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HMNF HMN Financial

Filed: 30 Oct 20, 11:56am
 
 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549 

FORM 10-Q

(Mark one)

☒       QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2020

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 0-2410

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

The Nasdaq Stock Market LLC

 

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 (§232.405 of this chapter) 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 check mark 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, 2020

Common stock, $0.01 par value

 

4,836,359

 

 

 
 

Part I – FINANCIAL INFORMATION

Item 1: Financial Statements

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

 

Consolidated Balance Sheets

 

 

  

September 30,

  

December 31,

 

(Dollars in thousands, except per share data)

 

2020

  

2019

 
  

(unaudited)

     

Assets

        

Cash and cash equivalents

 $76,027   44,399 

Securities available for sale:

        

Mortgage-backed and related securities (amortized cost $69,826 and $54,777)

  71,458   54,851 

Other marketable securities (amortized cost $46,874 and $52,751)

  47,106   52,741 
   118,564   107,592 
         

Loans held for sale

  7,225   3,606 

Loans receivable, net

  670,297   596,392 

Accrued interest receivable

  4,236   2,251 

Mortgage servicing rights, net

  2,880   2,172 

Premises and equipment, net

  10,342   10,515 

Goodwill

  802   802 

Core deposit intangible

  82   156 

Prepaid expenses and other assets

  6,798   8,052 

Deferred tax asset, net

  1,199   1,702 

Total assets

 $898,452   777,639 
         

Liabilities and Stockholders’ Equity

        

Deposits

 $787,023   673,870 

Accrued interest payable

  225   420 

Customer escrows

  1,857   2,413 

Accrued expenses and other liabilities

  8,204   8,288 

Total liabilities

  797,309   684,991 

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

  40,393   40,365 

Retained earnings, subject to certain restrictions

  114,724   107,547 

Accumulated other comprehensive income

  1,343   46 

Unearned employee stock ownership plan shares

  (1,498)  (1,643)

Treasury stock, at cost 4,292,303 and 4,284,840 shares

  (53,910)  (53,758)

Total stockholders’ equity

  101,143   92,648 

Total liabilities and stockholders’ equity

 $898,452   777,639 
 

 See accompanying notes to consolidated financial statements.

 

 

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)

 

2020

  

2019

  

2020

  

2019

 

Interest income:

             

Loans receivable

 $7,489   7,428   22,156   22,597 

Securities available for sale:

                

Mortgage-backed and related

  271   56   825   146 

Other marketable

  163   309   546   905 

Other

  26   205   149   381 

Total interest income

  7,949   7,998   23,676   24,029 
                 

Interest expense:

                

Deposits

  656   906   2,293   2,418 

Federal Home Loan Bank advances and other borrowings

  0   0   0   7 

Total interest expense

  656   906   2,293   2,425 

Net interest income

  7,293   7,092   21,383   21,604 

Provision for loan losses

  770   (420)  1,548   (1,452)

Net interest income after provision for loan losses

  6,523   7,512   19,835   23,056 
                 

Non-interest income:

                

Fees and service charges

  753   820   2,136   2,305 

Loan servicing fees

  347   324   976   957 

Gain on sales of loans

  3,005   845   6,503   1,835 

Other

  291   238   846   842 

Total non-interest income

  4,396   2,227   10,461   5,939 
                 

Non-interest expense:

                

Compensation and benefits

  3,916   3,849   11,762   11,496 

Occupancy and equipment

  1,101   1,142   3,335   3,284 

Data processing

  334   319   963   925 

Professional services

  241   428   1,175   1,081 

Other

  1,004   1,009   3,015   2,975 

Total non-interest expense

  6,596   6,747   20,250   19,761 

Income before income tax expense

  4,323   2,992   10,046   9,234 

Income tax expense

  1,222   916   2,869   2,677 

Net income

  3,101   2,076   7,177   6,557 

Other comprehensive income (loss), net of tax

  (202)  149   1,297   1,075 

Comprehensive income available to common shareholders

 $2,899   2,225   8,474   7,632 

Basic earnings per share

 $0.67   0.45   1.55   1.42 

Diluted earnings per share

 $0.67   0.45   1.54   1.41 
 

 

See accompanying notes to consolidated financial statements.

 

 
HMN FINANCIAL, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity
(unaudited)

 

                  

 

Unearned

         
                  

Employee

         
              

Accumulated

  

Stock

      

Total

 
      

Additional

      

Other

  

Ownership

      

Stock-

 
  

Common

  

Paid-in

  

Retained

  

Comprehensive

  

Plan

  

Treasury

  

Holders’

 

(Dollars in thousands)

 

Stock

  

Capital

  

Earnings

  

Income

  

Shares

  

Stock

  

Equity

 
                             

Balance, June 30, 2020

 $91   40,312   111,623   1,545   (1,546)  (53,910)  98,115 

Net income

          3,101               3,101 

Other comprehensive loss

              (202)          (202)

Amortization of restricted stock awards

      54                   54 

Earned employee stock ownership plan shares

      27           48       75 

Balance, September 30, 2020

 $91   40,393   114,724   1,343   (1,498)  (53,910)  101,143 
                             

Balance, December 31, 2019

 $91   40,365   107,547   46   (1,643)  (53,758)  92,648 

Net income

          7,177               7,177 

Other comprehensive gain

              1,297           1,297 

Stock repurchases

                      (360)  (360)

Restricted stock awards

      (268)              268   0 

Stock awards withheld for tax withholding

                      (60)  (60)

Amortization of restricted stock awards

      184                   184 

Earned employee stock ownership plan shares

      112           145       257 

Balance, September 30, 2020

 $91   40,393   114,724   1,343   (1,498)  (53,910)  101,143 

 

  
                  

 

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 

 

  

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)

 

2020

  

2019

 

Cash flows from operating activities:

        

Net income

 $7,177   6,557 

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

        

Provision for loan losses

  1,548   (1,452)

Depreciation

  785   838 

Amortization of premiums (discounts), net

  119   (10)

Amortization of deferred loan fees

  (350)  (153)

Amortization of core deposit intangible

  74   74 

Amortization of purchased asset fair value adjustments

  (26)  (29)

Amortization of mortgage servicing rights

  1,002   535 

Capitalized mortgage servicing rights

  (1,710)  (674)

Securities losses (gains), net

  40   (42)

(Gain) loss on sale of premises and equipment

  (6)  20 

Gain on sales of real estate

  (129)  0 

Gain on sales of loans

  (6,503)  (1,835)

Proceeds from sales of loans held for sale

  202,243   77,289 

Disbursements on loans held for sale

  (195,571)  (75,833)

Amortization of restricted stock awards

  184   138 

Amortization of unearned Employee Stock Ownership Plan shares

  145   144 

Earned Employee Stock Ownership Plan shares priced above original cost

  112   173 

Stock option compensation expense

  0   1 

(Increase) decrease in accrued interest receivable

  (1,985)  139 

(Decrease) increase in accrued interest payable

  (195)  31 

Decrease in other assets

  1,379   1,285 

(Decrease) increase in other liabilities

  (170)  923 

Other, net

  6   22 

Net cash provided by operating activities

  8,169   8,141 

Cash flows from investing activities:

        

Principal collected on securities available for sale

  11,050   1,347 

Proceeds collected on maturities of securities available for sale

  30,875   10,400 

Purchases of securities available for sale

  (51,218)  (15,246)

Purchase of Federal Home Loan Bank stock

  (79)  (1,040)

Redemption of Federal Home Loan Bank stock

  0   1,054 

Proceeds from sales of real estate

  434   0 

Net (increase) decrease in loans receivable

  (79,174)  1,008 

Proceeds from sale of premises and equipment

  63   195 

Purchases of premises and equipment

  (669)  (1,748)

Net cash used by investing activities

  (88,718)  (4,030)

Cash flows from financing activities:

        

Increase in deposits

  113,153   36,256 

Common Stock purchased

  (360)  0 

Stock awards withheld for tax withholding

  (60)  (45)

Proceeds from borrowings

  0   26,000 

Repayment of borrowings

  0   (26,000)

(Decrease) increase in customer escrows

  (556)  1,476 

Net cash provided by financing activities

  112,177   37,687 

Increase in cash and cash equivalents

  31,628   41,798 

Cash and cash equivalents, beginning of period

  44,399   20,709 

Cash and cash equivalents, end of period

 $76,027   62,507 

Supplemental cash flow disclosures:

        

Cash paid for interest

 $2,488   2,394 

Cash paid for income taxes

  2,041   2,189 

Supplemental noncash flow disclosures:

        

Loans transferred to loans held for sale

  3,960   4,054 

Transfer of loans to real estate

  139   166 

Right to use assets and lease obligations

  0   4,241 

 

  

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.

