SSBP Ssb Bancorp Inc Common Stock (QX)

ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This discussion and analysis reflects our consolidated financial statements and other relevant statistical data and is intended to enhance your understanding of our financial condition and results of operations. The information in this section has been derived from the consolidated financial statements, which appear elsewhere in this annual report. You should read the information in this section in conjunction with the other business and financial information provided in this annual report.

Overview

Our business consists primarily of making loans to real estate investors, businesses and consumers. We also invest in securities, which consist of Federal Home Loan Bank of Pittsburgh stock, mortgage-backed securities issued by U.S. government-sponsored entities, corporate bonds, tax-exempt municipal bonds, and U.S. Treasury notes. We also have a mortgage banking operation that generates one- to four-family residential mortgage loans through three mortgage loan originators and three correspondent mortgage banks. Such residential mortgage loans are originated both for sale in the secondary market and for retention in our portfolio. However, the origination of loans for sale became a larger focus for us at the beginning of 2017. We continue to rely less on correspondent banks for loan originations, focusing instead on self-generated originations.

We offer a variety of deposit accounts, including checking accounts, savings and money market accounts, and time deposits. We also utilize advances from the Federal Home Loan Bank of Pittsburgh for liquidity and for asset/liability management purposes.

We also offer various merchant services to businesses, consisting of multiple credit card processing solutions and other ancillary services such as Internet banking. These services are offered through a third-party partner.

Our results of operations rely heavily on net interest income, which is the difference between interest earned on interest-earning assets and interest expense on interest-bearing liabilities. The results of operations are also affected by non-interest income, non-interest expenses, and the provision for loan losses. Primary sources of non-interest income are gains on the sale of loans, earnings on bank-owned life insurance, and loan servicing fees. Primary non-interest expenses are personnel costs, occupancy, professional fees, federal deposit insurance premiums, and data processing.

Our financial condition and results of operations may also be affected by general and local economic and competitive conditions, changes in market interest rates, governmental policies, and actions of financial regulatory authorities.

Business Strategy

Our business strategy is to use our capital to both serve our community and maintain a profitable community savings bank. Our goals have been to grow our core deposit base, effectively manage our cost of funds, and develop strong business relationships with our customers. Our mortgage banking operations continue to generate gains on loan sales and servicing fee income. We continue to expand our base for non-interest income and have begun marketing our commercial loans as well.

Our current business strategy consists of the following:

Summary of Critical Accounting Policies and Estimates

A summary of our accounting policies is described in Note 1 to the financial statements. Critical accounting estimates are necessary in the application of certain accounting policies and procedures and are particularly susceptible to significant change. Critical accounting policies are defined as those involving significant judgments and assumptions by management that could have a material impact on the carrying value of certain assets or on income under different assumptions or conditions.

The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for qualifying public companies. As an emerging growth company, we may elect to delay adoption of new or revised financial accounting standards until such date that the standards are required to be adopted by non-issuer (private) companies. If such standards would not apply to non-issuer companies, no deferral would be applicable. Such an election is irrevocable during the period that a company is an emerging growth company. We have elected to take advantage of the benefits of extended transition periods. Accordingly, our financial statements may not be comparable to those of public companies that adopt new or revised financial accounting standards as of an earlier date.

Management believes the accounting policies discussed below to be the most critical accounting policies, which involve the most complex or subjective decisions or assessments.

Allowance for Loan Losses. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Loan losses are charged against the allowance when management believes that specific loans, or portions of loans, are uncollectible. The allowance for loan losses is evaluated on a regular basis, and at least quarterly, by management. Management reviews the nature and volume of the loan portfolio, local and national conditions that may adversely affect the borrower’s ability to repay, loss experience, the estimated value of any underlying collateral, and other relevant factors. The evaluation of the allowance for loan losses is characteristically subjective as estimates are required that are subject to continual change as more information becomes available.

The allowance consists of general and specific reserve components. The specific reserves are related to loans that are considered impaired. Loans that are classified as impaired are measured in accordance with applicable accounting guidance. The general reserve is allocated for non-impaired loans and includes evaluation of changes in the trend and volume of delinquency, our internal risk rating process and external conditions that may affect credit quality.

