TEB Bancorp, Inc. - Annual Report: 2021 (Form 10-K)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

For the Fiscal Year Ended June 30, 2021

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: 000-56049

TEB Bancorp, Inc.

(Exact Name of Registrant as Specified in its Charter)

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(414) 476-6434

(Registrant’s telephone number including area code)

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

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Securities registered pursuant to Section 12(g) of the Act: Common stock, par value $0.01 per share

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

Yes ☐   No ☒

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.

Yes ☐   No ☒

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 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 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.

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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 has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.  ☐

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

The aggregate value of the voting and non-voting common stock held by non-affiliates of the registrant, computed by reference to the closing price of the common stock of $7.50 as of December 31, 2020 (the last business day of the Registrant’s most recently completed second fiscal quarter) was $19.2 million.

As of September 23, 2021 there were 2,624,343 shares outstanding of the registrant’s common stock.

DOCUMENTS INCORPORATED BY REFERENCE

1.  Portions of the Proxy Statement for the 2021 Annual Meeting of Stockholders. (Part III)

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PART I

Forward Looking Statements

This annual report contains forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “assume,” “plan,” “seek,” “expect,” “will,” “may,” “should,” “indicate,” “would,” “contemplate,” “continue,” “potential,” “target” and words of similar meaning. These forward-looking statements include, but are not limited to:

These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change. Accordingly, you should not place undue reliance on such statements. We are under no duty to and do not take any obligation to update any forward-looking statements after the date of this annual report.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements:

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The COVID-19 pandemic has caused significant economic dislocation in the United States. Given its ongoing and dynamic nature, it is difficult to predict the full impact of the COVID-19 outbreak on our business. The extent of such impact will depend on future developments, which are highly uncertain, including when the coronavirus can be controlled and abated and how the economy continues to open. As a result of the COVID-19 pandemic and the related adverse local and national economic consequences, we could be subject to any of the following risks, any of which could have a material, adverse effect on our business, financial condition, liquidity, and results of operations:

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Because of these and other uncertainties, our future results may be materially different from the results indicated by these forward-looking statements.

TEB Bancorp, Inc.

TEB Bancorp, Inc., a Maryland corporation that was organized in 2018, is a bank holding company headquartered in Wauwatosa, Wisconsin. TEB Bancorp, Inc.’s common stock is traded on the OTC Pink Marketplace under the symbol “TBBA.” TEB Bancorp, Inc. conducts its operations primarily through its wholly owned subsidiary, The Equitable Bank, S.S.B., a Wisconsin-chartered savings bank (“The Equitable Bank”). TEB Bancorp, Inc. manages its operations as one unit, and thus does not have separate operating segments. At June 30, 2021, TEB Bancorp, Inc. had total assets of $315.7 million, net loans of $215.4 million, deposits of $269.9 million, and stockholders’ equity of $33.1 million.

TEB Bancorp, Inc. was formed as part of the mutual holding company reorganization of The Equitable Bank, S.S.B., which was completed in April 2019. In connection with the reorganization, TEB Bancorp, Inc. sold 1,309,547 shares of common stock to the public at $10.00 per share, representing 49.9% of its outstanding shares of common stock. TEB MHC has been organized as a mutual holding company under the laws of the State of Wisconsin and owns the remaining 50.1% of the outstanding common stock of TEB Bancorp, Inc.

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The executive offices of TEB Bancorp, Inc. are located at 2290 North Mayfair Road, Wauwatosa, Wisconsin 53226, and its telephone number is (414) 476-6434. Our website address is www.tebbancorp.com. Information on our website is not and should not be considered a part of this annual report.

TEB Bancorp, Inc. is subject to comprehensive regulation and examination by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”).

TEB MHC

TEB MHC was formed as a Wisconsin mutual holding company and will, for as long as it is in existence, own a majority of the outstanding shares of TEB Bancorp, Inc.’s common stock.

TEB MHC’s principal assets are the common stock of TEB Bancorp, Inc. it received in the reorganization and offering and $100,000 cash in initial capitalization, which was contributed from the net proceeds of the stock offering. Presently, the only business activity of TEB MHC is owning a majority of TEB Bancorp, Inc.’s common stock. TEB MHC is authorized, however, to engage in any other business activities that are permissible for mutual holding companies under state and federal law, including investing in loans and securities.

The Equitable Bank, S.S.B.

