UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended September 30, 2018

For the transition period from              to             

 

UNITED COMMUNITY FINANCIAL CORP.

(Exact name of the registrant as specified in its charter)

 

 

275 West Federal Street, Youngstown, Ohio 44503-1203

(Address of principal executive offices) (Zip Code)

Registrant’s telephone number, including area code: (330) 742-0500

Not Applicable

(Former name or former address, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  ☒    No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).

Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or emerging growth company. See definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act (Check one):

 

   

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☐ 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ☐    No  ☒

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 49,729,061 common shares as of October 31, 2018.

 

 

 

 

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TABLE OF CONTENTS

 

 

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PART I—FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

UNITED COMMUNITY FINANCIAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

 

 

See Notes to Consolidated Financial Statements.

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UNITED COMMUNITY FINANCIAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

 

(Continued)

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(Continued)

UNITED COMMUNITY FINANCIAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

 

 

See Notes to Consolidated Financial Statements.

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UNITED COMMUNITY FINANCIAL CORP.

CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY

(Unaudited)

 

 

 

See Notes to Consolidated Financial Statements.

 

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UNITED COMMUNITY FINANCIAL CORP.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

See Notes to Consolidated Financial Statements

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UNITED COMMUNITY FINANCIAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

United Community Financial Corp. (United Community or the Company) was incorporated in the State of Ohio in February 1998 for the purpose of owning all of the outstanding capital stock of Home Savings and Loan Company of Youngstown, Ohio (Home Savings and Loan) issued upon the conversion of Home Savings and Loan from a mutual savings association to a permanent capital stock savings association (Conversion). Upon consummation of the Conversion on July 8, 1998, United Community became the unitary thrift holding company for Home Savings and Loan.  Immediately following United Community’s acquisition of Ohio Legacy Corp. (OLCB) on January 31, 2017, Home Savings and Loan was merged into Premier Bank & Trust, OLCB’s wholly-owned, state-chartered bank subsidiary (PB&T), and the surviving bank changed its name to Home Savings Bank.  In connection with the OLCB acquisition, United Community became a financial holding company, and Home Savings Bank, its wholly-owned bank subsidiary following the merger (Home Savings or the Bank), is now an Ohio bank.

 

Home Savings conducts its business from its main office located in Youngstown, Ohio, 35 retail banking offices, 13 loan production centers and three wealth management offices located throughout Ohio, western Pennsylvania, West Virginia, southeast Michigan, Indiana and Kentucky.  

 

On January 29, 2016, United Community acquired James & Sons Insurance.  James & Sons Insurance was merged into HSB Insurance, LLC, a wholly-owned subsidiary of United Community.  HSB Insurance, LLC d/b/a James & Sons Insurance is an insurance agency that offers a wide variety of insurance products for business and residential customers, which include auto, homeowners, life-health, commercial, surety bonds and aviation. On February 28, 2017, HSB Insurance, LLC acquired certain assets of Eich Brothers Insurance. Eich Brothers Insurance is an insurance agency that offers insurance products for business and residential customers, which include auto, commercial, homeowners and life-health.  On July 1, 2017, HSB Insurance, LLC acquired certain assets of Stevens Insurance Agency, which offers insurance products for business and residential customers, including auto, commercial, homeowners and life-health.   On July 1, 2018, HSB Insurance, LLC acquired certain assets of the Steinhauser Insurance  Agency, which offers insurance products for business and residential customers, including auto, commercial, homeowners and life-health.  

 

HSB Capital, LLC, a wholly-owned subsidiary of United Community, was formed by United Community during 2016 for the purpose of providing mezzanine funding for customers.  Mezzanine loans are offered to customers in United Community’s market area and are expected to be repaid from the cash flow from the operations of the business.

 

HSB Insurance, Inc., a wholly-owned subsidiary of the Company which was formed and began operations on June 1, 2017, is a Delaware-based captive insurance company which insures against certain risks unique to the operations of the Company and its subsidiaries and for which insurance may not be currently available or economically feasible in today's insurance marketplace. HSB Insurance, Inc. pools resources with several other similar insurance company subsidiaries of financial institutions to spread a limited amount of risk among themselves.  HSB Insurance, Inc. is subject to regulations of the State of Delaware and undergoes periodic examinations by the Delaware Division of Insurance.

 

The accompanying consolidated financial statements of United Community have been prepared in accordance with instructions relating to Form 10-Q.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles (U.S. GAAP) for complete financial statements. However, such information reflects all adjustments (consisting solely of normal recurring adjustments) that are, in the opinion of management, necessary for a fair statement of results for the interim periods.

 

The results of operations for the three and nine months ended September 30, 2018, are not necessarily indicative of the results to be expected for the year ending December 31, 2018. The consolidated financial statements and notes thereto should be read in conjunction with the audited financial statements and notes contained in United Community’s Form 10-K for the year ended December 31, 2017.

 

The consolidated financial statements include the accounts of United Community and its subsidiaries, Home Savings, HSB Insurance, LLC, HSB Capital, LLC and HSB Insurance, Inc.  All material inter-company transactions have been eliminated.  Some items in the prior year financial statements were reclassified to conform to the current presentation. These reclassifications had no effect on prior year consolidated statements of operations or shareholders’ equity.

 

 

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On January 1, 2018, the Company adopted Accounting Standards Update (ASU) 2014-09 Revenue from Contracts with Customers and all subsequent amendments to the ASU (collectively, ASC 606), which (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revised when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets, such as other real estate owned.  The majority of the Company’s revenues come from interest income and other sources, including loans and securities, which are outside the scope of ASC 606.  The Company’s services that fall within the scope of ASC 606 are presented within noninterest income and are recognized as revenue as the Company satisfies its obligation to the customer.  Services within the scope of ASC 606 include insurance agency income, brokerage income, deposit related fees, debit/credit card income, trust income and the sale of other real estate owned.  Refer to Note 4, Revenue Recognition for further discussion on the Company’s accounting policies for revenue sources within the scope of ASC 606.

The Company adopted ASC 606 using the modified retrospective method applied to all contracts not completed as of January 1, 2018.  Results for reporting periods beginning after January 1, 2018 are presented under ASC 606 while prior period amounts continue to be reported in accordance with legacy GAAP.  The adoption of ASC 606 did not result in a change to the accounting for any of the in-scope revenue streams; as such, no cumulative effect adjustment was recorded.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities (ASU 2016-01). 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 (viii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities. The new guidance was effective for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2017.  The adoption of this guidance did not have a material effect on the consolidated financial statements and revised disclosures related to the fair value of loans.

In February 2016, the Financial Accounting Standards Board (FASB) issued ASU 2016-02 - Leases (Topic 842) (ASU 2012-02). ASU 2012-02 will require all organizations that lease assets to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. Additional qualitative and quantitative disclosures will be required so that users can understand more about the nature of an entity’s leasing activities. The new guidance is effective for annual reporting periods and interim reporting periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted. Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements and expects to recognize an increase in other assets and other liabilities for the rights and obligations created by leasing of branch offices.  Additionally, management is currently reviewing contracts to determine if any imbedded lease exists within the scope of this ASU. Management also expects minimal impact in the income statement with respect to occupancy expense related to leases.

In June 2016, the FASB Issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13).   ASU 2016-13 adds a new Topic 326 to the Accounting Standards Codification (Codification) and removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current U.S. GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. The revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for credit losses for the difference between the amortized cost basis of a financial instrument and the amount of amortized cost that the company expects to collect over the instrument’s contractual life. ASU 2016-13 also amends the credit loss measurement guidance for available-for-sale debt securities and beneficial interests in securitized financial assets. The guidance in ASU 2016-13 is effective for “public business entities,” as defined, that are SEC filers for fiscal years, and for interim periods with those fiscal years, beginning after December 15, 2019.  Early adoption of the guidance is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Management is currently evaluating the impact of the adoption of this guidance on the Company’s consolidated financial statements.  Management has aggregated and verified the necessary data and addressed any data-archiving improvements necessary for the implementation of this ASU.  Management is in the process of evaluating various models to be used.

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In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (ASU 2016-15), which amends the guidance in ASC 230 on the classification of certain cash receipts and payments in the statement of cash flows. The primary purpose of ASU 2016-15 is to reduce the diversity in practice that has resulted from the lack of consistent principles on this topic. ASU 2016-15’s amendments add or clarify guidance on eight cash flow issues:

For public business entities, the guidance in ASU 2016-15 is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years.  Early adoption is permitted for all entities. Entities must apply the guidance retrospectively to all periods presented but may apply it prospectively from the earliest date practicable if retrospective application would be impracticable.  The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment (ASU 2017-04). ASU 2017-04 eliminates Step 2 from the goodwill impairment test. Instead, under the new guidance, an entity is to perform its annual goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An impairment charge would be recognized for the amount by which the carrying amount exceeds the reporting unit's fair value. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

In March 2017, the FASB issued ASU 2017-08, Receivables - Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities (ASU 2017-08). ASU 2017-08 amends the amortization period for certain purchased callable debt securities held at a premium. It shortens the amortization period for the premium to the earliest call date. Under current U.S. GAAP, premiums on callable debt securities generally are amortized to the maturity date. The new guidance is effective for annual reporting periods, and interim reporting periods within those annual periods, beginning after December 15, 2018. Early adoption is permitted for interim or annual periods. The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting (ASU 2017-09). ASU 2017-09 applies to entities that change the terms or conditions of a share-based payment award.  The FASB adopted ASU 2017-09 to provide clarity and reduce diversity in practice as well as cost and complexity when applying the guidance in Topic 718, Compensation—Stock Compensation, to the modification of the terms and conditions of a share-based payment award.

The amendments in ASU 2017-09 include guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718.

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These amendments require the entity to account for the effects of a modification unless all of the following conditions are met:

The amendments are effective for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017. Early adoption is permitted, including adoption in any interim period. The amendments should be applied prospectively to an award modified on or after the adoption date.  The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception (ASU 2017-11).  ASU 2017-11 simplifies the accounting for certain financial instruments with down round features, a provision in an equity-linked financial instrument (or embedded feature) that provides a downward adjustment of the current exercise price based on the price of future equity offerings.

ASU 2017-11 will require companies to disregard the down round feature when assessing whether the instrument is indexed to its own stock, for purposes of determining liability or equity classification. Companies that provide earnings per share (EPS) data will adjust their basic EPS calculation for the effect of the feature when triggered (i.e., when the exercise price of the related equity-linked financial instrument is adjusted downward because of the down round feature) and will also recognize the effect of the trigger within equity.

