HMN FINANCIAL INC - Quarter Report: 2018 June (Form 10-Q)

 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2018

OR

 

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

 

For the transition period from _________ to _________

 

Commission File Number 0-24100

 

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware		41-1777397
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
1016 Civic Center Drive NW, Rochester, MN		55901
(Address of principal executive offices)		(Zip Code)
Registrant's telephone number, including area code:		(507) 535-1200

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes ☒                    No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes ☒                    No ☐

 

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

 

Large accelerated filer ☐	Accelerated filer ☐	Non-accelerated filer ☐	Smaller reporting company ☒
	(Do not check if a smaller reporting company)
Emerging growth company ☐

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

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ☐                    No ☒

 

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

 

Class		Outstanding at July 27, 2018
Common stock, $0.01 par value		4,609,440

 

 

 

HMN FINANCIAL, INC.

CONTENTS

 

PART I – FINANCIAL INFORMATION
		Page
Item 1:	Financial Statements	3
	Consolidated Balance Sheets at June 30, 2018 and December 31, 2017	3
	Consolidated Statements of Comprehensive Income for the Three Months and Six Months Ended June 30, 2018 and 2017	4
	Consolidated Statement of Stockholders' Equity for the Six-Month Period Ended June 30, 2018	5
	Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2018 and 2017	6
	Notes to Consolidated Financial Statements	7
Item 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3:	Quantitative and Qualitative Disclosures About Market Risk	35
Item 4:	Controls and Procedures	35
PART II – OTHER INFORMATION
Item 1:	Legal Proceedings	36
Item 1A:	Risk Factors	36
Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3:	Defaults Upon Senior Securities	36
Item 4:	Mine Safety Disclosures	36
Item 5:	Other Information	36
Item 6:	Exhibits	37
Signatures		38

 

 

 

		June 30,				December 31,
(Dollars in thousands)		2018				2017
		(unaudited)
Assets
Cash and cash equivalents		$	31,710				37,564
Securities available for sale:
Mortgage-backed and related securities (amortized cost $9,145 and $5,148)			8,895				5,068
Other marketable securities (amortized cost $73,433 and $73,653)			71,630				72,404
			80,525				77,472
Loans held for sale			3,624				1,837
Loans receivable, net			589,855				585,931
Accrued interest receivable			2,330				2,344
Real estate, net			701				627
Federal Home Loan Bank stock, at cost			867				817
Mortgage servicing rights, net			1,813				1,724
Premises and equipment, net			8,446				8,226
Goodwill			802				802
Core deposit intangible			305				355
Prepaid expenses and other assets			1,432				1,314
Deferred tax asset, net			3,875				3,672
Total assets		$	726,285				722,685
Liabilities and Stockholders’ Equity
Deposits		$	639,535				635,601
Accrued interest payable			264				146
Customer escrows			1,268				1,147
Accrued expenses and other liabilities			3,393				4,973
Total liabilities			644,460				641,867
Commitments and contingencies
Stockholders’ equity:
Serial-preferred stock: ($.01 par value) authorized shares 500,000; issued shares 0			0				0
Common stock ($.01 par value): authorized shares 16,000,000; issued shares 9,128,662			91				91
Additional paid-in capital			46,950				50,623
Retained earnings, subject to certain restrictions			94,690				91,448
Accumulated other comprehensive loss			(1,479	)			(957	)
Unearned employee stock ownership plan shares			(1,933	)			(2,030	)
Treasury stock, at cost 4,519,222 and 4,631,124 shares			(56,494	)			(58,357	)
Total stockholders’ equity			81,825				80,818
Total liabilities and stockholders’ equity		$	726,285				722,685

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		Three Months Ended								Six Months Ended
		June 30,								June 30,
(Dollars in thousands, except per share data)		2018				2017				2018				2017
Interest income:
Loans receivable		$	7,006				6,701				13,784				13,061
Securities available for sale:
Mortgage-backed and related			54				5				96				12
Other marketable			285				283				557				551
Other			111				10				177				34
Total interest income			7,456				6,999				14,614				13,658
Interest expense:
Deposits			526				329				994				622
Federal Home Loan Bank advances and other borrowings			0				132				2				247
Total interest expense			526				461				996				869
Net interest income			6,930				6,538				13,618				12,789
Provision for loan losses			295				269				170				(1	)
Net interest income after provision for loan losses			6,635				6,269				13,448				12,790
Non-interest income:
Fees and service charges			785				845				1,551				1,669
Loan servicing fees			297				306				598				607
Gain on sales of loans			679				488				1,123				1,007
Other			293				267				558				503
Total non-interest income			2,054				1,906				3,830				3,786
Non-interest expense:
Compensation and benefits			3,678				3,780				7,502				7,724
Occupancy and equipment			1,072				1,026				2,169				2,065
Data processing			334				260				629				552
Professional services			298				417				547				676
Other			931				956				2,020				1,769
Total non-interest expense			6,313				6,439				12,867				12,786
Income before income tax expense			2,376				1,736				4,411				3,790
Income tax expense			649				712				1,239				1,553
Net income			1,727				1,024				3,172				2,237
Other comprehensive (loss) income, net of tax			(105	)			173				(452	)			361
Comprehensive income available to common shareholders		$	1,622				1,197				2,720				2,598
Basic earnings per share		$	0.40				0.24				0.74				0.53
Diluted earnings per share		$	0.36				0.21				0.66				0.46

