ITEM 1.Business
Forward Looking Statements
We have included or incorporated by reference in this Annual Report on Form 10-K, and from time to time our management may make, statements that may constitute “forward-looking statements” within the meaning of the safe harbour provisions of the U.S. Private Securities Litigation Reform Act of 1995. Forward-looking statements are not historical facts but instead represent only our beliefs regarding future events, many of which, by their nature, are inherently uncertain and outside our control. These statements include statements other than historical information or statements of current condition and may relate to our future plans and objectives and results, as well as statements about the objective and effectiveness of our risk management and liquidity policies, statements about trends in or growth opportunities for our business, statements about our future status, and activities or reporting under U.S. banking and financial regulation. Forward-looking statements generally are identified by the words “believe,” “project,” “expect,” “anticipate,” “estimate,” “intend,” “strategy,” “future,” “opportunity,” “plan,” “may,” “should,” “will,” “would,” “will be,” “will continue,” “will likely result,” and similar expressions. By identifying these statements for you in this manner, we are alerting you to the possibility that our actual results and financial condition may differ, possibly materially, from the anticipated results and financial condition indicated in these forward-looking statements. Important factors that could cause our actual results and financial condition to differ from those indicated in the forward-looking statements include, among others, those discussed below and under “Risk Factors” in Part 1, Item 1A
ITEM 1A.Risk Factors
Changes in Interest Rates May Hurt our Profits and Asset Values.
Our earnings largely depend on our net interest income, which could be negatively affected by changes in interest rates. Net interest income is the difference between:
·the interest income we earn on our interest-earning assets, such as loans and securities; and
·the interest expense we pay on our interest-bearing liabilities, such as deposits and borrowings.
The rates we earn on our assets and the rates we pay on our liabilities are generally fixed for a contractual period of time. While we have taken steps to attempt to reduce our exposure to increases in interest rates, historically our liabilities generally have shorter contractual maturities than our assets. This imbalance can create significant earnings volatility, because market interest rates change over time. In a period of rising interest rates, the interest income earned on our assets may not increase as rapidly as the interest paid on our liabilities. Likewise, in a period of falling interest rates, the interest expense paid on our liabilities may not decrease as rapidly as the interest income received on our assets. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Management of Market Risk.”
In addition, changes in interest rates can affect the average life of loans and mortgage-backed securities. A reduction in interest rates causes increased prepayments of loans and mortgage-backed securities as borrowers tend to refinance their debt to reduce their borrowing costs. This creates reinvestment risk, which is the risk that we may not be able to reinvest the funds from faster prepayments at rates that are comparable to the rates we earned on the prepaid loans or securities. Additionally, increases in interest rates may decrease loan demand and/or make it more difficult for borrowers to repay adjustable-rate loans.
Changes in interest rates also affect the current market value of our interest-earning securities portfolio. Generally, the value of securities moves inversely with changes in interest rates. At September 30, 2018, the fair value of our total securities portfolio was $54.6 million. The unrealized net loss on securities totaled $2.3 million on a pre-tax basis at September 30, 2018.
We evaluate interest rate sensitivity using models that estimate the change in Magyar Bank’s net interest income over a range of interest rate scenarios. At September 30, 2018, in the event of an immediate 200 basis point increase in interest rates, the model projects that we would experience a $747,000, or 3.72%, decrease in net interest income in the first year following the change in interest rates, and a $442,000, or 2.13%, decrease in net interest income in the second year following the change in interest rates. At September 30, 2018, in the event of an immediate 100 basis point decrease in interest rates, the model projects that we would experience a $544,000, or 2.71%, decrease in net interest income in the first year following the change in interest rates, and a $886,000, or 4.27%, decrease in net interest income in the second year following the change in interest rates.
At September 30, 2018, our available-for-sale securities portfolio totaled $22.5 million, which included $20.1 million mortgage-backed securities. To the extent interest rates increase and the value of our available-for-sale portfolio decreases, our stockholders’ equity will be adversely affected.
Because We Intend to Continue our Emphasis on the Origination of Commercial Business Loans and Commercial Real Estate Loans, Our Lending Risk Has Increased in Recent Years and May Increase in Future Years.
At September 30, 2018, our portfolio of commercial business and commercial real estate loans totaled $272.7 million, or 53.2% of our total loans, compared to $248.2 million, or 52.4% of our total loans at September 30, 2017 and $238.4 million, or 52.1% of our total loans at September 30, 2016. It is our intent to continue to emphasize the origination of commercial business and commercial real estate loans. Commercial business and commercial real estate loans generally have more risk than one-to four-family residential mortgage loans. At September 30, 2018, our non-performing loans decreased to $906,000 from $2.4 million at September 30, 2017. Because the repayment of these loans depends on the successful management and operation of the borrower’s properties or related businesses, repayment of these loans has been and may continue to be affected by adverse conditions in the real estate market or the local economy. Further, these loans typically have larger loan balances, and several of our borrowers have more than one commercial business and commercial real estate loan outstanding with us. 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 mortgage loan. Finally, if we foreclose on a commercial business or commercial real estate loan, our holding period for the collateral, if any, typically is longer than for one- to four-family residential mortgage loans because there are fewer potential purchasers of the collateral. Because we plan to continue to emphasize the origination of these loans, it may be necessary to increase our allowance for loan losses because of the increased credit risk associated with these types of loans. Any increase to our allowance for loan losses would adversely affect our earnings.
We may be adversely affected by recent changes in tax laws.
The Tax Cuts and Jobs Act, which was enacted in December 2017, is likely to have both positive and negative effects on our financial performance. For example, the new legislation resulted in a reduction in the federal corporate tax rate from 35% to 21% beginning in 2018, which will have a favorable impact on our earnings and capital generation abilities. However, the new legislation also enacted limitations on certain deductions that will have an impact on the banking industry, borrowers and the market for single-family residential real estate. These limitations include (1) a lower limit on the deductibility of mortgage interest on single-family residential mortgage loans, (2) the elimination of interest deductions for certain home equity loans, (3) a limitation on the deductibility of business interest expense, and (4) a limitation on the deductibility of property taxes and state and local income taxes.
The recent changes in the federal tax laws may have an adverse effect on the market for, and the valuation of, residential properties, and on the demand for such loans in the future and could make it harder for borrowers to make their loan payments. In addition, these recent changes may also have a disproportionate effect on taxpayers in states with high residential home prices and high state and local taxes, like New Jersey and New York. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership, which could require an increase in our provision for loan losses, which would reduce our profitability and could materially adversely affect our business, financial condition and results of operations.
Additionally, legislation in New Jersey that was adopted in July 2018 will increase our state income tax liability and could increase our overall tax expense. The legislation imposes a temporary surtax on corporations earning New Jersey allocated income in excess of $1 million of 2.5% for tax years beginning on or after January 1, 2018 through December 31, 2019, and of 1.5% for tax years beginning on or after January 1, 2020 through December 31, 2021. The new legislation also requires combined filing for members of an affiliated group for tax years beginning on or after January 1, 2019, changing New Jersey's current status as a separate return state, and limits the deductibility of dividends received. These changes are not temporary. Regulations implementing the legislative changes have not yet been issued, so we cannot yet fully evaluate the impact of the legislation on our overall tax expense. However, the new legislation may cause us to lose the benefit of certain of our tax management strategies and may cause our total tax expense to increase.
A Worsening of Economic Conditions Could Reduce Demand for Our Products and Services and/or Result in Increases in Our Level of Non-performing Loans, Which Could Have an Adverse Effect on Our Results of Operations.
Unlike larger financial institutions that are more geographically diversified, our profitability depends primarily on the general economic conditions in New Jersey and the greater New York metropolitan area. Local economic conditions have a significant impact on our commercial real estate and construction and consumer loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. Almost all of our loans are to borrowers located in or secured by collateral located in New Jersey and the New York metropolitan area.
A deterioration in economic conditions could result in the following consequences, any of which could have a material adverse effect on our business, financial condition, liquidity and results of operations:
·demand for our products and services may decline;
·loan delinquencies, problem assets and foreclosures may increase;
·collateral for loans, especially real estate, may decline in value, in turn reducing customers’ future borrowing power, and reducing the value of assets and collateral associated with existing loans;
·the value of our securities portfolio may decline; and
·the net worth and liquidity of loan guarantors may decline, impairing their ability to honor commitments to us.
Moreover, a significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, an outbreak of hostilities or other international or domestic calamities, unemployment or other factors beyond our control could further impact these local economic conditions and could further negatively affect the financial results of our banking operations. In addition, deflationary pressures, while possibly lowering our operating costs, could have a significant negative effect on our borrowers, especially our business borrowers, and the values of underlying collateral securing loans, which could negatively affect our financial performance.
If Our Allowance for Loan Losses is Not Sufficient to Cover Actual Loan Losses, Our Earnings Could Decrease.
Our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, requiring additions to our allowance, which could materially decrease our net income. Our allowance for loan losses was 0.82% of total loans and 463.6% of total non-performing loans at September 30, 2018. 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 the repayment of many of our loans. In determining the amount of the allowance for loan losses, we review our loans and our loss and delinquency experience, and we evaluate economic conditions. Based on this review, we believe our allowance for loan losses is adequate to absorb losses in our loan portfolio as of September 30, 2018.
Bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities will have a material adverse effect on our financial condition and results of operations.
The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for the Company for our first fiscal year after December 15, 2020. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which may require us to increase our allowance for loan losses, and to greatly increase the types of data we will need to collect and review to determine the appropriate level of the allowance for loan losses. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.
Strong Competition Within Our Market Area May Limit Our Growth and Profitability.
Competition in the banking and financial services industry is intense. In our market area, we compete with commercial banks, savings institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, insurance companies, and brokerage and investment banking firms operating locally and elsewhere. Some of our competitors have substantially greater resources and lending limits than we, have greater name recognition and market presence that benefit them in attracting business, and offer certain services that we do not or cannot provide. In addition, larger competitors may be able to price loans and deposits more aggressively than we do. Our profitability depends upon our continued ability to successfully compete in our market area. The greater resources and deposit and loan products offered by some of our competitors may limit our ability to increase our interest-earning assets. For additional information see “Business of Magyar Bank-Competition.”
If We Declare Dividends on Our Common Stock, Magyar Bancorp, MHC Will Be Prohibited from Waiving the Receipt of Dividends by Current Federal Reserve Board Policy, Which May Result in Lower Dividends for All Other Stockholders.
The Board of Directors of Magyar Bancorp, Inc. has the authority to declare dividends on its common stock, subject to statutory and regulatory requirements. So long as Magyar Bancorp, MHC is regulated by the FRB, if Magyar Bancorp, Inc. pays dividends to its stockholders, it also will be required to pay dividends to Magyar Bancorp, MHC, unless Magyar Bancorp, MHC is permitted by the FRB to waive the receipt of dividends. The FRB’s current position is to not permit a mutual holding company to waive dividends declared by its subsidiary. Accordingly, because dividends will be required to be paid to Magyar Bancorp, MHC along with all other stockholders, the amount of dividends available for all other shareholders will be less than if Magyar Bancorp, MHC were permitted to waive the receipt of dividends.
Magyar Bancorp, MHC Exercises Voting Control Over Magyar Bancorp, Inc.; Public Stockholders Own a Minority Interest.
Magyar Bancorp, MHC owns a majority of Magyar Bancorp, Inc.’s common stock and, through its Board of Directors, exercises voting control over the outcome of all matters put to a vote of stock holders (including the election of directors), except for matters that require a vote greater than a majority. Public stockholders own a minority of the outstanding shares of Magyar Bancorp, Inc.’s common stock. The same directors and officers who manage Magyar Bancorp, Inc. and Magyar Bank also manage Magyar Bancorp, MHC. In addition, regulatory restrictions applicable to Magyar Bancorp, MHC prohibit the sale of Magyar Bancorp, Inc. unless the mutual holding company first undertakes a second-step conversion.
We Operate In A Highly Regulated Environment and May Be Adversely Affected By Changes In Laws And Regulations.
Magyar Bank is subject to extensive regulation, supervision and examination by the NJDBI, its chartering authority, and by the Federal Deposit Insurance Corporation, which insures Magyar Bank’s deposits. As a bank holding company, Magyar Bancorp, Inc. is subject to regulation and supervision by the Federal Reserve Board. Such regulation and supervision govern the activities in which financial institutions and their holding companies may engage and are intended primarily for the protection of the federal deposit insurance fund and depositors. These regulatory authorities have extensive discretion in connection with their supervisory and enforcement activities, including the imposition of restrictions on the operations of financial institutions, the classification of assets by financial institutions and the adequacy of financial institutions’ allowance for loan losses. Any change in such regulation and oversight, whether in the form of regulatory policy, regulations, or legislation, could have a material impact on Magyar Bank and Magyar Bancorp, Inc.
Magyar Bank’s operations are also subject to extensive regulation by other federal, state and local governmental authorities, and are subject to various laws and judicial and administrative decisions that impose requirements and restrictions on operations. These laws, rules and regulations are frequently changed by legislative and regulatory authorities. There can be no assurance that changes to existing laws, rules and regulations, or any other new laws, rules or regulations, will not be adopted in the future, which could make compliance more difficult or expensive or otherwise adversely affect our business, financial condition or prospects.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or Other Laws and Regulations Could Result in Fines or Sanctions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions, including restrictions on conducting acquisitions or establishing new branches. During the last year, several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, these policies and procedures may not be effective in preventing violations of these laws and regulations.
System Failure or Breaches of Our Network Security Could Subject Us to Increased Operating Costs as well as Litigation and Other Liabilities.
The computer systems and network infrastructure we and our third-party service providers use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from physical theft, fire, power loss, telecommunications failure or a similar catastrophic event, as well as from security breaches, denial of service attacks, viruses, worms and other disruptive problems caused by hackers. Any damage or failure that causes an interruption in our operations could have a material adverse effect on our financial condition and results of operations. Computer break-ins, phishing and other disruptions could also jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and may cause existing and potential customers to refrain from doing business with us. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures designed to prevent such damage, our security measures may not be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to encrypt and protect customer transaction data. A failure of such security measures could have a material adverse effect on our financial condition and results of operations.
It is possible that a significant amount of time and money may be spent to rectify the harm caused by a breach or hack. While we have general liability insurance, there are limitations on coverage as well as dollar amount. Furthermore, cyber incidents carry a greater risk of injury to our reputation. Finally, depending on the type of incident, banking regulators can impose restrictions on our business and consumer laws may require reimbursement of customer loss.
Risks Associated with Cyber-Security Could Negatively Affect Our Earnings.
The financial services industry has experienced an increase in both the number and severity of reported cyber attacks aimed at gaining unauthorized access to bank systems as a way to misappropriate assets and sensitive information, corrupt and destroy data, or cause operational disruptions
We have established policies and procedures to prevent or limit the impact of security breaches, but such events may still occur or may not be adequately addressed if they do occur. Although we rely on security safeguards to secure our data, these safeguards may not fully protect our systems from compromises or breaches.
