lsbk 20180930 10Q

PART I Financial Information

Item 1. Financial Statements

Lake Shore Bancorp, Inc. and Subsidiary


Consolidated Statements of Financial Condition

	September 30,		December 31,
	2018		2017
	(Unaudited)
	(Dollars in thousands, except share data)

Assets
Cash and due from banks	$	7,792	$	7,709
Interest earning deposits		2,459		6,570
Federal funds sold		27,818		26,634
Cash and Cash Equivalents		38,069		40,913
Securities available for sale		83,147		80,421
Federal Home Loan Bank stock, at cost		1,545		1,631
Loans receivable, net of allowance for loan losses 2018 $3,388; 2017 $3,283		388,437		365,063
Premises and equipment, net		9,383		9,373
Accrued interest receivable		2,044		1,801
Bank owned life insurance		20,100		18,077
Other assets		3,428		1,698
Total Assets	$	546,153	$	518,977
Liabilities and Stockholders' Equity
Liabilities
Deposits:
Interest bearing	$	376,892	$	350,535
Non-interest bearing		59,009		54,618
Total Deposits		435,901		405,153
Long-term debt		24,650		26,950
Advances from borrowers for taxes and insurance		1,625		3,000
Other liabilities		5,176		5,499
Total Liabilities	$	467,352	$	440,602
Stockholders' Equity
Common stock, $0.01 par value per share, 25,000,000 shares authorized; 6,827,741 shares issued and 6,046,819 shares outstanding at September 30, 2018 and 6,827,741 shares issued and 6,098,323 shares outstanding at December 31, 2017	$	68	$	68
Additional paid-in capital		30,870		30,719
Treasury stock, at cost (780,922 shares at September 30, 2018 and 729,418 shares at December 31, 2017)		(8,137)		(7,309)
Unearned shares held by ESOP		(1,471)		(1,535)
Unearned shares held by compensation plans		(273)		(540)
Retained earnings		58,339		56,181
Accumulated other comprehensive (loss) income		(595)		791
Total Stockholders' Equity		78,801		78,375
Total Liabilities and Stockholders' Equity	$	546,153	$	518,977

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary


Consolidated Statements of Income
		Three Months Ended September 30,				Nine Months Ended September 30,
		2018			2017	2018		2017
	(Unaudited)
	(Dollars in thousands, except per share data)
Interest Income
Loans, including fees		$	4,663	$	4,289	$	13,480	$	12,456
Investment securities, taxable			267		189		753		597
Investment securities, tax-exempt			403		388		1,193		1,259
Other			157		81		439		167
Total Interest Income			5,490		4,947		15,865		14,479
Interest Expense
Deposits			783		523		2,101		1,499
Long-term debt			134		139		413		328
Other			38		20		77		62
Total Interest Expense			955		682		2,591		1,889
Net Interest Income			4,535		4,265		13,274		12,590
Provision for Loan Losses			125		75		315		450
Net Interest Income after Provision for Loan Losses			4,410		4,190		12,959		12,140
Non-Interest Income
Service charges and fees			457		441		1,371		1,353
Earnings on bank owned life insurance			103		91		273		268
Unrealized (loss) gain on equity securities			(5)		-		9		-
Recovery on previously impaired investment securities			34		25		124		96
Gain on sale of securities available for sale			-		22		-		244
Net gain on sale of loans			4		1		10		10
Other			36		37		89		83
Total Non-Interest Income			629		617		1,876		2,054
Non-Interest Expenses
Salaries and employee benefits			2,083		1,898		6,182		5,610
Occupancy and equipment			587		565		1,735		1,740
Data processing			337		320		1,000		937
Professional services			237		231		716		703
Advertising			151		127		473		439
Postage and supplies			71		53		189		197
FDIC Insurance			40		38		114		111
Other			331		381		968		955
Total Non-Interest Expenses			3,837		3,613		11,377		10,692
Income before Income Taxes			1,202		1,194		3,458		3,502
Income Tax Expense			144		254		458		704
Net Income		$	1,058	$	940	$	3,000	$	2,798
Basic and diluted earnings per common share		$	0.17	$	0.15	$	0.49	$	0.46
Dividends declared per share		$	0.10	$	0.08	$	0.30	$	0.24

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Consolidated Statements of Comprehensive Income


	Three Months Ended September 30,
	2018		2017
	(Unaudited)
	(Dollars in thousands)
Net Income	$	1,058		940
Other Comprehensive Loss, net of tax benefit:
Unrealized holding losses on securities available for sale, net of tax benefit		(467)		(60)
Reclassification adjustments related to:
Recovery on previously impaired investment securities included in net income, net of tax expense		(27)		(16)
Net gain on sale of securities included in net income, net of tax expense		-		(15)
Total Other Comprehensive Loss		(494)		(91)
Total Comprehensive Income	$	564	$	849


	Nine Months Ended September 30,
	2018		2017
	(Unaudited)
	(Dollars in thousands)
Net Income	$	3,000	$	2,798
Other Comprehensive Loss, net of tax benefit:
Unrealized holding losses on securities available for sale, net of tax benefit		(1,444)		(34)
Reclassification adjustments related to:
Recovery on previously impaired investment securities included in net income, net of tax expense		(98)		(63)
Net gain on sale of securities included in net income, net of tax expense		-		(161)
Total Other Comprehensive Loss		(1,542)		(258)
Total Comprehensive Income	$	1,458	$	2,540

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Consolidated Statements of Stockholders’ Equity

Nine Months Ended September 30, 2018 and 2017 (Unaudited)


							Unearned		Unearned Shares				Accumulated
			Additional				Shares		Held by				Other
	Common		Paid-In		Treasury		Held by		Compensation		Retained		Comprehensive
	Stock		Capital		Stock		ESOP		Plans		Earnings		Income (Loss)		Total
	(Dollars in thousands, except share and per share data)
Balance - January 1, 2017	$	68	$	30,532	$	(7,300)	$	(1,620)	$	(578)	$	53,546	$	1,382	$	76,030
Net income		-		-		-		-		-		2,798		-		2,798
Other comprehensive loss, net of tax benefit of $133		-		-		-		-		-		-		(258)		(258)
ESOP shares earned (5,951 shares)		-		30		-		64		-		-		-		94
Stock based compensation		-		33		-		-		-		-		-		33
Compensation plan shares granted (27,348 shares)		-		-		270		-		(270)		-		-		-
Compensation plan shares forfeited (1,104 shares)		-		-		(10)		-		10		-		-		-
Compensation plan shares earned (20,569 shares)		-		72		-		-		220		-		-		292
Purchase of treasury stock, at cost (17,100 shares)		-		-		(269)		-		-		-		-		(269)
Cash dividends declared ($0.24 per share)		-		-		-		-		-		(559)		-		(559)
Balance - September 30, 2017	$	68	$	30,667	$	(7,309)	$	(1,556)	$	(618)	$	55,785	$	1,124	$	78,161

Balance - January 1, 2018	$	68	$	30,719	$	(7,309)	$	(1,535)	$	(540)	$	56,181	$	791	$	78,375
Net income		-		-		-		-		-		3,000		-		3,000
Other comprehensive loss, net of tax benefit of $410		-		-		-		-		-		-		(1,542)		(1,542)
Reclassification of the Income Tax Effects of the Tax Cuts and Jobs Act from AOCI		-		-		-		-		-		(156)		156		-
ESOP shares earned (5,951 shares)		-		36		-		64		-		-		-		100
Stock based compensation		-		33		-		-		-		-		-		33
Compensation plan shares granted (5,329 shares)		-		-		51		-		(51)		-		-		-
Compensation plan shares forfeited (10,433 shares)		-		-		(99)		-		93		-		-		(6)
Compensation plan shares earned (21,366 shares)		-		82		-		-		225		-		-		307
Purchase of treasury stock, at cost (46,400 shares)		-		-		(780)		-		-		-		-		(780)
Cash dividends declared ($0.30 per share)		-		-		-		-		-		(686)		-		(686)
Balance - September 30, 2018	$	68	$	30,870	$	(8,137)	$	(1,471)	$	(273)	$	58,339	$	(595)	$	78,801

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Consolidated Statements of Cash Flows


	Nine Months Ended September 30,
	2018		2017
	(Unaudited)
	(Dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income	$	3,000	$	2,798
Adjustments to reconcile net income to net cash provided by operating activities:
Net amortization of investment securities		66		88
Net amortization of deferred loan costs		423		425
Provision for loan losses		315		450
Recovery on previously impaired investment securities		(124)		(96)
Unrealized gain on equity securities		(9)		-
Gain on sale of investment securities		-		(244)
Originations of loans held for sale		(777)		(796)
Proceeds from sales of loans held for sale		787		806
Gain on sale of loans		(10)		(10)
Depreciation and amortization		579		648
Increase in bank owned life insurance, net		(273)		(268)
ESOP shares committed to be released		100		94
Stock based compensation expense		334		325
Increase in accrued interest receivable		(243)		(234)
(Increase) decrease in other assets		(6)		161
Decrease in other liabilities		(323)		(99)
Net Cash Provided by Operating Activities		3,839		4,048
CASH FLOWS FROM INVESTING ACTIVITIES
Activity in available for sale securities:
Sales		-		6,510
Maturities, prepayments and calls		6,215		8,980
Purchases		(10,826)		(2,402)
Purchases of Federal Home Loan Bank Stock		(20)		(375)
Redemptions of Federal Home Loan Bank Stock		106		84
Loan origination and principal collections, net		(25,426)		(37,384)
Additions to premises and equipment		(589)		(1,294)
Purchase of bank owned life insurance		(1,750)		-
Net Cash Used in Investing Activities		(32,290)		(25,881)
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposits		30,748		15,030
Net decrease in advances from borrowers for taxes and insurance		(1,375)		(1,475)
Proceeds from issuance of long-term debt		1,500		9,700
Repayment of long-term debt		(3,800)		(1,700)
Purchase of treasury stock		(780)		(269)
Cash dividends paid		(686)		(559)
Net Cash Provided by Financing Activities		25,607		20,727
Net Decrease in Cash and Cash Equivalents		(2,844)		(1,106)
CASH AND CASH EQUIVALENTS - BEGINNING		40,913		45,479
CASH AND CASH EQUIVALENTS - ENDING	$	38,069	$	44,373
SUPPLEMENTARY CASH FLOWS INFORMATION
Interest paid	$	2,564	$	1,869
Income taxes paid	$	477	$	750

SUPPLEMENTARY SCHEDULE OF NONCASH INVESTING ACTIVITIES
Foreclosed real estate acquired in settlement of loans	$	1,495	$	554

See notes to consolidated financial statements.

Lake Shore Bancorp, Inc. and Subsidiary

Notes to Consolidated Financial Statements (Unaudited)

Note 1 – Basis of Presentation

The interim consolidated financial statements include the accounts of Lake Shore Bancorp, Inc. (the “Company”, “us”, “our”, or “we”) and Lake Shore Savings Bank (the “Bank”), its wholly owned subsidiary. All intercompany accounts and transactions of the consolidated subsidiary have been eliminated in consolidation.

The interim consolidated financial statements included herein as of September 30, 2018 and for the three and nine months ended September 30, 2018 and 2017 have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission, and therefore, do not include all information or footnotes necessary for a complete presentation of the consolidated statements of financial condition, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). The consolidated statement of financial condition at December 31, 2017 has been derived from the audited consolidated financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete consolidated financial statements. The consolidated financial statements reflect all adjustments that are, in the opinion of management, necessary for a fair statement of such information and to make the financial statements not misleading. These interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the audited consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. The consolidated statements of income for the three and nine months ended September 30, 2018 are not necessarily indicative of the results for any subsequent period or the entire year ending December 31, 2018.

To prepare these consolidated financial statements in conformity with GAAP, management of the Company made a number of estimates and assumptions relating to the reporting of assets and liabilities and the reporting of revenue and expenses. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, securities valuation estimates, evaluation of impairment of securities and income taxes.

The Company has evaluated events and transactions occurring subsequent to the statement of financial condition as of September 30, 2018 for items that should potentially be recognized or disclosed in these consolidated financial statements. The evaluation was conducted through the date these consolidated financial statements were issued.

Note 2 – New Accounting Standards

The Company adopted Financial Accounting Standards Board (“FASB”) Accounting Standards Update ( “ASU”) 2018-02, “Income Statement – Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income” (ASU 2018-02) on January 1, 2018. ASU 2018-02 was issued to address the income tax accounting treatment of the stranded tax effects within other comprehensive income. This issue came about from the enactment of the Tax Cuts and Jobs Act (the “Tax Act”) on December 22, 2017 that changed the Company’s tax rate from 34% to 21%. ASU 2018-02 allows an entity to elect a reclassification from accumulated other comprehensive income (“AOCI”) to retained earnings for stranded tax effects resulting from the Tax Act. The amount of that reclassification should include the effect of tax rate changes on the deferred tax amount, any related valuation allowance and other income tax effects on the items in AOCI. Upon adoption of ASU 2018-02, the Company reclassified the income tax effect of the Tax Act from AOCI to retained earnings. The reclassification increased AOCI and decreased retained earnings by $156,000, with zero net effect on total shareholders’ equity. The Company uses the individual security approach for all available for sale securities when releasing income tax effects remaining in AOCI.

In July 2018, the FASB issued ASU 2018-11 “Leases (Topic 842): Targeted Improvements” (“ASU 2018-11”). ASU 2018-11 makes targeted improvements in order to provide relief to an entity’s costs to implement certain aspects of ASU 2016-02 “Leases” (Topic 842)” (“ASU 2016-02”). ASU 2018-11 allows lessors to combine

lease and associated non-lease components by class of underlying asset in contracts that meet certain criteria. For a lessor to qualify for this practical expedient, the lease and related non-lease components must have the same timing and pattern of transfer, and the lease component, if accounted for on a stand-alone basis, would be classified as an operating lease. ASU 2018-11 also provides entities with an optional transition method that allows entities to recognize a cumulative-effect adjustment to the opening balance of retained earnings in the ASU 2016-02 adoption period. This method eliminates the requirement for entities to restate the comparative periods presented to comply with ASU 2016-02. For public companies, this update will be effective for interim and annual periods beginning after December 15, 2018, and is to be applied on a modified retrospective basis. The amount of assets and liabilities to be added to the balance sheet under ASU 2016-02 and ASU 2018-11 are not expected to have a material impact on the Company’s consolidated financial statements per preliminary estimates.

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 clarifies the fair value measurement disclosure requirements of Accounting Standards Codification (“ASC”) 820 by adding, eliminating and modifying certain disclosure requirements. The amendments in ASU 2018-13 are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. This update is not expected to have a material effect on the Company’s consolidated financial statements.

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 requires credit losses on most financial assets measured at amortized cost and certain other instruments to be measured using an expected credit loss model (referred to as the current expected credit loss (“CECL”) model). Under the CECL model entities will estimate credit losses over the entire contractual term of the instrument (considering estimated prepayments, but not expected extensions or modifications unless reasonable expectation of a troubled debt restructuring exists) from the date of initial recognition of that instrument. Further, ASU 2016-13 made certain targeted amendments to the existing impairment for available for sale (“AFS”) debt securities. For an AFS debt security for which there is neither the intent nor a more-likely-than-not requirement to sell, an entity will record credit losses as an allowance rather than a write-down of the amortized cost basis. ASU 2016-13 is effective for public business entities that are U.S. Securities and Exchange Commission (“SEC”) filers for fiscal periods beginning after December 15, 2019, including interim reporting periods within those periods. An entity will apply the amendments in ASU 2016-13 through a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective. We are currently assessing the potential impact on our consolidated financial statements; however, due to the significant differences in the revised guidance from existing GAAP, the implementation of this guidance may result in material changes in our accounting for credit losses on financial instruments. We are also reviewing the impact of additional disclosures required under ASU 2016-13 on our ongoing financial reporting. Alternative methodologies are being considered, data requirements and integrity are being reviewed and enhancements to the current process are being considered. The Company is continuing to evaluate and implement this guidance.

