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HMN FINANCIAL INC - Quarter Report: 2023 June (Form 10-Q)

hmnf20230630_10q.htm
 

Table of Contents

 

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 June 30, 2023

 

OR

 

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

 

For the transition period from _________ to _________

 

Commission File Number 0-24100

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

41-1777397

(State or other jurisdiction of incorporation or organization)

 

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

   

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

 

55901

(Address of principal executive offices)

 

(Zip Code)

   

Registrant's telephone number, including area code:

 

(507) 535-1200

 

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

 

Title of Each Class

Trading Symbol(s)

Name of Each Exchange on Which Registered

Common Stock

HMNF

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 July 28, 2023

 
 

Common stock, $0.01 par value

 

4,487,362

 

 

 

 

HMN FINANCIAL, INC.

TABLE OF CONTENTS

 

 

PART I  FINANCIAL INFORMATION  
    Page

Item 1:

Financial Statements

3

     
 

Consolidated Balance Sheets at June 30, 2023 (unaudited) and December 31, 2022

3

     
 

Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2023 and 2022 (unaudited)

4

     
 

Consolidated Statements of Stockholders' Equity for the Three and Six Months Ended June 30, 2023 and 2022 (unaudited)

5

     
 

Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2023 and 2022 (unaudited)

6

     
 

Notes to Consolidated Financial Statements (unaudited)

7

     

Item 2:

Management's Discussion and Analysis of Financial Condition and Results of Operations

26

     

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

 

 

 

PART I FINANCIAL INFORMATION

Item 1 : Financial Statements

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

 

  

June 30,

  

December 31,

 

(Dollars in thousands, except share and per share data)

 

2023

  

2022

 
  

(unaudited)

     

Assets

        

Cash and cash equivalents

 $13,234   36,259 

Securities available for sale:

        

Mortgage-backed and related securities (amortized cost $197,666 and $216,621)

  176,027   192,688 

Other marketable securities (amortized cost $55,709 and $55,698)

  54,000   53,331 

Total securities available for sale (at fair value)

  230,027   246,019 
         

Loans held for sale (at fair value)

  1,916   1,314 

Loans receivable, net

  826,932   777,078 

Accrued interest receivable

  3,395   3,003 

Mortgage servicing rights, net

  2,789   2,986 

Premises and equipment, net

  16,282   16,492 

Goodwill

  802   802 

Prepaid expenses and other assets

  5,317   3,902 

Deferred tax asset, net

  8,673   8,347 

Total assets

 $1,109,367   1,096,202 
         

Liabilities and Stockholders Equity

        

Deposits

 $970,712   981,926 

Federal Home Loan Bank advances and Federal Reserve borrowings

  24,700   0 

Accrued interest payable

  1,115   298 

Customer escrows

  5,861   10,122 

Accrued expenses and other liabilities

  4,827   6,520 

Total liabilities

  1,007,215   998,866 

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 outstanding 4,487,362 and 4,480,976

  91   91 

Additional paid-in capital

  41,019   41,013 

Retained earnings, subject to certain restrictions

  140,025   138,409 

Accumulated other comprehensive loss

  (16,810)  (19,761)

Unearned employee stock ownership plan shares

  (966)  (1,063)

Treasury stock, at cost 4,641,300 and 4,647,686 shares

  (61,207)  (61,353)

Total stockholders’ equity

  102,152   97,336 

Total liabilities and stockholders’ equity

 $1,109,367   1,096,202 

 


 

See accompanying notes to consolidated financial statements (unaudited).

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Income (Loss)

(unaudited)

 

  

Three Months Ended

  

Six Months Ended

 
  

June 30,

  

June 30,

 

(Dollars in thousands, except per share data)

 

2023

  

2022

  

2023

  

2022

 

Interest income:

                

Loans receivable

 $9,619   7,165   18,622   13,916 

Securities available for sale:

                

Mortgage-backed and related

  600   708   1,252   1,435 

Other marketable

  200   108   343   169 

Other

  78   76   193   102 

Total interest income

  10,497   8,057   20,410   15,622 
                 

Interest expense:

                

Deposits

  2,549   287   4,352   570 

Customer escrows

  23   0   55   0 

Advances and other borrowings

  197   5   212   5 

Total interest expense

  2,769   292   4,619   575 
                 

Net interest income

  7,728   7,765   15,791   15,047 
                 

Provision for credit losses (1)

  256   66   248   362 

Net interest income after provision for credit losses

  7,472   7,699   15,543   14,685 
                 

Non-interest income:

                

Fees and service charges

  831   810   1,638   1,576 

Loan servicing fees

  391   396   791   782 

Gain on sales of loans

  334   814   629   1,682 

Other

  418   496   844   851 

Total non-interest income

  1,974   2,516   3,902   4,891 
                 

Non-interest expense:

                

Compensation and benefits

  4,459   4,162   9,264   8,450 

Occupancy and equipment

  914   897   1,864   1,947 

Data processing

  545   576   1,050   930 

Professional services

  292   260   529   789 

Other

  1,247   1,088   2,443   2,119 

Total non-interest expense

  7,457   6,983   15,150   14,235 

Income before income tax expense

  1,989   3,232   4,295   5,341 

Income tax expense

  568   943   1,240   1,565 

Net income

  1,421   2,289   3,055   3,776 

Other comprehensive income (loss), net of tax

  705   (6,251)  2,951   (16,269)

Comprehensive income (loss) available to common stockholders

 $2,126   (3,962)  6,006   (12,493)

Basic earnings per share

 $0.33   0.52   0.70   0.86 

Diluted earnings per share

 $0.32   0.52   0.70   0.86 

 


(1) The Company adopted Accounting Standards Update 2016-13 as of January 1, 2023. The 2022 amounts presented are calculated under the prior accounting standard.

 

See accompanying notes to consolidated financial statements (unaudited).

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders' Equity
For the Three and Six Months Ended June 30, 2023 and 2022

(unaudited)

 

                  

Unearned

         
                  

Employee

         
              

Accumulated

  

Stock

      

Total

 
      

Additional

      

Other

  

Ownership

      

Stock-

 
  

Common

  

Paid-In

  

Retained

  

Comprehensive

  

Plan

  

Treasury

  

Holders’

 

(Dollars in thousands)

 

Stock

  

Capital

  

Earnings

  

Loss

  

Shares

  

Stock

  

Equity

 

Balance, March 31, 2023

 $91   40,975   138,952   (17,515)  (1,014)  (61,267)  100,222 

Net income

          1,421               1,421 

Other comprehensive income

              705         705 

Dividends paid to stockholders ($0.08 per share)

          (348)              (348)

Restricted stock awards

      (60)              60   0 

Amortization of restricted stock awards

      57                   57 

Earned employee stock ownership plan shares

      47           48       95 

Balance, June 30, 2023

 $91   41,019   140,025   (16,810)  (966)  (61,207)  102,152 
                             

Balance, December 31, 2022

 $91   41,013   138,409   (19,761)  (1,063)  (61,353)  97,336 

Net income

          3,055               3,055 

Other comprehensive income

              2,951           2,951 

Adoption of ASU 2016-13 (see Note 3)

          (830)              (830)

Dividends paid to stockholders ($0.14 per share)

          (609)              (609)

Restricted stock awards

      (210)              210   0 

Stock awards withheld for tax withholding

                      (64)  (64)

Amortization of restricted stock awards

      111                   111 

Earned employee stock ownership plan shares

      105           97       202 

Balance, June 30, 2023

 $91   41,019   140,025   (16,810)  (966)  (61,207)  102,152 

 


 

                  

Unearned

         
                  

Employee

         
              

Accumulated

  

Stock

      

Total

 
      

Additional

      

Other

  

Ownership

      

Stock-

 
  

Common

  

Paid-In

  

Retained

  

Comprehensive

  

Plan

  

Treasury

  

Holders’

 

(Dollars in thousands)

 

Stock

  

Capital

  

Earnings

  

Loss

  

Shares

  

Stock

  

Equity

 

Balance, March 31, 2022

 $91   40,695   132,634   (11,601)  (1,208)  (59,988)  100,623 

Net income

          2,289               2,289 

Other comprehensive loss

              (6,251)          (6,251)

Dividends paid to stockholders ($0.06 per share)

          (262)              (262)

Stock repurchases

                      (706)  (706)

Restricted stock awards

      (43)              43   0 

Stock awards withheld for tax withholding

                      (17)  (17)

Amortization of restricted stock awards

      55                   55 

Earned employee stock ownership plan shares

      68           49       117 

Balance, June 30, 2022

 $91   40,775   134,661   (17,852)  (1,159)  (60,668)  95,848 
                             

Balance, December 31, 2021

 $91   40,740   131,413   (1,583)  (1,256)  (59,374)  110,031 

Net income

          3,776               3,776 

Other comprehensive loss

              (16,269)          (16,269)

Dividends paid to stockholders ($0.12 per share)

          (528)              (528)

Stock repurchases

                 (1,449)  (1,449)

Restricted stock awards

      (225)              225   0 

Stock awards withheld for tax withholding

                      (70)  (70)

Amortization of restricted stock awards

      117                   117 

Earned employee stock ownership plan shares

      143           97       240 

Balance, June 30, 2022

 $91   40,775   134,661   (17,852)  (1,159)  (60,668)  95,848 

 


 

See accompanying notes to consolidated financial statements (unaudited).

