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HMNF HMN Financial

Filed: 1 Nov 19, 11:03am
 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549 

FORM 10-Q

(Mark one)

[X]QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2019
 OR
  
[   ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from _________ to _________

     

Commission File Number 0-24100

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

41-1777397

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

   

1016 Civic Center Drive N.W., Rochester, MN

 

55901

(Address of principal executive offices)

 

(Zip Code)

   

Registrant's telephone number, including area code:

 

(507) 535-1200

 

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

Common Stock

HMNF

Nasdaq

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒       No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes ☒       No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

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

 

If an emerging growth company, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes ☐       No ☒


Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date.

 

Class

 

Outstanding at October 26, 2019

Common stock, $0.01 par value

 

4,843,822

 

 

 
 

Part I – FINANCIAL INFORMATION

Item 1: Financial Statements

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

  

September 30,

  

December 31,

 

(Dollars in thousands)

 

2019

  

2018

 
  

(unaudited)

     

Assets

        

Cash and cash equivalents

 $62,507   20,709 

Securities available for sale:

        

Mortgage-backed and related securities (amortized cost $22,126 and $8,159)

  22,187   8,023 

Other marketable securities (amortized cost $62,757 and $73,222)

  62,665   71,836 
   84,852   79,859 
         

Equity securities

  163   121 

Loans held for sale

  7,819   3,444 

Loans receivable, net

  583,102   586,688 

Accrued interest receivable

  2,217   2,356 

Real estate, net

  580   414 

Federal Home Loan Bank stock, at cost

  853   867 

Mortgage servicing rights, net

  1,994   1,855 

Premises and equipment, net

  10,325   9,635 

Goodwill

  802   802 

Core deposit intangible

  181   255 

Prepaid expenses and other assets

  5,608   2,668 

Deferred tax asset, net

  2,225   2,642 

Total assets

 $763,228   712,315 
         

Liabilities and Stockholders’ Equity

        

Deposits

 $659,608   623,352 

Accrued interest payable

  377   346 

Customer escrows

  2,924   1,448 

Accrued expenses and other liabilities

  9,129   4,022 

Total liabilities

  672,038   629,168 

Commitments and contingencies

        

Stockholders’ equity:

        

Serial preferred stock ($.01 par value): authorized 500,000 shares; issued 0

  0   0 

Common stock ($.01 par value): authorized 16,000,000 shares; issued 9,128,662

  91   91 

Additional paid-in capital

  40,259   40,090 

Retained earnings, subject to certain restrictions

  106,311   99,754 

Accumulated other comprehensive loss

  (21)  (1,096)

Unearned employee stock ownership plan shares

  (1,692)  (1,836)

Treasury stock, at cost 4,284,840 and 4,292,838 shares

  (53,758)  (53,856)

Total stockholders’ equity

  91,190   83,147 

Total liabilities and stockholders’ equity

 $763,228   712,315 
         

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(unaudited)

 

  

Three Months Ended
September 30,

  

Nine Months Ended
September 30,

 

(Dollars in thousands, except per share data)

 

2019

  

2018

  

2019

  

2018

 

Interest income:

             

Loans receivable

 $7,428   7,441   22,597   21,225 

Securities available for sale:

                

Mortgage-backed and related

  56   52   146   148 

Other marketable

  309   285   905   842 

Other

  205   192   381   369 

Total interest income

  7,998   7,970   24,029   22,584 
                 

Interest expense:

                

Deposits

  906   587   2,418   1,581 

Federal Home Loan Bank advances and other borrowings

  0   0   7   2 

Total interest expense

  906   587   2,425   1,583 

Net interest income

  7,092   7,383   21,604   21,001 

Provision for loan losses

  (420)  (652)  (1,452)  (482)

Net interest income after provision for loan losses

  7,512   8,035   23,056   21,483 
                 

Non-interest income:

                

Fees and service charges

  820   870   2,305   2,421 

Loan servicing fees

  324   343   957   941 

Gain on sales of loans

  845   489   1,835   1,612 

Other

  238   234   842   792 

Total non-interest income

  2,227   1,936   5,939   5,766 
                 

Non-interest expense:

                

Compensation and benefits

  3,849   3,574   11,496   11,076 

Occupancy and equipment

  1,142   1,073   3,284   3,242 

Data processing

  319   310   925   939 

Professional services

  428   326   1,081   873 

Other

  1,009   931   2,975   2,951 

Total non-interest expense

  6,747   6,214   19,761   19,081 

Income before income tax expense

  2,992   3,757   9,234   8,168 

Income tax expense

  916   1,045   2,677   2,284 

Net income

  2,076   2,712   6,557   5,884 

Other comprehensive income (loss), net of tax

  149   (218)  1,075   (670)

Comprehensive income available to common shareholders

 $2,225   2,494   7,632   5,214 

Basic earnings per share

 $0.45   0.62   1.42   1.37 

Diluted earnings per share

 $0.45   0.59   1.41   1.24 
                 

 

See accompanying notes to consolidated financial statements.

 

  

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity

For the Three and Nine Month Periods Ended September 30, 2019 and 2018

(unaudited)

 

                            
                  

Unearned

         
                  

Employee

         
              

Accumulated

  

Stock

      

Total

 
      

Additional

      

Other

  

Ownership

      

Stock-

 
  

Common

  

Paid-in

  

Retained

  

Comprehensive

  

Plan

  

Treasury

  

Holders’

 

(Dollars in thousands)

 

Stock

  

Capital

  

Earnings

  

Loss

  

Shares

  

Stock

  

Equity

 
                             

Balance, June 30, 2019

 $91   40,153   104,235   (170)  (1,740)  (53,758)  88,811 

Net income

          2,076               2,076 

Other comprehensive gain

              149           149 

Amortization of restricted stock awards

      48                   48 

Earned employee stock ownership plan shares

      58           48       106 

Balance, September 30, 2019

 $91   40,259   106,311   (21)  (1,692)  (53,758)  91,190 
                             

Balance, December 31, 2018

 $91   40,090   99,754   (1,096)  (1,836)  (53,856)  83,147 

Net income

          6,557               6,557 

Other comprehensive gain

              1,075           1,075 

Stock compensation expense

      1                   1 

Restricted stock awards

      (143)              143   0 

Stock awards withheld for tax withholding

                      (45)  (45)

Amortization of restricted stock awards

      138                   138 

Earned employee stock ownership plan shares

      173           144       317 

Balance, September 30, 2019

 $91   40,259   106,311   (21)  (1,692)  (53,758)  91,190 

 

                  

Unearned

         
                  

Employee

         
              

Accumulated

  

Stock

      

Total

 
      

Additional

      

Other

  

Ownership

      

Stock-

 
  

Common

  

Paid-in

  

Retained

  

Comprehensive

  

Plan

  

Treasury

  

Holders’

 

(Dollars in thousands)

 

Stock

  

Capital

  

Earnings

  

Loss

  

Shares

  

Stock

  

Equity

 
                             

Balance, June 30, 2018

 $91   46,950   94,690   (1,479)  (1,933)  (56,494)  81,825 

Net income

          2,712               2,712 

Other comprehensive loss

              (218)          (218)

Stock warrants purchased

      (4,464)                  (4,464)

Stock compensation expense

      5                   5 

Restricted stock awards

      1               (1)  0 

Amortization of restricted stock awards

      31                   31 

Earned employee stock ownership plan shares

      55           48       103 

Balance, September 30, 2018

 $91   42,578   97,402   (1,697)  (1,885)  (56,495)  79,994 
                             

Balance, December 31, 2017

 $91   50,623   91,448   (957)  (2,030)  (58,357)  80,818 

Net income

          5,884               5,884 

Amounts reclassified from accumulated other comprehensive loss

          70   (70)          0 

Other comprehensive loss

              (670)          (670)

Stock warrants purchased

      (6,453)                  (6,453)

Exercise of stock warrants

      (1,674)              1,674   0 

Stock compensation expense

      13                   13 

Restricted stock awards

      (188)              188   0 

Amortization of restricted stock awards

      104                   104 

Earned employee stock ownership plan shares

      153           145       298 

Balance, September 30, 2018

 $91   42,578   97,402   (1,697)  (1,885)  (56,495)  79,994 
                             

 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

 

  

Nine Months Ended

September 30,

 

(Dollars in thousands)

 

2019

  

2018

 

Cash flows from operating activities:

        

Net income

 $6,557   5,884 

Adjustments to reconcile net income to cash provided by operating activities:

        

Provision for loan losses

  (1,452)  (482)

Depreciation

  838   806 

Amortization of (discounts) premiums, net

  (10)  20 

Amortization of deferred loan fees

  (153)  (254)

Amortization of core deposit intangible

  74   75 

Amortization of purchased asset fair value adjustments

  (29)  (63)

Amortization of mortgage servicing rights

  535   412 

Capitalized mortgage servicing rights

  (674)  (533)

Securities (gains) losses, net

  (42)  12 

Loss on sale of premises and equipment

  20   0 

Gain on sales of real estate

  0   (80)

Gain on sales of loans

  (1,835)  (1,612)

Proceeds from sales of loans held for sale

  77,289   68,590 

Disbursements on loans held for sale

  (75,833)  (59,079)

Amortization of restricted stock awards

  138   104 

Amortization of unearned Employee Stock Ownership Plan shares

  144   145 

Earned Employee Stock Ownership Plan shares priced above original cost

  173   153 

Stock option compensation expense

  1   13 

Decrease in accrued interest receivable

  139   119 

Increase in accrued interest payable

  31   133 

Decrease (increase) in other assets

  1,285   (101)

Increase (decrease) in other liabilities

  923   (1,434)

Other, net

  22   (2)

Net cash provided by operating activities

  8,141   12,826 

Cash flows from investing activities:

        

Principal collected on securities available for sale

  1,347   1,478 

Proceeds collected on maturities of securities available for sale

  10,400   310 

Purchases of securities available for sale

  (15,246)  (4,888)

Purchase of Federal Home Loan Bank stock

  (1,040)  (322)

Redemption of Federal Home Loan Bank stock

  1,054   272 

Proceeds from sales of real estate

  0   367 

Net decrease (increase) in loans receivable

  1,008   (7,614)

Proceeds from sale of premises and equipment

  195   0 

Purchases of premises and equipment

  (1,748)  (2,333)

Net cash used by investing activities

  (4,030)  (12,730)

Cash flows from financing activities:

        

Increase in deposits

  36,256   15,829 

Warrants purchased

  0   (6,453)

Stock awards withheld for tax withholding

  (45)  0 

Proceeds from borrowings

  26,000   6,800 

Repayment of borrowings

  (26,000)  (6,800)

Increase in customer escrows

  1,476   1,040 

Net cash provided by financing activities

  37,687   10,416 

Increase in cash and cash equivalents

  41,798   10,512 

Cash and cash equivalents, beginning of period

  20,709   37,564 

Cash and cash equivalents, end of period

 $62,507   48,076 

Supplemental cash flow disclosures:

        

Cash paid for interest

 $2,394   1,448 

Cash paid for income taxes

  2,189   3,395 

Supplemental noncash flow disclosures:

        

Loans transferred to loans held for sale

  4,054   8,187 

Transfer of loans to real estate

  166   74 

Right to use assets and lease obligations

  4,241   0 
         

 

See accompanying notes to consolidated financial statements.