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																		Unearned
																		Employee
														Accumulated				Stock
						Additional								Other				Ownership								Total
		Common				Paid-In				Retained				Comprehensive				Plan				Treasury				Stockholders’
(Dollars in thousands)		Stock				Capital				Earnings				(Loss)				Shares				Stock				Equity
Balance, December 31, 2017		$	91				50,623				91,448				(957	)			(2,030	)			(58,357	)			80,818
Net income											3,172																3,172
Accounts reclassified from accumulated other comprehensive loss											70				(70	)											0
Other comprehensive loss															(452	)											(452	)
Stock warrants purchased							(1,989	)																			(1,989	)
Stock warrants exercised							(1,674	)															1,674				0
Stock compensation expense							8																				8
Restricted stock awards							(189	)															189				0
Amortization of restricted stock awards							73																				73
Earned employee stock ownership plan shares							98												97								195
Balance, June 30, 2018		$	91				46,950				94,690				(1,479	)			(1,933	)			(56,494	)			81,825

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		Six Months Ended June 30,
(Dollars in thousands)		2018				2017
Cash flows from operating activities:
Net income		$	3,172				2,237
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses			170				(1	)
Depreciation			528				464
Amortization of premiums, net			24				0
Amortization of deferred loan costs (fees)			15				(125	)
Amortization of core deposit intangible			50				50
Amortization of other purchased fair value adjustments			(23	)			(55	)
Amortization of mortgage servicing rights			268				269
Capitalized mortgage servicing rights			(357	)			(320	)
Securities gains, net			(22	)			0
Gain on sale of premises and equipment			0				(8	)
Gain on sales of real estate			0				(7	)
Gain on sales of loans			(1,123	)			(1,007	)
Proceeds from sale of loans held for sale			46,097				43,490
Disbursements on loans held for sale			(39,120	)			(36,046	)
Amortization of restricted stock awards			73				71
Amortization of unearned Employee Stock Ownership Plan shares			97				96
Earned Employee Stock Ownership Plan shares priced above original cost			98				72
Stock option compensation expense			8				21
Decrease in accrued interest receivable			14				18
Increase (decrease) in accrued interest payable			118				(23	)
(Increase) decrease in other assets			(73	)			233
Decrease in other liabilities			(1,625	)			(1,103	)
Other, net			(3	)			46
Net cash provided by operating activities			8,386				8,372
Cash flows from investing activities:
Principal collected on securities available for sale			893				416
Proceeds collected on maturities of securities available for sale			310				5,000
Purchases of securities available for sale			(4,888	)			(4,999	)
Purchase of Federal Home Loan Bank Stock			(322	)			(3,255	)
Redemption of Federal Home Loan Bank Stock			272				3,208
Proceeds from sales of real estate			0				42
Net increase in loans receivable			(11,825	)			(45,415	)
Proceeds from sale of premises and equipment			0				8
Purchases of premises and equipment			(746	)			(498	)
Net cash used by investing activities			(16,306	)			(45,493	)
Cash flows from financing activities:
Increase in deposits			3,934				41,294
Warrants purchased			(1,989	)			0
Stock awards withheld for tax withholding			0				(54	)
Proceeds from borrowings			6,800				80,600
Repayment of borrowings			(6,800	)			(80,600	)
Increase in customer escrows			121				212
Net cash provided by financing activities			2,066				41,452
(Decrease) increase in cash and cash equivalents			(5,854	)			4,331
Cash and cash equivalents, beginning of period			37,564				27,561
Cash and cash equivalents, end of period		$	31,710				31,892
Supplemental cash flow disclosures:
Cash paid for interest		$	878				892
Cash paid for income taxes			2,852				1,766
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale			7,670				6,641
Loans held for sale transferred to loans			0				164
Transfer of loans to real estate			74				40

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(1)  HMN Financial, Inc.