A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled principal and interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status and the financial condition of the borrower. Loans that experience payment shortfalls and insignificant payment delays are typically not considered impaired. Management looks at each loan individually and considers all the circumstances around the shortfall or delay including the borrower’s prior payment history, borrower contact regarding the reason for the delay or shortfall and the amount of the shortfall. Collateral dependent loans are measured against the fair value of the collateral, while other loans are measured by the present value of expected future cash flows discounted at the loan’s effective interest rate.

From time to time, we may choose to restructure the contractual terms of certain loans at the borrower’s request. We review all scenarios to determine the best payment structure with the borrower to improve the likelihood of repayment. Management reviews modified loans to determine if the loan should be classified as a trouble debt restructuring. A trouble debt restructuring is when a creditor, for economic or legal reasons related to a debtor’s financial difficulties, grants a concession to the borrower that it would not otherwise consider. Management considers the borrower’s ability to repay when a request to modify existing loan terms is presented. A transfer of assets to repay the loan balance, a modification of loan terms or a combination of these may occur. If an appropriate arrangement cannot be made, the loan is referred to legal counsel, at which time foreclosure will begin. If a loan is accruing at the time of restructuring, we review the loan to determine if it should be placed on non-accrual. It is our policy to keep a troubled debt restructured loan on non-accrual status for at least six months to ensure the borrower can repay, at that time management may consider its return to accrual status.

Troubled debt restructured loans are considered to be impaired loans.

Income Taxes. We account for income taxes in accordance with accounting guidance (ASC 740, Income Taxes). The income tax accounting guidance results in two components of income tax expense: current and deferred. Current income tax reflects taxes to be paid or refunded for the current period by applying the provisions of the enacted tax law to the taxable income or excess of deductions over revenues. U.S. GAAP requires that we use the Balance Sheet Method to determine the deferred income, which affects the differences between the book and tax bases of assets and liabilities, and any changes in tax rates and laws are recognized in the period of enactment. Deferred taxes are based on a valuation model and the determination on a quarterly basis whether all or a portion of the deferred tax asset will be recognized.

Fair Value Measurements. The fair value of a financial instrument is defined as the amount at which the instrument could be exchanged in a current transaction between willing parties, other than in a forced or liquidation sale. We estimate the fair value of a financial instrument and any related asset impairment using a variety of valuation methods. Where financial instruments are actively traded and have quoted market prices, quoted market prices are used for fair value. When the financial instruments are not actively traded, other observable market inputs, such as quoted prices of securities with similar characteristics, may be used, if available, to determine fair value. When observable market prices do not exist, we estimate fair value. These estimates are subjective in nature and imprecision in estimating these factors can impact the amount of revenue or loss recorded. A more detailed description of the fair values measured at each level of the fair value hierarchy and the methodology we utilize can be found in Note 16 of the financial statements.

Investment Securities. Available for sale and held to maturity securities are reviewed quarterly for possible other-than-temporary impairment. The review includes an analysis of the facts and circumstances of each individual investment such as the severity of loss, the length of time the fair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer and our intent and ability to hold the security to recovery. A decline in value that is considered to be other-than-temporary is recorded as a loss within non-interest income in the statements of net income. At December 31, 2018, we believe the unrealized losses are primarily a result of increases in market yields from the time of purchase. In general, as market yields rise, the fair value of securities will decrease; as market yields fall, the fair value of securities will increase. Management generally views changes in fair value caused by changes in interest rates as temporary; therefore, these securities have not been classified as other-than-temporarily impaired. Management has also concluded that based on current information we expect to continue to receive scheduled interest payments as well as the entire principal balance. Furthermore, management does not intend to sell these securities and does not believe it will be required to sell these securities before they recover in value.

Loan Portfolio

General . Loans are our primary interest-earning asset. At December 31, 2018, net loans represented 84.0% of our total assets.

Loan Portfolio Analysis. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated.

Loan Maturity. The following tables set forth certain information at December 31, 2018 and December 31, 2017 regarding the dollar amount of loan principal repayments becoming due during the periods indicated. The tables do not include any estimate of prepayments that may significantly shorten the average loan life and may cause actual repayment experience to differ from that shown below. Demand loans, which are loans having no stated repayment schedule or no stated maturity, are reported as due in one year or less.

