Item 7.Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion and analysis is presented to assist the reader in understanding and evaluating of the Company's financial condition and results of operations. It is intended to complement the consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Annual Report on Form 10-K and should be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the year ended December 31, 2020, compared to the year ended December 2019, and the financial condition as of December 31, 2020 compared to the financial condition as of December 31, 2019.
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As described in the notes to consolidated financial statements, we have two reportable segments: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market.
Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. We have provided below a discussion of the material results of operations for each segment on a separate basis for the year ended December 31, 2020, compared the year ended December 31, 2019, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of Waterstone Financial, which includes the consolidated operations of WaterStone Bank and Waterstone Mortgage Corporation, for the same periods.
For a discussion of our results of operations for the year ended December 31, 2019 compared to the year ended December 31, 2018, see “Part II, Item 7: Management’s Discussion and Analysis of Financial Condition and Results of Operations” Discussion of Results of Operations included in our 2019 Form 10-K, filed with the SEC on March 13, 2020.
Significant Items
Earnings comparisons among the three years ended December 31, 2020, 2019, and 2018 were impacted by the Significant Items summarized below.
COVID-19 and the CARES Act
The COVID-19 pandemic has caused economic and social disruption on an unprecedented scale. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption has resulted in the shuttering of businesses across the country, significant job loss, and aggressive measures by the federal government.
Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on our operations. While it is not possible to know the full universe or extent of these impacts as of the date this filing, we are disclosing potentially material items of which we are aware.
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Our fee income could be reduced due to COVID-19. In keeping with guidance from regulators, we are working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact our fee income in future periods.
Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.
Capital and liquidity
As of December 31, 2020, all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses.
We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession causes large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.
There were no Significant Items during the year ended December 31, 2019 or 2018.
Critical Accounting Policies
Critical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact on our income or the carrying value of our assets.
Allowance for Loan Losses. WaterStone Bank establishes valuation allowances on loans deemed to be impaired. A loan is considered impaired when, based on current information and events, it is probable that WaterStone Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral (specific component). WaterStone Bank recognizes the change in present value of expected future cash flows on impaired loans attributable to the passage of time as bad debt expense. On an ongoing basis, at least quarterly for financial reporting purposes, the fair value of collateral dependent impaired loans and real estate owned is determined or reaffirmed by the following procedures:
WaterStone Bank also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the credit portfolio (general component). The risk components that are evaluated include past loan loss experience; the level of non-performing and classified assets; current economic conditions; volume, growth, and composition of the loan portfolio; adverse situations that may affect the borrower’s ability to repay; the estimated value of any underlying collateral; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previously charged-off loans and reduced by charge-offs. Charge-offs approximate the amount by which the outstanding principal balance exceeds the estimated net realizable value of the underlying collateral. The appropriateness of the allowance for loan losses is reviewed and approved quarterly by the WaterStone Bank Board of Directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in the loan portfolio, and is based on a risk model developed and implemented by management and approved by the WaterStone Bank Board of Directors.
Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality and economic conditions. More specifically, if our future charge-off experience increases substantially from our past experience, or if the value of underlying loan collateral, in our case mostly real estate, declines in value by a substantial amount, or if unemployment in our primary market area increases significantly, our allowance for loan losses may be inadequate and we will incur higher provisions for loan losses and lower net income in the future.
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In addition, state and federal regulators periodically review the WaterStone Bank allowance for loan losses. Such regulators have the authority to require WaterStone Bank to recognize additions to the allowance at the time of their examination.
Income Taxes. The Company and its subsidiaries file consolidated federal, combined state income tax, and separate state income tax returns. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax return. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases as well as for net operating loss carry forwards. 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 as income or expense in the period that includes the enactment date.
Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions. Examples of positive evidence may include the existence of taxes paid in available carry-back years as well as the probability that taxable income will be generated in future periods. Examples of negative evidence may include cumulative losses in a current year and prior two years and general business and economic trends.
Positions taken in the Company’s tax returns are subject to challenge by the taxing authorities upon examination. The benefit of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Interest and penalties on income tax uncertainties are classified within income tax expense in the consolidated statements of operations.
Fair Value Measurements. The Company determines the fair value of its assets and liabilities in accordance with ASC 820. ASC 820 establishes a standard framework for measuring and disclosing fair value under generally accepted accounting principles. A number of valuation techniques are used to determine the fair value of assets and liabilities in the Company’s financial statements. The valuation techniques include quoted market prices for investment securities, appraisals of real estate from independent licensed appraisers and other valuation techniques. Fair value measurements for assets and liabilities where limited or no observable market data exists are based primarily upon estimates, and are often calculated based on the economic and competitive environment, the characteristics of the asset or liability and other factors. Therefore, the valuation results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of the asset or liability. Additionally, there are inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount rates and estimates of future cash flows, could significantly affect the results of current or future values. Significant changes in the aggregate fair value of assets and liabilities required to be measured at fair value or for impairment are recognized in the consolidated statements of operations under the framework established by generally accepted accounting principles.
Recent Accounting Pronouncements. Refer to Note 1 of our consolidated financial statements for a description of recent accounting pronouncements including the respective dates of adoption and effects on results of operations and financial condition.
Comparison of Consolidated Waterstone Financial, Inc. Financial Condition at December 31, 2020 and at December 31, 2019
Total Assets. Total assets increased by $188.2 million, or 9.4%, to $2.18 billion at December 31, 2020 from $2.00 billion at December 31, 2019. The increase in total assets primarily reflects an increase in loans held for sale, cash and cash equivalents, and prepaid expenses and other assets due to an increase in the fair market value of the loan rate lock commitments partially offset by a decrease in securities available for sale and loans receivable. The total assets increase reflects liability increases in deposits, additional short-term debt, and other liabilities due to hedging liabilities.
Cash and Cash Equivalents.Cash and cash equivalents increased $20.5 million to $94.8 million at December 31, 2020 from $74.3 million at December 31, 2019. The increase in cash and cash equivalents primarily reflects the additional source of funds through an increase in deposits and short-term borrowings along with available for sale securities payments and loans held for investment payoffs. Offsetting the increases, cash and cash equivalents decreased primarily due to the use of cash to fund loans held for sale, pay dividends, and repurchase shares since December 31, 2019.
Securities Available for Sale. Securities available for sale decreased by $18.9 million to $159.6 million at December 31, 2020 from $178.5 million at December 31, 2019. The decrease was due to paydowns in mortgage related securities and maturities of debt securities exceeding security purchases during the year.
Loans Held for Sale. Loans held for sale increased $181.9 million, or 82.6%, to $402.0 million at December 31, 2020 from $220.1 million at December 31, 2019. The increase was due primarily to the production increase of refinance products, which was driven by the reduction in mortgage rates compared to the end of last year.
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Loans Receivable. Loans receivable held for investment decreased $12.9 million, or 0.9%, to $1.38 billion at December 31, 2020 from $1.39 billion at December, 31, 2019. The decrease in total loans receivable was primarily attributable to decreases in the one- to four-family, multi-family, home equity, and consumer categories. Offsetting those decreases, the construction and land, commercial real estate, and commercial loan categories increased. The growth in the commercial loan category was driven by $18.1 million of PPP loans originated and still outstanding during the year ended December 31, 2020.
Allowance for Loan Losses. The allowance for loan losses increased $6.4 million to $18.8 million at December 31, 2020 from $12.4 million at December 31, 2019. The increase resulted from a provision due to increased economic uncertainty increasing the required allowance related to the loans collectively reviewed. The overall increase was primarily related to each of the one- to four-family, multi-family, construction and land, commercial real estate, consumer, and commercial categories. See Note 3 for further discussion on the allowance for loan losses.
Federal Home Loan Bank Stock. Total Federal Home Loan Bank stock increased $5.6 million to $26.7 million at December 31, 2020 from $21.1 million at December 31, 2019. The increase reflects the ownership requirements in conjunction with the additional FHLB borrowings.
Cash Surrender Value of Life Insurance. Total cash surrender value of life insurance decreased $6.1 million, to $63.6 million at December 31, 2020 from $69.7 million. The decrease is primarily related to the death benefit received on two policies during 2020 offset by continued earnings and annual premiums paid.
Real Estate Owned. Total real estate owned decreased $426,000, to $322,000 at December 31, 2020, compared to $748,000 at December 31, 2019. During the year ended December 31, 2020, $637,000 was transferred from loans to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $1.1 million. There were no write-downs during the year ended December 31, 2020.
Prepaid Expenses and Other Assets. Total prepaid expenses and other assets increased $26.3 million to $57.5 million at December 31, 2020 from $31.2 million at December 31, 2019. The increase was primarily due to increases in loan rate lock commitments, funding receivables from investors, and receivables from back-to-back interest rate swaps.
