BROADWAY FINANCIAL CORPORATION The following discussion is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity and other factors that have affected our reported results of operations and financial condition or may affect our future results or financial condition. Our MD&A should be read in conjunction with the Consolidated Financial Statements and related Notes included in Item 8, "Financial Statements and Supplementary Data," of this Annual Report on Form 10 K.
Overview
Total assets increased by$31.0 million to$440.4 million atDecember 31, 2019 from$409.4 million atDecember 31, 2018 . The growth in total assets was primarily comprised of an increase of$42.3 million in net loans receivable held for investment offset by decreases of$6.2 million in loans receivable held for sale,$3.7 million in securities available for sale,$1.1 million in interest-bearing cash in other banks and$833 thousand in REO. The Bank had no REO as ofDecember 31, 2019 . Total liabilities increased by$30.5 million to$391.5 million atDecember 31, 2019 from$361.0 million atDecember 31, 2018 . The increase in total liabilities during 2019 resulted primarily from increases of$16.3 million in total deposits and$14.0 million in FHLB advances We recorded a net loss of$206 thousand for the year endedDecember 31, 2019 compared to net earnings of$815 thousand for the year endedDecember 31, 2018 . The decrease in earnings was primarily attributable to an increase of$1.2 million in interest expense on deposits and a decline of$1.2 million in the loan loss provision recapture during 2019 compared to 2018. Also, non-interest expense increased by$515 thousand during 2019 compared to 2018, primarily due to higher professional services fees of$491 thousand and higher compensation costs of$302 thousand , offset by a decrease of$288 thousand in other expenses, primarily due to lower REO costs of$166 thousand and lower marketing costs of$88 thousand . These items were partially offset by higher net interest income of$153 thousand and an increase in gain on sale of loans of$134 thousand during 2019 compared to 2018.
Comparison of Operating Results for the Years Ended
General
Our most significant source of income is net interest income, which is the difference between our interest income and our interest expense. Generally, interest income is generated from our loans and investments (interest earning assets) and interest expense is incurred from deposits and borrowings (interest bearing liabilities). Typically, our results of operations are also affected by our provision for or loan loss provision recapture, non-interest income generated from service charges and fees on loan and deposit accounts, gains or losses on the sale of loans and REO, non-interest expenses, and income taxes.
Net Interest Income
For the year ended
Interest and fees on loans receivable increased by$1.6 million for the year endedDecember 31, 2019 compared to the same period a year ago. The increase was primarily due to an increase of 32 basis points in the average yield on loans receivable, which increased loan interest income by$677 thousand , an increase of$542 thousand in interest 31
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recoveries on non-accrual loans, and an increase of
Interest income on securities decreased by$54 thousand for the year endedDecember 31, 2019 compared to the prior year due to a decrease of$2.5 million in the average balance of securities, which decreased interest income by$66 thousand , offset by an increase of 7 basis points in the average yield on securities, which increased interest income by$12 thousand . Other interest income increased by$98 thousand for the year endedDecember 31, 2019 compared to the prior year. The increase in other interest income primarily resulted from a net increase in the average balance of interest earning cash deposits in other banks of$4.0 million , which increased interest income by$84 thousand , and an increase of 36 basis points in the average interest rate on deposits, which increased interest income by$61 thousand . These increases were partially offset by a decrease of$47 thousand in dividends on FHLB stock because the Bank received a special dividend during the fourth quarter of 2018 which it did not receive during 2019. Interest expense on deposits increased by$1.2 million for the year endedDecember 31, 2019 compared to the prior year, primarily due to an increase of 39 basis points in the average cost of deposits, which increased interest expense by$1.0 million , and an increase of$6.6 million in the average balance of deposits, which increased interest expense by$174 thousand . Interest expense on borrowings increased by$270 thousand for the year endedDecember 31, 2019 compared to the prior year, primarily due to an increase of$272 thousand in interest expense on FHLB advances. The interest expense on FHLB advances increased due to an increase of 29 basis points in the average cost of FHLB borrowings, which increased interest expense by$221 thousand and an increase of$2.3 million in the average balance of FHLB advances, which increased interest expense by$51 thousand . The increase in interest expense on FHLB advances was offset by a decrease of$2 thousand in interest expense on the Company's junior subordinated debentures due to a decrease of$209 thousand in the average balance of the Debentures, which decreased interest expense by$10 thousand , offset by an increase of 17 basis points in the average interest rate on the Debentures, which increased interest expense by$8 thousand .
