UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
For the Quarterly Period ended December 31, 2016
Or
For transition period from to
Commission File Number 001-35033
Oconee Federal Financial Corp.
(Exact Name of Registrant as Specified in Charter)
(State of Other Jurisdiction
of Incorporation)
(I.R.S Employer
Identification Number)
(864) 882-2765
Registrant’s telephone number, including area code
Not Applicable
(Former name or former address, if changed since last report)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨.
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post such files). Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
Indicate the number of shares outstanding of each of the Issuer’s classes of common stock as of the latest practicable date.
There were 5,790,965 shares of Common Stock, par value $0.01 per share, outstanding as of February 9, 2017.
OCONEE FEDERAL FINANCIAL CORP.
Form 10-Q Quarterly Report
Table of Contents
1
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share and per share data)
(Unaudited)
PART I
ITEM 1. FINANCIAL STATEMENTS
See accompanying notes to the consolidated financial statements
2
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
3
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
4
CONSOLIDATED STATEMENTS OF CASH FLOWS
5
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements of Oconee Federal Financial Corp., which include the accounts of its wholly owned subsidiary Oconee Federal Savings and Loan Association (the “Association”) (referred to herein as “the Company,” “we,” “us,” or “our”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Intercompany accounts and transactions are eliminated during consolidation. The Company is majority owned (71.91%) by Oconee Federal, MHC. These financial statements do not include the transactions and balances of Oconee Federal, MHC.
In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting only of normal recurring accruals) necessary to present fairly the Company’s financial position as of December 31, 2016 and June 30, 2016 and the results of operations and cash flows for the interim periods ended December 31, 2016 and 2015. All interim amounts have not been audited, and the results of operations for the interim periods herein are not necessarily indicative of the results of operations to be expected for the year or any other period. These consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended June 30, 2016.
Certain amounts have been reclassified to conform to the current period presentation. The reclassifications had no effect on net income or shareholders’ equity as previously reported.
Cash Flows: Cash and cash equivalents include cash on hand, federal funds sold, overnight interest-bearing deposits and amounts due from other depository institutions.
Use of Estimates: To prepare financial statements in conformity with GAAP, management makes estimates and assumptions based on available information. These estimates and assumptions affect the amounts reported in the consolidated financial statements and the disclosures provided, and actual results could differ.
In August 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-15, Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments. ASU 2016-15 provides cash flow statement classification guidance for certain transactions including how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. The guidance is effective for public business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years and should be applied retrospectively. Early adoption is permitted, including adoption in an interim period. The Company is assessing ASU 2016-15 but does not expect that it will have a significant impact on its accounting and disclosures.
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326) - Measurement of Credit Losses on Financial Instruments. The provisions of ASU 2016-13 were issued to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments that are not accounted for at fair value through net income, including loans held for investment, held-to-maturity debt securities, trade and other receivables, net investment in leases and other commitments to extend credit held by a reporting entity at each reporting date. ASU 2016-13 requires that financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The amendments in ASU 2016-13 eliminate the probable incurred loss recognition in current GAAP and reflect an entity’s current estimate of all expected credit losses. The measurement of expected credit losses is based upon historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the financial assets.
For purchased financial assets with a more-than-insignificant amount of credit deterioration since origination (“PCD assets”) that are measured at amortized cost, the initial allowance for credit losses is added to the purchase price rather than being reported as a credit loss expense. Subsequent changes in the allowance for credit losses on PCD assets are recognized through the statement of income as a credit loss expense.
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Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses rather than as a direct write-down to the security.
ASU 2016-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company is currently evaluating the impact of ASU 2016-13 on its accounting and disclosures.
In March 2016, the FASB issued ASU 2016-09, Compensation - Stock Compensation, which requires all income tax effects of awards to be recognized in the income statement when the awards vest or are settled. It also allows an employer to repurchase more of an employee’s shares than it can today for tax withholding purposes without triggering liability accounting and to make a policy election for forfeitures as they occur. The guidance is effective for public business entities for fiscal years beginning after December 15, 2016, and interim periods within those years. Early adoption is permitted. The Company does not believe that this new guidance will have a material effect on the consolidated financial statements.
Other accounting standards that have been issued or proposed by the FASB or other standards-setting bodies are not expected to have a material impact on the Company’s financial position, results of operations or cash flows.
Basic EPS is based on the weighted average number of common shares outstanding and is adjusted for ESOP shares not yet committed to be released. Unvested restricted stock awards, which contain rights to non-forfeitable dividends, are considered participating securities and the two-class method of computing basic and diluted EPS is applied. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as outstanding stock options, were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the earnings of the Company. Diluted EPS is calculated by adjusting the weighted average number of shares of common stock outstanding to include the effect of contracts or securities exercisable (such as stock options) or which could be converted into common stock, if dilutive, using the treasury stock method. The factors used in the earnings per common share computation follow:
7
During the three months ended December 31, 2016, no shares were considered anti-dilutive. During the six months ended December 31, 2016, 28,700 shares were considered anti-dilutive as the exercise price was below the average market price for the respective periods. During the three and six months ended December 31, 2015, 15,400 shares were considered anti-dilutive as the exercise price was below the average market price for the respective periods.
Debt, mortgage-backed and equity securities have been classified in the consolidated balance sheets according to management’s intent. U.S. Government agency mortgage-backed securities consist of securities issued by U.S. Government agencies and U.S. Government sponsored enterprises. Investment securities at December 31, 2016 and June 30, 2016 are as follows:
Securities pledged at December 31, 2016 and June 30, 2016 had fair values of $5,990 and $6,114, respectively. These securities were pledged to secure public deposits.
At December 31, 2016 and June 30, 2016, there were no holdings of securities of any one issuer, other than U.S. Government agencies and U.S. Government sponsored enterprises, in an amount greater than 10% of shareholders’ equity.
8
The following tables show the fair value and unrealized loss of securities that have been in unrealized loss positions for less than twelve months and for more than twelve months at December 31, 2016 and June 30, 2016. The tables also show the number of securities in an unrealized loss position for each category of investment security as of the respective dates.
The Company evaluates securities for other-than-temporary impairments (“OTTI”) at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. The Company considers the length of time and the extent to which the fair value has been less than cost and the financial condition and near-term prospects of the issuer. Additionally, the Company considers its intent to sell or whether it will be more likely than not it will be required to sell the security prior to the security's anticipated recovery in fair value. In analyzing an issuer's financial condition, the Company may consider whether the securities are issued by federal Government agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer's financial condition.
