Lake Shore Bancorp(LSBK) - 2019 Q4 - Annual Report

PART I Item 1. Business Lake Shore Bancorp, Inc. operates Lake Shore Savings Bank, focusing on retail deposits and commercial real estate lending in Western New York General Overview Lake Shore Bancorp, Inc. is a mid-tier holding company for Lake Shore Savings Bank, focused on deposits and loans, trading on Nasdaq - Lake Shore Bancorp, Inc. operates as a mid-tier holding company for Lake Shore Savings Bank[21] - A majority of the company's stock (61.4% as of December 31, 2019) is held by Lake Shore, MHC, a federally chartered mutual holding company[21] - The bank's main activities include attracting retail deposits and investing them primarily in commercial real estate loans, one- to four-family residential mortgages, and home equity lines of credit[28] Market Area and Competition The company primarily serves Erie and Chautauqua Counties, Western New York, competing via personalized service and local market knowledge - The primary market area is Erie and Chautauqua Counties in Western New York, including the city of Buffalo[33] - The region has seen economic growth led by the health care and education sectors, creating opportunities for the bank to serve small and middle-market customers[35][36] - Competition is intense from larger banks, credit unions, and online lenders. The company's competitive strategy relies on personalized service, local market knowledge, and community support[40][41] Lending Activities The bank shifted lending focus to commercial real estate and business loans to manage risk and improve yields, growing total loans to $471.5 million Loan Portfolio Composition (at December 31) | Loan Type | 2019 ($ thousands) | 2019 (%) | 2018 ($ thousands) | 2018 (%) | | :--- | :--- | :--- | :--- | :--- | | Commercial Real Estate | $211,220 | 44.8% | $150,475 | 38.3% | | Residential 1-4 Family | $154,749 | 32.8% | $155,024 | 39.5% | | Home Equity | $45,250 | 9.6% | $41,830 | 10.7% | | Commercial Construction | $32,299 | 6.9% | $22,252 | 5.7% | | Commercial Business (C&I) | $26,720 | 5.7% | $21,825 | 5.6% | | Consumer & Other | $1,297 | 0.3% | $1,156 | 0.3% | | Total Loans | $471,535 | 100.0% | $392,562 | 100.0% | Loan Originations (for the Year Ended December 31) | Loan Type | 2019 ($ thousands) | 2018 ($ thousands) | | :--- | :--- | :--- | | Commercial Real Estate | $54,981 | $38,299 | | Commercial Business (C&I) | $41,390 | $29,039 | | Commercial Construction | $30,864 | $11,839 | | Residential 1-4 Family | $21,958 | $29,642 | | Home Equity | $18,723 | $20,778 | | Consumer | $1,241 | $975 | | Total Originations | $169,157 | $130,572 | - The bank has strategically increased its focus on originating commercial real estate and commercial business loans to add adjustable-rate assets, increase yield, and manage interest rate risk[43] - To manage interest rate risk, the bank sells some long-term fixed-rate residential mortgage loans into the secondary market while retaining servicing rights. In 2019, $2.6 million of such loans were sold to FHLMC[56][58] Asset Quality The company maintains high asset quality, with non-performing loans at 0.75% in 2019, despite increased provision for loan losses from loan growth Non-Performing Assets (at December 31) | Metric | 2019 ($ thousands) | 2018 ($ thousands) | | :--- | :--- | :--- | | Non-performing loans | $3,547 | $3,218 | | Foreclosed real estate | $779 | $678 | | Total non-performing assets | $4,326 | $3,896 | | Non-performing loans / total net loans | 0.75% | 0.82% | | Non-performing assets / total assets | 0.71% | 0.71% | Allowance for Loan Losses Activity (Year Ended December 31) | Metric | 2019 ($ thousands) | 2018 ($ thousands) | | :--- | :--- | :--- | | Beginning Balance | $3,448 | $3,283 | | Provision for loan losses | $900 | $390 | | Net charge-offs | ($81) | ($225) | | Ending Balance | $4,267 | $3,448 | | ALL / total net loans | 0.91% | 0.88% | | ALL / non-performing loans | 120.30% | 107.15% | - The provision for loan losses increased by $0.51 million (130.8%) in 2019, mainly due to a $78.3 million increase in net loans and a rise in criticized commercial loans[101] - Total classified and criticized loans increased to $11.1 million in 2019 from $6.9 million in 2018, primarily due to two large commercial loan relationships being classified as 'special mention'[90] Investment Activities and Sources of Funds The company's $71.2 million investment portfolio supports liquidity, with deposits totaling $483.5 million as the primary funding source Securities Available for Sale (at December 31) | Security Type | 2019 Fair Value ($ thousands) | 2018 Fair Value ($ thousands) | | :--- | :--- | :--- | | Municipal bonds | $35,819 | $44,942 | | Mortgage-backed securities | $32,920 | $38,725 | | U.S. Government Agencies | $2,145 | $1,961 | | Asset-backed securities | $250 | $314 | | Equity securities | $67 | $24 | | Total | $71,201 | $86,193 | Deposit Composition (at December 31) | Deposit Type | 2019 ($ thousands) | 2019 (%) | 2018 ($ thousands) | 2018 (%) | | :--- | :--- | :--- | :--- | :--- | | Money market | $141,398 | 29.3% | $119,885 | 27.7% | | Non-interest bearing demand | $61,229 | 12.7% | $55,327 | 12.8% | | Interest bearing demand | $56,703 | 11.7% | $50,211 | 11.6% | | Savings | $53,628 | 11.1% | $52,050 | 12.0% | | Total core deposits | $312,958 | 64.7% | $277,473 | 64.2% | | Time deposits | $170,518 | 35.3% | $154,985 | 35.8% | | Total deposits | $483,476 | 100.0% | $432,458 | 100.0% | - The company owns Bank Owned Life Insurance (BOLI) policies totaling $22.0 million at December 31, 2019, used to offset costs of supplemental employee retirement benefit (SERP) plans[121] Supervision and Regulation The company and its subsidiaries are extensively regulated, consistently meeting capital requirements and maintaining 'well-capitalized' status - Lake Shore Savings Bank is regulated by the OCC, while the holding companies (Lake Shore Bancorp and Lake Shore, MHC) are regulated by the Federal Reserve Board[141] - The bank is subject to Basel III capital rules. To be well-capitalized, it must maintain a CET1 ratio of 6.5%, Tier 1 ratio of 8%, total risk-based capital ratio of 10%, and a leverage ratio of 5%[154][155] - As of December 31, 2019, Lake Shore Savings Bank's capital levels exceeded all applicable minimum requirements, including the fully phased-in 2.5% capital conservation buffer[152][154] - Lake Shore, MHC, as a 'grandfathered' mutual holding company, can waive its right to receive dividends from Lake Shore Bancorp, subject to member and Federal Reserve approval, which it has consistently done[188][189] Item 1A. Risk Factors The company faces economic, operational, interest rate, and regulatory risks, including COVID-19 impacts and limited public shareholder control - Economic/Credit Risk: The loan portfolio has a growing concentration in commercial real estate and business loans (57.6% of total), which carry higher credit risk than residential mortgages. The company's geographic concentration in Western New York makes it vulnerable to local economic downturns[197][198][206] - Operational Risk: The company highlights the significant risk of the COVID-19 pandemic, which could disrupt operations, reduce loan demand, and negatively impact financial results. Other operational risks include cybersecurity threats, reliance on key executives, and competition[209][214][212] - Interest Rate Risk: The company is generally liability-sensitive, meaning its liabilities re-price faster than its assets. A rising interest rate environment could increase funding costs more rapidly than asset yields, negatively impacting earnings[228] - Regulatory & Stock Risk: The ability to pay dividends depends on the bank's performance and the MHC's continued waiver of its dividends, which requires regulatory approval. Public shareholders have limited control as the MHC owns a majority of the voting stock[240][244] Item 1B. Unresolved Staff Comments The company reports no unresolved staff comments from the Securities and Exchange Commission - None[253] Item 2. Properties The company operates from a corporate headquarters and eleven owned branch offices in Western New York, valued at $8.0 million - The company operates through its corporate headquarters and eleven branch offices[254] - At December 31, 2019, the net book value of buildings and premises was $8.0 million, and the net book value of equipment and fixtures was $1.4 million[254] Item 3. Legal Proceedings The company is not involved in any material pending legal proceedings as of December 31, 2019 - The company is not involved in any material pending legal proceedings[257] Item 4. Mine Safety Disclosures This item is not applicable to the company - Not applicable[258] PART II Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities The company's common stock trades on Nasdaq under 'LSBK', maintains quarterly dividends, and actively repurchases shares - The company's common stock trades on the Nasdaq Global Market under the symbol 'LSBK'[260] Stock Repurchases (Q4 2019) | Period | Total Shares Purchased | Average Price Paid per Share | | :--- | :--- | :--- | | October 2019 | 6,500 | $14.95 | | November 2019 | 12,700 | $15.14 | | December 2019 | - | - | | Total | 19,200 | $15.08 | - A new stock repurchase plan was approved on September 6, 2019, allowing for the repurchase of up to 116,239 shares. As of December 31, 2019, 97,039 shares remained available for repurchase under this plan[263] Item 6. Selected Financial Data This section summarizes five years of key financial data, showing asset growth to $610.9 million and net income of $4.1 million in 2019 Selected Financial Highlights (Year Ended December 31) | Metric ($ in thousands, except per share) | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Total Assets | $610,869 | $545,708 | $518,977 | | Loans, net | $470,816 | $392,471 | $365,063 | | Total Deposits | $483,476 | $432,458 | $405,153 | | Total Stockholders' Equity | $82,840 | $79,804 | $78,375 | | Net Interest Income | $19,070 | $17,934 | $16,778 | | Net Income | $4,087 | $4,000 | $3,378 | | Diluted EPS | $0.68 | $0.66 | $0.55 | Selected Performance Ratios (Year Ended December 31) | Ratio | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Return on average assets | 0.71% | 0.75% | 0.67% | | Return on average equity | 4.99% | 5.07% | 4.34% | | Net interest margin | 3.58% | 3.61% | 3.61% | | Efficiency ratio | 73.83% | 75.62% | 73.89% | | Book value per share | $13.98 | $13.29 | $12.85 | Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses financial performance, noting a 2.2% net income increase to $4.1 million in 2019, driven by loan growth and asset expansion Comparison of Financial Condition (2019 vs. 2018) Total assets increased by $65.2 million to $610.9 million in 2019, driven by a 20.0% loan growth and 11.8% deposit increase - Total assets grew 11.9% to $610.9 million at Dec 31, 2019[303] - Net loans receivable increased by $78.3 million, or 20.0%, driven by a $60.7 million (40.4%) increase in commercial real estate loans and a $10.0 million (45.2%) increase in commercial construction loans[305][306] - Total deposits increased by $51.0 million, or 11.8%, with core deposits growing 12.8% and time deposits growing 10.0%[308] Comparison of Results of Operations (2019 vs. 2018 & 2018 vs. 2017) Net income increased 2.2% to $4.1 million in 2019 from net interest income growth; 2018 saw an 18.4% increase to $4.0 million from higher net interest income and lower tax - 2019 vs. 2018: Net income rose 2.2% to $4.1 million. The increase was driven by a 6.3% rise in net interest income, which was largely offset by a 130.8% increase in the provision for loan losses and a 3.2% increase in non-interest expenses[311][312][319][325] - 2018 vs. 2017: Net income rose 18.4% to $4.0 million. This was primarily due to a 6.9% increase in net interest income and a 50.6% decrease in income tax expense resulting from the lower corporate tax rate enacted by the Tax Cuts and Jobs Act[327][328][343] Key Income Statement Changes (2019 vs. 2018) | Item ($ thousands) | 2019 | 2018 | Change (%) | | :--- | :--- | :--- | :--- | | Net Interest Income | $19,070 | $17,934 | +6.3% | | Provision for Loan Losses | $900 | $390 | +130.8% | | Non-Interest Income | $2,492 | $2,474 | +0.7% | | Non-Interest Expense | $15,920 | $15,433 | +3.2% | | Net Income | $4,087 | $4,000 | +2.2% | Item 9A. Controls and Procedures Management concluded the company's disclosure controls and internal control over financial reporting were effective as of December 31, 2019 - The CEO and CFO concluded that the company's disclosure controls and procedures were effective as of the end of the period covered by the report[357] - Management concluded that the company's internal control over financial reporting was effective as of December 31, 2019, based on the COSO framework[360] PART III Items 10-14 (Directors, Compensation, Governance, etc.) Information for Items 10-14 (directors, compensation, governance) is incorporated by reference from the 2020 Proxy Statement - Information for these sections is incorporated by reference from the forthcoming 2020 Proxy Statement[365][366][367][368][369] PART IV Item 15. Exhibits and Financial Statement Schedules This section lists the financial statements and all exhibits filed as part of the Annual Report on Form 10-K - This item lists the financial statements and all exhibits filed with the Annual Report on Form 10-K[371][373] Financial Statements and Notes Consolidated Financial Statements The audited consolidated financial statements for 2019 show total assets of $610.9 million and net income of $4.1 million, with an unqualified opinion Consolidated Statement of Financial Condition (at December 31) | ($ in thousands) | 2019 | 2018 | | :--- | :--- | :--- | | Total Assets | $610,869 | $545,708 | | Loans receivable, net | $470,816 | $392,471 | | Securities available for sale | $71,201 | $86,193 | | Total Liabilities | $528,029 | $465,904 | | Total Deposits | $483,476 | $432,458 | | Total Stockholders' Equity | $82,840 | $79,804 | Consolidated Statement of Income (Year Ended December 31) | ($ in thousands) | 2019 | 2018 | 2017 | | :--- | :--- | :--- | :--- | | Net Interest Income | $19,070 | $17,934 | $16,778 | | Provision for Loan Losses | $900 | $390 | $510 | | Non-Interest Income | $2,492 | $2,474 | $2,655 | | Non-Interest Expenses | $15,920 | $15,433 | $14,360 | | Net Income | $4,087 | $4,000 | $3,378 | Notes to Consolidated Financial Statements The notes detail accounting policies, portfolio composition, loan loss allowance, capital adequacy, and employee benefits, confirming 'well-capitalized' status - The company adopted ASU 2016-02 (Leases) on January 1, 2019, resulting in the recognition of right-of-use assets of $0.904 million and lease liabilities of $0.916 million[445] - The company will adopt the new CECL accounting standard (ASU 2016-13) effective January 1, 2023, which is expected to increase the allowance for loan losses[447][448][449] Bank Regulatory Capital Ratios (at December 31, 2019) | Ratio | Actual | Minimum for Adequacy | To Be Well-Capitalized | | :--- | :--- | :--- | :--- | | Total capital (to risk weighted assets) | 18.02% | 8.00% | 10.00% | | Tier 1 capital (to risk weighted assets) | 17.09% | 6.00% | 8.00% | | CET 1 capital (to risk weighted assets) | 17.09% | 4.50% | 6.50% | | Tier 1 Leverage (to adjusted total assets) | 13.01% | 4.00% | 5.00% | - Subsequent to year-end, on February 5, 2020, the MHC members approved the waiver of dividends for the next twelve months, and the Federal Reserve provided its non-objection on February 28, 2020[602]