We also rely on the integrity and security of a variety of third party processors, payment, clearing and settlement systems, as well as the various participants involved in these systems, many of which have no direct relationship with us. Failure by these participants or their systems to protect our customers' transaction data may put us at risk for possible losses due to fraud or operational disruption.
Our customers are also the target of cyber-attacks and identity theft. Large scale identity theft could result in customers' accounts being compromised and fraudulent activities being performed in their name. We have implemented certain safeguards against these types of activities but they may not fully protect us from fraudulent financial losses.
The occurrence of a breach of security involving our customers' information, regardless of its origin, could damage our reputation and result in a loss of customers and business and subject us to additional regulatory scrutiny, and could expose us to litigation and possible financial liability. Any of these events could have a material adverse effect on our financial condition and results of operations.
ITEM 1B.
ITEM 1B.Unresolved Staff Comments
Not required for smaller reporting companies.
ITEM 2.
ITEM 2.Properties
The following table provides certain information with respect to our seven banking offices as of September 30, 2018:
The net book value of our premises, land and equipment was approximately $17.0 million at September 30, 2018.
For information regarding Magyar Bancorp, Inc.’s investment in mortgages and mortgage-related securities, see “Item 1. Business” herein.
ITEM 3.
ITEM 3.Legal Proceedings
In the ordinary course of business, we are a party to various legal actions which are incidental to the operation of our business. Although the ultimate outcome and amount of liability, if any, with respect to these legal actions cannot presently be ascertained with certainty, in the opinion of management, based upon information currently available to us, any resulting liability is believed to be immaterial to our consolidated financial position, results of operations and cash flows.
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) Our shares of common stock are traded on the NASDAQ Global Market under the symbol “MGYR.” At September 30, 2018, Magyar Bancorp, MHC owned 3,200,450 shares, or 54.0% of the issued shares of our common stock. The approximate number of holders of record of Magyar Bancorp, Inc.’s common stock as of September 30, 2018 was 405. Certain shares of Magyar Bancorp, Inc. are held in “nominee” or “street” name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. The following tables present quarterly market information for Magyar Bancorp, Inc. common stock for each quarter of the previous two fiscal years. Magyar Bancorp, Inc. began trading on the NASDAQ Global Market on January 24, 2006. The following information was provided by the NASDAQ Stock Market.
Dividend payments by Magyar Bancorp, Inc. would be dependent primarily on dividends it receives from Magyar Bank, because Magyar Bancorp, Inc. has no source of income other than dividends from Magyar Bank, earnings from the investment of proceeds from the sale of shares of common stock retained by Magyar Bancorp, Inc., and interest payments with respect to Magyar Bancorp, Inc.’s loan to the Employee Stock Ownership Plan. For more information on regulatory restrictions regarding the payment of dividends, see “Item 1 - Business- Supervision and Regulation- New Jersey Banking Regulation-Dividends.”
Other than its Employee Stock Ownership Plan, Magyar Bancorp, Inc. does not have any equity compensation plans that were not approved by stockholders. There were no stock options or shares of restricted stock available for issuance with respect to Magyar Bancorp’s equity compensation plans at September 30, 2018.
(b)Not applicable.
(c)Share repurchases.
The Company completed its first stock repurchase program of 130,927 shares in November 2007 and announced in November 2007 a second repurchase program of up to 5% of its publicly-held outstanding shares of common stock, or 129,924 shares, under which 81,000 shares had been repurchased as of September 30, 2018 at an average price of $8.33.
There were no repurchases of our common stock during the year ended September 30, 2018.
ITEM 6.
ITEM 6.Selected Financial Data
Not required for smaller reporting companies.
ITEM 7.
ITEM 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Magyar Bancorp, Inc. (the “Company”) is a Delaware-chartered mid-tier stock holding company whose most significant business activity is ownership of 100% of the common stock of Magyar Bank. Magyar Bank’s principal business is attracting retail deposits from the general public and investing those deposits, together with funds generated from operations, principal repayments on loans and securities and borrowed funds, into one-to four-family residential mortgage loans, multi-family and commercial real estate mortgage loans, home equity loans and lines of credit, commercial business loans and construction loans. Our results of operations depend primarily on our net interest income which is the difference between the interest we earn on our interest-earning assets and the interest we pay on our interest-bearing liabilities. Our net interest income is primarily affected by the market interest rate environment, the shape of the U.S. Treasury yield curve, the timing of the placement of interest-earning assets and interest-bearing liabilities, and the prepayment rate on our mortgage-related assets. Other factors that may affect our results of operations are general and local economic and competitive conditions, government policies and actions of regulatory authorities.
During the year ended September 30, 2018, the Company’s total assets grew $20.9 million, or 3.5%, to $624.0 million. The increase was attributable to a $37.7 million, or 8.0%, increase in loans receivable, net of allowance of loss. Partially offsetting the growth in loans were decreases in investment securities, which declined $7.1 million during the year, and other real estate owned, which declined $2.5 million during the year.
Total deposits increased $14.9 million, or 2.9%, to $530.1 million during the year ended September 30, 2018 from $515.2 million at September 30, 2017. The increases in deposits occurred in money market account balances, which increased $29.8 million, or 21.7%, in non-interest checking account balances, which increased $6.0 million, or 6.1%, in interest-bearing checking account balances, which increased $2.8 million, or 6.4%, and in certificates of deposit (including individual retirement accounts), which increased $2.3 million, or 1.8%. Partially offsetting these increases was a decrease in savings account balances, which decreased $26.0 million, or 24.2%. Deposits accounted for 85.0% of assets and 104.3% of net loans receivable at September 30, 2018.
The Company reported net income of $2.0 million for the year ended September 30, 2018. Net income increased $607,000, or 42.7%, compared with net income of $1.4 million for the year ended September 30, 2017. The increase in net income between the twelve month periods was attributable to higher net interest and dividend income, which increased $1.5 million. Partially offsetting this increase was higher non-interest expenses, which increased $880,000.
The Company’s net interest margin increased by 13 basis points to 3.49% for the year ended September 30, 2018 from 3.36% for the prior year ended September 30, 2017. In addition to growth in its interest earning assets during the year, the Company experienced higher yields on earning assets due to higher market interest rates.
Throughout 2019, we expect to continue increasing our commercial real estate and commercial business loans while managing non-interest expenses in order to increase profitability of the Company.
Critical Accounting Policies
Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. Critical accounting policies may involve complex subjective decisions or assessments. We consider the following to be our critical accounting policies.
Allowance for Loan Loss. The allowance for loan losses is the amount estimated by management as necessary to cover credit losses in the loan portfolio both probable and reasonably estimable at the balance sheet date. The allowance is established through the provision for loan losses which is charged against income. In determining the allowance for loan losses, management makes significant estimates and has identified this policy as one of our most critical. Due to the high degree of judgment involved, the subjectivity of the assumptions utilized and the potential for changes in the economic environment that could result in changes to the amount of the recorded allowance for loan losses, the methodology for determining the allowance for loan losses is considered a critical accounting policy by management.
As a substantial amount of our loan portfolio is collateralized by real estate, appraisals of the underlying value of property securing loans and discounted cash flow valuations of properties are critical in determining the amount of the allowance required for specific loans. Assumptions for appraisals and discounted cash flow valuations are instrumental in determining the value of properties. Overly optimistic assumptions or negative changes to assumptions could significantly affect the valuation of a property securing a loan and the related allowance determined. The assumptions supporting such appraisals and discounted cash flow valuations are carefully reviewed by management to determine that the resulting values reasonably reflect amounts realizable on the related loans.
Management performs a quarterly evaluation of the adequacy of the allowance for loan losses. We consider a variety of factors in establishing this estimate including, but not limited to, current economic conditions, delinquency statistics, geographic and industry concentrations, the adequacy of the underlying collateral, the financial strength of the borrower, results of internal loan reviews and other relevant factors. This evaluation is inherently subjective as it requires material estimates by management that may be susceptible to significant change based on changes in economic and real estate market conditions.
The evaluation has a specific and general component. The specific component relates to loans that are delinquent or otherwise identified as impaired through the application of our loan review process and our loan grading system. All such loans are evaluated individually, with principal consideration given to the value of the collateral securing the loan and discounted cash flows. Specific impairment allowances are established as required by this analysis. However, the Bank’s Federal and State regulators generally require that the specific reserve against impaired collateral-dependent loans be charged-off, reducing the carrying balance of the loan and allowance for loan loss. The general component is determined by segregating the remaining loans by type of loan, risk weighting (if applicable) and payment history. We analyze historical loss experience, delinquency trends, general economic conditions and geographic and industry concentrations in establishing the general portion of the reserve. This analysis establishes factors that are applied to the loan groups to determine the amount of the general component of the allowance for loan losses.
Actual loan losses may be significantly greater than the allowances we have established, which could have a material negative effect on our financial results.
Deferred Income Taxes. The Company records income taxes using the asset and liability method. Accordingly, deferred tax assets and liabilities: (i) are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; (ii) are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and (iii) are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled.
Deferred tax assets are likely to be realized and therefore do not have a valuation allowance.
Comparison of Financial Condition at September 30, 2018 and September 30, 2017
Total Assets. Total assets increased $20.9 million, or 3.5%, during the year ended September 30, 2018. The increase was attributable to a $37.7 million, or 8.0%, increase in loans receivable, net of allowance of loss. Partially offsetting the growth in loans were decreases in investment securities, which declined $7.1 million during the year, and other real estate owned, which declined $2.5 million during the year.
Loans Receivable. Total loans receivable at September 30, 2018 were comprised of $219.3 million (42.8%) in commercial real estate loans, $185.3 million (36.2%) in 1-4 family residential mortgage loans, $53.3 million (10.4%) in commercial business loans, $30.4 million (5.9%) in construction loans, and $24.2 million (4.7%) in home equity lines of credit and other loans. Total loans receivable at September 30, 2017 were comprised of $207.1 million (43.7%) in commercial real estate loans, $178.3 million (37.6%) in 1-4 family residential mortgage loans, $41.1 million (8.7%) in commercial business loans, $24.8 million (5.2%) in home equity lines of credit and other loans, and $22.6 million (4.8%) in construction loans.
Total non-performing loans decreased by $1.5 million to $906,000 during the year ended September 30, 2018 from $2.4 million at September 30, 2017. At September 30, 2018, non-performing loans consisted of three commercial real estate loans totaling $455,000, four 1-4 family residential mortgage loans (including home equity lines of credit) totaling $228,000, and two commercial business loans totaling $223,000. The ratio of non-performing loans to total loans was 0.18% at September 30, 2018 compared to 0.50% at September 30, 2017.
Once a loan is deemed non-performing, the value of the collateral securing the loan must be assessed, which is typically done by obtaining an updated third-party appraisal. To the extent that the current appraised value of collateral is insufficient to cover a collateral-dependent loan, the Company reduces the balance of the loan via a charge to the allowance for loan loss.
Non-performing loans secured by one-to four-family residential properties, including home equity lines of credit and other consumer loans, decreased $1.4 million to $228,000 at September 30, 2018 from $1.7 million at September 30, 2017. Magyar Bank had begun foreclosure proceedings on the majority of the properties as of September 30, 2018. Foreclosure of owner-occupied residential properties in the State of New Jersey can take several years. During the year ended September 30, 2018, Magyar Bank charged off $213,000 from these loans through a reduction of its allowance for loan loss and recovered $88,000 from prior year charge-offs.
Non-performing commercial real estate loans decreased $27,000, or 5.6%, to $455,000 at September 30, 2018 from $482,000 at September 30, 2017. Magyar Bank had begun foreclosure proceedings on the properties securing these loans at September 30, 2018. There were no charge-offs of non-performing commercial real estate loans while $23,000 was recovered from a prior year charge off during the year ended September 30, 2018.
Non-performing commercial business loans increased $10,000 to $223,000 at September 30, 2018 from $213,000 at September 30, 2017. During the year ended September 30, 2018, Magyar Bank charged off $170,000 in non-performing commercial business loans through a reduction of its allowance for loan loss and $1,000 was recovered from a prior year charge-off.
There were no non-performing construction loans at September 30, 2018 and 2017. There were no charge-offs of non-performing construction loans while $3,000 was recovered from a prior year charge off during the year ended September 30, 2018.
The ratio of non-performing loans and troubled debt restructurings to total loans receivable decreased to 0.18% at September 30, 2018 from 0.54% at September 30, 2017. The allowance for loan losses increased $725,000 to $4.2 million, or 463.6% of non-performing loans, at September 30, 2018 compared with $3.5 million, or 147.4% of non-performing loans, at September 30, 2017. Provisions for loan loss during the year ended September 30, 2018 were $997,000 while net charge-offs were $272,000, compared with a provision of $1.3 million and net charge-offs of $924,000 for the prior year period. The allowance for loan losses was 0.82% and 0.73% of gross loans outstanding at September 30, 2018 and 2017, respectively.
Investment Securities. Investment securities decreased $7.1 million, or 11.2%, to $56.1 million at September 30, 2018 from $63.2 million at September 30, 2017. Investment securities at September 30, 2018 consisted of $47.9 million in mortgage-backed securities issued by U.S. government agencies and U.S. government-sponsored enterprises, $4.8 million in U.S. government-sponsored enterprise debt securities, $3.0 million in corporate notes and $393,000 in “private-label” mortgage-backed securities. There were no other-than-temporary-impairment charges for the Company’s investment securities for the year ended September 30, 2018
Securities available-for-sale increased $10.7 million, or 90.2%, to $22.5 million at September 30, 2018 from $11.8 million at September 30, 2017. The increase was primarily the result of ten mortgage-backed securities totaling $12.6 million that were reclassified from the held-to-maturity portfolio. Upon adoption of ASU 2017-12, the Bank reclassified debt securities eligible to be hedged under the ASU from held-to-maturity to available-for-sale. In addition there were $1.4 million in security purchases, $2.8 million in principal and premium amortization and $756,000 in unrealized losses during the year.
Securities held-to-maturity decreased $17.7 million, or 34.5%, to $33.6 million at September 30, 2018 from $51.4 million at September 30, 2017. The decrease was primarily the result of ten mortgage-backed securities totaling $12.6 million that were reclassified to the available-for-sale portfolio with the adoption of ASU 2017-12. In addition there were $3.3 million in sales, $2.0 million in maturities, $3.2 million in principal and premium amortization and $1.5 million in unrealized losses during the year, partially offset by $3.5 million in security purchases.
Bank-Owned Life Insurance. The cash surrender value of life insurance held for directors and executive officers of Magyar Bank increased $293,000, or 2.5%, to $11.8 million at September 30, 2018 from $11.6 million at September 30, 2017. The increase in bank-owned life insurance was due to the increase in the cash surrender value of the existing policies.