Note 3 – Investment Securities

Debt Securities

The amortized cost and fair value of securities are as follows:


	September 30, 2018
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
		(Dollars in thousands)
SECURITIES AVAILABLE FOR SALE:
Debt Securities
U.S. Government Agencies	$	2,012	$	-	$	(123)	$	1,889
Municipal bonds		46,174		522		(265)		46,431
Mortgage-backed securities:
Collateralized mortgage obligations-private label		27		-		-		27
Collateralized mortgage obligations-government sponsored entities		31,626		4		(1,165)		30,465
Government National Mortgage Association		196		6		-		202
Federal National Mortgage Association		2,477		28		(37)		2,468
Federal Home Loan Mortgage Corporation		1,314		13		(29)		1,298
Asset-backed securities-private label		-		291		-		291
Asset-backed securities-government sponsored entities		44		1		-		45
Total Debt Securities	$	83,870	$	865	$	(1,619)	$	83,116
Equity Securities		22		9		-		31
Total Securities Available for Sale	$	83,892	$	874	$	(1,619)	$	83,147


	December 31, 2017
			Gross		Gross
	Amortized		Unrealized		Unrealized		Fair
	Cost		Gains		Losses		Value
		(Dollars in thousands)
SECURITIES AVAILABLE FOR SALE:
Debt Securities
U.S. Government Agencies	$	2,013	$	-	$	(26)	$	1,987
Municipal bonds		44,256		1,312		(6)		45,562
Mortgage-backed securities:
Collateralized mortgage obligations-private label		30		-		-		30
Collateralized mortgage obligations-government sponsored entities		28,195		28		(569)		27,654
Government National Mortgage Association		229		16		-		245
Federal National Mortgage Association		2,834		95		-		2,929
Federal Home Loan Mortgage Corporation		1,518		35		-		1,553
Asset-backed securities-private label		69		276		(1)		344
Asset-backed securities-government sponsored entities		57		3		-		60
Total Debt Securities	$	79,201	$	1,765	$	(602)	$	80,364
Equity Securities		22		35		-		57
Total Securities Available for Sale	$	79,223	$	1,800	$	(602)	$	80,421

Debt Securities

All of our collateralized mortgage obligations are backed by one- to four-family residential mortgages.

At September 30, 2018, thirty-two municipal bonds with a cost of $11.0 million and fair value of $11.1 million were pledged under a collateral agreement with the Federal Reserve Bank (“FRB”) of New York for liquidity borrowing. At December 31, 2017, thirty-three municipal bonds with a cost of $11.3 million and fair value of $11.7 million were pledged with the FRB. In addition, at September 30, 2018, twenty-one municipal bonds with a cost and fair value of $5.6 million were pledged as collateral for customer deposits in excess of the Federal Deposit Insurance Corporation (“FDIC”) insurance limits. At December 31, 2017, twenty municipal bonds with a cost of $5.1 million and fair value of $5.3 million were pledged as collateral for customer deposits in excess of the FDIC insurance limits.

The following table sets forth the Company’s investment in debt securities available for sale with gross unrealized losses of less than twelve months and gross unrealized losses of twelve months or more and associated fair values as of the dates indicated:


	Less than 12 months				12 months or more				Total
			Gross				Gross				Gross
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
	(Dollars in thousands)
September 30, 2018
U.S. Government Agencies	$	1,889	$	(123)	$	-	$	-	$	1,889	$	(123)
Municipal bonds		8,057		(255)		554		(10)		8,611		(265)
Mortgage-backed securities		15,304		(326)		17,068		(905)		32,372		(1,231)
	$	25,250	$	(704)	$	17,622	$	(915)	$	42,872	$	(1,619)


December 31, 2017
U.S. Government Agencies	$	1,987	$	(26)	$	-	$	-	$	1,987	$	(26)
Municipal bonds		491		(6)		-		-		491		(6)
Mortgage-backed securities		7,547		(57)		17,602		(512)		25,149		(569)
Asset-backed securities -private label		68		(1)		-		-		68		(1)
	$	10,093	$	(90)	$	17,602	$	(512)	$	27,695	$	(602)

The Company reviews all investment securities on an ongoing basis for the presence of other-than-temporary impairment (“OTTI”) with formal reviews performed quarterly.

At September 30, 2018, the Company’s investment portfolio included several debt securities in the “unrealized losses less than twelve months” category. The debt securities were not evaluated further for OTTI as the unrealized losses on the individual debt securities were less than 20% of book value, which management deemed to be immaterial, the securities were issued by government sponsored enterprises and management has the intent and ability to hold these securities.

At September 30, 2018, the Company had several debt securities in the “unrealized losses twelve months or more” category. These securities were not evaluated further for OTTI, as the unrealized losses were less than 20% of book value and management has the intent and ability to hold until maturity. Management believes the temporary impairments were due to declines in fair value resulting from changes in interest rates and/or increased credit liquidity spreads since the securities were purchased.

Management completed an OTTI analysis for two private label asset-backed securities, which did not have unrealized losses as of September 30, 2018. Management concluded that there was a limited risk of principal losses for these securities and that additional OTTI charges were not required as of September 30, 2018 on these securities.

The unrealized losses on debt securities shown in the previous tables were recorded as a component of other comprehensive loss, net of tax benefit on the Company’s Consolidated Statements of Stockholders’ Equity.

The following table presents a summary of the credit-related OTTI charges recognized as components of income:


	For The Nine Months Ended September 30,
	2018		2017
	(Dollars in thousands)
Beginning balance	$	435	$	554
Additions:
Credit loss not previously recognized		-		-
Reductions:
Losses realized during the period on OTTI previously recognized		-		-
Receipt of cash flows on previously recorded OTTI		(67)		(96)
Ending balance	$	368	$	458

A deterioration in credit quality and/or other factors that may limit the liquidity of a security in our portfolio might adversely affect the fair values of the Company’s investment portfolio and may increase the potential that certain unrealized losses will be designated as “other-than-temporary” and that the Company may incur additional write-downs in future periods.

During the nine months ended September 30, 2018, the Company did not sell any available for sale debt securities. During the nine months ended September 30, 2017, the Company sold eighteen municipal bonds for total proceeds of $6.5 million resulting in realized gains of $244,000.

Equity Securities

At September 30, 2018 and December 31, 2017, available for sale equity securities consisted of 22,368 shares of Federal Home Loan Mortgage Corporation (“FHLMC”) common stock. During the nine months ended September 30, 2018, the Company recognized an unrealized gain of $9,000 on the equity securities, which was recorded in noninterest income in the consolidated statements of income. There were no sales of equity securities during the nine months ended September 30, 2018.

Scheduled contractual maturities of available for sale securities are as follows:


	Amortized		Fair
	Cost		Value
	(Dollars in thousands)
September 30, 2018:
After one year through five years	$	5,472	$	5,570
After five years through ten years		24,450		24,772
After ten years		18,264		17,978
Mortgage-backed securities		35,640		34,460
Asset-backed securities		44		336
Equity securities		22		31
	$	83,892	$	83,147

Note 4 - Allowance for Loan Losses

Management segregates the loan portfolio into loan types and analyzes the risk level for each loan type when determining its allowance for loan losses. The loan types are as follows:

Real Estate Loans:

One- to Four-Family – are loans secured by first lien collateral on residential real estate primarily held in the Western New York region. These loans can be affected by economic conditions and the value of underlying properties. Western New York’s housing market has consistently demonstrated stability in home prices despite economic conditions. Furthermore, the Company has conservative underwriting standards and its residential lending policies and procedures ensure that its one- to four-family residential mortgage loans generally conform to secondary market guidelines.

Home Equity - are loans or lines of credit secured by first or second liens on owner-occupied residential real estate primarily held in the Western New York region. These loans can also be affected by economic conditions and the values of underlying properties. Home equity loans may have increased risk of loss if the Company does not hold the first mortgage resulting in the Company being in a secondary position in the event of collateral liquidation. The Company does not originate interest only home equity loans.

Commercial Real Estate – are loans used to finance the purchase of real property, which generally consists of developed real estate that is held as first lien collateral for the loan. These loans are secured by real estate properties that are primarily held in the Western New York region. 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, 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. Also, commercial real estate loans typically involve relatively large loan balances concentrated with single borrowers or groups of related borrowers.

Construction – are loans to finance the construction of either one- to four-family owner occupied homes or commercial real estate. At the end of the construction period, the loan automatically converts to either a one- to four-family or commercial mortgage, as applicable. Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion compared to the actual cost of construction. The Company limits its risk during construction as disbursements are not made until the required work for each advance has been completed and an updated lien search is performed. The completion of the construction progress is verified by a Company loan officer or inspections performed by an independent appraisal firm. Construction loans also expose us to the risk of construction delays which may impair the borrower’s ability to repay the loan.

Other Loans:

Commercial – includes business installment loans, lines of credit, and other commercial loans. Most of our commercial loans have fixed interest rates, and are for terms generally not in excess of 5 years. Whenever possible, we collateralize these loans with a lien on business assets and equipment and require the personal guarantees from principals of the borrower. Commercial loans generally involve a higher degree of credit risk because the collateral underlying the loans may be in the form of intangible assets and/or inventory subject to market obsolescence. Commercial loans can also involve relatively large loan balances to a single borrower or groups of related borrowers, with the repayment of such loans typically dependent on the successful operation of the commercial business and the income stream of the borrower. Such risks can be significantly affected by economic conditions. Although commercial loans may be collateralized by equipment or other business assets, the liquidation of collateral in the event of a borrower default may be an insufficient source of repayment because the equipment or other business assets may be obsolete or of limited use, among other things. Accordingly, the repayment of a commercial loan depends primarily on the credit worthiness of the borrowers (and any guarantors), while liquidation of collateral is a secondary and often insufficient source of repayment.

Consumer – consist of loans secured by collateral such as an automobile or a deposit account, unsecured loans and lines of credit. Consumer loans tend to have a higher credit risk due to the loans being either unsecured or secured by rapidly depreciable assets. Furthermore, consumer loan payments are dependent on the borrower’s continuing financial stability, and therefore are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy.

The allowance for loan losses is a valuation account that reflects the Company’s evaluation of the losses inherent in its loan portfolio. In order to determine the adequacy of the allowance for loan losses, the Company estimates losses by loan type using historical loss factors, as well as other environmental factors, such as trends in loan volume and loan type, loan concentrations, changes in the experience, ability and depth of the Company’s lending management, and national and local economic conditions. The Company's determination as to the classification of loans and the amount of loss allowances are subject to review by bank regulators, which can require the establishment of additional loss allowances.

The Company also reviews all loans on which the collectability of principal may not be reasonably assured, by reviewing payment status, financial conditions and estimated value of loan collateral. These loans are assigned an internal loan grade, and the Company assigns an amount of loss allowances to these classified loans based on loan grade.

Although the allocations noted below are by loan type, the allowance for loan losses is general in nature and is available to offset losses from any loan in the Company’s portfolio. The unallocated component of the allowance for loan losses reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for existing specific and general losses in the portfolio.

The following tables summarize the activity in the allowance for loan losses for the three and nine months ended September 30, 2018 and 2017 and the distribution of the allowance for loan losses and loans receivable by loan portfolio class and impairment method as of September 30, 2018 and December 31, 2017:


	Real Estate Loans								Other Loans
	One- to Four-Family(2)		Home Equity		Commercial		Construction - Commercial		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)
September 30, 2018
Allowance for Loan Losses:
Balance – July 1, 2018	$	440	$	86	$	1,887	$	329	$	658	$	30	$	44	$	3,474
Charge-offs		(23)		-		(181)		-		-		(9)		-		(213)
Recoveries		-		-		-		-		-		2		-		2
Provision (Credit)		18		2		249		(80)		(48)		2		(18)		125
Balance – September 30, 2018	$	435	$	88	$	1,955	$	249	$	610	$	25	$	26	$	3,388

Balance – January 1, 2018	$	511	$	122	$	1,663	$	347	$	544	$	35	$	61	$	3,283
Charge-offs		(23)		-		(181)		-		-		(32)		-		(236)
Recoveries		18		1		-		-		1		6		-		26
Provision (Credit)		(71)		(35)		473		(98)		65		16		(35)		315
Balance – September 30, 2018	$	435	$	88	$	1,955	$	249	$	610	$	25	$	26	$	3,388
Ending balance: individually evaluated for impairment	$	-	$	-	$	30	$	-	$	-	$	-	$	-	$	30
Ending balance: collectively evaluated for impairment	$	435	$	88	$	1,925	$	249	$	610	$	25	$	26	$	3,358

Gross Loans Receivable (1):
Ending balance	$	148,792	$	41,132	$	148,725	$	22,150	$	26,410	$	1,332	$	-	$	388,541
Ending balance: individually evaluated for impairment	$	179	$	19	$	665	$	-	$	61	$	-	$	-	$	924
Ending balance: collectively evaluated for impairment	$	148,613	$	41,113	$	148,060	$	22,150	$	26,349	$	1,332	$	-	$	387,617

⁽¹⁾

Gross Loans Receivable does not include allowance for loan losses of $(3,388) or deferred loan costs of $3,284.

⁽²⁾

Includes one- to four-family construction loans.


	Real Estate Loans								Other Loans
	One- to Four-Family(1)		Home Equity		Commercial		Construction - Commercial		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)
September 30, 2017
Allowance for Loan Losses:
Balance – July 1, 2017	$	471	$	124	$	1,888	$	302	$	331	$	32	$	75	$	3,223
Charge-offs		-		-		(75)		-		(2)		(8)		-		(85)
Recoveries		1		1		-		-		-		2		-		4
Provision (Credit)		54		10		(145)		15		167		5		(31)		75
Balance – September 30, 2017	$	526	$	135	$	1,668	$	317	$	496	$	31	$	44	$	3,217

Balance – January 1, 2017	$	432	$	114	$	1,803	$	149	$	338	$	28	$	18	$	2,882
Charge-offs		-		(3)		(75)		-		(20)		(36)		-		(134)
Recoveries		2		4		-		-		1		12		-		19
Provision (Credit)		92		20		(60)		168		177		27		26		450
Balance – September 30, 2017	$	526	$	135	$	1,668	$	317	$	496	$	31	$	44	$	3,217

⁽¹⁾

Includes one– to four-family construction loans.


	Real Estate Loans									Other Loans
	One- to Four-Family(2)		Home Equity		Commercial		Construction - Commercial		Commercial		Consumer		Unallocated		Total
	(Dollars in thousands)

December 31, 2017
Allowance for Loan Losses:
Balance – December 31, 2017	$	511	$	122	$	1,663	$	347	$	544	$	35	$	61	$	3,283
Ending balance: individually evaluated for impairment	$	-	$	-	$	-	$	-	$	-	$	-	$	-	$	-
Ending balance: collectively evaluated for impairment	$	511	$	122	$	1,663	$	347	$	544	$	35	$	61	$	3,283

Gross Loans Receivable (1):
Ending Balance	$	144,614	$	38,078	$	122,747	$	30,802	$	27,612	$	1,355	$	-	$	365,208
Ending balance: individually evaluated for impairment	$	184	$	21	$	1,498	$	-	$	54	$	-	$	-	$	1,757
Ending balance: collectively evaluated for impairment	$	144,430	$	38,057	$	121,249	$	30,802	$	27,558	$	1,355	$	-	$	363,451

⁽¹⁾

Gross Loans Receivable does not include allowance for loan losses of $(3,283) or deferred loan costs of $3,138.