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

 

  

Six Months Ended

June 30,

 

(Dollars in thousands)

 

2023

  

2022

 

Cash flows from operating activities:

        

Net income

 $3,055   3,776 

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

        

Provision for credit losses

  248   362 

Depreciation

  563   622 

Amortization of premiums, net

  402   547 

Amortization of deferred loan fees

  (90)  (313)

Amortization of core deposit intangible

  0   10 

Amortization of mortgage servicing rights and servicing costs

  412   465 

Capitalized mortgage servicing rights

  (215)  (419)

Deferred income tax expense

  0   550 

(Gains) losses recognized on equity securities, net

  (62)  53 

(Gains) losses on sale of premises and equipment

  (9)  0 

Gain on sale of real estate

  0   (113)

Gain on sales of loans

  (629)  (1,682)

Proceeds from sales of loans held for sale

  25,550   62,240 

Disbursements on loans held for sale

  (23,232)  (46,343)

Amortization of restricted stock awards

  111   117 

Amortization of unearned Employee Stock Ownership Plan shares

  97   97 

Earned Employee Stock Ownership Plan shares priced above original cost

  105   143 

Increase in accrued interest receivable

  (392)  (264)

Increase (decrease) in accrued interest payable

  817   (10)

Increase in other assets

  (82)  (405)

Decrease in other liabilities

  (1,858)  (1,523)

Other, net

  (1)  4 

Net cash provided by operating activities

  4,790   17,914 

Cash flows from investing activities:

        

Principal collected on securities available for sale

  18,554   24,223 

Proceeds collected on maturities of securities available for sale

  5,000   0 

Purchases of securities available for sale

  (5,013)  (30,043)

Purchase of Federal Home Loan Bank stock

  (5,318)  (1,743)

Redemption of Federal Home Loan Bank stock

  4,297   1,552 

Proceeds from sales of real estate

  0   402 

Net increase in loans receivable

  (53,543)  (37,436)

Proceeds from sale of premises

  42   4 

Purchases of premises and equipment

  (386)  (202)

Net cash used by investing activities

  (36,367)  (43,243)

Cash flows from financing activities:

        

(Decrease) increase in deposits

  (11,214)  28,197 

Purchase of treasury stock

  0   (1,449)

Stock awards withheld for tax withholding

  (64)  (70)

Dividends to stockholders

  (609)  (528)

Proceeds from borrowings

  128,120   31,000 

Repayment of borrowings

  (103,420)  (31,000)

Decrease in customer escrows

  (4,261)  (10)

Net cash provided by financing activities

  8,552   26,140 

(Decrease) increase in cash and cash equivalents

  (23,025)  811 

Cash and cash equivalents, beginning of period

  36,259   94,143 

Cash and cash equivalents, end of period

 $13,234   94,954 

Supplemental cash flow disclosures:

        

Cash paid for interest

 $3,803   585 

Cash paid for income taxes

  1,702   1,607 

Supplemental noncash flow disclosures:

        

Loans transferred to loans held for sale

  2,320   11,377 

Transfer of loans to real estate

  220   0 

Right to use assets obtained in exchange for lease liabilities

  0   258 

 


 

See accompanying notes to consolidated financial statements (unaudited).

 

 

HMN FINANCIAL, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

 

(1)

Description of the Business and Summary of Significant Accounting Policies 

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.

 

The Company adopted Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments on January 1, 2023, which changed the methodology used to estimate the allowance for credit losses on various types of financial instruments including loans, investment securities, and off-balance sheet credit exposures. See Note 3 - “New Accounting Standards, Note 7 - “Securities Available for Sale, and Note 9 - “Allowance for Credit Losses and Credit Quality Information” for more information on the changes in certain policies as a result of the adoption of ASU 2016-13.

 

The Company adopted ASU 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The amendments in this ASU eliminate the guidance for troubled debt restructurings (TDRs) by creditors in Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancing and restructures by creditors when a borrower is experiencing financial difficulty. See Note 3 - “New Accounting Standards and Note 9 - “Allowance for Credit Losses and Credit Quality Information” for more information on the changes in certain policies as a result of the adoption of ASU 2022-02.

 

 
(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 (loss), 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 unaudited consolidated financial statements presented in this report should be read in conjunction with the audited consolidated financial statements and the accompanying notes for the year ended December 31, 2022, included in the Company's Form 10-K filed with the Securities and Exchange Commission (SEC) on March 3, 2023. The results of operations for the three- and six-month periods ended June 30, 2023 are not necessarily indicative of the results which may be expected for the entire year.

 

The Company has evaluated subsequent events for potential recognition and/or disclosure through the date the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q were issued.

 

 

(3)

New Accounting Standards

In March 2022, the Financial Accounting Standards Board (FASB) issued ASU 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures. The amendments in this ASU eliminate the guidance for TDRs by creditors in Subtopic 310-40, Receivables-Troubled Debt Restructurings by Creditors, while enhancing disclosure requirements for certain loan refinancing and restructures by creditors when a borrower is experiencing financial difficulty. Specifically, rather than applying the recognition and measurement guidance for TDRs, an entity must apply the loan refinancing and restructuring guidance in paragraphs 310-20-35-9 through 35-11 to determine whether a modification results in a new loan or a continuation of an existing loan. For public business entities, such as HMN, the amendments in this ASU require that an entity disclose current period gross write-offs by year of origination for financing receivables and net investments in leases within the scope of Subtopic 326-20, Financial Instruments-Credit Losses-Measured at Amortized Cost in the vintage disclosures required by paragraph 326-20-50-6. The amendments in the ASU became effective for HMN when ASU 2016-13 was adopted on January 1, 2023 and the required disclosures were applied prospectively. See Note 9 Allowance for Credit Losses and Credit Quality Information for additional charge off disclosure information. Because there were no loan modifications to borrowers experiencing financial difficulties in the first six months of 2023, no additional disclosures relating to loan modifications were required in this Quarterly Report on Form 10-Q.

 

7

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments in this ASU affect all entities that measure credit losses on financial instruments including loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial asset that has a contractual right to receive cash that is not specifically excluded. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. To achieve this objective, the amendments in this ASU replace the incurred loss impairment methodology that was previously required by 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 applied the previously used 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. 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 adopted this ASU on January 1, 2023. The transition to the new ASU resulted in a cumulative-effect adjustment to the allowance for credit losses of $1.1 million, an increase in deferred tax assets of $0.3 million, and a decrease in retained earnings of $0.8 million as of the adoption date. In addition, a liability for $0.1 million was established for unfunded loan commitments as of the adoption date. The Company did not record an allowance for available for sale securities on January 1, 2023 as the investment portfolio consists almost entirely of debt securities implicitly backed by the U.S. Government for which credit risk is deemed negligible. The impact of this ASU could change in the future depending on the composition, characteristics, and credit quality of the securities portfolio as well as the economic conditions at future reporting periods. See Note 7 Securities Available For Sale and Note 9 Allowance for Credit Losses and Credit Quality Information.

 

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. This additional guidance requires enhanced review documentation and periodic reviews of the Company’s calculation of the allowance for credit losses by a third party.

 

 

(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.

 

8

 

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 off balance sheet financial instruments of the Company for which fair values are determined on a recurring basis as of June 30, 2023 and December 31, 2022.

 

  

Carrying Value at June 30, 2023

 

(Dollars in thousands)

 

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $230,027   0   230,027   0 

Equity securities

  287   0   287   0 

Commitments to extend credit

  (9)  0   (9)  0 

Total

 $230,305   0   230,305   0 
  

 

  

Carrying Value at December 31, 2022

 

(Dollars in thousands)

 

 

Total

  

Level 1

  

Level 2

  

Level 3

 

Securities available for sale

 $246,019   0   246,019   0 

Equity securities

  225   0   225   0 

Commitments to extend credit

  (28)  0   (28)  0 

Total

 $246,216   0   246,216   0 
  

 

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 June 30, 2023 and December 31, 2022.

 

  

Carrying Value at June 30, 2023

         

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Three Months Ended

June 30, 2023

Total Gains (Losses)

  

Six Months Ended

June 30, 2023

Total Gains (Losses)

 

Loans held for sale

 $1,916   0   1,916   0   (14)  (10)

Mortgage servicing rights

  2,789   0   0   2,789   0   0 

Collateral dependent loans

  1,614   0   1,614   0   69   26 

Real estate, net

  220   0   220   0   0   0 

Total

 $6,539   0   3,750   2,789   55   16 

 


 

  

Carrying Value at December 31, 2022

     

(Dollars in thousands)

 

Total

  

Level 1

  

Level 2

  

Level 3

  

Year Ended

December 31, 2022

Total Gains (Losses)

 

Loans held for sale

 $1,314   0   1,314   0   3 

Mortgage servicing rights, net

  2,986   0   0   2,986   0 

Impaired loans

  1,978   0   1,978   0   (46)

Total

 $6,278   0   3,292   2,986   (43)
  

 

 

(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 June 30, 2023 and December 31, 2022 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.

 

9

 

The estimated fair value of the Company’s financial instruments as of June 30, 2023 and December 31, 2022 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.

 

  

June 30, 2023

  

December 31, 2022

 
          

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

 $13,234   13,234   13,234             36,259   36,259   36,259           

Securities available for sale

  230,027   230,027      230,027          246,019   246,019      246,019        

Equity securities

  287   287      287          225   225      225        

Loans held for sale

  1,916   1,916      1,916          1,314   1,314      1,314        

Loans receivable, net

  826,932   755,122      755,122          777,078   724,497      724,497        

Federal Home Loan Bank stock

  2,304   2,304      2,304          1,283   1,283      1,283        

Accrued interest receivable

  3,395   3,395      3,395          3,003   3,003      3,003        

Mortgage servicing assets

  2,789   6,388         6,388       2,986   6,344         6,344     
                                                 

Financial liabilities:

                                                

Deposits

  970,712   905,964      905,964          981,926   983,420      983,420        

Other borrowings

  24,700   24,700      24,700          0   0      0        

Accrued interest payable

  1,115   1,115      1,115          298   298      298        

Off-balance sheet financial instruments:

                                                

Commitments to extend credit

  (9)  (9)           221,303   (28)  (28)           232,940 

Commitments to sell loans

  18   18            11,510   8   8            6,575 

 


 

Cash and Cash Equivalents

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

 

Securities Available for Sale

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

 

Equity Securities

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

 

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

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.

 

Mortgage Servicing Assets

The fair values of mortgage servicing assets were calculated by a third party using a discounted cash flow model-based technique that uses significant assumptions both observable and non-observable in the market. The non-observable assumptions reflect estimates of assumptions that market participants would use in pricing the mortgage servicing asset.

 

10

 

Deposits

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

 

Other Borrowings

The carrying amount of other borrowings approximates its fair value since it is short-term in nature.

 

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 non-owner sources. Comprehensive income (loss) is the total of net income and other comprehensive income or loss, which for the Company is comprised of unrealized gains or losses on securities available for sale. The components of other comprehensive income (loss) and the related tax effects were as follows:

 

  

For the Three Months Ended June 30,

 

(Dollars in thousands)

 

2023

  

2022

 

Securities available for sale:

 

Before

Tax

  

Tax

Effect (1)

  

Net of

Tax

  

Before

Tax

  

Tax

Effect

  

Net of

Tax

 

Unrealized gains (losses) arising during the period

 $106   (599)  705   (7,936)  (1,685)  (6,251)

Other comprehensive income (loss)

 $106   (599)  705   (7,936)  (1,685)  (6,251)

 


 

  

For the Six Months Ended June 30,

 

(Dollars in thousands)

 

2023

  

2022

 

Securities available for sale:

 

Before

Tax

  

Tax

Effect (1)

  

Net of

Tax

  

Before

Tax

  

Tax

Effect

  

Net of

Tax

 

Unrealized gains (losses) arising during the period

 $2,952   1   2,951   (21,682)  (5,413)  (16,269)

Other comprehensive income (loss)

 $2,952   1   2,951   (21,682)  (5,413)  (16,269)

 


(1)

The tax effect on gross unrealized gains (losses) was impacted by a change in the effective tax rate used in the second quarter of 2023 to allocate the total unrealized gains on securities between the deferred tax asset and other comprehensive income.

