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HMNF HMN Financial

Filed: 3 Aug 21, 11:07am
 
 

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 June 30, 2021

 

OR

 

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

 

For the transition period from _________ to _________

 

Commission File Number 0-24100

 

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

41-1777397

(State or Other Jurisdiction of Incorporation or Organization)

 

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

   

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

 

55901

(Address of Principal Executive Offices)

 

(Zip Code)

   

Registrant's Telephone Number, Including Area Code:

 

(507) 535-1200

 

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

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

Common Stock

HMNF

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

 

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

 

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

 

Class

 

Outstanding at July 28, 2021

Common stock, $0.01 par value

 

4,644,575

 

 

 

HMN FINANCIAL, INC.

TABLE OF CONTENTS

 

PART I  FINANCIAL INFORMATION 
  

Page

Item 1:

Financial Statements

3

   
 

Consolidated Balance Sheets at June 30, 2021 and December 31, 2020

3

   
 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2021 and 2020

4

   
 

Consolidated Statements of Stockholders' Equity for the Three and Six Months Ended June 30, 2021 and 2020

5

   
 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2021 and 2020

6

   
 

Notes to Consolidated Financial Statements

7

   

Item 2:

Management's Discussion and Analysis of Financial Condition and Results of Operations

24

   

Item 3:

Quantitative and Qualitative Disclosures About Market Risk

36

   

Item 4:

Controls and Procedures

36

   

PART II  OTHER INFORMATION

   

Item 1:

Legal Proceedings

37

   

Item 1A:

Risk Factors

37

   

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

37

   

Item 3:

Defaults Upon Senior Securities

37

   

Item 4:

Mine Safety Disclosures

37

   

Item 5:

Other Information

37

   

Item 6:

Exhibits

38

   

Signatures

39

 

 

 

PART I FINANCIAL INFORMATION

Item 1: Financial Statements

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

  

June 30,

  

December 31,

 

(Dollars in thousands)

 

2021

  

2020

 
  

(unaudited)

     

Assets

        

Cash and cash equivalents

 $100,406   86,269 

Securities available for sale:

        

Mortgage-backed and related securities (amortized cost $165,202 and $99,821)

  165,886   101,464 

Other marketable securities (amortized cost $45,690 and $46,491)

  45,648   46,626 
   211,534   148,090 
         

Loans held for sale

  7,380   6,186 

Loans receivable, net

  637,219   642,630 

Accrued interest receivable

  2,135   3,102 

Mortgage servicing rights, net

  3,160   3,043 

Premises and equipment, net

  9,871   10,133 

Goodwill

  802   802 

Core deposit intangible

  23   57 

Prepaid expenses and other assets

  6,154   7,241 

Deferred tax asset, net

  2,342   2,027 

Total assets

 $981,026   909,580 
         
         

Liabilities and Stockholders Equity

        

Deposits

 $862,282   795,204 

Accrued interest payable

  106   140 

Customer escrows

  2,382   1,998 

Accrued expenses and other liabilities

  8,298   8,986 

Total liabilities

  873,068   806,328 

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

  40,484   40,480 

Retained earnings, subject to certain restrictions

  125,795   117,849 

Accumulated other comprehensive income

  462   1,282 

Unearned employee stock ownership plan shares

  (1,353)  (1,450)

Treasury stock, at cost 4,484,087 and 4,359,552 shares

  (57,521)  (55,000)

Total stockholders’ equity

  107,958   103,252 

Total liabilities and stockholders’ equity

 $981,026   909,580 

 


 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(unaudited)

 

  

Three Months Ended

  

Six Months Ended

 
  

June 30,

  

June 30,

 

(Dollars in thousands, except per share data)

 

2021

  

2020

  

2021

  

2020

 

Interest income:

                

Loans receivable

 $7,557   7,427   14,917   14,667 

Securities available for sale:

                

Mortgage-backed and related

  440   265   831   554 

Other marketable

  62   171   169   383 

Other

  35   20   66   123 

Total interest income

  8,094   7,883   15,983   15,727 
                 

Interest expense:

                

Deposits

  410   745   863   1,637 

Total interest expense

  410   745   863   1,637 

Net interest income

  7,684   7,138   15,120   14,090 

Provision for loan losses

  (891)  318   (1,467)  778 

Net interest income after provision for loan losses

  8,575   6,820   16,587   13,312 
                 

Non-interest income:

                

Fees and service charges

  783   669   1,522   1,383 

Loan servicing fees

  384   297   779   629 

Gain on sales of loans

  1,665   2,364   3,438   3,498 

Other

  1,910   264   2,258   555 

Total non-interest income

  4,742   3,594   7,997   6,065 
                 

Non-interest expense:

                

Compensation and benefits

  4,096   3,799   7,917   7,846 

Occupancy and equipment

  1,104   1,111   2,211   2,234 

Data processing

  368   321   715   629 

Professional services

  283   447   486   934 

Other

  1,129   975   2,130   2,011 

Total non-interest expense

  6,980   6,653   13,459   13,654 

Income before income tax expense

  6,337   3,761   11,125   5,723 

Income tax expense

  1,809   1,070   3,179   1,647 

Net income

  4,528   2,691   7,946   4,076 

Other comprehensive income (loss), net of tax

  421   224   (820)  1,499 

Comprehensive income available to common stockholders

 $4,949   2,915   7,126   5,575 

Basic earnings per share

 $1.01   0.58   1.76   0.88 

Diluted earnings per share

 $1.00   0.58   1.74   0.88 
                 

 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity
For the Three and Six Months Ended June 30, 2021 and 2020

(unaudited)

 

                  

Unearned

         
              

Accumulated

  

Employee

         
      

Additional

      

Other

  

Stock

      

Total

 
  

Common

  

Paid-In

  

Retained

  

Comprehensive

  

Ownership

  

Treasury

  

Stockholders’

 

(Dollars in thousands)

 

Stock

  

Capital

  

Earnings

  

Income

  

Plan Shares

  

Stock

  

Equity

 

Balance, March 31, 2021

 $91   40,405   121,267   41   (1,401)  (55,339)  105,064 

Net income

          4,528               4,528 

Other comprehensive income

              421           421 

Stock repurchases

      0               (2,213)  (2,213)

Restricted stock awards

      (38)              38   0 

Stock awards withheld for tax withholding

                      (7)  (7)

Amortization of restricted stock awards

      61                   61 

Earned employee stock ownership plan shares

      56           48       104 

Balance, June 30, 2021

 $91   40,484   125,795   462   (1,353)  (57,521)  107,958 
                             

Balance, December 31, 2020

 $91   40,480   117,849   1,282   (1,450)  (55,000)  103,252 

Net income

          7,946               7,946 

Other comprehensive loss

              (820)          (820)

Stock repurchases

                      (2,736)  (2,736)

Restricted stock awards

      (222)              222   0 

Stock awards withheld for tax withholding

                      (7)  (7)

Amortization of restricted stock awards

      121                   121 

Earned employee stock ownership plan shares

      105           97       202 

Balance, June 30, 2021

 $91   40,484   125,795   462   (1,353)  (57,521)  107,958 
                             

 

 

                  

Unearned

         
              

Accumulated

  

Employee

         
      

Additional

      

Other

  

Stock

      

Total

 
  

Common

  

Paid-In

  

Retained

  

Comprehensive

  

Ownership

  

Treasury

  

Stockholders’

 

(Dollars in thousands)

 

Stock

  

Capital

  

Earnings

  

Income

  

Plan Shares

  

Stock

  

Equity

 

Balance, March 31, 2020

 $91   40,347   108,932   1,321   (1,595)  (54,061)  95,035 

Net income

          2,691               2,691 

Other comprehensive income

              224           224 

Restricted stock awards

      (151)              151   0 

Amortization of restricted stock awards

      84                   84 

Earned employee stock ownership plan shares

      32           49       81 

Balance, June 30, 2020

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

Balance, December 31, 2019

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

Net income

          4,076               4,076 

Other comprehensive income

              1,499           1,499 

Stock repurchases

                      (360)  (360)

Restricted stock awards

      (268)              268   0 

Stock awards withheld for tax withholding

                      (60)  (60)

Amortization of restricted stock awards

      130                   130 

Earned employee stock ownership plan shares

      85           97       182 

Balance, June 30, 2020

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

 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

 

