Item 1A.Risk Factors
An investment in our securities is subject to risks inherent in our business and the industry in which we operate.
Before making an investment decision, you should carefully consider the risks and uncertainties described below and all other information included in this report, as well as other reports we file with the SEC. The risks described below may adversely
affect our business, financial condition and operating results. In addition to these risks and the other risks and uncertainties described in Item 1, “Business-Forward Looking Statements” and Item 7, “Management's Discussion and Analysis of Financial
Condition and Results of Operations,” there may be additional risks and uncertainties that are not currently known to us or that we currently deem to be immaterial that could materially and adversely affect our business, financial condition or
operating results. The value or market price of our securities could decline due to any of these identified or other risks. Past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to
anticipate results or trends in future periods.
Risks Related to the COVID-19 Pandemic
The COVID-19 pandemic has adversely impacted our business and financial results, and the ultimate impact will depend on future
developments, which are highly uncertain and cannot be predicted, including the scope and duration of the pandemic and actions taken by governmental authorities in response to the pandemic.
The COVID-19 pandemic has created extensive disruptions to the global economy and to the lives of individuals throughout the world.
Governments, businesses, and the public have taken unprecedented actions to contain the spread of COVID-19 and to mitigate its effects, including quarantines, travel bans, shelter-in-place orders, closures of businesses and schools, fiscal stimulus,
and legislation designed to deliver monetary aid and other relief. While the scope, duration, and full effects of COVID-19 are continually evolving and not fully known, the pandemic and related efforts to contain it have disrupted global economic
activity, adversely affected the functioning of financial markets, impacted interest rates, increased economic and market uncertainty, and disrupted trade and supply chains. If these effects continue for a prolonged period or result in sustained
economic stress or recession, many of the risk factors identified in our Form 10-K could be exacerbated and such effects could have a material adverse impact on us in a number of ways related to credit, collateral, customer demand, funding,
operations, interest rate risk, human capital and self-insurance, as described in more detail below.
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Moreover, we rely on many third parties in our business operations, including the appraiser of the real property collateral, vendors
that supply essential services such as loan servicers, providers of financial information, systems and analytical tools and providers of electronic payment and settlement systems, and local and federal government agencies, offices, and courthouses.
In light of the developing measures responding to the pandemic, many of these entities may limit the availability and access of their services. For example, loan origination could be delayed due to the limited availability of real estate appraisers
for the collateral. Loan closings could be delayed related to reductions in available staff in recording offices or the closing of courthouses in certain counties, which slows the process for title work, mortgage and UCC filings in those counties. If
the third-party service providers continue to have limited capacities for a prolonged period or if additional limitations or potential disruptions in these services materialize, it may negatively affect our operations.
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Because there have been no comparable recent global pandemics that resulted in similar global impact, we do not yet know the full extent
of COVID-19’s effects on our business, operations, or the global economy as a whole. Any future development will be highly uncertain and cannot be predicted, including the scope and duration of the pandemic, the effectiveness of our work from home
arrangements, third party providers’ ability to support our operation, and any actions taken by governmental authorities and other third parties in response to the pandemic. The uncertain future development of this crisis could materially and
adversely affect our business, operations, operating results, financial condition, liquidity or capital levels.
Risks Related to Regulatory Matters
We operate in a highly regulated environment and we are subject to supervision, examination and enforcement action by various bank
regulatory agencies.
We are subject to extensive supervision, regulation, and examination by the WDFI, the Federal Deposit Insurance Corporation and the
Federal Reserve Board. As a result, we are limited in the manner in which we conduct our business, undertake new investments and activities, and obtain financing. This system of regulation is designed primarily for the protection of the Deposit
Insurance Fund and our depositors, and not for the benefit of our stockholders. Under this system of regulation, the regulatory authorities have extensive discretion in connection with their supervisory, enforcement, rulemaking and examination
activities and policies, including rules or policies that: establish minimum capital levels; restrict the timing and amount of dividend payments; govern the classification of assets; determine the adequacy of loan loss reserves for regulatory
purposes; and establish the timing and amounts of assessments and fees.
Moreover, as part of their examination authority, the banking regulators assign numerical ratings to banks and savings institutions
relating to capital, asset quality, management, liquidity, earnings and other factors. These ratings are inherently subjective and the receipt of a less than satisfactory rating in one or more categories may result in enforcement action by the
banking regulators against a financial institution. A less than satisfactory rating may also prevent a financial institution, such as WaterStone Bank or its holding company, from obtaining necessary regulatory approvals to access the capital markets,
paying dividends, acquiring other financial institutions or establishing new branches.
In addition, we must comply with significant anti-money laundering and anti-terrorism laws and regulations, Community Reinvestment Act
laws and regulations, and fair lending laws and regulations. Government agencies have the authority to impose monetary penalties and other sanctions on institutions that fail to comply with these laws and regulations, which could significantly affect
our business activities, including our ability to acquire other financial institutions or expand our branch network.
Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.
The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being
used for money laundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury’s Office of Financial Crimes Enforcement Network. These rules
require financial institutions to establish procedures for identifying and verifying the identity of customers seeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the last
year, several banking institutions have received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliance with these laws and regulations, these policies and
procedures may not be effective in preventing violations of these laws and regulations.
Monetary policies and regulations of the Federal Reserve Board could adversely affect our business, financial condition and results of
operations.