The Equitable Bank is a Wisconsin-chartered savings bank headquartered in Wauwatosa, Wisconsin. The Equitable Bank was originally chartered in 1927 as a Wisconsin-chartered mutual building and loan association under the name The Equitable Savings Building and Loan Association. In 1990, we changed our name to “The Equitable Bank, S.S.B.” and in 1993 we converted to a Wisconsin-chartered mutual savings bank.

We conduct our business from our main office and five branch offices, which are located in Milwaukee, Racine and Waukesha Counties, Wisconsin, and a loan production office, which is located in Ozaukee County, Wisconsin. Our primary market area is broadly defined as the Milwaukee, Wisconsin metropolitan area, which is geographically located in the southeast corner of the state. Our primary market area for deposits includes the communities in which we maintain our banking office locations, while our primary lending market area is broader, and also includes Ozaukee County, where we maintain our loan production office, Washington County, Wisconsin, which borders both Ozaukee County and Waukesha County, as well as Kenosha and Walworth County, Wisconsin, which border Racine County.

Our business consists primarily of taking deposits from the general public and investing those deposits, together with funds generated from operations, in one- to four-family residential real estate loans (both owner occupied and non-owner occupied), multifamily residential real estate loans and commercial real estate loans, and, to a lesser extent, consumer loans (primarily home equity lines of credit), construction, land and development loans, and commercial and industrial loans. Subject to market conditions, we expect to increase our focus on originating multifamily residential real estate, owner-occupied commercial real estate and non-owner occupied one- to four-family residential real estate loans in an effort to further diversify our overall loan portfolio, increase the overall yield earned on our loans and assist in managing interest rate risk. We also invest in securities, which have historically consisted primarily of obligations of states and political subdivisions. We offer a variety of deposit accounts, including checking accounts, savings accounts and certificate of deposit accounts. We borrow funds, primarily from the Federal Home Loan Bank of Chicago, to fund our operations as necessary.

The Equitable Bank is subject to comprehensive regulation and examination by the Wisconsin Department of Financial Institutions (the “WDFI”) and the Federal Deposit Insurance Corporation.

Our executive office is located at 2290 North Mayfair Road, Wauwatosa, Wisconsin 53226, and our telephone number at this address is (414) 476-6434.

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Mutual Holding Company Ownership Structure

Public stockholders own a minority of the outstanding shares of TEB Bancorp, Inc.’s common stock. As a result, stockholders other than TEB MHC are not able to exercise voting control over most matters put to a vote of stockholders. TEB MHC owns a majority of TEB Bancorp, Inc.’s common stock and, through its board of directors, is able to exercise voting control over most matters put to a vote of stockholders. The same directors and officers who manage The Equitable Bank also manage TEB Bancorp, Inc. and TEB MHC. The board of directors of TEB MHC must ensure that the interests of depositors of The Equitable Bank (as members of TEB MHC) are represented and considered in matters put to a vote of stockholders of TEB Bancorp, Inc. Therefore, TEB MHC may take action that the public stockholders believe to be contrary to their interests. For example, TEB MHC may exercise its voting control to defeat a stockholder nominee for election to the board of directors of TEB Bancorp, Inc.

In addition, stockholders are not able to force a merger or second-step conversion transaction without the consent of TEB MHC since such transactions also require the approval of a majority of all of the outstanding voting stock of TEB Bancorp, Inc., which can only be achieved if TEB MHC voted to approve such transactions. Some stockholders may desire a sale or merger transaction, since stockholders typically receive a premium for their shares, or a second-step conversion transaction, since, on a fully converted basis, most full stock institutions tend to trade at higher multiples than mutual holding companies. Stockholders could, however, prevent a second-step conversion or the implementation of equity incentive plans as under current regulations and policies, such matters also require the separate approval of the stockholders other than TEB MHC.

Market Area

We conduct our business from our main office and five branch offices, which are located in Milwaukee, Racine and Waukesha Counties, Wisconsin, and a loan production office, which is located in Ozaukee County, Wisconsin. Our primary market area is broadly defined as the Milwaukee, Wisconsin metropolitan area, which is geographically located in the southeast corner of the state. Our primary market area for deposits includes the communities in which we maintain our banking office locations, while our primary lending market area is broader, and also includes Ozaukee County, where we maintain our loan production office, as well as Washington County, Wisconsin, which borders both Ozaukee County and Waukesha County. The following discusses the demographics of the counties where our offices are located.