⁽²⁾

Includes one– to four- family construction loans.

A loan is considered impaired when, based on current information and events, it is probable that the Company will not be able to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan agreement. Factors considered in determining impairment include payment status, collateral value and the probability of collecting scheduled payments when due. Impairment is measured on a loan-by-loan basis for commercial real estate loans and commercial loans. Larger groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer, home equity, or one- to four-family loans for impairment disclosure, unless they are subject to a troubled debt restructuring.

The following is a summary of information pertaining to impaired loans at or for the periods indicated:


			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
							For the Nine Months Ended
	At September 30, 2018						September 30, 2018
	(Dollars in thousands)
With no related allowance recorded:
Residential, one- to four-family	$	179	$	179	$	-	$	181	$	10
Home equity		19		19		-		19		-
Commercial real estate		409		409		-		413		-
Commercial loans		61		61		-		73		1
Total impaired loans with no related allowance		668		668		-		686		11

With an allowance recorded:
Commercial real estate(1)		256		256		30		1,584		3
Total impaired loans with an allowance		256		256		30		1,584		3

Total of impaired loans:
Residential, one- to four-family		179		179		-		181		10
Home equity		19		19		-		19		-
Commercial real estate		665		665		30		1,997		3
Commercial loans		61		61		-		73		1
Total impaired loans	$	924	$	924	$	30	$	2,270	$	14

(1) Two commercial real estate loans with a combined recorded investment of $1.4 million and a related allowance of $60,000 were foreclosed upon during the nine months ended September 30, 2018 and included in Other Assets on the Consolidated Statement of Financial Condition at September 30, 2018.

			Unpaid				Average		Interest
	Recorded		Principal		Related		Recorded		Income
	Investment		Balance		Allowance		Investment		Recognized
							For the Year Ended
	At December 31, 2017						December 31, 2017
	(Dollars in thousands)
With no related allowance recorded:
Residential, one- to four-family	$	184	$	184	$	-	$	197	$	15
Home equity		21		21		-		21		-
Commercial real estate		1,498		1,498		-		1,674		222
Commercial loans		54		54		-		54		-
Total impaired loans with no related allowance		1,757		1,757		-		1,946		237

With an allowance recorded:
Commercial real estate(1)		-		-		-		230		-
Commercial loans(2)		-		-		-		50		6
Total impaired loans with an allowance		-		-		-		280		6

Total of impaired loans:
Residential, one- to four-family		184		184		-		197		15
Home equity		21		21		-		21		-
Commercial real estate		1,498		1,498		-		1,904		222
Commercial loans		54		54		-		104		6
Total impaired loans	$	1,757	$	1,757	$	-	$	2,226	$	243

(1)This loan was foreclosed upon during the year ended December 31, 2017 and was recorded in other assets at December 31, 2017.

(2)This loan was paid off during the year ended December 31, 2017.

The following tables provide an analysis of past due loans and non-accruing loans as of the dates indicated:


	30-59 Days		60-89 Days		90 Days or More		Total Past			Current	Total Loans		Loans on Non-
	Past Due		Past Due		Past Due		Due			Due	Receivable		Accrual
	(Dollars in thousands)
September 30, 2018:
Real Estate Loans:
Residential, one- to four-family	$	674	$	407	$	1,205	$	2,286	$	146,160	$	148,446	$	2,187
Home equity		153		52		341		546		40,586		41,132		336
Commercial		-		-		589		589		148,136		148,725		665
Construction - Commercial		-		-		-		-		22,150		22,150		-
Construction - Residential, one- to four-family		-		-		-		-		346		346		-
Other Loans:
Commercial		-		52		76		128		26,282		26,410		76
Consumer		9		4		-		13		1,319		1,332		-
Total	$	836	$	515	$	2,211	$	3,562	$	384,979	$	388,541	$	3,264

	30-59 Days		60-89 Days		90 Days or More		Total Past			Current	Total Loans		Loans on Non-
	Past Due		Past Due		Past Due		Due			Due	Receivable		Accrual
	(Dollars in thousands)
December 31, 2017:
Real Estate Loans:
Residential, one- to four-family	$	692	$	942	$	1,233	$	2,867	$	141,698	$	144,565	$	2,196
Home equity		27		59		212		298		37,780		38,078		235
Commercial		411		-		1,265		1,676		121,071		122,747		1,323
Construction - Commercial		-		-		-		-		30,802		30,802		-
Construction - Residential, one- to four-family		-		-		-		-		49		49		-
Other Loans:
Commercial		61		8		54		123		27,489		27,612		54
Consumer		22		2		22		46		1,309		1,355		25
Total	$	1,213	$	1,011	$	2,786	$	5,010	$	360,198	$	365,208	$	3,833

The accrual of interest on loans is discontinued when, in management’s opinion, the borrower may be unable to meet payments as they become due. A loan does not have to be 90 days delinquent in order to be classified as non-accrual. When interest accrual is discontinued, all unpaid accrued interest is reversed. If ultimate collection of principal is in doubt, all cash receipts on impaired loans are applied to reduce the principal balance. Interest income not recognized on non-accrual loans during the nine month periods ended September 30, 2018 and 2017 was $205,000 and $209,000, respectively.

The Company’s policies provide for the classification of loans as follows:

Pass/Performing;

Special Mention – does not currently expose the Company to a sufficient degree of risk but does possess credit deficiencies or potential weaknesses deserving the Company’s close attention;

Substandard – has one or more well-defined weaknesses and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. A substandard asset would be one inadequately protected by the current net worth and paying capacity of the obligor or pledged collateral, if applicable;

Doubtful – has 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; and

Loss – loan is considered uncollectible and continuance without the establishment of a specific valuation reserve is not warranted.

The Company’s Asset Classification Committee is responsible for monitoring risk ratings and making changes as deemed appropriate. Each commercial loan is individually assigned a loan classification. The Company’s consumer loans, including residential one- to four-family loans and home equity loans, are not classified as described above. Instead, the Company uses the delinquency status as the basis for classifying these loans. Generally, all consumer loans more than 90 days past due are classified and placed in non-accrual. Such loans that are well-secured and in the process of collection will remain in accrual status.

The following tables summarize the internal loan grades applied to the Company’s loan portfolio as of September 30, 2018 and December 31, 2017:


	Pass/Performing		Special Mention		Substandard		Doubtful		Loss		Total
	(Dollars in thousands)
September 30, 2018
Real Estate Loans:
Residential, one- to four-family	$	145,747	$	-	$	2,699	$	-	$	-	$	148,446
Home equity		40,640		-		492		-		-		41,132
Commercial		146,011		728		1,986		-		-		148,725
Construction - Commercial		22,150		-		-		-		-		22,150
Construction - Residential, one- to four-family		346		-		-		-		-		346
Other Loans:
Commercial		25,024		62		1,324		-		-		26,410
Consumer		1,328		-		4		-		-		1,332
Total	$	381,246	$	790	$	6,505	$	-	$	-	$	388,541


	Pass/Performing		Special Mention		Substandard		Doubtful		Loss		Total
	(Dollars in thousands)
December 31, 2017
Real Estate Loans:
Residential, one- to four-family	$	141,751	$	-	$	2,814	$	-	$	-	$	144,565
Home equity		37,611		-		467		-		-		38,078
Commercial		118,977		866		2,904		-		-		122,747
Construction - Commercial		30,802		-		-		-		-		30,802
Construction - Residential, one- to four-family		49		-		-		-		-		49
Other Loans:
Commercial		26,165		1,093		354		-		-		27,612
Consumer		1,342		-		11		-		2		1,355
Total	$	356,697	$	1,959	$	6,550	$	-	$	2	$	365,208

Troubled debt restructurings (“TDRs”) occur when we grant borrowers concessions that we would not otherwise grant but for economic or legal reasons pertaining to the borrower’s financial difficulties. A concession is made when the terms of the loan modification are more favorable than the terms the borrower would have received in the current market under similar financial difficulties. These concessions may include, but are not limited to, modifications of the terms of the debt, the transfer of assets or the issuance of an equity interest by the borrower to satisfy all or part of the debt, or the addition of borrower(s). The Company identifies loans for potential TDRs primarily through direct communication with the borrower and evaluation of the borrower’s financial statements, revenue projections, tax returns, and credit reports. Even if the borrower is not presently in default, management will consider the likelihood that cash flow shortages, adverse economic conditions, and negative trends may result in a payment default in the near future. Generally, we will not return a TDR to accrual status until the borrower has demonstrated the ability to make principal and interest payments under the restructured terms for at least six consecutive months. The Company’s TDRs are impaired loans, which may result in specific allocations and subsequent charge-offs if appropriate.

Some loan modifications classified as TDRs may not ultimately result in full collection of principal and interest, as modified, which may result in potential losses. These potential losses have been factored into our overall estimate of the allowance for loan losses.

The following table summarizes the loans that were classified as TDRs as of the dates indicated:


					Non-Accruing				Accruing				TDRs That Have Defaulted on Modified Terms Year to Date
	Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment		Number of Loans		Recorded Investment
	(Dollars in thousands)
At September 30, 2018
Real Estate Loans:
Residential, one- to four-family		5	$	179		-	$	-		5	$	179		-	$	-
Home equity		1		19		1		19		-		-		-		-
Total		6	$	198		1	$	19		5	$	179		-	$	-


At December 31, 2017
Real Estate Loans:
Residential, one- to four-family		5	$	184		-	$	-		5	$	184		-	$	-
Home equity		2		21		1		19		1		2		-		-
Total		7	$	205		1	$	19		6	$	186		-	$	-

No additional loan commitments were outstanding to these borrowers at September 30, 2018 and December 31, 2017.

There were no loans restructured and classified as TDRs during the three and nine month periods ended September 30, 2018 and September 30, 2017, respectively.

Foreclosed real estate consists of property acquired in settlement of loans which is carried at its fair value less estimated selling costs. Write-downs from cost to fair value less estimated selling costs are recorded at the date of acquisition or repossession and are charged to the allowance for loan losses. Foreclosed real estate was $1.7 million and $435,000 at September 30, 2018 and December 31, 2017, respectively, and was included as a component of other assets on the consolidated statements of financial condition. The recorded investment of consumer loans secured by residential real estate properties for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction was $1.4 million and $965,000 at September 30, 2018 and December 31, 2017, respectively.

Note 5 – Earnings per Share

Earnings per share was calculated for the three and nine months ended September 30, 2018 and 2017, respectively. Basic earnings per share is based upon the weighted average number of common shares outstanding, exclusive of unearned shares held by the Employee Stock Ownership Plan of Lake Shore Bancorp, Inc. (the “ESOP”), unearned shares held by the Lake Shore Bancorp, Inc. 2006 Recognition and Retention Plan (“RRP”), and unearned shares held by the Lake Shore Bancorp, Inc. 2012 Equity Incentive Plan (“EIP”). Diluted earnings per share is based upon the weighted average number of common shares outstanding and common share equivalents that would arise from the exercise of dilutive securities. Stock options are regarded as potential common stock and are considered in the diluted earnings per share calculations to the extent they would be dilutive and computed using the treasury stock method.

The calculated basic and diluted earnings per share are as follows:


	Three Months Ended September 30,
	2018		2017
Numerator – net income	$	1,058,000	$	940,000
Denominator:
Basic weighted average shares outstanding		6,074,753		6,115,140
Increase in weighted average shares outstanding due to:
Stock options		14,276		9,113
Diluted weighted average shares outstanding (1)		6,089,029		6,124,253

Earnings per share:
Basic	$	0.17	$	0.15
Diluted	$	0.17	$	0.15

	Nine Months Ended September 30,
	2018		2017
Numerator – net income	$	3,000,000	$	2,798,000
Denominator:
Basic weighted average shares outstanding		6,086,216		6,109,468
Increase in weighted average shares outstanding due to:
Stock options		13,462		9,093
Diluted weighted average shares outstanding (1)		6,099,678		6,118,561

Earnings per share:
Basic	$	0.49	$	0.46
Diluted	$	0.49	$	0.46

⁽¹⁾

Stock options to purchase 64,547 shares under the Company’s 2006 Stock Option Plan and 20,000 shares under the EIP at $14.38 for each plan were outstanding during the three and nine month periods ended September 30, 2017, but were not included in the calculation of diluted earnings per share because to do so would have been anti-dilutive. During the three and nine month periods ended September 30, 2018, there were no stock options excluded from the calculation of diluted earnings per share.

Note 6 – Commitments to Extend Credit

The Company has commitments to extend credit with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated statements of financial condition.

The Company’s exposure to credit loss is represented by the contractual amount of these commitments. There were no loss reserves associated with these commitments at September 30, 2018 and December 31, 2017. The Company follows the same credit policies in making commitments as it does for on-balance sheet instruments.

The following commitments to extend credit were outstanding as of the dates specified:


	Contract Amount
	September 30,		December 31,
	2018		2017
	(Dollars in thousands)

Commitments to grant loans	$	41,273	$	16,426
Unfunded commitments under lines of credit	$	48,969	$	41,395

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses. The commitments for lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer. At September 30, 2018 and December 31, 2017, the Company’s loan commitments with fixed interest rates for the next five years totaled $10.5 million and $7.9 million, respectively. The range of interest rates on these fixed rate commitments was 3.95% to 6.59% at September 30, 2018.

Note 7 – Stock-based Compensation

As of September 30, 2018, the Company had four stock-based compensation plans, which are described below. The compensation cost that has been recorded under salary and benefits expense in the non-interest expense section of the consolidated statements of income for these plans was $144,000 and $146,000 for the three months ended September 30, 2018 and 2017, respectively. The compensation cost that has been recorded for the nine months ended September 30, 2018 and 2017 was $434,000 and $418,000, respectively.

2006 Stock Option Plan

The Company’s 2006 Stock Option Plan (the “Stock Option Plan”), which was approved by the Company’s stockholders, permitted the grant of options to its employees and non-employee directors for up to 297,562 shares of common stock. The Stock Option Plan expired on October 24, 2016, and grants of options can no longer be awarded.

Both incentive stock options and non-qualified stock options have been granted under the Stock Option Plan. The exercise price of each stock option equals the market price of the Company’s common stock on the date of grant and an option’s maximum term is ten years. The stock options generally vest over a five year period.

A summary of the status of the Stock Option Plan during the nine months ended September 30, 2018 and 2017 is presented below:


	September 30, 2018				September 30, 2017
	Options		Weighted Average Exercise Price	Remaining Contractual Life	Options		Weighted Average Exercise Price	Remaining Contractual Life
Outstanding at beginning of year	82,321	$	12.98		82,826	$	12.95
Granted	-		-		-		-
Exercised	-		-		-		-
Forfeited	-		-		-		-
Outstanding at end of period	82,321	$	12.98	6.6 years	82,826	$	12.95	7.6 years

Options exercisable at end of period	30,681	$	10.61	6.6 years	18,279	$	7.88	7.6 years

Fair value of options granted		$	-			$	-

At September 30, 2018, stock options outstanding had an intrinsic value of $290,000 and there were no remaining options available for grant under the Stock Option Plan. There were no stock options exercised during the three and nine months ended September 30, 2018 and 2017. Compensation expense related to the Stock Option Plan for the three month period ended September 30, 2018 and 2017 was $8,000, respectively. Compensation expense related to the Stock Option Plan for the nine month period ended September 30, 2018 and 2017 was $25,000, respectively. At September 30, 2018, $104,000 of unrecognized compensation cost related to the Stock Option Plan is expected to be recognized over a period of 37 months.