 

Certain amounts in the consolidated financial statements for the prior year have been reclassified to conform to the current year presentation.

 

 

(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 statements 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 three and nine month periods ended September 30, 2020 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), were originally effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods. On November 26, 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses which delayed the implementation date of ASU 2016-13 for SEC smaller reporting companies, such as HMN, from the first quarter of 2020 to the first quarter of 2023. 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. The Company has not early adopted this ASU. 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 the Bank’s 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 when it is adopted in the first quarter of 2023.

 

 

On February 6, 2020, the FASB issued ASU 2020-02, Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842)-Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). The amendments in this ASU related to Leases (Topic 842) did not have any impact on the Company. The amendments in this ASU related to Topic 326 adds additional guidance related to the SEC’s expectations for the documentation of the measurement, review process, and the systematic methodology used by entities to determine the current credit losses under FASB ASC Topic 326. Management is currently in the process of reviewing how the Company’s credit loss calculation and review processes will be impacted by the additional guidance of this ASU when ASC Topic 326 is adopted in the first quarter of 2023.

 

 

(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 the Company’s 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, 2020 and December 31, 2019.

 

  

Carrying value at September 30, 2020

 

 

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $118,564   0   118,564   0 

Equity securities

  127   0   127   0 

Mortgage loan commitments

  266   0   266   0 

Total

 $118,957   0   118,957   0 

 

  

Carrying value at December 31, 2019

 

 

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $107,592   0   107,592   0 

Equity securities

  167   0   167   0 

Mortgage loan commitments

  14   0   14   0 

Total

 $107,773   0   107,773   0 
                 

 

There were no transfers between Levels 1, 2, or 3 during the three or nine month periods ended September 30, 2020.

 

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. 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, 2020 and December 31, 2019.

 

 

  

Carrying value at September 30, 2020

         

 

 

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Three months ended

September 30, 2020

total gains

  

Nine months ended

September 30, 2020

total gains

 

Loans held for sale

 $7,225   0   7,225   0   24   86 

Mortgage servicing rights

  2,880   0   2,880   0   0   0 

Loans (1)

  2,881   0   2,881   0   12   50 

Real estate, net (2)

  414   0   414   0   0   0 

Total

 $13,400   0   13,400   0   36   136 
                         

 

  

Carrying value at December 31, 2019

     

 

 

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Year ended

December 31, 2019 total losses

 

Loans held for sale

 $3,606   0   3,606   0   (40)

Mortgage servicing rights

  2,172   0   2,172   0   0 

Loans (1)

  3,126   0   3,126   0   (28)

Real estate, net (2)

  580   0   580   0   0 

Total

 $9,484   0   9,484   0   (68)
                     

(1)

Represents the carrying value of 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 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, 2020 and December 31, 2019 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, 2020 and December 31, 2019 are shown in the following table.

 

  

September 30, 2020

  

December 31, 2019

 
          

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

 $76,027   76,027   76,027               44,399   44,399   44,399             

Securities available for sale

  118,564   118,564       118,564           107,592   107,592       107,592         

Equity securities

  127   127       127           167   167       167         

Loans held for sale

  7,225   7,225       7,225           3,606   3,606       3,606         

Loans receivable, net

  670,297   674,804       674,804           596,392   600,863       600,863         

Federal Home Loan Bank stock

  932   932       932           854   854       854         

Accrued interest receivable

  4,236   4,236       4,236           2,251   2,251       2,251         

Financial liabilities:

                                                

Deposits

  787,023   787,975       787,975           673,870   673,945       673,945         

Accrued interest payable

  225   225       225           420   420       420         

Off-balance sheet financial instruments:

                                                

Commitments to extend credit

  266   266               191,522   14   14               178,804 

Commitments to sell loans

  (102)  (102)              48,199   (16)  (16)              10,098 

 

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.

 

Equity Securities

The fair values of equity securities were based upon quoted market prices.

 

 

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 is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value disclosures for all of the deposits reflect the exit price amount anticipated to be received from the sale of the deposits in an open market transaction.

 

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)

 

2020

  

2019

 

Securities available for sale:

 

Before tax

  

Tax effect

  

Net of tax

  

Before tax

  

Tax effect

  

Net of tax

 

Net unrealized (losses) gains arising during the period

 $(281)  (79)  (202)  206   57   149 

Other comprehensive income (loss)

 $(281)  (79)  (202)  206   57   149 

 

  

For the nine months ended September 30,

 

(Dollars in thousands)

 

2020

  

2019

 

Securities available for sale:

 

Before tax

  

Tax effect

  

Net of tax

  

Before tax

  

Tax effect

  

Net of tax

 

Net unrealized gains arising during the period

 $1,800   503   1,297   1,491   416   1,075 

Other comprehensive income

 $1,800   503   1,297   1,491   416   1,075 
                         

 

 

 

(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, 2020 and December 31, 2019.

 

  

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, 2020

                                

Mortgage-backed securities:

                                

Federal National Mortgage Association (FNMA)

  2  $10,254   (35)  0  $0   0  $10,254   (35)

Other marketable securities:

                                

Corporate obligations

  1   37   (1)  0   0   0   37   (1)

Corporate preferred stock

  0   0   0   1   595   (105)  595   (105)

Total temporarily impaired securities

  3  $10,291   (36)  1  $595   (105) $10,886   (141)

 

  

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, 2019

                                

Mortgage backed securities:

                                

FNMA

  4  $12,143   (65)  0  $0   0  $12,143   (65)

Other marketable securities:

                                

U.S. Government agency obligations

  0   0   0   4   19,972   (21)  19,972   (21)

Corporate preferred stock

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

Total temporarily impaired securities

  4  $12,143   (65)  5  $20,637   (56) $32,780   (121)
                                 

 

The Company reviews its 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 the Company’s 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, 2020 relates to a single trust preferred security that was issued by the holding company of a small community bank. As of September 30, 2020 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, 2020. 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, 2020 and December 31, 2019 is as follows:

 

 

(Dollars in thousands)

 

Amortized cost

  

Gross unrealized
gains

  

Gross unrealized
losses

  

Fair value

 

September 30, 2020:

                

Mortgage-backed securities:

                

FNMA

 $52,922   1,388   (35)  54,275 

Federal Home Loan Mortgage Corporation (FHLMC)

  16,783   272   0   17,055 

Collateralized mortgage obligations:

                

FNMA

  121   7   0   128 
   69,826   1,667   (35)  71,458 

Other marketable securities:

                

U.S. Government agency obligations

  45,046   333   0   45,379 

Municipal obligations

  1,091   5   0   1,096 

Corporate obligations

  37   0   (1)  36 

Corporate preferred stock

  700   0   (105)  595 
   46,874   338   (106)  47,106 
  $116,700   2,005   (141)  118,564 
                 

 

 

Dollars in thousands)

 

Amortized cost

  

Gross unrealized
gains

  

Gross unrealized losses

  

Fair value

 

December 31, 2019

                

Mortgage-backed securities:

                

FNMA

 $46,604   47   (65)  46,586 

FHLMC

  8,004   88   0   8,092 

Collateralized mortgage obligations:

                

FNMA

  169   4   0   173 
   54,777   139   (65)  54,851 

Other marketable securities:

                

U.S. Government agency obligations

  49,974   39   (21)  49,992 

Municipal obligations

  1,969   7   0   1,976 

Corporate obligations

  108   0   0   108 

Corporate preferred stock

  700   0   (35)  665 
   52,751   46   (56)  52,741 
  $107,528   185   (121)  107,592 
                 

 

The following table indicates amortized cost and estimated fair value of securities available for sale at September 30, 2020 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

 $63,341   64,159 

Due after one year through five years

  43,832   44,776 

Due after five years through ten years

  8,662   8,865 

Due after ten years

  865   764 

Total

 $116,700   118,564 
         

 

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, 2020 and December 31, 2019 is as follows:

 

 

(Dollars in thousands)

 