The following tables sets forth the dollar amount of all loans at December 31, 2018 that are due after December 31, 2019 and have either fixed interest rates or floating or adjustable interest rates. The amounts shown below exclude third-party loan and other net origination costs and the discount on loans previously held for sale.

Loan Originations, Purchases and Sales. The following table sets forth our loan origination, purchase and sale activity for the years indicated.

Asset Quality

Credit Risk Management. Management of asset quality is accomplished by internal controls, monitoring and reporting of key risk indicators, and both internal and independent third-party loan reviews. The primary objective of our loan review process is to measure borrower performance and assess risk for the purpose of identifying loan weakness in order to minimize loan loss exposure. From the time of loan origination through final repayment, commercial real estate and commercial business loans are assigned a risk rating based on pre-determined criteria and levels of risk. The risk rating is monitored annually for most loans; however, it may change during the life of the loan as appropriate.

Delinquency Procedures . When a borrower fails to make a required loan payment, we take a number of steps to have the borrower cure the delinquency and restore the loan to current status, including contacting the borrower by letter and phone at regular intervals. When the borrower is in default, we may commence collection proceedings. If a foreclosure action is instituted and the loan is not brought current, paid in full, or refinanced before the foreclosure sale, the real property securing the loan may be sold at foreclosure.

Delinquent Loans. The following tables set forth our loan delinquencies, including non-accrual loans, by type and amount at the dates indicated.

Non-performing Assets. Non-performing assets include loans that are 90 or more days past due or on non-accrual status, including troubled debt restructurings on non-accrual status, and real estate and other loan collateral acquired through foreclosure and repossession. Troubled debt restructurings include loans where management has granted a concession from the original terms to a borrower that is experiencing financial difficulties. Loans 90 days or greater past due may remain on an accrual basis if adequately collateralized and in the process of collection. For non-accrual loans, interest previously accrued but not collected is reversed and charged against income at the time a loan is placed on non-accrual status. Loans generally are returned to accrual status when the borrower has become current and has demonstrated continued ability to service the loan.

Real estate that we acquire as a result of foreclosure or by deed-in-lieu of foreclosure is classified as foreclosed real estate until it is sold. When property is acquired, it is initially recorded at the fair value less costs to sell at the date of foreclosure, establishing a new cost basis. Holding costs and declines in fair value after acquisition of the property result in charges against income.

The following table sets forth information regarding our non-performing assets at the dates indicated.

The cumulative amount of interest income not recognized on non-accrual loans for the years ended December 31, 2018 and December 31, 2017 was $357,000 and $278,000 respectively. For the years ended December 31, 2018 and 2017, interest income was negatively impacted by $79,000 and $55,000, respectively, as a result of nonaccrual loans not performing in accordance with their original terms. Interest income was minimally impacted by accruing troubled debt restructurings for the years ended December 31, 2018 and 2017 with the exception of the recognition of $95,000, related to recoveries of interest from prior periods in 2017.

Potential Problem Loans. Certain loans are identified during our loan review process that are currently performing according to their contractual terms and we expect to receive payment in full of principal and interest, but it is deemed probable that we will be unable to collect all the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. This may result from deteriorating conditions such as cash flows, collateral values or creditworthiness of the borrower. These loans are classified as impaired but are not accounted for on a non-accrual basis.

Other potential problem loans are those loans that are currently performing, but where known information about possible credit problems of the borrowers causes us to have concerns as to the ability of such borrowers to comply with contractual loan repayment terms. At December 31, 2018, there were no other potential problem loans.

Classified Assets. The following table sets forth information regarding our classified assets, as defined under applicable regulatory standards, and our special mention assets at the dates indicated.

Allowance for Loan Losses. The allowance for loan losses is maintained at levels considered adequate by management to provide for probable incurred loan losses inherent in the loan portfolio at the balance sheet reporting dates. The allowance for loan losses is based on management’s assessment of various factors affecting the loan portfolio, including portfolio composition, delinquent and non-accrual loans, national and local business conditions and loss experience and an overall evaluation of the quality of the underlying collateral.

The following table sets forth activity in our allowance for loan losses for the years indicated.

