HMN FINANCIAL INC - Quarter Report: 2021 September (Form 10-Q)

hmnf20210930_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

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

For the quarterly period ended September 30, 2021

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

For the transition period from _________ to _________

Commission File Number 0-24100

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Delaware		41-1777397
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1016 Civic Center Drive N.W., Rochester, MN		55901
(Address of principal executive offices)		(Zip Code)

Registrant's telephone number, including area code:		(507) 535-1200

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

Title of Each Class	Trading Symbol(s)	Name of Each Exchange on Which Registered
Common Stock	HMNF	The Nasdaq Stock Market LLC

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

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

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

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

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

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

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

Class		Outstanding at October 26, 2021
Common stock, $0.01 par value		4,594,575

Table of Contents

HMN FINANCIAL, INC.

TABLE OF CONTENTS

		Page
PART I - FINANCIAL INFORMATION

Item 1:	Financial Statements	3

	Consolidated Balance Sheets at September 30, 2021 and December 31, 2020	3

	Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2021 and 2020	4

	Consolidated Statements of Stockholders' Equity for the Three and Nine Months Ended September 30, 2021 and 2020	5

	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2021 and 2020	6

	Notes to Consolidated Financial Statements	7

Item 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	25

Item 3:	Quantitative and Qualitative Disclosures about Market Risk	37

Item 4:	Controls and Procedures	37

PART II - OTHER INFORMATION

Item 1:	Legal Proceedings	38

Item 1A:	Risk Factors	38

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	38

Item 3:	Defaults Upon Senior Securities	38

Item 4:	Mine Safety Disclosures	38

Item 5:	Other Information	38

Item 6:	Exhibits	39

Signatures		40

Table of Contents

Part I – FINANCIAL INFORMATION

Item 1: Financial Statements

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

	September 30,			December 31,
(Dollars in thousands)	2021			2020
	(unaudited)
Assets
Cash and cash equivalents	$	149,436			86,269
Securities available for sale:
Mortgage-backed and related securities (amortized cost $194,562 and $99,821)		194,307			101,464
Other marketable securities (amortized cost $40,690 and $46,491)		40,632			46,626
		234,939			148,090

Loans held for sale		5,754			6,186
Loans receivable, net		622,264			642,630
Accrued interest receivable		2,062			3,102
Mortgage servicing rights, net		3,232			3,043
Premises and equipment, net		9,815			10,133
Goodwill		802			802
Core deposit intangible		17			57
Prepaid expenses and other assets		5,683			7,241
Deferred tax asset, net		2,611			2,027
Total assets	$	1,036,615			909,580

Liabilities and Stockholders’ Equity
Deposits	$	915,302			795,204
Accrued interest payable		76			140
Customer escrows		3,212			1,998
Accrued expenses and other liabilities		8,091			8,986
Total liabilities		926,681			806,328
Commitments and contingencies
Stockholders’ equity:
Serial preferred stock ($.01 par value): authorized 500,000 shares; issued 0		0			0
Common stock ($.01 par value): authorized 16,000,000 shares; issued 9,128,662		91			91
Additional paid-in capital		40,610			40,480
Retained earnings, subject to certain restrictions		129,414			117,849
Accumulated other comprehensive (loss) income		(226	)		1,282
Unearned employee stock ownership plan shares		(1,304	)		(1,450	)
Treasury stock, at cost 4,534,087 and 4,359,552 shares		(58,651	)		(55,000	)
Total stockholders’ equity		109,934			103,252
Total liabilities and stockholders’ equity	$	1,036,615			909,580

See accompanying notes to consolidated financial statements.

Table of Contents

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income

(unaudited)

	Three Months Ended September 30,						Nine Months Ended September 30,
(Dollars in thousands, except per share data)	2021			2020			2021			2020
Interest income:
Loans receivable	$	7,837			7,489			22,754			22,156
Securities available for sale:
Mortgage-backed and related		457			271			1,288			825
Other marketable		57			163			226			546
Other		50			26			116			149
Total interest income		8,401			7,949			24,384			23,676

Interest expense:
Deposits		360			656			1,223			2,293
Total interest expense		360			656			1,223			2,293
Net interest income		8,041			7,293			23,161			21,383
Provision for loan losses		(886	)		770			(2,353	)		1,548
Net interest income after provision for loan losses		8,927			6,523			25,514			19,835

Non-interest income:
Fees and service charges		810			753			2,332			2,136
Loan servicing fees		389			347			1,168			976
Gain on sales of loans		1,471			3,005			4,909			6,503
Other		381			422			2,639			975
Total non-interest income		3,051			4,527			11,048			10,590

Non-interest expense:
Compensation and benefits		3,948			3,916			11,865			11,762
Occupancy and equipment		1,090			1,101			3,301			3,335
Data processing		384			334			1,099			963
Professional services		409			241			895			1,175
Other		1,075			1,135			3,205			3,144
Total non-interest expense		6,906			6,727			20,365			20,379
Income before income tax expense		5,072			4,323			16,197			10,046
Income tax expense		1,453			1,222			4,632			2,869
Net income		3,619			3,101			11,565			7,177
Other comprehensive (loss) income, net of tax		(688	)		(202	)		(1,508	)		1,297
Comprehensive income available to common stockholders	$	2,931			2,899			10,057			8,474
Basic earnings per share	$	0.82			0.67			2.57			1.55
Diluted earnings per share	$	0.81			0.67			2.55			1.54

See accompanying notes to consolidated financial statements.

Table of Contents

HMN FINANCIAL, INC. AND SUBSIDIARIES

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

(unaudited)

											Unearned
											Employee
								Accumulated			Stock
			Additional					Other			Ownership						Total
	Common		Paid-in			Retained		Comprehensive			Plan			Treasury			Stockholders’
(Dollars in thousands)	Stock		Capital			Earnings		Loss			Shares			Stock			Equity

Balance, June 30, 2021	$	91		40,484			125,795		462			(1,353	)		(57,521	)		107,958
Net income							3,619											3,619
Other comprehensive loss									(688	)								(688	)
Stock repurchases															(1,130	)		(1,130	)
Amortization of restricted stock awards				61														61
Earned employee stock ownership plan shares				65								49						114
Balance, September 30, 2021	$	91		40,610			129,414		(226	)		(1,304	)		(58,651	)		109,934

Balance, December 31, 2020	$	91		40,480			117,849		1,282			(1,450	)		(55,000	)		103,252
Net income							11,565											11,565
Other comprehensive loss									(1,508	)								(1,508	)
Stock repurchases															(3,866	)		(3,866	)
Restricted stock awards				(222	)										222			0
Stock awards withheld for tax withholding															(7	)		(7	)
Amortization of restricted stock awards				182														182
Earned employee stock ownership plan shares				170								146						316
Balance, September 30, 2021	$	91		40,610			129,414		(226	)		(1,304	)		(58,651	)		109,934

											Unearned
											Employee
								Accumulated			Stock
			Additional					Other			Ownership						Total
	Common		Paid-in			Retained		Comprehensive			Plan			Treasury			Stockholders’
(Dollars in thousands)	Stock		Capital			Earnings		Income			Shares			Stock			Equity

Balance, June 30, 2020	$	91		40,312			111,623		1,545			(1,546	)		(53,910	)		98,115
Net income							3,101											3,101
Other comprehensive loss									(202	)								(202	)
Amortization of restricted stock awards				54														54
Earned employee stock ownership plan shares				27								48						75
Balance, September 30, 2020	$	91		40,393			114,724		1,343			(1,498	)		(53,910	)		101,143

Balance, December 31, 2019	$	91		40,365			107,547		46			(1,643	)		(53,758	)		92,648
Net income							7,177											7,177
Other comprehensive gain									1,297									1,297
Stock repurchases															(360	)		(360	)
Restricted stock awards				(268	)										268			0
Stock awards withheld for tax withholding															(60	)		(60	)
Amortization of restricted stock awards				184														184
Earned employee stock ownership plan shares				112								145						257
Balance, September 30, 2020	$	91		40,393			114,724		1,343			(1,498	)		(53,910	)		101,143

See accompanying notes to consolidated financial statements.

Table of Contents

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

	Nine Months Ended September 30,
(Dollars in thousands)	2021			2020
Cash flows from operating activities:
Net income	$	11,565			7,177
Adjustments to reconcile net income to cash provided by operating activities:
Provision for loan losses		(2,353	)		1,548
Depreciation		757			785
Amortization of premiums, net		709			119
Amortization of deferred loan fees		(2,342	)		(350	)
Amortization of core deposit intangible		40			74
Amortization of purchased asset fair value adjustments		(20	)		(26	)
Amortization of mortgage servicing rights		881			1,002
Capitalized mortgage servicing rights		(1,070	)		(1,710	)
(Gains) losses recognized on equity securities, net		(69	)		40
Gain on sale of premises		(15	)		(6	)
Gain on sales of real estate		(1,492	)		(129	)
Gain on sales of loans		(4,909	)		(6,503	)
Proceeds from sales of loans held for sale		147,153			202,243
Disbursements on loans held for sale		(133,807	)		(195,571	)
Amortization of restricted stock awards		182			184
Amortization of unearned Employee Stock Ownership Plan shares		146			145
Earned Employee Stock Ownership Plan shares priced above original cost		170			112
Decrease (increase) in accrued interest receivable		1,040			(1,985	)
Decrease in accrued interest payable		(64	)		(195	)
Decrease in other assets		842			1,379
Decrease in other liabilities		(850	)		(170	)
Other, net		14			6
Net cash provided by operating activities		16,508			8,169
Cash flows from investing activities:
Principal collected on securities available for sale		27,739			11,050
Proceeds collected on maturities of securities available for sale		30,762			30,875
Purchases of securities available for sale		(148,149	)		(51,218	)
Purchase of Federal Home Loan Bank stock		(159	)		(79	)
Proceeds from sales of real estate		2,128			434
Net decrease (increase) in loans receivable		17,323			(79,174	)
Proceeds from sale of premises		16			63
Purchases of premises and equipment		(440	)		(669	)
Net cash used by investing activities		(70,780	)		(88,718	)
Cash flows from financing activities:
Increase in deposits		120,098			113,153
Purchase of treasury stock		(3,866	)		(360	)
Stock awards withheld for tax withholding		(7	)		(60	)
Increase (decrease) in customer escrows		1,214			(556	)
Net cash provided by financing activities		117,439			112,177
Increase in cash and cash equivalents		63,167			31,628
Cash and cash equivalents, beginning of period		86,269			44,399
Cash and cash equivalents, end of period	$	149,436			76,027
Supplemental cash flow disclosures:
Cash paid for interest	$	1,287			2,488
Cash paid for income taxes		5,310			2,041
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale		7,757			3,960
Transfer of loans to real estate		0			139

See accompanying notes to consolidated financial statements.

