ITEM 1. BUSINESS
HarborOne Bancorp, Inc.
HarborOne Bancorp, Inc. (hereafter referred to as “we”, “our”, “us”, “HarborOne Bancorp” or the “Company”) is a Massachusetts corporation that was formed in 2016 as part of the reorganization of HarborOne Bank (“HarborOne Bank” or the “Bank”) into a two-tier mutual holding company structure with a mid-tier stock holding company. The Company sold 14,454,396 shares of common stock at $10.00 per share, including 1,187,188 shares purchased by the Company’s Employee Stock Ownership Plan (“ESOP”). In addition, the Company issued 17,281,034 shares to HarborOne Mutual Bancshares, the Company’s mutual holding company parent (the “MHC”) and 385,450 shares to The HarborOne Foundation (the “Foundation”), a charitable foundation that was formed in connection with the stock offering and is dedicated to supporting charitable organizations operating in the Bank’s local community. A total of 32,120,880 shares of common stock were outstanding following the completion of the stock offering. At December 31, 2017 the Company had total assets of $2.68 billion, deposits of $2.01 billion and shareholders’ equity of $343.5 million on a consolidated basis. The Consolidated Financial Statements include the accounts of the Company, Legion Parkway Company LLC, a security corporation and subsidiary of the Company formed on July 13, 2016, the Bank and the Bank’s wholly-owned subsidiaries including Merrimack Mortgage Company, LLC (“Merrimack Mortgage” or “MMC”).
HarborOne Bancorp, Inc.’s corporate offices are located at 770 Oak Street, Brockton, Massachusetts 02301 and the telephone number is (508) 895-1000.
HarborOne Bank
HarborOne Bank is the largest state-chartered co-operative bank in New England. The Bank, originally established in 1917 as a state-chartered credit union, converted to a state-chartered co-operative bank on July 1, 2013. The Bank provides a variety of financial services to individuals and businesses online and through its fourteen full-service branches located in Abington, Attleboro, Bridgewater,
Brockton, Canton, Easton, Mansfield, Middleboro, Plymouth, Randolph and Raynham, Massachusetts and two limited-service bank offices in Brockton and Attleboro, Massachusetts, a commercial lending office in Providence, Rhode Island, and a loan office in Westford, Massachusetts. Acquired in 2015 and operated as a wholly owned subsidiary of the Bank, Merrimack Mortgage Company, LLC is a residential mortgage company headquartered in New Hampshire that maintains 34 offices in Massachusetts, New Hampshire and Maine, and is also licensed to lend in seven additional states.
We also provide a range of educational services through "HarborOne U," with classes on small business, financial literacy and personal enrichment at classroom sites adjacent to our Brockton and Mansfield locations.
Employees
As of December 31, 2017, the Company had 581 full time equivalent employees. None of the Company’s employees are represented by a labor union and management considers its relationship with employees to be good.
Available Information
Under Section 13(a) or 15(d) of the Exchange Act of 1934, as amended (the “Exchange Act”) HarborOne Bancorp, Inc. is required to file reports, proxy and information statements and other information with the Securities and Exchange Commission (“SEC”). The Company electronically files its annual report on Form 10-K, proxy, quarterly reports on Form 10-Q, and current reports on Form 8-K and other reports as required with the SEC. The SEC website www.sec.gov provides access to all forms which have been filed electronically. Additionally, the Company’s SEC filings and additional shareholder information are available free of charge on the Company’s website, www.harborone.com (within the Investor Relations section). Information on our website is not and should not be considered part of this annual report.
The Company’s common stock is traded on the NASDAQ stock market under the symbol “HONE”.
Market Area and Competition
The Company provides financial services to individuals, families, small to middle-market businesses and municipalities throughout Southeastern New England. While our primary deposit-gathering area is concentrated within our branch office communities located in the Massachusetts counties of Norfolk, Bristol and Plymouth, our lending area encompasses the broader market of Eastern Massachusetts, the greater Providence, Rhode Island metropolitan area and through our subsidiary Merrimack Mortgage, New Hampshire and southern Maine.
The Company faces significant competition both in attracting deposits and generating loans. Our primary competitors are savings banks, commercial and co-operative banks, credit unions, internet banks, as well as, other nonbank institutions that offer financial alternatives such as brokerage firms and insurance companies.
Our competition for loans comes from savings banks, commercial and co-operative banks, credit unions, internet banks and from other financial service providers, such as mortgage companies, mortgage brokers and the finance arms of auto makers. Competition for loans also comes from non-depository financial service companies entering the mortgage market, such as insurance companies, securities companies and specialty finance companies.
Many of the banks that operate in our primary market area are owned by large national and regional holding companies, are larger than we are and therefore may have greater resources or offer a broader range of products and services. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. Technological advances, for example, have lowered barriers to entry, allowed banks and other financial services companies to expand their geographic reach by providing services over the internet, and made it possible for non-depository institutions to offer products and services that traditionally have been provided by banks. Increased competition for deposits and the origination of loans could limit our growth in the future.
Lending Activities
The total gross loan portfolio amounted to $2.19 billion on December 31, 2017, or 81.8% of total assets. The portfolio consists of commercial loans, residential real estate loans, and consumer loans. Commercial loans consists of commercial real estate loans, commercial and industrial loans, commercial construction and small business loans. Residential real estate loans consists of residential mortgages, home equity lines of credit, second mortgages and construction loans that are secured primarily by owner-occupied
residences. Consumer loans are primarily auto loans and other personal loans. The Company also originates residential mortgages for sale, primarily through Merrimack Mortgage, as discussed further in Mortgage Banking Activity below.
Commercial Real Estate Loans. Our commercial real estate loans are generally secured by properties used for business purposes such as office buildings, retail development, manufacturing facilities, warehouse distribution, hospitality and apartment buildings. We currently focus our commercial real estate efforts on small- and mid-size owner occupants and investors in our market area seeking loans between $350,000 and $20 million. At December 31, 2017, commercial real estate loans were $655.4 million, or 30.0% of total loans, and consisted of $262.9 million of fixed-rate loans and $392.5 million of adjustable rate loans.
We originate fixed- and adjustable-rate commercial real estate loans typically with terms of five to ten years, though loans may be for terms of up to 20 years. Interest rates and payments on our adjustable-rate loans typically adjust in accordance with a designated index every three, five or seven years. Most of our adjustable-rate commercial real estate loans adjust every five years to a specified percentage above the corresponding FHLB Classic Advance borrowing rate and amortize over a 25-year term. We also offer interest rate swaps to accommodate customer needs. Loan amounts generally do not exceed 80.0% of the property's appraised value at the time the loan is originated.
We consider a number of factors when underwriting commercial real estate loans that include projected net cash flow to the loan’s debt service requirement, the age and condition of the collateral, the financial resources and income level of the sponsor and their experience in owning or managing similar properties. When circumstances warrant, personal guarantees are obtained from the principals of the borrower on commercial real estate. To monitor cash flows on income properties, we require borrowers and loan guarantors, where applicable, to provide annual financial statements on commercial real estate loans. In reaching a decision on whether to make a commercial real estate loan, we consider the net operating income of the property, the borrower’s expertise, credit history, profitability and the value of the underlying property. We generally require an independent appraisal or valuation, an environmental survey and a property condition report for commercial real estate loans.
In addition to originating these loans, we participate in commercial real estate loans with other financial institutions located primarily in Massachusetts and sell participation interests in commercial real estate loans to local financial institutions, primarily the portion of loans that exceed our borrowing limits or are in an amount that is considered prudent to manage our credit risk, see below Loan “Underwriting Risks - Loan Participations”.
At December 31, 2017, the average loan size of our outstanding commercial real estate loans was $3.3 million, and our four largest credits ranged from $15.0 million to $13.5 million. These loans were performing in accordance with their original terms at December 31, 2017. Our largest commercial real estate relationship totaled $28.4 million and financed medical and office buildings.
Commercial Loans. We originate commercial loans and lines of credit to a variety of professionals, sole proprietorships and small- to medium-sized businesses, primarily in Massachusetts and Rhode Island, with sales up to $50 million and borrowing needs up to $10 million, for working capital and other business purposes. At December 31, 2017, commercial loans were $109.5 million, or 5.0% of total loans and consisted of $35.2 million of fixed-rate loans and $74.3 million of adjustable rate loans.
Commercial loans are made with either variable or fixed rates of interest. Variable rates are based on a margin over the LIBOR index or the Prime rate as published in The Wall Street Journal, plus a margin. Fixed-rate business loans are generally indexed to a corresponding FHLB rate, plus a margin. Commercial loans typically have shorter maturity terms and higher interest spreads than real estate loans, but generally involve more credit risk because of the type and nature of the collateral. We generally require that our commercial customers maintain a deposit relationship with the Bank.
When making commercial loans, we consider the financial statements and the experience of the borrower, our lending history with the borrower, the debt service capabilities of the borrower, the projected cash flows of the business and the value of the collateral, primarily accounts receivable, inventory and equipment. Commercial loan amounts are determined based on the capacity for debt service and an evaluation of the age, condition and collectability of the collateral but generally, advance rates for certain asset classes would not exceed 80%.
At December 31, 2017, the average loan size of our outstanding commercial loans was $208,000 and our four largest commercial loan exposures ranged from $4.5 million to $5.5 million. These loans are secured by all business assets of the borrower and were performing according to their original terms at December 31, 2017.
Construction Loans. We originate commercial construction loans for commercial development projects, including industrial buildings, retail and office buildings and speculative residential real estate. We also originate residential real estate construction loans
to professional developers, contractors and builders, and to a lesser extent, individuals, to finance the construction of residential dwellings. At December 31, 2017, construction loan balances were $128.6 million, or 5.9% of total loans. Commercial construction balances were $116.7 million and homeowner construction balances were $11.9 million. At December 31, 2017, our commercial construction loan portfolio consisted of $5.1 million in loan balances that were secured by speculative residential real estate loan projects, $90.2 million in loans that were secured by commercial real estate speculative projects and $21.4 million secured by owner occupied commercial real estate projects. At December 31, 2017 unadvanced funds on total construction loans was $143.5 million, $137.3 million for commercial real estate construction and $6.2 million on residential real estate construction loans.
Our commercial construction loans generally call for the payment of interest only with interest rates tied to LIBOR or Prime rate as published in The Wall Street Journal, plus a margin. Construction loans for commercial real estate can be originated with principal balances of up to $20.0 million, but generally are lower; the average originated principal balance at December 31, 2017 was $5.7 million. Advances on commercial construction loans are made in accordance with a schedule reflecting the cost of construction and repayment is generally expected from permanent financing upon completion of construction.
Our residential real estate construction loans generally are fixed-rate loans that provide for the payment of interest only during the construction phase, which is usually 12 to 36 months. At the end of the construction phase, the loan may be paid in full or converted to a permanent mortgage loan. Before making a commitment to fund a construction loan, we generally require an appraisal of the property by an independent licensed appraiser. Our loan policy dictates a minimum equity contribution by the borrower of 20.0% and loan-to-value ratio not greater than 80.0% of the appraised market value estimated upon completion of the project. All borrowers are underwritten and evaluated for creditworthiness based on past experience, debt service ability, net worth analysis including available liquidity, and other credit factors. Advances are only made following an inspection of the property confirming completion of the required progress on the project and an update to the title completed by a bank approved attorney.
At December 31, 2017, our largest outstanding commercial construction loan relationship was $17.0 million. This project is secured by a first mortgage to develop an apartment building and was performing according to its original repayment terms at December 31, 2017.
One- to Four-Family Residential Real Estate Loans. We provide residential real estate loans for home purchase or refinancing on existing homes, most of which serve as the primary residence of the owner. At December 31, 2017, residential mortgage loans were $677.8 million, or 31.0% of total loans, and consisted of $585.5 million and $92.4 million of fixed-rate and adjustable-rate loans, respectively. We offer fixed-rate and adjustable-rate residential mortgage loans with terms up to 30 years
Our one- to four-family residential mortgage originations are generally underwritten to conform to Federal National Mortgage Association, or "Fannie Mae," and Federal National Home Loan Mortgage Corporation, or "Freddie Mac," underwriting guidelines. Our adjustable-rate mortgage loans generally adjust annually or after an initial fixed period that ranges from three to seven years and are adjusted to a rate equal to a specified percentage above the LIBOR or U.S. Treasury index. Depending on the loan type, the maximum amount by which the interest rate may be increased or decreased is generally 2.0% per adjustment period with the lifetime interest rate caps ranging from 5.0% to 6.0% over the initial interest rate of the loan.
Borrower demand for adjustable-rate compared to fixed-rate loans is a function of the level of interest rates, the expectations of changes in the level of interest rates, and the difference between the interest rates and loan fees offered for fixed-rate mortgage loans as compared to the interest rates and loan fees for adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate mortgage loans that can be originated at any time is largely determined by the demand for each in a competitive environment. The loan fees, interest rates and other provisions of mortgage loans are determined by us on the basis of our own pricing criteria and competitive market conditions.
While residential mortgage loans are normally originated with up to 30-year terms, such loans typically remain outstanding for substantially shorter periods because borrowers often prepay their loans in full either upon sale of the property pledged as security or upon refinancing the original loan. Therefore, average loan maturity is a function of, among other factors, the level of purchase and sale activity in the real estate market, prevailing interest rates and the interest rates payable on outstanding loans.
We originate one- to four-family residential mortgage loans with loan-to-value ratios up to 80.0% and we generally require private mortgage insurance for residential loans secured by a first mortgage with a loan-to-value ratio over 80.0%. We generally require all properties securing mortgage loans to be appraised by a licensed real estate appraiser. We generally require title insurance on all first mortgage loans. Exceptions to these lending policies are based on an evaluation of credit risk related to the borrower and the size of the loan. Borrowers must obtain hazard insurance, and flood insurance is required for loans on properties located in a flood zone.
In an effort to provide financing for first-time buyers, we offer adjustable- and fixed-rate loans to qualified individuals and originate the loans using modified underwriting guidelines, reduced interest rates and loan conditions and reduced closing costs. We also participate in publicly sponsored loan programs which provide competitive terms for low and moderate income home buyers.
The majority of the conforming fixed-rate one- to four-family residential mortgage loans we originate are sold to the secondary market mainly to Fannie Mae and Freddie Mac with servicing retained other than for specialized governmental programs that require servicing to be released. Generally, we hold in our portfolio nonconforming loans, shorter-term fixed-rate loans and adjustable-rate loans.
We generally do not (i) originate "interest only" mortgage loans on one- to four-family residential properties, (ii) offer loans that provide for negative amortization of principal such as "option ARM" loans where the borrower can pay less than the interest owed on their loan, (iii) offer "subprime" loans (loans that are made with low down payments to borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies or borrowers with questionable repayment capacity) or (iv) offer "Alt-A" loans (loans to borrowers having less than full documentation).
Second Mortgages and Equity Lines of Credit. We offer second mortgages and equity lines of credit, which are secured by owner-occupied residences. At December 31, 2017, second mortgages and equity lines of credit were $89.1 million, or 4.1% of total loans. Second mortgages are made at fixed interest rates and terms of up to fifteen years. Equity lines of credit have adjustable rates of interest that are indexed to the Prime rate as published in The Wall Street Journal plus or minus a margin, and generally are subject to an interest rate floor, with 10-year draws and repayment terms of between five and twenty years. We offer second mortgages and equity lines of credit with cumulative loan-to-value ratios generally up to 80.0%, when taking into account both the balance of the home equity loan and first mortgage loan. We hold a first mortgage position on the homes that secure second mortgages or equity lines of credit in approximately one-third of the portfolio.
The procedures for underwriting home equity lines of credit include an assessment of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral to the proposed loan amount. The procedures for underwriting residential mortgage loans apply equally to second mortgages and equity lines of credit.
Auto and Other Consumer Loans. We primarily focus on the origination of auto loans through indirect loans and lease assignments from Credit Union Leasing of America that are accounted for as loans. At December 31, 2017, auto loans were $513.7 million, or 23.5% of total loans and 97.3% of consumer loans. Other consumer loans, consisting primarily of unsecured lines of credit and personal loans, were $14.1 million, or 0.6% of total loans.
We originate auto loans through a network of approximately 275 auto dealers secured by new and used vehicles primarily in Massachusetts and Rhode Island. Our primary considerations when originating these loans are the borrower's ability to pay and the value of the underlying collateral. An indirect auto loan is originated when the borrower purchases or leases a motor vehicle at an auto dealership and elects to finance a portion of that purchase. The procedures for underwriting consumer loans include an assessment of the applicant's payment history on other debts and ability to meet existing obligations and payments on the proposed loan. Although the applicant's creditworthiness is a primary consideration, the underwriting process also includes a comparison of the value of the collateral, if any, to the proposed loan amount.
Loan Originations, Purchases and Sales. Loan originations come from a number of sources. The primary source of loan originations are our in-house loan originators, and to a lesser extent, local mortgage brokers and third party originators of residential loans, advertising and referrals from customers. We sell to the secondary market newly originated 30-year or longer term conforming fixed-rate residential mortgage loans and we hold in our portfolio nonconforming loans, shorter-term fixed-rate loans and adjustable-rate residential mortgage loans. Our decision to sell loans is based on prevailing market interest rate conditions and interest rate risk management. Loans are sold to third parties with servicing either retained or released. We occasionally purchase commercial business loans or participation interests in commercial real estate loans. In addition, we sell participation interests in commercial real estate loans to local financial institutions, primarily the portion of loans that exceed our borrowing limits or are in an amount that is considered prudent to manage our credit risk.
For the years ended December 31, 2017 and 2016, we originated loans of $1.70 billion and $2.21 billion of loans, respectively. During the same periods, we sold $1.16 billion and $1.50 billion of loans, respectively.
Mortgage Banking Activity. In addition to the lending activities previously discussed, we also originate residential mortgage loans for sale in the secondary market through Merrimack Mortgage. For the year ended December 31, 2017, Merrimack Mortgage
originated $1.02 billion in mortgage loans. Merrimack Mortgage sells loans on both a servicing-released and a servicing-retained basis. Merrimack Mortgage has contracted with a third party to service the loans for which it retains servicing.
Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed or insured by the federal government, such as a Federal Housing Authority Veterans’ Administration loan.
Loan Underwriting Risks.
Commercial Real Estate Loans. Loans secured by commercial real estate generally have larger balances and involve a greater degree of risk than residential mortgage loans. Of primary concern in commercial real estate lending is the borrower's creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject to adverse conditions in the real estate market or the economy to a greater extent than residential real estate loans. If we are forced to foreclose on a commercial real estate property due to default, we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Commercial Loans. Commercial loans also involve a greater degree of risk than residential mortgage loans. Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her employment or other income, and which are secured by real property whose value tends to be more easily ascertainable, commercial loans are typically made on the basis of the borrower's ability to make repayment from the cash flows of the borrower's business. As a result, the availability of funds for the repayment of commercial loans may depend substantially on the success of the business itself. Further, any collateral securing such loans may depreciate over time, may be difficult to appraise and may fluctuate in value.
Construction Loans. Construction financing is considered to involve a higher degree of risk of loss than long-term financing on improved, occupied real estate. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the property's value at completion of construction or development and the estimated cost (including interest) of construction. During the construction phase, a number of factors could result in delays and cost overruns. If the estimate of construction costs proves to be inaccurate, we may be required to advance funds beyond the amount originally committed to permit completion of the development. If the estimate of value proves to be inaccurate, we may be confronted, at or before the maturity of the loan, with a project having a value which is insufficient to assure full repayment. As a result of the foregoing, construction lending often involves the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of the borrower or guarantor to repay principal and interest. If we are forced to foreclose on a project before or at completion due to a default, we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs.
Residential Real Estate Loans. Due to historically low interest rate levels, borrowers generally have preferred fixed-rate loans in recent years. While we anticipate that our adjustable-rate loans will better offset the adverse effects on our net interest income of an increase in interest rates as compared to fixed-rate loans, the increased mortgage payments required of adjustable-rate loans in a rising interest rate environment could cause an increase in delinquencies and defaults. If we are forced to foreclose on a residential property due to default, the marketability of the underlying property also may be adversely affected in a high interest rate environment, and we may not be able to recover all of the unpaid balance of, and accrued interest on, the loan as well as related foreclosure and holding costs. In addition, although adjustable-rate loans help make our asset base more responsive to changes in interest rates, the extent of this interest sensitivity is limited by the annual and lifetime interest rate adjustment limits.
Consumer Loans. Consumer loans entail greater risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or secured by assets that depreciate rapidly. In such cases, repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections depend on the borrower's continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans.
Loan Participations. We cultivate relationships with other financial institutions to mitigate the risk of our lending activities by participating either as the lead bank or as a participant in various loan transactions. We purchase participation interests in larger balance loans from other financial institutions generally in our market area. Such participations are reviewed for compliance, are
underwritten and approved in accordance with our underwriting criteria. We actively monitor the performance of such loans and periodically receive updated financial statements of the borrower from the lead lender. These loans are subjected to regular internal reviews in accordance with our loan policy. We joined a community bank lending network operated by BancAlliance in 2014 in order to have the opportunity to participate in commercial loans and lines of business referred by the network. HarborOne Bank has adopted a loan policy specifically for loans originated through this program that provides for underwriting standards and limits maximum loans to one entity to $2.5 million as well as a total portfolio of $40 million. As of December 31, 2017, total exposure for this program was $26.0 million comprising 15 credits. All but one of these relationships were performing in accordance with their payment terms. There is one $2.0 million loan that is rated substandard, on nonaccrual and under a forbearance agreement. At December 31, 2017, the outstanding balances of commercial loan participations purchased outside of the BancAlliance network totaled $4.4 million. We also participate in commercial real estate loans that total $120.8 million and commercial construction loans that total $21.6 million. We were the lead bank in commercial real estate loans $170.7 million and commercial construction loans of $30.5 million with participation balances sold that totaled $70.4 million and $14.8 million, respectively, at December 31, 2017.
Loan Approval Procedures and Authority. Our lending activities follow written, nondiscriminatory underwriting standards and loan origination procedures established by our board of directors and management. Our board of directors has granted loan approval authority to certain executive officers. Commercial loans in excess of any officer's individual authority must be approved by a lending committee comprised of several executive officers. Commercial loans in excess of the lending committee authority must be approved by the board of directors or by the executive committee, which is comprised of our president and chief executive officer and three independent members of our Board of Directors. Commercial loans in excess of the "in-house limit" must be approved by the board of directors. The executive committee of the board of directors reviews all commercial and commercial real estate loan requests greater than $3 million. All mortgage and commercial real estate loans to any single borrower that exceed $3 million and commercial loans that exceed $3 million must be approved by the board of directors.
Loans-to-One Borrower Limit. The maximum amount that the Bank may lend to one borrower and the borrower's related entities is generally limited, by statute, to 20.0% of the Bank's capital, which is defined under Massachusetts law as the sum of the Bank's capital stock, surplus account and undivided profits. At December 31, 2017, the Bank's regulatory limit on loans-to-one borrower was $65.9 million. At that date, our largest lending relationship totaled $28.4 million and was comprised of eight loans to finance medical and general office space. These loans were performing in accordance with their original repayment terms at December 31, 2017. Our internal loans-to-one borrower limit is $38.5 million.
Investment Activities
General. At December 31, 2017, securities totaled $217.7 million. The securities portfolio consists of U.S. government obligations, residential mortgage-backed securities and collateralized mortgage obligations, state, county and municipal bonds and small business administration asset-backed securities. The goals of our investment policy are to provide and maintain liquidity to meet deposit withdrawal and loan funding needs, to help mitigate interest rate and market risk, to diversify our assets, and to generate a reasonable rate of return on funds within the context of our interest rate and credit risk objectives. Our board of directors approves our investment policy which is reviewed annually by the board of directors. Authority to make investments under the approved investment policy guidelines is delegated to our chief financial officer and chief executive officer. All investment transactions are reviewed at the next regularly scheduled meeting of the board of directors. We classify the majority of our securities as available-for-sale.
We have legal authority to invest in various types of securities, including U.S. Treasury obligations, securities of various government-sponsored enterprises and municipal governments, deposits at the Federal Home Loan Bank (“FHLB”), certificates of deposit of federally insured institutions and investment grade corporate bonds. We also are required to maintain an investment in FHLB stock. While we have the authority under applicable law to invest in marketable equity securities and derivative securities, we had no investments in such securities at December 31, 2017.
Sources of Funds
General. Deposits, borrowings and loan repayments are the major sources of our funds for lending and other investment purposes. Scheduled loan repayments are a relatively stable source of funds, while deposit inflows and outflows and loan prepayments are significantly influenced by general interest rates and money market conditions.
Deposit Accounts. At December 31, 2017, total deposits were $2.01 billion. Deposits are attracted from within our market area by sales efforts of our retail branch network, municipal department and commercial loan officers, advertising and through our website. We offer a broad selection of deposit instruments, including noninterest-bearing demand deposits (such as checking accounts),
interest-bearing demand accounts (such as NOW and money market accounts), savings accounts and term certificates of deposit. We also offer a variety of deposit accounts designed for businesses and municipalities operating in our market area. Our business banking deposit products include a commercial checking account, sweep accounts, money market accounts and checking accounts specifically designed for small businesses. We also offer remote deposit capture products, for business customers to meet their online banking needs. Additionally, the Bank has a municipal banking department that provides core depository services to local municipalities. At December 31, 2017 municipal deposits totaled $231.6 million. The Bank also participates in a reciprocal deposit program that provides access to FDIC insured deposit products in aggregate amounts exceeding the current insurance limits for depositors. At December 31, 2017 total reciprocal deposits were $174.3 million and included $116.0 million of municipal deposits.
The Bank utilizes a deposit listing service which targets institutional funds throughout the country. We generally prohibit the withdrawal of our listing service deposits prior to maturity. Also, when rates and terms are favorable, the Bank supplements the customer deposit base with brokered deposits. At December 31, 2017, we had $30.4 million of institutional deposits and $73.5 million of brokered deposits, which represented 5.2% of total deposits at December 31, 2017 with such funds having a weighted average remaining term to maturity of 9.1 months. In a rising rate environment, we may be unwilling or unable to pay a competitive rate. To the extent that such deposits do not remain with us, they may need to be replaced with borrowings, which could increase our cost of funds and negatively impact our interest rate spread, financial condition and results of operation.
Deposit account terms vary according to the minimum balance required, the time periods the funds must remain on deposit and the interest rate, among other factors. In determining the terms of our deposit accounts, we consider the rates offered by our competition, our liquidity needs, profitability to us, and customer preferences and concerns. We generally review our deposit mix and pricing on a weekly basis. Our deposit pricing strategy has generally been to offer competitive rates and to offer periodically special rates in order to attract deposits of a specific type or term.
Borrowings. As of December 31, 2017, total borrowings were $290.4 million. Borrowings consist of short-term and long-term obligations from the FHLB. The Bank is a member of the FHLB Boston which provides access to wholesale funding to supplement our supply of investable funds. The FHLB functions as a central reserve bank providing credit for its member financial institutions. As a member, we are required to own capital stock in the FHLB and are authorized to apply for advances on the security of such stock and certain of our whole first mortgage loans and other assets (principally securities which are obligations of, or guaranteed by, the United States), provided certain standards related to creditworthiness have been met. Advances are made under several different programs, each having its own interest rate and range of maturities. Depending on the program, limitations on the amount of advances are based either on a fixed percentage of an institution's net worth or on the FHLB's assessment of the institution's creditworthiness. At December 31, 2017, based on available collateral and our ownership of FHLB stock, and based upon our internal policy, we had access to additional FHLB advances of up to $197.7 million. All of our borrowings from the FHLB are secured by a blanket lien on residential real estate.
The Share Insurance Fund of the Co-operative Central Bank provides for borrowings for liquidity purposes and is available to all co-operative member banks. Loan advances will generally be made on an unsecured basis provided that the aggregate loan balance is less than 5.0% of total deposits of the member bank; the member bank's primary capital ratio is in excess of 5.0%; the member bank meets the required CAMELS rating; and the quarterly and year-to-date net income before extraordinary items is positive. At December 31, 2017, we had $5.0 million of borrowing capacity with the Co-operative Central Bank, none of which was outstanding.
The Company also has an available line of credit with the Federal Reserve Bank of Boston secured by 75% of the carrying value of indirect auto loans with an amortized balance amounting to $136.1 million of which no amount was outstanding at December 31, 2017.
Supervision and Regulation
General
The Bank is a Massachusetts stock co-operative bank and the wholly-owned subsidiary of the Company, which in turn is majority owned by the MHC. The MHC and the Company are registered bank holding companies. The Bank’s deposits are insured up to applicable limits by the Federal Deposit Insurance Corporation (“FDIC”) and by the Share Insurance Fund established by Massachusetts General Laws, or the “MGL,” for amounts in excess of the FDIC insurance limits. The Bank is subject to regulation, supervision and examination by the Massachusetts Commissioner of Banks, as its chartering agency, and by the FDIC, its primary federal regulator and deposit insurer. The Bank must also comply with consumer protection regulations issued by the Consumer Financial Protection Bureau (“CFPB”), as enforced by the FDIC.
As a bank holding company, the Company is subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Company is also subject to the rules and regulations of the SEC under the federal securities laws.
The federal and state regulatory framework applicable to bank holding companies and their subsidiaries is intended primarily for the protection of depositors and the deposit insurance funds, rather than for the protection of other creditors or shareholders. The regulatory structure also gives the regulatory authorities extensive discretion in connection with their supervisory and enforcement activities and examination policies, including policies concerning the establishment of deposit insurance assessment fees, classification of assets and establishment of adequate loan loss reserves for regulatory purposes. Any change in such regulatory requirements and policies, whether by the Massachusetts legislature, the Massachusetts Commissioner of Banks, the FDIC, the Federal Reserve or the United States Congress, could have a material adverse impact on the financial condition and results of operations of the Company and the Bank.
Set forth below are certain material regulatory requirements that are applicable to the Bank and the Company. This description of statutes and regulations is not intended to be a complete description of such statutes and regulations and their effects on the Bank and the Company.
Holding Company Regulation
General. The Company is a bank holding company within the meaning of the Bank Holding Company Act of 1956, or BHCA. As such, the Company is registered with the Federal Reserve and subject to regulation, examination, supervision and reporting requirements applicable to bank holding companies. In addition, the Federal Reserve has enforcement authority over the Company. Among other things, this authority enables the Federal Reserve to restrict or prohibit activities that are determined to be a serious risk to the Bank.
Permissible Activities. A bank holding company is generally prohibited from engaging in non-banking activities, or acquiring direct or indirect control of more than 5.0% of any class of the voting securities of any company engaged in non-banking activities. One of the principal exceptions to this prohibition is for activities that the Federal Reserve had determined to be closely related to banking or managing and controlling banks as of November 11, 1999. Some of the principal activities that the Federal Reserve had determined by regulation to be so closely related to banking are: (i) making or servicing loans; (ii) performing certain data processing services; (iii) providing discount brokerage services; (iv) acting as fiduciary, investment or financial advisor; (v) leasing personal or real property; (vi) making investments in corporations or projects designed primarily to promote community welfare; and (vii) acquiring a savings association whose direct and indirect activities are limited to those permitted for bank holding companies.
Acquisition of Control. The BHCA provides that no company may directly or indirectly acquire control of a bank without the prior approval of the Federal Reserve. Any company that acquires control of a bank becomes a "bank holding company" subject to registration, examination and regulation by the Federal Reserve. Pursuant to federal regulations, the term "company" is defined to include banks, corporations, partnerships, associations, and certain trusts and other entities, and a company has "control" of a bank or other company if the company owns, controls or holds with power to vote 25.0% or more of any class of voting stock of the bank or other company, controls in any manner the election of a majority of the directors of the bank or other company or if the Federal Reserve determines, after notice and opportunity for hearings that the Company has the power to exercise a controlling influence over the management or policies of the bank or other company. In addition, a bank holding company must obtain Federal Reserve approval prior to acquiring voting securities of a bank or bank holding company if, after such acquisition, the bank holding company would control more than 5.0% of any class of voting stock of the bank or bank holding company.
Under the federal Change in Bank Control Act, no person, directly or indirectly or acting in concert with one or more other persons, may acquire control of an insured depository institution or a depository institution holding company unless the appropriate federal banking agency has been given 60 days prior written notice and has not issued a notice disapproving the proposed acquisition. The Federal Reserve is the appropriate federal banking agency with respect to an acquisition of control of a bank holding company. Acquisitions subject to approval under the BHCA are exempt from the prior notice requirement. Control, as defined under the Change in Bank Control Act, as implemented by the Federal Reserve with respect to bank holding companies, means the power to directly or indirectly direct the management or policies of a bank holding company or to vote 25.0% or more of any class of voting securities of the bank holding company. Acquisition of more than 10.0% of any class of a bank holding company's voting stock is subject to a rebuttable presumption of control by the Federal Reserve if the bank holding company has registered securities under section 12 of the Securities Exchange Act or if no other person will own, control or hold the power to vote a greater percentage of that class of voting stock immediately after the acquisition. There are also rebuttable presumptions in the regulations concerning whether a group is "acting in concert," including presumed concerted action among members of an "immediate family." Accordingly, the filing of a notice with
the Federal Reserve would be required before any person or group of persons acting in concert could acquire 10.0% or more of the common stock of the Company, unless the person or group of persons files a rebuttal of control that is accepted by the Federal Reserve.
Capital. The Company is subject to the Federal Reserve's capital adequacy regulations for bank holding companies (on a consolidated basis). These capital standards have historically been similar to, though less stringent than, those of the FDIC for the Bank. Subject to certain exceptions, including an exception for bank holding companies with less than $1 billion of assets, the Dodd-Frank Act required the Federal Reserve to establish, for all bank holding companies, minimum consolidated capital requirements that are as stringent as those required for insured depository institutions. Under regulations enacted by the Federal Reserve and generally effective January 1, 2015, all such bank holding companies are subject to regulatory capital requirements that are the same as or more stringent than the capital requirements applicable to the Bank. These capital requirements include provisions that, when applicable, might limit the ability of the Company to pay dividends to its shareholders or repurchase its shares. For a description of these capital requirements, see "-Federal Banking Regulation-Capital Requirements."
Source of Strength. The Dodd-Frank Act codified the requirement that holding companies act as a source of financial strength. The Federal Reserve policy requires bank holding companies to act as a source of financial and managerial strength to their depository institution subsidiaries by providing capital, liquidity and other support in times of financial stress.
Dividends. The Federal Reserve has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bank holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if the prospective rate of earnings retention by the holding company appears consistent with the organization's capital needs, asset quality and overall financial condition. Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company's net income for the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company's overall rate or earnings retention is inconsistent with the company's capital needs and overall financial condition. The policy statement also states that a bank holding company should inform and consult with the Federal Reserve supervisory staff prior to redeeming or repurchasing common stock or perpetual preferred stock if the bank holding company is experiencing financial weaknesses or if the repurchase or redemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of the quarter in which the redemption or repurchase occurred. These regulatory policies may affect the ability of the Company to pay dividends, repurchase shares of common stock or otherwise engage in capital distributions. In addition, the ability of the Company to pay dividends may be restricted if the Bank becomes undercapitalized.
Massachusetts Holding Company Regulation. Under the Massachusetts banking laws, a company owning or controlling two or more banking institutions, including a co-operative bank, is regulated as a bank holding company. The term "company" is defined by the Massachusetts banking laws similarly to the definition of "company" under the Bank Holding Company Act. Each Massachusetts bank holding company: (i) must obtain the approval of the Massachusetts Board of Bank Incorporation before engaging in certain transactions, such as the acquisition of more than 5.0% of the voting stock of another banking institution; (ii) must register and file reports with the Massachusetts Commissioner of Banks; and (iii) is subject to examination by the Massachusetts Commissioner of Banks. Recent legislation enacted in Massachusetts provides an exemption from the requirement to obtain Board of Bank Incorporation approval for certain transactions involving a bank merger or consolidation subject to approval by the Massachusetts Commissioner of Banks. In addition, for a period of three years following completion of a stock issuance by a subsidiary of a mutual holding company, no person may directly or indirectly offer to acquire or acquire beneficial ownership of more than 10.0% of any class of equity security of such subsidiary without prior written approval of the Massachusetts Commissioner of Banks.
Federal Banking Regulation
Business Activities. Under federal law, all state-chartered FDIC-insured banks, including co-operative banks, have been limited in their activities as principal and in their equity investments to the type and the amount authorized for national banks, notwithstanding state law. Federal law permits exceptions to these limitations, including an exception that permits banks with grandfathered rights to make investments in common and preferred stock listed on a national securities exchange. The maximum permissible investment is the lesser of 100.0% of Tier 1 capital or the maximum amount permitted by Massachusetts law. Such grandfathered authority may be terminated under certain circumstances, including a change in charter or a determination by the FDIC that such investments pose a safety and soundness risk.
The FDIC is also authorized to permit state banks to engage in state authorized activities or investments not permissible for national banks (other than non-subsidiary equity investments) if they meet all applicable capital requirements and it is determined that such activities or investments do not pose a significant risk to the FDIC insurance fund. The FDIC has adopted regulations governing the procedures for institutions seeking approval to engage in such activities or investments. The Gramm-Leach-Bliley Act of 1999
specified that a state bank may control a subsidiary that engages in activities as principal that would only be permitted for a national bank to conduct in a "financial subsidiary," if a bank meets specified conditions and deducts its investment in the subsidiary for regulatory capital purposes.
Capital Requirements. The Federal Reserve has issued risk-based and leverage capital rules applicable to bank holding companies such as the Company, and the FDIC has issued similar rules that apply to insured state nonmember banks, such as the Bank. These rules are intended to reflect the relationship between the banking organization's capital and the degree of risk associated with its operations based on transactions recorded on-balance sheet as well as off-balance sheet items. The Federal Reserve and the FDIC may from time to time require that a banking organization maintain capital above the minimum levels discussed below, due to the banking organization's financial condition or actual or anticipated growth.
The capital adequacy rules define qualifying capital instruments and specify minimum amounts of capital as a percentage of assets that banking organizations are required to maintain. Common equity Tier 1 capital for banks and bank holding companies consists of common stockholders' equity and related surplus. Tier 1 capital for banks and bank holding companies generally consists of the sum of common shareholders' equity, non-cumulative perpetual preferred stock, and related surplus and, in certain cases and subject to limitations, minority interest in consolidated subsidiaries, less goodwill, other non-qualifying intangible assets and certain other deductions. Tier 2 capital generally consists of hybrid capital instruments, perpetual debt and mandatory convertible debt securities, cumulative perpetual preferred stock, term subordinated debt and intermediate-term preferred stock, and, subject to limitations, allowances for loan losses. The sum of Tier 1 and Tier 2 capital less certain required deductions represents qualifying total risk-based capital.
Under the capital rules, risk-based capital ratios are calculated by dividing Tier 1 and total risk-based capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of several risk-weight categories, based primarily on relative risk. The rules require banks and bank holding companies to maintain a minimum common equity Tier 1 capital ratio of 4.5%, a minimum Tier 1 capital ratio of 6.0%, a total capital ratio of 8.0% and a leverage ratio of 4.0%. Additionally, subject to a transition schedule, the capital rules require a bank holding company to establish a capital conservation buffer of common equity Tier 1 capital in an amount above the minimum risk-based capital requirements equal to 2.5% of total risk weighted assets, or face restrictions on the ability to pay dividends, pay discretionary bonuses, and to engage in share repurchases. The new capital conservation buffer requirement began phasing in on January 1, 2016 and is 1.25% at December 31, 2017.
Under the FDIC’s prompt corrective action rules, an insured state nonmember bank is considered “well capitalized” if it (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (v) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. The Bank is considered “well capitalized” under this definitions
Current capital rules do not establish standards for determining whether a bank holding company is well capitalized. However, for purposes of processing regulatory applications and notices, the Federal Reserve Regulation Y provides that a bank holding company is considered “well capitalized” if (i) on a consolidated basis, the bank holding company maintains a total risk-based capital ratio of 10% or greater, (ii) on a consolidated basis, the bank holding company maintains a Tier I risk-based ratio of 6% or greater, and (ii) the bank holding company is not subject to any written agreement, order capital directive, or prompt corrective action directive issued by the Board to meet and maintain a specific capital level for any capital measure. The Company is considered well capitalized under this definition.
Bank Dividends. A state non-member bank may not make a capital distribution that would reduce its regulatory capital below the amount required by the FDIC’s regulatory capital regulations or for the liquidation account established in connection with its conversion to stock form. In addition, the Bank’s ability to pay dividends is limited if the Bank does not have the capital conservation buffer required by new capital rules, which may limit the ability of the Bancorp to pay dividends to its shareholders. See “-Capital Requirements.”
Community Reinvestment Act and Fair Lending Laws. All institutions have a responsibility under the Community Reinvestment Act, or the "CRA," and related regulations to help meet the credit needs of their communities, including low- and moderate-income borrowers. In connection with its examination of a state non-member bank, the FDIC is required to assess the institution's record of compliance with the CRA. The CRA does not establish specific lending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes are best suited to its particular community, consistent with the CRA. The CRA does require the FDIC, in connection with its examination of a state non-member bank, to assess the institution's record of meeting the credit needs of its community and to take such record into account in its
evaluation of certain applications by such institution, including applications to acquire branches and other financial institutions. The CRA requires the FDIC to provide a written evaluation of an institution's CRA performance utilizing a four-tiered descriptive rating system. An institution's failure to comply with the provisions of the CRA could, at a minimum, result in denial of certain corporate applications such as branches or mergers, or in restrictions on its activities. The CRA requires all institutions insured by the FDIC to publicly disclose their rating. The Bank received a "Satisfactory" CRA rating in its most recent federal examination.
Massachusetts has its own statutory counterpart to the CRA that is applicable to the Bank. The Massachusetts version is generally similar to the CRA but uses a five-tiered descriptive rating system. Massachusetts law requires the Massachusetts Commissioner of Banks to consider, but not be limited to, a bank's record of performance under Massachusetts law in considering any application by the bank to establish a branch or other deposit-taking facility, to relocate an office or to merge or consolidate with or acquire the assets and assume the liabilities of any other banking institution. The Bank's most recent rating under Massachusetts law was "Satisfactory."
In addition, the Equal Credit Opportunity Act and the Fair Housing Act prohibit lenders from discriminating in their lending practices on the basis of characteristics specified in those statutes. The failure to comply with the Equal Credit Opportunity Act and the Fair Housing Act could result in enforcement actions by the FDIC, as well as other federal regulatory agencies and the Department of Justice.
Transactions with Related Parties. An insured depository institution's authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and federal regulation. An affiliate is generally a company that controls, is controlled by or is under common control with an insured depository institution such as the Bank; however, a subsidiary of a bank that engages in bank permissible activities is generally not treated as an affiliate. The MHC and the Company will be affiliates of HarborOne Bank because of their control of HarborOne Bank. In general, transactions between an insured depository institution and its affiliates are subject to certain quantitative limits and collateral requirements. Transactions with affiliates also must be consistent with safe and sound banking practices, generally not involve the purchase of low-quality assets and be on terms that are as favorable to the insured depository institution as comparable transactions with non-affiliates.
The Bank's authority to extend credit to its directors, executive officers and 10.0% shareholders, as well as to entities controlled by such persons, is currently governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve. Among other things, these provisions generally require that extensions of credit to insiders be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank's capital.
In addition, extensions of credit in excess of certain limits must be approved by HarborOne Bank's loan committee or board of directors. Extensions of credit to executive officers are subject to additional limits based on the type of extension involved.
Enforcement. The FDIC has extensive enforcement responsibility over state non-member banks and has authority to bring enforcement actions against all "institution-affiliated parties," including directors, officers, shareholders, attorneys, appraisers and accountants who knowingly or recklessly participate in wrongful action likely to have an adverse effect on an institution. Formal enforcement action by the FDIC may range from the issuance of a capital directive or cease and desist order to removal of officers and/or directors of the institution and the appointment of a receiver or conservator. Civil penalties cover a wide range of violations and actions, and range up to $25,000 per day, unless a finding of reckless disregard is made, in which case penalties may be as high as $1 million per day. The FDIC is required, with certain exceptions, to appoint a receiver or conservator for an insured state non-member bank if that bank was "critically undercapitalized" on average during the calendar quarter beginning 270 days after the date on which the institution became "critically undercapitalized." The FDIC may also appoint itself as conservator or receiver for an insured state non-member bank under specified circumstances, including: (1) insolvency; (2) substantial dissipation of assets or earnings through violations of law or unsafe or unsound practices; (3) existence of an unsafe or unsound condition to transact business; (4) insufficient capital; or (5) the incurrence of losses that will deplete substantially all of the institution's capital with no reasonable prospect of replenishment without federal assistance. The FDIC also has the authority to terminate deposit insurance.
Standards for Safety and Soundness. Federal law requires each federal banking agency to prescribe certain standards for all insured depository institutions. These standards relate to, among other things, internal controls, information systems and audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation and other operational and managerial standards as the agency deems appropriate. Interagency guidelines set forth the safety and soundness standards that the federal banking agencies use to identify and address problems at insured depository institutions before capital becomes impaired. If the appropriate
federal banking agency determines that an institution fails to meet any standard prescribed by the guidelines, the agency may require the institution to submit to the agency an acceptable plan to achieve compliance with the standard. If an institution fails to meet these standards, the appropriate federal banking agency may require the institution to implement an acceptable compliance plan. Failure to implement such a plan can result in further enforcement action, including the issuance of a cease and desist order or the imposition of civil money penalties.
Interstate Banking and Branching. Federal law permits well-capitalized and well-managed bank holding companies to acquire banks in any state, subject to Federal Reserve approval, certain concentration limits and other specified conditions. Interstate mergers of banks are also authorized, subject to regulatory approval and other specified conditions. In addition, pursuant to the Dodd-Frank Act, banks are now permitted to establish de novo branches on an interstate basis provided that branching is authorized by the law of the host state for banks chartered by the host state.
Prompt Corrective Action Regulations. The FDIC is required by law to take supervisory action against undercapitalized institutions under its jurisdiction, the severity of which depends upon the institution's level of capital.