September 30,

2020

  

 

December 31,
2019

 

Single family

 $130,843   120,064 

Commercial real estate:

        

Real estate rental and leasing

  213,696   192,502 

Other

  170,211   157,693 
   383,907   350,195 

Consumer

  59,271   69,949 

Commercial business

  106,796   64,227 

Total loans

  680,817   604,435 

Less:

        

Unamortized discounts

  13   15 

Net deferred loan fees (costs)

  975   (536)

Allowance for loan losses

  9,532   8,564 

Total loans receivable, net

 $670,297   596,392 
         

 

 

(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, 2020:

                 

Balance, June 30, 2020

 $938   5,382   1,464   865   8,649 

Provision for losses

  27   878   (64)  (71)  770 

Charge-offs

  0   0   (29)  (8)  (37)

Recoveries

  0   0   5   145   150 

Balance, September 30, 2020

 $965   6,260   1,376   931   9,532 
                     

For the nine months ended September 30, 2020:

                 

Balance, December 31, 2019

 $857   5,060   1,507   1,140   8,564 

Provision for losses

  108   1,913   (79)  (394)  1,548 

Charge-offs

  0   (730)  (74)  (8)  (812)

Recoveries

  0   17   22   193   232 

Balance, September 30, 2020

 $965   6,260   1,376   931   9,532 
                     

Allocated to:

                    

Specific reserves

 $62   451   119   93   725 

General reserves

  795   4,609   1,388   1,047   7,839 

Balance, December 31, 2019

 $857   5,060   1,507   1,140   8,564 
                     

Allocated to:

                    

Specific reserves

 $31   5   63   17   116 

General reserves

  934   6,255   1,313   914   9,416 

Balance, September 30, 2020

 $965   6,260   1,376   931   9,532 
                     

Loans receivable at December 31, 2019:

                    

Individually reviewed for impairment

 $974   1,166   976   735   3,851 

Collectively reviewed for impairment

  119,090   349,029   68,973   63,492   600,584 

Ending balance

 $120,064   350,195   69,949   64,227   604,435 
                     

Loans receivable at September 30, 2020:

                    

Individually reviewed for impairment

 $708   1,537   707   45   2,997 

Collectively reviewed for impairment

  130,135   382,370   58,564   106,751   677,820 

Ending balance

 $130,843   383,907   59,271   106,796   680,817 
                     

 

 

 

(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 
                     

 

The following table summarizes the amount of classified and unclassified loans at September 30, 2020 and December 31, 2019:

 

  

September 30, 2020

 
  

Classified

  

Unclassified

     

 

(Dollars in thousands)

 

Special
Mention

  

Substandard

  

Doubtful

  

Loss

  

Total

  

Total

  

Total Loans

 

Single family

 $274   2,313   31   0   2,618   128,225   130,843 

Commercial real estate:

                            

Real estate rental and leasing

  5,194   3,451   0   0   8,645   205,051   213,696 

Other

  5,537   5,574   0   0   11,111   159,100   170,211 

Consumer

  0   624   63   20   707   58,564   59,271 

Commercial business

  3,575   1,884   0   0   5,459   101,337   106,796 
  $14,580   13,846   94   20   28,540   652,277   680,817 
                             

 

  

December 31, 2019

 
  

Classified

  

Unclassified

     

 

(Dollars in thousands)

 

Special
Mention

  

Substandard

  

Doubtful

  

Loss

  

Total

  

Total

  

Total Loans

 

Single family

 $1,118   1,765   35   0   2,918   117,146   120,064 

Commercial real estate:

                            

Real estate rental and leasing

  3,489   9,114   0   0   12,603   179,899   192,502 

Other

  4,451   5,253   0   0   9,704   147,989   157,693 

Consumer

  0   842   69   65   976   68,973   69,949 

Commercial business

  5,710   2,516   0   0   8,226   56,001   64,227 
  $14,768   19,490   104   65   34,427   570,008   604,435 
                             

 

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, 2020 and December 31, 2019 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, 2020

                            

Single family

 $550   223   144   917   129,926   130,843   0 

Commercial real estate:

                            

Real estate rental and leasing

  0   0   0   0   213,696   213,696   0 

Other

  0   0   185   185   170,026   170,211   0 

Consumer

  360   49   300   709   58,562   59,271   0 

Commercial business

  0   0   0   0   106,796   106,796   0 
  $910   272   629   1,811   679,006   680,817   0 

December 31, 2019

                            

Single family

 $786   77   59   922   119,142   120,064   0 

Commercial real estate:

                            

Real estate rental and leasing

  0   0   0   0   192,502   192,502   0 

Other

  0   0   0   0   157,693   157,693   0 

Consumer

  527   31   206   764   69,185   69,949   0 

Commercial business

  147   13   550   710   63,517   64,227   0 
  $1,460   121   815   2,396   602,039   604,435   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, 2020 and December 31, 2019:

 

  

September 30, 2020

  

December 31, 2019

 

 

 

(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

 $588   607   0   544   563   0 

Commercial real estate:

                        

Real estate rental and leasing

  968   1,618   0   0   0   0 

Other

  399   479   0   0   0   0 

Consumer

  596   596   0   781   781   0 

Loans with an allowance recorded:

                        

Single family

  120   120   31   430   430   62 

Commercial real estate:

                        

Real estate rental and leasing

  170   170   5   184   184   16 

Other

  0   0   0   982   982   435 

Consumer

  111   111   63   195   195   119 

Commercial business

  45   597   17   735   1,287   93 

Total:

                        

Single family

  708   727   31   974   993   62 

Commercial real estate:

                        

Real estate rental and leasing

  1,138   1,788   5   184   184   16 

Other

  399   479   0   982   982   435 

Consumer

  707   707   63   976   976   119 

Commercial business

  45   597   17   735   1,287   93 
  $2,997   4,298   116   3,851   4,422   725 
                         

 

 

The following tables summarize average recorded investment and interest income recognized on impaired loans during the three and nine months ended September 30, 2020 and 2019.

 

  

For the three months ended
September 30, 2020

  

For the nine months ended

September 30, 2020

 

 

 

(Dollars in thousands)

 

Average

Recorded
Investment

  

Interest

Income
Recognized

  

Average
Recorded

Investment

  

Interest

Income
Recognized

 

Loans with no related allowance recorded:

                

Single family

 $606   6   585   23 

Commercial real estate:

                

Real estate rental and leasing

  985   0   493   33 

Other

  401   0   340   2 

Consumer

  586   3   640   9 

Commercial business

  4   0   2   0 

Loans with an allowance recorded:

                

Single family

  121   0   273   0 

Commercial real estate:

                

Real estate rental and leasing

  173   0   177   0 

Other

  0   0   487   0 

Consumer

  142   0   169   2 

Commercial business

  50   1   242   2 

Total:

                

Single family

  727   6   858   23 

Commercial real estate:

                

Real estate rental and leasing

  1,158   0   670   33 

Other

  401   0   827   2 

Consumer

  728   3   809   11 

Commercial business

  54   1   244   2 
  $3,068   10   3,408   71 
 ��               

 

  

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 
                 

 

 

At September 30, 2020 and December 31, 2019, non-accruing loans totaled $2.5 million and $2.1 million, respectively, for which the related allowance for loan losses was $0.1 million and $0.2 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 $2.2 million and $0.8 million, at September 30, 2020 and December 31, 2019, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

 

The non-accrual loans at September 30, 2020 and December 31, 2019 are summarized as follows:

 

 

(Dollars in thousands)

 

 

September 30, 2020

  

 

December 31, 2019

 
         

Single family

 $352   617 

Commercial real estate:

        

Real estate rental and leasing

  1,138   184 

Other

  399   0 

Consumer

  641   659 

Commercial business

  11   621 
  $2,541   2,081 
         

 

At September 30, 2020 and December 31, 2019 there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $1.5 million and $2.5 million, respectively. There were no loans that were restructured as TDR’s in the third quarter of 2020. Of the loans that were restructured as TDR’s in the third quarter of 2019, none were classified but performing, and $0.1 million were non-performing at September 30, 2019.