Table of Contents

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.

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

(2) Basis of Preparation

The accompanying unaudited consolidated financial statements were prepared in accordance with instructions for Form 10-Q and, therefore, do not include all disclosures necessary for a complete presentation of the consolidated balance sheets, consolidated statements of comprehensive income, consolidated statements of stockholders' equity and consolidated statements of cash flows in conformity with U.S. generally accepted accounting principles (GAAP). However, all normal recurring adjustments which are, in the opinion of management, necessary for the fair presentation of the interim financial statements have been included. The results of operations for the nine month period ended September 30, 2021 are not necessarily indicative of the results which may be expected for the entire year.

(3) New Accounting Standards

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology required in current GAAP with a methodology that reflects expected credit losses that requires consideration of a broader range of reasonable and supportable information to estimate credit losses. The amendments in this ASU will affect entities to varying degrees depending on the credit quality of the assets held by the entity, the duration of the assets held, and how the entity applies the current incurred loss methodology. The amendments in this ASU, for public business entities that are filers with the Securities and Exchange Commission (SEC), were originally effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods.

On November 26, 2019, the FASB issued ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments – Credit Losses which delayed the implementation date of ASU 2016-13 for SEC smaller reporting companies, such as HMN, from the first quarter of 2020 to the first quarter of 2023. All entities may adopt the amendments in the ASU early as of the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Amendments should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. The Company has not early adopted this ASU. Management has accumulated the charge off information necessary to calculate the appropriate life of loan loss percentages for the various loan categories, has identified several key metrics to help identify and project anticipated changes in the credit quality of the Bank’s loan portfolio upon enactment, and is in the process of evaluating the determination of potential qualitative reserve amounts and the impact that the adoption of this ASU will have on the Company’s consolidated financial statements when it is adopted in the first quarter of 2023.

Table of Contents

On February 6, 2020, the FASB issued ASU 2020-02, Financial Instruments-Credit Losses (Topic 326) and Leases (Topic 842)-Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842). The amendments in this ASU related to Leases (Topic 842) did not have any impact on the Company. The amendments in this ASU related to Topic 326 adds additional guidance related to the SEC’s expectations for the documentation of the measurement, review process and the systematic methodology used by entities to determine the current credit losses under FASB ASC Topic 326. Management is currently in the process of reviewing how the Company’s credit loss calculation and review processes will be impacted by the additional guidance of this ASU when ASC Topic 326 is adopted in the first quarter of 2023.

(4) Fair Value Measurements

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

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

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

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

The following table summarizes the assets and liabilities of the Company for which fair values are determined on a recurring basis as of September 30, 2021 and December 31, 2020.

	Carrying Value at September 30, 2021
(Dollars in thousands)	Total			Level 1		Level 2			Level 3
Securities available for sale	$	234,939			0		234,939			0
Equity securities		217			0		217			0
Mortgage loan commitments		(69	)		0		(69	)		0
Total	$	235,087			0		235,087			0

	Carrying Value at December 31, 2020
(Dollars in thousands)	Total		Level 1		Level 2		Level 3
Securities available for sale	$	148,090		0		148,090		0
Equity securities		149		0		149		0
Mortgage loan commitments		261		0		261		0
Total	$	148,500		0		148,500		0

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

Table of Contents

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

	Carrying Value at September 30, 2021
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Three Months Ended September 30, 2021 Total Losses			Nine Months Ended September 30, 2021 Total Losses
Loans held for sale	$	5,754		0		5,754		0		(91	)		(67	)
Mortgage servicing rights, net		3,232		0		3,232		0		0			0
Impaired loans		1,585		0		1,585		0		(34	)		(98	)
Total	$	10,571		0		10,571		0		(125	)		(165	)

	Carrying Value at December 31, 2020
(Dollars in thousands)	Total		Level 1		Level 2		Level 3		Year Ended December 31, 2020 Total Gains (Losses)
Loans held for sale	$	6,186		0		6,186		0		28
Mortgage servicing rights, net		3,043		0		3,043		0		0
Impaired loans		2,888		0		2,888		0		(76	)
Real estate, net		636		0		636		0		0
Total	$	12,753		0		12,753		0		(48	)

(5) Fair Value of Financial Instruments

ASC 825, Disclosures about Fair Values of Financial Instruments requires interim reporting period disclosure of the estimated fair values of the Company’s financial instruments, including assets, liabilities and off-balance sheet items for which it is practicable to estimate fair value. The fair value estimates are made as of September 30, 2021 and December 31, 2020 based upon relevant market information, if available, and upon the characteristics of the financial instruments themselves. Because no market exists for a significant portion of the Company’s financial instruments, fair value estimates are based upon judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors.

The estimated fair value of the Company’s financial instruments as of September 30, 2021 and December 31, 2020 are shown below. Following the table, there is an explanation of the methods and assumptions used to estimate the fair value of each class of financial instruments.

	September 30, 2021													December 31, 2020
							Fair Value Hierarchy													Fair Value Hierarchy
(Dollars in thousands)	Carrying Amount			Estimated Fair Value			Level 1		Level 2		Level 3	Contract Amount		Carrying Amount			Estimated Fair Value			Level 1		Level 2		Level 3	Contract Amount
Financial assets:
Cash and cash equivalents	$	149,436			149,436			149,436							86,269			86,269			86,269
Securities available for sale		234,939			234,939					234,939					148,090			148,090					148,090
Equity securities		217			217					217					149			149					149
Loans held for sale		5,754			5,754					5,754					6,186			6,186					6,186
Loans receivable, net		622,264			632,659					632,659					642,630			648,275					648,275
Federal Home Loan Bank stock		1,092			1,092					1,092					932			932					932
Accrued interest receivable		2,062			2,062					2,062					3,102			3,102					3,102
Financial liabilities:
Deposits		915,302			915,478					915,478					795,204			795,927					795,927
Accrued interest payable		76			76					76					140			140					140
Off-balance sheet financial instruments:
Commitments to extend credit		(69	)		(69	)							219,855		261			261								180,330
Commitments to sell loans		23			23								26,184		(44	)		(44	)							24,746

Cash and Cash Equivalents

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

Securities Available for Sale

The fair values of securities were based upon quoted market prices.

Equity Securities

The fair values of equity securities were based upon quoted market prices.

Table of Contents

Loans Held for Sale

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

Loans Receivable, net

The fair value of the loan portfolio, with the exception of the adjustable rate portfolio, was calculated by discounting the scheduled cash flows through the estimated maturity using anticipated prepayment speeds and using discount rates that reflect the credit and interest rate risk inherent in each loan portfolio. The fair value of the adjustable loan portfolio was estimated by grouping the loans with similar characteristics and comparing the characteristics of each group to the prices quoted for similar types of loans in the secondary market. The fair value disclosures for both the fixed and adjustable rate portfolios were adjusted to reflect the exit price amount anticipated to be received from the sale of the portfolio in an open market transaction.

Federal Home Loan Bank (FHLB) Stock

The carrying amount of FHLB stock approximates its fair value.

Accrued Interest Receivable

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

Deposits

The fair value of demand deposits, savings accounts and money market account deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using the rates currently offered for deposits of similar remaining maturities. The fair value disclosures for all of the deposits were adjusted to reflect the exit price amount anticipated to be received from the sale of the deposits in an open market transaction.

Accrued Interest Payable

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

Commitments to Extend Credit

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

Commitments to Sell Loans

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

(6) Other Comprehensive Income (Loss)

Other comprehensive income (loss) is defined as the change in equity during a period from transactions and other events from 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 September 30,
(Dollars in thousands)	2021									2020
Securities available for sale:	Before Tax			Tax Effect			Net of Tax			Before Tax			Tax Effect			Net of Tax
Gross unrealized losses arising during the period	$	(957	)		(269	)		(688	)		(281	)		(79	)		(202	)
Other comprehensive loss	$	(957	)		(269	)		(688	)		(281	)		(79	)		(202	)

	For the Nine Months Ended September 30,
(Dollars in thousands)	2021									2020
Securities available for sale:	Before Tax			Tax Effect			Net of Tax			Before Tax		Tax Effect		Net of Tax
Gross unrealized (losses) gains arising during the period	$	(2,092	)		(584	)		(1,508	)		1,800		503		1,297
Other comprehensive (loss) income	$	(2,092	)		(584	)		(1,508	)		1,800		503		1,297

Table of Contents

(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 September 30, 2021 and December 31, 2020.