  

Six Months Ended June 30,

 

(Dollars in thousands)

 

2021

  

2020

 

Cash flows from operating activities:

        

Net income

 $7,946   4,076 

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

        

Provision for loan losses

  (1,467)  778 

Depreciation

  507   570 

Amortization of premiums, net

  425   58 

Amortization of deferred loan fees

  (1,327)  (170)

Amortization of core deposit intangible

  34   49 

Amortization of other purchased fair value adjustments

  (15)  (19)

Amortization of mortgage servicing rights

  574   621 

Capitalized mortgage servicing rights

  (691)  (1,096)

(Gains) losses recognized on equity securities, net

  (49)  39 

Gains on sale of premises

  (15)  0 

(Gain) loss on sales of real estate

  (1,492)  2 

Gain on sales of loans

  (3,438)  (3,498)

Proceeds from sale of loans held for sale

  95,028   120,978 

Disbursements on loans held for sale

  (87,885)  (117,307)

Amortization of restricted stock awards

  121   130 

Amortization of unearned Employee Stock Ownership Plan shares

  97   97 

Earned Employee Stock Ownership Plan shares priced above original cost

  105   85 

Decrease (increase) in accrued interest receivable

  967   (1,129)

Decrease in accrued interest payable

  (34)  (149)

Decrease in other assets

  584   1,230 

(Decrease) increase in other liabilities

  (711)  1,467 

Other, net

  5   4 

Net cash provided by operating activities

  9,269   6,816 

Cash flows from investing activities:

        

Principal collected on securities available for sale

  16,534   6,047 

Proceeds collected on maturities of securities available for sale

  25,762   30,875 

Purchases of securities available for sale

  (107,299)  (25,102)

Purchase of Federal Home Loan Bank Stock

  (159)  (79)

Proceeds from sales of real estate

  2,128   34 

Net decrease (increase) in loans receivable

  3,413   (74,754)

Proceeds from sale of premises

  16   0 

Purchases of premises and equipment

  (246)  (303)

Net cash used by investing activities

  (59,851)  (63,282)

Cash flows from financing activities:

        

Increase in deposits

  67,078   78,889 

Purchase of treasury stock

  (2,736)  (360)

Stock awards withheld for tax withholding

  (7)  (60)

Increase (decrease) in customer escrows

  384   (592)

Net cash provided by financing activities

  64,719   77,877 

Increase in cash and cash equivalents

  14,137   21,411 

Cash and cash equivalents, beginning of period

  86,269   44,399 

Cash and cash equivalents, end of period

 $100,406   65,810 

Supplemental cash flow disclosures:

        

Cash paid for interest

 $897   1,786 

Cash paid for income taxes

  3,301   1,240 

Supplemental noncash flow disclosures:

        

Loans transferred to loans held for sale

  4,806   1,987 

Transfer of loans to real estate

  0   139 
         

 

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 2 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 six month period ended June 30, 2021 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 June 30, 2021 and December 31, 2020.

 

  

Carrying Value at June 30, 2021

 

(Dollars in thousands)

 

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $211,534   0   211,534   0 

Equity securities

  198   0   198   0 

Mortgage loan commitments

  186   0   186   0 

Total

 $211,918   0   211,918   0 
                 

 

  

Carrying Value at December 31, 2020

 

(Dollars in thousands)

 

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $148,090   0   148,090   0 

Equity securities

  149   0   149   0 

Mortgage loan commitments

  261   0   261   0 

Total

 $148,500   0   148,500   0 
                 

 

There were no transfers between Levels 1, 2 or 3 during the three or six month periods ended June 30, 2021.

 

 

The Company may also be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of the lower-of-cost-or-market accounting or write-downs of individual assets. The following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at June 30, 2021 and December 31, 2020.

 

  

Carrying Value at June 30, 2021

         

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Three Months Ended

June 30, 2021

Total Gains (Losses)

  

Six Months Ended

June 30, 2021

Total Gains (Losses)

 

Loans held for sale

 $7,380   0   7,380   0   137   24 

Mortgage servicing rights, net

  3,160   0   3,160   0   0   0 

Impaired loans

  1,583   0   1,583   0   (59)  (64)

Total

 $12,123   0   12,123   0   78   (40)
                         

 

  

Carrying Value at December 31, 2020

     

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Year Ended

December 31, 2020

Total Gains (Losses)

 

Loans held for sale

 $6,186   0   6,186   0   28 

Mortgage servicing rights, net

  3,043   0   3,043   0   0 

Impaired loans

  2,888   0   2,888   0   (76)

Real estate, net

  636   0   636   0   0 

Total

 $12,753   0   12,753   0   (48)
                     

 

 

 

(5) Fair Value of Financial Instruments

ASC 825, Disclosures about Fair Values of Financial Instruments requires interim reporting period disclosure of the estimated fair values of the Company’s 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 June 30, 2021 and December 31, 2020 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 June 30, 2021 and December 31, 2020 are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.

 

  June 30, 2021  December 31, 2020 
          

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

 $100,406   100,406   100,406               86,269   86,269   86,269             

Securities available for sale

  211,534   211,534       211,534           148,090   148,090       148,090         

Equity securities

  198   198       198           149   149       149         

Loans held for sale

  7,380   7,380       7,380           6,186   6,186       6,186         

Loans receivable, net

  637,219   640,968       640,968           642,630   648,275       648,275         

Federal Home Loan Bank stock

  1,092   1,092       1,092           932   932       932         

Accrued interest receivable

  2,135   2,135       2,135           3,102   3,102       3,102         

Financial liabilities:

                                                

Deposits

  862,282   862,597       862,597           795,204   795,927       795,927         

Accrued interest payable

  106   106       106           140   140       140         

Off-balance sheet financial instruments:

                                                

Commitments to extend credit

  186   186               209,513   261   261               180,330 

Commitments to sell loans

  (68)  (68)              25,652   (44)  (44)              24,746 

 

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.

 

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 (FHLB) Stock

The carrying amount of 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 were adjusted to 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 non-owner 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 June 30,

 

(Dollars in thousands)

 

2021

  

2020

 

Securities available for sale:

 

Before

Tax

  

Tax

Effect

  

Net of

Tax

  

Before

Tax

  

Tax

Effect

  

Net of

Tax

 

Gross unrealized gains arising during the period

 $586   165   421   311   87   224 

Other comprehensive income

 $586   165   421   311   87   224 

 

  

For the Six Months Ended June 30,

 

(Dollars in thousands)

 

2021

  

2020

 

Securities available for sale:

 

Before

Tax

  

Tax

Effect

  

Net of

Tax

  

Before

Tax

  

Tax

Effect

  

Net of

Tax

 

Gross unrealized (losses) gains arising during the period

 $(1,135)  (315)  (820)  2,081   582   1,499 

Other comprehensive (loss) income

 $(1,135)  (315)  (820)  2,081   582   1,499 
                         

 

 

(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 June 30, 2021 and December 31, 2020.

 

  

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

 

June 30, 2021

                                

Mortgage backed securities:

                                

Federal National Mortgage Association (FNMA)

  11  $50,861   (271)  0  $0   0  $50,861   (271)

Federal Home Loan Mortgage Corporation (FHLMC)

  10   46,790   (173)  0   0   0   46,790   (173)
Other marketable securities:                                

U.S. Government agency obligations

  7   34,906   (90)  0   0   0   34,906   (90)

Corporate preferred stock

  0   0   0   1   644   (56)  644   (56)

Total temporarily impaired securities

  28  $132,557   (534)  1  $644   (56) $133,201   (590)

 

  

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, 2020

                                

Mortgage backed securities:

                                

FNMA

  1  $4,956   (3)  0  $0   0  $4,956   (3)

Other marketable securities:

                                

Corporate preferred stock

  0   0   0   1   630   (70)  630   (70)

Total temporarily impaired securities

  1  $4,956   (3)  1  $630   (70) $5,586   (73)
                                 

 

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 June 30, 2021 relates to a single trust preferred security that was issued by the holding company of a small community bank. As of June 30, 2021 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 June 30, 2021 as the Company does not intend to sell 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 June 30, 2021 and December 31, 2020 is as follows:

 

(Dollars in thousands)

 