In addition to being affected by general economic conditions, our earnings and growth are affected by the policies of the Federal
Reserve Board. An important function of the Federal Reserve Board is to regulate the money supply and credit conditions. Among the instruments used by the Federal Reserve Board to implement these objectives are open market purchases and sales of U.S.
government securities, adjustments of the discount rate and changes in banks’ reserve requirements against bank deposits. These instruments are used in varying combinations to influence overall economic growth and the distribution of credit, bank
loans, investments and deposits. Their use also affects interest rates charged on loans or paid on deposits.
We are subject to the Community Reinvestment Act and fair lending laws, and failure to comply with these laws could lead to material
penalties.
The Community Reinvestment Act (“CRA”), the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and
regulations impose nondiscriminatory lending requirements on financial institutions. A successful regulatory challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions,
including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on mergers and acquisitions activity and restrictions on expansion. Private parties may also have the ability to challenge an
institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations.
The Federal Reserve Board may require us to commit capital resources to support WaterStone
Bank.
Federal law requires that a holding company act as a source of financial and managerial strength to its subsidiary
bank and to commit resources to support such subsidiary bank. Under the “source of strength” doctrine, the Federal Reserve Board may require a holding company to make capital injections into a troubled subsidiary bank and may charge the holding
company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it and therefore may be required
to borrow the funds or raise capital. Thus, any borrowing or funds needed to raise capital required to make a capital injection becomes more difficult and expensive and could have an adverse effect on our business, financial condition and results of
operations.
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Risks Related to Interest Rates
Changing interest rates may have a negative effect on our results of operations.
Our earnings and cash flows are dependent on our net interest income and income from our mortgage banking operations. Interest rates are
highly sensitive to many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Changes in market interest rates could
have an adverse effect on our financial condition and results of operations.
Decreases in interest rates often result in increased prepayments of loans and mortgage-related securities, as borrowers refinance their
loans to reduce borrowings costs. Under these circumstances, we are subject to reinvestment risk to the extent we are unable to reinvest the cash received from such prepayments in loans or other investments that have interest rates that are
comparable to the interest rates on existing loans and securities.
Increases in interest rates can also have an adverse impact on our results of operations. A portion of our loans have adjustable
interest rates. While the higher payment amounts we would receive on these loans in a rising interest rate environment may increase our interest income, some borrowers may be unable to afford the higher payment amounts, which may result in a higher
rate of loan delinquencies and defaults, as well as lower loan originations, as borrowers who may qualify for a loan based on certain mortgage repayments, may not be able to afford repayments based on higher interest rates for the same loan amounts.
The marketability of the underlying collateral also may be adversely affected in a high interest rate environment.
Although we have implemented asset and liability management strategies designed to reduce the effects of changes in interest rates on
our results of operations, any substantial, unexpected, prolonged change in market interest rate could have a material adverse effect on our financial condition and results of operations. Also, our interest rate models and assumptions likely may not
fully predict or capture the impact of actual interest rate changes on our balance sheet.
See “Management’s Discussion and Analysis of Financial Condition" and "Quantitative and Qualitative Disclosures About Market
Risk—Management of Market Risk.”
Risks Related to Lending Matters
We intend to increase our commercial business lending, and we intend to continue our commercial real estate and multi-family residential
real estate lending, which may expose us to increased lending risks and have a negative effect on our results of operations.
We continue to focus on originating commercial business, commercial real estate and multi-family residential real estate loans. These
types of loans generally have a higher risk of loss compared to our one- to four-family residential real estate loans. Commercial business loans may expose us to greater credit risk than loans secured by residential real estate because the collateral
securing these loans may not be sold as easily as residential real estate. In addition, commercial business and commercial real estate loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans
also have greater credit risk than residential real estate loans as repayment is generally dependent upon the successful operation of the borrower’s business. Also, the collateral underlying commercial business loans may fluctuate in value. Some of
our commercial business loans are collateralized by equipment, inventory, accounts receivable or other business assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable
may be uncollectible and inventories may be obsolete or of limited use. Multi-family residential real estate and commercial real estate loans involve increased risk because repayment is dependent on income being generated in amounts sufficient to
cover property maintenance and debt service. In addition, if loans that are collateralized by real estate become troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount
of principal and interest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our financial condition and results of operations.
If our allowance for loan losses is not sufficient to cover actual loan losses, our results of operations would be negatively affected.
In determining the amount of the allowance for loan losses, we analyze our loss and delinquency experience by loan categories and we
consider the effect of existing economic conditions. In addition, we make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of our borrowers and the value of the real estate and other
assets serving as collateral for the repayment of many of our loans. If the results of our analyses are incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to
our allowance and would decrease our net income. Our emphasis on loan growth and on increasing our portfolio of commercial real estate loans, as well as any future credit deterioration, could require us to increase our allowance further in the
future. In addition, any future credit deterioration, including as a result of COVID-19, could require us to increase our allowance for loan losses in the future.
In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan
losses or recognize further loan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect on our results of operations and financial condition.
We are subject to environmental liability risk associated with lending activities.
A significant portion of our loan portfolio is secured by real estate, and we could become subject to environmental liabilities with
respect to one or more of these properties. During the ordinary course of business, we may foreclose on and take title to properties securing defaulted loans. In doing so, there is a risk that hazardous or toxic substances could be found on these
properties. If hazardous conditions or toxic substances are found on these properties, we may be liable for remediation costs, as well as for personal injury and property damage, civil fines and criminal penalties regardless of when the hazardous
conditions or toxic substances first affected any particular property. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materially reduce the affected property’s value or limit our ability to use
or sell the affected property. In addition, future laws or regulations, or more stringent interpretations or enforcement policies with respect to existing laws and regulations may increase our exposure to environmental liability, and heightened
pressure from investors and other stakeholders may require us to incur additional expenses with respect to environmental matters. Although we have policies and procedures to perform an environmental review before initiating any foreclosure action on
nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. The remediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on
us.