None of the unrealized losses at December 31, 2016 were recognized into net income for the three or six months ended December 31, 2016 because the issuers’ bonds are of high credit quality, management does not intend to sell and it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates. The fair value of these securities is expected to recover as they approach their maturity date or reset date. None of the unrealized losses at June 30, 2016 were recognized as having OTTI during the year ended June 30, 2016.
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The following table presents the amortized cost and fair value of debt securities classified as available-for-sale at December 31, 2016 and June 30, 2016 by contractual maturity. FHLMC common stock is not presented in this table.
The following table presents the gross proceeds from sales of securities available-for-sale and gains or losses recognized for the three and six months ended December 31, 2016 and 2015:
The tax provision related to these net realized gains for the three and six months ended December 31, 2016 was $21 and $45, respectively, and for the three and six months ended December 31, 2015 was $0 and $3, respectively.
The components of loans at December 31, 2016 and June 30, 2016 were as follows:
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The following tables present the activity in the allowance for loan losses for the three and six months ended December 31, 2016 by portfolio segment:
11
The following table presents the recorded balances of loans and amount of allowance allocated based upon impairment method by portfolio segment at December 31, 2016:
The following tables present the activity in the allowance for loan losses for the three and six months ended December 31, 2015 by portfolio segment:
12
The following table presents the recorded balances of loans and amount of allowance allocated based upon impairment method by portfolio segment at June 30, 2016:
13
The tables below present loans that were individually evaluated for impairment by portfolio segment at December 31, 2016 and June 30, 2016, including the average recorded investment balance and interest earned for the six months ended December 31, 2016 and year ended June 30, 2016:
The unpaid principal balance and recorded investment includes PCI loans of $5,365 and $3,345, respectively, at December 31, 2016.
14
The unpaid principal balance and recorded investment in PCI loans was $6,546 and $3,921, respectively, at June 30, 2016.
15
Purchased Credit Impaired Loans:
The Company has purchased loans, for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected. The following table presents the carrying amount of those loans at December 31, 2016 and June 30, 2016:
Carrying amounts listed above are net of an allowance for loan losses of $151 and $129 at December 31, 2016 and June 30, 2016, respectively.
The following table presents the changes in the carrying value and the accretable yield on purchased credit impaired loans for the three and six months ended December 31, 2016 and 2015.
16
Income is not recognized on PCI loans if the Company cannot reasonably estimate cash flows expected to be collected. The carrying amount of such loans at December 31, 2016 and 2015 is as follows:
The following tables present the aging of past due loans as well as nonaccrual loans. Nonaccrual loans and accruing loans past due 90 days or more include both smaller balance homogenous loans and larger balance loans that are evaluated either collectively or individually for impairment. Separate tables are presented to show the aging of total past due loans and the aging of past due PCI loans only.
Total past due loans and nonaccrual loans at December 31, 2016:
17
PCI past due and nonaccrual loans at December 31, 2016:
PCI loans for which the Company cannot reasonably estimate the amount and timing of future cash flows are classified as nonaccrual.
Total past due and nonaccrual loans by portfolio segment at June 30, 2016:
PCI past due and nonaccrual loans at June 30, 2016:
18
Troubled Debt Restructurings:
At December 31, 2016 and June 30, 2016, total loans that have been modified as troubled debt restructurings were $1,585 and $1,588, respectively, which consisted of two agricultural loans, two home equity lines of credit, and one one-to-four family first liens at June 30, 2016 and an additional one-to-four family loan at December 31, 2016. All loans were acquired and initially recorded at fair value. An additional allowance of $34 and $55 at December 31, 2016 and June 30, 2016, respectively, has been specifically reserved for these loans. Additionally, there were no commitments to lend any additional amounts under either loan or any payment default on any loan after the modification. The one troubled debt restructuring during the six months ended December 31, 2016 involved renewal of a loan at a higher loan-to-value ratio than is offered on similar loans. No reductions of principal or interest rates were granted. No loans restructured during the twelve months ended December 31, 2016 defaulted.
Loan Grades:
The Company utilizes a grading system whereby all loans are assigned a grade based on the risk profile of each loan. Loan grades are determined based on an evaluation of relevant information about the ability of borrowers to service their debt such as current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. All loans, regardless of size, are analyzed and are given a grade based upon the management’s assessment of the ability of borrowers to service their debts.
Pass: Loan assets of this grade conform to a preponderance of our underwriting criteria and are acceptable as a credit risk, based upon the current net worth and paying capacity of the obligor. Loans in this category also include loans secured by liquid assets and secured loans to borrowers with unblemished credit histories.
Pass-Watch: Loan assets of this grade represent our minimum level of acceptable credit risk. This grade may also represent obligations previously rated “Pass”, but with significantly deteriorating trends or previously rated.
Special Mention: Loan assets of this grade have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of repayment prospects for the loan or of the institution’s credit position at some future date.
Substandard: Loan assets of this grade are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
Doubtful: Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
Portfolio Segments:
One-to-four family: One-to-four family residential loans consist primarily of loans secured by first or second deeds of trust on primary residences, and are originated as adjustable-rate or fixed-rate loans for the construction, purchase or refinancing of a mortgage. These loans are collateralized by owner-occupied properties located in the Company's market area. The Company currently originates residential mortgage loans for our portfolio with loan-to-value ratios of up to 80% for traditional owner-occupied homes.
For traditional homes, the Company may originate loans with loan-to-value ratios in excess of 80% if the borrower obtains mortgage insurance or provides readily marketable collateral. The Company may make exceptions for special loan programs that we offer. For example, the Company currently offers mortgages of up to $95 with loan-to-value ratios of up to 95% to low- to moderate-income borrowers solely for the purchase of their primary residence. The Company also originates residential mortgage loans for non-owner-occupied homes with loan-to-value ratios of up to 80%.
19
The Company has historically originated residential mortgage loans with loan-to-value ratios of up to 75% for manufactured or modular homes. The Company no longer offers residential mortgage loans for manufactured or modular homes as of December 1, 2014. However, renewals of existing performing credits that meet the Company’s underwriting requirements will be considered. The Company requires lower loan-to-value ratios for manufactured and modular homes because such homes tend to depreciate over time. Manufactured or modular homes must be permanently affixed to a lot to make them more difficult to move without the Company’s permission. Such homes must be "de-titled" by the State of South Carolina or Georgia so that they are taxed and must be transferred as residential homes rather than vehicles. The Company also obtains a mortgage on the real estate to which such homes are affixed.