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair

Value

 

June 30, 2021

                

Mortgage-backed securities:

                

FNMA

 $98,253   917   (271)  98,899 

FHLMC

  66,889   207   (173)  66,923 

Collateralized mortgage obligations:

                

FNMA

  60   4   0   64 
   165,202   1,128   (444)  165,886 

Other marketable securities:

                

U.S. Government agency obligations

  44,990   104   (90)  45,004 

Corporate preferred stock

  700   0   (56)  644 
   45,690   104   (146)  45,648 
  $210,892   1,232   (590)  211,534 

 

 

(Dollars in thousands)

 

Amortized

Cost

  

Gross

Unrealized

Gains

  

Gross

Unrealized

Losses

  

Fair

Value

 

December 31, 2020

                

Mortgage-backed securities:

                

FNMA

 $68,699   1,313   (3)  70,009 

FHLMC

  31,025   327   0   31,352 

Collateralized mortgage obligations:

                

FNMA

  97   6   0   103 
   99,821   1,646   (3)  101,464 

Other marketable securities:

                

U.S. Government agency obligations

  45,029   204   0   45,233 

Municipal obligations

  725   1   0   726 

Corporate obligations

  37   0   0   37 

Corporate preferred stock

  700   0   (70)  630 
   46,491   205   (70)  46,626 
  $146,312   1,851   (73)  148,090 
                 


The following table indicates amortized cost and estimated fair value of securities available for sale at June 30, 2021 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

 $69,884   70,096 

Due after one year through five years

  117,826   118,219 

Due after five years through ten years

  22,403   22,495 

Due after ten years

  779   724 

Total

 $210,892   211,534 
         

 

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 expected 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 June 30, 2021 and December 31, 2020 is as follows:

 

(Dollars in thousands)

 

June 30,

2021

  

December 31,

2020

 

Single family

 $150,270   135,023 

Commercial real estate:

        

Real estate rental and leasing

  200,662   202,400 

Other

  176,949   178,304 
   377,611   380,704 

Consumer

  46,266   55,391 

Commercial business

  74,118   82,673 

Total loans

  648,265   653,791 

Less:

        

Unamortized discounts

  11   12 

Net deferred loan fees

  1,120   450 

Allowance for loan losses

  9,915   10,699 

Total loans receivable, net

 $637,219   642,630 
         

 

 

(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 June 30, 2021:

                 

Balance, March 31, 2021

 $839   7,073   1,189   1,031   10,132 

Provision for losses

  90   (690)  (166)  (125)  (891)

Charge-offs

  0   0   (11)  0   (11)

Recoveries

  0   650   27   8   685 

Balance, June 30, 2021

 $929   7,033   1,039   914   9,915 
                     

For the six months ended June 30, 2021:

                 

Balance, December 31, 2020

 $1,030   7,295   1,389   985   10,699 

Provision for losses

  (101)  (912)  (336)  (118)  (1,467)

Charge-offs

  0   0   (42)  0   (42)

Recoveries

  0   650   28   47   725 

Balance, June 30, 2021

 $929   7,033   1,039   914   9,915 
                     

Allocated to:

                    

Specific allowance

 $29   95   100   14   238 

General allowance

  1,001   7,200   1,289   971   10,461 

Balance, December 31, 2020

 $1,030   7,295   1,389   985   10,699 
                     

Allocated to:

                    

Specific allowance

 $68   135   51   9   263 

General allowance

  861   6,898   988   905   9,652 

Balance, June 30, 2021

 $929   7,033   1,039   914   9,915 
                     

Loans receivable at December 31, 2020:

                 

Individually reviewed for impairment

 $857   1,484   750   35   3,126 

Collectively reviewed for impairment

  134,166   379,220   54,641   82,638   650,665 

Ending balance

 $135,023   380,704   55,391   82,673   653,791 
                     

Loans receivable at June 30, 2021:

                    

Individually reviewed for impairment

 $578   519   723   26   1,846 

Collectively reviewed for impairment

  149,692   377,092   45,543   74,092   646,419 

Ending balance

 $150,270   377,611   46,266   74,118   648,265 
                     

 

 

(Dollars in thousands)

 

Single
Family

  

Commercial
Real Estate

  

Consumer

  

Commercial

Business

  

Total

 

For the three months ended June 30, 2020:

                 

Balance, March 31, 2020

 $937   5,539   1,583   977   9,036 

Provision for losses

  1   556   (101)  (138)  318 

Charge-offs

  0   (730)  (34)  0   (764)

Recoveries

  0   17   16   26   59 

Balance, June 30, 2020

 $938   5,382   1,464   865   8,649 
                     

For the six months ended June 30, 2020:

                 

Balance, December 31, 2019

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

Provision for losses

  81   1,035   (15)  (323)  778 

Charge-offs

  0   (730)  (45)  0   (775)

Recoveries

  0   17   17   48   82 

Balance, June 30, 2020

 $938   5,382   1,464   865   8,649 
                     

 

The following table summarizes the amounts of classified and unclassified loans at June 30, 2021 and December 31, 2020.

 

  

June 30, 2021

 
  

Classified

      

Unclassified

     

(Dollars in thousands)

 

Special

Mention

  

Substandard

  

Doubtful

  

Loss

  

Total

  

Total

  

Total

Loans

 

Single family

 $990   1,570   27   42   2,629   147,641   150,270 

Commercial real estate:

                            

Real estate rental and leasing

  8,669   1,569   0   0   10,238   190,424   200,662 

Other

  7,388   8,099   0   0   15,487   161,462   176,949 

Consumer

  0   653   57   13   723   45,543   46,266 

Commercial business

  2,890   1,522   0   0   4,412   69,706   74,118 
  $19,937   13,413   84   55   33,489   614,776   648,265 

 

  

December 31, 2020

 
  

Classified

      

Unclassified

     

(Dollars in thousands)

 

Special

Mention

  

Substandard

  

Doubtful

  

Loss

  

Total

  

Total

  

Total

Loans

 

Single family

 $1,219   2,845   29   0   4,093   130,930   135,023 

Commercial real estate:

                            

Real estate rental and leasing

  8,065   3,483   0   0   11,548   190,852   202,400 

Other

  8,774   9,750   0   0   18,524   159,780   178,304 

Consumer

  0   600   132   18   750   54,641   55,391 

Commercial business

  1,968   2,482   0   0   4,450   78,223   82,673 
  $20,026   19,160   161   18   39,365   614,426   653,791 
                             

 

 

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 June 30, 2021 and December 31, 2020 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

 

June 30, 2021

                            

Single family

 $500   150   430   1,080   149,190   150,270   0 

Commercial real estate:

                            

Real estate rental and leasing

  333   0   0   333   200,329   200,662   0 

Other

  0   0   0   0   176,949   176,949   0 

Consumer

  329   64   291   684   45,582   46,266   0 

Commercial business

  25   0   0   25   74,093   74,118     
  $1,187   214   721   2,122   646,143   648,265   0 

December 31, 2020

                            

Single family

 $626   38   298   962   134,061   135,023   0 

Commercial real estate:

                            

Real estate rental and leasing

  0   0   0   0   202,400   202,400   0 

Other

  0   0   0   0   178,304   178,304   0 

Consumer

  458   66   279   803   54,588   55,391   0 

Commercial business

  0   0   0   0   82,673   82,673   0 
  $1,084   104   577   1,765   652,026   653,791   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 June 30, 2021 and December 31, 2020.

 

  

June 30, 2021

  

December 31, 2020

 

(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

 $423   442   0   740   759   0 

Commercial real estate:

                        

Real estate rental and leasing

  156   156   0   932   1,582   0 

Other

  194   194   0   211   211   0 

Consumer

  628   628   0   574   574   0 

Loans with an allowance recorded:

                        

Single family

  155   155   68   117   117   29 

Commercial real estate:

                        

Real estate rental and leasing

  0   0   0   166   166   5 

Other

  169   169   135   175   175   90 

Consumer

  95   95   51   176   176   100 

Commercial business

  26   578   9   35   586   14 

Total:

                        

Single family

  578   597   68   857   876   29 

Commercial real estate:

                        

Real estate rental and leasing

  156   156   0   1,098   1,748   5 

Other

  363   363   135   386   386   90 

Consumer

  723   723   51   750   750   100 

Commercial business

  26   578   9   35   586   14 
  $1,846   2,417   263   3,126   4,346   238 
                         

 

 

The following table summarizes the average recorded investment and interest income recognized on impaired loans for the three and six months ended June 30, 2021 and 2020.