The provisions of ASU 2017-11 related to down rounds are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted for all entities.  The adoption of this guidance is not expected to have a material impact on the Company’s consolidated financial statements.

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities (ASU 2017-12).  These amendments revise and expand hedge accounting for both financial (e.g., interest rate) and commodity risks.  Its provisions create more transparency around how economic results are presented, both on the face of the financial statements and in the footnotes.  It also makes certain targeted improvements to simplify the application of hedge accounting guidance.  ASU 2017-12 is effective for public business entities for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years.  For all other entities, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods beginning after December 15, 2020.  Early adoption, including adoption in an interim period, is permitted. If an entity early adopts in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period (i.e., the initial application date).  The adoption of this guidance is not expected to have an impact on the Company’s consolidated financial statements.

In May 2018, the FASB issued ASU 2018-06, Codification Improvements to Topic 942, Financial Services—Depository and Lending (ASU 2018-06).  ASU 2018-06 removes outdated guidance related to the Office of the Comptroller of the Currency’s Banking Circular 202, Accounting for Net Deferred Tax Charges (Circular 202) in Subtopic 942-740, Financial Services – Depository and Lending – Income Taxes.  The adoption of this guidance did not have an impact on the Company’s consolidated financial statements.

 

In June 2018, the FASB issued ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (ASU 2018-07).  The FASB issued ASU 2018-07 intending to reduce cost and complexity and to improve financial reporting for nonemployee share-based payments.  ASU 2018-07 expands the scope of Topic 718, Compensation—Stock Compensation (which currently only includes share-based payments to employees) to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees.  The amendments in ASU 2018-07 are effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. For all other companies, the amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted.  Management expects minimal impact in the income statement with respect to stock-based compensation.

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In July, the FASB issued ASU 2018-09, Codification Improvements.  ASU 2018-09 affects a wide variety of Topics in the Codification. The transition and effective date guidance is based on the facts and circumstances of each amendment. Some of the amendments in ASU 2018-09 do not require transition guidance and will be effective upon issuance of ASU 2018-09. However, many of the amendments do have transition guidance with effective dates for annual periods beginning after December 15, 2018, for public business entities. The adoption of this guidance is not expected to have an impact of the Company’s consolidated financial statements.

 

In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases (ASU 2018-10).  ASU 2018-10, among other things, amends Topic 842 affecting narrow aspects of the guidance issued in the amendments in ASU 2016-02.  The amendments in ASU 2018-10 affect the amendments in ASU 2016-02, which are not yet effective, but for which early adoption upon issuance is permitted. For entities that early-adopted Topic 842, the amendments are effective upon issuance of ASU 2018-10, and the transition requirements are the same as those in Topic 842.  The adoption of this guidance is not expected to have an impact of the Company’s consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-11, Leases (Topic 842): Targeted Improvements (ASU 2018-11).  ASU 2018-11 provides entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases).

 

The amendments also provide lessors with a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under the new revenue guidance (Topic 606) and certain criteria are met: If the nonlease component or components associated with the lease component are the predominant component of the combined component, an entity is required to account for the combined component in accordance with Topic 606. Otherwise, the entity must account for the combined component as an operating lease in accordance with Topic 842.

 

For entities that have not adopted Topic 842 before the issuance of ASU 2018-11, the effective date and transition requirements for the amendments related to separating components of a contract are the same as the effective date and transition requirements in ASU No. 2016-02. For entities that have adopted Topic 842 before the issuance of ASU No. 2018-11, the transition and effective date of the amendments related to separating components of a contract in ASU No. 2018-11 are as follows:

 

1. The practical expedient may be elected either in the first reporting period following the issuance of this Update or at the original effective date of Topic 842 for that entity.

 

2. The practical expedient may be applied either retrospectively or prospectively.

 

All entities, including early adopters, that elect the practical expedient related to separating components of a contract in ASU No. 2018-11 must apply the expedient, by class of underlying asset, to all existing lease transactions that qualify for the expedient at the date elected.  The adoption of this guidance is not expected to have an impact of the Company’s consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-12, Financial Services—Insurance (Topic 944): Targeted Improvements to the Accounting for Long Duration Contracts (ASU 2018-12).  ASU 2018-12 requires updated assumptions for liability measurement. Assumptions used to measure the liability for traditional insurance contracts, which are typically determined at contract inception, will now be reviewed, and, if there is a change, updated, at least annually, with the effect recorded in net income;

 

ASU 2018-12 also standardizes the liability discount rate. The liability discount rate will be a standardized, market-observable discount rate (upper-medium grade fixed-income instrument yield), with the effect of rate changes recorded in other comprehensive income;

 

ASU 2018-12 provides greater consistency in measurement of market risk benefits. The two previous measurement models have been reduced to one measurement model (fair value), resulting in greater uniformity across similar market-based benefits and better alignment with the fair value measurement of derivatives used to hedge capital market risk;

 

ASU 2018-12 simplifies amortization of deferred acquisition costs. Previous earnings-based amortization methods have been replaced with a more level amortization basis; and require enhanced disclosures. They include roll forwards and information about significant assumptions and the effects of changes in those assumptions.

 

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For public business entities, ASU 2018-12 is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. For all other entities, the amendments are effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. Early application is permitted.  The adoption of this guidance is not expected to have an impact of the Company’s consolidated financial statements.

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13).  ASU 2018-13 modifies the disclosure requirements in Topic 820, eliminating or modifying current disclosures.  It also adds two additional disclosure items that apply only to public companies with assets or liabilities measured under Level 3 of the Fair Value hierarchy.  ASU 2018-13 also revised the disclosure objective for fair value measurements so that companies may assess and reduce the content of fair value disclosures.  ASU 2018-13 becomes effective for all companies beginning after December 15, 2019, and interim periods within those years.   The adoption of this guidance is not expected to have an impact of the Company’s consolidated financial statements.

 

 

 

Stock Options:

On April 30, 2015, shareholders approved the United Community Financial Corp. 2015 Long-Term Incentive Compensation Plan (the 2015 Plan). The purpose of the 2015 Plan is to provide a means through which United Community may attract and retain employees and non-employee directors, to provide incentives that align their interest with those of United Community’s shareholders and promote the success of United Community’s business.  All employees and non-employee directors are eligible to participate in the 2015 Plan.  The 2015 Plan provides for the issuance of up to 1,200,000 shares that are to be used for awards of stock options, stock awards, stock units, stock appreciation rights (SARs), annual bonus awards and long-term incentive awards.

On April 26, 2007, shareholders approved the United Community Financial Corp. 2007 Long-Term Incentive Plan (as amended, the 2007 Plan). The purpose of the 2007 Plan was to promote and advance the interests of United Community and its shareholders by enabling United Community to attract, retain and reward directors, directors emeritus, managerial and other key employees of United Community, including Home Savings, by facilitating their purchase of an ownership interest in United Community. The 2007 Plan was terminated on April 30, 2015 upon the adoption of the 2015 Plan, although the 2007 Plan survives with respect to awards issued under the 2007 Plan that remain outstanding and exercisable.  The 2007 Plan provided for the issuance of up to 2,000,000 shares that were to be used for awards of restricted stock, stock options, performance awards, SARs, or other forms of stock-based incentive awards.  Because the 2007 Plan terminated, no additional awards may be made under it.

On July 12, 1999, shareholders approved the United Community Financial Corp. 1999 Long-Term Incentive Plan (as amended, the 1999 Plan). The purpose of the 1999 Plan was the same as the 2007 Plan. The 1999 Plan terminated on May 20, 2009, although the 1999 Plan survives with respect to options issued under the 1999 Plan remain outstanding and exercisable. The 1999 Plan provided for the grant of either incentive or nonqualified stock options. Options were awarded at exercise prices that were not less than the fair market value of the share at the grant date. The maximum number of common shares that could be issued under the 1999 Plan was 3,569,766. Because the 1999 Plan terminated, no additional options may be issued under it.

There were 50,000 stock options granted under the 2015 Plan during the nine months ended September 30, 2018 and none granted during the nine months ended September 30, 2017.  Pursuant to the terms of the 2015 Plan, any options granted must be exercised within 10 years from the date of grant.  Expenses related to prior stock option grants are included with salaries and employee benefits. The Company recognized $19,000 and $51,000 in stock option expense for the three and nine months ended September 30, 2018, respectively.  The Company recognized $0 and $1,000 in stock option expense for the three and nine months ended September 30, 2017, respectively.  The Company expects to recognize an additional $19,000 in stock option expense for the remainder of 2018.

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A summary of option activity for the nine months ended September 30, 2018 in the 2015 Plan, the 2007 Plan and the 1999 Plan is as follows:

 

 

Information related to stock options for the nine months ended September 30, 2018 and 2017 follows:

 

 

Information related to stock options granted during the nine months ended September 30, 2018 were as follows:

 

 

As of September 30, 2018, there were 50,000 nonvested stock options outstanding.

 

Outstanding stock options at September 30, 2018 have a weighted average remaining life of 3.68 years and may be exercised in the range of $1.20 to $9.66 per share.

Restricted Stock Awards:

The 2007 Plan permitted and the 2015 Plan permits the issuance of restricted stock awards to eligible employees and nonemployee directors. Nonvested shares at September 30, 2018 aggregated 227,651, of which 7,113 are expected to vest during the remainder of 2018, 128,034 in 2019, 37,744 in 2020 and 54,760 in 2021. Expense related to restricted stock awards is charged to salaries and employee benefits and is recognized over the vesting period of the awards based on the fair value of the shares at the grant date. The Company recognized approximately $243,000  and $714,000 in restricted stock award expense for the three and nine months ended September 30, 2018, respectively. The Company recognized approximately $240,000  and $696,000 in restricted stock award expense for the three and nine months ended September 30, 2017, respectively.  The Company expects to recognize additional expenses related to restricted stock awards of approximately $223,000 in 2018, $539,000 in 2019, $310,000 in 2020 and $150,000 in 2021.  The total average per share fair value of shares vested during the nine months ended September 30, 2018 was $9.64.

