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HMN FINANCIAL INC - Quarter Report: 2019 June (Form 10-Q)

hmnf20190630_10q.htm
 

 

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X]

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

 

For the quarterly period ended June 30, 2019

 

OR

 

[  ]

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

 

For the transition period from _________ to _________

 

Commission File Number 0-24100

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

41-1777397

(State or Other Jurisdiction of Incorporation or Organization)

 

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

     

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

 

55901

(Address of Principal Executive Offices)

 

(Zip Code)

     

Registrant's Telephone Number, Including Area Code:

 

(507) 535-1200


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

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

Common Stock

HMNF

Nasdaq

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes ☒     No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).      Yes ☒     No ☐

 

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

 

Large accelerated filer ☐ Accelerated filer ☐     Non-accelerated filer ☐  
Smaller reporting company ☒  Emerging growth company ☐  

                                 

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

 

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

 

APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☐       No ☐

 

APPLICABLE ONLY TO CORPORATE ISSUERS
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 19, 2019

Common stock, $0.01 par value

 

4,843,822

 

 

 

HMN FINANCIAL, INC.

CONTENTS

 

PART I – FINANCIAL INFORMATION

   

Page

Item 1:

Financial Statements

3

     
 

Consolidated Balance Sheets at June 30, 2019 and December 31, 2018

3

     
 

Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2019 and 2018

4

     
 

Consolidated Statements of Stockholders' Equity for the Three and Six Month Periods Ended June 30, 2019 and 2018

5

     
 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018

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

 

 

 

PART I – FINANCIAL INFORMATION

Item 1: Financial Statements

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 
   

June 30,

   

December 31,

 

(Dollars in thousands)

 

2019

   

2018

 
   

(unaudited)

         

Assets

               

Cash and cash equivalents

  $ 16,357       20,709  

Securities available for sale:

               

Mortgage-backed and related securities (amortized cost $7,351 and $8,159)

    7,435       8,023  

Other marketable securities (amortized cost $72,790 and $73,222)

    72,469       71,836  
      79,904       79,859  
                 
Equity Securities     145       121  

Loans held for sale

    5,912       3,444  

Loans receivable, net

    595,757       586,688  

Accrued interest receivable

    2,522       2,356  

Real estate, net

    444       414  

Federal Home Loan Bank stock, at cost

    853       867  

Mortgage servicing rights, net

    1,870       1,855  

Premises and equipment, net

    9,623       9,635  

Goodwill

    802       802  

Core deposit intangible

    206       255  

Prepaid expenses and other assets

    6,090       2,668  

Deferred tax asset, net

    2,282       2,642  

Total assets

  $ 722,767       712,315  
                 
                 

Liabilities and Stockholders’ Equity

               

Deposits

  $ 623,510       623,352  

Accrued interest payable

    305       346  

Customer escrows

    1,487       1,448  

Accrued expenses and other liabilities

    8,654       4,022  

Total liabilities

    633,956       629,168  

Commitments and contingencies

               

Stockholders’ equity:

               

Serial-preferred stock: ($.01 par value) authorized 500,000 shares; issued 0

    0       0  

Common stock ($.01 par value): Authorized 16,000,000 shares; issued 9,128,662

    91       91  

Additional paid-in capital

    40,153       40,090  

Retained earnings, subject to certain restrictions

    104,235       99,754  

Accumulated other comprehensive loss

    (170 )     (1,096 )

Unearned employee stock ownership plan shares

    (1,740 )     (1,836 )

Treasury stock, at cost 4,284,840 and 4,292,838 shares

    (53,758 )     (53,856 )

Total stockholders’ equity

    88,811       83,147  

Total liabilities and stockholders’ equity

  $ 722,767       712,315  

 


 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(unaudited)

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 

(Dollars in thousands, except per share data)

 

2019

   

2018

   

2019

   

2018

 

Interest income:

                               

Loans receivable

  $ 7,901       7,006       15,169       13,784  

Securities available for sale:

                               

Mortgage-backed and related

    44       54       90       96  

Other marketable

    304       285       596       557  

Other

    50       111       176       177  

Total interest income

    8,299       7,456       16,031       14,614  
                                 

Interest expense:

                               

Deposits

    822       526       1,512       994  

Federal Home Loan Bank advances and other borrowings

    7       0       7       2  

Total interest expense

    829       526       1,519       996  

Net interest income

    7,470       6,930       14,512       13,618  

Provision for loan losses

    (1,059 )     295       (1,032 )     170  

Net interest income after provision for loan losses

    8,529       6,635       15,544       13,448  
                                 

Non-interest income:

                               

Fees and service charges

    785       785       1,485       1,551  

Loan servicing fees

    318       297       633       598  

Gain on sales of loans

    611       679       990       1,123  

Other

    307       293       604       558  

Total non-interest income

    2,021       2,054       3,712       3,830  
                                 

Non-interest expense:

                               

Compensation and benefits

    3,737       3,678       7,647       7,502  

Occupancy and equipment

    1,081       1,072       2,142       2,169  

Data processing

    305       334       606       629  

Professional services

    381       298       653       547  

Other

    1,063       931       1,966       2,020  

Total non-interest expense

    6,567       6,313       13,014       12,867  

Income before income tax expense

    3,983       2,376       6,242       4,411  

Income tax expense

    1,121       649       1,761       1,239  

Net income

    2,862       1,727       4,481       3,172  

Other comprehensive income (loss), net of tax

    442       (105 )     926       (452 )

Comprehensive income available to common shareholders

  $ 3,304       1,622       5,407       2,720  

Basic earnings per share

  $ 0.62       0.40       0.97       0.74  

Diluted earnings per share

  $ 0.62       0.36       0.97       0.66  

 


 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity

For the Three and Six Month Periods Ended June 30, 2019 and 2018

(unaudited)

 

                                   

Unearned

                 
                           

Accumulated

   

Employee

                 
           

Additional

           

Other

   

Stock

           

Total

 
   

Common

   

Paid-In

   

Retained

   

Comprehensive

   

Ownership

   

Treasury

   

Stockholders’

 

(Dollars in thousands)

 

Stock

   

Capital

   

Earnings

   

(Loss)

   

Plan Shares

   

Stock

   

Equity

 

Balance, March 31, 2019

  $ 91       40,076       101,373       (612 )     (1,788 )     (53,791 )     85,349  

Net income

                    2,862                               2,862  

Other comprehensive income

                            442                       442  

Restricted stock awards

            (33 )                             33       0  

Amortization of restricted stock awards

            49                                       49  

Earned employee stock ownership plan shares

            61                       48               109  

Balance, June 30, 2019

  $ 91       40,153       104,235       (170 )     (1,740 )     (53,758 )     88,811  
                                                         

Balance, December 31, 2018

  $ 91       40,090       99,754       (1,096 )     (1,836 )     (53,856 )     83,147  

Net income

                    4,481                               4,481  

Other comprehensive income

                            926                       926  

Stock compensation expense

            1                                       1  

Restricted stock awards

            (143 )                             143       0  

Stock awards withheld for tax withholding

                                            (45 )     (45 )

Amortization of restricted stock awards

            90                                       90  

Earned employee stock ownership plan shares

            115                       96               211  

Balance, June 30, 2019

  $ 91       40,153       104,235       (170 )     (1,740 )     (53,758 )     88,811  

 

 

                                   

Unearned

                 
                           

Accumulated

   

Employee

                 
           

Additional

           

Other

   

Stock

           

Total

 
   

Common

   

Paid-In

   

Retained

   

Comprehensive

   

Ownership

   

Treasury

   

Stockholders’

 

(Dollars in thousands)

 

Stock

   

Capital

   

Earnings

   

(Loss)

   

Plan Shares

   

Stock

   

Equity

 

Balance, March 31, 2018

  $ 91       50,540       92,963       (1,374 )     (1,982 )     (58,183 )     82,055  

Net income

                    1,727                               1,727  

Other comprehensive loss

                            (105 )                     (105 )

Stock warrants purchased

            (1,989 )                                     (1,989 )

Stock warrants exercised

            (1,674 )                             1,674       0  

Stock compensation expense

            4                                       4  

Restricted stock awards

            (15 )                             15       0  

Amortization of restricted stock awards

            34                                       34  

Earned employee stock ownership plan shares

            50                       49               99  

Balance, June 30, 2018

  $ 91       46,950       94,690       (1,479 )     (1,933 )     (56,494 )     81,825  
                                                         

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  

 


 

See accompanying notes to consolidated financial statements.

 

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

 

   

Six Months Ended June 30,

 

(Dollars in thousands)

 

2019

   

2018

 

Cash flows from operating activities:

         

Net income

  $ 4,481       3,172  

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

         

Provision for loan losses

    (1,032 )     170  

Depreciation

    542       528  

Amortization of (discounts) premiums, net

    (7 )     24  

Amortization of deferred loan (fees) costs

    (182 )     15  

Amortization of core deposit intangible

    49       50  

Amortization of other purchased fair value adjustments

    (23 )     (23 )

Amortization of mortgage servicing rights

    307       268  

Capitalized mortgage servicing rights

    (322 )     (357 )

Securities gains, net

    (24 )     (22 )

Gain on sales of loans

    (990 )     (1,123 )

Proceeds from sale of loans held for sale

    37,775       46,097  

Disbursements on loans held for sale

    (37,923 )     (39,120 )

Amortization of restricted stock awards

    90       73  

Amortization of unearned Employee Stock Ownership Plan shares

    96       97  

Earned Employee Stock Ownership Plan shares priced above original cost

    115       98  

Stock option compensation expense

    1       8  

(Increase) decrease in accrued interest receivable

    (166 )     14  

(Decrease) increase in accrued interest payable

    (41 )     118  

Decrease (increase) in other assets

    872       (73 )

Increase (decrease) in other liabilities

    426       (1,625 )

Other, net

    16       (3 )

Net cash provided by operating activities

    4,060       8,386  

Cash flows from investing activities:

         

Principal collected on securities available for sale

    843       893  

Proceeds collected on maturities of securities available for sale

    400       310  

Purchases of securities available for sale

    0       (4,888 )

Purchase of Federal Home Loan Bank Stock

    (1,040 )     (322 )

Redemption of Federal Home Loan Bank Stock

    1,054       272  

Net increase in loans receivable

    (9,291 )     (11,825 )

Purchases of premises and equipment

    (530 )     (746 )

Net cash used by investing activities

    (8,564 )     (16,306 )

Cash flows from financing activities:

         

Increase in deposits

    158       3,934  

Warrants purchased

    0       (1,989 )

Stock awards withheld for tax withholding

    (45 )     0  

Proceeds from borrowings

    26,000       6,800  

Repayment of borrowings

    (26,000 )     (6,800 )

Increase in customer escrows

    39       121  

Net cash provided by financing activities

    152       2,066  

Decrease in cash and cash equivalents

    (4,352 )     (5,854 )

Cash and cash equivalents, beginning of period

    20,709       37,564  

Cash and cash equivalents, end of period

  $ 16,357       31,710  

Supplemental cash flow disclosures:

         

Cash paid for interest

  $ 1,560       878  

Cash paid for income taxes

    1,389       2,852  

Supplemental noncash flow disclosures:

         

Loans transferred to loans held for sale

    1,434       7,670  

Transfer of loans to real estate

    30       74  

Right to use assets and lease obligations

    4,237       0  

 

See accompanying notes to consolidated financial statements.