	Less Than Twelve Months							Twelve Months or More							Total
(Dollars in thousands)	# of Investments		Fair Value		Unrealized Losses			# of Investments		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
September 30, 2021
Mortgage backed securities:
Federal National Mortgage Association (FNMA)		16	$	72,635		(612	)		1	$	3,694		(51	)	$	76,329		(663	)
Federal Home Loan Mortgage Corporation (FHLMC)		16		73,242		(517	)		0		0		0			73,242		(517	)
Other marketable securities:
U.S. Government agency obligations		7		34,911		(85	)		0		0		0			34,911		(85	)
Corporate preferred stock		0		0		0			1		644		(56	)		644		(56	)
Total temporarily impaired securities		39	$	180,788		(1,214	)		2	$	4,338		(107	)	$	185,126		(1,321	)

	Less Than Twelve Months							Twelve Months or More							Total
(Dollars in thousands)	# of Investments		Fair Value		Unrealized Losses			# of Investments		Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
December 31, 2020
Mortgage backed securities:
FNMA		1	$	4,956		(3	)		0	$	0		0		$	4,956		(3	)
Other marketable securities:
Corporate preferred stock		0		0		0			1		630		(70	)		630		(70	)
Total temporarily impaired securities		1	$	4,956		(3	)		1	$	630		(70	)	$	5,586		(73	)

The Company reviews its investment portfolio on a quarterly basis for indications of impairment. This review includes analyzing the length of time and the extent to which the fair value has been lower than the cost, the market liquidity for the investment, the financial condition and near-term prospects of the issuer, including any specific events which may influence the operations of the issuer and the Company’s intent and ability to hold the investment for a period of time sufficient to recover the temporary loss. The unrealized losses on impaired securities other than the corporate preferred stock are the result of changes in interest rates. The unrealized losses reported for the corporate preferred stock at September 30, 2021 relates to a single trust preferred security that was issued by the holding company of a small community bank. As of September 30, 2021 all payments were current on the trust preferred security and the issuer’s subsidiary bank was considered to be “well capitalized” based on its most recent regulatory filing. Based on a review of the issuer, it was determined that the trust preferred security was not other-than-temporarily impaired at September 30, 2021 as the Company does not intend to sell and has the intent and ability to hold it for a period of time sufficient to recover the temporary loss. Management believes that the Company will receive all principal and interest payments contractually due on the security and that the decrease in the market value is primarily due to a lack of liquidity in the market for trust preferred securities. Management will continue to monitor the credit risk of the issuer and may be required to recognize other-than-temporary impairment charges on this security in future periods.

Table of Contents

A summary of securities available for sale at September 30, 2021 and December 31, 2020 is as follows:

(Dollars in thousands)	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
September 30, 2021:
Mortgage-backed securities:
FNMA	$	111,267		751		(663	)		111,355
FHLMC		83,244		172		(517	)		82,899
Collateralized mortgage obligations:
FNMA		51		2		0			53
		194,562		925		(1,180	)		194,307
Other marketable securities:
U.S. Government agency obligations		39,990		83		(85	)		39,988
Corporate preferred stock		700		0		(56	)		644
		40,690		83		(141	)		40,632
	$	235,252		1,008		(1,321	)		234,939

(Dollars in thousands)	Amortized cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
December 31, 2020
Mortgage-backed securities:
FNMA	$	68,699		1,313		(3	)		70,009
FHLMC		31,025		327		0			31,352
Collateralized mortgage obligations:
FNMA		97		6		0			103
		99,821		1,646		(3	)		101,464
Other marketable securities:
U.S. Government agency obligations		45,029		204		0			45,233
Municipal obligations		725		1		0			726
Corporate obligations		37		0		0			37
Corporate preferred stock		700		0		(70	)		630
		46,491		205		(70	)		46,626
	$	146,312		1,851		(73	)		148,090

The following table indicates amortized cost and estimated fair value of securities available for sale at September 30, 2021 based upon contractual maturity adjusted for scheduled repayments of principal and projected prepayments of principal based upon current economic conditions and interest rates.

(Dollars in thousands)	Amortized Cost		Fair Value
Due less than one year	$	85,676		85,595
Due after one year through five years		124,263		124,119
Due after five years through ten years		24,576		24,544
Due after ten years		737		681
Total	$	235,252		234,939

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

Table of Contents

(8) Loans Receivable, Net

A summary of loans receivable at September 30, 2021 and December 31, 2020 is as follows:

(Dollars in thousands)	September 30, 2021		December 31, 2020
Single family	$	157,502		135,023
Commercial real estate:
Real estate rental and leasing		196,167		202,400
Other		179,533		178,304
		375,700		380,704
Consumer		42,753		55,391
Commercial business		55,743		82,673
Total loans		631,698		653,791
Less:
Unamortized discounts		11		12
Net deferred loan fees		353		450
Allowance for loan losses		9,070		10,699
Total loans receivable, net	$	622,264		642,630

(9) Allowance for Loan Losses and Credit Quality Information

The allowance for loan losses is summarized as follows:

(Dollars in thousands)	Single Family			Commercial Real Estate			Consumer			Commercial Business			Total
For the three months ended September 30, 2021:
Balance, June 30, 2021	$	929			7,033			1,039			914			9,915
Provision for losses		13			(713	)		(72	)		(114	)		(886	)
Recoveries		0			0			30			11			41
Balance, September 30, 2021	$	942			6,320			997			811			9,070

For the nine months ended September 30, 2021:
Balance, December 31, 2020	$	1,030			7,295			1,389			985			10,699
Provision for losses		(88	)		(1,625	)		(408	)		(232	)		(2,353	)
Charge-offs		0			0			(42	)		0			(42	)
Recoveries		0			650			58			58			766
Balance, September 30, 2021	$	942			6,320			997			811			9,070

Allocated to:
Specific reserves	$	29			95			100			14			238
General reserves		1,001			7,200			1,289			971			10,461
Balance, December 31, 2020	$	1,030			7,295			1,389			985			10,699

Allocated to:
Specific reserves	$	38			152			88			8			286
General reserves		904			6,168			909			803			8,784
Balance, September 30, 2021	$	942			6,320			997			811			9,070

Loans receivable at December 31, 2020:
Individually reviewed for impairment	$	857			1,484			750			35			3,126
Collectively reviewed for impairment		134,166			379,220			54,641			82,638			650,665
Ending balance	$	135,023			380,704			55,391			82,673			653,791

Loans receivable at September 30, 2021:
Individually reviewed for impairment	$	445			684			724			18			1,871
Collectively reviewed for impairment		157,057			375,016			42,029			55,725			629,827
Ending balance	$	157,502			375,700			42,753			55,743			631,698

Table of Contents

(Dollars in thousands)	Single Family		Commercial Real Estate			Consumer			Commercial Business			Total
For the three months ended September 30, 2020:
Balance, June 30, 2020	$	938		5,382			1,464			865			8,649
Provision for losses		27		878			(64	)		(71	)		770
Charge-offs		0		0			(29	)		(8	)		(37	)
Recoveries		0		0			5			145			150
Balance, September 30, 2020	$	965		6,260			1,376			931			9,532

For the nine months ended September 30, 2020:
Balance, December 31, 2019	$	857		5,060			1,507			1,140			8,564
Provision for losses		108		1,913			(79	)		(394	)		1,548
Charge-offs		0		(730	)		(74	)		(8	)		(812	)
Recoveries		0		17			22			193			232
Balance, September 30, 2020	$	965		6,260			1,376			931			9,532

The following table summarizes the amount of classified and unclassified loans at September 30, 2021 and December 31, 2020:

	September 30, 2021
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
Single family	$	716		892		57		0		1,665		155,837		157,502
Commercial real estate:
Real estate rental and leasing		8,420		1,768		0		0		10,188		185,979		196,167
Other		10,716		6,486		0		0		17,202		162,331		179,533
Consumer		0		616		55		53		724		42,029		42,753
Commercial business		1,850		1,810		0		0		3,660		52,083		55,743
	$	21,702		11,572		112		53		33,439		598,259		631,698

	December 31, 2020
	Classified										Unclassified
(Dollars in thousands)	Special Mention		Substandard		Doubtful		Loss		Total		Total		Total Loans
Single family	$	1,219		2,845		29		0		4,093		130,930		135,023
Commercial real estate:
Real estate rental and leasing		8,065		3,483		0		0		11,548		190,852		202,400
Other		8,774		9,750		0		0		18,524		159,780		178,304
Consumer		0		600		132		18		750		54,641		55,391
Commercial business		1,968		2,482		0		0		4,450		78,223		82,673
	$	20,026		19,160		161		18		39,365		614,426		653,791

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

Table of Contents

The aging of past due loans at September 30, 2021 and December 31, 2020 is summarized as follows:

(Dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current Loans		Total Loans		Loans 90 Days or More Past Due and Still Accruing
September 30, 2021
Single family	$	1,072		47		161		1,280		156,222		157,502		0
Commercial real estate:
Real estate rental and leasing		0		0		325		325		195,842		196,167		0
Other		0		0		0		0		179,533		179,533		0
Consumer		219		39		238		496		42,257		42,753		0
Commercial business		0		0		0		0		55,743		55,743		0
	$	1,291		86		724		2,101		629,597		631,698		0
December 31, 2020
Single family	$	626		38		298		962		134,061		135,023		0
Commercial real estate:
Real estate rental and leasing		0		0		0		0		202,400		202,400		0
Other		0		0		0		0		178,304		178,304		0
Consumer		458		66		279		803		54,588		55,391		0
Commercial business		0		0		0		0		82,673		82,673		0
	$	1,084		104		577		1,765		652,026		653,791		0

Impaired loans include loans that are non-performing (non-accruing) and loans that have been modified in a troubled debt restructuring (TDR). The following table summarizes impaired loans and related allowances as of September 30, 2021 and December 31, 2020:

	September 30, 2021						December 31, 2020
(Dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Related Allowance		Recorded Investment		Unpaid Principal Balance		Related Allowance
Loans with no related allowance recorded:
Single family	$	356		375		0		740		759		0
Commercial real estate:
Real estate rental and leasing		0		0		0		932		1,582		0
Other		192		192		0		211		211		0
Consumer		592		592		0		574		574		0

Loans with an allowance recorded:
Single family		89		89		38		117		117		29
Commercial real estate:
Real estate rental and leasing		325		325		17		166		166		5
Other		167		167		135		175		175		90
Consumer		132		132		88		176		176		100
Commercial business		18		18		8		35		586		14

Total:
Single family		445		464		38		857		876		29
Commercial real estate:
Real estate rental and leasing		325		325		17		1,098		1,748		5
Other		359		359		135		386		386		90
Consumer		724		724		88		750		750		100
Commercial business		18		18		8		35		586		14
	$	1,871		1,890		286		3,126		4,346		238

Table of Contents

The following tables summarize average recorded investment and interest income recognized on impaired loans during the three and nine months ended September 30, 2021 and 2020.