An institution that has a total risk-based capital ratio of less than 8.0%, a Tier 1 risk-based capital ratio of less than 6.0%, a common equity Tier 1 ratio of less than 4.5% or a Tier 1 leverage ratio of less than 4.0% is considered to be "undercapitalized." An institution that has a total risk-based capital ratio of less than 6.0%, a Tier 1 risk-based capital ratio of less than 4.0%, a common equity Tier 1 ratio of less than 3.0% or a Tier 1 leverage ratio of less than 3.0% is considered to be "significantly undercapitalized." An institution that has a tangible capital to assets ratio equal to or less than 2.0% is deemed to be "critically undercapitalized."
Generally, a receiver or conservator must be appointed for an institution that is "critically undercapitalized" within specific time frames. The regulations also provide that a capital restoration plan must be filed with the FDIC within 45 days of the date that an institution is deemed to have received notice that it is "undercapitalized," "significantly undercapitalized" or "critically undercapitalized." Any holding company of an institution that is required to submit a capital restoration plan must guarantee performance under the plan in an amount of up to the lesser of 5.0% of the institution's assets at the time it was deemed to be undercapitalized by the FDIC or the amount necessary to restore the institution to adequately capitalized status. This guarantee remains in place until the FDIC notifies the institution that it has maintained adequately capitalized status for each of four consecutive calendar quarters. Institutions that are undercapitalized become subject to certain mandatory measures such as restrictions on capital distributions and asset growth. The FDIC may also take any one of a number of discretionary supervisory actions against undercapitalized institutions, including the issuance of a capital directive and the replacement of senior executive officers and directors.
Insurance of Deposit Accounts. The Deposit Insurance Fund of the FDIC insures deposits at FDIC-insured depository institutions such as the Bank. Deposit accounts in the Bank are insured by the FDIC up to a maximum of $250,000 per separately insured depositor and up to a maximum of $250,000 for self-directed retirement accounts. The FDIC charges insured depository institutions premiums to maintain the Deposit Insurance Fund.
Deposit premiums are based on assets. To determine its deposit insurance premium, the Bank computes the base amount of its average consolidated assets less its average tangible equity (defined as the amount of Tier 1 capital) and the applicable assessment rate. On April 26, 2016, the FDIC’s Board of Directors adopted a final rule that changed the manner in which deposit insurance assessment rates are calculated for established small banks, generally those banks with less than $10 billion of assets that have been insured for at least five years. Under the final rule, each of seven financial ratios and a weighted average of CAMELS component ratings will be multiplied by a corresponding pricing multiplier. The sum of these products is added to a uniform amount, with the resulting sum being an institution’s initial base assessment rate (subject to minimum or maximum assessment rates based on a bank’s CAMELS composite rating). This method takes into account various measures, including an institution’s leverage ratio, brokered deposit ratio, one year asset growth, the ratio of net income before taxes to total assets and considerations related to asset quality. Assessments for established small banks with a CAMELS rating of 1 or 2 range from 1.5 to 16 basis points, after adjustments, while assessment rates for established small banks with a CAMELS composite rating of 4 or 5 range from 11 to 30 basis points, after adjustments. Assessments for established small banks with a CAMELS rating of 3 range from 3 to 30 basis points.
The FDIC has authority to increase insurance assessments. Any significant increases would have an adverse effect on the operating expenses and results of operations of the Bank. Management cannot predict what assessment rates will be in the future.
Insurance of deposits may be terminated by the FDIC upon a finding that an institution has engaged in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC. We do not currently know of any practice, condition or violation that may lead to termination of our deposit insurance.
Prohibitions Against Tying Arrangements. State non-member banks are prohibited, subject to certain exceptions, from extending credit or offering any other service, or fixing or varying the consideration for such extension of credit or service, on the condition that the customer obtain some additional service from the institution or its affiliates or not obtain services of a competitor of the institution.
Federal Reserve System. Federal Reserve regulations require depository institutions to maintain noninterest-earning reserves against their transaction accounts (primarily NOW and regular checking accounts). The Bank’s required reserves can be in the form of vault cash and, if vault cash does not fully satisfy the required reserves, in the form of a balance maintained with the Federal Reserve Bank of Boston. The Federal Reserve regulations currently require that reserves be maintained against aggregate transaction accounts except for transaction accounts up to $16.0 million, which are exempt. Transaction accounts greater than $16.0 million up to $122.3 million have a reserve requirement of 3.0%, and those greater than $123.3 million have a reserve requirement of approximately $3.2 million plus 10.0% of the amount over $122.3 million. The Federal Reserve generally makes annual adjustments to the tiered reserves. The Bank is in compliance with these requirements.
Federal Home Loan Bank System. The Bank is a member of the FHLB of Boston, which is one of the 12 regional Federal Home Loan Banks comprising the FHLB System. Each FHLB serves as a central credit facility primarily for its member institutions as well as other entities involved in home mortgage lending. As a member of the FHLB, HarborOne Bank is required to acquire and hold shares of capital stock in the FHLB. As of December 31, 2017, HarborOne Bank was in compliance with this requirement. Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost. HarborOne Bank reviews for impairment based on the ultimate recoverability of the cost basis of the FHLB stock. As of December 31, 2017, no impairment has been recognized.
At its discretion, the FHLB may declare dividends on the stock. In 2015 and 2016 and 2017, the FHLB of Boston paid quarterly dividends with an annual yield of 2.54%, 3.63% and 4.14%, respectively. There can be no assurance that such dividends will continue in the future. Further, there can be no assurance that the impact of recent or future legislation on the FHLBs also will not cause a decrease in the value of the FHLB stock held by the Bank.
Massachusetts Banking Laws and Supervision
General. As a Massachusetts stock co-operative bank, the Bank is subject to supervision, regulation and examination by the Massachusetts Commissioner of Banks and to various Massachusetts statutes and regulations which govern, among other things, investment powers, lending and deposit-taking activities, borrowings, maintenance of surplus and reserve accounts and payment of dividends. In addition, the Bank is subject to Massachusetts consumer protection and civil rights laws and regulations. The approval of the Massachusetts Commissioner of Banks is required for a Massachusetts-chartered bank to establish or close branches, merge with other financial institutions, issue stock and undertake certain other activities. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Massachusetts Commissioner of Banks may be sanctioned. The Massachusetts Commissioner of Banks may suspend or remove directors or officers of a bank who have violated the law, conducted a bank's business in a manner that is unsafe, unsound or contrary to the depositors' interests, or been negligent in the performance of their duties. In addition, the Massachusetts Commissioner of Banks has the authority to appoint a receiver or conservator if it is determined that the bank is conducting its business in an unsafe or unauthorized manner, and under certain other circumstances.
Lending Activities. A Massachusetts co-operative bank may make a wide variety of mortgage loans including fixed-rate loans, adjustable-rate loans, variable-rate loans, participation loans, graduated payment loans, construction and development loans, condominium and co-operative loans, second mortgage loans and other types of loans that may be made in accordance with applicable regulations. Commercial loans may be made to corporations and other commercial enterprises with or without security. Consumer and personal loans may also be made with or without security.
Insurance Sales. A Massachusetts bank may engage in insurance sales activities if the Massachusetts Commissioner of Banks has approved a plan of operation for insurance activities and the bank obtains a license from the Massachusetts Division of Insurance. A bank may be licensed directly or indirectly through an affiliate or a subsidiary corporation established for this purpose. HarborOne Bank does not sell or refer insurance products, and has not sought approval for insurance sales activities.
Dividends. A Massachusetts co-operative bank may declare cash dividends from net profits not more frequently than quarterly. Non-cash dividends may be declared at any time. No dividends may be declared, credited or paid if the bank's capital stock is impaired. The approval of the Massachusetts Commissioner of Banks is required if the total of all dividends declared in any calendar year exceeds the total of its net profits for that year combined with its retained net profits of the preceding two years. Net profits for this
purpose means the remainder of all earnings from current operations plus actual recoveries on loans and investments and other assets after deducting current operating expenses, actual losses, accrued dividends on preferred stock, if any, and all federal and state taxes.
Parity Authority. A Massachusetts bank may, after providing 30 days' prior notice to the Massachusetts Commissioner of Banks, exercise any power and engage in any activity that has been authorized for national banks, federal savings associations or state banks in a state other than Massachusetts, provided that the activity is permissible under applicable federal law and not specifically prohibited by Massachusetts law. Such powers and activities must be subject to the same limitations and restrictions imposed on the national bank, federal thrift or out-of-state bank that exercised the power or activity.
Loans-to-One Borrower Limitations. Massachusetts banking law grants broad lending authority. However, with certain limited exceptions, total obligations to one borrower may not exceed 20.0% of the total of the bank's capital stock, surplus and undivided profits.
Loans to a Bank's Insiders. Massachusetts banking law prohibits any executive officer or director of a bank from borrowing or guaranteeing extensions of credit by such bank except to the extent permitted by federal law.
Regulatory Enforcement Authority. Any Massachusetts co-operative bank that does not operate in accordance with the regulations, policies and directives of the Massachusetts Commissioner of Banks may be subject to sanctions for non-compliance, including revocation of its charter. The Massachusetts Commissioner of Banks may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the bank's business in an unsafe or unsound manner or contrary to the depositors interests or been negligent in the performance of their duties. Upon finding that a bank has engaged in an unfair or deceptive act or practice, the Massachusetts Commissioner of Banks may issue an order to cease and desist and impose a fine on the bank concerned. The Massachusetts Commissioner of Banks also has authority to take possession of a bank and appoint a liquidating agent under certain conditions such as an unsafe and unsound condition to transact business, the conduct of business in an unsafe or unauthorized manner of impaired capital. In addition, Massachusetts consumer protection and civil rights statutes applicable to HarborOne Bank permit private individual and class action law suits and provide for the rescission of consumer transactions, including loans, and the recovery of statutory and punitive damage and attorney's fees in the case of certain violations of those statutes.
Co-operative Central Bank and Share Insurance Fund. All Massachusetts-chartered co-operative banks are required to be members of the Co-operative Central Bank, which maintains the Share Insurance Fund that insures co-operative bank deposits in excess of federal deposit insurance coverage. The Co-operative Central Bank is authorized to charge co-operative banks an annual assessment fee on deposit balances in excess of amounts insured by the FDIC. Assessment rates are based on the institution's risk category, similar to the method currently used to determine assessments by the FDIC discussed above under "-Federal Banking Regulation-Insurance of Deposit Accounts."
Protection of Personal Information. Massachusetts has adopted regulatory requirements intended to protect personal information. The requirements, which became effective March 1, 2010, are similar to existing federal laws such as the Gramm-Leach-Bliley Act that require organizations to establish written information security programs to prevent identity theft. The Massachusetts regulation also contains technology system requirements, especially for the encryption of personal information sent over wireless or public networks or stored on portable devices.
Massachusetts has additional statutes and regulations that are similar to certain of the federal provisions discussed below.
Other Regulations
Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank's operations are also subject to federal laws applicable to credit transactions, such as the:
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Truth-In-Lending Act, which governs disclosures of credit terms to consumer borrowers;
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Real Estate Settlement Procedures Act, which requires that borrowers of mortgage loans for one- to four-family residential real estate receive various disclosures, including good faith estimates of settlement costs, lender servicing and escrow account practices, and prohibiting certain practices that increase the cost of settlement services;
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Home Mortgage Disclosure Act, which requires financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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Equal Credit Opportunity Act, which prohibits discrimination on the basis of race, creed or other prohibited factors in extending credit;
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Fair Credit Reporting Act, which governs the use and provision of information to credit reporting agencies;
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Biggert-Waters Flood Insurance Reform Act of 2012, which mandates flood insurance for mortgage loans secured by residential real estate in certain areas; and rules and regulations of the various federal agencies charged with the responsibility of implementing such federal laws.
In addition, the CFPB issues regulations and standards under these federal consumer protection laws that affect our consumer businesses. These include regulations setting "ability to repay" and "qualified mortgage" standards for residential mortgage loans and mortgage loan servicing and originator compensation standards. The Bank is evaluating recent regulations and proposals, and devotes significant compliance, legal and operational resources to compliance with consumer protection regulations and standards.
The operations of the Bank also are subject to the:
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Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;
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Truth in Savings Act, which governs the disclosure of terms and conditions regarding interest and fees related to deposit accounts;
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Electronic Funds Transfer Act and Regulation E promulgated thereunder, which govern automatic deposits to and withdrawals from deposit accounts and customers' rights and liabilities arising from the use of automated teller machines and other electronic banking services;
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Check Clearing for the 21st Century Act (also known as "Check 21"), which gives "substitute checks," such as digital check images and copies made from that image, the same legal standing as the original paper check;
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USA PATRIOT Act, which requires depository institutions to, among other things, establish broadened anti-money laundering compliance programs, and due diligence policies and controls to ensure the detection and reporting of money laundering. Such required compliance programs are intended to supplement existing compliance requirements that also apply to financial institutions under the Bank Secrecy Act and the Office of Foreign Assets Control regulations; and
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Gramm-Leach-Bliley Act, which places limitations on the sharing of consumer financial information by financial institutions with unaffiliated third parties. Specifically, the Gramm-Leach-Bliley Act requires all financial institutions offering financial products or services to retail customers to provide such customers with the financial institution's privacy policy and provide such customers the opportunity to "opt out" of the sharing of certain personal financial information with unaffiliated third parties.
Federal Securities Laws
Our common stock is registered with the Securities and Exchange Commission under Section 12(b) of the securities Exchange Act of 1934, as amended. We are subject to information, proxy solicitation, insider trading restrictions, and other requirements under the Exchange Act.
Emerging Growth Company Status
We qualify as an “emerging growth company” under the Jumpstart Our Business startups Act of 2012. For as long as we are an emerging growth company, we may choose to take advantage of exemptions from various reporting requirements applicable to other public companies but not to emerging growth companies, including, but not limited to, reduced disclosure obligations regarding executive compensation, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved, and an exemption from having outside auditors attest as to our internal control over financial reporting. In addition, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to use the extended transition period to delay
adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies.
We could be an emerging growth company for up to five years. We will cease to be an emerging growth company upon the earliest of: (i) the end of the fiscal year following the fifth anniversary of our initial public offering in 2016, (ii) the first fiscal year after our annual gross revenues are $1.0 billion or more, (iii) the date on which we have, during the previous three-year period, issued more than $1.0 billion in non-convertible debt securities or (iv) the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeds $700 million as of the end of the second quarter of that fiscal year.
ITEM 1A.
ITEM 1A. RISK FACTORS
Risks Related to Our Business
The geographic concentration of our loan portfolio and lending activities makes us vulnerable to a downturn in the local economy.
While there is not a single employer or industry in our market area on which a significant number of our customers are dependent, a substantial portion of our loan portfolio is composed of loans secured by property located in the greater Boston metropolitan area. This makes us vulnerable to a downturn in the local economy and real estate markets. Adverse conditions in the local economy such as unemployment, recession, a catastrophic event or other factors beyond our control could impact the ability of our borrowers to repay their loans, which could impact our net interest income. Decreases in local real estate values caused by economic conditions or other events could adversely affect the value of the property used as collateral for our loans, which could cause us to realize a loss in the event of a foreclosure. For more information about our market area, see the sections of this Form 10-K entitled "Business of HarborOne Bank-Market Area" and "-Competition."
Commercial and commercial real estate loans carry greater credit risk than loans secured by owner occupied one- to four-family real estate.
We intend to continue our focus on prudently growing our commercial real estate, commercial construction and commercial loan portfolio. Our total commercial loan portfolio consisting of commercial real estate, commercial construction and commercial loans was $881.7 million, or 40.3% of total loans, at December 31, 2017. Given their larger balances and the complexity of the underlying collateral, commercial real estate, commercial construction and commercial loans generally expose a lender to greater credit risk than loans secured by owner occupied one- to four-family real estate. Also, many of our borrowers or related groups of borrowers have more than one of these types of loans outstanding. Consequently, an adverse development with respect to one loan or one credit relationship can expose us to significantly greater risk of loss compared to an adverse development with respect to a one- to four-family residential real estate loan. If loans that are collateralized by real estate or other business assets become troubled and the value of the collateral has been significantly impaired, then we may not be able to recover the full contractual amount of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses which would in turn adversely affect our operating results and financial condition. Further, if we foreclose on the collateral, our holding period for the collateral may be longer than for one- to four-family real estate loans because there are fewer potential purchasers of the collateral, which can result in substantial holding costs.
The unseasoned nature of our commercial and commercial real estate portfolio may result in changes to our estimates of collectability, which may lead to additional provisions or charge-offs, which could hurt our profits.
Our commercial real estate, commercial construction and commercial loan portfolio has increased $241.9 million, or 37.8%, from $639.8 million at December 31, 2016 to $881.7 million at December 31, 2017. A large portion of our commercial real estate, commercial construction and commercial loan portfolio is unseasoned and does not provide us with a significant payment or charge-off history pattern from which to judge future collectability. Currently we estimate potential charge-offs using peer data adjusted for qualitative factors specific to us. As a result, it may be difficult to predict the future performance of this part of our loan portfolio. These loans may have delinquency or charge-off levels above our historical experience or current estimates, which could adversely affect our future performance. Further, these types of loans generally have larger balances and involve a greater risk than one- to four-family residential mortgage loans. Accordingly, if we make any errors in judgment in the collectability of our commercial or commercial real estate loans, any resulting charge-offs may be larger on a per loan basis than those incurred historically with our residential mortgage loan or consumer loan portfolios.
Our construction loans are subject to various lending risks depending on the nature of the borrower’s business, its cash flow and our collateral.
At December 31, 2017, we had $128.6 million of construction loans, representing 5.9% of our total loan portfolio at that date. Additionally, we had $143.5 million in unadvanced construction funds as of December 31, 2017. Our construction loans are based upon estimates of costs to construct and the value associated with the completed project. These estimates may be inaccurate due to the uncertainties inherent in estimating construction costs, as well as the market value of the completed project, making it relatively difficult to accurately evaluate the total funds required to complete a project and the related loan-to-value ratio. As a result, construction loans often involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project and the ability of the borrower to sell or lease the property, rather than the ability of the borrower or guarantor to repay principal and interest. Delays in completing the project may arise from labor problems, material shortages and other unpredictable contingencies. If the estimate of construction costs is inaccurate, we may be required to advance additional funds to complete construction. If our appraisal of the value of the completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project.
Our portfolio of indirect auto lending exposes us to increased credit risks.
At December 31, 2017, $513.7 million, or 23.5% of our total loan portfolio, consisted of auto loans, primarily originated through automobile dealers for the purchase of new or used automobiles. We serve customers that cover a range of creditworthiness and the required terms and rates are reflective of those risk profiles. Auto loans are inherently risky as they are often secured by assets that may be difficult to locate and can depreciate rapidly. In some cases, repossessed collateral for a defaulted auto loan may not provide an adequate source of repayment for the outstanding loan and the remaining deficiency may not warrant further substantial collection efforts against the borrower. Auto loan collections depend on the borrower's continuing financial stability, and therefore, are more likely to be adversely affected by job loss, divorce, illness, or personal bankruptcy. Additional risk elements associated with indirect lending include the limited personal contact with the borrower as a result of indirect lending through non-bank channels, namely automobile dealers.
Our business may be adversely affected by credit risk associated with residential property.
At December 31, 2017, one- to four-family residential real estate loans comprised $677.8 million, or 31.0% of our total loan portfolio, and second mortgage and equity lines of credit comprised $89.1 million, or 4.1% of our total loan portfolio. One- to four-family residential mortgage lending, whether owner occupied or non-owner occupied, is generally sensitive to regional and local economic conditions that significantly impact the ability of borrowers to meet their loan payment obligations. Declines in real estate values could cause some of our residential mortgages to be inadequately collateralized, which would expose us to a greater risk of loss if we seek to recover on defaulted loans by selling the real estate collateral.
Residential loans with combined higher loan-to-value ratios are more sensitive to declining property values than those with lower combined loan-to-value ratios and therefore may experience a higher incidence of default and severity of losses. In addition, if the borrowers sell their homes, they may be unable to repay their loans in full from the sale proceeds. For those home equity loans and lines of credit secured by a second mortgage, it is unlikely that we will be successful in recovering all or a portion of our loan proceeds in the event of default unless we are prepared to repay the first mortgage loan and such repayment and the costs associated with a foreclosure are justified by the value of the property. For these reasons, we may experience higher rates of delinquencies, default and losses on our home equity loans.
If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings and capital could decrease.
At December 31, 2017, our allowance for loan losses totaled $18.5 million, which represented 0.84% of total loans. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other assets serving as collateral for many of our loans. In determining the amount of the allowance for loan losses, we review our loans, loss and delinquency experience, and commercial and commercial real estate peer data and we evaluate other factors including, among other things, current economic conditions. If our assumptions are incorrect, or if delinquencies or non-performing loans increase, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to our allowance, which could materially decrease our net income.
In addition, our regulators, as an integral part of their examination process, periodically review the allowance for loan losses and may require us to increase the allowance for loan losses by recognizing additional provisions for loan losses charged to income, or
to charge off loans, which, net of any recoveries, would decrease the allowance for loan losses. Any such additional provisions for loan losses or charge-offs could have a material adverse effect on our financial condition and results of operations.
Changes in interest rates may hurt our profits and asset value.
Like other financial institutions, we are subject to interest rate risk. Our primary source of income is net interest income, which is the difference between interest earned on loans and investments and interest paid on deposits and borrowings. Changes in the general level of interest rates can affect our net interest income by affecting the difference between the weighted-average yield earned on our interest-earning assets and the weighted-average rate paid on our interest-bearing liabilities, or interest rate spread, and the average life of our interest-earning assets and interest-bearing liabilities. Interest rates are highly sensitive to many factors, including government monetary policies, domestic and international economic and political conditions and other factors beyond our control.
While we pursue an asset/liability strategy designed to mitigate our risk from changes in interest rates, changes in interest rates may still have a material adverse effect on our financial condition and results of operations. Changes in the level of interest rates also may negatively affect our ability to originate loans, the value of our assets and our ability to realize gains from the sale of our assets, all of which ultimately affect our earnings.
An increase in interest rates may reduce our mortgage banking revenues, which would negatively impact our non-interest income.
We sell residential mortgage loans in the secondary market, which provides a significant portion of our non-interest income. We generate mortgage banking revenues primarily from gains on the sale of mortgage loans to investors on a servicing-released and retained basis. We also earn interest on loans held for sale while they are awaiting delivery to our investors. In a rising or higher interest rate environment, our originations of mortgage loans may decrease, resulting in fewer loans that are available to be sold to investors. This would result in a decrease in mortgage banking revenues. In addition, our results of operations are affected by the amount of non-interest expenses associated with mortgage banking activities, such as salaries and employee benefits, occupancy, equipment and data processing expense and other operating costs. During periods of reduced loan demand, our results of operations may be adversely affected to the extent that we are unable to reduce expenses commensurate with the decline in mortgage loan origination activity.
We may not be able to successfully implement our strategic plan.
Our growth is essential to improving our profitability, and we expect to continue to incur expenses related to the implementation of our strategic plan, including hiring initiatives and the development and marketing of new products and services. We may not be able to successfully implement our strategic plan, and therefore may not be able to increase profitability in the timeframe that we expect or at all, and could experience a decrease in profitability.
The successful implementation of our strategic plan will require, among other things that we attract new customers that currently bank at other financial institutions in our market area or adjacent markets. In addition, our ability to successfully grow will depend on several factors, including continued favorable market conditions, the competitive responses from other financial institutions in our market area, our ability to attract and retain experienced lenders, and our ability to maintain high asset quality as we increase our loan portfolio. While we believe we have the management resources and internal systems in place to successfully manage our future growth, growth opportunities may not be available and we may not be successful in implementing our business strategy. Further, it will take time to implement our business strategy, especially for our lenders to originate enough loans and for our branch network to attract enough favorably priced deposits to generate the revenue needed to offset the associated expenses. Our strategic plan, even if successfully implemented, may not ultimately produce positive results.
Our efficiency ratio is high, and we anticipate that it may remain high, as a result of the ongoing implementation of our business strategy.
Our non-interest expense totaled $109.4 million and $114.7 million for the years ended December 31, 2017 and 2016, respectively. Although we continue to analyze our expenses and pursue efficiencies where available, our efficiency ratio remains high as a result of our implementation of our business strategy. Our efficiency ratio totaled 88.34% and 89.47% for the years ended December 31, 2017 and 2016, respectively. If we are unable to successfully implement our business strategy and increase our revenues, our profitability could be adversely affected.
The building of market share through de novo branching and expansion of our commercial lending capacity will cause our expenses to increase faster than revenues.
We intend to continue to build market share through de novo branching, the establishment of additional loan production offices and the expansion of our commercial lending capacity. There can be considerable costs involved in opening branches and loan production offices and expanding our lending capacity that generally require a period of time to generate the necessary revenues to offset their costs, especially in areas in which we do not have an established presence. Accordingly, any such business expansion can be expected to negatively impact our earnings for some period of time until certain economies of scale are reached. Our expenses could be further increased if we encounter delays in the opening of any of our new branches or loan production offices. Finally, our business expansion may not be successful after establishment.
Our wholesale funding sources may prove insufficient to replace deposits at maturity and support our future growth.
We and our bank subsidiary must maintain sufficient funds to respond to the needs of depositors and borrowers. To manage liquidity, we draw upon a number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. These sources, include Federal Home Loan Bank advances, proceeds from the sale of investments and loans, and liquidity resources at the holding company. Our ability to manage liquidity will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable costs. In addition, if we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected. Turbulence in the capital and credit markets may adversely affect our liquidity and financial condition and the willingness of certain counterparties and customers to do business with us.
We use significant assumptions and estimates in our financial models to determine the fair value of certain assets, including mortgage servicing rights, origination commitments and loans held for sale. If our assumptions or estimates are incorrect, that may have a negative impact on the fair value of such assets and adversely affect our earnings.
We use internal and third party financial models that utilize market data to value certain assets, including mortgage servicing rights when they are initially acquired and on a quarterly basis thereafter. The methodology used to estimate these values is complex and uses asset-specific collateral data and market inputs for interest and discount rates and liquidity dates. Valuations are highly dependent upon the reasonableness of our assumptions and the predictability of the relationships that drive the results of our valuation methodologies. If prepayment speeds increase more than estimated, or if delinquency or default levels are higher than anticipated, we may be required to write down the value of certain assets, which could adversely affect our earnings. Prepayment speeds are significantly impacted by fluctuations in interest rates and are therefore difficult to predict. During periods of declining interest rates, prepayment speeds increase resulting in a decrease in the fair value of the mortgage servicing rights. In addition, there can be no assurance that, even if our models are correct, these assets could be sold for our carrying value should we chose or be forced to sell them in the open market.
Strong competition within our market area could hurt our profits and slow growth.
We face intense competition in making loans and attracting deposits. Price competition for loans and deposits sometimes results in us charging lower interest rates on our loans and paying higher interest rates on our deposits and may reduce our net interest income. Competition also makes it more difficult and costly to attract and retain qualified employees. Many of the institutions with which we compete have substantially greater resources and lending limits than we have and may offer services that we do not provide. We expect competition to increase in the future as a result of legislative, regulatory and technological changes and the continuing trend of consolidation in the financial services industry. If we are not able to effectively compete in our market area, our profitability may be negatively affected. The greater resources and broader offering of deposit and loan products of some of our competitors may also limit our ability to increase our interest-earning assets or deposits.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.
We are a community bank and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our market area and nearby Boston, Massachusetts, and Providence, Rhode Island. As a community bank, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we
serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or by events beyond our control, our business and operating results may be adversely affected.
Changes in accounting standards could affect reported earnings.
The bodies responsible for establishing accounting standards, including the Financial Accounting Standards Board (“FASB”), the SEC and other regulatory bodies, periodically change the financial accounting and reporting guidance that governs the preparation of our financial statements. These changes can materially impact how we record and report our financial condition and results of operations. In some cases, we could be required to apply new or revised guidance retroactively.
Of the newly issued guidance, the most significant to us is the FASB Accounting Standards Update (ASU) 2016-13, Financial Instruments - Credit Losses (Topic 326), commonly referred to as “CECL,” which introduces new guidance for the accounting for credit losses on instruments within its scope. CECL requires loss estimates for the remaining estimated life of the financial asset using historical experience, current conditions, and reasonable and supportable forecasts. It also modifies the impairment model for debt securities available for sale and provides for a simplified accounting model for purchased financial assets with credit deterioration since their origination. The impact of this Update will be dependent on the portfolio composition, credit quality and economic conditions at the time of adoption.
Our banking business is highly regulated, which could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business.
We are subject to regulation and supervision by the Federal Reserve, and the Bank is subject to regulation and supervision by the Massachusetts Commissioner of Banks and the FDIC. Federal and state laws and regulations govern numerous matters affecting us, including changes in the ownership or control of banks and bank holding companies, maintenance of adequate capital and the financial condition of a financial institution, permissible types, amounts and terms of extensions of credit and investments, permissible non-banking activities, the level of reserves against deposits and restrictions on dividend payments. The FDIC and the Massachusetts Commissioner of Banks have the power to issue cease and desist orders to prevent or remedy unsafe or unsound practices or violations of law by banks subject to their regulation, and the Federal Reserve possesses similar powers with respect to bank holding companies. These and other restrictions limit the manner in which we and HarborOne Bank may conduct business and obtain financing.
Because our business is highly regulated, the laws, rules, regulations, and supervisory guidance and policies applicable to us are subject to regular modification and change. Changes to statutes, regulations, or regulatory policies, including changes in interpretation or implementation of statutes, regulations, or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer, and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations, or policies could result in sanctions by regulatory agencies, civil money penalties, and/or reputation damage, which could have a material adverse effect on our business, financial condition, and results of operations. See the section of Form 10-K entitled "Supervision and Regulation" for a discussion of the regulations to which we are subject.
We are subject to capital and liquidity standards that require banks and bank holding companies to maintain more and higher quality capital and greater liquidity than has historically been the case.
We became subject to new capital requirements in 2015. These new standards, which now apply and will be fully phased-in over the next several years, force bank holding companies and their bank subsidiaries to maintain substantially higher levels of capital as a percentage of their assets, with a greater emphasis on common equity as opposed to other components of capital. The need to maintain more and higher quality capital, as well as greater liquidity, and generally increased regulatory scrutiny with respect to capital levels, may at some point limit our business activities, including lending, and our ability to expand. It could also result in our being required to take steps to increase our regulatory capital and may dilute shareholder value or limit our ability to pay dividends or otherwise return capital to our investors through stock repurchases. Pursuant to the Dodd-Frank Act, we were permitted to make a one-time, permanent election to continue to exclude accumulated other comprehensive income from capital. We made this election.
An increase in FDIC or Co-operative Central Bank insurance assessments could significantly increase our expenses.
The Dodd-Frank Act eliminated the maximum Deposit Insurance Fund ratio of 1.5% of estimated deposits, and the FDIC has established a long-term ratio of 2.0%. The FDIC has the authority to increase assessments in order to maintain the Deposit Insurance
Fund ratio at particular levels. In addition, if our regulators issue downgraded ratings of the Bank in connection with their examinations, the FDIC could impose significant additional fees and assessments on us. All Massachusetts-chartered co-operative banks are required to be members of the Co-operative Central Bank, which maintains the Share Insurance Fund that insures co-operative bank deposits in excess of federal deposit insurance coverage. The Co-operative Central Bank is authorized to charge co-operative banks an annual assessment fee on deposit balances in excess of amounts insured by the FDIC. Increases in assessments by either the FDIC or the Co-operative Central Bank could significantly increase our expenses.
If we are required to repurchase mortgage loans that we have previously sold, it could negatively affect our earnings.
In connection with selling residential mortgage loans in the secondary market, our agreements with investors contain standard representations and warranties and early payment default clauses that could require us to repurchase mortgage loans sold to these investors or reimburse the investors for losses incurred on loans in the event of borrower default within a defined period after origination or, in the event of breaches of contractual representations or warranties made at the time of sale that are not remedied within a defined period after we receive notice of such breaches, or refund the profit received from the sale of a loan to an investor if the borrower pays off the loan within a defined period after origination. If we are required to repurchase mortgage loans or provide indemnification or other recourse, this could significantly increase our costs and thereby affect our future earnings.
Changes in the valuation of our securities could adversely affect us.
Most of the securities in our portfolio are classified as available-for-sale. Accordingly, a decline in the fair value of our securities could cause a material decline in our reported equity and/or net income. At least quarterly, and more frequently when warranted by economic or market conditions, management evaluates all securities classified as available-for-sale with a decline in fair value below the amortized cost of the investment to determine whether the impairment is deemed to be other-than-temporary, or "OTTI." For impaired debt securities that are intended to be sold, or more likely than not will be required to be sold, the full amount of market decline is recognized as OTTI through earnings. Credit-related OTTI for all other impaired debt securities is recognized through earnings. Non-credit related OTTI for such debt securities is recognized in other comprehensive income, net of applicable taxes. A decline in the market value of our securities portfolio could adversely affect our earnings.
Changes in the valuation of goodwill could adversely affect us.
When the purchase price of an acquired business exceeds the fair value of its tangible assets, the excess is allocated to goodwill and other identifiable intangible assets. The amount of the purchase price that is allocated to goodwill is determined by the excess of the purchase price over the net identifiable assets acquired. At December 31, 2017, our goodwill and net intangible assets totaled $13.6 million. Under current accounting standards, if we determine goodwill or intangible assets are impaired, we will be required to write down the value of these assets. We may be required to take impairment charges in the future, which would have a negative effect on our shareholders' equity and financial results.
Our growth or future losses may require us to raise additional capital in the future, but that capital may not be available when it is needed or the cost of that capital may be very high.
We are required by our regulators to maintain adequate levels of capital to support our operations, we may at some point need to raise additional capital to support continued growth.
Our ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside our control, and on our financial condition and performance. Accordingly, we may not be able to raise additional capital if needed on terms that are acceptable to us, or at all. If we cannot raise additional capital when needed, our operations could be materially impaired and our financial condition and liquidity could be materially and adversely affected. In addition, if we are unable to raise additional capital when required by the Massachusetts Commissioner of Banks or the Federal Reserve, we may be subject to adverse regulatory action.
We may incur fines, penalties and other negative consequences from regulatory violations, possibly even inadvertent or unintentional violations.
The financial services industry is subject to intense scrutiny from bank supervisors in the examination process and aggressive enforcement of federal and state regulations, particularly with respect to mortgage-related practices and other consumer compliance
matters, and compliance with anti-money laundering, Bank Secrecy Act and Office of Foreign Assets Control regulations, and economic sanctions against certain foreign countries and nationals. Enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. We maintain systems and procedures designed to ensure that we comply with applicable laws and regulations; however, some legal and regulatory frameworks provide for the imposition of fines or penalties for noncompliance even though the noncompliance was inadvertent or unintentional and even though there was in place at the time systems and procedures designed to ensure compliance. Failure to comply with these and other regulations, and supervisory expectations related thereto, may result in fines, penalties, lawsuits, regulatory sanctions, reputation damage, or restrictions on our business.
Natural disasters, acts of terrorism and other external events could harm our business.
Natural disasters can disrupt our operations, result in damage to our properties, reduce or destroy the value of the collateral for our loans and negatively affect the economies in which we operate, which could have a material adverse effect on our results of operations and financial condition. A significant natural disaster, such as a tornado, hurricane, earthquake, fire or flood, could have a material adverse impact on our ability to conduct business, and our insurance coverage may be insufficient to compensate for losses that may occur. Acts of terrorism, war, civil unrest, violence or human error could cause disruptions to our business or the economy as a whole. While we have established and regularly test disaster recovery procedures, the occurrence of any such event could have a material adverse effect on our business, operations and financial condition.
We are subject to numerous laws designed to protect consumers, including the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose community investment and nondiscriminatory lending requirements on financial institutions. The Consumer Financial Protection Bureau, the Department of Justice and other federal agencies are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the Community Reinvestment Act, the Equal Credit Opportunity Act, the Fair Housing Act or other fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions, restrictions on expansion and restrictions on entering new business lines. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations.
We face continuing and growing security risks to our information base, including the information we maintain relating to our customers.
We are subject to certain operational risks, including, but not limited to, data processing system failures and errors, inadequate or failed internal processes, customer or employee fraud and catastrophic failures resulting from terrorist acts or natural disasters. In the ordinary course of business, we rely on electronic communications and information systems to conduct our business and to store sensitive data, including financial information regarding customers. Our electronic communications and information systems infrastructure could be susceptible to cyberattacks, hacking, identity theft or terrorist activity. We have implemented and regularly review and update extensive systems of internal controls and procedures as well as corporate governance policies and procedures intended to protect our business operations, including the security and privacy of all confidential customer information. In addition, we rely on the services of a variety of vendors to meet our data processing and communication needs. No matter how well designed or implemented our controls are, we cannot provide an absolute guarantee to protect our business operations from every type of problem in every situation. A failure or circumvention of these controls could have a material adverse effect on our business operations and financial condition.
We regularly assess and test our security systems and disaster preparedness, including back-up systems, but the risks are substantially escalating. As a result, cybersecurity and the continued enhancement of our controls and processes to protect our systems, data and networks from attacks, unauthorized access or significant damage remain a priority. Accordingly, we may be required to expend additional resources to enhance our protective measures or to investigate and remediate any information security vulnerabilities or exposures. Any breach of our system security could result in disruption of our operations, unauthorized access to confidential customer information, significant regulatory costs, litigation exposure and other possible damages, loss or liability. Such costs or losses could exceed the amount of available insurance coverage, if any, and would adversely affect our earnings. Also, any failure to prevent a security breach or to quickly and effectively deal with such a breach could negatively impact customer confidence, damaging our reputation and undermining our ability to attract and keep customers.
We may not be able to successfully implement future information technology system enhancements, which could adversely affect our business operations and profitability.
We invest significant resources in information technology system enhancements in order to provide functionality and security at an appropriate level. We may not be able to successfully implement and integrate future system enhancements, which could adversely impact the ability to provide timely and accurate financial information in compliance with legal and regulatory requirements, which could result in sanctions from regulatory authorities. Such sanctions could include fines and suspension of trading in our stock, among others. In addition, future system enhancements could have higher than expected costs and/or result in operating inefficiencies, which could increase the costs associated with the implementation as well as ongoing operations.
Failure to properly utilize system enhancements that are implemented in the future could result in impairment charges that adversely impact our financial condition and results of operations and could result in significant costs to remediate or replace the defective components. In addition, we may incur significant training, licensing, maintenance, consulting and amortization expenses during and after systems implementations, and any such costs may continue for an extended period of time.
We rely on other companies to provide key components of our business infrastructure.
Third-party vendors provide key components of our business infrastructure such as internet connections, network access and core application processing. While we have selected these third party vendors carefully, we do not control their actions. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers or otherwise conduct our business efficiently and effectively. Replacing these third party vendors could also entail significant delay and expense.
If our risk management framework does not effectively identify or mitigate our risks, we could suffer losses.
Our risk management framework seeks to mitigate risk and appropriately balance risk and return. We have established processes and procedures intended to identify, measure, monitor and report the types of risk to which we are subject, including credit risk, operations risk, compliance risk, reputation risk, strategic risk, market risk and liquidity risk. We seek to monitor and control our risk exposure through a framework of policies, procedures and reporting requirements. Management of our risks in some cases depends upon the use of analytical and/or forecasting models. If the models used to mitigate these risks are inadequate, we may incur losses. In addition, there may be risks that exist, or that develop in the future, that we have not appropriately anticipated, identified or mitigated. If our risk management framework does not effectively identify or mitigate our risks, we could suffer unexpected losses and could be materially adversely affected.
Changes in tax laws and regulations and differences in interpretation of tax laws and regulations may adversely impact our financial statements.
From time to time, local, state or federal tax authorities change tax laws and regulations, which may result in a decrease or increase to our deferred tax asset. In December 2017, we recognized a write-down of $243,000 in our deferred assets in connection with the adoption of the Tax Cuts and Jobs Act.
Local, state or federal tax authorities may interpret laws and regulations differently than we do and challenge tax positions that we have taken on tax returns. This may result in differences in the treatment of revenues, deductions, credits and/or differences in the timing of these items. The differences in treatment may result in payment of additional taxes, interest, penalties, or litigation costs that could have a material adverse effect on our results.
Acquisitions may disrupt our business and dilute stockholder value.
We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us either significant market presence or the potential to expand our market footprint and improve profitability through economies of scale or expanded services.
Acquiring other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks commonly associated with acquisitions, including, among other things:
·
difficulty in estimating the value of the target company;
·
payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term;
·
potential exposure to unknown or contingent tax or other liabilities of the target company;
·
exposure to potential asset quality problems of the target company;
·
potential volatility in reported income associated with goodwill impairment losses;
·
difficulty and expense of integrating the operations and personnel of the target company;
·
inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits;
·
potential disruptions to our business;
·
potential diversion of our management’s time and attention;
·
the possible loss of key employees and customers of the target company; and
·
potential changes in banking or tax laws or regulations that may affect the target company.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
At December 31, 2017, we conducted business throughout our Southeastern Massachusetts network of 14 full-service branches, two limited service branches, a commercial loan office in Providence, Rhode Island, a lending office in Westford, Massachusetts, 13 free-standing ATMs, and two campuses providing a range of educational services through “HarborOne U”. Merrimack Mortgage Company, LLC, a subsidiary of HarborOne Bank, is a full-service mortgage lender with 34 office in Massachusetts, New Hampshire and Maine, and also does business in seven additional states. We own 10 and lease 41 of our offices. At December 31, 2017, the total net book value of our land, buildings, furniture, fixtures and equipment was $24.5 million.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
We are not involved in any material pending legal proceedings as a plaintiff or as a defendant other than routine legal proceedings occurring in the ordinary course of business. We are not involved in any legal proceedings the outcome of which we believe would be material to our financial condition or results of operations.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
(a)The Company’s shares of common stock are traded on the NASDAQ Global Select Market under the symbol “HONE”. The approximate number of shareholders of record of the Company’s common stock as of March 6, 2018 was 1,488. The number of record-holders may not reflect the number of persons or entities holding stock in nominee name through banks, brokerage firms and other nominees.
The Company completed its initial public offering on June 29, 2016, and its stock commenced trading on June 30, 2016. The following table sets forth for the periods indicated the intra-day high and low sales prices per share of common stock as reported by NASDAQ. The Company has not paid any dividends to its stockholders to date. See “Dividends” below. On March 6, 2018, the closing market price of the Company’s common stock was $19.89.
Stock Performance Graph
The Company’s shares of common stock began trading on the NASDAQ Global Select Market on June 30, 2016. Accordingly, no comparative stock performance information is available for periods ending prior to this date. The performance graph below compares the Company’s cumulative shareholder return on its common stock since inception of trading on June 30, 2016 to the cumulative total return of the Russell 2000 index of small capitalization companies and the SNL U.S. Thrift Composite comprising thrifts with total assets of $1.0 billion to $5.0 billion. The initial offering price of the Company’s shares was $10.00 per share, however the graph below depicts the cumulative return on the stock since inception of trading at $12.99 per share on June 30, 2016. Total shareholder return is measured by dividing total dividends (assuming dividend reinvestment) for the measurement period plus share price change for the period from the share price at the beginning of the measurement period. The return is based on the initial investment of $100.00.
The following information in this Item 5 of this Annual Report 10-K is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to be liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates it by reference to such filing. The stock price performance shown on the stock performance graph and associated table below is not necessarily indicative of future price performance. Information used in the graph and table was obtained from a third party provider, a source believed to be reliable, but the Company is not responsible for any errors or omissions in such information.
The following chart depicts the total return performance of the Company:
(b) Not applicable.
(c) The Company adopted a share repurchase program on October 27, 2017. The Company may repurchase up to 1,633,155 shares of the Company’s common stock, or approximately 5% of the Company’s current issued and outstanding shares.
The following table sets forth information regarding the Company’s repurchases of its common stock during the three months ended December 31, 2017.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial and other data of the Company, as of December 31, 2017 and 2016 and for the years ended December 31, 2017, 2016 and 2015, set forth below are derived in part from, and should be read in conjunction with, the Consolidated Financial Statements of the Company and Notes thereto presented elsewhere herein.
			 		