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A summary of changes in the Company’s nonvested restricted shares for the nine months ended September 30, 2018 is as follows:

 

 

Annual Incentive Plan

The Annual Incentive Plan (AIP) provides incentive compensation awards to certain officers of the Company. Annual incentive awards are generally based upon the actual performance of the Company and individual participant performance for the twelve months ending December 31, compared to the actual performance of a peer group during the same twelve-month period. The target incentive awards for each year are measured as a percentage of the base salary of participating officers.  Once the awards under the AIP are calculated, they are paid in cash and/or restricted stock. The restricted stock vests equally over three years, beginning on the first anniversary of the date the restricted stock is issued.  The Company incurred $94,000  and $284,000 in expense for the restricted stock portion of the AIP for the three and nine months ended September 30, 2018 and $416,000 and $1.3 million for the cash portion of the AIP for the three and nine months ended September 30, 2018.  The Company incurred $100,000 and $222,000 in expense for the restricted stock portion of the AIP for the three and nine months ended September 30, 2017 and $431,000 and $1.3 million for the cash portion of the AIP for the three and nine months ended September 30, 2017.  

Long-term Incentive Plan

The Long-term Incentive Plan (LTIP) provides a long-term incentive compensation opportunity to certain executive officers, whose participation and target award opportunities will be approved by the Compensation Committee of the Board of Directors. Each participant in the LTIP will be granted a target number of Performance Share Units (PSUs).  Target PSUs will be determined as a percentage of base salary and translated into share units based on the Company’s average stock price at the appropriate measurement date.  The performance period for the annual grant for a given year will be from January 1, year 1 through December 31, year 3.   The Company incurred $167,000 and $548,000  in expense for the LTIP for the three and nine months ended September 30, 2018.  The Company incurred $146,000 and $295,000 in expense for the LTIP for the three and nine months ended September 30, 2017.

 

 

 

The Company recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.  To achieve this result, the following five steps are applied:

 

Step 1: Identify the contract(s) with the customer

Step 2: Identify the performance obligation(s) in the contract

Step 3: Determine the transaction price

Step 4: Allocate the transaction price to the performance obligations in the contract

Step 5: Recognize revenue when (or as) the entity satisfies a performance obligation

 

The new revenue guidance applies to all contracts with customers to provide goods or services in the ordinary course of business, except for loans and securities, which are specifically excluded from the scope.

 

Because loans and securities are outside the scope of the revenue standard, the Company will not use the new standard to account for gains and losses on its investments in securities, loans and derivatives.  The Company also will not use the standard to account for interest and dividend income on financial instruments owned or those included in the Company’s lending activities.  

 

Home Savings’ servicing of loans sold to investors requires Home Savings to provide specific administrative functions for the owner(s) of these assets.  These administrative functions include collecting cash flows from borrowers and remitting them to beneficial interest holders, monitoring delinquencies and executing foreclosures.  Servicing rights that relate to transferred financial assets meet the conditions for sale accounting under ASC 860.  ASC 860 requires the recognition of a servicing asset or liability when the benefits of servicing obtained from the contract are respectively greater than or less than adequate compensation (as defined in

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ASC 860) for performing the servicing.  While ASC 860 provides initial recognition and subsequent measurement guidance for recognized servicing assets and liabilities, it does not include any explicit guidance for recognizing contractually specified servicing fees when servicing income is equal to adequate compensation.   Therefore, income from servicing financial assets in the scope of ASC 860 is not in the scope of ASC 606, regardless of whether a servicing asset or liability exists. This is because ASC 606 contains an exception to its scope for contracts that fall under ASC 860.

 

Deposit-related fees and charges are in the scope of ASC 606, even though ASC 405 is listed as an exception to the scope of the standard. That is because ASC 405, which the Company applies to determine the appropriate liability accounting for customer deposits, does not provide a model for recognizing fees related to customer deposits (e.g., automated teller machine fees, nonsufficient funds fees, account maintenance or dormancy fees).  When reviewing standard customer agreements, fees are charged as the service is rendered and therefore there are no changes to recognizing income for deposit-related fees.

 

The Company records real estate owned and other repossessed assets (OREO) at fair value less costs to sell upon foreclosure. The objective is to sell OREO within a short period of time because of regulatory and capital requirements. After foreclosure, these assets are carried at the lower of their carrying amount or their fair value less selling costs, so significant gains and losses are uncommon upon sale. OREO is often sold in a transaction that, under the standard, may not be considered a contract with a customer because the sale of the asset is not an output of the entity’s ordinary activities. However, sales of  nonfinancial assets, including in substance nonfinancial assets, should be accounted for using new guidance in ASC 610-20, Other Income — Gains and Losses from the Derecognition of Nonfinancial Assets, which requires entities to apply certain measurement and recognition concepts of ASC 606. Accordingly, the Company recognizes the sale of a real estate property, along with any associated gain or loss, when control of the property transfers to the buyer. For sales of existing real estate properties, this generally will occur at a point in time.

 

Insurance agency income is within the scope of ASC 606.  Approximately 75% of the Company’s insurance agency income is derived from direct-bill customers.  With this arrangement, the customer is billed directly from the insurance carrier.  As a result, the insurance carrier pays a commission to the Company upon completion of the required documentation (policy application or renewal) and recognizes income at that time.  Due to the nature and timing of receipt of these commissions, there will be no change in the manner in which income is recognized.  Agency-billed customers account for approximately 25% of the overall insurance agency income.  Premiums are collected from customers and remitted to the insurance carrier, net of commission, within a short period of time.  At the time the premiums are remitted to the insurance carrier, all work is completed and revenue recognized at that time.  Due to the nature and timing of when the premiums are recognized, there will be no change to the timing of the recognition of insurance agency income.

 

Debit card fee income is earned as a result of standard interchange fees contractually obligated by Visa to be paid.  Interchange fees are charged to a merchant for the presentment of credit/debit card transactions.  The service is considered complete upon fulfillment of the transaction, which is when the interchange fee is earned and paid.  Credit card fees are paid when earned as a result of an agreement between the bank and a third party provider.  As a result, there is no change to the timing of recognition of this income.

 

Trust fee income is calculated based on assets under management.  Fees are recognized at the end of the month to which the service has been provided for customers billed monthly.  This amounts to approximately 85% of trust fee income recognized, which is collected within a short period of time after the fee is assessed to the customer.  Quarterly and annual fees are accrued and collected based on the contractual agreements with customers.  Fees are assessed to these customers and paid at the end of each quarter.  Due to the nature and timing of when monthly fees are assessed, there will be no change to the way those fees are currently recognized.  Quarterly and annual fees will continue to be recognized over the period when the fees are earned, regardless of when they are assessed to the customer.

 

Brokerage revenue is recognized each month as sales occur.  Brokerage revenue is paid from sales to customers by a third-party.  In a manner similar to that of insurance agency revenue, income is paid directly to the Bank by the third-party once the sale to the customer is complete.  Due to the nature and timing of when the income is earned, there will be no change to timing of when this income is recognized.

 

 

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Components of the available for sale portfolio are as follows:

 

 

 

Components of held to maturity securities portfolio are as follows:

 

 

 

Debt securities available for sale by contractual maturity, repricing or expected call date are shown below:

 

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Debt securities held to maturity by contractual maturity, repricing or expected call date are shown below:

 

 

 

Securities pledged for public funds were approximately $141.6 million at September 30, 2018 and approximately $129.8 million at December 31, 2017.  

Securities available for sale that have been in an unrealized loss position for less than twelve months or twelve months or more at September 30, 2018 are as follows:

 

 

Securities available for sale that have been in an unrealized loss position for less than twelve months or twelve months or more at December 31, 2017 are as follows:

 

 

All of the U.S. treasury and government sponsored entities and mortgage-backed securities available for sale that were temporarily impaired at September 30, 2018 and December 31, 2017, were impaired due to the level of interest rates at the time of purchase compared to current interest rates. Unrealized losses on these securities have not been recognized into income during the three and nine months ended September 30, 2018 and 2017 because the issuer’s securities are of high credit quality (rated AA or higher).  It is likely that management will not be required to sell the securities prior to their anticipated recovery and the decline in fair value is largely due to changes in interest rates and other market conditions. There is risk that longer term rates could rise further resulting in greater unrealized losses.  The Company expects to realize all interest and principal on these securities and has no intent to sell, and more than likely will not be required to sell, these securities before their anticipated recovery.

All of the obligations of U.S. states and political subdivisions held for sale that were temporarily impaired at September 30, 2018 and December 31, 2017, were impaired due to the level of interest rates at the time of purchase compared to current interest rates.  Unrealized losses on these securities have not been recognized into income for the three and nine months ended September 30, 2018 or 2017 because the issuer’s securities are of high credit quality (rated AA or higher), it is likely that management will not be required to sell, and has no intent to sell, the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions.

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Securities held to maturity that have been in an unrecognized loss position for less than twelve months or twelve months or more are as follows: 

 

 

During the third quarter of 2015, Home Savings transferred securities with a total amortized cost of $105.3 million with a corresponding fair value of $103.8 million from available for sale to held to maturity.  The net unrealizable loss, net of taxes, on these securities at the date of transfer was $999,000.  The fair value at the date of transfer becomes the securities’ new cost basis.  The unrealized holding loss at the time of transfer continues to be reported in accumulated other comprehensive income, net of tax, and is amortized over the remaining lives of the securities as an adjustment of the yield.  The amortization of the unamortized holding loss reported in accumulated other comprehensive income will directly offset the effect on interest income from the accretion of the reduced amortized cost for the transferred securities.  Because of this transfer, the total losses less than 12 months and greater than 12 months reported in the table above will not agree to the unrealized losses reported in the inventory of held to maturity securities.  The inventory table reports unrealized gains and losses based upon the transferred securities adjusted cost basis and current fair value.  The reporting of losses less than 12 months and greater than 12 months represents that actual period of time that these securities have been in an unrealized loss position and the securities amortized cost basis as if the transfer did not occur.

All of the mortgage-backed securities held to maturity that were temporarily impaired at September 30, 2018 and December 31, 2017, were impaired due to the level of interest rates at the time of purchase compared to current interest rates. Unrealized losses on these securities have not been recognized into income for the three and nine months ended September 30, 2018 and 2017 because the issuer’s securities are of high credit quality (rated AA or higher), it is likely that management will not be required to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions. There is risk that longer term rates could rise further resulting in greater unrealized losses.  The Company expects to realize all interest and principal on these securities and has no intent to sell and more than likely will not be required to sell these securities before their anticipated recovery.

All of the obligations of U.S. states and political subdivisions held to maturity that were temporarily impaired at September 30, 2018, and December 31, 2017, were impaired due to the level of interest rates at the time of purchase compared to current interest rates.   Unrealized losses on these securities have not been recognized into income for the three and nine months ended September 30, 2018 or 2017 because the issuer’s securities are of high credit quality (rated AA or higher).  It is likely that management will not be required to sell and has no intent to sell the securities prior to their anticipated recovery, and the decline in fair value is largely due to changes in interest rates and other market conditions.