	For the Three Months Ended September 30, 2021				For the Nine Months Ended September 30, 2021
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
Single family	$	390		0		564		4
Commercial real estate:
Real estate rental and leasing		78		0		540		0
Other		193		0		199		0
Consumer		610		0		577		6

Loans with an allowance recorded:
Single family		122		0		119		0
Commercial real estate:
Real estate rental and leasing		163		0		123		7
Other		168		0		163		0
Consumer		114		3		138		1
Commercial business		22		0		29		1

Total:
Single family		512		0		683		4
Commercial real estate:
Real estate rental and leasing		241		0		663		7
Other		361		0		362		0
Consumer		724		3		715		7
Commercial business		22		0		29		1
	$	1,860		3		2,452		19

	For the Three Months Ended September 30, 2020				For the Nine Months Ended September 30, 2020
(Dollars in thousands)	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
Loans with no related allowance recorded:
Single family	$	606		6		585		23
Commercial real estate:
Real estate rental and leasing		985		0		493		33
Other		401		0		340		2
Consumer		586		3		640		9
Commercial business		4		0		2		0

Loans with an allowance recorded:
Single family		121		0		273		0
Commercial real estate:
Real estate rental and leasing		173		0		177		0
Other		0		0		487		0
Consumer		142		0		169		2
Commercial business		50		1		242		2

Total:
Single family		727		6		858		23
Commercial real estate:
Real estate rental and leasing		1,158		0		670		33
Other		401		0		827		2
Consumer		728		3		809		11
Commercial business		54		1		244		2
	$	3,068		10		3,408		71

At September 30, 2021 and December 31, 2020, non-accruing loans totaled $1.8 million and $2.7 million, respectively, for which the related allowance for loan losses was $0.3 million and $0.2 million, respectively. All of the interest income that was recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-accruing loans for which no specific allowance has been recorded, because management determined that the value of the collateral was sufficient to repay the loan, totaled $1.1 million and $2.1 million, at September 30, 2021 and December 31, 2020, respectively. Non-accrual loans also include certain loans that have had terms modified in a TDR.

Table of Contents

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

(Dollars in thousands)	September 30, 2021		December 31, 2020
Single family	$	423		502
Commercial real estate:
Real estate rental and leasing		325		1,098
Other		360		386
Consumer		673		689
Commercial business		7		9
	$	1,788		2,684

At September 30, 2021 and December 31, 2020 there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $1.3 million and $1.5 million, respectively. Of the loans that were restructured as TDRs in the third quarter of 2021, none were classified but performing, and the amount that was non-performing at September 30, 2021 was not material.

The following table summarizes TDRs at September 30, 2021 and December 31, 2020:

	September 30, 2021						December 31, 2020
(Dollars in thousands)	Accruing		Non-Accruing		Total		Accruing		Non-Accruing		Total
Single family	$	22		236		258		355		257		612
Commercial real estate		0		359		359		0		211		211
Consumer		51		588		639		62		568		630
Commercial business		10		0		10		25		0		25
	$	83		1,183		1,266		442		1,036		1,478

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 consolidated balance sheets, as principal balances may be partially forgiven. The financial effects of TDRs are presented in the following tables and represent the difference between the outstanding recorded balance pre-modification and post-modification, for the three month and nine month periods ended September 30, 2021 and 2020.

	Three Months Ended September 30, 2021						Nine Months Ended September 30, 2021
(Dollars in thousands)	Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Troubled debt restructurings:
Single family		1	$	38		40		1	$	38		40
Commercial real estate:
Other		0		0		0		1		139		139
Consumer		0		0		0		1		93		94
Commercial business		0		0		0		1		14		14
Total		1	$	38		40		4	$	284		287

Table of Contents

	Three Months Ended September 30, 2020						Nine Months Ended September 30, 2020
(Dollars in thousands)	Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment		Number of Contracts		Pre-modification Outstanding Recorded Investment		Post-modification Outstanding Recorded Investment
Troubled debt restructurings:
Single family		0	$	0		0		1	$	94		101
Commercial real estate:
Other		0		0		0		2		293		293
Total		0	$	0		0		3	$	387		394

There were no loans that were restructured in the 12 months preceding September 30, 2021 and 2020 that subsequently defaulted during the three and nine months ended September 30, 2021 and 2020.

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

TDRs are reviewed for impairment following the same methodology as other impaired loans. For loans that are collateral-dependent, the value of the collateral is reviewed and additional reserves may be added to specific reserves as needed. Loans that are not collateral-dependent may have additional reserves established if deemed necessary. The reserves for TDRs were $0.2 million, or 2.7%, of the total $9.1 million in loan loss reserves at September 30, 2021 and $0.1 million, or 0.9%, of the total $10.7 million in loan loss reserves at December 31, 2020.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020 and the Bank’s regulators issued the Interagency Statement on Loan Modification and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus on April 7, 2020. Section 4013 of the CARES Act temporarily allows the Bank to grant modifications of loans to borrowers that were impacted by the pandemic without classifying the modifications as TDRs if the accommodation is granted before December 31, 2021. In accordance with the regulatory guidance, the Bank granted accommodations on certain loans to borrowers who were negatively impacted by the pandemic. At September 30, 2021, the Bank had $25.5 million of loans that had been granted loan accommodations in accordance with Section 4013 of the CARES Act. These accommodations are in addition to the TDRs that are disclosed above. All of the six remaining loans that were granted accommodations are in the hospitality industry and allow the borrowers to make interest only payments for periods up to December 31, 2021. Of these loans, $5.7 million were classified but still accruing at September 30, 2021 and all of these loans were current with their agreed upon payments. The commercial credit department continues to communicate regularly with the borrowers that have been granted loan accommodations and monitors their activity closely. This information is used to analyze the performance of these loans and to anticipate any potential issues that these loans may develop so that risk ratings may be appropriately adjusted in a timely manner. It is anticipated that most of the remaining borrowers that have been granted accommodations will be in a position to resume making their regular loan payments at the end of the accommodation period. Other borrowers may need additional accommodations when their initial accommodation period ends as their operations may need more time to recover from the impact of the pandemic.

Table of Contents

(10) Intangible Assets

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

(Dollars in thousands)	Nine Months Ended September 30, 2021			Twelve Months Ended December 31, 2020			Nine Months Ended September 30, 2020
Balance, beginning of period	$	3,043			2,172			2,172
Originations		1,070			2,189			1,710
Amortization		(881	)		(1,318	)		(1,002	)
Balance, end of period	$	3,232			3,043			2,880
Fair value of mortgage servicing rights	$	4,292			3,378			2,956

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 September 30, 2021.

Weighted

Loan

Average

Principal

Interest

Remaining

Number

(Dollars in thousands)

Balance

Rate

Term (months)

of Loans

Original term 30 year fixed rate

416,090

3.46

312

2,650

Original term 15 year fixed rate

118,843

2.88

142

1,068

Amortization expense for amortizing intangible assets was $0.9 million and $1.1 million for the nine month periods ended September 30, 2021 and 2020, respectively. The gross carrying amount of intangible assets and the associated accumulated amortization at September 30, 2021 and December 31, 2020 is presented in the following tables.

	September 30, 2021
	Gross
(Dollars in thousands)	Carrying Amount		Accumulated Amortization			Unamortized Amount
Mortgage servicing rights	$	5,775		(2,543	)		3,232
Core deposit intangible		574		(557	)		17
Goodwill		802		0			802
Total	$	7,151		(3,100	)		4,051

	December 31, 2020
	Gross
(Dollars in thousands)	Carrying Amount		Accumulated Amortization			Unamortized Amount
Mortgage servicing rights	$	5,691		(2,648	)		3,043
Core deposit intangible		574		(517	)		57
Goodwill		802		0			802
Total	$	7,067		(3,165	)		3,902

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

(Dollars in thousands)	Mortgage Servicing Rights		Core Deposit Intangible		Total Amortizing Intangible Assets
Year ending December 31,
2021	$	173		7		180
2022		666		10		676
2023		624		0		624
2024		585		0		585
2025		511		0		511
Thereafter		673		0		673
Total	$	3,232		17		3,249

Table of Contents

No amortization expense relating to goodwill is recorded as GAAP does not allow goodwill to be amortized but requires that it be tested for impairment at least annually, or sooner, if there are indications that impairment may exist.