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

 

 

(1) HMN Financial, Inc.

HMN Financial, Inc. (HMN or the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota, Iowa, and Wisconsin. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OIA), which does business as Home Federal Investment Services and offers financial planning products and services, and HFSB Property Holdings, LLC (HPH), which is currently inactive but has acted in the past as an intermediary for the Bank in holding and operating certain foreclosed properties.

 

The consolidated financial statements included herein are for HMN, the Bank, OIA and HPH. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

 

(2) Basis of Preparation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of comprehensive income, consolidated statement of stockholders' equity and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles (GAAP). However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the nine month period ended September 30, 2019 are not necessarily indicative of the results which may be expected for the entire year.

 

 

(3) New Accounting Standards

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. The amendments in this ASU, for public business entities that are filers with the Securities and Exchange Commission (SEC), are effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods. All entities may adopt the amendments in the ASU early as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Management has accumulated the charge off information necessary to calculate the appropriate life of loan loss percentages for the various loan categories, has identified several key metrics to help identify and project anticipated changes in the credit quality of our loan portfolio upon enactment, and is in the process of evaluating the determination of potential qualitative reserve amounts and the impact that the adoption of this ASU will have on the Company’s consolidated financial statements. On July 17, 2019, the FASB proposed a delay in the implementation date for this ASU for small SEC reporting companies, such as HMN, from the first quarter of 2020 to the first quarter of 2023. The proposed delay was reaffirmed by a tentative Board decision at the FASB Board meeting held on October 16, 2019 after reviewing comments received on the proposed delay. Management will monitor the progress of the proposed implementation date delay and will implement this ASU when the required implementation date is determined by the FASB.

 

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The Amendments in this ASU apply to all entities that are required, under existing GAAP, to make disclosures about recurring or nonrecurring fair value measurements and modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including the consideration of costs and benefits. The ASU removed, modified, and added various disclosure requirements in Topic 820. The amendments also eliminate at a minimum from the phrase an entity shall disclose at a minimum to promote the appropriate exercise of discretion by entities when considering fair value measurement disclosures and to clarify that materiality is an appropriate consideration of entities and their auditor when evaluating disclosure requirements. The amendments in the ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. An entity is permitted to early adopt the implementation of any removed or modified disclosures upon issuance of the ASU and delay adoption of the additional disclosures until their effective date. The Company has not opted to early adopt any portion of this ASU and the adoption in the first quarter of 2020 is not anticipated to have a material impact on the Company’s consolidated financial statements.

 

 

(4) Fair Value Measurements

ASC 820, Fair Value Measurements, establishes a framework for measuring the fair value of assets and liabilities using a hierarchy system consisting of three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

Level 1 - Valuation is based upon quoted prices for identical instruments traded in active markets that the Company has the ability to access.

 

Level 2 - Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which significant assumptions are observable in the market.

 

Level 3 – Valuation is generated from model-based techniques that use significant assumptions not observable in the market and are used only to the extent that observable inputs are not available. These unobservable assumptions reflect our own estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models and similar techniques.

 

The following table summarizes the assets and liabilities of the Company for which fair values are determined on a recurring basis as of September 30, 2019 and December 31, 2018.

 

  

Carrying value at September 30, 2019

 

(Dollars in thousands)

 

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $84,852   0   84,852   0 

Equity securities

  163   0   163   0 

Mortgage loan commitments

  19   0   19   0 

Total

 $85,034   0   85,034   0 

 

  

Carrying value at December 31, 2018

 

(Dollars in thousands)

 

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $79,859   0   79,859   0 

Equity securities

  121   0   121   0 

Mortgage loan commitments

  40   0   40   0 

Total

 $80,020   0   80,020   0 
                 

 

There were no transfers between Levels 1, 2, or 3 during the three or nine month periods ended September 30, 2019.

 

The Company may also be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of the lower-of-cost-or-market accounting or write-downs of individual assets. The following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at September 30, 2019 and December 31, 2018.

 

 

  

Carrying value at September 30, 2019

         

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Three months ended

September 30, 2019

total gains (losses)

  

Nine months ended

September 30, 2019

total gains (losses)

 

Loans held for sale

 $7,819   0   7,819   0   (29)  (60)

Mortgage servicing rights

  1,994   0   1,994   0   0   0 

Loans (1)

  2,605   0   2,605   0   61   36 

Real estate, net (2)

  580   0   580   0   0   0 

Total

 $12,998   0   12,998   0   32   (24)
                         

 

  

Carrying value at December 31, 2018

     

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Year ended

December 31, 2018

total gains (losses)

 

Loans held for sale

 $3,444   0   3,444   0   45 

Mortgage servicing rights

  1,855   0   1,855   0   0 

Loans (1)

  2,902   0   2,902   0   (97)

Real estate, net (2)

  414   0   414   0   0 

Total

 $8,615   0   8,615   0   (52)
                     

(1)

Represents the carrying value and related specific reserves on loans for which adjustments are based on the appraised value of the collateral. The carrying value of loans fully charged-off is zero.

(2)

Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

 

 

(5) Fair Value of Financial Instruments

ASC 825, Disclosures about Fair Values of Financial Instruments requires interim reporting period disclosure about the fair value of financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of September 30, 2019 and December 31, 2018 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors.

 

The estimated fair value of the Company’s financial instruments as of September 30, 2019 and December 31, 2018 are shown in the following table.

 

  

September 30, 2019

  

December 31, 2018

 
        Fair value hierarchy           Fair value hierarchy    

(Dollars in thousands)

 

Carrying

amount

  

Estimated

fair value

  

Level 1

  

Level 2

  

Level 3

  

Contract

amount

  

Carrying

amount

  

Estimated

fair value

  

 

Level 1

  

 

Level 2

  

Level 3

  

Contract amount

 
                                              

Financial assets:

                                             

Cash and cash equivalents

 $62,507   62,507   62,507               20,709   20,709   20,709             

Securities available for sale

  84,852   84,852       84,852           79,859   79,859       79,859         

Equity securities

  163   163       163           121   121       121         

Loans held for sale

  7,819   7,819       7,819           3,444   3,444       3,444         

Loans receivable, net

  583,102   587,285       587,285           586,688   578,978       578,978         

Federal Home Loan Bank stock

  853   853       853           867   867       867         

Accrued interest receivable

  2,217   2,217       2,217           2,356   2,356       2,356         

Financial liabilities:

                                                

Deposits

  659,608   659,604       659,604           623,352   623,439       623,439         

Accrued interest payable

  377   377       377           346   346       346         

Off-balance sheet financial instruments:

                                                

Commitments to extend credit

  19   19               183,781   40   40               146,978 

Commitments to sell loans

  4   4               25,554   (56)  (56)              7,289 

 

Cash and Cash Equivalents

The carrying amount of cash and cash equivalents approximates their fair value.

 

Securities Available for Sale

The fair values of securities were based upon quoted market prices for identical or similar instruments in active markets.

 

 

Loans Held for Sale

The fair values of loans held for sale were based upon quoted market prices for loans with similar interest rates and terms to maturity.

 

Loans Receivable, net

The fair value of the loan portfolio, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market. The fair value disclosures for both the fixed and adjustable rate portfolios were adjusted to reflect the exit price amount anticipated to be received from the sale of the portfolio in an open market transaction.

 

Federal Home Loan Bank Stock

The carrying amount of Federal Home Loan Bank (FHLB) stock approximates its fair value.

 

Accrued Interest Receivable

The carrying amount of accrued interest receivable approximates its fair value since it is short-term in nature and does not present unanticipated credit concerns.

 

Deposits

The fair value of demand deposits, savings accounts and money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit are estimated by discounting the future cash flows using the FHLB yield curve to the given maturity date.

 

Accrued Interest Payable

The carrying amount of accrued interest payable approximates its fair value since it is short-term in nature.

 

Commitments to Extend Credit

The fair values of commitments to extend credit are estimated using the fees normally charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counter parties.

 

Commitments to Sell Loans

The fair values of commitments to sell loans are estimated using the quoted market prices for loans with similar interest rates and terms to maturity.

 

 

(6) Other Comprehensive Income (Loss)

Other comprehensive income (loss) is defined as the change in equity during a period from transactions and other events from nonowner sources. Comprehensive income is the total of net income and other comprehensive income (loss), which for the Company is comprised of unrealized gains and losses on securities available for sale. The components of other comprehensive income (loss) and the related tax effects were as follows:

 

  

For the three months ended September 30,

 

(Dollars in thousands)

 

2019

  

2018

 

Securities available for sale:

 

Before tax

  

Tax effect

  

Net of tax

  

Before tax

  

Tax effect

  

Net of tax

 

Net unrealized gains (losses) arising during the period

 $206   57   149   (303)  (85)  (218)

Other comprehensive income (loss)

 $206   57   149   (303)  (85)  (218)

 

  

For the nine months ended September 30,

 

(Dollars in thousands)

 

2019

  

2018

 

Securities available for sale:

 

Before tax

  

Tax effect

  

Net of tax

  

Before tax

  

Tax effect

  

Net of tax

 

Net unrealized gains (losses) arising during the period

 $1,491   416   1,075   (928)  (258)  (670)

Other comprehensive income (loss)

 $1,491   416   1,075   (928)  (258)  (670)
                         

 

 

 

(7) Securities Available For Sale

The following table shows the gross unrealized losses and fair value for the securities available for sale portfolio, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2019 and December 31, 2018.