 

11

 
 

(7)

Securities Available For Sale

The following table shows the gross unrealized losses and fair values for the securities available for sale portfolio, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2023 and December 31, 2022.

 

  Less Than Twelve Months  Twelve Months or More  Total 

(Dollars in thousands)

 

# of

Investments

  

Fair

Value

  

Unrealized

Losses

  

# of

Investments

  

Fair

Value

  

Unrealized

Losses

  

Fair

Value

  

Unrealized

Losses

 

June 30, 2023

                                

Mortgage backed securities:

                                

Federal National Mortgage Association (FNMA)

  0  $0   0   34  $95,592   (11,535) $95,592   (11,535)

Federal Home Loan Mortgage Corporation (FHLMC)

  0   0   0   24   80,402   (10,101)  80,402   (10,101)

Collateralized mortgage obligations:

                                

FNMA

  0   0   0   1   34   (3)  34   (3)

Other marketable securities:

                                

U.S. Government agency obligations

  2   9,879   (133)  9   43,631   (1,367)  53,510   (1,500)

Corporate preferred stock

  0   0   0   1   490   (210)  490   (210)

Total temporarily impaired securities

  2  $9,879   (133)  69  $220,149   (23,216) $230,028   (23,349)

 

  

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, 2022

                                

Mortgage backed securities:

                                

FNMA

  12  $19,337   (1,629)  22  $85,599   (11,125) $104,936   (12,754)

FHLMC

  4   10,542   (1,214)  20   77,174   (9,963)  87,716   (11,177)

Collateralized mortgage obligations:

                                

FNMA

  1   36   (2)  0   0   0   36   (2)

Other marketable securities:

                                

U.S. government agency obligations

  4   19,334   (667)  7   33,507   (1,490)  52,841   (2,157)

Corporate preferred stock

  0   0   0   1   490   (210)  490   (210)

Total temporarily impaired securities

  21  $49,249   (3,512)  50  $196,770   (22,788) $246,019   (26,300)

 


 

The Company reviews its investment portfolio on a quarterly basis for indications of impairment due to credit-related and noncredit-related factors. This review includes analyzing 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 allow for any anticipated recovery in fair value.

 

As of June 30, 2023, the Company does not consider the unrealized losses on its securities available for sale to be attributable to credit-related factors. All of the Company’s investments, with the exception of the corporate preferred stock, are issued by U.S. government agencies, are implicitly guaranteed by the U.S. government, and have a long history of no credit losses. The unrealized losses on impaired securities, other than the corporate preferred stock, are the result of changes in interest rates. The unrealized losses reported for the corporate preferred stock at June 30, 2023 related to a single trust preferred security that was issued by the holding company of a community bank. As of June 30, 2023 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 impaired as a result of credit-related factors at June 30, 2023. The Company does not intend to sell the security and has the intent and ability to hold it for a period of time sufficient for recovery in amortized cost. 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 an other-than temporary impairment on this security in future periods by recording an allowance for credit losses. There were no other-than-temporary impairments charged to earnings during 2022. During the three- and six-month periods ended June 30, 2023 and June 30, 2022, there were no sales of securities.

 

12

 

The Company made an accounting policy election to exclude accrued interest receivable from the amortized cost basis of securities available for sale. Accrued interest receivable on securities available for sale was reported as a component of accrued interest receivable on the consolidated balance sheet, totaled $0.5 million at June 30, 2023, and was excluded from the estimated credit losses.

 

A summary of securities available for sale at June 30, 2023 and December 31, 2022 is as follows:

 

(Dollars in thousands)

 

Amortized

Cost

  

Gross Unrealized

Gains

  

Gross Unrealized

Losses

  

Fair Value

 

June 30, 2023

                

Mortgage-backed securities:

                

FNMA

 $107,126   0   (11,535)  95,591 

FHLMC

  90,503   0   (10,101)  80,402 

Collateralized mortgage obligations:

                

FNMA

  37   0   (3)  34 
   197,666   0   (21,639)  176,027 

Other marketable securities:

                

U.S. Government agency obligations

  55,009   0   (1,499)  53,510 

Corporate preferred stock

  700   0   (210)  490 
   55,709   0   (1,709)  54,000 
  $253,375   0   (23,348)  230,027 
  

 

(Dollars in thousands)

 

Amortized

Cost

  

Gross Unrealized

Gains

  

Gross Unrealized

Losses

  

Fair Value

 

December 31, 2022

                

Mortgage-backed securities:

                

FNMA

 $117,690   0   (12,754)  104,936 

FHLMC

  98,893   0   (11,177)  87,716 

Collateralized mortgage obligations:

                

FNMA

  38   0   (2)  36 
   216,621   0   (23,933)  192,688 

Other marketable securities:

                

U.S. Government agency obligations

  54,998   0   (2,157)  52,841 

Corporate preferred stock

  700   0   (210)  490 
   55,698   0   (2,367)  53,331 
  $272,319   0   (26,300)  246,019 
  

 

The Company had available for sale securities pledged as collateral for customer deposits in excess of the $250,000 insurance limit of the Federal Deposit Insurance Corporation. The securities pledged had a fair market value of $43.6 million and $45.9 million at June 30, 2023 and December 31, 2022, respectively.

 

The following table indicates amortized cost and estimated fair value of securities available for sale at June 30, 2023 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

 $90,555   84,341 

Due after one year through five years

  123,537   110,836 

Due after five years through fifteen years

  39,283   34,850 

Total

 $253,375   230,027 
  

 

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

 

13

 
 

(8)

Loans Receivable, Net

A summary of loans receivable at June 30, 2023 and December 31, 2022 is as follows:

 

(Dollars in thousands)

 

June 30,

2023

  

December 31,

2022

 

Single family

 $247,070   205,890 

Commercial real estate:

        

Real estate rental and leasing

  260,214   249,783 

Other

  223,186   221,562 
   483,400   471,345 

Consumer

  47,352   44,817 

Commercial business

  61,251   65,835 

Total loans

  839,073   787,887 

Less:

        

Unamortized discounts

  15   13 

Net deferred loan fees

  609   519 

Allowance for credit losses

  11,517   10,277 

Total loans receivable, net

 $826,932   777,078 
  

 

 

(9)

Allowance for Credit Losses and Credit Quality Information

The allowance for credit losses is summarized as follows:

 

(Dollars in thousands)

 

Single

Family

  

Commercial

Real Estate

  

Consumer

  

Commercial

Business

  

Total

 

For the three months ended June 30, 2023:

                    

Balance, March 31, 2023

 $959   7,561   620   2,202   11,342 

Provision for losses

  284   304   (12)  (376)  200 

Charge-offs

  0   0   (27)  0   (27)

Recoveries

  0   0   1   1   2 

Balance, June 30, 2023

 $1,243   7,865   582   1,827   11,517 
                     

For the six months ended June 30, 2023:

                    

Balance, December 31, 2022

 $1,261   7,026   1,058   932   10,277 

January 1, 2023 adoption of ASU 2016-13

  (259)  512   (485)  1,302   1,070 

Provision for losses

  240   327   35   (434)  168 

Charge-offs

  0   0   (27)  0   (27)

Recoveries

  1   0   1   27   29 

Balance, June 30, 2023

 $1,243   7,865   582   1,827   11,517 
                     

Allocated to:

                    

Individual allowance

 $33   0   112   17   162 

Collective allowance

  1,228   7,026   946   915   10,115 

Balance, December 31, 2022

 $1,261   7,026   1,058   932   10,277 
                     

Allocated to:

                    

Individual allowance

 $30   0   104   38   172 

Collective allowance

  1,213   7,865   478   1,789   11,345 

Balance, June 30, 2023

 $1,243   7,865   582   1,827   11,517 
                     

Loans receivable at December 31, 2022:

                    

Individually reviewed for impairment

 $908   179   492   561   2,140 

Collectively reviewed for impairment

  204,982   471,166   44,325   65,274   785,747 

Ending balance

 $205,890   471,345   44,817   65,835   787,887 

Loans receivable at June 30, 2023:

                    

Individually reviewed for impairment

 $653   176   457   500   1,786 

Collectively reviewed for impairment

  246,417   483,224   46,895   60,751   837,287 

Ending balance

 $247,070   483,400   47,352   61,251   839,073 
  

 

14

 

(Dollars in thousands)

 

Single Family

  

Commercial

Real Estate

  

Consumer

  

Commercial Business

  

Total

 

For the three months ended June 30, 2022:

                    

Balance, March 31, 2022

 $1,002   6,495   991   1,096   9,584 

Provision for losses

  66   91   70   (161)  66 

Charge-offs

  0   0   (15)  0   (15)

Recoveries

  0   0   1   8   9 

Balance, June 30, 2022

 $1,068   6,586   1,047   943   9,644 
                     

For the six months ended June 30, 2022:

                    

Balance, December 31, 2021

 $974   6,388   981   936   9,279 

Provision for losses

  94   198   80   (10)  362 

Charge-offs

  0   0   (16)  0   (16)

Recoveries

  0   0   2   17   19 

Balance, June 30, 2022

 $1,068   6,586   1,047   943   9,644 
  

 

The Company adopted ASU 2016-13 on January 1, 2023, and uses a standardized process to determine the appropriateness of the allowance for credit losses (ACL) for the commercial real estate, commercial business, single family, and consumer loan portfolios. The determination of the ACL for each of these portfolios is calculated on a pooled basis when similar risk characteristics exist and on an individual basis when loans do not share risk characteristics such as all non-performing loans. The determination of the quantitative pooled loan reserves for the commercial real estate and commercial business loan portfolios involves analyzing prior year losses over a full credit cycle by their assigned standardized risk ratings and applying these historic loss factors to the loans in the current portfolio with similar risk ratings. This process is referred to as a Vintage Loss Analysis. The determination of the quantitative pooled loan reserves for the single family and consumer loan portfolios involves analyzing prior year losses over a full credit cycle based on certain loan and borrower risk characteristics when the loans were originated and applying these historic loss factors to the loans in the current portfolio with similar risk characteristics. Qualitative reserves are also established and reflect management’s overall estimate of the extent to which current expected credit losses on collectively evaluated loans will differ from historical loss experience. The determination of the qualitative reserves for all of the loan categories involves an analysis and consideration of certain factors that are anticipated to have an impact on future credit losses including, but not limited to: actual and anticipated changes in the size, composition, and concentrations of the loan portfolios; national, regional, and local economic conditions including inflation and unemployment data; loan delinquencies, the level of non-accrual loans, and risk rating trends; lending policies, procedures, and staffing; the scope and results of loan quality reviews; and the demand for single family homes, commercial real estate, and building lots.