2006 Recognition and Retention Plan

The Company’s 2006 Recognition and Retention Plan (“RRP”), which was approved by the Company’s stockholders, permitted the grant of restricted stock awards (“Awards”) to employees and non-employee directors for up to 119,025 shares of common stock. The RRP expired on October 24, 2016, and as of October 24, 2016, all shares permitted under the plan have been granted.

As of September 30, 2018, there were 106,820 shares vested or distributed to eligible participants under the RRP. Compensation expense amounted to $23,000 for the three months ended September 30, 2018 and 2017, respectively. Compensation expense amounted to $67,000 and $66,000 for the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018, $130,000 of unrecognized compensation cost related to the RRP is expected to be recognized over a period of 37 months.

A summary of the status of unvested shares under the RRP for the nine months ended September 30, 2018 and 2017 is as follows:


	2018		Weighted Average Grant Price (per Share)	2017		Weighted Average Grant Price (per Share)
Unvested shares outstanding at beginning of year	17,119	$	13.06	24,110	$	12.96
Granted	-		-	-		-
Vested	(4,914)		12.17	(4,974)		12.14
Forfeited	-		-	-		-
Unvested shares outstanding at end of period	12,205	$	13.42	19,136	$	13.18

2012 Equity Incentive Plan

The Company’s 2012 Equity Incentive Plan (the “EIP”), which was approved by the Company’s stockholders on May 23, 2012, authorizes the issuance of up to 180,000 shares of common stock pursuant to grants of restricted stock awards and up to 20,000 shares of common stock pursuant to grants of incentive stock options and non-qualified stock options, subject to permitted adjustments for certain corporate transactions. Employees and directors of Lake Shore Bancorp or its subsidiaries are eligible to receive awards under the EIP, except that non-employees may not be granted incentive stock options.

The Board of Directors granted restricted stock awards under the EIP during the nine months ended September 30, 2018 as follows:


Grant Date	Number of Restricted Stock Awards	Vesting		Fair Value per Share of Award on Grant Date	Awardees

February 7, 2018	5,285	100% on December 14, 2018	$	17.00	Non-employee directors
April 24, 2018	44	100% on December 14, 2018		16.88	Non-employee director

A summary of the status of unvested restricted stock awards under the EIP for the nine months ended September 30, 2018 and 2017 is as follows:


	2018		Weighted Average Grant Price (per Share)	2017		Weighted Average Grant Price (per Share)
Unvested shares outstanding at beginning of year	42,915	$	14.40	26,072	$	12.77
Granted	5,329		17.00	27,348		15.90
Vested	(4,213)		12.16	(4,207)		12.16
Forfeited	(795)		14.85	(625)		13.76
Unvested shares outstanding at end of period	43,236	$	14.93	48,588	$	14.57

As of September 30, 2018, there were 36,010 shares vested or distributed to eligible participants under the EIP. Compensation expense related to restricted stock awards under the EIP amounted to $77,000 and $81,000 for the three months ended September 30, 2018 and 2017, respectively. Compensation expense related to EIP restricted stock awards during the nine months ended September 30, 2018 and 2017 was $234,000 and $224,000, respectively. At September 30, 2018, $220,000 of unrecognized compensation cost related to unvested restricted stock awards is expected to be recognized over a period of 15 months.

A summary of the status of stock options under the EIP for the nine months ended September 30, 2018 and 2017 is presented below:


	September 30, 2018				September 30, 2017
	Options		Exercise Price	Remaining Contractual Life	Options		Exercise Price	Remaining Contractual Life
Outstanding at beginning of year	20,000	$	14.38		20,000	$	14.38
Granted	-		-		-		-
Exercised	-		-		-		-
Forfeited	-		-		-		-
Outstanding at end of period	20,000	$	14.38	8.1 years	20,000	$	14.38	9.1 years

Options exercisable at end of period	3,998	$	14.38	8.1 years	-	$	-

Fair value of options granted			-				-

At September 30, 2018, stock options outstanding had an intrinsic value of $42,000 and there were no remaining options available for grant under the EIP. Compensation expense related to stock options outstanding under the EIP amounted to $3,000 for the three months ended September 30, 2018 and 2017, respectively, and amounted to $8,000 for the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018, $32,000 of unrecognized compensation cost related to unvested stock options is expected to be recognized over a period of 37 months.

Employee Stock Ownership Plan (“ESOP”)

The Company established the ESOP for the benefit of eligible employees of the Company and Bank. All Company and Bank employees meeting certain age and service requirements are eligible to participate in the ESOP. Participants’ benefits become fully vested after five years of service once the employee is eligible to participate in the ESOP. The Company utilized $2.6 million of the proceeds of its 2006 stock offering to extend a loan to the ESOP and the ESOP used such proceeds to purchase 238,050 shares of stock on the open market at an average price of $10.70 per share, plus commission expenses. As a result of the purchase of shares by the ESOP, total stockholders’ equity of the Company was reduced by $2.6 million. As of September 30, 2018, the balance of the loan to the ESOP was $1.6 million and the fair value of unallocated shares was $2.4 million. As of September 30, 2018, there were 70,031 allocated shares and 142,830 unallocated shares compared to 62,956 allocated shares and 150,765 unallocated shares at September 30, 2017. The ESOP compensation expense was $33,000 for the three months ended September 30, 2018 and $31,000 for the three months ended September 30, 2017 based on 1,984 shares earned in each of those quarters. The ESOP compensation expense was $100,000 for the nine months ended September 30, 2018 and $94,000 for the nine months ended September 30, 2017 based on 5,951 shares earned in each of those periods.

Note 8 - Fair Value of Financial Instruments

Management uses its best judgment in estimating the fair value of the Company’s financial instruments; however, there are inherent weaknesses in any estimation technique. Therefore, for substantially all financial instruments, the fair value estimates herein are not necessarily indicative of the amounts the Company could have realized in a sale transaction on the dates indicated. The estimated fair value amounts have been measured as of September 30, 2018 and December 31, 2017 and have not been re-evaluated or updated for purposes of these consolidated financial statements subsequent to those respective dates. The estimated fair values of these financial instruments subsequent to the respective reporting dates may be different than the amounts reported here.

The measurement of fair value under FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC Topic 820”) establishes a fair value hierarchy that prioritizes the inputs to valuation methods used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities measurements (Level 1) and the lowest priority to unobservable input measurements (Level 3). The three levels of the fair value hierarchy under ASC Topic 820 are as follows:

Level 1: Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

Level 2: Inputs other than quoted prices included in Level 1 that are observable for the asset or liability either directly or indirectly.

Level 3: Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

An asset’s or liability’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement.

For assets measured at fair value on a recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2018 and December 31, 2017 were as follows:


	Fair Value Measurements at September 30, 2018
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
		(Dollars in thousands)
Measured at fair value on a recurring basis:
Securities available for sale:
Debt Securities
U.S. Government Agencies	$	1,889	$	1,889	$	-	$	-
Municipal bonds		46,431		-		46,431		-
Mortgage-backed securities:
Collateralized mortgage obligations-private label		27		-		27		-
Collateralized mortgage obligations-government sponsored entities		30,465		-		30,465		-
Government National Mortgage Association		202		-		202		-
Federal National Mortgage Association		2,468		-		2,468		-
Federal Home Loan Mortgage Corporation		1,298		-		1,298		-
Asset-backed securities:
Private label		291		-		291		-
Government sponsored entities		45		-		45		-
Total Debt Securities	$	83,116	$	1,889	$	81,227	$	-
Equity Securities		31		-		31		-
Total Securities Available for Sale	$	83,147	$	1,889	$	81,258	$	-


	Fair Value Measurements at December 31, 2017
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
		(Dollars in thousands)
Measured at fair value on a recurring basis:
Securities available for sale:
Debt Securities
U.S. Government Agencies	$	1,987	$	1,987	$	-	$	-
Municipal bonds		45,562		-		45,562		-
Mortgage-backed securities:
Collateralized mortgage obligations-private label		30		-		30		-
Collateralized mortgage obligations-government sponsored entities		27,654		-		27,654		-
Government National Mortgage Association		245		-		245		-
Federal National Mortgage Association		2,929		-		2,929		-
Federal Home Loan Mortgage Corporation		1,553		-		1,553		-
Asset-backed securities:
Private label		344		-		-		344
Government sponsored entities		60		-		60		-
Total Debt Securities	$	80,364	$	1,987	$	78,033	$	344
Equity Securities		57		-		57		-
Total Securities Available for Sale	$	80,421	$	1,987	$	78,090	$	344

Any transfers between levels would be recognized as of the actual date of event or change in circumstances that caused the transfer. There were no reclassifications between the Level 1 and Level 2 categories for the nine months ended September 30, 2018 and for the year ended December 31, 2017. During the nine months ended September 30, 2018, asset-backed securities – private label were transferred from the Level 3 category to the Level 2 category. These securities were transferred to Level 2 because the Company changed its method of valuing these securities and that method now uses Level 2 inputs. These securities are now valued using Level 2 inputs because the price volatility associated with these securities has been reduced and management considers the quoted market price for these securities to be reasonable.

Level 2 inputs for assets or liabilities measured at fair value on a recurring basis might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

The fair value of securities available for sale are determined by obtaining quoted market prices on nationally recognized securities exchanges (Level 1) or matrix pricing (Level 2), which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted market prices for the specific securities, but rather by relying on the securities’ relationship to other benchmark quoted prices. The

fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. treasury yield curve, live trading levels, trade execution date, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things. Level 2 securities which are fixed income instruments that are not quoted on an exchange, but are traded in active markets, are valued using prices obtained from our custodian, who use third party data service providers. Securities available for sale measured within the Level 3 category as of December 31, 2017 consisted of private label asset-backed securities.

The following table presents a reconciliation of the securities available for sale measured at fair value on a recurring basis using significant unobservable inputs (Level 3), specifically, asset-backed securities - private label, for the nine months ended September 30, 2018 and 2017:


	2018		2017
		(Dollars in thousands)
Beginning Balance	$	344	$	832
Total gains - realized/unrealized:
Included in earnings		-		-
Included in other comprehensive loss		-		11
Total losses - realized/unrealized:		-
Included in earnings		-		-
Included in other comprehensive loss		-		(64)
Sales		-		-
Principal paydowns		-		(337)
Transfers to (out of) Level 3		(344)		-
Ending Balance	$	-	$	442

Both observable and unobservable inputs may be used to determine the fair value of assets and liabilities measured on a recurring basis that the Company has classified within the Level 3 category. As a result, any unrealized gains and losses for assets within the Level 3 category may include changes in fair value attributable to both observable (e.g., changes in market interest rates) and unobservable (e.g., changes in unobservable long-dated volatilities) inputs.

The following table presents additional quantitative information about the Level 3 inputs for the asset-backed securities - private label category. The fair values for this category were developed using the discounted cash flow technique with the following unobservable input ranges as of December 31, 2017 (dollars in thousands):

Unobservable Inputs

Security Category

Fair Value

Loan Type/Collateral

Credit Ratings

Constant Prepayment Speed (CPR)

Probability of Default (Annual Default Rate)

Loss Severity

December 31, 2017

Asset-backed securities - private label

344

Sub-prime First and Prime Second Lien - Residential Real Estate

B- thru D

5-12

3.0-5.0%

75.0% - 100.0%

At December 31, 2017, Level 3 inputs were determined by the Company’s management using inputs from its third party financial advisor on a quarterly basis. The significant unobservable inputs used in the fair value measurement of the reporting entity’s asset-backed, private label securities are prepayment rates, probability of default and loss severity in the event of default. Significant increases or decreases in any of those inputs in isolation would result in a significantly lower or higher fair value measurement. Generally, a change in the assumption used for the probability of default is accompanied by a directionally similar change in the

assumption used for the loss severity and a directionally opposite change in the assumption used for prepayment rates.

In addition to disclosure of the fair value of assets on a recurring basis, ASC Topic 820 requires disclosures for assets and liabilities measured at fair value on a non-recurring basis, such as impaired assets and foreclosed real estate. Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records non-recurring adjustments to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of these loans. Non-recurring adjustments also include certain impairment amounts for collateral-dependent loans calculated as required by ASC Topic 310, “Receivables – Loan Impairment,” when establishing the allowance for loan losses. An impaired loan is carried at fair value based on either a recent appraisal less estimated selling costs of underlying collateral or discounted cash flows based on current market conditions.

For assets measured at fair value on a non-recurring basis, the fair value measurements by level within the fair value hierarchy used at September 30, 2018 and December 31, 2017 were as follows:


	Fair Value Measurements
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Fair Value		(Level 1)		(Level 2)		(Level 3)
		(Dollars in thousands)
Measured at fair value on a non-recurring basis:

At September 30, 2018
Impaired loans	$	260	$	-	$	-	$	260
Foreclosed real estate		1,650		-		-		1,650

At December 31, 2017
Impaired loans	$	35	$	-	$	-	$	35
Foreclosed real estate		438		-		-		438

The following table presents additional quantitative information about assets measured at fair value on a non-recurring basis and for which the Company has utilized Level 3 inputs to determine fair value:


	Quantitative Information about Level 3 Fair Value Measurements
(Dollars in thousands)	Fair Value Estimate		Valuation Technique	Unobservable Input	Range
At September 30, 2018
Impaired loans	$	260	Market valuation of underlying collateral (1)	Direct Disposal Costs (2)	7.00-13.70%
Foreclosed real estate		1,650	Market valuation of property (1)	Direct Disposal Costs (2)	3.90-10.00%
At December 31, 2017
Impaired loans	$	35	Market valuation of underlying collateral (1)	Direct Disposal Costs (2)	7.00%
Foreclosed real estate		438	Market valuation of property (1)	Direct Disposal Costs (2)	7.00-16.80%

⁽¹⁾

Fair value is generally determined through independent third-party appraisals of the underlying collateral, which generally includes various Level 3 inputs which are not observable.

⁽²⁾

The fair value basis of impaired loans and foreclosed real estate may be adjusted to reflect management estimates of disposal costs including, but not necessarily limited to, real estate brokerage commissions, legal fees, and delinquent property taxes.

At September 30, 2018, impaired loans valued using Level 3 inputs had a carrying amount of $290,000 and valuation allowances of $30,000. By comparison at December 31, 2017, impaired loans valued using Level 3 inputs had a carrying amount of $35,000 and no valuation allowances.

Once a loan is determined to be impaired, the fair value of the loan continues to be evaluated based upon the market value of the underlying collateral securing the loan or by using a discounted future cash flow method if the loan is not collateral dependent. At September 30, 2018, impaired loans with a carrying amount that had been written down utilizing Level 3 inputs during the nine months ended September 30, 2018 comprised of one loan with a fair value of $226,000 and resulted in an additional provision for loan loss of $30,000.

At September 30, 2018, foreclosed real estate valued using Level 3 inputs had a carrying amount of $1.9 million and valuation allowances of $294,000. By comparison at December 31, 2017, foreclosed real estate valued using Level 3 inputs had a carrying amount of $557,000 and valuation allowances of $119,000.