          
  

Less Than Twelve Months

  

Twelve Months or More

  

Total

 

(Dollars in thousands)

 

# of

Investments

  

Fair Value

  

Unrealized

Losses

  

# of

Investments

  

Fair Value

  

Unrealized

Losses

  

Fair Value

  

Unrealized

Losses

 
                                 

September 30, 2019

                                

Mortgage-backed securities:

                                

Federal National Mortgage Association (FNMA)

  2  $5,744   (17)  0  $0   0  $5,744   (17)

Other marketable securities:

                                

U.S. Government agency obligations

  1   5,000   (6)  10   49,894   (97)  54,894   (103)

Corporate obligations

  0   0   0   1   108   (1)  108   (1)

Corporate preferred stock

  0   0   0   1   665   (35)  665   (35)

Total temporarily impaired securities

  3  $10,744   (23)  12  $50,667   (133) $61,411   (156)
                                 

 

  

Less Than Twelve Months

  

Twelve Months or More

  

Total

 

(Dollars in thousands)

 

# of

Investments

  

Fair Value

  

Unrealized

Losses

  

# of

Investments

  

Fair Value

  

Unrealized

Losses

  

Fair Value

  

Unrealized

Losses

 
                                 

December 31, 2018

                                

Mortgage-backed securities:

                                

FNMA

  0  $0   0   2  $3,769   (117) $3,769   (117)

Federal Home Loan Mortgage Corporation (FHLMC)

  1   4,060   (10)  0   0   0   4,060   (10)

Collateralized mortgage obligations:

                                

FNMA

  0   0   0   1   190   (9)  190   (9)

Other marketable securities:

                                

U.S. Government agency obligations

  0   0   0   14   68,735   (1,236)  68,735   (1,236)

Municipal obligations

  3   498   (2)  8   1,467   (8)  1,965   (10)

Corporate obligations

  0   0   0   1   172   (1)  172   (1)

Corporate preferred stock

  0   0   0   1   560   (140)  560   (140)

Total temporarily impaired securities

  4  $4,558   (12)  27  $74,893   (1,511) $79,451   (1,523)
                                 

 

We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the market liquidity for the investment, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer, and our intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. The unrealized losses on impaired securities other than the corporate preferred stock are the result of changes in interest rates. The unrealized losses reported for the corporate preferred stock at September 30, 2019 relates to a single trust preferred security that was issued by the holding company of a small community bank. As of September 30, 2019 all payments were current on the trust preferred security and the issuer’s subsidiary bank was considered to be “well capitalized” based on its most recent regulatory filing. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at September 30, 2019. The Company does not intend to sell the preferred stock and has the intent and ability to hold it for a period of time sufficient to recover the temporary loss. Management believes that the Company will receive all principal and interest payments contractually due on the security and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.

 

 

A summary of securities available for sale at September 30, 2019 and December 31, 2018 is as follows:

 

(Dollars in thousands)

 

Amortized cost

  

Gross unrealized

gains

  

Gross unrealized

losses

  

Fair value

 

September 30, 2019:

                

Mortgage-backed securities:

                

FNMA

 $13,424   16   (17)  13,423 

FHLMC

  8,522   60   0   8,582 

Collateralized mortgage obligations:

                

FNMA

  180   2   0   182 
   22,126   78   (17)  22,187 

Other marketable securities:

                

U.S. Government agency obligations

  59,978   41   (103)  59,916 

Municipal obligations

  1,971   6   0   1,977 

Corporate obligations

  108   0   (1)  107 

Corporate preferred stock

  700   0   (35)  665 
   62,757   47   (139)  62,665 
  $84,883   125   (156)  84,852 
                 

 

(Dollars in thousands)

 

Amortized cost

  

Gross unrealized

gains

  

Gross unrealized

losses

  

Fair value

 

December 31, 2018

                

Mortgage-backed securities:

                

FNMA

 $3,886   0   (117)  3,769 

FHLMC

  4,074   0   (10)  4,064 

Collateralized mortgage obligations:

                

FNMA

  199   0   (9)  190 
   8,159   0   (136)  8,023 

Other marketable securities:

                

U.S. Government agency obligations

  69,971   0   (1,236)  68,735 

Municipal obligations

  2,378   1   (10)  2,369 

Corporate obligations

  173   0   (1)  172 

Corporate preferred stock

  700   0   (140)  560 
   73,222   1   (1,387)  71,836 
  $81,381   1   (1,523)  79,859 
                 

 

The following table indicates amortized cost and estimated fair value of securities available for sale at September 30, 2019 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates.

 

(Dollars in thousands)

 

Amortized

Cost

  

Fair

Value

 

Due less than one year

 $45,667   45,642 

Due after one year through five years

  32,938   32,953 

Due after five years through ten years

  5,481   5,495 

Due after ten years

  797   762 

Total

 $84,883   84,852 
         

 

The allocation of mortgage-backed securities in the table above is based upon the anticipated future cash flow of the securities using estimated mortgage prepayment speeds. The allocation of other marketable securities that have call features is based on the anticipated cash flows to the call date if it is anticipated that the security will be called, or to the maturity date if it is not anticipated to be called.

 

 

 

(8) Loans Receivable, Net

A summary of loans receivable at September 30, 2019 and December 31, 2018 is as follows:

 

(Dollars in thousands)

 

September 30,

2019

  

December 31,

2018

 

Single family

 $113,062   110,698 

Commercial real estate:

        

Real estate rental and leasing

  181,904   195,564 

Other

  156,341   140,566 
   338,245   336,130 

Consumer

  73,125   72,532 

Commercial business

  66,330   75,496 

Total loans

  590,762   594,856 

Less:

        

Unamortized discounts

  16   17 

Net deferred loan costs

  (551)  (535)

Allowance for loan losses

  8,195   8,686 

Total loans receivable, net

 $583,102   586,688 
         

 

 

(9) Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

 

(Dollars in thousands)

 

Single Family

  

Commercial

Real Estate

  

Consumer

  

Commercial

Business

  

Total

 

For the three months ended September 30, 2019:

                 

Balance, June 30, 2019

 $867   4,762   1,632   1,363   8,624 

Provision for losses

  24   (42)  (37)  (365)  (420)

Charge-offs

  (2)  0   (46)  0   (48)

Recoveries

  0   0   2   37   39 

Balance, September 30, 2019

 $889   4,720   1,551   1,035   8,195 
                     

For the nine months ended September 30, 2019:

                 

Balance, December 31, 2018

 $833   4,869   1,622   1,362   8,686 

Provision for losses

  58   (1,834)  13   311   (1,452)

Charge-offs

  (2)  0   (92)  (869)  (963)

Recoveries

  0   1,685   8   231   1,924 

Balance, September 30, 2019

 $889   4,720   1,551   1,035   8,195 
                     

Allocated to:

                    

Specific reserves

 $98   451   172   73   794 

General reserves

  735   4,418   1,450   1,289   7,892 

Balance, December 31, 2018

 $833   4,869   1,622   1,362   8,686 
                     

Allocated to:

                    

Specific reserves

 $52   459   101   55   667 

General reserves

  837   4,261   1,450   980   7,528 

Balance, September 30, 2019

 $889   4,720   1,551   1,035   8,195 
                     

Loans receivable at December 31, 2018:

                    

Individually reviewed for impairment

 $1,226   1,311   856   303   3,696 

Collectively reviewed for impairment

  109,472   334,819   71,676   75,193   591,160 

Ending balance

 $110,698   336,130   72,532   75,496   594,856 
                     

Loans receivable at September 30, 2019:

                    

Individually reviewed for impairment

 $908   1,291   838   235   3,272 

Collectively reviewed for impairment

  112,154   336,954   72,287   66,095   587,490 

Ending balance

 $113,062   338,245   73,125   66,330   590,762 
                     

 

 

(Dollars in thousands)

 

Single Family

  

Commercial

Real Estate

  

Consumer

  

Commercial

Business

  

Total

 

For the three months ended September 30, 2018:

                 

Balance, June 30, 2018

 $881   5,242   1,623   1,582   9,328 

Provision for losses

  (10)  (287)  61   (416)  (652)

Charge-offs

  0   0   (16)  (15)  (31)

Recoveries

  0   0   5   182   187 

Balance, September 30, 2018

 $871   4,955   1,673   1,333   8,832 
                     

For the nine months ended September 30, 2018:

                 

Balance, December 31, 2017

 $900   5,073   1,630   1,708   9,311 

Provision for losses

  (6)  (316)  169   (329)  (482)

Charge-offs

  (24)  0   (141)  (270)  (435)

Recoveries

  1   198   15   224   438 

Balance, September 30, 2018

 $871   4,955   1,673   1,333   8,832 

 

The following table summarizes the amount of classified and unclassified loans at September 30, 2019 and December 31, 2018:

 

  

September 30, 2019

 
  

Classified

  

Unclassified

     

(Dollars in thousands)

 

Special

Mention

  

Substandard

  

Doubtful

  

Loss

  

Total

  

Total

  

Total Loans

 

Single family

 $1,134   1,703   36   0   2,873   110,189   113,062 

Commercial real estate:

                            

Real estate rental and leasing

  4,905   3,727   0   0   8,632   173,272   181,904 

Other

  4,132   4,683   0   0   8,815   147,526   156,341 

Consumer

  0   739   30   69   838   72,287   73,125 

Commercial business

  5,748   1,857   0   0   7,605   58,725   66,330 
  $15,919   12,709   66   69   28,763   561,999   590,762 

 

  

December 31, 2018

 
  

Classified

  

Unclassified

     

(Dollars in thousands)

 

Special

Mention

  

Substandard

  

Doubtful

  

Loss

  

Total

  

Total

  

Total Loans

 

Single family

 $150   1,771   40   0   1,961   108,737   110,698 

Commercial real estate:

                            

Real estate rental and leasing

  5,564   4,805   0   0   10,369   185,195   195,564 

Other

  4,879   5,118   0   0   9,997   130,569   140,566 

Consumer

  0   709   41   106   856   71,676   72,532 

Commercial business

  6,647   2,761   0   0   9,408   66,088   75,496 
  $17,240   15,164   81   106   32,591   562,265   594,856 
                             

 

Classified loans represent special mention, substandard (performing and non-performing), and non-performing loans categorized as doubtful and loss. Loans classified as special mention are loans that have potential weaknesses that, if left uncorrected, may result in deterioration of the repayment prospects for the asset or in the Bank’s credit position at some future date. Loans classified as substandard are loans that are generally inadequately protected by the current net worth and paying capacity of the obligor, or by the collateral pledged, if any. Loans classified as substandard have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. Substandard loans are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Loans classified as doubtful have the weaknesses of those classified as substandard, with additional characteristics that make collection in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. A loan classified as loss is essentially uncollateralized and/or considered uncollectible and of such little value that continuance as an asset on the balance sheet may not be warranted. Loans classified as substandard or doubtful require the Bank to perform an analysis of the individual loan and charge off any loans, or portion thereof, that are deemed uncollectible.