 

  

For the Three Months Ended June 30, 2021

  

For the Six Months Ended June 30, 2021

 

(Dollars in thousands)

 

Average Recorded

Investment

  

Interest Income

Recognized

  

Average Recorded

Investment

  

Interest Income

Recognized

 

Loans with no related allowance recorded:

                

Single family

 $580   1   633   2 

Commercial real estate:

                

Real estate rental and leasing

  614   0   720   0 

Other

  196   0   201   0 

Consumer

  570   2   571   2 

Loans with an allowance recorded:

                

Single family

  135   0   129   0 

Commercial real estate:

                

Real estate rental and leasing

  0   0   55   0 

Other

  154   0   161   0 

Consumer

  122   0   140   1 

Commercial business

  32   0   33   1 

Total:

                

Single family

  715   1   762   2 

Commercial real estate:

                

Real estate rental and leasing

  614   0   775   0 

Other

  350   0   362   0 

Consumer

  692   2   711   3 

Commercial business

  32   0   33   1 
  $2,403   3   2,643   6 
                 

 

  

For the Three Months Ended June 30, 2020

  

For the Six Months Ended June 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

 $604   7   584   18 

Commercial real estate:

                

Real estate rental and leasing

  501   13   334   33 

Other

  480   0   320   2 

Consumer

  591   3   654   6 

Commercial business

  4   0   3   0 

Loans with an allowance recorded:

                

Single family

  271   0   324   0 

Commercial real estate:

                

Real estate rental and leasing

  177   0   179   0 

Other

  484   0   650   0 

Consumer

  185   1   188   3 

Commercial business

  93   1   307   1 

Total:

                

Single family

  875   7   908   18 

Commercial real estate:

                

Real estate rental and leasing

  678   13   513   33 

Other

  964   0   970   2 

Consumer

  776   4   842   9 

Commercial business

  97   1   310   1 
  $3,390   25   3,543   63 
                 

 

At June 30, 2021 and December 31, 2020, non-accruing loans totaled $1.8 million and $2.7 million, respectively, for which the related allowance for loan losses was $0.3 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 $1.4 million and $2.1 million at June 30, 2021 and December 31, 2020, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

 

 

The non-accrual loans at June 30, 2021 and December 31, 2020 are summarized as follows:

 

(Dollars in thousands)

 

June 30,

2021

  

December 31,

2020

 

Single family

 $557   502 

Commercial real estate:

        

Real estate rental and leasing

  156   1,098 

Other

  363   386 

Consumer

  669   689 

Commercial business

  8   9 
  $1,753   2,684 
         

 

At June 30, 2021 and December 31, 2020 there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $1.3 million and $1.5 million, respectively. Of the loans that were restructured as TDRs in the second quarter of 2021, none were classified but performing, and $0.1 million were non-performing at June 30, 2021. There were 0 loans that were restructured as TDRs in the second quarter of 2020.

 

The following table summarizes TDRs at June 30, 2021 and December 31, 2020.

 

  

June 30, 2021

  

December 31, 2020

 

(Dollars in thousands)

 

Accruing

  

Non-

Accruing

  

Total

  

Accruing

  

Non-

Accruing

  

Total

 

Single family

 $22   249   271   355   257   612 

Commercial real estate

  0   363   363   0   211   211 

Consumer

  54   606   660   62   568   630 

Commercial business

  18   0   18   25   0   25 
  $94   1,218   1,312   442   1,036   1,478 
                         

 

As of June 30, 2021, the Bank had commitments to lend an additional $0.5 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, 2020, there were commitments to lend additional funds of $1.1 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 twelve 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 twelve 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 table and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the three and six month periods ending June 30, 2021 and 2020.

 

  

Three Months Ended

June 30, 2021

  

Six Months Ended

June 30, 2021

 

(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:

                        

Commercial real estate:

                        

Other

  0  $0   0   1  $139   139 

Consumer

  1   93   94   1   93   94 

Commercial business

  0   0   0   1   14   14 

Total

  1  $93   94   3  $246   247 
                         

 

 
  

Three Months Ended

June 30, 2020

  

Six Months Ended

June 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 
                         

 

There were 0 loans that were restructured in the twelve months preceding June 30, 2021 and 2020 that subsequently defaulted during the three and six months ended June 30, 2021 and 2020.

 

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 $0.3 million, or 2.6%, of the total $9.9 million in loan loss reserves at June 30, 2021 and $0.1 million, or 0.9%, of the total $10.7 million in loan loss reserves at December 31, 2020.

 

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020 and 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. Section 4013 of the CARES Act temporarily allows the Bank to grant modifications of loans to borrowers that were impacted by the pandemic without classifying the modifications as TDRs if the accommodation is granted before December 31, 2021. In accordance with the regulatory guidance, the Bank granted accommodations on certain loans to borrowers who were negatively impacted by the COVID-19 pandemic. At June 30, 2021, the Bank had $33.5 million of loans that had been granted loan accommodations in accordance with Section 4013 of the CARES Act. These accommodations are in addition to the TDRs that are disclosed above. The accommodations granted included $29.2 million of loans that are required to make interest only payments for periods up to December 31, 2021 and $4.3 million of loans that had their loan amortization period increased. Of these loans, $5.7 million were classified but still accruing at June 30, 2021 and all of these loans were current with their agreed upon payments. The commercial credit area continues to communicate regularly with the borrowers that have been granted loan accommodations and monitors their activity closely. This information is used to analyze the performance of these loans and to anticipate any potential issues that these loans may develop so that risk ratings may be appropriately adjusted in a timely manner. It is anticipated that most of the remaining borrowers that have been granted accommodations will be in a position to resume making their regular loan payments at the end of the initial accommodation period. Other borrowers, particularly in the hospitality and restaurant industries, may need additional accommodations when their initial accommodation period ends as their operations may need more time to recover from the impact of the pandemic.

 

 

 

(10) Intangible Assets

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

 

(Dollars in thousands)

 

Six Months Ended

June 30, 2021

  

Twelve Months Ended

December 31, 2020

  

Six Months Ended

June 30, 2020

 

Balance, beginning of period

 $3,043   2,172   2,172 

Originations

  691   2,189   1,096 

Amortization

  (574)  (1,318)  (621)

Balance, end of period

 $3,160   3,043   2,647 

Fair value of mortgage servicing rights

 $4,316   3,378   2,840 
             

 

All of the loans sold where the Company continues to service the loans are serviced for FNMA under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at June 30, 2021.

 

      

Weighted

  

Weighted

     
  

Loan

  

Average

  

Average

     
  

Principal

  

Interest

  

Remaining

  

Number

 

(Dollars in thousands)

 

Balance

  

Rate

  

Term (months)

  

of Loans

 

Original term 30 year fixed rate

 $407,078   3.50

%

  312   2,629 

Original term 15 year fixed rate

  120,211   2.90   142   1,079 
                 

 

Amortization expense for amortizing intangible assets was $0.6 million and $0.7 million for the six month periods ended June 30, 2021 and 2020, respectively. The gross carrying amount of intangible assets and the associated accumulated amortization at June 30, 2021 and December 31, 2020 is presented in the following tables.

 

  

June 30, 2021

 
  

Gross

         

(Dollars in thousands)

 

Carrying

Amount

  

Accumulated

Amortization

  

Unamortized

Amount

 

Mortgage servicing rights

 $6,015   (2,855)  3,160 

Core deposit intangible

  574   (551)  23 

Goodwill

  802   0   802 

Total

 $7,391   (3,406)  3,985 
             

 

  

December 31, 2020

 
  

Gross

         

(Dollars in thousands)

 

Carrying

Amount

  

Accumulated

Amortization

  

Unamortized

Amount

 

Mortgage servicing rights

 $5,691   (2,648)  3,043 

Core deposit intangible

  574   (517)  57 

Goodwill

  802   0   802 

Total

 $7,067   (3,165)  3,902 
             

 

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

 

(Dollars in thousands)

 

Mortgage

Servicing Rights

  

Core Deposit

Intangible

  

Total

Amortizing

Intangible Assets

 

Year ending December 31,

            

2021

 $338   13   351 

2022

  638   10   648 

2023

  597   0   597 

2024

  552   0   552 

2025

  471   0   471 

Thereafter

  564   0   564 

Total

 $3,160   23   3,183 
             

 

 

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.