Multi-family: Multi-family real estate loans generally have a maximum term of five years with a 30 year amortization period and a final balloon payment and are secured by properties containing five or more units in the Company's market area. These loans are generally made in amounts of up to 75% of the lesser of the appraised value or the purchase price of the property with an appropriate projected debt service coverage ratio. The Company's underwriting analysis includes considering the borrower's expertise and requires verification of the borrower's credit history, income and financial statements, banking relationships, independent appraisals, references and income projections for the property. The Company generally obtains personal guarantees on these loans.
Multi-family real estate loans generally present a higher level of risk than loans secured by one-to-four family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income-producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family residential real estate is typically dependent upon the successful operation of the related real estate project.
Home Equity: The Company offers home equity loans and lines of credit secured by first or second deeds of trust on primary residences in our market area. The Company’s home equity loans and lines of credit are limited to an 80% loan-to-value ratio (including all prior liens). Standard residential mortgage underwriting requirements are used to evaluate these loans. The Company offers adjustable-rate and fixed-rate options for these loans with a maximum term of 10 years. The repayment terms on lines of credit are interest only monthly with principle due at maturity. Home equity loans have a more traditional repayment structure with principal and interest due monthly. The maximum term on home equity loans is 10 years with an amortization schedule not exceed 20 years.
Nonresidential Real Estate: Nonresidential loans include those secured by real estate mortgages on churches, owner-occupied and non-owner-occupied commercial buildings of various types, retail and office buildings, hotels, and other business and industrial properties. The nonresidential real estate loans that the Company originates generally have terms of five to 20 years with amortization periods up to 20 years. The maximum loan-to-value ratio of our nonresidential real estate loans is generally 75%.
Loans secured by nonresidential real estate generally are larger than one-to-four family residential loans and involve greater credit risk. Nonresidential real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on such property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general, including the current adverse conditions. In addition, because a church's financial stability often depends on donations from congregation members rather than income from business operations, repayment may be affected by economic conditions that affect individuals located both in our market area and in other market areas with which we are not as familiar. In addition, due to the unique nature of church buildings and properties, the real estate securing church loans may be less marketable than other nonresidential real estate.
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The Company considers a number of factors in originating nonresidential real estate loans. The Company evaluates the qualifications and financial condition of the borrower, including credit history, cash flows, the applicable business plan, the financial resources of the borrower, the borrower's experience in owning or managing similar property and the borrower's payment history with the Company and other financial institutions. In evaluating the property securing the loan, the factors the Company considers include the net operating income of the mortgaged property before debt service and depreciation, the ratio of the loan amount to the appraised value of the mortgaged property and the debt service coverage ratio (the ratio of net operating income to debt service). For church loans, the Company also considers the length of time the church has been in existence, the size and financial strength of the denomination with which it is affiliated, attendance figures and growth projections and current operating budgets. The collateral underlying all nonresidential real estate loans is appraised by outside independent appraisers approved by our board of directors. Personal guarantees may be obtained from the principals of nonresidential real estate borrowers, and in the case of church loans, guarantees from the applicable denomination may be obtained.
Agricultural: These loans are secured by farmland and related improvements in the Company’s market area. These loans generally have terms of five to 20 years with amortization periods up to 20 years. The maximum loan-to-value ratio of these loans is generally 75%. The Company is managing a small number of these loans in our portfolio. We continue to closely monitor our existing relationships.
Loans secured by agricultural real estate generally are larger than one-to-four family residential loans and involve greater credit risk. Agricultural real estate loans often involve large loan balances to single borrowers or groups of related borrowers. Repayment of these loans depends to a large degree on the results of operations and management of the properties securing the loans or the businesses conducted on such property, and may be affected to a greater extent by adverse conditions in the real estate market or the economy in general, including the current adverse conditions.
Construction and Land: The Company makes construction loans to individuals for the construction of their primary residences and to commercial businesses for their real estate needs. These loans generally have maximum terms of twelve months, and upon completion of construction convert to conventional amortizing mortgage loans. Residential construction loans have rates and terms comparable to one-to-four family residential mortgage loans that the Company originates. Commercial construction loans have rate and terms comparable to commercial loans that we originate. During the construction phase, the borrower generally pays interest only. Generally, the maximum loan-to-value ratio of our owner-occupied construction loans is 80%. Residential construction loans are generally underwritten pursuant to the same guidelines used for originating permanent residential mortgage loans. Commercial construction loans are generally underwritten pursuant to the same guidelines used for originating commercial loans.
The Company also makes interim construction loans for nonresidential properties. In addition, the Company occasionally makes loans for the construction of homes "on speculation," but the Company generally permits a borrower to have only two such loans at a time. These loans generally have a maximum term of eight months, and upon completion of construction convert to conventional amortizing nonresidential real estate loans. These construction loans have rates and terms comparable to permanent loans secured by property of the type being constructed that we originate. Generally, the maximum loan-to-value ratio of these construction loans is 85%.
Commercial and Industrial Loans: Commercial and industrial loans are offered to businesses and professionals in the Company’s market area. These loans generally have short and medium terms on both a collateralized and uncollateralized basis. The structure of these loans are largely determined by the loan purpose and collateral. Sources of collateral can include a lien on furniture, fixtures, equipment, inventory, receivables and other assets of the company. A UCC-1 is typically filed to perfect our lien on these assets.
Commercial and industrial loans and leases typically are underwritten on the basis of the borrower’s or lessee’s ability to make repayment from the cash flow of its business and generally are collateralized by business assets. As a result, such loans and leases involve additional complexities, variables and risks and require more thorough underwriting and servicing than other types of loans and leases.
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Consumer and Other Loans: The Company offers installment loans for various consumer purposes, including the purchase of automobiles, boats, and for other legitimate personal purposes. The maximum terms of consumer loans is 18 months for unsecured loans and 18 to 60 months for loans secured by a vehicle, depending on the age of the vehicle. The Company generally only extends consumer loans to existing customers or their immediate family members, and these loans generally have relatively low balances.
Consumer loans may entail greater credit risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans.
Based on the most recent analysis performed, the risk grade of loans by portfolio segment are presented in the following tables. Separate tables are presented to show the risk grade of loans that have been acquired.
