TABLE OF CONTENTS

	Page
President's Letter to Shareholders	1
Selected Consolidated Financial and Other Data	2
Management's Discussion and Analysis of Financial Condition and Results of Operations	3
Report of Independent Registered Public Accounting Firm	15
Consolidated Balance Sheets	16
Consolidated Statements of Income	17
Consolidated Statements of Comprehensive Income	18
Consolidated Statements of Stockholders' Equity	19
Consolidated Statements of Cash Flows	20
Notes to Consolidated Financial Statements	21
Directors and Executive Officers	54
Banking Locations	54
Transfer Agent/Registrar	54
Investor Relations Contact	54

Quaint Oak Bancorp, Inc.

 

PRESIDENT'S LETTER TO SHAREHOLDERS

To our Valued Shareholders:

On behalf of the Board of Directors, Senior Management and Employees of the Quaint Oak Family of Companies, I am pleased to present our 2014 Annual Report to Shareholders.

Fiscal 2014 ended on a very positive note for Quaint Oak Bancorp with fourth quarter earnings recorded as the second best quarter in our history.  Additionally, the annual 2014 earnings were the best year in our history.  The increase in outstanding loan balances along with the increase in our subsidiary mortgage banking activity directly contributed to these results.

During 2014, as our income and balance sheet grew, we continued to invest in our company with a deposit product expansion.  As we enter 2015, with this expansion completed, the addition of business and consumer checking and their related bill-pay, debit card, remote deposit capture and mobile banking products, position us to improve our lower cost funding potential, appeal to a broader market and promote multi-product use within our current customer base.

Additionally, during 2014, we have taken the opportunity to focus on our existing Lehigh Valley Office.  The growth of that region has continued and the resurgence of the Allentown center city area has been significant.  We have, therefore, invested in refinishing the exterior of our office facility and strengthening the lending team based at the Lehigh Valley Office.  Those actions coupled with our expanded line of deposit products and an increase in marketing budget should place us in a positive position to participate in the region's growth.  We have not yet identified a cost effective opportunity for additional market expansion, however, during 2015, we intend to test market areas that may prove to become expansion possibilities in the future.  We continue to be ever mindful of our efficiency ratio and intend to maximize our existing markets prior to expansion into additional areas.

During 2014, we again aggressively pursued stock repurchases and repurchased an aggregate of 45,025 shares during the year.  The total stock repurchases now equal approximately 35% of the original shares issued in our initial public offering completed in July 2007.  At this juncture, we anticipate that the pace of stock repurchase will decline and our focus will be on asset and income growth.  In past years, we have been fortunate to increase our dividend rate each year since initiating the payment of dividends.  We hope our future performance will support this continued practice.   At February 27, 2015, our stock traded at $20.00 per share which represents a multiple of book value.  We believe the continued improvement in market price of our stock is a reflection on the combination of our repurchase plan, dividends and earnings.

As always, in conjunction with having maintained a strong repurchase plan, our current and continued business strategy includes long term profitability and payment of dividends reflecting our strong commitment to shareholder value.

 

Robert T. Strong

President and Chief Executive Officer

 

 

 

 

 

 

 

 

 

 

 

Quaint Oak Family of Companies

Quaint Oak Bancorp, Inc.

Quaint Oak Bank

Quaint Oak Abstract, LLC     ׀     Quaint Oak Mortgage, LLC     ׀     Quaint Oak Real Estate, LLC

Serving the Delaware Valley and the Lehigh Valley Markets

 

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

Set forth below is selected financial and other data of Quaint Oak Bancorp, Inc.  You should read the financial statements and related notes contained in this Annual Report which provide more detailed information.

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(1)	With the exception of end of period ratios, all ratios are based on average daily balances during the indicated periods.

(2)	Average interest rate spread represents the difference between the average yield on interest-earning assets and the average rate paid on interest-bearing liabilities, and net interest margin represents net interest income as a percentage of average interest-earning assets.

(3)	The efficiency ratio represents the ratio of non-interest expense divided by the sum of net interest income and non-interest income.

(4)	Asset quality ratios and capital ratios are end of period ratios, except for net charge-offs to average loans receivable.

(5)	Non-performing assets consist of non-performing loans and other real estate owned at December 31, 2014 and 2013.  Non-performing loans consist of non-accruing loans plus accruing loans 90 days or more past due.

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General

Quaint Oak Bancorp, Inc. (the "Company") was formed in connection with Quaint Oak Bank's (the "Bank") conversion to a stock savings bank completed on July 3, 2007.  The Company's results of operations are dependent primarily on the results of Quaint Oak Bank, a wholly owned subsidiary of the Company.

Quaint Oak Bank's profitability depends, to a large extent, on net interest income, which is the difference between the income earned on its loan and investment portfolios and the cost of funds, consisting of the interest paid on deposits and borrowings.  Results of operations are also affected by provisions for loan losses, fee income and other non-interest income and non-interest expense.  Non-interest expense principally consists of compensation, directors' fees and expenses, office occupancy and equipment expense, professional fees, FDIC deposit insurance assessment and other expenses.

Quaint Oak Bank's business consists primarily of originating residential, multi-family and commercial real estate loans secured by property in its market area.  Typically, single-family loans involve a lower degree of risk and carry a lower yield than commercial real estate, construction, commercial business and consumer loans.  Primarily since fiscal 2004, commercial real estate loans have increased as a percentage of Quaint Oak Bank's loan portfolio to 28.4% at December 31, 2014.  Quaint Oak Bank's loans are primarily funded by certificates of deposit, which typically have a higher interest rate than passbook, statement and eSavings accounts.  At December 31, 2014, certificates of deposit amounted to 61.9% of total assets compared to 63.0% of total assets at December 31, 2013.  In conjunction with the expansion of our commercial lending activities, we began offering a business checking account, along with a consumer checking account product in December 2014.  Management anticipates that certificates of deposit will continue to be a primary source of funding for Quaint Oak Bank's assets.

Our results of operations are significantly affected by general economic and competitive conditions, particularly with respect to changes in interest rates, government policies and actions of regulatory authorities as well as other factors beyond our control. Future changes in applicable law, regulations or government policies may materially affect our financial condition and results of operations.

Forward-Looking Statements Are Subject to Change

We make certain statements in this document as to what we expect may happen in the future. These statements usually contain the words "believe," "estimate," "project," "expect," "anticipate," "intend" or similar expressions. Because these statements look to the future, they are based on our current expectations and beliefs. Actual results or events may differ materially from those reflected in the forward-looking statements. You should be aware that our current expectations and beliefs as to future events are subject to change at any time, and we can give you no assurances that the future events will actually occur.