Other Real Estate Owned. Other real estate owned (“OREO”) decreased $2.5 million, or 22.3%, to $8.6 million at September 30, 2018 from $11.1 million at September 30, 2017.
During the year ended September 30, 2018, the Company sold ten properties totaling $2.7 million at a net gain of $184,000, invested $191,000 to complete or repair properties, and obtained title for one property previously securing a non-performing loan totaling $323,000. In addition, the carrying values of properties were reduced by $480,000 in valuation allowances and insurance proceeds. OREO at September 30, 2018 consisted of four residential properties (three of which were leased) totaling $2.0 million, four real estate lots/land totaling $3.2 million, and five commercial real estate buildings totaling $3.4 million. The Bank is determining the proper course of action for its OREO, which may include holding the properties until the real estate market improves, marketing the properties for individual sale, or selling multiple properties to an investor and developer.
Deposits. Total deposits increased $14.9 million, or 2.9%, to $530.1 million at September 30, 2018 from $515.2 million at September 30, 2017.
The Company’s deposit strategy during the year ended September 30, 2018 was focused on increasing and expanding customer relationships with Magyar Bank, including higher balance commercial deposit accounts. As a result of this strategy, the Bank was able to continue replacing higher-cost, single service time deposit account holders with non-interest bearing checking and money market account balances.
The increase in deposits during the twelve months ended September 30, 2018 occurred in money market account balances, which increased $29.8 million, or 21.7%, in non-interest checking account balances, which increased $6.0 million, or 6.1%, in interest-bearing checking account balances, which increased $2.8 million, or 6.4%, and in certificates of deposit (including individual retirement accounts), which increased $2.3 million, or 1.8%. Partially offsetting these increases was a decrease in savings account balances, which decreased $26.0 million, or 24.2%. Deposits accounted for 85.0% of assets and 104.3% of net loans receivable at September 30, 2018.
At September 30, 2018, the Company held $14.8 million in brokered certificates of deposit, compared with $10.3 million at September 30, 2017.
Borrowed Funds. Borrowings, which include Federal Home Loan Bank of New York advances, increased $3.6 million, or 11.3%, to $35.5 million, at September 30, 2018 from $31.9 million at September 30, 2017.
Stockholders’ Equity. Stockholders’ equity increased $1.9 million, or 3.9%, to $51.4 million at September 30, 2018 from $49.5 million at September 30, 2017. The increase in stockholders’ equity was attributable to the Company’s results of operations for the year ended September 30, 2018.
The Company did not repurchase any shares during the twelve months ended September 30, 2018. The Company has repurchased 81,000 shares pursuant to the second stock repurchase plan through September 30, 2018, reducing outstanding shares to 5,820,746.
The Company’s book value per share increased to $8.82 at September 30, 2018 from $8.50 at September 30, 2017. The increase was attributable to the Company’s results from operations.
Comparison of Operating Results for the Years Ended September 30, 2018 and 2017
Net Income. The Company’s net income was $2.0 million for the year ended September 30, 2018, reflecting a $607,000, or 42.7%, increase from $1.4 million for the year ended September 30, 2017. The increase in net income between the twelve month periods was attributable to higher net interest and dividend income, which increased $1.5 million. Partially offsetting this increase were higher non-interest expenses, which increased $880,000 between the annual periods.
For the year ended September 30, 2018, the net interest margin improved by 13 basis points to 3.49% from 3.36% the prior year period. In addition to growth in its interest earning assets during the year, the Company experienced higher yields on earning assets due to higher market interest rates.
Net Interest and Dividend Income. Net interest and dividend income increased $1.5 million, or 8.2%, to $19.7 million during the year ended September 30, 2018 from $18.2 million during the year ended September 30, 2017. Total interest and dividend income increased $2.4 million, or 10.8%, to $24.4 million for the year ended September 30, 2018 from $22.0 million for the year ended September 30, 2017 while interest expense increased $876,000, or 23.2%, to $4.6 million for the year ended September 30, 2018 from $3.8 million for the year ended September 30, 2017.
Average Balance Sheet. The following table presents certain information regarding our financial condition and net interest income for the years ended September 30, 2018, 2017 and 2016. The table presents the annualized average yield on interest-earning assets and the annualized average cost of interest-bearing liabilities. We derived the yields and costs by dividing annualized income or expense by the average balance of interest-earning assets and interest-bearing liabilities, respectively, for the periods shown. We derived average balances from daily balances over the periods indicated. Interest income includes fees that we consider adjustments to yields.
(1) Includes passbook savings, money market passbook and club accounts.
(2) Includes interest-bearing checking and money market accounts.
(3) Includes certificates of deposits and individual retirement accounts.
(4) Calculated as annualized net interest income divided by average total interest-earning assets.
Rate/Volume Analysis. The following table presents the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by average volume). The volume column shows the effects attributable to changes in volume (changes in average volume multiplied by prior rate). The net 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.
(1) Includes passbook savings, money market passbook and club accounts.
(2) Includes interest-bearing checking and money market accounts.
(3) Includes certificates of deposits and individual retirement accounts.
Interest and Dividend Income. Interest and dividend income increased $2.4 million, or 10.8%, to $24.4 million for the year ended September 30, 2018 from $22.0 million for the year ended September 30, 2017. The average balance of interest-earnings assets between the two periods increased $22.8 million, or 4.2%, to $564.5 million from $541.7 million, while the yield on the assets increased 25 basis points to 4.31% for the year ended September 30, 2018 from 4.06% for the same period prior year.
Interest income on loans increased $2.3 million, or 11.4%, to $22.6 million for the year ended September 30, 2018, while the average balance of loans increased $24.8 million, or 5.4%, to $487.1 million from $462.4 million. The average yield on such loans was 4.64% at September 30, 2018 compared with 4.39% at September 30, 2017. The increase in yield on loans reflected a $24.8 million increase in the average balance in loan receivables and the higher interest environment during the year ended September 30, 2018.
Interest earned on investment securities, excluding Federal Home Loan Bank of New York stock, increased $50,000, or 3.2%, to $1.6 million for the year ended September 30, 2018 from the prior year. The increase was primarily due to a 12 basis point increase in the average yield on investment securities to 2.14% from 2.02%, offset by a $2.0 million, or 2.6%, decrease in the average balance of investment securities and interest earning deposits to $75.2 million from $77.2 million from the prior year.
Interest Expense. Interest expense increased $876,000, or 23.2%, to $4.6 million for the year ended September 30, 2018 from $3.8 million for the year ended September 30, 2017. The average balance of interest-bearing liabilities increased $9.0 million, or 2.1%, to $446.2 million from $437.2 million between the two periods while the cost of such liabilities increased 18 basis points to 1.04% for the year ended September 30, 2018 from 0.86% for the same period prior year due to the higher market interest environment.
The average balance of interest-bearing deposits increased $6.9 million, or 1.7%, to $409.5 million for the year ended September 30, 2018 from $402.6 million for the prior year while the average cost of such deposits increased 19 basis points to 0.95% from 0.76%. Interest expense on average deposits increased $843,000, or 27.6%, to $3.9 million for the year ended September 30, 2018 from $3.1 million for the year ended September 30, 2017.
Interest expense on advances increased $33,000, or 4.6%, to $753,000 for the year ended September 30, 2018 from $720,000 for the year ended September 30, 2017. The average cost of borrowings decreased 3 basis points to 2.05% for the year ended September 30, 2018 from 2.08% for the year ended September 30, 2017. The average balance of advances and securities sold under agreements to repurchase increased $2.2 million to $36.7 million for the year ended September 30, 2018 from $34.5 million the prior year.
Provision for Loan Losses. We establish provisions for loan losses, which are charged to earnings, at a level necessary to absorb known and inherent losses that are both probable and reasonably estimable at the date of the financial statements. In evaluating the level of the allowance for loan losses, management considers historical loss experience, the types of loans and the amount of loans in the loan portfolio, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, peer group information and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as future events occur.
After an evaluation of these factors, management made a provision of $997,000 for the year ended September 30, 2018 compared with a $1.3 million provision for the prior year. There were net charge-offs of $272,000 for the year ended September 30, 2018 compared with $924,000 for the year ended September 30, 2017. The charge-offs resulted from updated valuations of collateral securing impaired loans.
Total non-performing loans decreased $1.5 million, or 61.6%, to $906,000 at September 30, 2018 from $2.4 million at September 30, 2017. The allowance for loan losses increased $725,000 to $4.2 million, or 20.9% of gross loans outstanding at September 30, 2018, from $3.5 million, or 0.73% of gross loans outstanding at September 30, 2017. The increase in the allowance for loan losses during the year ended September 30, 2018 was attributable to growth in total loan receivable.
Other Income. Other income increased $122,000 during the year ended September 30, 2018 due to higher gains on the sales of assets, partially offset by lower service charges.
Gains from the sales of assets increased $276,000 to $600,000 for the twelve months ended September 30, 2018 compared with $324,000 for the twelve months ended September 30, 2017. Gains from the sales of loans increased $169,000, or 52.2%, to $493,000 from $324,000 for the year ended September 30, 2017 while gains from the sales of investment securities increased $107,000 in the current year period.
Service charges decreased $159,000, or 12.7%, to $1.1 million for the year ended September 30, 2018 from $1.3 million for the prior year due to lower loan prepayment penalties and loan late charges received during the current year period.
Other Expenses. Other expenses increased $880,000, or 5.4%, to $17.3 million for the year ended September 30, 2018 compared to $16.4 million for the year ended September 30, 2017 due to higher compensation and occupancy expenses.
Compensation and employee benefit expenses increased $603,000, or 6.6%, to $9.7 million and occupancy expense increased $138,000, or 4.9%, to $2.9 million due in large part to the opening of the Bank’s seventh branch location in June of 2017. Compensation expense also increased from annual merit increases for employees, higher incentive plan accruals, and higher medical benefit expenses than the prior year period.
Income Tax Expense. The Company recorded tax expense of $1.5 million for the year ended September 30, 2018 compared with tax expense of $994,000 for the year ended September 30, 2017. The income tax expense increase was the result of higher income from operations and a $410,000 charge resulting from the write-down of deferred tax assets due to the enactment of the Tax Cuts and Jobs Act on December 22, 2017, which lowered the Company’s federal income tax rate from 34% to 21%.
The Company recognized additional tax expense in our tax provision for the year ended September 30, 2018 related to adjustment of our net deferred tax asset to reflect the new corporate tax rate. As a result, income tax expense was adjusted to reflect the effects of the change in the tax law and resulted in an increase in income tax expense of $410,000 for the year ended September 30, 2018.
The federal income tax rate change is administratively effective at the beginning of our fiscal year resulting in the use of a blended rate for the annual period. As a result, the blended statutory federal tax rate for the Company for the year ending September 30, 2018 is 24.0%. The Company utilized an effective combined federal and state tax rate of 30.3% and 41.1% for the years ended September 30, 2018 and September 30, 2017, respectively.
Management of Market Risk
General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, our Board of Directors has established an Asset and Liability Management Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate, given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the Board of Directors. Senior management monitors the level of interest rate risk on a regular basis and the Asset and Liability Committee meets at least on a quarterly basis to review our asset/liability policies and interest rate risk position.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. As part of our ongoing asset-liability management, we seek to manage our exposure to interest rate risk by retaining in our loan portfolio fewer fixed rate residential loans, by originating and retaining adjustable-rate loans in the residential, construction and commercial real estate loan portfolios, by using alternative funding sources, such as advances from the Federal Home Loan Bank of New York (“FHLBNY”), to “match fund” longer-term residential and commercial mortgage loans, and by originating and retaining variable rate home equity and short-term and medium-term fixed-rate commercial business loans. We have also increased money market account deposits as a percentage of our total deposits. Money market accounts offer a variable rate based on market indications. By following these strategies, we believe that we are well-positioned to react to changes in market interest rates.
Net Interest Income Analysis. The table below sets forth, as of September 30, 2018, the estimated changes in our Net Interest Income (“NII”) for each of the next two years that would result from the designated instantaneous changes in interest rates. These estimates require making certain assumptions including loan and mortgage-related investment prepayment speeds, reinvestment rates, and deposit maturities and decay rates. These assumptions are inherently uncertain and, as a result, we cannot precisely predict the impact of changes in interest rates on net interest income. Actual results may differ significantly due to timing, magnitude and frequency of interest rate changes and changes in market conditions. Further, certain shortcomings are inherent in the methodology used in the interest rate risk measurement. Modeling changes in net interest income require making certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates.
(1) Assumes an instantaneous uniform change in interest rates at all maturities.
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations of a short-term nature. Our primary sources of funds consist of deposit inflows, loan repayments and maturities and sales of securities. While maturities and scheduled amortization of loans and securities are predictable sources of funds, deposit flows and mortgage prepayments are greatly influenced by general interest rates, economic conditions and competition. Our Asset/Liability Management Committee is responsible for establishing and monitoring our liquidity targets and strategies in order to ensure that sufficient liquidity exists for meeting the borrowing needs of our customers as well as unanticipated contingencies. We seek to maintain a liquidity ratio of 5.0% of assets or greater. The liquidity ratio is calculated by determining the sum of the difference between liquid assets (cash and unpledged investment securities) and short-term liabilities (estimated 30-day deposit outflows), borrowing capacity from the FHLBNY, and brokered deposit capacity and dividing the sum by total assets. At September 30, 2018, our liquidity ratio was 14.6% of assets.
We regularly adjust our investments in liquid assets based upon our assessment of expected loan demand, expected deposit flows, yields available on interest-earning deposits and securities, and the objectives of our asset/liability management program. Excess liquid assets are invested generally in interest-earning deposits and short-and intermediate-term securities.
Our most liquid assets are cash and cash equivalents. The levels of these assets are dependent on our operating, financing, lending and investing activities during any given period. At September 30, 2018, cash and cash equivalents totaled $15.4 million. Securities classified as available-for-sale, which provide additional sources of liquidity from sales, totaled $22.5 million at September 30, 2018. At September 30, 2018, we also had the ability to borrow $134.3 million from the FHLBNY. On that date, we had an aggregate of $35.5 million in advances outstanding.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our consolidated Statements of Cash Flows included in our consolidated Financial Statements.
At September 30, 2018, we had $16.9 million in loan origination commitments outstanding. In addition to commitments to originate loans, we had $54.1 million in unused lines of credit to borrowers. Certificates of deposit due within one year of September 30, 2018 totaled $66.0 million, or 12.5% of total deposits. If these deposits do not remain with us, we will be required to seek other sources of funds, including other deposits and FHLBNY advances. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit (including individual retirement accounts and brokered certificate deposit accounts) due on or before September 30, 2019. We believe, however, that based on past experience a significant portion of our certificates of deposit (including individual retirement accounts and brokered certificate deposit accounts) will remain with us. We have the ability to attract and retain deposits by adjusting the interest rates offered.