Once a loan is foreclosed, the fair value of the real estate owned continues to be evaluated based upon the market value of the repossessed real estate originally securing the loan. At September 30, 2018, foreclosed real estate with a carrying value that had been written down utilizing Level 3 inputs during the nine months ended September 30, 2018 comprised of four properties with a fair value of $1.7 million and resulted in an additional provision for loan losses of $181,000 and subsequent write-downs recorded in non-interest expense of $22,000. At December 31, 2017, foreclosed real estate with a carrying value that had been written down utilizing Level 3 inputs during the year ended December 31, 2017 comprised of two properties with a fair value of $399,000 and resulted in an additional provision for loan losses of $75,000 and subsequent write-downs recorded in non-interest expense of $15,000.

The carrying amount and estimated fair value of the Company’s financial instruments, whether carried at cost or fair value, are as follows:


	Fair Value Measurements at September 30, 2018
	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	38,069	$	38,069	$	38,069	$	-	$	-
Securities available for sale		83,147		83,147		1,889		81,258		-
Federal Home Loan Bank stock		1,545		1,545		-		1,545		-
Loans receivable, net		388,437		371,524		-		-		371,524
Accrued interest receivable		2,044		2,044		-		2,044		-
Financial liabilities:
Deposits		435,901		438,844		-		438,844		-
Long-term debt		24,650		23,972		-		23,972		-
Accrued interest payable		84		84		-		84		-
Off-balance-sheet financial instruments		-		-		-		-		-


	Fair Value Measurements at December 31, 2017
	Carrying		Estimated		Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Other Unobservable Inputs
	Amount		Fair Value		(Level 1)		(Level 2)		(Level 3)
	(Dollars in thousands)
Financial assets:
Cash and cash equivalents	$	40,913	$	40,913	$	40,913	$	-	$	-
Securities available for sale		80,421		80,421		1,987		78,090		344
Federal Home Loan Bank stock		1,631		1,631		-		1,631		-
Loans receivable, net		365,063		356,275		-		-		356,275
Accrued interest receivable		1,801		1,801		-		1,801		-
Financial liabilities:
Deposits		405,153		408,348		-		408,348		-
Long-term debt		26,950		26,634		-		26,634		-
Accrued interest payable		57		57		-		57		-
Off-balance-sheet financial instruments		-		-		-		-		-

Note 9 – Treasury Stock

During the three months ended September 30, 2018, the Company repurchased 12,100 shares of common stock at an average cost of $17.24 per share. During the nine months ended September 30, 2018, the Company repurchased 46,400 shares of common stock at an average cost of $16.81 per share. These shares were repurchased pursuant to the Company’s publicly announced common stock repurchase program. As of September 30, 2018, there were 108,090 shares remaining to be repurchased under the existing stock repurchase program. During the nine months ended September 30, 2018, the Company transferred 5,329 shares of common stock out of treasury stock reserved for the 2012 Equity Incentive Plan, at an average cost of $9.39 per share to fund awards that had been granted under the plan. During the three and nine months ended September 30, 2018, there were 795 and 10,433 shares, respectively, transferred back into treasury stock reserved for the 2012 Equity Incentive Plan at an average cost of $9.81 and $9.42 per share, respectively, due to stock forfeitures.

During the three months ended September 30, 2017, the Company repurchased 3,600 shares of common stock at an average cost of $15.85 per share. During the nine months ended September 30, 2017, the Company repurchased 17,100 shares of common stock at an average cost of $15.75 per share. These shares were repurchased pursuant to the Company’s publicly announced common stock repurchase program. As of September 30, 2017, there were 67,401 shares remaining to be repurchased under the existing stock repurchase program. During the nine months ended September 30, 2017, the Company transferred 27,348 shares of common stock out of the treasury stock reserved for the 2012 Equity Incentive Plan, at an average cost of $9.88 per share to fund awards that had been granted under the plan. During the three and nine months ended September 30, 2017, there were 904 and 1,104 shares, respectively, transferred back into treasury stock reserved for the 2012 Equity Incentive Plan at an average cost of $9.59 and $9.58 per share, respectively, due to stock forfeitures.

Note 10 – Other Comprehensive Loss

In addition to presenting the Consolidated Statements of Comprehensive Income herein, the following table shows the tax effects allocated to the Company’s single component of other comprehensive loss for the periods presented:


	For the Three Months Ended September 30, 2018						For The Three Months Ended September 30, 2017
	Pre-Tax Amount		Tax Benefit		Net of Tax Amount		Pre-Tax Amount		Tax Benefit		Net of Tax Amount
	(Unaudited)
	(Dollars in thousands)
Net unrealized losses on securities available for sale:
Net unrealized losses arising during the period	$	(591)	$	124	$	(467)	$	(91)	$	31	$	(60)
Less: reclassification adjustment related to:
Recovery on previously impaired investment securities included in net income		(34)		7		(27)		(25)		9		(16)
Gain on sale of securities included in net income		-		-		-		(22)		7		(15)
Total Other Comprehensive Loss	$	(625)	$	131	$	(494)	$	(138)	$	47	$	(91)


	For the Nine Months Ended September 30, 2018						For The Nine Months Ended September 30, 2017
	Pre-Tax Amount		Tax Benefit		Net of Tax Amount		Pre-Tax Amount		Tax Benefit			Net of Tax Amount
	(Unaudited)
	(Dollars in thousands)
Net unrealized losses on securities available for sale:
Net unrealized losses arising during the period	$	(1,828)	$	384	$	(1,444)	$	(51)	$	17	$	(34)
Less: reclassification adjustment related to:
Recovery on previously impaired investment securities included in net income		(124)		26		(98)		(96)		33		(63)
Gain on sale of securities included in net income		-		-		-		(244)		83		(161)
Total Other Comprehensive Loss	$	(1,952)	$	410	$	(1,542)	$	(391)	$	133	$	(258)

The following table presents the amounts reclassified out of the single component of the Company’s accumulated other comprehensive loss for the indicated periods:


	Amounts Reclassified from Accumulated
Details about Accumulated Other	Other Comprehensive Loss				Affected Line Item
Comprehensive Loss	for the three months ended September 30,				on the Consolidated
Components	2018		2017		Statements of Income
	(Dollars in thousands)
Net unrealized gains and losses on securities available for sale:
Recovery on previously impaired investment securities	$	(34)	$	(25)	Recovery on previously impaired investment securities
Sale of securities		-		(22)	Gain on sale of securities available for sale
		(34)		(47)
Provision for income tax benefit		7		16	Income Tax Expense
Total reclassification for the period	$	(27)	$	(31)	Net Income


	Amounts Reclassified from Accumulated
Details about Accumulated Other	Other Comprehensive Loss				Affected Line Item
Comprehensive Loss	for the nine months ended September 30,				on the Consolidated
Components	2018		2017		Statements of Income
	(Dollars in thousands)
Net unrealized gains and losses on securities available for sale:
Recovery on previously impaired investment securities	$	(124)	$	(96)	Recovery on previously impaired investment securities
Sale of securities		-		(244)	Gain on sale of securities available for sale
		(124)		(340)
Provision for income tax benefit		26		116	Income Tax Expense
Total reclassification for the period	$	(98)	$	(224)	Net Income

Note 11 – Revenue Recognition

As of January 1, 2018, the Company adopted FASB ASU 2014-09 “Revenue from Contracts with Customers (Topic 606)” (“ASU 2014-09”) for non-interest revenue streams. The Company has elected to apply ASU 2014-09 using the modified retrospective method. The implementation of the new standard did not have a material impact on the measurement or recognition of revenue; and as such, a cumulative effect adjustment to retained earnings was not deemed necessary under the modified retrospective implementation method. The adoption of ASU 2014-09 did, however, require additional disclosures.

The Company’s non-interest revenue streams primarily result from services it provides to its deposit customers. When a customer makes a deposit, the Company records a liability under ASC 405 because the Company has an obligation to deliver cash to its customer on demand. A contract between the Company and a deposit account customer is typically documented in writing and is often terminable at will by the customer alone or by both the customer and the Company without penalty. The term of a deposit contract between a customer and the Company will likely be day-to-day or minute-to-minute, and the termination clause is likely similar to a renewal right where each day or minute represents the renewal of the contract. The Company generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers. The Company’s primary non-interest revenue streams within the scope of ASU 2014-

09 are described in further detail below. The Company has no material unsatisfied performance obligations as of September 30, 2018.

Service Charges on Deposit Accounts

Service charges and fees on deposit accounts consist of transaction-based fees, account maintenance fees, and overdraft service fees for various retail and business deposit customers. Transaction-based fees, such as stop payment charges, are recognized at the time the Company fulfills the customer’s request. Account maintenance fees, which relate primarily to monthly maintenance, are earned over the course of a month, representing the period over which the Company satisfies the performance obligation. Overdraft fees are recognized at the point in time that the overdraft occurs. Service charges on deposits are withdrawn directly from the customer’s account balance.

Fees, Interchange Income, and Other Service Charges

Fees, interchange income, and other service charges are primarily comprised of debit card income, ATM fees, merchant services income and other service charges. Debit card income is primarily comprised of interchange fees earned whenever the Company’s debit cards are used to purchase goods or services from a merchant via a card payment network, such as MasterCard. Interchange fees from cardholder transactions represent a percentage of the underlying transaction value. ATM fees are comprised of fees earned whenever a Company’s ATM or debit card is used at a non-Company ATM or a non-Company cardholder uses a Company ATM. ATM fees represent a fixed fee for the convenience to cardholders for accessibility of funds. Merchant services income mainly represents fees charged to merchants serviced by a third party vendor under contract with the Company for debit or credit card processing, and represents a percentage of the underlying transaction value. Other service charges include revenue from services provided to our retail or business customers, which may include fees for wire transfer processing, bill pay services, cashier’s checks and other services. The Company’s performance obligation for fees, interchange income and other service charges are largely satisfied, and related revenue recognized, when the services are rendered or upon completion. Payment is typically immediately or in the following month.

Other

Other non-interest income consists of safe deposit rental fees. Safe deposit box rental fees are charged to the customer on an annual basis and recognized upon receipt of payment. The Company determined that since rentals and renewals occur fairly consistently over time, revenue is recognized on a basis consistent with the duration of the performance obligation.

Gain/Losses on Sale of OREO

The Company records a gain or loss from the sale of OREO when control of the property transfers to the buyer, which generally occurs at the time of an executed deed. When the Company finances the sale of OREO to the buyer, the Company assesses whether the buyer is committed to perform their obligations under the contract and whether collectability of the transaction price is probable. Once these criteria are met, the OREO asset is derecognized and the gain or loss on sale is recorded upon the transfer of control of the property to the buyer. In determining the gain or loss on the sale, the Company adjusts the transaction price and related gain (loss) on sale if a significant financing component is present. There were no sales of OREO in which the Company financed the sale during the three and nine months ended September 30, 2018.

Contract Balances

The Company’s non-interest revenue streams are largely based on transactional activity. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not experience significant contract balances. As of September 30, 2018 and December 31, 2017, the Company did not have any significant contract balances.

The following presents non-interest income, segregated by revenue streams in-scope and out-of-scope of Topic 606, for the three and nine months ended September 30, 2018 and 2017:


	For the Three Months Ended				For the Nine Months Ended
	September 30, 2018		September 30, 2017		September 30, 2018		September 30, 2017
	(Dollars in thousands)
Non-Interest Income
In-Scope of Topic 606:
Service charges on deposit accounts	$	218	$	221	$	655	$	690
Fees, interchange income and other service charges		203		190		595		554
Other		9		9		30		30
Non-interest Income (in-scope of Topic 606)		430		420		1,280		1,274
Non-interest Income (out of scope of Topic 606)		199		197		596		780
Total Non-Interest Income	$	629	$	617	$	1,876	$	2,054

Note 12 – Subsequent Events

On October 24, 2018, the Board of Directors declared a quarterly cash dividend of $0.10 per share on the Company’s common stock, payable on November 19, 2018 to shareholders of record as of November 6, 2018. Lake Shore, MHC (the “MHC”), which holds 3,636,875 shares, or approximately 60.4% of the Company’s total outstanding stock, elected to waive its right to receive this cash dividend of approximately $364,000. On March 9, 2018, the MHC received the non-objection of the Federal Reserve Bank of Philadelphia to waive its right to receive dividends paid by the Company during the twelve months ending February 7, 2019, aggregating up to $0.40 per share. The MHC waived $364,000 of dividends during the three months ended September 30, 2018 and $1.1 million during the nine months ended September 30, 2018. Cumulatively, Lake Shore, MHC has waived approximately $10.5 million of cash dividends as of September 30, 2018. The dividends waived by Lake Shore, MHC are considered a restriction on the retained earnings of the Company.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements may be identified by words such as “believe,” “will,” “expect,” “project,” “may,” “could,” “anticipate,” “estimate,” “intend,” “plan,” “targets” and similar expressions. These statements are based upon our current beliefs and expectations and are subject to significant risks and uncertainties. Actual results may differ materially from those set forth in the forward-looking statements as a result of numerous factors.

The following factors, including the factors set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q (if applicable) and in Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in our forward-looking statements:

general and local economic conditions;

changes in interest rates, deposit flows, demand for mortgages and other loans, real estate values and competition;

the ability of our customers to make loan payments;

the effect of competition on rates of deposit and loan growth and net interest margin;

our ability to continue to control costs and expenses;

changes in accounting principles, policies or guidelines;

our success in managing the risks involved in our business;

inflation, and market and monetary fluctuations;

the impact of more stringent capital requirements being imposed by banking regulators;

changes in legislation or regulation, including the implementation of the Dodd-Frank Act; and

other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services.

Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q and in any other public statements we make may differ from actual outcomes. They can be affected by inaccurate assumptions we might make or known or unknown risks and uncertainties. Consequently, no forward-looking statements can be guaranteed. We undertake no obligation to publicly update any forward looking statement, whether as a result of new information, future events or otherwise. For a more complete discussion of certain risks, uncertainties and other factors affecting the Company, refer to the Company’s Risk Factors, contained in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Overview

The following discussion and analysis is presented to assist in the understanding and evaluation of our consolidated financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements and notes thereto appearing elsewhere in this Form 10-Q and should be read in conjunction therewith. The detailed discussion focuses on our consolidated financial condition as of September 30, 2018 compared to the consolidated financial condition as of December 31, 2017 and the consolidated results of operations for the three and nine months ended September 30, 2018 and 2017.

Our results of operations depend primarily on our net interest income, which is the difference between the interest income we earn on loans and investments and the interest expense we pay on deposits, borrowings and other interest-bearing liabilities. Net interest income is affected by the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates we earn or pay on these balances.

Our operations are also affected by non-interest income, such as service charges and fees and gains and losses on the sales of securities and loans, our provision for loan losses and non-interest expenses which include salaries and employee benefits, occupancy and equipment costs, data processing, professional services, advertising and other general and administrative expenses.

Financial institutions like us, in general, are significantly affected by economic conditions, competition, and the monetary and fiscal policies of the federal government. Lending activities are influenced by the demand for and supply of housing and commercial real estate, competition among lenders, interest rate conditions, and funds availability. Our operations and lending are principally concentrated in the Western New York area, and our operations and earnings are influenced by local economic conditions. Deposit balances and cost of funds are influenced by prevailing market rates on competing investments, customer preferences, and levels of personal income and savings in our primary market area. Operations are also significantly impacted by government policies and actions of regulatory authorities. Future changes in applicable law, regulations or government policies may materially impact the Company.