Allocation of Allowance for Loan Losses. The following tables set forth the allowance for loan losses allocated by loan category. The allowance for loan losses allocated to each category is not necessarily indicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories.

See Notes 2 and 7 to the financial statements for a complete discussion of the allowance for loan losses. Although we believe that we use the best information available to establish the allowance for loan losses, future adjustments to the allowance for loan losses may be necessary and our results of operations could be adversely affected if circumstances differ substantially from the assumptions used in making the determinations. Furthermore, while we believe we have established our allowance for loan losses in conformity with U.S. GAAP, there can be no assurance that regulators, in reviewing our loan portfolio, will not require us to increase our allowance for loan losses. In addition, because future events affecting borrowers and collateral cannot be predicted with certainty, there can be no assurance that the existing allowance for loan losses is adequate or that increases will not be necessary should the quality of any loans deteriorate as a result of the factors discussed above. Any material increase in the allowance for loan losses may adversely affect our financial condition and results of operations.

At December 31, 2018 and 2017, we had no investments in a single issuer (other than securities issued by the U.S. government and government agency), which had an aggregate book value in excess of 10% of our stockholders’ equity.

Securities Portfolio Maturities and Yields . The following table sets forth the stated maturities and weighted average yields of investment securities at December 31, 2018 and 2017. Weighted-average yields on tax-exempt securities are not presented on a tax equivalent basis. Certain mortgage-backed securities have adjustable interest rates and will reprice annually within the various maturity ranges. These repricing schedules are not reflected in the table below. Weighted average yield calculations on investment securities available for sale do not give effect to changes in fair value that are reflected as a component of equity.

Each reporting period, we evaluate all securities with a decline in fair value below the amortized cost of the investment to determine whether or not the impairment is deemed to be other-than-temporary. Other-than-temporary impairment (“OTTI”) is required to be recognized if (1) we intend to sell the security; (2) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis; or (3) for debt securities, the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. For impaired debt securities that we intend to sell, or more likely than not will be required to sell, the full amount of the depreciation is recognized as OTTI, resulting in a realized loss that is a charged to earnings through a reduction in our non-interest income. For all other impaired debt securities, credit-related OTTI is recognized through earnings and non-credit related OTTI is recognized in other comprehensive income/loss, net of applicable taxes. We did not recognize any OTTI during the years ended December 31, 2018 and 2017.

Deposits

Deposits continue to be our primary source of funds for our lending and investment activities. The majority of our deposits are from depositors who reside in our primary market area. Deposits are attracted through the offering of a broad selection of deposit instruments for both individuals and businesses. The following table sets forth the distribution of total deposits by account type at the dates indicated.

The following tables indicate the amount of jumbo certificates of deposit by time remaining until maturity at December 31, 2018 and 2017. Jumbo certificates of deposit require minimum deposits of $100,000.

The following tables set forth time deposit accounts classified by rate and maturity at December 31, 2018 and December 31, 2017.

Borrowings

We use advances from the Federal Home Loan Bank of Pittsburgh to supplement our investable funds. At December 31, 2018, we had $91.9 million of available borrowing capacity with the Federal Home Loan Bank of Pittsburgh and $31.4 million in advances outstanding. The following table sets forth information concerning our borrowings at the dates and for the years indicated.

Comparison of Financial Condition at December 31, 2018 and December 31, 2017

Total Assets. Total assets were $188.8 million as of December 31, 2018, an increase of $16.9 million, or 9.8% when compared to total assets of $172.0 million at December 31, 2017. The increase was due primarily to a $6.5 million increase in securities available for sale and an $18.0 million increase in loans - primarily commercial mortgages and commercial and industrial loans. The Bank borrowed an additional $5.0 million and added $3.7 million in deposits to fund the increase in assets.

Cash and Cash Equivalents. Cash and cash equivalents decreased $7.4 million, or 45.2%, to $9.0 million at December 31, 2018 from $16.5 million at December 31, 2017. The reduction in cash was due to the withdrawal of stock subscription funds held on account at SSB Bank for the purpose of purchasing SSB Bancorp, Inc. common stock in the Reorganization.