Our primary investing activities are the origination of loans and the purchase of securities. The balance of loans we originated in the current year was $80.0 million and $84.2 million, and purchased $4.9 million and $13.4 million of investment securities for the years ended September 30, 2018 and 2017, respectively.
Financing activities consist primarily of activity in deposit accounts and FHLBNY advances. We experienced a net increase in total deposits of $14.9 million for the year ended September 30, 2018 and a net increase in total deposits of $22.6 million for the year ended September 30, 2017. Deposit flows are affected by the overall level of interest rates, the interest rates and products offered by us and our local competitors and other factors.
Liquidity management is both a daily and long-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLBNY, which provide an additional source of funds. FHLBNY advances totaled $35.5 million and $31.9 million at September 30, 2018 and September 30, 2017, respectively. FHLBNY advances have primarily been used to fund loan demand.
Magyar Bank is subject to various regulatory capital requirements, (see “Supervision and Regulation-Federal Banking Regulation-Capital Requirements”). As of September 30, 2018, Magyar Bank’s Tier 1 capital as a percentage of the Bank's average assets was 8.61% and the total qualifying capital as a percentage of risk-weighted assets was 12.44%.
Bank-owned life insurance is a tax-advantaged financing transaction that is used to offset employee benefit plan costs. Policies are purchased insuring directors and officers of Magyar Bank using a single premium method of payment. Magyar Bank is the owner and beneficiary of the policies and records tax-free income through cash surrender value accumulation. We have minimized our credit exposure by choosing carriers that are highly rated and limiting the concentration of any one carrier. The investment in bank-owned life insurance has no significant impact on our capital and liquidity.
Off-Balance Sheet Arrangements and Aggregate Contractual Obligations
Commitments. As a financial services provider, we routinely are a party to various financial instruments with off-balance-sheet risks, such as commitments to extend credit, standby letters of credit and unused lines of credit. While these contractual obligations represent our future cash requirements, a significant portion of commitments to extend credit may expire without being drawn upon. Such commitments are subject to the same credit policies and approval process accorded to loans made by us. For additional information, see Note P, “Commitments,” and Note Q “Financial Instruments with Off-Balance-Sheet Risk” to our consolidated financial statements.
Contractual Obligations. In the ordinary course of our operations, we enter into certain contractual obligations. Such obligations include operating leases for premises and equipment.
The following table summarizes our significant fixed and determinable contractual obligations and other funding needs by payment date at September 30, 2018. The payment amounts represent those amounts due to the recipient and do not include any unamortized premiums or discounts or other similar carrying amount adjustments.
ITEM 7A.
ITEM 7A.Quantitative and Qualitative Disclosures About Market Risk
Not required for smaller reporting companies.
ITEM 8.
ITEM 8.Financial Statements and Supplementary Data
Consolidated Financial Statements:
Reports of Independent Registered Public Accounting Firms
Consolidated Balance Sheets as of September 30, 2018 and 2017
Consolidated Statements of Operations for the Years Ended September 30, 2018 and 2017
Consolidated Statements of Comprehensive Income for the Years Ended September 30, 2018 and 2017
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended September 30, 2018 and 2017
Consolidated Statements of Cash Flows for the Years Ended September 30, 2018 and 2017
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Magyar Bancorp, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Magyar Bancorp, Inc. and Subsidiary (the Company) as of September 30, 2018, the related consolidated statements of operations, comprehensive income, changes in stockholders' equity and cash flows for the year then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of September 30, 2018 and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. 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 audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audit, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material misstatement of the 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 financial statements. Our audit also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ RSM US LLP
We have served as the Company's auditor since 2018.
Blue Bell, Pennsylvania
December 20, 2018
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Magyar Bancorp, Inc.
We audited the accompanying consolidated balance sheets of Magyar Bancorp, Inc. and subsidiary (the “Company”) as of September 30, 2017, and the related consolidated statements of operations, comprehensive income, changes in stockholders’ equity and cash flows for the year then ended. The Company’s management is responsible for these consolidated financial statements. Our responsibility is to express an opinion on these consolidated financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of September 30, 2017, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.
/s/ Baker Tilly Virchow Krause, LLP
Iselin, New Jersey
December 21,
MAGYAR BANCORP, INC. AND SUBSIDIARY
Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Data)
The accompanying notes are an integral part of these consolidated financial statements.
MAGYAR BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Operations
(In Thousands, Except Share and Per Share Data)
The accompanying notes are an integral part of these consolidated financial statements.
MAGYAR BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Comprehensive Income
(In Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
MAGYAR BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Changes in Stockholders' Equity
For the Year Ended September 30, 2018 and 2017
(In Thousands, Except for Share Amounts)
(1) In January 2018, the Company adopted ASU 2018-02, as a result, the Company made a policy election to release income tax effects, as a result of the Tax Act, from AOCI to retained earnings.
The accompanying notes are an integral part of these consolidated financial statements.
MAGYAR BANCORP, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
(In Thousands)
The accompanying notes are an integral part of these consolidated financial statements.
Table of Contents MAGYAR BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 2018 and 2017
NOTE A - ORGANIZATION
On January 23, 2006, Magyar Bank (the “Bank”) completed a reorganization involving a series of transactions by which Bank’s corporate structure was changed from a mutual savings bank to the mutual holding company form of ownership. Magyar Bank became a New Jersey-chartered stock savings bank subsidiary of Magyar Bancorp, Inc., a Delaware-chartered mid-tier stock holding company. Magyar Bancorp, Inc. (the “Company”) owns 100% of the outstanding shares of common stock of Magyar Bank. Magyar Bancorp, Inc. is a majority-owned subsidiary of Magyar Bancorp, MHC, a New Jersey-chartered mutual holding company.
Magyar Bancorp, MHC, owns 54.0%, or 3,200,450, of the issued shares of common stock of Magyar Bancorp, Inc. Of the remaining shares, 2,620,296, or 44.2%, are held by public stockholders and 102,996, or 1.8%, are held by Magyar Bancorp, Inc. in treasury stock. So long as Magyar Bancorp, MHC exists, it will be required to own a majority of the voting stock of Magyar Bancorp, Inc. Magyar Bancorp, Inc. and Magyar Bancorp, MHC are subject to comprehensive regulation and examination by the Board of Governors of the Federal Reserve System and the New Jersey Department of Banking and Insurance.
The Bank is subject to regulations issued by the New Jersey Department of Banking and Insurance and the Federal Deposit Insurance Corporation (the “FDIC”). The Bank’s administrative office is located in New Brunswick, New Jersey. The Bank has seven branch offices which are located in New Brunswick, North Brunswick, South Brunswick, Branchburg, Bridgewater, and Edison, New Jersey, and a loan product office located in Keyport, New Jersey. The Bank’s savings deposits are insured by the FDIC through the Deposit Insurance Fund (DIF); also, the Bank is a member of the Federal Home Loan Bank of New York.
MagBank Investment Company, a New Jersey investment corporation subsidiary of the Bank, was formed on August 15, 2006 for the purpose of buying, selling and holding investment securities.
Hungaria Urban Renewal, LLC is a Delaware limited-liability corporation established in 2002 as a qualified intermediary operating for the purpose of acquiring and developing the Bank’s new main office. The Bank owns a 100% interest in Hungaria Urban Renewal, LLC, which has no other business other than owning the Bank’s main office site.
Magyar Service Corporation, a New Jersey corporation, is a wholly owned, non-bank subsidiary of the Bank. Magyar Service Corporation, which also operates under the name Magyar Financial Services, receives commissions from annuity and life insurance sales referred to a licensed, non-bank financial planner.
The Bank competes with other banking and financial institutions in its primary market areas. Commercial banks, savings banks, savings and loan associations, credit unions and money market funds actively compete for savings and time certificates of deposit and all types of loans. Such institutions, as well as consumer financial and insurance companies, may be considered competitors of the Bank with respect to one or more of the services it renders.
The Bank is subject to regulations of certain state and federal agencies and, accordingly, the Bank is periodically examined by such regulatory authorities. As a consequence of the regulation of commercial banking activities, the Bank’s business is particularly susceptible to future state and federal legislation and regulations.
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
1. Basis of Financial Statement Presentation
The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America (US GAAP) and predominant practices within the banking industry. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiary, the Bank, and its wholly-owned subsidiaries MagBank Investment Company, Magyar Service Corporation, and Hungaria Urban Renewal, LLC. All intercompany balances and transactions have been eliminated in the consolidated financial statements.
Table of Contents MAGYAR BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The Company has evaluated subsequent events and transactions occurring subsequent to the consolidated balance sheet date of September 30, 2018, for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were available to be issued.
In preparing financial statements in conformity with US GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
The principal estimates that are particularly susceptible to significant change in the near term relate to the allowance for loan losses and the deferred tax asset. The evaluation of the adequacy of the allowance for loan losses includes an analysis of the individual loans and overall risk characteristics and size of the different loan portfolios, and takes into consideration current economic and market conditions, the capability of specific borrowers to pay specific loan obligations, as well as current loan collateral values. However, actual losses on specific loans, which also are encompassed in the analysis, may vary from estimated losses.
The Company records income taxes using the asset and liability method. Accordingly, deferred tax assets and liabilities: (i) are recognized for the expected future tax consequences of events that have been recognized in the financial statements or tax returns; (ii) are attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases; and (iii) are measured using enacted tax rates expected to apply in the years when those temporary differences are expected to be recovered or settled.
Where applicable, deferred tax assets are reduced by a valuation allowance for any portions determined not likely to be realized. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income tax expense in the period of enactment. The valuation allowance is adjusted, by a charge or credit to income tax expense, as changes in facts and circumstances warrant.
2. Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks, time deposits with original maturities less than three months and overnight deposits.
3. Investment Securities
The Company classifies its investment securities into one of three portfolios: held to maturity, available for sale or trading. Investments in debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity securities and reported at amortized cost. Debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as trading securities and reported at fair value, with unrealized holding gains and losses included in earnings. Debt securities not classified as either trading securities or as held to maturity securities are classified as available for sale securities and reported at fair value, with unrealized holding gains or losses, net of deferred income taxes, reported in the accumulated other comprehensive income (“AOCI”) component of stockholders’ equity. Equity securities, with certain exceptions, are measured at fair value with changes in fair value recognized in net income.
If the fair value of a security is less than its amortized cost, the security is deemed to be impaired. Management evaluates all securities with unrealized losses quarterly to determine if such impairments are “temporary” or “other-than-temporary” in accordance with applicable accounting guidance. The Company accounts for temporary impairments based upon security classification as either available for sale, held to maturity or trading. Temporary impairments on “available for sale” securities are recognized, on a tax-effected basis, through AOCI with offsetting entries adjusting the carrying value of the security and the balance of deferred taxes. Conversely, the Company does not adjust the carrying value of “held to maturity” securities for temporary impairments, although information concerning the amount and duration of impairments on held to maturity securities is generally disclosed in periodic consolidated financial statements. The carrying value of securities held in a trading portfolio is adjusted to their fair value through earnings on a daily basis. However, the Company maintained no securities in trading portfolios at or during the periods presented in these consolidated financial statements.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The Company accounts for other-than-temporary impairments based upon several considerations. First, other-than-temporary impairments on securities that the Company has decided to sell as of the close of a fiscal period, or will, more likely than not, be required to sell prior to the full recovery of the their fair value to a level equal to or exceeding their amortized cost, are recognized in operations. If neither of these criteria apply, then the other-than-temporary impairment is separated into credit-related and noncredit-related components. The credit-related impairment generally represents the amount by which the present value of the cash flows that are expected to be collected on an other-than-temporarily impaired security fall below its amortized cost while the noncredit-related component represents the remaining portion of the impairment not otherwise designated as credit-related. The Company recognizes credit-related, other-than-temporary impairments in earnings, while noncredit-related, other-than-temporary impairments on debt securities are recognized, net of deferred taxes, in AOCI.
Federal law requires a member institution of the Federal Home Loan Bank (“FHLB”) system to purchase and hold restricted stock of its district FHLB according to a predetermined formula. This stock is restricted in that it may only be sold to the FHLB and all sales must be at par. Accordingly, the FHLB restricted stock is carried at cost, less any applicable impairment charges.
Premiums and discounts on all securities are amortized or accreted to maturity by use of the level-yield method considering the impact of principal amortization and prepayments on mortgage-backed securities. Gain or loss on sales of securities is recognized on the specific identification method.
4. Loans and Allowance for Loan Losses
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are stated at the amount of unpaid principal, adjusted for net deferred loan fees and costs, and reduced by an allowance for loan losses. Interest on loans is accrued and credited to operations based upon the principal amounts outstanding. The allowance for loan losses is established through a provision for possible loan losses charged to operations. Loans are charged against the allowance for loan losses when management believes that the collectability of the principal is unlikely.
Income recognition of interest is discontinued when, in the opinion of management, the collectability of such interest becomes doubtful. A loan is generally classified as non-accrual when the scheduled payment(s) due on the loan is delinquent for more than three months. Loan origination fees and certain direct origination costs are deferred and amortized over the life of the related loans as an adjustment to the yield on loans receivable using the effective interest method.
Management uses a ten point internal risk rating system to monitor the credit quality of the overall loan portfolio. The first six categories are considered not criticized, and are aggregated as “Pass” rated. The criticized rating categories utilized by management generally follow bank regulatory definitions. The Special Mention category includes assets that are currently protected but are potentially weak, resulting in an undue and unwarranted credit risk, but not to the point of justifying a Substandard classification. Loans in the Substandard category have well-defined weaknesses that jeopardize the liquidation of the debt, and have a distinct possibility that some loss will be sustained if the weaknesses are not corrected. All loans greater than three months past due are considered Substandard. Any portion of a loan that has been charged off is placed in the Loss category.
To help ensure that risk ratings are accurate and reflect the present and future capacity of borrowers to repay a loan as agreed, the Bank has a structured loan rating process with several layers of internal and external oversight. Generally, consumer and residential mortgage loans are included in the Pass categories unless a specific action, such as severe delinquency, bankruptcy, repossession, or death occurs to raise awareness of a possible credit event. The Bank’s Commercial Loan Officers are responsible for the timely and accurate risk rating of the loans in their portfolios at origination and on an ongoing basis. The Asset Review Committee performs monthly reviews of all commercial relationships internally rated 6 (“Watch”) or worse. Confirmation of the appropriate risk grade is performed by an external loan review company that semi-annually reviews and assesses loans within the portfolio. Generally, the external consultant reviews commercial relationships greater than $500,000 and/or criticized relationships greater than $250,000. Detailed reviews, including plans for resolution, are performed on loans classified as Substandard on a monthly basis.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The allowance for loan losses is maintained at an amount management deems adequate to cover estimated losses. In determining the level to be maintained, management evaluates many factors, including current economic trends, industry experience, historical loss experience, industry loan concentrations, the borrowers’ ability to repay and repayment performance, and estimated collateral values. In the opinion of management, the present allowance is adequate to absorb reasonable, foreseeable loan losses. While management uses the best information available to make such evaluations, future adjustments to the allowance may be necessary based on changes in economic conditions or any of the other factors used in management’s determination. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for losses on loans. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination. Charge-offs to the allowance are made when the loan is transferred to other real estate owned or other determination of a confirmed loss. Recoveries on loans previously charged off are also recorded through the allowance.