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
All material intercompany balances and transactions have been eliminated in consolidation. When necessary, certain amounts in prior year financial statements have been reclassified to conform to the current year’s presentation. The following discussion and analysis is presented to assist the reader in understanding and evaluating of the Company's financial condition and results of operations. It is intended to complement the Consolidated Financial Statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-K and should be read in conjunction therewith.
Overview
On June 29, 2016, the Company completed its conversion from the mutual holding company to the stock holding company form of organization. The Company sold 32,120,880 shares of common stock at $10.00 per share, including 17,281,188 shares to the MHC. The Company’s principal subsidiary is the Bank. The Bank is a state chartered co-operative bank whose primary subsidiary is a residential mortgage company, Merrimack Mortgage Company, LLC., acquired on July 1, 2015.
As described in the notes to Consolidated Financial Statements, we have two reportable segments: HarborOne Bank and Merrimack Mortgage. The Bank segment provides consumer and business banking products and services to customers. Consumer products include loan and deposit products, and business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The Merrimack Mortgage segment consists of originating residential mortgage loans primarily for sale in the secondary market and the servicing of those loans.
The HarborOne Bank segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses. The Merrimack Mortgage segment generates the significant majority of our noninterest income. We have provided below a discussion of the material results of operations for each segment on a separate basis for the year ended December 31, 2017 and 2016, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of the Company, which includes the operations of HarborOne Bank and Merrimack Mortgage, for the same periods.
For revenue, net income, assets, and other financial information for each of the Company’s reportable segments, see Part II, Item 8. “Financial Statements and Supplementary Data - Note 23: Segment Reporting.”
Critical Accounting Policies
Certain of our accounting policies, which are important to the portrayal of our financial condition, require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates associated with these policies are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Our significant accounting policies are discussed in detail in Note 1 to our Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K.
The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an "emerging growth company" we have elected to use the extended transition period to delay adoption of new or revised accounting pronouncements applicable to public companies until such pronouncements are made applicable to private companies. Accordingly, our Consolidated Financial Statements may not be comparable to the financial statements of public companies that comply with such new or revised accounting standards. As of December 31, 2017, there is no significant difference in the comparability of the financial statements as a result of the extended transition period.
Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions. Management believes that the most critical accounting policies, which involve the most complex or subjective decisions or assessments, are as follows:
Allowance for Loan Losses. The allowance for loan losses is the amount estimated by management as necessary to cover losses inherent in the loan portfolio at the balance sheet date. The allowance is established through the provision for loan losses, which
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
is charged to income. The allowance consists of general, allocated and unallocated components. Determining the amount of the allowance for loan losses necessarily involves a high degree of judgment. Among the material estimates required to establish the allowance are: the likelihood of default; the loss exposure at default; the amount and timing of future cash flows on impaired loans; the value of collateral; and the determination of loss factors to be applied to the various elements of the portfolio. All of these estimates are susceptible to significant change. Management reviews the level of the allowance at least quarterly and establishes the provision for loan losses based upon an evaluation of the portfolio, past loss experience, current economic conditions and other factors related to the collectability of the loan portfolio. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic or other conditions differ substantially from the assumptions used in making the evaluation. In addition, the FDIC and the Massachusetts Commissioner of Banks, as an integral part of their examination process, periodically review our allowance for loan losses and may require us to recognize adjustments to the allowance based on their judgments about information available to them at the time of their examination. A large loss could deplete the allowance and require increased provisions to replenish the allowance, which would adversely affect earnings. See Note 6, “Loans” within Notes to Consolidated Financial Statements included in item 8 of this annual report.
Goodwill. The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized for the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Identifiable intangible assets include core deposit premium and non-compete contracts and are being amortized on a straight-line basis over their estimated lives. Management assesses the recoverability of goodwill at least on an annual basis and all intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. The impairment test uses a combined qualitative and quantitative approach. The initial qualitative approach assesses whether the existence of events or circumstances led to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after this assessment, the Company determines that it is more likely than not that the fair value is less than the carrying value, a quantitative impairment test is performed. The quantitative impairment test compares book value to the fair value of the reporting unit. If the carrying amount exceeds fair value, an impairment charge is recorded through earnings. Management has identified two reporting units for purposes of testing goodwill for impairment. The Company’s reporting units are the same as the segments used for segment reporting - the Bank, including the two security corporations, and MMC.
Deferred Tax Assets. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. Management reviews deferred tax assets on a quarterly basis to identify any uncertainties pertaining to realization of such assets. In determining whether a valuation allowance is required against deferred tax assets, management assesses historical and forecasted operating results, including a review of eligible carryforward periods, tax planning opportunities and other relevant considerations. We believe the accounting estimate related to the valuation allowance is a critical estimate because the underlying assumptions can change from period to period. For example, tax law changes or variances in future projected operating performance could result in a change in the valuation allowance. Should actual factors and conditions differ materially from those used by management, the actual realization of net deferred tax assets could differ materially from the amounts recorded in the financial statements. If we were not able to realize all or part of our deferred tax assets in the future, an adjustment to the related valuation allowance would be charged to income tax expense in the period such determination was made and could have a negative impact on earnings. In addition, if actual factors and conditions differ materially from those used by management, we could incur penalties and interest imposed by taxing authorities.
Derivatives. Derivative instruments are used in relation to our mortgage banking activities and require significant judgment and estimates in determining their fair value. We hold derivative instruments, which consist of interest rate lock agreements related to expected funding of fixed-rate mortgage loans to customers and forward commitments to sell mortgage loans. Our objective in obtaining the forward commitments is to mitigate the interest rate risk associated with the interest rate lock commitments and the mortgage loans that are held for sale. Derivatives related to these commitments are recorded as either a derivative asset or a derivative liability in the balance sheet and are measured at fair value, with adjustments recorded in “Mortgage banking income”.
Mortgage Servicing Rights. We recognize the rights to service mortgage loans for others as a separate asset referred to as “mortgage servicing rights” or “MSRs”. MSRs are generally recognized when loans are sold and the servicing is retained by us and are recorded at fair value. We base the fair value of our MSRs on a valuation performed by a third-party valuation specialist. This specialist determines fair value based on the present value of estimated future net servicing income cash flows, and incorporates assumptions that market participants would use to estimate fair value, including estimates of prepayment speeds, discount rates, default rates, servicing costs, contractual servicing fee income, and ancillary income. Changes in the fair value of MSRs occur primarily in connection with the collection/realization of expected cash flows, as well as changes in the valuation inputs and assumptions. Changes in the fair value of residential MSRs are reported in “Mortgage banking income”.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Please see the Notes to the Consolidated Financial Statements for additional discussion of accounting policies.
Comparison of Financial Condition at December 31, 2017 and December 31, 2016
Total Assets. Total assets increased $236.6 million, or 9.7%, to $2.68 billion at December 31, 2017 from $2.45 billion at December 31, 2016. The increase was primarily due to a $194.7 million, or 9.8% increase in net loans as we continued to focus on commercial loan growth.
Cash and Cash Equivalents. At December 31, 2017 cash and cash equivalents were $80.8 million, an increase of 60.9% from $50.2 million. The increase was primarily due to HarborOne Bancorp, Inc.’s participation in the Bank’s reciprocal deposit program that was established in June of 2017. Through the program, $38.0 million of the Company’s $69.4 million deposit at the Bank was converted to multiple deposits at other financial institutions which are not eliminated in consolidation.
Loans Held for Sale. Loans held for sale at December 31, 2017 were $59.5 million, a decrease of $26.9 million from $86.4 million at December 31, 2016, primarily due to a decrease in mortgage origination activity. Of the loans held for sale at December 31, 2017, $55.5 million were originated by Merrimack Mortgage and $4.0 million were originated by the Bank.
Loans, net. At December 31, 2017, net loans were $2.18 billion, an increase of $194.7 million, or 9.8%, from $1.98 billion at December 31, 2016, primarily due to an increase in commercial real estate, commercial, and construction loans, reflecting the continued execution of our commercial loan growth strategy. Commercial real estate loans increased $159.6 million, or 32.2%, to $655.4 million at December 31, 2017 from $495.8 million at December 31, 2016. Commercial loans increased $9.0 million, or 9.0%, to $109.5 million at December 31, 2017 and construction loans increased $70.2 million, or 120.1%, to $128.6 million at December 31, 2017, primarily due to commercial construction loan originations and disbursements. Consumer loans decreased $35.3 million, or 6.3%, including the sale of $5.0 million of indirect auto loans. Our residential portfolio decreased by $4.0 million, or 0.5%, for the same period due to decreased mortgage loan demand in 2017 as interest rates increased and resulted in our portfolio payoffs outpacing originations. The allowance for loan losses was $18.5 million at December 31, 2017 and $17.0 million December 31, 2016.
The following table provides the composition of our loan portfolio at the dates indicated:
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The following table sets forth our loan originations, sales, purchases and principal repayment activities during the periods indicated:
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The following table sets forth certain information at December 31, 2017 regarding scheduled contractual maturities during the period indicated. The table does not include any estimate of prepayments. Demand loans having no stated schedule of repayments and no stated maturity are reported as due in one year or less. The following table also sets forth the rate structure of loans scheduled to mature after one year. The amounts shown below exclude net deferred loan fees.
Generally, the actual maturity of loans is shorter than their contractual maturity due to prepayments. The average life of residential real estate loans are impacted by the current interest rate environment. The average life tends to increase when current mortgage loan rates are higher than the rates of the loans in the portfolio and decrease when current rates are lower than the rates of the loans in the portfolio. Also, commercial and commercial real estate loans may be renewed at or near maturity resulting in significant differences in principal payments actually received as compared to amounts contractually due in a period.
Securities. Total investment securities at December 31, 2017 were $217.7 million, an increase of $33.4 million, or 18.1%, from December 31, 2016. The purchase of $59.2 million of securities were partially offset by $25.8 million in prepayments, calls and amortization of securities. The total security portfolio was 8.1% of total assets as of December 31, 2017 as compared to 7.5% as of December 31, 2016. The following table provides the composition of our securities available for sale and our securities held to maturity at the dates indicated:
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The following table sets forth the stated maturities and weighted average yields of investment securities at December 31, 2017:
Mortgage servicing rights. Mortgage servicing rights are created as a result of our mortgage banking origination activities and accounted for at fair value. At December 31, 2017, we serviced mortgage loans for others with an aggregate outstanding principal balance of $1.93 billion. Total mortgage servicing rights were $21.1 million at December 31, 2017, compared to $20.3 million at December 31, 2016. The $759,000 increase was primarily due to new loan servicing rights added partially offset by changes in market interest rates and loan repayments.
The following table represents the activity for mortgage servicing rights and the related fair value changes during the periods noted:
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The fair value of our mortgage servicing rights is determined by a third party provider that determines the appropriate prepayment speed, discount and default rate assumptions based on our portfolio. Any measurement of fair value is limited by the conditions existing and assumptions made at a particular point in time. Those assumptions may not be appropriate if they are applied to a different point in time. The following table presents weighted average assumptions utilized in determining the fair value of mortgage servicing rights at December 31, 2017 and 2016:
Prepayment speeds are significantly impacted by mortgage rates. Decreasing mortgage rates normally encourage increased mortgage refinancing activity, which reduces the life of the loans underlying the mortgage servicing rights, thereby reducing the value of mortgage servicing rights.
Management has made the strategic decision not to hedge mortgage servicing assets at this point. Therefore, any future declines in interest rates would likely cause further decreases in the fair value of the mortgage servicing rights, and a corresponding detriment to earnings, whereas increases in interest rates would result in increases in fair value, and a corresponding benefit to earnings. Management may choose to hedge the mortgage servicing assets in the future or limit the balance of mortgage servicing rights by selling them or selling loans with the servicing released.
Deposits. Deposits increased $209.0 million, or 11.6%, to $2.01 billion at December 31, 2017 from $1.80 billion at December 31, 2016. The following table sets forth information concerning the composition of deposits:
The growth in deposits was driven by an increase of $60.2 million in retail deposits, $51.0 million in municipal deposits and $97.8 million in wholesale deposits. Wholesale deposits includes brokered deposits of $73.5 million, $30.4 million in certificates of deposits from institutional investors, $10.0 million provided through the Certificate of Deposit Account Registry Service(“CDARS”) and $38.0 million in deposits from HarborOne Bancorp, Inc. The Bank participates in a reciprocal deposit program that converts the Company’s deposit at the Bank into multiple deposits at other financial institutions which are not eliminated in consolidation. The reciprocal deposit program provides access to FDIC-insured deposit products in aggregate amounts exceeding the current limits for depositors. Total deposits includes $174.2 million in reciprocal deposits, including the Company’s $38.0 million deposit and $116.0 million in municipal deposits. The wholesale deposits provide a channel for the Company to seek additional funding outside the Bank’s core market. The increase in retail money market accounts reflects demand for our competitively priced products in the rising interest rate environment. During the year ended December 31, 2017, we continued to focus on enhancing our deposit mix in order to better manage our cost of funds and to expand our customer relationships.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The following table sets forth the average balances and weighted average rates of our deposit products at the dates indicated:
The following table sets forth our certificates of deposit classified by interest rate as of the dates indicated:
The following table sets forth the amount and maturities of our certificates of deposit by interest rate at December 31, 2017:
The following table sets forth the maturity of certificates of deposit of $100,000 or more as of December 31, 2017:
Borrowings. Total borrowings from the FHLB were $290.3 million at December 31, 2017, an increase of $15.2 million from $275.1 million at December 31, 2016. The increase reflects $91.2 million in long-term FHLB borrowings to extend short-term borrowings, which decreased $36.0 million, partially offset by $40.0 million in maturities of FHLB borrowings.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The following table sets forth information concerning balances and interest rates on our borrowings at the dates and for the periods indicated:
Stockholders’ equity. Total stockholders’ equity was $343.5 million at December 31, 2017 compared to $329.4 million at December 31, 2016. The increases from the prior period reflect the Company’s $10.4 million in net income, $2.1 million from the issuance of stock-based compensation and $1.1 million from ESOP shares committed.
Comparison of Results of Operations for the Years Ended December 31, 2017 and 2016
HarborOne Bancorp, Inc. Consolidated
Overview. Consolidated net income for the year ended December 31, 2017 was $10.4 million compared to net income of $5.9 million for the year ended December 31, 2016. One-time items impacting 2017 net income include a $1.2 million reversal of a contingent consideration accrual for the acquisition of Merrimack Mortgage Company, LLC that was settled in the fourth quarter and is included in other income, an accrual of $925,000 to freeze the director’s post retirement benefit plan included in other expenses and a charge of $243,000 related to the revaluation of the Company’s net deferred tax assets as a result of the enactment of the Tax Cuts and Jobs Act of 2017 (the “Tax Act of 2017”), which is included in the income tax provision. The 2016 results include a one-time, pre-tax contribution of $4.8 million to establish the Foundation.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Average Balances and Yields. The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated, on a consolidated basis. Interest income on tax-exempt securities has been adjusted to a fully taxable-equivalent (FTE) basis using a federal tax rate of 35%. All average balances are daily average balances. Non-accrual loans were included in the computation of average balances, but have been reflected in the table as loans carrying a zero yield. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Rate/Volume Analysis. The following table presents, on a tax equivalent basis, the effects of changing rates and volumes on our net interest income for the periods indicated, on a consolidated basis. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The total column represents the sum of the prior columns. For purposes of this table, changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately based on the changes due to rate and the changes due to volume.
Interest and Dividend Income. Interest and dividend income increased $15.5 million, or 20.8% in 2017, compared to 2016, primarily reflecting the repositioning of the balance sheet to higher yielding commercial loans. Loan income increased $14.0 million to $83.9 million, average loans increased by $234.5 million and the yield increased 25 basis points from a year ago.
Interest Expense. Compared to 2016, interest expense for the year ended December 31, 2017 increased $2.2 million, or 15.8% to $15.9 million from $13.8 million. The increase reflects an increase in average interest bearing deposits of 11.3% combined with a 8 basis point increase in cost of deposit funds, partially offset by an increase in average FHLB borrowings of 12.1% that was tempered by a 25 basis point decrease in borrowing costs. Borrowing maturities repriced at lower rates during 2017 resulting in the 25 basis improvement in borrowing costs.
Net Interest and Dividend Income. Compared to 2016, net interest and dividend income for the year ended December 31, 2017 increased $13.4 million, or 21.9%, to $74.3 million from $61.0 million. The tax equivalent net interest spread increased 17 basis points to 2.88% for the year ended December 31, 2017 from 2.71% for the year ended December 31, 2016, and net interest margin on a tax equivalent basis increased 19 basis points to 3.04% for the year ended December 31, 2017 from 2.85% for the year ended December 31, 2016.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Segments. The company has two reportable segments: HarborOne Bank and Merrimack Mortgage. Revenue from HarborOne Bank consists primarily of interest earned on loans and investment securities and service charges on deposit accounts. Revenue from Merrimack Mortgage is comprised of interest earned on loans and fees received as a result of the residential mortgage origination, sale and servicing process. The table below shows the results of operations for the Company’s segments HarborOne Bank and Merrimack Mortgage for the years ended December 31, 2017 and 2016, and the increase or decrease in those results.
HarborOne Bank Segment
Results of Operations for the Years Ended December 31, 2017 and 2016.
Net Income. Bank net income for the year ended December 31, 2017 increased $2.8 million to $7.5 million from $4.7 million for the year ended December 31, 2016. The increase in net income reflects an increase of $13.4 million in net interest income and a $1.8 million decrease in provision for loan losses partially offset by a $920,000 decrease in noninterest income, a $6.2 million increase in noninterest expense, and a $5.2 million increase in the income tax provision.
Provision for Loan Losses. We recorded a provision for loan losses of $2.4 million for the year ended December 31, 2017 compared to $4.2 million for the year ended December 31, 2016. The provision reflects the continued growth in commercial loans shifting the composition of the loan portfolio to a higher percentage of commercial lending, which requires a higher level of loan loss reserves than loans secured by automobiles and residential property. Despite a similar commercial portfolio growth level in 2017 as compared to 2016, the provision was lower in 2017 due to updated peer data that resulted in lower general reserve rates on the commercial portfolio. Due to a lack of historical loss experience for our commercial real estate and commercial loan portfolio, we utilize peer loss data for general reserves. The level of net charge-offs was flat, recording $895,000 for the year ended December 31, 2017 as compared to $904,000 for the year ended December 31, 2016. Additionally, credit quality improved as nonaccrual loans declined to $17.9 million at December 31, 2017 from $21.2 million at December 31, 2016.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Noninterest Income. Compared to the year ended December 31, 2016, total noninterest income for the year ended December 31, 2017 decreased $920,000, or 4.6%, to $19.3 million from $20.2 million. The following table sets forth the components on non-interest income:
Total mortgage banking income decreased $2.1 million or 52.1% primarily due to a decrease in mortgage loan originations and sales of approximately 50.0% as compared to 2016. The higher mortgage interest rates and tight real estate inventories contributed to the decreased demand for residential real estate loans.
Deposit account fees increased $647,000 or 5.6% primarily due to increased debit card interchange income.
Other noninterest income increased $899,000 or 35.4% primarily due to a $1.2 million reversal of contingent consideration for the Merrimack Mortgage earn-out agreement that was settled in full in the fourth quarter of 2017. The earn-out was settled in anticipation of a consolidation of Merrimack Mortgage and the Bank’s residential mortgage lending division in 2018.
Noninterest Expense. Noninterest expense for the year ended December 31, 2017 increased $6.2 million, or 9.1% to $74.5 million from $68.3 million for the year ended December 31, 2016. The following table sets forth the components on noninterest expense:
Compensation and benefits increased $2.3 million or 5.9%. Contributing to the increase was a $1.9 million increase in salary expense due to a full year of expense for commercial lending and credit support staff and annual salary increases. Also contributing to the increase was an equity awards program for Bank employees established by the Company in 2017 that amounted to $1.5 million in
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
expense. The increases were partially offset by a $703,000 decrease in supplemental retirement expense due to additional expenses in 2016 for full vesting of the supplemental retirement for an executive.
Occupancy and equipment increased $963,000 or 11.3% primarily due to increased software licensing costs and other technology and equipment costs.
Marketing increased $1.0 million or 42.9% related to marketing costs to broaden our market reach and brand name recognition.
Professional fees increased $1.2 million or 59.2% due to increased consulting and audit and tax expenses.
Other expenses increased $858,000 or 22.8% and primarily reflects a $925,000 expense accrual to freeze the director postretirement benefit plan.
Income Tax Provision. For the year ended December 31, 2017, the Bank recorded an expense of $7.4 million representing an effective tax rate of 49.6%. For the year ended December 31, 2016, the tax provision expense was $2.2 million representing an effective tax rate of 32.0%. The effective tax rate increase reflects the impact of the enactment of the Tax Act of 2017. The Tax Act of 2017 resulted in significant changes to the U.S. tax code, including a reduction in the top corporate income tax rate from 35% to 21% effective January 1, 2018. As a result of the reduction in tax rate, the Bank revalued its net deferred tax asset as of the enactment date and recorded an additional $2.0 million tax provision in 2017.
Merrimack Mortgage Segment
Results of Operations for the Year Ended December 31, 2017 and 2016.
Net Income. Merrimack Mortgage recorded net income $3.8 million for the year ended December 31, 2017 as compared to $4.1 million for the year ended December 31, 2016. The Merrimack Mortgage segment’s results are heavily impacted by prevailing rates, refinancing activity and home sales.
Noninterest Income. For the years ended December 31, 2017 and 2016, noninterest income totaled $35.3 million and $46.9 million, respectively. Noninterest income is primarily from mortgage banking income for which the following table provides further detail:
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
In the years ended December 31, 2017 and 2016, Merrimack Mortgage originated $1.02 billion and $1.36 billion, respectively of residential mortgage loans. The following tables provide additional loan production detail (dollars presented in thousands):
Overall, gain on sale of mortgage loans decreased $10.8 million or 26.8% due to decreased residential mortgage demand largely a result of decreased refinance activity in 2017. Included in the gain on mortgage sales was $2.2 million of originated mortgage servicing rights for the year ended December 31, 2017 as compared to $7.4 million for the year ended December 31, 2016. The decrease in originated mortgage servicing rights is due to a decrease in volume of servicing-retained sales in 2017 due in part to better pricing on servicing-released mortgage sales in 2017.
Processing, underwriting and closing fees decreased $1.1 million or 23.2% consistent with the decrease in origination volume.
Secondary market loan servicing fees, net of guarantee fees increased $1.1 million or 42.9% due to the increase in loans serviced. At December 31, 2017, the unpaid balance of the servicing portfolio totaled $1.39 billion as compared to $1.21 billion at December 31, 2016.
During the year ended December 31, 2017, the fair value of mortgage servicing rights decreased $1.3 million as compared to a decrease of $352,000 in 2016. The 10 year Treasury Constant Maturity rate (“10 year CMT”) decreased 5 basis points for the twelve months ended December 31, 2017 as compared to an increase of 18 basis points for the 12 months ended December 31, 2016. The 10 year CMT decreased 50 basis points in the first quarter of 2016 and, despite increasing, the losses recorded during 2016 were not fully recovered. Decreasing interest rates generally result in a decrease in mortgage servicing rights fair value as the assumed prepayment speeds of the underlying mortgage loans tend to increase. Conversely, as interest rates rise and prepayment speeds slow, mortgage servicing rights fair value tends to increase. At December 31, 2017 and 2016, mortgage servicing rights were $16.0 million and $15.1 million, respectively.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Noninterest Expense. Noninterest expense decreased $7.5 million or 18.0%, to $34.2 million for the year ended December 31, 2017 from $41.7 million. The following table sets forth the components on noninterest expense:
Compensation and benefits decreased $5.0 million or 16.6% due to the decrease in closed loan volume in 2017 as compared to 2016 resulting in a decrease in commission expense of $3.8 million. Additionally, Merrimack Mortgage paid $281,000 in incentives and other benefits in 2017 as compared to $1.4 million in 2016.
Occupancy and equipment increased $511,000 or 30.7% primarily due to a conversion to a new mortgage origination system in anticipation of the integration of Merrimack Mortgage and the Bank’s residential lending group.
Loan expense decreased $2.9 million or 34.5% due to the decrease in closed loan volume in 2017 as compared to 2016.
Income Tax Provision. For the year ended December 31, 2017, Merrimack Mortgage recorded a tax benefit of $998,000 and for the year ended December 31, 2016, a tax provision expense of $3.1 million. The net tax benefit in 2017 is due to a $2.2 million benefit recorded as a result of the revaluation of deferred tax liabilities, primarily related to mortgage servicing rights, due to the Tax Act of 2017.
Comparison of Consolidated Results of Operations for the Years Ended December 31, 2016 and 2015
HarborOne Bancorp, Inc. Consolidated
Overview. Consolidated net income for the year ended December 31, 2016 was $5.9 million compared to net income of $5.8 million for the year ended December 31, 2015. The Company was formed as a mutual holding company to a stock holding company on June 29, 2016. The 2016 results include a one-time contribution of $4.8 million to The HarborOne Foundation.
Interest and Dividend Income. Interest and dividend income increased $8.0 million, or 11.9%, compared to the year ended December 31, 2015, primarily reflecting the repositioning of the balance sheet to higher yielding commercial loans. Loan income increased $8.5 million to $70.0 million and average loans increased by $184.9 million from the prior year.
Interest Expense. Compared to the same period in 2015, interest expense for the year ended December 31, 2016 decreased $814,000, or 5.6% to $13.8 million from $14.6 million. The decrease reflects a decrease in average FHLB borrowing of 16.0% combined with a 5 basis point increase in FHLB borrowing costs, partially offset by average deposit growth of 4.8% that was tempered by a 3 basis point decrease in cost of deposit funds. Average FHLB borrowings decreased due to the prepayment of FHLB borrowings in the second quarter of 2016.
Net Interest and Dividend Income. Compared to 2015, net interest and dividend income for the year ended December 31, 2016 increased $8.8 million, or 16.8%, to $61.0 million from $52.2 million. The tax equivalent net interest spread increased 21 basis points to 2.71% for the year ended December 31, 2016 from 2.50% for the year ended December 31, 2015, and net interest margin on a tax equivalent basis also increased 24 basis points to 2.85% for the year ended December 31, 2016 from 2.61% for the year ended December 31, 2015.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The table below shows the results of operations for the Company’s segments HarborOne Bank and Merrimack Mortgage for the years ended December 31, 2016 and 2015, the increase or decrease in those results.
HarborOne Bank Segment
Net Income. Bank net income for the year ended December 31, 2016 increased $324,000 to $4.7 million from $4.4 million for the year ended December 31, 2015. The increase in net income reflects an increase of $8.0 million in net interest income and $2.8 million in noninterest income partially offset by increases of $7.0 million in noninterest expense, $2.9 million in provision for loan losses and $564,000 in income tax provision.
Provision for Loan Losses. We recorded a provision for loan losses of $4.2 million for the year ended December 31, 2016 compared to $1.3 million for the year ended December 31, 2015. The increase in provision reflects the continued growth in commercial loans shifting the composition of the loan portfolio to a higher percentage of commercial lending, which requires a higher level of loan loss reserves than loans secured by automobiles and residential property. The increase was partially offset by a decrease in the level of net charge-offs to $904,000 for the year ended December 31, 2016 compared to $1.5 million for the same period in 2015. Additionally, credit quality improved as nonaccrual loans declined to $21.2 million at December 31, 2016 from $29.4 million at December 31, 2015.
Noninterest Income. Compared to the year ended December 31, 2015, total noninterest income for the year ended December 31, 2016 increased $2.8 million, or 16.3%, to $20.2 million from $17.3 million. Total mortgage banking income increased $1.9 million as other mortgage banking income increased $1.9 million. Other noninterest income increased $968,000 or 6.4%, to $16.1 million for the year ended December 31, 2016. The components of the increase include $380,000 related to the income recognized on commercial loan swaps and a deposit fee income increase of $470,000, primarily due to increased debit card interchange income.
Noninterest Expense. Noninterest expense for the year ended December 31, 2016 increased $7.0 million, or 11.4% to $68.3 million from $61.2 million for the year ended December 31, 2015. The increase primarily reflects increased compensation and benefit costs of $6.6 million, as the Bank continued it’s hiring of additional commercial lending and credit support staff during 2016. The significant compensation and benefit increases were $2.5 million in salaries, $1.2 million in ESOP expense and $1.2 million in incentive plan expenses. Other elements of the year over year increase in noninterest expense are increases in marketing expense of $554,000, data processing of $437,000 and loan expenses of $316,000 offset by decreases in prepayment penalties on FHLB borrowings of $580,000 and other expenses of $404,000. The decrease in other expenses was primarily due to a decrease in expenses related to strategic initiatives in 2016.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Income Tax Provision. For the year ended December 31, 2016, the Bank recorded an expense of $2.2 million representing an effective tax rate of 32.0%. For the year ended December 31, 2015, the tax provision expense was $1.6 million representing an effective tax rate of 27.3%. The effective rate for 2016 was negatively impacted by nondeductible expenses related to the ESOP and the stock offering.
Merrimack Mortgage Segment
Results of Operations for the Year Ended December 31, 2016 and Since Acquisition on July 1, 2015 to December 31, 2015.
Results of operations for the periods ended December 31, 2016 and 2015 are discussed below. The Bank acquired Merrimack Mortgage on July 1, 2015.
Net Income. Merrimack Mortgage recorded net income $4.1 million for the year ended December 31, 2016. For the six months ended December 31, 2015 net income was $1.4 million.
Noninterest Income. During the year ended December 31, 2016, noninterest income totaled $46.9 million. Included in this amount was gains on sale of mortgage loans of $40.2 million and loan fees, including servicing related income, of $6.8 million. For the six months ended December 31, 2015, noninterest income was $18.0 million, including $15.0 million in gains on sales of mortgage loans and $3.0 million in loan fees.
In the year ended December 31, 2016, Merrimack Mortgage originated $1.36 billion of residential mortgage loans and for the six months ended December 31, 2015 $547.8 million loans were originated.
Included in the gain on mortgage sales was $7.4 million of originated mortgage servicing rights for the year ended December 31, 2016. Originated mortgage serving rights were $2.6 million for the six months ended December 31, 2015. During the year ended December 31, 2016, Merrimack Mortgage sold $733.0 million of loans to Freddie Mac, Fannie Mae and to the Government National Mortgage Association (“Ginnie Mae”) and recorded an average originated mortgage servicing right gain of 1.00% of the underlying mortgage amount. For the six months ended December 31, 2015, there were $259.0 million of agency loan sales at an average originated mortgage servicing right gain of 1.02%.
Merrimack Mortgage’s mortgage loan servicing activities for the year ended December 31, 2016 consisted of $4.6 million in processing, underwriting and closing fees from customers and secondary market loan servicing fees, net of loan guarantee fees of $2.5
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
million. For the six months ended December 31, 2015, processing, underwriting and closing fees were $2.0 million and secondary market loan servicing fees, net of guarantee fees were $728,000. At December 31, 2016, the unpaid balance of the servicing portfolio totaled $1.21 billion as compared to $708.7 million at December 31, 2015.
During the year ended December 31, 2016 the fair value of mortgage servicing rights decreased $352,000 as compared to an increase of $283,000 in 2015. Decreasing interest rates generally result in a decrease in mortgage servicing rights fair value as the assumed prepayment speeds of the underlying mortgage loans tend to increase. Conversely, as interest rates rise and prepayment speeds slow, mortgage servicing rights fair value tend to increase. Although rates had begun to rise at the end of 2016 they had not fully recovered which resulted in the decrease in mortgage servicing rights fair value for 2016.
Noninterest Expense. Noninterest expense for the year ended December 31, 2016 was $41.7 million, compensation and benefits expense was $29.8 million, including $8.6 million in salary expense and $17.4 million in commission related expenses, or 1.28% of closed loan volume. Additionally, loan expenses were $8.3 million and included $6.8 million of direct loan origination expenses associated with the origination of $1.36 billion of mortgage loans and sub-servicing related expenses were $684,000. Occupancy expenses were $1.7 million for the year ended December 31, 2016 and is primarily rent.
Compensation and benefit expenses totaled $12.5 million for the six months ended December 31, 2015. Salary expense was primarily commission-related expenses of $7.1 million, or 1.31% of closed loan volume. Loan expenses totaled $2.8 million for the six months ended December 31, 2015, and included direct loan origination expenses of $1.9 million associated with the origination of $547.8 million of mortgage loans, $333,000 for subservicing expenses and $200,000 in repurchase reserve expense. Occupancy expense totaled $853,000 for the six months ended December 31, 2015, and primarily consisted of rent expense.
Asset Quality
The following table provides information with respect to our nonperforming assets, and troubled debt restructurings, at the dates indicated. We did not have any accruing loans past due 90 days or more at the dates presented.
Income related to impaired loans included in interest income for the years ended December 31, 2017, 2016 and 2015, amounted to $2.3 million, $2.7 million and $3.0 million, respectively. If nonperforming and restructured loans had been performing in accordance with their original terms, we estimate the income earned on those loans to be $2.3 million, $2.7 million and $3.2 million for the years ended December 31, 2017, 2016 and 2015, respectively.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The Company utilizes a ten grade internal loan rating system for commercial real estate, commercial construction and commercial loans. Loans not rated consist primarily of residential construction loans and certain smaller balance commercial real estate and commercial loans that are managed by exception.
The following table presents our risk rated loans considered classified or special mention in accordance with our internal risk rating system:
None of the special mention assets at December 31, 2017, 2016 or 2015 were on nonaccrual.
			 		