Critical Accounting Policies

In reviewing and understanding financial information for the Company, you are encouraged to read and understand the significant accounting policies used in preparing our financial statements.  These policies are described in Note 2 of the notes to our financial statements. The accounting and financial reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. Accordingly, the consolidated financial statements require certain estimates, judgments, and assumptions, which are believed to be reasonable, based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the periods presented. The following accounting policies comprise those that management believes are the most critical to aid in fully understanding and evaluating our reported financial results. These policies require numerous estimates or economic assumptions that may prove inaccurate or may be subject to variations which may significantly affect our reported results and financial condition for the period or in future periods.

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The allowance for loan losses is maintained at a level considered adequate to provide for losses that can be reasonably anticipated. Management performs a quarterly evaluation of the adequacy of the allowance. The allowance is based on the Company's past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of any underlying collateral, composition of the loan portfolio, current economic conditions and other relevant factors. This evaluation is inherently subjective as it requires material estimates that may be susceptible to significant revision as more information becomes available.

The allowance consists of specific, general and unallocated components. The specific component relates to loans that are identified as impaired. For loans that are identified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component covers pools of loans by loan class. These pools of loans are evaluated for loss exposure based upon historical loss rates for each of these categories of loans, adjusted for qualitative factors. These significant factors may include changes in lending policies and procedures, changes in existing general economic and business conditions affecting our primary lending areas, credit quality trends, collateral value, loan volumes and concentrations, seasoning of the loan portfolio, recent loss experience in particular segments of the portfolio, duration of the current business cycle and bank regulatory examination results. The applied loss factors are reevaluated quarterly to ensure their relevance in the current economic environment.  Residential mortgage lending generally entails a lower risk of default than other types of lending. Consumer loans and commercial real estate loans generally involve more risk of collectability because of the type and nature of the collateral and, in certain cases, the absence of collateral. It is the Company's policy to establish a specific reserve for loss on any delinquent loan when it determines that a loss is probable. An unallocated component is maintained to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of the collateral if the loan is collateral dependent.  An allowance for loan losses is established for an impaired loan if its carrying value exceeds its estimated fair value. The estimated fair values of substantially all of the Company's impaired loans are measured based on the estimated fair value of the loan's collateral.

A loan is considered a troubled debt restructuring ("TDR") if the Company, for economic or legal reasons related to a debtor's financial difficulties, grants a concession to the debtor that it would not otherwise consider. Concessions granted under a TDR typically involve a temporary or permanent reduction in payments or interest rate or an extension of a loan's stated maturity date at less than a current market rate of interest. Loans identified as TDRs are designated as impaired.

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Management's Discussion and Analysis of Financial Condition and Results of Operations

 

For loans secured by real estate, estimated fair values are determined primarily through third-party appraisals. When a real estate secured loan becomes impaired, a decision is made regarding whether an updated certified appraisal of the real estate is necessary. This decision is based on various considerations, including the age of the most recent appraisal, the loan-to-value ratio based on the original appraisal and the condition of the property. Appraised values are discounted to arrive at the estimated selling price of the collateral, which is considered to be the estimated fair value. The discounts also include estimated costs to sell the property.

The allowance calculation methodology includes further segregation of loan classes into risk rating categories. The borrower's overall financial condition, repayment sources, guarantors and value of collateral, if appropriate, are evaluated annually for all loans (except one-to-four family residential owner-occupied loans) where the total amount outstanding to any borrower or group of borrowers exceeds $500,000, or when credit deficiencies arise, such as delinquent loan payments. Credit quality risk ratings include regulatory classifications of special mention, substandard, doubtful and loss. Loans criticized special mention have potential weaknesses that deserve management's close attention. If uncorrected, the potential weaknesses may result in deterioration of the repayment prospects. Loans classified substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They include loans that are inadequately protected by the current sound net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans classified doubtful have all the weaknesses inherent in loans classified substandard with the added characteristic that collection or liquidation in full, on the basis of current conditions and facts, is highly improbable. Loans classified as a loss are considered uncollectible and are charged to the allowance for loan losses. Loans not classified are rated pass. In addition, Federal regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses and may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination, which may not be currently available to management. Based on management's comprehensive analysis of the loan portfolio, management believes the current level of the allowance for loan losses is adequate.

Income Taxes.  Deferred income tax assets and liabilities are determined using the liability (or balance sheet) method.  Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various assets and liabilities and net operating loss carryforwards and gives current recognition to changes in tax rates and laws.  The realization of our deferred tax assets principally depends upon our achieving projected future taxable income.  We may change our judgments regarding future profitability due to future market conditions and other factors.  We may adjust our deferred tax asset balances if our judgments change.

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Comparison of Financial Condition at December 31, 2014 and December 31, 2013

General. The Company's total assets at December 31, 2014 were $155.6 million, an increase of $28.2 million, or 22.1%, from $127.4 million at December 31, 2013.  This growth in total assets was primarily due to increases in loans receivable, net of $16.4 million, loans held for sale of $1.5 million, cash and cash equivalents of $7.8 million, and investment in bank-owned life insurance of $3.5 million, partially offset by a decrease in investment in interest-earning time deposits of $973,000 and a decrease in other real estate owned, net of $463,000.

Cash and Cash Equivalents.Cash and cash equivalents increased $7.8 million, or 125.4%, from $6.2 million at December 31, 2013 to $14.0 million at December 31, 2014 as excess deposits and proceeds from the maturities of investments in interest-earning time deposits, not used to fund loans, were invested in liquid money market accounts.

Investment in Interest-Earning Time Deposits.  Investment in interest-earning time deposits decreased $973,000, or 12.7%, from $7.6 million at December 31, 2013 to $6.7 million at December 31, 2014 primarily due to the maturity and redemption of time deposits.  The Company used these funds to fund loans.  At December 31, 2014, $2.3 million of interest-earning time deposits are scheduled to mature in one year or less.

Loans Held for Sale.  Loans held for sale increased $1.5 million to $2.6 million at December 31, 2014 from $1.1 million at December 31, 2013 as the Bank's mortgage banking subsidiary, Quaint Oak Mortgage, LLC, originated $53.3 million of one-to-four family residential loans during the year ended December 31, 2014 and sold $51.8 million of loans in the secondary market during this same period.