A loan is considered impaired when, based upon current information and events, it is probable that a creditor will be unable to collect all amounts due including principal and interest, according to the contractual terms of the loan agreement. The Company measures impaired loans based on the present value of expected future cash flows discounted at the loan’s effective interest rate or as a practical expedient, at the loan’s current observable market price, or the fair value of the collateral if the loan is collateral dependent. The amount by which the recorded investment of an impaired loan exceeds the measurement value is recognized by creating a valuation allowance through a charge to the provision for loan losses. Impairment criteria generally do not apply to those smaller-balance homogeneous loans that are collectively evaluated for impairment which, for the Company, includes one- to four-family first mortgage loans and consumer loans, other than those modified in a troubled debt restructuring.
The Company records cash receipts on impaired loans that are non-performing as a reduction to principal before applying amounts to interest or late charges unless specifically directed by the Bankruptcy Court to apply payments otherwise. The Company may continue to recognize interest income on impaired loans where there is no confirmed loss.
5. Premises and Equipment
Premises and equipment are carried at cost less accumulated depreciation, and include capitalized expenditures for new facilities, major betterments and renewals. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method based upon the estimated useful lives of the related assets for financial reporting purposes and using the mandated methods by asset type for income tax purposes. Leasehold improvements are depreciated using the straight-line method based upon the initial term of the lease.
The Company accounts for the impairment of long-lived assets in accordance with US GAAP, which requires recognition and measurement for the impairment of long-lived assets to be held and used or to be disposed of by sale. The Company had no impaired long-lived assets at September 30, 2018 and 2017.
6. Revenue recognition
The Company recognizes revenue in the consolidated statements of income as it is earned and when collectability is reasonably assured. The primary source of revenue is interest income from interest earning assets, which is recognized on the accrual basis of accounting using the effective interest method. The recognition of revenues from interest earning assets is based upon formulas from underlying loan agreements, securities contracts, or other similar contracts. Non-interest income is recognized on the accrual basis of accounting as services are provided or as transactions occur. Non-interest income includes earnings on bank-owned life insurance, deposit accounts, merchant services, ATM and debit card fees, mortgage banking activities, and other miscellaneous services and transactions.
7. Other Real Estate Owned
Real estate acquired through foreclosure, or a deed-in-lieu of foreclosure, is recorded at fair value less estimated selling costs at the date of acquisition or transfer, and subsequently at the lower of its net cost or fair value less estimated selling costs. Adjustments to the carrying value at the date of acquisition or transfer are charged to the allowance for loan losses. The carrying value of the individual properties is subsequently adjusted to the extent it exceeds estimated fair value less estimated selling costs, at which time a provision for losses on such real estate is charged to operations.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Operating expenses of holding real estate, net of related income, are charged against income as incurred. Gains on sales of real estate are recognized, normally at closing, when down payment and certain other requirements are met; otherwise such gains are deferred and recognized on the installment method of accounting. Losses on the disposition of real estate, including expenses incurred in connection with the disposition, are charged to operations.
8. Pension and Postretirement Plans
The Company sponsors qualified defined benefit pension plan and supplemental executive retirement plan (SERP). The qualified defined benefit pension plan is funded with trust assets invested in a diversified portfolio of debt and equity securities. Accounting for pensions and other postretirement benefits involves estimating the cost of benefits to be provided well into the future and attributing that cost over the time period each employee works. This involves extensive use of assumptions about inflation, investment returns, mortality, turnover, and discount rates. Among other factors, changes in interest rates, investment returns and the market value of plan assets can (i) affect the level of plan funding; (ii) cause volatility in the net periodic pension cost; and (iii) increase our future contribution requirements. A significant decrease in investment returns or the market value of plan assets or a significant decrease in interest rates could increase our net periodic pension costs and adversely affect our results of operations. A significant increase in our contribution requirements with respect to our qualified defined benefit pension plan could have an adverse impact on our cash flow. Changes in the key actuarial assumptions would impact net periodic benefit expense and the projected benefit obligation for our defined benefit and other postretirement benefit plan. See Note M, “Pension Plan,” and Note N, “Non-Qualified Compensation Plan” for information on these plans and the assumptions used.
9. Income Taxes
The Company and its subsidiaries file consolidated federal and individual state income tax returns. Income taxes are allocated based on the contribution of their respective income or loss to the consolidated income tax return.
The Company records income taxes on the basis of reported income using the asset and liability method. Accordingly, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. To the extent that current available evidence about the future raises doubt about the realization of a deferred tax asset, a valuation allowance is established. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company follows the provisions of Financial Accounting Standards Board Accounting Standards Codification Topic 740, which provides clarification on accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. The guidance prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
The Company recorded additional tax expense for the year ended September 30, 2018 due to higher income from operations and the write-down of its net deferred tax asset due to the enactment of the Tax Cuts and Jobs Act on December 22, 2017, which lowered the Company’s federal income tax rate from 34% to 21%. The Company recognized additional tax expense in its tax provision for the year ended September 30, 2018 related to adjustment of our net deferred tax asset to reflect the new corporate tax rate. See Note L, “Income Taxes” for information on the Company’s income tax expense and deferred tax asset for the years ended September 30, 2018 and 2017.
At September 30, 2018 and 2017, no significant income tax uncertainties have been included in the Company’s Consolidated Balance Sheets. The Company’s policy is to recognize interest and penalties on unrecognized tax benefits in income tax expense in the Consolidated Statements of Operations. No interest and penalties were recorded during the years ended September 30, 2018 and 2017. The tax years subject to examination by the taxing authorities are the years ended September 30, 2013 and forward.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
10. Advertising Costs
The Company expenses advertising costs as incurred.
11. Earnings Per Share
Basic income per share is calculated by dividing income available to common stockholders by the weighted average number of shares of common stock outstanding for the period. The weighted average common shares outstanding include shares held by the Magyar Bancorp, MHC and shares allocated to the Employee Stock Ownership Plan.
Diluted income per share is calculated by adjusting the weighted average common shares outstanding to reflect the potential dilution that could occur using the treasury stock method if securities or other contracts to issue common stock, such as stock options and unvested restricted stock, were exercised and converted into common stock. The resulting shares issued would share in the earnings of the Company. Shares issued and shares reacquired during the period are weighted for the portion of the period that they were outstanding. In periods of loss, dilution is not calculated and diluted loss per share is equal to basic loss per share.
The following table illustrates the reconciliation of the numerators and denominators of the basic and diluted earnings per share (EPS) calculations. All stock options were anti-dilutive at September 30, 2018 and 2017.
12. Comprehensive Income (Loss) and Accumulated Other Comprehensive Income (Loss)
Comprehensive income (loss) includes net income as well as certain other items which result in a change to equity during the period. The other items allocated to comprehensive income (loss), as well as the related income tax effects, for the years ended September 30, 2018 and 2017 were as follows:
Table of Contents MAGYAR BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 2018 and 2017
(a) Realized gains on securities transactions included in gains on sales of investment securities in the accompanying Consolidated Statements of Operations
(b) Tax effect included in income tax expense in the accompanying Consolidated Statements of Operations
The components of accumulated other comprehensive loss at September 30, 2018 and 2017 were as follows:
13. Bank-Owned Life Insurance
The Company has purchased Bank-Owned Life Insurance policies (“BOLI”). BOLI involves the purchasing of life insurance by the Company on directors and executive officers. The proceeds are used to help defray the costs of non-qualified compensation plans. The Company is the owner and beneficiary of the policies. BOLI is recorded on the Consolidated Balance Sheets at its cash surrender value and changes in the cash surrender value are recorded in other income in the Consolidated Statement of Operations.
14. Off-Balance Sheet Credit Related Financial Instruments
In the ordinary course of business, the Company has entered into commitments to extend credit, including commitments under commercial lines of credit. Such financial instruments are recorded when they are funded. The Company does not engage in the use of derivative financial instruments. See Note Q, “Financial Instruments With Off-Balance Risk”.
15. Segment Reporting
The Company acts as an independent, community, financial services provider, and offers traditional banking and related financial services to individual, business and government customers. The Company offers a full array of commercial and retail financial services, including the taking of time, savings and demand deposits; the making of commercial, consumer and home equity loans; and the provision of other financial services.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Management does not separately allocate expenses, including the cost of funding loan demand, between the commercial and retail operations of the Company. As such, discrete financial information is not available and segment reporting would not be meaningful.
16. New Accounting Pronouncements
In connection with the preparation of quarterly and annual reports in accordance with the Securities and Exchange Commission’s (“SEC”) Securities Exchange Act of 1934, SEC Staff Accounting Bulletin Topic 11.M requires the disclosure of the impact that recently issued accounting standards will have on financial statements when they are adopted in the future.
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which will supersede the current revenue recognition requirements in Topic 605, Revenue Recognition. The ASU is based on the principle that revenue is recognized to depict the transfer of 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. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In August 2015, the FASB issued ASU 2015-14 which deferred the effective date of ASU 2014-09 by one year. The new guidance is effective for public companies for periods beginning after December 15, 2017. The ASU permits application of the new revenue recognition guidance to be applied using one of two retrospective application methods.
Based on our evaluation under the current guidance, we estimated that substantially all of our interest income and non-interest income will not be impacted by the adoption of ASU 2014-09 because either the revenue from those contracts with customers is covered by other guidance in US GAAP or the revenue recognition outcomes anticipated with the adoption of ASU 2014-09 will likely be similar to our current revenue recognition practices. The Company evaluated certain noninterest revenue streams, including, deposit related fees, service and interchange fees, and merchant income to determine the potential impact of the guidance on the Company’s consolidated financial statements. The Company expects additional financial statement disclosures of non-interest income revenue streams with the adoption of this ASU. In addition, we are reviewing our business processes, systems and controls to support recognition and disclosures under the new standard. The Company is expected to use the modified retrospective method for transition in which the cumulative effect will be recognized at the date of adoption with no restatement of comparative periods presented. The adoption of the ASU is not expected to have a material effect on the Company’s consolidated financial statements.
In January 2016, FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-01, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income; (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements; and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. In addition, the amendments in this ASU require an entity to disclose the fair value of its financial instruments using the exit price notion. Exit price 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. For public entities, the guidance is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. The Company has updated the fair value disclosure on Note R “Fair Value Disclosures” in this report to reflect adoption of this standard, to include using the exit price notion in the fair value disclosure of financial instruments. The Company`s adoption of the ASU did not have a significant impact on the Company's consolidated financial statements.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which will supersede the current lease requirements in Topic 840. The ASU requires lessees to recognize a right of use asset and related lease liability for all leases, with a limited exception for short-term leases. Leases will be classified as either finance or operating, with the classification affecting the pattern of expense recognition in the statement of income. Currently, leases are classified as either capital or operating, with only capital leases recognized on the balance sheet. The reporting of lease related expenses in the statements of operations and cash flows will be generally consistent with the current guidance. The new guidance will be effective for years beginning after December 15, 2018 for public companies. Once effective, the standard will be applied using a modified retrospective transition method to the beginning of the earliest period presented. The Company is currently assessing the impacts this new standard will have on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses. ASU 2016-13 requires entities to report “expected” credit losses on financial instruments and other commitments to extend credit rather than the current “incurred loss” model. These expected credit losses for financial assets held at the reporting date are to be based on historical experience, current conditions, and reasonable and supportable forecasts. This ASU will also require enhanced disclosures to help investors and other 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. These disclosures include qualitative and quantitative requirements that provide additional information about the amounts recorded in the financial statements. For public business entities that are U.S. Securities and Exchange Commission filers, the amendments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently evaluating the impact the adoption of ASU 2016-13 will have on its consolidated financial statements.
In August 2017, the FASB issued the ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. The purpose of this guidance is to better align a company’s financial reporting for hedging relationships with the company’s risk management activities by expanding strategies that qualify for hedge accounting, modifying the presentation of certain hedging relationships in the financial statements and simplifying the application of hedge accounting in certain situations. ASU 2017-12 is effective for fiscal years beginning after December 15, 2018, with early adoption permitted in any interim or annual period before the effective date. ASU 2017-12 will be applied using a modified retrospective approach through a cumulative-effect adjustment related to the elimination of the separate measurement of ineffectiveness to the balance of accumulated other comprehensive income with a corresponding adjustment to retained earnings as of the beginning of the fiscal year in which the amendments in this update are adopted. The amended presentation and disclosure guidance is required only prospectively. Upon adoption, the ASU allows for the reclassification of debt securities eligible to be hedged under the ASU from held-to-maturity to available-for-sale. The Company adopted ASU 2017-12 during the quarter ended December 31, 2017 and reclassified ten mortgage-backed securities totaling $12.6 million from the held-to-maturity portfolio to the available-for-sale portfolio.
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. The amendments in this update affect any entity that is required to apply the provisions of Topic 220, Income Statement- Reporting Comprehensive Income. Deferred tax assets (“DTAs”) related to defined pension benefit plans and securities available for sale that were revalued as of December 31, 2017 created “stranded tax effects” in Accumulated Other Comprehensive Income (“AOCI”) due to the enactment of the Tax Cuts and Jobs Act (the “Tax Act”). Existing GAAP required recognition of the tax rate change effects on the DTA revaluation as an adjustment to income tax expense. As a result the AOCI contained the stranded amounts from prior periods at the previous tax rate. ASU 2018-12 permits the reclassification of the stranded amounts from AOCI to retained earnings resulting from the Tax Act. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Act, the underlying GAAP guidance that requires the effect of a change in tax laws or rates to be included in income from continuing operations is not affected. The amendments in this update are optional and are effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption of the amendments is permitted, including adoption in any interim period.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The Company adopted the provisions of ASU 2018-02 effective September 30, 2018 and elected to record a reclassification adjustment of $188,000 from AOCI to retained earnings in the consolidated statements of stockholders’ equity for stranded tax effects resulting from enactment of the Tax Act.
NOTE C - STOCK-BASED COMPENSATION
The Company follows FASB Accounting Standards Codification (“ASC”) Section 718, Compensation-Stock Compensation, which covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights, and employee share purchase plans. ASC 718 requires that compensation cost relating to share-based payment transactions be recognized in financial statements. The cost is measured based on the fair value of the equity or liability instruments issued.
Stock options generally vest over a five-year service period and expire ten years from issuance. The fair values of all option grants were estimated using the Black-Scholes option-pricing model. Management recognizes compensation expense for the fair values of these awards, which have graded vesting, on a straight-line basis over the vesting period of the awards. Once vested, these awards are irrevocable.
There was no activity for the Company’s stock option plan for the year ended September 30, 2018.