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

(11) Leases

The Company accounts for its leases in accordance with ASU 2016-02, Leases (Topic 842) and as of September 30, 2021, a $2.6 million right-of-use asset and an offsetting lease payment obligation liability were recorded on the consolidated balance sheet in other assets and other liabilities, respectively.

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

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

The table below summarizes the Company’s net lease cost for the three and nine months ended September 30, 2021.

(Dollars in thousands)		Three Months Ended September 30, 2021				Nine Months Ended September 30, 2021
Operating lease cost		$	223				672

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

	Three Months Ended						Nine Months Ended
(Dollars in thousands)	September 30, 2021			September 30, 2020			September 30, 2021			September 30, 2020
Cash paid for amounts included in the measurement of lease liabilities:
Operating cash flows from operating leases	$	223			224			672			669
Weighted-average remaining lease term – operating leases, in years		3.0			3.9			3.0			3.9
Weighted-average discount rate – operating leases		2.19	%		2.19	%		2.19	%		2.19	%

The table below summarizes the maturities of remaining lease liabilities:

(Dollars in thousands)	September 30, 2021
2021	$	229
2022		932
2023		807
2024		729
2025		15
Total lease payments		2,712
Less: Interest		(92	)
Present value of lease liabilities	$	2,620

Table of Contents

Subsequent to the end of the third quarter, on October 8, 2021, the Company executed the purchase option on the corporate office building and terminated the existing agreement to lease the building. The purchase of the building for $7.8 million eliminated approximately $2.3 million of the above right-of-use asset and the offsetting lease payment obligation liability as of the purchase date. Therefore, the reported amounts in future periods for the right-of-use asset and the offsetting lease payment obligation liability are expected to decline substantially from the amounts reported at September 30, 2021.

(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 share:

	Three Months Ended September 30,				Nine Months Ended September 30,
(Dollars in thousands, except per share data)	2021		2020		2021		2020
Weighted average number of common shares outstanding used in basic earnings per share calculation		4,432,447		4,628,292		4,494,761		4,624,266
Net dilutive effect of:
Restricted stock awards and options		33,421		22,550		33,122		25,312
Weighted average number of shares outstanding adjusted for effect of dilutive securities		4,465,868		4,650,842		4,527,883		4,649,578
Income available to common stockholders	$	3,619		3,101		11,565		7,177
Basic earnings per common share	$	0.82		0.67		2.57		1.55
Diluted earnings per common share	$	0.81		0.67		2.55		1.54

(13) Regulatory Capital and Oversight

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

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

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

Table of Contents

The Bank’s average total assets for the quarter ended September 30, 2021 were $992.6 million, its adjusted total assets were $991.8 million, and its risk-weighted assets were $690.2 million. The following table presents the Bank’s capital amounts and ratios at September 30, 2021 for actual capital, required capital and excess capital, including ratios in order to qualify as being well capitalized under the prompt corrective actions regulations.

	Actual					Required to be Adequately Capitalized					Excess Capital					To Be Well Capitalized Under Prompt Corrective Action Provisions
(Dollars in thousands)	Amount		Percent of Assets			Amount		Percent of Assets			Amount		Percent of Assets			Amount		Percent of Assets
September 30, 2021
Common equity tier 1 capital	$	95,568		13.85	%	$	31,060		4.50	%	$	64,508		9.35	%	$	44,865		6.50	%
Tier 1 capital leverage		95,568		9.64			39,674		4.00			55,894		5.64			49,592		5.00
Tier 1 risk-based capital		95,568		13.85			41,414		6.00			54,154		7.85			55,219		8.00
Total risk-based capital		104,201		15.10			55,219		8.00			48,982		7.10			69,023		10.00

The Bank must maintain a capital conservation buffer of 2.50% composed of common equity Tier 1 capital above its minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Management believes that, as of September 30, 2021, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the current prompt corrective action regulations, including the capital conservation buffer described above. However, there can be no assurance that the Bank will continue to maintain such status in the future. The Office of the Comptroller of the Currency (OCC) has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be “well-capitalized” in the future.

(14) Stockholders’ Equity

The Company was authorized to repurchase up to $4.9 million additional shares of its common stock under the existing board-approved share repurchase program at September 30, 2021. The Company did not declare any dividends on its common stock but did repurchase 50,000 shares of its common stock in the open market for $1.1 million under the share repurchase program during the third quarter of 2021.

(15) Commitments and Contingencies

The Bank issues standby letters of credit which guarantee the performance of customers to third parties. The standby letters of credit issued and available at September 30, 2021 were approximately $5.6 million, expire over the next twenty-four months and are collateralized primarily with commercial real estate mortgages. Since the conditions under which the Bank is required to fund the standby letters of credit may not materialize, the cash requirements are expected to be less than the total outstanding commitments.

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. The Company is, and expects to become, engaged in foreclosure proceedings, collection actions and other litigation as part of its normal banking activities. Among the various current litigation matters, the Company is involved in a bankruptcy litigation claim where the bankruptcy trustee is attempting to recover $2.5 million related to the principal and interest payments made to the Bank prior to the bankruptcy filing of a former customer of the Bank.

The Company examines each legal matter, and, in those situations where it determines that a particular legal matter presents loss contingencies that are both probable and reasonably estimable, establishes an appropriate accrual. In many situations, the Company is not able to estimate reasonably possible losses due to the preliminary nature of the legal matter, as well as a variety of other factors and uncertainties. For those legal matters where the Company is able to estimate a range of reasonably possible losses, management currently estimates that the aggregate range of losses from all of the Company’s outstanding litigation is from $0 to $0.7 million in excess of the amounts accrued, if any. This estimated aggregate range is based on an assessment of the information currently available to the Company and the actual aggregate losses could be higher. However, the Company does not believe these losses are probable at this time. The Company reassesses all of its potential loss positions based on the available information each quarter and the estimated range of reasonably possible losses may change in the future. The Company typically vigorously pursues all available defenses related to litigation but may consider other alternatives, including settlement, in situations where there is an opportunity to resolve a legal matter on terms that are considered to be favorable to the Company when considering the continued expense and distraction of defending against any particular legal action.

Table of Contents

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.

Table of Contents

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 nine months ended September 30, 2021:
Interest income - external customers	$	24,384			0			0			24,384
Non-interest income - external customers		11,047			1			0			11,048
Intersegment interest income		0			22			(22	)		0
Intersegment non-interest income		176			12,054			(12,230	)		0
Interest expense		1,245			0			(22	)		1,223
Provision for loan losses		(2,353	)		0			0			(2,353	)
Non-interest expense		19,906			635			(176	)		20,365
Income tax expense		4,755			(123	)		0			4,632
Net income		12,054			11,565			(12,054	)		11,565
Total assets		1,035,945			110,072			(109,402	)		1,036,615
At or for the nine months ended September 30, 2020:
Interest income - external customers	$	23,676			0			0			23,676
Non-interest income - external customers		10,590			0			0			10,590
Intersegment interest income		0			32			(32	)		0
Intersegment non-interest income		175			7,609			(7,784	)		0
Interest expense		2,325			0			(32	)		2,293
Provision for loan losses		1,548			0			0			1,548
Non-interest expense		19,992			562			(175	)		20,379
Income tax expense		2,967			(98	)		0			2,869
Net income		7,609			7,177			(7,609	)		7,177
Total assets		897,694			101,308			(100,550	)		898,452
At or for the quarter ended September 30, 2021:
Interest income - external customers	$	8,401			0			0			8,401
Non-interest income - external customers		3,051			0			0			3,051
Intersegment interest income		0			8			(8	)		0
Intersegment non-interest income		59			3,773			(3,832	)		0
Interest expense		368			0			(8	)		360
Provision for loan losses		(886	)		0			0			(886	)
Non-interest expense		6,766			199			(59	)		6,906
Income tax expense		1,490			(37	)		0			1,453
Net income		3,773			3,619			(3,773	)		3,619
Total assets		1,035,945			110,072			(109,402	)		1,036,615
At or for the quarter ended September 30, 2020:
Interest income - external customers	$	7,949			0			0			7,949
Non-interest income - external customers		4,527			0			0			4,527
Intersegment interest income		0			9			(9	)		0
Intersegment non-interest income		58			3,251			(3,309	)		0
Interest expense		665			0			(9	)		656
Provision for loan losses		770			0			0			770
Non-interest expense		6,591			194			(58	)		6,727
Income tax expense		1,257			(35	)		0			1,222
Net income		3,251			3,101			(3,251	)		3,101
Total assets		897,694			101,308			(100,550	)		898,452

Table of Contents

Item 2:

MANAGEMENT'S DISCUSSION AND ANALYSIS

OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Information

Safe Harbor Statement

This quarterly report on Form 10-Q and other reports filed by the Company with the SEC may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “project,” “continue,” “may,” “will,” “would,” “could,” “should,” and “trend,” or similar statements or variations of such terms and include, but are not limited to, those relating to growing the Company’s core deposit relationships and loan balances; enhancing the financial performance of its core banking operations; maintaining credit quality; maintaining net interest margins; reducing non-performing assets; generating improved financial results; the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; expectations for core capital and strategies and potential strategies for maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the anticipated impacts of the COVID-19 pandemic and efforts to mitigate the same on the general economy, clients, deposit balances, and the allowance for loan losses; the anticipated benefits that will be realized by clients from government assistance programs related to the COVID-19 pandemic, including the forgiveness of loans under the Paycheck Protection Program (PPP) loans, the Company’s expectations relating to repurchases of its common stock during the COVID-19 pandemic and requests for loan payment accommodation from borrowers; the amount of the Bank’s non-performing assets in future periods and the appropriateness of the allowances therefor; the payment of dividends or repurchases of stock by HMN; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer of the trust preferred securities held by the Bank; the anticipated results of litigation and the Company’s assessment of the impact on its financial statements; the ability of the Bank to pay dividends to HMN; the ability to remain well capitalized; the impact of new accounting pronouncements; and compliance by the Bank with regulatory standards generally (including the Bank’s status as “well-capitalized”) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject and possible responses of the OCC, Board of Governors of the Federal Reserve System, the Bank, and the Company due to any failure to comply with any such regulatory standard, directive or requirement.