Net Loans. Net loans increased $18.0 million, or 12.8%, to $158.5 million at December 31, 2018 from $140.6 million at December 31, 2017. The change is primarily due to an increase in commercial real estate of $9.4 million, or 18.7%, to $59.5 million at December 31, 2018 from $50.1 million at December 31, 2017. Commercial and industrial loans increased $7.7 million, or 67.3%, to $19.2 million at December 31, 2018 from $11.5 million at December 31, 2017. One-to-four family mortgages remained relatively flat year over year. Consumer loans increased $1.4 million, or 34.6%, to $5.4 million at December 31, 2018 from $4.0 million at December 31, 2017.

During the year, the volumes in originations were as follows: $18.6 million in one- to four-family mortgages, an increase of $1.3 million over the $17.3 million originated in 2017; $12.0 million in commercial mortgages, a decrease of $12.8 million from the $24.8 originated in 2017; $9.0 million in construction loans, an increase of $2.6 million over the $6.4 million originated in 2017. Originations of commercial and industrial, and consumer loans increased $7.9 million as compared to the prior year.

Loans purchased during 2018 were $3.9 million in one-to-four family, a decrease of $2.8 million or 41.5% as compared to 2017; there were no commercial mortgages purchased in 2018 or 2017. Construction loans purchased were $1.9 million, a decrease of $3.6 million or 65.3% as compared to 2017. This decrease is due to our strategy to originate more loans as opposed to purchasing loans.

$12.6 million in loans that were reported as held for sale at December 31, 2016 were transferred to loans held for investment in 2017. SSB sold loans in the amount of $9.7 million, a decrease of $11.8 million or 55.0% as compared to $21.5 million in 2017. Most of the difference is due to a $6.9 million pool of seasoned loans sold in 2017.

The largest increase in our loan portfolio commercial and industrial loan portfolio. This growth reflects our strategy to invest in higher yielding adjustable rate loans to improve net margins and manage interest rate risk. We continue to sell selected, conforming 15-year and 30-year fixed rate mortgage loans to the Federal Home Loan Bank of Pittsburgh on a servicing retained basis through its mortgage purchase program.

Loans Held for Sale. There were no loans held for sale at December 31, 2018 or 2017. The loans that were held-for-sale at year end 2016 totaled $19.9 million. In June 2017, $6.9 million of one – to – four family mortgages were sold and the remaining held for sale portfolio was reclassified to held for investment. The decision to reclassify the loans as being held for investment was made as there was less demand for one-to-four family and commercial mortgage loans on the secondary market.

Available for Sale Securities. Available for sale securities decreased by approximately $6.5 million, or 246.6%, to $9.1 million at December 31, 2018 from $2.6 million at December 31, 2017. The increase is due to management efforts to increase liquidity through the purchase of available for sale securities. The increases were mostly due to a $3.3 million increase in mortgage-backed securities in government-sponsored entities and a $3.2 million increase in corporate bonds. There were slight decreases in obligations of state and political subdivisions and U.S. treasuries.

Deposits. Deposits increased $3.7 million, or 2.8%, to $136.1 million at December 31, 2018 from $132.4 million at December 31, 2017. Core deposits decreased $7.7 million, or 15.3%, to $43.0 million at December 31, 2018 from $50.7 million at December 31, 2017. The primary reason for the decrease was loss $10.1 million in Business Demand Deposits for the purpose of buying stock of SSB Bancorp in the offering completed in January 2018. Time deposits increased $11.4 million, or 14.0%, to $93.1 million at December 31, 2018 from $81.7 million at December 31, 2017. The increase in time deposits was primarily due to an increase in deposits obtained through brokers and listing services in order to fund the increase in loans and investments.

Stockholders’ Equity. Stockholders’ equity increased $8.2 or 67.8% to $20.3 million at December 31, 2018 from $12.1 million at December 31, 2017. The majority is due to $8.7 million in paid-in capital that was received as a result of the Reorganization completed in January 2018. Consolidated net Income was $380,000 for the year 2018, increasing retained earnings by 3.1%. This was partially offset by other comprehensive loss of $51,000 related to net changes in unrealized gains/losses in the available-for-sale securities portfolio as well as $837,000 in unearned employee stock ownership plan that did not exist at December 31, 2017.