Proceeds from the sale of available for sale securities were $0 million and $9.7 million, for the three months ended September 30, 2018 and 2017, respectively.  Gross gains of $0 and $236,000 were realized on these sales during the three months ended September 30, 2018 and 2017, respectively.  Gross losses of $0 and $0 were realized on these sales during these same periods.  

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Proceeds from the sale of available for sale securities were $10.4 million and $62.9 million, for the nine months ended September 30, 2018 and 2017, respectively.  Gross gains of $233,000 and $610,000 were realized on these sales during the nine months ended September 30, 2018 and 2017, respectively.  Gross losses of $0 and $44,000 were realized during the nine months ended September 30, 2018 and 2017, respectively. 

 

Portfolio loans consist of the following:

 

 

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The following tables present the balance in the allowance for loan losses and the recorded investment in loans by portfolio segment and are based on impairment method as of September 30, 2018 and December 31, 2017 and activity for the three and nine months ended September 30, 2018 and 2017.

Allowance For Loan Losses

 

 

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Allowance For Loan Losses

 

The allowance for loan losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. Management estimates the allowance balance required based on an analysis using past loan loss experience, the nature and volume of the portfolio, information about specific borrower situations, estimated collateral values, general economic conditions in the market area and other factors. Allocations of the allowance may be made for specific loans, but the entire allowance is available for any loan that, in management’s judgment, should be charged-off.

Other loans not reviewed specifically by management are evaluated as a homogenous group of loans (generally single-family residential mortgage loans and all consumer credits except marine loans) using a loss factor applied to the outstanding loan balance to determine the level of reserve required. This loss factor consists of two components, a quantitative and a qualitative component. The quantitative component is based on a historical analysis of all charged-off loans, net of recoveries. In determining the qualitative factors, consideration is given to such attributes as lending policies, economic conditions, nature and volume of the portfolio, management, loan quality trend, loan review, collateral value, concentrations, economic cycles and other external factors.  As of September 30, 2018, the Company evaluated 25 quarters of net charge-off history and applied this information to the current period.  This component is combined with the qualitative component to arrive at the loss factor, which is applied to the outstanding balance of homogenous loans.

 

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The following table presents loans individually evaluated for impairment by class of loans as of and for nine months ended September 30, 2018:

Impaired Loans

(Dollars in thousands)

 

 

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The following table presents loans individually evaluated for impairment by class of loans as of and for nine months ended September 30, 2017:

Impaired Loans

(Dollars in thousands)

 

 

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The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2017:

Impaired Loans

(Dollars in thousands)

 

 

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The following table presents the average balance, interest income recognized and cash basis income recognized for loans individually evaluated for impairment by class of loans for the three months ended September 30, 2018:

 

 

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The following table presents the average balance, interest income recognized and cash basis income recognized for loans individually evaluated for impairment by class of loans for the three months ended September 30, 2017:

 

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Home Savings reclassifies a collateralized mortgage loan and a consumer loan secured by real estate to real estate owned and other repossessed assets once it has either obtained legal title to the real estate collateral or the borrower voluntarily conveys all interest in the real property to the Bank to satisfy the loan through a deed in lieu of foreclosure or similar legal agreement.  The table below presents loans that are in the process of foreclosure at September 30, 2018 and December 31, 2017, but legal title, deed in lieu of foreclosure or similar legal agreement to the property has not yet been obtained:

 

 

The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days and still on accrual by class of loans as of September 30, 2018:

Nonaccrual Loans and Loans Past Due Over 90 Days and Still Accruing

As of September 30, 2018

 

 

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The following table presents the recorded investment in nonaccrual loans and loans past due over 90 days and still on accrual by class of loans as of December 31, 2017:

Nonaccrual Loans and Loans Past Due Over 90 Days and Still Accruing

As of December 31, 2017

 

 

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The following table presents an age analysis of past-due loans, segregated by class of loans as of September 30, 2018:

Past Due Loans

(Dollars in thousands)

 

 

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The following table presents an age analysis of past-due loans, segregated by class of loans as of December 31, 2017:

Past Due Loans

(Dollars in thousands)

 

 

As of September 30, 2018 and December 31, 2017, the Company has a recorded investment in troubled debt restructurings of $17.6 million and $19.8 million, respectively.  The Company allocated $1.1 million of specific allowance for those loans at September 30, 2018 and $1.6 million at December 31, 2017.  The Company has committed to lend, to existing troubled debt restructuring relationships, additional amounts totaling up to $40,000 and $37,000 at September 30, 2018 and December 31, 2017, respectively.  

 

There were no loans modified as troubled debt restructurings during the three months ended September 30, 2018.

 

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The following table presents loans by class modified as troubled debt restructurings that occurred during the three months ended September 30, 2017:

 

 

The troubled debt restructuring described above had no effect on the allowance for loan losses and resulted in no charge-offs during the three months ended September, 2017.  

 

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The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2018:

 

 

The troubled debt restructurings described above increased the allowance for loan losses by $3,000 and resulted in no charge-offs during the nine months ended September 30, 2018.  

 

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The following table presents loans by class modified as troubled debt restructurings that occurred during the nine months ended September 30, 2017:

 

 

The troubled debt restructurings described above increased the allowance for loan losses by $6,000 and resulted in no charge-offs during the nine months ended September 30, 2017.

 

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The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within a twelve-month cycle following the modification during the period ended September 30, 2018.

 

 

The troubled debt restructurings that subsequently defaulted described above resulted in no charge-offs during the three and nine months ended September 30, 2018, and had no effect on the provision for loan losses.

The following table presents loans by class modified as troubled debt restructurings for which there was a payment default within a twelve month cycle following the modification during the period ended September 30, 2017:

 

 

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The troubled debt restructurings that subsequently defaulted described above resulted in no charge-offs during the three and nine months ended September 30, 2017, and had no effect on the provision for loan losses.

A troubled debt restructuring is considered to be in payment default once it is 30 days contractually past due under the modified terms.

In order to determine whether a borrower is experiencing financial difficulty, an evaluation is performed of the probability that the borrower will be in payment default on any of its debt in the foreseeable future without the modification. This evaluation is performed in accordance with the Company’s internal underwriting policy.

Credit Quality Indicators:

The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, such as: current financial information, historical payment experience, credit documentation, public information and current economic trends. The Company analyzes loans individually by classifying the loans as to credit risk. This analysis includes homogeneous loans past due 90 cumulative days, and all non-homogeneous loans, including commercial loans and commercial real estate loans. Smaller balance homogeneous loans are primarily monitored by payment status.

Asset quality ratings are divided into two groups: Pass (unclassified) and Classified. Within the unclassified group, certain loans that display potential weakness are risk rated as special mention. In addition, there are three classified risk ratings: substandard, doubtful and loss. These specific credit risk categories are defined as follows:

Special Mention. Loans classified as special mention have potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date.

Substandard. Loans classified as substandard are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful. Loans classified as doubtful have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loss. Loans classified as loss are considered uncollectible and of such little value, that continuance as assets is not warranted. Although there may be a chance of recovery on these assets, it is not practical or desirable to defer writing off the asset.

The Company monitors loans on a monthly basis to determine if they should be included in one of the categories listed above. All impaired non-homogeneous credits classified as substandard, doubtful or loss are analyzed on an individual basis for a specific reserve requirement. This analysis is performed on each individual credit at least annually or more frequently if warranted.

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As of September 30, 2018 and December 31, 2017, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows:

September 30, 2018

(Dollars in thousands)

 

 

December 31, 2017

(Dollars in thousands)

 

 

 

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Purchased Credit Impaired Loans:

The Company has purchased loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and it was probable, at acquisition, that all contractually required payments would not be collected.  The carrying amount of those loans is as follows:

 

 

Accretable yield, or income expected to be collected, is as follows:

 

 

For the purchased credit impaired loans disclosed above, there was a decrease of $55,000 in the allowance for loan losses for the three and nine months ended September 30, 2018 and there was no change in the allowance for loan losses for the three and nine months ended September 30, 2017.  

 

Income is not recognized on purchased credit impaired loans if the Company cannot reasonably estimate cash flows expected to be collected.  The carrying amounts of such loans are as follows:

 

 

 

Mortgage loans serviced for others, which are not reported in United Community’s assets, totaled $1.4 billion as of September 30, 2018 and $1.3 billion as of December 31, 2017. Mortgage banking income is comprised of gains recognized on the sale of loans and changes in fair value of mortgage banking derivatives.

The principal balances of mortgage loans serviced for others are as follows:

 

 

During the second quarter of 2017, the Company sold $27.9 million of adjustable rate one-to four-family mortgages to a private investor in a bulk mortgage loan sale.  The Company recognized 45 basis points of mortgage service release premium as part of the gain recognized on this sale.   Customer escrow balances with loans serviced for FHLMC, FNMA and the private investor totaled $9.6 million and $15.3 million at September 30, 2018 and December 31, 2017, respectively.

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Activity for capitalized mortgage servicing rights, included in other assets, was as follows:

 

 

Activity in the valuation allowance for mortgage servicing rights was as follows:

 

 

The fair value of mortgage servicing rights as of September 30, 2018, was approximately $11.7 million and at December 31, 2017, the fair value was approximately $10.9 million.

Key economic assumptions in measuring the value of mortgage servicing rights at September 30, 2018, and December 31, 2017, were as follows:

 

 

 

Real estate owned and other repossessed assets at September 30, 2018 and December 31, 2017 were as follows:

 

 

Activity in the valuation allowance was as follows:

 

 

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Expenses related to foreclosed and repossessed assets include:

 

 

 

Fair value is the exchange price that would be received for an asset if paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity’s own beliefs about the assumptions that market participants would use in pricing an asset or liability.

United Community uses the following methods and significant assumptions to estimate the fair value of each type of financial instrument:

Available for sale securities: The fair values of securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs). For securities where quoted prices are not available, fair values are calculated based on market prices of similar securities (Level 2), using matrix pricing.  Matrix pricing is a mathematical technique commonly used to price debt securities that are not actively traded, values debt securities without relying on the securities’ relationship to other benchmark quoted securities (Level 2 inputs).

Impaired loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value. Impaired loans carried at fair value generally receive specific allocations of the allowance for loan losses. For collateral dependent loans, fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Non-real estate collateral may be valued using an appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or discounted based on management’s historical knowledge, changes in market conditions from the time of the valuation, and management’s expertise and knowledge of the client and client’s business, resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for additional impairment and adjusted accordingly.