To operate successfully, we must manage various types of risk, including but not limited to, interest rate risk, credit risk, liquidity risk, operational and information technology risks, strategic risk, reputation risk and compliance risk. A significant form of market risk for the Company is interest rate risk, as the Company’s assets and liabilities are sensitive to changes in interest rates. Interest rate risk is the exposure of our net interest income to adverse movements in interest rates. Net interest income is our primary source of revenue and interest rate risk is a significant non-credit related risk to which our Company is exposed. Net interest income is affected by changes in interest rates as well as fluctuations in the level and duration of our assets and liabilities. In addition to directly impacting net interest income, changes in interest rates can also affect the amount of new loan originations, the ability of borrowers and debt issuers to repay loans and debt securities, the volume of loan repayments and refinancing, the flow and mix of deposits and the fair value of available for sale securities. In recent years, the Company has adjusted its strategies to manage interest rate risk by originating a greater volume of shorter-term, adjustable rate commercial real estate and commercial business loans and increasing its concentration of core deposits, which are less interest rate sensitive. In the third quarter of 2018 the Company entered into an interest rate swap arrangement with a notional amount of $3.0 million to convert a portion of its fixed rate residential, one- to four-family real estate loans into adjustable rate interest-earning assets, to better manage its exposure to movements in interest rates.

Credit risk is the risk to our earnings and stockholders’ equity that results from customers, to whom loans have been made, and from issuers of debt securities in which the Company has invested, failing to repay their obligations. The magnitude of this risk depends on the capacity and willingness of borrowers and debt issuers to repay and the sufficiency of the value of collateral obtained to secure the loans made or investments purchased. This risk is managed by policies approved by the Company’s Board of Directors, review of compliance with the policies and periodic reporting and evaluation of loans or securities that are non-performing or demonstrate other characteristics of potential loss.

Management Strategy

There have been no material changes in the Company’s management strategy from what was disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

Critical Accounting Policies

Disclosure of the Company’s significant accounting policies is included in the notes to the consolidated financial statements of the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. Some of these policies require significant judgment, estimates and assumptions to be made by management, most particularly in connection with determining the provision for loan losses and the appropriate level of the allowance for loan losses, as well as management’s evaluation of securities valuation, impairment of securities and income taxes. There have been no material changes in critical accounting policies since December 31, 2017.

Analysis of Net Interest Income

Net interest income represents the difference between the interest we earn on our interest-earning assets, such as commercial loans, residential mortgage loans and investment securities, and the expense we pay on interest-bearing liabilities, such as deposits and borrowings. Net interest income depends on both the volume of our interest-earning assets and interest-bearing liabilities and the interest rates we earn or pay on them.

Average Balances, Interest and Average Yields. The following tables set forth certain information relating to our average balance sheet and reflect the average yield on interest-earning assets and average cost of interest-bearing liabilities, interest earned and interest paid for the periods indicated. Such yields and costs are derived by dividing interest income or expense by the average balance of interest-earning assets or interest-bearing liabilities, respectively, for the periods indicated. Average balances are derived from daily balances over the periods indicated. The average balances for loans are net of allowance for loan losses, but include non-accrual

loans. Interest income on securities does not include a tax equivalent adjustment for bank qualified municipal bonds.


	For the Three Months Ended					For the Three Months Ended
	September 30, 2018					September 30, 2017
	Average		Interest Income/		Yield/	Average		Interest Income/		Yield/
	Balance		Expense		Rate(2)	Balance		Expense		Rate(2)
	(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	32,972	$	157	1.90%	$	31,466	$	81	1.03%
Securities(1)		85,797		670	3.12%		76,678		577	3.01%
Loans		383,810		4,663	4.86%		362,198		4,289	4.74%
Total interest-earning assets		502,579		5,490	4.37%		470,342		4,947	4.21%
Other assets		40,089					37,924
Total assets	$	542,668				$	508,266

Interest-bearing liabilities
Demand & NOW accounts	$	51,223	$	15	0.12%	$	49,850	$	16	0.13%
Money market accounts		118,713		238	0.80%		87,099		72	0.33%
Savings accounts		52,825		8	0.06%		54,211		8	0.06%
Time deposits		150,178		522	1.39%		146,987		427	1.16%
Borrowed funds & other interest-bearing liabilities		25,466		172	2.70%		27,806		159	2.29%
Total interest-bearing liabilities		398,405		955	0.96%		365,953		682	0.75%
Other non-interest bearing liabilities		65,101					64,080
Stockholders' equity		79,162					78,233
Total liabilities & stockholders' equity	$	542,668				$	508,266
Net interest income			$	4,535				$	4,265
Interest rate spread					3.41%					3.46%
Net interest margin					3.61%					3.63%

⁽¹⁾

The tax equivalent adjustment for bank qualified municipal securities results in rates of 3.62% and 4.05% for the three months ended September 30, 2018 and 2017, respectively.

⁽²⁾

Annualized.

	For the Nine Months Ended					For the Nine Months Ended
	September 30, 2018					September 30, 2017
	Average		Interest Income/		Yield/	Average		Interest Income/		Yield/
	Balance		Expense		Rate(2)	Balance		Expense		Rate(2)
	(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	35,002	$	439	1.67%	$	29,798	$	167	0.75%
Securities(1)		83,481		1,946	3.11%		81,737		1,856	3.03%
Loans		375,989		13,480	4.78%		348,716		12,456	4.76%
Total interest-earning assets		494,472		15,865	4.28%		460,251		14,479	4.19%
Other assets		38,754					37,325
Total assets	$	533,226				$	497,576

Interest-bearing liabilities
Demand & NOW accounts	$	50,466	$	42	0.11%	$	50,688	$	48	0.13%
Money market accounts		112,796		572	0.68%		83,694		183	0.29%
Savings accounts		53,070		23	0.06%		53,933		23	0.06%
Time deposits		149,611		1,464	1.30%		147,664		1,245	1.12%
Borrowed funds & other interest-bearing liabilities		26,834		490	2.43%		22,678		390	2.29%
Total interest-bearing liabilities		392,777		2,591	0.88%		358,657		1,889	0.70%
Other non-interest bearing liabilities		61,645					61,424
Stockholders' equity		78,804					77,495
Total liabilities & stockholders' equity	$	533,226				$	497,576
Net interest income			$	13,274				$	12,590
Interest rate spread					3.40%					3.49%
Net interest margin					3.58%					3.65%

⁽¹⁾

The tax equivalent adjustment for bank qualified municipal securities results in rates of 3.61% and 4.09% for the nine months ended September 30, 2018 and 2017, respectively.

⁽²⁾

Annualized.

Rate Volume Analysis. The following tables analyze the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. The tables show the amount of the change in interest income or expense caused by either changes in outstanding balances (volume) or changes in interest rates. The effect of a change in volume is measured by applying the average rate during the first period to the volume change between the two periods. The effect of changes in rate is measured by applying the change in rate between the two periods to the average volume during the first period. Changes attributable to both rate and volume, which cannot be segregated, have been allocated proportionately to the absolute value of the change due to volume and the change due to rate.

	Three Months Ended September 30, 2018
	Compared to
	Three Months Ended September 30, 2017
	Rate		Volume		Net Change
		(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	72	$	4	$	76
Securities		22		71		93
Loans, including fees		113		261		374
Total interest-earning assets		207		336		543
Interest-bearing liabilities:
Demand & NOW accounts		(1)		-		(1)
Money market accounts		132		34		166
Savings accounts		-		-		-
Time deposits		86		9		95
Total deposits		217		43		260
Other interest-bearing liabilities:
Borrowed funds & other interest-bearing liabilities		26		(13)		13
Total interest-bearing liabilities		243		30		273
Total change in net interest income	$	(36)	$	306	$	270


	Nine Months Ended September 30, 2018
	Compared to
	Nine Months Ended September 30, 2017
	Rate		Volume			Net Change
	(Dollars in thousands)
Interest-earning assets:
Interest-earning deposits & federal funds sold	$	238	$	34	$	272
Securities		50		40		90
Loans, including fees		46		978		1,024
Total interest-earning assets		334		1,052		1,386
Interest-bearing liabilities:
Demand & NOW accounts		(6)		-		(6)
Money market accounts		308		81		389
Savings accounts		-		-		-
Time deposits		202		17		219
Total deposits		504		98		602
Other interest-bearing liabilities:
Borrowed funds & other interest-bearing liabilities		38		62		100
Total interest-bearing liabilities		542		160		702
Total change in net interest income	$	(208)	$	892	$	684

The average balance of the loan portfolio increased by $21.6 million, or 6.0%, during the three months ended September 30, 2018 as compared to the third quarter of 2017. This increase was primarily due to an increase in the average balance of higher yielding commercial real estate, home equity and commercial business loans, which increased the overall average yield of interest-earning assets by 16 basis points during the third quarter

of 2018. The 21 basis points increase in the average interest rate paid on interest bearing liabilities during the three month period ended September 30, 2018 as compared to third quarter 2017 was primarily due to an increase in the average interest rates being paid on money market accounts, time deposit accounts and borrowings as a result of an increase in market rates and competition for deposit accounts. The net interest margin and interest rate spread decreased by two basis points and five basis points, respectively, for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017, primarily due to the increase in the average interest rate being paid on interest bearing liabilities during the third quarter of 2018.

The average balance of the loan portfolio increased by $27.3 million, or 7.8%, during the nine months ended September 30, 2018 as compared to the same nine month period in 2017. The increase in the average balance of the loan portfolio was primarily due to an increase in the average balance of higher yielding commercial real estate, home equity and commercial business loans, which increased the overall average yield of interest-earning assets by nine basis points during the nine months ended September 30, 2018. The 18 basis points increase in the average interest rate paid on interest bearing liabilities during the nine months ended September 30, 2018 as compared to the same period in 2017 was primarily due to an increase in the average interest rates being paid on money market accounts, time deposit accounts and borrowings as a result of an increase in market rates and competition for deposit accounts. The net interest margin and interest rate spread decreased by seven basis points and nine basis points, respectively, for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, primarily due to the increase in the average interest rate being paid on interest bearing liabilities during the nine months ended September 30, 2018.

Comparison of Financial Condition at September 30, 2018 and December 30, 2017

Total assets at September 30, 2018 were $546.2 million, an increase of $27.2 million, or 5.2%, from $519.0 million at December 31, 2017. The increase in total assets was primarily due to a $23.4 million increase in loans receivable, a $2.7 million increase in securities available for sale, a $2.0 million increase in bank owned life insurance, and a $1.7 million increase in other assets partially offset by a $2.8 million decrease in cash and cash equivalents.

Cash and cash equivalents decreased by $2.8 million, or 7.0%, from $40.9 million at December 31, 2017 to $38.1 million at September 30, 2018. The decrease was primarily due to a net cash outflow of $25.4 million relating to net loan originations and principal collections and a net cash outflow of $4.6 million for purchases, sales and maturities on the investment portfolio, partially offset by a $30.7 million increase in deposits during the nine months ended September 30, 2018.

Securities available for sale increased by $2.7 million, or 3.4%, to $83.1 million at September 30, 2018 compared to $80.4 million at December 31, 2017. The increase was primarily due to $10.8 million of new securities purchased, partially offset by the receipt of $6.2 million for maturities, prepayments and calls of securities and $2.0 million of unrealized losses on the securities portfolio during the nine months ended September 30, 2018. The unrealized losses on the securities portfolio were primarily due to an increase in market interest rates during the first nine months of 2018.

Net loans receivable increased during the nine months ended September 30, 2018 as shown in the table below:


	At September 30,		At December 31,		Change
	2018		2017		$		%
	(Dollars in thousands)
Real Estate Loans:
Residential, one- to four-family	$	148,446	$	144,565	$	3,881	2.7	%
Home equity		41,132		38,078		3,054	8.0	%
Commercial		148,725		122,747		25,978	21.2	%
Construction - Commercial		22,150		30,802		(8,652)	(28.1)	%
Construction - Residential, one- to four-family		346		49		297	606.1	%
Total real estate loans		360,799		336,241		24,558	7.3	%
Other Loans:
Commercial		26,410		27,612		(1,202)	(4.4)	%
Consumer		1,332		1,355		(23)	(1.7)	%
Total gross loans		388,541		365,208		23,333	6.4	%
Allowance for loan losses		(3,388)		(3,283)		(105)	3.2	%
Net deferred loan costs		3,284		3,138		146	4.7	%
Loans receivable, net	$	388,437	$	365,063	$	23,374	6.4	%

As fixed rate one- to four-family residential real estate loans present additional interest rate risk to our loan portfolio as a result of the longer duration of these types of assets, we remain strategically focused in 2018 on originating shorter duration commercial real estate and commercial business loans to diversify our asset mix, to reduce interest rate risk, to take advantage of the opportunities available to serve small businesses in our market area, and to increase our net interest margin.

Loans Past Due and Non-Performing Assets. The following table presents information regarding our non-accrual loans, accruing loans delinquent 90 days or more, non-performing loans, foreclosed real estate, and non-performing and performing loans classified as troubled debt restructurings, as of the dates indicated.


	At September 30,			At December 31,
	2018			2017
	(Dollars in thousands)
Loans past due 90 days or more but still accruing:
Real estate loans:
Residential, one- to four-family	$	-		$	-
Home equity		10			-
Commercial		-			-
Construction – Commercial and Residential, one- to four-family		-			-
Other loans:
Commercial		-			-
Consumer		-			-
Total	$	10		$	-
Loans accounted for on a non-accrual basis:
Real estate loans:
Residential, one- to four-family	$	2,187		$	2,196
Home equity		336			235
Commercial		665			1,323
Construction – Commercial and Residential, one- to four-family		-			-
Other loans:
Commercial		76			54
Consumer		-			25
Total non-accrual loans		3,264			3,833
Total non-performing loans		3,274			3,833
Foreclosed real estate		1,710			435
Total non-performing assets	$	4,984		$	4,268
Ratios:
Non-performing loans as a percent of total loans:		0.84	%		1.05	%
Non-performing assets as a percent of total assets:		0.91	%		0.82	%
Troubled debt restructuring:
Loans accounted for on a non-accrual basis
Real estate loans:
Home equity	$	19		$	19
Performing loans
Real estate loans:
Residential, one- to four-family	$	179		$	184
Home equity		-			2

Total non-performing loans decreased by $559,000, or 14.6%, to $3.3 million at September 30, 2018 from $3.8 million at December 31, 2017, primarily due to the foreclosure of two non-performing commercial real estate loans during the first nine months of 2018.

The following table sets forth activity in our allowance for loan losses and other ratios at or for the dates indicated.


	At or for the Nine Months Ended September 30,
	2018		2017
	(Dollars in thousands)
Balance at beginning of period	$	3,283	$	2,882
Provision for loan losses		315		450
Charge-offs:
Real estate loans:
Residential, one- to four-family		(23)		-
Home equity		-		(3)
Commercial		(181)		(75)
Construction – Commercial and Residential, one- to four-family		-		-
Other loans:
Commercial		-		(20)
Consumer		(32)		(36)
Total charge-offs		(236)		(134)
Recoveries:
Real estate loans:
Residential, one- to four-family		18		2
Home equity		1		4
Commercial		-		-
Construction – Commercial and Residential, one- to four-family		-		-
Other loans:
Commercial		1		1
Consumer		6		12
Total recoveries		26		19
Net charge-offs		(210)		(115)
Balance at end of period	$	3,388	$	3,217
Average loans outstanding	$	375,989	$	348,716
Allowance for loan losses as a percent of total net loans		0.87%		0.89%
Allowance for loan losses as a percent of non-performing loans		103.48%		85.83%
Ratio of net charge-offs to average loans outstanding(1)		0.07%		0.04%

(1) Annualized

Bank owned life insurance (“BOLI”) increased by $2.0 million, or 11.2%, to $20.1 million at September 30, 2018 as compared to $18.1 million at December 31, 2017. During the nine months ended September 2018, the Company purchased an additional $1.8 million of BOLI to offset the costs of benefits provided under an employee retention agreement entered into during 2018.