 

 

The aging of past due loans at September 30, 2019 and December 31, 2018 is summarized as follows:

 

(Dollars in thousands)

 

30-59 Days

Past Due

  

60-89 Days

Past Due

  

90 Days

or More

Past Due

  

Total

Past Due

  

Current

Loans

  

Total Loans

  

Loans 90 Days

or More Past

Due and Still

Accruing

 

September 30, 2019

                            

Single family

 $386   78   61   525   112,537   113,062   0 

Commercial real estate:

                            

Real estate rental and leasing

  738   0   0   738   181,166   181,904   0 

Other

  531   0   105   636   155,705   156,341   0 

Consumer

  287   40   323   650   72,475   73,125   0 

Commercial business

  589   0   0   589   65,741   66,330   0 
  $2,531   118   489   3,138   587,624   590,762   0 

December 31, 2018

                            

Single family

 $680   325   77   1,082   109,616   110,698   0 

Commercial real estate:

                            

Real estate rental and leasing

  0   0   0   0   195,564   195,564   0 

Other

  0   0   0   0   140,566   140,566   0 

Consumer

  391   100   279   770   71,762   72,532   0 

Commercial business

  21   0   0   21   75,475   75,496   0 
  $1,092   425   356   1,873   592,983   594,856   0 
                             

 

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a troubled debt restructuring (TDR). The following table summarizes impaired loans and related allowances as of September 30, 2019 and December 31, 2018:

 

  

September 30, 2019

  

December 31, 2018

 

(Dollars in thousands)

 

Recorded

Investment

  

Unpaid

Principal

Balance

  

Related

Allowance

  

Recorded

Investment

  

Unpaid

Principal

Balance

  

Related

Allowance

 

Loans with no related allowance recorded:

                        

Single family

 $488   507   0   458   477   0 

Commercial real estate:

                        

Other

  0   0   0   25   1,682   0 

Consumer

  677   677   0   515   515   0 

Loans with an allowance recorded:

                        

Single family

  420   420   52   768   768   98 

Commercial real estate:

                        

Real estate rental and leasing

  188   188   16   201   201   21 

Other

  1,103   1,103   443   1,085   1,085   430 

Consumer

  161   161   101   341   341   172 

Commercial business

  235   787   55   303   854   73 

Total:

                        

Single family

  908   927   52   1,226   1,245   98 

Commercial real estate:

                        

Real estate rental and leasing

  188   188   16   201   201   21 

Other

  1,103   1,103   443   1,110   2,767   430 

Consumer

  838   838   101   856   856   172 

Commercial business

  235   787   55   303   854   73 
  $3,272   3,843   667   3,696   5,923   794 
                         

 

 

The following tables summarize average recorded investment and interest income recognized on impaired loans during the three and nine months ended September 30, 2019 and 2018.

 

  

For the three months ended

September 30, 2019

  

For the nine months ended

September 30, 2019

 

(Dollars in thousands)

 

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Average

Recorded

Investment

  

Interest

Income

Recognized

 

Loans with no related allowance recorded:

                

Single family

 $551   6   499   17 

Commercial real estate:

                

Other

  0   0   13   0 

Consumer

  612   3   530   17 

Loans with an allowance recorded:

                

Single family

  579   1   684   2 

Commercial real estate:

                

Real estate rental and leasing

  191   0   195   0 

Other

  1,061   20   1,065   22 

Consumer

  192   3   241   8 

Commercial business

  248   3   286   8 

Total:

                

Single family

  1,130   7   1,183   19 

Commercial real estate:

                

Real estate rental and leasing

  191   0   195   0 

Other

  1,061   20   1,078   22 

Consumer

  804   6   771   25 

Commercial business

  248   3   286   8 
  $3,434   36   3,513   74 
                 

 

  

For the three months ended

September 30, 2018

  

For the nine months ended

September 30, 2018

 

(Dollars in thousands)

 

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Average

Recorded

Investment

  

Interest

Income

Recognized

 

Loans with no related allowance recorded:

                

Single family

 $511   6   467   18 

Commercial real estate:

                

Real estate rental and leasing

  34   15   34   30 

Other

  95   29   95   77 

Consumer

  608   4   508   14 

Loans with an allowance recorded:

                

Single family

  840   0   882   0 

Commercial real estate:

                

Real estate rental and leasing

  105   1   53   7 

Other

  2,327   0   1,821   57 

Consumer

  358   4   409   9 

Commercial business

  318   3   406   12 

Total:

                

Single family

  1,351   6   1,349   18 

Commercial real estate:

                

Real estate rental and leasing

  139   16   87   37 

Other

  2,422   29   1,916   134 

Consumer

  966   8   917   23 

Commercial business

  318   3   406   12 
  $5,196   62   4,675   224 
                 

 

At September 30, 2019 and December 31, 2018, non-accruing loans totaled $1.5 million and $2.7 million, respectively, for which the related allowance for loan losses was $0.1 million and $0.7 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-accruing loans for which no specific allowance has been recorded, because management determined that the value of the collateral was sufficient to repay the loan, totaled $0.6 million and $0.4 million, at September 30, 2019 and December 31, 2018, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

 

 

The non-accrual loans at September 30, 2019 and December 31, 2018 are summarized as follows:

 

(Dollars in thousands)

 

 

September 30, 2019

  

 

December 31, 2018

 
         

Single family

 $574   730 

Commercial real estate:

        

Real estate rental and leasing

  188   201 

Other

  105   1,110 

Consumer

  513   489 

Commercial business

  99   148 
  $1,479   2,678 
         

 

At September 30, 2019 and December 31, 2018 there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $2.2 million and $2.5 million, respectively. Of the loans that were restructured in the third quarter of 2019, none were classified but performing, and $0.1 million were non-performing at September 30, 2019. The loans that were restructured in the third quarter of 2018 were not considered material.

 

The following table summarizes TDRs at September 30, 2019 and December 31, 2018:

 

  

 

September 30, 2019

  

 

December 31, 2018

 

(Dollars in thousands)

 

 

Accrual

  

Non-Accrual

  

Total

  

Accrual

  

Non-Accrual

  

Total

 

Single family

 $333   253   586   496   140   636 

Commercial real estate

  998   0   998   0   1,110   1,110 

Consumer

  325   184   509   367   155   522 

Commercial business

  137   0   137   155   53   208 
  $1,793   437   2,230   1,018   1,458   2,476 
                         

 

TDR concessions can include reduction of interest rates, extension of maturity dates, forgiveness of principal and/or interest due, or acceptance of real estate or other assets in full or partial satisfaction of the debt. Loan modifications are not reported as TDRs after 12 months if the loan was modified at a market rate of interest for comparable risk loans, and the loan is performing in accordance with the terms of the restructured agreement for the entire 12 month period. All loans classified as TDRs are considered to be impaired.

 

When a loan is modified as a TDR, there may be a direct, material impact on the loans within the balance sheet, as principal balances may be partially forgiven. The financial effects of TDRs are presented in the following tables and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the three month and nine month periods ended September 30, 2019 and 2018.

 

  

Three Months Ended

September 30, 2019

  

Nine Months Ended

September 30, 2019

 

(Dollars in thousands)

 

Number of

Contracts

  

Pre-

modification

Outstanding

Recorded

Investment

  

Post-

modification

Outstanding

Recorded

Investment

  

Number of

Contracts

  

Pre-

modification

Outstanding

Recorded

Investment

  

Post-

modification

Outstanding

Recorded

Investment

 

Troubled debt restructurings:

                        

Single family

  0  $0   0   3  $176   181 

Consumer

  1   58   58   4   118   118 

Total

  1  $58   58   7  $294   299 
                         

 

 

  

Three Months Ended

September 30, 2018

  

Nine Months Ended

September 30, 2018

 

(Dollars in thousands)

 

Number of

Contracts

  

Pre-

modification

Outstanding

Recorded

Investment

  

Post-

modification

Outstanding

Recorded

Investment

  

Number of

Contracts

  

Pre-

modification

Outstanding

Recorded

Investment

  

Post-

modification

Outstanding

Recorded

Investment

 

Troubled debt restructurings:

                        

Single family

  0  $0   0   1  $55   58 

Commercial real estate:

                        

Real estate rental and leasing

  0   0   0   1   54   54 

Other

  0   0   0   2   1,518   1,518 

Consumer

  2   2   2   10   335   336 

Commercial business

  0   0   0   1   70   70 

Total

  2  $2   2   15  $2,032   2,036 
                         

 

There were no loans that were restructured in the 12 months preceding September 30, 2019 and 2018 that subsequently defaulted during the three and nine months ended September 30, 2019 and 2018, respectively.

 

The Company considers a loan to have defaulted when it becomes 90 or more days past due under the modified terms, when it is placed in non-accrual status, when it becomes other real estate owned, or when it becomes non-compliant with some other material requirement of the modification agreement. Loans that were non-accrual prior to modification remain on non-accrual status for at least six months following modification. Non-accrual TDR loans that have performed according to the modified terms for six months may be returned to accrual status. Loans that were accruing prior to modification remain on accrual status after the modification as long as the loan continues to perform under the new terms.

 

TDRs are reviewed for impairment following the same methodology as other impaired loans. For loans that are collateral-dependent, the value of the collateral is reviewed and additional reserves may be added to specific reserves as needed. Loans that are not collateral-dependent may have additional reserves established if deemed necessary. The reserves for TDRs were $0.6 million, or 7.2%, of the total $8.2 million in loan loss reserves at September 30, 2019 and $0.6 million, or 7.2%, of the total $8.7 million in loan loss reserves at December 31, 2018.

 

The following is additional information with respect to loans acquired through acquisitions:

 

(Dollars in thousands)

 

Contractual

Principal

Receivable

  

Accretable

Difference

  

Carrying

Amount

 

Purchased performing loans:

            

Balance at June 30, 2019

 $5,842   (157)  5,685 

Change due to payments/refinances

  (486)  8   (478)

Balance at September 30, 2019

 $5,356   (149)  5,207 
             

 

(Dollars in thousands)

 

Contractual

Principal

Receivable

  

Non-Accretable

Difference

  

Carrying

Amount

 

Purchased credit impaired loans:

            

Balance at June 30, 2019

 $185   (4)  181 

Change due to payments/refinances

  0   1   1 

Balance at September 30, 2019

 $185   (3)  182 
             

 

As a result of acquisitions, the Company has loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount of those loans as of September 30, 2019 was $0.2 million.

 

No material provision for loan losses was recognized during the period ended September 30, 2019 related to acquired loans, as there was no significant change to the credit quality of those loans.

 

 

 

(10) Intangible Assets

The Company’s intangible assets consist of mortgage servicing rights, core deposit intangibles, and goodwill. A summary of mortgage servicing activity is as follows:

 

(Dollars in thousands)

 

Nine Months ended

September 30, 2019

  

Twelve Months ended

December 31, 2018

  

Nine Months ended

September 30, 2018

 

Balance, beginning of period

 $1,855   1,724   1,724 

Originations

  674   682   533 

Amortization

  (535)  (551)  (412)

Balance, end of period

 $1,994   1,855   1,845 

Fair value of mortgage servicing rights

 $2,922   3,901   3,641 
             

 

All of the loans sold where the Company continues to service the loans are serviced for FNMA under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at September 30, 2019.