Loans Receivable, Net.  Loans receivable, net, increased $16.4 million, or 15.4%, to $123.3 million at December 31, 2014 from $106.9 million December 31, 2013.  This increase was funded primarily by deposits.  Increases within the portfolio occurred in commercial real estate loans which increased $9.7 million, or 37.4%, one-to-four family residential non-owner occupied loans which increased $5.1 million, or 11.6%, multi-family residential loans which increased $4.1 million, or 68.2%, home equity loans which increased $1.3 million, or 22.5%, and commercial business loans which increased $563,000, or 302.7%.  These increases were partially offset by decreases of $1.8 million, or 20.4%, in residential mortgage one-to-four family owner occupied loans, $1.7 million, or 10.8%, in construction loans, and $257,000, or 13.7%, in commercial lines of credit.  The Company continues its strategy of diversifying its loan portfolio with higher yielding and shorter-term loan products and selling substantially all of its newly originated one-to-four family owner-occupied loans into the secondary market.

Bank-Owned Life Insurance.  In the second quarter of 2014 the Company purchased $3.5 million in bank-owned life insurance (BOLI) as a mechanism for funding various employee benefit costs.  The Company is the beneficiary of these policies that insure the lives of certain officers of its subsidiaries.

Premises and Equipment, Net.  Premises and equipment, net, increased $2,000, or 0.1%, to $1.639 million at December 31, 2014 from $1.637 million at December 31, 2013.

Other Real Estate Owned, Net. Other real estate owned (OREO) amounted to $111,000 at December 31, 2014, consisting of one property.  This compares to six properties that totaled $574,000 at December 31, 2013.  During the year ended December 31, 2014, the Company transferred one property in the amount of $111,000 to OREO, made $28,000 of capital improvements to the properties, and sold six properties totaling $602,000.

Deposits. Total interest-bearing deposits increased $20.4 million, or 19.8%, to $123.8 million at December 31, 2014 from $103.3 million at December 31, 2013.  This increase in interest-bearing deposits was primarily attributable to increases of $16.1 million in certificates of deposit, $4.3 million in eSavings accounts, and $159,000 in statement savings accounts, partially offset by an $82,000 decrease in passbook accounts.  Total non-interest bearing checking accounts amounted to $640,000 at December 31, 2014 compared to none at December 31, 2013, as the Company introduced business and consumer checking products in December 2014.

 

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Federal Home Loan Bank Borrowings. Total Federal Home Loan Bank borrowings increased $6.0 million, or 109.1%, to $11.5 million at December 31, 2014 from $5.5 million at December 31, 2013.  During the year ended December 31, 2014, the Company borrowed $6.0 million in overnight funding to fund loan demand and made no repayments.  In the third quarter of 2014 the Company converted $4.5 million of the $11.5 million of overnight funds into term loans with maturities between two and five years to take advantage of current FHLB borrowing rates.

Stockholders' Equity.  Total stockholders' equity increased $589,000, or 3.5% to $17.6 million at December 31, 2014 from $17.0 million at December 31, 2013.  Contributing to the increase was net income for the year ended December 31, 2014 of $1.2 million, common stock earned by participants in the employee stock ownership plan of $140,000, amortization of stock awards and options under our stock compensation plans of $132,000, and the issuance of stock under the Bank's 401(k) Plan of $64,000.  These increases were partially offset by the purchase of 45,025 shares of the Company's stock as part of the Company's stock repurchase program for an aggregate purchase price of $760,000, dividends paid of $211,000, and an increase in other comprehensive loss of $18,000.

Comparison of Operating Results for the Years Ended December 31, 2014 and 2013

General. Net income amounted to $1.2 million for the year ended December 31, 2014 compared to $702,000 for the year ended December 31, 2013.  The $540,000, or 76.9% increase was primarily the result of an increase in net interest income of $953,000 and an increase in non-interest income of $506,000, partially offset by increases in non-interest expense of $488,000, the provision for income taxes of $277,000, and the provision for loan losses of $154,000.

Net Interest Income.  Net interest income increased $953,000, or 20.7%, to $5.6 million for the year ended December 31, 2014 from $4.6 million for the year ended December 31, 2013.  The increase was driven by a $991,000, or 15.8% increase in interest income, partially offset by a $38,000, or 2.3% increase in interest expense.

Interest Income.  Interest income increased $991,000, or 15.8%, to $7.3 million for the year ended December 31, 2014 from $6.3 million for the year ended December 31, 2013.  The increase in interest income was primarily due to a $22.3 million increase in average loans receivable, net, including loans held for sale, which increased from an average balance of $96.4 million for the year ended December 31, 2013 to an average balance of $118.7 million for the year ended December 31, 2014, and had the effect of increasing interest income $1.3 million.  Offsetting this increase was a 29 basis point decline in the yield on loans receivable, net, including loans held for sale, from 6.27% for the year ended December 31, 2013 to 5.98% for the year ended December 31, 2014, which had the effect of decreasing interest income by $337,000.

 

 

 

 

 

 

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Quaint Oak Bancorp, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

 

		Year Ended December 31,
		2014												2013
		Average Balance				Interest				Average Yield/ Rate				Average Balance				Interest				Average Yield/ Rate
Interest-earning assets:		(Dollars in thousands)
Short-term investments and investment securities available for sale		$	14,233			$	183				1.29	%		$	20,242			$	252				1.24	%
Loans receivable, net (1)(2)(3)			118,656				7,098				5.98				96,358				6,038				6.27
Total interest-earning assets			132,889				7,281				5.48	%			116,600				6,290				5.39	%
Non-interest-earning assets			7,584												5,587
Total assets		$	140,473											$	122,187
Interest-bearing liabilities:
Passbook accounts		$	2,719				4				0.15	%		$	2,783				5				0.18	%
Statement savings accounts			5,721				21				0.37				5,512				21				0.38
eSavings accounts			16,027				119				0.74				13,547				103				0.76
Certificate of deposit accounts			88,518				1,534				1.73				80,901				1,511				1.87
Total deposits			112,985				1,678				1.49				102,743				1,640				1.60
FHLB borrowings			9,073				42				0.46				1,486				42				2.83
Total interest-bearing liabilities			122,058				1,720				1.41	%			104,229				1,682				1.61	%
Non-interest-bearing liabilities			1,429												1,043
Total liabilities			123,487												105,272
Stockholders' Equity			16,986												16,915
Total liabilities and Stockholders' Equity		$	140,473											$	122,187
Net interest-earning assets		$	10,831											$	12,371
Net interest income; average interest rate spread						$	5,561				4.07	%						$	4,608				3.78	%
Net interest margin (4)											4.18	%											3.95	%
Average interest-earning assets to average interest-bearing liabilities											108.87	%											111.87	%

 

 

 

 

 

 

 

 

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Quaint Oak Bancorp, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

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(1)	Includes loans held for sale.