Total loans by risk grade and portfolio segment at December 31, 2016:
Total loans by risk grade and portfolio segment at June 30, 2016:
22
At December 31, 2016, consumer mortgage loans secured by residential real estate properties totaling $488 were in formal foreclosure proceedings and are included in one-to-four family loans.
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 other 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 reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
Investment Securities:
The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level 3).
Impaired Loans:
The fair value of impaired loans with specific allocations of the allowance for loan losses is generally based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are typically significant and result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
Real Estate Owned:
Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals, which are updated no less frequently than annually. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are evaluated on a quarterly basis for additional impairment and adjusted accordingly.
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Appraisals for both collateral-dependent impaired loans and real estate owned are performed by certified general appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by the Company. Once received, management reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with independent data sources such as recent market data or industry-wide statistics. On an annual basis, the Company compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value.
Loan Servicing Rights:
Fair value is determined based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data and results in a Level 3 classification.
Assets and liabilities measured at fair value on a recurring basis at December 31, 2016 and June 30, 2016 are summarized below:
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Presented in the table below are assets measured at fair value on a nonrecurring basis using level 3 inputs at December 31, 2016 and June 30, 2016:
The Company's impaired loans at December 31, 2016 and June 30, 2016 were measured at fair value based primarily upon the estimated value of real estate collateral less costs to sell. The carrying amounts of these loans were $2,732 and $2,463, respectively, which consisted of valuation allowances of $185 and $184, respectively. The impact to the provision for loan losses from the change in the valuation allowance for the three and six months ended December 31, 2016 was a decrease of $22 and an increase of $1, respectively, and for the three and six months ended December 31, 2015 was an increase of $262 and $292, respectively.
Real estate owned is carried at the lower of carrying value or fair value less costs to sell. The carrying value of real estate owned and their respective valuation allowances at December 31, 2016 and June 30, 2016 were $752 and $1,354 and $102 and $102, respectively. The resulting write-downs for measuring real estate owned at the lower of carrying or fair value less costs to sell for the three and six months ended December 31, 2016, were $0 and $103, respectively. The resulting write-downs for measuring real estate owned at the lower of carrying or fair value less costs to sell for the three and six months ended December 31, 2015, were $15 and $110, respectively.
The tables below present a reconciliation of all Level 3 assets measured at fair value on a recurring basis using significant unobservable inputs for the three and six months ended December 31, 2016 and 2015:
25
The table below presents the valuation methodology and unobservable inputs for Level 3 assets measured at fair value on a non-recurring basis at December 31, 2016 and June 30, 2016.
26
Many of the Company’s assets and liabilities are short-term financial instruments whose carrying amounts reported in the consolidated balance sheet approximate fair value. These items include cash and cash equivalents, accrued interest receivable and payable balances, variable rate loan and deposits that re-price frequently and fully. The estimated fair values of the Company’s remaining on-balance sheet financial instruments at December 31, 2016 and June 30, 2016 are summarized below:
Employees participate in an Employee Stock Ownership Plan (“ESOP”). The ESOP borrowed from the Company to purchase 248,842 shares of the Company’s common stock at $10 per share during 2011. The Company makes discretionary contributions to the ESOP and pays dividends on unallocated shares to the ESOP, and the ESOP uses funds it receives to repay the loan. When loan payments are made, ESOP shares are allocated to participants based on relative compensation and expense is recorded. Dividends on allocated shares increase participant accounts.
Participants receive the shares at the end of employment. The Company makes contributions to the ESOP each December. In December 2016, $50 of discretionary contributions were made to the ESOP for debt retirement, which resulted in the release of additional shares and recognition of additional compensation expense of $88 for both the three and six months ended December 31, 2016. In December 2015, $100 of discretionary contributions were made to the ESOP for debt retirement, which resulted in the release of additional shares and recognition of additional compensation expense of $160 for both the three and six months ended December 31, 2015. Total ESOP compensation expense for the three and six months ended December 31, 2016 was $181 and $273, respectively, and for the three and six months ended December 31, 2015 was $250 and $340, respectively.
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Shares held by the ESOP at December 31, 2016 and June 30, 2016 were as follows:
On April 5, 2012, the shareholders of Oconee Federal Financial Corp. approved the Oconee Federal Financial Corp. 2012 Equity Incentive Plan (the “Plan”) for employees and directors of the Company. The Plan authorizes the issuance of up to 435,472 shares of the Company’s common stock, with no more than 124,420 of shares as restricted stock awards and 311,052 as stock options, either incentive stock options or non-qualified stock options. The exercise price of options granted under the Plan may not be less than the fair market value on the date the stock option is granted. The compensation committee of the board of directors has sole discretion to determine the amount and to whom equity incentive awards are granted.
On February 5, 2016, the compensation committee of the board of directors approved the issuance of 21,000 stock options to purchase Company stock and 7,000 shares of restricted stock were granted to officers. Stock options and restricted stock have vesting periods of five years or seven years, a percentage of which vests annually on each anniversary of the grant date. The weighted average vesting period of stock options and restricted stock granted was 5.7 years and 6.0 years, respectively. Stock options expire ten years after issuance. Apart from the vesting schedule for both stock options and restricted stock, there are no performance-based conditions or any other material conditions applicable to the awards issued.
The following table summarizes stock option activity for the six months ended December 31, 2016:
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The fair value for each option grant is estimated on the date of grant using the Black-Scholes-Merton option pricing model that uses the following assumptions. The Company uses the U.S. Treasury yield curve in effect at the time of the grant to determine the risk-free interest rate. The expected dividend yield is estimated using the projected annual dividend level and recent stock price of the Company’s common stock at the date of grant. Expected stock volatility is based on historical volatilities of the SNL Financial Index of Thrifts. The expected life of the options is calculated based on the “simplified” method as provided for under generally accepted accounting principles.
The weighted-average fair value of options granted and assumptions used in the Black-Scholes-Merton option pricing model in the fiscal years are listed below:
Stock options are assumed to be earned ratably over their respective vesting periods and charged to compensation expense based upon their grant date fair value and the number of options assumed to be earned. There were 23,750 and 21,835 options that were earned during the six months ended December 31, 2016 and 2015, respectively. Stock-based compensation expense for stock options for the three and six months ended December 31, 2016 was $14 and $28, respectively, and for the three and six months ended December 31, 2015 was $12 and $24, respectively. Total unrecognized compensation cost related to stock options was $97 at December 31, 2016 and is expected to be recognized over a weighted-average period of 2.4 years.