The table below shows changes in deposit balances by type of deposit account between September 30, 2018 and December 31, 2017:


	At September 30,		At December 31,		Change
	2018		2017		$		%
	(Dollars in thousands)
Core Deposits
Demand deposits and NOW accounts:
Non-interest bearing	$	59,009	$	54,618	$	4,391	8.0	%
Interest bearing		55,322		49,869		5,453	10.9	%
Money market		117,224		99,305		17,919	18.0	%
Savings		52,164		52,922		(758)	(1.4)	%
Total core deposits		283,719		256,714		27,005	10.5	%
Non-core Deposits
Time deposits		152,182		148,439		3,743	2.5	%
Total deposits	$	435,901	$	405,153	$	30,748	7.6	%

The increase in total deposits was primarily due to growth in core deposits. The growth in core deposits was the result of the Company’s continued strategic focus on growing lower-cost core deposits among its retail and commercial customers in an effort to manage interest expense and strengthen customer relationships.

Our borrowings, consisting of advances from the Federal Home Loan Bank of New York (“FHLBNY”), decreased by $2.3 million, or 8.5%, from $27.0 million at December 31, 2017 to $24.7 million at September 30, 2018. The decrease was due to the use of excess liquidity to pay off long-term debt which matured during the first nine months of 2018.

Total stockholders’ equity increased $426,000, or 0.5%, from $78.4 million at December 31, 2017 to $78.8 million at September 30, 2018. The increase in stockholders’ equity was primarily due to net income of $3.0 million and a $151,000 increase in additional paid in capital attributed to stock based compensation, partially offset by $1.4 million in other comprehensive losses, $780,000 of treasury stock repurchases and $686,000 in cash dividends paid during the first nine months of 2018.

Comparison of Results of Operations for the Three Months Ended September 30, 2018 and 2017

General. Net income was $1.1 million for the three months ended September 30, 2018, or $0.17 per diluted share, an increase of $118,000, or 12.6%, compared to net income of $940,000, or $0.15 per diluted share, for the three months ended September 30, 2017. Net income for the three months ended September 30, 2018 reflected a $270,000 increase in net interest income and an $110,000 decrease in income tax expense which was partially offset by a $224,000 increase in non-interest expenses and a $50,000 increase in provision for loan losses.

Interest Income. Interest income increased by $543,000, or 11.0%, for the three months ended September 30, 2018 to $5.5 million compared to the three months ended September 30, 2017 primarily due to an increase in loan interest income. Loan interest income increased by $374,000, or 8.7%, to $4.7 million for the three months ended September 30, 2018 compared to the three months ended September 30, 2017, primarily due to an increase in the average balance of the loan portfolio of $21.6 million, or 6.0%, from $362.2 million for the three months ended September 30, 2017 to $383.8 million for the three months ended September 30, 2018. The

average yield on the loan portfolio increased from 4.74% for the three months ended September 30, 2017 to 4.86% for the three months ended September 30, 2018. The increase in the average balance of loans and average yield was primarily due to an increase in the average balance of higher yielding commercial real estate, home equity and commercial business loans.

Investment interest income increased $93,000, or 16.1%, to $670,000 for the three months ended September 30, 2018 compared to the three months ended September 30, 2017. The average balance and average yield on the investment portfolio increased from $76.7 million and 3.01% for the three months ended September 30, 2017 to $85.8 million and 3.12% for the three months ended September 30, 2018. The increase in the average balance and average yield of the investment portfolio was primarily due to the purchase of higher yielding securities, which was partially offset by paydowns received on lower yielding securities since September 30, 2017.

Other interest income was $157,000 for the three months ended September 30, 2018, a $76,000, or 93.8%, increase as compared to the three months ended September 30, 2017. This increase was primarily due to an 87 basis points increase in the average yield on the interest-earning deposits and federal funds sold portfolio. The average yield increased from 1.03% for the three months ended September 30, 2017 to 1.90% for the three months ended September 30, 2018. The average yield increased as a result of a 100 basis points increase in the fed funds rate since September 30, 2017. The average balance of the interest-earning deposits and federal funds sold portfolio increased by $1.5 million, or 4.8%, from $31.5 million for the three months ended September 30, 2017 to $33.0 million for the three months ended September 30, 2018. The increase in the average balance was primarily due to an increase in deposits that have not yet been utilized to fund loan originations or securities purchases.

Interest Expense. Interest expense increased $273,000, or 40.0%, to $955,000 for the three months ended September 30, 2018 compared to $682,000 for the three months ended September 30, 2017 primarily due to an increase in interest paid on deposits. Interest paid on deposits increased by $260,000, or 49.7%, to $783,000 for the three months ended September 30, 2018 when compared to the three months ended September 30, 2017. Interest expense was primarily impacted by a 47 and 23 basis points increase, respectively, in the average interest rates paid on money market and time deposit accounts as a result of the increase in short term interest rates since September 30, 2017. The increase was also due to a $31.6 million increase in average core deposits for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017 as a result of the Company’s continued strategic focus on growing lower cost core deposits. The average balance of deposits for the three months ended September 30, 2018 was $372.9 million with an average rate of 0.84% compared to the average balance of deposits of $338.1 million and an average rate of 0.62% for the three months ended September 30, 2017.

Provision for Loan Losses. A $125,000 provision to the allowance for loan losses was recorded during the three months ended September 30, 2018, which was a $50,000, or 66.7%, increase in comparison to the provision recorded during the three months ended September 30, 2017. The increase in the provision expense was primarily due to a $121,000 increase in reserves related to charge-offs on two previously impaired commercial real estate loans that were foreclosed upon during the third quarter of 2018.

The $125,000 provision recorded during the three months ended September 30, 2018 was a result of a comprehensive quarterly evaluation. The evaluation reflects analyses of individual borrowers and historical

loss experience, supplemented as necessary by credit judgment that considers observable trends, conditions, and other relevant environmental and economic factors. The quarterly evaluation consisted of the following:

$249,000 provision for commercial real estate loans, which included a:

$150,000 general allowance on performing commercial real estate loans, primarily due to an $11.8 million net increase in the loan portfolio during the three months ended September 30, 2018 to reflect inherent losses within the portfolio;

$121,000 specific allowance related to charge-offs on two previously impaired commercial real estate loans that were foreclosed upon during the third quarter of 2018; which was partially offset by a

$22,000 credit provision for a decrease in criticized/classified commercial real estate loans; and a

$128,000 credit provision for commercial real estate – construction loans and commercial business loans as a result of a $7.1 million and $3.3 million decrease, respectively, in commercial - construction loans and commercial business loans during the third quarter of 2018.

During the three months ended September 30, 2017, the Company recorded a $75,000 provision to the allowance for loan losses. The quarterly evaluation consisted of the following:

$145,000 net credit provision for commercial real estate loans which included a:

$175,000 credit provision attributed to the reduction in the reserve for one substandard criticized commercial real estate loan during the quarter, which was partially offset by a;

$30,000 provision recorded for a $264,000 increase in special mention criticized commercial real estate loans during the quarter;

$167,000 provision for commercial business loans primarily due to a $1.1 million increase in special mention criticized commercial business loans during the three months ended September 30, 2017;

$16,000 general allowance on performing construction loans due to a $1.3 million, or 4.5%, increase in the construction loan portfolio during the three months ended September 30, 2017 to reflect inherent losses within the portfolio;

$68,000 provision on one-to four-family, home equity and consumer loans primarily to reflect inherent losses within these portfolios as a result of an increase in the historical average net charge-off rates for these loan types, as well as in classified loans during the three months ended September 30, 2017; and a

$31,000 unallocated credit provision for loan losses during the three months ended September 30, 2017, to reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio.

Refer to Note 4 of the Notes to the Consolidated Financial Statements for additional details on the provision for loan losses.

Non-interest Income. Non-interest income increased by $12,000, or 1.9%, to $629,000 for the three months ended September 30, 2018 as compared to $617,000 for the three months ended September 30, 2017. The increase was primarily attributed to a $16,000 increase in service charges and fees, a $12,000 increase in earnings on bank owned life insurance and a $9,000 increase in recoveries on previously impaired investment securities during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. The increase was partially offset by there being no sales of securities during the third quarter of 2018 as compared to a $22,000 pre-tax realized gain on the sale of securities during the third quarter of 2017.

Non-interest Expenses. Non-interest expenses increased $224,000, or 6.2%, from $3.6 million for the three months ended September 30, 2017 to $3.8 million for the three months ended September 30, 2018. Salaries and employee benefits increased $185,000, or 9.8%, primarily due to annual salary increases and higher expenses related to health insurance, retirement benefits and stock compensation awards. Occupancy and equipment expenses increased $22,000, or 3.9%, primarily due to higher maintenance and repair expenses. Advertising expenses increased $24,000, or 18.9%, primarily due to the development of new marketing campaigns during the third quarter of 2018. Postage and supplies increased $18,000, or 34.0%, and data processing expenses increased $17,000, or 5.3%, during the third quarter of 2018 when compared to the third

quarter of 2017. These increases were partially offset by a decrease in other expenses of $50,000, or 13.1%, primarily due to a decrease in foreclosure related expenses.

Income Taxes Expense. Income tax expense decreased by $110,000, or 43.3%, from $254,000 for the three months ended September 30, 2017 to $144,000 for the three months ended September 30, 2018. The income tax expense decreased primarily due to a decrease in the effective tax rate, which was partially offset by an increase in income before income taxes. The effective tax rate for the three months ended September 30, 2018 was 12.0%, while the effective tax rate for the three months ended September 30, 2017 was 21.3%. The decrease in the effective tax rate was primarily due to the Tax Cuts and Jobs Act (“Tax Act”), which lowered the federal corporate tax rate from 34% to 21% as of January 1, 2018. The impact of the lower corporate tax rate was partially offset by a decrease in the projected mix of tax-exempt income derived from our municipal bond portfolio and bank-owned life insurance in relation to our projection of pre-tax income for the current year.

Comparison of Results of Operations for the Nine Months Ended September 30, 2018 and 2017

General. Net income was $3.0 million for the nine months ended September 30, 2018, or $0.49 per diluted share, an increase of $202,000, or 7.2%, compared to net income of $2.8 million, or $0.46 per diluted share, for the nine months ended September 30, 2017. Net income for the nine months ended September 30, 2018 reflected a $684,000 increase in net interest income, a $246,000 decrease in income tax expense and a $135,000 decrease in provision for loan losses which was partially offset by a $685,000 increase in non-interest expenses and a $178,000 decrease in non-interest income.

Interest Income. Interest income for the nine months ended September 30, 2018 was $15.9 million, an increase of $1.4 million, or 9.6%, compared to the nine months ended September 30, 2017 primarily due to an increase in loan interest income. Loan interest income increased by $1.0 million, or 8.2%, to $13.5 million for the nine months ended September 30, 2018 compared to $12.5 million for the nine months ended September 30, 2017, primarily due to an increase in the average balance of the loan portfolio of $27.3 million, or 7.8%, from $348.7 million for the nine months ended September 30, 2017 to $376.0 million for the nine months ended September 30, 2018. The increase in the average balance of loans was primarily due to an increase in the origination of higher yielding commercial real estate, home equity and commercial business loans. The average yield on the loan portfolio increased from 4.76% for the nine months ended September 30, 2017 to 4.78% for the nine months ended September 30, 2018 primarily due to net growth in the overall loan portfolio. The increase in the average yield was partially impacted by the prior year receipt of $202,000 of interest income on one non-performing commercial real estate loan which paid off during the first nine months of 2017. The average yield on the loan portfolio would have been 4.69% for the nine months ended September 30, 2017 if the $202,000 of interest income received on the non-performing loan payoff was excluded.

Investment interest income increased $90,000, or 4.9%, to $1.9 million for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017. The average yield on the investment portfolio increased from 3.03% for the nine months ended September 30, 2017 to 3.11% for the nine months ended September 30, 2018. The increase in the average yield was primarily due to the purchase of higher yielding securities and the paydowns of lower yielding securities. The average balance of the investment portfolio increased from $81.7 million for the nine months ended September 30, 2017 to $83.5 million for the nine months ended September 30, 2018. The increase was primarily due to the purchase of securities, which was partially offset by paydowns received on the securities portfolio since September 30, 2017.

Other interest income was $439,000 for the nine months ended September 30, 2018, a $272,000, or 162.8%, increase as compared to the nine months ended September 30, 2017. This increase was primarily due to a 92 basis points increase in the average yield on the interest-earning deposit and federal funds sold portfolio. The average yield increased from 0.75% for the nine months ended September 30, 2017 to 1.67% for the nine months ended September 30, 2018. The average yield increased as a result of a 100 basis points increase in the fed funds rate since September 30, 2017. The average balance of the interest-earning deposits and federal funds sold portfolio increased by $5.2 million, or 17.5%, from $29.8 million for the nine months ended September 30, 2017 to $35.0 million for the nine months ended September 30, 2018. The increase in the average balance

was primarily due to an increase in deposits that have not yet been utilized to fund loan originations or securities purchases.

Interest Expense. Interest expense increased $702,000, or 37.2%, to $2.6 million for the nine months ended September 30, 2018, when compared to the same nine month period in 2017. Interest paid on deposits increased by $602,000, or 40.2%, to $2.1 million for the nine months ended September 30, 2018 when compared to the nine months ended September 30, 2017. Deposit interest expense was primarily impacted by a 39 and 18 basis points increase, respectively, in the average interest rates paid on money market and time deposit accounts as a result of the increase in short term market interest rates since September 30, 2017. The increase was also due to a $28.0 million, or 14.9%, increase in average core deposits for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 as a result of the Company’s continued strategic focus on growing lower cost core deposits. The average balance of deposits for the nine months ended September 30, 2018 was $365.9 million with an average rate of 0.77% compared to the average balance of deposits of $336.0 million and an average rate of 0.59% for the nine months ended September 30, 2017.

Interest expense related to advances from the FHLBNY increased $85,000, or 25.9%, to $413,000 for the nine months ended September 30, 2018 when compared to the nine months ended September 30, 2017 primarily due to an increase in the average balance and average rate of FHLBNY advances. The average balance of advances from the FHLBNY for the nine months ended September 30, 2018 was $26.0 million with an average rate of 2.12% compared to an average balance of $21.8 million and an average rate of 2.01% for the nine months ended September 30, 2017. The increase in the average balance was due to additional borrowings that allowed the Bank to take advantage of low fixed-rates to fund loan growth and the increase in the average rate paid was primarily due to the increase in market interest rates since the nine months ended September 30, 2017.

Provision for Loan Losses. A $315,000 provision to the allowance for loan losses was recorded during the nine months ended September 30, 2018, which was a $135,000, or 30.0%, decrease in comparison to the provision recorded during the nine months ended September 30, 2017. The decrease in provision expense was primarily due to a higher provision being recorded for the downgrade in loan classification for two commercial loan relationships during the nine months ended September 30, 2017. As of September 30, 2018, these specific commercial loans were performing, and well collateralized by commercial real estate, as well as fixtures and equipment.