Deposits. Deposits increased by $117.1 million to $1.18 billion at December 31, 2020, from $1.07 billion at December 31, 2019. The increase was driven by an increase of $97.4 million in money market and savings deposits and $58.2 million in demand deposits offset by a decrease of $38.4 million in time deposits.
Borrowings. Total borrowings increased $24.5 million to $508.1 million at December 31, 2020, from $483.6 million at December 31, 2019. The community banking segment added $29.0 million in short-term FHLB borrowings. External short-term borrowings at the mortgage banking segment decreased a total of $4.5 million to $9.0 million at December 31, 2020 from $13.6 million at December 31, 2019.
Other Liabilities. Other liabilities increased $27.9 million to $75.0 million at December 31, 2020 compared to $47.1 million at December 31, 2019. Other liabilities increased primarily due to liabilities resulting from payables due on back-to-back swaps, legal settlement, accrued compensation, dividends payable, and forward commitments to sell loans at the mortgage banking segment.
Shareholders’ Equity. Shareholders’ equity increased by $19.4 million, or 4.9%, to $413.1 million at December 31, 2020 from $393.7 million at December 31, 2019. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, an increase in fair value of the security portfolio, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends and the repurchase of stock.
Comparison of Community Banking Segment Operations for the Years Ended December 31, 2020 and 2019
Net income from our community banking segment for the year ended December 31, 2020 totaled $21.2 million compared to $24.6 million for the year ended December 31, 2019. Net interest income increased $597,000 to $54.6 million for the year ended December 31, 2020 compared to $54.0 million for the year ended December 31, 2019. Net interest income increased primarily due to a decrease in interest expense as interest on time deposits decreased as replacement rates were lower. Partially offsetting the decrease in interest expense, interest income decreased primarily due to decreases in loan interest, mortgage-related securities, and debt securities, federal funds sold and short-term investments interest.
The Company delayed adoption of ASC Topic 326 as permitted under the CARES Act. The Company calculated the allowance using the incurred loss model. Provision for loan losses was $6.1 million for the year ended December 31, 2020 compared to a negative provision of $1.1 million for the year ended December 31, 2019 as economic conditions significantly worsened during the year ended December 31, 2020.
Noninterest income increased $3.7 million for the year ended December 31, 2020 due primarily to increases in loan fees and a gain from death benefits on bank owned life insurance. The loan fees increased primarily due to loan prepayment fees and fees earned on loan swaps. Cash surrender value of life insurance decreased as the balance decreased due to death benefit proceeds received on two bank owned life insurance policies. Other income increased primarily due to gain on death benefits, wealth management fees, and rental income.
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Compensation, payroll taxes, and other employee benefits expense increased $2.0 million to $20.2 million due primarily to an increase in salaries expense, health insurance expense, and variable compensation. Occupancy, office furniture and equipment decreased due primarily to computer supplies and snow plowing expense. Data processing and advertising expense increased primarily due to the rollout of a new digital banking platform and promotions for deposit customers during the year ended December 31, 2020. Communications expense, real estate owned, and other expenses increased while professional fees expense decreased.
Comparison of Mortgage Banking Segment Operations for the Years Ended December 31, 2020 and 2019
Net income totaled $59.9 million for the year ended December 31, 2020 compared to $11.2 million for the year ended December 31, 2019. We originated $4.43 billion in mortgage loans held for sale (including sales to the community banking segment) during the year ended December 31, 2020, which represents an increase of $1.51 billion, or 51.6%, from the $2.92 billion originated during the year ended December 31, 2019. The increase in loan production volume was driven by a $1.18 billion, or 216.2%, increase in refinance products driven by a decrease in fixed mortgage rates. Mortgage purchase products increased $330.2 million, or 13.9% due to an increased housing demand. Total mortgage banking noninterest income increased $109.7 million, or 86.5%, to $236.7 million during the year ended December 31, 2020 compared to $126.9 million during the year ended December 31, 2019. The increase in mortgage banking noninterest income was related to a 51.6% increase in volume and an 20.2% increase in gross margin on loans originated and sold for the year ended December 31, 2020 compared to December 31, 2019. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The increase in gross margin on loans originated and sold reflects industry demand due to the low rate environment resulting in higher volume. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.
Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Our origination efforts continue to be focused on loans made for the purpose of residential purchases, as opposed to mortgage refinance. The percentage of origination volume related to purchase activity decreased to 61.1% from 81.4% of total originations for the year ended December 31, 2020 and 2019, respectively, as refinance demand accelerated from the low rate environment. The mix of loan type trended towards more conventional loans and less governmental loans; with conventional loans and governmental loans comprising 75.8% and 24.2%, respectively of all loan originations, respectively, during the year ended December 31, 2020, compared to 69.5% and 30.5% of all originations, respectively, during the year ended December 31, 2019.
During the year ended December 31, 2020, mortgage servicing rights related to $975.9 million in loans receivable with a book value of $6.4 million were sold at a gain of $600,000. There were no sales of mortgage servicing rights during the year ended December 31, 2019.
Total compensation, payroll taxes and other employee benefits increased $35.2 million, or 41.8%, to $119.4 million for the year ended December 31, 2020 compared to $84.2 million for the year ended December 31, 2019. The increase in compensation expense was primarily a result of the increase in commission expense as fundings increased, along with an increase in bonus and incentives due to a record level of originations. In addition, branch manager pay increased as branches were more profitable due to increased volume and margin during the year. Occupancy, office furniture, and equipment expense decreased due to lower rent expense as underperforming branches closed offset by an increase in computer expenses to accommodate remote work. Advertising expense decreased as the low rate environment attracted customers. Loan processing expenses increased as loan costs increased due to loan application volume. Professional fees increased primarily due to a $4.25 million legal settlement in 2020 (see further discussion in Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information) along with ongoing litigation costs. Other noninterest expense increased primarily due to increased provision for loan sale losses driven by an increase in sales volumes and increased uncertainty regarding selling loans to third party investors from COVID-19 pandemic challenges and the amortization of mortgage servicing rights as the value of the servicing portfolio has increased in 2020 compared to 2019.
Waterstone Mortgage Corporation originates loans in various states. The states where we originate greater than 10% of total activity are Florida and New Mexico.
Comparison of Consolidated Waterstone Financial, Inc. Results of Operations for the Years Ended December 31, 2020 and 2019
Years Ended December 31,
(Dollars in Thousands, except per share amounts)
Earnings per share - basic 3.32 1.38
Earnings per share - diluted 3.30 1.37
Return on average assets 3.77 % 1.82 %
Return on average equity 20.18 % 9.14 %
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Average Balance Sheets, Interest and Yields/Costs
The following table set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans were included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.
Years Ended December 31,
Average Average Average Average Average Average
Balance Interest Rate Balance Interest Rate Balance Interest Rate
(Dollars in Thousands)
Interest-earning assets:
Interest-bearing liabilities:
Noninterest-bearing liabilities
Net interest margin on a fully tax equivalent basis 2.68 % 2.85 % 3.11 %
(1) Includes net deferred loan fee amortization income of $1.7 million, $672,000 and $622,000 for the years ended December 31, 2020, 2019, and 2018, respectively.
(2) Includes available for sale securities.
(3) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the years ended December 31, 2020, 2019, and 2018. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.79%, 2.49%, and 2.29% for the years ended
December 31, 2020, 2019, and 2018, respectively.
(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.
(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(6)Net interest margin represents net interest income divided by average total interest-earning assets.
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Rate/Volume Analysis
The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume. There were no out-of-period items or adjustments for either of the years ending December 31, 2020 or 2019.
Years Ended December 31, Years Ended December 31,
Increase (Decrease) due to Increase (Decrease) due to
Volume Rate Net Volume Rate Net
(In Thousands)
Interest and dividend income:
Interest expense:
Demand accounts 9 (4 ) 5 - - -
(2) Non-accrual loans have been included in average loans receivable balance.
(3) Includes available for sale securities.
(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the years ended December 31, 2020, 2019, and 2018.
Net Interest Income
Net interest income increased $1.3 million, or 2.5%, to $53.5 million during the year ended December 31, 2020 compared to $52.2 million during the year ended December 31, 2019.
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Provision for Loan Losses
The Company delayed adoption of ASC Topic 326 as permitted under the CARES Act. As a result, the Company calculated the current year allowance using the incurred loss model. The provision for loan losses was $6.3 million for the year ended December 31, 2020 compared to a negative provision for loan losses of $900,000 for the year ended December 31, 2019 as economic conditions worsened due to the COVID-19 pandemic along with an increase of loan downgrades to our Watch category. Additional qualitative risk factors were applied to each of the loan categories primarily to account for the significant increase in the unemployment rate and those downgrades. We had a provision for loan losses of $6.1 million at the community banking segment and $265,000 for the mortgage banking segment. Net recoveries were $96,000 for the year ended December 31, 2020.
The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for loan losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Loss" section.