The following is a summary of the status of the Company’s stock option activity and related information for its option plan for the year ended September 30, 2017 and 2018.
There were no grants, vested shares or forfeitures of non-vested restricted stock awards as of or during the twelve months ended September 30, 2018 and 2017.
There were no stock option and stock award expenses included with compensation expense for the years ended September 30, 2018 and 2017.
The Company has an Employee Stock Ownership Plan ("ESOP") for the benefit of employees who meet the eligibility requirements as defined in the plan. The ESOP trust purchased 217,863 shares of common stock in the open market using proceeds of a loan from the Company. The total cost of shares purchased by the ESOP trust was $2.3 million, reflecting an average cost per share of $10.58. The Bank will make cash contributions to the ESOP on an annual basis sufficient to enable the ESOP to make the required loan payments to the Company. The loan bears a variable interest rate that adjusts annually to Prime Rate (4.50% at January 1, 2018) with principal and interest payable annually in equal installments over thirty years. The loan is secured by shares of the Company’s stock.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
As the debt is repaid, shares are released as collateral and allocated to qualified employees. Accordingly, the shares pledged as collateral are reported as unearned ESOP shares in the Consolidated Balance Sheets. The Company accounts for its ESOP in accordance with FASB ASC Topic 718, “Employer’s Accounting for Employee Stock Ownership Plans”. As shares are released from collateral, the Company reports compensation expense equal to the current market price of the shares, and the shares become outstanding for earnings per share computations. The Company's contribution expense for the ESOP was $157,000 and $154,000 for years ended September 30, 2018 and 2017, respectively.
The following table presents the components of the ESOP shares as of September 30, 2018:
The aggregate fair value of the unreleased shares at September 30, 2018 was approximately $482,000.
NOTE D - INVESTMENT SECURITIES
The amortized cost, gross unrealized gains or losses and fair value of the Company’s investment securities available-for-sale and held-to-maturity are as follows:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The contractual maturities of mortgage-backed securities generally exceed 10 years; however, the effective lives are expected to be shorter due to anticipated prepayments. The amortized cost and fair value of the Company’s securities available-for-sale at September 30, 2018 are summarized in the following table:
(1)Available-for-sale mortgage-backed securities - residential include an amortized cost of $1.5 million and a fair value of $1.5 million for obligations of U.S. government agencies issued by the Government National Mortgage Association and obligations of U.S. government-sponsored enterprises issued by Federal National Mortgage Association and Federal Home Loan Mortgage Corporation which had an amortized cost of $19.3 million and a fair value of $18.6 million. There were no residential mortgage backed securities issued by non-U.S. government agencies and government-sponsored enterprises.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The maturities of the debt securities and the mortgage-backed securities held to maturity at September 30, 2018 are summarized in the following table:
(1)Held-to-maturity mortgage-backed securities - residential include an amortized cost of $568,000 and a fair value of $475,000 for obligations of U.S. government agencies issued by the Government National Mortgage Association and obligations of U.S. government-sponsored enterprises issued by Federal National Mortgage Association and Federal Home Loan Mortgage Corporation which had an amortized cost of $26.3 million and a fair value of $25.5 million. Also included are mortgage backed securities issued by non-U.S. government agencies and government-sponsored enterprises with an amortized cost of $393,000 and a fair value of $394,000.
(2)Held-to-maturity mortgage-backed securities - commercial include an amortized cost of $904,000 and a fair value of $895,000 for obligations of U.S. government agencies issued by the Small Business Administration.
There were no sales of securities from the available-for-sale portfolios during the year ended September 30, 2018 and 2017.
There were $3.4 million sales of securities from the held-to-maturity portfolios during the year ended September 30, 2018 and there were no sales from the held-to-maturity portfolios during the year ended September 30, 2017. In accordance with ASC 320 “Investments- Debt and Equity Securities”, sales from the held to maturity portfolio occurred after the Company had already collected a substantial portion (at least 85 percent) of the principal outstanding at acquisition due to prepayments on the debt security. The net gain on sales of held-to-maturity securities totaled $107,000 for the year ended September 30, 2018.
As of September 30, 2018 and 2017, securities having an estimated fair value of approximately $25.0 million and $21.8 million, respectively, were pledged to secure public deposits.
Details of securities with unrealized losses at September 30, 2018 and 2017 are as follows:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The investment securities listed above currently have fair values less than amortized cost and therefore contain unrealized losses. The Company evaluated these securities and determined that the decline in value was primarily related to fluctuations in the interest rate environment and were not related to any company or industry specific event.
The Company anticipates full recovery of amortized costs with respect to these securities. The Company does not intend to sell these securities and has determined that it is not more likely than not that the Company would be required to sell these securities prior to maturity or market price recovery. Management has considered factors regarding other than temporarily impaired securities and determined that there are no securities with impairment that is other than temporary as of September 30, 2018 and 2017.
NOTE E - LOANS RECEIVABLE, NET
Loans receivable are comprised of the following:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Certain directors and executive officers of the Company have loans with the Bank. Such loans were made in the ordinary course of business at the Bank’s normal credit terms, including interest rate and collateralization, and do not represent more than a normal risk of collection. Total loans receivable from directors and executive officers, and affiliates thereof, were approximately $2.8 million and $2.9 million at September 30, 2018 and 2017, respectively. There were $137,000 in new advances on existing lines of credit during the year ended September 30, 2018 and there were no principal additions during the year ended September 30, 2017. Total principal repayments were approximately $231,000 and $305,000 for the year ended September 30, 2018 and 2017, respectively.
At September 30, 2018 and 2017, the Company was servicing loans for others amounting to approximately $41.4 million and $38.7 million, respectively. The Company held mortgage servicing rights in the amount of $45,000 and $69,000 at September 30, 2018 and 2017, respectively. Servicing loans for others generally consists of collecting mortgage payments, maintaining escrow accounts, disbursing payments to investors, and foreclosure processing. Loan servicing income is recorded on the cash basis and includes servicing fees from investors and certain charges collected from borrowers, such as late payment fees. In connection with loans serviced for others, the Company held borrowers’ escrow balances of approximately $78,000 and $97,000 at September 30, 2018 and 2017, respectively.
The segments of the Bank’s loan portfolio are disaggregated to a level that allows management to monitor risk and performance. The residential mortgage loan segment is further disaggregated into two classes: amortizing term loans, which are primarily first liens, and home equity lines of credit, which are generally second liens. The commercial loan segment is further disaggregated into three classes: loans secured by multifamily structures, owner-occupied commercial structures, and non-owner occupied nonresidential properties. The construction loan segment consists primarily of developers or investors for the purpose of acquiring, developing and constructing residential or commercial structures and to a lesser extent one-to-four family residential construction loans made to individuals for the acquisition of and/or construction on a lot or lots on which a residential dwelling is to be built. Construction loans to developers and investors have a higher risk profile because the ultimate buyer, once development is completed, is generally not known at the time of the loan. The commercial business loan segment consists of loans made for the purpose of financing the activities of commercial customers and consists primarily of revolving lines of credit. The consumer loan segment consists primarily of stock-secured installment loans, but also includes unsecured personal loans and overdraft lines of credit connected with customer deposit accounts.
Management evaluates individual loans in all segments for possible impairment if the loan either is in nonaccrual status, or is risk rated Substandard and is greater than 90 days past due. Loans are considered to be 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 evaluating impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. 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.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Once the determination has been made that a loan is impaired, the recorded investment in the loan is compared to the fair value of the loan using one of three methods: (a) the present value of expected future cash flows discounted at the loan’s effective interest rate; (b) the loan’s current observable market price; or (c) the fair value of the collateral securing the loan, less anticipated selling and disposition costs. The method is selected on a loan-by loan basis, with management primarily utilizing the fair value of collateral method. If there is a shortfall between the fair value of the loan and the recorded investment in the loan, the Company charges the difference to the allowance for loan loss as a charge-off and carries the impaired loan on its books at fair value. It is the Company’s policy to evaluate impaired loans on an annual basis to ensure the recorded investment in a loan does not exceed its fair value.
The following tables present impaired loans by class, segregated by those for which a specific allowance was required and those for which a specific allowance was not necessary for the periods presented:
The average recorded investment in impaired loans was $6.1 million and $8.6 million for the years ended September 30, 2018 and 2017, respectively. The Company’s impaired loans include $1.2 million in delinquent loans and $4.7 million in performing Troubled Debt Restructurings (“TDRs”), as TDRs remain impaired loans until fully repaid. During the years ended September 30, 2018 and 2017, interest income of $238,000 and $253,000, respectively, was recognized for TDR loans while no interest income was recognized for delinquent non-accrual loans.
The following tables present the classes of the loan portfolio summarized by the aggregate Pass and the criticized categories of Special Mention, Substandard and Doubtful within the Bank’s internal risk rating system for the periods presented:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Management further monitors the performance and credit quality of the loan portfolio by analyzing the age of the portfolio as determined by the length of time a recorded payment is past due. The following tables present the classes of the loan portfolio summarized by the aging categories of performing loans and nonaccrual loans for the periods presented:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The amount of interest income not recognized on non-accrual loans was approximately $40,000 and $106,000 for the years ended September 30, 2018 and 2017, respectively. At September 30, 2018 and September 30, 2017, there were no commitments to lend additional funds to borrowers whose loans are classified as non-accrual.
An allowance for loan losses (“ALL”) is maintained to absorb losses from the loan portfolio. The ALL is based on management’s continuing evaluation of the risk characteristics and credit quality of the loan portfolio, assessment of current economic conditions, diversification and size of the portfolio, adequacy of collateral, past and anticipated loss experience, and the amount of NPLs.
The Bank’s methodology for determining the ALL is based on the requirements of ASC Section 310-10-35 for loans individually evaluated for impairment (discussed above) and ASC Subtopic 450-20 for loans collectively evaluated for impairment, as well as the Interagency Policy Statements on the Allowance for Loan and Lease Losses and other bank regulatory guidance.
Loans that are collectively evaluated for impairment are analyzed with general allowances being made as appropriate. For general allowances, historical loss trends are used in the estimation of losses in the current portfolio. These historical loss amounts are modified by other qualitative and economic factors.
The loans are segmented into classes based on their inherent varying degrees of risk, as described above. Management tracks the historical net charge-off activity by segment and utilizes this figure, as a percentage of the segment, as the general reserve percentage for pooled, homogenous loans that have not been deemed impaired. Typically, an average of losses incurred over 5 historical years is used.
Non-impaired credits are segregated for the application of qualitative factors. Management has identified a number of additional qualitative factors which it uses to supplement the historical charge-off factor because these factors are likely to cause estimated credit losses associated with the existing loan pools to differ from historical loss experience. The additional factors that are evaluated quarterly and updated using information obtained from internal, regulatory, and governmental sources are: national and local economic trends and conditions; levels of and trends in delinquency rates and non-accrual loans; trends in volumes and terms of loans; effects of changes in lending policies; experience, ability, and depth of lending staff; value of underlying collateral; and concentrations of credit from a loan type, industry and/or geographic standpoint.
Management reviews the loan portfolio on a quarterly basis using a defined, consistently applied process in order to make appropriate and timely adjustments to the ALL. When information confirms all or part of specific loans to be uncollectible, these amounts are promptly charged off against the ALL. Since loans individually evaluated for impairment are promptly written down to their fair value, typically there is no portion of the ALL for loans individually evaluated for impairment.
The following tables summarize the activity in the allowance for loan losses by loan category for the years ended September 30, 2018 and 2017:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The following tables summarize the ALL by loan category, segregated into the amount required for loans individually evaluated for impairment and the amount required for loans collectively evaluated for impairment as of September 30, 2018 and September 30, 2017:
The allowance for loan losses is based on estimates, and actual losses will vary from current estimates. Management believes that the segmentation of the loan portfolio into homogeneous pools and the related historical loss ratios and other qualitative factors, as well as the consistency in the application of assumptions, result in an ALL that is representative of the risk found in the components of the portfolio at any given date.
A TDR is a loan that has been modified whereby the Bank has agreed to make certain concessions to a borrower to meet the needs of both the borrower and the Bank to maximize the ultimate recovery of a loan. TDR occurs when a borrower is experiencing, or is expected to experience, financial difficulties and the loan is modified using a modification that would otherwise not be granted to the borrower. The types of concessions granted generally included, but are not limited to interest rate reductions, limitations on the accrued interest charged, term extensions, and deferment of principal.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
A default on a troubled debt restructured loan for purposes of this disclosure occurs when a borrower is 90 days past due or a foreclosure or repossession of the applicable collateral has occurred. There was one TDR during the year ended September 30, 2017, and there were no TDRs during the year ended September 30, 2018. The following table summarizes the TDRs during the year ended September 30, 2017:
The Company held no interest-only mortgage loans at September 30, 2018 and held interest-only loans with principal balances of $6.1 million at September 30, 2017. The average interest-only term on these loans was 10 years at which time the loans reset to fully amortize over 20 years, on average.
Total loans pledged as collateral against Federal Home Loan Bank of New York borrowings was $172.4 million and $177.6 million as of September 30, 2018 and 2017, respectively.
NOTE F - ACCRUED INTEREST RECEIVABLE
The following is a summary of accrued interest receivable:
NOTE G - PREMISES AND EQUIPMENT
Premises and equipment consist of the following:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
For the years ended September 30, 2018 and 2017, depreciation expense included in occupancy expense amounted to approximately $861,000 and $816,000, respectively.
Hungaria Urban Renewal, LLC was formed in 2002 and its sole purpose was to purchase the land and construct the office building for which the Company is the primary tenant. The Bank owns a 100% interest in Hungaria Urban Renewal, LLC, which has no other business other than owning the Bank’s main office site. At September 30, 2018, Hungaria Urban Renewal, LLC accounted for approximately $3.1 million, $9.3 million and $0 of land, building, furniture, fixtures and equipment, net of depreciation, respectively. At September 30, 2017, Hungaria Urban Renewal, LLC accounted for approximately $3.1 million, $9.7 million, and $0 of land, building, and furniture, fixtures and equipment, net of depreciation, respectively.
NOTE H - OTHER REAL ESTATE OWNED
The Company held $8.6 million of real estate owned properties at September 30, 2018 and $11.1 million at September 30, 2017. The Company incurred write-downs totaling $418,000 and $218,000 on these properties for the years ended September 30, 2018 and 2017; these amounts were carried as valuation allowances at September 30, 2018 and 2017, respectively. Further declines in real estate values may result in increased foreclosed real estate expense in the future. Routine holding costs are charged to expense as incurred and improvements to real estate owned that enhance the value of the real estate are capitalized.
NOTE I - DEPOSITS
A summary of deposits by type of account follows:
The current FDIC insurance limit on bank deposit accounts is $250,000. The aggregate amount of deposit accounts with a minimum denomination of $250,000 was approximately $266.6 million at September 30, 2018 compared with $227.2 million at September 30, 2017. The aggregate amount of certificate deposits, including individual retirement accounts with balance of $250,000 or more was $35.6 million at September 30, 2018 compared with $31.5 million at September 30, 2017.