Comparison of Results of Operations for the Years Ended December 31, 2018 and 2017

Net Income. Net income decreased $209,000, or 35.4%, to $380,000 for the year ended December 31, 2018 from $589,000 for the year ended December 31, 2017. This increase was due to a $971,000 increase, or 32.2%, in noninterest expense to $4.0 million for the year ended December 31, 2018 from $3.0 million for the year ended December 31, 2017. Noninterest income dropped by $67,000, or 12.7%, to $460,000 for the year ended December 31, 2018, from $527,000 for the year ended December 31, 2017. Offsetting these effects was an increase in net interest income of $211,000, or 5.4%, to $4.1 million for the year ended December 31, 2018, from $3.9 million for the year ended December 31, 2017.

Interest and Dividend Income. Interest and dividend income increased $795,000, or 12.8%, to $7.0 million for the year ended December 31, 2018 from $6.2 million for the year ended December 31, 2017. This increase was due to an increase of $624,000, or 10.4%, in interest on loans to $6.6 million for the year ended December 31, 2018, from $6.0 million for the year ended December 31, 2017. The increased interest is due to a $15.6 million increase in average total loans for the year ended December 31, 2018. Also, the weighted average yield on the loan portfolio was 4.41% for the year ended December 31, 2018 compared to 4.39% for the year ended December 31, 2017. Aside from loan growth, there was a $37,000 increase in income from interest-bearing deposits to $83,000 for the year ended December 31, 2018 from $46,000 for the year ended December 31, 2017. There was also a $143,000 increase in income from investment securities to $286,000 for the year ended December 31, 2018 from $144,000 for the year ended December 31, 2017. The increase in income from investment securities is due to the increase in the average investment securities of $1.9 million to $4.9 million for the year ended December 31, 2018, from $3.0 million for the year ended December 31, 2017. The average yield of the portfolio also increased to 2.82% for the year ended December 31, 2018, from 2.14% for the year ended December 31, 2017. These increases were slightly offset by a decrease in income from certificates of deposit of $8,000 to $15,000 for the year ended December 31, 2018 from $23,000 for the year ended December 31, 2017.

Average interest-earning assets increased $19.4 million, from $146.0 million for the year ended December 31, 2017 to $165.3 million for the year ended December 31, 2018, while the yield on the interest earning-assets increased 5 basis points, from 4.20% to 4.25% when comparing the two periods.

Interest Expense. Total interest expense increased $583,000, or 25.2%, to $2.9 million for the year ended December 31, 2018 from $2.3 million for the year ended December 31, 2017. Interest expense on deposit accounts increased $427,000, or 24.1%, to $2.2 million for the year ended December 31, 2018 from $1.8 million for the year ended December 31, 2017. The increase was primarily due to an increase in the average balance of interest-bearing deposits from $115.4 million for the year ended December 31, 2017 to $119.8 million for the year ended December 31, 2018; an increase of $4.4 million or 3.8%. This was accompanied by a 30 basis point increase in the weighted average cost from 1.54% to 1.84%. There was a reclassification of a business checking account type from interest-bearing demand accounts to noninterest-bearing demand accounts. At year end, the amount reclassed from interest-bearing demand to noninterest-bearing demand totaled $8.7 million.

Interest expense on Federal Home Loan Bank advances increased $156,000, or 28.7%, to $700,000 for the year ended December 31, 2018 from $544,000 for the year ended December 31, 2017. The average balance increased from $25.5 million to $28.4 million when comparing the two periods. The increase in the average balance of advances is due to management utilizing advances as a funding source for loan originations and investment purchases. The cost of the advances also increased by 34 basis points from 2.13% for the year ended December 31, 2017, to 2.47% for the year ended December 31, 2018.

Net Interest Income. Net interest income increased $211,000, or 5.4%, to $4.1 million for the year ended December 31, 2018 from $3.9 million for the year ended December 31, 2017. This increase was due to an increase in our average net loans of $15.6 million to $150.4 million for the year ended December 31, 2018, from $134.8 million for year ended December 31, 2017. Average interest earning assets increased by $19.4 million when comparing the two periods, while average interest-bearing liabilities increased by only $7.2 million ($12.4 million without the reclassification noted above) over the same two periods. Offsetting this increase, the yield of interest earning assets increased by 5 basis points when comparing the two periods, while the cost of interest-bearing liabilities increased by 32 basis points over the two periods.