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The foreclosure process may adversely impact our recoveries on
non-performing loans
The judicial foreclosure process is protracted, which
delays our ability to resolve non-performing loans through the sale of the underlying collateral. The longer timelines have been the result of the economic crisis, additional consumer protection initiatives related to the foreclosure process,
increased documentary requirements and judicial scrutiny, and, both voluntary and mandatory programs under which lenders may consider loan modifications or other alternatives to foreclosure. These reasons and the legal and regulatory responses have
impacted the foreclosure process and completion time of foreclosures for residential mortgage lenders. This may result in a material adverse effect on collateral values and our ability to minimize its losses.
Risks Related to Operational Matters
We rely heavily on certificates of deposit, which has increased our cost of funds and could continue to do so in the future.
Our reliance on certificates of deposit to fund our operations has resulted in a higher cost of funds than would otherwise be the case
if we had a higher percentage of demand deposits, savings deposits and money market accounts. In addition, if our certificates of deposit do not remain with us, we may be required to access other sources of funds, including loan sales, other types of
deposits, including replacement certificates of deposit, securities sold under agreements to repurchase, advances from the Federal Home Loan Bank of Chicago and other borrowings. Depending on market conditions, we may be required to pay higher rates
on such deposits or other borrowings than we currently pay on our certificates of deposit.
We may not be able to attract and retain skilled people.
Our success depends, in large part, on our ability to attract and retain skilled people. Competition for the best people in most
activities engaged in by us can be intense, and we may not be able to hire sufficiently skilled people or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because
of their skills, knowledge of our markets, years of industry experience, and the difficulty of promptly finding qualified replacement personnel.
Loss of key employees may disrupt relationships with certain customers.
Our business is primarily relationship-driven in that many of our key employees have extensive customer relationships. Loss of a key
employee with such customer relationships may lead to the loss of business if the customers were to follow that employee to a competitor. While we believe our relationship with our key personnel is good, we cannot guarantee that all of our key
personnel will remain with our organization. Loss of such key personnel, should they enter into an employment relationship with one of our competitors, could result in the loss of some of our customers.
Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks.
We operate in diverse markets and rely on the ability of our employees and systems to process a high number of transactions. Operational
risk is the risk of loss resulting from our operations, including but not limited to, the risk of fraud by employees or persons outside our company, the execution of unauthorized transactions by employees, errors relating to transaction processing
and technology, breaches of the internal control system and compliance requirements, and business continuation and disaster recovery. Insurance coverage may not be available for such losses, or where available, such losses may exceed insurance
limits. This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicable regulatory standards, adverse business decisions or their implementation,
and customer attrition due to potential negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action, and suffer
damage to our reputation.
Risks associated with system failures, interruptions, or breaches of cybersecurity could negatively affect our earnings.
Information technology systems are critical to our business. We use various technology systems to manage our customer relationships,
general ledger, securities investments, deposits and loans. We have established policies and procedures to prevent or limit the effect of system failures, interruptions, and security breaches, but such events may still occur or may not be adequately
addressed if they do occur. Although we take numerous protective measures and otherwise endeavor to protect and maintain the privacy and security of confidential data, these systems may be vulnerable to unauthorized access, computer viruses, other
malicious code, cyber-attacks, cyber-theft and other events that could have a security impact. If one or more of such events were to occur, this potentially could jeopardize confidential and other information processed and stored in, and transmitted
through, our systems or otherwise cause interruptions or malfunctions in our or our customers' operations.
In addition, we outsource a majority of our data processing to certain third-party providers. If these third-party providers encounter
difficulties, or if we have difficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adversely affected. Threats to information security also exist in
the processing of customer information through various other vendors and their personnel.
The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers
and business, subject us to additional regulatory scrutiny, or expose us to litigation and possible financial liability. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate
vulnerabilities or other exposures, and we may be subject to litigation and financial losses that are not fully covered by our insurance. Any of these events could have a material adverse effect on our financial condition and results of operations.
Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses.
Our risk management framework is designed to minimize risk and loss to us. We seek to identify, measure, monitor, report and control our
exposure to risk, including strategic, market, liquidity, compliance and operational risks. While we use a broad and diversified set of risk monitoring and mitigation techniques, these techniques are inherently limited because they cannot anticipate
the existence or future development of currently unanticipated or unknown risks. Recent economic conditions and heightened legislative and regulatory scrutiny of the financial services industry, among other developments, have increased our level of
risk. Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks.
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Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.
Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of
loss due to fraud and other financial crimes. We have experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to prevent such losses, losses may still occur.
Our funding sources may prove insufficient to replace deposits at maturity and support our future growth.
We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a
number of funding sources in addition to core deposit growth and repayments and maturities of loans and investments. As we continue to grow, we are likely to become more dependent on these sources, which may include Federal Home Loan Bank advances,
proceeds from the sale of loans, federal funds purchased and brokered certificates of deposit. Adverse operating results or changes in industry conditions could lead to difficulty or an inability to access these additional funding sources. Our
financial flexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth at acceptable interest rates. If we are required to rely more heavily on
more expensive funding sources to support future growth, our revenues may not increase proportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.