At September 30, 2018, certificates of deposit (including retirement accounts and brokered certificate deposit accounts) have contractual maturities as follows (in thousands):
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
NOTE J - BORROWINGS
1. Federal Home Loan Bank of New York Advances
Long term Federal Home Loan Bank of New York (“FHLBNY”) advances at September 30, 2018 and September 30, 2017 totaled approximately $35.5 million and $31.9 million, respectively. The weighted average interest rate on advances outstanding at September 30, 2018 and 2017 were 2.09% and 2.00%, respectively. The advances were collateralized by unencumbered qualified assets consisting of one-to-four family residential and commercial real estate mortgage loans. Advances are made pursuant to several different credit programs offered from time to time by the FHLBNY.
Long term FHLBNY advances as of September 30, 2018 mature as follows (in thousands):
Additionally, the Company has established an Overnight Line of Credit arrangement with the FHLBNY. The total amount available under the line of credit is based on the amount of eligible collateral pledged to the FHLBNY. At September 30, 2018 and 2017, the Company had available credit from the FHLBNY totaling $78.7 million and $92.6 million, respectively. Information concerning short-term borrowings with the FHLBNY is summarized as follows:
2. Securities Sold Under Reverse Repurchase Agreements
Qualifying repurchase agreements are treated as financings and are reflected as a liability in the Consolidated Balance Sheets. The Company did not have repurchase agreements outstanding at September 30, 2018 and September 30, 2017.
NOTE K - SERVICING POLICY
The Company originates and sells loans receivable secured by one-to four-family residential properties and commercial business loans guaranteed by the Small Business Administration (the “SBA”). The Company has sold loans on a servicing retained basis and on a servicing released basis. Loans sold with servicing retained and servicing released during the year ended September 30, 2018 were $8.7 million and $0, respectively. Loans sold with servicing retained and servicing released during the year ended September 30, 2017 were $4.7 million and $0, respectively. The Company accounts for sales in accordance with ASC 860, Transfers and Servicing. Upon sale, the receivables are removed from the balance sheet, mortgage servicing rights are recorded as an asset for servicing rights retained, and a gain on sale, if applicable, is recognized for the difference between the carrying value of the receivables and the sales proceeds, net of origination costs.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Gains on sales of loans, representing the difference between the total sales price received for the loans and the allocated cost of the loans, are recognized when mortgage loans are sold and delivered to the purchasers. Loans are accounted for as sold when control of the mortgage is surrendered. Control over the mortgage loans is deemed surrendered when (1) the mortgage loans have been isolated from the Company, (2) the buyer has the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the mortgage loans and (3) the Company does not maintain effective control over the mortgage loans through either (a) an agreement that entitles and obligates the Company to repurchase or redeem the mortgage loans before maturity, or (b) the ability to unilaterally cause the buyer to return specific mortgage loans.
The Company services one-to-four family residential mortgage loans for investors in the secondary mortgage market, which are not included in the Consolidated Balance Sheets. The Company’s fee is a percentage of the principal balance and is recognized as income when received. At September 30, 2018 and 2017, the Company was servicing such sold loans in the amount of $8.5 million and $10.1 million, respectively. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans. Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing revenues and are included in other assets on the Consolidated Balance Sheets. Activity in mortgage servicing rights during the years ended September 30, 2018 and 2017 are summarized as follows:
Mortgage servicing rights are carried at the lower of amortized cost or fair value. Fair values are estimated using discounted cash flows based on a current market interest rate.
The Company also services the SBA guaranteed portion of commercial business loans sold to investors in the secondary market, which are not included in the Consolidated Balance Sheets. The Company’s fee is a percentage of the principal balance and is recognized as income when received. At September 30, 2018 and 2017, the Company was servicing SBA loans sold in the amount of $26.5 million and $22.4 million, respectively. Loan servicing includes collecting and remitting loan payments, accounting for principal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certain insurance and tax payments on behalf of the borrowers and generally administering the loans.
NOTE L - INCOME TAXES
The income tax expense is comprised of the following components for the years ended September 30, 2018 and 2017:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
A reconciliation of income tax at the statutory tax rate to the effective income tax expense for the years ended September 30, 2018 and 2017 is as follows:
The major sources of temporary differences and their deferred tax effect at September 30, 2018 and 2017 are as follows:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion 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 temporary differences are deductible and carry forwards are available.
There were no valuation allowances for the year ended September 30, 2018 and 2017. The Company has considered future market growth, forecasted earnings, future taxable income, feasible and permissible tax planning strategies in determining the realizability of deferred tax assets. If the Company was to determine that it would not be able to realize a portion of its net deferred tax asset in the future for which there is currently no valuation allowance, an adjustment to the net deferred tax asset would be charged to earnings in the period such determination was made.
On December 22, 2017, the Tax Cuts and Jobs Act was signed into law. ASC 740 (Income Taxes) requires the recognition of the effect of changes in tax laws or rates in the period in which the legislation is enacted. The changes in the deferred tax assets and liabilities remeasured at the new 21% federal tax rate are reflected in income tax expense for the year ended September 30, 2018. The Company expensed $410,000 due to the impact of the lower corporate tax rates on the deferred tax assets and liabilities.
NOTE M - PENSION PLAN
The Company had a noncontributory defined benefit pension plan (the “Plan”) covering all eligible employees. On January 26, 2006, the Plan was frozen and amended to eliminate future benefit accruals after February 15, 2006.
Plan assets are invested in six diversified investment funds of the Pentegra Retirement Trust (the “Trust”), a no load series open-ended mutual fund. The Trust has been given discretion by the Plan Sponsor to determine the appropriate strategic asset allocation versus plan liabilities, as governed by the Trust’s Statement of Investment Objectives and Guidelines. The long-term investment objective is to be invested 65% in equity securities (equity mutual funds) and 35% in debt securities (bond mutual funds). Asset rebalancing is performed at least annually, with interim adjustments made when the investment mix varies more than 5% from the target (i.e., a 10% target range). Risk/volatility is further managed by the distinct investment objectives of each of the Trust funds and the diversification within each fund.
The following table sets forth the Plan’s funded status and amounts recognized in the Company’s Consolidated Balance Sheets at September 30, 2018 and September 30, 2017.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Net pension cost for the years ended September 30, 2018 and 2017 included the following components:
For the year ended September 30, 2018 and 2017, the weighted average discount rate used in determining the actuarial net periodic pension cost was 4.00% and 3.75%, respectively. For the year ended September 30, 2018 and 2017, the weighted average discount rate used in determining the actuarial present value of the projected benefit obligation was 4.25% and 4.00%, respectively.
The long-term rate-of-return-on-assets assumption was set based on historical returns earned by equities and fixed income securities, adjusted to reflect expectations of future returns as applied to the plan’s target allocation of asset classes. Equities and fixed income securities were assumed to earn rates of return in the ranges of 6-8% and 3-5%, respectively, with an assumed long-term inflation rate of 2.5% reflected within these ranges for the year ended September 30, 2018. When these overall return expectations are applied to the plan’s target allocation, the result is an expected rate of return of 5.0% to 7.0%. Accordingly, the expected long-term rate of return on assets was 7.00% for both 2018 and 2017.
Current Asset Allocation
The Plan’s weighted-average asset allocations at September 30, 2018 and 2017, by asset category are as follows:
The target asset allocation set for the assets of the Plan are in equity securities ranging from 40 percent to 70 percent and in debt securities ranging from 30 percent to 60 percent. In general, the Plan assets are investment securities that are well-diversified in terms of industry, capitalization and asset class. The Plan assets are mostly a mix of U.S. Treasury security indexed funds, mutual funds indexed to the performance of Fortune 500 U.S. companies, debt securities held in bond funds, domestic and foreign common equity funds, and a money market fund. The Plan’s exposure to a concentration of credit risk is limited by the diversification of the investments into various investment options with multiple asset managers.
Expected Contributions
For the fiscal year ending September 30, 2019, the Company expects to contribute $67,299 to the Plan.
Estimated Future Benefit Payments
The following benefit payments are expected to be paid as follows (in thousands):
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Included in the funded status of the Plan at September 30, 2018 and 2017, are actuarial losses of $1,292,000 and $1,494,000, respectively. These amounts are included, net of related income tax effects of $363,000 and $597,000, respectively, in the accumulated other comprehensive loss component of stockholders’ equity. During the year ending September 30, 2019, approximately $105,000 of the actuarial losses is expected to be amortized into net periodic pension expense.
The following table presents the Plan assets that are measured at fair value on a recurring basis by level within the fair value hierarchy under ASC Topic 820. Financial assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. See Note R for further detail regarding fair value hierarchy.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Equity and debt securities are reported at fair value in the table above utilizing exchange quoted prices in active markets for identical instruments (Level 1 inputs).
NOTE N - NONQUALIFIED COMPENSATION PLAN
The Company maintains a Supplemental Executive Retirement Plan (“SERP”) for the benefit of its senior officers. In addition, the Company also adopted voluntary Deferred Income and Emeritus Plans on behalf of its directors and those directors elected by the Board as “Director Emeritus.” The SERP provides the Company with the opportunity to supplement the retirement income of selected officers to achieve equitable wage replacement at retirement while the Deferred Income Plan provides participating directors with an opportunity to defer all or a portion of their fees into a tax deferred accumulation account for future retirement. The Director Emeritus Plan enables the Company to reward its directors for longevity of service in consideration of their availability and consultation. The SERP is based upon achieving retirement benefits equal to two percent multiplied by the number of service years multiplied by the final salary.
In 2001, the Company adopted a New Director Emeritus Plan (the “New Plan”), which supplemented the prior Director Emeritus Plans. Under the New Plan, the directors will be entitled to a benefit upon attainment of his/her benefit age. The directors will receive an annual amount in monthly installments based on his/her total Board and Committee fees in the twelve months prior to attainment of his/her benefit age. The amount will be ten percent (10%) plus two and one-half percent (2 1/2%) for each year of service as a Director, with a minimum of fifty percent (50%), provided the Director has served for at least five (5) years, and a maximum of sixty percent (60%). The maximum benefit increases for any Director serving as Chairman of the Board to seventy-five percent (75%).
The Company funds the plans through a modified endowment contract. Income recorded for the plans represents life insurance income as recorded based on the projected increases in cash surrender values of life insurance policies. As of September 30, 2018 and 2017, the Life Insurance Contracts had cash surrender values of approximately $11,843,000 and $11,550,000, respectively.
The Company is recording benefit costs so that the cost of each participant’s retirement benefits is being expensed and accrued over the participant’s active employment so as to result in a liability at retirement date equal to the present value of the benefits expected to be provided.
NOTE O - 401(K) EMPLOYEE CONTRIBUTION PLAN
The Company has a defined contribution 401(k) plan covering all employees, as defined under the plan document. Employees may contribute to the plan, as defined under the plan document, and the Company can make discretionary contributions. The Company contributed $163,000 and $145,000 to the plan for the years ended September 30, 2018 and 2017, respectively, and is included in compensation and employee benefits in the accompanying Consolidated Statements of Operations.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
NOTE P - COMMITMENTS
1.Lease Commitments
Approximate future minimum payments under non-cancelable operating leases are due as follows for the years indicated (in thousands):
Total rental expense, included in occupancy expense, was approximately $803,000 and $732,000 for the years ended September 30, 2018 and 2017, respectively.
2. Contingencies
The Company and its subsidiaries, from time to time, are a party to routine litigation that arises in the normal course of business. In the opinion of management, the resolution of this litigation, if any, would not have a material adverse effect on the Company’s consolidated financial position or results of operations.
NOTE Q - FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
The Company may use derivative financial instruments, such as interest rate floors and collars, as part of its interest rate risk management. Interest rate caps and floors are agreements whereby one party agrees to pay or receive a floating rate of interest on a notional principal amount for a predetermined period of time if certain market interest rate thresholds are met. The Company considers the credit risk inherent in these contracts to be negligible. As of September 30, 2018 and 2017, the Company did not hold any interest rate floors or collars.
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 are commitments to extend credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the Consolidated Balance Sheets.
The Company’s exposure to credit loss in the event of nonperformance by the other parties to the financial instrument for commitments to extend credits is represented by the contractual notional amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
At September 30, 2018 and 2017, the Company had outstanding commitments (substantially all of which expire within one year) to originate one-to four-family residential loans, construction loans, commercial real estate loans, commercial business loans and consumer loans. These commitments were comprised of fixed and variable rate loans.
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
NOTE R - FAIR VALUE DISCLOSURES
The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The Company’s securities available-for-sale are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record at fair value other assets or liabilities on a non-recurring basis, such as held-to-maturity securities, mortgage servicing rights, loans receivable and other real estate owned, or OREO. These non-recurring fair value adjustments involve the application of lower-of-cost-or-market accounting or write-downs of individual assets.
In accordance with ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), the Company groups its assets and liabilities at fair value in three levels, based on the markets in which the assets are traded and the reliability of the assumptions used to determine fair value. These levels are:
Level 1- Valuation is based upon quoted prices for identical instruments traded in active markets.
Level 2- Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active and model-based valuation techniques for which all significant assumptions are observable in the market.
Level 3- Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include the use of option pricing models, discounted cash flow models and similar techniques. The results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability.
The Company bases its fair values on 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. ASC 820 requires the Company to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
The following is a description of valuation methodologies used for assets measured at fair value on a recurring basis.
Securities available-for-sale
The Company’s available-for-sale portfolio is carried at estimated fair value on a recurring basis, with any unrealized gains and losses, net of taxes, reported as accumulated other comprehensive income/loss in stockholders’ equity. The securities available-for-sale portfolio consists of U.S. government and government-sponsored enterprise obligations, municipal bonds, and mortgage-backed securities. The fair values of these securities are obtained from an independent nationally recognized pricing service. An independent pricing service provides prices which are categorized as Level 2, as quoted prices in active markets for identical assets are generally not available for the securities.
The following table provides the level of valuation assumptions used to determine the carrying value of the Company’s assets measured at fair value on a recurring basis at September 30, 2018 and 2017:
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Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The following is a description of valuation methodologies used for assets measured at fair value on a non-recurring basis.
Mortgage Servicing Rights
Mortgage Servicing Rights (MSR’s) are carried at the lower of amortized cost or estimated fair value. The estimated fair value of MSRs is determined through a calculation of future cash flows, incorporating estimates of assumptions market participants would use in determining fair value including market discount rates, prepayment speeds, servicing income, servicing costs, default rates and other market driven data, including the market’s perception of future interest rate movements and, as such, are classified as Level 3. No valuation write-downs were made to MSR’s during the years ended September 30, 2018 and 2017.