 

The Company’s total expected loss estimate is based, in part, on the maximum historical credit loss experience of each pool of loans over a full credit cycle and all available portfolio data is considered in the analysis. When historical credit loss experience is not sufficient for a specific portfolio, the Company may supplement its own portfolio data with external data. Assessing these numerous factors involves significant judgement.

 

Collateral dependent loans are those for which the borrower is experiencing financial difficulty and repayment is expected to be provided substantially through the operation or sale of the collateral. These loans do not typically share similar risk characteristics with other loans and expected credit losses are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluation. Estimates of expected credit losses for collateral dependent loans, whether or not foreclosure is probable, are based on the fair value of the collateral, adjusted for selling costs when repayment depends on the sale of the collateral. The appropriateness of the ACL on individually reviewed collateral dependent loans 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 these 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 credit losses in the periods in which the adjustments become known and loans are charged off to the extent they are deemed to be uncollectible. Because of the size of some loans, changes in estimates can have a significant impact on the credit loss provision. The Company increases its allowance for credit losses by charging the provision for credit losses against income and by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for credit losses and recording loan charge-offs. The methodology for establishing the allowance for credit losses takes into consideration probable losses that have been identified in connection with the loans individually reviewed as well as the expected losses in each identified pool of loans that have not been individually reviewed.

 

15

 

The Company made an accounting policy election to exclude accrued interest receivable from the amortized cost basis of loans. Accrued interest receivable on loans is reported as a component of accrued interest receivable on the consolidated balance sheet and totaled $2.9 million at June 30, 2023 and is excluded from the estimated credit losses.

 

In addition to the ACL on loans, the Company has established an ACL on unfunded commitments that is included in other liabilities on the consolidated balance sheets. This reserve is maintained at a level that management believes is sufficient to absorb losses arising from unfunded loan commitments. This amount is determined quarterly based on an estimate of outstanding commitments that are anticipated to be funded and multiplying those amounts by the loss rate for their loan category. The allowance for unfunded commitments at June 30, 2023 was $0.2 million.

 

The provision for credit losses is determined by the Company as the amount to be added to the ACL for various types of financial instruments including loans, investment securities, and off-balance sheet credit exposures after net charge-offs have been deducted to bring the ACL to a level that, in management’s judgment, is necessary to absorb expected credit losses over the lives of the respective financial instruments. No provision for credit losses was recorded on available-for-sale investment securities in the three or six-month periods ended June 30, 2023.

 

The following table presents the components of the provision for credit losses for the three- and six-month periods ended June 30, 2023 and 2022.

 

(Dollars in thousands)

 

Three months ended

June 30, 2023

  

Six months ended

June 30, 2023

 

Provision for credit losses on:

        

Loans (1)

 $200   168 

Unfunded commitments

  56   80 

Total

 $256   248 
  

 

(Dollars in thousands)

 

Three months ended

June 30, 2022

  

Six month ended

June 30, 2022

 

Provision for credit losses on:

        

Loans (1)

 $66   362 

Unfunded commitments

  0   0 

Total

 $66   362 
  

(1)The Company adopted ASU 2016-13 as of January 1, 2023. The 2022 amounts presented are calculated under the prior accounting standard.

 

16

 

The following table presents total loans by risk categories and year of origination as of June 30, 2023:

 

(Dollars in thousands)

 

2023

  

2022

  

2021

  

2020

  

2019

  

Prior

  

Revolving

  

Total

 

Single family

                                

Unclassified

 $52,788   62,140   66,483   36,420   11,571   16,476   0   245,878 

Special Mention

  0   0   0   0   0   0   0   0 

Substandard

  80   459   0   82   187   342   0   1,150 

Doubtful

  0   0   0   0   25   17   0   42 

Loss

  0   0   0   0   0   0   0   0 
   52,868   62,599   66,483   36,502   11,783   16,835   0   247,070 
                                 

Commercial Real Estate

                                

Unclassified

  33,570   195,116   115,449   80,905   15,300   12,636   0   452,976 

Special Mention

  150   6,677   2,708   163   0   1,038   0   10,736 

Substandard

  2,202   1,644   292   13,322   647   1,581   0   19,688 

Doubtful

  0   0   0   0   0   0   0   0 

Loss

  0   0   0   0   0   0   0   0 
   35,922   203,437   118,449   94,390   15,947   15,255   0   483,400 
                                 

Consumer

                                

Unclassified

  9,081   9,351   2,012   2,397   2,993   5,616   15,378   46,828 

Special Mention

  24   0   0   0   0   0   0   24 

Substandard

  0   30   137   0   4   165   64   400 

Doubtful

  0   16   0   0   0   0   0   16 

Loss

  0   0   35   0   0   0   49   84 
   9,105   9,397   2,184   2,397   2,997   5,781   15,491   47,352 

Current period gross write offs

  0   1   0   0   0   26   0   27 
                                 

Commercial Business

                                

Unclassified

  10,230   9,485   4,112   4,136   286   935   26,393   55,577 

Special Mention

  0   603   0   0   0   0   29   632 

Substandard

  1,604   497   253   328   30   39   2,291   5,042 

Doubtful

  0   0   0   0   0   0   0   0 

Loss

  0   0   0   0   0   0   0   0 
   11,834   10,585   4,365   4,464   316   974   28,713   61,251 
                                 

Total Loans

 $109,729   286,018   191,481   137,753   31,043   38,845   44,204   839,073 

 


 

Credit Quality Indicators

The Company categorized loans into risk categories based on relevant information about the ability of borrowers to service their debt. The information considered includes information, such as: current financial information, historical payment experience, credit documentation, public information, and current economic trends, among other factors. The Company established a risk rating at origination for all commercial real estate and commercial business loans and management monitors the loans on an ongoing basis for any changes in the borrower’s ability to service their debt. Management also affirms the risk ratings for these loans on an annual basis. The Company uses the following definitions for classifying loans.

 

Special Mention - 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.

 

Substandard - 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.

 

17

 

Doubtful - 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.

 

Loss - Loans classified as loss are essentially uncollateralized and/or considered uncollectible and of such little value that continuance as an asset on the balance sheet may not be warranted.

 

Classified loans are categorized as special mention, substandard, doubtful, and loss. Loans classified as substandard, doubtful, or loss require the Bank to perform an analysis of the individual loan and charge off any loans, or portion thereof, that are deemed uncollectible. Loans not meeting the criteria above to require an individual analysis that are not classified as special mention are considered to be unclassified or pass-rated loans.

 

The aging of past due loans at June 30, 2023 and December 31, 2022 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

 

June 30, 2023

                            

Single family

 $1,581   42   187   1,810   245,260   247,070   0 

Commercial real estate:

                            

Real estate rental and leasing

  0   0   0   0   260,214   260,214   0 

Other

  0   0   0   0   223,186   223,186   0 

Consumer

  264   63   90   417   46,935   47,352   0 

Commercial business

  0   0   0   0   61,251   61,251   0 

Total

 $1,845   105   277   2,227   836,846   839,073   0 
December 31, 2022                             

Single family

 $380   145   481   1,006   204,884   205,890   0 

Commercial real estate:

                            

Real estate rental and leasing

  0   0   0   0   249,783   249,783   0 

Other

  578   0   0   578   220,984   221,562   0 

Consumer

  394   123   88   605   44,212   44,817   0 

Commercial business

  0   0   0   0   65,835   65,835   0 

Total

 $1,352   268   569   2,189   785,698   787,887   0 

 


 

The Company considers a loan to have defaulted when it becomes 90 or more days past due and the loan is classified as non-accruing. When a loan is classified as non-accruing, any accrued interest on the loan is reversed from interest income and any subsequent interest on the loan is recognized using the cash basis method of income recognition. A non-accruing loan may be reclassified as an accruing loan after the loan becomes current.

 

18

 

The following table presents the carrying value of collateral dependent individually analyzed loans as of June 30, 2023:

 

  

June 30, 2023

 

(Dollars in thousands)

 

Recorded

Investment

  

Unpaid

Principal

Balance

  

Related

Allowance

 

Loans with no related allowance recorded:

            

Single family

 $424   441   0 

Commercial real estate:

            

Other

  176   176   0 

Consumer

  313   313   0 
             

Loans with an allowance recorded:

            

Single family

  229   229   30 

Consumer

  144   144   104 

Commercial business

  500   500   38 
             

Total:

            

Single family

  653   670   30 

Commercial real estate:

            

Other (1)

  176   176   0 

Consumer (2)

  457   457   104 

Commercial business (3)

  500   500   38 

Total

 $1,786   1,803   172 
  
 

(1)

Secured by commercial land.

 

(2)

Secured by second mortgages on single family housing and recreational vehicles.

 

(3)

Secured by business equipment primarily related to the farming and trucking industries.

 

The following table presents, under previously applicable GAAP, loans individually evaluated for impairment by portfolio segment as of December 31, 2022:

 

  

December 31, 2022

 

(Dollars in thousands)

 

Recorded

Investment

  

Unpaid

Principal

Balance

  

Related

Allowance

 

Loans with no related allowance recorded:

            

Single family

 $667   685   0 

Commercial real estate:

            

Other

  179   179   0 

Consumer

  338   338   0 
             

Loans with an allowance recorded:

            

Single family

  241   241   33 

Consumer

  154   154   112 

Commercial business

  561   561   17 
             

Total:

            

Single family

  908   926   33 

Commercial real estate:

            

Other (1)

  179   179   0 

Consumer (2)

  492   492   112 

Commercial business (3)

  561   561   17 

Total

 $2,140   2,158   162 
  
 

(1)

Secured by commercial land.

 

(2)

Secured by second mortgages on single family housing and recreational vehicles.

 

(3)

Secured by business equipment primarily related to the farming and trucking industries.