(2)	Includes non-accrual loans during the respective periods.  Calculated net of deferred fees and discounts, loans in process and allowance for loan losses.

Non-performing loans amounted to $2.8 million, or 2.30% of net loans receivable at December 31, 2014, consisting of twenty-two loans, sixteen of which are on non-accrual status and six of which are 90 days or more past due and accruing interest. Comparably, non-performing loans amounted to $1.9 million, or 1.79% of net loans receivable at December 31, 2013, consisting of seventeen loans, ten of which were on non-accrual status and seven of which were 90 days or more past due and accruing interest.  The non-performing loans at December 31, 2014 include thirteen one-to-four family non-owner occupied residential loans, five commercial real estate loans, two one-to-four family owner-occupied residential loans, one multi-family residential loan, and one home equity loan, and all are generally well-collateralized or adequately reserved for.  During the quarter ended December 31, 2014, three loans were placed on non-accrual status resulting in the reversal of approximately $13,000 of previously accrued interest income, and one loan that was on non-accrual in the amount of $303,000 was paid-off via a short- sale that resulted in a write-off of approximately $58,000.  At December 31, 2014, the Company had eleven loans totaling $951,000 that were identified as troubled debt restructurings. Two of these loans totaling $155,000 were on non-accrual, three loans totaling $215,000 were 30 days delinquent, and six loans totaling $581,000 were performing in accordance with their modified terms.  The allowance for loan losses as a percent of total loans receivable was 0.92% at December 31, 2014 and 0.87% at December 31, 2013.

 

 

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Quaint Oak Bancorp, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Other real estate owned (OREO) amounted to $111,000 at December 31, 2014, consisting of one property.  This compares to six properties that totaled $574,000 at December 31, 2013.  During the quarter ended December 31, 2014, the Company sold one property totaling $98,000, and realized a loss of $22,000 on the sale. For the year ended December 31, 2014, the Company transferred one property into OREO totaling $111,000.  There was no charge-off through the allowance for loan losses in conjunction with this transfer. For the year ended December 31, 2014, the Company made $28,000 of capital improvements to the properties, and sold six properties totaling $602,000 at an aggregate loss of $63,000.  Non-performing assets amounted to $2.9 million, or 1.89% of total assets at December 31, 2014 compared to $2.5 million, or 1.95% of total assets at December 31, 2013.

Non-Interest Income.  Non-interest income increased $506,000, or 33.8%, from $1.5 million for the year ended December 31, 2013 to $2.0 million for the year ended December 31, 2014.  The increase was primarily attributable to a $610,000 increase in net gains on the sales of loans, a $164,000 increase in the gain on the sale of SBA loans, a $49,000 increase in income from bank-owned life insurance, and a $4,000 increase in other income.  These increases were partially offset by a $140,000 decrease in fee income generated by Quaint Oak Bank's mortgage banking and title abstract subsidiaries, an $88,000 decrease in the gain on the sale of investment securities, a $53,000 decrease in other fees and service charges, and a $40,000 increase in the loss on sale of other real estate owned.

Non-Interest Expense.  Non-interest expense increased $488,000, or 10.3%, from $4.7 million for the year ended December 31, 2013 to $5.2 million for the year ended December 31, 2014.  Salaries and employee benefits expense accounted for $510,000 of the change as this expense increased 17.5%, from $2.9 million for the year ended December 31, 2013 to $3.4 million for the year ended December 31, 2014 due primarily to increased staff as the Company continues to expand its mortgage banking and lending operations.  Other expense accounted for $114,000 of the change as this expense increased 28.5%, from $400,000 for the year-ended December 31, 2013 to $514,000 for the year ended December 31, 2014 due primarily to an increase in charitable contributions and loan collection expenses other than legal fees which are included in professional fees.  Occupancy and equipment expense accounted for $57,000 of the change as this expense increased 11.8%, from $485,000 for the year ended December 31, 2013 to $542,000 for the year ended December 31, 2014.  The increase in occupancy and equipment expense was primarily attributable to computer system upgrades.  FDIC deposit insurance assessment accounted for $24,000 of the change as this expense increased 31.2%, from $77,000 for the year ended December 31, 2013 to $101,000 for the year ended December 31, 2014.    The increase in FDIC deposit insurance assessment was primarily attributable to a refund of unused prepaid assessment credits during the quarter ended June 30, 2013.   Offsetting these increases was a decrease in professional fees which declined $163,000, or 31.1%, from $524,000 for the year ended December 31, 2013 to $361,000 for the year ended December 31, 2014, due primarily to a reduction in legal fees related to loan collections. Also offsetting the increases in non-interest expense was a decrease in other real estate owned expense which declined $32,000, or 69.6%, from $46,000 for the year ended December 31, 2013 to $14,000 for the year ended December 31, 2014, a decrease in directors' fees and expenses which declined $17,000, or 7.7%, from $222,000 for the year ended December 31, 2013 to $205,000 for the year ended December 31, 2014, and a decrease in advertising expenses which declined $5,000, or 6.3% from $80,000 for the year ended December 31, 2013 to $75,000 for the year ended December 31, 2014.  The decrease in other real estate owned expense was due primarily to a reduction in OREO properties during 2014 and more efficient management of the properties, while the decline in directors' fees and expenses was due primarily to a reduction in the number of committee meetings.

Provision for Income Tax. The provision for income tax increased $277,000, or 66.4%,  from $417,000 for the year ended December 31, 2013 to $694,000 for the year ended December 31, 2014 due primarily to the increase in pre-tax income as our effective tax rate remained relatively consistent at 35.8% for the 2014 fiscal year compared to 37.3% for the 2013 fiscal year..

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Quaint Oak Bancorp, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Exposure to Changes in Interest Rates

The Company's ability to maintain net interest income depends upon its ability to earn a higher yield on assets than the rates it pays on deposits and borrowings.  The Company's interest-earning assets consist primarily of loans collateralized by real estate which have longer maturities than our liabilities, consisting primarily of certificates of deposit, eSavings accounts and to a lesser extent borrowings.  Consequently, the Company's ability to maintain a positive spread between the interest earned on assets and the interest paid on deposits and borrowings can be adversely affected when market rates of interest rise.  At December 31, 2014 and 2013, certificates of deposit amounted to $96.3 million and $80.2 million, respectively, or 61.9% and 63.0%, respectively, of total assets at such dates.

Gap Analysis.  The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring a bank's interest rate sensitivity "gap."  An asset and liability is said to be interest rate sensitive within a specific time period if it will mature or reprice within that time period.  The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time period and the amount of interest-bearing liabilities maturing or repricing within that same time period.  A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities.  A gap is considered negative when the amount of interest rate sensitive liabilities exceeds the amount of interest rate sensitive assets.  During a period of rising interest rates, a negative gap would tend to adversely affect net interest income while a positive gap would tend to result in an increase in net interest income.  Conversely, during a period of falling interest rates, a negative gap would tend to result in an increase in net interest income while a positive gap would tend to affect adversely net interest income.  Our current interest rate risk management policy provides that our one-year interest rate gap as a percentage of total assets should not exceed positive or negative 20%.  This policy was adopted by our management and Board of Directors based upon their judgment that it established an appropriate benchmark for the level of interest-rate risk, expressed in terms of the one-year gap, for the Company.  If our one-year gap position approaches or exceeds the 20% policy limit, management will obtain simulation results in order to determine what steps might appropriately be taken, in order to maintain our one-year gap in accordance with the policy.  Alternatively, depending on the then-current economic scenario, we could determine to make an exception to our policy or we could determine to revise our policy.  Our one-year cumulative gap was a positive 14.0% at December 31, 2014, compared to 18.5% at December 31, 2013.

The following table sets forth the amounts of our interest-earning assets and interest-bearing liabilities outstanding at December 31, 2014, which we expect, based upon certain assumptions, to reprice or mature in each of the future time periods shown. Except as stated below, the amount of assets and liabilities shown which reprice or mature during a particular period were determined in accordance with the earlier of term to repricing or the contractual maturity of the asset or liability.  The table sets forth an approximation of the projected repricing of assets and liabilities at December 31, 2014, on the basis of contractual maturities, anticipated prepayments, and scheduled rate adjustments within a three-month period and subsequent selected time intervals.  The loan amounts in the table reflect principal balances expected to be redeployed and/or repriced as a result of contractual amortization and anticipated prepayments of adjustable-rate loans and fixed-rate loans, and as a result of contractual rate adjustments on adjustable-rate loans.  The Company's annual historical prepayment rates are applied to loans.  Statement and eSavings accounts and other passbook accounts are assumed to have annual rates of withdrawal, or "decay rates," of 40% and 20%, respectively.

11

Quaint Oak Bancorp, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

_____________________

(1)	Interest-earning assets are included in the period in which the balances are expected to be redeployed and/or repriced as a result of anticipated prepayments, scheduled rate adjustments and contractual maturities.

(2)	For purposes of the gap analysis, loans receivable includes non-performing loans gross of the allowance for loan losses and deferred loan fees.

(3)	Interest-rate sensitivity gap represents the difference between net interest-earning assets and interest-bearing liabilities.

Liquidity and Capital Resources

The Company's primary sources of funds are deposits, amortization and prepayment of loans and to a lesser extent, loan sales and other funds provided from operations.  While scheduled principal and interest payments on loans are a relatively predictable source of funds, deposit flows and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.  The Company sets the interest rates on its deposits to maintain a desired level of total deposits.  In addition, the Company invests excess funds in short-term interest-earning assets that provide additional liquidity.  At December 31, 2014, the Company's cash and cash equivalents amounted to $13.9 million.  At such date, the Company also had $2.3 million invested in interest-earning time deposits maturing in one year or less.

The Company uses its liquidity to fund existing and future loan commitments, to fund deposit outflows, to invest in other interest-earning assets and to meet operating expenses.  At December 31, 2014, Quaint Oak Bank had outstanding commitments to originate loans of $7.8 million and commitments under unused lines of credit of $21.4 million.

12

Quaint Oak Bancorp, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

At December 31, 2014, certificates of deposit scheduled to mature in less than one year totaled $27.3 million.  Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case.

In addition to cash flow from loan payments and prepayments and deposits, the Company has significant borrowing capacity available to fund liquidity needs.  If the Company requires funds beyond its ability to generate them internally, borrowing agreements exist with the Federal Home Loan Bank of Pittsburgh, which provide an additional source of funds.  As of December 31, 2014, we had $11.5 million of borrowings from the Federal Home Loan Bank of Pittsburgh and had $61.4 million in borrowing capacity.  In addition, as of December 31, 2014 Quaint Oak Bank had $1.0 million in borrowing capacity with the Federal Reserve Bank of Philadelphia.  There were no borrowings under this facility at December 31, 2014.  Quaint Oak Bank currently has two additional line of credit commitments with two different banks totaling $1.5 million.  There were no borrowings under these lines of credit at December 31, 2014.

Our stockholders' equity amounted to $17.6 million at December 31, 2014, an increase of $589,000, or 3.5% from $17.0 million at December 31, 2013. Contributing to the increase was net income for the year ended December 31, 2014 of $1.2 million, common stock earned by participants in the employee stock ownership plan of $140,000, amortization of stock awards and options under our stock compensation plans of $132,000, and the issuance of stock under the Bank's 401(k) Plan of $64,000.  These increases were partially offset by the purchase of 45,025 shares of the Company's stock as part of the Company's stock repurchase program for an aggregate purchase price of $760,000, dividends paid of $211,000, and an increase in other comprehensive loss of $18,000.   For further discussion of the stock compensation plans, see Note 12 in the Notes to Consolidated Financial Statements contained elsewhere herein.

Quaint Oak Bank is required to maintain regulatory capital sufficient to meet tier 1 leverage, tier 1 risk-based and total risk-based capital ratios of at least 4.00%, 4.00% and 8.00%, respectively.  At December 31, 2014, Quaint Oak Bank exceeded each of its capital requirements with ratios of 10.74%, 15.38% and 16.50%, respectively. As a savings and loan holding company, the Company is not currently subject to any regulatory capital requirements.  For further discussion of the Bank's regulatory capital requirements, see Note 15 in the Notes to Consolidated Financial Statements contained elsewhere herein.

Off-Balance Sheet Arrangements

Commitments.  At December 31, 201 4, we had unfunded commitments under lines of credit of $21.4 million and $7.8 million of commitments to originate loans.  We had no commitments to advance additional amounts pursuant to outstanding lines of credit or undisbursed construction loans.

13

Quaint Oak Bancorp, Inc.

Management's Discussion and Analysis of Financial Condition and Results of Operations

 

Contractual Cash Obligations

The following table summarizes our contractual cash obligations at December 31, 2014.  The balances in the table do not reflect interest due on these obligations.

Impact of Inflation and Changing Prices

The consolidated financial statements and related financial data presented herein have been prepared in accordance with accounting principles generally accepted in the United States of America which generally require the measurement of financial position and operating results in terms of historical dollars, without considering changes in relative purchasing power over time due to inflation. Unlike most industrial companies, virtually all of the Company's assets and liabilities are monetary in nature.  As a result, interest rates generally have a more significant impact on the Company's performance than does the effect of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates.

14

Quaint Oak Bancorp, Inc.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

S.R. Snodgrass, P.C. * 2100 Corporate Drive, Suite 400 * Wexford, Pennsylvania 15090-8399 * Phone: (724) 934-0344 * Facsimile: (724) 934-0345

 

 

15

Quaint Oak Bancorp, Inc.

 

Consolidated Balance Sheets

16

Quaint Oak Bancorp, Inc.

 

 

 

17

Quaint Oak Bancorp, Inc.

 

Consolidated Statements of Comprehensive Income

18

Quaint Oak Bancorp, Inc.

 

 

																		Unallocated
		Common Stock																Common				Accumulated
		Number of								Additional								Stock Held				Other								Total
		Shares								Paid-in				Treasury				by Benefit				Comprehensive				Retained				Stockholders'
		Outstanding				Amounts				Capital				Stock				Plans				Income (Loss)				Earnings				Equity
													(In thousands, except shares data)
BALANCE – DECEMBER 31, 2012			983,821			$	14			$	13,559			$	(3,716	)		$	(823	)		$	60			$	7,743			$	16,837
Common stock allocated by ESOP											58								87												145
Treasury stock purchased			(35,972	)											(563	)															(563	)
Stock based compensation expense											128																				128
Release of 8,544 vested RRP shares											(80	)							80												--
Cash dividends declared     ($0.19  per share)																											(185	)			(185	)
Net income																											702				702
Other comprehensive loss,  net																							(78	)							(78	)
BALANCE – DECEMBER 31, 2013			947,849			$	14			$	13,665			$	(4,279	)		$	(656	)		$	(18	)		$	8,260			$	16,986
Common stock allocated by ESOP											59								81												140
Treasury stock purchased			(45,025	)											(760	)															(760	)
Reissuance of treasury stock under    Stock Incentive Plan			2,738								(28	)			28																-
Reissuance of treasury stock under 401(k)  Plan			3,723								26				38																64
Stock based compensation expense											132																				132
Release of 2,779 vested RRP shares											(26	)							26												-
Cash dividends declared    ($0.23 per share)																											(211	)			(211	)
Net income																											1,242				1,242
Other comprehensive loss,  net																							(18	)							(18	)
BALANCE – DECEMBER 31, 2014			909,285			$	14			$	13,828			$	(4,973	)		$	(549	)		$	(36	)		$	9,291			$	17,575

 

 

See accompanying notes to consolidated financial statements.

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Quaint Oak Bancorp, Inc.

 

 

Consolidated Statements of Cash Flows

		Years Ended December 31,
		2014				2013
Cash Flows from Operating Activities		(In Thousands)
Net income		$	1,242			$	702
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses			394				240
Depreciation expense			167				142
Net accretion of securities discounts			--				(4	)
Accretion of deferred loan fees and costs, net			(273	)			(155	)
Deferred income taxes			(164	)			(71	)
Stock-based compensation expense			272				273
Gain on the sales of investment securities			--				(88	)
Net gain on the sale of loans			(1,442	)			(832	)
Gain on the sale of SBA loans			(164	)			--
Net loss on sale of other real estate owned			63				23
Increase in the cash surrender value of bank-owned life insurance			(49	)			--
Changes in assets and liabilities which provided (used) cash:
Loans held for sale-originations			(53,261	)			(43,870	)
Loans held for sale-proceeds			53,245				48,479
Accrued interest receivable			(53	)			(78	)
Prepaid expenses and other assets			(89	)			346
Accrued interest payable			31				(4	)
Accrued expenses and other liabilities			147				(112	)
Net Cash Provided by Operating Activities			66				4,991
Cash Flows from Investing Activities
Net decrease in investment in interest-earning time deposits			973				499
Purchase of investment securities available for sale			(52	)			(53	)
Proceeds from calls of investment securities available for sale			--				500
Proceeds from the sale of securities available for sale			--				1,839
Net increase in loans receivable			(16,512	)			(23,152	)
Net (increase) decrease in investment in Federal Home Loan Bank stock			(106	)			16
Purchase of bank-owned life insurance			(3,500	)			--
Proceeds from the sale of other real estate owned			539				92
Capitalized expenditures on other real estate owned			(28	)			(48	)
Purchase of premises and equipment			(169	)			(171	)
Net Cash Used in Investing Activities			(18,855	)			(20,478	)
Cash Flows from Financing Activities
Net increase in demand deposits and savings accounts			4,982				3,752
Net increase in certificate accounts			16,099				2,534
Repayment of  Federal Home Loan Bank borrowings			(4,500	)			(2,000	)
Proceeds from Federal Home Loan Bank borrowings			10,500				5,500
Dividends paid			(211	)			(185	)
Purchase of treasury stock			(760	)			(563	)
Proceeds from the reissuance of treasury stock			64				--
Increase in advances from borrowers for taxes and insurance			368				233
Net Cash Provided by Financing Activities			26,542				9,271
Net Increase (Decrease)  in Cash and Cash Equivalents			7,753				(6,216	)
Cash and Cash Equivalents – Beginning of Year			6,184				12,400
Cash and Cash Equivalents – End of Year		$	13,937			$	6,184
Supplementary Disclosure of Cash Flow and Non-Cash Information:
Cash payments for interest		$	1,689				1,686
Cash payments for income taxes		$	855				295
Transfer of loans to other real estate owned		$	111				471

20

 

