Lake Shore Bancorp 10-K 2017
Securities and Exchange Commission
Washington, D.C. 20549
☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File No.: 000-51821
Lake Shore Bancorp, Inc.
(Exact Name of Registrant as Specified in Its Charter)
31 East Fourth Street, Dunkirk, NY 14048
(Address of Principal Executive Offices, including zip code)
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: Common Stock, $0.01 par value per share
Name of each exchange on which registered: The NASDAQ Stock Market, LLC
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes [ ] No [X]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes [ ] No [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X]No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer [ ]Accelerated filer [ ]
Non-accelerated filer [ ] (Do not check if smaller reporting company)Smaller reporting company [X]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The aggregate market value of the voting stock held by non-affiliates of the registrant as of June 30, 2016 was $25,821,799 based on the per share closing price as of June 30, 2016 on the Nasdaq Global Market for the registrant’s common stock, which was $13.03.
There were 6,115,822 shares of the registrant’s common stock, $.01 par value per share, outstanding at March 30, 2017.
DOCUMENTS INCORPORATED BY REFERENCE:
For over 125 years, the Bank has served the local community of Dunkirk, New York. In 1987, we opened our second office in Fredonia, New York. Since 1993, we have expanded to eleven branch offices. In addition, we have added three administrative office buildings which comprise our corporate headquarters in Dunkirk, New York. Our principal business consists of (1) attracting retail deposits from the general public in the areas surrounding our corporate headquarters and main branch office in Dunkirk, New York and ten other branch offices in Chautauqua and Erie Counties, New York and (2) investing those deposits, together with funds generated from operations, primarily in one- to four-family residential mortgage loans, commercial real estate loans, home equity lines of credit and, to a lesser extent, commercial business loans, consumer loans, and investment securities. Our revenues are principally derived from interest generated from our loans and interest earned and dividends received on our investment securities. Our primary sources of funds for lending and investments are deposits, borrowings, receipts of loan principal and interest payments, mortgage-backed and asset-backed securities payments, proceeds from sales, maturities and calls of investment securities and income resulting from operations in prior periods.
Lake Shore Bancorp’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are made available free of charge on our website, www.lakeshoresavings.com, as soon as reasonably practicable after such reports are electronically filed with, or furnished to, the Securities and Exchange Commission. Such reports are also available on the Securities and Exchange Commission’s website at www.sec.gov. Information on our website shall not be considered a part of this Form 10-K.
Furthermore, the Erie County region and the City of Buffalo have recently experienced economic expansion led by major growth in the health care and education sectors, and resurgence in the central business district, which has led to an influx of private investment in development of hotels and housing in the downtown sector. Major construction projects have been recently completed or are currently underway on the waterfront and at the Buffalo Niagara Medical Campus. The Buffalo Niagara Medical Campus has grown significantly with the construction of a new children’s hospital, expansion of an existing cancer/research hospital and construction of a new medical school by the State University of New York at Buffalo. Development on the waterfront has centered around redevelopment of property for mixed use, including public access and private development that includes office space, ice rinks, hotels and restaurants. The economic development within the region also impacts the small business and middle-market customers that we focus on and we believe we will be able to capitalize on opportunities created by economic growth in this section of our market area.
We face intense competition both in making loans and attracting deposits. New York State has a significant number of financial institutions, many of which are branches of large money centers and regional and super regional banks which have resulted from the consolidation of the banking industry in New York and surrounding states. Some of these competitors have greater resources than we do and may offer services that we do not or cannot provide. For example, we do not offer trust or investment services. Customers who seek “one stop shopping” may be drawn to our competitors who offer such services.