 

19

 

The following table summarizes the average recorded investment and interest income recognized on loans individually evaluated for impairment under previously applicable GAAP during the three- and six-month periods ended June 30, 2022:

 

  

For the three months ended
June 30, 2022

  

For the six months ended

June 30, 2022

 

(Dollars in thousands)

 

Average

Recorded

Investment

  

Interest

Income

Recognized

  

Average Recorded Investment

  

Interest

Income

Recognized

 

Loans with no related allowance recorded:

                

Single family

 $439   1   377   4 

Commercial real estate:

                

Other

  183   2   185   10 

Consumer

  330   3   359   5 
                 

Loans with an allowance recorded:

                

Single family

  83   0   84   0 

Commercial real estate:

                

Other

  3,326   0   3,407   0 

Consumer

  162   0   150   1 

    Commercial business

  7   0   7   0 
                 

Total

                

Single family

  522   1   461   4 

Commercial real estate:

                

Other

  3,509   2   3,592   10 

    Consumer

  492   3   509   6 

    Commercial business

  7   0   7   0 
  $4,530   6   4,569   20 
  

 

At June 30, 2023 and December 31, 2022, non-accruing loans totaled $1.5 million and $1.9 million, respectively, for which the related allowance for credit losses was $0.2 million for both periods. All of the interest income recognized for non-accruing loans was recognized using the cash basis method of income recognition. Non-accruing loans for which no specific allowance has been recorded because management determined that the value of the collateral was sufficient to repay the loan totaled $0.7 million and $1.0 million at June 30, 2023 and December 31, 2022, respectively.

 

The non-accrual loans at June 30, 2023 and December 31, 2022 are summarized as follows:

 

(Dollars in thousands)

 

June 30,

2023

  

December 31,

2022

 
         

Single family

 $653  $908 

Consumer

  407   441 

Commercial business

  471   529 
  $1,531  $1,878 
  

 

There were no single family loans that were in the process of foreclosure at June 30, 2023 and there were $0.2 million at December 31, 2022.

 

The Company adopted ASU 2022-02, Financial Instruments-Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures on January 1, 2023. The amendments in this ASU were applied prospectively, and therefore, loan modification and charge off information is provided for only those items occurring after the January 1, 2023 adoption date.

 

Based on the guidance in ASU 2022-02, a loan modification or refinancing results in a new loan if the terms of the new loan are at least as favorable to the lender as the terms with customers with similar collection risks that are not refinancing or restructuring their loans and the modification to the terms of the loan are more than minor. If a loan modification or refinancing does not result in a new loan, it is classified as a loan modification.

 

20

 

There are additional disclosures for modification of loans with borrowers experiencing financial difficulty that result in a direct change in the timing or amount of contractual cash flows. The disclosures are applicable to situations where there is principal forgiveness, interest rate reductions, other-than-insignificant payment delays, term extensions, or a combination of any of these items. If the Company modifies any loans to borrowers in financial distress that involves principal forgiveness, the amount of principal that is forgiven is charged off against the ACL. The Company had no loan modifications to borrowers experiencing financial difficulties in the first six months of 2023 and there were no modifications to borrowers experiencing financial difficulties that were outstanding at June 30, 2023.

 

 

(10)

Intangible Assets

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

 

(Dollars in thousands)

 

Six Months Ended

June 30, 2023

  

Twelve Months Ended

December 31, 2022

  

Six Months Ended

June 30, 2022

 

Balance, beginning of period

 $2,986   3,280   3,280 

Originations

  215   615   419 

Amortization

  (412)  (909)  (465)

Balance, end of period

 $2,789   2,986   3,234 

Fair value of mortgage servicing rights

 $6,388   6,344   6,103 
  

 

All of the loans sold where the Company continues to service the loans are serviced for FNMA under the individual loan sale program. The following is a summary of the risk characteristics of the loans being serviced for FNMA at June 30, 2023:

 

      

Weighted

  

Weighted

     
  Loan  

Average

  

Average

     
  Principal  

Interest

  

Remaining

  

Number

 

(Dollars in thousands)

 Balance  

Rate

  

Term (months)

  

of Loans

 

Original term 15 year fixed rate

 $100,685   2.91%

 

  131   984 

Original term 30 year fixed rate

  429,056   3.66   304   2,681 
  

 

Amortization expense for intangible assets was $0.4 million and $0.5 million for the six month periods ended June 30, 2023 and 2022, respectively. The gross carrying amount of intangible assets and the associated accumulated amortization at June 30, 2023 and December 31, 2022 is presented in the following table.

 

  

June 30, 2023

 
  

Gross

      

Unamortized

 
  

Carrying

  

Accumulated

  

Intangible

 

(Dollars in thousands)

 

Amount

  

Amortization

  

Assets

 

Mortgage servicing rights

 $6,056   (3,267)  2,789 

Goodwill

  802   0   802 

Total

 $6,858   (3,267)  3,591 
  

 

  

December 31, 2022

 
  

Gross

      

Unamortized

 
  

Carrying

  

Accumulated

  

Intangible

 

(Dollars in thousands)

 

Amount

  

Amortization

  

Assets

 

Mortgage servicing rights

 $5,995   (3,009)  2,986 

Core deposit intangible

  574   (574)  0 

Goodwill

  802   0   802 

Total

 $7,371   (3,583)  3,788 
  

 

21

 

The following table indicates the estimated future amortization expense for mortgage servicing rights:

 

(Dollars in thousands)

 

Mortgage

Servicing

Rights

 

Year ending December 31,

    

2023

 $363 

2024

  685 

2025

  622 

2026

  527 

2027

  354 

Thereafter

  238 

Total

 $2,789 
  

 

The projection of amortization is based on existing asset balances and the existing interest rate environment as of June 30, 2023. The Company’s actual experience may be significantly different depending upon changes in mortgage interest rates and other market conditions.

 

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.

Goodwill was tested for impairment at June 30, 2023 due to the Company’s stock price being less than its book value and the Company determined that it was not permanently impaired and no write down was required.

 

 

(11)

Leases

The Company accounts for its leases in accordance with ASC Topic 842. 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 (loss).

 

The Company’s leases relate to office space and bank branches with remaining lease terms between fourteen and fifty-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. As of June 30, 2023 a $0.4 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 costs were $0.1 million for the three- and six-month periods ended June 30, 2023 and 2022.

 

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

 

  

Three Months Ended June 30,

  

Six Months Ended June 30,

 

(Dollars in thousands)

 

2023

  

2022

  

2023

  

2022

 

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

                

Operating cash flows from operating leases

 $55   58   110   115 

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

  2.4   2.5   2.4   2.5 

Weighted-average discount rate – operating leases

  2.67%  2.44%  2.67%  2.44%

 


 

22

 

The table below summarizes the maturity of remaining lease liabilities at June 30, 2023:

 

(Dollars in thousands)

 

 

June 30, 2023

 

2023

 $117 

2024

  212 

2025

  58 

2026

  27 

2027

  25 

Total lease payments

  439 

Less: Interest

  (15)

Present value of lease liabilities

 $424 
  

 

 

(12)

Earnings per Common Share

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

 

  

Three Months Ended June 30,

  

Six Months Ended June 30,

 

(Dollars in thousands, except per share data)

 

2023

  

2022

  

2023

  

2022

 

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

  4,346,778   4,360,717   4,342,872   4,375,936 

Net dilutive effect of:

                

Restricted stock awards and options

  27,650   33,442   28,385   33,662 

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

  4,374,428   4,394,159   4,371,257   4,409,598 

Income available to common stockholders

 $1,421   2,289   3,055   3,776 

Basic earnings per common share

 $0.33   0.52   0.70   0.86 

Diluted earnings per common share

 $0.32   0.52   0.70   0.86 
  

 

 

(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 Bank in its Small Bank Holding Company Policy Statement (Policy Statement), has exempted small bank holding companies with assets less than $3 billion from the above capital requirements. The Policy Statement also includes savings and loan holding companies that meet the Policy Statement’s qualitative requirements for exemption. The Company currently meets the qualitative exemption requirements, and therefore, is exempt from the above capital requirements.

 

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

 

The Bank’s average total assets and adjusted total assets for the second quarter of 2023 were both $1.1 billion and its risk-weighted assets were $904.2 million. The following table presents the Bank’s capital amounts and ratios at June 30, 2023 for actual capital, required capital and excess capital, including ratios in order to qualify as being well capitalized under the prompt corrective actions regulations.

 

23

 
  

Actual

  

Required to be

Adequately Capitalized

  

Excess Capital

  

To Be Well Capitalized

Under Prompt

Corrective Action

Provisions

 

(Dollars in thousands)

 

Amount

  

Percent of

Assets(1)

  

Amount

  

Percent of

Assets(1)

  

Amount

  

Percent of

Assets(1)

  

Amount

  

Percent of

Assets(1)

 

June 30, 2023

                                

Common equity Tier 1 capital

 $102,707   11.36

%

 $40,688   4.50

%

 $62,019   6.86

%

 $58,772   6.50

%

Tier 1 leverage

  102,707   9.25   44,424   4.00   58,283   5.25   55,531   5.00 

Tier 1 risk-based capital

  102,707   11.36   54,251   6.00   48,456   5.36   72,334   8.00 

Total risk-based capital

  114,013   12.61   72,334   8.00   41,679   4.61   90,418   10.00 

 


(1) Based upon the Bank’s adjusted total assets for the purpose of the Tier 1 leverage capital ratio and risk-weighted assets for the purpose of the risk-based capital ratios.

 

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 June 30, 2023, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the current prompt corrective action regulations, including the capital conservation buffer described above. However, there can be no assurance that the Bank will continue to maintain such status in the future. The Office of the Comptroller of the Currency has extensive discretion in its supervisory and enforcement activities and can adjust the requirement to be well-capitalized in the future.

 

 

(14)

Stockholders Equity

The Company did not repurchase any shares of its common stock in the open market during the first six months of 2023. At June 30, 2023, the Company was authorized to repurchase up to $6.0 million of its common stock under the existing share repurchase program. The Company declared a quarterly dividend of 6 cents per share of common stock outstanding that was paid to stockholders on March 8, 2023 and a quarterly dividend of 8 cents per share of common stock outstanding that was paid to stockholders on June 7, 2023.

 

 

(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 June 30, 2023 were approximately $10.3 million, expire over the next seventeen 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. 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. 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.

 

 

(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.

 

24

 

The Company evaluates performance and allocates resources based on the segment’s net income, return on average assets and return on average equity. Each corporation is managed separately with its own officers and board of directors. The following table sets forth certain information about the reconciliations of reported profit and assets for each of the Company’s reportable segments.