 

Projections of amortization are based on existing asset balances and the existing interest rate environment as of June 30, 2021. The Company's actual experiences may be significantly different depending upon changes in mortgage interest rates and other market conditions.

 

 

(11) Leases

The Company accounts for its leases in accordance with ASU 2016-02, Leases (Topic 842) and as of June 30, 2021 a $2.8 million right-of-use asset and an offsetting lease payment obligation liability were recorded on the consolidated balance sheet in other assets and other liabilities, respectively.

 

Operating lease right-of-use assets represent 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 fourteen and forty-six months. Certain leases contain extension options which typically range from three to ten 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 for the three and six months ended June 30, 2021.

 

(Dollars in thousands)

 

Three Months

Ended
June 30, 2021

  

Six Months

Ended
June 30, 2021

 

Operating lease cost

 $223   449 
         

 

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

 

  

Three Months Ended

  

Six Months Ended

 

(Dollars in thousands)

 

June 30,

2021

  

June 30,

2020

  

June 30,

2021

  

June 30,

2020

 

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

                

Operating cash flows from operating leases

 $223   223   449   445 

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

  3.3   4.2   3.3   4.2 

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)

 

June 30, 2021

 

2021

 $452 

2022

  932 

2023

  807 

2024

  729 

2025

  15 

Total lease payments

  2,935 

Less: Interest

  (107)

Present value of lease liabilities

 $2,828 
     

 

 

 

(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 common share.

 

  

Three Months Ended June 30,

  

Six Months Ended June 30,

 

(Dollars in thousands, except per share data)

 

2021

  

2020

  

2021

  

2020

 

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

  4,492,502   4,618,555   4,526,434   4,622,231 

Net dilutive effect of:

                

Restricted stock awards and options

  34,394   25,664   32,983   26,691 

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

  4,526,896   4,644,219   4,559,417   4,648,922 

Income available to common stockholders

 $4,528   2,691   7,946   4,076 

Basic earnings per common share

 $1.01   0.58   1.76   0.88 

Diluted earnings per common share

 $1.00   0.58   1.74   0.88 
                 

 

 

(13) Regulatory Capital and Oversight

The Bank is 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, 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 also made corresponding revisions to the prompt corrective action framework and include capital ratios and buffer requirements. 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 Small Bank Holding Company Policy Statement (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 June 30, 2021 were $977.2 million, its adjusted total assets were $976.5 million, and its risk-weighted assets were $689.6 million. The following table presents the Bank’s capital amounts and ratios at June 30, 2021 for actual capital, required capital and excess capital, including ratios in order to qualify as being well capitalized under the prompt corrective actions 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

 

June 30, 2021

                                

Common equity Tier 1 capital

 $97,789   14.18

%

 $31,033   4.50

%

 $66,756   9.68

%

 $44,826   6.50

%

Tier 1 capital leverage

  97,789   10.01   39,059   4.00   58,730   6.01   48,823   5.00 

Tier 1 risk-based capital

  97,789   14.18   41,378   6.00   56,411   8.18   55,171   8.00 

Total risk-based capital

  106,425   15.43   55,171   8.00   51,254   7.43   68,963   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 June 30, 2021, 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 $1.8 million of its common stock under the existing board-approved share repurchase program at June 30, 2021. The Company did not declare any dividends on its common stock but did repurchase 108,000 shares of its common stock in the open market for $2.2 million under the share repurchase program during the second quarter of 2021. Subsequent to the end of the quarter, on July 27, 2021, the board approved an additional $4.2 million for the share repurchase program, increasing to $6.0 million the amount of its common stock authorized to be repurchased under the share repurchase program as of that date.

 

 

(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 June 30, 2021 were approximately $5.0 million, expire over the next sixteen 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 $2.0 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 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 six months ended June 30, 2021:

                

Interest income – external customers

 $15,983   0   0   15,983 

Non-interest income – external customers

  7,996   1   0   7,997 

Intersegment interest income

  0   14   (14)  0 

Intersegment non-interest income

  117   8,281   (8,398)  0 

Interest expense

  877   0   (14)  863 

Provision for loan losses

  (1,467)  0   0   (1,467)

Non-interest expense

  13,140   436   (117)  13,459 

Income tax expense

  3,265   (86)  0   3,179 

Net income

  8,281   7,946   (8,281)  7,946 

Total assets

  981,023   107,421   (107,418)  981,026 

At or for the six months ended June 30, 2020:

                

Interest income – external customers

  15,727   0   0   15,727 

Non-interest income – external customers

  6,065   0   0   6,065 

Intersegment interest income

  0   23   (23)  0 

Intersegment non-interest income

  117   4,358   (4,475)  0 

Interest expense

  1,660   0   (23)  1,637 

Provision for loan losses

  778   0   0   778 

Non-interest expense

  13,403   368   (117)  13,654 

Income tax expense

  1,710   (63)  0   1,647 

Net income

  4,358   4,076   (4,358)  4,076 

Total assets

  862,046   98,247   (97,510)  862,783 

At or for the quarter ended June 30, 2021:

                

Interest income – external customers

 $8,094   0   0   8,094 

Non-interest income – external customers

  4,742   0   0   4,742 

Intersegment interest income

  0   6   (6)  0 

Intersegment non-interest income

  59   4,687   (4,746)  0 

Interest expense

  416   0   (6)  410 

Provision for loan losses

  (891)  0   0   (891)

Non-interest expense

  6,831   208   (59)  6,980 

Income tax expense

  1,852   (43)  0   1,809 

Net income

  4,687   4,528   (4,687)  4,528 

Total assets

  981,023   107,421   (107,418)  981,026 

At or for the quarter ended June 30, 2020:

                

Interest income – external customers

 $7,883   0   0   7,883 

Non-interest income – external customers

  3,594   0   0   3,594 

Intersegment interest income

  0   8   (8)  0 

Intersegment non-interest income

  58   2,834   (2,892)  0 

Interest expense

  753   0   (8)  745 

Provision for loan losses

  318   0   0   318 

Non-interest expense

  6,529   182   (58)  6,653 

Income tax expense

  1,101   (31)  0   1,070 

Net income

  2,834   2,691   (2,834)  2,691 

Total assets

  862,046   98,247   (97,510)  862,783 

 

 

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-looking Information

Safe Harbor Statement

This quarterly report on Form 10-Q 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,” and “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; expectations for core capital and 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, clients, deposit balances, and the allowance for loan losses; the anticipated benefits that will be realized by clients from government assistance programs related to the COVID-19 pandemic, including the forgiveness of loans under the Paycheck Protection Program, the Company’s expectations relating to repurchases of its common stock during the COVID-19 pandemic and requests for loan payment accommodation from borrowers; the amount of the Bank’s non-performing assets in future periods and the appropriateness of the allowances therefor; 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; 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 Office of the Comptroller of the Currency (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 (FRB) 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 Federal Home Loan Bank and the FRB; 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 in this quarterly report on Form 10-Q, each as 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, 2020 and Part II, Item 1A of its subsequently filed quarterly reports on Form 10-Q. All statements in this quarterly report on 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 other qualitative factors 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, the actual loss experience and other qualitative factors. 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. Activity in the first six months of 2021 resulted in a decrease in the allowance and a credit to the loan loss provision. 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 U.S. generally accepted accounting principles (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 realizability of the deferred tax assets is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies and assessments of the current and future economic and business conditions. The 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 on outstanding litigation matters.

 

COVID-19 Pandemic

In 2020, the spread of COVID-19 slowed economic activity in many countries, including the United States. Millions of Americans were at some point ordered to stay home, including those residing in the states of Minnesota and Wisconsin, and many businesses were ordered to be closed for a period of time or to operate at reduced capacities in order to reduce the spread of COVID-19. These orders severely reduced the flow of commerce which reduced, or entirely eliminated, the revenue streams for many small businesses. This reduction in income forced many small businesses to close temporarily, furlough employees, or terminate operations entirely.