Notes to Consolidated Financial Statements

Note 1 - Nature of Operations

On July 3, 2007, Quaint Oak Savings Bank completed its conversion from a Pennsylvania chartered mutual savings bank to a Pennsylvania chartered stock savings bank and changed its name to Quaint Oak Bank ("Bank").  In connection with the conversion, Quaint Oak Bank formed Quaint Oak Bancorp, Inc., a Pennsylvania chartered corporation (the "Company" or "Quaint Oak Bancorp"), which offered and sold 1,388,625 shares of its common stock at a price of $10.00 per share to eligible depositors of the Bank.  Upon completion of the conversion and the offering, all of Quaint Oak Bank's common stock is owned by Quaint Oak Bancorp, and all of Quaint Oak Bancorp's common stock is, in turn, owned by the public.  The Company sold 1,388,625 shares of its common stock, raising $13,886,250 of gross proceeds.  Costs incurred in connection with the conversion and offering totaled $535,000 and were recorded as a reduction of the proceeds from the offering.  The Company invested approximately $7.1 million or 53.0% of the net proceeds in Quaint Oak Bank.  All remaining proceeds were retained by Quaint Oak Bancorp for future capital needs.  The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, Quaint Oak Bank along with its wholly owned subsidiaries.  At December 31, 2014, the Bank has five wholly-owned subsidiaries, Quaint Oak Mortgage, LLC, Quaint Oak Real Estate, LLC, Quaint Oak Abstract, LLC, QOB Properties, LLC, and Quaint Oak Insurance Agency, LLC, each a Pennsylvania limited liability company.  The mortgage, real estate and abstract companies offer mortgage banking, real estate sales and title abstract services, respectively, in the Lehigh Valley region of Pennsylvania, and began operation in July 2009.  QOB Properties, LLC began operations in July 2012 and holds Bank properties acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure.  The insurance agency is currently inactive.  All significant intercompany balances and transactions have been eliminated.

The Bank is subject to regulation by the Pennsylvania Department of Banking and Securities and the Federal Deposit Insurance Corporation.  Pursuant to the Bank's election under Section 10(l) of the Home Owners' Loan Act, the Company is a savings and loan holding company regulated by the Board of Governors of the Federal Reserve System.  The market area served by the Bank is principally Bucks County, Pennsylvania and to a lesser extent, Montgomery and Philadelphia Counties in Pennsylvania.  The Bank has two locations: the main office location in Southampton, Pennsylvania and a branch banking office in the Lehigh Valley area of Pennsylvania. The principal deposit products offered by the Bank are certificates of deposit, passbook savings accounts, statement savings accounts and eSavings accounts.  In December 2014 the Bank introduced non-interest bearing checking accounts for businesses and consumers. The principal loan products offered by the Bank are fixed and adjustable rate residential and commercial mortgages, construction loans, home equity loans, lines of credit, and commercial business loans.

Note 2 - Summary of Significant Accounting Policies

Use of Estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period.  Actual results could differ from those estimates.  The Company's most significant estimates are the determination of the allowance for loan losses, the assessment of other than temporarily impaired securities and valuation of deferred tax assets.

21

 

Notes to Consolidated Financial Statements (Continued)

Note 2 - Summary of Significant Accounting Policies (Continued)

Significant Group Concentrations of Credit Risk

The Bank has a significant concentration of loans in Philadelphia County, Pennsylvania.  The concentration of credit by type of loan is set forth in Note 7.  Although the Bank has a diversified loan portfolio, its debtors' ability to honor their contracts is influenced by the region's economy. During the year ended December 31, 2014, one investor purchased a total of 68% of all loans sold by the Bank from its mortgage loans held for sale, and the sales to this investor accounted for approximately 69% of the gain on loans sold during the year.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include non-interest and interest-earning demand deposits and money market accounts with various financial institutions, all of which mature within ninety days of acquisition.

Investment Securities

Management determines the appropriate classification of debt securities at the time of purchase and reevaluates such designation as of each balance sheet date.

Securities classified as available for sale are those securities that the Company intends to hold for an indefinite period of time but not necessarily to maturity.  Any decision to sell a security classified as available for sale would be based on various factors, including significant movement in interest rates, changes in maturity mix of the Company's assets and liabilities, liquidity needs, regulatory capital requirements, and other similar factors.  Securities available for sale are carried at fair value.  Unrealized gains and losses are reported in other comprehensive income, net of related deferred tax effects.  Realized gains and losses, determined on the basis of the cost of the specific securities sold, are included in earnings.  Premiums and discounts are recognized in interest income using the interest method over the terms of the securities.

Securities classified as held to maturity are those debt securities the Company has both the intent and ability to hold to maturity regardless of the changes in market conditions, liquidity needs, or changes in general economic conditions.  These securities are carried at cost adjusted for amortization of premium and accretion of discount, which are recognized in interest income using the interest method over the terms of the securities.

The Company follows the accounting guidance related to recognition and presentation of other-than-temporary impairment.  This accounting guidance amended the recognition guidance for other-than-temporary impairments of debt securities and expanded the financial statement disclosures for other-than-temporary impairment losses on debt and equity securities.  The recent guidance replaced the "intent and ability" indication in existing guidance by specifying that (a) if a company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss.  When an entity does not intend to sell the security, and it is more likely than not the entity will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income.  For held-to-maturity debt securities, the amount of an other-than-temporary impairment recorded in other comprehensive income for the noncredit portion of a previous other-than-temporary impairment should be amortized prospectively over the remaining life of the security on the basis of the timing of future estimated cash flows of the security.  The Company recognized no other-than-temporary impairment charges during the years ended December 31, 2014 and 2013.

 

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Notes to Consolidated Financial Statements (Continued)

Note 2 - Summary of Significant Accounting Policies (Continued)

Federal Home Loan Bank Stock

Federal law requires a member institution of the Federal Home Loan Bank (FHLB) system to hold restricted stock of its district Federal Home Loan Bank according to a predetermined formula.  FHLB stock is carried at cost and evaluated for impairment. When evaluating FHLB stock for impairment, its value is determined based on the ultimate recoverability of the par value of the stock. We evaluate our holdings of FHLB stock for impairment each reporting period. No impairment charges were recognized on FHLB stock during the years ended December 31, 2014 and 2013.

Loans Receivable

Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at their outstanding unpaid principal balances, net of an allowance for loan losses and any deferred fees.  Interest income is accrued on the unpaid principal balance.  Loan origination fees and costs are deferred and recognized as an adjustment of the yield (interest income) of the related loans.  The Bank is generally amortizing these amounts over the contractual life of the loan.

The loans receivable portfolio is segmented into residential loans, commercial real estate loans, construction loans, commercial business, and consumer loans.  The residential loan segment has two classes: one-to-four family residential owner occupied loans and one-to-four family residential non-owner occupied loans.  The commercial real estate loan segment consists of the following classes: multi-family (five or more) residential, commercial real estate and commercial lines of credit.  Construction loans are generally granted for the purpose of building a single residential home.  Commercial business loans are loans to businesses primarily for purchase of business essential equipment. Business essential equipment is equipment necessary for a business to support or assist with the day-to-day operation or profitability of the business.  The consumer loan segment consists of the following classes: home equity loans and other consumer loans.  Included in the home equity class are home equity loans and home equity lines of credit.  Included in the other consumer are loans secured by saving accounts and auto loans.

The accrual of interest is generally discontinued when principal or interest has become 90 days past due unless the loan is in the process of collection and is either guaranteed or well secured.  When a loan is placed on nonaccrual status, unpaid interest credited to income in the current year is reversed and unpaid interest accrued in prior years is charged against the allowance for loan losses.  Interest received on nonaccrual loans generally is either applied against principal or reported as interest income, according to management's judgment as to the collectability of principal.  Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time and the ultimate collectability of the total contractual principal and interest is no longer in doubt.

Allowance for Loan Losses

The allowance for loan losses represents management's estimate of losses inherent in the loan portfolio as of the balance sheet date and is recorded as a reduction to loans. The allowance for loan losses is increased by the provision for loan losses, and decreased by charge-offs, net of recoveries. Loans deemed to be uncollectible are charged against the allowance for loan losses, and subsequent recoveries, if any, are credited to the allowance. All, or part, of the principal balance of loans receivable are charged off to the allowance as soon as it is determined that the repayment of all, or part, of the principal balance is highly unlikely. Because all identified losses are immediately charged off, no portion of the allowance for loan losses is restricted to any individual loan or groups of loans, and the entire allowance is available to absorb any and all loan losses.

 

 

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25

 

Notes to Consolidated Financial Statements (Continued)

Note 2 - Summary of Significant Accounting Policies (Continued)

Premises and Equipment

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the expected useful lives of the related assets that range from three to thirty-nine years.  The costs of maintenance and repairs are expensed as incurred.  Costs of major additions and improvements are capitalized.

Other Real Estate Owned

Other real estate owned or foreclosed assets are comprised of property acquired through a foreclosure proceeding or acceptance of a deed in lieu of foreclosure and loans classified as in-substance foreclosures.  A loan is classified as in-substance foreclosure when the Bank has taken possession of the collateral regardless of whether formal foreclosure proceedings take place.  Other real estate properties are initially recorded at fair value, net of estimated selling costs at the date of foreclosure, establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of cost or fair value less estimated costs to sell.  Net revenue and expenses from operations and additions to the valuation allowance are included in other expenses.

Advertising Costs

The Company expenses all advertising costs as incurred. Advertising costs are included in non-interest expense on the Consolidated Statements of Income.

Transfers of Financial Assets

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

Income Taxes

Deferred income taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences and deferred tax liabilities are recognized for taxable temporary differences.  Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

The Company follows guidance related to accounting for uncertainty in income taxes, which sets out a consistent framework to determine the appropriate level of tax reserves to maintain for uncertain tax positions.  A tax position is recognized as a benefit only if it is more likely than not that the tax position would be sustained in a tax examination, with a tax examination presumed to occur.  The amount recognized is the largest amount of tax benefit that has more than 50 percent likelihood of being realized upon examination.  For tax positions not meeting the more likely than not test, no tax benefit is recorded.  The Company had no material uncertain tax positions or accrued interest and penalties as of December 31, 2014 and 2013.  The Company's policy is to account for interest as a component of interest expense and penalties as components of other expense.  The Company is no longer subject to examination by taxing authorities for the years before January 1, 2011.

26

 

Notes to Consolidated Financial Statements (Continued)

Note 2 - Summary of Significant Accounting Policies (Continued)

Comprehensive Income (Loss)

Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains and losses be included in net income.  Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the stockholders' equity section of the balance sheet, such items, along with net income, are components of comprehensive income (loss).

Treasury Stock and Unallocated Common Stock

The acquisition of treasury stock by the Company, including unallocated stock held by certain benefit plans, is recorded under the cost method.  At the date of subsequent reissue, treasury stock is reduced by the cost of such stock on a first-in, first-out basis with any excess proceeds credited to additional paid-in capital.

Share-Based Compensation

Stock compensation accounting guidance (FASB ASC 718, Compensation-Stock Compensation) requires that the compensation cost relating to share-based payment transactions be recognized in financial statements.  That cost is measured based on the grant date fair value of the equity or liability instruments issued.  The stock compensation accounting guidance covers a wide range of share-based compensation arrangements including stock option and restricted share plans.

The stock compensation accounting guidance requires that compensation cost for all stock awards be calculated and recognized over the employees' service period, generally defined as the vesting period.  For awards with graded-vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.  A Black-Scholes model is used to estimate the fair value of stock options, while the closing price of the Company's common stock on the grant date is used for restricted stock awards.

At December 31, 2014, the Company has three share-based plans: the 2008 Recognition and Retention Plan ("RRP"), the 2008 Stock Option Plan, and the 2013 Stock Incentive Plan.  Awards under these plans were made in May 2008 and 2013.  These plans are more fully described in Note 12.

The Company also has an employee stock ownership plan ("ESOP").  This plan is more fully described in Note 12.  As ESOP shares are committed to be released and allocated among participants, the Company recognizes compensation expense equal to the average market price of the shares over the period earned.

Earnings Per Share

Amounts reported in earnings per share reflect earnings available to common stockholders for the period divided by the weighted average number of shares of common stock outstanding during the period, exclusive of unearned ESOP shares, unvested restricted stock (RRP) shares and treasury shares.  Stock options and unvested restricted stock are regarded as potential common stock and are considered in the diluted earnings per share calculations to the extent they would have a dilutive effect if converted to common stock, computed using the "treasury stock" method.

Off-Balance Sheet Financial Instruments

In the ordinary course of business, the Bank has entered into off-balance sheet financial instruments consisting of commitments to extend credit.  Such financial instruments are recorded in the consolidated balance sheet when they are funded.

27