Noninterest Income
Years Ended December 31,
(Dollars in Thousands)
Increase in cash surrender value of life insurance 1,905 1,935 (30 ) -1.6 %
Total noninterest income increased $113.3 million, or 86.6%, to $244.0 million during the year ended December 31, 2020 compared to $130.8 million during the year ended December 31, 2019. The increase resulted primarily from an increase in mortgage banking income along with increases in service charges on loans and deposit and other income categories.
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Noninterest Expenses
Years Ended December 31,
(Dollars in Thousands)
Total noninterest expenses increased $46.8 million, or 34.3%, to $183.1 million during the year ended December 31, 2020 compared to $136.3 million during the year ended December 31, 2019.
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Income Taxes
Income tax expense increased $15.3 million to $27.0 million during the year ended December 31, 2020, compared to $11.7 million during the year ended December 31, 2019 as pretax income increased $60.5 million. Income tax expense was recognized during the year ended December 31, 2020 at an effective rate of 24.9% compared to an effective rate of 24.5% during the year ended December 31, 2019. The Company recognized a benefit of $354,000 related to the proceeds received on the bank owned life insurance death benefit during the year ended December 31, 2020.
Liquidity and Capital Resources
We maintain liquid assets at levels we consider adequate to meet our liquidity needs. The liquidity ratio is equal to average daily cash and cash equivalents for the period divided by average total assets. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The operational adequacy of our liquidity position at any point in time is dependent upon the judgment of the Chief Financial Officer as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators. Regulatory liquidity, as required by the WDFI, is based on current liquid assets as a percentage of the prior month’s average deposits and short-term borrowings. Minimum primary liquidity is equal to 4.0% of deposits and short-term borrowings and minimum total regulatory liquidity is equal to 8.0% of deposits and short-term borrowings. The Bank’s primary and total regulatory liquidity at December 31, 2020 were 12.2% and 23.1%, respectively.
Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used to manage long- and short-term cash flows include advances from the FHLB.
A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At December 31, 2020 and 2019, $94.8 million and $74.3 million, respectively, of our assets were invested in cash and cash equivalents. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage related securities, increases in deposit accounts, Federal funds purchased and advances from the FHLB.
Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flows included in our Consolidated Financial Statements.
During the years ended December 31, 2020, and 2019, we originated $4.33 billion and $2.85 billion in loans for sale and sold loans of $4.40 billion and $2.90 billion. During the year ended December 31, 2020, loan repayments net of loan originations resulted in a positive cash flows of $12.4 million, respectively. During the year ended December 31, 2019, loan originations net of loan repayments resulted in a negative cash flows of $9.9 million. Cash received from the principal repayments of debt and mortgage related securities and maturity and calls of debt securities totaled $50.5 million and $40.0 million for the years ended December 31, 2020 and 2019, respectively. We purchased $29.5 million and $28.9 million in debt securities and mortgage related securities classified as available for sale during the years ended December 31, 2020 and 2019, respectively. The net increases in deposits were $117.1 million and $29.3 million for the years ending December 31, 2020 and 2019. We received a $9.6 million death benefit on a bank owned life insurance policy in 2020. There was a net increase in borrowings of $24.5 million and $48.5 million for the years ended December 31, 2020 and 2019. During the years ended December 31, 2020 and 2019, we repurchased common stock of $36.2 million and $22.8 million, respectively. During the years ended December 31, 2020 and 2019, we paid cash dividends on common stock of $31.5 million and $26.0 million, respectively.
Deposits increased by $117.1 million from December 31, 2019 to December 31, 2020. The increase was driven by an increase of $97.4 million in money market and savings deposits and $58.2 million in demand deposits offset by a decrease of $38.4 million in time deposits. Deposit flows are generally affected by the level of interest rates, market conditions and products offered by local competitors and other factors.
Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At December 31, 2020, we had $29.0 million in short term advances from the FHLB. At December 31, 2020, we had $470.0 million in long term advances from the FHLB with contractual maturity dates in 2027, 2028, and 2029. The 2027 advance has a contractual maturity date in December 2027. There are two 2028 advances that have contractual maturities in 2028. The remaining 2028 advance maturities have single call options in March 2021, and May 2021, along with two advances that have quarterly call options beginning in June 2020 and September 2020. The 2029 advance maturities have quarterly call options currently available and the other options that began in November 2020, beginning in August 2021, and beginning in May 2022. As an additional source of funds, the mortgage banking segment has a repurchase agreement. At December 31, 2020, we had $9.1 million outstanding under the repurchase agreement with a total outstanding commitment of $55.0 million.
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At December 31, 2020, we had outstanding commitments to originate loans receivable of $23.9 million. In addition, at December 31, 2020, we had unfunded commitments under construction loans of $74.2 million, unfunded commitments under business lines of credit of $19.2 million and unfunded commitments under home equity lines of credit and standby letters of credit of $14.9 million. At December 31, 2020, certificates of deposit scheduled to mature in less than one year totaled $576.9million. Based on prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits are not retained by us, we will have to utilize other funding sources, such as Federal Home Loan Bank of Chicago advances, Federal Reserve Discount Window or brokered deposits to maintain our level of assets. However, such borrowings may not be available on attractive terms, or at all, if and when needed. Alternatively, we would reduce our level of liquid assets, such as our cash and cash equivalents and securities available for sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.
Capital
Shareholders’ equity increased by $19.4 million, or 4.9%, to $413.1 million at December 31, 2020 from $393.7 million at December 31, 2019. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, an increase in fair value of the security portfolio, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends and the repurchase of stock.
The Company's Board of Directors authorized a stock repurchase program in the third quarter of 2020. As of December 31, 2020, the Company had repurchased 10.7 million shares at an average price of $14.39 under previously approved stock repurchase plans.
Waterstone Financial, Inc. and WaterStone Bank are subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories. At December 31, 2020, Waterstone Financial, Inc. and WaterStone Bank exceeded all regulatory capital requirements and are considered “well capitalized” under regulatory guidelines. See “Supervision and Regulation—Capital Requirements” and Note 9 - Regulatory Capital of the notes to the consolidated financial statements.
Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements
WaterStone Bank has various financial obligations, including contractual obligations and commitments that may require future cash payments. The following tables present information indicating various non-deposit contractual obligations and commitments of WaterStone Bank as of December 31, 2020 and the respective maturity dates.
Contractual Obligations
More Than More Than
One Year Three Years
One Year or Through Through Five Over Five
Total Less Three Years Years Years
(In Thousands)
Deposits without a stated maturity (1) $ $483,542 $ $483,542 $ - $ - $ -
_______________
(1) Excludes interest.
(2) Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest that will accrue on the advances. See call provisions in Note 8 - Borrowings.
(3) Represents non-cancellable operating leases for offices and equipment.
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Other Commitments
More than More than
One Year Three
through Years
One Year Three Through Over Five
Total or Less Years Five Years Years
(In Thousands)
Real estate loan commitments(1) $ $23,891 $ $23,891 $ - $ - $ -
Unused portion of home equity lines of credit(2) 13,653 13,653 - - -
Unused portion of construction loans(3) 74,173 74,173 - - -
Unused portion of business lines of credit 19,207 19,207 - - -
Standby letters of credit 1,296 1,296 - - -
_______________
(1) Commitments for loans are extended to customers for up to 90 days after which they expire.
(2) Unused portions of home equity loans are available to the borrower for up to 10 years.
(3) Unused portions of construction loans are available to the borrower for up to one year.
See Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information.
Impact of Inflation and Changing Prices
The financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies, our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects of inflation.
Quarterly Financial Information
The following table sets forth certain unaudited quarterly data for the periods indicated:
Quarter Ended
March 31 June 30 September 30 December 31
(In thousands, except per share data)
Provision (credit) for loan losses (680 ) 30 (80 ) (170 )
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Item 7A.Quantitative and Qualitative Disclosures About Market Risk
Management of Market Risk
General.The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, WaterStone Bank’s board of directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.
We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as three to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLBC. These measures should reduce the volatility of our net interest income in different interest rate environments.
Income Simulation. Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time. At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities. Our most recent simulation uses projected repricing of assets and liabilities at December 31, 2020 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rate assumptions may have a significant impact on interest income simulation results. Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our mortgage related assets that may in turn affect our interest rate sensitivity position. When interest rates rise, prepayment speeds slow and the average expected lives of our assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a positive impact on net interest income and earnings.
The following interest rate scenario displays the percentage change in net interest income over a one-year time horizon assuming increases of 100, 200 and 300 basis points and a decrease of 100 basis points. The results incorporate actual cash flows and repricing characteristics for balance sheet accounts following an instantaneous parallel change in market rates based upon a static (no growth balance sheet).
Analysis of Net Interest Income Sensitivity
Immediate Change in Rates
(Dollar Amounts in Thousands)
At December 31, 2020, a 100 basis point instantaneous increase in interest rates had the effect of increasing forecast net interest income over the next 12 months by 4.33% while a 100 basis point decrease in rates had the effect of decreasing net interest income by 4.82%.