 

 

In the first quarter of 2021, vaccines began to be distributed to targeted groups. During the second quarter of 2021, the distribution of the vaccines became more widely available to the general public and business activity improved because of the lessened impact of COVID-19 pandemic resulting from the increased vaccination rates and the removal of pandemic-focused restrictions.

 

Despite the progress made in the vaccination of the general public during the second quarter of 2021, the extent of the impact of COVID-19 on the Company is difficult to determine as it is not clear how many people will take the vaccines, or how effective the vaccines will be against variants of the virus, among other factors. In addition, it is not clear 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. 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.

 

The CARES Act was signed into law on March 27, 2020 and 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. Section 4013 of the CARES Act temporarily allows the Bank to grant modifications of loans to borrowers that were impacted by the pandemic without classifying the modifications as TDRs if the accommodation is granted before December 31, 2021. In accordance with Section 4013 of the CARES Act, the Bank granted accommodations on certain loans to borrowers. See “Note 9 Allowance for Loan Losses and Credit Quality Information for further information.

 

Paycheck Protection Program

The CARES Act allocated $349 billion in funding to help small businesses that were negatively impacted by the COVID-19 pandemic. The Bank actively participated in helping businesses that were negatively impacted by COVID-19 that applied for forgivable loans under the Paycheck Protection Program (PPP) as part of the CARES Act. The Bank had the following activity related to the first round of the PPP during 2020 and through June 30, 2021:

 

Dollars in thousands

 

Number of

Loans

  

Amount

  

Net

Deferred

Fees

 

Originated

  413  $53,153  $1,837 

Repaid

  (130)  (19,484)  - 

Net deferred fees recognized

  -   -   (1,097)

Balance, December 31, 2020

  283   33,669   740 

Repaid

  (243)  (21,419)  - 

Net deferred fees recognized

  -   -   (597)

Balance, March 31, 2021

  40   12,250   143 

Repaid

  (35)  (11,334)  - 

Net deferred fees recognized

  -   -   (126)

Balance, June 30, 2021

  5  $916  $17 
             

 

 

The Consolidated Appropriations Act of 2021, which was signed into law on December 27, 2020, allocated $284 billion to the SBA to fund a second round of the PPP and extended the application period for the program to March 31, 2021. The application period was later extended to May 31, 2021. The Bank actively participated in the second round of the program and began submitting applications for borrowers on January 15, 2021 when the application window opened. The program was adjusted for the second round to allow applications from both first time borrowers and those that obtained loans during the first round of the program. The revised program, among other things, requires that borrowers demonstrate or certify that they experienced a 25% or greater reduction in gross receipts from a quarter in 2020 compared to the same quarter in 2019 and certify that current economic uncertainty makes the loan request necessary to support their ongoing operations. The Bank had the following activity related to the second round of the PPP through June 30, 2021:

 

Dollars in thousands

 

Number of

Loans

  

Amount

  

Net

Deferred

Fees

 

Originated

  416  $26,798  $1,476 

Net deferred fees recognized

  -   -   (29)

Balance, March 31, 2021

  416   26,798   1,447 

Originated

  50   2,167   149 

Repaid

  (182)  (6,539)  - 

Net deferred fees recognized

  -   -   (522)

Balance, June 30, 2021

  284  $22,426  $1,074 
             

 

It is anticipated that the majority of the outstanding loans at June 30, 2021 will be forgiven by the SBA. The remaining net deferred fees will be recognized into income over the remaining lives of the loans.

 

 

RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2021 COMPARED TO THE SAME PERIODS ENDED JUNE 30, 2020

 

Net Income

Net income for the second quarter of 2021 was $4.5 million, an increase of $1.8 million, compared to net income of $2.7 million for the second quarter of 2020. Diluted earnings per share for the second quarter of 2021 was $1.00, an increase of $0.42 from the diluted earnings per share of $0.58 for the second quarter of 2020. The increase in net income between the periods was primarily because of a $1.6 million increase in other non-interest income primarily related to a gain that was realized on the sale of real estate owned, a $1.2 million decrease in the provision for loan losses primarily because of the recovery of a previously charged off commercial real estate loan and the reduction of qualitative reserves related to improvements in the economic environment because of the lessened impact of the COVID-19 pandemic and a $0.6 million increase in net interest income primarily related to the yield enhancements realized on PPP loans that were repaid during the period. These increases in net income were partially offset by a $0.7 million decrease in the gain on sales of loans due to a decrease in mortgage loan originations and sales, a $0.7 million increase in income tax expense as a result of the increase in pre-tax income between the periods and a $0.3 million increase in non-interest expenses primarily related to an increase in compensation expense.

 

Net income was $7.9 million for the six month period ended June 30, 2021, an increase of $3.8 million compared to net income of $4.1 million for the six month period ended June 30, 2020. Diluted earnings per share for the six month period ended June 30, 2021 was $1.74, an increase of $0.86 per share compared to diluted earnings per share of $0.88 for the same period in 2020. The increase in net income between the periods was primarily because of a $2.3 million decrease in the provision for loan losses. The provision for loan losses decreased primarily because of the reduction of required qualitative reserves due to improvements in the economic environment because of the lessened impact of the COVID-19 pandemic and also because of an increase in the recoveries received on previously charged off loans between the periods. Other non-interest income increased $1.7 million primarily because of the gain that was realized on the sale of real estate owned. Net interest income increased $1.0 million primarily because of the increase in the yield enhancements that were realized on PPP loans that were repaid during the period. These increases in net income were partially offset by a $1.6 million increase in income tax expense as a result of the increase in pre-tax income between the periods.

 

Net Interest Income

Net interest income was $7.7 million for the second quarter of 2021, an increase of $0.6 million, or 7.6%, compared to $7.1 million for the second quarter of 2020. Interest income was $8.1 million for the second quarter of 2021, an increase of $0.2 million, or 2.7%, from $7.9 million for the second quarter of 2020. Interest income increased primarily because of the $0.6 million in yield enhancements recognized on PPP loans that were repaid during the period. Interest income also increased because of the $139.4 million increase in the average interest-earning assets between the periods. These increases in interest income were partially offset by a decrease in the average yield earned on interest-earning assets which was 3.44% for the second quarter of 2021, a decrease of 50 basis points from 3.94% for the second quarter of 2020. The decrease in the average yield is primarily related to the decrease in the prime rate that occurred in the first quarter of 2020, which lowered the rate on adjustable rate loans in the portfolio as well as any new or renewing fixed rate loans that were originated since that time.

 

 

Interest expense was $0.4 million for the second quarter of 2021, a decrease of $0.3 million, or 45.0%, compared to $0.7 million for the second quarter of 2020. Interest expense decreased despite the $127.7 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 0.19% for the second quarter of 2021, a decrease of 21 basis points from 0.40% for the second quarter of 2020. The decrease in the interest paid on interest-bearing liabilities was primarily because of the decrease in deposit rates as a result of the decrease in the federal funds rate that occurred in the first quarter of 2020.

 

Net interest margin (net interest income divided by average interest-earning assets) for the second quarter of 2021 was 3.27%, a decrease of 30 basis points, compared to 3.57% for the second quarter of 2020. 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 decrease in the prime rate that occurred in the first quarter of 2020.

 

Net interest income was $15.1 million for the first six months of 2021, an increase of $1.0 million, or 7.3%, compared to $14.1 million for the same period of 2020. Interest income was $16.0 million for the first six months of 2021, an increase of $0.3 million, or 1.6%, from $15.7 million for the first six months of 2020. Interest income increased primarily because of the $1.2 million in yield enhancements recognized on PPP loans that were repaid during the period. Interest income also increased because of the $146.9 million increase in the average interest-earning assets between the periods. These increases in interest income were partially offset by a decrease in the average yield earned on interest-earning assets which was 3.50% for the first six months of 2021, a decrease of 59 basis points from 4.09% for the first six months of 2020. The decrease in the average yield is primarily related to the decrease in the prime rate that occurred in the first quarter of 2020 which lowered the rate on adjustable rate loans in the portfolio as well as any new or renewing fixed rate loans that were originated since that time.