A number of factors, many of which are, and may continue to be, amplified by the COVID-19 pandemic and efforts to mitigate the same, could cause actual results to differ materially from the Company’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and the Federal Reserve Bank (FRB) in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as continued shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with traditional and alternate funding sources, including changes in collateral advance rates and policies of the FHLB and the FRB; technological, computer-related or operational difficulties including those from any third party cyberattack; results of litigation; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; domestic and international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the future operating results, financial condition, cash flow requirements and capital spending priorities of the Company and the Bank; the availability of internal and, as required, external sources of funding; 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 Form 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” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 and Part II, Item 1A of its subsequently filed quarterly reports on Form 10-Q. All statements in this quarterly report on Form 10-Q, including forward-looking statements, speak only as of the date they are made, and the Company undertakes no duty to update any of the forward-looking statements after the date of this quarterly report on Form 10-Q.

Table of Contents

General

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

Critical Accounting Estimates

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

Allowance for Loan Losses and Related Provision

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

Table of Contents

The appropriateness of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans is typically based on the appraised value of the property less estimated selling costs. The estimates are reviewed periodically and any adjustments are recorded in the provision for loan losses in the periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios, the actual loss experience and other qualitative factors. The Company increases its allowance for loan losses by charging the provision for loan losses against income and by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for loan losses and recording loan charge-offs. Activity in the first nine months of 2021 resulted in a decrease in the allowance and a credit to the loan loss provision. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future.

Income Taxes

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

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

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

Litigation
Estimates related to litigation are inherently subjective and the ultimate resolution of any litigation may be different than current management estimates. See “Note 15 Commitments and Contingencies” for further information on outstanding litigation matters.

Table of Contents

COVID-19 Pandemic

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

In the first quarter of 2021, vaccines began to be distributed to targeted groups. In the second quarter of 2021, the distribution of the vaccines became more widely available to the general public and business activity improved because of the lessened impact of COVID-19 pandemic resulting from the increased vaccination rates and the removal of pandemic-focused restrictions. In the third quarter of 2021, a delta variant of the COVID-19 virus appeared in the United States and COVID-19 infections increased, which resulted in the re-implementation of certain pandemic-focused restrictions.

Because of the resurgence of COVID-19 infections caused by the delta variant, the extent of the impact of COVID-19 on the Company is difficult to determine as it is not clear how effective the vaccines will be against the delta variant or any future variants of the virus, among other factors. In addition, it is not clear when, or if, businesses will re-hire those workers displaced by the pandemic or what the long-term implications will be on customer behaviors as a result of the pandemic. Up to this point, the Company has not seen a negative impact on its deposit relationships as many of its clients have been able to conduct their business with the Bank through the drive ups, ATMs, night drop, on-line banking website, or by using its mobile banking app. The impact on the Bank’s loan portfolio is also unclear for many of the same reasons.

The CARES Act was signed into law on March 27, 2020 and the Bank’s regulators issued the Interagency Statement on Loan Modification and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus on April 7, 2020. Section 4013 of the CARES Act temporarily allows the Bank to grant modifications of loans to borrowers that were impacted by the pandemic without classifying the modifications as TDRs if the accommodation is granted before December 31, 2021. In accordance with Section 4013 of the CARES Act, the Bank granted accommodations on certain loans to borrowers. See “Note 9 Allowance for Loan Losses and Credit Quality Information” for further information.

Paycheck Protection Program

The Bank actively participated in helping businesses that were negatively impacted by COVID-19 that applied for forgivable loans under the PPP as part of the CARES Act. The CARES Act, which was signed into law on March 27, 2020 and allocated $349 billion in funding to help small businesses that were negatively impacted by the COVID-19 pandemic. The Bank had the following activity related to the first round of the PPP during 2020 and through September 30, 2021:

(Dollars in thousands)	Number of Loans			Amount			Net Deferred Fees
Originated		413		$	53,153			1,837
Repaid		(130	)		(19,484	)		-
Net deferred fees recognized		-			-			(1,097	)
Balance, December 31, 2020		283			33,669			740
Repaid		(243	)		(21,419	)		-
Net deferred fees recognized		-			-			(597	)
Balance, March 31, 2021		40			12,250			143
Repaid		(35	)		(11,334	)		-
Net deferred fees recognized		-			-			(126	)
Balance, June 30, 2021		5			916			17
Repaid		(5	)		(916	)		-
Net deferred fees recognized		-			-			(17	)
Balance, September 30, 2021		0		$	0			0

Table of Contents

The Consolidated Appropriations Act of 2021, which was signed into law on December 27, 2020, allocated $284 billion to the Small Business Administration (SBA) to fund a second round of the PPP. The Bank actively participated in the second round of the PPP and had the following activity through September 30, 2021:

(Dollars in thousands)	Number of Loans			Amount			Net Deferred Fees
Originated		416		$	26,798			1,476
Net deferred fees recognized		-			-			(29	)
Balance, March 31, 2021		416			26,798			1,447
Originated		50			2,167			149
Repaid		(182	)		(6,539	)		-
Net deferred fees recognized		-			-			(522	)
Balance, June 30, 2021		284			22,426			1,074
Repaid		(232	)		(15,371	)		-
Net deferred fees recognized		-			-			(805	)
Balance, September 30, 2021		52		$	7,055			269

It is anticipated that the majority of the outstanding loans at September 30, 2021 will be forgiven by the SBA and that the remaining net deferred fees will be recognized into income when the loan is repaid.

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

Net Income

Net income was $3.6 million for the third quarter of 2021, an increase of $0.5 million, compared to net income of $3.1 million for the third quarter of 2020. Diluted earnings per share for the third quarter of 2021 was $0.81, an increase of $0.14 per share, compared to diluted earnings per share of $0.67 for the third quarter of 2020. The increase in net income between the periods was primarily because of a $1.7 million decrease in the provision for loan losses. The provision for loan losses decreased primarily because of a reduction in certain loan loss reserve percentages as a result of an internal analysis of the loan portfolio and economic improvements related to the COVID-19 pandemic. Net interest income also increased $0.7 million primarily because of an increase in the yield enhancements realized on PPP loans that were repaid during the period. These increases in net income between the periods were partially offset by a $1.5 million decrease in the gain on sales of loans due to a decrease in mortgage loan activity. Income tax expense also increased $0.3 million as a result of the increased pre-tax income between the periods.

Net income was $11.6 million for the nine month period ended September 30, 2021, an increase of $4.4 million, or 61.1%, compared to net income of $7.2 million for the nine month period ended September 30, 2020. Diluted earnings per share for the nine month period ended September 30, 2021 was $2.55, an increase of $1.01 per share, compared to diluted earnings per share of $1.54 for the same period in 2020. The increase in net income between the periods was primarily because of a $3.9 million decrease in the provision for loan losses. The provision for loan losses decreased primarily because of the reduction in the required reserves due to improvements in the economic environment related to the COVID-19 pandemic and the results of an internal analysis of the loan portfolio. Other non-interest income increased $1.8 million due primarily to an increase in the gains that were realized on the sale of real estate owned. Net interest income increased $1.8 million primarily due to an increase in the yield enhancements that were realized on PPP loans that were repaid during the period. These increases in net income were partially offset by a $1.6 million decrease in the gain on sales of loans due to a decrease in mortgage loan activity between the periods. Income tax expense also increased $1.7 million as a result of the increased pre-tax income between the periods.

Net Interest Income

Net interest income was $8.0 million for the third quarter of 2021, an increase of $0.7 million, or 10.3%, from $7.3 million for the third quarter of 2020. Interest income was $8.4 million for the third quarter of 2021, an increase of $0.5 million, or 5.7%, from $7.9 million for the third quarter of 2020. Interest income increased primarily because of the $0.8 million in yield enhancements recognized on PPP loans that were repaid during the period. Interest income also increased because of the $107.7 million increase in the average interest-earning assets between the periods. These increases in interest income were partially offset by a decrease in the average yield earned on interest-earning assets which was 3.47% for the third quarter of 2021, a decrease of 24 basis points from 3.71% for the third quarter of 2020. The decrease in the average yield is primarily related to the decrease in the prime rate that occurred in the first quarter of 2020, which lowered the rate on adjustable rate loans in the portfolio as well as any new or renewing fixed rate loans that were originated since that time.

Table of Contents

Interest expense was $0.4 million for the third quarter of 2021, a decrease of $0.3 million, or 45.1%, from $0.7 million for the third quarter of 2020. Interest expense decreased despite the $96.6 million increase in the average interest-bearing liabilities and non-interest bearing deposits between the periods primarily because of the decrease in the average interest rate paid on deposits. The average interest rate paid on interest-bearing liabilities and non-interest bearing deposits was 0.16% for the third quarter of 2021, a decrease of 18 basis points from 0.34% for the third quarter of 2020. The decrease in the interest paid on interest-bearing liabilities was primarily because of the decrease in deposit rates as a result of the decrease in the federal funds rate in the first quarter of 2020.

Net interest margin (net interest income divided by average interest-earning assets) for the third quarter of 2021 was 3.32%, a decrease of 8 basis points, compared to 3.40% for the third quarter of 2020. The decrease in the net interest margin is primarily related to the decrease in the average yield earned on interest-earning assets as a result of the decrease in the prime rate that occurred in the first quarter of 2020.