 

The following table summarizes TDRs at September 30, 2020 and December 31, 2019:

 

  

September 30, 2020

  

December 31, 2019

 

 

(Dollars in thousands)

 

Accrual

  

Non-Accrual

  

Total

  

Accrual

  

Non-Accrual

  

Total

 

Single family

 $356   261   617   357   266   623 

Commercial real estate

  0   214   214   983   0   983 

Consumer

  66   589   655   316   429   745 

Commercial business

  35   0   35   114   0   114 
  $457   1,064   1,521   1,770   695   2,465 
                         

 

As of September 30, 2020, the Bank had commitments to lend an additional $1.3 million to a borrower who has TDR and non-accrual loans. These additional funds are for the construction of single family homes with a maximum loan-to-value ratio of 75%. These loans are secured by the homes under construction. At December 31, 2019, there were commitments to lend additional funds of $0.8 million to this same borrower.

 

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 consolidated balance sheets, 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, 2020 and 2019.

 

 

  

Three Months Ended

September 30, 2020

  

Nine Months Ended

September 30, 2020

 

 

 

 

 

(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  $94   101 

Commercial real estate:

                        

Other

  0   0   0   2   293   293 

Total

  0  $0   0   3  $387   394 
                         

 

  

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 
                         

 

There were no loans that were restructured in the 12 months preceding September 30, 2020 and 2019 that subsequently defaulted during the three and nine months ended September 30, 2020 and 2019, 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 $0.1 million, or 1.1%, of the total $9.5 million in loan loss reserves at September 30, 2020 and $0.6 million, or 7.2%, of the total $8.6 million in loan loss reserves at December 31, 2019.

 

In the first nine months of 2020 the Company deferred loan payments for up to six months for some borrowers that were negatively impacted by the COVID-19 pandemic. In accordance with the regulatory guidance in the Interagency Statement on Loan Modification and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus that was issued on April 7, 2020, these deferred amounts were not included in the TDR information noted above. Furthermore, based on management’s review the risk ratings on these loans were not changed and the loans continue to accrue interest based on the applicable guidance. Management will continue to monitor the performance and condition of these loans and make any necessary changes to their classification that may be required based on future regulatory guidance. A summary of deferred loans at September 30, 2020 and June 30, 2020 by industry and collateral type is as follows:

 

 

 

(Dollars in thousands)

 

Balance
September 30, 2020

  

Balance
June 30, 2020

 

Commercial real estate loans by industry:

        

Hotels (1)

 $54,660   54,660 

Retail/Office

  7,127   20,322 

Theaters

  11,269   11,269 

Multi-family

  0   11,195 

Single family

  0   4,675 

Restaurant/Bar

  2,876   4,477 

Other

  5,747   9,449 

Total commercial loans

  81,679   116,047 
         

Consumer loans by collateral type:

        

Single family

  366   2,955 

Other

  0   77 

Total consumer loans

  366   3,032 

Total deferred loans

 $82,045   119,079 
  

 

 

(1)

Approximately $38.5 million of the hotel properties are located in Minnesota with approximately $21.3 million located in Rochester, Minnesota, $13.8 million in the Minneapolis/St. Paul, Minnesota metro area, and $3.4 million in St. Cloud, Minnesota.

 

All of the borrowers whose loan deferral period ended during the third quarter of 2020 had resumed making their normal payments and none of the loans removed from the deferral list were classified as non-performing as of September 30, 2020. The initial deferral period for all remaining deferred loans at September 30, 2020 is scheduled to end in the fourth quarter of 2020. The Company’s commercial credit department continues to communicate regularly with the borrowers that have had their loan payments deferred and monitors their activity closely. This information is used to analyze the performance of these borrowers and to help anticipate any potential issues that these borrowers may have when their initial deferral period ends. It is anticipated that some of the remaining borrowers with deferred loan payments will be in a position to resume making their regular loan payments, while other borrowers, particularly in the hospitality and restaurant industries, may need to have their loan terms modified for a period of time until their operations recover more fully from the impacts of the pandemic.

 

 

(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, 2020

  

Twelve Months ended

December 31, 2019

  

Nine Months ended

September 30, 2019

 

Balance, beginning of period

 $2,172   1,855   1,855 

Originations

  1,710   1,097   674 

Amortization

  (1,002)  (780)  (535)

Balance, end of period

 $2,880   2,172   1,994 

Fair value of mortgage servicing rights

 $2,956   3,390   2,922 
             

 

All of the loans sold where the Company continues to service the loans are serviced for FNMA under the mortgage-backed security program or the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at September 30, 2020.

 

      

Weighted

  

Weighted

     
  

Loan

  

Average

  

Average

     
  

Principal

  

Interest

  

Remaining

  

Number

 

(Dollars in thousands)

 

Balance

  

Rate

  

Term (months)

  

of Loans

 

Original term 30 year fixed rate

  $380,018   3.74

%

  311   2,593 

Original term 15 year fixed rate

  117,870   3.03   140   1,064 
                 

 

The gross carrying amount of intangible assets and the associated accumulated amortization at September 30, 2020 and December 31, 2019 is presented in the following table. Amortization expense for amortizing intangible assets was $1.1 million and $0.6 million for the nine month periods ended September 30, 2020 and 2019, respectively.

 

 

  

September 30, 2020

 
  

Gross

         

 

(Dollars in thousands)

 

Carrying

Amount

  

Accumulated Amortization

  

Unamortized Amount

 

Mortgage servicing rights

 $6,018   (3,138)  2,880 

Core deposit intangible

  574   (492)  82 

Goodwill

  802   0   802 

Total

 $7,394   (3,630)  3,764 
             

 

  

December 31, 2019

 
 ��

Gross

         

 

(Dollars in thousands)

 

Carrying

Amount

  

Accumulated Amortization

  

Unamortized Amount

 

Mortgage servicing rights

 $4,968   (2,796)  2,172 

Core deposit intangible

  574   (418)  156 

Goodwill

  802   0   802 

Total

 $6,344   (3,214)  3,130 
             

 

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,

            

2020

 $156   25   181 

2021

  596   47   643 

2022

  550   10   560 

2023

  495   0   495 

2024

  437   0   437 

Thereafter

  646   0   646 

Total

 $2,880   82   2,962 
             

 

Projections of amortization are based on existing asset balances and the existing interest rate environment as of September 30, 2020. The Company's actual experience may be different depending upon changes in mortgage interest rates and other market conditions.

 

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. The Company’s stock was trading at a price below its book value at September 30, 2020 and therefore, goodwill was analyzed for impairment. Based on the analysis, the Company determined that goodwill was not permanently impaired and no write down was required at September 30, 2020.

 

 

(11) Leases

The Company accounts for its leases in accordance with ASU 2016-02, Leases (Topic 842) and as of September 30, 2020, a $3.4 million right-of-use asset and an offsetting lease payment obligation liability were recorded on the consolidated balance sheets in other assets and other liabilities, respectively.

 

Operating lease right-of-use assets represent the Company’s right to use an underlying asset during the lease term and operating lease liabilities represent its 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 22 and 54 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.

 

 

The table below summarizes the Company’s net lease cost:

 

(Dollars in thousands)

 

Three Months Ended
September 30, 2020

  

Nine Months Ended
September 30, 2020

 

Operating lease cost

 $224   669 
         

 

The table below summarizes other information related to the Company’s operating leases:

 

(Dollars in thousands)

 

Three Months
Ended
September 30,
2020

  

Three Months
Ended
September 30,
2019

  

Nine Months
Ended
September 30,
2020

  

Nine Months
Ended
September 30,
2019

 

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

                

Operating cash flows from operating leases

 $224   221   669   667 

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

  3.9   5.0   3.9   5.0 

Weighted-average discount rate – operating leases

  2.19%  2.19%  2.19%  2.19%
                 

 

The table below summarizes the maturities of remaining lease liabilities:

 

(Dollars in thousands)

 

 

September 30, 2020

 

2020

 $222 

2021

  902 

2022

  924 

2023

  802 

2024

  667 

2025 and thereafter

  11 

Total lease payments

  3,528 

Less: Interest

  (153)

Present value of lease liabilities

 $3,375 
     

 

 

(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)

 

2020

  

2019

  

2020

  

2019

 

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

  4,628   4,614   4,624   4,606 

Net dilutive effect of:

                

Restricted stock awards and options

  23   28   26   29 

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

  4,651   4,642   4,650   4,635 

Income available to common shareholders

 $3,101   2,076   7,177   6,557 

Basic earnings per common share

 $0.67   0.45   1.55   1.42 

Diluted earnings per common share

 $0.67   0.45   1.54   1.41 
                 

 

