ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements Are Subject to Change
We make certain statements in this document as to what we expect may happen in the future. These statements usually contain the words
“believe,” “estimate,” “project,” “expect,” “anticipate,” “intend” or similar expressions. Because these statements look to the future, they are based on our current expectations and beliefs. Actual results or events may differ materially
from those reflected in the forward-looking statements. You should be aware that our current expectations and beliefs as to future events are subject to change at any time, and we can give you no assurances that the future events will
actually occur.
General
The Company was formed in connection with the Bank’s conversion to a stock savings bank completed on July 3, 2007. The Company’s results of operations are dependent primarily on the results
of the Bank, which is a wholly owned subsidiary of the Company. The Bank’s results of operations depend, to a large extent, on net interest income, which is the difference between the income earned on its loan and investment portfolios
and the cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by provisions for loan losses, fee income and other non-interest income and non-interest expense. Non-interest
expense principally consists of compensation, directors’ fees and expenses, office occupancy and equipment expense, data processing expense, professional fees, advertising expense, FDIC deposit insurance assessment, and other expenses.
Our results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and actions of regulatory authorities. Future changes in applicable
law, regulations or government policies may materially impact our financial condition and results of operations.
At September 30, 2019, the Bank has five wholly-owned subsidiaries, Quaint Oak Mortgage, LLC, Quaint Oak Real Estate, LLC, Quaint Oak Abstract, LLC, QOB Properties, LLC, and Quaint Oak
Insurance Agency, LLC, each a Pennsylvania limited liability company. The mortgage company offers mortgage banking in the Lehigh Valley, Delaware Valley and Philadelphia County region of Pennsylvania. The real estate and abstract
companies offer real estate sales and title abstract services, respectively, primarily in the Lehigh Valley region of Pennsylvania. These companies began operation in July 2009. In February 2019, Quaint Oak Mortgage opened a mortgage
banking office in Philadelphia, Pennsylvania. QOB Properties, LLC began operations in July 2012 and holds Bank properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure. Quaint Oak Insurance
Agency, LLC, located in Chalfont, Pennsylvania, began operations in August 2016 and provides a broad range of personal and commercial insurance coverage solutions.
Critical Accounting Policies
The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking
industry. Accordingly, the consolidated financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. The following accounting policies comprise those that management believes are
the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may
significantly affect our reported results and financial condition for the period or in future periods.
Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of losses inherent in the loan portfolio as of the balance
sheet date and is recorded as a reduction to loans receivable. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged
against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the
repayment of all, or part, of the principal balance is highly unlikely. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and
the entire allowance is available to absorb any and all loan losses.
The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the
adequacy of the allowance. The allowance is based on the Company’s past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any
underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision
as more information becomes available.
The allowance consists of specific, general and unallocated components. The specific component relates to loans that are designated as impaired. For loans that are designated as impaired, an
allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class. These
pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These significant factors may include changes in lending policies and procedures,
changes in existing general economic and business conditions affecting our primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in
particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are reevaluated quarterly to ensure their relevance in the current economic environment.
Residential owner occupied mortgage lending generally entails a lower risk of default than other types of lending. Consumer loans and commercial real estate loans generally involve more risk of collectability because of the type and
nature of the collateral and, in certain cases, the absence of collateral. It is the Company’s policy to establish a specific reserve for loss on any delinquent loan when it determines that a loss is probable. An unallocated component is
maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies
for estimating specific and general losses in the portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when
due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments
when due. Loans that experience insignificant payment delays and payment shortfalls generally are not considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking
into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the collateral if the loan is
collateral dependent. An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company’s impaired loans are measured
based on the estimated fair value of the loan’s collateral.
A loan is identified as a troubled debt restructuring (“TDR”) if the Company, for economic or legal reasons related to a debtor’s financial difficulties, grants a concession to the debtor
that it would not otherwise consider. Concessions granted under a TDR typically involve a temporary or permanent reduction in payments or interest rate or an extension of a loan’s stated maturity date at less than a current market rate of
interest. Loans identified as TDRs are designated as impaired.
For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made
regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal
and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the
property.