Our competition for loans comes principally from commercial banks, savings banks, mortgage banking companies, credit unions, online retail mortgage lenders and other financial service companies. The most direct competition for deposits comes from credit unions, commercial banks and savings banks. We face additional competition for deposits from non-depository competitors such as mutual funds, securities and brokerage firms and insurance companies. We are significantly smaller than many of the financial institution competitors in our market area. Some of our competitors are not subject to the same degree of regulation as that imposed on federal savings banks or federally insured institutions, and these other institutions may be able to price loans and deposits more aggressively. We remain very competitive in Chautauqua County, New York and, as of June 30, 2016 (the latest date such information is available), we had 14.6% of total deposits and ranked 4th out of the 11 banks in this market area, according to the Federal Deposit Insurance Corporation (“FDIC”) annual deposit market share report. Our deposit market share in Erie County, New York has increased since we entered this market area in 2003. We believe the primary factors in competing for deposits and loans is through personalized service, knowledge of local market area and economy, local decision making, technological convenience via mobile banking and active participation and support of the communities we serve.
General. Historically, as a thrift institution, we have primarily originated residential mortgage loans, including home equity loans. In recent years, we have become more focused on originating commercial real estate and commercial business loans, also known as C&I Lending, to add adjustable rate loans to our portfolio, limit interest rate risk and to position ourselves for a rising interest rate environment. At December 31, 2016, we had total gross loans of $326.2 million. We retain the majority of loans that we originate.
However, we have sold residential mortgage loans into the secondary market, with retention of servicing rights, from time to time. Beginning in the fourth quarter of 2014 through the third quarter of 2016, we sold fixed rate, conforming long-term residential mortgage loans with low yields (interest rates below 5% and maturities of 30 years) at the time of origination, with servicing retained, in order to manage interest rate risk and we may do so again in the future, when deemed appropriate. In prior years we have purchased a limited number of equipment loans from a third party broker, which are secured by first liens on equipment purchased by small businesses located throughout the Northeastern United States. We have not purchased these types of loans since the first quarter of 2015.
The interest rates we offer for loans are affected principally by the demand for loans, the supply of money available for lending purposes and the interest rates offered by our competitors. These factors, in turn, are affected by general and local economic conditions and monetary policies of the federal government, including the Federal Reserve Board.
Loan Portfolio. The following table sets forth the composition of our loan portfolio, by type of loan, in dollar amounts and in percentages at the dates indicated. We did not have any loans held for sale as of these dates.
The following table presents our loan originations, purchases, sales, and principal repayments for the years indicated.
(2) During 2016, 2015 and 2014, we sold $3.9 million, $8.3 million and $1.5 million, respectively, of long-term fixed rate residential mortgage loans with low yields to the Federal Home Loan Mortgage Corporation (“FHLMC”) in order to offset long-term interest rate risk.
One- to Four-Family Residential Mortgage Lending. At December 31, 2016, we had one- to four-family residential loans of $149.3 million, or 45.8% of the total loan portfolio. Of one- to four-family residential mortgage loans outstanding on that date, 95.4% were fixed rate loans and 4.6% were adjustable rate loans. At December 31, 2016, approximately 57.9% of our one- to four-family residential mortgage portfolio was secured by property located in Chautauqua County, 35.9% by property located in Erie County and 6.2% by property located elsewhere, primarily in New York State.
Our residential mortgage loan originations are obtained from customers, residents of our local communities or referrals from local real estate agents, brokers, attorneys and builders. Lake Shore Savings historically had retained the majority of residential mortgage loans that it originated. As a result, Lake Shore Savings is exposed to increases in market interest rates, because the yield earned on fixed-rate assets would remain fixed, while the rates paid by Lake Shore Savings for deposits and borrowings may increase, which could result in lower net interest income. In an effort to manage interest rate risk, the Bank sold low yield, long-term fixed rate residential mortgages (primarily yields less than 5% and terms of 30 years) at origination
on the secondary market, with servicing retained, beginning in the fourth quarter of 2014 and continuing through the third quarter of 2016. We may continue this practice in the future if deemed appropriate.
One- to four-family real estate loans can be affected by economic conditions and the value of the underlying collateral. The majority of our one- to four-family residential loans are backed by property located in Western New York and are affected by economic conditions in this market area. Western New York’s housing market has consistently demonstrated stability in home prices despite economic conditions, resulting in stable collateral value and lower risk of loss.
Commercial real estate lending involves additional risks compared with one- to four-family residential lending, because payments on loans secured by commercial real estate properties are often dependent on the successful operation or management of the properties, the borrower’s ability to make repayments from the cash flow of the borrower’s business or rental income and/or the collateral value of the commercial real estate securing the loan, and repayment of such loans may be subject to adverse conditions in the real estate market
or economic conditions to a greater extent than one- to four-family residential mortgage loans. In addition tenancy of the properties needs to be monitored as to lease rates, term of lease and tenant worthiness. Also, commercial real estate loans typically involve larger loan balances to single borrowers or groups of related borrowers, which generally require substantially greater evaluation and oversight efforts. Our loan policies limit the amount of loans to a single borrower or group of borrowers to reduce this risk and are designed to set such limits within those prescribed by applicable federal and state statutes and regulations. We engage a third party to conduct a credit review of the commercial real estate portfolio, including compliance with the Bank’s underwriting standards and policy requirements.
Commercial Loans. In addition to commercial real estate loans, we also engage in commercial business lending primarily to small businesses, including business installment loans, lines of credit, and other commercial loans. At December 31, 2016, commercial business loans totaled $20.4 million, or 6.3% of the total loan portfolio. This amount includes $1.3 million of equipment loans that we have purchased from a third party broker. The average principal amount of a commercial business loan at the time of origination is approximately $131,000 at December 31, 2016. The largest outstanding commercial business loan in our portfolio as of December 31, 2016 was $2.1 million secured by a tax credit receivable. This loan was performing in accordance with its terms on that date. Most of our commercial business loans have fixed interest rates, and are for terms generally not in excess of 5 years. In underwriting commercial business loans, consideration is typically given to the financial condition and the debt service coverage capabilities of the borrower/project, projected cash flows and collateral value. Whenever possible, we collateralize these loans with a first lien on business assets and equipment and require personal guarantees from principals of the borrower. Interest rates on commercial business loans generally have higher yields than rates on one- to four-family residential mortgages. We offer commercial loan services designed to give business owners borrowing opportunities for modernization, inventory, equipment, construction, consolidation, real estate, working capital, vehicle purchases, and the refinancing of existing corporate debt.
Loan Approval Procedures and Authority. Our lending policies are approved by our Board of Directors. During 2016, home equity loans and consumer loans secured by real estate in excess of $25,000 and all one- to four-family residential mortgage loans up to $417,000 require approval by the Internal Residential Loan Committee. If these types of loans are between $417,000 and $1.0 million, then the approval of two individuals, one of which is the following: President and Chief Executive Officer, Chief Financial Officer, Executive Vice President – Commercial Division, Vice President of Banking Operations and Enterprise Risk Management, Vice President - Commercial Portfolio Business Development Officer, along with another member of the Internal Residential Loan Committee is required. If these types of loans are in excess of $1.0 million, then full Board approval is required. For all commercial loans, including commercial real estate loans, certain Vice Presidents and Commercial Lending Officers have authority to approve loans for total one obligor credit up to $100,000. Commercial loans with total one obligor credit in excess of $100,000 and up to $1.0 million require the approval of two members of the Internal Commercial Loan Committee, one of which must be either the: President and Chief Executive Officer or Executive Vice President – Commercial Division. Commercial loans with total one obligor credit in excess of $1.0 million and up to $3.0 million require majority approval by the Board Loan Committee. Commercial loans with total obligor credit in excess of $3.0 million require full Board approval.
Additionally, branch managers are granted authority to approve certain loans, mainly consumer loans, in smaller amounts deemed appropriate by our Board of Directors. Levels of lending authority for consumer loans are established and granted to specific branch managers and loan officers based on position and experience and are reviewed on an annual basis.
Current Lending Procedures. Upon receipt of a completed loan application from a prospective borrower, we order a credit report and verify certain other information. If necessary, we obtain additional financial or credit related information. We require an appraisal for all residential and commercial real estate loans and home equity loans, including loans made to refinance existing mortgage loans. Appraisals are performed by licensed third-party appraisal firms that have been approved by our Board of Directors. An appraisal management firm has been hired to handle all requests for appraisals on residential real estate loans. We require title insurance on all one- to four-family residential and commercial real estate loans and certain other loans. We also require hazard insurance on all real estate loans, and if applicable, we require borrowers to obtain flood insurance prior to closing. Based on loan-to-value ratios and lending guidelines, escrow accounts may be required for such items as real estate taxes, hazard insurance, flood insurance, and private mortgage insurance premiums.
The collection procedures for consumer loans include the sending of periodic late notices and letters to a borrower once a loan is past due. On a monthly basis, a review is made of all consumer loans which are 30 days or more past due. Consumer loans that are 180 days delinquent, where the borrowers have failed to demonstrate repayment ability, are classified as loss and charged-off. Once a charge-off decision has been made, the collections manager or management pursues the use of collection agencies or legal action such as small claims court, judgments, salary garnishment and repossessions in an attempt to collect the deficiency from the borrower.
Real estate acquired as a result of foreclosure is classified as foreclosed real estate until such time as it is sold. We carry foreclosed real estate at its fair value less estimated selling costs at the date of acquisition. If a foreclosure action is commenced and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the property could be sold at the foreclosure sale (to an outside bidder). If not, and we retain the property, then we will sell the real property securing the loan as soon thereafter as practical. Our foreclosed real estate totaled $412,000 at December 31, 2016 and $712,000 at December 31, 2015.
(1)The increase in non-accrual commercial real estate loans from 2015 to 2016 was primarily due to one commercial real estate loan, with a loan balance of $1.0 million, as of December 31, 2016.
Our recorded investment in non-accrual loans totaled $5.7 million at December 31, 2016 and $4.5 million at December 31, 2015. If all non-accrual loans had been current in accordance with their terms during the years ended December 31, 2016, 2015 and 2014, interest income on such loans would have amounted to $366,000, $391,000 and $381,000, respectively.
Classification of Loans. Federal regulations require us to regularly review and classify our loans. In addition, our regulators have the authority to identify problem loans and, if appropriate, require them to be classified. There are three classifications for problem loans: substandard, doubtful and loss. “Substandard loans” have one or more defined weaknesses and are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. A substandard loan would be one inadequately protected by the current net worth and paying capacity of the obligor or pledged collateral, if applicable. “Doubtful loans” have all the weaknesses inherent in substandard loans with the additional characteristic that the weaknesses present make collection or liquidation in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. A loan classified as a “loss” is considered uncollectible and of such little value that its continuance on the books is not warranted. This does not mean that an asset does not have recovery or salvage value, but simply that it is not practical or desirable to defer writing off all or a portion of a worthless asset even though partial recovery may occur in the future. Regulations also provide for a “special mention” category, (i.e. criticized loans) described as loans which do not currently expose us to a sufficient degree of risk to warrant classification but do possess credit deficiencies or potential weaknesses deserving our close attention.
The allowance for loan losses is established through a provision for loan losses based on management evaluation of the losses inherent in the loan portfolio. When we classify loans as either substandard or doubtful, we set aside a loss reserve for such loans as we deem prudent. When we classify problem loans as loss, we typically charge-off the loan balance outstanding against the allowance for loan losses reserve. Our determination as to the classification of our loans and the amount of our loss allowances are subject to review by our regulators, which can require that we establish additional loss allowances. We regularly review our loan portfolio to determine whether any loans require classification in accordance with applicable regulations.
The following table shows the aggregate amounts of our classified and criticized loans at the dates indicated.
The total classified and criticized loans as of December 31, 2016 and 2015 includes $5.9 million and $4.7 million of nonperforming loans, respectively.
Delinquencies. The following table provides information about delinquencies in our loan portfolio at the dates indicated.