The following table summarizes non-vested restricted stock activity for the six months ended December 31, 2016:
The fair value of the restricted stock awards is amortized to compensation expense over their respective vesting periods and is based on the market price of the Company’s common stock at the date of grant multiplied by the number of shares granted that are expected to vest. The weighted-average grant date fair value of restricted stock granted on January 23, 2015 was $20.01 per share or $252. The weighted-average grant date fair value of restricted stock granted on February 5, 2016 was $19.40 per share or $136. Stock-based compensation expense for restricted stock included in noninterest expense for the three and six months ended December 31, 2016 was $62 and $123, respectively, and for the three and six months ended December 31, 2015 was $64 and $127, respectively. Unrecognized compensation expense for non-vested restricted stock awards was $424 at December 31, 2016 and is expected to be recognized over a weighted-average period of 2.9 years.
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Mortgage loans serviced for others are not reported as assets; however, the underlying mortgage servicing rights associated with servicing these mortgage loans serviced for others is recorded as an asset in the consolidated balance sheet.
The principal balances of those loans at December 31, 2016 and June 30, 2016 are as follows:
Custodial escrow balances maintained in connection with serviced loans were $811 and $1,007 at December 31, 2016 and June 30, 2016.
Activity for loan servicing rights for the three and six months ended December 31, 2016 and 2015 is as follows:
Fair value at December 31, 2016 was determined using a discount rate of 9.63%, prepayment speed assumptions ranging from 5.1% to 12.7% Conditional Prepayment Rate (“CPR”) depending on the loans coupon, term and seasoning, and a weighted average default rate of 0.61%. Fair value at December 31, 2015 was determined using a discount rate of 9.75%, prepayment speed assumptions ranging from 5.2% to 17.5% CPR depending on the loans’ coupon, term and seasoning, and a weighted average default rate of 0.61%.
Supplemental cash flow information for the six months ended December 31, 2016 and 2015 is as follows:
On January 26, 2017, the Board of Directors of Oconee Federal Financial Corp. (the “Company”) declared a quarterly cash dividend of $0.10 per share of the Company’s common stock. The dividend is payable to stockholders of record as of February 9, 2017, and will be paid on or about February 23, 2017.
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This Quarterly Report contains forward-looking statements, which can be identified by the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions. These forward-looking statements include:
These forward-looking statements are based on our current beliefs and expectations 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. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this Quarterly Report.
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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Because of these and a wide variety of other uncertainties, our actual future results may be materially different from the results indicated by these forward-looking statements.
Critical Accounting Policies
There are no material changes to the critical accounting policies disclosed in the Annual Report on Form 10-K for Oconee Federal Financial Corp. for the year ended June 30, 2016, as filed with the Securities and Exchange Commission.
Comparison of Financial Condition at December 31, 2016 and June 30, 2016
Our total assets decreased by $3.6 million, or 0.7%, to $482.1 million at December 31, 2016 from $485.6 million at June 30, 2016. Total cash and cash equivalents decreased $2.0 million, or 7.2%, to $25.7 million at December 31, 2016 from $27.7 million at June 30, 2016. Our available-for-sale securities portfolio also decreased from $132.1 million at June 30, 2016 to $120.7 million at December 31, 2016. Proceeds from sales and calls of securities and excess cash was used to fund loan growth. Gross loans increased $9.5 million, or 3.2%, to $301.5 million at December 31, 2016 from $292.1 million at June 30, 2016. This increase is a result of increased loan demand experienced during the six months ended December 31, 2016.
Deposits decreased $3.2 million, or 0.8%, to $396.4 million at December 31, 2016 from $399.6 million at June 30, 2016. The decrease in our deposits reflected a decrease of $8.9 million in certificates of deposit and $387 thousand in savings deposits, offset by an increase in money market deposits of $3.2 million and NOW and demand deposits of $2.9 million. The increase in money market deposits reflects an increase in rate on certain money market accounts during the six months ended December 31, 2016 and increased efforts to offer and market our deposit products. We believe the decline in our certificates of deposit reflects depositors moving their deposits into higher yielding investments in the market.
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Oconee Federal, MHC’s cash is held on deposit with the Company. We generally do not accept brokered deposits and no brokered deposits were accepted during the six months ended December 31, 2016.
We had no advances from the Federal Home Loan Bank of Atlanta as of December 31, 2016 or June 30, 2016. We have credit available under a loan agreement with the Federal Home Loan Bank of Atlanta in the amount of 25% of our total assets as of December 31, 2016, or approximately $120.6 million.
Total shareholders’ equity decreased $1.5 million, or 1.8%, to $83.9 million at December 31, 2016 compared to $85.4 million at June 30, 2016. Our net income of $2.6 million was fully offset by our other comprehensive loss of $2.7 for the six months ended December 31, 2016. The increase in other comprehensive loss was a result of the rising interest rate environment relative to the interest rate environment in which the investment securities were purchased. Management did not believe the unrealized losses represented an other-than-temporary impairment. Dividends of $1.1 million and share repurchases of $778 thousand also contributed to the decrease in shareholders’ equity during the period. The Company and the Bank exceeded all minimum regulatory capital requirements for the period.
Nonperforming Assets
The table below sets forth the amounts and categories of our nonperforming assets at the dates indicated.
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Interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $127 thousand and $97 thousand for the six months ended December 31, 2016 and 2015, respectively. Interest of $45 thousand and $31 thousand, respectively, was recognized on these loans and is included in net income for the six months ended December 31, 2016 and 2015, respectively.
Interest income that would have been recorded had our troubled debt restructured loans been current in accordance with their original terms was $66 thousand and $37 thousand, respectively, for the six months ended December 31, 2016 and 2015.
Nonperforming assets decreased $182 thousand from June 30, 2016 to December 31, 2016. Nonaccrual loans increased $420 thousand while real estate owned decreased $602 thousand. There were no accruing loans past due 90 days or more at either date. The increase in nonaccrual loans primarily related to seasonal fluctuations and an increase in our TDRs as we continue to work with borrowers to avoid foreclosure. Nonperforming assets to total assets and nonperforming assets to loans and real estate owned were 1.02% and 1.63%, respectively, at December 31, 2016 compared to 1.05% and 1.74%, respectively at June 30, 2016.