The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower’s overall financial condition, repayment sources, guarantors and
value of collateral, if appropriate, are evaluated annually for all loans (except one-to-four family residential owner-occupied loans) where the total amount outstanding to any borrower or group of borrowers exceeds $500,000, or when
credit deficiencies arise, such as delinquent loan payments. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans criticized special mention have potential weaknesses
that deserve management’s close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the
liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent
in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are
charged to the allowance for loan losses. Loans not classified are rated pass. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may
require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management’s
comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.
Income Taxes. Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net
deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various assets and liabilities and net operating loss carryforwards and gives current recognition to
changes in tax rates and laws. The realization of our deferred tax assets principally depends upon our achieving projected future taxable income. We may change our judgments regarding future profitability due to future market conditions
and other factors. We may adjust our deferred tax asset balances if our judgments change.
Comparison of Financial Condition at September 30, 2019 and December 31, 2018
General. The Company’s total assets at September 30, 2019 were $293.8 million, an increase of $22.4 million, or 8.3%, from $271.4 million at
December 31, 2018. This growth in total assets was primarily due to a $20.5 million, or 9.4%, increase in loans receivable, net, an $11.4 million, or 223.0%, increase in loans held for sale, a $5.2 million, or 106.5%, increase in
investment in interest-earning time deposits, a $2.6 million, or 39.5%, increase in investment securities available for sale, and a $2.1 million, or 198.9%, increase in prepaid expenses and other assets. These increases were partially
offset by a $20.5 million, or 78.8%, decrease in cash and cash equivalents.
Cash and Cash Equivalents. Cash and cash equivalents decreased $20.5 million, or 78.8%, from $26.0 million at December 31, 2018 to $5.5 million at
September 30, 2019 as excess liquidity, along with deposits and Federal Home Loan Bank borrowings, were used primarily to fund a $20.5 million increase in loans receivable, net, an $11.4 million increase in loans held for sale, a $5.2
million increase in investment in interest-earning time deposits, and a $2.6 million increase in investment securities available for sale.
Investment in Interest-Earning Time Deposits. Investment in interest-earning time deposits increased $5.2 million, or 106.5%, from $4.9 million at
December 31, 2018 to $10.2 million at September 30, 2019 as the Company invested excess liquidity into higher yielding interest-earning assets.
Investment Securities Available for Sale. Investment securities available for sale increased $2.6 million, or 39.5%, from $6.7 million at December
31, 2018 to $9.3 million at September 30, 2019, as the Company invested excess liquidity into higher yielding interest-earning assets.
Loans Held for Sale. Loans held for sale increased $11.4 million or 223.0%, from $5.1 million at December 31, 2018 to $16.5 million at September 30,
2019 as the Bank’s mortgage banking subsidiary, Quaint Oak Mortgage, LLC, originated $98.0 million of one-to-four family residential loans during the nine months ended September 30, 2019 and sold $86.3 million of loans in the secondary
market during this same period. The Bank did not originate any equipment loans held for sale during the nine months ended September 30, 2019 but sold $258,000 of equipment loans during this same period.
Loans Receivable, Net. Loans receivable, net, increased $20.5 million, or 9.4%, to $237.4 million at September 30, 2019 from $216.9 million December
31, 2018. This increase was funded primarily from deposits, FHLB borrowings, and excess liquidity. Increases within the loan portfolio occurred in commercial business loans which increased $17.4 million, or 73.5%, commercial real estate
loans which increased a $7.0 million, or 6.8%, construction loans which increased $3.4 million, or 34.5%, and other consumer loans which increased $8,000, or 42.1%. These increases were partially offset by a $5.2 million, or 10.9%,
decrease in one-to-four family residential non-owner occupied loans, an $842,000, or 3.5%, decrease in multi-family residential loans, a $789,000, or 11.9%, decrease in one-to-four family residential owner occupied loan, and a $358,000,
or 8.2%, decrease in home equity loans. The Company continues its strategy of diversifying its loan portfolio with higher yielding and shorter-term loan products and selling substantially all of its newly originated one-to-four family
owner-occupied loans into the secondary market.