 

(Dollars in thousands)

 

Home Federal

Savings Bank

  

Other

  

Eliminations

  

Consolidated

Total

 

At or for the six months ended June 30, 2023:

                

Interest income – external customers

 $20,410   0   0   20,410 

Non-interest income – external customers

  3,902   0   0   3,902 

Intersegment interest income

  0   140   (140)  0 

Intersegment non-interest income

  130   3,287   (3,417)  0 

Interest expense

  4,759   0   (140)  4,619 

Provision for credit losses

  248   0   0   248 

Non-interest expense

  14,847   433   (130)  15,150 

Income tax expense (benefit)

  1,301   (61)  0   1,240 

Net income

  3,287   3,055   (3,287)  3,055 

Total assets

  1,109,224   102,234   (102,091)  1,109,367 

At or for the six months ended June 30, 2022:

                

Interest income – external customers

 $15,622   0   0   15,622 

Non-interest income – external customers

  4,891   0   0   4,891 

Intersegment interest income

  0   17   (17)  0 

Intersegment non-interest income

  117   4,071   (4,188)  0 

Interest expense

  592   0   (17)  575 

Provision for credit losses

  362   0   0   362 

Non-interest expense

  13,947   405   (117)  14,235 

Income tax expense (benefit)

  1,658   (93)  0   1,565 

Net income

  4,071   3,776   (4,071)  3,776 

Total assets

  1,081,228   95,980   (95,199)  1,082,009 

At or for the quarter ended June 30, 2023:

                

Interest income – external customers

 $10,497   0   0   10,497 

Non-interest income – external customers

  1,974   0   0   1,974 

Intersegment interest income

  0   76   (76)  0 

Intersegment non-interest income

  72   1,539   (1,611)  0 

Interest expense

  2,845   0   (76)  2,769 

Provision for credit losses

  256   0   0   256 

Non-interest expense

  7,305   224   (72)  7,457 

Income tax expense (benefit)

  598   (30)  0   568 

Net income

  1,539   1,421   (1,539)  1,421 

Total assets

  1,109,224   102,234   (102,091)  1,109,367 

At or for the quarter ended June 30, 2022:

                

Interest income – external customers

 $8,057   0   0   8,057 

Non-interest income – external customers

  2,516   0   0   2,516 

Intersegment interest income

  0   8   (8)  0 

Intersegment non-interest income

  58   2,433   (2,491)  0 

Interest expense

  300   0   (8)  292 

Provision for credit losses

  66   0   0   66 

Non-interest expense

  6,841   200   (58)  6,983 

Income tax expense (benefit)

  991   (48)  0   943 

Net income

  2,433   2,289   (2,433)  2,289 

Total assets

  1,081,228   95,980   (95,199)  1,082,009 

 

25

 
 
Item 2: HMN FINANCIAL, INC.  

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 HMN Financial, Inc (HMN or the Company) with the Securities and Exchange Commission (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 “anticipate,” “continue,” “could,” “expect,” “future,” “may,” “project” and “will,” or similar statements or variations of such terms and include, but are not limited to, those relating to: enacted and expected changes to the federal funds rate and the resulting impacts on consumer deposits, loan originations, and related aspects of the Bank’s business; the anticipated impacts of inflation and rising interest rates on the general economy, the Bank’s clients, and the allowance for credit losses; anticipated future levels of the provision for credit losses; anticipated level of future asset growth; and the payment of dividends by HMN.

 

A number of factors, many of which may be amplified by the deterioration in economic conditions, 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 Office of the Comptroller of the Currency and the Federal Reserve Bank of Minneapolis (FRB) in the event of non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with traditional and alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank and the Federal Reserve Bank; technological, computer-related or operational difficulties including those from any third party cyberattack; reduced demand for financial services and loan products; adverse developments affecting the financial services industry, such as recent bank failures or concerns involving liquidity; 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; the Company’s 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 “Risk Factors” section of the Company’s Annual Report on Form 10-K for the year ended December 31, 2022 and Part II, Item 1A of its subsequently filed quarterly reports on Form 10-Q. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements. 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.

 

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, 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 credit 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

While our significant accounting policies are described in the notes to our consolidated financial statements, we believe the following discussion addresses our most critical accounting estimates, which are those estimates made in accordance with U.S. generally accepted accounting principles (GAAP) that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. The Company has identified the following critical accounting estimates 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 Credit Losses and Related Provision

The Company adopted Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments on January 1, 2023. Under ASU 2016-13, the allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are also not included in the collective evaluations. The collective reserve amount is assessed based on size and risk characteristics of the various portfolio segments, past loss history and other adjustments determined to have a potential impact on future credit losses.

 

The Company has a standardized process to determine the appropriateness of the credit loss allowance for the commercial real estate, commercial business, single family, and consumer loan portfolios. The determination of the allowance for each of these portfolios is calculated on a pooled basis with individual determination of the allowance for all non-performing loans. The determination of the quantitative pooled loan reserves for the commercial real estate and commercial business loan portfolios involves analyzing prior year losses by their assigned standardized risk ratings and applying these historic loss factors to the loans in the current portfolio with similar risk rating. This process is referred to as a Vintage Loss Analysis. The determination of the quantitative pooled loan reserves for the single family and consumer loan portfolios involves analyzing prior year losses based on certain loan and borrower risk characteristics when the loans were originated and applying these historic loss factors to the loans in the current portfolio with similar risk characteristics. Qualitative reserves are also established and reflect management’s overall estimate of the extent to which current expected credit losses on collectively evaluated loans will differ from historical loss experience. The determination of the qualitative reserves for all of the loan categories involves an analysis and consideration of certain factors that are anticipated to have an impact on future credit losses including, but not limited to: actual and anticipated changes in the size, composition, and concentrations of the loan portfolios; national, regional, and local economic conditions including inflation and unemployment data; loan delinquencies; the scope and results of loan quality reviews; level of non-accrual loans, and risk rating trends; lending policies, procedures, and staffing; and the demand for single family homes, commercial real estate, and building lots.

 

The appropriateness of the allowance for credit losses on individually reviewed collateral dependent loans 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 non-performing 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 credit losses in the periods in which the adjustments become known and loans are charged off to the extent they are deemed to be uncollectible. Because of the size of some loans, changes in estimates can have a significant impact on the credit loss provision. The Company increases its allowance for credit losses by charging the provision for credit losses against income and by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for credit losses and recording loan charge-offs. The methodology for establishing the allowance for credit losses takes into consideration probable losses that have been identified in connection with the loans individually reviewed as well as the expected losses in each identified pool of loans that have not been individually reviewed. Although management believes that based on current conditions the allowance for credit losses is maintained at an appropriate amount to provide for the expected loan losses in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for credit losses and adjustments may be required in the future. See “Note 3 - New Accounting Pronouncements in the Notes to Consolidated Financial Statements for further information on the impact to the Company’s financial statements when ASU 2016-13 was adopted on January 1, 2023.

 

 

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 two largest relating to the net unrealized losses on securities available for sale and the allowance for credit losses. For tax purposes, the net unrealized losses on securities available for sale are not recognized unless the securities are sold and the loss becomes realized. For book purposes, the unrealized losses, net of income taxes, are reported as a separate component of stockholders’ equity until realized. For the allowance for credit losses, only the net charge-offs are deductible for taxes, while the entire provision for credit losses is used to determine book income. A deferred tax asset for both of these items 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.

 

 

RESULTS OF OPERATIONS FOR THE THREE AND SIX MONTH PERIODS ENDED JUNE 30, 2023 COMPARED TO THE SAME PERIODS ENDED JUNE 30, 2022

 

Net Income

Net income was $1.4 million for the second quarter of 2023, a decrease of $0.9 million compared to net income of $2.3 million for the second quarter of 2022. Diluted earnings per share for the second quarter of 2023 was $0.32, a decrease of $0.20 from diluted earnings per share of $0.52 for the second quarter of 2022. The decrease in net income between the periods was primarily because of a $0.5 million decrease in the gain on sales of loans due to a decrease in mortgage loan sales, a $0.3 million increase in compensation expense due to annual salary increases, a $0.2 million increase in the provision for credit losses, and a $0.2 million increase in other expenses primarily because of an increase in Federal Deposit Insurance Corporation (FDIC) insurance expense. These decreases in net income were partially offset by a reduction in income tax expense between the periods as a result of the reduced pretax income.

 

 

Net income was $3.1 million for the six-month period ended June 30, 2023, a decrease of $0.7 million, or 19.1%, compared to net income of $3.8 million for the six-month period ended June 30, 2022. Diluted earnings per share for the six-month period ended June 30, 2023 was $0.70, a decrease of $0.16 per share compared to diluted earnings per share of $0.86 for the same period in 2022. The decrease in net income between the periods was because of a $1.1 million decrease in the gain on sales of loans because of a decrease in mortgage loan sales, a $0.8 million increase in compensation expense due primarily to annual salary increases, and a $0.3 million increase in other expenses primarily because of an increase in FDIC insurance expense. These decreases in net income were partially offset by a $0.8 million increase in net interest income due to an increase in interest rates and the amount of average interest earning assets outstanding, a $0.4 million reduction in income tax expense as a result of the reduced pretax income between the periods, and a $0.3 million decrease in professional expenses due to a decrease in legal fees.

 

Net Interest Income

Net interest income was $7.7 million for the second quarter of 2023, a decrease of $0.1 million, or 0.5%, compared to $7.8 million for the second quarter of 2022. Interest income was $10.5 million for the second quarter of 2023, an increase of $2.4 million, or 30.3%, from $8.1 million for the second quarter of 2022. Interest income increased because of the $62.1 million increase in the average interest-earning assets between the periods and also because of the increase in the average yield earned on interest-earning assets between the periods. The average yield earned on interest-earning assets was 3.94% for the second quarter of 2023, an increase of 72 basis points from 3.22% for the second quarter of 2022. The increase in the average yield is primarily related to the increase in market interest rates as a result of the 3.50% increase in the prime interest rate between the periods.

 

Interest expense was $2.8 million for the second quarter of 2023, an increase of $2.5 million, or 848.3%, compared to $0.3 million for the second quarter of 2022. Interest expense increased primarily because of the increase in the average interest rate paid on interest-bearing liabilities between the periods. Interest expense also increased because of the $52.2 million increase in the average interest-bearing liabilities and non-interest bearing deposits between the periods. The average interest rate paid on interest-bearing liabilities and non-interest bearing deposits was 1.13% for the second quarter of 2023, an increase of 100 basis points from 0.13% for the second quarter of 2022. The increase in the average rate paid is primarily related to the change in the types of funding sources as more brokered deposits, certificates of deposit, and Federal Home Loan Bank (FHLB) advances were used in the second quarter of 2023 than in the second quarter of 2022. These funding sources generally have higher interest rates than traditional checking and money market accounts. The increase in market interest rates as a result of the 3.50% increase in the federal funds rate between the periods also contributed to higher funding costs in the second quarter of 2023 when compared to the same period in 2022.

 

Net interest margin (net interest income divided by average interest-earning assets) for the second quarter of 2023 was 2.90%, a decrease of 20 basis points, compared to 3.10% for the second quarter of 2022. The decrease in the net interest margin is primarily because the increase in the average rate paid on interest-bearing liabilities and non-interest bearing deposits exceeded the increase in the average yield earned on interest-earning assets between the periods.