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Analysis of Net Interest Margin
The following table sets forth average balance sheets, average annualized yields and rates, and certain other information for the periods indicated. No tax-equivalent yield adjustments were made, as the effect thereof was not material. All average balances are daily average balances. Nonaccrual loans were included in the computation of average balances, but have been reflected in the tables as loans carrying a zero yield. The yields set forth below include the effect of net deferred costs, discounts and premiums that are amortized or accreted to income.
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Comparison of Operating Results for the Three Months Ended December 31, 2016 and December 31, 2015
General. We reported net income of $1.3 million for the three months ended December 31, 2016 compared to $949 thousand for the three months ended December 31, 2015. Interest income decreased $182 thousand for the three months ended December 31, 2016 while interest expense increased $28 thousand resulting in a net decrease to net interest income of $210 thousand. Noninterest income increased $43 thousand for the three months ended December 31, 2016 compared to December 31, 2015 due primarily to gains recognized on the sales of securities available-for-sale and PCI loans. Total noninterest expense decreased $449 thousand due to lower salaries and employee benefits expenses and the net change in the loan servicing asset.
Interest Income. Interest income decreased by $182 thousand, or 4.1%, to $4.2 million for the three months ended December 31, 2016. The yield on interest earning-assets decreased 17 basis points from 4.02% for the three months ended December 31, 2015 to 3.85% for the three months ended December 31, 2016. The decrease was slightly offset by an increase in total average interest-earning assets of $1.1 million to $441.4 million for the three months ended December 31, 2016 from $440.3 million for the three months ended December 31, 2015.
Interest income on loans was $3.6 million for the three months ended December 31, 2016 compared to $3.9 million for the three months ended December 31, 2015. The yield on loans decreased 25 basis points from 5.13% for the three months ended December 31, 2015 to 4.88% for the three months ended December 31, 2016. The average balance of loans also decreased by $2.0 million, or 0.7%, to $298.4 million for the three months ended December 31, 2016 from $300.4 million for the three months ended December 31, 2015. The decrease in the average balance of our loans is reflective of the run-off in the months following the acquisition of Stephens Federal Bank in December 2014. As a result of the acquisition, we obtained loans with slightly higher coupon rates from ours, which had a positive effect of increasing our overall loan portfolio yield.
Interest income on investment securities increased by $19 thousand, or 3.5%, to $568 thousand for the three months ended December 31, 2016 from $549 thousand for the three months ended December 31, 2015. The increase reflected an increase in the average balance of securities of $5.7 million, or 4.7%, to $126.1 million for the three months ended December 31, 2016 from $120.4 million for the three months ended December 31, 2015 offset by a decrease of two basis points in the yield on securities to 1.80% from 1.82%. The increase in the average balances of our investment securities is reflective of our efforts to continue to invest in high-quality investment securities during periods of low loan demand.
The average balance of interest-earning deposits decreased $2.6 million from the three months ended December 31, 2015 to the three months ended December 31, 2015 while the yield increased 32 basis points over the same period.
Interest Expense. Interest expense increased by $28 thousand, or 9.5%, to $323 thousand for the three months ended December 31, 2016 from $295 thousand for the three months ended December 31, 2015. The increase reflected an increase of four basis points in the average rate paid on deposits for the three months ended December 31, 2016 to 0.35% from 0.31% for the three months ended December 31, 2015. The increase in the average rate paid on deposits is reflective of our efforts to keep our cost of funds as low as possible but still maintain our competitiveness in our market area among other banking institutions. Average interest-bearing deposits were $369.8 million for the three months ended December 31, 2016 compared to $376.0 million for the three months ended December 31, 2015.
The largest increase in interest expense related to expense on money market deposits, which increased $23 thousand, or 46.9%, to $72 thousand for the three months ended December 31, 2016 from $49 thousand for the three months ended December 31, 2015. Average money market deposit balances increased $17.1 million from $62.1 million for the three months ended December 31, 2015 to $79.2 million for the three months ended December 31, 2016. The increase resulted from a successful money market campaign during the year ended June 30, 2016.
The average rate paid on certificates of deposit increased from 0.39% at December 31, 2015 to 0.43% for the three months ended December 31, 2016 while average balances decreased from $239.5 million for the three-month period ended December 31, 2015 to $213.9 million for the three-month period ended December 31, 2016. Lower volume resulted in a decrease in interest expense of $1 thousand for certificates of deposit.
The average balance of NOW and demand deposits decreased by $1.7 million while the average rate increased two basis points and the average balance of savings deposits increased $4.1 million and average rates increased four basis points.
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Net Interest Income. Net interest income before the provision for loan losses decreased by $210 thousand, or 5.1%, to $3.9 million for the three months ended December 31, 2016. Our interest rate spread and net interest margin for the three months ended December 31, 2016 decreased to 3.50% and 3.55%, respectively, from 3.71% and 3.75%, respectively, for the three months ended December 31, 2015. The lower yield and lower average balance of loans primarily contributed to the decrease in net interest margin for the three months ended December 31, 2016.
Provision for Loan Losses. We recorded a provision for loan losses of $24 thousand for the three months ended December 31, 2016 compared with $277 thousand for the three months ended December 31, 2015. There were no net charge-offs for the three months ended December 31, 2016 compared to $140 thousand for the three months ended December 31, 2015. Primarily all of the charge-offs for the three months ended December 31, 2015 were related to loans we acquired. The lower provision is due to lower net charge-offs, a smaller balance of PCI loans and the length of time that the PCI loans have been on the books.
Our total allowance for loan losses was $996 thousand, or 0.33%, of total gross loans, at December 31, 2016 and $922 thousand, or 0.32%, of total gross loans at June 30, 2016. The ending allowance for specifically identified impaired loans was $185 thousand at December 31, 2016 compared to $184 thousand at June 30, 2016. The recorded investment in impaired loans at December 31, 2016 was $5.2 million compared to $5.4 million at June 30, 2016. The allowance for specifically identified impaired loans at December 31, 2016 and June 30, 2016 includes an allowance of $151 thousand and $129 thousand, respectively for PCI loans.
The general valuation allowance at December 31, 2016 and June 30, 2016 was $811 thousand and $738 thousand, respectively. Total loans evaluated collectively for impairment increased $9.6 million, or 3.3%, to $296.3 million at December 31, 2016 compared to $286.7 million at June 30, 2016. No general valuation allowance has been recorded for the acquired portion of our loan portfolio that was not determined to be PCI.