 

(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 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, 2020 were $886.7 million, its adjusted total assets were $885.8 million, and its risk-weighted assets were $655.1 million. The following table presents the Bank’s capital amounts and ratios at September 30, 2020 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, 2020

                                

Common equity tier 1 capital

 $86,209   13.16

%

 $29,481   4.50

%

 $56,728   8.66

%

 $42,583   6.50

%

Tier 1 capital leverage

  86,209   9.73   35,432   4.00   50,777   5.73   44,291   5.00 

Tier 1 risk-based capital

  86,209   13.16   39,307   6.00   46,902   7.16   52,410   8.00 

Total risk-based capital

  94,414   14.41   52,410   8.00   42,004   6.41   65,512   10.00 
                                 

 

The Bank must maintain a capital conservation buffer of 2.50% 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. Management believes that, as of September 30, 2020, 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 (OCC) 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 was authorized to repurchase up to $5.6 million additional shares of its common stock under the existing board-approved share repurchase program at September 30, 2020. The Company suspended its stock repurchase program through September 30, 2020 and did not repurchase any of its common stock in the open market during the second or third quarters of 2020. The suspension of the stock repurchase program was done in order to preserve capital while the Company evaluated its capital needs as a result of the stressed economic environment related to the COVID-19 pandemic. Although, the evaluation of capital needs is an ongoing process, the stock repurchase program is no longer suspended. The Company did not pay any dividends on its common stock in the third quarter of 2020 and no dividends are anticipated to be paid in the fourth quarter of 2020.

 

 

(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, 2020 were approximately $7.0 million, expire over the next 14 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 $1.9 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 the Company’s outstanding litigation is from $0 to $0.9 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, 2020:

                

Interest income - external customers

 $23,676   0   0   23,676 

Non-interest income - external customers

  10,461   0   0   10,461 

Intersegment interest income

  0   32   (32)  0 

Intersegment non-interest income

  175   7,609   (7,784)  0 

Interest expense

  2,325   0   (32)  2,293 

Provision for loan losses

  1,548   0   0   1,548 

Non-interest expense

  19,863   562   (175)  20,250 

Income tax expense

  2,967   (98)  0   2,869 

Net income

  7,609   7,177   (7,609)  7,177 

Total assets

  897,694   101,308   (100,550)  898,452 

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 quarter ended September 30, 2020:

                

Interest income - external customers

 $7,949   0   0   7,949 

Non-interest income - external customers

  4,396   0   0   4,396 

Intersegment interest income

  0   9   (9)  0 

Intersegment non-interest income

  58   3,251   (3,309)  0 

Interest expense

  665   0   (9)  656 

Provision for loan losses

  770   0   0   770 

Non-interest expense

  6,460   194   (58)  6,596 

Income tax expense

  1,257   (35)  0   1,222 

Net income

  3,251   3,101   (3,251)  3,101 

Total assets

  897,694   101,308   (100,550)  898,452 

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 
  ��              

 

 

 

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 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,” “project,” “continue,” “may,” “will,” “would,” “could,” “should,” “trend,” or similar statements or variations of such terms and include, but are not limited to, those relating to growing the Company’s core deposit relationships and loan balances; enhancing the financial performance of its core banking operations; maintaining credit quality; maintaining net interest margins; reducing non-performing assets; generating improved financial results; the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; its expectations for core capital and its strategies and potential strategies for maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the anticipated impacts of the COVID-19 pandemic and efforts to mitigate the same on the general economy, the Company’s clients, and the allowance for loan losses; the anticipated benefits that will be realized by its clients from government assistance programs related to the COVID-19 pandemic; the Company’s expectations relating to repurchases of its common stock during the COVID-19 pandemic; the amount of the Bank’s non-performing assets in future periods and the appropriateness of the allowances therefor; anticipated future levels of the provision for loan losses; future losses on non-performing non-accruing and purchased loans; the amount and composition of non-interest and interest bearing liabilities; the need for an availability of alternate funding sources; the payment of dividends or repurchases of stock by HMN; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; requests for loan payment accommodations from borrowers; 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 the Company’s assessment of the impact on its 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 and possible responses of the OCC, Board of Governors of the Federal Reserve System, the Bank, and the Company due to any failure to comply with any such regulatory standard, directive, or requirement.

 

A number of factors, many of which are, and may continue to be amplified by, the COVID-19 pandemic and efforts to mitigate the same, 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 the Federal Reserve Bank in the event of 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 FHLB and the Federal Reserve Bank; technological, computer-related or operational difficulties including those from any third party cyberattack; 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; the Company’s 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 Form 10-K and Form 10-Q filed 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” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 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 the Company undertakes no duty to update any of the forward-looking statements after the date of this quarterly report on Form 10-Q.

 

 

General

HMN is the stock savings bank holding company for 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, data processing costs, professional services, deposit insurance, amortization expense on mortgage servicing assets, advertising 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 and 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 any adjustments 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 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 GAAP, 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 ability to realize 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 positive evidence considered 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.


Litigation
Estimates related to litigation are inherently subjective and the ultimate resolution of any litigation may be different than current management estimates. See “Note 15 Commitments and Contingencies” for further information.

 

 

COVID-19 Pandemic

The spread of COVID-19 has slowed the economic activity in many countries, including the United States, in the first nine months of 2020. Millions of Americans have at some point been ordered to stay home, including those residing in the states of Minnesota and Wisconsin, and many businesses have been ordered to be closed or to operate at reduced capacities in order to reduce the spread of COVID-19. These orders have severely reduced the flow of commerce which has reduced, or entirely eliminated, the revenue streams for many small businesses. This reduction in income has forced many small businesses to close temporarily or furlough employees. The Company has also been impacted by the disruption in economic activity that has occurred. The Bank has implemented the following measures in response to the COVID-19 pandemic:

 

 

The Bank temporarily closed the lobbies in all of its locations and for a period of time conducted business entirely through the drive-ups at the branches that have them. Branches without drive-up facilities were closed for a period of time in order to meet the social distancing guidelines recommended by health officials. Beginning on June 22, 2020 the Bank re-opened all of its lobbies, except the Marshalltown, Iowa location, to walk-in services during limited hours while continuing to offer drive-up service during normal business hours. The Bank continues to encourage its customers to conduct business through its on-line loan and deposit account services, as well as the ATM and night drop facilities that are available at its branches.

 

 

None of the Bank’s market areas are currently under a stay-at-home order. However, Bank employees who are able to perform their duties remotely continue to work from their homes and the majority of the corporate staff is currently working from home.

 

 

The Bank’s regulators issued the Interagency Statement on Loan Modification and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus on April 7, 2020. In accordance with the regulatory guidance, the Bank offered loan payment accommodations to certain customers by deferring the loan payments for up to six months on their outstanding loans with the Bank. At September 30, 2020, the Bank had deferred payments on loans to existing customers in the amount of $82.0 million. See additional information on deferred loan payments in Note 9 – Allowance for Loan Losses and Credit Quality Information. The deferred loan balances have decreased substantially since June 30, 2020. It is anticipated that some of the remaining borrowers with deferred loan payments will be in a position to resume making their regular loan payments, while other borrowers, particularly in the hospitality and restaurant industries, may need to have their loan terms modified for a period of time until their operations recover more fully from the impacts of the pandemic.

 

 

The Bank actively participated in helping businesses that were negatively impacted by COVID-19 and that applied for forgivable loans under the Paycheck Protection Program (PPP) in connection with the Coronavirus Aid, Relief, and Economic Security Act (CARES Act). The CARES Act, which was signed into law on March 27, 2020, allocated $349 billion in funding to help small businesses that were negatively impacted by the COVID-19 pandemic. As of September 30, 2020 the Bank had 410 loans with outstanding balances of $53.1 million under the program. The remaining net deferred fees associated with these loans totaling $1.4 million at September 30, 2020 and will be recognized into income over the remaining lives of the loans. During the third quarter, the Company began to help clients that received PPP loans navigate the application process to get the appropriate amount of their loans forgiven in accordance with the program requirements, although, no approvals of loan forgiveness had been obtained from the SBA as of September 30, 2020.