Other Real Estate Owned. Other real estate owned (OREO) amounted to $2.0 million at September 30, 2019, consisting of four properties that were
collateral for a non-performing construction loan. During the nine months ended September 30, 2019, the Company made a total of $319,000 in capital improvements to the properties. The balance of these OREO properties totaled $1.7
million at December 31, 2018. Non-performing assets amounted to $2.9 million, or 0.99% of total assets at September 30, 2019 compared to $2.8 million, or 1.04% of total assets at December 31, 2018.
Prepaid Expenses and Other Assets. Prepaid expenses and other assets increased $2.1 million, or 198.9%, due primarily to the adoption of Financial
Accounting Standards Board accounting standard ASU 2016-02, Leases (Topic 842) by the Company on January 1, 2019. This standard requires a lessee to recognize the assets and liabilities that
arise from leases on the balance sheet by recognizing a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. The impact of adopting this
accounting standard on the Company’s balance sheet was approximately $1.3 million at September 30, 2019.
Deposits. Total deposits increased $10.2 million, or 4.8%, to $222.2 million at September 30, 2019 from $211.9 million at December 31, 2018. This
increase in deposits was primarily attributable to increases of $9.0 million, or 5.4%, in certificates of deposit, $1.2 million, or 4.6%, in money market accounts, and $634,000 or 56.6%, in savings accounts. These increases were partially
offset by decreases of $497,000, or 2.8%, in non-interest bearing checking accounts and $184,000, or 95.8%, in passbook accounts.
Federal Home Loan Bank Advances. Aggregate FHLB borrowings increased $10.3 million, or 42.8%, from $24.0 million at December 31, 2018 to $34.3 million
at September 30, 2019. Long-term borrowings increased $10.3 million, or 68.5%, from $15.0 million at December 31, 2018 to $25.3 million at September 30, 2019, as a result of a $9.0 million term-out of short-term borrowings at varying
maturities and $3.3 million of additional long-term borrowings, partially offset by the repayment of $2.0 million of long-term borrowings that matured in June and September 2019. Short-term borrowings were $9.0 mllion at both December 31,
2018 and September 30, 2019, as a result of the $9.0 million term-out of short-term borrowings replaced in the third quarter of 2019, with $9.0 million of short-term borrowings in order to fund loan demand.
Subordinated Debt. On December 27, 2018, the Company issued $8.0 million in subordinated notes. These notes have a maturity date of December 31, 2028,
and bear interest at a fixed rate of 6.50%. The Company may, at its option, at any time on an interest payment date on or after December 31, 2023, redeem the notes, in whole or in part, at par plus accrued interest to the date of
redemption. The balance of subordinated debt, net of unamortized debt issuance costs, was $7.9 million at September 30, 2019 and $7.8 million at December 31, 2018.
Stockholders’ Equity. Total stockholders’ equity increased $1.7 million, or 7.2%, to $25.5 million at September 30, 2019 from $23.8 million at
December 31, 2018. Contributing to the increase was net income for the nine months ended September 30, 2019 of $1.9 million, the reissuance of treasury stock for exercised stock options of $190,000, common stock earned by participants in
the employee stock ownership plan of $136,000, amortization of stock awards and options under our stock compensation plans of $130,000, the reissuance of treasury stock under the Bank’s 401(k) Plan of $31,000, and other comprehensive
income, net of $27,000. These increases were partially offset by dividends paid of $496,000 and by the purchase of treasury stock of $186,000.
Comparison of Operating Results for the Three Months Ended September 30, 2019 and 2018
General. Net income amounted to $802,000 for the three months ended September 30, 2019, an increase of $144,000, or 21.9%, compared to net income of
$658,000 for three months ended September 30, 2018. The increase in net income on a comparative quarterly basis was primarily the result of an increase in non-interest income of $424,000, an increase in net interest income of $59,000,
and a decrease in the provision for loan losses of $26,000, partially offset by an increase in non-interest expense of $260,000 and an increase in the provision for income taxes of $105,000.
Net Interest Income. Net interest income increased $59,000, or 2.8%, to $2.17 million for the three months ended September 30, 2019 from $2.12
million for the three months ended September 30, 2018. The increase was driven by a $425,000, or 13.7%, increase in interest income, partially offset by a $366,000, or 36.6%, increase in interest expense.