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Item 8.Financial Statements and Supplementary Data
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Waterstone Financial, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated statements of financial condition of Waterstone Financial, Inc. and Subsidiaries (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 1, 2021 expressed an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Loan Losses - Adjustments to historical loss ratios
As described in Notes 1 and 3 to the consolidated financial statements, the Company’s allowance for loan losses totaled $18,823,000, which consists of a reserve on loans collectively evaluated for impairment (“general reserve”) of $18,800,000 and a reserve on loans individually evaluated for impairment (“specific reserve”) of $23,000 at December 31, 2020. Management’s estimate of the allowance for loan losses is based on its assessment of probable loan losses inherent in the Company’s loan portfolio at December 31, 2020. The Company’s general reserve is estimated by applying historical loss ratios, adjusted for risk components not reflected in the historical loss experience, to the balance of the non-impaired loan portfolio. Historical loss ratios are calculated for each loan category based on historical losses experienced by the Company. Adjustments to historical loss ratios are made for differences in various risk components including changes in lending policies and personnel, economic conditions, portfolio origination activity, interest rates, and past due and classified loan trends. The adjustments to historical loss ratios require a significant amount of judgement by management and are highly sensitive to changes in significant assumptions.
We identified the adjustments to historical loss ratios in the general reserve component of the allowance for loan losses as a critical audit matter as auditing the underlying adjustments required significant auditor judgment as amounts determined by management rely on analysis that is highly subjective and are highly sensitive to changes in significant assumptions.
Our audit procedures related to the adjustments to historical loss ratios in the general reserve component of the allowance for loan losses included the following, among others:
/s/ RSM US LLP
We have served as the Company's auditor since 2014.
Chicago, Illinois
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Waterstone Financial, Inc. and Subsidiaries
Consolidated Statements of Financial Condition
December 31, 2020 and 2019
December 31,
Assets (In Thousands, except share data)
Securities available for sale (at fair value) 159,619 178,476
Federal Home Loan Bank stock (at cost) 26,720 21,150
Cash surrender value of life insurance 63,573 69,665
Liabilities and Shareholders’ Equity
Liabilities:
Advance payments by borrowers for taxes 3,522 4,212
Commitments and contingencies (Note 14)
Shareholders’ equity:
Accumulated other comprehensive income, net of taxes 2,326 642
See accompanying notes to consolidated financial statements
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Waterstone Financial, Inc. and Subsidiaries
Consolidated Statements of Operations
Years ended December 31, 2020, 2019 and 2018
Years ended December 31,
(In Thousands, except per share amounts)
Interest income:
Debt securities, federal funds sold and short-term investments 3,363 4,528 4,086
Interest expense:
Provision (credit) for loan losses 6,340 (900 ) (1,060 )
Noninterest income:
Increase in cash surrender value of life insurance 1,905 1,935 1,848
Noninterest expenses:
Real estate owned (8 ) (146 ) 1
Income per share:
Weighted average shares outstanding:
See accompanying notes to consolidated financial statements
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Waterstone Financial, Inc. and Subsidiaries
Consolidated Statements of Comprehensive Income
Years ended December 31, 2020, 2019 and 2018
Years ended December 31,
(In Thousands)
Other comprehensive income (loss), net of tax:
See accompanying notes to consolidated financial statements
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Waterstone Financial, Inc. and Subsidiaries
Consolidated Statements of Changes in Shareholders’ Equity
Years Ended December 31, 2020, 2019 and 2018
Common Stock
Comprehensive income:
Other comprehensive loss: - - - - - (1,884 ) (1,884 )
Total comprehensive income 28,870
Reclassification for net deferred tax liability revaluation - - - (5 ) - - (5 )
Stock based compensation expense - - 1,760 - - - 1,760
Comprehensive income:
Other comprehensive income: - - - - - 3,003 3,003
Total comprehensive income 38,906
Stock compensation activity 50 - 659 - - - 659
Stock based compensation expense - - 1,067 - - - 1,067
Comprehensive income:
Other comprehensive income: - - - - - 1,684 1,684
Total comprehensive income 82,829
Stock based compensation expense - - 716 - - - 716
See accompanying notes to consolidated financial statements
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Waterstone Financial, Inc. and Subsidiaries
Consolidated Statements of Cash Flows
Years ended December 31, 2020, 2019 and 2018
Years ended December 31,
(In Thousands)
Operating activities:
Provision (credit) for loan losses 6,340 (900 ) (1,060 )
Origination of mortgage servicing rights (13,406 ) (354 ) (427 )
Gain on death benefit on bank owned life insurance (1,456 ) - -
Decrease (increase) in accrued interest receivable 387 (7 ) (413 )
Increase in cash surrender value of life insurance (1,905 ) (1,935 ) (1,848 )
Decrease (increase) in prepaid income tax 113 330 (1,178 )
Net gain on real estate owned (107 ) (304 ) (265 )
Gain on sale of mortgage servicing rights (600 ) - (417 )
Change in other assets and other liabilities, net 7,523 (1,013 ) 545
Investing activities:
Purchases of:
Debt securities (10,125 ) - -
Bank owned life insurance (180 ) (180 ) (180 )
Mortgage banking branch - - (163 )
Proceeds from:
Proceeds on sales of mortgage servicing rights 6,985 - 1,433
Death benefit from bank owned life insurance 9,633 - 474
Net cash provided by (used in) investing activities 44,176 (1,152 ) (78,438 )
Financing activities:
Net decrease in advance payments by borrowers for taxes (690 ) (159 ) (505 )
Supplemental information:
Cash paid or credited during the period for:
Noncash investing activities:
Loans receivable transferred to other real estate 637 1,052 545
Dividends declared but not paid in other liabilities 5,232 3,501 3,798
See accompanying notes to consolidated financial statements
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Waterstone Financial, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
Years ended December 31, 2020, 2019 and 2018
1) Summary of Significant Accounting Policies
The following significant accounting and reporting policies of Waterstone Financial, Inc. and subsidiaries (collectively, the “Company”), conform to U.S. generally accepted accounting principles, or (“GAAP”), and are used in preparing and presenting these consolidated financial statements.
Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not result in any changes to previously reported net income. The Company reclassed certain line items in the Consolidated Statements of Cash Flows. The Company reclassified the Cost of Shares Repurchased line item presented in prior periods to the Additional Paid in Capital line item in the Consolidated Statements of Financial Condition. The Cost of Shares Repurchased column was reclassified to the Additional Paid in Capital line in the Consolidated Statements of Changes in Shareholders’ Equity.
a) Nature of Operations
The Company is a one-bank holding company with two operating segments – community banking and mortgage banking. WaterStone Bank SSB (the "Bank" or "WaterStone Bank") is principally engaged in the business of attracting deposits from the general public and using such deposits to originate real estate, business and consumer loans.
The Bank provides a full range of financial services to customers through branch locations in southeastern Wisconsin. The Bank is subject to the regulations of certain federal and state agencies and undergoes periodic examinations by those regulatory authorities.
The Bank owns a mortgage banking subsidiary that originates residential real estate loans held for sale at various branch offices across the country. Mortgage banking volume fluctuates widely in connection with movements in interest rates. Mortgage banking income is reported as a single line item in the statements of operations while mortgage banking expense is distributed among the various noninterest expense lines. Compensation, payroll taxes and other employee benefits expense fluctuates in relation to fluctuations in mortgage banking income.
b) Principles of Consolidation
The consolidated financial statements include the accounts and operations of Waterstone Financial, Inc. and its wholly owned subsidiary, WaterStone Bank. The Bank has the following wholly owned subsidiaries: Wauwatosa Investments, Inc., Waterstone Mortgage Corporation, and Main Street Real Estate Holdings, LLC. All significant intercompany accounts and transactions have been eliminated in consolidation.
c) Use of Estimates
The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include: the allowance for loan losses, income taxes, and fair value measurements.
e) Cash and Cash Equivalents
The Company considers federal funds sold and highly liquid debt instruments with a maturity of three months or less when purchased to be cash equivalents.
e) Securities
Available for Sale Securities
At the time of purchase, investment securities are classified as available for sale, as management has the intent and ability to hold such securities for an indefinite period of time, but not necessarily to maturity. Any decision to sell investment securities available for sale would be based on various factors, including, but not limited to asset/liability management strategies, changes in interest rates or prepayment risks, liquidity needs, or regulatory capital considerations. Available for sale securities are carried at fair value, with the unrealized gains and losses, net of deferred tax, reported as a separate component of equity in accumulated other comprehensive income (loss). The cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity or, in the case of mortgage-backed securities and collateralized mortgage obligations, over the estimated life of the security. Such amortization or accretion is included in interest income from securities. Realized gains or losses on securities sales (using specific identification method) are included in noninterest income. Declines in value judged to be other than temporary are included in net impairment losses recognized in earnings in the consolidated statements of operations.
