exposure to changes in market interest rates. Accordingly, the board of directors established a management-level Asset/Liability Management Committee (the “ALCO”), which takes responsibility for overseeing the asset/liability management process and related procedures. The ALCO meets on at least a quarterly basis and reviews asset/liability strategies, liquidity positions, alternative funding sources, interest rate risk measurement reports, capital levels and economic trends at both national and local levels. Our interest rate risk position is also monitored quarterly by the board of directors.

We try to manage our interest rate risk to minimize the exposure of our earnings and capital to changes in market interest rates. We have implemented the following strategies to manage our interest rate risk: originating loans with adjustable interest rates; promoting core deposit products; selling a portion of fixed-rate one- to four-family residential real estate loans; maintaining investments as available-for-sale; diversifying our loan portfolio; utilizing interest rate swaps; and strengthening our capital position. By following these strategies, we believe that we are better positioned to react to changes in market interest rates.

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

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The following table presents the estimated changes in our net portfolio value that would result from changes in market interest rates at September 30, 2020.

 

The NPV ratio in the -100 bp change in interest rates scenario was -26.9% at September 30, 2020 versus a policy limit of -10.0%.  An extremely low interest rate environment may artificially reduce the calculated inherent value of the Bank’s non-maturity deposits, which can inordinately impact the sensitivity of the NPV ratio resulting in a mathematical aberration.  

 

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

Economic Value of Equity. Like most financial institutions, our profitability depends to a large extent upon our net interest income, which is the difference between our interest income on interest-earning assets, such as loans and securities, and our interest expense on interest-bearing liabilities, such as deposits and borrowed funds. Accordingly, our results of operations depend largely on movements in market interest rates and our ability to manage our interest-rate sensitive assets and liabilities in response to these movements. Factors such as inflation, recession and instability in financial markets, among other factors beyond our control, may affect interest rates.

In a rising interest rate environment, we would expect that the rates on our deposits and borrowings would reprice upwards faster than the rates on our long-term loans and investments, which would be expected to compress our interest rate spread and have a negative effect on our profitability. Furthermore, increases in interest rates may adversely affect the ability of our borrowers to make loan repayments on adjustable-rate loans, as the interest owed on such loans would increase as interest rates increase. Conversely, decreases in interest rates can result in increased prepayments of loans and mortgage-related securities, as borrowers refinance to reduce their borrowing costs. Under these circumstances, we are subject to reinvestment risk as we may have to redeploy such loan or securities proceeds into lower-yielding assets, which might also negatively impact our income. If interest rates rise, we expect that our economic value of equity would decrease. Economic value of equity represents the present value of the expected cash flows from our assets less the present value of the expected cash flows arising from our liabilities. The Company’s economic value of equity analysis as of September 30, 2020 estimated that, in the event of an instantaneous 200 basis point increase in interest rates, the Company would experience a 0.3% decrease in economic value of equity. At the same date, our analysis estimated that, in the event of an instantaneous 100 basis point decrease in interest rates, the Company would experience a 26.9% decrease in the economic value of equity. As noted above, we believe this decrease is a mathematical aberration due to the current extremely low interest rate environment.

Any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition, liquidity, and results of operations. Changes in the level of interest rates also may negatively affect our ability to originate real estate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings. Also, our interest rate risk modeling techniques and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet or projected operating results. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations of Federal Savings Bank— Management of Market Risk.”

 

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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, 2020.  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 as of September 30, 2020.

During the quarter ended September 30, 2020, there were no changes in the Company’s internal controls over financial reporting that materially affected, or were reasonably likely to materially affect, the Company’s internal control over financial reporting.

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PART II – OTHER INFORMATION

We are not involved in any pending legal proceedings as a plaintiff or a defendant other than routine legal proceedings occurring in the ordinary course of business. At September 30, 2020, we were not involved in any legal proceedings the outcome of which we believe would be material to our consolidated financial condition or results of operations.

As of September 30, 2020, the Company believes that the risk factors applicable to it have not changed materially from those disclosed in the Company’s Definitive Prospectus dated May 14, 2019,  as filed with the Securities and Exchange Commission on May 23, 2019, and the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2020, as filed with the Securities and Exchange Commission on August 14, 2020.

Not applicable.

None.

Not applicable.

On September 23, 2020, the board of directors of the Company authorized the repurchase of up to 136,879 shares of the Company’s outstanding common stock, which equals approximately 2.3% of all shares currently outstanding and approximately 5.0% of the currently outstanding shares owned by stockholders other than the MHC.  The Company intends to conduct any repurchases through open market purchases, including by means of a trading plan adopted under SEC Rule 10b5-1, or in privately negotiated transactions, subject to market conditions and other factors.  There is no guarantee as to the exact number of shares that the Company may repurchase.  The Company will hold any repurchased shares in its treasury.  The Company intends to commence any repurchases, subject to market conditions and other factors, after it files this Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, with the SEC.

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SIGNATURES

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

 

 

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