Risks Related to Competitive Matters
Consumers may decide to use alternative options to complete financial transactions.
Technology is allowing parties to complete financial transactions through alternative methods that historically have involved banks.
Consumers can now easily access historically banking needs through online banking accounts, brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete certain transactions without the assistance of
banks.
The removal of banking with financial transactions could result in the loss of customer loans, customer deposits, and the related fee
income generated from those loans and deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Strong competition within our market areas may limit our growth and profitability.
Competition in the banking and financial services industry is intense. In our market areas, we compete with commercial banks, savings
institutions, mortgage brokerage firms, credit unions, finance companies, mutual funds, money market funds, insurance companies, and brokerage firms operating locally and elsewhere. Some of our competitors have greater name recognition and market
presence and offer certain services that we do not or cannot provide, all of which benefit them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we do. Competitive factors driven
by consumer sentiment or otherwise can also reduce our ability to generate fee income, such as through overdraft fees.
Risks Related to Mortgage Banking Operations
Secondary mortgage market conditions could have a material impact on our financial condition and results of operations.
Our mortgage banking operations provide a significant portion of our non-interest income. In addition to being affected by interest
rates, the secondary mortgage markets are also subject to investor demand for residential mortgage loans and increased investor yield requirements for these loans. These conditions may fluctuate or worsen in the future. In light of current
conditions, there is greater risk in retaining mortgage loans pending their sale to investors. We believe our ability to retain fixed-rate residential mortgage loans is limited. As a result, a prolonged period of secondary market illiquidity may
reduce our loan production volumes and could have a material adverse effect on our financial condition and results of operations.
Changes in the programs offered by secondary market purchasers or our ability to qualify for their programs may reduce our mortgage
banking revenues, which would negatively impact our non-interest income.
We generate mortgage revenues primarily from gains on the sale of single-family mortgage loans pursuant to programs currently offered by
Fannie Mae, Freddie Mac, Ginnie Mae and non-GSE investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any future changes in these programs, our eligibility to participate in such
programs, the criteria for loans to be accepted or laws that significantly affect the activity of such entities could, in turn, materially adversely affect our results of operations.
If we are required to repurchase mortgage loans that we have previously sold, it could negatively affect our earnings.
One of our primary business operations is our mortgage banking, which involves originating residential mortgage loans for sale in the
secondary market under agreements that contain representations and warranties related to, among other things, the origination and characteristics of the mortgage loans. We may be required to repurchase mortgage loans that we have sold in cases of
borrower default or breaches of these representations and warranties. If we are required to repurchase mortgage loans or provide indemnification or other recourse, this could increase our costs and thereby affect our future earnings.
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Risks Related to Economic Matters
Changes in economic conditions could adversely affect our earnings, as our borrowers’ ability to repay loans and the value of the
collateral securing our loans decline.
Economic conditions have an impact, to some extent, on our overall performance. Conditions such as an economic recession, rising
unemployment, changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore, our earnings. Because a majority of our loans are secured by real
estate, decreases in real estate values could adversely affect the value of property used as collateral. Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which
could have an adverse impact on our earnings. Consequently, declines in the economy in our market area could have a material adverse effect on our financial condition and results of operations.
Because most of our borrowers are located in the Milwaukee, Wisconsin metropolitan area, a prolonged downturn in the local economy, or a
decline in local real estate values, could cause an increase in nonperforming loans or a decrease in loan demand, which would reduce our profits.
Substantially all of our loans are secured by real estate located in our primary market area. Weakness in our local economy and our
local real estate markets could adversely affect the ability of our borrowers to repay their loans and the value of the collateral securing our loans, which could adversely affect our results of operations. Real estate values are affected by various
factors, including supply and demand, changes in general or regional economic conditions, interest rates, governmental rules or policies and natural disasters. Weakness in economic conditions also could result in reduced loan demand and a decline in
loan originations. In particular, a significant decline in real estate values would likely lead to a decrease in new loan originations and increased delinquencies and defaults by our borrowers.
Risks Related to Accounting Matters
Changes in our accounting policies or in accounting standards could materially affect how we report our financial condition and results
of operations.
Our accounting policies are essential to understanding our financial condition and results of operations. Some of these policies require
the use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make difficult, subjective, and complex judgments about
matters that are inherently uncertain, and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are
incorrect, we may experience material losses.
From time to time, the Financial Accounting Standards Board and the Securities and Exchange Commission change the financial accounting
and reporting standards or the interpretation of those standards that govern the preparation of our financial statements. These changes are beyond our control, can be hard to predict and could materially affect how we report our financial condition
and results of operations. We could also be required to apply a new or revised standard retroactively, which may result in our restating our prior period financial statements.
The need to account for certain assets at estimated fair value may adversely affect our results of operations.
We report certain assets, such as loans held for sale, at estimated fair value. Generally, for assets that are reported at fair value,
we use quoted market prices or valuation models that utilize observable market inputs to estimate fair value. Because we carry these assets on our books at their estimated fair value, we may incur losses even if the asset in question presents
minimal credit risk.
Other Risks Related to Our Business
A protracted government shutdown may result in reduced loan originations and related gains on sale and could negatively affect our
financial condition and results of operations.