 

The extent of the impact of COVID-19 on the Company is difficult to determine as it is not clear how long the reduced economic activity will persist, when, or if, a vaccine for COVID-19 will be developed, when, or if, businesses will re-hire those workers displaced by the pandemic, or what the long-term implications will be on customer behaviors as a result of the pandemic, among other factors. Up to this point, the Company has not seen a negative impact on its deposit relationships as many of its clients have been able to conduct their business with the Bank through the drive-ups, ATMs, night drop, on-line banking website, or by using its mobile banking app. The impact on the Bank’s loan portfolio is also unclear for many of the same reasons.

 

 

RESULTS OF OPERATIONS FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2020 COMPARED TO THE SAME PERIODS ENDED SEPTEMBER 30, 2019

 

Net Income

Net income was $3.1 million for the third quarter of 2020, an increase of $1.0 million, compared to net income of $2.1 million for the third quarter of 2019. Diluted earnings per share for the third quarter of 2020 was $0.67, an increase of $0.22 per share, compared to diluted earnings per share of $0.45 for the third quarter of 2019. The increase in net income was primarily because of a $2.2 million increase in the gain on sales of mortgage loans between the periods. The increase in the gain on sales of mortgage loans was due primarily to the increase in mortgage loan refinance activity in the current period as a result of the lower interest rate environment between the periods. Net interest income increased $0.2 million primarily because of a decrease in interest expense between the periods. These increases in net income were partially offset by a $1.2 million increase in the provision for loan losses between the periods. The provision for loan losses increased primarily because of the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic. Income tax expense also increased $0.3 million as a result of the increased pre-tax income between the periods.

 

 

Net income was $7.2 million for the nine month period ended September 30, 2020, an increase of $0.6 million, or 9.5%, compared to net income of $6.6 million for the nine month period ended September 30, 2019. Diluted earnings per share for the nine month period ended September 30, 2020 was $1.54, an increase of $0.13 per share, compared to diluted earnings per share of $1.41 for the same period in 2019. The increase in net income was primarily because of a $4.7 million increase in the gain on sales of mortgage loans between the periods. The increase in the gain on sales of mortgage loans was due primarily to the increase in mortgage loan refinance activity in the current period as a result of the lower interest rate environment between the periods. This increase in net income was partially offset by a $3.0 million increase in the provision for loan losses between the periods. The provision for loan losses increased primarily because of the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic and also because of the decrease in the net recoveries received in the current period when compared to the same period of 2019. Non-interest expenses increased $0.5 million due primarily to an increase in compensation expense between the periods. Net interest income decreased $0.2 million primarily because of a decrease in the yield earned on interest earning assets due to the decrease in the average prime rate between the periods. Income tax expense also increased $0.2 million as a result of the increased pre-tax income between the periods.

 

Net Interest Income

Net interest income was $7.3 million for the third quarter of 2020, an increase of $0.2 million, or 2.8%, from $7.1 million for the third quarter of 2019. Interest income was $7.9 million for the third quarter of 2020, a decrease of $0.1 million, or 0.6%, from $8.0 million for the third quarter of 2019. Interest income decreased despite the $143.4 million increase in the average interest-earning assets between the periods primarily because of the decrease in the average yield earned on interest-earning assets. The average yield earned on interest-earning assets was 3.71% for the third quarter of 2020, a decrease of 76 basis points from 4.47% for the third quarter of 2019. The decrease in the average yield is primarily related to the decrease in the average prime rate between the periods.

 

Interest expense was $0.7 million for the third quarter of 2020, a decrease of $0.2 million, or 27.6%, from $0.9 million for the third quarter of 2019. Interest expense decreased despite the $133.7 million increase in the average interest-bearing liabilities and non-interest bearing deposits between the periods primarily because of the decrease in the average interest rate paid on deposits. The average interest rate paid on interest-bearing liabilities and non-interest bearing deposits was 0.34% for the third quarter of 2020, a decrease of 22 basis points from 0.56% for the third quarter of 2019. The decrease in the interest paid on interest-bearing liabilities was primarily because of the decrease in the average federal funds rate between the periods.

 

Net interest margin (net interest income divided by average interest-earning assets) for the third quarter of 2020 was 3.40%, a decrease of 57 basis points, compared to 3.97% for the third quarter of 2019. The decrease in the net interest margin is primarily related to the decrease in the average yield earned on interest-earning assets as a result of the prime rate decreases that occurred between the periods.

 

Net interest income was $21.4 million for the first nine months of 2020, a decrease of $0.2 million, or 1.0%, from $21.6 million for the same period in 2019. Interest income was $23.7 million for the nine months ended September 30, 2020, a decrease of $0.3 million, or 1.5%, from $24.0 million for the same nine month period in 2019. Interest income decreased despite the $103.0 million increase in the average interest-earning assets between the periods primarily because of the decrease in the average yield earned on interest-earning assets. The average yield earned on interest-earning assets was 3.95% for the first nine months of 2020, a decrease of 65 basis points from 4.60% for the first nine months of 2019. The decrease in the average yield is primarily related to the decrease in the average prime rate between the periods.

 

 

Interest expense was $2.3 million for the first nine months of 2020, a decrease of $0.1 million, or 5.4%, compared to $2.4 million in the first nine months of 2019. Interest expense decreased despite the $97.8 million increase in the average interest-bearing liabilities and non-interest bearing deposits between the periods primarily because of the decrease in the average interest rate paid on deposits. The average interest rate paid on interest-bearing liabilities and non-interest bearing deposits was 0.42% for the first nine months of 2020, a decrease of 9 basis points from 0.51% for the first nine months of 2019. The decrease in the interest paid on interest-bearing liabilities was primarily because of the decrease in the average federal funds rate between the periods.

 

Net interest margin (net interest income divided by average interest-earning assets) for the first nine months of 2020 was 3.57%, a decrease of 57 basis points, compared to 4.14% for the first nine months of 2019. The decrease in the net interest margin is primarily related to the decrease in the average yield earned on interest-earning assets as a result of the prime rate decreases that occurred between the periods.

 

A summary of the Company’s net interest margin for the three and nine month periods ended September 30, 2020 and 2019 is as follows:

 

  

For the three month period ended

 
  

September 30, 2020

  

September 30, 2019

 

(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

 $103,132   434   1.67

%

 $80,286   365   1.80

%

Loans held for sale

  9,309   65   2.76   3,557   43   4.72 

Single family loans, net

  134,460   1,325   3.92   115,844   1,236   4.23 

Commercial loans, net

  474,325   5,390   4.52   398,674   5,229   5.20 

Consumer loans, net

  60,473   709   4.66   73,788   920   4.95 

Other

  71,180   26   0.15   37,355   205   2.18 

Total interest-earning assets

  852,879   7,949   3.71   709,504   7,998   4.47 
                         

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

                        

Checking accounts

  129,276   41   0.13   93,024   23   0.10 

Savings accounts

  93,022   17   0.07   80,269   16   0.08 

Money market accounts

  221,991   190   0.34   173,606   303   0.69 

Certificates

  111,847   408   1.45   127,888   564   1.75 

Total interest-bearing liabilities

  556,136           474,787         

Non-interest checking

  219,512           166,972         

Other non-interest bearing deposits

  2,218           2,415         

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

 $777,866   656   0.34  $644,174   906   0.56 

Net interest income

     $7,293          $7,092     

Net interest rate spread

          3.37

%

          3.91

%

Net interest margin

          3.40

%

          3.97

%

                         

 

 

  

For the nine month period ended

 
  

September 30, 2020

  

September 30, 2019

 

(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

 $100,889   1,371   1.81

%

 $79,163   1,051   1.77

%

Loans held for sale

  6,942   156   2.99   2,417   82   4.51 

Mortgage loans, net

  130,441   3,907   4.00   115,162   3,744   4.35 

Commercial loans, net

  446,580   15,781   4.72   402,469   15,966   5.30 

Consumer loans, net

  64,570   2,312   4.78   73,384   2,805   5.11 

Other

  51,030   149   0.39   24,886   381   2.05 

Total interest-earning assets

  800,452   23,676   3.95   697,481   24,029   4.60 
                         

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

                        

Checking accounts

  115,110   102   0.12   95,748   73   0.10 

Savings accounts

  87,587   48   0.07   79,599   47   0.08 

Money market accounts

  205,868   684   0.44   174,565   878   0.67 

Certificates

  118,422   1,459   1.65   120,376   1,420   1.58 

Advances and other borrowings

  0   0   0.00   384   7   2.54 

Total interest-bearing liabilities

  526,987           470,672         

Non-interest checking

  200,965           159,820         

Other non-interest bearing deposits

  2,384           2,030         

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

 $730,336   2,293   0.42  $632,522   2,425   0.51 

Net interest income

     $21,383          $21,604     

Net interest rate spread

          3.53

%

          4.09

%

Net interest margin

          3.57

%

          4.14

%

                         

 

Provision for Loan Losses

The provision for loan losses was $0.8 million for the third quarter of 2020, an increase of $1.2 million from the ($0.4) million provision for loan losses for the third quarter of 2019. The provision for loan losses increased between the periods primarily because of the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic.