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Other Than Temporary Impairment
One of the significant estimates related to securities is the evaluation of investments for other than temporary impairment. The Company assesses investment securities with unrealized loss positions for other than temporary impairment on at least a quarterly basis. When the fair value of an investment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated as either temporary or other than temporary. In evaluating other than temporary impairment, management considers the length of time and extent to which the fair value has been less than cost and the expected recovery period of the security, the financial condition and near-term prospects of the issuer, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in the near term. Declines in the fair value of investment securities below amortized cost are deemed to be other than temporary when the Company cannot assert that it will recover its amortized cost basis, including whether the present value of cash flows expected to be collected is less than the amortized cost basis of the security. If it is more likely than not that the Company will be required to sell the security before recovery or if the Company has the intent to sell, an other than temporary impairment write down is recognized in earnings equal to the difference between the security’s amortized cost and its fair value. If it is not more likely than not that the Company will be required to sell the security before recovery and if the Company does not intend to sell, the other than temporary impairment write down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to other factors, which is recognized as a separate component of equity. Following the recognition of an other than temporary impairment representing credit loss, the book value of an investment less the impairment loss realized becomes the new cost basis. The determination as to whether an other than temporary impairment exists and, if so, the amount considered other than temporarily impaired, or not impaired, is subjective and, therefore, the timing and amount of other than temporary impairments constitute material estimates that are subject to significant change.
Federal Home Loan Bank Stock
Federal Home Loan Bank ("FHLB") stock is carried at cost, which is the amount that the stock is redeemable by tendering to the FHLB or the amount at which shares can be sold to other FHLB members.
f) Loans Held for Sale
The origination of residential real estate loans is an integral component of the business of the Company. The Company generally sells its originations of long-term fixed interest rate mortgage loans in the secondary market, and on a selective basis, retains the rights to service the loans sold. Gains and losses on the sales of these loans are determined using the specific identification method. Mortgage loans originated for sale are generally sold within 45 days after closing.
The Company has elected to carry loans held for sale at fair value. Fair value is generally determined by estimating a gross premium or discount, which is derived from pricing currently observable in the market. The amount by which cost differs from market value is accounted for as a valuation adjustment to the carrying value of the loans. Changes in value are included in mortgage banking income in the consolidated statements of operations.
Costs to originate loans held for sale are expensed as incurred and are included on the appropriate noninterest expense lines of the statements of operations. Salaries, commissions and related payroll taxes are the primary costs to originate and comprised approximately 76.0% of total mortgage banking noninterest expense for 2020.
The value of mortgage loans held for sale and other residential mortgage loan commitments to customers are hedged by utilizing both best efforts and mandatory forward commitments to sell loans to investors in the secondary market. Such forward commitments are generally entered into at the time when applications are taken to protect the value of the mortgage loans from increases in market interest rates during the period held. The Company recognizes revenue associated with the expected future cash flows of servicing loans at the time a forward loan commitment is made.
g) Loans Receivable and Related Interest Income
Loans are classified as held for investment when management has both the intent and ability to hold the loan for the foreseeable future, or until maturity or payoff. Loans are carried at the principal amount outstanding, net of any unearned income, charge-offs and unamortized deferred fees and costs. Loan origination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loan yield. Amortization is based on a level-yield method over the contractual life of the related loans or until the loan is paid in full.
Loan interest income is recognized on the accrual basis. Accrual of interest is generally discontinued either when reasonable doubt exists as to the full, timely collection of interest or principal, or when a loan becomes contractually past due 90 days or more with respect to interest or principal. At that time, previously accrued and uncollected interest on such loans is reversed and additional income is recorded only to the extent that payments are received and the collection of principal is reasonably assured. Generally, loans are restored to accrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longer in doubt.
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A loan is accounted for as a troubled debt restructuring if the Company, for economic reasons related to the borrower’s financial condition, grants a concession to the borrower that it would not otherwise consider. A troubled debt restructuring typically involves a modification of terms such as a reduction of the stated interest rate, a deferral of principal payments or a combination of both for a temporary period of time. If the borrower was performing in accordance with the original contractual terms at the time of the restructuring, the restructured loan is accounted for on an accruing basis as long as the borrower continues to comply with the modified terms. If the loan was not accounted for on an accrual basis at the time of restructuring, the restructured loan remains in non-accrual status until the loan completes a minimum of six consecutive contractual payments.
The provisions of the CARES Act included an election to not apply the guidance on accounting for troubled debt restructurings to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. In December 2020, the Consolidated Appropriations Act, 2021 was passed, which extended the TDR provisions of the CARES Act to January 1, 2022. The Company elected to adopt these provisions of the CARES Act.
h) Allowance for Loan Losses
The allowance for loan losses is presented as a reserve against loans and represents the Company’s assessment of probable loan losses inherent in the loan portfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to income. Estimated loan losses are charged against the allowance when the loan balance is confirmed to be uncollectible directly or indirectly by the borrower or upon initiation of a foreclosure action by the Company. Subsequent recoveries, if any, are credited to the allowance.
The allowance provides for probable losses that have been identified with specific customer relationships and for probable losses believed to be inherent in the loan portfolio, but have not been specifically identified. The Company utilizes its own loss history to estimate inherent losses on loans. Although the Bank allocates portions of the allowance to specific loans and loan types, the entire allowance is available for any loan losses that occur.
The Company evaluates the need for specific valuation allowances on loans that are considered impaired. A loan is considered impaired when, based on current information and events, it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. Within the loan portfolio, all non-accrual loans and loans modified under troubled debt restructurings have been determined by the Company to meet the definition of an impaired loan. In addition, other loans may be considered impaired loans. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan’s original effective interest rate or the fair value of the underlying collateral.
The Company also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the loan portfolio. The risk components that are evaluated include lending policies and personnel, economic conditions, portfolio origination activity, interest rates, and past due and classified loan trends.
The appropriateness of the allowance for loan losses is approved quarterly by the Company’s board of directors. The allowance reflects management’s best estimate of the amount needed to provide for the probable loss on impaired loans, as well as other credit risks of the Company, and is based on a risk model developed and implemented by management and approved by the Company’s board of directors.
Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in economic conditions. In addition, federal regulators periodically review the Company’s allowance for loan losses. Such regulators have the authority to require the Company to recognize additions to the allowance at the time of their examination.
i) Real Estate Owned
Real estate owned consists of properties acquired through, or in lieu of, loan foreclosure. Real estate owned is transferred into the portfolio at estimated net realizable value. To the extent that the net carrying value of the loan exceeds the estimated fair value of the property at the date of transfer, the excess is charged to the allowance for loan losses within 90 days of being transferred. Subsequent write-downs to reflect current fair value, as well as gains and losses upon disposition and revenue and expenses incurred in maintaining such properties, are treated as period costs and included in real estate owned in the consolidated statements of operations.
j) Mortgage Servicing Rights
The Company sells residential mortgage loans in the secondary market and, on a selective basis, retains the right to service the loans sold. Upon sale, a mortgage servicing rights asset is capitalized, which represents the then current fair value of future net cash flows expected to be realized for performing servicing activities. Mortgage servicing rights, when purchased, are initially recorded at fair value. Mortgage servicing rights are amortized over the period of estimated net servicing income, and assessed for impairment at each reporting date. Mortgage servicing rights are carried at the lower of the initial capitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets in the consolidated statements of financial condition. To the extent that the Company sells mortgage servicing rights, a gain is recognized for the amount of which sale proceeds exceed the remaining unamortized cost of the servicing rights that were sold. Gains on sale of mortgage servicing rights are included in other noninterest income in the consolidated statements of operations.
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k) Cash Surrender Value of Life Insurance
The Company purchases bank owned life insurance on the lives of certain employees. The Company is the beneficiary of the life insurance policies. The cash surrender value of life insurance is reported at the amount that would be received in cash if the polices were surrendered. Increases in the cash value of the policies and proceeds of death benefits received are recorded in noninterest income. The increase in cash surrender value of life insurance is not subject to income taxes, as long as the Company has the intent and ability to hold the policies until the death benefits are received.
l) Office Properties and Equipment
Office properties and equipment, including leasehold improvements and software, are stated at cost, net of depreciation and amortization. Depreciation and amortization are computed on the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over the lease term, if shorter than the estimated useful life. Maintenance and repairs are charged to expense as incurred, while additions or major improvements are capitalized and depreciated over their estimated useful lives. Estimated useful lives of the assets are 10 to 30 years for office properties, three years to 10 years for equipment, and three years for software.
m) Income Taxes
The Company and its subsidiaries file consolidated federal and combined state income tax returns. The provision for income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax returns. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, as well as net operating loss carry forwards. 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 as income or expense in the period that includes the enactment date.
The Company evaluates the realizability of its deferred tax assets on a quarterly basis. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that a deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and business conditions.