Other real estate owned: Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. These assets are subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is commonly based on recent real estate appraisals. These appraisals may utilize a single valuation approach or a combination of approaches including comparable sales and the income approach. Adjustments are routinely made in the appraisal process by the independent appraisers to adjust for differences between the comparable sales and income data available. Such adjustments are usually significant and typically result in a Level 3 classification of the inputs for determining fair value. Real estate owned properties are individually evaluated at least annually for additional impairment and adjusted accordingly.

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Appraisals for both collateral-dependent impaired loans and other real estate owned are performed by certified appraisers (for commercial properties) or certified residential appraisers (for residential properties) whose qualifications and licenses have been reviewed and verified by Home Savings. Once received, a member of the Special Assets Department reviews the assumptions and approaches utilized in the appraisal as well as the overall resulting fair value in comparison with the independent data sources such as recent market data or industry-wide statistics. In addition to the Special Assets Department review, a third party independent review is also performed.  On an annual basis, Home Savings compares the actual selling price of collateral that has been sold to the most recent appraised value to determine what additional adjustment should be made to the appraisal value to arrive at fair value. At the time a property is acquired and classified as real estate owned, the fair value is determined utilizing the most appropriate method. A fair value in excess of $250,000 will be supported by an appraisal. After determination of fair value, each property will be recorded at the lower of cost (i.e., recorded investment in the loan) or the estimated net realizable value on the date of transfer to real estate owned. In determining net realizable value, reductions to fair market value may be taken for estimated costs of sale, conditions that must be remedied immediately upon acquisition, and other factors that negatively impact the marketability and prompt sale of the property.

Mortgage servicing rights: On a quarterly basis, loan servicing rights are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. If the carrying amount of an individual tranche exceeds fair value, impairment is recorded on that tranche so that the servicing asset is carried at fair value. Fair value is determined at a tranche level, based on market prices for comparable mortgage servicing contracts, when available, or alternatively based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model utilizes assumptions that market participants would use in estimating future net servicing income and that can be validated against available market data (Level 2).

Loans held for sale: Loans held for sale are carried at the lower of cost or fair value, which is evaluated on a pool-level basis. The fair value of loans held for sale is determined using quoted prices for similar assets, adjusted for specific attributes of that loan or other observable market data, such as outstanding commitments from third party investors (Level 2).

Loans held for sale, at fair value:  The Company elected the fair value option for all conventional residential one-to four-family loans held for sale originated after January 1, 2016 and all permanent construction loans held for sale originated on or after January 1, 2015.   The fair value of conventional loans held for sale is determined using the current 15 day forward contract price for either 15 or 30 year conventional mortgages (Level 2).

The fair value of the Company’s permanent construction loans held for sale is determined using the current 60 day forward contract price for 30 year conventional loans which is then adjusted by extrapolating this rate to the estimated time period remaining until construction is complete.  The fair value is also adjusted for unobservable market data such as estimated fall out rates and the estimated time from origination to completion of construction (Level 3).  

Purchased and written certificate of deposit option: Home Savings periodically enters into written and purchased option derivative instruments to facilitate the Power CD. The written and purchased options are mirror derivative instruments which are carried at fair value on the consolidated balance sheets. Home Savings uses an independent third party that performs a market valuation analysis for purchased and written certificate of deposit options. (Level 2).

Interest rate swaps:  The fair values of interest rate swaps are based on valuation models using observable market data as of the measurement date (Level 2).  Home Savings’ interest rate swaps are traded in an over-the-counter market where quoted market prices are not always available.  Therefore, the fair values of interest rate swaps are determined using quantitative models that utilize multiple market inputs.  The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position.  The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services.

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Assets and Liabilities Measured on a Recurring Basis: Assets and liabilities measured at fair value on a recurring basis are summarized below:

 

 

 

There were no transfers between Level 1 and Level 2 during the first nine months of 2018 or fiscal year 2017.

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The table below presents a reconciliation of all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the three months ended September 30, 2018 and 2017.  

 

 

The following table presents quantitative information about recurring Level 3 fair value measurements at September 30, 2018:

 

 

The following table presents quantitative information about recurring Level 3 fair value measurements at December 31, 2017:

 

The fair value of loans held for sale, at fair value was determined using pricing from a quoted market, discounted for the length of time to the completion of the construction project.

Assets and Liabilities Measured on a Non-Recurring Basis: Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

 

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Impaired loans with specific allocations of the allowance for loan losses, carried at fair value, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net carrying amount of $431,000 at September 30, 2018, that includes a specific valuation allowance of $488,000. This resulted in an increase of the provision for loan losses of $40,000 and $187,000 during the three and nine months ended September 30, 2018, respectively. Impaired loans with specific allocations of the allowance for loan losses, carried at fair value, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net carrying amount of $1.2 million at September 30, 2017, which includes a specific valuation allowance of $42,000. This resulted in an increase in the provision for loan losses of $92,000 and $571,000 for the three and nine months ended September 30, 2017.  Impaired loans with specific allocations of the allowance for loan losses, carried at fair value, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a net carrying amount of $1.7 million at December 31, 2017, that includes a specific valuation allowance of $491,000.

The significant unobservable (Level 3) inputs used in the fair value measurement of collateral for collateral dependent impaired loans included in the above table primarily relate to the adjustment between carrying values versus appraised value. During the reported periods, discounts applied to appraisals for estimated selling costs were 10%.

At September 30, 2018, $282,000 in mortgage servicing rights were carried at fair value, resulting in a net valuation allowance of $26,000.  At September 30, 2017, mortgage servicing rights carried at fair value totaled $125,000, resulting in a net valuation allowance of $15,000.  Mortgage servicing rights are valued by an independent third party that is active in purchasing and selling these instruments.  A net impairment reflected in other income totaled $6,000 and $17,000 for the three and nine months ended September 30, 2018, respectively.  Net impairment reflected in other income totaled $10,000 and $15,000 for the three and nine months ended September 30, 2017.  The value reflects the characteristics of the underlying loans.  

At September 30, 2018, other real estate owned, carried at fair value, which is measured for impairment using the fair value of the property less estimated selling costs, and had a net carrying amount of $342,000, with a valuation allowance of $297,000. This resulted in expense of $49,000 and $82,000 during the three and nine months ended September 30, 2018.  At September 30, 2017, other real estate owned, carried at fair value, which is measured for impairment using the fair value of the property less estimated selling costs, and had a net carrying amount of $580,000 with a valuation allowance of $423,000. This resulted in expense of $53,000 and $15,000 during the three and nine months ended September 30, 2017. At December 31, 2017, other real estate owned had a net carrying amount of $436,000, with a valuation allowance of $403,000.

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The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at September 30, 2018:

 

 

The following table presents quantitative information about Level 3 fair value measurements for financial instruments measured at fair value on a nonrecurring basis at December 31, 2017:

 

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Auto and recreational vehicle loans were excluded from the table above as their value is considered immaterial.

The Company has elected the fair value option for newly originated residential mortgage and permanent construction loans held for sale.  These loans are intended for sale and the Company believes that fair value is the best indicator of the resolution of these loans.  Interest income is recorded based on the contractual terms of the loan and in accordance with the Company’s policy on loans held for investment.  None of these loans are 90 or more days past due nor on nonaccrual status as of September 30, 2018 and December 31, 2017.  

 

 

The total amount of gains and losses from changes in fair value included in earnings for the three and nine months ended September 30, 2018 and 2017 for loans held for sale, at fair value were:

 

 

In accordance with U.S. GAAP, the carrying value and estimated fair values of financial instruments at September 30, 2018 and December 31, 2017, were as follows:

 

 

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The methods and assumptions, not previously presented, used to estimate fair values are described as follows:

(a) Cash and Cash Equivalents

The carrying amounts of cash and short-term instruments approximate fair values and are classified as Level 1.

(b) FHLB Stock

It is not practical to determine the fair value of FHLB stock due to restrictions placed on its transferability.

(c) Held to maturity securities

Fair values for held to maturity securities are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows.

(d) Loans

Beginning January 1, 2018, fair values of loans, excluding loans held for sale, are estimated based on the price received to sell the asset (exit price), considering the lifetime credit risk of the loan portfolio. For variable rate loans that reprice frequently and with no significant change in credit risk, fair values are based the weighted average next repricing date and weighted average index, resulting in a Level 3 classification.  Fair values for other loans are estimated using the weighted average months to maturity and weighted average contractual interest rate, using weightings based on principal balances, resulting in a Level 3 classification. Impaired loans are valued at the lower of cost or fair value as described previously. The methods utilized to estimate the fair value of loans represent an exit price.

At December 31, 2017, fair values of loans, excluding loans held for sale, were estimated as follows: For variable rate, loans that reprice frequently and with no significant change in credit risk, fair values were based on carrying values resulting in a Level 3 classification.   Fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similarly credit quality resulting in a Level 3 classification.  Impaired loans were valued at the lower of cost or fair value.  The methods utilized at December 31, 2017 to estimate fair value did not necessarily represent an exit price.

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(e) Deposits

The fair values disclosed for demand deposits (e.g., interest and non-interest checking, savings, and certain types of money market accounts) are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amount) resulting in a Level 1 classification. The carrying amounts of variable rate, fixed-term money market accounts approximate their fair values at the reporting date resulting in a Level 1 classification. Fair values for fixed and variable rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of deposit to a schedule of aggregated expected monthly maturities on time deposits resulting in a Level 2 classification.

(f) Other Borrowings

Short-term borrowings, generally, maturing within 90 days, approximate their fair values resulting in a Level 2 classification. The fair values of Home Savings long-term borrowings are estimated using discounted cash flow analyses based on the current borrowing rates for similar types of borrowing arrangements resulting in a Level 2 classification.

(g) Accrued Interest Receivable/Payable

The carrying amounts of accrued interest approximate fair value resulting in a Level 2 or Level 3 classification, depending on the classification of the underlying asset or liability.

(h) Off-balance Sheet Instruments

Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. The fair value of commitments is not material.

 

 

Supplemental disclosures of cash flow information are summarized below.

 

 

 

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The Company has granted stock compensation awards with nonforfeitable dividend rights which are considered participating securities. As such, earnings per share is computed using the two-class method as required by ASC 206-10-45. Basic earnings per common share is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the period which, excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock compensation awards, but also excludes awards considered participating securities. There were zero and 50,000 stock options that were anti-dilutive for the three and nine months ended September 30, 2018, respectively.  There were no stock options that were anti-dilutive for the three and nine months ended September 30, 2017.  