 

      

Weighted

  

Weighted

     
  

Loan

  

Average

  

Average

     
  

Principal

  

Interest

  

Remaining

  

Number

 

(Dollars in thousands)

 

Balance

  

Rate

  

Term (months)

  

of Loans

 

Original term 30 year fixed rate

 $321,139   4.16

%

  307   2,400 

Original term 15 year fixed rate

  90,370   3.20   128   938 

Adjustable rate

  49   4.63   260   2 

 

The gross carrying amount of intangible assets and the associated accumulated amortization at September 30, 2019 and 2018 is presented in the following table. No amortization expense relating to goodwill is recorded as GAAP does not allow goodwill to be amortized, but requires that it be tested for impairment at least annually, or sooner, if there are indications that impairment may exist. Amortization expense for amortizing intangible assets was $0.6 million and $0.5 million for the nine month periods ended September 30, 2019 and 2018, respectively.

 

  

September 30, 2019

 
  

Gross

         

(Dollars in thousands)

 

Carrying

Amount

  

Accumulated

Amortization

  

Unamortized

Amount

 

Mortgage servicing rights

 $4,788   (2,794)  1,994 

Core deposit intangible

  574   (393)  181 

Goodwill

  802   0   802 

Total

 $6,164   (3,187)  2,977 

 

  

September 30, 2018

 
  

Gross

         

 

(Dollars in thousands)

 

Carrying

Amount

  

Accumulated

Amortization

  

Unamortized

Amount

 

Mortgage servicing rights

 $4,457   (2,612)  1,845 

Core deposit intangible

  574   (294)  280 

Goodwill

  802   0   802 

Total

 $5,833   (2,906)  2,927 
             

 

The following table indicates the estimated future amortization expense for amortizing intangible assets:

 

(Dollars in thousands)

 

 

Mortgage
Servicing
Rights

  

 

Core

Deposit
Intangible

  

Total

Amortizing

Intangible

Assets

 

Year ended December 31,

            

2019

 $129   25   154 

2020

  460   99   559 

2021

  413   47   460 

2022

  358   10   368 

2023

  284   0   284 

Thereafter

  350   0   350 

Total

 $1,994   181   2,175 
             

 

 

Projections of amortization are based on existing asset balances and the existing interest rate environment as of September 30, 2019. The Company's actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

 

 

(11) Leases

On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842) and as of September 30, 2019 a $4.2 million right-of-use asset and an offsetting lease payment obligation liability were recorded on the consolidated balance sheet in other assets and other liabilities, respectively.

 

Operating lease right-of-use assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents the Company’s incremental borrowing rate at the lease commencement date. Because the Company only has operating leases and the right-of-use asset is offset by a lease payment obligation liability, the lease payments are the only amount that is recorded in occupancy expense in the consolidated statements of comprehensive income.

 

The Company’s leases relate to office space and bank branches with remaining lease terms between 35 and 67 months. Certain leases contain extension options which typically range from 3 to 10 years. Because these extension options are not considered reasonably certain of exercise, they are not included in the lease term. As of September 30, 2019, operating lease right-of-use assets and liabilities were $4.2 million.

 

The table below summarizes our net lease cost:

 

(Dollars in thousands)

 

Three Months Ended
September 30, 2019

  

Nine Months Ended
September 30, 2019

 

Operating lease cost

 $221   667 
         

 

The table below summarizes other information related to our operating leases:

 

(Dollars in thousands)

 

Three Months Ended
September 30, 2019

  

Nine Months Ended
September 30, 2019

 

Cash paid for amounts included in the measurement of lease liabilities:

        

Operating cash flows from operating leases

 $221   667 

Weighted-average remaining lease term – operating leases, in years

  5.0   5.0 

Weighted-average discount rate – operating leases

  2.19

%

  2.19%
         

 

The table below summarizes the maturity of remaining lease liabilities:

 

(Dollars in thousands)

 

 

September 30, 2019

 

2019

 $221 

2020

  886 

2021

  895 

2022

  932 

2023

  807 

2024 and thereafter

  743 

Total lease payments

  4,484 

Less: Interest

  (243)

Present value of lease liabilities

 $4,241 
     

 

 

 

(12) Earnings per Common Share

The following table reconciles the weighted average shares outstanding and the earnings available to common shareholders used for basic and diluted earnings per share:

 

  

Three Months Ended September 30,

  

Nine Months Ended September 30,

 

(In thousands, except per share data)

 

2019

  

2018

  

2019

  

2018

 

Weighted average number of common shares outstanding used in basic earnings per share calculation

  4,614   4,358   4,606   4,296 

Net dilutive effect of:

                

Restricted stock awards, options, and warrants

  28   252   29   458 

Weighted average number of shares outstanding adjusted for effect of dilutive securities

  4,642   4,610   4,635   4,754 

Income available to common shareholders

 $2,076   2,712   6,557   5,884 

Basic earnings per common share

 $0.45   0.62   1.42   1.37 

Diluted earnings per common share

 $0.45   0.59   1.41   1.24 
                 

 

 

(13) Regulatory Capital and Oversight

The Company and the Bank are subject to the Basel III regulatory capital requirements. The Basel III requirements, among other things, (i) apply a set of capital requirements to the Bank (the Company is exempt, pursuant to the Small Bank Holding Company Policy Statement (Policy Statement) described below), including requirements relating to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and a higher minimum Tier 1 capital requirement, and (iii) set forth rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include capital ratios and buffer requirements which became fully phased in on January 1, 2019. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

The Board of Governors of the Federal Reserve System (FRB) amended its Policy Statement, to exempt small bank holding companies with assets less than $3 billion from the above capital requirements. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company currently meets the qualitative exemption requirements, and therefore, is exempt from the above capital requirements.

 

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table and defined in the regulation) of Common Equity Tier 1 capital to risk weighted assets, Tier 1 capital to adjusted total assets, Tier 1 capital to risk weighted assets, and total capital to risk weighted assets.

 

The Bank’s average total assets for the quarter ended September 30, 2019 were $743.2 million, its adjusted total assets were $742.0 million, and its risk-weighted assets were $613.2 million. The following table presents the Bank’s capital amounts and ratios at September 30, 2019 for actual capital, required capital, and excess capital, including ratios in order to qualify as being well capitalized under the prompt corrective action regulations.

 

  

Actual

  

Required to be

Adequately Capitalized

  

Excess Capital

  

To Be Well Capitalized

Under Prompt Corrective

Action Provisions

 

(Dollars in thousands)

 

Amount

  

Percent of

Assets

  

Amount

  

Percent of

Assets

  

Amount

  

Percent of

Assets

  

Amount

  

Percent of

Assets

 

September 30, 2019

                                

Common equity tier 1 capital

 $81,642   13.31

%

 $27,596   4.50

%

 $54,046   8.81

%

 $39,861   6.50

%

Tier 1 capital leverage

  81,642   11.00   29,679   4.00   51,963   7.00   37,098   5.00 

Tier 1 risk-based capital

  81,642   13.31   36,795   6.00   44,847   7.31   49,060   8.00 

Total risk-based capital

  89,314   14.56   49,060   8.00   40,254   6.56   61,325   10.00 
                                 

 

The Bank must maintain a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. On January 1, 2019, the capital conservation buffer amount increased to 2.50% and is fully phased in. Management believes that, as of September 30, 2019, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the current prompt corrective action regulations, including the capital conservation buffer described above. However, there can be no assurance that the Bank will continue to maintain such status in the future. The Office of the Comptroller of the Currency has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be “well-capitalized” in the future.

 

 

 

(14) Stockholders’ Equity

The Company may repurchase up to $6 million of its common stock under the existing share repurchase program. The Company did not repurchase any shares of its common stock in the open market under the share repurchase program or pay any dividends on its common stock during the three or nine month periods ended September 30, 2019.

 

 

(15) Commitments and Contingencies

The Bank issues standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit issued and available at September 30, 2019 were approximately $5.1 million, expire over the next 35 months, and are collateralized primarily with commercial real estate mortgages. Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.

 

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. The Company is, and expects to become, engaged in foreclosure proceedings, collection actions, and other litigation as part of its normal banking activities. Among the various current litigation matters, the Company is involved in a bankruptcy litigation claim where the bankruptcy trustee is attempting to recover $3.7 million related to the principal and interest payments made to the Bank prior to the bankruptcy filing of a former customer of the Bank.

 

The Company examines each legal matter, and, in those situations where it determines that a particular legal matter presents loss contingencies that are both probable and reasonably estimable, establishes an appropriate accrual. In many situations, the Company is not able to estimate reasonably possible losses due to the preliminary nature of the legal matter, as well as a variety of other factors and uncertainties. For those legal matters where the Company is able to estimate a range of reasonably possible losses, management currently estimates that the aggregate range of losses from all of our outstanding litigation is from $0 to $1.4 million in excess of the amounts accrued, if any. This estimated aggregate range is based on an assessment of the information currently available to the Company and the actual aggregate losses could be higher. However, the Company does not believe these losses are probable to occur at this time. The Company reassesses all of its potential loss positions based on the available information each quarter and the estimated range of reasonably possible losses may change in the future. The Company typically vigorously pursues all available defenses related to litigation but may consider other alternatives, including settlement, in situations where there is an opportunity to resolve a legal matter on terms that are considered to be favorable to the Company when considering the continued expense and distraction of defending against any particular legal action.

 

Based on the Company’s current understanding of all of the outstanding legal matters, management does not believe that judgments or settlements arising from any pending or threatened litigation, individually or in the aggregate, would have a material adverse effect on the consolidated financial condition or results of operations. However, litigation is unpredictable and the actual results of litigation cannot be determined with any certainty. Therefore, the ultimate aggregate resolution of any, or all, of the current outstanding legal matters could have a material adverse effect on the Company’s results of operations in the future.

 

 

(16) Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore is included in the “Other” category.

 

The Company evaluates performance and allocates resources based on the segment’s net income, return on average assets and return on average equity. Each corporation is managed separately with its own officers and board of directors.

 

 

The following table sets forth certain information about the reconciliations of reported profit and assets for each of the Company’s reportable segments.