 

Interest expense was $0.9 million for the first six months of 2021, a decrease of $0.7 million, or 47.3%, compared to $1.6 million for the same period of 2020. Interest expense decreased despite the $137.4 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 0.21% for the first six months of 2021, a decrease of 26 basis points from 0.47% for the first six months of 2020. The decrease in the interest paid on interest-bearing liabilities was primarily because of the decrease in deposit rates as a result 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 six months of 2021 was 3.31%, a decrease of 35 basis points, compared to 3.66% for the first six months of 2020. 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 decrease in the average prime rate between the periods.

 

 

A summary of the Company’s net interest margin for the three and six month periods ended June 30, 2021 and 2020 is as follows:

 

  

For the three month period ended

 
  

June 30, 2021

  

June 30, 2020

 

(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

 $197,739   502   1.02

%

 $96,241   436   1.82

%

Loans held for sale

  4,821   38   3.14   8,736   67   3.07 

Single family loans, net

  155,205   1,418   3.66   129,584   1,306   4.05 

Commercial loans, net

  442,794   5,571   5.05   455,330   5,293   4.68 

Consumer loans, net

  47,235   530   4.50   64,864   761   4.72 

Other

  95,750   35   0.15   49,435   20   0.16 

Total interest-earning assets

  943,544   8,094   3.44   804,190   7,883   3.94 
                         

Interest-bearing liabilities:

                        

Checking accounts

  161,288   48   0.12   112,605   30   0.11 

Savings accounts

  113,717   18   0.06   88,528   16   0.07 

Money market accounts

  240,852   141   0.24   204,939   201   0.39 

Certificate accounts

  95,306   203   0.86   119,722   498   1.67 

Total interest-bearing liabilities

  611,163           525,794         

Non-interest checking

  251,196           209,194         

Other non-interest bearing deposits

  2,425           2,142         

Total interest-bearing liabilities and non-interest bearing deposits

 $864,784   410   0.19  $737,130   745   0.40 

Net interest income

     $7,684          $7,138     

Net interest rate spread

          3.25

%

          3.54

%

Net interest margin

          3.27

%

          3.57

%

                         

 

  

For the six month period ended

 
  

June 30, 2021

  

June 30, 2020

 

(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

 $181,220   1,000   1.11

%

 $99,755   937   1.89

%

Loans held for sale

  4,953   75   3.04   5,745   91   3.18 

Single family loans, net

  150,114   2,747   3.69   128,409   2,581   4.04 

Commercial loans, net

  440,351   10,943   5.01   432,556   10,390   4.83 

Consumer loans, net

  49,722   1,152   4.67   66,641   1,605   4.84 

Other

  94,495   66   0.14   40,844   123   0.61 

Total interest-earning assets

  920,855   15,983   3.50   773,950   15,727   4.09 
                         

Interest-bearing liabilities:

                        

Checking accounts

  157,802   92   0.12   107,949   61   0.11 

Savings accounts

  109,778   34   0.06   84,839   32   0.07 

Money market accounts

  232,255   270   0.23   197,718   494   0.50 

Certificate accounts

  97,541   467   0.97   121,746   1,050   1.73 

Total interest-bearing liabilities

  597,376           512,252         

Non-interest checking

  243,874           191,590         

Other non-interest bearing deposits

  2,485           2,468         

Total interest-bearing liabilities and non-interest bearing deposits

 $843,735   863   0.21  $706,310   1,637   0.47 

Net interest income

     $15,120          $14,090     

Net interest rate spread

          3.29

%

          3.62

%

Net interest margin

          3.31

%

          3.66

%

                         

 

Provision for Loan Losses

The provision for loan losses was ($0.9) million for the second quarter of 2021, a decrease of $1.2 million compared to $0.3 million for the second quarter of 2020. The provision for loan losses was ($1.5) million for the first six months of 2021, a decrease of $2.3 million compared to $0.8 million for the first six months of 2020. The provision for loan losses decreased primarily because of the reduction of qualitative reserves due to improvements in the economic environment because of the lessened impact of the COVID-19 pandemic and also because of an increase in the recoveries received on previously charged off loans between the periods.

 

 

During 2020, the Company increased its allowance for loan losses due to the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic. The amount of the increase in the allowance for loan losses related to the economic environment was based, in part, on the amount of loans to borrowers in the hospitality, restaurant and entertainment industries that were negatively impacted by the COVID-19 pandemic. At June 30, 2021, the Bank had $33.5 million of loans that had been granted loan accommodations in accordance with Section 4013 of the CARES Act. The accommodations granted included $29.2 million of loans that are required to make interest only payments for periods up to December 31, 2021 and $4.3 million of loans that had their loan amortization period increased. Of these loans, $5.7 million were classified but still accruing at June 30, 2021 and all of these loans were current with their agreed upon payments. The commercial credit area continues to communicate regularly with the borrowers that have been granted loan accommodations and monitors their activity closely. This information is used to analyze the performance of these loans and to anticipate any potential issues that these loans may develop so that risk ratings may be appropriately adjusted in a timely manner. It is anticipated that most of the remaining borrowers that have been granted accommodations will be in a position to resume making their regular loan payments at the end of the initial accommodation period. Other borrowers, particularly in the hospitality and restaurant industries, may need additional accommodations when their initial accommodation period ends as their operations may need more time to recover from the impact 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 the Company’s past loan loss history and qualitative reserves for other items determined to have a potential impact on future loan losses. The general reserves decreased during the second quarter as a result of a decrease in the required qualitative reserves due to an improvement in business activity because of the lessened impact of COVID-19 pandemic resulting from increased vaccination rates and the removal of pandemic-focused restrictions during the period. Despite the progress made in the vaccination of the general public during the period, it was determined that economic risks related to the pandemic continued to exist and more time was needed to prudently evaluate the impact that these risks would have on the Company’s loan portfolio before more qualitative reserves would be released from the allowance for loan losses.

 

A reconciliation of the Company’s allowance for loan losses for the three and six month periods ended June 30, 2021 and 2020 is summarized as follows:

 

       

(Dollars in thousands)

 

2021

  

2020

 

Balance at March 31,

 $10,132   9,036 

Provision

  (891)  318 

Charge offs:

        

Consumer

  (11)  (34)

Commercial real estate

  0   (730)

Recoveries

  685   59 

Balance at June 30,

 $9,915   8,649 
         

Allocated to:

        

General allowance

 $9,652   8,495 

Specific allowance

  263   154 
  $9,915   8,649 
         

 

       

(Dollars in thousands)

 

2021

  

2020

 

Balance at January 1,

 $10,699   8,564 

Provision

  (1,467)  778 

Charge offs:

        

Consumer

  (42)  (45)

Commercial real estate

  0   (730)

Recoveries

  725   82 

Balance at June 30,

 $9,915   8,649 
         

 

The $0.7 million of recoveries relates primarily to a commercial loan in the transportation industry.

 

 

NonInterest Income

Non-interest income was $4.7 million for the second quarter of 2021, an increase of $1.1 million, or 31.9%, from $3.6 million for the second quarter of 2020. Other non-interest income increased $1.6 million due primarily to a $1.5 million gain that was realized on the sale of real estate owned. Fees and service charges increased $0.1 million between the periods due primarily to an increase in debit card income. Loan servicing fees increased $0.1 million 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 non-interest income were partially offset by a $0.7 million decrease in the gain on sales of loans primarily because of a decrease in single family loan originations and sales between the periods.  

        

Non-interest income was $8.0 million for the first six months of 2021, an increase of $1.9 million, or 31.9%, from $6.1 million for the first six months of 2020. Other non-interest income increased $1.7 million due primarily to a $1.5 million gain that was realized on the sale of commercial real estate owned. Loan servicing fees increased $0.2 million between the periods due to an increase in the aggregate balances of single family mortgage loans that were being serviced for others. Fees and service charges increased $0.1 million between the periods due primarily to an increase in debit card income. These increases in non-interest income were partially offset by a slight decrease in the gain on sales of loans primarily because of a decrease in single family loan originations and sales between the periods.   