Impaired Loans
Loans which meet certain criteria are evaluated individually for impairment. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. All amounts due according to the contractual terms means that both the contractual interest and principal payments of a loan will be collected as scheduled in the loan agreement. Three impairment measurement methods are used, depending upon the collateral securing the asset: 1) the present value of expected future cash flows discounted at the loan’s effective interest rate; 2) the asset’s observable market price; or 3) the fair value of the collateral if the asset is collateral dependent. The regulatory agencies require this method for loans from which repayment is expected to be provided solely by the underlying collateral. The Company’s impaired loans are generally collateral dependent and, as such, are carried at the estimated fair value of the collateral less estimated selling and disposition costs. Fair value is estimated through current appraisals, and adjusted as necessary, by management, to reflect current market conditions and, as such, are generally classified as Level 3.
Appraisals of collateral securing impaired loans are conducted by approved, qualified, and independent third-party appraisers. Such appraisals are ordered via the Bank’s credit administration department, independent from the lender who originated the loan, once the loan is deemed impaired, as described in the previous paragraph. Impaired loans are generally re-evaluated with an updated appraisal within one year of the last appraisal. However, the Company also obtains updated appraisals on performing construction loans that are approaching their maturity date to determine whether or not the fair value of the collateral securing the loan remains sufficient to cover the loan amount prior to considering an extension. The Company discounts the appraised “as is” value of the collateral for estimated selling and disposition costs and compares the resulting fair value of collateral to the outstanding loan amount. If the outstanding loan amount is greater than the discounted fair value, the Company requires a reduction in the outstanding loan balance or additional collateral before considering an extension to the loan. If the borrower is unwilling or unable to reduce the loan balance or increase the collateral securing the loan, it is deemed impaired and the difference between the loan amount and the fair value of collateral, net of estimated selling and disposition costs, is charged off through a reduction of the allowance for loan loss.
Table of Contents MAGYAR BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 2018 and 2017
Other Real Estate Owned
Other real estate owned is carried at lower of cost or estimated fair value less disposal costs. The estimated fair value of the real estate is determined through current appraisals, and adjusted as necessary, by management, to reflect current market conditions. As such, other real estate owned is generally classified as Level 3. Valuation write-downs totaling $418,000 were made to seven properties held as other real estate owned during the year ended September 30, 2018. The properties were written down based on an updated appraisal of the real estate.
The following tables provide the level of valuation assumptions used to determine the carrying value of our assets measured at fair value on a non-recurring basis at September 30, 2018 and 2017:
Impaired loans reported for the period ended September 30, 2018 consisted of two loans with aggregate loan balances of $351,000 reduced by $90,000 in cumulative charge-offs. There were no specific loss reserves at September 30, 2018.
The following table presents additional quantitative information about assets measured at fair value on a nonrecurring basis and for which Company has utilized Level 3 inputs to determine fair value:
Table of Contents MAGYAR BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 2018 and 2017
(1)Fair value is generally determined through independent appraisals for the underlying collateral, which generally include various level 3 inputs which are not identifiable.
(2)Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted average of liquidation expenses and other appraisal adjustments are presented as a percent of the appraisal.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate fair value:
Cash and interest earning deposits with banks: The carrying amounts are a reasonable estimate of fair value.
Held to maturity securities: The fair values of Company’s held to maturity securities are obtained from an independent nationally recognized pricing service. The Company’s independent pricing service provides prices which are categorized as Level 2, as quoted prices in active markets for identical assets are generally not available for the securities.
Federal Home Loan Bank Stock: FHLB stock is carried at cost. The carrying value approximates fair value based upon the redemption price provision of FHLB stock.
Loans receivable: Fair value for the loan portfolio, excluding impaired loans, is estimated based on discounted cash flow analysis using interest rates currently offered for loans with similar terms to borrowers of similar credit quality.
Bank owned life insurance: The carrying amounts are based on the cash surrender values of the individual policies, which is a reasonable estimate of fair value.
Deposits: The fair value of savings deposits with no stated maturity, such as money market deposit accounts, interest-bearing checking accounts and savings accounts, is equal to the amount payable on demand. The fair value of certificates of deposit including retirement accounts is based on the discounted value of contractual cash flows. The discount rate is equivalent to the rate currently offered by the Bank for deposits of similar size, type and maturity.
Accrued interest receivable and payable: For these short-term instruments, the carrying amount is a reasonable estimate of fair value.
Federal Home Loan Bank of New York advances: The fair value of borrowings is based on the discounted value of contractual cash flows. The discount rate is equivalent to the rate currently offered by the Federal Home Loan Bank of New York for borrowings of similar maturity and terms.
Table of Contents MAGYAR BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The fair value of commitments to extend credit is estimated based on the amount of unamortized deferred loan commitment fees. The fair value of letters of credit is based on the amount of unearned fees plus the estimated cost to terminate the letters of credit. Fair values of unrecognized financial instruments including commitments to extend credit and the fair value of letters of credit are considered immaterial.
The following presents the carrying amount, fair value, and placement in the fair value hierarchy of the Company’s financial instruments carried at cost or amortized cost as of September 30, 2018 and September 30, 2017. This table excludes financial instruments for which the carrying amount approximates fair value, which includes cash and cash equivalents, FHLB stock, bank owned life insurance, accrued interest receivable, interest and non-interest bearing demand, savings deposits, and accrued interest payable. For short-term financial assets such as cash and cash equivalents, the carrying amount is a reasonable estimate of fair value due to the relatively short time between the origination of the instrument and its expected realization. For financial liabilities such as interest-bearing demand, NOW, and money market savings deposits, the carrying amount is a reasonable estimate of fair value due to these products having no stated maturity.
NOTE S - REGULATORY CAPITAL
The Company and Bank are required to maintain minimum amounts of capital to total “risk-weighted” assets, as defined by the banking regulators. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and Bank’s assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
The federal banking agencies have substantially amended the regulatory risk-based capital rules applicable to the Bank. The amendments implemented the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. The amended rules included new minimum risk-based capital and leverage ratios, which became effective in January 2017, with certain requirements to be phased in beginning in 2018. The rule includes a new common equity Tier 1 capital (“CET1”) to risk-weighted assets ratio of 4.5% of risk-weighted assets, which is in addition to the Tier 1 and Total risk-based capital requirements. The interim final rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and requires a minimum leverage ratio of 4.0%. The required minimum ratio of total capital to risk-weighted assets will remain 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) became effective for the Company and the Bank on January 1, 2015.
Table of Contents MAGYAR BANCORP, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
September 30, 2018 and 2017
The amended rules also established a “capital conservation buffer” of 2.5% beginning in January 2016 (phased in over four years at 0.625% per year) above the new regulatory minimum capital ratios, and would result in the following phased-in minimum ratios when fully implemented: (i) a common equity Tier 1 capital ratio of 7.0%; (ii) a Tier 1 capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement phased in at 0.625% of risk-weighted assets and will increase each year until fully implemented in January 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations will establish a maximum percentage of eligible retained income that could be utilized for such actions.
As of September 30, 2018, the most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.
The following table sets forth the Company’s and the Bank’s actual and required capital levels under those measures:
(1) Includes 1.875% capital conservation buffer
(2) Includes 2.50% capital conservation buffer
(3) Includes 1.25% capital conservation buffer
(4) Includes 2.50% capital conservation buffer
ITEM 9.
ITEM 9.Changes In and Disagreements with Accountants on Accounting and Financial Disclosure
On May 8, 2018, the Audit Committee of the Company’s Board of Directors (the “Audit Committee”) decided to dismiss Baker Tilly Virchow Krause LLP (“Baker Tilly”) as the Company’s independent registered public accounting firm effective May 11, 2018.
The audit reports of Baker Tilly on the Company’s consolidated financial statements as of and for the years ended September 30, 2017 and 2016 did not contain an adverse opinion or a disclaimer of opinion, and were not qualified or modified as to uncertainty, audit scope or accounting principles.
During the years ended September 30, 2017 and 2016 and through May 11, 2018, there were (1) no disagreements with Baker Tilly on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, that, if not resolved to the satisfaction of Baker Tilly, would have caused them to make reference to such disagreements in its report on the Company’s financial statements for such periods, and (2) no reportable events (as defined in Item 304(a)(1)(v) of Regulation S-K).
The Audit Committee appointed RSM US LLP (“RSM”) to serve as the Company’s independent registered public accounting firm effective May 11, 2018. During the two most recent fiscal years and through May 11, 2018, the Company did not consult with RSM regarding any matters or events set forth in Item 304(a)(2)(i) or (ii) of SEC Regulation S-K.
ITEM 9A.
ITEM 9A.Controls and Procedures
Disclosure Controls and Procedures
Under the supervision and with the participation of our management, including our Principal Executive Officer and Principal Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, the Principal Executive Officer and Principal Financial Officer concluded that, as of the end of the period covered by this report, our disclosure controls and procedures were effective.
Changes in Internal Control over Financial Reporting
There has been no change in Magyar Bancorp, Inc.'s internal control over financial reporting during Magyar Bancorp, Inc.'s fourth quarter of fiscal year 2018 that has materially affected, or is reasonably likely to materially affect, Magyar Bancorp, Inc.'s internal control over financial reporting.
Report by Management on Internal Control over Financial Reporting
The management of Magyar Bancorp, Inc. is responsible for establishing and maintaining adequate internal control over financial reporting. Magyar Bancorp Inc.'s internal control system was designed to provide reasonable assurance to the Magyar Bancorp, Inc.'s management and board of directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Magyar Bancorp, Inc.'s management assessed the effectiveness of the Company's internal control over financial reporting as of September 30, 2018. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) 2013 in Internal Control-Integrated Framework. Based on our assessment, we believe that, as of September 30, 2018, the Company's internal control over financial reporting was effective based on those criteria.
The Annual Report on Form 10-K does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to exemption rules of the Securities and Exchange Commission that permit the Company to provide only management's report in this annual report.
ITEM 9B.
ITEM 9B.Other Information
None.
PART III
ITEM 10.
ITEM 10.Directors, Executive Officers, and Corporate Governance
Magyar Bancorp, Inc. has adopted a Code of Ethics that applies to Magyar Bancorp, Inc.’s principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions. The Code of Ethics, and any amendments to and waivers from the Code of Ethics, will be posted on the Company’s website located at www.magbank.com. A copy of the Code will be furnished without charge upon written request to the Secretary, Magyar Bancorp, Inc., 400 Somerset Street, New Brunswick, New Jersey.
Information concerning directors and executive officers of Magyar Bancorp, Inc. is incorporated herein by reference from our definitive Proxy Statement related to our 2018 Annual Meeting of Stockholders (the “Proxy Statement”), specifically the section captioned “Proposal I - Election of Directors.”
ITEM 11.
ITEM 11.Executive Compensation
Information concerning executive compensation is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal I - Election of Directors.”
ITEM 12.
ITEM 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information concerning security ownership of certain owners and management is incorporated herein by reference from our Proxy Statement, specifically the sections captioned “Voting Securities and Principal Holders Thereof” and “Proposal I - Election of Directors.”
ITEM 13.
ITEM 13.Certain Relationships and Related Transactions, and Director Independence
Information concerning relationships and transactions is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Transactions with Certain Related Persons.”
ITEM 14.
ITEM 14.Principal Accountant Fees and Services
Information concerning principal accountant fees and services is incorporated herein by reference from our Proxy Statement, specifically the section captioned “Proposal IV - Ratification of Appointment of Independent Registered Public Accounting Firm.”
PART IV
ITEM 15.
ITEM 15.Exhibits and Financial Statement Schedules
3.1Certificate of Incorporation of Magyar Bancorp, Inc.*
3.2Bylaws of Magyar Bancorp, Inc.*
4Form of Common Stock Certificate of Magyar Bancorp, Inc.*
10.1Form of Employee Stock Ownership Plan*
10.2Restated Executive Supplemental Retirement Income Agreement for Elizabeth E. Hance**
10.3Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Elizabeth E. Hance**
10.4Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Joseph J. Lukacs, Jr.**
10.5Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Salvatore J. Romano**
10.6Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Joseph A. Yelencsics**
10.7Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Edward C. Stokes, III**
10.8Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Martin A. Lukacs**
10.9Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Thomas Lankey**
10.10Restated Director Supplemental Retirement Income and Deferred Compensation Agreement for Andrew G. Hodulik**
10.11Form of Employment Agreement for Elizabeth E. Hance*
10.12Form of Change in Control Agreement for Executive Officers*
10.13Executive Supplemental Retirement Income Agreement for Jon Ansari**
10.14Executive Supplemental Retirement Income Agreement for John Fitzgerald**
10.15Separation Agreement, between Magyar Bancorp and Elizabeth E. Hance***
10.162006 Equity Incentive Plan****
21Subsidiaries of Registrant*
23Consent of Experts and Counsel
31.1Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101The following materials from the Company’s Annual Report on Form 10-K for the year ended September 30, 2018, formatted in XBRL (Extensible Business Reporting Language): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statement of Comprehensive Income, (iv) the Consolidated Statements of Changes in Stockholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Notes to Consolidated Financial Statements.
_____________________________
*Incorporated by reference to the Registration Statement on Form SB-2 of Magyar Bancorp, Inc. (file no. 333-128392), originally filed with the Securities and Exchange Commission on September 16, 2005, as amended.
**Incorporated by reference to the Annual Report on Form 10-KSB of Magyar Bancorp, Inc. (file no. 000-51726), originally filed with the Securities and Exchange Commission on December 29, 2006.
***Incorporated by reference to the Quarterly Report on Form 10-Q of Magyar Bancorp, Inc. (file no. 000-51726), originally filed with the Securities and Exchange Commission on February 16, 2010.
****Incorporated by reference to the Plan filed as an attachment to the Company’s proxy statement dated January 8, 2007, filed with the Securities and Exchange Commission on January 8, 2007.
ITEM 16.Form 10-K Summary
None
SIGNATURES
Pursuant to the requirements of Section 13 or 15 (d) of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
MAGYAR BANCORP, INC.
December 20, 2018 By: /s/ John S. Fitzgerald
Date
John S. Fitzgerald
President and Chief Executive Officer
(Duly Authorized Representative)
Pursuant to the requirements of the Securities Exchange of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signatures
Title
Date
/s/ John S. Fitzgerald
President and Chief Executive Officer
December 20, 2018
John S. Fitzgerald
(Principal Executive Officer)
/s/ Jon R. Ansari
Executive Vice President and Chief Financial Officer
December 20, 2018
Jon R. Ansari
(Principal Financial and Accounting Officer)
/s/ Thomas Lankey
Chairman of the Board
December 20, 2018
Thomas Lankey
/s/ Andrew Hodulik
Vice Chairman of the Board
December 20, 2018
Andrew Hodulik
/s/ Martin A. Lukacs
Director
December 20, 2018
Martin A. Lukacs, D.M.D.
/s/ Joseph A. Yelencsics
Director
December 20, 2018
Joseph A. Yelencsics
/s/ Edward C. Stokes
Director
December 20, 2018
Edward C. Stokes, III