 

 

 

Other comprehensive income (loss) included in the consolidated statements of shareholders’ equity consists of unrealized gains and losses on available for sale securities, accretion of unrealized losses on held to maturity securities and disproportionate tax effects. The change includes reclassification of net gains or (losses) on sales of securities of $0 and $236,000 for the three months ended September 30, 2018 and 2017, respectively, and $233,000 and $566,000 for the nine months ended September 30, 2018 and 2017, respectively.  Reclassifications also includes accretion of unrealized losses on held to maturity securities.    

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Other comprehensive income (loss) components and related tax effects for the three-month periods are as follows:

 

 

 

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Other comprehensive income (loss) components and related tax effects for the nine-month periods are as follows:

 

 

 

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As of June 30, 2014, management concluded it was more likely than not that the Company’s net deferred tax asset (DTA) would be realized and accordingly determined a full deferred tax valuation allowance was no longer required. Upon reversal of the former full deferred tax valuation allowance as of June 30, 2014, certain disproportionate tax effects are retained in accumulated other comprehensive income (loss) totaling approximately a ($16.6) million loss. Almost the entire disproportionate tax effect is attributable to valuation allowance expense recorded through other comprehensive income (loss) on the tax benefit of losses sustained on the available for sale securities portfolio while the Company was in a full deferred tax valuation allowance. This valuation allowance was appropriately reversed through continuing operations at June 30, 2014, leaving the original expense in accumulated other comprehensive income (loss), where it will remain in accordance with the Company’s election of the “portfolio approach”, until such time as the Company would cease to have an available for sale security portfolio.

The following are significant amounts reclassified out of each component of accumulated comprehensive income (loss) for the three months ended September 30, 2018:

 

 

The following are significant amounts reclassified out of each component of accumulated comprehensive income (loss) for the three months ended September 30, 2017:

 

 

The following are significant amounts reclassified out of each component of accumulated comprehensive income (loss) for the nine months ended September 30, 2018:

 

 

The following are significant amounts reclassified out of each component of accumulated comprehensive income (loss) for the nine months ended September 30, 2017:

 

 

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The Company is exposed to certain risk arising from both its business operations and economic conditions.  The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments.  Specifically, the Company enters into derivative financial instruments to manage exposures that arise from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates.  The Company’s derivative financial instruments are used to manage differences in the amount, timing, and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s loan portfolio.  

 

Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers.  The Company executes interest rate swaps with commercial banking customers to facilitate their respective risk management strategies.  Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions.  As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.  

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the Balance Sheet as of September 30, 2018.

 

 

 

The table below presents the effect of the Company’s derivative financial instruments that are not designated as hedging instruments on the Income Statement as of September 30, 2018 and September 30, 2017.

 

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The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company’s derivatives as of September 30, 2018 and December 31, 2017. The net amounts of derivative assets or liabilities can be reconciled to the tabular disclosure of fair value. The tabular disclosure of fair value provides the location that derivative assets and liabilities are presented on the Balance Sheet.

 

 

The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.

As of September 30, 2018, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk, related to these agreements was $25,000. As of September 30, 2018, the Company has minimum collateral posting thresholds with certain of its derivative counterparties and has not posted collateral.

 

Home Savings and United Community are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary actions by regulators that, if undertaken, could have a direct material effect on Home Savings and United Community. The regulations require Home Savings to meet specific capital adequacy guidelines in keeping with the regulatory framework for prompt corrective action that involve quantitative measures of Home Savings’ assets, liabilities, and certain off balance sheet items as calculated under regulatory accounting practices. Home Savings’ capital classification is also subject to qualitative judgments by the regulators about components of capital, risk weightings, and other factors.

The Basel III Capital Rules establish a common equity Tier 1 minimum capital requirement (4.5% of risk-weighted assets), a minimum Tier 1 capital to risk-based assets requirement (6% of risk-weighted assets) and assigns a risk weight (150%) to exposures that are more than 90 days past due or are on nonaccrual status and to certain commercial real estate facilities that finance the acquisition, development or construction of real property. The rules also require unrealized gains and losses on certain available-for-sale securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-in or opt-out is exercised. In connection with the adoption of the Basel III Capital Rules, United Community and Home Savings elected to opt-out of the requirement to include most components of accumulated other comprehensive income in Common Equity Tier 1.  The rule limits a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a “capital conservation buffer” consisting of 2.5% of common equity Tier 1 capital risk-based weighted assets in addition to the amount necessary to meeting its minimum risk-based capital requirements.

The capital conservation buffer requirement will be phased in through January 1, 2019, when the full capital conservation buffer requirement will be effective. The capital conservation buffer for 2018 is 1.875%.  The capital conservation buffer for 2017 was 1.25%.  The final rule also implemented consolidated capital requirements.

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Quantitative measures established by regulation for capital adequacy require Home Savings to maintain minimum ratios of Tier 1 (or Core) capital (as defined in the regulations) to average total assets (as defined) and of total risk-based capital (as defined) to risk-weighted assets (as defined).  United Community and Home Savings’ Common Equity Tier 1 capital consists of common stock and related paid-in capital, net of treasury stock, and retained earnings. Common Equity Tier 1 for both United Community and Home Savings is reduced by intangible assets, net of associated deferred tax liabilities and subject to transition provisions. Actual and regulatory required capital ratios for Home Savings, along with the dollar amount of capital implied by such ratios, are presented below.

 

 

 

 

Management believes that as of September 30, 2018 and December 31, 2017, Home Savings met all capital adequacy requirements to which it was subject.  As of September 30, 2018 and December 31, 2017, Home Savings met the capital requirements to be deemed well capitalized. There are no known conditions that would change this classification subsequent to September 30, 2018.  

 

The components of Home Savings’ regulatory capital are as follows:

 

 

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Actual and regulatory required consolidated capital ratios for United Community, along with the dollar amount of capital implied by such ratios, are presented below.

 

 

 

United Community’s capital also exceeded the “well capitalized” ratios of 6.0% Tier 1 risk-based capital and 10% total risk-based capital required for United Community to engage in activities permissible only for a bank holding company that meets financial holding company requirements.

The components of United Community’s consolidated regulatory capital are as follows:

 

 

 

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Significant components of the deferred tax assets and liabilities are as follows:

 

The Company’s ultimate realization of the net deferred tax asset is dependent upon the generation of future taxable income during the periods in which temporary differences become deductible. Management considers the nature and amount of historical and projected future taxable income, the scheduled reversal of deferred tax assets and liabilities, and available tax planning strategies in making this assessment. The amount of deferred taxes recognized could be impacted by changes to any of these variables.

 

Effective tax rates differ from the statutory federal income tax rate of 21% for 2018 and 35% for 2017 due to the following:

 

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Goodwill:

The change in goodwill during the periods presented is as follows:

 

 

Impairment exists when a reporting unit’s carrying value of goodwill exceeds its fair value.  If the carrying amount of a reporting unit is zero or less than zero, a qualitative analysis of whether it is more likely than not that the reporting unit goodwill is impaired will be performed.  The qualitative assessment indicated that it was more likely than not that the fair value of the reporting unit exceeded its carrying value, resulting in no impairment.  The Company did not have any reporting units with a carrying amount of zero or less than zero at September 30, 2018 or December 31, 2017.

Acquired Intangible Assets:

 

 

On July 1, 2018, HSB Insurance, LLC acquired certain assets of Steinhauser Insurance Agency, which increased the customer list intangible gross carrying amount by $325,000.  Aggregate amortization expense for the three months ended September 30, 2018 and 2017 was $128,000 and $113,000, respectively.  Aggregate amortization expense for the nine months ended September 30, 2018 and 2017 was $373,000 and $308,000, respectively.  Estimated amortization expense for the remainder of 2018 and the next five years is as follows:

 

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The Company invests in qualified affordable housing projects.  At September 30, 2018 and December 31, 2017, the balance of the investment for qualified affordable housing projects was $8.5 million and $5.8 million, respectively.  These balances are reflected in other assets on the consolidated balance sheet.  Total unfunded commitments related to the investments in qualified affordable housing projects totaled $6.7 million and $5.3 million at September 30, 2018 and December 31, 2017, respectively.  The Company expects to fulfill these commitments over the next eight to ten years.

 

During the three months ended September 30, 2018 and 2017, the Company recognized amortization expense of $124,000 and $44,000, respectively, which was included within income tax expense on the consolidated statements of income. During the nine months ended September 30, 2018 and 2017, the Company recognized amortization expense of $367,000 and $134,000, respectively.  

 

Additionally, during the three months ended September 30, 2018 and 2017, the Company recognized tax credits and other benefits from its investment in affordable housing tax credits of $141,000 and $55,000, respectively.  During the nine months ended September 30, 2018 and 2017, the Company recognized tax credits and other benefits from its investment in affordable housing tax credits of $418,000 and $165,000, respectively.  During the three and nine months ended September 30, 2018 and 2017, the Company incurred no impairment losses.

 

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

UNITED COMMUNITY FINANCIAL CORP.

 

 

Notes:

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Forward-Looking Statements

When used in this Form 10-Q or other materials we have filed or may file with the Securities and Exchange Commission, the words or phrases “will likely result,” “are expected to,” “plan to,” “will continue,” “is anticipated,” “estimate,” “project” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties, including changes in economic conditions in United Community’s market area, changes in policies by regulatory agencies, fluctuations in interest rates, demand for loans in Home Savings’ market area and competition that could cause actual results to differ materially from results presently anticipated or projected. United Community cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. United Community advises readers that the factors listed above and Item 1A in our Annual Report on Form 10-K for the year ended December 31, 2017 could affect United Community’s financial performance and could cause United Community’s actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements. United Community undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made.

Material Changes in Financial Condition at September 30, 2018 and December 31, 2017

Cash and cash equivalents increased $7.4 million from December 31, 2017 to September 30, 2018.  The increase was primarily due to additional fed funds sold that were on hand at September 30, 2018 offset by less cash held in the branches.

Available for sale securities decreased $28.5 million during the first nine months of 2018.  The decrease in the available for sale securities balance since December 31, 2017 was mainly the result of pay downs, amortization of premiums/discounts on the securities and sales totaling $10.4 million.  The sales were completed to provide additional liquidity for lending activity.  In addition, the unrealized loss in the available for sale portfolio was $1.1 million at December 31, 2017, compared to a net unrealized loss of $10.3 million at September 30, 2018.  The increase in interest rates during 2018 impacted the change in unrealized losses.  