Our mortgage banking operations provide a significant portion of our non-interest income. During any protracted federal government
shutdown, we may not be able to close certain loans and we may not be able to recognize non-interest income on the sale of loans. Some of the loans we originate are sold directly to government agencies, and some of these sales may be unable to be
consummated during the shutdown. In addition, we believe that some borrowers may determine not to proceed with their home purchase and not close on their loans, which would result in a permanent loss of the related non-interest income. A federal
government shutdown could also result in reduced income for government employees or employees of companies that engage in business with the federal government, which could result in greater loan delinquencies, increases in our nonperforming,
criticized and classified assets and a decline in demand for our products and services.
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Legal and regulatory proceedings and related matters could adversely affect us or the financial services industry in general.
We, and other participants in the financial services industry upon whom we rely to operate, have been and may in the future become
involved in legal and regulatory proceedings. Most of the proceedings we consider to be in the normal course of our business or typical for the industry; however, it is inherently difficult to assess the outcome of these matters, and other
participants in the financial services industry or we may not prevail in any proceeding or litigation.
Any litigation or regulatory proceeding could entail substantial costs and divert management’s attention away from our operations, and
any adverse determination could have a materially adverse effect on our business, brand or image, or our financial condition and results of our operations.
We are currently a defendant in multiple lawsuits alleging that Waterstone Mortgage Corporation violated certain provisions of the Fair
Labor Standards Act. Although we intend to vigorously defend our interests in this matter and pursue all possible defenses against the claims, we may ultimately be required to pay significant damages and attorney fees, which would adversely affect
our financial condition and results of operations. See Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for additional information.
We will be required to transition from the use of LIBOR in the future.
We have certain loans indexed to LIBOR to calculate the loan interest
rate. The LIBOR index will be discontinued for U.S. Dollar settings effective June 30, 2023. At this time, no consensus exists as to what rate or rates may become acceptable alternatives to LIBOR. The implementation of a substitute index or indices
for the calculation of interest rates under our loan agreements with our borrowers may incur significant expenses in effecting the transition, may result in reduced loan balances if borrowers do not accept the substitute index or indices, and may
result in disputes or litigation with customers over the appropriateness or comparability to LIBOR of the substitute index or indices, which could have an adverse effect on our results of operations. Additionally, since alternative rates are
calculated differently, the transition may change our market risk profile, requiring changes to risk and pricing models.
Changes in the valuation of our securities portfolio could adversely affect our profits.
Our securities portfolio may be impacted by fluctuations in fair value, potentially reducing accumulated other comprehensive income
and/or earnings. Fluctuations in fair value may be caused by changes in market interest rates, lower market prices for securities and limited investor demand. Management evaluates securities for other-than-temporary impairment on a monthly basis,
with more frequent evaluation for selected issues. In analyzing a debt issuer’s financial condition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have
occurred, industry analysts’ reports and, to a lesser extent given the relatively insignificant levels of depreciation in our debt portfolio, spread differentials between the effective rates on instruments in the portfolio compared to risk-free
rates. In analyzing an equity issuer’s financial condition, management considers industry analysts’ reports, financial performance and projected target prices of investment analysts within a one-year time frame. If this evaluation shows impairment
to the actual or projected cash flows associated with one or more securities, a potential loss to earnings may occur. Changes in interest rates can also have an adverse effect on our financial condition, as our available-for-sale securities are
reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates. We increase or decrease our stockholders’ equity by the amount of change in the estimated fair value of the available-for-sale securities, net of
taxes. The declines in fair value could result in other-than-temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect on our net income and capital levels.
New lines of business or new products and services may subject us to additional risks.
From time to time, we may implement new lines of business or offer new products and services within existing lines of business. In
addition, we will continue to make investments in research, development, and marketing for new products and services. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not
fully developed. In developing and marketing new lines of business and/or new products and services we may invest significant time and resources. Initial timetables for the development and introduction of new lines of business and/or new products or
services may not be achieved and price and profitability targets may not prove feasible. Furthermore, if customers do not perceive our new offerings as providing significant value, they may fail to accept our new products and services. External
factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, the burden on management and
our information technology of introducing any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development
and implementation of new lines of business or new products or services could have a material adverse effect on our business, financial condition and results of operations.
Increasing scrutiny and evolving expectations from customers, regulators, investors, and other stakeholders with respect to our
environmental, social and governance practices may impose additional costs on us or expose us to new or additional risks.
Companies are facing increasing scrutiny from customers, regulators, investors, and other stakeholders related to their environmental,
social and governance (“ESG”) practices and disclosure. Investor advocacy groups, investment funds and influential investors are also increasingly focused on these practices, especially as they relate to the environment, health and safety, diversity,
labor conditions and human rights. Increased ESG related compliance costs could result in increases to our overall operational costs. Failure to adapt to or comply with regulatory requirements or investor or stakeholder expectations and standards
could negatively impact our reputation, ability to do business with certain partners, and our stock price. New government regulations could also result in new or more stringent forms of ESG oversight and expanding mandatory and voluntary reporting,
diligence, and disclosure.
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Acquisitions may disrupt our business and dilute stockholder value.
We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a
result, negotiations may take place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us either significant market presence or the potential to expand
our market footprint and improve profitability through economies of scale or expanded services.
Acquiring other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks
commonly associated with acquisitions, including, among other things:
• difficulty in estimating the value of the target company;
• exposure to potential asset quality problems of the target company;
• potential disruption to our business;
• potential diversion of our management’s time and attention;
• the possible loss of key employees and customers of the target company; and
Various factors may make takeover attempts more difficult to achieve.
Our articles of incorporation and bylaws, federal regulations, Maryland law, shares of restricted stock and stock options that we have
granted or may grant to employees and directors and stock ownership by our management and directors, and various other factors may make it more difficult for companies or persons to acquire control of Waterstone Financial without the consent of our
board of directors. A shareholder may want a takeover attempt to succeed because, for example, a potential acquiror could offer a premium over the then prevailing price of our common stock.
Item 1B. Unresolved Staff Comments
None
- 37 -
Item 2.Properties
We operate from our corporate center, our 14 full-service banking offices, our drive-through office and 14 automated teller machines,
located in Milwaukee, Washington and Waukesha Counties, Wisconsin. The net book value of our premises, land, equipment and leasehold improvements was $22.3 million at December 31, 2021. The following table sets forth information with respect to our corporate center and our full-service banking offices as of December 31, 2021.
(1) Leased property
In addition to our banking offices, as of December 31, 2021, Waterstone Mortgage Corporation had 11 offices in New Mexico, nine offices in Florida, seven offices in Wisconsin, three offices in each of Arizona, Colorado, Illinois, Oklahoma, and Texas, two offices in
each of Idaho, Minnesota, Ohio, and Pennsylvania, and one office in each of Alabama, Arkansas, California, Georgia, Indiana, Iowa, Maryland, Michigan, New Hampshire, and Tennessee.
Item 3.Legal Proceedings
See Note 14 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to consolidated financial statements for
additional information.
Item 4.Mine Safety Disclosures
Not applicable.
- 38 -
Part II
Item 5.Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchase of
Equity Securities
Our shares of common stock are traded on the NASDAQ Global Select Market® under the symbol WSBF. The approximate number of shareholders
of record of Waterstone common stock as of February 25, 2022 was 1,400. On that same date there were 24,230,968 shares of common stock issued and outstanding.
Following are the Company's monthly common stock repurchases during the fourth quarter of 2021.
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PERFORMANCE GRAPH
Set forth below is a line graph comparing the cumulative total shareholder return on Waterstone Financial common stock, based on the
market price of the common stock and assuming reinvestment of cash dividends, with the cumulative total return of companies on the SNL Thrift NASDAQ Index and the Russell 2000. The graph assumes $100 was invested on December 31, 2016, in Waterstone
Financial, Inc. common stock and each of those indices.
Waterstone Financial, Inc.
Item 6. [Reserved]
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, 2021, compared to the
year ended December 2020, and the financial condition as of December 31, 2021 compared to the financial condition as of December 31, 2020.
- 40 -
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, 2021, compared the year ended December 31, 2020, 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, 2020 compared to the year ended December 31, 2019, 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 2020 Form 10-K, filed with the SEC on March 2, 2021.
Significant Items
Earnings comparisons among the three years ended December 31, 2021 and 2020 were impacted by the Significant Items summarized below. There
were no Significant Items during the year ended December 31, 2019.
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 has been 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 included extensive emergency funding for hospitals and providers. 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.
- 41 -
Capital and liquidity
As of December 31, 2021, all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory
requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses.
We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term
funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession causes large numbers of our deposit customers to withdraw their
funds, we might become more reliant on volatile or more expensive sources of funding.
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.
In June 2016, the FASB issued ASU 2016-13, Financial
Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments 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 (AFS) debt securities should be recorded through an allowance for credit losses rather than a write-down.
Based on our current analysis, we estimate that the impact of the
standard on the allowance for credit losses ("ACL") as of December 31, 2021, would have been within a range of no change to a 10% increase and is in the process of
finalizing the review of the most recent model run and the related underlying assumptions. Within the ACL calculation, we generally expect the ACL to be lower for commercial loans as they are shorter duration loans compared to the longer
duration residential and real estate loans. We expect the standard may potentially have a material impact on the financial statements and we expect more volatility in the
credit loss estimate over economic cycles. The ACL related to AFS securities is immaterial as the portfolio consists entirely of municipal securities with low expected losses. This estimate is subject to change based on continuing review
of the models, assumptions, methodologies and judgments. Going forward, the quarterly evaluation of the allowance for loan losses will likely introduce additional volatility
to earnings from changes in economic conditions and forecasts, as well as changes in the underlying loan portfolio.
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.
- 43 -
Selected Financial Data
The summary financial information presented below is derived in part from the Company’s audited financial statements, although the table itself is not
audited.
At or for the Year Ended December 31,
(In Thousands, except per share amounts)
Selected Financial Condition Data:
Selected Operating Data:
Per common share:
- 44 -
At or for the Year Ended December 31,
Selected Financial Ratios and Other Data:
Performance Ratios:
Capital Ratios:
Waterstone Financial, Inc.:
WaterStone Bank:
Asset Quality Ratios:
Other Data:
Number of full-service banking offices 14 14 13 11 11
(1) Represents the difference between the weighted average yield on average interest-earning assets and the
weighted average cost of interest-bearing liabilities.
(2) Represents net interest income as a percent of average interest-earning assets.
(3) Represents noninterest expense divided by the sum of net interest income and noninterest income.
(4) Represents dividends paid per share divided by basic earnings per share.
Comparison of Consolidated Waterstone Financial, Inc. Financial Condition at December 31, 2021 and at December 31, 2020
Total
Assets. Total assets increased by $31.3 million, or 1.4%, to $2.22 billion at December 31, 2021 from $2.18 billion at December
31, 2020. The increase in total assets primarily reflects an increase in cash and cash equivalents and securities available for sale,
partially offset by a decrease in loans receivable and loans held for sale. The total assets increase reflects liability increases in deposits and retained earnings, due to net income.