Interest Income. Interest income increased $425,000 or 13.7%, to $3.5 million for the three months ended September 30, 2019 from $3.1 million for the
three months ended September 30, 2018. The increase in interest income was primarily due to a $26.8 million increase in average loans receivable, net, including loans held for sale, which increased from an average balance of $215.9
million for the three months ended September 30, 2018 to an average balance of $242.7 million for the three months ended September 30, 2019, and had the effect of increasing interest income $364,000. Also contributing to this increase
was a five basis point increase in the yield on average loans receivable, net, including loans held for sale, which increased from 5.43% for the three months ended September 30, 2018 to 5.48% for the three months ended September 30, 2019,
which had the effect of increasing interest income $29,000 The increase in interest income was also due to a $5.3 million increase in investment in interest-earning time deposits which increased from an average balance of $4.9 million
for the three months ended September 30, 2018 to an average balance of $10.2 million for the three months ended September 30, 2019, which had the effect of increasing interest income $25,000. Also contributing to this increase was a 108
basis point increase in the yield on investment in interest-earning time deposits which increased from 1.87% for the three months ended September 30, 2018 to 2.95% for the three months ended September 30, 2019, which had the effect of
increasing interest income $27,000. The increase in interest income was partially offset by an $11.8 million decrease in average cash and cash equivalents due from banks, interest bearing, which decreased from an average balance of $19.6
million for the three months ended September 30, 2018 to an average balance of $7.8 million for the three months ended September 30, 2019, and had the effect of decreasing interest income $60,000.
Interest Expense. Interest expense increased $366,000 or 36.6%, to $1.4 million for the three months ended September 30, 2019 from $1.0 million for
the three months ended September 30, 2018. The increase in interest expense was primarily attributable to a $15.3 million increase in average certificate of deposit accounts which increased from an average balance of $160.7 million for
the three months ended September 30, 2018 to an average balance of $176.0 million for the three months ended September 30, 2019, and had the effect of increasing interest expense $76,000. Also contributing to this increase was a 38 basis
point increase in rate on average certificate of deposit accounts, which increased from 1.98% for the three months ended September 30, 2018 to 2.36% for the three months ended September 30, 2019, and had the effect of increasing interest
expense by $166,000. The increase in interest expense was also due to average subordinated debt of $7.9 million for the three months ended September 30, 2019, at the applicable interest rate of 6.5%, which had the effect of increasing
interest expense by $130,000 compared to none for the three months ended September 30, 2018. The average interest rate spread decreased from 3.18% for the three months ended September 30, 2018 to 2.92% for the three months ended
September 30, 2019 while the net interest margin decreased from 3.39% for the three months ended September 30, 2018 to 3.20% for the three months ended September 30, 2019.
Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of
interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are
based on daily balances.
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Provision for Loan Losses. The Company’s provision for loan losses decreased $26,000, or 14.2%, from $183,000 for the three months ended September
30, 2018 to $157,000 for the three months ended September 30, 2019, based on an evaluation of the allowance relative to such factors as volume of the loan portfolio, concentrations of credit risk, prevailing economic conditions, prior
loan loss experience and amount of non-performing loans at September 30, 2019.
Non-performing loans amounted to $932,000 or 0.39% of net loans receivable at September 30, 2019, consisting of seven loans, three of which are on non-accrual status and four of which are
90 days or more past due and accruing interest. Comparably, non-performing loans amounted to $1.2 million, or 0.54% of net loans receivable at December 31, 2018, consisting of nine loans, three of which were on non-accrual status and
three of which were 90 days or more past due and accruing interest. The non-performing loans at September 30, 2019 include four one-to-four family non-owner occupied residential loans, two commercial real estate loans, and one
one-to-four family owner occupied residential loan, and all are generally well-collateralized or adequately reserved for. The allowance for loan losses as a percent of total loans receivable was 0.95% at September 30, 2019 and 0.90% at
December 31, 2018.
Non-Interest Income.