According to information from S&P Global Market Intelligence as of August 2021, from 2016 to 2021, the population decreased in Milwaukee County by 1.6%, and experienced increases in Racine, Waukesha and Ozaukee Counties of 0.6%, 2.4% and 2.0%, respectively, compared to 1.0% for Wisconsin and 2.6% for the United States as a whole. Projections indicate that through 2026, the population will remain fairly stable in Milwaukee County (-0.1%), with modest increases (less than 1.8%) for Racine, Waukesha and Ozaukee Counties, as well as for Wisconsin, compared to projected United States population growth of 2.9%. Trends in numbers of households in our market area, Wisconsin and the United States as a whole were consistent with trends in population, and projections for the numbers of households are also consistent with the projections for population changes.

The median household income for 2021 was $54,231, $64,161, $93,695 and $88,966 for Milwaukee, Racine, Waukesha and Ozaukee Counties, respectively, compared to $66,361 in Wisconsin and $67,761 for the United States as a whole. By 2026, the projected annual growth rates in median household income are expected to be 2.0%, 1.1%, 1.9% and 1.6% in Milwaukee, Racine, Waukesha and Ozaukee Counties, respectively, compared to 1.8% for Wisconsin and 1.7% for the United States as a whole.

Unemployment rates as of June 2021 and 2020 are set forth in the following table.

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While our primary market area has a diversified local economy, for 2021, in each of Milwaukee, Racine, Waukesha and Ozaukee Counties, as well as the State of Wisconsin, the three largest employment sectors consisted of education/healthcare/social services, the service sector and manufacturing, with manufacturing being the largest employment sector in Racine County.

We believe that we have developed products and services that will meet the financial needs of our current and future customer base; however, we plan, and believe it is necessary, to expand the range of products and services that we offer to be more competitive in our market area. Our marketing strategies focus on the strength of our knowledge of local consumer and small business markets, as well as expanding relationships with current customers and reaching out to develop new, profitable business relationships.

Competition

We face competition within our market area both in making loans and attracting deposits. Our market area has a concentration of financial institutions that include large money center and regional banks, community banks and credit unions. We also face competition from savings institutions, mortgage banking firms, consumer finance companies and, with respect to deposits, from money market funds, brokerage firms, mutual funds and insurance companies. As of June 30, 2021 (the most recent date for which data is available), our market share of deposits represented 0.40% of Federal Deposit Insurance Corporation-insured deposits in Milwaukee County, ranking us 17th in market share of deposits out of 27 institutions operating in the county. In addition, as of that date, our market share of deposits represented 0.53% of Federal Deposit Insurance Corporation-insured deposits in Racine County, ranking us 14th in market share of deposits out of 14 institutions operating in the county, and our market share of deposits represented 0.14% of Federal Deposit Insurance Corporation-insured deposits in Waukesha County, ranking us 32nd in market share of deposits out of 34 institutions operating in the county.

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Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio by type of loan at the dates indicated. Included with the loans described in the table below, at June 30, 2021, we had $6.9 million of loans held for sale, $5.6 million of loans in process and $99,000 of deferred loan fees.

Contractual Maturities. The following tables set forth the contractual maturities of our total loan portfolio at June 30, 2021. Demand loans, loans having no stated repayment schedule or maturity, and overdraft loans are reported as being due in one year or less. The tables present contractual maturities and do not reflect repricing or the effect of prepayments. Actual maturities may differ.

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The following table sets forth our fixed and adjustable-rate loans at June 30, 2021 that are contractually due after June 30, 2021. Our balloon loans are included as fixed-rate loans for purposes of this table.

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The following describes our most significant categories of loan types at June 30, 2021.

One- to Four-Family Real Estate Loans – Owner Occupied. At June 30, 2021, $72.0 million, or 33.2% of our total loan portfolio, consisted of owner-occupied one- to four-family residential real estate loans. We offer adjustable-rate owner-occupied residential real estate loans with maturities up to 30 years that include an initial introductory rate period of up to 10 years. Our adjustable-rate owner-occupied residential real estate loans have a competitive initial rate. After the initial fixed period (ranging between one to ten years) the rate adjusted to a predetermined margin plus the current index based on the 1 Year LIBOR. The rate adjustments are limited to 2.0% for the first change with subsequent adjustments every six months limited to 1.0%. The lifetime cap is limited to 6.0% over the initial rate.

On February 1, 2021, the bank discontinued offering the 1 Year LIBOR as an index, replacing it with the 30 day average Secured Overnight Financing Rate (SOFR). Any loans originated and locked after this date will adjust to predetermined margin plus the current index based on 30 day SOFR as published by the Federal Reserve Bank of New York. The rate adjustments are limited to 2.0% for the first change with subsequent adjustments every six months limited to 1.0%. The life time cap is limited to 6% over the initial rate.