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
At December 31, 2017, our allowance for loan losses was $18.5 million, or 0.84% of total loans and 103.55% of nonperforming loans. At December 31, 2016, our allowance for loan losses was $17.0 million, or 0.85% of total loans and 80.12% of nonperforming loans. Nonperforming loans at December 31, 2017 were $17.9 million, or 0.81% of total loans, compared to $21.2 million, or 1.06% of total loans, at December 31, 2016. The allowance for loan losses is maintained at a level that represents management’s best estimate of losses in the loan portfolio at the balance sheet date. However, there can be no assurance that the allowance for loan losses will be adequate to cover losses which may be realized in the future or that additional provisions for loan losses will not be required.
Delinquencies. The following table provides information about delinquencies in our loan portfolio at the dates indicated.
			 		
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
The following table sets forth the breakdown of the allowance for loan losses by loan category at the dates indicated:
			 		
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Analysis of Loan Loss Experience. The following table sets forth an analysis of the allowance for loan losses for the periods indicated:
For the years ended December 31, 2017 and 2016, we recorded a provision for loan losses of $2.4 million and $4.2 million, respectively. This decrease reflects commercial and commercial real estate loan growth partially offset by lower general reserves on the commercial portfolio based on updated peer data. Additionally general reserves on residential real estate decreased as the historical charge off rate base improved. Charge off rates, as the basis for residential real estate and consumer loan general reserve allocations, directly impact the allowance for loan loss analysis as does lower allocated reserves resulting from the improved credit quality.
Management of Market Risk
Net Interest Income Analysis. The Bank uses income simulation as the primary tool for measuring interest-rate risk inherent in our balance sheet at a given point in time by showing the effect on net interest income, over specified time frames and using different interest rate shocks and ramps. The assumptions include, but are not limited to, management’s best assessment of the effect of changing interest rates on the prepayment speeds of certain assets and liabilities, projections for account balances in each of the product lines offered and the historical behavior of deposit rates and balances in relation to changes in interest rates. These assumptions are inherently changeable, and as a result, the model is not expected to precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income. Actual results will differ from the simulated results due to timing, magnitude, and frequency of interest rate changes as well as changes in the balance sheet composition and market conditions. Assumptions are supported with quarterly back testing of the model to actual market rate shifts.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
As of December 31, 2017, net interest income simulation results for the Bank indicated that our exposure over one year to changing interest rates was within our guidelines. The following table presents the estimated impact of interest rate changes on our estimated net interest income over one year:
Economic Value of Equity Analysis. The Bank also uses the net present value of equity at risk, or "EVE," methodology. This methodology calculates the difference between the present value of expected cash flows from assets and liabilities. The comparative scenarios assume an immediate parallel shift in the yield curve up 300 basis points and down 100 basis points.
The board of directors and management review the methodology’s measurements for both net interest income and EVE on a quarterly basis to determine whether the exposure resulting from the changes in interest rates remains within established tolerance levels and develops appropriate strategies to manage this exposure.
The table below sets forth, as of December 31, 2017, the estimated changes in the net economic value of equity that would result from the designated changes in the United States Treasury yield curve under an instantaneous parallel shift for the Bank. Computations of prospective effects of hypothetical interest rate changes are based on numerous assumptions, including relative levels of market interest rates, loan prepayments and deposit decay, and should not be relied upon as indicative of actual results.
Liquidity Management and Capital Resources
Liquidity measures the Company’s ability to meet both current and future financial obligations of a short and long term nature. Liquidity planning is necessary for the Company to ensure it has the ability to respond to the needs of its customers as well as opportunities for earnings enhancements. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows, calls of investment securities and prepayments on loans are greatly influenced by general interest rates, economic conditions and competitions.
The Company has both a liquidity and contingent liquidity policy. The management of both policies is monitored by ALCO which is responsible for establishing and monitoring liquidity targets as well as strategies to meet these targets. The projected cash flows are stress tested quarterly to estimate the needs for contingent funding outside of the normal course of business. To supplement liquidity the Company has available collateral at both the Federal Home Loan Bank of Boston (“FHLBB”), Federal Reserve Bank of Boston and Co-operative Central Bank. At December 31, 2017 the bank had $197.7 million of collateral available at the FHLBB, $136.1 million at Federal Reserve Bank of Boston and $5.0 million with the Co-Operative Central Bank. At December 31, 2017 the Bank had $290.4 million outstanding with the FHLBB.
Our cash flows are composed of three primary classifications: cash flows from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Our most liquid assets are cash and cash equivalents. The level of these assets is dependent on our operating, financing, lending and investing activities during any given period. At December 31, 2017 cash and cash equivalents totaled $80.8 million.
Net cash provided by operating activities was $43.9 million for the year ended December 31, 2017 compared to $4.3 million of net cash used by operating activities for the year ended December 31, 2016. Our primary investing activities are originating loans and purchasing securities. Net cash used in investing activities was $237.4 million and $254.4 million for the years ended December 31, 2017 and 2016, respectively. During the years ended December 31, 2017 and December 31, 2016, we had $207.8 million and $303.5 million, respectively, of loan originations and participation-in loan purchases, net of principal payments. We also sold portfolio loans of $5.0 million and $39.8 million in 2017 and 2016, respectively. During the year ended December 31, 2017, we purchased $59.2 million of securities and received proceeds from the maturities, prepayments and calls totaling $25.4 million. During the year ended December 31, 2016, those amounts were $43.7 million and $41.0 million, respectively. Net cash provided by financing activities, consisting primarily of the activity in deposit accounts, FHLB advances and the issuance of common stock, was $224.1 million and $268.3 million for the years ended December 31, 2017 and 2016, respectively. The net increase in deposits was $209.0 million for the year ended December 31, 2017 as compared to a net increase of $113.5 million for the prior year. During the year ended December 31, 2016 the issuance of common stock resulted in $140.5 million in cash from financing activities.
HarborOne Bank is subject to various regulatory capital requirements. At December 31, 2017, HarborOne Bank exceeded all regulatory capital requirements and was considered “well capitalized” under regulatory guidelines. See Note 19 to our audited Consolidated Financial Statements included in Part II, Item 8 of this Form 10-K.
At December 31, 2017, we had outstanding commitments to originate loans of $86.8 million and unadvanced funds on loans of $293.2 million. We anticipate that we will have sufficient funds available to meet our current loan origination commitments. Certificates of deposit that are scheduled to mature in less than one year from December 31, 2017 totaled $316.2 million. Management expects, based on historical experience, that a substantial portion of the maturing certificates of deposit will be renewed. However, if a substantial portion of these deposits is not retained, we may use FHLB advances or raise interest rates on deposits to attract new accounts, which may result in higher levels of interest expense.
Off-Balance Sheet Arrangements and Contractual Obligations
Commitments We are a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit, which involve elements of credit and interest rate risk in excess of the amount recognized in the accompanying Consolidated Balance Sheets. The contract amount of these instruments reflects the extent of involvement we have in these particular classes of financial instruments. We use the same credit policies in making commitments as we do for on-balance sheet instruments. Our exposure to credit loss is represented by the contractual amount of the instruments. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments and unadvanced funds on lines-of-credit generally have fixed expiration dates and may expire without being drawn upon. Therefore, the total commitment amount does not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis. In addition, from time to time we enter into commitments to sell mortgage loans that we originate. For additional information, see Note 14 of the Notes to Consolidated Financial Statements.
Contractual Obligations. We are obligated to make future payments according to various contracts. The following table presents the expected future payments of contractual obligations aggregated by obligation type at December 31, 2017.
HarborOne Bancorp, Inc.
Management’s Discussion and Analysis
Impact of Inflation and Changing Prices
Our Consolidated Financial Statements and related notes have been prepared in accordance with U.S. GAAP. U.S. GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration of changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than the effects of inflation.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding quantitative and qualitative disclosures about market risk appears under Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the caption “Management of Market Risk”.
			 		