Net interest income was $23.2 million for the first nine months of 2021, an increase of $1.8 million, or 8.3%, from $21.4 million for the same period in 2020. Interest income was $24.4 million for the nine month period ended September 30, 2021, an increase of $0.7 million, or 3.0%, from $23.7 million for the same nine month period in 2020. Interest income increased primarily because of the $2.1 million in yield enhancements recognized on PPP loans that were repaid during the period. Interest income also increased because of the $133.8 million increase in the average interest-earning assets between the periods. These increases in interest income were partially offset by a decrease in the average yield earned on interest-earning assets which was 3.49% for the first nine months of 2021, a decrease of 46 basis points from 3.95% for the first nine months of 2020. The decrease in the average yield is primarily related to the decrease in the prime rate that occurred in the first quarter of 2020, which lowered the rate on adjustable rate loans in the portfolio as well as any new or renewing fixed rate loans that were originated since that time.

Interest expense was $1.2 million for the first nine months of 2021, a decrease of $1.1 million, or 46.7%, compared to $2.3 million in the first nine months of 2020. Interest expense decreased despite the $123.8 million increase in the average interest-bearing liabilities and non-interest bearing deposits between the periods primarily because of the decrease in the average interest rate paid on deposits. The average interest rate paid on interest-bearing liabilities and non-interest bearing deposits was 0.19% for the first nine months of 2021, a decrease of 23 basis points from 0.42% for the first nine months of 2020. The decrease in the interest paid on interest-bearing liabilities was primarily because of the decrease in deposit rates as a result of the decrease in the federal funds rate in the first quarter of 2020.

Net interest margin (net interest income divided by average interest-earning assets) for the first nine months of 2021 was 3.31%, a decrease of 26 basis points, compared to 3.57% for the first nine months of 2020. The decrease in the net interest margin is primarily related to the decrease in the average yield earned on interest-earning assets as a result of the decrease in the prime rate that occurred in the first quarter of 2020.

Table of Contents

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

	For the Three Month Period Ended
	September 30, 2021							September 30, 2020
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
Interest-earning assets:
Securities available for sale	$	215,811		514		0.94	%	$	103,132		434		1.67	%
Loans held for sale		5,991		40		2.63			9,309		65		2.76
Single family loans, net		164,591		1,442		3.48			134,460		1,325		3.92
Commercial loans, net		420,062		5,840		5.52			474,325		5,390		4.52
Consumer loans, net		43,955		515		4.65			60,473		709		4.66
Other		110,173		50		0.18			71,180		26		0.15
Total interest-earning assets		960,583		8,401		3.47			852,879		7,949		3.71

Interest-bearing liabilities and non-interest-bearing deposits:
Checking accounts		155,373		45		0.11			129,276		41		0.13
Savings accounts		115,526		18		0.06			93,022		17		0.07
Money market accounts		249,335		138		0.22			221,991		190		0.34
Certificate accounts		91,595		159		0.69			111,847		408		1.45
Total interest-bearing liabilities		611,829							556,136
Non-interest checking		259,721							219,512
Other non-interest bearing deposits		2,923							2,218
Total interest-bearing liabilities and non-interest-bearing deposits	$	874,473		360		0.16		$	777,866		656		0.34
Net interest income			$	8,041						$	7,293
Net interest rate spread						3.31	%						3.37	%
Net interest margin						3.32	%						3.40	%

	For the Nine Month Period Ended
	September 30, 2021							September 30, 2020
(Dollars in thousands)	Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate			Average Outstanding Balance		Interest Earned/ Paid		Yield/ Rate
Interest-earning assets:
Securities available for sale	$	192,877		1,514		1.05	%	$	100,889		1,371		1.81	%
Loans held for sale		5,303		114		2.88			6,942		156		2.99
Single family loans, net		154,992		4,189		3.61			130,441		3,907		4.00
Commercial loans, net		433,514		16,783		5.18			446,580		15,781		4.72
Consumer loans, net		47,779		1,668		4.67			64,570		2,312		4.78
Other		99,778		116		0.16			51,030		149		0.39
Total interest-earning assets		934,243		24,384		3.49			800,452		23,676		3.95

Interest-bearing liabilities and non-interest-bearing deposits:
Checking accounts		156,983		137		0.12			115,110		102		0.12
Savings accounts		111,715		52		0.06			87,587		48		0.07
Money market accounts		238,011		408		0.23			205,868		684		0.44
Certificate accounts		95,537		626		0.88			118,422		1,459		1.65
Total interest-bearing liabilities		602,246							526,987
Non-interest checking		249,215							200,965
Other non-interest bearing deposits		2,632							2,384
Total interest-bearing liabilities and non-interest-bearing deposits	$	854,093		1,223		0.19		$	730,336		2,293		0.42
Net interest income			$	23,161						$	21,383
Net interest rate spread						3.30	%						3.53	%
Net interest margin						3.31	%						3.57	%

Table of Contents

Provision for Loan Losses

The provision for loan losses was ($0.9) million for the third quarter of 2021, a decrease of $1.7 million compared to $0.8 million for the third quarter of 2020. The provision for loan losses was ($2.4) million for the first nine months of 2021, a decrease of $3.9 million compared to $1.5 million for the first nine months of 2020. The provision for loan losses decreased primarily because of the reduction in the required reserves due to improvements in the economic environment related to the COVID-19 pandemic and the results of an internal analysis of the loan portfolio. During 2020, the Company increased its allowance for loan losses due to the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic. In 2021, significant progress was made in the vaccination of the general public and many of the pandemic-focused restrictions have been reduced or eliminated. The amount of the allowance for loan losses established in 2020 related to the economic environment was based, in part, on the amount of loans to borrowers in the hospitality, restaurant and entertainment industries that were negatively impacted by the COVID-19 pandemic. The underlying operations supporting many of the loans that were initially negatively impacted by the pandemic have improved and the amount of loans requiring accommodations decreased in 2021. At September 30, 2021, the Company had six loans in the hospitality industry totaling $25.5 million that had been granted loan accommodations in accordance with Section 4013 of the CARES Act. The accommodations granted allow the borrowers to make interest only payments for periods up to December 31, 2021. Of these loans, $5.7 million were classified but still accruing at September 30, 2021 and all of these loans were current with their agreed upon payments. The commercial credit department continues to communicate regularly with the borrowers that have been granted loan accommodations and monitors their activity closely. It is anticipated that most of the remaining borrowers that have been granted accommodations will be in a position to resume making their regular loan payments at the end of the initial accommodation period. However, some of the borrowers may need additional accommodations when their initial accommodation period ends as their operations may need more time to recover from the impact of the pandemic.

The allowance for loan losses is made up of general reserves on the entire loan portfolio and specific reserves on impaired loans. The general reserve amount includes quantitative reserves based on our past loan loss history and qualitative reserves for other items determined to have a potential impact on future loan losses. The reserves decreased during the third quarter primarily as a result of an internal analysis of the loan portfolio.

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

(Dollars in thousands)	2021			2020
Balance at June 30,	$	9,915			8,649
Provision		(886	)		770
Charge offs:
Consumer		0			(29	)
Commercial business		0			(8	)
Recoveries		41			150
Balance at September 30,	$	9,070			9,532

Allocated to:
General allowance	$	8,784			9,416
Specific allowance		286			116
	$	9,070			9,532

(Dollars in thousands)	2021			2020
Balance at January 1,	$	10,699			8,564
Provision		(2,353	)		1,548
Charge offs:
Consumer		(42	)		(74	)
Commercial real estate		0			(730	)
Commercial business		0			(8	)
Recoveries		766			232
Balance at September 30,	$	9,070			9,532

Non‑Interest Income

Non-interest income was $3.1 million for the third quarter of 2021, a decrease of $1.4 million, or 32.6%, from $4.5 million for the third quarter of 2020. Gain on sales of loans decreased $1.5 million between the periods primarily because of a decrease in single family loan originations and sales. Other non-interest income decreased slightly due primarily to a decrease in the gains recognized on the sale of other real estate owned between the periods. Fees and service charges increased $0.1 million between the periods due primarily to an increase in debit card income. Loan servicing fees increased slightly between the periods due to an increase in the aggregate balances of single family mortgage loans that were being serviced for others.

Table of Contents

Non-interest income was $11.0 million for the first nine months of 2021, an increase of $0.4 million, or 4.3%, from $10.6 million for the same period of 2020. Other non-interest income increased $1.7 million due primarily to a $1.4 million increase in the gains realized on the sale of commercial real estate owned between the periods and also because of an increase in the fees earned on the sale of uninsured investment products. Fees and service charges increased $0.2 million between the periods due primarily to an increase in debit card income. Loan servicing fees increased $0.2 million between the periods due to an increase in the aggregate balances of single family mortgage loans that were being serviced for others. These increases in non-interest income were partially offset by a $1.6 million decrease in the gain on sales of loans due to a decrease in single family loan originations and sales between the periods.

Non‑Interest Expense

Non-interest expense was $6.9 million for the third quarter of 2021, an increase of $0.2 million, or 2.7%, from $6.7 million for the third quarter of 2020. Professional services expense increased $0.2 million between the periods primarily because of an increase in legal expenses relating to an ongoing bankruptcy litigation claim. Data processing costs increased $0.1 million between the periods due to an increase in debit card processing expenses. Compensation and benefits expense increased slightly between the periods primarily because of a decrease in the direct loan origination compensation costs that were deferred as a result of the decreased mortgage loan production between the periods. These increases in non-interest expense were partially offset by a $0.1 million decrease in other non-interest expense due primarily to a decrease in mortgage servicing expense between the periods. Occupancy and equipment expense decreased slightly between the periods due to a decrease in building related expenses.