Analysis of Net Interest Income
Net interest income is the difference between income on interest earning assets
and the expense on interest bearing liabilities. Net interest income depends
upon the relative amounts of interest earning assets and interest bearing
liabilities and the interest rates earned or paid on them. The following table
sets forth average balances, average yields and costs, and certain other
information for the years indicated. All average balances are daily average
balances. The yields set forth below include the effect of deferred loan fees,
deferred origination costs, and discounts and premiums that are amortized or
accreted to interest income or expense. We do not accrue interest on loans that
are on non-accrual status; however, the balance of these loans is included in
the total average balance, which has the effect of reducing average loan yields.
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For the year ended December 31,
2019 2018
Average Average
Average Yield/ Average Yield/(Dollars in Thousands) Balance Interest Cost Balance
Interest Cost Assets Interest-earning assets: Interest-earning deposits and other short-term investments$ 19,447 $ 439 2.26%$ 15,470 $ 294 1.90% Securities 13,531 359 2.65% 16,019 413 2.58% Loans receivable(1) 375,206 15,845 (2) 4.22% 366,453 14,279 (3) 3.90% FHLB stock 2,916 204 7.00% 2,916 251 8.61% Total interest-earning assets 411,100$ 16,847 4.10% 400,858$ 15,237 3.80% Non-interest-earning assets 10,809 10,225 Total assets$ 421,909 $ 411,083 Liabilities and Stockholders' Equity Interest-bearing liabilities: Money market deposits$ 25,297 $ 222 0.88%$ 37,489 $ 320 0.85% Passbook deposits 45,548 285 0.63% 41,975 175 0.42% NOW and other demand deposits 34,091 11 0.03% 34,779 31 0.09% Certificate accounts 180,611 3,758 2.08% 164,703 2,563 1.56% Total deposits 285,547 4,276 1.50% 278,946 3,089 1.11% FHLB advances 77,049 1,862 2.42% 74,729 1,590 2.13% Junior subordinated debentures 4,891 248 5.07% 5,100 250 4.90% Total interest-bearing liabilities 367,487$ 6,386 1.74%$ 358,775 $ 4,929 1.37% Non-interest-bearing liabilities 5,566 4,699 Stockholders' Equity 48,856 47,609 Total liabilities and stockholders' equity$ 421,909 $ 411,083 Net interest rate spread (4)$ 10,461 2.36%$ 10,308 2.43% Net interest rate margin (5) 2.54% 2.57% Ratio of interest-earning assets to interest-bearing liabilities 111.87% 111.73%
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º (1)
º Amount is net of deferred loan fees, loan discounts and loans in process,
and includes deferred origination costs, loan premiums and loans receivable
held for sale.
º (2)
º Includes non-accrual interest of $567 thousand , reflecting interest
recoveries on non-accrual loans that were paid off, and deferred cost
amortization of $254 thousand for the year ended December 31, 2019 .
º (3)
º Includes non-accrual interest of $40 thousand , reflecting interest
recoveries on non-accrual loans that were paid off, and deferred cost
amortization of $503 thousand for the year ended December 31, 2018 .
º (4)º Net interest rate spread represents the difference between the yield on
average interest-earning assets and the cost of average interest-bearing
liabilities.
º (5)
º Net interest rate margin represents net interest income as a percentage of
average interest-earning assets.
Changes in our net interest income are a function of changes in both rates and
volumes of interest earning assets and interest bearing liabilities. The
following table sets forth information regarding changes in our interest income
and expense for the years indicated. Information is provided in each category
with respect to (i) changes attributable to changes in volume (changes in volume
multiplied by prior rate), (ii) changes attributable to changes in rate
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(changes in rate multiplied by prior volume), and (iii) the total change. The
changes attributable to the combined impact of volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
Year ended December 31, 2019 Year ended December 31, 2018
Compared to Compared to
Year ended December 31, 2018 Year ended December 31, 2017
Increase (Decrease) in Net Increase (Decrease) in Net
Interest Income Interest Income
Due to Due to Due to Due to
Volume Rate Total Volume Rate Total
(In thousands)
Interest-earning
assets:
Interest-earning
deposits and other
short-term
investments $ 84 $ 61 $ 145 $ (232 ) $ 153 $ (79 )
Securities (66 ) 12 (54 ) 66 29 95
Loans receivable,
net 347 1,219 1,566 (588 ) (530 ) (1,118 )
FHLB stock - (47 ) (47 ) 6 46 52
Total
interest-earning
assets 365 1,245 1,610 (748 ) (302 ) (1,050 )
Interest-bearing
liabilities:
Money market
deposits (107 ) 9 (98 ) (6 ) 58 52
Passbook deposits 16 94 110 10 40 50
NOW and other demand
deposits (1 ) (19 ) (20 ) 2 9 11
Certificate accounts 266 929 1,195 (203 ) 781 578
Total deposits 174 1,013 1,187 (197 ) 888 691
FHLB advances 51 221 272 (302 ) 141 (161 )
Junior subordinated
debentures (10 ) 8 (2 ) - 51 51
Total
interest-bearing
liabilities 215 1,242 1,457 (499 ) 1,080 581
Change in net
interest income $ 150 $ 3 $ 153 $ (249 ) $ (1,382 ) $ (1,631 )
Loan Loss Provision/Recapture
For the year ended December 31, 2019 , we recorded a net loan loss provision
recapture of $7 thousand , which was comprised of a loan loss provision recapture
of $348 thousand in the first quarter due to payoffs of non-accrual loans,
offset by loan loss provisions of $47 thousand in the third quarter and
$294 thousand in the fourth quarter due to growth in the loan portfolio. In
contrast, the Bank recorded a loan loss provision recapture of $1.3 million for
calendar year 2018 due to the overall improvement in the environmental factors
used in the Bank's analysis of the ALLL. See "Allowance for Loan Losses" for
additional information.
Non-Interest Income
For the year ended December 31, 2019 , non-interest income totaled $1.1 million
compared to $865 thousand for the same period a year ago. The increase of
$187 thousand in non-interest income was primarily due to an increase of
$134 thousand in gain on sale of loans, an increase of $42 thousand in service
charges on deposits, and an increase in miscellaneous fees of $11 thousand
during 2019 compared to 2018.
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Non-Interest Expense
For the year endedDecember 31, 2019 , non-interest expense totaled$12.1 million compared to$11.6 million for the same period a year ago. The increase of$515 thousand in non-interest expense was primarily due to increases of$491 thousand in professional services expense ($315 thousand of which was related to non-recurring matters),$302 thousand in compensation and benefits expense and$66 thousand in information services expenses, offset primarily by decreases of$288 thousand in other expenses (primarily due to decreases of$166 thousand in REO expense,$88 thousand in marketing expense,$68 thousand inFDIC insurance expense (primarily due to$56 thousand of Small Bank Assessment credits that the Bank received due toFDIC excess reserves) and$11 thousand in supervisory examination costs),$16 thousand in amortization of an investment in a low-income housing limited partnership,$14 thousand in corporate insurance expense,$13 thousand in occupancy expense, and$9 thousand in costs of office services and supplies. Professional services expense increased by$491 thousand during the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 primarily due to$285 thousand in legal-related matters,$116 thousand in third party audit costs, and$90 thousand in consulting fees. Compensation and benefits expense increased by$302 thousand during the year endedDecember 31, 2019 compared to the same period of 2018 primarily due to increases of$281 thousand in stock-related salary costs,$46 thousand in salary costs and$8 thousand in deferred compensation costs associated with loans originated for the portfolio, offset by decreases of$28 thousand in other benefits cost and$7 thousand in other employment related costs.
Income Taxes
We recorded an income tax benefit of$345 thousand for the year endedDecember 31, 2019 and an income tax expense of$56 thousand for the year endedDecember 31, 2018 . The income tax benefit for 2019 included a tax benefit of$147 thousand on our pretax loss of$551 thousand and tax credits of$198 thousand . Income tax expense for the year 2018 resulted from a standard tax provision of$261 thousand , offset by tax credits of$205 thousand .
The deferred tax asset totaled
Section 382 of the Internal Revenue Code imposes limitations on a corporation's ability to utilize net operating loss carryforwards, tax credit carryovers and other income tax attributes when there is an ownership change. Generally, the rules provide that an ownership change is deemed to have occurred when the cumulative increase of each 5% or more stockholder and certain groups of stockholders treated as 5% or more stockholders, as determined under Section 382, exceeds 50% over a specified "testing" period, generally equal to three years. Section 382 applies rules regarding the treatment of new groups of stockholders treated as 5% stockholders due to issuances of stock and other equity transactions, which may cause a change of control to occur. The Company has performed an analysis of the potential impact of Section 382 and has determined that the Company did not undergo an ownership change during 2019 or 2018 and any potential limitations imposed under Section 382 do not currently apply.
Comparison of Financial Condition at
Total Assets
Total assets increased by
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receivable held for investment offset by decreases of
Loans Receivable Held for Sale
The Bank had no loans held for sale as ofDecember 31, 2019 compared to$6.2 million as ofDecember 31, 2018 . During 2019, the Bank originated$15.2 million in loans held for sale, transferred$1.5 million to loans held for sale from loans held for investment, sold$22.8 million in loans held for sale, and received$115 thousand in loan repayments. During 2018, the Bank originated$20.2 million in loans held for sale, transferred$16.9 million to loans held for investment, sold$19.3 million in loans held for sale and received$159 thousand in loan repayments.
Loans Receivable Held for Investment
Loans receivable held for investment, net of the allowance for loan losses, totaled$397.8 million atDecember 31, 2019 , compared to$355.6 million atDecember 31, 2018 . During 2019, the Bank originated$114.4 million in new loans,$103.1 million of which were multi-family loans,$9.5 million of which were commercial real estate loans,$1.7 million of which were construction loans, and$49 thousand of which were commercial loans. Of the multi-family loans originated, we allocated$87.9 million , or 85%, to loans held for investment and$15.2 million , or 15%, to loans held for sale. In addition, we transferred net loans of$1.5 million to loans held for sale from loans held for investment during 2019. During 2018, the Bank originated$99.0 million in new loans,$96.0 million of which were multi-family loans. Of the multi-family loans originated during 2018, we allocated$75.8 million , or 79%, to loans held for investment and$20.2 million , or 21%, to loans held for sale. We transferred$16.9 million of loans to loans held for investment from loans held for sale during 2018.
No loans were transferred to REO during 2019 or 2018. The one REO owned by the
Bank as of
Allowance for Loan Losses
We record a provision for loan losses as a charge to earnings when necessary in order to maintain the ALLL at a level sufficient, in management's judgment, to absorb probable incurred losses in the loan portfolio. At least quarterly we assess the overall quality of the loan portfolio and general economic trends in the local market. The determination of the appropriate level for the allowance is based on that review, considering such factors as historical loss experience for each type of loan, the size and composition of our loan portfolio, the levels and composition of our loan delinquencies, non-performing loans and net loan charge-offs, the value of underlying collateral on problem loans, regulatory policies, general economic conditions, and other factors related to the collectability of loans in the portfolio. Our ALLL increased to$3.2 million or 0.79% of our gross loans receivable held for investment atDecember 31, 2019 compared to$2.9 million , or 0.82% of our gross loans receivable held for investment atDecember 31, 2018 . The ALLL increased by$253 thousand during 2019 due to loan loss recoveries of$260 thousand , offset by a net loan loss recapture of$7 thousand . During 2019, the Bank recorded a loan loss provision recapture of$348 thousand in the first quarter of 2019, offset by loan loss provisions of$47 thousand in the third quarter and$294 thousand in the fourth quarter due to growth in the loan portfolio. In contrast, during 2018, the ALLL decreased by$1.2 million to$2.9 million from$4.1 million atDecember 31, 2017 due to a loan loss provision recapture of$1.3 million , offset by loan loss recoveries of$114 thousand . The reduction in ALLL during 2018 was due to the overall improvement in the environmental factors used in the Company's analysis of the allowance for loan and lease losses. 36
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Our loan delinquencies and non-performing loans ("NPLs") are at their lowest
levels since December 2009 . We had total delinquencies of $18 thousand at
December 31, 2019 compared to $35 thousand at December 31, 2018 . NPLs consist of
delinquent loans that are 90 days or more past due and other loans, including
troubled debt restructurings that do not qualify for accrual status. At
December 31, 2019 , NPLs totaled $424 thousand compared to $911 thousand at
December 31, 2018 . The decrease of $487 thousand in NPLs was primarily due to
payoffs of $423 thousand , repayments of $83 thousand .
In connection with our review of the adequacy of our ALLL, we track the amount
and percentage of our NPLs that are paying currently, but nonetheless must be
classified as NPL for reasons unrelated to payments, such as lack of current
financial information and an insufficient period of satisfactory performance. As
of December 31, 2019 , $406 thousand of our $424 thousand of NPLs were current in
their payments. Also, in determining the ALLL, we consider the ratio of the ALLL
to NPLs, which increased to 750.47% at December 31, 2019 from 321.51% at
December 31, 2018 .
When reviewing the adequacy of the ALLL, we also consider the impact of
charge-offs, including the changes and trends in loan charge-offs. There were no
loan charge-offs during 2019 and 2018. In determining charge-offs, we update our
estimates of collateral values on NPLs by obtaining new appraisals at least
every nine months. If the estimated fair value of the loan collateral less
estimated selling costs is less than the recorded investment in the loan, a
charge-off for the difference is recorded to reduce the loan to its estimated
fair value, less estimated selling costs. Therefore, any losses inherent in our
total NPLs are recognized periodically through charge-offs. The impact of
updating these estimates of collateral value and recognizing any required
charge-offs is to increase charge-offs and reduce the ALLL required on these
loans. Due to prior charge-offs and increases in collateral values, the average
recorded investment in NPLs was only 21% of estimated fair value less estimated
selling costs as of December 31, 2019 .
Loan loss recoveries totaled $260 thousand during 2019 and $114 thousand during
2018. Recoveries during 2019 and 2018 primarily resulted from the payoffs of
non-accrual loans which had been previously partially charged off.
Impaired loans at December 31, 2019 were $5.3 million , compared to $6.4 million
at December 31, 2018 . The decrease of $1.1 million in impaired loans was
primarily due to payoffs and repayments. Specific reserves for impaired loans
were $147 thousand or 2.74% of the aggregate impaired loan amount at
December 31, 2019 compared to $227 thousand , or 3.56% of the aggregate impaired
loan amount at December 31, 2018 . Excluding specific reserves for impaired
loans, our coverage ratio (general allowance as a percentage of total
non-impaired loans) was 0.76% at December 31, 2019 compared to 0.77% at
December 31, 2018 . The decrease in the coverage ratio during 2019 was due to
overall improvement in the credit quality of the loan portfolio, which had a
favorable impact on the environmental factors used in our analysis of the ALLL.
We believe that the ALLL is adequate to cover probable incurred losses in the
loan portfolio as of December 31, 2019 , but there can be no assurance that
actual losses will not exceed the estimated amounts. In addition, the OCC and
the FDIC periodically review the ALLL as an integral part of their examination
process. These agencies may require an increase in the ALLL based on their
judgments of the information available to them at the time of their
examinations.
Total Liabilities
Total liabilities increased by$30.5 million to$391.5 million atDecember 31, 2019 from$361.0 million atDecember 31, 2018 . The increase in total liabilities was primarily comprised of increases of$16.3 million in deposits and$14.0 million in FHLB advances. 37
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Deposits
Deposits increased by
One customer relationship accounted for approximately 10% of our deposits atDecember 31, 2019 . We expect to maintain this relationship with the customer for the foreseeable future. Borrowings Total borrowings atDecember 31, 2019 consisted of advances to the Bank from the FHLB of$84.0 million , and junior subordinated debentures issued by the Company of$4.3 million , compared to advances from the FHLB of$70.0 million and junior subordinated debentures of$5.1 million atDecember 31, 2018 . During 2019, the Bank paid off$8.0 million in maturing FHLB advances, borrowed$22.5 million in new advances from the FHLB and repaid$765 thousand of its junior subordinated debentures. The weighted average cost of FHLB advances increased by 29 basis points to 2.42% atDecember 31, 2019 from 2.13% atDecember 31, 2018 primarily due to higher interest rates. Stockholders' Equity Stockholders' equity was$48.8 million , or 11.09% of the Company's total assets atDecember 31, 2019 , compared to$48.4 million , or 11.83% of the Company's total assets atDecember 31, 2018 . The Company's book value was$1.75 per share as ofDecember 31, 2019 , compared to$1.77 per share as ofDecember 31, 2018 .
Capital Resources
Our principal subsidiary, Broadway Federal, must comply with capital standards established by the OCC in the conduct of its business. Failure to comply with such capital requirements may result in significant limitations on its business or other sanctions. As a "small bank holding company", we are not subject to consolidated capital requirements under the new Basel III capital rules. The current regulatory capital requirements and possible consequences of failure to maintain compliance are described in Part I, Item 1 "Business-Regulation" and in Note 13 of the Notes to Consolidated Financial Statements.
Liquidity
The objective of liquidity management is to ensure that we have the continuing ability to fund operations and meet our obligations on a timely and cost-effective basis. The Bank's sources of funds include deposits, advances from the FHLB, other borrowings, proceeds from the sale of loans, REO, and investment securities, and payments of principal and interest on loans and investment securities. The Bank is currently approved by the FHLB to borrow up to 40% of total assets to the extent the Bank provides qualifying collateral and holds sufficient FHLB stock. The approved limit and collateral requirement would have permitted the Bank to borrow an additional$39.7 million atDecember 31, 2019 . The Bank's primary uses of funds include withdrawals of and interest payments on deposits, originations of loans, purchases of investment securities, and the payment of operating expenses. Also, when the Bank has more funds than required for reserve requirements or short-term liquidity needs, the Bank invests excess cash with theFederal Reserve Bank or other financial institutions. The Bank's liquid assets atDecember 31, 2019 consisted of$15.6 million in cash and cash equivalents and$11.0 million in securities available-for-sale that were not pledged, compared to$16.7 million in cash and cash equivalents and$14.7 million in securities available-for-sale that were 38
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not pledged at
The Company's liquidity, separate from the Bank, is based primarily on the proceeds from financing transactions, including the private placements completed inAugust 2013 ,October 2014 andDecember 2016 and dividends received from the Bank in 2017, 2018 and 2019. The Bank is currently under no prohibition to pay dividends but is subject to restrictions as to the amount of the dividends it can pay based on normal regulatory guidelines. The Company recorded consolidated net cash inflows from operating activities of$8.5 million and$234 thousand during the years endedDecember 31, 2019 and 2018, respectively. Net cash inflows from operating activities during 2019 were primarily attributable to proceeds from sales and repayments of loans receivable held for sale of$23.1 million , offset by originations of loans receivable held for sale of$15.2 million . Net cash inflows from operating activities during 2018 were primarily attributable to proceeds from sales and repayments of loans receivable held for sale of$19.6 million , offset by originations of loans receivable held for sale of$20.3 million and a loan loss recapture of$1.3 million . The Company recorded consolidated net cash outflows from investing activities of$39.1 million and$818 thousand during the years endedDecember 31, 2019 and 2018, respectively. Net cash outflows from investing activities during 2019 were primarily attributable to a net increase in loans receivable held for investment of$44.0 million , offset by principal repayments on available-for-sale securities of$4.1 million and proceeds from the sale of REO of$820 thousand . Net cash outflows from investing activities during 2018 were primarily attributable to a net increase in loans receivable held for investment of$3.2 million , offset by principal repayments on available-for-sale securities of$2.4 million . The Company recorded consolidated net cash inflows from financing activities of$29.5 million during the year endedDecember 31, 2019 and net cash outflows from financing activities of$5.0 million during the year endedDecember 31, 2018 . Net cash inflows from financing activities during 2019 were primarily attributable to an increase in proceeds from FHLB advances of$22.0 million and an increase in deposits of$16.3 million , offset by repayments of FHLB advances of$8.0 million and repayments of junior subordinated debentures of$765 thousand . Net cash outflows from financing activities during 2018 were primarily attributable to repayments of FHLB advances of$27.5 million and a net outflow of deposits of$9.9 million , offset by an increase in proceeds from FHLB advances of$32.5 million .
Off-Balance-Sheet Arrangements and Contractual Obligations
We are party to financial instruments with off-balance-sheet risk in the normal course of our business, primarily in order to meet the financing needs of our customers. These instruments involve, to varying degrees, elements of credit, interest rate and liquidity risk. In accordance with GAAP, these instruments are either not recorded in the consolidated financial statements or are recorded in amounts that differ from the notional amounts. Such instruments primarily include lending commitments and lease commitments as described below. Lending commitments include commitments to originate loans and to fund lines of credit. Commitments to extend credit are agreements to lend to a customer if there is no violation of any condition established in the commitment. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee by the borrower. Since some of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate creditworthiness on a case-by-case basis. Our maximum exposure to credit risk is represented by the contractual amount of the instruments.
In addition to our lending commitments, we have contractual obligations related to operating lease commitments. Operating lease commitments are obligations under various non-cancellable operating leases on buildings and land
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used for office space and banking purposes. The following table details our
contractual obligations at
More than
More than three years
Less than one year to to More than
one year three years five years five years Total
(Dollars in thousands)
Certificates of
deposit $ 168,441 $ 20,823 $ 971 $ - $ 190,235
FHLB advances 33,500 40,500 10,000 - 84,000
Junior subordinated
debentures 1,020 2,040 1,275 - 4,335
Commitments to
originate loans 5,930 - - - 5,930
Commitments to fund
unused lines of credit 1,670 - - 300 1,970
Operating lease
obligations 529 182 - - 711
Total contractual
obligations $ 211,090 $ 63,545 $ 12,246 $ 300 $ 287,181 Impact of Inflation and Changing Prices
Our consolidated financial statements, including accompanying notes, have been prepared in accordance with GAAP which require the measurement of financial position and operating results primarily in terms of historical dollars without considering the changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in increased costs of our operations. Unlike industrial companies, nearly all our assets and liabilities are monetary in nature. As a result, interest rates have a greater impact on our performance than do the effects of general levels of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assessments by management, and which could potentially result in materially different results under different assumptions and conditions. This discussion highlights those accounting policies that management considers critical. All accounting policies are important, however, and therefore you are encouraged to review each of the policies included in Note 1 "Summary of Significant Accounting Principles" of the Notes to Consolidated Financial Statements beginning at page F-8 to gain a better understanding of how our financial performance is measured and reported. Management has identified the Company's critical accounting policies as follows:
Allowance for Loan Losses
The determination of the allowance for loan losses is considered critical due to
the high degree of judgment involved, the subjectivity of the underlying
assumptions used, and the potential for changes in the economic environment that
could result in material changes in the amount of the allowance for loan losses
considered necessary. The allowance is evaluated on a regular basis by
management and the Board of Directors and is based on a periodic review of the
collectability of the loans in light of historical experience, the nature and
size of the loan portfolio, adverse situations that may affect borrowers'
ability to repay, the estimated value of any underlying collateral, prevailing
economic conditions and feedback from regulatory examinations. See Item 1,
"Business - Asset Quality - Allowance for Loan Losses" for a full discussion of
the allowance for loan losses.
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Real Estate Owned ("REO")
REO consists of property acquired through foreclosure or deed in lieu of foreclosure and is recorded at the fair value, less estimated costs to sell, at the time of acquisition. The excess, if any, of the loan balance over the fair value of the property at the time of transfer from loans to REO is charged to the allowance for loan losses. After the transfer to REO, if the fair value of the property less estimated selling costs declines to an amount less than the carrying value of the property, the deficiency is charged to income as a provision expense and a valuation allowance is established. Operating costs after acquisition are expensed as incurred. Due to changing market conditions, there are inherent uncertainties in the assumptions made with respect to the estimated fair value of REO. Therefore, the amount ultimately realized may differ from the amounts reflected in the accompanying consolidated financial statements. Income Taxes Deferred 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 balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. A valuation allowance is established against deferred tax assets when, based upon the available evidence including historical and projected taxable income, it is more likely than not that some or all the deferred tax asset will not be realized. In assessing the realization of deferred tax assets, management evaluates both positive and negative evidence, including the existence of any cumulative losses in the current year and the prior two years, the amount of taxes paid in available carry-back years, forecasts of future income and available tax planning strategies. This analysis is updated quarterly. Based on this analysis, we determined that no valuation allowance was required on our deferred tax assets, which totaled$5.2 million and$5.0 million atDecember 31, 2019 and 2018, respectively. See Note 11 "Income Taxes" of the Notes to Consolidated Financial Statements in Item 8, "Financial Statements and Supplementary Data."
Fair Value Measurements
Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Significant unobservable inputs that reflect a company's own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Fair values are estimated using relevant market information and other assumptions, as more fully disclosed in Note 5 of the Notes to Consolidated Financial Statements. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and other factors, especially in the absence of broad markets for items. Changes in assumptions or in market conditions could significantly affect the estimates.
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