Held to maturity securities declined $4.2 million to $78.7 million at September 30, 2018 compared to December 31, 2017.  This change was primarily the result of pay downs and the amortization of premiums/discounts on the securities.

Net loans increased $149.1 million to $2.1 billion during the first nine months of 2018 primarily as a result of growth in the commercial loan portfolio.  Commercial loan balances were $931.8 million at September 30, 2018 compared to $822.6 million at December 31, 2017.    Residential one-to four-family mortgage loans increased $29.0 million during the last nine months and consumer loan balances increased $9.6 million for the same period.  See Note 6 to the consolidated financial statements for additional information regarding the composition of loans.

The allowance for loan losses is a valuation allowance for probable incurred credit losses established through a provision for loan losses charged to expense. The allowance for loan losses was $21.3 million at September 30, 2018, up from $21.2 million reported at December 31, 2017.   The increase in the allowance was primarily driven by the increase in loan balances.  The allowance for loan losses as a percentage of loans was 0.98% at September 30, 2018, compared to 1.05% at December 31, 2017.  

The allowance for loan losses as a percentage of nonperforming loans was 235.43% at September 30, 2018, compared to 181.17% at December 31, 2017.  Loan losses are charged against the allowance when the uncollectability of a loan balance is confirmed. Subsequent recoveries, if any, are added back to the allowance. Home Savings’ allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables,” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies”.  As of September 30, 2018, the Company evaluated 25 quarters of net charge-off history and applied this information to the current period.  This component is combined with the qualitative component to arrive at the loss factor, which is applied to the outstanding balance of homogenous loans.

A loan is considered impaired when there is a deterioration of the credit worthiness of the borrower to the extent that the collection of the full amount of principal and interest is no longer probable. The total outstanding balance of all impaired loans, including purchase credit impaired loans, was $23.9 million at September 30, 2018 as compared to $27.4 million at December 31, 2017.

Included in impaired loans above are certain loans Home Savings considers to be troubled debt restructurings (TDR). A loan is considered a TDR if Home Savings grants a concession to a debtor experiencing financial difficulty that it would otherwise not consider. The concession either stems from an agreement between the creditor and the debtor or is imposed by law or a court. If the debtor is not currently experiencing financial difficulties, but would probably be in payment default in the future without the modification, then this type of restructure also could be considered a TDR.

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TDR loans aggregated $17.6 million at September 30, 2018 compared to $19.8 million at December 31, 2017.  Of the $17.6 million at September 30, 2018, $15.6 million were performing loans according to their modified terms.  The remaining balance of TDR loans of $2.0 million were considered nonperforming.

Nonperforming loans consist of nonaccrual loans and loans past due 90 days and still accruing. Nonperforming loans were $9.1 million, or 0.42% of loans, at September 30, 2018, compared to $11.7 million, or 0.59% of loans, at December 31, 2017.

Loans held for sale, carried at lower of cost or market, were $0 at September 30, 2018, compared to $211,000 at December 31, 2017.  Loans held for sale, carried at fair value, were $95.2 million at September 30, 2018, compared to $83.5 million at December 31, 2017.  The change was primarily due to increased volume of construction loans.  These loans are not sold until construction of the residence is complete, which is usually within nine to ten months of origination.  Home Savings continues to sell a majority of its newly originated fixed rate mortgage loans into the secondary market as part of its risk management strategy and anticipates continuing to do so in the future.

Real estate owned and other repossessed assets decreased $346,000 to $907,000 primarily due to sales exceeding acquisitions during the nine months ended September 30, 2018.  Real estate owned and other repossessed assets are recorded at the fair market value of the property less costs to sell. Appraisals are obtained at least annually on real estate properties that exceed $1.0 million in value. A valuation allowance may be established on any property to properly reflect the asset at fair value.  

Bank Owned Life Insurance (BOLI) is maintained on select officers and employees of Home Savings whereby Home Savings is the beneficiary. BOLI is recorded at its cash surrender value, or the amount currently realizable. Increases in the Home Savings’ policy cash surrender value are tax exempt and death benefit proceeds received by Home Savings are tax-free. Income from these policies and changes in the cash surrender value are recorded in other income. There is no post-termination coverage, split dollar or other benefits provided to participants covered by the BOLI.  Home Savings recognized $1.3 million as other non-interest income based on the change in cash value of the policies in the nine months ended September 30, 2018 compared to $1.2 million for the nine months ended September 30, 2017.

Total deposits increased $395.7 million from $2.0 billion at December 31, 2017, to $2.4 billion at September 30, 2018.  The increase in deposits is the result of growth in customer deposits (excluding brokered certificates of deposits) which totaled $136.5 million for the nine months ended September 30, 2018.  Non-interest bearing customer deposits grew $28.6 million during the first nine months of 2018 while interest bearing customer deposits grew $107.9 million.  Growth in money market accounts and certificate of deposit balances drove the majority of the increase in interest bearing deposits.  Brokered deposits grew by $259.3 million for the nine months ended September 30, 2018.  Brokered CD balances were increased to take advantage of favorable pricing relative to FHLB advances.  Proceeds from this increase were used to pay down FHLB advances.        

FHLB advances decreased from $356.5 million at December 31, 2017 to $95.0 million at September 30, 2018.  The change was primarily due to an increase in brokered deposit balances that were used to pay down FHLB advances.

Shareholders’ equity increased $11.8 million to $306.0 million at September 30, 2018 from $294.3 million at December 31, 2017.  The increase is primarily due to the $27.6 million of net income earned during the period offset by dividends paid to shareholders of $9.5 million.  In addition, a negative change in accumulated other comprehensive income of $7.1 million also offset the increase due to earnings.  

Book value per common share as of September 30, 2018 was $6.13 as compared to $5.90 per common share as of December 31, 2017. Book value per share is calculated as total shareholders’ equity divided by the number of common shares outstanding. Tangible book value per share is calculated as total shareholders’ equity less goodwill and other intangible assets divided by the number of common shares outstanding.

Material Changes in Results of Operations for the Three Months Ended

September 30, 2018 and September 30, 2017

Net Income. United Community recognized net income for the three months ended September 30, 2018, of $9.5 million, or $0.19 per diluted common share compared to net income of $7.6 million for the three months ended September 30, 2017, or $0.15 per diluted share.  The continued growth in net interest income from higher earning assets, strong credit metrics, a lower provision for loan loss allowance along with a strong focus on expense control and change in tax law have all contributed to the increase in net income.

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Net Interest Income. Net interest income was $21.6 million in the third quarter of 2018 up from the $20.5 million recorded in the third quarter of 2017.  The growth of interest earning assets drove this increase offset by a 12 basis point decline in the net interest margin.  Net interest margin was 3.33% for the third quarter of 2018 compared to 3.45% in the third quarter of 2017. The net interest margin was positively impacted in the third quarter of 2017 by the recognition of additional purchase accounting accretion related to the acquisition completed in the first quarter of 2017.  The yield on interest earning assets increased 22 basis points year over year driven by an increase in the yield on net loans of 20 basis points.  The yield on loans increased due to increases in market rates and the subsequent repricing of floating and adjustable rate loans.  The yield on securities was down 13 basis points compared to a year ago due to the passage of the Tax Cuts and Jobs Act of 2017 in December 2017 which negatively impacts the yield on tax exempt securities in 2018.  

Interest income increased by $3.6 million in the third quarter of 2018 compared to the same period in 2017, to $27.7 million from $24.0 million. The increase is primarily a result of an increase in average earning assets of $204.3 million along with the increase in the yield on average interest earning assets of 22 basis points.  Average total loans, net increased $230.9 million in the third quarter of 2018 compared to the same period in 2017 while average securities declined $37.7 million during this same period.  Interest income from total loans, net increased to $25.3 million for the quarter ended September 30, 2018 compared to $21.6 million for the same period in 2017.  Income from securities decreased $213,000 for the quarter ended September 30, 2018 compared to the quarter ended September 30, 2017.  

 

Interest expense increased by $2.5 million in the third quarter of 2018 to $6.1 million compared to the same period in 2017. This increase was primarily due to a $126.4 million increase in average interest-bearing liabilities due to growth along with a 43 basis point increase in the cost of interest-bearing liabilities.  The increase in the cost of interest-bearing liabilities was primarily due to increases in market rates.  The cost of average interest-bearing deposits increased 49 basis points to 106 basis points for the three months ended September 30, 2018 from 57 basis points for the three months ended September 30, 2017.  The cost of average borrowed funds increased to 2.39% for the quarter ending September 30, 2018 compared to 1.45% for the quarter ended September 30, 2017.

 

 

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Provision for Loan Losses. A provision for loan losses is charged to income to bring the total allowance for loan losses to a level considered by management to be adequate, based on management’s evaluation of such factors as the delinquency status of loans, current economic conditions, the net realizable value of the underlying collateral, changes in the composition of the loan portfolio and prior loan loss experience. The Company recognized a loan loss provision of $251,000 in the third quarter of 2018, compared to $721,000 in the third quarter of 2017.  The decrease in provision expense in the third quarter of 2018 was primarily driven by improving credit quality.    

Noninterest Income. Non-interest income was $6.1 million in the third quarter of 2018 compared to $6.3 million in the third quarter of 2017.  The majority of the difference between periods was due to a $279,000 change in mortgage banking income.  The decline in mortgage banking income was primarily due to competitive conditions which compressed the Company’s margin in this business unit even as saleable origination volumes were greater.  In addition, during the third quarter of 2017, the Company recognized $236,000 in security gains compared to none in the third quarter of 2018.  Increases in fee income related to agency, brokerage, debit card and trust helped to offset the declines in mortgage banking and security gains.

Noninterest Expense. Non-interest expense increased to $15.8 million during the third quarter of 2018 compared to $15.5 million during the third quarter of 2017.  The increase is primarily due to normal increases in salaries and employee benefits, higher financial institutions tax and legal and consulting fees offset by declines in equipment and data processing and other expenses.

Income Taxes. During the three months ended September 30, 2018, the Company recognized tax expense of $2.2 million on pre-tax income of $11.7 million, compared to tax expense of $3.1 million on pre-tax income of $10.6 million for the three months ended September 30, 2017.  The decline in tax expense was primarily due to the reduction in the Company’s tax rate to 21% from 35% due to the passage of the Tax Cuts and Jobs Act of 2017 on December 22, 2017.  See Note 15 to the consolidated financial statements for additional information regarding the composition of income taxes.