 

The provision for loan losses was $1.5 million for the first nine months of 2020, an increase of $3.0 million compared to the ($1.5) million provision for loan losses for the first nine months of 2019. The provision for loan losses increased between the periods primarily because of the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic and also because of the decrease in the net recoveries received in the current period when compared to the same period of 2019.

 

The amount of the increase in the allowance for loan losses in both the three and nine month periods ended September 30, 2020 related to the economic environment was based, in part, on the amount of loans to borrowers that continued to have their loan payments deferred because of the impact of the pandemic. At September 30, 2020 the Bank had $82.0 million of loans to borrowers who had their loan payments deferred for up to six months compared to $119.1 million of loans to borrowers who had their payments deferred at June 30, 2020.

 

 

A summary of deferred loans at September 30, 2020 and June 30, 2020 by industry and collateral type is as follows:

 

 

(Dollars in thousands)

 

Balance
September 30, 2020

  

Balance
June 30, 2020

 

Commercial real estate loans by industry:

        

Hotels (1)

 $54,660   54,660 

Retail/Office

  7,127   20,322 

Theaters

  11,269   11,269 

Multi-family

  0   11,195 

Single family

  0   4,675 

Restaurant/Bar

  2,876   4,477 

Other

  5,747   9,449 

Total commercial loans

  81,679   116,047 
         

Consumer loans by collateral type:

        

Single family

  366   2,955 

Other

  0   77 

Total consumer loans

  366   3,032 

Total deferred loans

 $82,045   119,079 
         

(1)

Approximately $38.5 million of the hotel properties are located in Minnesota with approximately $21.3 million located in Rochester, Minnesota, $13.8 million in the Minneapolis/St. Paul, Minnesota metro area, and $3.4 million in St. Cloud, Minnesota.

 

All of the borrowers whose loan deferral period ended during the third quarter of 2020 had resumed making their normal payments and none of the loans removed from the deferral list were classified as non-performing as of September 30, 2020. The initial deferral period for all remaining deferred loans at September 30, 2020 is scheduled to end in the fourth quarter of 2020. The commercial credit department continues to communicate regularly with the borrowers that have had their loan payments deferred and monitors their activity closely. This information is used to analyze the performance of these borrowers and to help anticipate any potential issues that these borrowers may have when their initial deferral period ends. It is anticipated that some of the remaining borrowers with deferred loan payments will be in a position to resume making their regular loan payments, while other borrowers, particularly in the hospitality and restaurant industries, may need to have their loan terms modified for a period of time until their operations recover more fully from the impacts of the pandemic.

 

The allowance for loan losses is made up of general reserves on the entire loan portfolio and specific reserves on impaired loans. The general reserve amount includes quantitative reserves based on our past loan loss history and qualitative reserves for other items determined to have a potential impact on future loan losses. The general reserves increased during the three and nine month periods ended September 30, 2020 as a result of an increase in our qualitative allowance for loan losses. The qualitative allowance amount increased because of the current economic stress caused by the disruption in business activity as a result of the COVID-19 pandemic and an increase in reserves related to an analysis of the Bank’s charged off loan history. Total non-performing assets were $3.0 million at September 30, 2020, an increase of $0.3 million, or 11.0%, from $2.7 million at December 31, 2019.

 

A reconciliation of the allowance for loan losses for the three and nine month periods ended September 30, 2020 and 2019 is summarized as follows:

 

 

(Dollars in thousands)

 

2020

  

2019

 

Balance at June 30,

 $8,649   8,624 

Provision

  770   (420)

Charge offs:

        

Single family

  0   (2)

Consumer

  (29)  (46)

Commercial business

  (8)  0 

Recoveries

  150   39 

Balance at September 30,

 $9,532   8,195 
         

Allocated to:

        

General allowance

 $9,416   7,528 

Specific allowance

  116   667 
  $9,532   8,195 
         

 

 

 

(Dollars in thousands)

 

2020

  

2019

 

Balance at January 1,

 $8,564   8,686 

Provision

  1,548   (1,452)

Charge offs:

        

Single family

  0   (2)

Commercial real estate

  (730)  0 

Consumer

  (74)  (92)

Commercial business

  (8)  (869)

Recoveries

  232   1,924 

Balance at September 30,

 $9,532   8,195 
         

 

The $0.7 million of commercial real estate charge offs during the nine month period ended September 30, 2020 relates to a commercial property in the transportation industry whose tenant filed for bankruptcy and the appraised value of the property decreased. The $0.9 million in commercial business loan charge offs in the three and nine month periods ended September 30, 2019 relates primarily to two commercial business loans that were charged off due to the bankruptcy filing of the borrowers. The $1.9 million of recoveries in the nine month period ended September 30, 2019 relates primarily to the repayment of a commercial real estate loan of which $1.7 million had previously been charged off.   

 

Non-Interest Income

Non-interest income was $4.4 million for the third quarter of 2020, an increase of $2.2 million, or 97.4%, from $2.2 million for the third quarter of 2019. Gain on sales of loans increased $2.2 million between the periods primarily because of an increase in single family loan originations and sales. Other non-interest income increased $0.1 million due primarily to an increase in the fees earned on the sale of uninsured investment products between the periods. Loan servicing fees increased slightly between the periods due to an increase in the aggregate balances of single family mortgage loans that were being serviced for others. These increases in the non-interest income were partially offset by a decrease of $0.1 million in fees and service charges earned between the periods due primarily to a decrease in the overdraft fees collected.

 

Non-interest income was $10.5 million for the first nine months of 2020, an increase of $4.6 million, or 76.1%, from $5.9 million for the same period of 2019. Gain on sales of loans increased $4.7 million between the periods primarily because of an increase in single family loan originations and sales. Loan servicing fees increased slightly between the periods due to an increase in the aggregate balances of single family mortgage loans that were being serviced for others. Other non-interest income increased slightly due primarily to an increase in the fees earned on the sale of uninsured investment products between the periods. These increases in the non-interest income were partially offset by a decrease of $0.2 million in the fees and services charges earned between the periods due primarily to a decrease in the overdraft fees collected.

 

Non-Interest Expense

Non-interest expense was $6.6 million for the third quarter of 2020, a decrease of $0.1 million, or 2.2%, from $6.7 million for the third quarter of 2019. Professional services expense decreased $0.2 million between the periods primarily because of a decrease in legal expenses relating to an ongoing bankruptcy litigation claim. Occupancy and equipment expense decreased slightly between the periods due to a decrease in depreciation and non-capitalized equipment costs. Other non-interest expense decreased slightly due primarily to an increase in the gains recognized on the sale of other real estate owned between the periods. These decreases in non-interest expense were partially offset by a $0.1 million increase in compensation and benefits expense related to the increased mortgage loan production between the periods. Data processing costs increased slightly between the periods due to an increase in internet and mobile banking expenses.

 

Non-interest expense was $20.3 million for the first nine months of 2020, an increase of $0.5 million, or 2.5%, from $19.8 million for the same period of 2019. Compensation and benefits expense increased $0.3 million primarily related to the increased mortgage loan production between the periods. Professional services expense increased $0.1 million between the periods primarily because of an increase in legal expenses relating to an ongoing bankruptcy litigation claim. Occupancy and equipment costs increased $0.1 million between the periods due to an increase in depreciation and non-capitalized equipment costs. Data processing costs increased slightly between the periods due to an increase in internet and mobile banking expenses. 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.

 

 

Income Taxes

Income tax expense was $1.2 million for the third quarter of 2020, an increase of $0.3 million from $0.9 million for the third quarter of 2019. Income tax expense was $2.9 million for the first nine months of 2020, an increase of $0.2 million from $2.7 million for the first nine months of 2019. The increase in income tax expense between the periods is primarily the result of an increase 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, 2019.