 

 

(Dollars in thousands)

 

Home Federal

Savings Bank

  

Other

  

Eliminations

  

Consolidated
Total

 

At or for the nine months ended September 30, 2019:

                

Interest income - external customers

 $24,029   2   (2)  24,029 

Non-interest income - external customers

  5,939   0   0   5,939 

Intersegment non-interest income

  176   7,015   (7,191)  0 

Interest expense

  2,427   0   (2)  2,425 

Provision for loan losses

  (1,452)  0   0   (1,452)

Non-interest expense

  19,363   574   (176)  19,761 

Income tax expense

  2,791   (114)  0   2,677 

Net income

  7,015   6,557   (7,015)  6,557 

Total assets

  762,445   91,388   (90,605)  763,228 
                 

At or for the nine months ended September 30, 2018:

                

Interest income - external customers

 $22,584   0   0   22,584 

Non-interest income - external customers

  5,766   0   0   5,766 

Intersegment non-interest income

  164   6,328   (6,492)  0 

Interest expense

  1,583   0   0   1,583 

Provision for loan losses

  (482)  0   0   (482)

Non-interest expense

  18,703   542   (164)  19,081 

Income tax expense

  2,382   (98)  0   2,284 

Net income

  6,328   5,884   (6,328)  5,884 

Total assets

  737,289   79,228   (79,072)  737,445 
                 

At or for the quarter ended September 30, 2019:

                

Interest income - external customers

 $7,998   2   (2)  7,998 

Non-interest income - external customers

  2,227   0   0   2,227 

Intersegment non-interest income

  59   2,235   (2,294)  0 

Interest expense

  908   0   (2)  906 

Provision for loan losses

  (420)  0   0   (420)

Non-interest expense

  6,604   202   (59)  6,747 

Income tax expense

  957   (41)  0   916 

Net income

  2,235   2,076   (2,235)  2,076 

Total assets

  762,445   91,388   (90,605)  763,228 
                 

At or for the quarter ended September 30, 2018:

                

Interest income - external customers

 $7,970   0   0   7,970 

Non-interest income - external customers

  1,936   0   0   1,936 

Intersegment non-interest income

  59   2,864   (2,923)  0 

Interest expense

  587   0   0   587 

Provision for loan losses

  (652)  0   0   (652)

Non-interest expense

  6,087   186   (59)  6,214 

Income tax expense

  1,079   (34)  0   1,045 

Net income

  2,864   2,712   (2,864)  2,712 

Total assets

  737,289   79,228   (79,072)  737,445 
                 

 

 

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-looking Information

 

Safe Harbor Statement 

This quarterly report and other reports filed by the Company with the Securities Exchange Commission (SEC) may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to growing our core deposit relationships and loan balances, enhancing the financial performance of our core banking operations, maintaining credit quality, maintaining net interest margins, reducing non-performing assets, and generating improved financial results (including profitability); the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; our expectations for core capital and our strategies and potential strategies for maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the amount of the Bank’s non-performing assets and the appropriateness of the allowance therefor; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount of yield enhancements relating to non-accruing and purchased loans; the amount and composition of non-interest and interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer of the trust preferred securities held by the Bank; the anticipated results of litigation and our assessment of the impact on our financial statements; the ability of the Bank to pay dividends to HMN; the ability to remain well capitalized; the impact of new accounting pronouncements; and compliance by the Bank with regulatory standards generally (including the Bank’s status as “well-capitalized”) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (FRB), the Bank, and the Company to any failure to comply with any such regulatory standard, directive or requirement.

 

A number of factors could cause actual results to differ materially from the Company’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as continued shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with traditional and alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank (FHLB); technological, computer-related or operational difficulties; results of litigation; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; domestic and international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the future operating results, financial condition, cash flow requirements and capital spending priorities of the Company and the Bank; the availability of internal and, as required, external sources of funding; our ability to attract and retain employees; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in the Company’s most recent filings on Forms 10-K and 10-Q with the SEC. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 and Part II, Item 1A of its subsequently filed quarterly reports on Form 10-Q. All statements in this Form 10-Q, including forward-looking statements, speak only as of the date they are made, and we undertake no duty to update any of the forward-looking statements after the date of this quarterly report on Form 10-Q.

 

 

General

HMN Financial, Inc. (HMN or the Company) is the stock savings bank holding company for Home Federal Savings Bank (the Bank), which operates community banking and loan production offices in Minnesota, Iowa and Wisconsin. The earnings of the Company are primarily dependent on the Bank's net interest income, which is the difference between interest earned on loans and investments, and the interest paid on interest-bearing liabilities such as deposits and other borrowings. The difference between the average rate of interest earned on assets and the average rate paid on liabilities is the "interest rate spread". Net interest income is produced when interest-earning assets equal or exceed interest-bearing liabilities and there is a positive interest rate spread. Net interest income and net interest rate spread are affected by changes in interest rates, the volume and composition of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company's net earnings are also affected by the generation of non-interest income, which consists primarily of gains from the sale of loans and real estate owned, fees for servicing loans, commissions on the sale of uninsured investment products, and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of compensation and benefits, occupancy and equipment expenses, provisions for loan losses, professional services, data processing costs, other non-interest expenses and income taxes. The earnings of financial institutions, such as the Bank, are also significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of business credit, single family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of deposits are influenced by prevailing market rates of interest on competing investments, account maturities and the levels of personal income and savings.

 

Critical Accounting Estimates

Critical accounting policies are those policies that the Company's management believes are the most important to understanding the Company’s financial condition and operating results. These critical accounting policies often involve estimates and assumptions that could have a material impact on the Company’s financial statements. The Company has identified the following critical accounting policies that management believes involve the most difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates, assumptions and other factors used.

 

Allowance for Loan Losses and Related Provision

The allowance for loan losses is based on periodic analysis of the loan portfolio and is maintained at an amount considered to be appropriate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, actual and anticipated changes in the size of the portfolios, national and regional economic conditions such as unemployment data, loan delinquencies, local economic conditions, demand for single family homes, demand for commercial real estate and building lots, loan portfolio composition, historical loss experience and observations made by the Company's ongoing internal audit and regulatory exam processes. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the appropriateness of the loan loss allowance for its homogeneous single family and consumer loan portfolios and its non-homogeneous loan portfolios. The determination of the allowance on the homogeneous single family and consumer loan portfolios is calculated on a pooled basis with individual determination of the allowance for all non-performing loans. The determination of the allowance for the non-homogeneous commercial, commercial real estate and multi-family loan portfolios involves assigning standardized risk ratings and loss factors that are periodically reviewed. The loss factors are estimated based on the Company's own loss experience and are assigned to all loans without identified credit weaknesses. For each non-performing loan, the Company also performs an individual analysis of impairment that is based on the expected cash flows or the value of the assets collateralizing the loans and establishes any necessary reserves or charges off all loans, or portions thereof, that are deemed uncollectible.

 

 

The appropriateness of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans is typically based on the appraised value of the property less estimated selling costs. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases its allowance for loan losses by charging the provision for loan losses against income and by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for loan losses and recording loan charge-offs. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.

 

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal and state income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities.

 

The Company maintains significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan and real estate losses. For tax purposes only the net charge-offs are deductible while the entire provision for loan losses is used to determine book income. A deferred tax asset is created because of the timing difference of when the expense is recognized for book and tax purposes. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies, and assessments of the current and future economic and business conditions. The Company considers both positive and negative evidence regarding the ultimate realizability of deferred tax assets. Positive evidence includes the Company’s cumulative net income in the prior three year period, the ability to implement tax planning strategies to accelerate taxable income recognition, and the probability that taxable income will be generated in future periods. The Company could not currently identify any negative evidence. It is possible that future conditions may differ substantially from those anticipated in determining that no valuation allowance was required on deferred tax assets, and adjustments may be required in the future.

 

Determining the ultimate settlement of any tax position requires significant estimates and judgments in arriving at the amount of tax benefits to be recognized in the financial statements. It is possible that the tax benefits realized upon the ultimate resolution of a tax position may result in tax benefits that are significantly different from those estimated.

 

 

RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2019 COMPARED TO THE SAME PERIODS ENDED SEPTEMBER 30, 2018

 

Net Income

Net income was $2.1 million for the third quarter of 2019, a decrease of $0.6 million, compared to net income of $2.7 million for the third quarter of 2018. Diluted earnings per share for the third quarter of 2019 was $0.45, a decrease of $0.14 per share, compared to diluted earnings per share of $0.59 for the third quarter of 2018. The decrease in net income between the periods was primarily because of a $0.5 million increase in non-interest expenses primarily related to increased compensation and professional services costs, a $0.3 million decrease in net interest income due to an increase in the average rates paid on deposits, and a $0.3 million increase in the loan loss provision. These decreases in net income were partially offset by a $0.4 million increase in the gain on sales of loans between the periods and a $0.1 million decrease in income tax expense as a result of the decreased pre-tax income between the periods.

 

 

Net income was $6.6 million for the nine month period ended September 30, 2019, an increase of $0.7 million, or 11.4%, compared to net income of $5.9 million for the nine month period ended September 30, 2018. Diluted earnings per share for the nine month period ended September 30, 2019 was $1.41, an increase of $0.17 per share, compared to diluted earnings per share of $1.24 for the same period in 2018. The increase in net income between the periods was primarily because of a $1.0 million decrease in the provision for loan losses, a $0.6 million increase in net interest income, and a $0.2 million increase in the gain on sales of loans. These increases in net income were partially offset by a $0.4 million increase in compensation expense related to the increased mortgage loan production and annual salary increases, a $0.4 million increase in income tax expense as a result of the increased pre-tax income, and a $0.2 million increase in professional services expenses between the periods.

 

Net Interest Income

Net interest income was $7.1 million for the third quarter of 2019, a decrease of $0.3 million, or 3.9%, from $7.4 million for the third quarter of 2018. Interest income was $8.0 million for the third quarter of 2019, the same as for the third quarter of 2018. Interest income remained flat despite the increase in the average federal funds rate between the periods as competitive pricing in our markets did not allow for increased loan rates when the federal funds rate increased in the fourth quarter of 2018. The average yield earned on interest-earning assets was 4.47% for the third quarter of 2019, the same as for the third quarter of 2018.

 

Interest expense was $0.9 million for the third quarter of 2019, an increase of $0.3 million, or 54.3%, from $0.6 million for the third quarter of 2018. The average interest rate paid on interest-bearing liabilities and non-interest-bearing deposits was 0.56% for the third quarter of 2019, an increase of 20 basis points from 0.36% for the third quarter of 2018. The increase in the interest paid on interest-bearing liabilities was primarily because of the increase in the average federal funds rate between the periods which increased the cost of deposits between the periods.

 

Net interest margin (net interest income divided by average interest-earning assets) for the third quarter of 2019 was 3.97%, a decrease of 17 basis points, compared to 4.14% for the third quarter of 2018. The decrease in the net interest margin is primarily related to the increase in interest expense as a result of an increase in the average federal funds rate between the periods while rates on interest earning assets remained flat.

 

Net interest income was $21.6 million for the first nine months of 2019, an increase of $0.6 million, or 2.9%, from $21.0 million for the same period in 2018. Interest income was $24.0 million for the nine month period ended September 30, 2019, an increase of $1.4 million, or 6.4%, from $22.6 million for the same nine month period in 2018. Interest income increased primarily because of the higher interest amounts earned on interest-earning assets as a result of the increase in the average federal funds rate between the periods. Interest income also increased $0.3 million because of an increase in the amount of yield enhancements recognized between the periods on non-accruing loans that were paid off. The average yield earned on interest-earning assets was 4.60% for the nine month period ended September 30, 2019, an increase of 28 basis points from 4.32% for the same nine month period in 2018. The average yield earned on the average interest-earning assets increased 5 basis points as a result of the change in yield enhancements recognized between the periods.