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

 

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

 

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

 

 

(2)  Basis of Preparation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of comprehensive income, consolidated statement of stockholders' equity and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles (GAAP). However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the six-month period ended June 30, 2018 are not necessarily indicative of the results which may be expected for the entire year.

 

 

(3)  New Accounting Standards

In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02, Leases (Topic 842). The amendments in the ASU create Topic 842, Leases, and supersede the lease requirements in Topic 840, Leases. The objective of this ASU is to establish the principles that lessees and lessors shall apply to report useful information to users of financial statements about the amount, timing, and uncertainty of cash flows arising from a lease. The main difference between previous GAAP and this ASU is the recognition of lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The amendment requires a lessee to recognize in the statement of financial position a liability to make lease payments (the lease liability) and the right-of-use asset representing its right to use the underlying asset for the lease term. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply that will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified. The amendments in the ASU, for public business entities, are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The adoption of this ASU in the first quarter of 2019 is not anticipated to have a material impact on the Company’s consolidated financial statements.

 

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

 

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities. The amendments in this ASU shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount as discounts continue to be amortized to maturity. This ASU is intended to more closely align the amortization period of premiums and discounts to expectations incorporated in market pricing on the underlying securities. In most cases, market participants price securities to the call date that produces the worst yield when the coupon is above current market rates and price securities to maturity when the coupon is below market rates. As a result, the amendments more closely align interest income recorded on bonds held at a premium or a discount with the economics of the underlying instrument. This ASU is intended to reduce diversity in practice and is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 with early adoption permitted. Upon adoption, the amendments should be applied using a modified retrospective basis through a cumulative-effect adjustment directly to retained earnings as of the beginning of the period of adoption. Additionally, in the period of adoption, an entity should provide disclosures about a change in accounting principles. The adoption of this ASU in the first quarter of 2019 is not anticipated to have a material impact on the Company’s consolidated financial statements.

 

 

(4)  Fair Value Measurements

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

 

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

 

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

 

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

 

The following table summarizes the assets and liabilities of the Company for which fair values are determined on a recurring basis as of June 30, 2018 and December 31, 2017.

 

 

 

 

There were no transfers between Levels 1, 2, or 3 during the three or six month periods ended June 30, 2018.

 

The Company may also be required, from time to time, to measure certain other financial assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of the lower-of-cost-or-market accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis that were held at December 31, 2017 and at June 30, 2018, the following table provides the level of valuation assumptions used to determine each adjustment and the carrying value of the related individual assets or portfolios at June 30, 2018 and December 31, 2017.

 

 

⁽¹⁾     Represents carrying value and related write-downs of loans for which adjustments are based on the appraised value of the collateral. The carrying value of loans fully charged-off is zero.

⁽²⁾     Represents the fair value and related losses of foreclosed real estate and other collateral owned that were measured at fair value subsequent to their initial classification as foreclosed assets.

 

 

 

(5)  Fair Value of Financial Instruments

Generally accepted accounting principles require interim reporting period disclosure about the fair value of financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value hierarchy level for each asset and liability, as defined in Note 4, have been included in the following table for June 30, 2018 and December 31, 2017. The fair value estimates are made based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. The estimated fair value of the Company’s financial instruments as of June 30, 2018 and December 31, 2017 are shown in the following table.

 

 

Cash and Cash Equivalents

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

 

Securities Available for Sale

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

 

Loans Held for Sale

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

 

Loans Receivable, net

The fair value of the loan portfolio, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market. The fair value disclosures for both the fixed and adjustable rate portfolios were adjusted to reflect the exit price amount anticipated to be received from the sale of the portfolio in an open market transaction as required upon adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities beginning in the first quarter of 2018.

 

Federal Home Loan Bank Stock

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

 

Accrued Interest Receivable

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

 

Deposits

The fair value of demand deposits, savings accounts and certain money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value disclosures for all of the deposits were adjusted to reflect the exit price amount anticipated to be received from the sale of the deposits in an open market transaction as required upon adoption of ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10) Recognition and Measurement of Financial Assets and Financial Liabilities beginning in the first quarter of 2018.

 

The fair value estimate for deposits does not include the benefit that results from the low cost funding provided by the Company's existing deposits and long-term customer relationships compared to the cost of obtaining different sources of funding. This benefit is commonly referred to as the core deposit intangible.

 

 

Accrued Interest Payable

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

 

Commitments to Extend Credit

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

 

Commitments to Sell Loans

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

 

 

(6)  Other Comprehensive Income (Loss)

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

 

 

 

 

(7)  Securities Available For Sale

The following table shows the gross unrealized losses and fair value for the securities available for sale portfolio, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2018 and December 31, 2017.

 

 

 

 

We review our investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the market liquidity for the investment, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer, and our intent and ability to hold the investment for a period of time sufficient to recover the temporary loss.

 

The unrealized losses on U.S. Government agency obligations are the result of changes in interest rates. The unrealized losses reported for the corporate preferred stock at June 30, 2018 relates to a single trust preferred security that was issued by the holding company of a small community bank. As of June 30, 2018 all payments were current on the trust preferred security and the issuer’s subsidiary bank was considered to be “well capitalized” based on its most recent regulatory filing. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at June 30, 2018. The Company does not intend to sell the preferred stock and has the intent and ability to hold it for a period of time sufficient to recover the temporary loss. Management believes that the Company will receive all principal and interest payments contractually due on the security and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.

 

A summary of securities available for sale at June 30, 2018 and December 31, 2017 is as follows:

 

 

 

 

The following table indicates amortized cost and estimated fair value of securities available for sale at June 30, 2018 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates.

 

 

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

 

 

(8)  Loans Receivable, Net

A summary of loans receivable at June 30, 2018 and December 31, 2017 is as follows:

 

 

 

 

(9)  Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

 

 

 

 

The following table summarizes the amount of classified and unclassified loans at June 30, 2018 and December 31, 2017:

 

 

 

 

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

 

 

The aging of past due loans at June 30, 2018 and December 31, 2017 is summarized as follows:

 

 

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a troubled debt restructuring (TDR). The following table summarizes impaired loans and related allowances as of June 30, 2018 and December 31, 2017:

 

 

 

The following table summarizes the average recorded investment and interest income recognized on impaired loans for the three and six months ended June 30, 2018 and 2017:

 

 

 

At June 30, 2018 and December 31, 2017, non-accruing loans totaled $3.0 million and $3.1 million, respectively, for which the related allowance for loan losses was $0.7 million and $0.9 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-accruing loans for which no specific allowance has been recorded, because management determined that the value of the collateral was sufficient to repay the loan, totaled $0.6 million and $0.4 million at June 30, 2018 and December 31, 2017, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

 

 

The non-accrual loans at June 30, 2018 and December 31, 2017 are summarized as follows:

 

 

At June 30, 2018 and December 31, 2017 there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $2.6 million and $3.0 million, respectively. For the loans that were restructured in the second quarter of 2018, $0.2 million were classified but performing and $26,000 were non-performing at June 30, 2018. For the loans that were restructured in the second quarter of 2017, $0.1 million were classified but performing and $0.2 million were non-performing at June 30, 2017.

 

The following table summarizes TDRs at June 30, 2018 and December 31, 2017:

 

 

As of June 30, 2018, the Bank had commitments to lend an additional $1.2 million to a borrower who has TDR and non-accrual loans. These additional funds are for the construction of single family homes with a maximum loan-to-value ratio of 75%. These loans are secured by the home under construction. At December 31, 2017, there were commitments to lend additional funds of $0.8 million to this same borrower.

 

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

 

 

When a loan is modified as a TDR, there may be a direct, material impact on the loans within the balance sheet, as principal balances may be partially forgiven. The financial effects of TDRs are presented in the following table and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the three month and six month periods ending June 30, 2018 and June 30, 2017.

 

 

 

The following tables summarize the loans that were restructured in the 12 months preceding June 30, 2018 and June 30, 2017 and subsequently defaulted during the three and six months ended June 30, 2018 and June 30, 2017.

 

 

 

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

 

 

TDRs are reviewed for impairment following the same methodology as other impaired loans. For loans that are collateral-dependent, the value of the collateral is reviewed and additional reserves may be added to specific reserves as needed. Loans that are not collateral-dependent may have additional reserves established if deemed necessary. The reserves for TDRs were $0.6 million, or 6.8%, of the total $9.3 million in loan loss reserves at June 30, 2018 and $0.9 million, or 9.8%, of the total $9.3 million in loan loss reserves at December 31, 2017.

 

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

 

 

 

As a result of acquisitions, the Company has loans for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable at acquisition that all contractually required payments would not be collected. The carrying amount of those loans as of June 30, 2018 was $0.4 million.

 

No material provision for loan losses was recognized during the three and six month periods ended June 30, 2018 related to acquired loans as there was no significant change to the credit quality of those loans.