Cash
and Cash Equivalents.Cash and cash equivalents increased $282.0 million to $376.7 million at December 31, 2021 from $94.8 million at December 31, 2020.
The increase in cash and cash equivalents primarily reflects the additional source of funds through an increase in deposits, as well as paydowns of loans receivable and loans held for sale.Offsetting the increases, cash and cash equivalents decreased primarily due to the use of cash to pay dividends and repurchase shares since December 31, 2020.
Securities Available
for Sale. Securities available for sale increased by $19.4 million to $179.0 million at December 31, 2021 from $159.6 million at December 31, 2020.
The increase was primarily due to purchases of mortgage-related securities exceeding security paydowns for the year and maturities of debt securities.
Loans Held for Sale. Loans held for sale decreased $89.3 million, or 22.2%, to $312.7 million at December 31, 2021 from $402.0 million at December 31, 2020 due to the
decrease of refinancing activity resulting from the increase in mortgage rates.
- 45 -
Loans Receivable. Loans receivable held for investment decreased $169.4 million, or 12.3%, to $1.21 billion at December 31, 2021 from $1.38 billion at December, 31, 2020. The decrease in total loans receivable was
attributable to decreases in each of the one- to four-family, multi-family, home equity, commercial, and consumer loan categories.
Allowance for Loan
Losses. The allowance for loan losses decreased $3.0 million to $15.8 million at December 31, 2021 from $18.8 million at
December 31, 2020. The overall decrease was primarily related to each of the one- to four-family, multi-family, home equity,
construction and land, commercial real estate, consumer, and commercial categories. See Note 3 for further discussion on the allowance for loan losses.
Real Estate Owned.
Total real estate owned decreased $174,000 to $148,000 at December 31, 2021, compared to $322,000 at December 31, 2020. During the year ended December 31, 2021,
no loans were transferred from loans receivable to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $172,000.
There was $2,000 in other activity applied to the balance and no writedowns during the year ended December 31, 2021.
Prepaid Expenses and
Other Assets. Total prepaid expenses and other assets decreased $12.4 million to $45.1 million at December 31, 2021 from $57.5 million at December 31, 2020. The decrease was primarily due to the sale of mortgage servicing rights along with
decreases in derivative assets and unrealized gain on loan swaps offset by an increase in funding receivable on loans sold.
Deposits.
Deposits increased by $48.5 million to $1.23 billion at December 31, 2021, from $1.18 billion at December 31, 2020. The increase was driven by an increase of $97.0 million in money market and savings deposits and $26.2 million in demand deposits offset by a
decrease of $74.7 million in time deposits.
Borrowings.
Total borrowings decreased $30.9 million to $477.1 million at December 31, 2021, from $508.1 million at December 31, 2020. The community banking segment paid off $24.0 million in short-term FHLB borrowings. External short-term borrowings at the mortgage banking
segment decreased a total of $6.9 million to $2.1 million at December 31, 2021 from $9.0 million at December 31, 2020.
Other Liabilities.
Other liabilities decreased $6.5 million to $68.5 million at December 31, 2021 compared to $75.0 million at December 31, 2020. Other liabilities decreased primarily due to liabilities resulting from payables due on back-to-back swaps, payment of a
legal settlement, accrued compensation, tax escrow checks clearing, and forward commitments to sell loans at the mortgage banking segment offset by an increase in dividends payable as a special dividend was declared in December 2021.
Shareholders’
Equity. Shareholders’ equity increased by $19.7 million, or 4.8%, to $432.8 million at December 31, 2021 from $413.1 million
at December 31, 2020. Shareholders' equity increased primarily due to net income, and additional paid-in capital as stock options were
exercised and equity awards vested. 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, 2021 and 2020
Net income from our community banking segment for the year ended December 31, 2021 totaled $28.3 million compared to $21.2 million for the year ended December 31, 2020. Net interest income increased $1.4 million to $56.1 million for the year ended December 31, 2021 compared to $54.6 million for the year ended December 31, 2020.
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 and mortgage-related securities interest as replacement rates were lower.
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act, as amended. The Company calculated
the current year allowance using the incurred loss model. There was a negative provision for loan losses of $4.1 million for the year ended December 31, 2021 compared to a $6.1 million provision for loan losses for the year ended December 31, 2020.
During the year ended December 31, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance. Additionally, we recorded net recoveries of $945,000
during the year ended December 31, 2021.
Noninterest income decreased $2.7 million for the year ended December 31, 2021 due primarily to a decrease in loan fees due to fees earned on loan swap originations in 2020. Noninterest income also decreased as we recognized
gains from death benefit received on two bank owned life insurance policies during the year ended December 31, 2020.
- 46 -
Compensation, payroll taxes, and other employee benefits expense increased $61,000 to $20.3 million primarily due to an increase in employee stock ownership plan expenses offset by a decrease in salaries. Data processing expense decreased $245,000 due to the implementation of
a new digital banking platform in 2020. Other noninterest expense decreased $533,000 as certain loan-related expenses decreased offset by a decrease of credits received for FDIC premiums in 2020 but not in 2021.