Consistent with our strategy to increase our noninterest income while managing interest rate risk, we have historically sold substantially all of our fixed-rate owner-occupied, “conforming” (as described below) one- to four-family real estate loans, with the majority made up of 30-year fixed-rate loans. The loans are closed in our name, and are then sold to our investors who provide Fannie Mae and Freddie Mac conventional products as well as FHA and VA government loans. The loans are typically purchased and funded by the investors within 30 days of the originations. We earn interest income on the loans until they are purchased.

One- to four-family, owner-occupied residential real estate loans are generally underwritten according to Fannie Mae or Freddie Mac guidelines, and we refer to loans that conform to such guidelines as “conforming loans.” We generally originate one- to four-family owner-occupied real estate loans in amounts up to the maximum conforming loan limits as established by Fannie Mae, which is generally $548,250 for single-family homes in our market area. However, loans in excess of $548,250 (which are referred to as “jumbo loans”) may be originated and sold on a servicing released basis as well. We retain the majority of “jumbo loans” in our loan portfolio. We generally underwrite jumbo loans in accordance to our portfolio underwriting guidelines. At June 30, 2021, the average size of our one- to four-family, owner-occupied residential real estate loans originated for our portfolio was $157,000.

Generally, we originate loans with loan-to-value ratios of up to 80% but we also originate loans with loan-to-value ratios of up to 97%. Any loans we originate with loan-to-value ratios in excess of 80% require private mortgage insurance.

We do not offer “interest only” mortgage loans on permanent one- to four-family residential properties (where the borrower pays interest for an initial period, after which the loan converts to a fully amortizing loan). We do not offer loans that provide for negative amortization of principal, such as “Option ARM” loans, where the borrower can pay less than the interest owed on the loan, resulting in an increased principal balance during the life of the loan. We do not offer

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“subprime loans” (loans that generally target borrowers with weakened credit histories typically characterized by payment delinquencies, previous charge-offs, judgments, bankruptcies, or borrowers with questionable repayment capacity as evidenced by low credit scores or high debt-burden ratios) or Alt-A loans (traditionally defined as loans having less than full documentation).

One- to Four-Family Real Estate Loans – Non-Owner Occupied. At June 30, 2021, $22.4 million, or 10.3% of our total loan portfolio, consisted of one- to four-family non-owner occupied real estate loans. Our real estate underwriting policies provide that such loans may be made in amounts of up to 80% of the appraised value of the property. Our one- to four-family non-owner occupied real estate loans generally have adjustable rates with 30-year terms and a fixed initial rate ranging between three to seven years. Our adjustable-rate mortgages one- to four-family non-owner occupied real estate loans have a competitive initial rate that typically resets to an applicable margin with an adjustment every six months, up to 2% over the 1 Year LIBOR Rate after the initial three-, five- or seven-year fixed period with a lifetime rate cap of 14.50%.

On February 1, 2021, the bank discontinued offering the 1 year LIBOR as an index, placing it with the 30 day average Secured Overnight Financing Rate (SOFR).Any loans orignated and locked after February 1, 2021 adjusted to a predetermined margin plus the current index based on the 30 day SOFR as published by the Federal Reserve Bank of New York. After the initial fixed rate period they reset to an appliable margin every six months up to 2% over the 30 day SOFR and have a lifetime cap of 14.50%.

We generally target one- to four-family non-owner occupied loans with balances up to $250,000. At June 30, 2021, our average one- to four-family non-owner occupied real estate loan was $127,000. Virtually all of our one- to four-family non-owner occupied real estate loans are secured by properties located in our primary lending area.

When originating one- to four-family non-owner occupied real estate loans, we consider the net operating income of the property, the borrower’s expertise and credit history, the global cash flow of the borrowers and the value of the underlying property. We generally require that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before debt service to debt service) of at least 1.00x, using 75% of estimated or actual rents against principal, interest, taxes and insurance (PITI) for one and two unit properties, and at least 1.00x using 70% of estimated or actual rents against PITI for three or four unit properties.

Generally, one- to four-family real estate loans made to business entities require the principals to execute the loan agreements in their individual capacity through personal guarantees, as well as signing on behalf of such business entity.

Once a borrower exceeds $1.0 million in loans, we require one- to four-family non-owner occupied loan borrowers to provide annually updated financial statements and federal tax returns. Additionally, these borrowers with larger exposure are subject to underwriting standards similar to multifamily loans, which include a global debt service requirement of 1.20x.