 

Net interest income was $15.8 million for the first six months of 2023, an increase of $0.8 million, or 4.9%, compared to $15.0 million for the same period of 2022. Interest income was $20.4 million for the first six months of 2023, an increase of $4.8 million, or 30.6%, from $15.6 million for the first six months of 2022. Interest income increased because of the $58.4 million increase in the average interest-earning assets between the periods and also because of the increase in the average yield earned on interest-earning assets between the periods. The average yield earned on interest-earning assets was 3.87% for the first six months of 2023, an increase of 73 basis points from 3.14% for the first six months of 2022. The increase in the average yield is primarily related to the increase in market interest rates as a result of the 3.50% increase in the prime interest rate between the periods.

 

 

Interest expense was $4.6 million for the first six months of 2023, an increase of $4.0 million, or 703.3%, compared to $0.6 million for the same period of 2022. Interest expense increased primarily because of the increase in the average interest rate paid on interest-bearing liabilities between the periods. Interest expense also increased because of the $49.9 million increase in the average interest-bearing liabilities and non-interest bearing deposits between the periods. The average interest rate paid on interest-bearing liabilities and non-interest bearing deposits was 0.96% for the first six months of 2023, an increase of 83 basis points from 0.13% for the first six months of 2022. The increase in the average rate paid is primarily related to the change in the types of funding sources used between the periods as more brokered deposits, certificates of deposits, and FHLB advances were used in the first six months of 2023 than in the first six months of 2022. These funding sources generally have interest rates that are higher than traditional checking and money market accounts. The increase in market interest rates was a result of the 3.50% increase in the federal funds rate between the periods also contributed to the higher funding costs in the first six months of 2023 when compared to the same period in 2022.

 

Net interest margin (net interest income divided by average interest-earning assets) for the first six months of 2023 was 3.00%, a decrease of 2 basis points, compared to 3.02% for the first six months of 2022. The decrease in the net interest margin is primarily because the increase in the average rate paid on interest-bearing liabilities and non-interest bearing deposits exceeded the increase in the average yield earned on interest-earning assets as a result of the increase in the prime rate between the periods.

 

A summary of the Company’s net interest margin for the three- and six-month periods ended June 30, 2023 and 2022 is as follows:

 

   

For the three-month period ended

 
   

June 30, 2023

   

June 30, 2022

 

(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

  $ 259,187       800       1.24

%

  $ 299,138       816       1.09

%

Loans held for sale

    1,872       29       6.24       2,710       30       4.53  

Single family loans, net

    225,065       2,195       3.91       175,948       1,511       3.44  

Commercial loans, net

    527,900       6,663       5.06       459,406       5,151       4.50  

Consumer loans, net

    47,518       732       6.18       41,869       473       4.53  

Other

    6,661       78       4.70       27,012       76       1.13  

Total interest-earning assets

    1,068,203       10,497       3.94       1,006,083       8,057       3.22  
                                                 

Interest-bearing liabilities:

                                               

Checking accounts

    169,870       253       0.60       155,832       38       0.10  

Savings accounts

    115,658       28       0.10       124,170       18       0.06  

Money market accounts

    267,075       1,049       1.58       267,024       158       0.24  

Retail certificate accounts

    89,436       474       2.13       77,655       71       0.37  

Wholesale certificate accounts

    62,978       745       4.74       1,301       2       0.59  

Customer escrows

    4,737       23       2.00       0       0       0.00  

Advances and other borrowings

    14,419       197       5.48       1,968       5       1.04  

Total interest-bearing liabilities

    724,173                       627,950                  

Non-interest checking

    252,008                       296,715                  

Other non-interest bearing liabilities

    3,043                       2,350                  

Total interest-bearing liabilities and non-interest bearing deposits

  $ 979,224       2,769       1.13     $ 927,015       292       0.13  

Net interest income

          $ 7,728                     $ 7,765          

Net interest rate spread

                    2.81

%

                    3.09

%

Net interest margin

                    2.90

%

                    3.10

%

   

 

 

   

For the six-month period ended

 
   

June 30, 2023

   

June 30, 2022

 

(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

  $ 263,909       1,595       1.22

%

  $ 297,264       1,604       1.09

%

Loans held for sale

    1,546       47       6.16       3,335       65       3.93  

Single family loans, net

    216,643       4,146       3.86       173,014       2,947       3.43  

Commercial loans, net

    525,425       13,036       5.00       454,371       9,959       4.42  

Consumer loans, net

    46,655       1,393       6.02       41,301       945       4.61  

Other

    8,726       193       4.46       35,256       102       0.58  

Total interest-earning assets

    1,062,904       20,410       3.87       1,004,541       15,622       3.14  
                                                 

Interest-bearing liabilities:

                                               

Checking accounts

    165,811       441       0.54       158,061       79       0.10  

Savings accounts

    118,185       54       0.09       122,610       36       0.06  

Money market accounts

    262,944       1,704       1.31       258,929       290       0.23  

Retail certificate accounts

    82,725       697       1.70       80,216       161       0.40  

Wholesale certificate accounts

    62,018       1,456       4.73       1,419       4       0.63  

Customer escrows

    5,560       55       2.00       0       0       0.00  

Advances and other borrowings

    7,856       212       5.44       990       5       1.04  

Total interest-bearing liabilities

    705,099                       622,225                  

Non-interest checking

    266,989                       300,187                  

Other non-interest bearing liabilities

    2,735                       2,492                  

Total interest-bearing liabilities and non-interest bearing deposits

  $ 974,823       4,619       0.96     $ 924,904       575       0.13  

Net interest income

          $ 15,791                     $ 15,047          

Net interest rate spread

                    2.91

%

                    3.01

%

Net interest margin

                    3.00

%

                    3.02

%

 

Provision for Credit Losses

The provision for credit losses was $0.3 million for the second quarter of 2023, an increase of $0.2 million compared to $0.1 million for the second quarter of 2022. The provision for credit losses increased primarily because of the additional loan growth that was experienced in the second quarter of 2023 when compared to the same period in 2022. The provision for credit losses was $0.2 million in the first six months of 2023, a decrease of $0.2 million compared to $0.4 million for the first six months of 2022. The provision for credit losses decreased between the periods primarily because the impact on the provision of the additional loan growth that was experienced in the first six months of 2023 was less than it was for the same period in 2022 under the prior accounting standard.

 

The allowance for credit losses is measured on a collective (pool) basis when similar risk characteristics exist. Loans that do not share risk characteristics are evaluated on an individual basis. Loans evaluated individually are not included in the collective evaluations. The collective reserve amount is assessed based on size and risk characteristics of the various portfolio segments, past loss history and other adjustments determined to have a potential impact on future credit losses. The collective reserve amount increased from March 31, 2023 primarily because of the loan growth that was experienced during the second quarter. The collective reserve amount increased from December 31, 2022 primarily because of the adoption of ASU 2016-13 on January 1, 2023 and also because of the loan growth that was experienced during the first six months of 2023. The Company’s qualitative reserve adjustments did not materially change during the second quarter or the first six months of 2023 due to management’s perception that economic conditions had not materially changed, including those related to the elevated inflation rate, and enacted and expected increases in the federal funds rate.

 

 

A reconciliation of the Company’s allowance for credit losses for the three- and six-month periods ended June 30, 2023 and 2022 is summarized as follows:

 

   

Three Months Ended June 30,

 

(Dollars in thousands)

 

2023

      2022(1)  

Balance at March 31,

  $ 11,342       9,584  

Provision

    200       66  

Charge offs:

               

Consumer

    (27 )     (15 )

Recoveries

    2       9  

Balance at June 30,

  $ 11,517       9,644  

Allocated to:

               

Collective allowance

  $ 11,345       9,240  

Individual allowance

    172       404  
    $ 11,517       9,644  
   

 

   

Six Months Ended June 30,

 

(Dollars in thousands)

 

2023

      2022(1)  

Balance at January 1,

  $ 10,277       9,279  

Adoption of ASU 2016-13

    1,070       0  

Provision

    168       362  

Charge offs:

               

Consumer

    (27 )     (16 )

Recoveries

    29       19  

Balance at June 30,

  $ 11,517       9,644  
   
 

(1)

The 2022 amounts presented are calculated under prior accounting standard.

 

On January 1, 2023, the Company adopted ASU 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The transition to this ASU resulted in a cumulative-effect adjustment to the allowance for credit losses of $1.1 million, an increase in deferred tax assets of $0.3 million, and a decrease to retained earnings of $0.8 million as of the adoption date. In addition, a liability of $0.1 million was established for projected future losses on unfunded commitments on outstanding lines of credit upon adoption. The projected liability for unfunded commitments increased $0.1 million during the first six months of 2023 and the provision for credit losses was increased to reflect the change.

 

Non-Interest Income

Non-interest income was $2.0 million for the second quarter of 2023, a decrease of $0.5 million, or 21.5%, from $2.5 million for the second quarter of 2022. Gain on sales of loans decreased $0.5 million between the periods because of a decrease in single family loan sales due primarily to an increase in the amount of originated mortgage loans that were placed into the loan portfolio. The increase in mortgage loans that were placed into the portfolio was the result of a targeted effort to originate loans to our executive banking clients. Other non-interest income decreased $0.1 million due primarily to a decrease in the gains realized on the sale of real estate owned between the periods. Fees and service charges increased slightly between the periods due primarily to an increase in the commitment fees earned on unused commercial lines of credit. Loan servicing fees decreased slightly between the periods due to a decrease in the aggregate balances of single family loans that were being serviced for others as more serviced loans were paid off than were added to the servicing portfolio during the period.          

 

Non-interest income was $3.9 million for the first six months of 2023, a decrease of $1.0 million, or 20.2%, from $4.9 million for the first six months of 2022. Gain on sales of loans decreased $1.1 million between the periods because of a decrease in single family loan sales due primarily to an increase in the amount of originated mortgage loans that were placed into the loan portfolio. The increase in mortgage loans that were placed into the portfolio was the result of a targeted effort to originate loans to our executive banking clients. Other non-interest income decreased slightly between the periods due primarily to a decrease in the gains realized on the sale of real estate owned. These decreases were partially offset by a $0.1 million increase in fees and service charges between the periods due primarily to an increase in the commitment fees earned on unused commercial lines of credit. Loan servicing fees increased slightly between the periods due to an increase in the aggregate balances of commercial loans that were being serviced for others.

 

 

Non-Interest Expense

Non-interest expense was $7.5 million for the second quarter of 2023, an increase of $0.5 million, or 6.8%, from $7.0 million for the second quarter of 2022. Compensation and benefits expense increased $0.3 million primarily because of annual salary increases and also because of a decrease in the direct loan origination compensation costs that were deferred as a result of the reduced commercial loan production between the periods. Other non-interest expense increased $0.2 million between the periods primarily because of an increase in FDIC insurance expense due to an increase in the assessment rates. Occupancy and equipment expense increased slightly due primarily to an increase in building expenses between the periods. Professional services increased slightly between the periods primarily because of an increase in legal expenses. These increases in non-interest expense were partially offset by a slight decrease in data processing expenses due to a decrease in system processing charges between the periods.