Comparison of Mortgage Banking Segment Operations for the Years Ended December 31, 2021 and 2020
Net income totaled $42.5 million for the year ended December 31, 2021 compared to $59.9 million for the year ended December 31, 2020. We originated $4.23 billion in mortgage loans held for sale (including sales to the community banking
segment) during the year ended December 31, 2021, which represents a decrease of $201.7 million, or 4.6%, from the $4.43 billion
originated during the year ended December 31, 2020. The decrease in loan production volume was driven by a $433.6 million, or 25.2%,
decrease in refinance products driven by an increase in fixed mortgage rates. Mortgage purchase products increased $231.9 million, or 8.6% due to an increased housing demand. Total mortgage banking noninterest income decreased $39.1 million, or 16.5%, to $197.6 million during the year ended December 31, 2021 compared to $236.7 million during the year ended December 31, 2020. The decrease in mortgage banking
noninterest income was related to an 11.6% decrease in gross margin on loans originated and by a 4.6% decrease in loan production volume for the year ended December 31, 2021 compared to the 2020 period. Gross margin on loans originated is the
ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The decrease in gross margin on loans originated and sold reflects pricing competition in the industry to gain market
share. 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 increased to
69.5% from 61.1% of total originations for the year ended December 31, 2021 and 2020, respectively, as refinance demand decelerated due to an increase in interest rates
over the past year. The mix of loan type trended towards more conventional loans and less governmental loans; with conventional loans and governmental loans comprising 76.6% and 23.4%, respectively of all loan originations, respectively,
during the year ended December 31, 2021, compared to 75.8% and 24.2% of all originations, respectively, during the year ended December
31, 2020.
During the year ended December 31, 2021, the Company sold mortgage servicing rights related to $1.24 billion in loans serviced for third
parties. The sale generated $12.4 million in net proceeds and a $4.0 million gain. 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.
Total compensation, payroll taxes and other employee
benefits decreased $4.2 million, or 3.5%, to $115.3 million for the year ended December 31, 2021 compared to $119.4 million for the year ended December 31, 2020. The decrease primarily related to decreased commission expense and branch manager compensation driven by decreased loan origination volume and branch profitability as
gross margins decreased. Professional fees decreased 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 related to the 2020 settlement. Additionally, the Company received a legal settlement
in 2021 offsetting legal expenses. Other noninterest expense decreased primarily due to decreased provision for loan sale losses as there was additional uncertainity in the prior year regarding selling loans to third party investors from COVID-19
pandemic challenges. Offsetting the decreases, the amortization of mortgage servicing rights increased as the value of the servicing portfolio has increased in 2021 compared to 2020.
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, 2021 and 2020
Years Ended December 31,
(Dollars in Thousands, except per share amounts)
Earnings per share - basic 2.98 3.32
Earnings per share - diluted 2.96 3.30
Return on average assets 3.20 % 3.77 %
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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 2.69 % 2.68 % 2.85 %
(1) Includes net deferred loan fee amortization income of $2.1 million, $1.7 million and $672,000 for the years ended December 31, 2021, 2020, and 2019, 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, 2021, 2020, and 2019. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 0.97%,1.79%, and 2.49% for the years ended
December 31, 2021, 2020, and 2019, respectively.
(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average
interest-bearing liabilities and is presented on a fully tax equivalent basis.
(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.
(6)Net interest margin represents net interest income
divided by average total interest-earning assets.
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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, 2021 or 2020.
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:
(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, 2021, 2020, and 2019.
Net Interest Income
Net interest income increased $2.0 million, or 3.8%, to $55.5 million during the year ended December
31, 2021 compared to $53.5 million during the year ended December 31, 2020.
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Provision for Loan Losses
The Company delayed adoption of ASC Topic 326 as permited under the CARES Act and subsequently under the Consolidated Appropriations
Act. The Company calculated the current year allowance using the incurred loss model. The negative provision for loan losses was $4.0 million for the year ended December 31, 2021 compared to a provision for loan losses of $6.3 million for the year
ended December 31, 2020. During the year ended December 31, 2021, we made adjustments to our qualitative factors, primarily to account for the improvement in certain economic factors along with a decrease in loan balance. We had a negative provision
for loan losses of $4.1 million at the community banking segment and $110,000 in provision for loan losses for the mortgage banking segment. Net recoveries were $945,000 for the year ended December 31, 2021 as loans with prior charge-offs paid in
full.
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 1,615 1,905 (290 ) (15.2 %)
Total noninterest income decreased $40.8 million, or 16.7%, to $203.2 million during the year ended
December 31, 2021 compared to $244.0 million during the year ended December 31, 2020. The decrease resulted primarily from a decrease in mortgage banking income along with decreases in service charges on loans and deposits and increase in cash
surrender value of life insurance.
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Noninterest Expenses
Years Ended December 31,
(Dollars in Thousands)
Total noninterest expenses decreased $12.5 million, or 6.8%, to $170.6 million during the year ended
December 31, 2021 compared to $183.1 million during the year ended December 31, 2020.
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Income Taxes
Income tax expense decreased $5.7 million to $21.3 million during the year ended December 31, 2021, compared to $27.0 million during the year ended December 31, 2020
as pretax income decreased $16.0 million. Income tax expense was recognized during the year ended December 31, 2021 at an effective
rate of 23.1% compared to an effective rate of 24.9% during the year ended December 31, 2020. During the year ended December 31, 2021, the Company recorded a $949,000 return to provision income tax adjustment to reflect actual state tax apportionment based on the final 2020 tax returns. There was no return
to provision adjustment during the year ended December 31, 2020. 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, 2021 were 33.1% and 46.5%, 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, 2021 and 2020,
$376.7 million and $94.8 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.