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

 

(1) HMN Financial, Inc.

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

 

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

 

 

(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, 2019 are not necessarily indicative of the results which may be expected for the entire year.

 

 

(3) New Accounting Standards

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. The amendments in this ASU, for public business entities that are filers with the Securities and Exchange Commission (SEC), 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 determination of potential qualitative reserve amounts and the impact that the adoption of this ASU will have on the Company’s consolidated financial statements. On July 17, 2019, the FASB proposed a delay in the implementation date for this ASU for small SEC reporting companies, such as HMN, from the first quarter of 2020 to the first quarter of 2023. Management will monitor the progress of the proposed implementation date delay and will implement this ASU when the required implementation date is determined by the FASB.     

 

 

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement. The Amendments in this ASU apply to all entities that are required, under existing GAAP, to make disclosures about recurring or nonrecurring fair value measurements and modify the disclosure requirements on fair value measurements in Topic 820, Fair Value Measurement, including the consideration of costs and benefits. The ASU removed, modified, and added various disclosure requirements in Topic 820. The amendments also eliminate at a minimum from the phrase an entity shall disclose at a minimum to promote the appropriate exercise of discretion by entities when considering fair value measurement disclosures and to clarify that materiality is an appropriate consideration of entities and their auditor when evaluating disclosure requirements. The amendments in the ASU are effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. An entity is permitted to early adopt the implementation of any removed or modified disclosures upon issuance of the ASU and delay adoption of the additional disclosures until their effective date. The Company has not opted to early adopt any portion of this ASU and the adoption in the first quarter of 2020 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, 2019 and December 31, 2018.

 

   

Carrying value at June 30, 2019

 

 

(Dollars in thousands)

 

Total

   

Level 1

   

Level 2

   

Level 3

 

Securities available for sale

  $ 80,049       0       80,049       0  

Mortgage loan commitments

    98       0       98       0  

Total

  $ 80,147       0       80,147       0  
                                 

 

   

Carrying value at December 31, 2018

 

 

(Dollars in thousands)

 

Total

   

Level 1

   

Level 2

   

Level 3

 

Securities available for sale

  $ 79,980       0       79,980       0  

Mortgage loan commitments

    40       0       40       0  

Total

  $ 80,020       0       80,020       0  
                                 

 

There were no transfers between Levels 1, 2, or 3 during the three or six month periods ended June 30, 2019.

 

 

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 June 30, 2019 and December 31, 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, 2019 and December 31, 2018.

 

   

Carrying value at June 30, 2019

                 

 

 

(Dollars in thousands)

 

Total

   

Level 1

   

Level 2

   

Level 3

   

Three months ended

June 30, 2019

total gains (losses)

   

Six months ended

June 30, 2019

total gains (losses)

 

Loans held for sale

  $ 5,912       0       5,912       0       (29 )     (31 )

Mortgage servicing rights

    1,870       0       1,870       0       0       0  

Loans (1)

    2,821       0       2,821       0       62       (26 )

Real estate, net (2)

    444       0       444       0       0       0  

Total

  $ 11,047       0       11,047       0       33       (57 )
                                                 

 

   

Carrying value at December 31, 2018

         

 

 

(Dollars in thousands)

 

Total

   

Level 1

   

Level 2

   

Level 3

   

Year ended

December 31, 2018 total gains (losses)

 

Loans held for sale

  $ 3,444       0       3,444       0       45  

Mortgage servicing rights, net

    1,855       0       1,855       0       0  

Loans(1)

    2,902       0       2,902       0       (97 )

Real estate, net(2)

    414       0       414       0       0  

Total

  $ 8,615       0       8,615       0       (52 )
                                         

(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

ASC 825, Disclosures about Fair Values of Financial Instruments requires interim reporting period disclosure about the fair value of financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of June 30, 2019 and December 31, 2018 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, 2019 and December 31, 2018 are shown in the following table.

 

   

June 30, 2019

   

December 31, 2018

 
                   

Fair value hierarchy

                           

Fair value hierarchy

         

(Dollars in thousands)

 

Carrying

amount

   

Estimated

fair value

   

Level 1

   

Level 2

   

Level 3

   

Contract

amount

   

Carrying

amount

   

Estimated

fair value

   

 

Level 1

   

 

Level 2

   

Level 3

   

Contract amount

 

Financial assets:

                                                                                               

Cash and cash equivalents

  $ 16,357       16,357       16,357                               20,709       20,709       20,709                          

Securities available for sale

    80,049       80,049               80,049                       79,980       79,980               79,980                  

Loans held for sale

    5,912       5,912               5,912                       3,444       3,444               3,444                  

Loans receivable, net

    595,757       592,889               592,889                       586,688       578,978               578,978                  

Federal Home Loan Bank stock

    853       853               853                       867       867               867                  

Accrued interest receivable

    2,522       2,522               2,522                       2,356       2,356               2,356                  

Financial liabilities:

                                                                                               

Deposits

    623,510       623,194               623,194                       623,352       623,439               623,439                  

Accrued interest payable

    305       305               305                       346       346               346                  

Off-balance sheet financial instruments:

                                                                                               

Commitments to extend credit

    98       98                               165,424       40       40                               146,978  

Commitments to sell loans

    (25 )     (25 )                             16,797       (56 )     (56 )                             7,289  

 

 

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.

 

Federal Home Loan Bank Stock

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

 

Accrued Interest Receivable

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

 

Deposits

The fair value of demand deposits, savings accounts and money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit are estimated by discounting the future cash flows using the FHLB yield curve to the given maturity date.

 

Accrued Interest Payable

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

 

Commitments to Extend Credit

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

 

Commitments to Sell Loans

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

 

 

(6) Other Comprehensive Income (Loss)

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

 

       
   

For the three months ended June 30,

 

(Dollars in thousands)

 

2019

   

2018

 

Securities available for sale:

 

Before tax

   

Tax effect

   

Net of tax

   

Before tax

   

Tax effect

   

Net of tax

 

Net unrealized gains (losses) arising during the period

  $ 614       172       442       (146 )     (41 )     (105 )

Other comprehensive income (loss)

  $ 614       172       442       (146 )     (41 )     (105 )

 

   

For the six months ended June 30,

 

(Dollars in thousands)

 

2019

   

2018

 

Securities available for sale:

 

Before tax

   

Tax effect

   

Net of tax

   

Before tax

   

Tax effect

   

Net of tax

 

Net unrealized gains (losses) arising during the period

  $ 1,285       359       926       (625 )     (173 )     (452 )

Other comprehensive income (loss)

  $ 1,285       359       926       (625 )     (173 )     (452 )
                                                 

 

 

 

(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, 2019 and December 31, 2018.

 

   

Less Than Twelve Months

   

Twelve Months or More

   

Total

 

(Dollars in thousands)

 

# of

Investments

   

Fair

Value

   

Unrealized

Losses

   

# of

Investments

   

Fair

Value

   

Unrealized

Losses

   

Fair

Value

   

Unrealized

Losses

 

June 30, 2019

                                                               

Other marketable securities:

                                                               

U.S. Government agency obligations

    0     $ 0       0       13     $ 64,759       (238 )   $ 64,759       (238 )

Municipal obligations

    0       0       0       3       602       0       602       0  

Corporate obligations

    0       0       0       1       141       (1 )     141       (1 )

Corporate preferred stock

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

Total temporarily impaired securities

    0     $ 0       0       18     $ 66,097       (344 )   $ 66,097       (344 )

 

   

Less Than Twelve Months

   

Twelve Months or More

   

Total

 

(Dollars in thousands)

 

# of

Investments

   

Fair

Value

   

Unrealized

Losses

   

# of

Investments

   

Fair

Value

   

Unrealized Losses

   

Fair

Value

   

Unrealized

Losses

 

December 31, 2018

                                                               

Mortgage backed securities:

                                                               

Federal National Mortgage Association (FNMA)

    0     $ 0       0       2     $ 3,769       (117 )   $ 3,769       (117 )

Federal Home Loan Mortgage
Corporation (FHLMC)

    1       4,060       (10 )     0       0       0       4,060       (10 )

Collateralized mortgage obligations:

                                                               

FNMA

    0       0       0       1       190       (9 )     190       (9 )

Other marketable securities:

                                                               

U.S. Government agency obligations

    0       0       0       14       68,735       (1,236 )     68,735       (1,236 )

Municipal obligations

    3       498       (2 )     8       1,467       (8 )     1,965       (10 )

Corporate obligations

    0       0       0       1       172       (1 )     172       (1 )

Corporate preferred stock

    0       0       0       1       560       (140 )     560       (140 )

Total temporarily impaired securities

    4     $ 4,558       (12 )     27     $ 74,893       (1,511 )   $ 79,451       (1,523 )
                                                                 

 

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 impaired securities other than the corporate preferred stock are the result of changes in interest rates. The unrealized losses reported for the corporate preferred stock at June 30, 2019 relates to a single trust preferred security that was issued by the holding company of a small community bank. As of June 30, 2019 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, 2019. The Company does not intend to sell the security 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, 2019 and December 31, 2018 is as follows:

 

 

(Dollars in thousands)

 

Amortized

cost

   

Gross unrealized

gains

   

Gross unrealized

losses

   

Fair value

 

June 30, 2019

                               

Mortgage-backed securities:

                               

FNMA

  $ 3,535       16       0       3,551  

FHLMC

    3,628       66       0       3,694  

Collateralized mortgage obligations:

                               

FNMA

    188       2       0       190  
      7,351       84       0       7,435  

Other marketable securities:

                               

U.S. Government agency obligations

    69,976       16       (238 )     69,754  

Municipal obligations

    1,973       7       0       1,980  

Corporate obligations

    141       0       (1 )     140  

Corporate preferred stock

    700       0       (105 )     595  
      72,790       23       (344 )     72,469  
    $ 80,141       107       (344 )     79,904  

 

December 31, 2018

 

Amortized

cost

   

Gross unrealized

gains

   

Gross unrealized

losses

   

Fair value

 

Mortgage-backed securities:

                               

FNMA

  $ 3,886       0       (117 )     3,769  

FHLMC

    4,074       0       (10 )     4,064  

Collateralized mortgage obligations:

                               

FNMA

    199       0       (9 )     190  
      8,159       0       (136 )     8,023  

Other marketable securities:

                               

U.S. Government agency obligations

    69,971       0       (1,236 )     68,735  

Municipal obligations

    2,378       1       (10 )     2,369  

Corporate obligations

    173       0       (1 )     172  

Corporate preferred stock

    700       0       (140 )     560  
      73,222       1       (1,387 )     71,836  
    $ 81,381       1       (1,523 )     79,859  
                                 

 

The following table indicates amortized cost and estimated fair value of securities available for sale at June 30, 2019 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates.

 

 

 

(Dollars in thousands)

 

 

Amortized

Cost

   

 

Fair

Value

 

Due less than one year

  $ 47,331       47,208  

Due after one year through five years

    30,207       30,177  

Due after five years through ten years

    1,868       1,889  

Due after ten years

    735       630  

Total

  $ 80,141       79,904  
                 

 

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

 

 

 

(8) Loans Receivable, Net

A summary of loans receivable at June 30, 2019 and December 31, 2018 is as follows:

 

 

 

(Dollars in thousands)

 

June 30,

2019

   

 

December 31,

2018

 

Single family

  $ 109,391       110,698  

Commercial real estate:

               

Real estate rental and leasing

    197,789       195,564  

Other

    153,015       140,566  
      350,804       336,130  

Consumer

    73,553       72,532  

Commercial business

    70,092       75,496  

Total loans

    603,840       594,856  

Less:

               

Unamortized discounts

    16       17  

Net deferred loan costs

    (557 )     (535 )

Allowance for loan losses

    8,624       8,686  

Total loans receivable, net

  $ 595,757       586,688  
                 

 

 

(9) Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

 

(Dollars in thousands)

 

Single
Family

   

Commercial
Real Estate

   

Consumer

   

Commercial

Business

   

Total

 
For the three months ended June 30, 2019:                                        

Balance, March 31, 2019

  $ 933       4,892       1,588       1,260       8,673  

Provision for losses

    (66 )     (1,805 )     47       765       (1,059 )

Charge-offs

    0       0       (7 )     (826 )     (833 )

Recoveries

    0       1,675       4       164       1,843  

Balance, June 30, 2019

  $ 867       4,762       1,632       1,363       8,624  
                                         
For the six months ended June 30, 2019:                                        

Balance, December 31, 2018

  $ 833       4,869       1,622       1,362       8,686  

Provision for losses

    34       (1,792 )     50       676       (1,032 )

Charge-offs

    0       0       (46 )     (869 )     (915 )

Recoveries

    0       1,685       6       194       1,885  

Balance, June 30, 2019

  $ 867       4,762       1,632       1,363       8,624  
                                         

Allocated to:

                                       

Specific allowance

  $ 98       451       172       73       794  

General allowance

    735       4,418       1,450       1,289       7,892  

Balance, December 31, 2018

  $ 833       4,869       1,622       1,362       8,686  
                                         

Allocated to:

                                       

Specific allowance

  $ 91       453       163       62       769  

General allowance

    776       4,309       1,469       1,301       7,855  

Balance, June 30, 2019

  $ 867       4,762       1,632       1,363       8,624  
                                         

Loans receivable at December 31, 2018:

                                 

Individually reviewed for impairment

  $ 1,226       1,311       856       303       3,696  

Collectively reviewed for impairment

    109,472       334,819       71,676       75,193       591,160  

Ending balance

  $ 110,698       336,130       72,532       75,496       594,856  
                                         

Loans receivable at June 30, 2019:

                                       

Individually reviewed for impairment

  $ 1,350       1,212       768       260       3,590  

Collectively reviewed for impairment

    108,041       349,592       72,785       69,832       600,250  

Ending balance

  $ 109,391       350,804       73,553       70,092       603,840  
                                         

 

 

 

(Dollars in thousands)

 

Single

Family

   

Commercial

Real Estate

   

Consumer

   

Commercial

Business

   

Total

 

For the three months ended June 30, 2018:

                                       

Balance, March 31, 2018

  $ 809       5,198       1,423       1,699       9,129  

Provision for losses

    72       (147 )     254       116       295  

Charge-offs

    0       0       (56 )     (255 )     (311 )

Recoveries

    0       191       2       22       215  

Balance, June 30, 2018

  $ 881       5,242       1,623       1,582       9,328  
                                         

For the six months ended June 30, 2018:

                                       

Balance, December 31, 2017

  $ 900       5,073       1,630       1,708       9,311  

Provision for losses

    4       (29 )     109       86       170  

Charge-offs

    (23 )     0       (125 )     (255 )     (403 )

Recoveries

    0       198       9       43       250  

Balance, June 30, 2018

  $ 881       5,242       1,623       1,582       9,328  
                                         

 

The following table summarizes the amount of classified and unclassified loans at June 30, 2019 and December 31, 2018:

 

   

June 30, 2019

 
   

Classified

           

Unclassified

         

 

(Dollars in thousands)

 

Special

Mention

   

Substandard

   

Doubtful

   

Loss

   

Total

   

Total

   

Total

Loans

 

Single family

  $ 282       2,152       37       0       2,471       106,920       109,391  

Commercial real estate:

                                                       

Real estate rental and leasing

    4,891       3,297       0       0       8,188       189,601       197,789  

Other

    2,838       4,938       0       0       7,776       145,239       153,015  

Consumer

    0       633       31       128       792       72,761       73,553  

Commercial business

    5,996       3,841       0       0       9,837       60,255       70,092  
    $ 14,007       14,861       68       128       29,064       574,776       603,840  

 

   

December 31, 2018

 
   

Classified

           

Unclassified

         

 

(Dollars in thousands)

 

Special

Mention

   

Substandard

   

Doubtful

   

Loss

   

Total

   

Total

   

Total

Loans

 

Single family

  $ 150       1,771       40       0       1,961       108,737       110,698  

Commercial real estate:

                                                       

Real estate rental and leasing

    5,564       4,805       0       0       10,369       185,195       195,564  

Other

    4,879       5,118       0       0       9,997       130,569       140,566  

Consumer

    0       709       41       106       856       71,676       72,532  

Commercial business

    6,647       2,761       0       0       9,408       66,088       75,496  
    $ 17,240       15,164       81       106       32,591       562,265       594,856  
                                                         

 

 

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, 2019 and December 31, 2018 are summarized as follows:

 

 

 

(Dollars in thousands)

 

30-59 Days

Past Due

   

60-89 Days

Past Due

   

90 Days

or More

Past Due

   

Total

Past Due

   

Current

Loans

   

Total Loans

   

Loans 90 Days

or More

Past Due and

Still Accruing

 

June 30, 2019

                                                       

Single family

  $ 981       128       117       1,226       108,165       109,391       0  

Commercial real estate:

                                                       

Real estate rental and leasing

    0       0       0       0       197,789       197,789       0  

Other

    235       0       0       235       152,780       153,015       0  

Consumer

    559       93       302       954       72,599       73,553       0  

Commercial business

    0       40       27       67       70,025       70,092          
    $ 1,775       261       446       2,482       601,358       603,840       0  

December 31, 2018

                                                       

Single family

  $ 680       325       77       1,082       109,616       110,698       0  

Commercial real estate:

                                                       

Real estate rental and leasing

    0       0       0       0       195,564       195,564       0  

Other

    0       0       0       0       140,566       140,566       0  

Consumer

    391       100       279       770       71,762       72,532       0  

Commercial business

    21       0       0       21       75,475       75,496       0  
    $ 1,092       425       356       1,873       592,983       594,856       0  
                                                         

 

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a troubled debt restructuring (TDR). The following table summarizes impaired loans and related allowances as of June 30, 2019 and December 31, 2018:

 

   

June 30, 2019

   

December 31, 2018

 

 

 

 

(Dollars in thousands)

 

Recorded

Investment

   

Unpaid

Principal

Balance

   

Related

Allowance

   

Recorded

Investment

   

Unpaid

Principal

Balance

   

Related

Allowance

 

Loans with no related allowance recorded:

                                               

Single family

  $ 613       632       0       458       477       0  

Commercial real estate:

                                               

Other

    0       0       0       25       1,682       0  

Consumer

    546       546       0       515       515       0  
                                                 

Loans with an allowance recorded:

                                               

Single family

    737       737       91       768       768       98  

Commercial real estate:

                                               

Real estate rental and leasing

    193       193       20       201       201       21  

Other

    1,019       1,019       433       1,085       1,085       430  

Consumer

    222       222       163       341       341       172  

Commercial business

    260       812       62       303       854       73  
                                                 

Total:

                                               

Single family

    1,350       1,369       91       1,226       1,245       98  

Commercial real estate:

                                               

Real estate rental and leasing

    193       193       20       201       201       21  

Other

    1,019       1,019       433       1,110       2,767       430  

Consumer

    768       768       163       856       856       172  

Commercial business

    260       812       62       303       854       73  
    $ 3,590       4,161       769       3,696       5,923       794  
                                                 

 

 

The following table summarizes the average recorded investment and interest income recognized on impaired loans for the three and six months ended June 30, 2019 and 2018:

 

   

For the three months ended June 30, 2019

   

For the six months ended June 30, 2019

 

 

(Dollars in thousands)

 

Average Recorded

Investment

   

Interest Income

Recognized

   

Average Recorded

Investment

   

Interest Income

Recognized

 

Loans with no related allowance recorded:

                               

Single family

  $ 526       7       503       13  

Commercial real estate:

                               

Other

    13       0       17       0  

Consumer

    464       5       481       10  

Loans with an allowance recorded:

                               

Single family

    773       1       771       4  

Commercial real estate:

                               

Real estate rental and leasing

    196       0       198       0  

Other

    1,036       0       1,052       0  

Consumer

    230       2       267       5  

Commercial business

    304       2       303       4  

Total:

                               

Single family

    1,299       8       1,274       17  

Commercial real estate:

                               

Real estate rental and leasing

    196       0       198       0  

Other

    1,049       0       1,069       0  

Consumer

    694       7       748       15  

Commercial business

    304       2       303       4  
    $ 3,542       17       3,592       36  
                                 

 

   

For the three months ended June 30, 2018

   

For the six months ended June 30, 2018

 

 

(Dollars in thousands)

 

Average Recorded

Investment

   

Interest Income

Recognized

   

Average Recorded

Investment

   

Interest Income

Recognized

 

Loans with no related allowance recorded:

                               

Single family

  $ 425       4       421       10  

Commercial real estate:

                               

Real estate rental and leasing

    35       15       35       15  

Other

    165       24       118       48  

Consumer

    506       4       475       9  

Loans with an allowance recorded:

                               

Single family

    809       0       908       0  

Commercial real estate:

                               

Other

    1,279       0       1,287       0  

Consumer

    416       2       433       5  

Commercial business

    373       2       417       4  

Total:

                               

Single family

    1,234       4       1,329       10  

Commercial real estate:

                               

Real estate rental and leasing

    35       15       35       15  

Other

    1,444       24       1,405       48  

Consumer

    922       6       908       14  

Commercial business

    373       2       417       4  
    $ 4,008       51       4,094       91  
                                 

 

At both June 30, 2019 and December 31, 2018, non-accruing loans totaled $2.7 million, for which the related allowance for loan losses for both periods was $0.7 million. 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, 2019 and December 31, 2018, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

 

 

The non-accrual loans at June 30, 2019 and December 31, 2018 are summarized as follows:

 

(Dollars in thousands)

 

June 30,

2019

   

December 31,

2018

 

Single family

  $ 854       730  

Commercial real estate:

               

Real estate rental and leasing

    193       201  

Other

    1,019       1,110  

Consumer

    458       489  

Commercial business

    144       148  
    $ 2,668       2,678  
                 

 

At June 30, 2019 and December 31, 2018 there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $2.4 million and $2.5 million, respectively. For the loans that were restructured in the second quarter of 2019, none were classified but performing and $0.2 million were non-performing at June 30, 2019. 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.

 

The following table summarizes TDRs at June 30, 2019 and December 31, 2018:

 

   

June 30, 2019

   

December 31, 2018

 

 

(Dollars in thousands)

 

Accruing

   

Non-

Accrual

   

Total

   

Accruing

   

Non-

Accrual

   

Total

 

Single family

  $ 495       303       798       496       140       636  

Commercial real estate

    0       1,019       1,019       0       1,110       1,110  

Consumer

    333       134       467       367       155       522  

Commercial business

    116       44       160       155       53       208  
    $ 944       1,500       2,444       1,018       1,458       2,476  
                                                 

 

As of June 30, 2019, the Bank had commitments to lend an additional $0.7 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, 2018, there were commitments to lend additional funds of $0.9 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, 2019 and June 30, 2018.

 

   

Three Months Ended

June 30, 2019

   

Six Months Ended

June 30, 2019

 

 

 

 

 

 

(Dollars in thousands)

 

Number of

Contracts

   

 

Pre-

modification

Outstanding

Recorded

Investment

   

Post-

modification

Outstanding

Recorded

Investment

   

Number of

Contracts

   

Pre-

modification

Outstanding

Recorded

Investment

   

Post-

modification

Outstanding

Recorded

Investment

 

Troubled debt restructurings:

                                               

Single family

    2     $ 155       157       3     $ 176       181  

Consumer

    1       34       34       3       60       60  

Total

    3     $ 189       191       6     $ 236       241  

 

 

   

Three Months Ended

June 30, 2018

   

Six Months Ended

June 30, 2018

 

 

 

 

 

 

(Dollars in thousands)

 

Number of

Contracts

   

 

Pre-

modification Outstanding Recorded

Investment

   

Post-

modification Outstanding Recorded

Investment

   

Number of

Contracts

   

Pre-

modification Outstanding Recorded

Investment

   

Post-

modification Outstanding Recorded

Investment

 

Troubled debt restructurings:

                                               

Single family

    0     $ 0       0       1     $ 55       58  

Commercial real estate:

                                               

Real estate rental and leasing

    0       0       0       1       54       54  

Other

    1       244       244       2       1,518       1,518  

Consumer

    4       216       216       8       334       334  

Commercial business

    0       0       0       1       70       70  

Total

    5     $ 460       460       13     $ 2,031       2,034  
                                                 

 

There were no loans that were restructured in the twelve months preceding June 30, 2019 that subsequently defaulted during the three and six months ended June 30, 2019.

 

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

 

   

Three Months Ended

June 30, 2018

   

Six Months Ended

June 30, 2018

 

 

 

 

 

 

(Dollars in thousands)

 

Number of

Contracts

   

 

Pre-

modification

Outstanding

Recorded

Investment

   

 

Number of

Contracts

   

Pre-

modification Outstanding

Recorded

Investment

 

Troubled debt restructurings that subsequently defaulted:

                               

Commercial business

    1     $ 116       1     $ 116  

Total

    1     $ 116       1     $ 116  
                                 

 

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 7.2%, of the total $8.6 million in loan loss reserves at June 30, 2019 and $0.6 million, or 7.2%, of the total $8.7 million in loan loss reserves at December 31, 2018.

 

 

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

 

(Dollars in thousands)

 

Contractual

Principal

Receivable

   

Accretable

Difference

   

Net

Carrying

Amount

 

Purchased performing loans:

                       

Balance at March 31, 2019

  $ 7,110       (173 )     6,937  

Change due to payments/refinances

    (1,268 )     16       (1,252 )

Balance at June 30, 2019

  $ 5,842       (157 )     5,685  
                         

 

(Dollars in thousands)

 

Contractual

Principal

Receivable

   

Non-

Accretable

Difference

   

Net

Carrying

Amount

 

Purchased credit impaired loans:

                       

Balance at March 31, 2019

  $ 186       (5 )     181  

Change due to payments/refinances

    (1 )     1       0  

Balance at June 30, 2019

  $ 185       (4 )     181  
                         

 

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 that all contractually required payments would not be collected. The carrying amount of those loans as of June 30, 2019 was $0.2 million.

 

No material provision for loan losses was recognized during the three and six month periods ended June 30, 2019 related to acquired loans as there was no significant change to the credit quality of those loans.

 

 

(10) Intangible Assets

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

 

 

 

(Dollars in thousands)

 

Six Months ended

June 30, 2019

   

 

Twelve Months ended

December 31, 2018

   

 

Six Months ended

June 30, 2018

 
                         

Balance, beginning of period

  $ 1,855       1,724       1,724  

Originations

    322       682       357  

Amortization

    (307 )     (551 )     (268 )

Balance, end of period

  $ 1,870       1,855       1,813  

Fair value of mortgage servicing rights

  $ 3,245       3,901       3,620  
                         

 

All of the loans sold where the Company continues to service the loans are serviced for FNMA under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at June 30, 2019.

 

           

Weighted

   

Weighted

         
   

Loan

   

Average

   

Average

         
   

Principal

   

Interest

   

Remaining

   

Number

 

(Dollars in thousands)

 

Balance

   

Rate

   

Term (months)

   

of Loans

 

Original term 30 year fixed rate

  $ 311,660       4.19

%

    306       2,360  

Original term 15 year fixed rate

    89,797       3.20       127       939  

Adjustable rate

    53       4.63       263       2  

 

The gross carrying amount of intangible assets and the associated accumulated amortization at June 30, 2019 and 2018 is presented in the following tables. No amortization expense relating to goodwill is recorded as GAAP does not allow goodwill to be amortized but requires that it be tested for impairment at least annually, or sooner, if there are indications that impairment may exist. Amortization expense for amortizing intangible assets was $0.4 million and $0.3 million for the six months ended June 30, 2019 and 2018, respectively.

 

 

   

June 30, 2019

 
   

Gross

                 

 

(Dollars in thousands)

 

Carrying

Amount

   

Accumulated

Amortization

   

Unamortized

Amount

 

Mortgage servicing rights

  $ 4,660       (2,790 )     1,870  

Core deposit intangible

    574       (368 )     206  

Goodwill

    802       0       802  

Total

  $ 6,036       (3,158 )     2,878  
                         

 

   

June 30, 2018

 
   

Gross

                 

 

(Dollars in thousands)

 

Carrying

Amount

   

Accumulated

Amortization

   

Unamortized

Amount

 

Mortgage servicing rights

  $ 4,394       (2,581 )     1,813  

Core deposit intangible

    574       (269 )     305  

Goodwill

    802       0       802  

Total

  $ 5,770       (2,850 )     2,920  
                         

 

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

 

 

 

(Dollars in thousands)

 

 

Mortgage

Servicing Rights

   

 

Core Deposit

Intangible

   

Total

Amortizing

Intangible Assets

 

Year ending December 31,

                       

2019

  $ 246       50       296  

2020

    423       99       522  

2021

    380       47       427  

2022

    322       10       332  

2023

    248       0       248  

Thereafter

    251       0       251  

Total

  $ 1,870       206       2,076  
                         

 

Projections of amortization are based on existing asset balances and the existing interest rate environment as of June 30, 2019. The Company's actual experiences may be significantly different depending upon changes in mortgage interest rates and other market conditions.

 

 

(11) Leases

On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842) and as of June 30, 2019 a $4.2 million right-of-use asset and an offsetting lease payment obligation liability were recorded on the consolidated balance sheet in other assets and other liabilities, respectively.

 

Operating lease right-of-use assets represent our right to use an underlying asset during the lease term and operating lease liabilities represent our obligation to make lease payments arising from the lease. Right-of-use assets and operating lease liabilities are recognized at lease commencement based on the present value of the remaining lease payments using a discount rate that represents the Company’s incremental borrowing rate at the lease commencement date. Because the Company only has operating leases and the right-of-use asset is offset by a lease payment obligation liability, the lease payments are the only amount that is recorded in occupancy expense in the consolidated statements of comprehensive income.

 

The Company’s leases relate to office space and bank branches with remaining lease terms between 10 and 66 months. Certain leases contain extension options which typically range from 3 to 10 years. Because these extension options are not considered reasonably certain of exercise, they are not included in the lease term.

 

The table below summarizes our net lease cost:

 

(Dollars in thousands)

 

Three Months

Ended
June 30, 2019

   

Six Months

Ended
June 30, 2019

 

Operating lease cost

  $ 221       446  
                 

 

 

The table below summarizes other information related to our operating leases:

 

(Dollars in thousands)

 

Three Months

Ended
June 30, 2019

   

Six Months

Ended
June 30, 2019

 

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

               

Operating cash flows from operating leases

  $ 221       446  

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

    -       5.1  

Weighted-average discount rate – operating leases

    -       2.21 %
                 

 

The table below summarizes the maturity of remaining lease liabilities:

 

(Dollars in thousands)

 

 

June 30, 2019

 

2019

  $ 442  

2020

    858  

2021

    853  

2022

    889  

2023

    764  

2024 and thereafter

    685  

Total lease payments

    4,491  

Less: Interest

    (254 )

Present value of lease liabilities

  $ 4,237  
         

 

 

(12) Earnings per Common Share

The following table reconciles the weighted average shares outstanding and the earnings available to common shareholders used for basic and diluted earnings per common share:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(In thousands, except per share data)

 

2019

   

2018

   

2019

   

2018

 

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

    4,606       4,291       4,602       4,264  

Net dilutive effect of:

                               

Restricted stock awards, options, and warrants

    31       457       30       561  

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

    4,637       4,748       4,632       4,825  

Income available to common shareholders

  $ 2,862       1,727       4,481       3,172  

Basic earnings per common share

  $ 0.62       0.40       0.97       0.74  

Diluted earnings per common share

  $ 0.62       0.36       0.97       0.66  
                                 

 

 

(13) Regulatory Capital and Oversight

The Company and the Bank are subject to the Basel III regulatory capital requirements. The Basel III requirements, among other things, (i) apply a set of capital requirements to the Bank (the Company is exempt, pursuant to the Small Bank Holding Company Policy Statement (Policy Statement) described below), including requirements relating to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and a higher minimum Tier 1 capital requirement, and (iii) set forth rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include capital ratios and buffer requirements which became fully phased in on January 1, 2019. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

 

The Board of Governors of the Federal Reserve System (FRB) amended its Policy Statement, to exempt small bank holding companies with assets less than $3 billion from the above capital requirements. The Policy Statement was also expanded to include savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company currently meets the qualitative exemption requirements, and therefore, is exempt from the above capital requirements.

 

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the following table and defined in the regulation) of Common Equity Tier 1 capital to risk weighted assets, Tier 1 capital to adjusted total assets, Tier 1 capital to risk weighted assets, and total capital to risk weighted assets.

 

The Bank’s average total assets for the quarter ended June 30, 2019 were $717.0 million, its adjusted total assets were $715.8 million, and its risk-weighted assets were $622.5 million. The following table presents the Bank’s capital amounts and ratios at June 30, 2019 for actual capital, required capital, and excess capital, including ratios in order to qualify as being well capitalized under the Prompt Corrective Action regulations.

 

   

Actual

   

Required to be Adequately Capitalized

   

Excess Capital

   

To Be Well Capitalized

Under Prompt Corrective

Action Provisions

 

(Dollars in thousands)

 

Amount

   

Percent of Asset

   

Amount

   

Percent of Assets

   

Amount

   

Percent of Assets

   

Amount

   

Percent of Assets

 

June 30, 2019

                                                               

Common equity tier 1 capital

  $ 84,382       13.56

%

  $ 28,013       4.50

%

  $ 56,369       9.06

%

  $ 40,463       6.50

%

Tier 1 capital leverage

    84,382       11.79       28,631       4.00       55,751       7.79       35,788       5.00  

Tier 1 risk-based capital

    84,382       13.56       37,350       6.00       47,032       7.56       49,800       8.00  

Total risk-based capital

    92,173       14.81       49,800       8.00       42,373       6.81       62,250       10.00  
                                                                 

 

The Bank must maintain a capital conservation buffer composed of common equity Tier 1 capital above its minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. On January 1, 2019, the capital conservation buffer amount increased to 2.50% and is fully phased in. Management believes that, as of June 30, 2019, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the current prompt corrective action regulations, including the capital conservation buffer described above. However, there can be no assurance that the Bank will continue to maintain such status in the future. The Office of the Comptroller of the Currency has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be “well-capitalized” in the future.

 

 

(14) Stockholders’ Equity

The Company may repurchase up to $6 million of its common stock under the existing share repurchase program. The Company did not repurchase any shares of its common stock in the open market under the share repurchase program or pay any dividends on its common stock during the three or six month periods ended June 30, 2019.

 

 

(15) Commitments and Loss Contingencies

The Bank issues standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit issued and available at June 30, 2019 were approximately $6.0 million, expire over the next 38 months, and are collateralized primarily with commercial real estate mortgages. Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.

 

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. The Company is, and expects to become, engaged in foreclosure proceedings, collection actions, and other litigation as part of its normal banking activities. Among the various current litigation matters, the Company is involved in a bankruptcy litigation claim where the bankruptcy trustee is attempting to recover $3.9 million related to the principal and interest payments made to the Bank prior to the bankruptcy filing of a former customer of the Bank.

 

 

The Company examines each legal matter, and, in those situations where it determines that a particular legal matter presents loss contingencies that are both probable and reasonably estimable, establishes an appropriate accrual. In many situations, the Company is not able to estimate reasonably possible losses due to the preliminary nature of the legal matter, as well as a variety of other factors and uncertainties. For those legal matters where the Company is able to estimate a range of reasonably possible losses, management currently estimates that the aggregate range of losses from all of our outstanding litigation is from $0 to $1.5 million in excess of the amounts accrued, if any. This estimated aggregate range is based on an assessment of the information currently available to the Company and the actual aggregate losses could be higher. However, the Company does not believe these losses are probable of occurring at this time. The Company reassesses all of its potential loss positions based on the available information each quarter and the estimated range of reasonably possible losses may change in the future. The Company typically vigorously pursues all available defenses related to litigation but may consider other alternatives, including settlement, in situations where there is an opportunity to resolve a legal matter on terms that are considered to be favorable to the Company when considering the continued expense and distraction of defending against any particular legal action.

 

Based on the Company’s current understanding of all of the outstanding legal matters, management does not believe that judgments or settlements arising from any pending or threatened litigation, individually or in the aggregate, would have a material adverse effect on the consolidated financial condition or results of operations. However, litigation is unpredictable and the actual results of litigation cannot be determined with any certainty. Therefore, the ultimate aggregate resolution of any, or all, of the current outstanding legal matters could have a material adverse effect on the Company’s results of operations in the future.

 

 

(16) Business Segments

The Bank has been identified as a reportable operating segment in accordance with the provisions of ASC 280. HMN, the holding company, did not meet the quantitative thresholds for a reportable segment and therefore is included in the “Other” category.

 

The Company evaluates performance and allocates resources based on the segment’s net income, return on average assets and return on average equity. Each corporation is managed separately with its own officers and board of directors.

 

 

The following table sets forth certain information about the reconciliations of reported profit and assets for each of the Company’s reportable segments.

 

 

(Dollars in thousands)

 

Home Federal Savings Bank

   

 

Other

   

 

Eliminations

   

Consolidated

Total

 

 

 

At or for the six months ended June 30, 2019:

                               

Interest income - external customers

  $ 16,031       0       0       16,031  

Non-interest income - external customers

    3,712       0       0       3,712  

Intersegment non-interest income

    117       4,780       (4,897 )     0  

Interest expense

    1,519       0       0       1,519  

Provision for loan losses

    (1,032 )     0       0       (1,032 )

Non-interest expense

    12,759       372       (117 )     13,014  

Income tax expense

    1,834       (73 )     0       1,761  

Net income

    4,780       4,481       (4,780 )     4,481  

Total assets

    721,757       89,006       (87,996 )     722,767  
                                 

At or for the six months ended June 30, 2018:

                               

Interest income - external customers

  $ 14,614       0       0       14,614  

Non-interest income - external customers

    3,830       0       0       3,830  

Intersegment non-interest income

    105       3,464       (3,569 )     0  

Interest expense

    996       0       0       996  

Provision for loan losses

    170       0       0       170  

Non-interest expense

    12,616       356       (105 )     12,867  

Income tax expense

    1,303       (64 )     0       1,239  

Net income

    3,464       3,172       (3,464 )     3,172  

Total assets

    726,121       81,590       (81,426 )     726,285  
                                 

At or for the quarter ended June 30, 2019:

                               

Interest income - external customers

  $ 8,299       0       0       8,299  

Non-interest income - external customers

    2,021       0       0       2,021  

Intersegment non-interest income

    58       3,018       (3,076 )     0  

Interest expense

    829       0       0       829  

Provision for loan losses

    (1,059 )     0       0       (1,059 )

Non-interest expense

    6,427       198       (58 )     6,567  

Income tax expense

    1,163       (42 )     0       1,121  

Net income

    3,018       2,862       (3,018 )     2,862  

Total assets

    721,757       89,006       (87,996 )     722,767  
                                 

At or for the quarter ended June 30, 2018:

                               

Interest income - external customers

  $ 7,456       0       0       7,456  

Non-interest income - external customers

    2,054       0       0       2,054  

Intersegment non-interest income

    52       1,870       (1,922 )     0  

Interest expense

    526       0       0       526  

Provision for loan losses

    295       0       0       295  

Non-interest expense

    6,191       174       (52 )     6,313  

Income tax expense

    680       (31 )     0       649  

Net income

    1,870       1,727       (1,870 )     1,727  

Total assets

    726,121       81,590       (81,426 )     726,285  

 

 

 

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Forward-looking Information

 

Safe Harbor Statement 

This quarterly report and other reports filed by the Company with the SEC may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to growing our core deposit relationships and loan balances, enhancing the financial performance of our core banking operations, maintaining credit quality, reducing non-performing assets, and generating improved financial results (including profitability); the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; our expectations for core capital and our strategies and potential strategies for maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the amount of the Bank’s non-performing assets and the appropriateness of the allowance therefor; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount of yield enhancements relating to non-accruing and purchased loans; the amount and composition of non-interest and interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer of the trust preferred securities held by the Bank; the anticipated results of litigation and our assessment of the impact on our financial statements; the ability of the Bank to pay dividends to HMN; the ability to remain well capitalized; the impact of new accounting pronouncements; and compliance by the Bank with regulatory standards generally (including the Bank’s status as “well-capitalized”) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (FRB), the Bank, and the Company to any failure to comply with any such regulatory standard, directive or requirement.

A number of factors could cause actual results to differ materially from the Company’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with traditional and alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank (FHLB); technological, computer-related or operational difficulties; results of litigation; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the future operating results, financial condition, cash flow requirements and capital spending priorities of the Company and the Bank; the availability of internal and, as required, external sources of funding; our ability to attract and retain employees; or other significant uncertainties. Additional factors that may cause actual results to differ from the Company’s assumptions and expectations include those set forth in the Company’s most recent filings on Forms 10-K and 10-Q with the SEC. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” sections of the Company’s Annual Report on Forms 10-K for the year ended December 31, 2018 and Part II, Item 1A of its subsequently filed quarterly reports on Form 10-Q. All statements in this Form 10-Q, including forward-looking statements, speak only as of the date they are made, and we undertake no duty to update any of the forward-looking statements after the date of this quarterly report on Form 10-Q.

 

 

General

HMN Financial, Inc. (HMN or the Company) is the stock savings bank holding company for Home Federal Savings Bank (the Bank), which operates community banking and loan production offices in Minnesota, Iowa and Wisconsin. The earnings of the Company are primarily dependent on the Bank's net interest income, which is the difference between interest earned on loans and investments, and the interest paid on interest-bearing liabilities such as deposits and other borrowings. The difference between the average rate of interest earned on assets and the average rate paid on liabilities is the "interest rate spread". Net interest income is produced when interest-earning assets equal or exceed interest-bearing liabilities and there is a positive interest rate spread. Net interest income and net interest rate spread are affected by changes in interest rates, the volume and composition of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company's net earnings are also affected by the generation of non-interest income, which consists primarily of gains from the sale of loans and real estate owned, fees for servicing loans, commissions on the sale of uninsured investment products, and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of compensation and benefits, occupancy and equipment expenses, provisions for loan losses, professional services, data processing costs, other non-interest expenses and income taxes. The earnings of financial institutions, such as the Bank, are also significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of business credit, single family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of deposits are influenced by prevailing market rates of interest on competing investments, account maturities and the levels of personal income and savings.

 

Critical Accounting Estimates

Critical accounting policies are those policies that the Company's management believes are the most important to understanding the Company’s financial condition and operating results. These critical accounting policies often involve estimates and assumptions that could have a material impact on the Company’s financial statements. The Company has identified the following critical accounting policies that management believes involve the most difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates, assumptions and other factors used.

 

Allowance for Loan Losses and Related Provision

The allowance for loan losses is based on periodic analysis of the loan portfolio and is maintained at an amount considered to be appropriate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, actual and anticipated changes in the size of the portfolios, national and regional economic conditions such as unemployment data, loan delinquencies, local economic conditions, demand for single family homes, demand for commercial real estate and building lots, loan portfolio composition, historical loss experience and observations made by the Company's ongoing internal audit and regulatory exam processes. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the appropriateness of the loan loss allowance for its homogeneous single family and consumer loan portfolios and its non-homogeneous loan portfolios. The determination of the allowance on the homogeneous single family and consumer loan portfolios is calculated on a pooled basis with individual determination of the allowance for all non-performing loans. The determination of the allowance for the non-homogeneous commercial, commercial real estate and multi-family loan portfolios involves assigning standardized risk ratings and loss factors that are periodically reviewed. The loss factors are estimated based on the Company's own loss experience and are assigned to all loans without identified credit weaknesses. For each non-performing loan, the Company also performs an individual analysis of impairment that is based on the expected cash flows or the value of the assets collateralizing the loans and establishes any necessary reserves or charges off all loans, or portions thereof, that are deemed uncollectible.

 

 

The appropriateness of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status, and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans is typically based on the appraised value of the property less estimated selling costs. The estimates are reviewed periodically and adjustments, if any, are recorded in the provision for loan losses in the periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios and the actual loss experience. The Company increases its allowance for loan losses by charging the provision for loan losses against income and by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for loan losses and recording loan charge-offs. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.

 

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal and state income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities.

 

The Company maintains significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan and real estate losses. For tax purposes only the net charge-offs are deductible while the entire provision for loan losses is used to determine book income. A deferred tax asset is created because of the timing difference of when the expense is recognized for book and tax purposes. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies, and assessments of the current and future economic and business conditions. The Company considers both positive and negative evidence regarding the ultimate realizability of deferred tax assets. Positive evidence includes the Company’s cumulative net income in the prior three year period, the ability to implement tax planning strategies to accelerate taxable income recognition, and the probability that taxable income will be generated in future periods. The Company could not currently identify any negative evidence. It is possible that future conditions may differ substantially from those anticipated in determining that no valuation allowance was required on deferred tax assets, and adjustments may be required in the future.

 

Determining the ultimate settlement of any tax position requires significant estimates and judgments in arriving at the amount of tax benefits to be recognized in the financial statements. It is possible that the tax benefits realized upon the ultimate resolution of a tax position may result in tax benefits that are significantly different from those estimated.

 

 

RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2019 COMPARED TO THE SAME PERIODS ENDED JUNE 30, 2018

 

Net Income

Net income for the second quarter of 2019 was $2.9 million, an increase of $1.2 million, compared to net income of $1.7 million for the second quarter of 2018. Diluted earnings per share for the second quarter of 2019 was $0.62, an increase of $0.26 from the diluted earnings per share of $0.36 for the second quarter of 2018. The increase in net income between the periods was primarily because of the $1.4 million decrease in the provision for loan losses and a $0.5 million increase in net interest income. These increases were partially offset by an increase in other non-interest expenses of $0.3 million and a $0.5 million increase in income tax expense as a result of the increased pre-tax income between the periods.

 

 

Net income was $4.5 million for the six month period ended June 30, 2019, an increase of $1.3 million, or 41.3%, compared to net income of $3.2 million for the six month period ended June 30, 2018. Diluted earnings per share for the six month period ended June 30, 2019 was $0.97, an increase of $0.31 per share compared to diluted earnings per share of $0.66 for the same period in 2018. The increase in net income between the periods was primarily because of the $1.2 million decrease in the provision for loan losses and a $0.9 million increase in net interest income. These increases were partially offset by a $0.5 million increase in income tax expense as a result of the increased pre-tax income between the periods.

 

Net Interest Income

Net interest income was $7.5 million for the second quarter of 2019, an increase of $0.6 million, or 7.8%, from $6.9 million for the second quarter of 2018. Interest income increased primarily because of the higher interest amounts earned on interest-earning assets as a result of the increase in the federal funds rate between the periods. Interest income also increased $0.4 million between the periods because of an increase in the amount of yield enhancements recognized on non-accruing loans that were paid off. The average yield earned on interest-earning assets was 4.83% for the second quarter of 2019, an increase of 56 basis points from 4.27% for the second quarter of 2018. The average yield earned on average interest-earning assets increased 30 basis points as a result of the change in yield enhancements recognized between the periods.

 

Interest expense was $0.8 million for the second quarter of 2019, an increase of $0.3 million, or 57.4%, from $0.5 million for the second quarter of 2018. The average interest rate paid on non-interest and interest-bearing liabilities was 0.53% for the second quarter of 2019, an increase of 20 basis points from 0.33% for the second quarter of 2018. The increase in the interest paid on non-interest and interest-bearing liabilities was primarily because of the increase in the federal funds rate between the periods which increased the cost of deposits.

 

Net interest margin (net interest income divided by average interest-earning assets) for the second quarter of 2019 was 4.35%, an increase of 38 basis points, compared to 3.97% for the second quarter of 2018. The increase in the net interest margin is primarily related to the increase in interest income between the periods as a result of the change in the yield enhancements recognized and an increase in the federal funds rate.

 

Net interest income was $14.5 million for the first six months of 2019, an increase of $0.9 million, or 6.6%, from $13.6 million for the same period in 2018. Interest income increased primarily because of the higher interest amounts earned on interest-earning assets as a result of the increase in the federal funds rate between the periods. Interest income also increased $0.5 million because of an increase in the amount of yield enhancements recognized between the periods on non-accruing loans that were paid off. The average yield earned on interest-earning assets was 4.68% for the six month period ended June 30, 2019, an increase of 43 basis points from 4.25% for the same six month period in 2018. The average yield earned on the average interest-earning assets increased 19 basis points as a result of the change in yield enhancements recognized between the periods.

 

Interest expense was $1.5 million for the first six months of 2019, an increase of $0.5 million, or 52.5%, compared to $1.0 million for the first six months of 2018. The average interest rate paid on non-interest and interest-bearing liabilities was 0.49% for the first six months of 2019, an increase of 17 basis points from 0.32% for the first six months of 2018. The increase in the interest paid on non-interest and interest-bearing liabilities was primarily because of the increase in the federal funds rate between the periods which increased the cost of deposits.

 

Net interest margin (net interest income divided by average interest-earning assets) for the first six months of 2019 was 4.23%, an increase of 27 basis points, compared to 3.96% for the first six months of 2018. The increase in the net interest margin is primarily related to the increase in interest income between the periods as a result of the increase in the federal funds rate and the change in the yield enhancements recognized.

 

 

A summary of the Company’s net interest margin for the three and six month periods ended June 30, 2019 and 2018 is as follows:

 

   

For the three month period ended

 
   

June 30, 2019

   

June 30, 2018

 

(Dollars in thousands)

 

Average

Outstanding

Balance

   

Interest

Earned/

Paid

   

Yield/

Rate

   

Average

Outstanding

Balance

   

Interest

Earned/

Paid

   

Yield/

Rate

 

Interest-earning assets:

                                               

Securities available for sale

  $ 78,393       347       1.78

%

  $ 80,263       339       1.69

%

Loans held for sale

    2,482       27       4.36       2,389       27       4.51  

Mortgage loans, net

    113,786       1,248       4.40       110,939       1,137       4.11  

Commercial loans, net

    407,854       5,678       5.58       405,553       4,957       4.90  

Consumer loans, net

    73,777       950       5.16       72,070       885       4.92  

Other

    12,161       49       1.62       29,353       111       1.52  

Total interest-earning assets

    688,453       8,299       4.83       700,567       7,456       4.27  
                                                 

Interest-bearing liabilities and non-interest bearing deposits:

                                               

NOW accounts

    96,579       25       0.10       88,327       11       0.05  

Savings accounts

    80,013       16       0.08       78,850       16       0.08  

Money market accounts

    168,605       306       0.73       199,279       203       0.41  

Certificates

    118,893       475       1.60       115,871       296       1.02  

Advances and other borrowings

    1,152       7       2.54       0       0       0.00  

Total interest-bearing liabilities

    465,242                       482,327                  

Non-interest checking

    155,921                       154,323                  

Other non-interest bearing deposits

    1,610                       1,448                  

Total interest-bearing liabilities and non-interest bearing deposits

  $ 622,773       829       0.53     $ 638,098       526       0.33  

Net interest income

          $ 7,470                     $ 6,930          

Net interest rate spread

                    4.30

%

                    3.94

%

Net interest margin

                    4.35

%

                    3.97

%

                                                 

 

 

   

For the six month period ended

 
   

June 30, 2019

   

June 30, 2018

 

(Dollars in thousands)

 

Average

Outstanding

Balance

   

Interest

Earned/

Paid

   

Yield/

Rate

   

Average

Outstanding

Balance

   

Interest

Earned/

Paid

   

Yield/

Rate

 

Interest-earning assets:

                                               

Securities available for sale

  $ 78,592       686       1.76

%

  $ 79,274       653       1.66

%

Loans held for sale

    1,838       39       4.30       1,730       38       4.47  

Mortgage loans, net

    114,814       2,508       4.41       112,268       2,259       4.06  

Commercial loans, net

    404,399       10,737       5.35       403,035       9,726       4.87  

Consumer loans, net

    73,178       1,885       5.19       72,229       1,761       4.92  

Other

    18,549       176       1.91       25,179       177       1.42  

Total interest-earning assets

    691,370       16,031       4.68       693,715       14,614       4.25  
                                                 

Interest-bearing liabilities and non-interest bearing deposits:

                                               

NOW accounts

    97,132       49       0.10       88,982       21       0.05  

Savings accounts

    79,259       31       0.08       78,017       31       0.08  

Money market accounts

    175,052       576       0.66       194,871       388       0.40  

Certificates

    116,558       856       1.48       113,798       554       0.98  

Advances and other borrowings

    579       7       2.54       283       2       1.71  

Total interest-bearing liabilities

    468,580                       475,951                  

Non-interest checking

    156,185                       153,796                  

Other non-interest bearing deposits

    1,835                       1,494                  

Total interest-bearing liabilities and non-interest bearing deposits

  $ 626,600       1,519       0.49     $ 631,241       996       0.32  

Net interest income

          $ 14,512                     $ 13,618          

Net interest rate spread

                    4.19

%

                    3.93

%

Net interest margin

                    4.23

%

                    3.96

%

                                                 

 

 

Provision for Loan Losses

The provision for loan losses was ($1.1 million) for the second quarter of 2019, a decrease of $1.4 million compared to $0.3 million for the second quarter of 2018. The provision for loan losses was ($1.0 million) for the first six months of 2019, a decrease of $1.2 million compared to $0.2 million for the first six months of 2018. The credit provision amounts for the three and six month periods ending June 30, 2019 were primarily the result of the increase in the net recoveries received on previously charged off commercial loans during the three and six month periods of 2019 compared to the same periods of 2018. The net recoveries combined with the continued improvement in the credit quality of the loan portfolio resulted in a reduction of the overall allowance for loan losses required between the periods.

 

A reconciliation of the Company’s allowance for loan losses for the three and six month periods ended June 30, 2019 and 2018 is summarized as follows:

 

             

(Dollars in thousands)

 

2019

   

2018

 
                 

Balance at March 31,

  $ 8,673       9,129  

Provision

    (1,059 )     295  

Charge offs:

               

Consumer

    (7 )     (56 )

Commercial business

    (826 )     (255 )

Recoveries

    1,843       215  

Balance at June 30,

  $ 8,624       9,328  
                 

Allocated to:

               

General allowance

  $ 7,855       8,534  

Specific allowance

    769       794  
    $ 8,624       9,328  
                 

 

             

(Dollars in thousands)

 

2019

   

2018

 
                 

Balance at January 1,

  $ 8,686       9,311  

Provision

    (1,032 )     170  

Charge offs:

               

Consumer

    (46 )     (125 )

Commercial business

    (869 )     (255 )

Single family

    0       (23 )

Recoveries

    1,885       250  

Balance at June 30,

  $ 8,624       9,328  
                 

 

The decrease in the allowance for loan losses reflects the improvement in the credit quality of the loan portfolio between the periods. The $0.8 million and $0.9 million in commercial business loan charge offs in the three and six month periods ending June 30, 2019 relates primarily to two commercial business loans that were charged off due to the bankruptcy filing of the borrowers. The $1.8 million and $1.9 million of recoveries in the three and six month periods ending June 30, 2019 relates primarily to the repayment of a commercial real estate loan of which $1.7 million had previously been charged off.

 

Non-Interest Income

Non-interest income was $2.0 million for the second quarter of 2019, a decrease of $0.1 million, or 1.6%, from $2.1 million for the same period of 2018. Gain on sales of loans decreased $0.1 million between the periods primarily because of a decrease in commercial government guaranteed loan sales. Loan servicing income increased slightly due to an increase in the single family loan servicing fees earned. Other non-interest income increased slightly due to an increase in the fees earned on the sales of uninsured investment products between the periods.

 

Non-interest income was $3.7 million for the first six months of 2019, a decrease of $0.1 million, or 3.1%, from $3.8 million for the same six month period of 2018. Gain on sales of loans decreased $0.1 million between the periods primarily because of a decrease in commercial government guaranteed loan sales. Fees and service charges decreased $0.1 million between the periods due primarily to a decrease in overdraft fees. These decreases in non-interest income were partially offset by a slight increase in other non-interest income due to an increase in the sale of uninsured investment products and a slight increase in loan servicing income earned on single family loans between the periods.

 

 

Non-Interest Expense

Non-interest expense was $6.6 million for the second quarter of 2019, an increase of $0.3 million, or 4.0%, from $6.3 million for the second quarter of 2018. Other non-interest expense increased $0.1 million due primarily to an increase in loan related expenses. Professional services expense increased $0.1 million due primarily to an increase in legal expenses between the periods. Compensation and benefits expense increased $0.1 million primarily because of an increase in pension costs between the periods. Occupancy and equipment costs increased slightly between the periods due to an increase in depreciation and maintenance costs. These increases in non-interest expense were partially offset by a slight decrease in data processing expense primarily because of a decrease in phone and internet costs between the periods due to a change in vendors.

 

Non-interest expense was $13.0 million for the first six months of 2019, an increase of $0.1 million, or 1.1%, from $12.9 million for the same six month period of 2018. Compensation and benefits expense increased $0.1 million primarily because of an increase in pension costs between the periods. Professional services expense increased $0.1 million due primarily to an increase in legal expenses between the periods. These increases in non-interest expense were partially offset by a $0.1 million decrease in other non-interest expense between the periods due primarily to a decrease in the losses incurred on deposit accounts. Occupancy and equipment costs decreased slightly between the periods due to a decrease in non-capitalized equipment and software costs. Data processing costs decreased slightly because of a decrease in phone and internet costs between the periods due to a change in vendors.

 

Income Taxes

Income tax expense was $1.1 million for the second quarter of 2019, an increase of $0.5 million from $0.6 million for the second quarter of 2018. Income tax expense was $1.8 million for the first six months of 2019, an increase of $0.6 million from $1.2 million for the first six months of 2018. The increase in income tax expense between the periods is primarily the result of an increase in pre-tax income.

 

 

FINANCIAL CONDITION

Non-Performing Assets

The following table summarizes the amounts and categories of non-performing assets in the Bank’s portfolio and loan delinquency information as of the end of the three most recently completed quarters.

 

   

June 30,

   

March 31,

   

December 31,

 

(Dollars in thousands)

 

2019

   

2019

   

2018

 
                         

Non-Performing Loans:

                       

Single family

  $ 854     $ 751     $ 730  

Commercial real estate

    1,212       1,275       1,311  

Consumer

    458       283       489  

Commercial business

    144       212       148  

Total

    2,668       2,521       2,678  
                         

Foreclosed and Repossessed Assets:

                       

Single family

    30       30       0  

Commercial real estate

    414       414       414  

Consumer

    12       0       0  

Total non-performing assets

  $ 3,124     $ 2,965     $ 3,092  

Total as a percentage of total assets

    0.43

%

    0.41

%

    0.43

%

Total non-performing loans

  $ 2,668     $ 2,521     $ 2,678  

Total as a percentage of total loans receivable, net

    0.45

%

    0.42

%

    0.46

%

Allowance for loan loss to non-performing loans

    323.18

%

    343.90

%

    324.27

%

                         

Delinquency Data:

                       

Delinquencies (1)

                       

30+ days

  $ 1,991     $ 1,554     $ 1,453  

90+ days

    0       0       0  

Delinquencies as a percentage of loan portfolio (1)

                       

30+ days

    0.33

%

    0.25

%

    0.24

%

90+ days

    0.00

%

    0.00

%

    0.00

%

 

(1) Excludes non-accrual loans. 

           

 

Total non-performing assets were $3.1 million at June 30, 2019, an increase of $0.1 million, or 5.3%, from $3.0 million at March 31, 2019. Non-performing loans increased $0.1 million and foreclosed and repossessed assets remained the same during the second quarter of 2019.

 

Total non-performing assets were $3.1 million at June 30, 2019, the same as they were at December 31, 2018.

 

Dividends

The declaration of dividends is subject to, among other things, the Company's financial condition and results of operations, the Bank's compliance with regulatory capital requirements and other regulatory restrictions, tax considerations, industry standards, economic conditions, general business practices and other factors. The Company has not made any dividend payments to common stockholders during the three year period ended June 30, 2019.

 

 

LIQUIDITY AND CAPITAL RESOURCES

For the six months ended June 30, 2019, the net cash provided by operating activities was $4.1 million. The Company collected $0.4 million from maturing securities, $0.8 million from principal repayments on securities, and $1.1 million from the redemption of FHLB stock. The Company purchased $1.0 million in FHLB stock and paid out $0.5 million for premises and equipment. Net loans receivable increased $9.3 million and the Company had a net increase in deposit balances of $0.2 million. The Company also received and repaid $26.0 million in borrowings.

 

The Company has certificates of deposits with outstanding balances of $78.0 million that mature over the next 12 months. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that cash outflow from certificates that do not renew will be replaced with other deposits or FHLB advances. Federal Reserve Bank borrowings or proceeds from the sale of securities could also be used to fund unanticipated outflows of certificates of deposits.

 

The Company had two deposit customers that individually had aggregate deposits greater than $5.0 million as of June 30, 2019. The $22.3 million in funds held by these customers may be withdrawn at any time, but management believes that the majority of these deposits will not be withdrawn from the Bank over the next twelve months. If these deposits are withdrawn, it is anticipated that they would be replaced with deposits from other customers or FHLB advances. Federal Reserve Bank borrowings or proceeds from the sale of securities could also be used to replace unanticipated outflows of large checking and money market deposits.

 

The Company had the ability to borrow $181.9 million from the FHLB at June 30, 2019, based on the collateral value of the loans pledged. The credit policy of the FHLB relating to the collateral value of the loans collateralizing the available line of credit with the FHLB may change such that the current collateral pledged to secure future advances is no longer acceptable or the formulas for determining the excess pledged collateral may change. The FHLB could also reduce the amount of funds it will lend to the Bank. It is not anticipated that the Bank will need to find alternative funding sources in the next twelve months to replace the available borrowings from the FHLB. However, if needed, excess collateral currently pledged to the FHLB could be pledged to the Federal Reserve Bank and the Bank could borrow additional funds from the Federal Reserve Bank based on the increased collateral levels or obtain additional deposits.

 

The Company’s primary source of cash is dividends from the Bank. At June 30, 2019, the Company had $2.5 million in cash and other assets that could readily be turned into cash. The primary use of cash by the Company is the payment of operating expenses.

 

The Company also serves as a source of capital, liquidity, and financial support to the Bank. Depending upon the operating performance of the Bank and the Company’s other liquidity and capital needs, including Company level expenses, the Company may find it prudent, subject to prevailing capital market conditions and other factors, to raise additional capital through issuance of its common stock or other equity securities. Additional capital would also potentially permit the Company to implement a strategy of growing Bank assets. Depending on the circumstances, if it were to raise capital, the Company may deploy it to the Bank for general banking purposes, or may retain some or all of it for use by the Company.

 

 

If the Company were to raise capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders, and, if issued at a price less than the Company’s book value, would dilute the per share book value of the Company’s common stock, and could result in a change in control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to the Company’s current stockholders, which may adversely impact the Company’s current stockholders. The Company’s ability to raise additional capital through the issuance of equity securities, if deemed prudent, will depend on, among other factors, conditions in the capital markets at that time, which are outside of its control, and on the Company’s financial performance and plans.

 

Market Risk  

Market risk is the risk of loss from adverse changes in market prices and rates. The Company’s market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.

 

The Company’s profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company’s earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. The Company monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located in the following Asset/Liability Management section of this report discloses the Company’s projected changes in net interest income based upon immediate interest rate changes called rate shocks. The Company utilizes a model that uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities under different interest rate changes.

 

The following table discloses the projected changes in the market value of the Company’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis-point changes in interest rates from interest rates in effect on June 30, 2019.

 

   

Market Value

 
(Dollars in thousands)                                    

Basis point change in interest rates

    -200       -100       0    

+100

   

+200

 

Total market risk sensitive assets

  $ 729,287       718,485       705,774       695,172       681,538  

Total market risk sensitive liabilities

    686,070       640,162       598,661       562,759       532,321  

Off-balance sheet financial instruments

    (65 )     (345 )     0       (619 )     (609 )

Net market risk

  $ 43,282       78,668       107,113       133,032       149,826  

Percentage change from current market value

    (59.59

)%

    (26.56

)%

    0.00

%

    24.20

%

    39.88

%

                                         

 

The preceding table was prepared utilizing a model using the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon their review of historical prepayment speeds and future prepayment projections. Fixed rate loans were assumed to prepay at annual rates of between 7% to 42%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 5% and 60%, depending on the note rate and the period to maturity. Mortgage-backed securities were projected to have prepayments based upon the underlying collateral securing the instrument. Certificate accounts were assumed not to be withdrawn until maturity. Passbook accounts and money market accounts were assumed to decay at an annual rate of 0% and 1%, respectively. Retail checking accounts, commercial checking accounts and money market accounts were assumed to decay at annual rates of 0%, 28% and 32%, respectively. Callable investments were projected to be called at the first call date where the projected interest rate on similar remaining term instruments was less than the interest rate on the callable investment.

 

 

Certain shortcomings are inherent in the method of analysis presented in the above table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the Interest Spread) will remain constant over the interest changes disclosed in the table. Changes in Interest Spread could impact projected market value changes. Certain assets, such as ARMs, have features which restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets that are approaching their lifetime interest rate caps could be different from the values disclosed in the table. Certain liabilities, such as certificates of deposit, have fixed rates that restrict interest rate changes until maturity. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may also decrease in the event of a substantial sustained increase in interest rates.

 

Asset/Liability Management

The Company’s management reviews the impact that changing interest rates will have on its net interest income projected for the next twelve months to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income during the twelve month period ending June 30, 2020 of immediate interest rate changes called rate shocks.

 

(Dollars in thousands)

 

Rate Shock in

Basis Points

   

Projected

Change in Net

Interest Income

   

Percentage

Change

 

+200

    $ 2,004       7.07 %

+100

      988       3.49  
0       0       0.00  
-100       (1,444 )     (5.10 )
-200       (3,034 )     (10.71 )

 

The preceding table was prepared utilizing the Model Assumptions. Certain shortcomings are inherent in the method of analysis presented in the foregoing table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. 

 

The increase in interest income in a rising rate environment is primarily because there are more adjustable rate loans that would re-price to higher interest rates than there are deposits that would re-price in the next twelve months.

 

In an attempt to manage its exposure to changes in interest rates, management closely monitors interest rate risk. The Bank has an Asset/Liability Committee that meets frequently to discuss changes in the interest rate risk position and projected profitability. This Committee makes adjustments to the asset/liability position of the Bank that are reviewed by the Board of Directors of the Bank. This Committee also reviews the Bank's portfolio, formulates investment strategies and oversees the timing and implementation of transactions as intended to assure attainment of the Bank's objectives in an effective manner. In addition, each quarter the Board reviews the Bank's asset/liability position, including simulations of the effect on the Bank's capital of various interest rate scenarios.

 

In managing its asset/liability composition, the Bank may, at times, depending on the relationship between long-term and short-term interest rates, market conditions and consumer preference, place more emphasis on managing net interest margin than on better matching the interest rate sensitivity of its assets and liabilities in an effort to enhance net interest income. Management believes that the increased net interest income resulting from a mismatch in the maturity of its asset and liability portfolios can, in certain situations, provide high enough returns to justify the increased exposure to sudden and unexpected changes in interest rates.

 

To the extent consistent with its interest rate spread objectives, the Bank attempts to manage its interest rate risk and has taken a number of steps to restructure its balance sheet in order to better match the maturities of its assets and liabilities. In the past, more long-term fixed rate loans were placed into the single family loan portfolio. In recent years, the Bank has continued to focus its 30 year fixed rate single family residential lending program on loans that are saleable to third parties and generally places only adjustable rate or shorter-term fixed rate loans that meet certain risk characteristics into its loan portfolio. A significant portion of the Bank’s commercial loan production continues to be in adjustable rate loans that reprice every one, two or three years.

 

 

Off-Balance Sheet Arrangements

The Company has no off-balance sheet arrangements other than commitments to originate and sell loans in the ordinary course of business.

 

Item 3: Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

 

Item 4: Controls and Procedures

Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms.

 

Changes in internal controls. There was no change in the Company’s internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

HMN FINANCIAL, INC.

 

PART II - OTHER INFORMATION

 

Item 1.

Legal Proceedings.

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. See Note 15- Commitments and Loss Contingencies of the Notes to the Consolidated Financial Statements for more information.

 

Item 1A.

Risk Factors.

There have been no material changes to the Company’s risk factors contained in its Annual Report on Form 10-K for the year ended December 31, 2018. For a further discussion of our Risk Factors, see Part I, Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2018.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

(a) Not applicable.

(b) Not applicable.

(c) On November 28, 2018, the Board of Directors announced a new share repurchase program pursuant to which the Company may purchase shares of its common stock for an aggregate purchase price not to exceed $6 million. The share repurchase program does not obligate the Company to purchase any shares and has no set expiration date. No shares were repurchased by the Company during the three or six month periods ended June 30, 2019.

 

Item 3.

Defaults Upon Senior Securities.

None.

 

Item 4.

Mine Safety Disclosures.

Not applicable.

 

Item 5.

Other Information.

None.

 

 

Item 6.

Exhibits.

 

INDEX TO EXHIBITS

 

Exhibit

 

Filing

Number

Exhibit

Status

     

31.1

Rule 13a-14(a)/15d-14(a) Certification of CEO

Filed Electronically

     

31.2

Rule 13a-14(a)/15d-14(a) Certification of CFO

Filed Electronically

     

32

Section 1350 Certifications of CEO and CFO

Filed Electronically

     

101

Financial statements from the Quarterly Report on Form 10-Q of the Company for the period ended June 30, 2019, filed with the SEC on August 2, 2019, formatted in Extensible Business Reporting Language (XBRL); (i) the Consolidated Balance Sheets at June 30, 2019 and December 31, 2018, (ii) the Consolidated Statements of Comprehensive Income for the Three Months and Six Months Ended June 30, 2019 and 2018, (iii) the Consolidated Statements of Stockholders’ Equity for the Three and Six Month Periods Ended June 30, 2019 and 2018, (iv) the Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2019 and 2018, and (v) Notes to Consolidated Financial Statements.

Filed Electronically

 

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

HMN FINANCIAL, INC. 

 

  Registrant  

 

 

 

 

 

 

 

 

Date:   August 2, 2019                                    

/s/ Bradley Krehbiel

 

 

Bradley Krehbiel, President and Chief Executive Officer 

 

 

(Principal Executive Officer) 

 

     
     
Date:  August 2, 2019                                     /s/ Jon Eberle  
  Jon Eberle, Senior Vice President and  
  Chief Financial Officer  
  (Principal Financial Officer)  

 

38