 

Non-interest expense was $15.2 million for the first six months of 2023, an increase of $1.0 million, or 6.4%, from $14.2 million for the first six months of 2022. Compensation and benefits expense increased $0.8 million primarily because of annual salary increases and also because of a decrease in the direct loan origination compensation costs that were deferred as a result of the reduced commercial loan production between the periods. Other non-interest expense increased $0.3 million primarily because of an increase in advertising costs and an increase in FDIC insurance expense due to an increase in assessment rates between the periods. Data processing expenses increased $0.1 million between the periods primarily because of the change to an outsourced data processing relationship at the end of the first quarter of 2022. These increases in non-interest expense were partially offset by a $0.3 million decrease in professional services expense between the periods primarily because of a decrease in legal expenses relating to a bankruptcy litigation claim that was settled in the first quarter of 2022. Occupancy and equipment expense decreased $0.1 million due primarily to a decrease in noncapitalized software costs between the periods.

 

Income Taxes

Income tax expense was $0.6 million for the second quarter of 2023, a decrease of $0.3 million from $0.9 million for the second quarter of 2022. Income tax expense was $1.2 million for the first six months of 2023, a decrease of $0.4 million from $1.6 million for the first six months of 2022. The decrease in income tax expense between the periods is primarily the result of a decrease in pre-tax income.

 

 

FINANCIAL CONDITION

 

Non-Performing Assets

The following table summarizes the amounts and categories of non-performing assets in the Bank’s portfolio and loan delinquency information as of the end of the two most recently completed quarters and December 31, 2022.

 

   

June 30,

   

March 31,

   

December 31,

 

(Dollars in thousands)

 

2023

   

2023

   

2022

 

Non‑performing loans:

                       

Single family

  $ 653     $ 890     $ 908  

Consumer

    407       494       441  

Commercial business

    471       474       529  

Foreclosed and repossessed assets:

                       

Single family

    220       0       0  

Total non‑performing assets

  $ 1,751     $ 1,858     $ 1,878  

Total as a percentage of total assets

    0.16

%

    0.17

%

    0.17

%

Total as a percentage of total loans receivable

    0.18

%

    0.23

%

    0.24

%

Allowance for credit losses to non-performing loans

    752.44

%

    610.45

%

    547.24

%

                         

Delinquency data:

                       

Delinquencies (1)

                       

30+ days

  $ 1,480     $ 271     $ 1,405  

90+ days

    0       0       0  

Delinquencies as a percentage of loan portfolio (1)

                       

30+ days

    0.18

%

    0.03

%

    0.18

%

90+ days

    0.00

%

    0.00

%

    0.00

%

(1) Excludes non-accrual loans.

 

 

Total non-performing assets were $1.8 million at June 30, 2023 compared to $1.9 million at both March 31, 2023 and December 31, 2022.

 

Dividends

The Company declared a quarterly dividend of 8 cents per share of common stock outstanding that was paid on June 7, 2023. The declaration and amount of any future cash dividends remains subject to the sole discretion of the Board of Directors and will depend upon many factors, including the Company’s results of operations, financial condition, capital requirements, regulatory and contractual restrictions, business strategy and other factors deemed relevant by the Board of Directors.

 

LIQUIDITY AND CAPITAL RESOURCES

For the six months ended June 30, 2023, the net cash provided by operating activities was $4.8 million. The Company collected $18.6 million in principal repayments on securities, collected $5.0 million on securities that matured, purchased FHLB stock for $5.3 million, purchased securities available for sale of $5.0 million, and received redemptions on FHLB stock of $4.3 million. The Company had a net decrease in deposit balances of $11.2 million and a decrease of customer escrows of $4.3 million during the first six months of 2023. It also obtained $0.1 million in treasury stock for the taxes payable on stock awards, paid dividends to stockholders of $0.6 million, purchased $0.4 million of premises and equipment, received proceeds from borrowings of $128.1 million and repaid borrowings of $103.4 million. Loans receivable also increased $53.5 million during the first six months of 2023.

 

The Company has certificates of deposit with outstanding balances of $116.7 million that come due over the next twelve months. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that cash outflows from deposits that do not renew will be replaced with a combination of deposits from other customers, brokered deposits, or with FHLB advances. FRB borrowings could also be used to fund unanticipated outflows of certificates of deposit.

 

The Company had seven deposit customers each with aggregate deposits greater than $5.0 million as of June 30, 2023. The $106.5 million in funds held by these customers may be withdrawn at any time, but management anticipates that the majority of these deposits will not be withdrawn from the Bank over the next twelve months. If these deposits were withdrawn, it is anticipated that they would be replaced with deposits from other customers, brokered deposits, or with FHLB advances. FRB borrowings could also be used to replace unanticipated outflows of large checking and money market deposits.

 

The Company estimates that approximately 23% of total deposits exceeded the Federal Deposit Insurance limit of $250,000 at June 30, 2023. While these funds may be withdrawn at any time, management anticipates that the majority of these deposits will not be withdrawn from the Bank over the next twelve months. If these deposits were withdrawn, it is anticipated that they would be replaced with deposits from other customers, brokered deposits, or with FHLB advances. FRB borrowings could also be used to replace unanticipated outflows of large checking and money market deposits.

 

The Company had the ability to borrow $216.3 million from the FHLB at June 30, 2023 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 $79.1 million from the FRB at June 30, 2023 based on the collateral value of the loans pledged. The Company also has the ability to pledge securities as collateral to increase the borrowing capacity of the Company by $128.7 million.

 

The Company’s primary source of cash is dividends from the Bank. At June 30, 2023, the Company had $15.4 million in cash. The primary use of cash by the Company is the payment of operating expenses, the repurchase of Company stock, and the payment of dividends to stockholders.

 

 

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 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. Accordingly, the Company may not be able to raise additional capital, if deemed prudent, on favorable economic terms or other terms acceptable to it.

 

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 Management’s Discussion and Analysis discloses the Company's projected changes in net interest income based upon immediate interest rate changes called rate shocks. The Company utilizes a model that uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities under different interest rate changes.

 

The following table discloses the projected changes in the market value of the Company’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis-point changes in interest rates from interest rates in effect on June 30, 2023.

 

(Dollars in thousands)

 

Market Value

 

Basis point change in interest rates

   

 

-200

      -100       0    

+100

   

+200

 

Total market-risk sensitive assets

  $ 1,070,279       1,044,092       1,018,476       994,023       969,892  

Total market-risk sensitive liabilities

    930,299       879,004       838,428       805,725       778,152  

Off-balance sheet financial instruments

    72       42       0       150       286  

Net market risk

  $ 139,908       165,046       180,048       188,148       191,454  

Percentage change from current market value

    (22.29

)%

    (8.33

)%

    0.00

%

    4.50

%

    6.33

%

   

 

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 2% to 44%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 7% and 44%, depending on the note rate and the period to maturity. Mortgage-backed securities were projected to have prepayments based upon the underlying collateral securing the instrument. Certificate accounts were assumed not to be withdrawn until maturity. Passbook accounts and money market accounts were assumed to decay at an annual rate of 1% and 46%, respectively. Retail checking accounts, commercial checking accounts and commercial money market accounts were assumed to decay at annual rates of 9%, 39% 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 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 June 30, 2024 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

    $ 400       1.18%  

+100

      216       0.64  
0       0       0.00  
-100       (317 )     (0.94)  
-200       (972 )     (2.87)  

 

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

 

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

 

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

 

To the extent consistent with its interest rate spread objectives, the Bank attempts to manage its interest rate risk and has taken a number of steps to structure its balance sheet to better match the maturities of its assets and liabilities. The Bank sells almost all of its originated 30-year fixed rate single family residential 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. In addition, a significant portion of the Bank’s commercial loans that are placed into the portfolio are adjustable rate loans or fixed rate loans that reprice in five years or less.

 

 

Off-Balance Sheet Arrangements

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

 

Item 3: Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

 

Item 4: Controls and Procedures

Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, the Company conducted an evaluation, under the supervision and with the participation of the Company’s management, including the principal executive officer and principal financial officer, of the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the Exchange Act)). Based on this evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures 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.

 

 

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. The Company is, and expects to become, engaged in a number of foreclosure proceedings and other collection actions as part of its normal operations. Based on our current understanding of these pending legal proceedings, management does not believe that judgments or settlements arising from any pending or threatened litigation matters, individually or in the aggregate, would have a material adverse effect on the Company’s consolidated financial statements.

 

ITEM 1A.

Risk Factors.

The risks described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022, 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 Company did not purchase any of its own stock during the second quarter of 2023. On March 1, 2023, the Company announced that the Board of Directors increased the amount of shares authorized to be repurchased to $6.0 million. Share repurchases may be executed through various means, including through open market transactions, privately negotiated transactions or otherwise. The repurchase program 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.

 

 

ITEM 6.

Exhibits.

 

 

INDEX TO EXHIBITS

Exhibit

   

Filing Status

Number

Exhibit

   
       

10.1

Form of Executive Severance Agreement

 

Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed June 9, 2023

       

31.1

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

 

Filed Electronically

       

31.2

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

 

Filed Electronically

       

32

Section 1350 Certifications of CEO and CFO

 

Filed Electronically

       

101

Financial statements from the Quarterly Report on Form 10-Q of the Company for the period ended June 30, 2023, filed with the Securities and Exchange Commission on August 3, 2023 formatted in Inline Extensible Business Reporting Language (iXBRL); (i) the Consolidated Balance Sheets at June 30, 2023 and December 31, 2022, (ii) the Consolidated Statements of Comprehensive Income for the Three and Six Months Ended June 30, 2023 and 2022, (iii) the Consolidated Statements of Stockholders’ Equity for the Three and Six Months Ended June 30, 2023 and 2022, (iv) the Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2023 and 2022, 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 June 30, 2023 (formatted as Inline XBRL and contained in Exhibit 101).

 

Filed Electronically

 

 

SIGNATURES

 

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

 

      HMN FINANCIAL, INC.
       
      Registrant
       
       
Date: August 3, 2023   /s/ Bradley Krehbiel
      Bradley Krehbiel, President and Chief Executive Officer
      (Duly Authorized Officer)
       
       
       
Date: August 3, 2023   /s/ Jon Eberle
      Jon Eberle, Senior Vice President and
      Chief Financial Officer
      (Principal Financial and Accounting Officer)

 

40