Multifamily Real Estate Loans. At June 30, 2021 multifamily real estate loans were $91.9 million, or 42.4%, of our total loan portfolio. We originate individual multifamily real estate loans to experienced, growing small- and mid-size owners and investors in our market areas. Our multifamily real estate loans are generally secured by properties consisting of five to 40 rental units within our market. However, due to the highly competitive nature and the limited inventory in our market, we have expanded beyond our market, but within the State of Wisconsin, for multifamily opportunities without compromising credit quality.

We originate balloon loans with a variety of fixed-rate periods, typically up to seven years, with amortization terms up 25 years, although we will provide amortization terms up to 30 years on an exception basis. Interest rates and payments on our balloon loans are typically determined based on our internal pricing requirements and the current competitive market. Multifamily real estate loan amounts generally do not exceed 75% of the property’s appraised value at the time the loan is originated. We require each property to meet a minimum debt service ratio of 1.20x (calculated as net operating income divided by debt service). In addition, each borrowing entity must meet a global debt service ratio of 1.20x. We require multifamily real estate borrowers with loans in excess of $500,000 to submit annual financial statements including federal tax returns (both business and personal), personal financial statement for each

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borrower/guarantor and an updated rent roll for each property. Properties with a loan in excess of $300,000 are subject to bi-annual inspections to verify appropriate maintenance is being performed.

Commercial Real Estate Loans. In recent years, we have sought to increase our originations of owner-occupied commercial real estate loans, and we have limited our originations of non-owner occupied commercial real estate loans. At June 30, 2021, we had $18.1 million in commercial real estate loans, representing 8.3% of our total loan portfolio, and $2.5 million in commercial and industrial loans, representing 1.2% of our total loan portfolio. Most of our commercial real estate loans are balloon loans with a three-, five- or seven-year initial term and a 25-year amortization period. The maximum loan-to-value ratio of our commercial real estate loans is generally 75%. These loans are secured by traditional commercial property types including industrial, office, retail and warehouse/storage facilities.

We consider a number of factors in originating commercial real estate loans. We evaluate the qualifications and financial condition of the borrower, including credit history, profitability and expertise, as well as the value and condition of the property securing the loan. We require each property to meet a minimum debt service ratio of 1.20x (calculated as net operating income divided by debt service). In addition, each borrowing entity must meet a global debt service ratio of 1.20x. When evaluating the qualifications of the borrower, we consider the financial resources of the borrower, the borrower’s experience in owning or managing similar property and the borrower’s payment history with us and other financial institutions. In evaluating the property securing the loan, the factors we consider include the strength and stability of the net operating income of the mortgaged property and the ratio of the loan amount to the appraised value of the mortgaged property, along with our assessing any environmental concerns associated with the property. The significant majority of our commercial real estate loans are appraised by outside independent appraisers approved by the board of directors. Under applicable regulations, we are only required to obtain independent appraisals on commercial real estate loans in amounts greater than $500,000 for non-owner-occupied properties and $1.0 million for owner-occupied properties, and any decision not to obtain an outside, independent appraisal is made in accordance with these regulations. Personal guarantees are generally obtained from any principals of the underlying borrowing entity having a 25% or greater ownership/membership interest. We require all commercial real estate borrowers having an overall loan exposure of $500,000 or greater to provide annually updated financial statements and federal tax returns, which are used to conduct an annual review of the relationship.

Home Equity Loans and Lines of Credit. At June 30, 2021, home equity loans and lines of credit (which we categorize as consumer loans) totaled $16.6 million, with $7.4 million in outstanding balances. This total consisted of $787,000 of home equity loans and $6.6 million of home equity lines of credit. The underwriting standards utilized for home equity lines of credit include a determination of the applicant’s credit history, an assessment of the applicant’s ability to meet existing obligations and payments on the proposed loan and the value of the collateral securing the loan. Home equity lines of credit are offered with a loan-to-value ratio up to 80%. However, we offer special programs to borrowers who satisfy certain underwriting criteria (such as having an additional banking relationship) with loan-to-value ratios of up to 85%. Our home equity loans and lines of credit are generally 10-year balloon loans. Our home equity lines of credit have adjustable rates of interest which are indexed to the prime rate, as reported in The Wall Street Journal.

Loan Underwriting Risks

Commercial Real Estate and Multifamily Real Estate Loans. Loans secured by commercial and multifamily real estate generally have larger balances and involve a greater degree of risk than one- to four-family residential real estate loans. The primary concerns in commercial and multifamily real estate lending are the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Payments on loans secured by income properties often depend on successful operation and management of the properties. As a result, repayment of such loans may be subject, to a greater extent than residential real estate loans, to adverse conditions in the real estate market or the economy. To monitor cash flows on income properties, we require borrowers and loan guarantors to provide annual financial statements on commercial real estate loans. In reaching a decision on whether to make a commercial or multifamily real estate loan, we consider and review a global cash flow analysis of the borrower and consider the net operating income of the property, the borrower’s expertise, credit history and profitability and the value of the underlying property. A Phase I environmental site assessment is obtained when the possibility exists that hazardous materials may have existed on the site, or the site may have been impacted by adjoining properties that handled hazardous materials.

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If we foreclose on a commercial or multifamily real estate loan, the marketing and liquidation period to convert the real estate asset to cash can be lengthy with substantial holding costs. In addition, vacancies, deferred maintenance, repairs and market stigma can result in prospective buyers expecting sale price concessions to offset their real or perceived economic losses for the time it takes them to return the property to profitability. Depending on the individual circumstances, initial charge-offs and subsequent losses on commercial and multifamily real estate loans can be unpredictable and substantial.

One- to Four-Family Non-Owner Occupied Residential Real Estate Loans. One- to four-family non-owner occupied residential real estate loans are subject to some of the same risks as our commercial real estate and multifamily real estate loans, in that they depend on the borrower’s creditworthiness and the feasibility and cash flow potential of the project. Such loans are also subject to similar risks with respect to foreclosures and subsequent operations of the property and resale.

Construction, Land and Development Loans. Our construction loans are based upon estimates of costs and values associated with the completed project. Underwriting is focused on the borrowers’ financial strength, credit history and demonstrated ability to produce a quality product and effectively market and manage their operations.

Construction lending involves additional risks when compared with permanent lending because funds are advanced upon the security of the project, which is of uncertain value prior to its completion. Because of the uncertainties inherent in estimating construction costs, as well as the market value of the completed project and the effects of governmental regulation of real property, it is relatively difficult to evaluate accurately the total funds required to complete a project and the related loan-to-value ratio. In addition, generally during the term of a construction loan, interest may be funded by the borrower or disbursed from an interest reserve set aside from the construction loan budget. These loans often involve the disbursement of substantial funds with repayment primarily dependent on the success of the ultimate project and the ability of the borrower to sell or lease the property or obtain permanent take-out financing, rather than the ability of the borrower or guarantor to repay principal and interest. If the appraised value of a completed project proves to be overstated, we may have inadequate security for the repayment of the loan upon completion of construction of the project and may incur a loss.

Balloon Loans. Although balloon mortgage loans may reduce to an extent our vulnerability to changes in market interest rates because they may reprice at the end of the term, subject to renegotiation of rate and terms at maturity, the ability of the borrower to renew or repay the loan and the marketability of the underlying collateral may be adversely affected if real estate values decline prior to the expiration of the term of the loan or in a rising interest rate environment.

Adjustable-Rate Loans. While we anticipate that adjustable-rate loans will better offset the adverse effects of an increase in interest rates as compared to fixed-rate loans, an increased monthly payment required of adjustable-rate loan borrowers in a rising interest rate environment could cause an increase in delinquencies and defaults. The marketability of the underlying collateral also may be adversely affected in a high interest rate environment.

Originations, Purchases and Sales of Loans

Residential lending activities are conducted by salaried and commissioned loan personnel operating at our main and branch office locations and our loan production office. Loans we originate are underwritten pursuant to our policies and procedures. Loans originated with the intent for sale are also underwritten pursuant to secondary market guidelines. Our ability to originate fixed-rate loans, adjustable-rate loans or balloon loans depends on relative customer demand for such loans, which can be affected by current and expected future levels of market interest rates. We originate residential real estate loans through our loan originators, marketing efforts, our customer base, walk-in customers and referrals from real estate brokers, builders, accountants and financial advisors.

Commercial lending activities are conducted by salaried commercial lenders operating primarily out of our main location. All loans originated by us are underwritten pursuant to our policies and procedures. Our commercial loans are typically fixed-rate balloon loans with terms between three and seven years, with loan rates dependent on current and expected future levels of market interest rates. Commercial and multifamily lending are sourced primarily through loan

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originator contacts, networking and marketing efforts, our customer base and referrals from real estate brokers, accountants and financial advisors.

We currently sell a significant majority of the fixed-rate one- to four-family residential real estate loans we originate on the secondary market. The loans are closed in our name, and are then sold to our investors who provide Fannie Mae and Freddie Mac conventional products as well as FHA and VA government loans. During the year ended June 30, 2021, we originated $520.3 million of one- to four-family residential real estate loans and sold $496.5 million, and during the year ended June 30, 2020, we originated $355.3 million of one- to four-family residential real estate loans and sold $334.9 million.

Loan Approval Procedures and Authority

Pursuant to applicable law, the aggregate amount of loans that we are permitted to make to any one borrower or a group of related borrowers is generally limited to 20% of our capital. This limit may be increased to 50% of capital for loans secured by certain assets. At June 30, 2021, based on the 20% limitation, our loans-to-one-borrower limit was approximately $7.1 million. On the same date, we had no borrowers with outstanding balances in excess of this amount. At June 30, 2021, our largest loan relationship with one borrower was for $5.5 million, which was secured by a mix of multifamily buildings, with the underlying loans performing in accordance with their original terms on that date.

Our lending is subject to written underwriting standards and origination procedures. Decisions on loan applications are made on the basis of detailed applications submitted by the prospective borrower, credit histories that we obtain, and property valuations (consistent with our appraisal policy) prepared by outside independent licensed appraisers approved by our board of directors as well as internal evaluations, where permitted by regulations. The loan applications are designed primarily to determine the borrower’s ability to repay the requested loan, and the more significant items on the application are verified through use of credit reports, bank statements and tax returns.

All loan approval amounts are based on the aggregate loans, including total balances of outstanding loans and the proposed loan to the individual borrower and any related entity. Subject to our underwriting procedures, each of our Chairman of the Board, our President and Chief Executive Officer, Executive Vice President, and Vice President of Mortgage Lending has individual authorization to approve certain residential loans up to $1.0 million, or aggregate exposure up to $2.0 million. Any residential loan above $1.0 million, and any commercial loan above $500,000, requires Loan Committee approval. Our Loan Committee consists of our Chairman of the Board, our President and Chief Executive Officer, our Executive Vice President, our Chief Credit Officer and our Vice President of Mortgage Lending. Commercial loans above $2.0 million require board approval and any commercial borrowing relationship exceeding $3.0 million requires board approval for all subsequent loans.

Delinquencies and Asset Quality

Delinquency Procedures. Our loss recovery process for delinquent loans does not provide a set formula for all borrowers; rather, we tailor our recovery efforts based on the borrower’s credit history with The Equitable Bank, their other account relationships with The Equitable Bank, their current employment situation and other individual circumstances. Our loan recovery specialists contact delinquent borrowers through telephone calls and/or mailing notices, typically beginning when a loan payment becomes 17 days past due. We may request receivership for delinquent loans that are 120 or more days past due, or we can initiate foreclosure procedures at that time if approved by our Chairman of the Board or President and Chief Executive Officer. Alternatively, we may determine that it is in the best interests of The Equitable Bank to work further with the borrower to arrange a workout plan.

Loans Past Due and Non-Performing Assets. Loans are reviewed on a regular basis. Management determines that a loan is impaired or non-performing when it is probable at least a portion of the loan will not be collected in accordance with the original terms due to a deterioration in the financial condition of the borrower or the value of the underlying collateral if the loan is collateral dependent. When a loan is determined to be impaired, the measurement of the loan in the allowance for loan losses is based on present value of expected future cash flows, except that all collateral-dependent loans are measured for impairment based on the fair value of the collateral. Non-accrual loans are loans for which collectability is questionable and, therefore, interest on such loans will no longer be recognized on an accrual basis. All

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loans that become 90 days or more delinquent are placed on non-accrual status unless the loan is well secured and in the process of collection. When loans are placed on non-accrual status, unpaid accrued interest is fully reversed, and further income is recognized only to the extent received on a cash basis or cost recovery method.

When we acquire real estate as a result of foreclosure, the real estate is classified as real estate owned. Initially, the real estate owned is recorded at the fair value less costs to sell. Then after foreclosure, each foreclosed real estate parcel is carried at the lower of carrying amount or fair value, less estimated costs to sell. Soon after acquisition, we order a new appraisal to determine the current market value of the property. Any excess of the recorded value of the loan satisfied over the market value of the property is charged against the allowance for loan losses, or, if the existing allowance is inadequate, charged to expense of the current period. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of estimated fair value less estimated costs to sell.

A loan is classified as a troubled debt restructuring if, for economic or legal reasons related to the borrower’s financial difficulties, we grant a concession to the borrower that we would not otherwise consider. This usually includes a modification of loan terms, such as a reduction of the interest rate to below market terms, capitalizing past due interest or extending the maturity date and possibly a partial forgiveness of the principal amount due. Interest income on restructured loans is accrued after the borrower demonstrates the ability to pay under the restructured terms through a sustained period of repayment performance, which is generally six consecutive months.

Delinquent Loans. The following tables set forth our loan delinquencies, including non-accrual loans, by type and amount at the dates indicated.

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Non-Performing Assets. The following table sets forth information regarding our non-performing assets. There were no non-accruing troubled debt restructured loans as of June 30, 2021, 2020 2019, and 2018. As of September 30, 2017, there were $1.4 million in non-accruing troubled debt restructurings. Troubled debt restructurings include loans for which either a portion of interest or principal has been forgiven, or loans modified at interest rates materially less than current market rates.

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Interest income that would have been recorded for the fiscal year ended June 30, 2021 had non-accruing loans been current according to their original terms amounted to $44,000. We recognized $20,000 of interest income for these loans for the fiscal year ended June 30, 2021. In addition, interest income that would have been recorded for the fiscal year ended June 30, 2021 had accruing troubled debt restructurings been current according to their original terms, amounted to $2,000. We recognized $5,000 of interest income for these loans for the fiscal year ended June 30, 2021.

Classified Assets. Federal regulations provide for the classification of loans and other assets, such as debt and equity securities considered to be of lesser quality, as “substandard,” “doubtful” or “loss.” An asset is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. “Substandard” assets include those characterized by the “distinct possibility” that the insured institution will sustain

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“some loss” if the deficiencies are not corrected. Assets classified as “doubtful” have all of the weaknesses inherent in those classified “substandard,” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions, and values, “highly questionable and improbable.” Assets classified as “loss” are those considered “uncollectible” and of such little value that their continuance as assets without the establishment of a specific loss allowance is not warranted. Assets which do not currently expose the insured institution to sufficient risk to warrant classification in one of the aforementioned categories but possess weaknesses are designated as “special mention” by our management.

When an insured institution classifies problem assets as either substandard or doubtful, it may establish general allowances in an amount deemed prudent by management to cover probable accrued losses. General allowances represent loss allowances which have been established to cover probable accrued losses associated with lending activities, but which, unlike specific allowances, have not been allocated to particular problem assets. When an insured institution classifies problem assets as “loss,” it is required either to establish a specific allowance for losses equal to 100% of that portion of the asset so classified or to charge-off such amount. An institution’s determination as to the classification of its assets and the amount of its valuation allowances is subject to review by the regulatory authorities, which may require the establishment of additional general or specific loss allowances.

On the basis of our review of our assets, our classified and special mention assets at the dates indicated were as follows:

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During the year ended June 30, 2021, classified assets improved by $2.7 million year over year. Activities having the largest impact on the balances include net proceeds from OREO sales of $2.0 million and $153,000 in charge-offs on OREO properties. In addition, $523,000 in assets consisting of seven residential real estate loans were no longer classified as of June 30, 2021.

Allowance for Loan Losses

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s evaluation of the collectability of the loan portfolio, including the nature of the portfolio, credit concentrations, trends in historical loss experience, specific impaired loans, and economic conditions, including the impact of COVID-19. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows. Because of uncertainties associated with regional economic conditions, collateral values, and future cash flows on impaired loans, it is reasonably possible that management’s estimate of probable credit losses inherent in the loan portfolio and the related allowance may change materially in the near-term. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by full and partial charge-offs, net of recoveries. Changes in the allowance relating to impaired loans are charged or credited to the provision for loan losses. Management’s periodic evaluation of the adequacy of the allowance is based on various factors, including, but not limited to, management’s ongoing review and grading of loans, facts and issues related to specific loans, historical loan loss and delinquency experience, trends in past due and non-accrual loans, existing risk characteristics of specific loans or loan pools, changes in the nature, volume and terms of loans, the fair value of underlying collateral, changes in lending personnel, current economic conditions and other qualitative and quantitative factors which could affect potential credit losses.

In addition, the WDFI and the Federal Deposit Insurance Corporation periodically review our allowance for loan losses and as a result of such reviews, we may have to adjust our allowance for loan losses or recognize further loan charge-offs.

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The following table sets forth activity in our allowance for loan losses for the periods indicated.