Note 10– Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities
The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
| | September 30, 2020 | | | December 31, 2019 | | | March 31, 2021 | | | December 31, 2020 | |
| | | (In Thousands) | | | (In Thousands) | |
| Financial instruments whose contract amounts represent potential credit risk: | | | | | | | | | | | | |
| Commitments to extend credit under amortizing loans (1) | | $ | 18,290 | | | $ | 13,389 | | | $ | 20,302 | | | $ | 23,891 | |
| Commitments to extend credit under home equity lines of credit (2) | | | 13,742 | | | | 13,776 | | | | 12,767 | | | | 13,653 | |
| Unused portion of construction loans (3) | | | 77,017 | | | | 90,439 | | | | 65,790 | | | | 74,173 | |
| Unused portion of business lines of credit | | | 19,558 | | | | 14,623 | | | | 18,221 | | | | 19,207 | |
| Standby letters of credit | | | 1,296 | | | | 885 | | | | 1,246 | | | | 1,296 | |
(1) Commitments for loans are extended to customers for up to 90 days after which they expire. Excludes commitments to originate loans held for sale, which are discussed in the following footnote.
(2) Unused portions of home equity loans are available to the borrower for up to 10 years.
(3) Unused portions of construction loans are available to the borrower for up to one year.
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 and may require payment of a fee. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral obtained generally consists of mortgages on the underlying real estate.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds mortgages on the underlying real estate as collateral supporting those commitments for which collateral is deemed necessary.
The Company has determined that there are 0 probable losses related to commitments to extend credit or the standby letters of credit as of September 30, 2020March 31, 2021 and December 31, 2019.2020.
Residential mortgage loans sold to others are predominantly conventional residential first lien mortgages. The Company’s agreements to sell residential mortgage loans in the normal course of business usually require certain representations and warranties on the underlying loans sold related to credit information, loan documentation and collateral, which if subsequently are untrue or breached, could require the Company to repurchase certain loans affected. The Company has only been required to make insignificant repurchases as a result of breaches of these representations and warranties. The Company’s agreements to sell residential mortgage loans also contain limited recourse provisions. The recourse provisions are limited in that the recourse provision ends after certain payment criteria have been met. With respect to these loans, repurchase could be required if defined delinquency issues arose during the limited recourse period. Given that the underlying loans delivered to buyers are predominantly conventional first lien mortgages, historical experience has resulted in insignificant losses and repurchase activity. The Company's reserve for losses related to these recourse provisions totaled $3.2$2.5 million and $921,000$2.9 million as of September 30, 2020March 31, 2021 and December 31, 2019,2020, respectively.
In the normal course of business, the Company, or its subsidiaries, are involved in various legal proceedings. In the opinion of management, any liability resulting from pending proceedings would not be expected to have a material adverse effect on the Company's consolidated financial statements.
Herrington et al. v. Waterstone Mortgage Corporation
Waterstone Mortgage Corporation was a defendant in a class action lawsuit that was filed in the United States District Court for the Western District of Wisconsin and subsequently compelled to arbitration before the American Arbitration Association. The plaintiff class alleged that Waterstone Mortgage Corporation violated certain provisions of the Fair Labor Standards Act (FLSA) and failed to pay loan officers consistent with their employment agreements. On July 5, 2017, the arbitrator issued a Final Award finding Waterstone Mortgage Corporation liable for unpaid minimum wages, overtime, unreimbursed business expenses, and liquidated damages under the FLSA. On December 8, 2017, the District Court confirmed the award in large part, and entered a judgment against Waterstone in the amount of $7.3 milllion in damages to Claimants, $3.3 million in attorney fees and costs, and a $20,000 incentive fee to Plaintiff Herrington.
Subsequently, the Seventh Circuit Court of Appeals issued a ruling in October 2018 vacating the District Court’s order enforcing the arbitration award, and remanded the case to the District Court. On April 25, 2019, the District Court held that Plaintiff’s claims must be resolved through single-plaintiff arbitration. As a result, it vacated the July 5, 2017 arbitration award in its entirety, and issued a revised judgement in Waterstone’s favor.
In May 2019, Herrington re-initiated her individual arbitration. The arbitrator issued a written award on February 18, 2020 in which he found Waterstone liable for damages, based on an assumed workweek of 50 hours and $100 in unreimbursed expenses per workweek, awarding Herrington $14,952 in damages on her claims. Herrington has since sought $4.9 million in fees and costs on her award, which includes fees dating back to 2011 and the vacated proceeding. On May 6, 2020, the arbitrator issued an award that would allow Herrington to recover $1.1 million in attorney fees and costs.
Herrington has moved to confirm the award and Waterstone has subsequently moved to vacate the award in court. If the award is confirmed, Waterstone retains its appellate rights to challenge the award before the Seventh Circuit. Waterstone believes that it has meaningful avenues to vacate the award. However, given the details of these recent developments, Waterstone does believe that it has met the criteria with respect to recognizing a loss contingency under GAAP. As such, the Company recorded a loss reserve with respect to this matter for approximately $1.1 million during the three months ended March 31, 2020.
Various Claimants v. Waterstone Mortgage Corporation
Subsequent to the aforementioned decision by the United States District Court for the Western District of Wisconsin, which ruled that claims brought forth under the Herrington class action lawsuit must be resolved through single-plaintiff arbitration, in May 2019, approximately 89 of the prior claimants in the aforementioned class action lawsuit filed new demands in arbitration asserting similar claims (“the Arbitrations”). Currently, the total amount of arbitrations is approximately 100, as some other individuals who filed in court have been compelled to arbitration. Waterstone has answered the arbitration demands and denies the allegations, and Waterstone will continue to vigorously defend its interests in these matters. The first hearings are scheduled for the latter half of 2020. Waterstone does not believe a loss is probable at this time, as that term is used in assessing loss contingencies. Accordingly, in accordance with the authoritative guidance in the evaluation of contingencies, the Company has not recorded an accrual related to these matters. However, an unfavorable outcome is reasonably possible with respect to these individual matters and Waterstone would not characterize the chance of any loss as “remote.” Given the early stage of the individual proceedings, Waterstone cannot yet offer an opinion on the estimated range of any possible loss, in the event of an unfavorable opinion in any of the proceedings.
Raleen Johnson v. Watestone
Subsequent to the aforementioned decision by the United States District Court for the Western District of Wisconsin vacating the prior collective award, on May 3, 2019, Raeleen Johnson and approximately 35 other Loan Originators who were prior Claimants in the Herrington Arbitration also filed a claim in the Eastern District of Wisconsin, in the United States District Court for the Eastern District of Wisconsin, Johnson et al. v. Waterstone Mortgage Corporation. The Johnson action claims that Waterstone Mortgage Corporation violated the FLSA by failing to pay loan officers minimum and overtime wages. They also allege Waterstone breached its contractual agreement regarding their compensation.
The Johnson action was plead as a class and collective action, brought on behalf of Johnson and other Waterstone loan originators. The Court issued a scheduling order in March 2020, setting a discovery cutoff in December 2020 and deadline to file dispositive motions in January 2021. However, Johnson did not move for certification of her claims, and in August 2020, the Court issued an order finding that since no motion for certification had been filed, the case would not proceed as a class action.
Tentative Resolution of Claims
In September 2020, the parties reached a tentative agreement to resolve all of the above claims, including the Herrington individual arbitration and resulting $1.1 million award, the Arbitrations, and the Raeleen Johnson action. The proposed settlement payment is $4.25 million in total, which would fully resolve all of the alleged claims and all attorney fees and costs. The proposed settlement is contingent on it being approved by the individual claimants in the above actions. If the claimants do not approve the terms of the settlement, Waterstone may void the agreement.
As a result of the tentative agreement, the parties have agreed to stay all activity in the pending actions pending completion of the settlement, including the arbitrations set in 2020. The Johnson court issued an order vacating all pretrial dates, and the Herrington court issued an order postponing entry of judgment given the tentative agreement. Given the tentative proposed agreement, Waterstone does believe that it has met the criteria with respect to recognizing a loss contingency under GAAP. As such, the Company recorded a loss reserve with respect to this matter for approximately $4.25 million as of September 30, 2020. As the $1.1 million award related to Herrington was previously recognized during the three months ended March 31, 2020, the impact on the statement of operations during the three months ended September 30, 2020 amounted to charge to earnings of approximately $3.2 million.
Note 11 – Derivative Financial Instruments
Mortgage Banking Derviatives
In connection with its mortgage banking activities, the Company enters into derivative financial instruments as part of its strategy to manage its exposure to changes in interest rates. Mortgage banking derivatives include interest rate lock commitments provided to customers to fund mortgage loans to be sold in the secondary market and forward commitments for the future delivery of such loans to third party investors. It is the Company’s practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on its commitments to fund the loans as well as on its portfolio of mortgage loans held for sale. The Company’s mortgage banking derivatives have not been designated as hedge relationships. These instruments are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of ASC 815. Changes in the fair value of derivatives not designated in hedging relationships are recorded as a component of mortgage banking income in the Company’s consolidated statements of operations. The Company does not use derivatives for speculative purposes.
Forward commitments to sell mortgage loans represent commitments obtained by the Company from a secondary market agency to purchase mortgages from the Company at specified interest rates and within specified periods of time. Commitments to sell loans are made to mitigate interest rate risk on interest rate lock commitments to originate loans and loans held for sale. At September 30,March 31, 2021, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of approximately $754.0 million and interest rate lock commitments with an aggregate notional amount of approximately $518.1 million. The fair value of the forward commitments to sell mortgage loans at March 31, 2021 included a gain of $6.6 million that is reported as a component of other assets on the Company's consolidated statement of financial condition. The fair value of the interest rate locks at March 31, 2021 included a gain of $5.0 million that is reported as a component of other assets on the Company's consolidated statements of financial condition. At December 31, 2020, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of approximately $896.8$779.9 million and interest rate lock commitments with an aggregate notional amount of approximately $636.6$486.2 million. The fair value of the forward commitments to sell mortgage loans at September 30,December 31, 2020 included a loss of $445,000$5.1 million that is reported as a component of other liabilities on the Company's consolidated statement of financial condition. The fair value of the interest rate locks at September 30,December 31, 2020 included a gain of $12.6 million that is reported as a component of other assets on the Company's consolidated statements of financial condition. At December 31, 2019, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of $345.0 million and interest rate lock commitments with an aggregate notional amount of approximately $174.3 million. The fair value of the forward commitments to sell mortgage loans at December 31, 2019 included a gain of $3,000 that is reported as a component of other assets on the Company's consolidated statement of financial condition. The fair value of the interest rate locks at December 31, 2019 included a gain of $1.8$11.1 million that is reported as a component of other assets on the Company's consolidated statements of financial condition.
In determining the fair value of its derivative loan commitments, the Company considers the value that would be generated by the loan arising from exercise of the loan commitment when sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondary mortgage market. The fair value of these commitments is recorded on the consolidated statements of financial condition with the changes in fair value recorded as a component of mortgage banking income.
The significant unobservable input used in the fair value measurement of the Company's mortgage banking derivatives, including interest rate lock commitments, is the loan pull through rate. This represents the percentage of loans currently in a lock position which the Company estimates will ultimately close. Generally, the fair value of an interest rate lock commitment will be positively (negatively) impacted when the prevailing interest rate is lower (higher) than the interest rate lock commitment. Generally, an increase in the pull through rate will result in the fair value of the interest rate lock increasing when in a gain position, or decreasing when in a loss position. The pull through rate is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The pull through rate is computed using historical data and the ratio is periodically reviewed by the Company.
Interest Rate Swaps
The Company may offer derivative contracts to its customers in connection with their risk management needs. The Company manages the risk associated with these contracts by entering into an equal and offsetting derivative with a third-party dealer through back-to-back swaps. These derivatives generally work together as an economic interest rate hedge, but the Company does not designate them for hedge accounting treatment. Consequently, changes in fair value of the corresponding derivative financial asset or liability are recorded as either a charge or credit to current earnings during the period in which the changes occurred. The fair value of the swaps is recorded as both an asset and a liability, in other assets and other liabilities on the Company's consolidated statement of financial condition, respectively, in equal amounts for these transactions.
The aggregate amortizing notional value of back-to-back swaps with various commercial borrowers was $108.0$106.9 million at September 30, 2020March 31, 2021 and $30.9$107.5 million at December 31, 2019.2020. The Company receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These swaps mature in December 2029 to June 2037. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported as a component of other assets on the Company's consolidated statement of financial condition of $5.8$2.8 million as of September 30, 2020March 31, 2021 and $680,000$3.9 million as of December 31, 2019.2020. As of September 30, 2020March 31, 2021 and December 31, 2019,2020, 0 back-to-back swaps were in default.
The aggregate amortizing notional value of back-to-back swaps with dealer counterparties was $108.0$106.9 million as of September 30, 2020March 31, 2021 and $30.9$107.5 million as of December 31, 2019.2020. The Company pays fixed rates and receives floating rates based upon LIBOR on the swaps with dealer counterparties. These swaps maturity dates range from December 2029 to June 2037. Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported as a component of other liabilities on the Company's consolidated statement of financial condition of $5.8$2.8 million as of September 30, 2020March 31, 2021 and $680,000$3.9 million as of December 31, 2019.2020. No right of offset existed with dealer counterparty swaps as of September 30, 2020March 31, 2021 and December 31, 2019.2020.
All changes in the fair value of these instruments are recorded in other non-interest income. The Company pledged $7.8 million in0 mortgage backed securities to secure its obligation under these contracts at September 30, 2020March 31, 2021 and $710,000$7.2 million in cashmortgage backed securities at December 31, 2019.
Note 12 – Earnings Per Share
Earnings per share are computed using the two-class method. Basic earnings per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the applicable period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares.
There were 124,00035,000 and 110,000113,000 antidilutive shares of common stock for the three months ended September 30, 2020March 31, 2021 and 20192020, respectively. .There were 123,000 and 110,000 antidilutive shares of common stock for the nine months ended September 30, 2020 and 2019, respectively.
Presented below are the calculations for basic and diluted earnings per share:
| | Three months ended September 30, | | | Nine months ended September 30, | | | Three months ended March 31, | |
| | | 2020 | | | 2019 | | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | (In Thousands, except per share amounts) | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Net income | | $ | 26,293 | | | $ | 10,924 | | | $ | 53,310 | | | $ | 27,109 | | | $ | 21,344 | | | | 6,069 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted average shares outstanding | | | 24,297 | | | | 25,772 | | | | 24,720 | | | | 26,168 | | | | 23,735 | | | | 25,405 | |
| Effect of dilutive potential common shares | | | 83 | | | | 190 | | | | 122 | | | | 204 | | | | 215 | | | | 207 | |
| Diluted weighted average shares outstanding | | | 24,380 | | | | 25,962 | | | | 24,842 | | | | 26,372 | | | | 23,950 | | | | 25,612 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Basic earnings per share | | $ | 1.08 | | | $ | 0.42 | | | $ | 2.16 | | | $ | 1.04 | | | $ | 0.90 | | | | 0.24 | |
| Diluted earnings per share | | $ | 1.08 | | | $ | 0.42 | | | $ | 2.15 | | | $ | 1.03 | | | $ | 0.89 | | | | 0.24 | |
Note 13 – Fair Value Measurements
ASC Topic 820, "Fair Value Measurements and Disclosures" defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements. The standard also emphasizes that fair value (i.e., the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. When considering the assumptions that market participants would use in pricing the asset or liability, this accounting standard establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.
Level 1 inputs - In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that we have the ability to access.
Level 2 inputs - Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets where there are few transactions and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.
Level 3 inputs - Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability.
In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.
The following table presents information about our assets recorded in our consolidated statements of financial condition at their fair value on a recurring basis as of September 30, 2020March 31, 2021 and December 31, 2019,2020, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.
| | | | | Fair Value Measurements Using | | | | | | Fair Value Measurements Using | |
| | | September 30, 2020 | | | Level 1 | | | Level 2 | | | Level 3 | | | March 31, 2021 | | | Level 1 | | | Level 2 | | | Level 3 | |
| | | (In Thousands) | | | (In Thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Available-for-sale securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities | | $ | 26,100 | | | $ | 0 | | | $ | 26,100 | | | $ | 0 | | | $ | 24,578 | | | $ | 0 | | | $ | 24,578 | | | $ | 0 | |
| Collateralized mortgage obligations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Government sponsored enterprise issued | | | 59,519 | | | | 0 | | | | 59,519 | | | | 0 | | | | 68,415 | | | | 0 | | | | 68,415 | | | | 0 | |
| Private-label issued | | | 3,650 | | | | 0 | | | | 3,650 | | | | 0 | | | | 3,130 | | | | 0 | | | | 3,130 | | | | 0 | |
| Government sponsored enterprise bonds | | | 2,499 | | | | 0 | | | | 2,499 | | | | 0 | | | | 2,468 | | | | 0 | | | | 2,468 | | | | 0 | |
| Municipal securities | | | 50,162 | | | | 0 | | | | 50,162 | | | | 0 | | | | 52,241 | | | | 0 | | | | 52,241 | | | | 0 | |
| Other debt securities | | | 11,271 | | | | 0 | | | | 11,271 | | | | 0 | | | | 11,431 | | | | 0 | | | | 11,431 | | | | 0 | |
| Loans held for sale | | | 385,803 | | | | 0 | | | | 385,803 | | | | 0 | | | | 341,293 | | | | 0 | | | | 341,293 | | | | 0 | |
| Mortgage banking derivative assets | | | 12,600 | | | | 0 | | | | 0 | | | | 12,600 | | | | 11,601 | | | | 0 | | | | 0 | | | | 11,601 | |
| Interest rate swap assets | | | 5,794 | | | | 0 | | | | 5,794 | | | | 0 | | | | 2,816 | | | | 0 | | | | 2,816 | | | | 0 | |
| Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage banking derivative liabilities | | | 445 | | | | 0 | | | | 0 | | | | 445 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | |
| Interest rate swap liabilities | | | 5,794 | | | | 0 | | | | 5,794 | | | | 0 | | | | 2,816 | | | | 0 | | | | 2,816 | | | | 0 | |
| | | | | Fair Value Measurements Using | | | | | | Fair Value Measurements Using | |
| | | December 31, 2019 | | | Level 1 | | | Level 2 | | | Level 3 | | | December 31, 2020 | | | Level 1 | | | Level 2 | | | Level 3 | |
| | | (In Thousands) | | | (In Thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Assets | | | | | | | | | | | | | | | | | | | | | | | | |
| Available-for-sale securities | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage-backed securities | | $ | 34,150 | | | $ | 0 | | | $ | 34,150 | | | $ | 0 | | | $ | 25,100 | | | $ | 0 | | | $ | 25,100 | | | $ | 0 | |
| Collateralized mortgage obligations | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Government sponsored enterpris issued | | | | 63,284 | | | | 0 | | | | 63,284 | | | | 0 | |
| Private-label | | | | 3,665 | | | | 0 | | | | 3,665 | | | | 0 | |
| Government sponsored enterprise issued | | | 81,754 | | | | 0 | | | | 81,754 | | | | 0 | | | | 2,503 | | | | 0 | | | | 2,503 | | | | 0 | |
| Municipal securities | | | 53,692 | | | | 0 | | | | 53,692 | | | | 0 | | | | 53,614 | | | | 0 | | | | 53,614 | | | | 0 | |
| Other debt securities | | | 8,880 | | | | 0 | | | | 8,880 | | | | 0 | | | | 11,453 | | | | 0 | | | | 11,453 | | | | 0 | |
| Loans held for sale | | | 220,123 | | | | 0 | | | | 220,123 | | | | 0 | | | | 402,003 | | | | 0 | | | | 402,003 | | | | 0 | |
| Mortgage banking derivative assets | | | 1,835 | | | | 0 | | | | 0 | | | | 1,835 | | | | 11,057 | | | | 0 | | | | 0 | | | | 11,057 | |
| Interest rate swap assets | | | 680 | | | | 0 | | | | 680 | | | | 0 | | | | 3,892 | | | | 0 | | | | 3,892 | | | | 0 | |
| Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage banking derivative liabilities | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 5,140 | | | | 0 | | | | 0 | | | | 5,140 | |
| Interest rate swap liabilities | | | 680 | | | | 0 | | | | 680 | | | | 0 | | | | 3,892 | | | | 0 | | | | 3,892 | | | | 0 | |
The following summarizes the valuation techniques for assets recorded in our consolidated statements of financial condition at their fair value on a recurring basis:
Available-for-sale securities – The Company’s investment securities classified as available for sale include: mortgage-backed securities, collateralized mortgage obligations, government sponsored enterprise bonds, municipal securities and other debt securities. The fair value of mortgage-backed securities, collateralized mortgage obligations and government sponsored enterprise bonds are determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities, prepayment models and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. These model and matrix measurements are classified as Level 2 in the fair value hierarchy. The fair value of municipal and other debt securities is determined by a third party valuation source using observable market data utilizing a multi-dimensional relational pricing model. Standard inputs to this model include observable market data such as benchmark yields, reported trades, broker quotes, rating updates and issuer spreads. These model measurements are classified as Level 2 in the fair value hierarchy. The change in fair value is recorded through an adjustment to the statement of comprehensive income.
Loans held for sale – The Company carries loans held for sale at fair value under the fair value option model. Fair value is generally determined by estimating a gross premium or discount, which is derived from pricing currently observable in the secondary market, principally from observable prices for forward sale commitments. Loans held-for-sale are considered to be Level 2 in the fair value hierarchy of valuation techniques. The change in fair value is recorded through an adjustment to the statement of income.
Mortgage banking derivatives - Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company utilizes a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment and then multiplying by quoted investor prices. The Company also utilizes a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. While there are Level 2 and 3 inputs used in the valuation models, the Company has determined that one or more of the inputs significant in the valuation of both of the mortgage banking derivatives fall within Level 3 of the fair value hierarchy. The change in fair value is recorded through an adjustment to the statement of income.
Interest rate swap assets/liabilities - The Company offers loan level swaps to its customers and offsets its exposure from such contracts by entering into mirror image swaps with a financial institution / swap counterparty. The fair values of derivatives are based on valuation models using observable market data as of the measurement date. Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. Interest rate swap assets and liabilities are considered to be Level 2 in the fair value hierarchy of valuation techniques. The change in fair value is recorded through an adjustment to the statement of operations, within other income and other expense.
The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 20202021 and 2019.2020.
| | Nine months ended September 30, | | | Three months ended March 31, | |
| | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | (In Thousands) | | | (In Thousands) | |
| | | | | | | | | | | | | |
| Mortgage derivative, net balance at the beginning of the period | | $ | 1,835 | | | $ | 898 | | | $ | 5,917 | | | $ | 1835 | |
| Mortgage derivative gain, net | | | 10,320 | | | | 2,345 | | | | 5,684 | | | | (3,282 | ) |
| Mortgage derivative, net balance at the end of the period | | $ | 12,155 | | | $ | 3,243 | | | $ | 11,601 | | | $ | (1,447 | ) |
There were no transfers in or out of Level 1, 2 or 3 measurements during the periods.
Assets Recorded at Fair Value on a Non-recurring Basis
The following tables present information about our assets recorded in our consolidated statements of financial condition at their fair value on a non-recurring basis as of September 30, 2020March 31, 2021 and December 31, 2019,2020, and indicate the fair value hierarchy of the valuation techniques utilized to determine such fair value.
| | | | | Fair Value Measurements Using | | | | | | Fair Value Measurements Using | |
| | | September 30, 2020 | | | Level 1 | | | Level 2 | | | Level 3 | | | March 31, 2021 | | | Level 1 | | | Level 2 | | | Level 3 | |
| | | (In Thousands) | | | (In Thousands) | |
| Impaired loans, net (1) | | $ | 186 | | | $ | 0 | | | $ | 0 | | | $ | 186 | | | $ | 185 | | | $ | 0 | | | $ | 0 | | | $ | 185 | |
| Real estate owned | | | 772 | | | | 0 | | | | 0 | | | | 772 | | | | 150 | | | | 0 | | | | 0 | | | | 150 | |
| Impaired mortgage servicing rights | | | 235 | | | | 0 | | | | 0 | | | | 235 | | | | 189 | | | | 0 | | | | 0 | | | | 189 | |
| | | | | Fair Value Measurements Using | | | | | | Fair Value Measurements Using | |
| | | December 31, 2019 | | | Level 1 | | | Level 2 | | | Level 3 | | | December 31, 2020 | | | Level 1 | | | Level 2 | | | Level 3 | |
| | | (In Thousands) | | | (In Thousands) | |
| Impaired loans, net (1) | | $ | 185 | | | $ | 0 | | | $ | 0 | | | $ | 185 | | | $ | 185 | | | $ | 0 | | | $ | 0 | | | $ | 185 | |
| Real estate owned | | | 748 | | | | 0 | | | | 0 | | | | 748 | | | | 322 | | | | 0 | | | | 0 | | | | 322 | |
| Impaired mortgage servicing rights | | | 206 | | | | 0 | | | | 0 | | | | 206 | | | | 189 | | | | 0 | | | | 0 | | | | 189 | |
(1) Represents collateral-dependent impaired loans, net, which are included in loans.
Loans – We do not record loans at fair value on a recurring basis. On a non-recurring basis, loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at net realizable value of the underlying collateral. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of impaired loans, loans that have been deemed to be impaired are considered to be Level 3 in the fair value hierarchy of valuation techniques. At September 30,March 31, 2021, loans determined to be impaired with an outstanding balance of $206,000 were carried net of specific reserves of $21,000 for a fair value of $185,000. At December 31, 2020, loans determined to be impaired with an outstanding balance of $210,000$208,000 were carried net of specific reserves of $24,000 for a fair value of $186,000. At December 31, 2019, loans determined to be impaired with an outstanding balance of $224,000 were carried net of specific reserves of $39,000$23,000 for a fair value of $185,000. Impaired loans collateralized by assets which are valued in excess of the net investment in the loan do not require any specific reserves.
Real estate owned – On a non-recurring basis, real estate owned is recorded in our consolidated statements of financial condition at the lower of cost or fair value. Fair value is determined based on third party appraisals and, if less than the carrying value of the foreclosed loan, the carrying value of the real estate owned is adjusted to the fair value. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of the properties, real estate owned is considered to be Level 3 in the fair value hierarchy of valuation techniques. There were 0 writedowns during the ninethree months ended September 30,March 31, 2021 and 2020, and 2019, respectively. At September 30, 2020March 31, 2021 and December 31, 2019,2020, real estate owned totaled $772,000$150,000 and $748,000,$322,000, respectively.
Mortgage servicing rights – The Company utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of mortgage servicing rights. The model utilizes prepayment assumptions to project cash flows related to the mortgage servicing rights based upon the current interest rate environment, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The model considers characteristics specific to the underlying mortgage portfolio, such as: contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges and costs to service. Given the significance of the unobservable inputs utilized in the estimation process, mortgage servicing rights are classified as Level 3 within the fair value hierarchy. The Company records the mortgage servicing rights at the lower of amortized cost or fair value. At September 30, 2020March 31, 2021 and December 31, 20192020, there were $98,000 and $77,000, respectively, of impairment on mortgage servicing rights.
For Level 3 assets and liabilities measured at fair value on a non-recurring basis as of September 30, 2020,March 31, 2021, the significant unobservable inputs used in the fair value measurements were as follows:
| | | | | | Significant Unobservable Input Value | | | | | | | Significant Unobservable Input Value | |
| | | Fair Value at September 30, 2020 | | Valuation Technique | Significant Unobservable Inputs | | Minimum Value | | | Maximum Value | | | Weighted Average | | | Fair Value at March 31, 2021 | | Valuation Technique | Significant Unobservable Inputs | | Minimum Value | | | Maximum Value | | | Weighted Average | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Mortgage banking derivatives, net | | $ | 12,155 | | Pricing models | Pull through rate | | | 12.0 | % | | | 95.0 | % | | | 86.0 | % | | $ | 11,601 | | Pricing models | Pull through rate | | | 18.0 | % | | | 99.8 | % | | | 91.4 | % |
| Impaired loans | | | 186 | | Market approach | Discount rates applied to appraisals | | | 15.0 | % | | | 15.0 | % | | | 15.0 | % | | | 206 | | Market approach | Discount rates applied to appraisals | | | 15.0 | % | | | 15.0 | % | | | 15.0 | % |
| Real estate owned | | | 772 | | Market approach | Discount rates applied to appraisals | | | 13.0 | % | | | 59.0 | % | | | 48.0 | % | | | 150 | | Market approach | Discount rates applied to appraisals | | | 34.8 | % | | | 34.8 | % | | | 34.8 | % |
| Mortgage servicing rights | | | 235 | | Pricing models | Prepayment rate | | | 7.9 | % | | | 36.4 | % | | | 15.2 | % | | | 12,972 | | Pricing models | Prepayment rate | | | 8.1 | % | | | 33.7 | % | | | 9.2 | % |
| | | | | | | Discount rate | | | 9.5 | % | | | 14.3 | % | | | 10.0 | % | | | | | | Discount rate | | | 8.1 | % | | | 12.0 | % | | | 9.6 | % |
| | | | | | | Cost to service | | $ | 76.46 | | | $ | 164.13 | | | $ | 83.17 | | | | | | | Cost to service | | $ | 77.01 | | | $ | 839.34 | | | $ | 82.92 | |
A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.
Fair value information about financial instruments follows, whether or not recognized in the consolidated statements of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.
The carrying amounts and fair values of the Company’s financial instruments consist of the following:
| | September 30, 2020 | | | December 31, 2019 | | | March 31, 2021 | | | December 31, 2020 | |
| | | Carrying amount | | | Fair Value | | | Carrying amount | | | Fair Value | | | Carrying amount | | | Fair Value | | | Carrying amount | | | Fair Value | |
| | | Total | | | Level 1 | | | Level 2 | | | Level 3 | | | Total | | | Level 1 | | | Level 2 | | | Level 3 | | | Total | | | Level 1 | | | Level 2 | | | Level 3 | | | Total | | | Level 1 | | | Level 2 | | | Level 3 | |
| | | (In Thousands) | | | (In Thousands) | |
| Financial Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Cash and cash equivalents | | $ | 86,562 | | | $ | 86,562 | | | $ | 86,562 | | | $ | 0 | | | $ | 0 | | | $ | 74,300 | | | $ | 74,300 | | | $ | 65,800 | | | $ | 8,500 | | | $ | 0 | | | $ | 198,401 | | | $ | 198,401 | | | $ | 198,401 | | | $ | 0 | | | $ | 0 | | | $ | 94,767 | | | $ | 94,767 | | | $ | 94,767 | | | $ | 0 | | | $ | 0 | |
| Securities available-for-sale | | | 153,201 | | | | 153,201 | | | | 0 | | | | 153,201 | | | | 0 | | | | 178,476 | | | | 178,476 | | | | 0 | | | | 178,476 | | | | 0 | | | | 162,263 | | | | 162,263 | | | | 0 | | | | 162,263 | | | | 0 | | | | 159,619 | | | | 159,619 | | | | 0 | | | | 159,619 | | | | 0 | |
| Loans held for sale | | | 385,803 | | | | 385,803 | | | | 0 | | | | 385,803 | | | | 0 | | | | 220,123 | | | | 220,123 | | | | 0 | | | | 220,123 | | | | 0 | | | | 341,293 | | | | 341,293 | | | | 0 | | | | 341,293 | | | | 0 | | | | 402,003 | | | | 402,003 | | | | 0 | | | | 402,003 | | | | 0 | |
| Loans receivable | | | 1,434,132 | | | | 1,448,660 | | | | 0 | | | | 0 | | | | 1,448,660 | | | | 1,388,031 | | | | 1,426,224 | | | | 0 | | | | 0 | | | | 1,426,224 | | | | 1,335,423 | | | | 1,334,335 | | | | 0 | | | | 0 | | | | 1,334,335 | | | | 1,375,137 | | | | 1,374,898 | | | | 0 | | | | 0 | | | | 1,374,898 | |
| FHLB stock | | | 26,720 | | | | 26,720 | | | | 0 | | | | 26,720 | | | | 0 | | | | 21,150 | | | | 21,150 | | | | 0 | | | | 21,150 | | | | 0 | | | | 26,720 | | | | 26,720 | | | | 0 | | | | 26,720 | | | | 0 | | | | 26,720 | | | | 26,720 | | | | 0 | | | | 26,720 | | | | 0 | |
| Accrued interest receivable | | | 5,163 | | | | 5,163 | | | | 5,163 | | | | 0 | | | | 0 | | | | 5,344 | | | | 5,344 | | | | 5,344 | | | | 0 | | | | 0 | | | | 4,924 | | | | 4,924 | | | | 4,924 | | | | 0 | | | | 0 | | | | 4,957 | | | | 4,957 | | | | 4,957 | | | | 0 | | | | 0 | |
| Mortgage servicing rights | | | 8,422 | | | | 9,926 | | | | 0 | | | | 0 | | | | 9,926 | | | | 282 | | | | 282 | | | | 0 | | | | 0 | | | | 282 | | | | 8,830 | | | | 12,972 | | | | 0 | | | | 0 | | | | 12,972 | | | | 5,977 | | | | 7,075 | | | | 0 | | | | 0 | | | | 7,075 | |
| Mortgage banking derivative assets | | | 12,600 | | | | 12,600 | | | | 0 | | | | 0 | | | | 12,600 | | | | 1,835 | | | | 1,835 | | | | 0 | | | | 0 | | | | 1,835 | | | | 11,601 | | | | 11,601 | | | | 0 | | | | 0 | | | | 11,601 | | | | 11,057 | | | | 11,057 | | | | 0 | | | | 0 | | | | 11,057 | |
| Interest rate swap asset | | | 5,794 | | | | 5,794 | | | | 0 | | | | 5,794 | | | | 0 | | | | 680 | | | | 680 | | | | 0 | | | | 680 | | | | 0 | | | | 2,816 | | | | 2,816 | | | | 0 | | | | 2,816 | | | | 0 | | | | 3,892 | | | | 3,892 | | | | 0 | | | | 3,892 | | | | 0 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Financial Liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Deposits | | | 1,184,651 | | | | 1,185,424 | | | | 440,501 | | | | 744,923 | | | | 0 | | | | 1,067,776 | | | | 1,070,083 | | | | 328,005 | | | | 742,078 | | | | 0 | | | | 1,219,691 | | | | 1,220,776 | | | | 513,937 | | | | 706,839 | | | | 0 | | | | 1,184,870 | | | | 1,186,062 | | | | 483,542 | | | | 702,520 | | | | 0 | |
| Advance payments by borrowers for taxes | | | 25,987 | | | | 25,987 | | | | 25,987 | | | | 0 | | | | 0 | | | | 4,212 | | | | 4,212 | | | | 4,212 | | | | 0 | | | | 0 | | | | 12,048 | | | | 12,048 | | | | 12,048 | | | | 0 | | | | 0 | | | | 3,522 | | | | 3,522 | | | | 3,522 | | | | 0 | | | | 0 | |
| Borrowings | | | 552,126 | | | | 572,521 | | | | 0 | | | | 572,521 | | | | 0 | | | | 483,562 | | | | 483,846 | | | | 0 | | | | 483,846 | | | | 0 | | | | 490,505 | | | | 514,121 | | | | 0 | | | | 514,121 | | | | 0 | | | | 508,074 | | | | 545,107 | | | | 0 | | | | 545,107 | | | | 0 | |
| Accrued interest payable | | | 1,314 | | | | 1,314 | | | | 1,314 | | | | 0 | | | | 0 | | | | 1,559 | | | | 1,559 | | | | 1,559 | | | | 0 | | | | 0 | | | | 1,035 | | | | 1,035 | | | | 1,035 | | | | 0 | | | | 0 | | | | 1,137 | | | | 1,137 | | | | 1,137 | | | | 0 | | | | 0 | |
| Mortgage banking derivative liabilities | | | 445 | | | | 445 | | | | 0 | | | | 0 | | | | 445 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 0 | | | | 5,140 | | | | 5,140 | | | | 0 | | | | 0 | | | | 5,140 | |
| Interest rate swap liability | | | 5,794 | | | | 5,794 | | | | 0 | | | | 5,794 | | | | 0 | | | | 680 | | | | 680 | | | | 0 | | | | 680 | | | | 0 | | | | 2,816 | | | | 2,816 | | | | 0 | | | | 2,816 | | | | 0 | | | | 3,892 | | | | 3,892 | | | | 0 | | | | 3,892 | | | | 0 | |
The following methods and assumptions were used by the Company in determining its fair value disclosures for financial instruments.
Cash and Cash Equivalents
The carrying amount reported in the consolidated statements of financial condition for cash and cash equivalents is a reasonable estimate of fair value.
Securities
The fair value of securities is generally determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. Prepayment models are used for mortgage related securities with prepayment features.
Loans Held for Sale
Fair value is estimated using the prices of the Company’s existing commitments to sell such loans and/or the quoted market price for commitments to sell similar loans.
Loans Receivable
The fair value estimation process for the loan portfolio uses an exit price concept and reflects discounts the Company believes are consistent with discounts in the market place. Fair values are estimated for portfolios of loans with similar characteristics. Loans are segregated by type such as one- to four-family, multi-family, home equity, construction and land, commercial real estate, commercial, and other consumer. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar maturities. The fair value analysis also includes other assumptions to estimate fair value, intended to approximate those a market participant would use in an orderly transaction, with adjustments for discount rates, interest rates, liquidity, and credit spreads, as appropriate.
FHLB Stock
For FHLB stock, the carrying amount is the amount at which shares can be redeemed with the FHLB and is a reasonable estimate of fair value.
Deposits and Advance Payments by Borrowers for Taxes
The fair values for interest-bearing and noninterest-bearing negotiable order of withdrawal accounts, savings accounts, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturities to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. The advance payments by borrowers for taxes are equal to their carrying amounts at the reporting date.
Borrowings
Fair values for borrowings are estimated using a discounted cash flow calculation that applies current interest rates to estimated future cash flows of the borrowings.
Accrued Interest Payable and Accrued Interest Receivable
For accrued interest payable and accrued interest receivable, the carrying amount is a reasonable estimate of fair value.
Commitments to Extend Credit and Standby Letters of Credit
Commitments to extend credit and standby letters of credit are generally not marketable. Furthermore, interest rates on any amounts drawn under such commitments would be generally established at market rates at the time of the draw. Fair values for the Company’s commitments to extend credit and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparty’s credit standing, and discounted cash flow analyses. The fair value of the Company’s commitments to extend credit was not material at September 30, 2020March 31, 2021 and December 31, 2019.2020.
Mortgage Banking Derivative Assets and Liabilities
Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment, and then multiplying by quoted investor prices. The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. On the Company’s consolidated statements of financial condition, instruments that have a positive fair value are included in prepaid expenses and other assets, and those instruments that have a negative fair value are included in other liabilities.
Interest Rate Swap Assets and Liabilities
The carrying value and fair value of existing derivative financial instruments are based upon independent valuation models, which use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative contract. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.
Note 14 – Segment Reporting
Selected financial and descriptive information is required to be provided about reportable operating segments, considering a "management approach" concept as the basis for identifying reportable segments. The management approach is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and assessing performance. Consequently, the segments are evident from the structure of the enterprise's internal organization, focusing on financial information that an enterprise's chief operating decision-makers use to make decisions about the enterprise's operating matters.
The Company has determined that it has 2 reportable segments: community banking and mortgage banking. The Company's operating segments are presented based on its management structure and management accounting practices. The structure and practices are specific to the Company and therefore, the financial results of the Company's business segments are not necessarily comparable with similar information for other financial institutions.
Community Banking
The community banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin along with a loan office in Minneapolis, Minnesota.Wisconsin. Within this segment, the following products and services are provided: (1) lending solutions such as residential mortgages, home equity loans and lines of credit, personal and installment loans, real estate financing, business loans, and business lines of credit; (2) deposit and transactional solutions such as checking, credit, debit and pre-paid cards, online banking and bill pay, and money transfer services; (3) investable funds solutions such as savings, money market deposit accounts, IRA accounts, certificates of deposit, and (4) fixed and variable annuities, insurance as well as trust and investment management accounts.
Consumer products include loan and deposit products: mortgage, home equity loans and lines, personal term loans, demand deposit accounts, interest bearing transaction accounts and time deposits. Consumer products also include personal investment services. Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, demand deposit accounts, interest bearing transaction accounts and time deposits.
Mortgage Banking
The mortgage banking segment provides residential mortgage loans for the primary purpose of sale on the secondary market. Mortgage banking products and services are provided by offices in 4821 states with the ability to lend in 48 states.
Presented below is the segment information:
| | As of or for the three months ended September 30, 2020 | |
| | | Community Banking | | | Mortgage Banking | | | Holding Company and Other | | | Consolidated | |
| | | (In Thousands) | |
| | | | | | | | | | | | | |
| Net interest income (expense) | | $ | 13,461 | | | $ | (58 | ) | | $ | 6 | | | $ | 13,409 | |
| Provision for loan losses | | | 1,000 | | | | 25 | | | | 0 | | | | 1,025 | |
| Net interest income (expense) after provision for loan losses | | | 12,461 | | | | (83 | ) | | | 6 | | | | 12,384 | |
| | | | | | | | | | | | | | | | | |
| Noninterest income | | | 3,104 | | | | 73,143 | | | | (484 | ) | | | 75,763 | |
| | | | | | | | | | | | | | | | | |
| Noninterest expenses: | | | | | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | | 5,000 | | | | 34,559 | | | | (154 | ) | | | 39,405 | |
| Occupancy, office furniture and equipment | | | 874 | | | | 1,595 | | | | 0 | | | | 2,469 | |
| Advertising | | | 252 | | | | 609 | | | | 0 | | | | 861 | |
| Data processing | | | 490 | | | | 426 | | | | 6 | | | | 922 | |
| Communications | | | 113 | | | | 226 | | | | 0 | | | | 339 | |
| Professional fees | | | 266 | | | | 4,465 | | | | 7 | | | | 4,738 | |
| Real estate owned | | | 11 | | | | 0 | | | | 0 | | | | 11 | |
| Loan processing expense | | | 0 | | | | 1,336 | | | | 0 | | | | 1,336 | |
| Other | | | 818 | | | | 2,444 | | | | (342 | ) | | | 2,920 | |
| Total noninterest expenses | | | 7,824 | | | | 45,660 | | | | (483 | ) | | | 53,001 | |
| Income before income taxes | | | 7,741 | | | | 27,400 | | | | 5 | | | | 35,146 | |
| Income tax expense | | | 1,565 | | | | 7,284 | | | | 4 | | | | 8,853 | |
| Net income | | $ | 6,176 | | | $ | 20,116 | | | $ | 1 | | | $ | 26,293 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 2,118,968 | | | $ | 458,526 | | | $ | (356,672 | ) | | $ | 2,220,822 | |
| | As of or for the three months ended September 30, 2019 | |
| | | Community Banking | | | Mortgage Banking | | | Holding Company and Other | | | Consolidated | |
| | | (In Thousands) | |
| | | | | | | | | | | | | |
| Net interest income (expense) | | $ | 13,885 | | | $ | (774 | ) | | $ | 43 | | | $ | 13,154 | |
| Provision for loan losses | | | (150 | ) | | | 70 | | | | 0 | | | | (80 | ) |
| Net interest income (expense) after provision for loan losses | | | 14,035 | | | | (844 | ) | | | 43 | | | | 13,234 | |
| | | | | | | | | | | | | | | | | |
| Noninterest income | | | 1,415 | | | | 36,535 | | | | (456 | ) | | | 37,494 | |
| | | | | | | | | | | | | | | | | |
| Noninterest expenses: | | | | | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | | 4,075 | | | | 23,616 | | | | (177 | ) | | | 27,514 | |
| Occupancy, office furniture and equipment | | | 942 | | | | 1,687 | | | | 0 | | | | 2,629 | |
| Advertising | | | 202 | | | | 711 | | | | 0 | | | | 913 | |
| Data processing | | | 588 | | | | 411 | | | | 4 | | | | 1,003 | |
| Communications | | | 90 | | | | 268 | | | | 0 | | | | 358 | |
| Professional fees | | | 223 | | | | 688 | | | | 43 | | | | 954 | |
| Real estate owned | | | 24 | | | | 0 | | | | 0 | | | | 24 | |
| Loan processing expense | | | 0 | | | | 858 | | | | 0 | | | | 858 | |
| Other | | | 583 | | | | 1,725 | | | | (329 | ) | | | 1,979 | |
| Total noninterest expenses | | | 6,727 | | | | 29,964 | | | | (459 | ) | | | 36,232 | |
| Income before income taxes | | | 8,723 | | | | 5,727 | | | | 46 | | | | 14,496 | |
| Income tax expense | | | 1,982 | | | | 1,584 | | | | 6 | | | | 3,572 | |
| Net income | | $ | 6,741 | | | $ | 4,143 | | | $ | 40 | | | $ | 10,924 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 1,969,835 | | | $ | 301,565 | | | $ | (265,971 | ) | | $ | 2,005,429 | |
| | | As of or for the three months ended March 31, 2021 | |
| | | Community Banking | | | Mortgage Banking | | | Holding Company and Other | | | Consolidated | |
| | | (In Thousands) | |
| | | | | | | | | | | | | |
| Net interest income | | $ | 14,247 | | | | (350 | ) | | | 55 | | | | 13,952 | |
| Provision (credit) for loan losses | | | (1,100 | ) | | | 30 | | | | 0 | | | | (1,070 | ) |
| Net interest income after provision (credit) for loan losses | | | 15,347 | | | | (380 | ) | | | 55 | | | | 15,022 | |
| | | | | | | | | | | | | | | | | |
| Noninterest income | | | 1,243 | | | | 55,035 | | | | (79 | ) | | | 56,199 | |
| | | | | | | | | | | | | | | | | |
| Noninterest expenses: | | | | | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | | 4,975 | | | | 29,262 | | | | (114 | ) | | | 34,123 | |
| Occupancy, office furniture and equipment | | | 1,025 | | | | 1,540 | | | | 0 | | | | 2,565 | |
| Advertising | | | 209 | | | | 615 | | | | 0 | | | | 824 | |
| Data processing | | | 511 | | | | 454 | | | | 6 | | | | 971 | |
| Communications | | | 119 | | | | 212 | | | | 0 | | | | 331 | |
| Professional fees | | | 194 | | | | (524 | ) | | | 15 | | | | (315 | ) |
| Real estate owned | | | (12 | ) | | | 0 | | | | 0 | | | | (12 | ) |
| Loan processing expense | | | 0 | | | | 1,335 | | | | 0 | | | | 1,335 | |
| Other | | | 440 | | | | 2,681 | | | | 57 | | | | 3,178 | |
| Total noninterest expenses | | | 7,461 | | | | 35,575 | | | | (36 | ) | | | 43,000 | |
| Income before income taxes | | | 9,129 | | | | 19,080 | | | | 12 | | | | 28,221 | |
| Income tax expense (benefit) | | | 1,786 | | | | 5,096 | | | | (5 | ) | | | 6,877 | |
| Net income | | $ | 7,343 | | | | 13,984 | | | | 17 | | | | 21,344 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 2,132,366 | | | | 411,750 | | | | (346,105 | ) | | | 2,198,011 | |
| | As of or for the nine months ended September 30, 2020 | |
| | | Community Banking | | | Mortgage Banking | | | Holding Company and Other | | | Consolidated | |
| | | (In Thousands) | |
| | | | | | | | | | | | | |
| Net interest income (expense) | | $ | 40,070 | | | $ | (948 | ) | | $ | 62 | | | $ | 39,184 | |
| Provision for loan losses | | | 6,075 | | | | 235 | | | | 0 | | | | 6,310 | |
| Net interest income (expense) after provision for loan losses | | | 33,995 | | | | (1,183 | ) | | | 62 | | | | 32,874 | |
| | | | | | | | | | | | | | | | | |
| Noninterest income | | | 7,068 | | | | 168,159 | | | | (1,096 | ) | | | 174,131 | |
| | | | | | | | | | | | | | | | | |
| Noninterest expenses: | | | | | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | | 15,074 | | | | 86,085 | | | | (464 | ) | | | 100,695 | |
| Occupancy, office furniture and equipment | | | 2,754 | | | | 4,990 | | | | 0 | | | | 7,744 | |
| Advertising | | | 797 | | | | 1,828 | | | | 0 | | | | 2,625 | |
| Data processing | | | 1,773 | | | | 1,234 | | | | 16 | | | | 3,023 | |
| Communications | | | 301 | | | | 693 | | | | 0 | | | | 994 | |
| Professional fees | | | 690 | | | | 6,935 | | | | 22 | | | | 7,647 | |
| Real estate owned | | | 55 | | | | 0 | | | | 0 | | | | 55 | |
| Loan processing expense | | | 0 | | | | 3,620 | | | | 0 | | | | 3,620 | |
| Other | | | 1,930 | | | | 8,235 | | | | (670 | ) | | | 9,495 | |
| Total noninterest expenses | | | 23,374 | | | | 113,620 | | | | (1,096 | ) | | | 135,898 | |
| Income before income taxes | | | 17,689 | | | | 53,356 | | | | 62 | | | | 71,107 | |
| Income tax expense | | | 3,293 | | | | 14,492 | | | | 12 | | | | 17,797 | |
| Net income | | $ | 14,396 | | | $ | 38,864 | | | $ | 50 | | | $ | 53,310 | |
| | As of or for the nine months ended September 30, 2019 | |
| | | Community Banking | | | Mortgage Banking | | | Holding Company and Other | | | Consolidated | |
| | | (In Thousands) | |
| | | | | | | | | | | | | |
| Net interest income (expense) | | $ | 40,547 | | | $ | (1,511 | ) | | $ | 35 | | | $ | 39,071 | |
| Provision (credit) for loan losses | | | (850 | ) | | | 120 | | | | 0 | | | | (730 | ) |
| Net interest income (expense) after provision for loan losses | | | 41,397 | | | | (1,631 | ) | | | 35 | | | | 39,801 | |
| | | | | | | | | | | | | | | | | |
| Noninterest income | | | 3,375 | | | | 94,470 | | | | (904 | ) | | | 96,941 | |
| | | | | | | | | | | | | | | | | |
| Noninterest expenses: | | | | | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | | 13,502 | | | | 62,255 | | | | (530 | ) | | | 75,227 | |
| Occupancy, office furniture and equipment | | | 2,858 | | | | 5,227 | | | | 0 | | | | 8,085 | |
| Advertising | | | 603 | | | | 2,231 | | | | 0 | | | | 2,834 | |
| Data processing | | | 1,538 | | | | 1,091 | | | | 12 | | | | 2,641 | |
| Communications | | | 265 | | | | 774 | | | | 0 | | | | 1,039 | |
| Professional fees | | | 651 | | | | 1,734 | | | | 53 | | | | 2,438 | |
| Real estate owned | | | 75 | | | | 0 | | | | 0 | | | | 75 | |
| Loan processing expense | | | 0 | | | | 2,542 | | | | 0 | | | | 2,542 | |
| Other | | | 1,707 | | | | 4,823 | | | | (475 | ) | | | 6,055 | |
| Total noninterest expenses | | | 21,199 | | | | 80,677 | | | | (940 | ) | | | 100,936 | |
| Income before income taxes | | | 23,573 | | | | 12,162 | | | | 71 | | | | 35,806 | |
| Income tax expense | | | 5,263 | | | | 3,415 | | | | 19 | | | | 8,697 | |
| Net income | | $ | 18,310 | | | $ | 8,747 | | | $ | 52 | | | $ | 27,109 | |
| | | As of or for the three months ended March 31, 2020 | |
| | | Community Banking | | | Mortgage Banking | | | Holding Company and Other | | | Consolidated | |
| | | (In Thousands) | |
| | | | | | | | | | | | | |
| Net interest income | | $ | 12,908 | | | | (379 | ) | | | (3 | ) | | | 12,526 | |
| Provision for loan losses | | | 750 | | | | 35 | | | | 0 | | | | 785 | |
| Net interest income after provision for loan losses | | | 12,158 | | | | (414 | ) | | | (3 | ) | | | 11,741 | |
| | | | | | | | | | | | | | | | | |
| Noninterest income | | | 1,028 | | | | 30,798 | | | | (362 | ) | | | 31,464 | |
| | | | | | | | | | | | | | | | | |
| Noninterest expenses: | | | | | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | | 5,168 | | | | 19,387 | | | | (154 | ) | | | 24,401 | |
| Occupancy, office furniture and equipment | | | 1,014 | | | | 1,727 | | | | 0 | | | | 2,741 | |
| Advertising | | | 248 | | | | 652 | | | | 0 | | | | 900 | |
| Data processing | | | 605 | | | | 395 | | | | 6 | | | | 1,006 | |
| Communications | | | 97 | | | | 241 | | | | 0 | | | | 338 | |
| Professional fees | | | 198 | | | | 1,620 | | | | 14 | | | | 1,832 | |
| Real estate owned | | | 11 | | | | 0 | | | | 0 | | | | 11 | |
| Loan processing expense | | | 0 | | | | 1,076 | | | | 0 | | | | 1,076 | |
| Other | | | 580 | | | | 2,552 | | | | (229 | ) | | | 2,903 | |
| Total noninterest expenses | | | 7,921 | | | | 27,650 | | | | (363 | ) | | | 35,208 | |
| Income (loss) before income taxes | | | 5,265 | | | | 2,734 | | | | (2 | ) | | | 7,997 | |
| Income tax expense | | | 1,154 | | | | 768 | | | | 6 | | | | 1,928 | |
| Net income (loss) | | $ | 4,111 | | | | 1,966 | | | | (8 | ) | | | 6,069 | |
| | | | | | | | | | | | | | | | | |
| Total assets | | $ | 2,018,092 | | | | 311,570 | | | | (272,986 | ) | | | 2,056,676 | |
Note 15 – Leases
The Company has entered into operating lease agreements for 2 of its community banking branch locations, all of its mortgage banking office locations, and some of its office equipment. The leases have fixed terms defined regarding the payments and length. The Company elected not to include short-term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the consolidated statements of financial condition. Some of the leases included options to extend the leases. These options are reviewed and factored into the length of the lease if the option is expected to be extended. Leases did not contain an implicit rate; therefore, the Company used the incremental borrowing rates for the discount rate. There were no sale and leaseback transactions, leveraged leases, or lease transactions with related parties during the three or nine months ended September 30, 2020March 31, 2021 and DecemberMarch 31, 2020.
At September 30, 2020,March 31, 2021, the Company had lease liabilities totaling $7.0$7.5 million and right-of-use assets totaling $6.5$7.1 million related to these leases. Lease liabilities and right-of-use assets are reflected in other liabilities and other assets, respectively, on the consolidated statements of financial condition.
The cost components of our operating leases were as follows for the three and nine months ended September 30, 2020March 31, 2021 and September 30, 2019:March 31, 2020:
| | Three months ended September 30, 2020 | | | Three months ended September 30, 2019 | | | Nine months ended September 30, 2020 | | | Nine months ended September 30, 2019 | | | Three months ended March 31, 2021 | | | Three months ended March 31, 2020 | |
| | | (In Thousands) | | | (In Thousands) | |
| Operating lease cost | | $ | 786 | | | $ | 809 | | | $ | 2,380 | | | $ | 2,371 | | | $ | 770 | | | $ | 824 | |
| Variable cost | | | 134 | | | | 111 | | | | 374 | | | | 527 | | | | 117 | | | | 109 | |
| Short-term lease cost | | | 184 | | | | 230 | | | | 563 | | | | 757 | | | | 151 | | | | 193 | |
| Total | | $ | 1,104 | | | $ | 1,150 | | | $ | 3,317 | | | $ | 3,655 | | | $ | 1,038 | | | $ | 1,126 | |
At September 30, 2020,March 31, 2021, the Company had leases that had not yet commenced, but will create approximately $578,000$13,000 of additional lease liabilities and right-of-use assets for the Company in the fourthsecond quarter of 2020.2021.
The table below summarizes other information related to our operating leases:
| | Nine months ended September 30, 2020 | | | Three months ended March 31, 2021 | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| Cash paid for amounts included in the measurement of lease liabilities | | | | | | |
| Operating cash flows from operating leases | | $ | 2,689 | | | $ | 859 | |
| Initial recognition of right of use asset | | | 474 | | | | 602 | |
| Initial recognition of lease liabilities | | | 474 | | | | 602 | |
| Weighted average remaining lease term - operating leases, in years | | | 2.7 | | | | 3.4 | |
| Weighted average discount rate - operating leases | | | 5.3 | % | | | 5.2 | % |
As of September 30, 2020,March 31, 2021, lease liability information for the Company is summarized in the following table.
| Maturity analysis | | Operating leases | | | Operating leases | |
| | | (In Thousands) | | | (In Thousands) | |
| One year or less | | $ | 2,930 | | | $ | 2,742 | |
| More than one year through two years | | | 1,988 | | | | 2,128 | |
| More than two years through three years | | | 1,511 | | | | 1,484 | |
| More than three years through four years | | | 715 | | | | 804 | |
| More than four years through five years | | | 92 | | | | 452 | |
| More than five years | | | 918 | | | | 874 | |
| Total lease payments | | | 8,154 | | | | 8,484 | |
| Present value discount | | | (1,182 | ) | | | (952 | ) |
| Lease liability | | $ | 6,972 | | | $ | 7,532 | |
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Information
This Quarterly Report on Form 10-Q may contain various forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions and verbs in the future tense. These forward-looking statements include, but are not limited to:
| ● | | Statements of our goals, intentions and expectations; |
| ● | | Statements regarding our business plans, prospects, growth and operating strategies; |
| ● | | Statements regarding the quality of our loan and investment portfolio; and |
| ● | | Estimates of our risks and future costs and benefits. |
These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:
| ● | | general economic conditions, either nationally or in our market area, including employment prospects, that are different than expected; |
| ● | | the effect of any pandemic; including COVID-19; |
| ● | | competition among depository and other financial institutions; |
| ● | | inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues, the fair value of financial instruments or the origination levels in our lending business, or increase the level of defaults, losses or prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets; |
| ● | | adverse changes in the securities or secondary mortgage markets; |
| ● | | changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements; |
| ● | | changes in monetary or fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board; |
| ● | | our ability to manage market risk, credit risk and operational risk in the current economic conditions; |
| ● | | our ability to enter new markets successfully and capitalize on growth opportunities; |
| ● | | our ability to successfully integrate acquired entities; |
| ● | | decreased demand for our products and services; |
| ● | | changes in tax policies or assessment policies; |
| ● | | the inability of third-party providers to perform their obligations to us; |
| ● | | changes in consumer demand, spending, borrowing and savings habits; |
| ● | | changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board; |
| ● | | our ability to retain key employees; |
● | | cyber attacks, computer viruses and other technological risks that may breach the security of our websites or other systems to obtain unauthorized access to confidential information and destroy data or disable our systems; |
| ● | | technological changes that may be more difficult or expensive than expected; |
| ● | | the ability of third-party providers to perform their obligations to us; |
| ● | | the effects of any federal government shutdown; |
| ● | | the ability of the U.S. Government to manage federal debt limits; |
| ● | | significant increases in our loan losses; and |
| ● | | changes in the financial condition, results of operations or future prospects of issuers of securities that we own. |
See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2020).
The risks included here are not exhaustive. Other sections of this report may include additional factors which could adversely affect our business and financial performance. New risks emerge from time to time and it is not possible for management to predict all such risks, nor can it assess the impact of all such risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.
Overview
The following discussion and analysis is presented to assist the reader in understanding and evaluating the Company’s financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Quarterly Report on Form 10-Q and should be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the three and nine months ended September 30,March 31, 2021 and 2020 and 2019 and the financial condition as of September 30, 2020March 31, 2021 compared to the financial condition as of December 31, 2019.2020.
As described in the notes to the unaudited consolidated financial statements, we have two reportable segments: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin along with a loan production office in Minneapolis, Minnesota.Wisconsin. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted by offices in 21 states through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market.
Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. We have provided below a discussion of the material results of operations for each segment on a separate basis for the three and nine months ended September 30,March 31, 2021 and 2020, and 2019, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of the Company, which includes the consolidated operations of the Bank and Waterstone Mortgage Corporation, for the same periods.
Significant Items
Earnings comparisons for the three and nine months ended September 30,March 31, 2021 and 2020 and 2019 were impacted by the Significant Itemssignificant items summarized below.
COVID-19 and the CARES Act
The COVID-19 pandemic has caused economic and social disruption on an unprecedented scale. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption has resulted in the shuttering of businesses across the country, significant job loss, and aggressive measures by the federal government.
Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably,In March 2020, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In additionMarch 2021, the American Rescue Plan Act of 2021 (the American Rescue Plan Act) was signed into law which provides approximately $1.9 trillion in spending to address the generalcontinued impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on our operations.COVID-19. While it is not possible to know the full universe or extent of these impacts as of the date this filing, we are disclosing potentially material items of which we are aware.
The CARES Act allowsallowed for a temporary delay in the adoption of accounting guidance under Accounting Standards Codification Topic 326, “Financial Instruments – Credit Losses (“CECL”) until the earlier of December 31, 2020 or after the end of the COVID-19 national emergency. During the quarter ended March 31, 2020, pursuant to the recently-enacted CARES Act and guidance from the Securities and Exchange Commission (“SEC”) and Financial Accounting Standards Board (“FASB”), we elected to delay adoption of CECL. Our September 30,On December 27, 2020, the Consolidated Appropriations Act, 2021 was signed into law. Among other provisions, this Act extended the temporary delay on the adoption of CECL until January 1, 2022. The financial statements included in this Quarterly Report on Form 10-Q include an allowance for loan losses that was prepared under the existing incurred loss methodology.
• | Under the CARES Act, loans less than 30 days past due as of December 31, 2019 and COVID-19 modifications are considered current. A financial institution suspended the requirements under accounting principles generally accepted in the United States (US GAAP) for loan modifications related to COVID-19 that would otherwise be categorized as a troubled debt restructuring (“TDR”). This includes a suspension of the requirement to determine impairment of these modifications for accounting purposes. In keeping with regulatory guidance to work with borrowers during this unprecedented situation, the Company has executed a payment deferral program for our lending clients that are adversely affected by the pandemic. As of September 30, 2020, the Company had modified eight loans totaling $3.2 million consisting of principal or principal and interest. In accordance with the CARES Act issued in April 2020, these modifications for accounting purposes. In keeping with regulatory guidance to work with borrowers during this unprecedented situation, the Company has executed a payment deferral program for our lending clients that are adversely affected by the pandemic. As of March 31, 2021, the Company had two modified loans totaling $910,000 consisting of principal deferrals or principal and interest deferrals. These short-term deferrals are not considered troubled debt restructurings. |
The CARES Act authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new loan program call the Paycheck Protection Program (“PPP”). As a qualified SBA lender, we were automatically authorized to originate PPP loans. The Company is actively participating in assisting our customers with applications for resources through the program. PPP loans will have: (a) an interest rate of 1.0%, (b) a five-year loan term to maturity for loans made on or after June 5, 2020 (loans made prior to June 5, 2020 have a two-year term, however borrowers and lenders may mutually agree to extend the maturity for such loans to five years); and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP. As of September 30, 2020,March 31, 2021, we have funded 279419 loans totaling $30.1$43.2 million. The $30.1During the three months ended March 31, 2021, the Company originated a total of $13.1 million isin PPP loans for customers and recognized $354,000 in fees received from the SBA. As of March 31, 2021, we have PPP loans outstanding as of September 30, 2020.totaling $19.4 million.
Our fee income could be reduced due to COVID-19. In keeping with guidance from regulators, we are working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact our fee income in future periods.
Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.
As of September 30, 2020March 31, 2021, all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses.
We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.
There were no Significant Items during the three and nine months ended September 30, 2019.
Comparison of Community Banking Segment Results of Operations for the Three Months Ended September 30,March 31, 2021 and 2020 and 2019
Net income totaled $6.2$7.3 million for the three months ended September 30, 2020March 31, 2021 compared to $6.7$4.1 million for the three months ended September 30, 2019.March 31, 2020. Net interest income decreased $424,000increased $1.3 million to $13.5$14.2 million for the three months ended September 30, 2020March 31, 2021 compared to $13.9$12.9 million for the three months ended September 30, 2019. Interest income on loans increased on volume offset by a decrease in interest earned in the other interest-earning asset categories.March 31, 2020. Interest expense decreased as funding rates decreased. Offsetting the decrease in interest expense, interest income on loans, mortgage-related securities, and other interest-earning asset categories decreased as replacement rates were lower than in the prior year.
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current quarter allowance using the incurred loss model. There was a negative provision for loan losses of $1.0$1.1 million for the three months ended September 30, 2020March 31, 2021 compared to a negative$750,000 provision of $150,000for loan losses for the three months ended September 30, 2019.March 31, 2020. During the three months ended September 30, 2020,March 31, 2021, we made adjustments to our qualitative factors, primarily to account for the significant increaseimprovement in loans downgraded to our Watch caterogy.certain economic factors along with a decrease in loan balance.
Total noninterest income increased $1.7 million$215,000 due primarily to gains as a result of two death benefits received on bank-owned life insurance policies in the current quarter. The loan fees increased primarily due to loan prepayment fees and fees earned on loan swaps.fees. Cash surrender value of life insurance decreased as the balance decreased year over year as a result of the death benefits.benefits in the prior year leading to a lower insurance balance. Other income slightly increased primarily due to wealth management and rental income.revenue.
Compensation, payroll taxes, and other employee benefits expense increased $925,000decreased $193,000 to $5.0 million due primarily to an increasedecrease in salaries expense, health insurance expense, and variable compensation.expense. Occupancy, office furniture and equipment decreasedincreased slighty due primarily to decreased computer and furniture and equipmentincreased snow removal expense. Advertising expense increaseddecreased primarily due to deposit promotions for the new branch opening during the three months ended September 30,March 31, 2020. Data processing feesexpense decreased $94,000 due to the implementation of a new digital conversion fees that began in 2019. Professional fees increased for the three months ended September 30, 2020 due to additional audit and legal feesbanking platform in 2020. Other noninterest expense increaseddecreased $140,000 as certain loan expenses decreased offset by a resultdecrease of a creditcredits received for FDIC insurance received during the three months ended September 30, 2019premiums in 2020 but not during the three months ended September 30, 2020.in 2021.
Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30,March 31, 2021 and 2020 and 2019
Net income totaled $20.1$14.0 million for the three months ended September 30, 2020March 31, 2021 compared to $4.1$2.0 million for the three months ended September 30, 2019.March 31, 2020. We originated $1.30$1.12 billion in mortgage loans held for sale (including sales to the community banking segment) during the three months ended September 30, 2020,March 31, 2021, which represents an increase of $445.4$406.3 million, or 52.3%57.3%, from the $851.3$708.8 million originated during the three months ended September 30, 2019.March 31, 2020. The increase in loan production volume was driven by a $286.8$264.8 million, or 160.4%117.9%, increase in refinance products as mortgage rates decreased. Mortgage purchase products increased $158.7$141.4 million, or 23.6%29.2% due to the high demand offor single family homes.homes and fixed-rate mortgages. Total mortgage banking noninterest income increased $36.6$24.2 million, or 100.2%78.7%, to $73.1$55.0 million during the three months ended September 30, 2020March 31, 2021 compared to $36.5$30.8 million during the three months ended September 30, 2019.March 31, 2020. The increase in mortgage banking noninterest income was related to a 52.3%57.3% increase in volume and a 26.5%19.2% increase in gross margin on loans originated and sold for the three months ended September 30, 2020March 31, 2021 compared to September 30, 2019.March 31, 2020. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The gross margin on loans originated and sold expansion reflects increased industry demand due to the current low rate environment. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.
Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 64.1%56.1% of total originations during the three months ended September 30, 2020,March 31, 2021, compared to 79.0%68.3% of total originations during the three months ended September 30, 2019,March 31, 2020, respectively, as refinance demand accelerated from the low rate environment. The mix of loan type trended towards more conventional loans and less governmental loans; with conventional loans and governmental loans comprising 75.6%79.0% and 24.4%21.0% of all loan originations, respectively, during the three months ended September 30, 2020,March 31, 2021, compared to 70.1%71.3% and 29.9%28.7% of all loan originations, respectively, during the three months ended September 30, 2019.March 31, 2020.
Total compensation, payroll taxes and other employee benefits increased $10.9$9.9 million, or 46.3%50.9%, to $34.6$29.3 million for the three months ended September 30, 2020March 31, 2021 compared to $23.6$19.4 million for the three months ended September 30, 2019.March 31, 2020. The increase in compensation expense was primarily a result of the increase in commission expense, as fundings increased, bonus, and incentives due to record originations. In addition, branch manager pay increased as branches were more profitable. Professional fees increased duedecreased $2.1 million to a tentative settlement agreement$524,000 of income during the quarter ended March 31, 2021 compared to $1.6 million of expense during the quarter ended March 31, 2020. The decrease related to receiving a legal settlement and lower litigation costs compared to the prior year as the Herrington litigation (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information).settlement was resolved. Occupancy, office furniture, and equipment decreased due to lower rent driven by a reduction in branches as underperforming branches closed over the past year. Advertising expense decreased as the low rate environment attracted customers.and depreciation expenses. Loan processing expenses increased due primarily to increased application and funding volumes as interest rates remain low in 2020.low. Other noninterest expense increased primarily due to amortization of mortgage servicing rights as the valuesize of the servicing portfolio has increased in 20202021 compared to 2019.2020.
Consolidated Waterstone Financial, Inc. Results of Operations
| | Three months ended September 30, | | | Three months ended March 31, | |
| | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | (Dollars in Thousands, except per share amounts) | | | (Dollars in Thousands, except per share amounts) | |
| | | | | | | | | | | | | |
| Net income | | $ | 26,293 | | | | 10,924 | | | $ | 21,344 | | | | 6,069 | |
| Earnings per share - basic | | | 1.08 | | | | 0.42 | | | | 0.90 | | | | 0.24 | |
| Earnings per share - diluted | | | 1.08 | | | | 0.42 | | | | 0.89 | | | | 0.24 | |
| Annualized return on average assets | | | 4.78 | % | | | 2.17 | % | | | 3.99 | % | | | 1.21 | % |
| Annualized return on average equity | | | 26.30 | % | | | 11.15 | % | | | 20.49 | % | | | 6.24 | % |
| | | | | | | | | | | | | | | | | |
Net Interest Income
Average Balance Sheets, Interest and Yields/Costs
The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.
| | Three months ended September 30, | | | Three months ended March 31, | |
| | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | Average Balance | | | Interest | | | Yield/Cost | | | Average Balance | | | Interest | | | Yield/Cost | | | Average Balance | | | Interest | | | Yield/Cost | | | Average Balance | | | Interest | | | Yield/Cost | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| Assets | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Loans receivable and held for sale (1) | | $ | $1,766,715 | | | $ | $18,224 | | | | 4.10 | % | | $ | $1,579,575 | | | $ | $18,558 | | | | 4.66 | % | | $ | $1,657,260 | | | $ | $16,603 | | | | 4.06 | % | | $ | $1,562,097 | | | $ | $17,687 | | | | 4.55 | % |
| Mortgage related securities (2) | | | 96,529 | | | | 588 | | | | 2.42 | % | | | 114,051 | | | | 737 | | | | 2.56 | % | | | 90,457 | | | | 491 | | | | 2.20 | % | | | 112,089 | | | | 702 | | | | 2.52 | % |
| Debt securities, federal funds sold and short-term investments (2)(3) | | | 166,160 | | | | 801 | | | | 1.92 | % | | | 169,621 | | | | 1,157 | | | | 2.71 | % | | | 273,929 | | | | 948 | | | | 1.40 | % | | | 206,485 | | | | 1,134 | | | | 2.21 | % |
| Total interest-earning assets | | | 2,029,404 | | | | 19,613 | | | | 3.84 | % | | | 1,863,247 | | | | 20,452 | | | | 4.35 | % | | | 2,021,646 | | | | 18,042 | | | | 3.62 | % | | | 1,880,671 | | | | 19,523 | | | | 4.18 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-earning assets | | | 160,526 | | | | | | | | | | | | 137,723 | | | | | | | | | | | | 147,781 | | | | | | | | | | | | 132,283 | | | | | | | | | |
| Total assets | | $ | $2,189,930 | | | | | | | | | | | $ | $2,000,970 | | | | | | | | | | | $ | $2,169,427 | | | | | | | | | | | $ | $2,012,954 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities and equity | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand accounts | | $ | $50,590 | | | | 11 | | | | 0.09 | % | | $ | $37,015 | | | | 8 | | | | 0.09 | % | | $ | $55,552 | | | | 10 | | | | 0.07 | % | | $ | $39,886 | | | | 8 | | | | 0.08 | % |
| Money market, savings, and escrow accounts | | | 282,349 | | | | 473 | | | | 0.67 | % | | | 206,474 | | | | 298 | | | | 0.57 | % | | | 314,418 | | | | 247 | | | | 0.32 | % | | | 218,942 | | | | 427 | | | | 0.78 | % |
| Time deposits | | | 741,265 | | | | 3,011 | | | | 1.62 | % | | | 739,544 | | | | 4,173 | | | | 2.24 | % | | | 705,712 | | | | 1,260 | | | | 0.72 | % | | | 734,147 | | | | 3,883 | | | | 2.13 | % |
| Total interest-bearing deposits | | | 1,074,204 | | | | 3,495 | | | | 1.29 | % | | | 983,033 | | | | 4,479 | | | | 1.81 | % | | �� | 1,075,682 | | | | 1,517 | | | | 0.57 | % | | | 992,975 | | | | 4,318 | | | | 1.75 | % |
| Borrowings | | | 531,588 | | | | 2,640 | | | | 1.98 | % | | | 509,099 | | | | 2,745 | | | | 2.14 | % | | | 482,665 | | | | 2,500 | | | | 2.10 | % | | | 495,595 | | | | 2,608 | | | | 2.12 | % |
| Total interest-bearing liabilities | | | 1,605,792 | | | | 6,135 | | | | 1.52 | % | | | 1,492,132 | | | | 7,224 | | | | 1.92 | % | | | 1,558,347 | | | | 4,017 | | | | 1.05 | % | | | 1,488,570 | | | | 6,926 | | | | 1.87 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing deposits | | | 129,911 | | | | | | | | | | | | 86,849 | | | | | | | | | | | | 138,446 | | | | | | | | | | | | 92,627 | | | | | | | | | |
| Other noninterest-bearing liabilities | | | 56,451 | | | | | | | | | | | | 33,130 | | | | | | | | | | | | 50,188 | | | | | | | | | | | | 40,609 | | | | | | | | | |
| Total noninterest-bearing liabilities | | | 186,362 | | | | | | | | | | | | 119,979 | | | | | | | | | | | | 188,634 | | | | | | | | | | | | 133,236 | | | | | | | | | |
| Total liabilities | | | 1,792,154 | | | | | | | | | | | | 1,612,111 | | | | | | | | | | | | 1,746,981 | | | | | | | | | | | | 1,621,806 | | | | | | | | | |
| Equity | | | 397,776 | | | | | | | | | | | | 388,859 | | | | | | | | | | | | 422,446 | | | | | | | | | | | | 391,148 | | | | | | | | | |
| Total liabilities and equity | | $ | $2,189,930 | | | | | | | | | | | $ | $2,000,970 | | | | | | | | | | | $ | $2,169,427 | | | | | | | | | | | $ | $2,012,954 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income / Net interest rate spread (4) | | | | | | | 13,478 | | | | 2.32 | % | | | | | | | 13,228 | | | | 2.43 | % | | | | | | | 14,025 | | | | 2.57 | % | | | | | | | 12,597 | | | | 2.31 | % |
| Less: taxable equivalent adjustment | | | | | | | 69 | | | | 0.01 | % | | | | | | | 74 | | | | 0.01 | % | | | | | | | 73 | | | | 0.02 | % | | | | | | | 71 | | | | 0.02 | % |
| Net interest income / Net interest rate spread, as reported | | | | | | $ | $13,409 | | | | 2.31 | % | | | | | | $ | $13,154 | | | | 2.42 | % | | | | | | $ | $13,952 | | | | 2.55 | % | | | | | | $ | $12,526 | | | | 2.29 | % |
| Net interest-earning assets (5) | | $ | $423,612 | | | | | | | | | | | $ | $371,115 | | | | | | | | | | | $ | $463,299 | | | | | | | | | | | $ | $392,101 | | | | | | | | | |
Net interest margin (6) | | | | | | | | | | | | | | | | | | | | | | | 2.80 | % | | | | | | | | | | | | | | | | | | | | | | | 2.68 | % |
| Tax equivalent effect | | | | | | | | | | | 0.01 | % | | | | | | | | | | | 0.02 | % | | | | | | | | | | | 0.01 | % | | | | | | | | | | | 0.01 | % |
| Net interest margin on a fully tax equivalent basis (6) | | | | | | | | | | | 2.64 | % | | | | | | | | | | | 2.82 | % | | | | | | | | | | | 2.81 | % | | | | | | | | | | | 2.69 | % |
| Average interest-earning assets to average interest-bearing liabilities | | | | | | | | | | | 126.38 | % | | | | | | | | | | | 124.87 | % | | | | | | | | | | | 129.73 | % | | | | | | | | | | | 126.34 | % |
__________
(1) Interest income includes net deferred loan fee amortization income of $349,000$604,000 and $136,000$171,000 for the three months ended September 30,March 31, 2021 and 2020, and 2019, respectively.
(2) Average balance of mortgage related and debt securities are based on amortized historical cost.
(3) Interest income from tax-exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2020March 31, 2021 and 2019.2020. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.751.30% and 2.53%2.07% for the three months ended September 30,March 31, 2021 and 2020, and 2019, respectively.
(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.
(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
| | Three months ended September 30, | | | Three months ended March 31, | |
| | | 2020 versus 2019 | | | 2021 versus 2020 | |
| | | Increase (Decrease) due to | | | Increase (Decrease) due to | |
| | | Volume | | | Rate | | | Net | | | Volume | | | Rate | | | Net | |
| | | (In Thousands) | | | (In Thousands) | |
| Interest income: | | | | | | | | | | | | | | | | | | |
| Loans receivable and held for sale (1)(2) | | $ | 2,030 | | | $ | (2,364 | ) | | $ | (334 | ) | | $ | 1,412 | | | $ | (2,496 | ) | | $ | (1,084 | ) |
| Mortgage related securities (3) | | | (107 | ) | | | (42 | ) | | | (149 | ) | | | (127 | ) | | | (84 | ) | | | (211 | ) |
| Debt securities, federal funds sold and short-term investments (3)(4) | | | (23 | ) | | | (333 | ) | | | (356 | ) | | | 1,523 | | | | (1,709 | ) | | | (186 | ) |
| Total interest-earning assets | | | 1,900 | | | | (2,739 | ) | | | (839 | ) | | | 2,808 | | | | (4,289 | ) | | | (1,481 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest expense: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand accounts | | | 3 | | | | - | | | | 3 | | | | 3 | | | | (1 | ) | | | 2 | |
| Money market, savings, and escrow accounts | | | 118 | | | | 57 | | | | 175 | | | | 511 | | | | (691 | ) | | | (180 | ) |
| Time deposits | | | 10 | | | | (1,172 | ) | | | (1,162 | ) | | | (145 | ) | | | (2,478 | ) | | | (2,623 | ) |
| Total interest-earning deposits | | | 131 | | | | (1,115 | ) | | | (984 | ) | | | 369 | | | | (3,170 | ) | | | (2,801 | ) |
| Borrowings | | | 150 | | | | (255 | ) | | | (105 | ) | | | (79 | ) | | | (29 | ) | | | (108 | ) |
| Total interest-bearing liabilities | | | 281 | | | | (1,370 | ) | | | (1,089 | ) | | | 290 | | | | (3,199 | ) | | | (2,909 | ) |
| Net change in net interest income | | $ | 1,619 | | | $ | (1,369 | ) | | $ | 250 | | | $ | 2,518 | | | $ | (1,090 | ) | | $ | 1,428 | |
______________
(1) Interest income includes net deferred loan fee amortization income of $349,000$604,000 and $136,000$171,000 for the three months ended September 30,March 31, 2021 and 2020, and 2019, respectively.
(2) Non-accrual loans have been included in average loans receivable balance.
(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.
(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2020March 31, 2021 and September 30, 2019.March 31, 2020.
Net interest income increased $255,000,$1.4 million, or 1.9%11.4%, to $13.4$14.0 million during the three months ended September 30, 2020March 31, 2021 compared to $13.2$12.5 million during the three months ended September 30, 2019.March 31, 2020.
| ● | | Interest income on loans decreased $334,000$1.1 million due primarily to a 5649 basis point decrease in average yield on loans as London Interbank Offered Rate (LIBOR) and U.S. Treasury rates continued to decrease, partially offset by an increase of $187.1$95.2 million, or 11.8%6.1%, in average loans. The increase in average loan balance was driven by a $49.7 million, or 3.6%, increase in the average balance of loans held in portfolio and by an increase of $137.5$141.6 million, or 68.8%84.0%, in the average balance of loans held for sale.sale partially offset by a $46.5 million, or 3.3%, decrease in the average balance of loans held in portfolio. |
| ● | | Interest income from mortgage-related securities decreased $149,000$211,000 as the yield decreased 1432 basis points and the average balance decreased $17.5$21.6 million. |
| ● | | Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) decreased $351,000$188,000 due to a 7877 basis point decrease in the average yield. The decrease in average yield was primarily driven by the decrease in federal funds rate over the past year and asdue to higher yielding securities have matured.maturing. The average balance decreased $3.5increased $67.4 million to $166.2$273.9 million due to ahigher cash balances offset by lower municipal securities balances. The increase in average cash balances as maturities that occurred throughoutresulted fron the past 12 months were not replaced due to market conditions. Offsetting those decreases, the balance of FHLB stock increased with additional FHLB borrowings.growth in deposits outpacing loan growth. |
| ● | | Interest expense on time deposits decreased $1.2$2.6 million, or 27.8%67.6%, primarily due to a 62141 basis point decrease in average cost of time deposits. Offset the decrease in average cost of time deposits,Additionally, the average balance of time deposits increased $1.7decreased $28.4 million compared to the prior year period. |
| ● | | Interest expense on money market, savings, and escrow accounts increased $175,000,decreased $180,000, or 58.7%42.2%, due primarily to a 1046 basis point increasedecrease in average cost of money market, savings, and escrow accounts along with an increaseaccounts. Partially offsetting the decrease in average cost, the average balance of $75.9increased $95.5 million. Money market accounts have beencontinue to be a focus over the year and the Company has aggressivelyagressively marketed new and existing customers through various new offerings and new branches that opened within the past 12 months.offerings. |
| ● | | Interest expense on borrowings decreased $105,000,$108,000, or 3.8%4.1%, due to a decrease in the average cost of borrowings of 16two basis points to 1.98%2.10% during the three months ended September 30, 2020March 31, 2021 compared to 2.14%2.12% during the three months ended September 30, 2019. The decrease in the cost of borrowings resulted from the new short-term fundings borrowed at a lower rate. Offsetting the decrease in rate,March 31, 2020. Additionally, the average borrowing volume increased $22.5decreased $12.9 million to $531.6$482.7 million during the three months ended September 30, 2020,March 31, 2021, compared to $509.1$495.6 million during the three months ended September 30, 2019.March 31, 2020. The increasedecrease was primarily due to the funding of the loans held for sale.increase in average deposits. |
Provision for Loan Losses
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act and subsequently under the Consolidated Appropriations Act. The Company calculated the current quarter allowance using the incurred loss model. The negative provision for loan losses was $1.0$1.1 million for the three months ended September 30, 2020March 31, 2021 compared to $80,000$750,000 of negative provision for loan losses for the three months ended September 30, 2019 as there was an increase in loans downgradedMarch 31, 2020. During the three months ended March 31, 2021, we made adjustments to our Watch category. Additional qualitative risk factors, were applied to each of the loan categories primarily to account for the downgrades.improvement in certain economic factors along with a decrease in loan balance. We had a negative provision for loan losses of $1.0$1.1 million at the community banking segment and $25,000a provision for loan losses of $30,000 for the mortgage banking segment. Net recoveries were $85,000$27,000 for the three months ended September 30, 2020.March 31, 2021.
The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for loan losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Losses"Loss" section.
Noninterest Income
| | Three months ended September 30, | | | Three months ended March 31, | |
| | | 2020 | | | 2019 | | | $ Change | | | % Change | | | 2021 | | | 2020 | | | $ Change | | | % Change | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Service charges on loans and deposits | | $ | 672 | | | $ | 503 | | | $ | 169 | | | | 33.6 | % | | $ | 690 | | | $ | 481 | | | $ | 209 | | | | 43.5 | % |
| Increase in cash surrender value of life insurance | | | 714 | | | | 728 | | | | (14 | ) | | | (1.9 | )% | | | 301 | | | | 353 | | | | (52 | ) | | | (14.7 | )% |
| Mortgage banking income | | | 72,112 | | | | 36,062 | | | | 36,050 | | | | 100.0 | % | | | 54,391 | | | | 30,406 | | | | 23,985 | | | | 78.9 | % |
| Other | | | 2,265 | | | | 201 | | | | 2,064 | | | | 1,026.9 | % | | | 817 | | | | 224 | | | | 593 | | | | 264.7 | % |
| Total noninterest income | | $ | 75,763 | | | $ | 37,494 | | | $ | 38,269 | | | | 102.1 | % | | $ | 56,199 | | | $ | 31,464 | | | $ | 24,735 | | | | 78.6 | % |
Total noninterest income increased $38.3$24.7 million, or 102.1%78.6%, to $75.8$56.2 million during the three months ended September 30, 2020March 31, 2021 compared to $37.5$31.5 million during the three months ended September 30, 2019.March 31, 2020. The increase resulted primarily from an increase in mortgage banking income, service charges on loan and deposits, and other noninterest income.
| ● | | The increase in mortgage banking income was primarily the result of an increase in loan origination volume and gross margin on loans originated and sold. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. Total loan origination volume on a consolidated basis increased $445.8$421.4 million, or 54.2%61.3%, to $1.27$1.11 billion during the three months ended September 30, 2020March 31, 2021 compared to $822.8$687.7 million during the three months ended September 30, 2019.March 31, 2020. Gross margin on loans originated and sold increased 26.5%19.2% at the mortgage banking segment. See "Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30, 2020March 31, 2021 and 2019"2020" above for additional discussion of the increase in mortgage banking income. |
| ● | | Service charges on loans and deposits increased primarily due to loan prepayment fees and fees earned on loan swaps.fees. |
| ● | | The decrease in cash surrender value of life insurance was due primarily to ana decrease in balance as death benefit proceeds were received on two policies.policies in the prior year. |
| ● | | The increase in other noninterest income was due primarily to increases in gain from death benefit on bank owned life insurance, mortgage servicing fee income and wealth management revenue, and rental income.revenue. Mortgage servicing fee income increased as loans sold with servicing rights retained increased due to market conditions. |
Noninterest Expenses
| | Three months ended September 30, | | | Three months ended March 31, | |
| | | 2020 | | | 2019 | | | $ Change | | | % Change | | | 2021 | | | 2020 | | | $ Change | | | % Change | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | $ | 39,405 | | | $ | 27,514 | | | $ | 11,891 | | | | 43.2 | % | | $ | 34,123 | | | $ | 24,401 | | | $ | 9,722 | | | | 39.8 | % |
| Occupancy, office furniture and equipment | | | 2,469 | | | | 2,629 | | | | (160 | ) | | | (6.1 | )% | | | 2,565 | | | | 2,741 | | | | (176 | ) | | | (6.4 | )% |
| Advertising | | | 861 | | | | 913 | | | | (52 | ) | | | (5.7 | )% | | | 824 | | | | 900 | | | | (76 | ) | | | (8.4 | )% |
| Data processing | | | 922 | | | | 1,003 | | | | (81 | ) | | | (8.1 | )% | | | 971 | | | | 1,006 | | | | (35 | ) | | | (3.5 | )% |
| Communications | | | 339 | | | | 358 | | | | (19 | ) | | | (5.3 | )% | | | 331 | | | | 338 | | | | (7 | ) | | | (2.1 | )% |
| Professional fees | | | 4,738 | | | | 954 | | | | 3,784 | | | | 396.6 | % | | | (315 | ) | | | 1,832 | | | | (2,147 | ) | | | (117.2 | )% |
| Real estate owned | | | 11 | | | | 24 | | | | (13 | ) | | | (54.2 | )% | | | (12 | ) | | | 11 | | | | (23 | ) | | | (209.1 | )% |
| Loan processing expense | | | 1,336 | | | | 858 | | | | 478 | | | | 55.7 | % | | | 1,335 | | | | 1,076 | | | | 259 | | | | 24.1 | % |
| Other | | | 2,920 | | | | 1,979 | | | | 941 | | | | 47.5 | % | | | 3,178 | | | | 2,903 | | | | 275 | | | | 9.5 | % |
| Total noninterest expenses | | $ | 53,001 | | | $ | 36,232 | | | $ | 16,769 | | | | 46.3 | % | | $ | 43,000 | | | $ | 35,208 | | | $ | 7,792 | | | | 22.1 | % |
Total noninterest expenses increased $16.8$7.8 million, or 46.3%22.1%, to $53.0$43.0 million during the three months ended September 30, 2020March 31, 2021 compared to $36.2$35.2 million during the three months ended September 30, 2019.March 31, 2020.
| ● | | Compensation, payroll taxes and other employee benefits expense at our mortgage banking segment increased $10.9$9.9 million, or 46.3%50.9%, to $34.6$29.3 million during the three months ended September 30, 2020.March 31, 2021. The increase in compensation expense was primarily a result of an increase in commission expense as fundings increased and branch manager pay increased as branches were more profitable. |
| ● | | Compensation, payroll taxes and other employee benefits expense at the community banking segment increased $925,000,decreased $193,000, or 22.7%3.7%, to $5.0 million during the three months ended September 30, 2020.March 31, 2021. The increasedecrease was due primarily to an increase in salaries expense due to annual raises and additional branches, health insurance expense as claims increased, and variable compensation as executives are eligible for an increased bonus.decreased. |
| ● | | Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $92,000$187,000 to $1.6$1.5 million during the three months ended September 30, 2020,March 31, 2021, primarily resulting from lower rent expense offset by an increase in computer equipment expense to accomodate remote working.and depreciation expense. |
| ● | | Occupancy, office furniture and equipment expense at the community banking segment decreased $68,000increased $11,000 to $874,000$1.0 million during the three months ended September 30, 2020.March 31, 2021. The decreaseincrease was due primarily to decreased computer and furniture and equipment expenses.increased snow removal expense. |
| ● | | Advertising expense decreased $52,000,$76,000, or 5.7%8.4%, to $861,000$824,000 during the three months ended September 30, 2020.March 31, 2021. This was primarily due to marketing decreases at the community banking segment due to lower customer promotions. Advertising at the mortgage banking segment decreased as volumes were largely driven by lower rates. Advertising at the community banking segment increased due to promotions for deposit customers.a low rate environment drove demand. |
| ● | | Data processing expense decreased $81,000,$35,000, or 8.1%3.5%, to $922,000$971,000 during the three months ended September 30, 2020.March 31, 2021. This was primarily due to increased conversion expenses for the new ditigal banking platform rollout at the community banking segment during the three months ended September 30, 2019.March 31, 2020. |
| ● | | Professional fees increased $3.8decreased $2.1 million to $4.7 million$315,000 of income during the three months ended September 30, 2020. This wasMarch 31, 2021. The decrease is primarily duerelated to receiving a $4.25 million tentative legal settlement (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities oflower litigation costs compared to the notes to unaudited consolidated financial statements for additional information). prior year as the Herrington settlement was resolved. |
| ● | | Loan processing expense increased $478,000,$259,000, or 55.7%24.1%, to $1.3 million during the three months ended September 30, 2020.March 31, 2021. This was primarily due to an increase in loan costs associated with the increased application volumes as mortgage rates declined.remain low. |
| ● | | Other noninterest expense increased $941,000,$275,000, or 47.5%9.5%, to $2.9$3.2 million during the three months ended September 30, 2020.March 31, 2021. The increase at the mortgage banking segment was primarily due to amortization of mortgage servicing rights as the valuesize of the servicing portfolio has increased in 20202021 compared to 2019.2020. Additionally, other noninterest expenses increased at the community banking segment as thecertain loan expenses decreased offset by a decrease of credits received for FDIC issued a credit for the three months ended September 30, 2019premiums in 2020 but not for the three months ended September 30, 2020.in 2021. |
Income Taxes
Income tax expense totaled $8.9$6.9 million for the three months ended September 30, 2020March 31, 2021 compared to $3.6$1.9 million during the three months ended September 30, 2019.March 31, 2020. Income tax expense was recognized on the statement of income during the three months ended September 30, 2020March 31, 2021 at an effective rate of 25.2%24.4% of pretax income compared to 24.6%24.1% during the three months ended September 30, 2019.March 31, 2020. The increase in rate is primarily due to higher pretax income. The Company recognized a benefit of $354,000 relatedincome, relative to the proceeds received on the bank owned life insurance death benefit during the three months ended September 30, 2020.permanent deductions.
Comparison of Community Banking Segment for the Nine Months Ended September 30, 2020 and 2019
Net income decreased $3.9 million for the nine months ended September 30, 2020 to $14.4 million compared to net income of $18.3 million for the nine months ended September 30, 2019. Net interest income decreased $477,000 to $40.1 million for the nine months ended September 30, 2020 compared to $40.5 million for the nine months ended September 30, 2019. Net interest income decreased primarily due to a decrease from mortgage-related securities and other interest-earning assets interest. Offsetting the decreases on net interest income, interest income on loans increased due to an increase in volume and interest expense on time deposits decreased as replacement rates were lower.
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current quarter allowance using the incurred loss model. Provision for loan losses was $6.1 million for the nine months ended September 30, 2020 compared to a negative provision of $850,000 for the nine months ended September 30, 2019 as economic conditions significantly worsened during the nine months ended September 30, 2020.
Total noninterest income increased $3.7 million due primarily to increases in loan fees and a gain from death benefits on bank owned life insurance. The loan fees increased primarily due to loan prepayment fees and fees earned on loan swaps. Cash surrender value of life insurance decreased as the balance decreased due to death benefit proceeds received on two bank owned life insurance policies. Other income increased primarily due to gain on death benefits, wealth management fees, and rental income.
Compensation, payroll taxes, and other employee benefits expense increased $1.6 million to $15.1 million due primarily to an increase in salaries expense, health insurance expense, and variable compensation. Occupancy, office furniture and equipment decreased due primarily to computer and snow plowing expense. Data processing and advertising expense increased primarily due to the rollout of a new ditigal banking platform and promotions for deposit customers during the nine months ended September 30, 2020. Communications expenese, professional fees, and other expenses, increased while real estate owned expenses decreased.
Comparison of Mortgage Banking Segment Operations for the NineMonths Ended September 30, 2020 and 2019
Net income totaled $38.9 million for the nine months ended September 30, 2020 compared to $8.7 million for the nine months ended September 30, 2019. We originated $3.15 billion in mortgage loans held for sale (including sales to the community banking segment) during the nine months ended September 30, 2020, which represents an increase of $1.00 billion, or 46.7%, from the $2.15 billion originated during the nine months ended September 30, 2019. The increase in loan production volume was driven by a $870.9 million, or 265.7%, increase in refinance products as mortgage rates decreased. Mortgage purchase products increased $131.3 million, or 7.2% due to an increased housing demand. Total mortgage banking noninterest income increased $73.7 million, or 78.0%, to $168.2 million during the nine months ended September 30, 2020 compared to $94.5 million during the nine months ended September 30, 2019. The increase in mortgage banking noninterest income was related to a 46.7% increase in volume and an 17.8% increase in gross margin on loans originated and sold for the nine months ended September 30, 2020 compared to September 30, 2019. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The increase in gross margin on loans originated and sold reflects industry demand due to the low rate environment resulting in higher volume. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.
Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Our origination efforts continue to be focused on loans made for the purpose of residential purchases, as opposed to mortgage refinance. The percentage of origination volume related to purchase activity decreased to 61.9% from 84.7% of total originations for the nine months ended September 30, 2020 and 2019, respectively, as refinance demand accelerated from the low rate environment. The mix of loan type trended towards more conventional loans and less governmental loans; with conventional loans and governmental loans comprising 74.7% and 25.3% of all loan originations, respectively, during the nine months ended September 30, 2020, compared to 69.7% and 30.3% of all originations, respectively, during the nine months ended September 30, 2019.
Total compensation, payroll taxes and other employee benefits increased $23.8, or 38.3%, to $86.1 million for the nine months ended September 30, 2020 compared to $62.3 million for the nine months ended September 30, 2019. The increase in compensation expense was primarily a result of the increase in commission expense as fundings increased, bonus and incentives due to record originations. In addition, branch manager pay increased as branches were more profitable. Occupancy, office furniture, and equipment expense decreased due to lower rent expense as underperforming branches closed offset by an increase in computer expenses to accommodate remote work. Advertising expense decreased as the low rate environment attracted customers. Loan processing expenses increased for the nine months ended September 30, 2020 as loan costs increased due to loan application volume. Professional fees increased primarily due to a $4.25 million legal settlement (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information) along with ongoing litigation costs. Other noninterest expense increased primarily due to increased provision for loan sale losses as there was additional uncertainity regarding selling loans to third party investors from COVID-19 pandemic challenges and the amortization of mortgage servicing rights as the value of the servicing portfolio has increased in 2020 compared to 2019.
.
Consolidated Waterstone Financial, Inc. Results of Operations
| | Nine months ended September 30, | |
| | | 2020 | | | 2019 | |
| | | (Dollars in Thousands, except per share amounts) | |
| | | | | | | |
| Net income | | $ | 53,310 | | | $ | $27,109 | |
| Earnings per share - basic | | | 2.16 | | | | 1.04 | |
| Earnings per share - diluted | | | 2.15 | | | | 1.03 | |
| Annualized return on average assets | | | 3.35 | % | | | 1.84 | % |
| Annualized return on average equity | | | 18.02 | % | | | 9.21 | % |
| | | | | | | | | |
Net Interest Income
Average Balance Sheets, Interest and Yields/Costs
The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.
| | Nine months ended September 30, | |
| | | 2020 | | | 2019 | |
| | | Average Balance | | | Interest | | | Yield/Cost | | | Average Balance | | | Interest | | | Yield/Cost | |
| | | (Dollars in Thousands) | |
| Assets | | | | | | | | | | | | | | | | | | |
| Interest-earning assets: | | | | | | | | | | | | | | | | | | |
| Loans receivable and held for sale (1) | | $ | $1,696,493 | | | $ | $54,404 | | | | 4.28 | % | | $ | $1,536,532 | | | $ | $53,688 | | | | 4.67 | % |
| Mortgage related securities (2) | | | 104,752 | | | | 1,960 | | | | 2.50 | % | | | 114,748 | | | | 2,260 | | | | 2.63 | % |
| Debt securities, federal funds sold and short-term investments (2)(3) | | | 178,775 | | | | 2,703 | | | | 2.02 | % | | | 181,375 | | | | 3,741 | | | | 2.76 | % |
| Total interest-earning assets | | | 1,980,020 | | | | 59,067 | | | | 3.98 | % | | | 1,832,655 | | | | 59,689 | | | | 4.35 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-earning assets | | | 146,959 | | | | | | | | | | | | 133,530 | | | | | | | | | |
| Total assets | | $ | $2,126,979 | | | | | | | | | | | $ | $1,966,185 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Liabilities and equity | | | | | | | | | | | | | | | | | | | | | | | | |
| Interest-bearing liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
| Demand accounts | | $ | $45,275 | | | | 27 | | | | 0.08 | % | | $ | $36,345 | | | | 23 | | | | 0.08 | % |
| Money market, savings, and escrow accounts | | | 251,377 | | | | 1,364 | | | | 0.72 | % | | | 192,195 | | | | 891 | | | | 0.62 | % |
| Time deposits | | | 735,350 | | | | 10,369 | | | | 1.88 | % | | | 737,286 | | | | 11,899 | | | | 2.16 | % |
| Total interest-bearing deposits | | | 1,032,002 | | | | 11,760 | | | | 1.52 | % | | | 965,826 | | | | 12,813 | | | | 1.77 | % |
| Borrowings | | | 545,631 | | | | 7,913 | | | | 1.94 | % | | | 484,572 | | | | 7,579 | | | | 2.09 | % |
| Total interest-bearing liabilities | | | 1,577,633 | | | | 19,673 | | | | 1.67 | % | | | 1,450,398 | | | | 20,392 | | | | 1.88 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | | |
| Noninterest-bearing deposits | | | 112,777 | | | | | | | | | | | | 92,075 | | | | | | | | | |
| Other noninterest-bearing liabilities | | | 41,502 | | | | | | | | | | | | 30,345 | | | | | | | | | |
| Total noninterest-bearing liabilities | | | 154,279 | | | | | | | | | | | | 122,420 | | | | | | | | | |
| Total liabilities | | | 1,731,912 | | | | | | | | | | | | 1,572,818 | | | | | | | | | |
| Equity | | | 395,067 | | | | | | | | | | | | 393,367 | | | | | | | | | |
| Total liabilities and equity | | $ | $2,126,979 | | | | | | | | | | | $ | $1,966,185 | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| Net interest income / Net interest rate spread (4) | | | | | | | 39,394 | | | | 2.31 | % | | | | | | | 39,297 | | | | 2.47 | % |
| Less: taxable equivalent adjustment | | | | | | | 210 | | | | 0.01 | % | | | | | | | 226 | | | | 0.01 | % |
| Net interest income / Net interest rate spread, as reported | | | | | | $ | $39,184 | | | | 2.30 | % | | | | | | $ | $39,071 | | | | 2.46 | % |
| Net interest-earning assets (5) | | $ | $402,387 | | | | | | | | | | | $ | $382,257 | | | | | | | | | |
Net interest margin (6) | | | | | | | | | | | 2.64 | % | | | | | | | | | | | 2.85 | % |
| Tax equivalent effect | | | | | | | | | | | 0.02 | % | | | | | | | | | | | 0.02 | % |
| Net interest margin on a fully tax equivalent basis (6) | | | | | | | | | | | 2.66 | % | | | | | | | | | | | 2.87 | % |
| Average interest-earning assets to average interest-bearing liabilities | | | | | | | | | | | 125.51 | % | | | | | | | | | | | 126.36 | % |
__________
(1) Interest income includes net deferred loan fee amortization income of $948,000 and 458,000 for the nine months ended September 30, 2020 and 2019, respectively.
(2) Average balance of mortgage related and debt securities are based on amortized historical cost.
(3) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2020 and 2019. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.86% and 2.59% for the nine months ended September 30, 2020 and 2019, respectively.
(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.
(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(6) Net interest margin represents net interest income divided by average total interest-earning assets.
Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
| | Nine months ended September 30, | |
| | | 2020 versus 2019 | |
| | | Increase (Decrease) due to | |
| | | Volume | | | Rate | | | Net | |
| | | (In Thousands) | |
| Interest income: | | | | | | | | | |
| Loans receivable and held for sale (1)(2) | | $ | 5,385 | | | $ | (4,669 | ) | | $ | 716 | |
| Mortgage related securities (3) | | | (176 | ) | | | (124 | ) | | | (300 | ) |
| Debt securities, federal funds sold and short-term investments (3) (4) | | | (55 | ) | | | (983 | ) | | | (1,038 | ) |
| Total interest-earning assets | | | 5,154 | | | | (5,776 | ) | | | (622 | ) |
| | | | | | | | | | | | | |
| Interest expense: | | | | | | | | | | | | |
| Demand accounts | | | 4 | | | | - | | | | 4 | |
| Money market, savings, and escrow accounts | | | 310 | | | | 163 | | | | 473 | |
| Time deposits | | | (30 | ) | | | (1,500 | ) | | | (1,530 | ) |
| Total interest-earning deposits | | | 284 | | | | (1,337 | ) | | | (1,053 | ) |
| Borrowings | | | 776 | | | | (442 | ) | | | 334 | |
| Total interest-bearing liabilities | | | 1,060 | | | | (1,779 | ) | | | (719 | ) |
| Net change in net interest income | | $ | 4,094 | | | $ | (3,997 | ) | | $ | 97 | |
______________
(1) | Interest income includes net deferred loan fee amortization income of $948,000 and $458,000 for the nine months ended September 30, 2020 and 2019, respectively.
|
(2) Non-accrual loans have been included in average loans receivable balance.
(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.
(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2020 and 2019.
Net interest income increased $113,000, or 0.3%, to $39.2 million during the nine months ended September 30, 2020 compared to $39.1 million during the nine months ended September 30, 2019.
● | | Interest income on loans increased $716,000 due primarily to an increase of $160.0 million, or 10.4%, in average loans offset by a 39 basis point decrease in average yield on loans as LIBOR and U.S. Treasury rates continue to decrease. The increase in average loan balance was driven by a $37.4 million, or 2.7%, increase in the average balance of loans held in portfolio and by an increase of $122.5 million, or 76.9%, in the average balance of loans held for sale. |
● | | Interest income from mortgage related securities decreased $300,000 primarily as the yield decreased 13 basis points. Additionally, the average balance decreased $10.0 million. |
● | | Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) decreased $1.0 million due to a 73 basis point decrease in the average yield. The decrease in average yield was primarily driven by the decrease in federal funds rate over the past year and as higher yielding securities have matured. The average balance decreased $2.6 million to $178.8 million due to lower municipal securities balances as maturities occurred throughout the past 12 months and were not replaced due to market conditions. Offsetting those decreases, the balance of FHLB stock increased with additional FHLB borrowings. |
● | | Interest expense on time deposits decreased $1.5 million, or 12.9%, primarily due to a 28 basis point decrease in average cost of time deposits. Additionally, the average balance of time deposits decreased $1.9 million compared to the prior year period. |
● | | Interest expense on money market, savings, and escrow accounts increased $473,000, or 53.1%, due primarily to a 10 basis point increase in average cost of money market, savings, and escrow accounts along with an increase in average balance of $59.2 million. Money market accounts have been a focus over the year and the Company has aggressively marketed new customers through various new offerings and new branches that opened within the past 12 months. |
● | | Interest expense on borrowings increased $334,000, or 4.4%, due to an increase of $61.1 million to $545.6 million in average borrowing volume during the nine months ended September 30, 2020. The increase was primarily due to the funding of the loans held for sale. Offsetting the increase in volume, the average cost of borrowings decreased 15 basis points to 1.94% during the nine months ended September 30, 2020, compared to 2.09% during the nine months ended September 30, 2019. The decrease in the cost of borrowings resulted from the new short-term fundings borrowed at a lower rate. |
Provision for Loan Losses
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current year allowance using the incurred loss model. The provision for loan losses was $6.3 million for the nine months ended September 30, 2020 compared to a negative provision for loan losses of $730,000 for the nine months ended September 30, 2019 as economic conditions worsened due to the COVID-19 pandemic along with an increase of loan downgrades to our Watch category. Additional qualitative risk factors were applied to each of the loan categories primarily to account for the significant increase in the unemployment rate and those downgrades. We had a provision for loan losses of $6.1 million at the community banking segment and $235,000 for the mortgage banking segment. Net recoveries were $147,000 for the nine months ended September 30, 2020.
The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for loan losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Losses" section.
Noninterest Income
| | | | | Nine months ended September 30, | |
| | | 2020 | | | 2019 | | | $ Change | | | % Change | |
| | | | | | (Dollars in Thousands) | |
| | | | | | | | | | | | | |
| Service charges on loans and deposits | | $ | 3,384 | | | $ | 1,272 | | | $ | 2,112 | | | | 166.0 | % |
| Increase in cash surrender value of life insurance | | | 1,587 | | | | 1,579 | | | | 8 | | | | 0.5 | % |
| Mortgage banking income | | | 166,292 | | | | 93,526 | | | | 72,766 | | | | 77.8 | % |
| Other | | | 2,868 | | | | 564 | | | | 2,304 | | | | 408.5 | % |
| Total noninterest income | | $ | 174,131 | | | $ | 96,941 | | | $ | 77,190 | | | | 79.6 | % |
Total noninterest income increased $77.2 million, or 79.6%, to $174.1 million during the nine months ended September 30, 2020 compared to $96.9 million during the nine months ended September 30, 2019. The increase resulted primarily from an increase in mortgage banking income along with increases in all noninterest income categories.
● | | The increase in mortgage banking income was primarily the result of an increase in loan origination volume and gross margin on loans originated and sold. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. Total loan origination volume on a consolidated basis increased $970.9 million, or 46.4%, to $3.06 billion during the nine months ended September 30, 2020 compared to $2.09 billion during the nine months ended September 30, 2019. Gross margin on loans originated and sold increased 17.8% at the mortgage banking segment. See "Comparison of Mortgage Banking Segment Results of Operations for the Nine Months Ended September 30, 2020 and 2019" above for additional discussion of the increase in mortgage banking income. |
● | | Service charges on loans and deposits increased primarily due to loan prepayment fees and fees earned on loan swaps. |
● | | The increase in cash surrender value of life insurance was due primarily to an increase in average balance. |
● | | The increase in other noninterest income was due primarily to increases in gain from death benefit on bank owned life insurance, mortgage servicing fee income, wealth management revenue, and rental income. Mortgage servicing fee income increased as loans sold with servicing rights retained increased due to market conditions. |
Noninterest Expenses
| | Nine months ended September 30, | |
| | | 2020 | | | 2019 | | | $ Change | | | % Change | |
| | | (Dollars in Thousands) | |
| | | | | | | | | | | | | |
| Compensation, payroll taxes, and other employee benefits | | $ | $100,695 | | | $ | 75,227 | | | $ | 25,468 | | | | 33.9 | % |
| Occupancy, office furniture and equipment | | | 7,744 | | | | 8,085 | | | | (341 | ) | | | (4.2 | )% |
| Advertising | | | 2,625 | | | | 2,834 | | | | (209 | ) | | | (7.4 | )% |
| Data processing | | | 3,023 | | | | 2,641 | | | | 382 | | | | 14.5 | % |
| Communications | | | 994 | | | | 1,039 | | | | (45 | ) | | | (4.3 | )% |
| Professional fees | | | 7,647 | | | | 2,438 | | | | 5,209 | | | | 213.7 | % |
| Real estate owned | | | 55 | | | | 75 | | | | (20 | ) | | | (26.7 | )% |
| Loan processing expense | | | 3,620 | | | | 2,542 | | | | 1,078 | | | | 42.4 | % |
| Other | | | 9,495 | | | | 6,055 | | | | 3,440 | | | | 56.8 | % |
| Total noninterest expenses | | $ | $135,898 | | | $ | 100,936 | | | $ | 34,962 | | | | 34.6 | % |
Total noninterest expenses increased $35.0 million, or 34.6%, to $135.9 million during the nine months ended September 30, 2020 compared to $100.9 million during the nine months ended September 30, 2019.
● | | Compensation, payroll taxes and other employee benefit expense at our mortgage banking segment increased $23.8 million, or 38.3%, to $86.1 million for the nine months ended September 30, 2020. The increase in compensation expense was primarily a result of an increase in commission expense as fundings increased and branch manager pay increased as branches were more profitable. |
● | | Compensation, payroll taxes and other employee benefits expense at the community banking segment increased $1.6 million, or 11.6%, to $15.1 million during the nine months ended September 30, 2020. The increase was due primarily to an increase in salaries expense due to annual raises, health insurance expense as claims increased, and variable compensation as executives are eligible for an increased bonus. Offsetting the increases, equity award expense decreased as a majority of awards granted in 2015 had a final vesting in 2019. |
● | | Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $237,000 to $5.0 million during the nine months ended September 30, 2020, resulting from lower rent expense as a result of underperforming branches closing. Offsetting the decreases, computer expenses increased to accomodate remote working. |
● | | Occupancy, office furniture and equipment expense at the community banking segment decreased $104,000 to $2.8 million during the nine months ended September 30, 2020. The decrease was due primarily to lower computer, furniture and equipment, and snow plowing expense. |
● | | Advertising expense decreased $403,000 at the mortgage banking segment as lower rates generated customer activity. Offsetting the decrease at the mortgage banking segment, advertising increased $194,000 at the community banking segment to promote the opening of a new branch, the new digital banking platform, and promotions for deposit customers. |
● | | Data processing expense increased $382,000, or 14.5%, to $3.0 million during the nine months ended September 30, 2020. This was primarily due to the new ditigal banking platform rollout at the community banking segment and new contracts at the mortgage banking segment as technology investments continue to increase. |
● | | Professional fees expense increased $5.2 million, or 213.7%, to $7.6 million primarily as a result of an increase in legal fees at the mortgage banking segment for a $4.25 million tentative legal settlement (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information) and ongoing litigation costs along with an increase in audit expense at the community banking segment.
|
● | | Loan processing expense increased $1.1 million, or 42.4%, to $3.6 million during the nine months ended September 30, 2020. This was primarily due to an increase in loan costs associated with the application volumes as mortgage rates declined. |
● | | Other noninterest expense increased $3.4 million for the nine months ended September 30, 2020 due to an increase at the mortgage banking segment. The increase at the mortgage banking segment was primarily due to an increased provision for loan sale losses as there was additional uncertainity regarding selling loans to third party investors from COVID-19 pandemic challenges. Additionally, amortization of mortgage servicing rights increased as the value of the servicing portfolio has increased in 2020 compared to 2019. Other noninterest expenses increased at the community banking segment due primarily to loan related costs for the nine months ended September 30, 2020 along with a decrease in other regulator fees. |
Income Taxes
Income tax expense totaled $17.8 million for the nine months ended September 30, 2020 compared to $8.7 million during the nine months ended September 30, 2019. Income tax expense was recognized on the statement of income during the nine months ended September 30, 2020 at an effective rate of 25.0% of pretax income compared to 24.3% during the nine months ended September 30, 2019. During the nine months ended September 30, 2020, the Company recognized a benefit of approximately $82,000 related to stock awards exercised compared to a benefit of $113,000 recognized during the nine months ended September 30, 2019. The Company recognized a benefit of $354,000 related to the proceeds received on the bank owned life insurance death benefit during the nine months ended September 30, 2020.
Comparison of Financial Condition at September 30, 2020March 31, 2021 and December 31, 20192020
Total Assets – Total assets increased by $224.5$13.4 million, or 11.2%0.6%, to $2.22$2.20 billion at September 30, 2020March 31, 2021 from $2.00$2.18 billion at December 31, 2019.2020. The increase in total assets primarily reflects an increase in loans held for sale, loans receivablecash and cash equivalents, and prepaid expenses and other assets due to an increase in various receivables at the fair market value of the loan rate lock commitmentsmortgage banking segment, partially offset by a decrease in securities availableloans receivable and loans held for sale. The total assets increase reflects liability increases in deposits additional short-term debt,and advance payments by borrowers for taxes, and other liabilities due to hedging liabilities.taxes.
Cash and Cash Equivalents – Cash and cash equivalents increased $12.3$103.6 million, or 16.5%109.4%, to $86.6$198.4 million at September 30, 2020,March 31, 2021, compared to $74.3$94.8 million at December 31, 2019.2020. The increase in cash and cash equivalents primarily reflects the additional source of funds through an increase in deposits short-term borrowings, and advance payments by borrowers for taxes.
Securities Available for Sale – Securities available for sale decreased $25.3increased $2.6 million to $153.2$162.3 million at September 30, 2020.March 31, 2021. The decreaseincrease was primarily due to paydowns inpurchases of mortgage-related securities exceeding security paydowns for the year and maturities of debt securities exceeding security purchases for the year.securities.
Loans Held for Sale - Loans held for sale increased $165.7decreased $60.7 million to $385.8$341.3 million at September 30, 2020March 31, 2021 due to the increasedecrease of refinancing activity resulting from the reductionincrease in mortgage rates.
Loans Receivable - Loans receivable held for investment increased $46.1decreased $39.7 million to $1.43$1.34 billion at September 30, 2020.March 31, 2021. The increasedecrease in total loans receivable was attributable to increasesdecreases in commercial real estate,one- to four-family, construction and land, multi-family, and commercial loan categories. The growth in the commercial loan category was driven by $30.1 million of PPP loans originated during the nine months ended September 30, 2020. Partially offsetting those increases, one- to four-family, home equity, and consumer loan categories. Partially offsetting those decreases, multi-family, commercial real estate, and commercial loan categories decreased.increased.
The following table shows loan originations during the periods indicated.
| | For the | | | For the | | | For the | |
| | | Nine months ended September 30, | | | | | | Three months ended March 31, | |
| | | 2020 | | | 2019 | | | December 31, 2019 | | | 2021 | | | 2020 | |
| | | | | | (In Thousands) | | | | | | | |
| Real estate loans originated for investment: | | | | | | | | | | | | | | | |
| Residential | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 90,290 | | | $ | 66,113 | | | $ | 95,461 | | | $ | 13,256 | | | $ | 30,515 | |
| Multi-family | | | 133,027 | | | | 64,301 | | | | 110,136 | | | | 29,212 | | | | 26,979 | |
| Home equity | | | 4,914 | | | | 3,756 | | | | 5,804 | | | | 2,652 | | | | 1,850 | |
| Construction and land | | | 41,418 | | | | 48,567 | | | | 59,814 | | | | 9,733 | | | | 11,710 | |
| Commercial real estate | | | 26,637 | | | | 24,645 | | | | 49,710 | | | | 1,554 | | | | 15,137 | |
| Total real estate loans originated for investment | | | 296,286 | | | | 207,382 | | | | 320,925 | | | | 56,407 | | | | 86,191 | |
| Consumer loans originated for investment | | | 275 | | | | 55 | | | | 55 | | | | 23 | | | | 275 | |
| Commercial business loans originated for investment | | | 41,944 | | | | 5,426 | | | | 7,517 | | | | 9,733 | | | | 4,390 | |
| Total loans originated for investment | | $ | 338,505 | | | $ | 212,863 | | | $ | 328,497 | | | $ | 66,163 | | | $ | 90,856 | |
| | | | | | | | | | | | | | | | | | | | | |
Allowance for Loan Losses - The allowance for loan losses increased $6.5decreased $1.0 million to $18.8$17.8 million at September 30, 2020.March 31, 2021. The increasedecrease resulted from a negative provision due to increasedimprovement in certain economic uncertainity increasingfactors, decreasing the required allowance related to the loans collectively reviewed. The overall increasedecrease was primarily related to each of the one- to four-family, multi-family, home equity, construction and land, commercial real estate, consumer, and commercial categories. See Note 3 for further discussion on the allowance for loan losses.
Real Estate Owned – Total real estate owned increased $24,000decreased $172,000 to $772,000$150,000 at September 30, 2020.March 31, 2021. During the ninethree months ended September 30, 2020, $369,000 ofMarch 31, 2021, no loans were transferred from loans receivable to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $345,000.$172,000. There were no writedowns during the ninethree months ended September 30, 2020.March 31, 2021.
Prepaid expenses and other assets – Total prepaid expenses and other assets increased $34.0$6.7 million to $54.8$64.3 million at September 30, 2020.March 31, 2021. The increase was primarily due to increases in loan rate lock commitments, funding receivables from investors and receivables from back-to-back interest rate swaps.hedging receivables.
Deposits – Total deposits increased $116.9$34.8 million to $1.18$1.22 billion at September 30, 2020.March 31, 2021. The increase was driven by an increase of $73.3$23.6 million in money market and savings deposits, $39.2$6.8 million in demand deposits, and $4.4 million in time deposits.
Borrowings – Total borrowings increased $68.6decreased $17.6 million, or 14.2%3.5%, to $552.1$490.5 million at September 30, 2020.March 31, 2021. The community banking segment added $34.0segmen paid off $25.0 million in short-term FHLB borrowings. External short-term borrowings at the mortgage banking segment increased a total of $34.6$7.4 million at September 30, 2020March 31, 2021 from December 31, 2019.2020.
Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $21.8$8.5 million to $26.0$12.0 million at September 30, 2020.March 31, 2021. The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid in the fourth quarter.
Other Liabilities - Other liabilities increased $11.5decreased $29.9 million to $58.6$45.1 million at September 30, 2020March 31, 2021 compared to December 31, 2019.2020. Other liabilities increaseddecreased primarily due to liabilies resulting from payables due on back-to-back swaps, accrued compensation, and forward commitments to sell loans at the mortgage banking segment. Offsetting the increase, other liabilities decreased related to a seasonal decrease in outstanding checks related to advance payments by borrowers for taxes. The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid in the fourth quarter. At the time at which the disbursements are made, the outstanding checks are classified as other liabilities in the statements of financial condition. These amounts remain classified as other liabilities until settled. Additionally, other liabilities decreased due to the payment of the legal settlement and lower forward commitments to sell loans at the mortgage banking segment.
Shareholders’ Equity – Shareholders' equity increased $5.7$17.6 million to $399.4$430.7 million at September 30, 2020March 31, 2021 from December 31, 2019.2020. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, an increase in fair value of the security portfolio, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends, a decrease in the fair value of the security portfolio, and the repurchase of stock.
ASSET QUALITY
NONPERFORMING ASSETS
| | At September 30, | | | At December 31, | | | At March 31, | | | At December 31, | |
| | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| Non-accrual loans: | | | | | | | | | | | | |
| Residential | | | | | | | | | | | | |
| One- to four-family | | $ | 5,299 | | | $ | 5,985 | | | $ | 3,734 | | | $ | 5,072 | |
| Multi-family | | | 616 | | | | 667 | | | | 314 | | | | 341 | |
| Home equity | | | 75 | | | | 70 | | | | 59 | | | | 63 | |
| Construction and land | | | - | | | | - | | | | 43 | | | | 43 | |
| Commercial real estate | | | 51 | | | | 303 | | | | 30 | | | | 41 | |
| Commercial | | | - | | | | - | | | | - | | | | - | |
| Consumer | | | - | | | | - | | | | - | | | | - | |
| Total non-accrual loans | | | 6,041 | | | | 7,025 | | | | 4,180 | | | | 5,560 | |
| | | | | | | | | | | | | | | | | |
| Real estate owned | | | | | | | | | | | | | | | | |
| One- to four-family | | | 70 | | | | 46 | | | | - | | | | - | |
| Multi-family | | | - | | | | - | | | | - | | | | - | |
| Construction and land | | | 1,256 | | | | 1,256 | | | | 150 | | | | 322 | |
| Commercial real estate | | | - | | | | - | | | | - | | | | - | |
| Total real estate owned | | | 1,326 | | | | 1,302 | | | | 150 | | | | 322 | |
| Valuation allowance at end of period | | | (554 | ) | | | (554 | ) | |
| Total real estate owned, net | | | 772 | | | | 748 | | |
| Total nonperforming assets | | $ | 6,813 | | | $ | 7,773 | | | $ | 4,330 | | | $ | 5,882 | |
| | | | | | | | | | | | | | | | | |
| Total non-accrual loans to total loans | | | 0.42 | % | | | 0.51 | % | | | 0.31 | % | | | 0.40 | % |
| Total non-accrual loans to total assets | | | 0.27 | % | | | 0.35 | % | | | 0.19 | % | | | 0.25 | % |
| Total nonperforming assets to total assets | | | 0.31 | % | | | 0.39 | % | | | 0.20 | % | | | 0.27 | % |
All loans that are 90 days or more past due with respect to principal and interest are recognized as non-accrual. Troubled debt restructurings that are non-accrual either due to being past due greater than 90 days or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans that are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower review. When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered. This process generally takes place when a loan is contractually past due between 60 and 89 days. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan is determined to be uncollectible, typically coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off.
The following table sets forth activity in our non-accrual loans for the periods indicated.
| | At or for the Nine Months | | | At or for the Three Months | |
| | | Ended September 30, | | | Ended March 31, | |
| | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | (In Thousands) | | | (In Thousands) | |
| | | | | | | | | | | | | |
| Balance at beginning of period | | $ | 7,025 | | | $ | 6,555 | | | $ | 5,560 | | | $ | 7,025 | |
| Additions | | | 2,327 | | | | 2,241 | | | | 171 | | | | 1,206 | |
| Transfers to real estate owned | | | (369 | ) | | | (946 | ) | | | - | | | | - | |
| Charge-offs | | | (3 | ) | | | (8 | ) | | | - | | | | - | |
| Returned to accrual status | | | (1,563 | ) | | | (237 | ) | | | (902 | ) | | | (821 | ) |
| Principal paydowns and other | | | (1,376 | ) | | | (1,292 | ) | | | (649 | ) | | | (608 | ) |
| Balance at end of period | | $ | 6,041 | | | $ | 6,313 | | | $ | 4,180 | | | $ | 6,802 | |
Total non-accrual loans decreased by $984,000,$1.4 million, or 14.0%24.8%, to $6.0$4.2 million as of September 30, 2020March 31, 2021 compared to $7.0$5.6 million as of December 31, 2019.2020. The ratio of non-accrual loans to total loans receivable was 0.42%0.31% at September 30, 2020March 31, 2021 compared to 0.51%0.40% at December 31, 2019.2020. During the ninethree months ended September 30, 2020, $2.3 millionMarch 31, 2021, $171,000 in loans were placed on non-accrual status. Offsetting this activity, $1.6 million$902,000 returned to accrual status $1.4 millionand $649,000 in principal payments were received and $369,000 transferred to real estate owned during the ninethree months ended September 30, 2020.March 31, 2021.
Of the $6.0$4.2 million in total non-accrual loans as of September 30, 2020, $4.9March 31, 2021, $3.0 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary. A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset. Based upon these specific reviews, a total of $1.2 million$118,000 in cumulative partial net charge-offs have been recorded over the life of these loans as of September 30, 2020.March 31, 2021. Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a "non-performing" status and are disclosed as impaired loans. In addition, specific reserves totaling $24,000$21,000 have been recorded as of September 30, 2020.March 31, 2021. The remaining $1.2 million of non-accrual loans were reviewed on an aggregate basis and $237,000$233,000 in general valuation allowance was deemed appropriate related to those loans as of September 30, 2020.March 31, 2021. The $237,000$233,000 in valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.
The outstanding principal balance of our five largest non-accrual loans as of September 30, 2020March 31, 2021 totaled $2.1$1.7 million, which represents 34.5%41.7% of total non-accrual loans as of that date. These five loans have not had any cumulative life-to-date net charge-offs and $24,000$21,000 in specific valuation allowance was deemed necessary based on net realizable collateral value with respect to these five loans as of September 30, 2020.March 31, 2021.
For the nine months ended September 30, 2020, gross interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $311,000. We received $320,000 of interest payments on such loans during the nine months ended September 30, 2020. Interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.
ThereAs of March 31, 2021, there were no accruing loans 90 or more days past due and still accruing interest. As of December 31, 2020, there was a $586,000 loan that was 90 days or more at September 30, 2020 ordays past due and still accruing interest. The bank received full payoff of the loan subsequent to December 31, 2019.2020.
TROUBLED DEBT RESTRUCTURINGS
The following table summarizes information with respect to the accrual status of our troubled debt restructurings:
| | As of September 30, 2020 | | | As of March 31, 2021 | |
| | | Accruing | | | Non-accruing | | | Total | | | Accruing | | | Non-accruing | | | Total | |
| | | (In Thousands) | | | (In Thousands) | |
| | | | | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 2,736 | | | $ | 564 | | | $ | 3,300 | | | $ | 2,728 | | | $ | 1,088 | | | $ | 3,816 | |
| Multi-family | | | - | | | | 272 | | | | 272 | | |
| Commercial real estate | | | 5,986 | | | | - | | | | 5,986 | | | | 6,934 | | | | - | | | | 6,934 | |
| Commercial | | | | 1,097 | | | | - | | | | 1,097 | |
| | | $ | 8,722 | | | $ | 836 | | | $ | 9,558 | | | $ | 10,759 | | | $ | 1,088 | | | $ | 11,847 | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | As of December 31, 2019 | | | As of December 31, 2020 | |
| | | Accruing | | | Non-accruing | | | Total | | | Accruing | | | Non-accruing | | | Total | |
| | | (In Thousands) | | | (In Thousands) | |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| One- to four-family | | $ | 2,740 | | | $ | 685 | | | $ | 3,425 | | | $ | 2,733 | | | $ | 532 | | | $ | 3,265 | |
| Multi-family | | | - | | | | 308 | | | | 308 | | |
| Commercial real estate | | | 278 | | | | 7 | | | | 285 | | | | 7,207 | | | | - | | | | 7,207 | |
| Commercial | | | | 1,097 | | | | - | | | | 1,097 | |
| | | $ | 3,018 | | | $ | 1,000 | | | $ | 4,018 | | | $ | 11,037 | | | $ | 532 | | | $ | 11,569 | |
All troubled debt restructurings are considered to be impaired, are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the unaudited consolidated financial statements. Specific reserves have been established to the extent that collateral-based impairment analyses indicate that a collateral shortfall exists.
We do not participate in government-sponsored troubled debt restructuring programs. Our troubled debt restructurings are short-term modifications. Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. Restructured terms do not include a reduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at the end of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists.
If a restructured loan is current in all respects and a minimum of six consecutive restructured payments have been received, it can be considered for return to accrual status. After a restructured loan that is current in all respects reverts to contractual/market terms, if a credit department review indicates no evidence of elevated market risk, the loan is removed from the troubled debt restructuring classification.
We modified loans for borrowers that were not considered troubled debt restructings under the CARES Act. Loans less than 30 days past due as of December 31, 2019 were allowed for modifications if the borrower experienced a COVID-19 hardship. As of September 30, 2020,March 31, 2021, the Company has modified $3.2 millionhad $910,000 of one-to four-family loans consisting of the deferral of principal and interest or deferral of interest. In accordance with the CARES Act, these short term deferrals are not considered troubled debt restructurings.
The following table summarizes information with respect to the loans modified under the CARES Act as of September 30, 2020.
| | September 30, 2020 | |
| | | | |
| Loan modifications: | | | |
| Residential real estate: | | | |
| One- to four-family | | $ | 2,915 | |
| Commercial real estate | | | 225 | |
| Commercial | | | 32 | |
| Total loan modifications | | $ | 3,172 | |
| Total loan modifications to total loans receivable | | | 0.22 | % |
LOAN DELINQUENCY
The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:
| | At September 30, | | | At December 31, | | | At March 31, | | | At December 31, | |
| | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| | | | | | | | | | | | | |
| Loans past due less than 90 days | | $ | 2,503 | | | $ | 1,833 | | | $ | 4,346 | | | $ | 3,938 | |
| Loans past due 90 days or more | | | 3,052 | | | | 4,632 | | | | 2,576 | | | | 3,958 | |
| Total loans past due | | $ | 5,555 | | | $ | 6,465 | | | $ | 6,922 | | | $ | 7,896 | |
| | | | | | | | | | | | | | | | | |
| Total loans past due to total loans receivable | | | 0.39 | % | | | 0.47 | % | | | 0.52 | % | | | 0.57 | % |
Past due loans decreased by $910,000,$974,000, or 14.1%12.3%, to $5.6$6.9 million at September 30, 2020March 31, 2021 from $6.5$7.9 million at December 31, 2019.2020. Loans past due 90 days or more decreased by $1.4 million, or 34.9%, primarily in the one- to four-family and commercial loan categories during the three months ended March 31, 2021. Loans past due less than 90 days increased by $670,000,$408,000, or 36.6%10.4%, primarily in the one- to four-family loan category. Loans past due 90 days or more decreased by $1.6 million, or 34.1%, primarily in the one- to four-family during the nine months ended September 30, 2020.
REAL ESTATE OWNED
Total real estate owned increaseddecreased by $24,000, or 3.2%,$172,000 to $772,000$150,000 at September 30, 2020,March 31, 2021, compared to $748,000$322,000 at December 31, 2019.2020. During the ninethree months ended September 30, 2020, $369,000 ofMarch 31, 2021, no loans were transferred to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $345,000.$172,000. There were no write downs during the ninethree months ended September 30, 2020.March 31, 2021. New appraisals received on real estate owned and collateral dependent impaired loans are based upon an “as is value” assumption. During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:
| ● | | Applying an updated adjustment factor (as described previously) to an existing appraisal; |
| ● | | Confirming that the physical condition of the real estate has not significantly changed since the last valuation date; |
| ● | | Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral; |
| ● | | Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and |
| ● | | Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company). |
Virtually all habitable real estate owned (both residential and commercial properties) is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are recorded at the lower of carrying value or fair value, less costs to sell, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned within 90 days of being transferred. Subsequent write-downs to reflect current fair market value, as well as gains and losses upon disposition and revenue and expenses incurred in maintaining such properties, are treated as period costs and included in real estate owned in the consolidated statements of income. The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions.
ALLOWANCE FOR LOAN LOSSES
| | At or for the Nine Months | | | At or for the Three Months | |
| | | Ended September 30, | | | Ended March 31, | |
| | | 2020 | | | 2019 | | | 2021 | | | 2020 | |
| | | (Dollars in Thousands) | | | (Dollars in Thousands) | |
| | | | | | | | | | | | | |
| Balance at beginning of period | | $ | 12,387 | | | $ | 13,249 | | | $ | 18,823 | | | $ | 12,387 | |
| Provision (credit) for loan losses | | | 6,310 | | | | (730 | ) | | | (1,070 | ) | | | 785 | |
| Charge-offs: | | | | | | | | | | | | | | | | |
| Mortgage | | | | | | | | | | | | | | | | |
| One- to four-family | | | 9 | | | | 69 | | | | 14 | | | | 6 | |
| Multi-family | | | 5 | | | | 2 | | | | - | | | | - | |
| Home equity | | | 13 | | | | 44 | | | | - | | | | - | |
| Commercial real estate | | | - | | | | 2 | | | | - | | | | - | |
| Construction and land | | | - | | | | - | | | | - | | | | - | |
| Consumer | | | 10 | | | | 5 | | | | - | | | | 1 | |
| Commercial | | | - | | | | - | | | | - | | | | - | |
| Total charge-offs | | | 37 | | | | 122 | | | | 14 | | | | 7 | |
| Recoveries: | | | | | | | | | | | | | | | | |
| Mortgage | | | | | | | | | | | | | | | | |
| One- to four-family | | | 132 | | | | 116 | | | | 11 | | | | 47 | |
| Multi-family | | | 17 | | | | 13 | | | | 23 | | | | 3 | |
| Home equity | | | 22 | | | | 19 | | | | 4 | | | | 6 | |
| Commercial real estate | | | 11 | | | | 2 | | | | 2 | | | | 4 | |
| Construction and land | | | 2 | | | | - | | | | 1 | | | | 1 | |
| Consumer | | | - | | | | - | | | | - | | | | - | |
| Commercial | | | - | | | | - | | | | - | | | | - | |
| Total recoveries | | | 184 | | | | 150 | | | | 41 | | | | 61 | |
| Net recoveries | | | (147 | ) | | | (28 | ) | | | (27 | ) | | | (54 | ) |
| Allowance at end of period | | $ | 18,844 | | | $ | 12,547 | | | $ | 17,780 | | | $ | 13,226 | |
| | | | | | | | | | | | | | | | | |
| Ratios: | | | | | | | | | | | | | | | | |
| Allowance for loan losses to non-accrual loans at end of period | | | 311.94 | % | | | 198.75 | % | | | 425.36 | % | | | 194.44 | % |
| Allowance for loan losses to loans receivable at end of period | | | 1.31 | % | | | 0.91 | % | | | 1.33 | % | | | 0.94 | % |
| Net recoveries to average loans outstanding (annualized) | | | (0.01 | )% | | | 0.00 | % | | | (0.01 | )% | | | (0.02 | )% |
| (Provision) credit for loan losses to net recoveries | | | (4,292.52 | )% | | | 2,607.14 | % | | | 3,962.96 | % | | | (1,453.70 | )% |
| Net recoveries to beginning of the period allowance (annualized) | | | (1.59 | )% | | | (0.28 | )% | | | (0.58 | )% | | | (1.75 | )% |
The allowance for loan losses increased $6.5decreased $1.0 million to $17.8 million at March 31, 2021, compared to $18.8 million at September 30, 2020, compared to $12.4 million at December 31, 2019.2020. The increasedecrease in allowance for loan losses reflects the $6.3$1.1 million provision.negative provision for loan losses. The negative provision recorded during the current year reflects an increased allocation relatedadjustments to the economic condition qualatitive factor as a result of the COVID-19 pandemic in each of the loan categories. Additionally, there were increased qualatitiveour qualitative factors, primarily to account for an increase ofthe slight improvement in certain economic factors along with a decrease in loan downgrades to our Watch category.balance.
We had net recoveries of $147,000,$27,000, or 0.01% of average loans annualized, for the ninethree months ended September 30, 2020,March 31, 2021, compared to net recoveries of $28,000,$54,000, or less than 0.01%0.02% of average loans annualized, for the ninethree months ended September 30, 2019.March 31, 2020. Of the $147,000$27,000 in recoveries during the ninethree months ended September 30, 2020,March 31, 2021, the majority of the activity related to loans secured by one- to four-family residential and multi-family loans.
Our underwriting policies and procedures emphasize that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral. Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation.
The allowance for loan losses has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Any future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors. To the best of management’s knowledge, all probable losses have been provided for in the allowance for loan losses.
Management is validating the CECL model and methodologies; however we expect the change in the allowance for credit loss, including reserves for unfunded commitments, not to exceed 110% of the March 31, 2021 allowance based on a parallel computation. When finalized, this one-time increase as a result of the adoption of CECL will be recorded, net of tax, as an adjustment to retained earnings effective on the earlier of the termination date of the national emergency declaration by the President or January 1, 2022. This estimate is subject to change based on continuing refinement and validation of the model and methodologies.
The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the appropriateness of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet our liquidity needs. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The level of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators.
Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLB.
During the ninethree months ended September 30, 2020,March 31, 2021, primary uses of cash and cash equivalents included: $3.06$1.11 billion in funding loans held for sale, $46.3 million$17.6 for funding of loans receivable, $32.7 million in purchases of our common stock, $21.7 million for cash dividends paid, $5.6 million for purchases of FHLB stock, $4.5short-term borrowings, $16.2 million for purchases of mortgage related securities, and$4.8 million for cash dividends paid, $5.0 million for purchases of debt securities.advance payments by borrowers for taxes, and $4.3 million to pay a legal settlement.
During the ninethree months ended September 30, 2020March 31, 2021, primary sources of cash and cash equivalents included: $3.07$1.22 billion in proceeds from the sale of loans held for sale, $34.0 million in proceeds from short-term FHLB borrowings, $34.6 million in proceeds from additional short-term borrowings, $116.9$39.7 for net loan receivables decrease, $34.8 million from an increase in deposits, $33.6$11.0 million in principal repayments on mortgage related securities, $3.8 million in maturities of debt securities, $53.3and $21.3 million in net income, $9.6 million in proceeds from death benefits on bank owned life insurance, and a $9.9 million increase in advance payments by borrowers for taxes.income.
During the ninethree months ended September 30, 2019,March 31, 2020, primary uses of cash and cash equivalents included: $2.09 billion$687.7 million in funding loans held for sale, $22.9$21.3 million for cash dividends paid, $12.1 million for purchasesfunding of mortgage related securities, and $22.7loans receivable, $14.2 million in purchases of our common stock.stock, $2.4 million for cash dividends paid, $2.5 million for purchases of debt securities, a $3.0 million decrease in advance payments by borrowers for taxes, $1.4 million in repayment of short-term debt, and $686,000 for purchases of mortgage related securities.
During the ninethree months ended September 30, 2019,March 31, 2020, primary sources of cash and cash equivalents included: $2.09 billion$676.9 million in proceeds from the sale of loans held for sale, $40.0 million in additional proceeds from long-termshort-term FHLB borrowings, $1.1$18.3 million from an increase in deposits, $40.7 million in additional proceeds from short-term borrowings, $21.9$9.7 million in principal repayments on mortgage related securities, $7.7 million from a decrease in loans receivable, and $27.1$6.1 million in net income.income
A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At September 30,March 31, 2021 and 2020, and 2019, respectively, $86.6$198.4 million and $66.2$59.1 million of our assets were invested in cash and cash equivalents. At September 30, 2020,March 31, 2021, cash and cash equivalents were comprised of the following: $54.7$160.1 million in cash held at the Federal Reserve Bank and other depository institutions and $31.9$38.3 million in federal funds sold and short-term investments. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts, advances from the FHLB, and repurchase agreements from other institutions.
Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At September 30, 2020,March 31, 2021, we had $470.0 million in long-termlong term advances from the FHLB with contractual maturity dates in 2027, 2028, and 2029. The 2027 advance has a contractual maturity date in December 2027. There are four 2028 advances that have contractual maturities in 2028. The remaining 2028 advance maturities have single call options in March 2021 and May 2021, along with two advances that have quarterly call options. Two advances are currently callable quarterly.options beginning in June 2020 and September 2020. The 2029 advance maturities have quarterly call optionoptions currently available and the other options beginningthat began in November 2020, beginning in August 2021, and beginning in May 2022. We had $34.0 million in short-term advances with the FHLB and contractual maturities in October 2020 and May 2021. As an additional source of funds, the mortgage banking segment has a repurchase agreement. At September 30, 2020,March 31, 2021, we had $48.1$16.5 million outstanding under the repurchase agreement with a total outstanding commitment of $55.0$35.0 million.
At September 30, 2020,March 31, 2021, we had outstanding commitments to originate loans receivable of $16.8$20.3 million. In addition, at September 30, 2020,March 31, 2021, we had unfunded commitments under construction loans of $76.2$65.8 million, unfunded commitments under business lines of credit of $22.8$18.2 million and unfunded commitments under home equity lines of credit and standby letters of credit of $14.4$14.0 million. At September 30, 2020,March 31, 2021, certificates of deposit scheduled to mature in one year or less totaled $701.2$594.2 million. Based on prior experience, management believes that, subject to the Bank’s funding needs, a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits is not retained by us, we will have to utilize other funding sources, such as FHLB advances, in order to maintain our level of assets. However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed. Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.
Waterstone Financial, Inc. is a separate legal entity from WaterStone Bank and must provide for its own liquidity to pay dividends to its shareholders, repurchase shares of its common stock, and for other corporate purposes. The primary source of liquidity for Waterstone Financial, Inc. is dividend payments from WaterStone Bank. The ability of WaterStone Bank to pay dividends is subject to regulatory restrictions. At September 30, 2020,March 31, 2021, Waterstone Financial, Inc. (on an unconsolidated basis) had liquid assets totaling $26.9$54.5 million.
Capital
Shareholders' equity increased $5.7$17.6 million to $399.4$430.7 million at September 30, 2020March 31, 2021 from December 31, 2019.2020. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vesting, the fair value of the security portfolio,vested, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends, a decrease in the fair value of the security portfolio, and the repurchase of stock.
The Company's Board of Directors authorized a stock repurchase program in the third quarter of 2020. As of September 30, 2020,March 31, 2021, the Company had repurchased 10.510.7 million shares at an average price of $14.34$14.39 under previously approved stock repurchase plans.
WaterStone Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories. At September 30, 2020,March 31, 2021, WaterStone Bank exceeded all regulatory capital requirements and is considered “well capitalized” under regulatory guidelines. See “Notes to Unaudited Consolidated Financial Statements - Note 8 - Regulatory Capital.”
Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements
The following tables present information indicating various contractual obligations and commitments of the Company as of September 30, 2020March 31, 2021 and the respective maturity dates.
| | | | | | | | More than | | | More than | | | | | | | | | | | | More than | | | More than | | | | |
| | | | | | | | | One Year | | | Three Years | | | Over | | | | | | | | | One Year | | | Three Years | | | Over | |
| | | | | | One Year | | | Through | | | Through | | | Five | | | | | | One Year | | | Through | | | Through | | | Five | |
| | | Total | | | or Less | | | Three Years | | | Five Years | | | Years | | | Total | | | or Less | | | Three Years | | | Five Years | | | Years | |
| | | (In Thousands) | | | (In Thousands) | |
| Demand deposits (3) | | $ | 169,218 | | | $ | $169,218 | | | $ | - | | | $ | - | | | $ | - | | | $ | 194,978 | | | $ | $194,978 | | | $ | - | | | $ | - | | | $ | - | |
| Money market and savings deposits (3) | | | 271,283 | | | | 271,283 | | | | - | | | | - | | | | - | | | | 318,959 | | | | 318,959 | | | | - | | | | - | | | | - | |
| Time deposit (3) | | | 744,150 | | | | 701,230 | | | | 41,088 | | | | 1,832 | | | | - | | | | 705,754 | | | | 594,237 | | | | 109,558 | | | | 1,959 | | | | - | |
| Repurchase agreements (3) | | | 48,126 | | | | 48,126 | | | | - | | | | - | | | | - | | | | 16,505 | | | | 16,505 | | | | - | | | | - | | | | - | |
| Federal Home Loan Bank advances (1) | | | 504,000 | | | | 34,000 | | | | - | | | | - | | | | 470,000 | | | | 474,000 | | | | 4,000 | | | | - | | | | - | | | | 470,000 | |
| Operating leases (2) | | | 8,925 | | | | 2,958 | | | | 3,500 | | | | 1,549 | | | | 918 | | | | 8,572 | | | | 2,822 | | | | 3,620 | | | | 1,256 | | | | 874 | |
| | | $ | 1,745,702 | | | $ | $1,226,815 | | | $ | $44,588 | | | $ | $3,381 | | | $ | $470,918 | | | $ | 1,718,768 | | | $ | $1,131,501 | | | $ | $113,178 | | | $ | $3,215 | | | $ | $470,874 | |
(1) Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest which will accrue on the advances. See call provisions in Note 7 - Borrowings.
(2) Represents non-cancelable operating leases for offices and equipment.
(3) Excludes interest.
See Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information.
Off-Balance Sheet Commitments
The following table details the amounts and expected maturities of significant off-balance sheet commitments as of September 30, 2020.March 31, 2021.
| | | | | | | | More than | | | More than | | | | | | | | | | | | More than | | | More than | | | | |
| | | | | | | | | One Year | | | Three Years | | | Over | | | | | | | | | One Year | | | Three Years | | | Over | |
| | | | | | One Year | | | Through | | | Through | | | Five | | | | | | One Year | | | Through | | | Through | | | Five | |
| | | Total | | | or Less | | | Three Years | | | Five Years | | | Years | | | Total | | | or Less | | | Three Years | | | Five Years | | | Years | |
| | | (In Thousands) | | | (In Thousands) | |
| Real estate loan commitments (1) | | $ | 18,290 | | | $ | 18,290 | | | $ | - | | | $ | - | | | $ | - | | | $ | 20,302 | | | $ | 20,302 | | | $ | - | | | $ | - | | | $ | - | |
| Unused portion of home equity lines of credit (2) | | | 13,742 | | | | 13,742 | | | | - | | | | - | | | | - | | | | 12,767 | | | | 12,767 | | | | - | | | | - | | | | - | |
| Unused portion of construction loans (3) | | | 77,017 | | | | 77,017 | | | | - | | | | - | | | | - | | | | 65,790 | | | | 65,790 | | | | - | | | | - | | | | - | |
| Unused portion of business lines of credit | | | 19,558 | | | | 19,558 | | | | - | | | | - | | | | - | | | | 18,221 | | | | 18,221 | | | | - | | | | - | | | | - | |
| Standby letters of credit | | | 1,296 | | | | 1,296 | | | | - | | | | - | | | | - | | | | 1,246 | | | | 1,246 | | | | - | | | | - | | | | - | |
| Total Other Commitments | | $ | 129,903 | | | $ | 129,903 | | | $ | - | | | $ | - | | | $ | - | | | $ | 118,326 | | | $ | 118,326 | | | $ | - | | | $ | - | | | $ | - | |
General: 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 and generally have fixed expiration dates or other termination clauses.
(1) Commitments for loans are extended to customers for up to 90 days after which they expire.
(2) Unused portions of home equity loans are available to the borrower for up to 10 years.
(3) Unused portions of construction loans are available to the borrower for up to one year.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Management of Market Risk
General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, WaterStone Bank’s board of directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as three to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLB. These measures should reduce the volatility of our net interest income in different interest rate environments.
Income Simulation. Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time. At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities. Our most recent simulation uses projected repricing of assets and liabilities at September 30, 2020March 31, 2021 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rate assumptions may have a significant impact on interest income simulation results. Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our mortgage related assets that may in turn affect our interest rate sensitivity position. When interest rates rise, prepayment speeds slow and the average expected lives of our assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a positive impact on net interest income and earnings.
The following interest rate scenario displays the percentage change in net interest income over a one-year time horizon assuming increases of 100, 200 and 300 basis points and a decreases of 100 basis points. The results incorporate actual cash flows and repricing characteristics for balance sheet accounts following an instantaneous parallel change in market rates based upon a static no growth, balance sheet.
Analysis of Net Interest Income Sensitivity
| | Immediate Change in Rates | | | Immediate Change in Rates | |
| | | | +300 | | | | +200 | | | | +100 | | | | -100 | | | | +300 | | | | +200 | | | | +100 | | | | -100 | |
| | | (Dollar Amounts in Thousands) | | | (Dollar Amounts in Thousands) | |
| As of September 30, 2020 | | | | | | | | | | | | | | | | | |
| As of March 31, 2021 | | | | | | | | | | | | | | | | | |
| Dollar Change | | $ | $1,115 | | | | 1,519 | | | | 982 | | | | (1,993 | ) | | $ | $8,118 | | | | 6,380 | | | | 3,272 | | | | (2,427 | ) |
| Percentage Change | | | 1.95 | % | | | 2.65 | | | | 1.71 | | | | (3.48 | ) | | | 14.75 | % | | | 11.59 | | | | 5.95 | | | | (4.41 | ) |
At September 30, 2020,March 31, 2021, a 100 basis point instantaneous increase in interest rates had the effect of increasing forecast net interest income over the next 12 months by 1.71%5.95% while a 100 basis point decrease in rates had the effect of decreasing net interest income by 3.48%4.41%.
Item 4.
Controls and ProceduresDisclosure Controls and Procedures: Company management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on 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 are effective.
Internal Control Over Financial Reporting: There have been no material 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 Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1.
Legal Proceedings
The information required by this item is set forth in Part I, Item 1, Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities.
Except as previously disclosed, thereThere have been no material changes in risk factors applicable to the Company from those disclosed in “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and Quarterly report on Form 10-Q for the quarter ended March 31, 2020.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
Following are the Company’s monthly common stock repurchases during the thirdfirst quarter of 2020:2021:
| Period | | Total Number of Shares Purchased | | | Average Price Paid per Share | | | Total Number of Shares Purchased as Part of Publicly Announced Plans | | | Maximum
Number of
Shares that May
Yet Be
Purchased Under
the Plan(a) | |
| July 1, 2020 - July 31, 2020 | | | 52,650 | | | $ | $15.31 | | | | 52,650 | | | | 1,947,350 | |
| August 1, 2020 - August 31, 2020 | | | 299,990 | | | | 15.57 | | | | 299,990 | | | | 1,647,360 | |
| September 1, 2020 - Setember 30, 2020 | | | 447,322 | | | | 15.31 | | | | 447,322 | | | | 1,200,038 | |
| Total | | | 799,962 | | | $ | $15.41 | | | | 799,962 | | | | 1,200,038 | |
| Period | | Total Number of Shares Purchased | | | Average Price Paid per Share | | | Total Number of Shares Purchased as Part of Publicly Announced Plans | | | Maximum
Number of
Shares that May
Yet Be
Purchased Under
the Plan(a) | |
| January 1, 2021 - January 31, 2021 | | | 400 | | | $ | $18.03 | | | | 400 | | | | 996,363 | |
| February 1, 2021 - February 28, 2021 | | | - | | | | - | | | | - | | | | 996,363 | |
| March 1, 2021 - March 31, 2021 | | | - | | | | - | | | | - | | | | 996,363 | |
| Total | | | 400 | | | $ | $18.03 | | | | 400 | | | | 996,363 | |
| (a) | On July 21, 2020, the Board of Directors announced the completion of the then-existing stock repurchase plan and authorized the repurchase of 2,000,000 shares of common stock pursuant to a new share repurchase plan. The maximum amount of shares were purchased under this plan.This plan has no expiration date. |
Item 3.
Defaults Upon Senior Securities
Not applicable.
Item 4.
Mine Safety Disclosures
Not applicable.
Item 5.
Other Information
Not applicable.
| Exhibit No. | | Description | | Filed Herewith | |
| | | Form of Incentive Stock Option Agreement (1) | | | |
| | | Form of Non-Qualified Stock Option Agreement (1) | | | |
| | | Form of Restricted Stock Award Agreement (1) | | | |
| | | Form of Performance Based Restricted Stock Unit Agreement (1) | | | |
| | | Form of Performance Based Restricted Stock Award Agreement (1) | | | |
| | | | Sarbanes-Oxley Act Section 302 Certification signed by the Chief Executive Officer of Waterstone Financial, Inc. | | | | X |
| | | | Sarbanes-Oxley Act Section 302 Certification signed by the Chief Financial Officer of Waterstone Financial, Inc. | | | | X |
| | | | Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Executive Officer of Waterstone Financial, Inc. | | | | X |
| | | | Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of Waterstone Financial, Inc. | | | | X |
| | 101 | | The following financial statements from Waterstone Financial, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2020,March 31, 2021, formatted in Inline Extensive Business Reporting Language (XBRL): (i) consolidated statements of financial condition, (ii) consolidated statements of income, (iii) consolidated statements of comprehensive income, (iv) consolidated statements of changes in shareholders' equity, (v) consolidated statements of cash flows and (vi) the notes to consolidated financial statements. | | | | X |
| | 104 | | Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101) | | | | X |
(1) Incorporated by reference to the registration Statement on Form S-1 (Registration No. 333-249232), initially filed with the U.S. Securities and Exchange Commission on October 1, 2020.
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.
| | WATERSTONE FINANCIAL, INC. (Registrant) | | | |
Date: November 4, 2020May 5, 2021 | | | | |
| | /s/ Douglas S. Gordon | | | |
| | Douglas S. Gordon | | | |
| | Chief Executive Officer Principal Executive Officer | | | |
Date: November 4, 2020May 5, 2021 | | | | |
| | /s/ Mark R. Gerke | | | |
| | Mark R. Gerke | | | |
| | Chief Financial Officer Principal Financial Officer | | | |