The $315,000 provision recorded during the nine months ended September 30, 2018 was a result of a comprehensive quarterly evaluation. The quarterly evaluation reflects analyses of individual borrowers and historical loss experience, supplemented as necessary by credit judgment that considers observable trends,

conditions, and other relevant environmental and economic factors. The quarterly evaluation consisted of the following:

$473,000 net provision for commercial real estate loans, which included a:

$304,000 general allowance on performing commercial real estate loans; primarily due to a $26.0 million, or 21.2%, increase in the loan portfolio since December 31, 2017, to reflect inherent losses within the portfolio;

$181,000 provision for charge-offs on two previously impaired commercial real estate loans that were foreclosed upon during the third quarter of 2018; which was partially offset by a

$12,000 credit to reflect a $1.1 million decrease in criticized/classified commercial real estate loans during the nine months ended September 30, 2018;

$65,000 provision for commercial business loans to reflect an increase in reserves on criticized and classified commercial business loans;

$98,000 credit provision on construction – commercial real estate loans, primarily due to a $8.7 million, or 28.1%, decrease in this loan portfolio since December 31, 2017;

$90,000 credit provision on one-to four-family, home equity, construction – one- to four- family and consumer loans which reflected a:

$72,000 credit provision for changes in the related environmental factors used to qualitatively assess inherent loan losses; and an

$18,000 credit to reflect a decrease in the historical average net charge-off rate for these loan types over the last five years; partially offset by $30,000 of net charge-offs recorded during the nine months ended September 30, 2018; and a

$35,000 unallocated credit to the provision for loan losses to reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio.

During the nine months ended September 30, 2017, a provision of $450,000 to the allowance for loan losses was recorded as a result of a comprehensive quarterly evaluation. The quarterly evaluation consisted of the following:

$177,000 general allowance on performing commercial business loans; primarily due to a $2.9 million, or 14.2%, increase in the loan portfolio since December 31, 2016 and due to a $895,000 increase in criticized and classified loans during the nine months ended September 30, 2017;

$169,000 general allowance on performing construction loans, primarily due to a $16.9 million, or 16.5%, increase in the construction loan portfolio since December 31, 2016, to reflect inherent losses within the portfolio;

$138,000 provision for one-to four-family, home equity, and consumer loans to reflect an increase in classified loans, an increase in the historical average net charge-off rate for these loan types over the last five years and for net charge-offs recorded during the nine months ended September 30, 2017;

$60,000 net credit provision for commercial real estate loans, which included a:

$390,000 credit provision on impaired commercial real estate loans; primarily due to an increase in the estimated collateral value for one impaired commercial real estate loan, as a result of an increase in the occupancy rate;

$176,000 credit provision for changes in the related environmental factors used to qualitatively assess inherent loan losses on commercial real estate loans; partially offset by a

$215,000 provision to reflect inherent risk associated with growth in commercial real estate loan originations. The commercial real estate loan portfolio increased $15.8 million, or 14.8%, since December 31, 2016;

$216,000 provision for the downgrade of certain performing commercial real estate loans; and a

$75,000 provision for the charge-off of one foreclosed loan during the nine months ended September 30, 2017;

$26,000 unallocated provision for loan losses to reflect the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating allocated and general losses in the portfolio.

Refer to Note 4 of the Notes to the Consolidated Financial Statements for additional details on the provision for loan losses.

Non-Interest Income. Non-interest income decreased by $178,000, or 8.7%, from $2.1 million for the nine months ended September 30, 2017 to $1.9 million for the nine months ended September 30, 2018. The decrease was primarily attributed to there being no sales of securities during the nine months ended September 30, 2018 as compared to a $244,000 pre-tax realized gain on the sale of securities during the nine months ended September 30, 2017. The decrease was partially offset by a $28,000 increase in recoveries on previously impaired investment securities, an $18,000 increase in service charges and fees and a $9,000 increase in unrealized gains on equity securities during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017.

Non-Interest Expenses. Non-interest expenses increased by $685,000, or 6.4%, from $10.7 million for the nine months ended September 30, 2017 to $11.4 million for the nine months ended September 30, 2018. Salaries and employee benefits increased $572,000, or 10.2%, primarily due to annual salary increases and higher expenses related to health insurance, retirement benefits and stock compensation awards. Data processing expenses increased $63,000, or 6.7%, due to implementation of new technology and growth in deposit and loan accounts. Advertising expenses increased $34,000, or 7.7%, primarily due to the development of new marketing campaigns during the first nine months of 2018.

Income Taxes Expense. Income tax expense decreased by $246,000, or 34.9%, from $704,000 for the nine months ended September 30, 2017 to $458,000 for the nine months ended September 30, 2018. The income tax expense decreased primarily due to a decrease in the effective tax rate and a decrease in income before income taxes. The effective tax rate for the nine months ended September 30, 2018 was 13.2%, while the effective tax rate for the nine months ended September 30, 2017 was 20.1%. The decrease in the effective tax rate was primarily due to the Tax Act, which lowered the federal corporate tax rate from 34% to 21% as of January 1, 2018. The impact of the lower corporate tax rate was partially offset by a decrease in the projected mix of tax-exempt income derived from our municipal bond portfolio and bank-owned life insurance in relation to our projection of pre-tax income for the current year.

Liquidity and Capital Resources

Liquidity describes our ability to meet the financial obligations that arise during the ordinary course of business. Liquidity is primarily needed to fund loan commitments, to pay the deposit withdrawal requirements of our customers as well as to fund current and planned expenditures. Our primary sources of funds consist of deposits, fed funds balances, scheduled amortization and prepayments of loans and securities, maturities and sales of investments and loans, interest earning deposits at other financial institutions and funds provided from operations. We have written agreements with the FHLBNY, which allows us to borrow the maximum lending values designated by the type of collateral pledged. As of September 30, 2018, the maximum amount that we can borrow from the FHLBNY was $104.5 million and was collateralized by a pledge of certain fixed-rate residential, one- to four-family loans. At September 30, 2018, we had outstanding advances under this agreement of $24.7 million. We have a written agreement with the Federal Reserve Bank discount window for overnight borrowings which is collateralized by a pledge of our securities, and allows us to borrow up to the value of the securities pledged, which was equal to a book value of $11.0 million and a fair value of $11.1 million as of September 30, 2018. There were no balances outstanding with the Federal Reserve Bank at September 30, 2018. We have also established lines of credits with correspondent banks for $22.0 million, of which $20.0 million is unsecured and the remaining $2.0 million will be secured by a pledge of our securities when a draw is made. There were no borrowings on these lines as of September 30, 2018.

Historically, loan repayments and maturing investment securities were a relatively predictable source of funds. However, deposit flows, calls of investment securities, and prepayments of loans and mortgage-backed securities are strongly influenced by interest rates, general and local economic conditions, and competition in the marketplace. These factors reduce the predictability of the timing of these sources of funds. To the extent possible, the Bank manages the cash flows of its loan and deposit portfolios by the rates it offers customers.

Our primary investing activities include the origination of loans and the purchase of investment securities. For the nine months ended September 30, 2018, we originated loans of approximately $96.6 million as compared to approximately $92.3 million of loans originated during the nine months ended September 30, 2017. Loan originations exceeded principal repayments and other deductions during the first nine months of 2018 by $25.4 million. The loan originations were funded through principal payments received on loans and securities, customer deposits, borrowings and cash reserves. Purchases of investment securities totaled $10.8 million and $2.4 million during the nine months ended September 30, 2018 and 2017, respectively.

At September 30, 2018, we had loan commitments to borrowers of approximately $41.2 million and overdraft lines of protection, unused home equity lines of credit and unused commercial lines of credit of approximately $49.0 million. Total deposits were $435.9 million at September 30, 2018, as compared to $405.2 million at December 31, 2017. The increase in total deposits was primarily due to growth in core deposits during the first nine months of 2018. The Company’s strategic focus is on growing lower-cost core deposits among its retail and commercial customers in an effort to manage interest expenses. Time deposit accounts scheduled to mature within one year were $54.8 million at September 30, 2018. Based on our deposit retention experience, current pricing strategy, and competitive pricing policies, we anticipate that a significant portion of these time deposits will remain with us following their maturity.

We are committed to maintaining a strong liquidity position; therefore, we monitor our liquidity position on a daily basis. We anticipate that we will have sufficient funds to meet our current funding commitments. The marginal cost of new funding, however, whether from deposits or borrowings from the FHLBNY, will be carefully considered as we monitor our liquidity needs. Therefore, in order to minimize our cost of funds, we may consider additional borrowings from the FHLBNY in the future.

We do not anticipate any material capital expenditures in 2018. We do not have any balloon or other payments due on any long-term obligations, other than the borrowing agreements noted above. Our off-balance sheet items include loan commitments as described in Note 6 in the Notes to our Consolidated Financial Statements and, as of September 30, 2018, an interest swap agreement for a notional amount of $3.0 million which is not designated as a hedging instrument and does not have a material impact on our consolidated statements of income.

Capital

As of January 1, 2015, new regulations that substantially amended the bank capital requirements became applicable to us. These regulations implement the Basel III regulatory capital reforms and changes required by the Dodd-Frank Act, as discussed in the “Supervision and Regulation – Federal Banking Regulation – Capital Requirements” section included in our Annual Report on Form 10-K for the year ended December 31, 2017.

As a result of the recently enacted Economic Growth, Regulatory Relief, and Consumer Protection Act, the federal banking agencies are required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes. The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement. The federal banking agencies must set the minimum capital for the new Community Bank Leverage Ratio at not less than 8% and not more than 10%. A financial institution can elect to be subject to this new definition.

As of September 30, 2018, as shown in the table below, the Bank’s Tier 1 and risk-based capital levels exceeded levels necessary to be considered “Well Capitalized” under Prompt Corrective Action provisions, as determined by the Office of the Comptroller of the Currency (the “OCC”), our primary regulator.

The Bank’s actual capital amounts and ratios and those required by the regulatory standards in effect as of the dates presented are as follows:


At September 30, 2018	Actual Ratio		Minimum For Capital Adequacy Purposes			To Be Well Capitalized Under Prompt Corrective Action Provisions
Common Equity Tier 1 ("CET1") capital (to risk-weighted assets)	19.42	%	>=	4.50	%	>=	6.50	%
Tier 1 capital (to risk-weighted assets)	19.42	%	>=	6.00	%	>=	8.00	%
Total capital (to risk-weighted assets)	20.30	%	>=	8.00	%	>=	10.00	%
Tier 1 Leverage (to adjusted total assets)	13.84	%	>=	4.00	%	>=	5.00	%
At December 31, 2017	Actual Ratio		Minimum For Capital Adequacy Purposes			To Be Well Capitalized Under Prompt Corrective Action Provisions
CET 1 capital (to risk-weighted assets)	20.82	%	>=	4.50	%	>=	6.50	%
Tier 1 capital (to risk-weighted assets)	20.82	%	>=	6.00	%	>=	8.00	%
Total capital (to risk-weighted assets)	21.75	%	>=	8.00	%	>=	10.00	%
Tier 1 Leverage (to adjusted total assets)	14.40	%	>=	4.00	%	>=	5.00	%

In order to avoid limitations on distributions, including dividend payments, and certain discretionary bonus payments to executive officers, an institution must hold a capital conservation buffer above its minimum risk-based capital requirements. As of September 30, 2018, the Bank's capital conservation buffer was 12.30% exceeding the minimum of 1.875% for 2018.

Off-Balance Sheet Arrangements

Other than loan commitments and an interest rate swap agreement that is not designated as a hedging instrument, as noted above, we do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that is material to investors. Refer to Note 6 in the Notes to our Consolidated Financial Statements for a summary of loan commitments outstanding as of September 30, 2018.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable as the Company is a smaller reporting company.

Item 4. Controls and Procedures.

Disclosure Controls and Procedures

The Company’s management, with the participation of its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13(a)-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures were effective.

Changes in Internal Control over Financial Reporting

There have not been any changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934) during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

PART II

Item 1A. Risk Factors.

There have been no material changes in the Company’s risk factors from those disclosed in its Annual Report on Form 10-K.

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

The following table reports information regarding repurchases by Lake Shore Bancorp of its common stock in each month of the quarter ended September 30, 2018:

COMPANY PURCHASES OF EQUITY SECURITIES



Period	Total Number of Shares Purchased		Average Price Paid per Share	Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs	Maximum Number of Shares that May Yet be Purchased Under the Plans or Programs (1)

July 1 through July 31, 2018	3,400	$	17.25	3,400	116,790
August 1 through August 31, 2018	7,100		17.30	7,100	109,690
September 1 through September 30, 2018	1,600		16.93	1,600	108,090
Total	12,100	$	17.24	12,100	108,090

⁽¹⁾

On May 16, 2018, our Board of Directors approved a new stock repurchase plan pursuant to which we can repurchase up to 121,190 shares of our outstanding common stock. This amount represented approximately 5% of our outstanding common stock not owned by the MHC as of May 16, 2018. The repurchase plan does not have an expiration date and superseded all of the prior stock repurchase programs. This plan superseded the prior Board of Directors approved stock repurchase plan from December 11, 2015 which had 34,101 shares available to purchase at May 15, 2018.

Item 6. Exhibits



			31.1				Certification by the Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002*
			31.2				Certification by the Chief Financial Officer Pursuant to Section 302 of the Sarbanes- Oxley Act of 2002*
			32.1				Certification by the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
			32.2				Certification by the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*
			101.INS				XBRL Instance Document*
			101.SCH				XBRL Taxonomy Extension Schema Document*
			101.CAL				XBRL Taxonomy Calculation Linkbase Document*
			101.DEF				XBRL Taxonomy Extension Definition Linkbase Document*
			101.LAB				XBRL Taxonomy Label Linkbase Document*
			101.PRE				XBRL Taxonomy Presentation Linkbase Document*

________________

*Filed herewith.

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.


		LAKE SHORE BANCORP, INC.
		(Registrant)

November 13, 2018	By:	/s/ Daniel P. Reininga
		Daniel P. Reininga
		President and Chief Executive Officer
		(Principal Executive Officer)

November 13, 2018	By:	/s/ Rachel A. Foley
		Rachel A. Foley
		Chief Financial Officer
		(Principal Financial and Accounting Officer)


LAKE SHORE BANCORP, INC.
(Exact name of registrant as specified in its charter)

United States			20-4729288
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification Number)

31 East Fourth Street, Dunkirk, New York			14048
(Address of principal executive offices)			(Zip code)

(716) 366-4070
(Registrant’s telephone number, including area code)


Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☒	Smaller reporting company ☒
Emerging growth company ☐

		TABLE OF CONTENTS

ITEM		PART I	PAGE

1	FINANCIAL STATEMENTS
	-	Consolidated Statements of Financial Condition as of September 30, 2018 (Unaudited) and December 31, 2017	1
	-	Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited)	2
	-	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2018 and 2017 (Unaudited)	3
	-	Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2018 and 2017 (Unaudited)	4
	-	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017 (Unaudited)	5
	-	Notes to Unaudited Consolidated Financial Statements	6
2	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		35
3	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		53
4	CONTROLS AND PROCEDURES		53

		PART II

1A	RISK FACTORS		54
2	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		54
6	EXHIBITS		54
SIGNATURES			55