			
		
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Index to Consolidated Financial Statements
			 		
Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of HarborOne Bancorp, Inc.:
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of HarborOne Bancorp, Inc. and subsidiary (the “Company”) as of December 31, 2017 and 2016, the related consolidated statements of net income, comprehensive income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2017, and the related notes to the consolidated financial statements (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2017 and 2016, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2017, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ Wolf & Company, P.C.
We have served as the Company's auditor since 2008.
Boston, Massachusetts
March 9, 2018
			 		
HarborOne Bancorp, Inc.
Consolidated Balance Sheets
			
		
The accompanying notes are an integral part of these Consolidated Financial Statements.
			 		
HarborOne Bancorp, Inc.
Consolidated Statements of Operations
			
		
The accompanying notes are an integral part of these Consolidated Financial Statements.
			 		
HarborOne Bancorp, Inc.
Consolidated Statements of Comprehensive Income
			
		
Amortization of prior service cost is included in compensation and benefits in the Consolidated Statements of Operations. Realized gains on securities available for sale are included in gain on sale and call of securities, net, in the Consolidated Statements of Operations. The related income tax expense on reclassifications for securities available for sale for the years ended December 31, 2016 and 2015 was $113,000 and $118,000, respectively. The related income tax benefit on reclassification adjustment for amortization of prior service cost for the years ended December 31, 2017, 2016 and 2015 was $327,000, $93,000 and $93,000, respectively.
The accompanying notes are an integral part of these Consolidated Financial Statements.
			 		
HarborOne Bancorp, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
			
		
The accompanying notes are an integral part of these Consolidated Financial Statements.
			 		
HarborOne Bancorp, Inc.
Consolidated Statements of Cash Flows
			
		
(continued)
The accompanying notes are an integral part of these Consolidated Financial Statements.
HarborOne Bancorp, Inc.
Consolidated Statements of Cash Flows
			
		
The accompanying notes are an integral part of these Consolidated Financial Statements.
			 		
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Consolidation
HarborOne Bancorp, Inc. (the “Company”) is a mid-tier stock holding company whose principal subsidiary is HarborOne Bank (the “Bank”). The Bank is a state-chartered co-operative bank whose primary subsidiary is a residential mortgage banking company, Merrimack Mortgage Company, LLC (“Merrimack Mortgage” or “MMC”) acquired on July 1, 2015. The Consolidated Financial Statements include the accounts of the Company, the Company’s subsidiaries Legion Parkway Company LLC, a security corporation formed on July 13, 2016 and HarborOne Bank; and the Bank’s wholly-owned subsidiaries. In addition to Merrimack Mortgage, the Bank has two security corporation subsidiaries. The security corporations were established for the purpose of buying, holding and selling securities on their own behalf. The Company established Legion Parkway Company LLC for the same purpose. All significant intercompany balances and transactions have been eliminated in consolidation.
Stock Conversion
On June 29, 2016, the Bank reorganized into a two-tier mutual holding company structure with a mid-tier stock holding company. The Company sold 14,454,396 shares of common stock at $10.00 per share, including 1,187,188 shares purchased by the Company’s Employee Stock Ownership Plan (“ESOP”). In addition, the Company issued 17,281,034 shares to HarborOne Mutual Bancshares, the Company’s mutual holding company parent (the “MHC”) and 385,450 shares to The HarborOne Foundation (the “Foundation”), a charitable foundation that was formed in connection with the stock offering and is dedicated to supporting charitable organizations operating in the Bank’s local community. A total of 32,120,880 shares of common stock were outstanding following the completion of the stock offering. The direct costs of the Company’s stock offering of $3.9 million were deferred and deducted from the proceeds of the offering.
Upon the completion of the stock offering, a special “liquidation account” was established for the benefit of certain depositors of the Bank in an amount equal to the percentage ownership interest in the equity of the Company held by persons other than the MHC as of the date of the latest balance sheet contained in the prospectus. The Company is not permitted to pay dividends on its capital stock if the Company’s shareholders’ equity would be reduced below the amount of the liquidation account. The liquidation account is reduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases in an eligible account holder’s qualifying deposits do not restore such holder’s interest in the liquidation account.
Nature of Operations
The Company, originally established in 1917 as a state-chartered credit union, converted to a state-chartered co-operative bank on July 1, 2013. The Company provides a variety of financial services to individuals and businesses through its fourteen full-service and two limited-service bank offices in eastern Massachusetts, a commercial lending office in Providence, Rhode Island, and a loan office in Westford, Massachusetts. Merrimack Mortgage maintains 33 offices in Massachusetts, New Hampshire, and Maine, and is also licensed to lend in seven additional states.
The Company’s primary deposit products are checking, money market, savings and term certificate of deposit accounts while its primary lending products are commercial real estate, commercial, residential mortgages and consumer loans, including indirect automobile lending. The Company also originates, sells and services residential mortgage loans primarily through Merrimack Mortgage.
Use of Estimates
In preparing Consolidated Financial Statements in conformity with GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuations of mortgage servicing rights, derivatives, goodwill and deferred tax assets.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Changes in Accounting Principle
Effective January 1, 2015, the Company elected to account for its mortgage servicing assets at fair value. All of the Company’s mortgage servicing assets are classified in a single class of servicing assets. In conjunction with its acquisition of MMC, the Company evaluated its accounting policies in the mortgage banking business and decided to elect the fair value option for mortgage servicing assets to be consistent across the combined Company. A cumulative-effect adjustment of $1.6 million, net of tax, was made to retained earnings as of January 1, 2015. Changes in fair value are reported in mortgage banking income.
Significant Group Concentration of Credit Risk
The Company has cash and federal fund balances on deposit at correspondent banks that exceed insurable limits. The Company has not experienced any losses on such amounts. At December 31, 2017, the Company had a concentration of cash on deposit at the Federal Reserve Bank amounting to $26.4 million. Most of the Company’s lending activities are with borrowers located within eastern Massachusetts. The ability and willingness of residential and consumer borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the borrowers’ geographic area and real estate values. Note 6 provides the detail of the Company’s loan portfolio and Note 4 provides the detail of the Company’s investment portfolio. The Company does not have any significant concentrations to any one industry or customer.
Reclassifications
Certain previously reported amounts have been reclassified to conform to the current year’s presentation.
Cash and Cash Equivalents
Cash equivalents include amounts due from banks and short-term investments with original maturities of less than 90 days at time of purchase. Short-term investments mature daily or on demand and are stated at cost, which approximates fair value.
Securities
Debt securities that management has the positive intent and ability to hold to maturity are classified as held to maturity and are carried at amortized cost, adjusted for the amortization of premiums or the accretion of discounts. Securities not classified as held to maturity are classified as available for sale and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income (loss).
Gains or losses on disposition of securities are recorded on the trade date and are determined using the specific identification method. Premiums and discounts are recognized in interest income using the effective interest method over the terms of the securities, except for premiums on callable securities, which are amortized to the earliest call date, effective January 1, 2017 upon adoption of Financial Accounting Standards Board (“FASB”) Accounting Standards Update (“ASU”) 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities.
Each reporting period, the Company evaluates all securities with a decline in fair value below the amortized cost of the investment to determine whether or not the impairment is deemed to be other-than-temporary (“OTTI”).
OTTI is required to be recognized if (1) the Company intends to sell the security; (2) it is “more likely than not” that the Company will be required to sell the security before recovery of its amortized cost basis; or (3) the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For all impaired debt securities that the Company intends to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI through earnings. Credit-related OTTI for all other impaired debt securities is recognized through earnings. Non-credit related OTTI for such debt securities is recognized in other comprehensive income (loss), net of applicable taxes.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Federal Home Loan Bank Stock
The Company, as a member of the Federal Home Loan Bank (“FHLB”) system, is required to maintain an investment in capital stock of the FHLB of Boston. Based on redemption provisions of the FHLB, the stock has no quoted market value and is carried at cost. At its discretion, the FHLB may declare dividends on the stock. The Company reviews FHLB stock for impairment based on the ultimate recoverability of the cost basis. As of December 31, 2017, no impairment has been recognized.
Mortgage Loans Held for Sale
Residential mortgage loans originated with the intent to sell are classified as held-for-sale and are carried at fair value. At the time of the acquisition of MMC, the Company evaluated its accounting policies for loans held for sale, and elected to use the fair value option. The fair value option better aligns the accounting method with management’s strategies for managing the risks of mortgage loans held for sale. Loan origination costs for loans held for sale that the Company accounts for under the fair value option are recognized in noninterest expense when incurred. Changes in fair value are recognized in mortgage banking income.
Interest income on mortgage loans held for sale is recorded in interest income.
Loans
Loans held for investment are reported at their outstanding unpaid principal balances adjusted for charge-offs, the allowance for loan losses, and any unamortized deferred origination fees and costs.
Loan origination fees are offset with related direct incremental loan origination costs and the resulting net amount is deferred and amortized to interest income using the level-yield method over the remaining life of the loan.
Accrual of interest on loans is discontinued when collectability of principal or interest is uncertain or when payments of principal or interest have become contractually past due 90 days or more. Past due status is based on contractual terms of the loan. However, a loan may remain on accrual status if both the value of any collateral securing the loan is sufficient to cover principal and accrued interest thereon, and the loan is in the process of collection. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful.
Interest received on nonaccrual loans is either applied against principal or reported as income according to management’s judgment as to the collectability of principal. Interest accruals are resumed on such loans only when they are brought current with respect to interest and principal and when, in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.
The Company’s loan portfolio includes residential real estate, commercial real estate, construction, commercial and consumer segments. Residential real estate loans include classes for one- to four-family and second mortgages and equity lines of credit. Consumer loans include classes for auto and personal loans.
Allowance for Loan Losses
The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectability of a loan balance is confirmed and generally do not exceed the time frame provided in The Uniform Retail Credit Classification and Account Management Policy. Subsequent recoveries, if any, are credited to the allowance.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The allowance for loan losses is evaluated on a regular basis by management. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The allowance consists of general, allocated and unallocated components, as further described below.
General component
The general component of the allowance for loan losses is based on historical and peer loss experience adjusted for qualitative factors stratified by the Company’s loan segments. Management uses a rolling average of historical losses based on a time frame appropriate to capture relevant loss data for each loan segment except commercial real estate and commercial loans. Due to the lack of historical loss experience for our commercial real estate and commercial loan portfolio, we utilize peer loss data. Adjustments to loss rates are considered for the following qualitative factors: levels/trends in delinquencies; trends in volume and terms of loans; effects of changes in risk selection and underwriting standards and other changes in lending policies, procedures and practices; experience/ability/depth of lending management and staff; and national and local economic trends and conditions. There were no changes in the Company’s policies or methodology pertaining to the general component of the allowance for loan losses during the year ended December 31, 2017. The qualitative factors are determined based on the various risk characteristics of each loan segment. Risk characteristics relevant to each portfolio segment are as follows:
Residential real estate - The Company generally does not originate portfolio loans with a loan-to-value ratio greater than 80 percent without obtaining private mortgage insurance and does not generally grant loans that would be classified as subprime upon origination. The Company generally has first or second liens on property securing equity lines of credit. Loans in this segment are generally collateralized by residential real estate and repayment is dependent on the credit quality of the individual borrower. The overall health of the economy, including unemployment rates and housing prices, can have an effect on the credit quality in this segment.
Commercial real estate - Loans in this segment are primarily secured by income-producing properties and owner occupied commercial properties in southeastern New England. The underlying cash flows generated by the properties and operations can be adversely impacted by a downturn in the due to vacancy rates and diminished cash flows, which in turn, could have an effect on the credit quality in this segment. Management obtains financial statements annually and continually monitors the cash flows of these loans.
Construction - Loans in this segment include both residential and commercial construction loans. Residential construction loans include loans to build one- to four-family owner-occupied properties, which are subject to the same credit quality factors as residential real estate loans. Commercial construction loans may include speculative real estate development loans for which payment is derived from lease or sale of the property. Credit risk is affected by cost overruns, time to lease or sell at an adequate price, and market conditions.
Commercial - Loans in this segment are made to businesses and are generally secured by assets of the business. Repayment is expected from the cash flows of the business. A weakened economy, and resultant decreased consumer or business spending, could have an effect on the credit quality in this segment.
Consumer - Loans in this segment are generally secured by automobiles or are unsecured and repayment is dependent on the credit quality of the individual borrower.
Allocated component
The allocated component relates to loans that are classified as impaired. Residential real estate, commercial, commercial real estate and construction loans are evaluated for impairment on a loan-by-loan basis. Impairment is determined by nonaccrual status, whether a loan is subject to a troubled debt restructuring agreement or in the case of certain loans, based on the internal credit rating. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly,
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
except for troubled debt restructuring (“TDR”), the Company does not separately identify individual consumer loans for impairment evaluation.
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 classified as 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.
The Company periodically may agree to modify the contractual terms of loans. When a loan is modified and a concession is made to a borrower experiencing financial difficulty, the modification is considered a TDR. All TDRs are initially classified as impaired. Impairment is measured 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 is established when the discounted cash flows or collateral value of the impaired loan is lower than the carrying value of that loan.
Unallocated component
The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general reserves in the portfolio. The unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. Additionally the Company's unseasoned commercial portfolio and use of peer group data to establish general reserves for the commercial portfolio adds another element of imprecision to management's estimates.
Property and Equipment
Land is carried at cost. Buildings, leasehold improvements, and furniture and equipment are carried at cost, less accumulated depreciation and amortization, computed on the straight-line method over the estimated useful lives of the assets or the terms of the leases, if shorter. Expected terms include lease option periods to the extent that the exercise of such options is reasonably assured. Maintenance and repairs are charged to expense as incurred and improvements are capitalized.
Retirement Plan Annuities
Retirement plan annuities are reflected on the balance sheets at the face amount of the policies. Changes in recorded value are reflected in income on retirement plan annuities on the Consolidated Statements of Operations.
Bank-owned life insurance
Bank-owned life insurance policies are reflected on the Consolidated Balance Sheets at net cash surrender value. Changes in the net cash surrender value of the policies, as well as insurance proceeds received, are reflected in bank-owned life insurance income on the Consolidated Statements of Operations and are not subject to income taxes. The Company is the beneficiary on these life insurance policies which are purchased for select employees of the Company.
Employee Stock Ownership Plan
Compensation expense for the Company’s ESOP is recorded at an amount equal to the shares committed to be allocated by the ESOP multiplied by the average fair market value of the shares during the year. The Company recognizes compensation expense ratably
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
over the year based upon the Company’s estimate of the number of shares committed to be allocated by the ESOP. The difference between the average fair market value and the cost of the shares committed to be allocated by the ESOP is recorded as an adjustment to additional paid-in capital.
Mortgage Servicing Rights
The Company services mortgage loans for others. Mortgage servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets and are carried at fair value.
For all mortgage servicing assets, fair value is estimated using market prices when available or, alternatively, using a third party valuation model that calculates the present value of estimated future cash flows based on current prepayment assumptions.
Derivative Financial Instruments
The Company is party to a variety of derivative transactions, including derivative loan commitments, forward loan sale commitments and interest rate swap contracts. The Company enters into derivative contracts in order to meet the financing needs of its customers. The Company also enters into derivative contracts as a means of reducing its interest rate risk and market risk.
Derivative Loan Commitments
Mortgage loan commitments qualify as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding. Loan commitments that are derivatives are recognized at fair value on the Consolidated Balance Sheets in other assets and other liabilities with changes in their fair values recorded in mortgage banking income.
Forward Loan Sale Commitments
To protect against the price risk inherent in derivative loan commitments, the Company utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments. Mandatory delivery contracts are accounted for as derivative instruments. Generally, the Company’s best efforts contracts meet the definition of derivative instruments when the loans to the underlying borrowers close, and are accounted for as derivative instruments at that time. Forward loan sale commitments are recognized at fair value on the Consolidated Balance Sheets in other assets and other liabilities with changes in their fair values recorded in mortgage banking income.
Interest Rate Swaps
The Company’s interest rate swap contracts are transacted to meet the financing needs of the Company’s commercial customers. Offsetting swap agreements are simultaneously transacted to effectively eliminate the Company’s market and interest rate risk associated with the swaps. Interest rate swaps are recognized on the Consolidated Balance Sheets in other assets and other liabilities with changes in their fair values recorded in other income.
Transfers of Financial Assets
Transfers of an entire financial asset, a group of entire financial assets, or a participating interest in an entire financial asset are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
when (1) the assets have been isolated from the Company, (2) the transferee obtains the right to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets.
During the normal course of business, the Company may transfer a portion of a financial asset, for example, a participation loan or the government guaranteed portion of a loan. In order to be eligible for sale treatment, the transfer of the portion of the loan must meet the criteria of a participating interest. If it does not meet the criteria of a participating interest, the transfer must be accounted for as a secured borrowing. In order to meet the criteria for a participating interest, all cash flows from the loan must be divided proportionately, the rights of each loan holder must have the same priority, the loan holders must have no recourse to the transferor other than standard representations and warranties and no loan holder has the right to pledge or exchange the entire loan.
Other Real Estate Owned and Repossessed Assets
Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less estimated costs to sell when legal title is obtained, establishing a new cost basis. Subsequently, valuations are periodically updated by management and the assets are carried at the lower of carrying amount or fair value less estimated costs to sell. The excess (deficiency) of any consideration received as compared to the carrying value of other real estate owned is recorded as a gain (loss) on sale of other real estate owned. Revenues and expenses from operations and changes in the valuation allowance and any direct write-downs are included in foreclosed and repossessed assets expense. Repossessed assets includes automobiles to be sold which are recorded at estimated fair value, less costs to sell, with the initial charge to the allowance for loan losses and the subsequent gain or loss on sale recorded to foreclosed and repossessed assets expense.
Goodwill and Identifiable Intangible Assets
The assets (including identifiable intangible assets) and liabilities acquired in a business combination are recorded at fair value at the date of acquisition. Goodwill is recognized for the excess of the acquisition cost over the fair values of the net assets acquired and is not subsequently amortized. Identifiable intangible assets include core deposit premium and non-compete contracts and are being amortized on a straight-line basis over their estimated lives. Management assesses the recoverability of goodwill at least on an annual basis and all intangible assets whenever events or changes in circumstances indicate that their carrying value may not be recoverable. The impairment test uses a combined qualitative and quantitative approach. The initial qualitative approach assesses whether the existence of events or circumstances led to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after this assessment, the Company determines that it is more likely than not that the fair value is less than the carrying value, a quantitative impairment test is performed. The quantitative impairment test compares book value to the fair value of the reporting unit. If the carrying amount exceeds fair value, an impairment charge is recorded through earnings. Management has identified two reporting units for purposes of testing goodwill for impairment. The Company’s reporting units are the same as the segments used for segment reporting - the Bank, including the two security corporations, and MMC.
Advertising Costs
Advertising costs are expensed as incurred.
Income Taxes
Deferred tax assets and liabilities are determined using the liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws in the period on enactment. Accordingly, changes resulting from the Tax Act of 2017 enacted on December 22, 2017 have been recognized in the Consolidated Financial Statements as of and for the year ended December 31, 2017 (see Note 13). A valuation allowance is established against deferred tax assets when, based upon the available evidence including historical and projected taxable income, it is more likely than not that some or all of the deferred tax assets will not be realized.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The Company elected to early adopt FASB ASU 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, therefore excess tax benefits or deficiencies are recorded in the income statement as part of the provision for income taxes on a prospective basis. For interim reporting purposes, the excess tax benefits or deficiencies are recorded as discrete items in the period in which they occur. In addition, when calculating incremental shares for earnings per share, excess tax benefits are excluded from assumed proceeds. There was no income tax benefit recorded in the provision for income taxes relating to excess tax benefits on share-based compensation for the year ended December 31, 2017.
We record uncertain tax positions in accordance with FASB ASU 740, Income Taxes, on the basis of a two-step process in which (1) we determine whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The determination of whether or not a tax position has met the more likely than not recognition threshold considers the facts, circumstances and information available at the reporting date and is subject to management’s judgment. The Company records interest and penalties as part of income tax expense.
Stock-based Compensation Plans
The Company’s stock-based compensation plans provide for awards of stock options, restricted stock and other stock-based compensation to directors, officers and employees. The cost of employee services received in exchange for awards of equity instruments is based on the grant-date fair value of those awards. Compensation cost is recognized over the requisite service period as a component of compensation expense. The Company uses the Black-Scholes option-pricing model to determine the fair value of stock options granted, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. In accordance with ASU 2016-09, the Company has elected to account for forfeitures of share-based payments by recognizing forfeitures of awards as they occur (e.g., when an award does not vest because the employee leaves the Company or does not meet specific performance measures).
Earnings Per Share
Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Unallocated ESOP shares are not deemed outstanding for earnings per share calculations. The restricted stock awards are participating securities; therefore unvested awards are included as common shares outstanding in the computation of basic earnings per share. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate to outstanding stock options awards and are determined using the treasury stock method.
Treasury Stock
Any shares repurchased under the Company’s share repurchase programs were purchased in open-market transactions and are held as treasury stock. All treasury stock is held at cost. The Company adopted a share repurchase program on October 27, 2017. The Company may repurchase up to 1,633,155 shares of the Company’s common stock, or approximately 5% of the Company’s current issued and outstanding shares.
Recent Accounting Pronouncements
As an “emerging growth company” as defined in Title 1 of the Jumpstart Our Business Startups (JOBS) Act, the Company has elected to use the extended transition period to delay the adoption of new or reissued accounting pronouncements applicable to public companies until such pronouncements are made applicable to non-public companies. As of December 31, 2017, there is no significant difference in the comparability of the financial statements as a result of this extended transition period.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income; (“ASU 2018-02”). ASU 2018-02 amends ASU Topic 220 and allows a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act of 2017. Consequently, this amendment eliminates the stranded tax effects resulting from the Tax Act of 2017. As permitted, the Company early adopted this amendment in the first quarter of 2018 and reclassified $104,000 from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act of 2017.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815), Targeted Improvements to Accounting for Hedging Activities. This guidance changes the recognition and presentation requirements of hedge accounting, including eliminating the requirement to separately measure and report hedge ineffectiveness and presenting all items that affect earnings in the same income statement line as the hedged item. This guidance also provides new alternatives for applying hedge accounting to additional hedging strategies, measuring the hedged item in fair value hedges of interest rate risk, reducing the complexity of applying hedge accounting by easing the requirements for effectiveness testing, hedge documentation and application of the critical terms match method, and reducing the risk of material error corrections if a company applies the shortcut method inappropriately. This update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The Company does not currently have any hedging derivatives within the scope of the ASU.
In June 2016, FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Entities will now use forward-looking information to better form their credit loss estimates. The ASU also requires enhanced disclosures to help financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an entity’s portfolio. For public entities that are SEC filers, this ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. For non-public entities, this ASU is effective for fiscal years beginning after December 15, 2020, and for interim periods within fiscal years beginning after December 15, 2021. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Management has identified an implementation team that is in the process of developing an understanding of this pronouncement, evaluating the impact of this pronouncement and researching additional software resources that could assist with the implementation. The adoption of the ASU may result in an increase in the allowance for loan losses but the magnitude of the increase and its impact has not yet been quantified and depends on economic conditions at the time of adoption.
In February 2016, FASB issued ASU 2016-02, Leases (Topic 842). This update requires a lessee to record a right-to-use asset and a liability representing the obligation to make lease payments for long-term leases. For public business entities, this update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. For non-public business entities, this update is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years beginning after December 15, 2020. While we are currently evaluating the impact of the new standard, we expect an increase to the Consolidated Balance Sheets for right-of-use assets and associated lease liabilities but no material impact to the Consolidated Statement of Operations, for arrangements previously accounted for as operating leases.
In January 2016, FASB issued ASU 2016-01, Financial Instruments - Overall, (Subtopic 825-10). The amendments in this update address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Targeted improvements to generally accepted accounting principles include the requirement for equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income, the elimination of the requirement for non-public business entities to disclose the fair value of financial instruments measured at amortized cost and the elimination of the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value for financial instruments measured at amortized cost. This update also requires companies to utilize and “exit price” fair value methodology when measuring the fair value of financial instruments. For public business entities, the amendments in this update are effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For non-public business entities, the amendments in this update are effective for fiscal years
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15, 2019. Management currently does not expect this to have a material impact on the Company's Consolidated Financial Statements as the Company does not currently hold any equity securities.
In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this update create Topic 606, Revenue from Contracts with Customers, and supersede the revenue recognition requirements in Topic 605, Revenue Recognition, including most industry-specific revenue recognition guidance throughout the Industry Topics of the Codification. The core principle of Topic 606 is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve the core principle, a company should apply a five step approach to revenue recognition. For public business entities, this ASU is effective for annual reporting periods, including interim periods, beginning after December 15, 2017. For non-public business entities, this ASU is effective for annual reporting periods beginning after December 31, 2018, and interim periods within fiscal years beginning after December 15, 2019. Early application is permitted, but only for annual reporting periods beginning after December 15, 2016. The Bank's primary source of revenue is interest income on financial assets and income from mortgage banking activities, which are explicitly excluded from the scope of the new guidance. As a result, adoption is not expected to have a material impact on the Company’s Consolidated Financial Statements. However, the Company will continue to monitor developments and additional guidance up to the effective date of these amendments.
2.CASH AND DUE FROM BANKS
The Company is required to maintain average balances on hand or with the Federal Reserve Bank. At December 31, 2017 and 2016, reserve balances amounted to $2.3 million and $3.6 million, respectively.
3.SHORT-TERM INVESTMENTS
Short-term investments consist of interest-bearing deposit accounts with balances of $64.4 million and $33.8 million as of December 31, 2017 and 2016, respectively.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
4.SECURITIES
The amortized cost and fair value of securities with gross unrealized gains and losses is as follows:
Two mortgage-backed securities with a total fair value of $5.8 million are pledged as collateral for interest rate swap agreements as of December 31, 2017 (see Note 15). All of the U.S. government-sponsored collateralized mortgage obligations and residential mortgage-backed securities are pledged to secure advances with the FHLB of Boston as of December 31, 2017 (see Note 12).
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The amortized cost and fair value of debt securities by contractual maturity at December 31, 2017 is as follows:
U.S. government-sponsored residential mortgage-backed securities, collateralized mortgage obligations and securities whose underlying assets are loans from the U.S. Small Business Administration (“SBA asset-backed securities”) have stated maturities of six to twenty-seven years; however, it is expected that such securities will have shorter actual lives due to prepayments.
The following table shows proceeds and gross realized gains and losses related to the sales and calls of securities for the periods indicated:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Information pertaining to securities with gross unrealized losses at December 31, 2017 and December 31, 2016 aggregated by investment category and length of time that individual securities have been in a continuous loss position follows:
Management evaluates securities for OTTI at each reporting period, and more frequently when economic or market concerns warrant such evaluation.
At December 31, 2017, forty-two debt securities with an amortized cost of $134.8 million have unrealized losses with aggregate depreciation of 0.97% from the Company’s amortized cost basis. The unrealized losses on the Company’s securities were primarily caused by changes in interest rates. All of these investments are guaranteed by government-sponsored enterprises. Accordingly, it is expected that the securities would not be settled at a price less than the par value of the investment. Because the decline in fair value is attributable to changes in interest rates and not to credit quality, and because the Company does not intend to sell the investments and it is more likely than not that the Company will not be required to sell the investments before recovery of their amortized cost basis, which may be maturity, the Company does not consider these investments to be OTTI at December 31, 2017
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
5.MORTGAGE LOANS HELD FOR SALE
At December 31, 2017 and 2016, there were no mortgage loans held for sale that were greater than ninety days past due.
The following table provides the fair value and contractual principal balance outstanding of mortgage loans held for sale accounted for under the fair value option:
Changes in the fair value of mortgage loans held for sale are classified in mortgage banking income in the Consolidated Statements of Operations. None of the changes in fair value for 2017 or 2016 are attributable to instrument-specific credit risk. Included in mortgage banking income is $30.5 million, $43.0 million and $16.5 million of gains on the sale of mortgage loans held for sale, including originated mortgage servicing rights, for the years ended December 31, 2017, 2016 and 2015, respectively.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
6.LOANS
A summary of the balances of loans follows:
During the years ended December 31, 2017, 2016 and 2015, the Company sold indirect auto loans of $5.0 million, $10.0 million and $31.3 million, respectively, and recognized gain on sale of consumer loans of $78,000, $79,000 and $136,000, respectively. The unpaid principal balance of indirect auto loans serviced for others was $22.4 million and $31.4 million at December 31, 2017 and 2016, respectively.
The Company did not sell any residential portfolio loans during the year ended December 31, 2017. During the years ended December 31, 2016 and 2015, the Company sold residential portfolio loans of $29.5 million and $24.0 million, respectively, and recognized gains on sales of $572,000 and $281,000, respectively.
The Company has transferred a portion of its originated commercial real estate loans to participating lenders. The amounts transferred have been accounted for as sales and are therefore not included in the Company’s accompanying Consolidated Balance Sheets. The Company and participating lenders share ratably in cash flows and any gains or losses that may result from a borrower’s lack of compliance with contractual terms of the loan. The Company continues to service the loans on behalf of the participating lenders and, as such, collects cash payments from the borrowers, remits payments to participating lenders and disburses required escrow funds to relevant parties. At December 31, 2017 and 2016, the Company was servicing loans for participants aggregating $85.2 million and $45.3 million, respectively.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The following is the activity in the allowance for loan losses for the years ended December 31, 2017, 2016 and 2015 follows:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Allocation of the allowance to loan segments at December 31, 2017 and 2016 follows:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The following is a summary of past due and non-accrual loans at December 31, 2017 and 2016:
At December 31, 2017 and 2016, there were no loans past due 90 days or more and still accruing.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The following information pertains to impaired loans:
Interest income recognized and interest income recognized on a cash basis in the table above represents interest income for the years ended December 31, 2017, 2016 and 2015, not for the time period designated as impaired. No additional funds are committed to be advanced in connection with impaired loans.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The following table sets forth troubled debt restructurings (“TDRs”) during the years ended December 31, 2017, 2016 and 2015. There were two commercial TDRs in the second quarter of 2017, which paid off in the fourth quarter of 2017, which are not included in the table below.
For 2015 through 2017, residential real estate troubled debt restructurings included rate reductions ranging from 0.50% to 3.50% for periods of two to twenty-eight years, interest only periods of two to thirty-six months and extensions of maturity dates of eighteen months to twenty-eight years. There was one commercial troubled debt restructuring in 2016, which included an extension of maturity date and compliance with specific covenants.
The recorded investment of troubled debt restructurings was $26.4 million and $32.6 million at December 31, 2017 and 2016, respectively. Of these loans, $6.1 million and $7.5 million were nonaccruing at December 31, 2017 and 2016, respectively.
Although not general practice, there were modifications that included extending maturity dates. These amounts show an increase from the pre-modification balance due to capitalized delinquent interest and/or escrow. All TDR loans are considered impaired and management performs a discounted cash flow calculation to determine the amount of impairment reserve required on each loan. TDR loans which subsequently default are reviewed to determine if the loan should be deemed collateral dependent. In either case, any reserve required is recorded as part of the allowance for loan losses.
For the years ended December 31, 2017, 2016 and 2015, there were no significant troubled debt restructures that defaulted in the first twelve months of restructure. A default is defined as two or more payments in arrears.
Credit Quality Information
The Company uses a ten grade internal loan rating system for commercial real estate, commercial construction and commercial loans, as follows:
Loans rated 1 - 6 are considered “pass” rated loans with low to average risk.
Loans rated 7 are considered “special mention.” These loans are starting to show signs of potential weakness and are being closely monitored by management.
Loans rated 8 are considered “substandard.” Generally, a loan is considered substandard if it is inadequately protected by the current net worth and paying capacity of the obligors and/or the collateral pledged. There is a distinct possibility that the Company will sustain some loss if the weakness is not corrected.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Loans rated 9 are considered “doubtful.” Loans classified as doubtful have all the weaknesses inherent in those classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, highly questionable and improbable.
Loans rated 10 are considered “uncollectible” (loss), and of such little value that their continuance as loans is not warranted.
Loans not rated consist primarily of residential construction loans and certain smaller balance commercial real estate and commercial loans that are managed by exception.
On an annual basis, or more often if needed, the Company formally reviews the ratings on all commercial real estate, construction and commercial loans. Annually, the Company engages an independent third party to review a significant portion of loans within these segments. Management uses the results of these reviews as part of its annual review process.
On a monthly basis, the Company reviews the residential construction, residential real estate and consumer installment portfolios for credit quality primarily through the use of delinquency reports.
The following table presents the Company’s loans by risk rating at December 31, 2017 and 2016:
7.MORTGAGE LOAN SERVICING
The Company sells residential mortgages to government-sponsored entities and other parties. The Company retains no beneficial interests in these loans, but may retain the servicing rights of the loans sold. Mortgage loans serviced for others are not included in the accompanying Consolidated Balance Sheets. The unpaid principal balances of mortgage loans serviced for others were $1.93 billion and $1.85 billion as of December 31, 2017 and 2016, respectively.
The risks inherent in mortgage servicing rights (“MSRs”) relate primarily to changes in prepayments that result from shifts in mortgage interest rates. Effective January 1, 2015, the Company elected to account for MSRs at fair value. The Company obtains valuations from independent third parties to determine the fair value of MSRs. Key assumptions and inputs used in the estimation
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
of fair value include prepayment speeds, discount rates, default rates, cost to service, and contractual servicing fees. At December 31, 2017 and 2016, the following weighted average assumptions were used in the calculation of fair value of MSRs:
The following summarizes changes to mortgage servicing rights for the years ended December 31, 2017, 2016 and 2015:
For the years ended December 31, 2017, 2016 and 2015, contractually specified servicing fees included in other mortgage banking income amounted to $5.2 million, $4.1 million, and $2.1 million respectively.
8.OTHER REAL ESTATE LOANS AND REPOSSESSED ASSETS
Income and expenses applicable to foreclosed and repossessed assets include the following:
Foreclosed and repossessed assets consist of four and nine residential real estate properties with recorded values of $665,000 thousand and $1.8 million at December 31, 2017 and 2016, respectively. Foreclosed and repossessed assets also includes five automobiles with recorded values of $97,000 at December 31, 2017. There were no repossessed automobiles at December 31, 2016. All foreclosed and repossessed assets are held for sale. Mortgage loans in the process of foreclosure totaled $4.5 million and $4.8 million as of December 31, 2017 and 2016, respectively, and are reported in loans.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
9.PROPERTY AND EQUIPMENT
A summary of the cost and accumulated depreciation of property and equipment follows:
Depreciation and amortization expense amounted to $2.9 million, $2.6 million and $2.6 million for the years ended December 31, 2017, 2016 and 2015, respectively.
At December 31, 2017 and 2016, bank buildings and fixed assets in process represents building improvements and equipment not placed in service.
Pursuant to the terms of noncancelable operating lease agreements in effect at December 31, 2017, pertaining to property and equipment, future minimum lease payments under various operating leases are as follows:
The noncancelable lease agreements contain options to extend for periods from three to twenty years, the cost of which is not included above. Rent expense amounted to $1.7 million, $1.6 million and $1.2 million for the years ended December 31, 2017, 2016 and 2015 and is included in occupancy and equipment expenses in the accompanying Consolidated Statements of Operations.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
10.GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consist of the following:
Goodwill
On July 1, 2015, goodwill in the amount of $10.2 million was recognized in connection with the MMC acquisition. The goodwill represents the excess of the value of MMC over the fair value of assets acquired and liabilities assumed arising from the acquisition. MMC originates residential mortgage loans for sale in the secondary market and services residential mortgage loans for secondary market investors. MMC conducts business throughout the northeastern United States. The acquisition of MMC enables the Company to expand its mortgage banking business. MMC has been identified as a reporting unit for purposes of goodwill impairment testing. Refer to Note 23, Segment Reporting for more information.
Other Intangible Assets
As part of the acquisition of MMC, the Company entered into a non-compete agreement with the sellers of MMC. The Company accounts for this agreement as an intangible asset and is amortizing it over the four year period of the agreement. Amortization expense for this asset of $88,000, $89,000 and $44,000 was recorded in 2017, 2016 and 2015, respectively. The Company expects to record amortization expense of $88,000 in 2018, with the remaining amount of $44,000 in 2019. Amortization expense of $138,000 was recorded in 2015 for core deposit intangible assets and it was fully amortized in 2015. Refer to Note 14, Other Commitments and Contingencies, Contingent Consideration.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
11.DEPOSITS
A summary of deposit balances, by type, is as follows:
The Company has established a relationship to participate in a reciprocal deposit program with other financial institutions. At December 31, 2017, total reciprocal deposits were $174.2 million: $126.2 million in money markets, $38.0 million in regular savings and $10.0 million in term certificates. There were no reciprocal deposits at December 31, 2016.
A summary of certificate accounts by maturity at December 31, 2017 is as follows:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
12.BORROWED FUNDS
Borrowed funds at December 31, 2017 and 2016 consist of FHLB advances. Short-term advances were $44.0 million and $80.0 million at December 31, 2017 and 2016, respectively, with a weighted average rate of 1.50% and 0.77%, respectively. Long-term advances are summarized by scheduled maturity below:
None of the FHLB advances were callable at December 31, 2017 and 2016.
The FHLB advances are secured by a blanket security agreement on qualified collateral defined primarily as 81% of the carrying value of first mortgage loans on residential property. All of the U.S. government-sponsored collateralized mortgage obligations and residential mortgage-backed securities are pledged to secure advances with the FHLB of Boston as of December 31, 2017.
The Company also has an available line of credit with the Federal Reserve Bank secured by 75% of the carrying value of indirect auto loans with an amortized balance amounting to $136.1 million and $207.9, million, respectively, of which no amount was outstanding at December 31, 2017 and 2016, respectively.
13.INCOME TAXES
Allocation of the federal and state income taxes between current and deferred portions for the years ended December 31, 2017, 2016 and 2015 are as follows:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The reasons for the differences between the statutory federal income tax and the actual income tax provision (benefit) for the years ended December 31, 2017, 2016 and 2015 are summarized as follows:
The tax effects of each item that give rise to deferred taxes at December 31, 2017 and 2016 are as follows:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
A summary of the change in the net deferred tax asset (liability) for the years ended December 31, 2017, 2016 and 2015 is as follows:
The Tax Act of 2017 was enacted on December 22, 2017, resulting in changes in U.S. corporate tax rates, business-related exclusions, deductions and credits. Enactment of Tax Act of 2017 required the Company to reflect the changes associated with the law's provisions in its consolidated financial statements as of the enactment date. Accordingly, the Company revalued its deferred tax assets and liabilities and recorded a net reduction in the Company’s net deferred tax asset and an additional income tax provision in the amount of $243,000 in the Company’s Consolidated Financial Statements.
The Company’s income tax returns are subject to review and examination by federal and state taxing authorities. The Company is currently open to audit under the applicable statutes of limitations by the Internal Revenue Service (“IRS”) and Massachusetts Department of Revenue for the years ended December 31, 2014 through 2017.
At December 31, 2017, the Bank had a net operating loss carryforward in the state of New Hampshire of $3.3 million related to the acquisition of MMC. The recorded deferred tax asset is $5,000 at December 31, 2017. The net operating loss expires on December 31, 2024. The state of New Hampshire limits the use of acquired net operating losses that can be used by the Bank each year based on Internal Revenue Code 382. This limitation is $550,000 per year. Management believes it is more likely than not that it will be able to utilize the New Hampshire net operating loss carryforward prior to expiration.
The Company may carryforward charitable contributions to the succeeding five taxable years. The utilization of the charitable contribution carryforward may not exceed 10% of taxable income as defined by the federal taxation laws. At December 31, 2017, the Company had a charitable contribution carryforward for federal income tax purposes of $3.2 million. This carryforward was generated from the Company’s creation of the Foundation to which it contributed 385,450 shares of its common stock and $965,000 in cash in connection with the offering in June 2016. Management believes it is more likely than not that it will utilize the benefit over the five year carryforward period.
During 2017, federal and state amended tax returns were filed that requested tax refunds of approximately $3.2 million. These refunds reflected the change in the tax basis of certain assets not reflected on the original tax return filings. In addition, net operating loss carryforwards and related uncertain tax benefits were recognized in the 2016 tax return filings. The amended 2016 tax return filings reflect "unrecognized tax benefits", which are defined as the aggregate differences between tax return positions and the benefits recognized in the Consolidated Financial Statements. Interest on the 2016 uncertain tax positions was reflected in the determination of tax expense for 2017. Federal tax refunds for years 2014 and 2015 in the amount of $826,000 and $1.3 million, respectively, were received during January 2018.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
At December 31, 2017, the balance of unrecognized tax benefits, the amount of related interest accrued and what management believes to be the range of reasonably possible changes in the next 12 months, are:
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in making this assessment. Based on the level of historical taxable income and projections for future taxable income over the periods the deferred tax assets are expected to be deductible, management believes it is more likely than not that its deferred tax assets are realizable. It should be noted, however, that factors beyond management’s control, such as the general economy and real estate values, can affect future levels of taxable income, and no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences.
14.OTHER COMMITMENTS AND CONTINGENCIES
Loan Commitments
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and advance funds on various lines of credit. Those commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the accompanying Consolidated Financial Statements.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments as it does for on-balance sheet instruments.
The following off-balance sheet financial instruments were outstanding at December 31, 2017 and 2016. The contract amounts represent credit risk.
Commitments to extend credit and unadvanced portion of construction loans are agreements to lend to a customer, as long as there is no violation of any condition established in the contract. Commitments to grant loans generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for unadvanced funds on construction loans, home equity and revolving lines of credit may expire without being drawn upon; therefore, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. Commitments to grant loans, unadvanced construction loans and home equity lines of credit are collateralized by real estate, while revolving lines of credit are unsecured.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Employment Agreements
The Company has entered into employment agreements with certain executive officers. The term of the agreements commenced on the effective date of the signed agreements and continues thereafter until terminated, as defined by the agreements. The agreements generally provide for a specified minimum annual compensation and the continuation of benefits currently received. However, such employment can be terminated for cause, as defined, without incurring any continuing obligations. In addition, some of the agreements provide for severance payments to the officers following a change in control, as defined.
Reserve for Residential Mortgage Loan Repurchase Losses
The Company sells residential mortgage loans on a “whole-loan” basis to government-sponsored entities (“GSEs” or “Agencies”) Fannie Mae and Freddie Mac and also to non-agency investors. These loan sales occur under industry standard contractual provisions that include various representations and warranties, which typically cover ownership of the loan, compliance with loan criteria set forth in the applicable agreement, validity of the lien securing the loan and other similar matters. The Company may be required to repurchase certain loans sold with identified defects, indemnify the investor, or reimburse the investor for any credit losses incurred. The Company establishes mortgage repurchase reserves related to various representations and warranties that reflect management’s estimate for which we have a repurchase obligation. The reserves are established by a charge to loan expenses in our Consolidated Statements of Operations. At December 31, 2017 and 2016, this reserve totaled $688,000 and $727,000, respectively, and is included in other liabilities and accrued expenses on our Consolidated Balance Sheets.
The repurchase reserve is applicable to loans the Company originated and sold with representations and warranties, which is representative of the entire sold portfolio. The repurchase loss liability is estimated by origination year and to the extent that repurchase demands are made by investors, we may be able to successfully appeal such repurchase demands. The reserve considers anticipated future losses and the Company’s lack of historical experience with the make-whole demands. The reserve for residential mortgage loan repurchase losses represents our best estimate of the probable loss that we may incur due to the representations and warranties in our loan sales contracts with investors. Repurchase losses depend upon economic factors and other external conditions that may change over the life of the underlying loans. Additionally, lack of access to the servicing records of loans sold on a service released basis adds difficulty to the estimation process. To the extent that future investor repurchase demand and appeals success differ from past experience, the Company could have increased demands and increased loss severities on repurchases, causing future additions to the repurchase reserve.
Certain loans were sold with recourse provisions, and at December 31, 2017 and 2016, the related maximum contingent liability related to loans sold amounted to $1.6 million and $2.9 million, respectively. Based on discounted cash flow of projected losses on sold loans in this portfolio at December 31, 2017, the Company had no recourse liability and at December 31, 2016, the Company’s recourse liability was $2,000. These amounts are included in other liabilities and accrued expenses on our Consolidated Balance Sheets.
Contingent Consideration
A portion of the purchase price of MMC was contingent on future results of MMC. The Company recorded a contingent liability of $3.5 million in July 2015, at the time of the acquisition. The contingent liability was based on estimated future pre-tax earnings for the four-year period ending June 30, 2019. The contingency was settled in full in the fourth quarter of 2017 and the Company reversed the $1.2 million remaining contingent liability which is included in other income. The contingent liability as of December 31, 2016 was $3.3 million.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Other
In the ordinary course of business, various legal claims arise from time to time and, in the opinion of management based on discussion with legal counsel, management does not believe these claims will have a material effect on the Company’s financial position or results of operations.
15.DERIVATIVES
Interest Rate Risk Management - Derivative Instruments Not Designated As Hedging Instruments
The Company is party to a variety of derivative transactions, including derivative loan commitments, forward loan sale commitments and interest rate swap contracts. The Company enters into derivative contracts in order to meet the financing needs of its customers. The Company also enters into derivative contracts as a means of reducing its interest rate risk and market risk.
All derivatives are recognized in the Consolidated Balance Sheets at fair value. Changes in the fair value of derivatives are recognized in earnings. The Company did not have any fair value hedges or cash flow hedges at December 31, 2017 and 2016.
Derivative Loan Commitments
Mortgage loan commitments qualify as derivative loan commitments if the loan that will result from exercise of the commitment will be held for sale upon funding. The Company enters into commitments to fund residential mortgage loans at specified times in the future, with the intention that these loans will subsequently be sold in the secondary market. A mortgage loan commitment binds the Company to lend funds to a potential borrower at a specified interest rate and within a specified period of time, generally up to 60 days after inception of the rate lock.
Outstanding derivative loan commitments expose the Company to the risk that the price of the loans arising from exercise of the loan commitment might decline from inception of the rate lock to funding of the loan due to increases in mortgage interest rates. If interest rates increase, the value of these loan commitments decreases. Conversely, if interest rates decrease, the value of these loan commitments increases.
Forward Loan Sale Commitments
The Company utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to mitigate the risk of potential decreases in the values of loans that would result from the exercise of the derivative loan commitments.
With a “mandatory delivery” contract, the Company commits to deliver a certain principal amount of mortgage loans to an investor at a specified price on or before a specified date. If the Company fails to deliver the amount of mortgages necessary to fulfill the commitment by the specified date, it is obligated to pay a “pair-off” fee, based on then-current market prices, to the investor to compensate the investor for the shortfall.
With a “best efforts” contract, the Company commits to deliver an individual mortgage loan of a specified principal amount and quality to an investor if the loan to the underlying borrower closes. Generally, the price the investor will pay the seller for an individual loan is specified prior to the loan being funded (e.g., on the same day the lender commits to lend funds to a potential borrower).
The Company expects that these forward loan sale commitments will experience changes in fair value opposite to the change in fair value of derivative loan commitments.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Interest Rate Swaps
The Company enters into interest rate swap agreements that are transacted to meet the financing needs of its commercial customers. Offsetting interest rate swap agreements are simultaneously transacted with a third-party financial institution to effectively eliminate the Company’s interest rate risk associated with the customer swaps. The primary risks associated with these transactions arise from exposure to the ability of the counterparties to meet the terms of the contract. Mortgage-backed securities with a fair value of $5.8 million are pledged to secure the Company’s liability for the offsetting interest rate swaps. The interest rate swap notional amount below is the aggregate notional amount of the customer swap and the offsetting third-party swap.
The following tables present the fair values of derivative instruments in the Consolidated Balance Sheets:
The following table presents information pertaining to the Company’s derivative instruments on the Consolidated Statements of Operations:
16.COMPENSATION AND BENEFIT PLANS
Defined Contribution Plan
The Company provides a savings plan which qualifies under Section 401(k) of the Internal Revenue Code and provides for voluntary contributions by participating employees up to the maximum amount permitted by law. The Company may contribute 9.3% of each employee’s compensation plus 5.7% of the employee’s compensation in excess of the social security wage base on a discretionary basis up to regulatory maximums. Contributions expensed were $2.1 million, $2.0 million and $1.7 million for the years ended December 31, 2017, 2016 and 2015, respectively.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Management Incentive Program
The Company from time to time creates incentive compensation plans for senior management and other officers to participate in at varying levels. In addition, the Company may also pay a discretionary bonus to senior management, officers, and/or nonofficers of the Company. These programs are administered by the Compensation Committee of the Board of Directors. The expense for the incentive plans amounted to $2.0 million, $2.9 million and $2.3 million for the years ended December 31, 2017, 2016 and 2015, respectively.
Supplemental Retirement Plans
The Company provides supplemental retirement benefits to two senior executive officers of the Company under the terms of the Supplemental Executive Retirement Plan Agreements (the “Agreements”). Benefits to be paid under the Agreements are based primarily on the officer’s compensation and estimated mortality. The Agreements are funded with annuities purchased by the Company. During 2015, one agreement expired and was settled in accordance with the terms of the agreement and a new supplemental retirement plan was put in place. At December 31, 2017, 2016 and 2015, included in other liabilities and accrued expenses is the Company’s obligation under the plans of $4.7 million, $3.8 million and $2.2 million, respectively. The retirement benefits, as defined in the Agreements, are accrued by charges to compensation expense over the required service periods of the officers. Compensation expense related to these benefits was $933,000, $1.6 million and $1.6 million, for the years ended December 31, 2017, 2016 and 2015, respectively.
Split-Dollar Life Insurance Arrangements
The Company has collateral assignment split dollar life insurance agreements with an executive officer and a retired executive, whereby the Company will make annual premium payments for the executives’ life insurance policies. The Company has the unqualified right to receive from the insurer an amount which is equal to the lesser of the cash surrender value of the policy or the aggregate un-reimbursed amount of premium payments with respect to the policy for which the Company paid. The final payment was made in 2016. At December 31, 2015, included in other liabilities and accrued expenses is the Company’s obligation under the agreements of $135,000. In 2016, the Company terminated the agreement with one of the officers and ownership of the policy was transferred to the Company to fully reimburse the Company for premiums paid on the policy of $1.2 million. An endorsement split dollar life insurance agreement was established for the officer whereby the Company will pay to the executives’ estates or beneficiaries a portion of the death benefit that the Company will receive as beneficiary of such policy. Expense associated with this post retirement benefit for the years ended December 31, 2017, 2016 and 2015 amounted to $106,000, $101,000 and $16,000, respectively. The cash surrender value of the new policy is included in bank-owned life insurance on the Consolidated Balance Sheets.
Deferred Compensation Plan
The Company is the sole owner of an annuity policy pertaining to one of the Company’s executives. The Company has an agreement with this executive whereby upon retirement the Company will pay to the executive an amount equal to the cash surrender value of the annuity less premiums paid accumulated at an interest rate of 1.5% per year. At December 31, 2017, 2016 and 2015, included in other liabilities and accrued expenses is the Company’s obligation under the plan of $293,000, $265,000 and $238,000, respectively. For the years ended December 31, 2017, 2016 and 2015, the expense amounted to $28,000, $27,000 and $26,000, respectively.
The Company has agreements with two executive officers whereby the Company will pay the cost of the premium for individual supplemental medical and prescription drug coverage for their lifetime upon retirement at age 65 or later. Spousal coverage is provided each year the executive is eligible for coverage and the spouse is age 65 or over. At December 31, 2017, 2016 and 2015, included in other liabilities and accrued expenses is the Company’s obligation under the plan of $226,000, $216,000 and $183,000, respectively. For the years ended December 31, 2017, 2016 and 2015, the expense amounted to $10,000, $33,000 and $68,000, respectively.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Long-Term Incentive Plan
During 2015, the Company entered into a long-term incentive plan with several executive officers. Benefits are earned annually based on the Company’s achievement of performance goals. The plan is administered by the Company’s Board of Directors. Included in other liabilities and accrued expenses at December 31, 2017, 2016 and 2015 is $1.3 million, $810,000 and $336,000, respectively, for this plan. For the years ended December 31, 2017, 2016 and 2015, the expense amounted to $453,000, $474,000 and $336,000, respectively. The plan was amended effective January 1, 2018 and no further incentive awards will be awarded under the plan.
Post-Retirement Life Insurance
Employees who are covered under the Company’s bank-owned life insurance program can elect to participate in the benefits of the program while employed by the Company. The Company granted post-employment coverage to certain executives. This post retirement benefit is included in other liabilities and accrued expenses at December 31, 2017, 2016 and 2015 in the amount of $142,000, $136,000 and $79,000, respectively. For the years ended December 31, 2017, 2016 and 2015, the expense amounted to $7,000, $57,000 and $57,000, respectively.
Employee Stock Ownership Plan
On June 29, 2016, the Company established an ESOP to provide eligible employees the opportunity to own Company stock. The plan is a tax-qualified retirement plan for the benefit of the eligible Company employees. The ESOP shares were purchased through a loan from the Company and as the debt is repaid, shares are released. Contributions are allocated to eligible participants on the basis of compensation, subject to federal tax limits. The unreleased shares are deducted from stockholders' equity as unearned ESOP shares in the accompanying Consolidated Balance Sheets. The number of shares committed to be released per year is 59,359 through 2035.
Total compensation expense recognized in connection with the ESOP was $1.1 million and $951,000 for the years ended December 31, 2017 and 2016, respectively.
ESOP Restoration Plan
During 2016, the Company also adopted an ESOP Restoration Plan for the benefit of ESOP eligible employees whose annual compensation exceeds the amount of annual compensation permitted to be recognized under the ESOP by the Internal Revenue Code. Under the ESOP Restoration Plan, eligible participants would receive a credit each year equal to the amount they would have received under the ESOP but for the Internal Revenue Service imposed compensation limit. Any benefits earned under the ESOP Restoration Plan would become payable at the earliest of six months and a day after the participant’s separation of service from the Bank, the participant’s death, a change in control of the Company or upon termination of the ESOP Restoration Plan. These benefits are accrued over the period during which employees provide services to earn these benefits. For the year ended December 31, 2017 and 2016, $182,000 and $13,000, respectively was accrued for the ESOP Restoration Plan.
Directors’ Retirement Plan
The Company has an unfunded director fee continuation plan which provides postretirement benefits to eligible directors of
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
the Company. Participants in the plan must have at least six years of service as a director to be vested in the benefit which is determined based on number of years of service. The Company elected to curtail the plan in 2017.
Based on the actuarial analysis, the funded status of the plan and the components of net periodic cost are as follows:
The following assumptions were used to determine the benefit obligation and net periodic cost at or for the years ended December 31:
The following is a summary of benefit payments expected to be paid by the director’s retirement plan over the next ten years:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
17.RELATED PARTY TRANSACTIONS
The Bank has made loans to directors and officers, in the ordinary course of business at arms-length terms, amounting to $500,000 and $1.2 million at December 31, 2017 and 2016, respectively. There were no new loans granted in 2017. New loans granted were $2,000 in 2016. Loan repayments and reductions due to officer retirements were $720,000 and $135,000 in 2017 and 2016, respectively.
18.STOCK-BASED COMPENSATION
Under the HarborOne Bancorp, Inc. 2017 Stock Option and Incentive Plan (the “Equity Plan”), adopted on August 9, 2017, the Company may grant options, stock appreciation rights, restricted stock, restricted units, unrestricted stock awards, cash based awards, performance share awards, and dividend equivalent rights to its directors, officers and employees. Total shares reserved for issuance under the plan are 2,077,577. Both incentive stock options and non-qualified stock options may be granted under the Equity Plan, with the total shares reserved for options equaling 1,483,984. The exercise price of each option equals the market price of the Company’s stock on the date of grant and the maximum term of each option is ten years. The total number of shares reserved for restricted stock or restricted units is 593,593. Options and awards vest ratably over three years. The fair value of shares awarded is based on the market price at the date of grant.
Expense related to options and restricted stock granted to directors is recognized within other noninterest expense.
The Company has standard form agreements used for stock option and restricted stock awards. The standard form agreements used for the Chief Executive Officer and all other executive officers have previously been disclosed in Securities and Exchange Commission filings and generally provide that: (1) any unvested options or unvested restricted stock vest upon a Change in Control; and, that (2) any stock options which vest pursuant to a Change in Control, which is an event described in Section 280G of the Internal Revenue Code of 1986, will be cashed out at the difference between the acquisition price and the exercise price of the stock option.
Stock Options
The fair values of option grants in 2017 were estimated on the date of the grant using the Black-Scholes option-pricing model with the following assumptions:
·
Volatility is based on peer group volatility due to lack of sufficient trading history for the Company.
·
Expected life represents the period of time that the option is expected to be outstanding, taking into account the contractual term and the vesting period.
·
Expected dividend yield is based on the Company’s history and expectation of dividend payouts.
·
The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for a period equivalent to the expected life of the option.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
A summary of the status of the Company’s stock option grants at December 31, 2017, is presented in the table below:
For the year ended December 31, 2017, stock-based compensation expense applicable to the stock options was $845,000 and the recognized tax benefit related to this expense was $238,000.
Restricted Stock
Shares issued upon vesting may be either authorized but unissued shares or reacquired shares held by the Company. Any shares not issued because vesting requirements are not met will again be available for issuance under the plan. The fair market value of shares awarded, based on the market price at the date of grant, is unearned compensation to be amortized over the applicable vesting period.
The following table presents the activity in non-vested stock awards under the Equity Plan for the year ended December 31, 2017:
Total expense for the restricted stock awards was $1.3 million for the year ended December 31, 2017, and the recognized tax benefit related to this expense was $351,000.
19.MINIMUM REGULATORY CAPITAL REQUIREMENTS
The Company and Bank are subject to various regulatory capital requirements administered by the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (the “FDIC”). Failure to meet minimum capital requirements can result in mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s Consolidated Financial Statements.
Under the capital rules, risk-based capital ratios are calculated by dividing Tier 1 and total risk-based capital, respectively, by risk-weighted assets. Assets and off-balance sheet credit equivalents are assigned to one of several risk-weight categories, based primarily on relative risk. The rules require banks and bank holding companies to maintain a minimum common equity Tier 1 capital ratio of 4.5%, a minimum Tier 1 capital ratio of 6.0%, a total capital ratio of 8.0% and a leverage ratio of 4.0%. Additionally, subject to a transition schedule, the capital rules require a bank holding company to establish a capital conservation buffer of common equity
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Tier 1 capital in an amount above the minimum risk-based capital requirements equal to 2.5% of total risk weighted assets, or face restrictions on the ability to pay dividends, pay discretionary bonuses, and to engage in share repurchases.
The FDIC has amended its prompt corrective action rules to reflect the revisions made by the revised capital rules described above. Under the FDIC’s revised rules, which became effective January 1, 2015, an insured state nonmember bank is considered “well capitalized” if it (i) has a total risk-based capital ratio of 10.0% or greater; (ii) a Tier 1 risk-based capital ratio of 8.0% or greater; (iii) a common Tier 1 equity ratio of 6.5% or greater, (iv) a leverage capital ratio of 5.0% or greater; and (v) is not subject to any written agreement, order, capital directive, or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. A bank holding company is considered “well capitalized” if the bank holding company (i) has a total risk-based capital ratio of at least 10.0%, (ii) has a Tier 1 risk-based capital ratio of at least 6.0%, and (iii) is not subject to any written agreement order, capital directive or prompt corrective action directive to meet and maintain a specific capital level for any capital measure. Prompt corrective action provisions are not applicable to bank holding companies.
At December 31, 2017, the capital levels of both the Company and the Bank exceeded all regulatory capital requirements and their regulatory capital ratios were above the minimum levels required to be considered well capitalized for regulatory purposes and also exceeded the minimum capital requirements including the applicable capital conservation buffer of 1.25% (which increased to 1.875% on January 1, 2018).
The Company’s and Bank’s regulatory capital ratios as of December 31, 2017 and 2016 are presented in the table below.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Dividend Restrictions
The Bank is subject to dividend restrictions imposed by various regulators, including a limitation on the total of all dividends that the Bank may pay to the Company in any calendar year. The total of all dividends shall not exceed the Bank’s net income for the current year (as defined by statute), plus the Bank’s net income retained for the two previous years, without regulatory approval. Dividends from the Bank are an important source of funds to the Company to make dividend payments on its common stock and for its other cash needs. The ability of the Company and the Bank to pay dividends is dependent on regulatory policies and regulatory capital requirements. The ability to pay such dividends in the future may be adversely affected by new legislation or regulations, or by changes in regulatory policies relating to capital, safety and soundness, and other regulatory concerns.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
20.COMPREHENSIVE INCOME (LOSS)
Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities are reported as a separate component of the retained earnings section of the balance sheets, such items, along with net income, are components of comprehensive income (loss).
The components of accumulated other comprehensive loss, included in stockholders’ equity, are as follows:
The following tables present changes in accumulated other comprehensive loss by component for the years ended December 31, 2017, 2016 and 2015:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
21.FAIR VALUE OF ASSETS AND LIABILITIES
Determination of Fair Value
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The fair value of an asset or liability is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various assets or liabilities. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the asset or liability.
The following methods and assumptions were used by the Company in estimating fair value disclosures:
Cash and cash equivalents - The carrying amounts of cash and short-term instruments approximate fair values based on the short-term nature of the assets.
Securities - All fair value measurements are obtained from a third-party pricing service and are not adjusted by management. Securities measured at fair value in Level 1 are based on quoted market prices in an active exchange market. Securities measured at fair value in Level 2 are based on pricing models that consider standard input factors such as observable market data, benchmark yields, interest rate volatilities, broker/dealer quotes, credit spreads and new issue data.
Federal Home Loan Bank stock - The fair value of FHLB stock is equal to cost based on redemption provisions.
Mortgage loans held for sale - Fair values are based on prevailing market prices for similar commitments.
Loans - Fair values for mortgage loans and other loans are estimated using discounted cash flow analyses, using market interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Fair values for non-performing loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.
Retirement plan annuities - The carrying value of the annuities are based on their contract values which approximate fair value.
Mortgage servicing rights - Fair value is based on market prices for comparable mortgage servicing contracts, when available, or alternatively, is based on a valuation model that calculates the present value of estimated future net servicing income.
Deposits and mortgagors’ escrow accounts - The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) and mortgagors’ escrow accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). Fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies market interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.
Borrowed funds - The fair values of borrowed funds are estimated using discounted cash flow analyses based on the current incremental borrowing rates in the market for similar types of borrowing arrangements.
Accrued interest - The carrying amounts of accrued interest approximate fair value.
Forward loan sale commitments and derivative loan commitments - Forward loan sale commitments and derivative loan commitments are based on fair values of the underlying mortgage loans and the probability of such commitments being exercised. The assumptions for pull-through rates are derived from internal data and adjusted using management judgment. Derivative loan commitments include the non-refundable costs of originating the loan based on the Company’s internal cost analysis that is not observable and the value of servicing. The weighted average pull-through rate for derivative loan commitments was 86% at both December 31, 2017 and 2016.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Interest rate swaps - The Company’s interest rate swaps are traded in over-the-counter markets where quoted market prices are not readily available. For these interest rate derivatives, fair value is determined by a third party utilizing models that use primarily market observable inputs, such as swap rates and yield curves. The pricing models used to value interest rate swaps calculate the sum of each instrument’s fixed and variable cash flows, which are then discounted using an appropriate yield curve to arrive at the fair value of each swap. The pricing models do not contain a high level of subjectivity as the methodologies used do not require significant judgment. The Company incorporates credit valuation analysis for counterparty nonperformance risk in the fair value measurement, including the impact of netting applicable credit enhancements such as available collateral.
Off-balance sheet credit-related instruments - Fair values for off-balance sheet, credit related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of off-balance sheet instruments are immaterial.
Fair Value Hierarchy
The Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 - Valuation is based on quoted prices in active markets for identical assets or liabilities. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.
Level 2 - Valuation is based on 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 for substantially the full term of the assets or liabilities.
Level 3 - Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include assets and liabilities whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as assets and liabilities for which the determination of fair value requires significant management judgment or estimation.
Transfers between levels are recognized at the end of the reporting period, if applicable. Transfers did not occur in the periods presented.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Assets and Liabilities Measured at Fair Value on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below:
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
The table below presents, for the years ended December 31, 2017, 2016 and 2015, the changes in Level 3 assets and liabilities that are measured at fair value on a recurring basis.
Assets Measured at Fair Value on a Non-recurring Basis
The Company may also be required, from time to time, to measure certain other financial assets on a nonrecurring basis in accordance with generally accepted accounting principles. These adjustments to fair value usually result from application of lower-of-cost-or-market accounting or write-downs of individual assets. There were no liabilities measured at fair value on a non-recurring basis at December 31, 2017 and 2016. The following table summarizes the fair value hierarchy used to determine each adjustment and the carrying value of the related individual assets.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Losses in the following table represent the amount of the fair value adjustments recorded during the period on the carrying value of the assets held at December 31, 2017 and 2016, respectively.
Losses applicable to write-downs of impaired loans and other real estate owned and repossessed assets are based on the appraised value of the underlying collateral less estimated costs to sell. The losses on impaired loans is not recorded directly as an adjustment to current earnings, but rather as a component in determining the allowance for loan losses. The losses on other real estate owned and repossessed assets represent adjustments in valuation recorded during the time period indicated and not for losses incurred on sales. Appraised values are typically based on a blend of (a) an income approach using observable cash flows to measure fair value, and (b) a market approach using observable market comparables. These appraised values may be discounted based on management’s historical knowledge, expertise or changes in market conditions from time of valuation.
Summary of Fair Values of Financial Instruments
The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows. Certain financial instruments and all nonfinancial instruments are exempt from disclosure requirements. Accordingly, the aggregate fair value amounts presented herein may not necessarily represent the underlying fair value of the Company.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
22.EARNINGS PER SHARE (“EPS”)
Basic EPS represents net income attributable to common shareholders divided by the weighted-average number of common shares outstanding during the period. Unvested restricted shares are participating securities and included in the computation of basic earnings per share. Diluted EPS is computed by dividing net income attributable to common shareholders by the weighted-average number of common shares outstanding, plus the effect of potential dilutive common stock equivalents outstanding during the period. Unallocated ESOP shares are not deemed outstanding for EPS calculations. For the year ended December 31, 2017, earnings per common share have been computed based on the following:
Options for 1,326,063 shares were not included in the computation of diluted earnings per share for the year ended December 31, 2017 because to do so would have been antidilutive.
23.SEGMENT REPORTING
The Company has two reportable segments: HarborOne Bank and Merrimack Mortgage. Revenue from HarborOne Bank consists primarily of interest earned on loans and investment securities and service charges on deposit accounts. Revenue from Merrimack Mortgage comprises interest earned on loans and fees received as a result of the residential mortgage origination, sale and servicing process.
The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Segment profit and loss is measured by net income on a legal entity basis. Intercompany transactions are eliminated in consolidation.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
Information about the reportable segments and reconciliation to the Consolidated Financial Statements at December 31, 2017, 2016 and 2015, and for the years then ended are presented in the tables below.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
24.CONDENSED FINANCIAL STATEMENTS OF PARENT COMPANY
Condensed financial information relative to HarborOne Bancorp, Inc.’s balance sheet at December 31, 2017 and 2016 and the related statements of net income and cash flows for the years ended December 31, 2017 and 2016 are presented below. The statement of stockholder’s equity is not presented below as the parent company’s stockholder’s equity is that of the consolidated company.
HarborOne Bancorp, Inc.
Notes to Consolidated Financial Statements
			
		
25.SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
			 		
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURES
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Conclusion Regarding the Effectiveness of Disclosure 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) promulgated under the Exchange Act) as of December 31, 2017. In designing and evaluating the Company’s disclosure controls and procedures, the Company and its management recognize that any controls and procedures, no matter how well-designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. 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 are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported as of the end of the period covered by this annual report.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the fourth quarter that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
Management of HarborOne Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) under the Exchange Act as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s Board of Directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. HarborOne Bancorp, Inc.'s internal control over financial reporting includes those policies and procedures that:
(i) pertain to the maintenance of records that in reasonable detail accurately and fairly reflects the transactions and disposition of the assets of the Company;
(ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and
(iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013).
Based on our assessment and those criteria, management believes that the Company maintained effective internal control over financial reporting as of December 31, 2017.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE
The information required herein is incorporated by reference from the Company’s proxy statement relating to its May 10, 2018 Annual Meeting of Stockholders (the “Definitive Proxy Statement”) that will be filed with the Commission within 120 days following the fiscal year end December 31, 2017 under the headings of “Board of Director Information,” “Executive Officer Information,” and “Section 16(a) Beneficial Ownership Reporting Compliance.”
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required herein is incorporated by reference from the Definitive Proxy Statement under the headings of “Director Compensation,” “Executive Compensation,” and “Compensation Committee Interlocks and Insider Participation.”
.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Securities Authorized for Issuance Under Equity Compensation Plans
The following table sets forth information as of December 31, 2017 about the securities authorized for issuance under the Company’s equity compensation plan, the 2017 Stock Option and Incentive Plan. The Company’s shareholders previously approved the plan and all amendments are subject to shareholder approval. The Company has no other equity compensation plans that have not been approved by shareholders.
The information required herein by item 403 of Regulation S-K regarding the security ownership of management and certain beneficial owners is incorporated by reference from the Definitive Proxy statement under the heading “Stock Ownership and Other Matters.”
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required herein is incorporated by reference from the Definitive Proxy Statement under the heading “Board of Director Information- Related Party Transactions” and “Board of Director Information-Director Independence.”
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required herein is incorporated by reference from the Definitive Proxy Statement under the heading “Proposals to be Voted upon at the Annual Meeting - Ratification of Appointment of Independent Registered Public Accounting Firm (Proposal 2).”
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
EXHIBIT INDEX
The following exhibits are included in this Annual Report on Form 10-K for the year ended December 31, 2016 (and are numbered in accordance with Item 601 of Regulation S-K):
Exhibit No.
Description
2.1
Plan of Reorganization and Minority Stock Issuance (incorporated by reference to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
3.1
Articles of Organization of HarborOne Bancorp, Inc. (incorporated by reference to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
3.2
By-Laws of HarborOne Bancorp, Inc. (incorporated by reference to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
4.1
Form of Common Stock Certificate of HarborOne Bancorp, Inc. (incorporated by reference to Exhibit 4.1 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
10.1+
HarborOne Bank Employee Stock Ownership Plan (incorporated by reference to Exhibit 10.1 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
10.2+
HarborOne ESOP Restoration Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
10.3+
HarborOne Senior Management Long Term Incentive Plan (incorporated by reference to Exhibit 10.3 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
10.4+
HarborOne Bancorp, Inc. 2017 Stock Option and Incentive Plan (incorporated herein by reference to the Company’s Form 8-K filed with the Commission on August 10, 2017)
10.5+
Form of Restricted Stock Award Agreement Under the HarborOne Bancorp, Inc. 2017 Stock Option and Incentive Plan (incorporated by reference to Exhibit 10.2 to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 11, 2017)
10.6+
Form of Restricted Stock Award Agreement Under the HarborOne Bancorp, Inc. 2017 Stock Option and Incentive Plan (incorporated by reference to Exhibit 10.3 to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 11, 2017)
10.7+
Form of Restricted Stock Award Agreement Under the HarborOne Bancorp, Inc. 2017 Stock Option and Incentive Plan (incorporated by reference to Exhibit 10.4 to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 11, 2017)
10.8+
Form of Incentive Stock Option Agreement Under the HarborOne Bancorp, Inc. 2017 Stock Option and Incentive Plan (incorporated by reference to Exhibit 10.5 to the Registrant’s Quarterly Report on Form 10-Q filed with the Commission on August 11, 2017)
10.9+
Form of Change in Control Agreement (incorporated by reference to Exhibit 10.9 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
10.10+
HarborOne Bank Director Retirement Plan (incorporated by reference to Exhibit 10.10 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
10.11+
First Amendment to Director Retirement Plan (incorporated by reference to Exhibit 10.11 to Amendment No.1 of the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on April 8, 2016)
Subsidiaries of the Registrant (incorporated by reference to Exhibit 21 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
23*
Consent of Registered Public Accounting Firm
Power of Attorney (incorporated by reference to Exhibit 24.1 to the Registrant’s Registration Statement on Form S-1 filed with the Securities and Exchange Commission on March 4, 2016)
31.1*
Certification of Chief Executive Officer Required by Rule 13a-14(a) and Rule 15d-14(a) of the Exchange Act
31.2*
Certification of Chief Financial Officer Required by Rule 13a-14(a) and Rule 15d-14(a) of the Exchange Act
32.1**
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of December 31, 2017 and 2016, (ii) the Consolidated Statements of Operations for the years ended December 31, 2017 and 2016, (iii) the Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2017 and 2016, (iv) the Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2017 and 2016, (v) the Consolidated Statements of Cash Flows for the years ended December 31, 2017 and 2016, and (vi) the Notes to the Consolidated Financial Statements.
* Filed herewith
** Furnished herewith
+ Management contract or compensatory plan or agreement
ITEM 16. FORM 10-K SUMMARY
None.
			 		
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.
HarborOne Bancorp, Inc.
Date:
March 9, 2018
By:
/s/ James W. Blake
James W. Blake
President, Chief Executive Officer and Director
(Principal Executive Officer)
Date: March 9, 2018
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
By:
/s/ James W. Blake
By:
/s/ Joseph F. Casey
James W. Blake
Joseph F. Casey
President, Chief Executive Officer and Director
Executive Vice President, Chief Operating Officer, Chief Financial Officer, Treasurer and Director
(Principal Executive Officer)
(Principal Accounting and Financial Officer)
Date: March 9, 2018
Date: March 9, 2018
By:
/s/ Joseph F. Barry
By:
/s/ Timothy R. Lynch
Joseph F. Barry,
Timothy R. Lynch,
Director
Chairman and Director
Date: March 9, 2018
Date: March 9, 2018
By:
/s/ David P. Frenette, Esq.
By:
/s/ William A. Payne
David P. Frenette, Esq.,
William A. Payne,
Director
Director
Date: March 9, 2018
Date: March 9, 2018
By:
/s/ Gordon Jezard
By:
/s/ Wallace H. Peckham, III
Gordon Jezard,
Wallace H. Peckham, III,
Director
Director
Date: March 9, 2018
Date: March 9, 2018
By:
/s/ Edward F. Kent
By:
/s/ Michael Sullivan
Edward F. Kent,
Michael J. Sullivan,
Director
Director
Date: March 9, 2018
Date: March 9, 2018
`
/s/ Barry R. Koretz
Barry R. Koretz,
Director
Date: March 9, 2018