Non-interest income increased $424,000 or 34.7%, from $1.2 million for the three months ended September 30, 2018 to $1.6 million for the three months ended September 30, 2019 due primarily to a $323,000, or 48.0%, increase in net
gain on loans held for sale, a $76,000, or 27.8%, increase in mortgage banking and title abstract fees, a $36,000, or 87.8%, increase in real estate sales commissions, net, a $16,000, or 19.5%, increase in gain on the sales of SBA loans,
an $8,000, or 7.9%, increase in insurance commissions, and a $2,000, or 10.5%, increase in income from bank-owned life insurance. These increases were partially offset by a $37,000, or 115.6%, decrease in other fees and service charges.
Non-Interest Expense. Total non-interest expense increased $260,000, or 11.4%, from $2.3 million for the three months ended September 30, 2018 to
$2.5 million for the three months ended September 30, 2019 due primarily to a $207,000, or 13.2%, increase in salaries and employee benefits expense, a $34,000, or 20.5%, increase in other expenses, a $31,000, or 20.7%, increase in
occupancy and equipment expense, a $17,000, or 32.1%, increase in advertising expense, a $13,000, or 12.0%, increase in data processing expense, a $4,000, or 50.0%, increase in other real estate owned expense, and a $1,000, or 8.3%,
increase in amortization of other intangible. These increases were partially offset by a $47,000 decrease in FDIC deposit insurance expense. The increase in salaries and employee benefits expense was due primarily to increased staff in
lending, compliance and information technology. The decrease in FDIC deposit insurance assessment was due to an FDIC Small Bank Assessment credit which was applied to and reduced the September quarterly 2019 assessment to zero.
Provision for Income Tax. The provision for income tax increased $105,000, or 48.4%, from $217,000 for the three months ended September 30, 2018 to
$322,000 for the three months ended September 30, 2019 due primarily to an increase in pre-tax income and an increase in our effective tax rate from 24.8% for the three months ended September 30, 2018 to 28.6% for the three months ended
September 30, 2019. The increase in our effective tax rate was primarily due to a tax deduction taken in 2018 related to the exercise of non-qualified stock options.
Comparison of Operating Results for the Nine Months Ended September 30, 2019 and 2018
General. Net income amounted to $1.9 million for the nine months ended September 30, 2019, an increase of $399,000, or 26.9%, compared to net income
of $1.5 million for nine months ended September 30, 2018. The increase in net income was primarily the result of an increase in non-interest income of $950,000, an increase in net interest income of $255,000, and a decrease in the
provision for loan losses of $30,000, partially offset by an increase in non-interest expense of $506,000 and an increase in the provision for income taxes of $330,000.
Net Interest Income. Net interest income increased $255,000, or 4.1%, to $6.41 million for the nine months ended September 30, 2019 from $6.15
million for the nine months ended September 30, 2018. The increase was driven by a $1.5 million, or 16.4%, increase in interest income, partially offset by a $1.2 million, or 43.5%, increase in interest expense.
Interest Income. Interest income increased $1.5 million, or 16.4%, to $10.4 million for the nine months ended September 30, 2019 from $8.9 million
for the nine months ended September 30, 2018. The increase in interest income was primarily due to a $19.5 million increase in average loans receivable, net, including loans held for sale, which increased from an average balance of
$212.5 million for the nine months ended September 30, 2018 to an average balance of $232.0 million for the nine months ended September 30, 2019, and had the effect of increasing interest income $779,000. Also contributing to this
increase was a 22 basis point increase in the yield on average loans receivable, net, including loans held for sale, which increased from 5.33% for the nine months ended September 30, 2018 to 5.55% for the nine months ended September 30,
2019, which had the effect of increasing interest income $393,000. The increase in interest income was also due to a $4.6 million increase in investment in interest-earning time deposits which increased from an average balance of $4.9
million for the nine months ended September 30, 2018 to an average balance of $9.5 million for the nine months ended September 30, 2019, which had the effect of increasing interest income $63,000. Also contributing to this increase was a
94 basis point increase in the yield on investment in interest-earning time deposits which increased from 1.85% for the nine months ended September 30, 2018 to 2.79% for the nine months ended September 30, 2019, which had the effect of
increasing interest income $67,000. The increase in interest income was also due to a $1.8 million increase in average cash and cash equivalents due from banks, interest bearing, which increased from an average balance of $16.4 million
for the nine months ended September 30, 2018 to an average balance of $18.2 million for the nine months ended September 30, 2019, and had the effect of increasing interest income $24,000. Also contributing to this increase was a 63 basis
point increase in the yield on average cash and cash equivalents due from banks, interest bearing, which increased from 1.80% for the nine months ended September 30, 2018 to 2.43% for the nine months ended September 30, 2019, and had the
effect of increasing interest income $87,000.
Interest Expense. Interest expense increased $1.2 million, or 43.5%, to $4.0 million for the nine months ended September 30, 2019 from $2.8 million
for the nine months ended September 30, 2018. The increase in interest expense was primarily attributable to a $21.1 million increase in average certificate of deposit accounts which increased from an average balance of $154.8 million
for the nine months ended September 30, 2018 to an average balance of $175.9 million for the nine months ended September 30, 2019, and had the effect of increasing interest expense $300,000. Also contributing to this increase was a 40
basis point increase in rate on average certificate of deposit accounts, which increased from 1.89% for the nine months ended September 30, 2018 to 2.29% for the nine months ended September 30, 2019, and had the effect of increasing
interest expense by $521,000. The increase in interest expense was also due to average subordinated debt of $7.8 million for the nine months ended September 30, 2019, at the applicable interest rate of 6.5%, which had the effect of
increasing interest expense by $389,000 compared to none for the nine months ended September 30, 2018. The average interest rate spread decreased from 3.19% for the nine months ended September 30, 2018 to 2.92% for the nine months ended
September 30, 2019 while the net interest margin decreased from 3.38% for the nine months ended September 30, 2018 to 3.18% for the nine months ended September 30, 2019.
Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following table shows for the periods indicated the total dollar amount of
interest from average interest-earning assets and the resulting yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates, and the net interest margin. All average balances are
based on daily balances.
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Provision for Loan Losses. The Company decreased its provision for loan losses by $30,000, or 8.6%, from $348,000 for the nine months ended September
30, 2018 to $318,000 for the nine months ended September 30, 2019. As was the case for the quarter, the decrease was based on an evaluation of the allowance relative to such factors as volume of the loan portfolio, concentrations of
credit risk, prevailing economic conditions, prior loan loss experience and amount of non-performing loans. See additional discussion under “Comparison of Operating Results for the Three Months Ended September 30, 2019 and 2018-Provision
for Loan Losses.”
Non-Interest Income. Non-interest income increased $950,000, or 31.8%, from $3.0 million for the nine months ended September 30, 2018 to $3.9
million for the nine months ended September 30, 2019 primarily due to a $717,000, or 45.4%, increase in net gain on loans held for sale, a $219,000, or 36.5%, increase in mortgage banking and title abstract fees, a $133,000, or 126.7%,
increase in gain on the sales of SBA loans, and a $24,000, or 8.5%, increase in insurance commissions. These increases were partially offset by a $65,000, or 43.3%, decrease in other fees and service charges, a $63,000, or 100%,
decrease in the gain on the sales of other real estate owned, and a $15,000, or 10.5%, decrease in real estate sales commissions, net.
Non-Interest Expense. Non-interest expense increased $506,000, or 7.4%, from $6.9 million for the nine months ended September 30, 2018 to $7.4
million for the nine months ended September 30, 2019 due primarily to a $315,000, or 6.5%, increase in salaries and employee benefits expense, a $93,000, or 19.1%, increase in other expenses, a $69,000, or 15.5%, increase in occupancy
and equipment expenses, a $54,000, or 18.8%, increase in data processing expense, a $51,000, or 31.7%, increase in advertising expense, a $19,000, or 12.8%, increase in directors’ fees and expenses, a $13,000, or 130.0% increase in
other real estate owned expense, and a $1,000, or 2.8%, increase in amortization of other intangible. These increases were partially offset by a $100,000, or 71.4% decrease in FDIC deposit insurance expense and a $9,000, or 3.1%,
decrease in professional fees. The increase in salaries and employee benefits expense was due primarily to increased staff in lending, compliance and information technology. The decrease in FDIC deposit insurance assessment was due to
a reduction in the Bank’s assessment multiplier and the FDIC Small Bank Assessment credit which was applied to and reduced the September quarterly 2019 assessment to zero.
Provision for Income Tax. The provision for income tax increased $330,000, or 74.7%, from $442,000 for the nine months ended September 30, 2018 to
$772,000 for the nine months ended September 30, 2019 due primarily to an increase in pre-tax income and an increase in our effective tax rate from 23.0% for the nine months ended September 30, 2018 to 29.1% for the nine months ended
September 30, 2019. The increase in our effective tax rate was primarily due to a tax deduction taken in 2018 related to the exercise of non-qualified stock options
Operating Segments
The Company’s operations consist of two reportable operating segments: Banking and Mortgage Banking. Our Banking Segment generates revenues primarily from its lending, deposit gathering
and fee business activities. Our Mortgage Banking Segment originates residential mortgage loans which are sold into the secondary market along with the loans’ servicing rights. Detailed segment information appears in Note 12 in the
Notes to Consolidated Financial Statements.
Our Banking Segment reported a pre-tax segment profit (“PTSP”) for the three months ended September 30, 2019 of $426,000, a $53,000, or 11.1%, decrease from the same period in 2018.
This decrease in PTSP was due to an increase in non-interest expense which was partially offset by increases in net interest income and non-interest income and a decrease in the provision for loan losses. The increase in non-interest
expense was due primarily to increases in salaries and employees benefits expense and other expense. The increase in net interest income was primarily attributable to an increase in interest income, driven by higher average loan
balances and yields, partially offset by a higher cost of funds. The increase in cost of funds was impacted by the interest expense related to $8.0 million in subordinated debt issued in December 2018. The increase in non-interest
income, was primarily due to an increase in title abstract fees and the gain on the sale of SBA loans.
Our Mortgage Banking Segment reported a PTSP for the three months ended September 30, 2019 of $698,000, a $302,000, or 76.3%, increase from the same period in 2018. The increase in PTSP
was primarily due to the increase in non-interest income which was driven by an increases in net gain on the sale of loans and processing fees. This increase was partially offset by a decrease in net interest income and an increase
in non-interest expense.
Our Banking Segment reported a pre-tax segment profit (“PTSP”) for the nine months ended September 30, 2019 of $1.3 million, a $14,000, or 1.0%, decrease from the same period in 2018.
This decrease in PTSP was primarily due to an increase in non-interest expense, which was partially offset by an increase in net interest income. The increase in net interest income was primarily attributable to an increase in
interest income, driven by higher average loan balances and yields, partially offset by a higher cost of funds. As was the case with the quarter the increase in cost of funds was impacted by the interest expense related to $8.0
million in subordinated debt issued in December 2018. Also as was the case for the quarter, the increase in non-interest expense was due primarily to increases in salaries and employees benefits expense and other expense.
Our Mortgage Banking Segment reported a PTSP for the nine months ended September 30, 2019 of $1.3 million, a $743,000, or 129.7%, increase from the same period in 2018. The increase in
PTSP was primarily due to the increase in non-interest income which was driven by an increases in net gain on the sale of loans and processing fees. This increase was partially offset by an increase in non-interest expense and
decrease in net interest income.
Liquidity and Capital Resources
The Company’s primary sources of funds are deposits, amortization and prepayment of loans and to a lesser extent, loan sales and other funds provided from operations. While scheduled
principal and interest payments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition. The Company sets the
interest rates on its deposits to maintain a desired level of total deposits. In addition, the Company invests excess funds in short-term interest-earning assets that provide additional liquidity. At September 30, 2019, the Company’s
cash and cash equivalents amounted to $5.5 million. At such date, the Company also had $2.0 million invested in interest-earning time deposits maturing in one year or less.
The Company uses its liquidity to fund existing and future loan commitments, to fund deposit outflows, to invest in other interest-earning assets and to meet operating expenses. At
September 30, 2019, Quaint Oak Bank had outstanding commitments to originate loans of $10.2 million, commitments under unused lines of credit of $20.3 million, and $1.8 million under standby letters of credit.
At September 30, 2019, certificates of deposit scheduled to mature in less than one year totaled $66.6 million. Based on prior experience, management believes that a significant portion
of such deposits will remain with us, although there can be no assurance that this will be the case.
In addition to cash flow from loan payments and prepayments and deposits, the Company has significant borrowing capacity available to fund liquidity needs. If the Company requires funds
beyond its ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Pittsburgh (FHLB), which provide an additional source of funds. As of September 30, 2019, we had $34.3 million of borrowings
from the FHLB and had $141.0 million in borrowing capacity. Under terms of the collateral agreement with the FHLB of Pittsburgh, we pledge residential mortgage loans as well as Quaint Oak Bank’s FHLB stock as collateral for such
advances. In addition, as of September 30, 2019 Quaint Oak Bank had $725,000 in borrowing capacity with the Federal Reserve Bank of Philadelphia. There were no borrowings under this facility at September 30, 2019.
Our stockholders’ equity amounted to $25.5 million at September 30, 2019, an increase of $1.7 million, or 7.2%, from $23.8 million at December 31, 2018. Contributing to the increase was
net income for the nine months ended September 30, 2019 of $1.9 million, the reissuance of treasury stock for exercised stock options of $190,000, common stock earned by participants in the employee stock ownership plan of $136,000,
amortization of stock awards and options under our stock compensation plans of $130,000, the reissuance of treasury stock under the Bank’s 401(k) Plan of $31,000, and other comprehensive income, net of $27,000. These increases were
partially offset by dividends paid of $496,000 and by the purchase of treasury stock of $186,000. For further discussion of the stock compensation plans, see Note 10 in the Notes to Unaudited Consolidated Financial Statements contained
elsewhere herein.
Quaint Oak Bank is required to maintain regulatory capital sufficient to meet tier 1 leverage, common equity tier 1 capital, tier 1 risk-based and total risk-based capital ratios of at
least 4.00%, 4.50%, 6.00%, and 8.00%, respectively. At September 30, 2019, Quaint Oak Bank exceeded each of its capital requirements with ratios of 10.72%, 13.43%, 13.43% and 14.46%, respectively. As a small savings and loan holding
company eligible for exemption, the Company is not currently subject to any regulatory capital requirements.
Off-Balance Sheet Arrangements
In the normal course of operations, we engage in a variety of financial transactions that, in accordance with generally accepted accounting principles are not recorded in our financial
statements. These transactions involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Such transactions are used primarily to manage customers’ requests for funding and take the form of loan commitments
and lines of credit. Our exposure to credit loss from non-performance by the other party to the above-mentioned financial instruments is represented by the contractual amount of those instruments. We use the same credit policies in
making commitments and conditional obligations as we do for on-balance sheet instruments. In general, we do not require collateral or other security to support financial instruments with off–balance sheet credit risk.
Commitments. At September 30, 2019, we had unfunded commitments under lines of credit of $20.3 million, $10.2 million of commitments to originate
loans, and $1.8 million under standby letters of credit. We had no commitments to advance additional amounts pursuant to outstanding lines of credit or undisbursed construction loans.
Impact of Inflation and Changing Prices
The consolidated financial statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of
America which generally require the measurement of financial position and operating results in terms of historical dollars, without considering changes in relative purchasing power over time due to inflation. Unlike most industrial
companies, virtually all of the Company’s assets and liabilities are monetary in nature. As a result, interest rates generally have a more significant impact on the Company’s performance than does the effect of inflation. Interest
rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 4. CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2019. Based on their evaluation of the Company’s disclosure controls and procedures, the Company’s Chief Executive Officer and Chief
Financial Officer have concluded that our disclosure controls and procedures are designed to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and regulations are operating in an effective manner.
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15(d)-15(f) under the Securities Exchange Act of 1934) occurred during the third fiscal quarter of fiscal 2019
that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II
The Company is not involved in any pending legal proceedings other than routine legal proceedings occurring in the ordinary course of business, which involve amounts in the aggregate believed by
management to be immaterial to the financial condition and operating results of the Company.
Not applicable.
(a) Not applicable.
(b) Not applicable.
(c) Purchases of Equity Securities
The Company’s repurchases of its common stock made during the quarter ended September 30, 2019 including stock-for-stock option exercises of outstanding stock options, are set forth in the table below:
Notes to this table:
Not applicable.
Not applicable.
Not applicable.
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.