To the best of our knowledge, we have recorded all losses that are both probable and reasonably estimable for the three months ended December 31, 2016 and 2015. There have been no changes to our allowance for loan loss methodology.
Noninterest Income. Noninterest income increased $43 thousand, or 9.5%, to $495 thousand for the three months ended December 31, 2016 from $452 thousand for the three months ended December 31, 2015. Gains on the disposition of PCI loans of $120 thousand were recognized for the three months ended December 31, 2016 compared to $90 thousand for the three months ended December 31, 2015. Gains on sales of investment securities available for sale were $57 thousand for the three months ended December 31, 2016. There were no gains on sales of investment securities for the three months ended December 31, 2015. Gains on sales of securities are largely market driven, as we generally have no need to sell securities and would only expect to do so if a gain will be realized. Service charges and mortgage banking income declined for comparable periods as a result of decreased activity.
Noninterest Expense. Noninterest expense for the three months ended December 31, 2016 decreased by $449 thousand, or 15.5%, to $2.5 million from $2.9 million for the same period in 2015. Salaries and employee benefits decreased $228 thousand from $1.9 million for the three months ended December 31, 2015 to $1.6 million for the three months ended December 31, 2016 due to decreases in the discretional contributions to the ESOP and profit sharing plans in 2016.
When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value. These servicing rights are then measured at each reporting date and changes are recorded as “change in loan servicing asset” on the consolidated statements of income and comprehensive income. For the three months ended December 31, 2016, we recognized income for the increase in the loan servicing asset of $196 thousand compared to an expense of $21 thousand for the three months ended December 31, 2015. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
Expenses related to foreclosed assets decreased from $47 thousand for the three months ended December 31, 2015 to $2 thousand for the three months ended December 31, 2016. Expenses related to foreclosed assets for the three months ended December 31, 2015 included a provision for potential losses of $15 thousand. There were also more properties held in real estate owned at December 31, 2015 compared to December 31, 2016 resulting in higher expenses. Real estate owned is carried at the lower of its carrying value or fair value, less costs to sell. We typically do not experience large gains or losses on real estate properties sold.
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Income Tax Expense. Income tax expense for the three months ended December 31, 2016 was $618 thousand compared with $452 thousand for the three months ended December 31, 2015. Our effective income tax rate was 31.9% and 32.3% for the same periods, respectively. The slight decrease in our effective tax rate is primarily due to a higher volume of tax-free investment securities.
Comparison of Operating Results for the Six Months Ended December 31, 2016 and December 31, 2015
General. We reported net income of $2.6 million for the six months ended December 31, 2016 compared to $2.4 million for the six months ended December 31, 2015. Interest income decreased $162 thousand for the six months ended December 31, 2016 while interest expense increased $59 thousand resulting in a net decrease to net interest income of $221 thousand. A provision for loan losses of $89 thousand was recognized for the six months ended December 31, 2016 compared to $422 thousand for the six months ended December 31, 2015. Noninterest income decreased $545 thousand for the six months ended December 31, 2016 compared to December 31, 2015 primarily due to a reduction in gains recognized on the disposition of PCI loans. Total noninterest expense decreased $629 thousand as a result of decreased foreclosed asset expenses, lower salaries and employee benefits and the change in the loan servicing asset.
Interest Income. Interest income decreased by $162 thousand, or 1.8%, to $8.6 million for the six months ended December 31, 2016. The yield on interest earning-assets decreased twelve basis points from 4.03% for the six months ended December 31, 2015 to 3.91% for the six months ended December 31, 2016. The decrease was slightly offset by an increase in total average interest-earning assets of $5.8 million to $442.4 million for the six months ended December 31, 2016 from $436.6 million for the six months ended December 31, 2015.
Interest income on loans was $7.4 million for the six months ended December 31, 2016 compared to $7.7 million for the six months ended December 31, 2015. The yield on loans decreased 11 basis points from 5.10% for the six months ended December 31, 2015 to 4.99% for the six months ended December 31, 2016, and the average balance of loans decreased by $7.7 million, or 2.5%, to $295.7 million for the six months ended December 31, 2016 from $303.4 million for the six months ended December 31, 2015. The decrease in the average balance of our loans is reflective of the run-off in the months following the acquisition of Stephens Federal Bank in December 2014. As a result of the acquisition, we obtained loans with slightly higher coupon rates from ours, which had a positive effect of increasing our overall loan portfolio yield.
Interest income on investment securities increased by $161 thousand, or 15.7%, to $1.2 million for the six months ended December 31, 2016 from $1.0 million for the six months ended December 31, 2015. The increase reflected an increase in the average balance of securities of $12.6 million, or 10.9%, to $128.7 million for the six months ended December 31, 2016 from $116.1 million for the six months ended December 31, 2015 and an increase of eight basis points in the yield on securities to 1.85% from 1.77%. The increase in the average balances of our investment securities is reflective of our efforts to continue to invest in high-quality investment securities during periods of low loan demand. The increase in the yield on our investment securities is reflective of our efforts to shift our portfolio concentration to investments in municipal securities, which give us slightly higher yields and in some cases provide tax-exempt income.
Interest Expense. Interest expense increased by $59 thousand, or 10.1%, to $643 thousand for the six months ended December 31, 2016 from $584 thousand for the six months ended December 31, 2015. The increase reflected an increase of three basis points in the average rate paid on deposits for the six months ended December 31, 2016 to 0.34% from 0.31% for the six months ended December 31, 2015. The increase in the average rate paid on deposits is reflective of our efforts to keep our cost of funds as low as possible but still maintain our competitiveness in our market area among other banking institutions. Average interest-bearing deposits were $371.9 million for the six months ended December 31, 2016 compared to $371.2 million for the six months ended December 31, 2015.
The largest increase in interest expense related to expense on money market deposits, which increased $67 thousand, or 100.0%, to $134 thousand for the six months ended December 31, 2016 from $67 thousand for the six months ended December 31, 2015. Average money market deposit balances increased $27.7 million from $50.6 million for the six months ended December 31, 2015 to $78.3 million for the six months ended December 31, 2016. The increases resulted from a successful money market campaign during the year ended June 30, 2016.
The average rate paid on certificates of deposit was 0.42% for the six months ended December 31, 2016 compared to 0.40% for the six months ended December 31, 2015. Average balances decreased from $245.1 million for the six-month period ended December 31, 2015 to $217.3 million for the six-month period ended December 31, 2016. Lower volume resulted in a decrease in interest expense of $29 thousand for certificates of deposit.