       

NonInterest Expense

Non-interest expense was $7.0 million for the second quarter of 2021, an increase of $0.3 million, or 4.9%, from $6.7 million for the second quarter of 2020. Compensation and benefits expense increased $0.3 million primarily because of a decrease in the direct loan origination compensation costs that were deferred as a result of the decreased mortgage loan production between the periods. Other non-interest expense increased $0.2 million due primarily to a decrease in the direct loan printing and supply costs that were deferred as a result of the decreased mortgage loan production and also because of an increase in charitable contributions between the periods. Data processing expense increased slightly between the periods due to an increase in debit card processing costs because of increased activity. These increases in non-interest expense were partially offset by a $0.2 million decrease in professional services expense between the periods primarily because of a decrease in legal expenses relating to an ongoing bankruptcy litigation claim. Occupancy and equipment expense decreased slightly due to a decrease in the purchase of non-capitalized equipment between the periods.

 

Non-interest expense was $13.5 million for the first six months of 2021, a decrease of $0.2 million, or 1.4%, from $13.7 million for the first six months of 2020. Professional services expense decreased $0.4 million between the periods primarily because of a decrease in legal expenses relating to an ongoing bankruptcy litigation claim. Occupancy and equipment costs decreased slightly between the periods due to a decrease in depreciation and non-capitalized software costs. These decreases were partially offset by a $0.1 million increase in other non-interest expenses due primarily to an increase in FDIC insurance premiums between the periods, a $0.1 million increase in data processing expense between the periods due to an increase in debit card processing costs because of increased activity and a $0.1 million increase in compensation and benefits expense due to a decrease in the direct loan origination compensation costs that were deferred as a result of the decreased mortgage loan production between the periods.

 

Income Taxes

Income tax expense was $1.8 million for the second quarter of 2021, an increase of $0.7 million from $1.1 million for the second quarter of 2020. Income tax expense was $3.2 million for the first six months of 2021, an increase of $1.6 million from $1.6 million for the first six months of 2020. The increase in income tax expense between the periods is primarily the result of an increase in pre-tax income.

 

 

FINANCIAL CONDITION

 

NonPerforming 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 three most recently completed quarters.

 

  

June 30,

  

March 31,

  

December 31,

 

(Dollars in thousands)

 

2021

  

2021

  

2020

 
             

Non‑performing loans:

            

Single family

 $557  $497  $502 

Commercial real estate

  519   1,408   1,484 

Consumer

  669   612   689 

Commercial

  8   8   9 

Total

  1,753   2,525   2,684 
             

Foreclosed and repossessed assets:

            

Commercial real estate

  0   636   636 

Consumer

  0   30   0 
   0   666   636 

Total non‑performing assets

 $1,753  $3,191  $3,320 

Total as a percentage of total assets

  0.18

%

  0.33

%

  0.37

%

Total as a percentage of total loans receivable, net

  0.28

%

  0.39

%

  0.42

%

Allowance for loan loss to non-performing loans

  565.75

%

  401.37

%

  398.72

%

             

Delinquency data:

            

Delinquencies (1)

            

30+ days

 $1,255  $1,147  $995 

90+ days

  0   0   0 

Delinquencies as a percentage of loan portfolio (1)

            

30+ days

  0.19

%

  0.17

%

  0.15

%

90+ days

  0.00

%

  0.00

%

  0.00

%

(1) Excludes non-accrual loans.

Total non-performing assets were $1.8 million at June 30, 2021, a decrease of $1.4 million, or 45.1%, from $3.2 million at March 31, 2021 and a decrease of $1.5 million, or 47.2%, from $3.3 million at December 31, 2020. Non-performing loans decreased $0.7 million and foreclosed and repossessed assets decreased $0.7 million during the second quarter of 2021. Non-performing loans decreased $0.9 million and foreclosed and repossessed assets decreased $0.6 million during the first six months of 2021.

 

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 declared any dividend during the three year period ended June 30, 2021.

 

 

LIQUIDITY AND CAPITAL RESOURCES

For the six months ended June 30, 2021, the net cash provided by operating activities was $9.3 million. The Company collected $25.8 million from called or maturing securities, purchased securities of $107.3 million, received proceeds from the sales of real estate of $2.1 million and received $16.5 million in principal repayments on securities. The Company purchased $0.2 million in FHLB stock and $0.2 million of premises and equipment. Net loans receivable decreased $3.4 million and the Company had a net increase in deposit balances of $67.1 million. The Company also purchased $2.7 million of treasury stock and customer escrow accounts increased $0.4 million.

 

The Company has certificates of deposit with outstanding balances of $66.4 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. FRB borrowings or proceeds from the sale of securities could also be used to fund unanticipated outflows of certificates of deposits.

 

 

The Company had ten deposit customers that individually had aggregate deposits greater than $5.0 million as of June 30, 2021. The $102.0 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. FRB 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 $172.5 million from the FHLB at June 30, 2021, 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, the Bank could borrow an additional $50.4 million from the FRB at June 30, 2021 based on the collateral value of the loans pledged.

 

The Company’s primary source of cash is dividends from the Bank. At June 30, 2021, the Company had $8.3 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 expense and the purchase of treasury stock.

 

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 the market value of 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 June 30, 2021.

 

  

Market Value

 

(Dollars in thousands)

Basis point change in interest rates

 

‑100

  0  

+100

  

+200

 

Total market risk sensitive assets

 $984,853   973,112   950,867   928,441 

Total market risk sensitive liabilities

  898,585   844,768   799,383   760,002 

Off-balance sheet financial instruments

  325   0   906   1,730 

Net market risk

 $85,943   128,344   150,578   166,709 

Percentage change from current market value

  (33.04

)%

  0.00

%

  17.32

%

  29.89

%

                 

 

The preceding table was prepared utilizing a model using the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 2% to 55%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 6% and 51%, 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 money market accounts were assumed to decay at an annual rate of 8% and 17%, respectively. Retail checking accounts, commercial checking accounts and money market accounts were assumed to decay at annual rates of 6%, 22%, and 13%, respectively. Callable investments were projected to be called at the first call date where the projected interest rate on similar remaining term instruments was less than the interest rate on the callable 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 June 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

  $2,525   9.15%

+100

   1,266   4.59 
0   0   0.00 
-100   (1,420)  (5.14)

 

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 decrease in interest income in a declining rate environment is primarily because there are more loans and investments that would reprice to lower interest rates than there are deposits that would be able to be repriced 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 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 were 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 for more information.

 

ITEM 1A.

Risk Factors.

The risks described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020, 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.

 

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 second quarter of 2021:

 

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)

 

April 1, 2021 to April 30, 2021

  20,000  $20.03   20,000  $3,625,781 

May 1, 2021 to May 31, 2021

  88,000   20.60   88,000  $1,813,341 

June 1, 2021 to June 30, 2021

  0   N/A   0  $1,813,341 

Total

  108,000  $20.49   108,000  $1,813,341 

 

 

(a)

On November 28, 2018, the Company’s board of directors announced a share repurchase authorization, pursuant to which the Company may, from time to time, purchase shares of its common stock for an aggregate purchase price not to exceed $6.0 million. On July 27, 2021, our board of directors announced an increase of $4,187,259 in the aggregate purchase price authorized to be repurchased which increased the total amount available to $6.0 million. Share repurchases may be executed through various means, including through open market transactions, privately negotiated transactions or otherwise. The repurchase authorization does not obligate the Company to purchase any shares and has no set expiration date.

 

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

   
101Financial statements from the Quarterly Report on Form 10-Q of the Company for the period ended June 30, 2021, filed with the SEC on August 3, 2021, formatted in Inline Extensible Business Reporting Language (iXBRL); (i) the Consolidated Balance Sheets at June 30, 2021 and December 31, 2020, (ii) the Consolidated Statements of Comprehensive Income for the Three Months and Six Months Ended June 30, 2021 and 2020, (iii) the Consolidated Statements of Stockholders’ Equity for the Three and Six Month Periods Ended June 30, 2021 and 2020, (iv) the Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2021 and 2020, and (v) Notes to Consolidated Financial Statements.Filed Electronically
   

104

Cover Page Interactive Data File from the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2021 (formatted as Inline XBRL and contained in Exhibit 101).

Filed Electronically

 

38

 

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:

August 3, 2021 /s/ Bradley Krehbiel

 

  

Bradley Krehbiel, President and Chief Executive Officer
(Principal Executive Officer) 

 

  

 

    
Date:August 3, 2021 /s/ Jon Eberle
   Jon Eberle, Senior Vice President and Chief Financial Officer
(Principal Financial Officer)

 

39