Positions taken in the Company’s tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of uncertain tax positions are initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the tax authorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of being realized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Interest and penalties on income tax uncertainties are classified within income tax expense in the consolidated statements of operations.
n) Earnings Per Share
Earnings per share (EPS) are computed using the two-class method. Basic earnings per share is computed by dividing net income allocated to common shareholders by the weighted average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised. Shares of the Employee Stock Ownership Plan committed to be released are considered outstanding for both common and diluted EPS.
o) Comprehensive Income
Comprehensive income is the total of reported net income and changes in unrealized gains or losses, net of tax, on securities available for sale.
p) Employee Stock Ownership Plan (ESOP)
Compensation expense under the ESOP is equal to the fair value of common shares released or committed to be released to participants in the ESOP in each respective period. Common stock purchased by the ESOP and not committed to be released to participants is included in the consolidated statements of financial condition at cost as a reduction of shareholders’ equity.
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q) Share Repurchases
The Company has a share repurchase program. Repurchases under the repurchase program may be made in the open market, through block trades and other negotiated transactions. The share repurchase program transactions take place primarily in open market transactions, subject to market conditions. There is no fixed termination date for the repurchase program, and the program may be suspended. Under Maryland law, shares repurchased are constituted as authorized but unissued. The Company reduced the common stock at par value and to the extent the cost acquired exceeds par value, it is recorded through additional paid-in capital on the consolidated statements of financial condition and consolidated statements of changes in shareholders’ equity.
r) Impact of Recent Accounting Pronouncements
ASC Topic 326 "Financial Instruments - Credit Losses." Authoritative accounting guidance under ASC Topic 326, "Financial Instruments - Credit Losses" amended the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information for credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The authoritative guidance also requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected (net of the allowance for credit losses). In addition, the credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses rather than a write-down.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. It included an option for entities to delay the adoption of ASC Topic 326 until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. Due to the uncertainty on the economy and unemployment from COVID-19, the Company has determined to delay its adoption of ASC Topic 326 and has calculated and recorded its provision for loan losses under the incurred loss model that existed prior to ASC Topic 326. On December 27, 2020, the 2021 Consolidated Appropriations Act was signed into law. The legislation extended the delay of the adoption of ASC Topic 326 allowed under the CARES Act until the earlier of the termination date of the national emergency declaration by the President or January 1, 2022.
The Company has input the available historical Company data to build an internal model and is reviewing the assumptions to support the calculation under ASC Topic 326. Management’s methodology for estimating the allowance for credit losses under the current expected credit losses (CECL) model includes the use of relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience by vintage classified by loans with similar risk profiles provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as changes in underwriting standards, portfolio mix, portfolio volume, delinquency rates, interest rates, or other relevant factors. Management will continue to review and adjust these and other factors. Ongoing evaluations have been performed by vintage adjusted for prepayments. For two portfolio segments, management expects to use a weighted average remaining maturity methodology, which contemplates loss expectations on a pool basis, relying on historic loss rates. Management is validating the CECL model and methodologies.
When finalized, this one-time change as a result of the adoption of CECL will be recorded, net of tax, as an adjustment to retained earnings effective on the earlier of the termination date of the national emergency declaration by the President or January 1, 2022.
Financial statement users should be aware that the allowance for credit loss is, by design, inherently sensitive to changes in economic outlook, loan and lease portfolio composition, portfolio duration, and other factors.
As we continue to evaluate the provisions of ASC Topic 326 as of and for the year ended December 31, 2020, we are considering the following in developing our forecast and its effect on our CECL calculations:
•Duration, extent and severity of COVID-19;
•Effect of government assistance; and
•Unemployment and effect on economies and markets.
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2) Securities
Securities Available for Sale
The amortized cost and fair value of the Company’s investment in securities follow:
Amortized cost Gross unrealized gains Gross unrealized losses Fair value
(In Thousands)
Collateralized mortgage obligations
Government sponsored enterprise bonds 2,500 3 - 2,503
Amortized cost Gross unrealized gains Gross unrealized losses Fair value
(In Thousands)
Collateralized mortgage obligations
The Company’s mortgage-backed securities and collateralized mortgage obligations issued by government sponsored enterprises are guaranteed by one of the following government sponsored enterprises: Fannie Mae, Freddie Mac or Ginnie Mae. At December 31, 2020, $785,000of the Company's mortgage related securities were pledged as collateral to secure mortgage banking related activities and $7.2 million were pledged as collateral to secure back-to-back swaps. At December 31, 2019, $1.2 million of the Company's mortgage related securities were pledged as collateral to secure mortgage banking related activities.
The amortized cost and fair value of securities at December 31, 2020, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because issuers or borrowers may have the right to prepay obligations with or without prepayment penalties.
Amortized cost Fair value
(In Thousands)
Debt securities:
Due after one year through five years 36,309 37,520
Due after five years through ten years 18,146 17,808
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Gross unrealized losses on securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
Less than 12 months 12 months or longer Total
Fair value Unrealizedloss Fairvalue Unrealized loss Fairvalue Unrealized loss
(In Thousands)
Mortgage-backed securities $ 2,089 $ (15 ) $ - $ - $ 2,089 $ (15 )
Collateralized mortgage obligations
Government sponsored enterprise issued 4,880 (13 ) - - 4,880 (13 )
Municipal securities - - - - - -
Less than 12 months 12 months or longer Total
Fairvalue Unrealized loss Fairvalue Unrealized loss Fairvalue Unrealized loss
(In Thousands)
Collateralized mortgage obligations
Municipal securities 100 (1 ) - - 100 (1 )
The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. In evaluating whether a security’s decline in market value is other-than-temporary, management considers the length of time and extent to which the fair value has been less than cost, financial condition of the issuer and the underlying obligors, quality of credit enhancements, volatility of the fair value of the security, the expected recovery period of the security and ratings agency evaluations. In addition, the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds and the value of any underlying collateral.
As of December 31, 2020, the Company identified one municipal security that was deemed to be other-than-temporarily impaired. The security was issued by a tax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company received audited financial statements with respect to the municipal issuer that called into question the ability of the underlying taxing district that issued the securities to operate as a going concern. During the year ended December 31, 2012, the Company’s analysis of the security in this municipality resulted in $77,000 in credit losses that were charged to earnings with respect to this municipal security. An additional $17,000 credit loss was charged to earnings during the year ended December 31, 2014 with respect to this security as a sale occurred at a discounted price. As of December 31, 2020, the remaining impaired security had an amortized cost of $116,000 and a total life-to-date impairment of $94,000.
As of December 31, 2020, the Company had one corporate debt security, included in other debt securities, which had been in an unrealized loss position for twelve months or longer. This security was determined not to be other-than-temporarily impaired as of December 31, 2020. The Company has determined that the decline in fair value of these securities is not attributable to credit deterioration, and as the Company does not intend to sell nor is it more likely than not that it will be required to sell these securities before recovery of the amortized cost basis, this security is not considered other-than-temporarily impaired.
The unrealized losses for the other debt security with an unrealized loss greater than 12 months is due to the current slope of the yield curve. The security earns a floating rate that is indexed to the 10 year Treasury interest rate.
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3) Loans Receivable
Loans receivable at December 31, 2020 and 2019 are summarized as follows:
December 31,
Mortgage loans: (In Thousands)
Residential real estate:
The Company provides several types of loans to its customers, including residential, construction, commercial and consumer loans. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to one borrower or to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. While credit risks tend to be geographically concentrated in the Company’s Milwaukee metropolitan area and while 73.7% of the Company’s loan portfolio involves loans that are secured by residential real estate, there are no concentrations with individual or groups of related borrowers. While the real estate collateralizing these loans is primarily residential in nature, it ranges from owner-occupied single family homes to large apartment complexes.
Qualifying loans receivable totaling $1.07 billion were pledged as collateral against $499.0 million and $470.0 million in outstanding Federal Home Loan Bank of Chicago advances under a blanket security agreement at December 31, 2020 and December 31, 2019, respectively.
Certain of the Company's executive officers, directors, employees, and their related interests have loans with the Bank. As of December 31, 2020 and December 31, 2019, loans aggregating approximately $7.2 million and $6.3 million, respectively, were outstanding to such parties. None of these loans were past due or considered impaired as of December 31, 2020 and December 31, 2019.
An analysis of past due loans receivable as of December 31, 2020 and 2019 follows:
Mortgage loans: (In Thousands)
Residential real estate:
Mortgage loans: (In Thousands)
Residential real estate:
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As of December 31, 2020, there was a $586,000 loan that was 90 or more days past due and still accruing interest. The bank received full payoff of the loan subsequent to December 31, 2020. As of December 31, 2019, there were no loans that were 90 or more days past due and still accruing interest.