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The average balance of NOW and demand deposits decreased by $1.6 million while the average rate increased four basis points and the average balance of savings deposits increased $2.5 million and the average rate increased six basis points.
Net Interest Income. Net interest income before the provision for loan losses decreased by $221 thousand, or 2.7%, to $8.0 million for the six months ended December 31, 2016. Our interest rate spread and net interest margin for the six months ended December 31, 2016 decreased to 3.57% and 3.62%, respectively, from 3.72% and 3.77%, respectively, for the six months ended December 31, 2015. Average loan volume, which has the highest yield, decreased by $7.7 million, significantly contributing to the decrease in net interest margin for the six months ended December 31, 2016.
Provision for Loan Losses. We recorded a provision for loan losses of $89 thousand for the six months ended December 31, 2016 compared with $422 thousand for the six months ended December 31, 2015. Net charge-offs for the six months ended December 31, 2016 were $15 thousand compared to $282 thousand for the six months ended December 31, 2015. Primarily all of the charge-offs for the six months ended December 31, 2016 and 2015 were related to loans we acquired. The lower provision is due to lower net charge-offs, a smaller balance of PCI loans and the length of time that the PCI loans have been on the books.
To the best of our knowledge, we have recorded all losses that are both probable and reasonably estimable for the six months ended December 31, 2016 and 2015. There have been no changes to our allowance for loan loss methodology.
Noninterest Income. Noninterest income decreased $545 thousand, or 36.1%, to $963 thousand for the six months ended December 31, 2016 from $1.5 million for the six months ended December 31, 2015. Gains on the disposition of PCI loans of $809 thousand were recognized for the six months ended December 31, 2015 compared to $196 thousand for the six months ended December 31, 2016. Gains on sales of investment securities available for sale increased from $9 thousand for the six months ended December 31, 2015 to $125 thousand for the six months ended December 31, 2016. Gains on sales of securities are largely market driven, as we generally have no need to sell securities and would only expect to do so if a gain will be realized.
Noninterest Expense. Noninterest expense for the six months ended December 31, 2016 decreased by $629 thousand, or 11.1%, to $5.0 million from $5.7 million for the same period in 2015. Expenses related to foreclosed assets decreased from $222 thousand for the six months ended December 31, 2015 to $37 thousand for the six months ended December 31, 2016. Total expenses related to foreclosed assets were offset by net gains realized on sales of real estate owned of $86 thousand for the six months ended December 31, 2016. A net loss of $69 thousand was recognized on sales of real estate owned for the six months ended December 31, 2015. There were also more properties held in real estate owned at December 31, 2015 compared to December 31, 2016 resulting in higher expenses. Real estate owned is carried at the lower of its carrying value or fair value, less costs to sell. We typically do not experience large gains or losses on real estate properties sold.
When mortgage loans are sold with servicing retained, servicing rights are initially recorded at fair value. These servicing rights are then measured at each reporting date and changes are recorded as “change in loan servicing asset” on the consolidated statements of income and comprehensive income. For the six months ended December 31, 2016, we recognized income for the increase in the loan servicing asset of $173 thousand compared to an expense of $86 thousand for the six months ended December 31, 2015. The fair values of servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.
Salaries and employee benefits decreased $205 thousand from the six months ended December 31, 2015 to the six months ended December 31, 2016 due to decreases in the discretional contributions to the ESOP and profit sharing plans in 2016.
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Income Tax Expense. Income tax expense for both the six month periods ended December 31, 2016 and 2015 was $1.2 million. Our effective income tax rate was 32.2% and 34.1% for the same periods, respectively. The decrease in our effective tax rate is primarily due to a higher volume of tax-free investment securities.
Liquidity and Capital Resources
Our primary sources of funds are deposits and the proceeds from principal and interest payments on loans and investment securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. We generally manage the pricing of our deposits to be competitive within our market and to increase core deposit relationships.
Liquidity management is both a daily and long-term responsibility of management. We adjust our investments in liquid assets based upon management’s assessment of (i) expected loan demand, (ii) expected deposit flows, (iii) yields available on interest-earning deposits and investment securities, and (iv) the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning overnight deposits, federal funds sold, and short and intermediate-term U.S. Government sponsored agencies and mortgage-backed securities of short duration. If we require funds beyond our ability to generate them internally, we have credit available under a loan agreement with the Federal Home Loan Bank of Atlanta in the amount of 25% of total assets (as of December 31, 2016), or approximately $120.6 million.
Common Stock Dividends. On August 25, 2016 and November 25, 2016, the Company paid a $0.10 per share cash dividend on its common stock for a total of $1.1 million.
Equity Compensation Plans. During the three months ended December 31, 2016, no shares of restricted stock or stock options were issued to management.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Disclosures of quantitative and qualitative market risk are not required by smaller reporting companies, such as the Company.
ITEM 4. CONTROLS AND PROCEDURES
An evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of December 31, 2016. Based on that evaluation, the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective.
During the quarter ended December 31, 2016, there have been no changes in the Company’s internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Securities and Exchange Act of 1934, amended) that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II
ITEM 1. LEGAL PROCEEDINGS
There are various claims and lawsuits in which the Company is periodically involved incidental to the Company’s business. In the opinion of management, no material loss is expected from any of such pending claims or lawsuits.
ITEM 1A. RISK FACTORS
Disclosures of risk factors are not required of smaller reporting companies, such as the Company.
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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) None.
(b) Not applicable.
(c) Issuer Repurchases. On November 24, 2015, the Board of Directors authorized the repurchase of up to 175,000 of the Company’s common stock, which represents approximately 10.2% of the Company’s issued and outstanding shares (excluding shares that Oconee Federal, MHC currently holds).
In connection with the authorization of this stock repurchase program, the Board of Directors terminated the Company’s existing stock repurchase program, which had authorized the Company to purchase up to 150,000 shares of its issued and outstanding common stock. The Company had previously purchased a total of 113,400 shares of its common stock at a weighted average price of $16.04 per share under the existing stock repurchase program.
The following table sets forth information in connection with repurchases of the Company’s common stock for the period October 1, 2016 through December 31, 2016.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
The exhibits required by Item 601 of Regulation S-K are included with this Form 10-Q and are listed in the “Index to Exhibits” immediately following the Signatures.
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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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INDEX TO EXHIBITS
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