Provision for Loan Losses. Based on management’s analysis of the allowance for loan losses, we recorded a provision for loan losses of $150,000 for the year ended December 31, 2018 compared to a provision of $247,000 for the year ended December 31, 2017. The decrease in the provision for the year ended December 31, 2018 was primarily due to changes in FAS 5 qualitative factors used when calculating the allowance for loan losses.

Non-Interest Income. Non-interest income decreased $67,000 to $460,000 for the year ended December 31, 2018 compared to $527,000 for the year ended December 31, 2017. Gains on the sale of loans decreased by $165,000 to $182,000 for the year ended December 31, 2018 from $348,000 for the year ended December 31, 2017. Offsetting this decrease was an increase in loan servicing fees of $47,000, or 48.4%, to $143,000 for the year ended December 31, 2018 from $97,000 for the year ended December 31, 2017, reflecting sales of loans with servicing rights retained. Earnings on bank-owned life insurance increased by $19,000 and other noninterest income increased by $34,000 further offsetting the decrease in gain on sale of loans.

Non-Interest Expense. Non-interest expense increased $970,000, or 32.2%, to $4.0 million for the year ended December 31, 2018 from $3.0 for the year ended December 31, 2017. The increase was due primarily to a $341,000 or 94.9% increase in professional fees, a $281,000 or 19.3% increase in salary and employee benefits, a 114,000 or 43.6% increase in occupancy, a $53,000 or 60.1% increase in director fees, a $51,000 or 18.0% increase in data processing a $31,000 or 24.5% increase in federal deposit insurance, a $15,000 or 27.5% increase contributions and donations, and an $85,000 increase in other noninterest expenses. Noninterest expense has been driven up by additional costs associated with the growth of the institution.

Income Taxes. The income tax provision decreased by $521,000, or 89.2%, to $63,000 for the year ended December 31, 2018 from $584,000 for the year ended December 31, 2017. The effective tax rate was 14.2% for the year ended December 31, 2018 and 49.8% for the year ended December 31, 2017. The decrease in tax expense was primarily due to the Tax Cuts and Jobs Act which caused us to write down our net deferred tax asset by $203,000 as of the enactment date of December 22, 2017, as well as lowered the federal corporate tax rate in 2018. Additionally, the decrease in net income for the year ended December 31, 2018, when compared to the year ended December 31, 2017, contributed to the decrease in income taxes.

Revision of Prior Period Financial Statements

During the 4th quarter of 2018, the Company identified and corrected an error related to its accounting treatment of accrued interest on investor sold loans and loan participations affecting 2 ^nd and 3 ^rd quarters of 2018. Prior period accrued interest receivable accounts were overstated at June 30, 2018, and September 30, 2018, by $140,000 and $335,000, respectively. The Company was able to identify the sources of the issues and it resulted in the Company correcting interest income and provision for income taxes for the 2 ^nd and 3 ^rd quarters of 2018. On the corresponding balance sheet, the Company’s accrued interest receivable and income taxes receivable was understated. The net effect was an overstatement of total assets and total liabilities and stockholders’ equity at June 30, 2018 and September 30, 2018.

The Company has evaluated the effects of this error and concluded that they are immaterial to the two quarters affected. Since the errors happened in the 2nd and 3rd quarters of 2018, the Company has revised its financial statements as of and for the six months and three months ended June 30, 2018 and as of and for the nine months and three months ended September 30, 2018. The tables below show the originally reported and revised income and balance sheet information.

Average Balance Sheet

The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting annualized average yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented. Average balances have been calculated using daily balances. Nonaccrual loans are included in average balances only. Loan fees are included in interest income on loans and are not material. Yields on tax exempt investment securities are not presented on a tax equivalent basis. Any adjustments necessary to present such yields on a tax equivalent basis are insignificant.

Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on net interest income. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. Changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionally based on the changes due to rate and the changes due to volume. Changes exclude recoveries of loan interest amounts that relate to prior periods.