A summary of the activity for the years ended December 31, 2020, 2019 and 2018 in the allowance for loan losses follows:
(In Thousands)
Charge-offs (69 ) (14 ) (1 ) - - - - (84 )
A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of the year ended December 31, 2020 follows:
(In Thousands)
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A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of the year ended December 31, 2019 follows:
(In Thousands)
The following table presents information relating to the Company’s internal risk ratings of its loans receivable as of December 31, 2020 and 2019:
At December 31, 2020 (In Thousands)
At December 31, 2019 (In Thousands)
Factors that are important to managing overall credit quality include sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an allowance for loan losses, and sound non-accrual and charge-off policies. Our underwriting policies require an officers' loan committee review and approval of all loans in excess of $500,000 except for residential loans which has an approval limit in excess of $1.0 million. A member of the credit department, independent of the loan originator, performs a loan review for all loans. Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans. To do so, we maintain a loan review system under which our credit management personnel review non-owner occupied one- to four-family, multi-family, construction and land, and commercial real estate that individually, or as part of an overall borrower relationship exceed $1.0 million in potential exposure and review commercial loans that individually, or as part of an overall borrower relationship exceed $200,000 in potential exposure. Loans meeting these criteria are reviewed on an annual basis, or more frequently, if the loan renewal is less than one year. With respect to this review process, management has determined that pass loans include loans that exhibit acceptable financial statements, cash flow and leverage. Watch loans have potential weaknesses that deserve management’s attention, and if left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit. Substandard loans are considered inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged. These loans generally have a well-defined weakness that may jeopardize liquidation of the debt and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Finally, a loan is considered to be impaired when it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement. Management has determined that all non-accrual loans and loans modified under troubled debt restructurings meet the definition of an impaired loan.
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The Company’s procedures dictate that an updated valuation must be obtained with respect to underlying collateral at the time a loan is deemed impaired. Updated valuations may also be obtained upon transfer from loans receivable to real estate owned based upon the age of the prior appraisal, changes in market conditions or known changes to the physical condition of the property.
Estimated fair values are reduced to account for sales commissions, broker fees, unpaid property taxes and additional selling expenses to arrive at an estimated net realizable value. This estimated adjustment factor is based upon the Company’s actual experience with respect to sales of real estate owned over the prior two years. In situations in which we are placing reliance on an appraisal that is more than one year old, an additional adjustment factor is applied to account for downward market pressure since the date of appraisal. The additional adjustment factor is based upon relevant sales data available for our general operating market as well as company-specific historical net realizable values as compared to the most recent appraisal prior to disposition.
With respect to multi family income producing real estate, appraisals are reviewed and estimated collateral values are adjusted by updating significant appraisal assumptions to reflect current real estate market conditions. Significant assumptions reviewed and updated include the capitalization rate, rental income and operating expenses. These adjusted assumptions are based upon recent appraisals received on similar properties as well as on actual experience related to real estate owned and currently under Company management.
The following tables present data on impaired loans as of and for the year ended December 31, 2020 and 2019.
As of or for the Year Ended December 31, 2020
Total Impaired with Reserve
Multi family - - - - - -
Home equity - - - - - -
Construction and land - - - - - -
Commercial real estate - - - - - -
Consumer - - - - - -
Commercial - - - - - -
Total Impaired with no Reserve
Consumer - - - - - -
Total Impaired
Consumer - - - - - -
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As of or for the Year Ended December 31, 2019
Total Impaired with Reserve
Multi family - - - - - -
Home equity - - - - - -
Construction and land - - - - - -
Consumer - - - - - -
Commercial - - - - - -
Total Impaired with no Reserve
Construction and land - - - - - -
Consumer - - - - - -
Commercial - - - - - -
Total Impaired
Construction and land - - - - - -
Consumer - - - - - -
Commercial - - - - - -
The difference between a loan’s recorded investment and the unpaid principal balance represents a partial charge-off resulting from a confirmed loss due to the value of the collateral securing the loan being below the loan balance and management’s assessment that the full collection of the loan balance is not likely.
When a loan is considered impaired, interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower’s financial condition and prospects for repayment, including consideration of the borrower’s sustained historical repayment performance and other relevant factors.
The determination as to whether an allowance is required with respect to impaired loans is based upon an analysis of the value of the underlying collateral and/or the borrower’s intent and ability to make all principal and interest payments in accordance with contractual terms. The evaluation process is subject to the use of significant estimates and actual results could differ from estimates. This analysis is primarily based upon third party appraisals and/or a discounted cash flow analysis. In those cases in which no allowance has been provided for an impaired loan, the Company has determined that the estimated value of the underlying collateral exceeds the remaining outstanding balance of the loan. Of the total $16.4 million of impaired loans as of December 31, 2020 for which no allowance has been provided, $866,000 in charge-offs have been recorded to reduce the unpaid principal balance to an amount that is commensurate with the loan’s net realizable value, using the estimated fair value of the underlying collateral. To the extent that further deterioration in property values continues, the Company may have to reevaluate the sufficiency of the collateral servicing these impaired loans resulting in additional provisions to the allowance for loans losses or charge-offs.
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The following presents data on troubled debt restructurings:
Accruing Non-accruing Total
Amount Number Amount Number Amount Number
(Dollars in Thousands)
Multi family - - - - - -
Accruing Non-accruing Total
Amount Number Amount Number Amount Number
(Dollars in Thousands)
Troubled debt restructurings involve granting concessions to a borrower experiencing financial difficulty by modifying the terms of the loan in an effort to avoid foreclosure. Typical restructured terms include six months to twelve months of principal forbearance, a reduction in interest rate or both. In no instances have the restructured terms included a reduction of outstanding principal balance. At December 31, 2020, $11.6 million in loans had been modified in troubled debt restructurings and $532,000 of these loans were included in the non-accrual loan total. The remaining $11.0 million, while meeting the internal requirements for modification in a troubled debt restructuring, were current with respect to payments under their original loan terms at the time of the restructuring, and thus continued to be included with accruing loans. Provided these loans perform in accordance with the modified terms, they will continue to be accounted for on an accrual basis.
All loans that have been modified in a troubled debt restructuring are considered to be impaired. As such, an analysis has been performed with respect to all of these loans to determine the need for a valuation reserve. When a loan is expected to perform in accordance with the restructured terms and ultimately return to and perform under contract terms, a valuation allowance is established equal to the excess of the present value of the expected future cash flows under the original contract terms as compared with the modified terms, including an estimated default rate. When there is doubt as to the borrower’s ability to perform under the restructured terms or ultimately return to and perform under market terms, a valuation allowance is established equal to the impairment when the carrying amount exceeds fair value of the underlying collateral. As a result of the impairment analysis, no valuation allowance has been deemed necessary as of December 31, 2020 with respect to the $11.6 million in troubled debt restructurings. As of December 31, 2019, $7,000 in valuation allowance had been established with respect to the $4.0 million in troubled debt restructurings.
If an updated credit department review indicates no other evidence of elevated credit risk and the borrower completes a minimum of six consecutive contractual payments, the loan is returned to accrual status at that time.
The following presents troubled debt restructurings by concession type at December 31, 2020 and 2019:
Performing inaccordance withmodified terms In Default Total
Amount Number Amount Number Amount Number
(Dollars in Thousands)
Interest reduction and principal forbearance $ 3,236 4 $ - - $ 3,236 4
Performing inaccordance withmodified terms In Default Total
Amount Number Amount Number Amount Number
(Dollars in Thousands)
Interest reduction and principal forbearance $ 3,246 6 $ 448 2 $ 3,694 8
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The following presents data on troubled debt restructurings:
For the Year Ended
Amount Number Amount Number
(Dollars in Thousands)
Loans modified as a troubled debt restructure
Commercial real estate $ 8,031 3 $ - -
There were no troubled debt restructurings within the past twelve months for which there was a default during the year ended December 31, 2020.
The provisions of the CARES Act and the 2021 Consolidated Appropriations Act included an election to not apply the guidance on accounting for troubled debt restructurings to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) January 1, 2022 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Company elected to adopt these provisions of the CARES Act. At December 31, 2020, the Company had approximately $1.2 million in outstanding loans subject to interest and principal and principal deferral agreements.
The following table presents data on non-accrual loans:
As of December 31,
(Dollars in Thousands)
Residential
Construction and land 43 -
Commercial real estate 41 303
Commercial - -
Consumer - -
Total non-accrual loans to total loans 0.40 % 0.51 %
Total non-accrual loans to total assets 0.25 % 0.35 %
4) Office Properties and Equipment
Office properties and equipment are summarized as follows:
December 31,
(In Thousands)
Depreciation of premises and equipment totaled $2.5 million, $2.5 million and $2.3 million for the years ended December 31, 2020, 2019 and 2018, respectively.
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5) Real Estate Owned
Real estate owned is summarized as follows:
December 31,
(In Thousands)
One- to four-family $ - $ 46
Multi-family - -
Commercial real estate - -
Valuation allowance at end of period - (554 )
Total real estate owned, net $ 322 $ 748
The following table presents the activity in real estate owned:
Year Ended December 31,
(In Thousands)
Real estate owned at beginning of period $ 748 $ 2,152
Transferred in from loans receivable 637 1,052
Write downs - -
Other activity - (10 )
Real estate owned at end of period $ 322 $ 748
Residential one- to four-family mortgage loans that were in the process of foreclosure were $1.7 million and $2.3 million at December 31, 2020 and December 31, 2019, respectively.
6) Mortgage Servicing Rights
The following table presents the activity related to the Company’s mortgage servicing rights:
Year ended December 31,
(In Thousands)
Mortgage servicing rights at beginning of the period $ 282 $ 109
Mortgage servicing rights at end of the period 5,977 359
Valuation allowance during the period - (77 )
Mortgage servicing rights at the end of the period, net $ 5,977 $ 282
During the year ended December 31, 2020, on a consolidated basis, $4.33 billion in residential loans were originated for sale, which excludes the loans originated from Waterstone Mortgage Corporation and purchased by WaterStone Bank. During the same period, sales of loans held for sale totaled $4.15 billion, generating mortgage banking income of $233.2 million. The unpaid principal balance of loans serviced for others was $871.8 million and $64.9 million at December 31, 2020 and December 31, 2019 respectively. Loans serviced for others are not reflected in the consolidated statements of financial condition.
The fair value of mortgage servicing rights was $7.0 million at December 31, 2020 and $282,000 at December 31, 2019.
During the year ended December 31, 2020, the Company sold mortgage servicing rights related to $975.9 million in loans receivable and with a book value of $6.4 million for $7.0 million resulting in a gain on sale of $600,000. During the year ended December 31, 2019, the Company sold no mortgage servicing rights.
The following table shows the estimated future amortization expense for mortgage servicing rights at December 31, 2020 for the years ended December 31 periods indicated:
(In Thousands)
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7) Deposits
The aggregate amount of time deposit accounts with balances greater than $250,000 at December 31, 2020 and 2019 amounted to $102.6 million and $91.7 million, respectively.
A summary of interest expense on deposits is as follows:
Years ended December 31,
(In Thousands)
Interest-bearing demand deposits $ 38 $ 33 $ 33
Money market, savings, and escrow deposits 1,768 1,247 599
A summary of the contractual maturities of time deposits at December 31, 2020 is as follows:
(In Thousands)
Three to four years 1,057
Four through five years 1,216
8) Borrowings
Borrowings consist of the following:
Balance WeightedAverageRate Balance WeightedAverageRate
(Dollars in Thousands)
Short term:
Long term:
Federal Home Loan Bank advances maturing:
The short-term repurchase agreement represents the outstanding portion of a total $55.0 million commitment with one unrelated bank. The short-term repurchase agreement is utilized by Waterstone Mortgage Corporation to finance loans originated for sale. This agreement is secured by the underlying loans being financed. Related interest rates are based upon the note rate associated with the loans being financed. The short-term repurchase agreement had a $9.1 million balance at December 31, 2020 and a $13.6 million balance at December 31, 2019.
The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. In addition, the Company enters into agreements under which it sells loans held for sale subject to an obligation to repurchase the same loans. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of assets. The obligation to repurchase the assets is reflected as a liability in the Company's consolidated statements of financial condition, while the securities and loans held for sale underlying the repurchase agreements remain in the respective investment securities and loans held for sale asset accounts. In other words, there is no offsetting or netting of the investment securities or loans held for sale assets with the repurchase agreement liabilities. The Company's repurchase agreement is subject to master netting agreements, which sets forth the rights and obligations for repurchase and offset. Under the master netting agreement, the Company is entitled to set off the collateral placed with a single counterparty against obligations owed to that counterparty.
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The $29.0 million short-term advances consists of one $25.0 million advance with a fixed rate of 0.25% and a maturity date of January 4, 2021 and one $4.0 million advance with a fixed rate of 0.00% and a maturity date of May 1, 2021.
The $50.0 million advance due in 2027 has a fixed rate of 1.73% and has a contractual maturity date in December 2027.
The $255.0 million in advances due in 2028 consists of one $25.0 million advance with a fixed rate of 2.16%, one $25.0 million advance with a fixed rate of 2.40%, two advances totaling $55.0 million with a fixed rate of 2.27% both with a FHLB single call option in March 2021, two advances totaling $50.0 million with fixed rates of 2.34% and 2.48% both with a FHLB single call option in May 2021, one advance of $50.0 million with a fixed rate of 2.34% and with a FHLB quarterly call option currently available, and one advance of $50.0 million with a fixed rate of 2.57% and with a FHLB quarterly call option that currently available.
The $165.0 million in advances due in 2029 consists of one $50.0 million advance with a fixed rate of 1.98% with a FHLB quarterly call option in May 2022, one $50.0 million advance with a fixed rate of 1.75% with a FHLB quarterly call option beginning in August 2021, one $25.0 million advance with a fixed rate of 1.52% with a FHLB quarterly call option currently available, and one advance of $40.0 million with a fixed rate of 1.02% and with a FHLB quarterly call option currently available.
The Company selects loans that meet underwriting criteria established by the Federal Home Loan Bank Chicago (FHLBC) as collateral for outstanding advances. The Company’s borrowings at the FHLBC are limited to 80% of the carrying value of unencumbered one- to four-family mortgage loans, 64% of the carrying value of home equity loans and 75% of the carrying value of over four-family loans. In addition, these advances are collateralized by FHLBC stock of $26.7 million at December 31, 2020 and $21.2 million at December 31, 2019. In the event of prepayment, the Company is obligated to pay all remaining contractual interest on the advance.
9) Regulatory Capital
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements, or overall financial performance deemed by the regulators to be inadequate, 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 condition and results of operations. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company's and Bank’s assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. The Company's and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
As required by applicable legislation, the federal banking agencies were required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes. The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement.
The federal banking agencies must set the minimum capital for the new Community Bank Leverage Ratio at not less than 8% and not more than 10%. Beginning in the second quarter 2020 and until the end of the year, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the Community Bank Leverage Ratio framework; and qualified community banks will have until January 1, 2022, before the Community Bank Leverage Ratio requirement is re-established at greater than 9%. Pursuant to Section 4012 of the CARES Act and related interim final rules, the Community Bank Leverage Ratio will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. A financial institution can elect to be subject to this new definition, and opt-out of this new definition, at any time. As a qualified community bank, we elected to opt-out of this definition during the second quarter of 2020.
Prompt corrective action regulations provide five classifications: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If only adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.
The minimum capital ratios set forth in the Regulatory Capital Plans will be increased and other minimum capital requirements will be established if and as necessary. In accordance with the Regulatory Capital Plans, the Bank will not pursue any acquisition or growth opportunity, declare any dividend or conduct any stock repurchase that would cause the Bank's total risk-based capital ratio and/or its Tier 1 leverage ratio to fall below the established minimum capital levels or the capital levels required for capital adequacy plus the capital conservation buffer. The minimum capital conservation buffer is 2.5%.
As of December 31, 2020, the Bank was well-capitalized, with all capital ratios exceeding the well-capitalized requirement. There are no conditions or events that management believes have changed the Bank’s prompt corrective action capitalization category.
The Bank is subject to regulatory restrictions on the amount of dividends it may declare and pay to the Company without prior regulatory approval, and to regulatory notification requirements for dividends that do not require prior regulatory approval.
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The actual and required capital amounts and ratios as of December 31, 2020 and 2019 are presented in the table below:
Amount Ratio Amount Ratio Amount Ratio Amount Ratio
(Dollars In Thousands)
Total capital (to risk-weighted assets)
Tier I capital (to risk-weighted assets)
Common Equity Tier 1 Capital (to risk-weighted assets)
Tier I capital (to average assets)
State of Wisconsin (to total assets)
(Dollars In Thousands)
Total capital (to risk-weighted assets)
Tier I capital (to risk-weighted assets)
Common Equity Tier 1 Capital (to risk-weighted assets)
Tier I capital (to average assets)
State of Wisconsin (to total assets)
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10) Stock Based Compensation
Stock-Based Compensation Plan
In 2006, the Company’s shareholders approved the 2006 Equity Incentive Plan. All stock awards granted under this plan vest over a period of five years and are required to be settled in shares of the Company’s common stock. The exercise price for all stock options granted was equal to the quoted NASDAQ market closing price on the date that the awards were granted and the stock options expire ten years after the grant date, if not exercised. All restricted stock grants are issued from previously unissued shares.
In 2015, the Company's shareholders approved the 2015 Equity Incentive Plan. A total of 2,530,000 stock options and 1,012,000 restricted shares were approved for award. The exercise price for all stock options granted was equal to the quoted NASDAQ market close price on the date that the awards were granted and expire ten years after the grant date, if not exercised.