 

  

September 30,

  

June 30,

  

December 31,

 

(Dollars in thousands)

 

2020

  

2020

  

2019

 

Non-Performing Loans:

            

Single family

 $352  $390  $617 

Commercial real estate

  1,537   1,579   184 

Consumer

  641   475   659 

Commercial business

  11   27   621 

Total

  2,541   2,471   2,081 
             

Foreclosed and Repossessed Assets:

            

Single family

  0   269   166 

Commercial real estate

  414   414   414 

Total non-performing assets

 $2,955  $3,154  $2,661 

Total as a percentage of total assets

  0.33

%

  0.37

%

  0.34

%

Total non-performing loans

 $2,541  $2,471  $2,081 

Total as a percentage of total loans receivable, net

  0.38

%

  0.37

%

  0.35

%

Allowance for loan losses to non-performing loans

  375.19

%

  349.92

%

  411.45

%

             

Delinquency Data:

            

Delinquencies (1)

            

30+ days

 $995  $775  $1,167 

90+ days

  0   0   0 

Delinquencies as a percentage of loan portfolio (1)

            

30+ days

  0.14

%

  0.11

%

  0.19

%

90+ days

  0.00

%

  0.00

%

  0.00

%

             

(1) Excludes non-accrual loans.

 

Total non-performing assets were $3.0 million at September 30, 2020, a decrease of $0.2 million, or 6.3%, from $3.2 million at June 30, 2020 and an increase of $0.3 million, or 11.0%, from $2.7 million at December 31, 2019. Non-performing loans increased $0.1 million and foreclosed and repossessed assets decreased $0.3 million during the third quarter of 2020. Non-performing loans increased $0.5 million and foreclosed and repossessed assets decreased $0.2 million during the first nine months of 2020.

 

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, 2020.

 

LIQUIDITY AND CAPITAL RESOURCES

For the nine months ended September 30, 2020, the net cash provided by operating activities was $8.2 million. The Company received $30.9 million from maturing or called securities, $11.1 million from principal repayments on securities and $0.4 million in proceeds from the sale of real estate. The Company purchased $51.2 million in securities available for sale, $0.1 million in FHLB stock, and paid $0.7 million for the purchase of premises and equipment. Net loans receivable increased $79.2 million, customer escrows decreased $0.6 million, and the Company had a net increase in deposit balances of $113.2 million. The Company also purchased $0.4 million of its common stock and received $0.1 million in common stock from for tax withholding on stock awards.

 

 

The Company has certificates of deposits with outstanding balances of $79.0 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 six deposit customers that individually had aggregate deposits greater than $5.0 million as of September 30, 2020. The $84.5 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 $169.5 million from the FHLB at September 30, 2020, 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, 2020, the Company had $12.1 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, 2020.

 

  

Market Value

 

(Dollars in thousands)

Basis point change in interest rates

  -100   0  

+100

  

+200

 

Total market risk sensitive assets

 $892,277   889,391   873,335   856,952 

Total market risk sensitive liabilities

  855,635   800,113   749,848   706,718 

Off-balance sheet financial instruments

  1,230   0   1,699   3,278 

Net market risk

 $35,412   89,278   121,788   146,956 
Percentage change from current market value  (60.34)%  0.00%  36.41%  64.60%
                 

 

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 3% to 55%, 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 54%, 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 8%, 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 9% and 12%, 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, 2021 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

  $2,742   9.86

%

+100

   1,313   4.72 
0   0   0.00 
-100   (1,172)  (4.22)

 

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.

The updated risks described below and those identified in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC, under “Part 1, Item 1A. Risk Factors” could affect the Company’s financial performance and could cause its actual results for future periods to differ materially from its anticipated results or other expectations, including those expressed in any forward-looking statements made in this Quarterly Report on Form 10-Q.

 

The global COVID-19 outbreak is harming the Company’s business and results of operations.

In December 2019, a COVID-19 outbreak was reported in China, and, in March 2020, the World Health Organization declared it a pandemic. Since that time, the COVID-19 has spread throughout the United States, including in the regions and communities in which the Company operates. In response, many state and local governments, including the states of Minnesota and Wisconsin, had instituted emergency restrictions that substantially limited the operation of non-essential businesses and the activities of individuals, although many states have begun phased re-opening and lifting such emergency restrictions. However, several states that began re-openings have re-implemented restrictions in response to a surge in COVID-19 cases. The extent, duration, and magnitude of the COVID-19 pandemic is highly uncertain and will continue to depend on future developments. These restrictions could result in significant adverse effects on the Bank’s borrowers and many different types of small and mid-sized businesses within the Company’s client base, particularly those in the retail, hospitality and food and beverage industries, among many others, and has resulted in a significant number of layoffs and furloughs of employees nationwide and in the regions and communities in which the Company operates. The ultimate effect of COVID-19 on the local or broader economy is not known nor is the ultimate length of the restrictions described and any accompanying effects. Moreover, the Federal Reserve has taken action to lower the Federal Funds rate, which may negatively affect interest income and, therefore, earnings, financial condition and results of operation of the Company.

 

The effect of COVID-19 and related events, including those described above and those not yet known or knowable, has had a negative effect on the stock price, business prospects, financial condition and results of operations of the Company, including as a result of quarantines, market volatility, market downturns, changes in consumer behavior, business closures, deterioration in the credit quality of borrowers or the potential inability of borrowers to satisfy their obligations to the Company (and any related forbearances or restructurings that may be implemented), declines in the value of collateral securing outstanding loans, branch or office closures and business interruptions. The bank regulatory agencies and various governmental authorities are urging financial institutions to work prudently with borrowers who are or may be unable to meet their contractual payment obligations because of the effects of COVID-19. Further, demand for loans and other products and services that the Company offers and whose success it relies on to drive growth, is highly dependent upon the business environment in the primary markets in which the Company operates and in the United States as a whole.

 

There have been no other material changes to the Company’s risk factors contained in its Annual Report on Form 10-K for the year ended December 31, 2019. For a further discussion of the Company’s Risk Factors, see Part I, Item 1A. of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

The following table provides information with respect to purchases made by the Company of its own stock during the third quarter of 2020:

 

Period

 

Total Number
of Shares
Purchased

  

Average Price
Paid per Share

 

Total Number of Shares
Purchased as Part of
Publicly Announced Plans
or Programs (a)

  

Maximum Number (or
Approximate Dollar Value) of
Shares that May Yet Be
Purchased under the Plans or
Programs (a)

 

July 1, 2020 to July 31, 2020

  0  $N/A    0  $5,640,000 

August 1, 2020 to August 31, 2020

  0   N/A    0  $5,640,000 

September 1, 2020 to September 30, 2020

  0   N/A    0  $5,640,000 

Total

  0  $N/A    0  $5,640,000 

 

(a) On November 28, 2018, the Board of Directors announced a share repurchase program pursuant to which the Company may purchase shares of its common stock for an aggregate purchase price not to exceed $6.0 million. The share repurchase program does not obligate the Company to purchase any shares and has no set expiration date. The Company suspended its stock repurchase program through September 30, 2020 and did not repurchase any of its common stock in the open market during the second or third quarters of 2020. The suspension of the stock repurchase program was done in order to preserve capital while the Company evaluated its capital needs as a result of the stressed economic environment related to the COVID-19 pandemic. Although, the evaluation of capital needs is an ongoing process, the stock repurchase program is no longer suspended.    

 

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, 2020, filed with the SEC on October 30, 2020, formatted in Extensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at September 30, 2020 and December 31, 2019, (ii) the Consolidated Statements of Comprehensive Income for the Three Month and Nine Month Periods Ended September 30, 2020 and 2019, (iii) the Consolidated Statements of Stockholders’ Equity for the Three and Nine Month Periods Ended September 30, 2020 and 2019, (iv) the Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2020 and 2019, 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: October 30, 2020

By:

/s/ Bradley Krehbiel

 

 

 

Bradley Krehbiel, President and Chief Executive Officer

 

 

 

 (Principal Executive Officer)

 

    
    
Date: October 30, 2020By:/s/ Jon Eberle 
  Jon Eberle 
  Senior Vice President, Chief Financial Officer, and Treasurer 
  (Principal Financial Officer) 

 

42