 

Interest expense was $2.4 million for the first nine months of 2019, an increase of $0.8 million, or 53.2%, compared to $1.6 million in the first nine months of 2018. The average interest rate paid on interest-bearing liabilities and non-interest-bearing deposits was 0.51% for the first nine months of 2019, an increase of 18 basis points from 0.33% for the first nine months of 2018. The increase in the interest paid on non-interest and interest-bearing liabilities was primarily because of the increase in the average federal funds rate between the periods which increased the cost of deposits.

 

Net interest margin (net interest income divided by average interest-earning assets) for the first nine months of 2019 was 4.14%, an increase of 12 basis points, compared to 4.02% for the first nine months of 2018. The increase in the net interest margin is primarily related to the increase in interest income between the periods as a result of the increase in the average federal funds rate.

 

 

A summary of the Company’s net interest margin for the three and nine month periods ended September 30, 2019 and 2018 is as follows:

 

  

For the three-month period ended

 
  

September 30, 2019

  

September 30, 2018

 

(Dollars in thousands)

 

Average

Outstanding

Balance

  

Interest

Earned/

Paid

  

Yield/

Rate

  

Average

Outstanding

Balance

  

Interest

Earned/

Paid

  

Yield/

Rate

 

Interest-earning assets:

                        

Securities available for sale

 $80,286   365   1.80

%

 $79,755   337   1.68

%

Loans held for sale

  3,557   43   4.72   1,757   24   5.45 

Single family loans, net

  115,844   1,236   4.23   112,221   1,154   4.08 

Commercial loans, net

  398,674   5,229   5.20   399,517   5,349   5.31 

Consumer loans, net

  73,788   920   4.95   72,257   914   5.02 

Other

  37,355   205   2.18   42,344   192   1.80 

Total interest-earning assets

 $709,504   7,998   4.47  $707,851   7,970   4.47 
                         

Interest-bearing liabilities and non-interest-bearing deposits:

                        

Checking accounts

  93,024   23   0.10   84,491   19   0.09 

Savings accounts

  80,269   16   0.08   78,191   16   0.08 

Money market accounts

  173,606   303   0.69   204,599   221   0.43 

Certificates

  127,888   564   1.75   115,620   331   1.14 

Total interest-bearing liabilities

 $474,787          $482,901         

Non-interest checking

  166,972           160,410         

Other non-interest bearing deposits

  2,415           1,709         

Total interest-bearing liabilities and non-interest-bearing deposits

 $644,174   906   0.56  $645,020   587   0.36 

Net interest income

      7,092           7,383     

Net interest rate spread

          3.91

%

          4.11

%

Net interest margin

          3.97

%

          4.14

%

                         

 

 

  

For the nine-month period ended

 
  

September 30, 2019

  

September 30, 2018

 

(Dollars in thousands)

 

Average

Outstanding

Balance

  

Interest

Earned/

Paid

  

Yield/

Rate

  

Average

Outstanding

Balance

  

Interest

Earned/

Paid

  

Yield/

Rate

 

Interest-earning assets:

                        

Securities available for sale

 $79,163   1,051   1.77

%

 $79,436   990   1.67

%

Loans held for sale

  2,417   82   4.51   1,739   62   4.80 

Single family loans, net

  115,162   3,744   4.35   112,252   3,412   4.06 

Commercial loans, net

  402,469   15,966   5.30   401,850   15,076   5.02 

Consumer loans, net

  73,384   2,805   5.11   72,238   2,675   4.95 

Other

  24,886   381   2.05   30,964   369   1.59 

Total interest-earning assets

 $697,481   24,029   4.60  $698,479   22,584   4.32 
                         

Interest-bearing liabilities and non-interest-bearing deposits:

                        

Checking accounts

  95,748   73   0.10   87,468   41   0.06 

Savings accounts

  79,599   47   0.08   78,075   46   0.08 

Money market accounts

  174,565   878   0.67   198,149   610   0.41 

Certificates

  120,376   1,420   1.58   114,412   884   1.03 

Advances and other borrowings

  384   7   2.54   188   2   1.71 

Total interest-bearing liabilities

 $470,672          $478,292         

Non-interest checking

  159,820           156,026         

Other non-interest bearing deposits

  2,030           1,567         

Total interest-bearing liabilities and non-interest-bearing deposits

 $632,522   2,425   0.51  $635,885   1,583   0.33 

Net interest income

      21,604           21,001     

Net interest rate spread

          4.09

%

          3.99

%

Net interest margin

          4.14

%

          4.02

%

                         

 

 

Provision for Loan Losses

The provision for loan losses was ($0.4) million for the third quarter of 2019, an increase of $0.3 million from the ($0.7) million provision for loan losses for the third quarter of 2018. The credit provision amount for the period was primarily the result of certain adversely classified commercial loans being paid off during the period. These payoffs, combined with the continued improvement in the credit quality of the loan portfolio, resulted in a reduction of the overall allowance for loan losses required between the periods.

 

The provision for loan losses was ($1.5) million for the first nine months of 2019, a decrease of $1.0 million compared to the ($0.5) million provision for loan losses for the first nine months of 2018. The credit provision amount for the period was primarily the result of the increase in net recoveries received during the nine month period ended September 30, 2019 when compared to the same period of 2018. The net recoveries, combined with the continued improvement in the credit quality of the loan portfolio, resulted in a reduction of the overall allowance for loan losses required between the periods.

 

A reconciliation of the Company’s allowance for loan losses for the three and nine month periods ended September 30, 2019 and 2018 is summarized as follows:

 

  

Three months ended September 30,

 

(Dollars in thousands)

 

2019

  

2018

 

Balance at June 30,

 $8,624  $9,328 

Provision

  (420)  (652)

Charge offs:

        

Single family

  (2)  0 

Consumer

  (46)  (16)

Commercial business

  0   (15)

Recoveries

  39   187 

Balance at September 30,

 $8,195  $8,832 
         

Allocated to:

        

General allowance

 $7,528  $7,771 

Specific allowance

  667   1,061 
  $8,195  $8,832 
         

 

  

Nine months ended September 30,

 

(Dollars in thousands)

 

2019

  

2018

 

Balance at January 1,

 $8,686  $9,311 

Provision

  (1,452)  (482)

Charge offs:

        

Single family

  (2)  (24)

Consumer

  (92)  (141)

Commercial business

  (869)  (270)

Recoveries

  1,924   438 

Balance at September 30,

 $8,195  $8,832 
         

 

Non-Interest Income

Non-interest income was $2.2 million for the third quarter of 2019, an increase of $0.3 million, or 15.0%, from $1.9 million for the third quarter of 2018. Gain on sales of loans increased $0.4 million between the periods primarily because of an increase in single family loan sales. Fees and service charges decreased $0.1 million due to a decrease in the loan commitment fees earned between the periods. Loan servicing fees decreased slightly between the periods due to a decrease in the commercial loans servicing fees earned.

 

Non-interest income was $5.9 million for the first nine months of 2019, an increase of $0.1 million, or 3.0%, from $5.8 million for the same period of 2018. Gain on sales of loans increased $0.2 million between the periods primarily because of an increase in single family loan sales. Other non-interest income increased $0.1 million due primarily to an increase in the gains recognized on equity securities between the periods. Fees and service charges decreased $0.1 million due to a decrease in the loan commitment fees earned between the periods. Loan servicing fees increased slightly between the periods due to an increase in single family loan servicing fees earned.

 

 

Non-Interest Expense

Non-interest expense was $6.7 million for the third quarter of 2019, an increase of $0.5 million, or 8.6%, from $6.2 million for the third quarter of 2018. Compensation and benefits expense increased $0.3 million primarily because of annual salary increases and an increase in the compensation paid as a result of the increased mortgage loan production between the periods. Professional services expense increased $0.1 million due primarily to an increase in legal expenses between the periods. Other non-interest expense increased $0.1 million due primarily to an increase in mortgage loan servicing expenses caused by the increase in serviced loans that were refinanced between the periods. Occupancy and equipment costs increased $0.1 million between the periods due to an increase in depreciation and maintenance costs.

 

Non-interest expense was $19.8 million for the first nine months of 2019, an increase of $0.7 million, or 3.6%, from $19.1 million for the same period of 2018. Compensation and benefits expense increased $0.4 million primarily because of annual salary increases and an increase in the compensation paid as a result of the increased mortgage loan production between the periods. Professional services expense increased $0.2 million due primarily to an increase in legal expenses between the periods. Other non-interest expense increased slightly due to an increase in mortgage loan servicing expenses caused by the increase in serviced loans that were refinanced between the periods. Occupancy and equipment costs increased slightly between the periods due to an increase in depreciation and maintenance costs.

 

Income Taxes

Income tax expense was $0.9 million for the third quarter of 2019, a decrease of $0.1 million from $1.0 million for the third quarter of 2018. Income tax expense was $2.7 million for the first nine months of 2019, an increase of $0.4 million from $2.3 million for the first nine months of 2018. The change in income tax expense between the periods is primarily the result of a change in pre-tax income.

 

 

FINANCIAL CONDITION

Non-Performing Assets

The following table summarizes the amounts and categories of non-performing assets in the Bank’s portfolio and loan delinquency information as of the end of the two most recently completed quarters and December 31, 2018.

 

  

September 30,

  

June 30,

  

December 31,

 

(Dollars in thousands)

 

2019

  

2019

  

2018

 

Non-Performing Loans:

            

Single family

 $574  $854  $730 

Commercial real estate

  293   1,212   1,311 

Consumer

  513   458   489 

Commercial business

  99   144   148 

Total

  1,479   2,668   2,678 
             

Foreclosed and Repossessed Assets:

            

Single family

  166   30   0 

Commercial real estate

  414   414   414 

Consumer

  0   12   0 

Total non-performing assets

 $2,059  $3,124  $3,092 

Total as a percentage of total assets

  0.27

%

  0.43

%

  0.43

%

Total non-performing loans

 $1,479  $2,668  $2,678 

Total as a percentage of total loans receivable, net

  0.25

%

  0.45

%

  0.46

%

Allowance for loan losses to non-performing loans

  554.16

%

  323.18

%

  324.27

%

             

Delinquency Data:

            

Delinquencies (1)

            

30+ days

 $2,541  $1,991  $1,453 

90+ days

  0   0   0 

Delinquencies as a percentage of loan portfolio (1)

            

30+ days

  0.42

%

  0.33

%

  0.24

%

90+ days

  0.00

%

  0.00

%

  0.00

%

             

(1) Excludes non-accrual loans.

 

Total non-performing assets were $2.1 million at September 30, 2019, a decrease of $1.0 million, or 34.1%, from $3.1 million at June 30, 2019 and a decrease of $1.0 million, or 33.4%, from $3.1 million at December 31, 2018. Non-performing loans decreased $1.2 million and foreclosed and repossessed assets increased $0.2 million for both the three and nine month periods of 2019. The decrease in the non-performing loans was primarily related to a $1.3 million non-performing loan relationship that was reclassified as an accruing loan during the third quarter of 2019.

 

 

Dividends

The declaration of dividends is subject to, among other things, the Company's financial condition and results of operations, the Bank's compliance with regulatory capital requirements and other regulatory restrictions, tax considerations, industry standards, economic conditions, general business practices and other factors. The Company has not made any dividend payments to common stockholders during the three year period ended September 30, 2019.

 

 

LIQUIDITY AND CAPITAL RESOURCES

For the nine months ended September 30, 2019, the net cash provided by operating activities was $8.1 million. The Company received $10.4 million from maturing or called securities, $1.3 million from principal repayments on securities, $1.1 million from the redemption of FHLB stock, and $0.2 million from the sale of premises and equipment. The Company purchased $1.0 million in FHLB stock and paid $1.7 million for the purchase of premises and equipment. Net loans receivable decreased $1.0 million, customer escrows increased $1.5 million, and the Company had a net increase in deposit balances of $36.3 million. The Company also received and repaid $26.0 million in borrowings.

 

The Company has certificates of deposits with outstanding balances of $80.3 million that mature over the next 12 months. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that cash outflow from certificates that do not renew will be replaced with other deposits or FHLB advances. Federal Reserve Bank borrowings or proceeds from the sale of securities could also be used to fund unanticipated outflows of certificates of deposits.

 

The Company had four deposit customers that individually had aggregate deposits greater than $5.0 million as of September 30, 2019. The $45.9 million in funds held by these customers may be withdrawn at any time, but management believes that the majority of these deposits will not be withdrawn from the Bank over the next twelve months. If these deposits are withdrawn, it is anticipated that they would be replaced with deposits from other customers or FHLB advances. Federal Reserve Bank borrowings or proceeds from the sale of securities could also be used to replace unanticipated outflows of large checking and money market deposits.

 

The Company had the ability to borrow $187.0 million from the FHLB at September 30, 2019, based on the collateral value of the loans pledged. The credit policy of the FHLB relating to the collateral value of the loans collateralizing the available line of credit with the FHLB may change such that the current collateral pledged to secure future advances is no longer acceptable or the formulas for determining the excess pledged collateral may change. The FHLB could also reduce the amount of funds it will lend to the Bank. It is not anticipated that the Bank will need to find alternative funding sources in the next twelve months to replace the available borrowings from the FHLB. However, if needed, excess collateral currently pledged to the FHLB could be pledged to the Federal Reserve Bank and the Bank could borrow additional funds from the Federal Reserve Bank based on the increased collateral levels or obtain additional deposits.

 

The Company’s primary source of cash is dividends from the Bank. At September 30, 2019, the Company had $7.7 million in cash and other assets that could readily be turned into cash. The primary use of cash by the Company is the payment of operating expenses.

 

The Company also serves as a source of capital, liquidity, and financial support to the Bank. Depending upon the operating performance of the Bank and the Company’s other liquidity and capital needs, including Company level expenses, the Company may find it prudent, subject to prevailing capital market conditions and other factors, to raise additional capital through issuance of its common stock or other equity securities. Additional capital would also potentially permit the Company to implement a strategy of growing Bank assets. Depending on the circumstances, if it were to raise capital, the Company may deploy it to the Bank for general banking purposes, or may retain some or all of it for use by the Company.

 

 

If the Company were to raise capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders, and, if issued at a price less than the Company’s book value, would dilute the per share book value of the Company’s common stock, and could result in a change in control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to the Company’s current stockholders, which may adversely impact the Company’s current stockholders. The Company’s ability to raise additional capital through the issuance of equity securities, if deemed prudent, will depend on, among other factors, conditions in the capital markets at that time, which are outside of its control, and on the Company’s financial performance and plans.

 

Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.

 

The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. The Company monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located in the following Asset/Liability Management section of this report discloses the Company’s projected changes in net interest income based upon immediate interest rate changes called rate shocks. The Company utilizes a model that uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities under different interest rate changes.

 

The following table discloses the projected changes in market value to the Company’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on September 30, 2019.

 

  

Market Value

 
(Dollars in thousands)                  

Basis point change in interest rates

  -200   -100   0  

+100

  

+200

 

Total market risk sensitive assets

 $772,714   765,786   752,957   742,858   728,588 

Total market risk sensitive liabilities

  748,172   698,133   654,329   615,692   582,926 

Off-balance sheet financial instruments

  209   85   0   (243)  (446)

Net market risk

 $24,333   67,568   98,628   127,409   146,108 

Percentage change from current market value

  (75.33

)%

  (31.49

)%

  0.00

%

  29.18

%

  48.14

%

                     

 

The preceding table was prepared utilizing a model using the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 2% to 52%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 5% and 59%, depending on the note rate and the period to maturity. Mortgage-backed securities were projected to have prepayments based upon the underlying collateral securing the instrument. Certificate accounts were assumed not to be withdrawn until maturity. Passbook accounts and retail money market accounts were assumed to decay at an annual rate of 6% and 9%, respectively. Retail checking accounts were assumed to decay at an annual rate of 11%. Commercial checking and money market accounts were assumed to decay at annual rates of 20% and 31%, respectively. Callable investments were projected to be called at the first call date where the projected interest rate on similar remaining term instruments is less than the interest rate on the callable advance or investment.

 

 

Certain shortcomings are inherent in the method of analysis presented in the above table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the Interest Spread) will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets that are approaching their lifetime interest rate caps could be different from the values disclosed in the table. Certain liabilities, such as certificates of deposit, have fixed rates that restrict interest rate changes until maturity. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may also decrease in the event of a substantial sustained increase in interest rates.

 

Asset/Liability Management

The Company’s management reviews the impact that changing interest rates will have on the Company’s net interest income projected for the next twelve months to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income during the twelve month period ending September 30, 2020 of immediate interest rate changes called rate shocks.

 

(Dollars in thousands)

 

Rate Shock in

Basis Points

  

Projected

Change in Net

Interest Income

  

Percentage

Change

 

+200

  $2,315   8.38

%

+100

   1,169   4.23 
0   0   0.00 
-100   (1,442)  (5.22)
-200   (3,071)  (11.12)

 

The preceding table was prepared utilizing the Model Assumptions. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income.

 

The increase in interest income in a rising rate environment is primarily because there are more adjustable rate loans that would re-price to higher interest rates than there are deposits that would re-price higher to the same extent in the next twelve months. The decrease in interest income in a declining rate environment is primarily because there are more loans and investments that would re-price to lower interest rates than there are deposits that would be able to be re-priced lower to the same extent in the next twelve months.

 

In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee that meets frequently to discuss changes in the interest rate risk position and projected profitability. This Committee makes adjustments to the asset/liability position of the Bank that are reviewed by the Board of Directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions as intended to assure attainment of the Bank's objectives in an effective manner. In addition, each quarter the Board reviews the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.

 

In managing its asset/liability composition, the Bank may, at times, depending on the relationship between long-term and short-term interest rates, market conditions and consumer preference, place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, in certain situations, provide high enough returns to justify the increased exposure to sudden and unexpected changes in interest rates.

 

To the extent consistent with its interest rate spread objectives, the Bank attempts to manage its interest rate risk and has taken a number of steps to restructure its balance sheet in order to better match the maturities of its assets and liabilities. In the past, more long-term fixed rate loans were placed into the single family loan portfolio. In recent years, the Bank has continued to focus its 30 year fixed rate single family residential lending program on loans that are saleable to third parties and generally places only adjustable rate or shorter-term fixed rate loans that meet certain risk characteristics into its loan portfolio. A significant portion of the Bank’s commercial loan production continues to be in adjustable rate loans that reprice every one, two, or three years.

 

 

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than commitments to originate, fund, and sell loans in the ordinary course of business.

 

Item 3: Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

 

Item 4: Controls and Procedures

Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

 

Changes in internal controls. There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

HMN FINANCIAL, INC.


PART II - OTHER INFORMATION

 

Item 1.

Legal Proceedings.

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. See Note 15- Commitments and Contingencies of the Notes to the Consolidated Financial Statements for more information.

 

Item 1A.

Risk Factors.

There have been no material changes to the Company’s risk factors contained in its Annual Report on Form 10-K for the year ended December 31, 2018. For a further discussion of our Risk Factors, see Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

(a) Not applicable.

(b) Not applicable.

(c) On November 28, 2018, the Board of Directors announced a new share repurchase program pursuant to which the Company may purchase shares of its common stock for an aggregate purchase price not to exceed $6 million. The share repurchase program does not obligate the Company to purchase any shares and has no set expiration date. No shares were repurchased by the Company during the three or nine month periods ended September 30, 2019.

 

Item 3.

Defaults Upon Senior Securities.

None.

 

Item 4.

Mine Safety Disclosures.

Not applicable.

 

Item 5.

Other Information.

None.

  

 

Item 6.          Exhibits.

 

 

INDEX TO EXHIBITS

 

Exhibit

 

Filing

Number

Exhibit

Status

   

31.1

Rule 13a-14(a)/15d-14(a) Certification of CEO

Filed Electronically

   

31.2

Rule 13a-14(a)/15d-14(a) Certification of CFO

Filed Electronically

   

32

Section 1350 Certifications of CEO and CFO

Filed Electronically

   

101

Financial statements from the Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2019, filed with the SEC on November 1, 2019, formatted in Extensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at September 30, 2019 and December 31, 2018, (ii) the Consolidated Statements of Comprehensive Income for the Three Month and Nine Month Periods Ended September 30, 2019 and 2018, (iii) the Consolidated Statements of Stockholders’ Equity for the Three and Nine Month Periods Ended September 30, 2019 and 2018, (iv) the Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2019 and 2018, and (v) Notes to Consolidated Financial Statements.

Filed Electronically

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

HMN FINANCIAL, INC.

Registrant

  
  
Date: November 1, 2019   

 By:     /s/ Bradley Krehbiel

            Bradley Krehbiel, President and Chief Executive Officer

            (Principal Executive Officer)

  
  
  
Date: November 1, 2019

By:      /s/ Jon Eberle

            Jon Eberle,

            Senior Vice President, Chief Financial Officer, and Treasurer

            (Principal Financial Officer)

 

37