Material Changes in Results of Operations for the Nine Months Ended

September 30, 2018 and September 30, 2017

Net Income. United Community recognized net income for the nine months ended September 30, 2018, of $27.6 million, or $0.55 per diluted common share compared to net income of $17.3 million for the nine months ended September 30, 2017, or $0.35 per diluted share.  The results for the first nine months of 2017 were negatively impacted by the recognition of $5.0 million of merger expense related to the acquisition of OLCB.  The continued growth in net interest income from higher earning assets, reduced loan loss provision along with a strong focus on expense control have all contributed to the increase in net income.

Net Interest Income. Net interest income was $64.5 million in the first nine months of 2018 up from the $59.5 million recorded in the first nine months of 2017.  The growth of interest earning assets drove this increase offset by a 2 basis point decline in the net interest margin.  Net interest margin was 3.38% for the first nine months of 2018 compared to 3.40% for the first nine months of 2017.  The yield on interest earning assets increased 29 basis points year over year driven by an increase in yield on net loans of 26 basis points.  The yield on loans increased due to increases in market rates and the subsequent repricing of floating and adjustable rate loans.  The yield on securities was down 8 basis points compared to a year ago due to the passage of the Tax Cuts and Jobs Act of 2017 in December 2017 negatively impacting the yield on tax exempt securities in 2018.  

Interest income increased by $11.7 million in the first nine months of 2018 compared to the same period in 2017, to $80.4 million from $68.7 million. The increase is primarily a result of an increase in average earning assets of $193.0 million along with an increase in the yield on average interest earning assets of 29 basis points.  Average total loans, net increased $262.1 million in the first nine months compared to the same period in 2017 while average securities declined $66.7 million during this same period.  Interest income from total loans, net increased to $73.2 million for the nine months ended September 30, 2018 compared to $60.7 million for the same period in 2017.  Income from securities decreased to $6.0 million for the nine months ended September 30, 2018 compared to $7.1 million for the nine months ended September 30, 2017.  

 

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Interest expense increased by $6.8 million in the first nine months of 2018 to $16.0 million compared to the same period in 2017. This increase was primarily due to a $117.2 million increase in average interest-bearing liabilities due to growth along with a 41 basis point increase in the cost of interest-bearing liabilities.  The increase in the cost of interest-bearing liabilities was primarily due to increases in market interest rates.  The cost of average interest-bearing deposits increased 40 basis points to 91 basis points for the nine months ended September 30, 2018 from 51 basis points for the nine months ended September 30, 2017.  The cost of average borrowed funds increased to 2.10% for the nine months ending September 30, 2018 compared to 1.22% for the nine months ended September 30, 2017.

 

 

Provision for Loan Losses. A provision for loan losses is charged to income to bring the total allowance for loan losses to a level considered by management to be adequate, based on management’s evaluation of such factors as the delinquency status of loans, current economic conditions, the net realizable value of the underlying collateral, changes in the composition of the loan portfolio and prior loan loss experience. The Company recognized a loan loss provision of $520,000 in the first nine months of 2018, compared to $3.0 million in the first nine months of 2017.  Provision expense in the first nine months of 2017 was primarily driven by net charge-offs totaling $1.6 million while there has only been $390,000 in net charge-offs during the first nine months of 2018.  Improving credit quality continues to drive the low levels of loan loss provision.  

Noninterest Income. Non-interest income was $17.8 million in the first nine months of 2018 compared to $18.8 million in the first nine months of 2017.  The primary driver of the decrease was mortgage banking income which was down $1.2 million year over year.  The decrease was primarily due to margin compression offset by increased saleable volume.

Noninterest Expense. Non-interest expense decreased to $47.9 million during the first nine months of 2018 compared to $50.9 million during the first nine months of 2017.  The decrease is primarily due to $5.0 million in merger expense incurred during the first quarter of 2017.  Offsetting this was an increase in salaries and employee benefits expense of $1.6 million.

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Income Taxes. During the nine months ended September 30, 2018, the Company recognized tax expense of $6.2 million on pre-tax income of $33.8 million, compared to tax expense of $7.0 million on pre-tax income of $24.3 million for the nine months ended September 30, 2017.  The increased pre-tax income discussed above was the primary reason for the increased income tax offset by a reduction in the Company’s tax rate to 21% from 35% due to the passage of the Tax Cuts and Jobs Act of 2017 on December 22, 2017.  See Note 15 to the consolidated financial statements for additional information regarding the composition of income taxes.

Liquidity

United Community's liquidity, primarily represented by cash and cash equivalents, is a result of its operating, investing and financing activities.

The principal source of funds for United Community are deposits, loan repayments, maturities of securities, borrowings from financial institutions, repurchase agreements and other funds provided by operations.  Home Savings also has the ability to borrow from the Federal Home Loan Bank.  While scheduled loan repayments and maturing investments are relatively predictable, deposit flows and early loan prepayments are more influenced by interest rates, general economic conditions and competition.  Investments in liquid assets maintained by United Community and Home Savings are based upon management's assessment of (1) the need for funds, (2) expected deposit flows, (3) yields available on short-term liquid assets, and (4) objectives of the asset and liability management program.  At September 30, 2018, approximately $757.8 million of Home Savings’ certificates of deposit were expected to mature within one year.  Based on past experience and Home Savings’ prevailing pricing strategies, management believes that a substantial percentage of such certificates will be renewed with Home Savings at maturity, although there can be no assurance that this will occur.

Home Savings’ Asset/Liability Committee (ALCO) is responsible for establishing and monitoring liquidity guidelines, policies and procedures.  ALCO uses a variety of methods to monitor the liquidity position of Home Savings including a liquidity analysis that measures potential sources and uses of funds over future time periods out to one year.  ALCO also performs contingency funding analyses to determine Home Savings’ ability to meet potential liquidity needs under stress scenarios that cover varying time horizons ranging from immediate to long-term.

At September 30, 2018, United Community had total on-hand liquidity, defined as cash and cash equivalents, unencumbered securities and additional FHLB borrowing capacity, of $774.5 million.

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UNITED COMMUNITY FINANCIAL CORP.

AVERAGE BALANCE SHEETS

The following table presents the total dollar amounts of interest income and interest expense on the indicated amounts of average interest-earning assets or interest-bearing liabilities, together with the weighted average interest rates for the three months ended September 30, 2018 and 2017. Average balance calculations were based on daily balances.

 

 

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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk.

Qualitative Aspects of Market Risk. The principal market risk affecting United Community is interest rate risk. United Community is subject to interest rate risk to the extent that its interest-earning assets reprice differently than its interest-bearing liabilities. Interest rate risk is defined as the sensitivity of United Community’s earnings and net asset values to changes in interest rates. As part of its efforts to monitor and manage the interest rate risk, the Board of Directors of Home Savings has adopted an interest rate risk policy that requires the Home Savings Board to review quarterly reports related to interest rate risk and to set exposure limits annually for Home Savings as a guide to management in setting and implementing day-to-day operating strategies.

Quantitative Aspects of Market Risk. As part of its interest rate risk analysis, Home Savings uses the net portfolio value (NPV) and net interest income methodology. Generally, NPV is the discounted present value of the difference between incoming cash flows on interest-earning and other assets and outgoing cash flows on interest-bearing and other liabilities. The application of the methodology attempts to quantify interest rate risk as the change in the NPV and net interest income that would result from various levels of theoretical basis point changes in market interest rates.

Home Savings uses an NPV and earnings simulation model prepared internally as its primary method to identify and manage its interest rate risk profile. The model is based on actual cash flows and repricing characteristics for all financial instruments and incorporates market-based assumptions regarding the impact of changing interest rates on future volumes and the prepayment rate of applicable financial instruments. Assumptions based on the historical behavior of deposit rates and balances in relation to changes in interest rates also are incorporated into the model. These assumptions inherently are uncertain and, as a result, the model cannot measure precisely NPV or net interest income or precisely predict the impact of fluctuations in interest rates on net interest rate changes as well as changes in market conditions and management strategies.

Presented below are analyses of Home Savings’ interest rate risk as measured by changes in NPV and net interest income for instantaneous and sustained parallel shifts of 100 basis point increments in market interest rates.  As noted, for the quarter ended September 30, 2018 and the year ended December 31, 2017, the percentage changes fall within the policy limits set by the Board of Directors of Home Savings as the minimum NPV ratio and the maximum change in interest income the Home Savings Board deems advisable in the event of various changes in interest rates. See the table below for Board adopted policy limits.

 

 

 

For the quarter ended September 30, 2018, and year ended December 31, 2017, it was only meaningful to calculate a drop of 100 basis points.  

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As with any method of measuring interest rate risk, certain shortcomings are inherent in the above approach. For example, although certain assets and liabilities may have similar maturities or periods of repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Further, in the event of a change in interest rates, expected rates of prepayment on loans and early withdrawal levels from certificates of deposit may deviate significantly from those assumed in making risk calculations.

Potential Impact of Changes in Interest Rates. Home Savings’ profitability depends to a large extent on its net interest income, which is the difference between interest income from loans and securities and interest expense on deposits and borrowings. Like most financial institutions, Home Savings’ short-term interest income and interest expense are affected significantly by changes in market interest rates and other economic factors beyond its control.

ITEM 4. Controls and Procedures.

 

Evaluation of Disclosure Controls and Procedures

 

As of September 30, 2018, United Community’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of United Community’s disclosure controls and procedures, as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on this evaluation, United Community’s Chief Executive Officer and Chief Financial Officer concluded that United Community’s disclosure controls and procedures as of September 30, 2018 were effective.  

 

Changes in Internal Control over Financial Reporting

 

There were no changes in United Community’s internal control over financial reporting that occurred during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, United Community’s internal control over financial reporting.

 

 

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PART II. OTHER INFORMATION

UNITED COMMUNITY FINANCIAL CORP.

ITEM 1. Legal Proceedings.

United Community and its subsidiaries may, from time-to-time, be parties to litigation arising in the normal course of business. While it is impossible to determine the ultimate resolution of these contingent matters, management believes any resulting liability would not have a material effect upon United Community’s financial statements.

ITEM 1A. Risk Factors.

There have been no material changes in United Community’s risk factors as outlined in United Community’s Annual Report on

Form 10-K for the year ended December 31, 2017.  

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds.

 

 

ITEM 3. Defaults Upon Senior Securities

Not Applicable

ITEM 4. Mine Safety Disclosures

Not Applicable

ITEM 5. Other Information

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ITEM 6. Exhibits.

 

 

 

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UNITED COMMUNITY FINANCIAL CORP.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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