Non-interest expense was $20.4 million for the first nine months of 2021, which is unchanged from the same period of 2020. Data processing costs increased $0.1 million between the periods due to an increase in debit card processing expenses. Compensation and benefits expense increased $0.1 million between the periods primarily because of a decrease in the direct loan origination compensation costs that were deferred as a result of the decreased mortgage loan production between the periods. Other non-interest expense increased $0.1 million due primarily to an increase in FDIC insurance costs. These increases in non-interest expense were partially offset by a $0.3 million decrease in professional service expense between the periods primarily because of a decrease in legal expenses relating to an ongoing bankruptcy litigation claim. Occupancy and equipment costs decreased slightly between the periods due to a decrease in depreciation and non-capitalized equipment costs.

Income Taxes

Income tax expense was $1.5 million for the third quarter of 2021, an increase of $0.3 million from $1.2 million for the third quarter of 2020. Income tax expense was $4.6 million for the first nine months of 2021, an increase of $1.7 million from $2.9 million for the first nine months of 2020. The increase in income tax expense between the periods is primarily the result of an increase in pre-tax income.

Table of Contents

FINANCIAL CONDITION

Non‑Performing Assets

The following table summarizes the amounts and categories of non-performing assets in the Company’s portfolio and loan delinquency information as of the end of the two most recently completed quarters and December 31, 2020.

	September 30,			June 30,			December 31,
(Dollars in thousands)	2021			2021			2020
Non‑performing loans:
Single family	$	423		$	557		$	502
Commercial real estate		685			519			1,484
Consumer		673			669			689
Commercial		7			8			9
Total		1,788			1,753			2,684

Foreclosed and repossessed assets:
Commercial real estate		0			0			636
Total non‑performing assets	$	1,788		$	1,753		$	3,320
Total as a percentage of total assets		0.17	%		0.18	%		0.37	%
Total as a percentage of total loans receivable, net		0.29	%		0.28	%		0.42	%
Allowance for loan losses to non-performing loans		507.15	%		565.75	%		398.72	%

Delinquency data:
Delinquencies ⁽¹⁾
30+ days	$	1,113		$	1,255		$	995
90+ days		0			0			0
Delinquencies as a percentage of loan portfolio ⁽¹⁾
30+ days		0.17	%		0.19	%		0.15	%
90+ days		0.00	%		0.00	%		0.00	%

⁽¹⁾ Excludes non-accrual loans.

Total non-performing assets were $1.8 million at September 30, 2021, which is unchanged from June 30, 2021 and a decrease of $1.5 million, or 46.1%, from $3.3 million at December 31, 2020. Non-performing loans decreased $0.9 million and foreclosed and repossessed assets decreased $0.6 million during the first nine months of 2021.

Dividends

The declaration of dividends is subject to, among other things, the Company's financial condition and results of operations, the Bank's compliance with regulatory capital requirements and other regulatory restrictions, tax considerations, industry standards, economic conditions, general business practices and other factors. The Company has not declared any dividend payments to common stockholders during the three year period ended September 30, 2021.

LIQUIDITY AND CAPITAL RESOURCES

For the nine months ended September 30, 2021, the net cash provided by operating activities was $16.5 million. The Company received $30.8 million from maturing or called securities, $27.7 million from principal repayments on securities and $2.1 million in proceeds from the sale of real estate. The Company purchased $148.1 million in securities available for sale, $0.2 million in FHLB stock and paid $0.4 million for the purchase of premises and equipment. Net loans receivable decreased $17.3 million, customer escrows increased $1.2 million and the Company had a net increase in deposit balances of $120.1 million. The Company also purchased $3.9 million of its common stock.

The Company has certificates of deposits with outstanding balances of $61.4 million that mature over the next 12 months. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that cash outflow from certificates that do not renew will be replaced with other deposits or FHLB advances. FRB borrowings or proceeds from the sale of securities could also be used to fund unanticipated outflows of certificates of deposits.

Table of Contents

The Company had ten deposit customers that individually had aggregate deposits greater than $5.0 million as of September 30, 2021. The $137.7 million in funds held by these customers may be withdrawn at any time, but management believes that the majority of these deposits will not be withdrawn from the Bank over the next twelve months. If these deposits are withdrawn, it is anticipated that they would be replaced with deposits from other customers or FHLB advances. FRB borrowings or proceeds from the sale of securities could also be used to replace unanticipated outflows of large checking and money market deposits.

The Company had the ability to borrow $172.4 million from the FHLB at September 30, 2021, based on the collateral value of the loans pledged. The credit policy of the FHLB relating to the collateral value of the loans collateralizing the available line of credit with the FHLB may change such that the current collateral pledged to secure future advances is no longer acceptable or the formulas for determining the excess pledged collateral may change. The FHLB could also reduce the amount of funds it will lend to the Bank. It is not anticipated that the Bank will need to find alternative funding sources in the next twelve months to replace the available borrowings from the FHLB. However, if needed, the Bank could borrow an additional $52.3 million from the FRB at September 30, 2021 based on the collateral value of the loans pledged.

The Company’s primary source of cash is dividends from the Bank. At September 30, 2021, the Company had $13.2 million in cash and other assets that could readily be turned into cash. The primary use of cash by the Company is the payment of operating expense and the purchase of treasury stock.

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

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

Market Risk

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

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

Table of Contents

The following table discloses the projected changes in market value to 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 September 30, 2021.

(Dollars in thousands)	Market Value
Basis point change in interest rates	‑100			0			+100			+200
Total market risk sensitive assets	$	1,046,797			1,035,466			1,014,182			992,002
Total market risk sensitive liabilities		943,283			888,458			842,615			802,846
Off-balance sheet financial instruments		254			0			797			1,474
Net market risk	$	103,260			147,008			170,770			187,682
Percentage change from current market value		(29.76	%)		0.00	%		16.16	%		27.67	%

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 3% to 56%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 6% and 50%, 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 retail money market accounts were assumed to decay at an annual rate of 8% and 17%, respectively. Retail checking accounts were assumed to decay at an annual rate of 6%. Commercial checking and money market accounts were assumed to decay at annual rates of 22% and 13%, respectively. Callable investments were projected to be called at the first call date where the projected interest rate on similar remaining term instruments was less than the interest rate on the callable advance or investment.

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

Asset/Liability Management

The Company’s management reviews the impact that changing interest rates will have on the Company’s net interest income projected for the next twelve months to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income during the twelve month period ending September 30, 2022 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	$	2,327			8.96	%
+100		1,147			4.42
0		0			0.00
-100		(1,539	)		(5.93	)

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 loans and investments that would re-price to higher interest rates than there are deposits that would re-price higher to the same extent in the next twelve months. The decrease in interest income in a declining rate environment is primarily because there are more loans and investments that would re-price to lower interest rates than there are deposits that would be able to be re-priced lower to the same extent in the next twelve months.

Table of Contents

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, fund and sell loans in the ordinary course of business.

Item 3: Quantitative and Qualitative Disclosures about Market Risk

Not applicable.

Item 4: Controls and Procedures

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

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

Table of Contents

HMN FINANCIAL, INC.

PART II ‑ OTHER INFORMATION

ITEM 1.

Legal Proceedings.

From time to time, the Company is party to legal proceedings arising out of its lending and deposit operations. See Note 15 – Commitments and Contingencies for more information.

ITEM 1A.

Risk Factors.

The risks described in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed with the SEC, under “Part 1, Item 1A. Risk Factors” could affect the Company’s financial performance and could cause its actual results for future periods to differ materially from its anticipated results or other expectations, including those expressed in any forward-looking statements made in this Quarterly Report on Form 10-Q.

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

The following table provides information with respect to purchases made by the Company of its own stock during the third quarter of 2021:

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (a)		Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased under the Plans or Programs (a)
July 1, 2021 to July 31, 2021		0	$	N/A		0	$	6,000,000
August 1, 2021 to August 31, 2021		50,000		22.59		50,000		4,870,500
September 1, 2021 to September 30, 2021		0		N/A		0		4,870,500
Total		50,000	$	22.59		50,000	$	4,870,500

(a)

On July 27, 2021, the Company’s board of directors announced an increase of $4.2 million in the amount of shares authorized to be repurchased, from time to time, under the share repurchase program. This authorization increased the total amount available for stock repurchases to an aggregate purchase price of $6.0 million. Share repurchases may be executed through various means, including through open market transactions, privately negotiated transactions or otherwise. The repurchase authorization does not obligate the Company to purchase any shares and has no set expiration date.

ITEM 3.

Defaults Upon Senior Securities.

None.

ITEM 4.

Mine Safety Disclosures.

Not applicable.

ITEM 5.

Other Information.

None.

Table of Contents

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 September 30, 2021, filed with the SEC on November 2, 2021, formatted in Inline Extensible Business Reporting Language (iXBRL); (i) the Consolidated Balance Sheets at September 30, 2021 and December 31, 2020, (ii) the Consolidated Statements of Comprehensive Income for the Three Months and Nine Months Ended September 30, 2021 and 2020, (iii) the Consolidated Statements of Stockholders’ Equity for the Three and Nine Month Periods Ended September 30, 2021 and 2020 (iv) the Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2021 and 2020, and (v) Notes to Consolidated Financial Statements.	Filed Electronically

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

Table of Contents

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: November 2, 2021	By:	/s/ Bradley Krehbiel
		Bradley Krehbiel, President and Chief Executive Officer (Principal Executive Officer)


Date: November 2, 2021	By:	/s/ Jon Eberle
		Jon Eberle, Senior Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer)