Waterstone Financial, Inc. - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

☒ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2020

☐ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number 001-36271

WATERSTONE FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Maryland	90-1026709
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

11200 W. Plank Court Wauwatosa, Wisconsin	53226
(Address of principal executive offices)	(Zip Code)

(414) 761-1000

(Registrant’s telephone number, including area code)

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

Title of each class		Trading Symbol		Name of each exchange on which registered
Common Stock, $0.01 Par Value		WSBF		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 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, or a smaller reporting company. See 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 ☒

The number of shares outstanding of the issuer’s common stock, $0.01 par value per share, was 25,161,736 at November 3, 2020.

WATERSTONE FINANCIAL, INC.

10-Q INDEX

	Page No.

PART I. FINANCIAL INFORMATION

Item l. Financial Statements
Consolidated Statements of Financial Condition as of September 30, 2020 (unaudited) and December 31, 2019	3
Consolidated Statements of Income for the three and nine months ended September 30, 2020 and 2019 (unaudited)	4
Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2020 and 2019 (unaudited)	5
Consolidated Statements of Changes in Shareholders’ Equity for the three and nine months ended September 30, 2020 and 2019 (unaudited)	6-7
Consolidated Statements of Cash Flows for the nine months ended September 30, 2020 and 2019 (unaudited)	8
Notes to Consolidated Financial Statements (unaudited)	9-40

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	41-65
Item 3. Quantitative and Qualitative Disclosures about Market Risk	66
Item 4. Controls and Procedures	67

PART II. OTHER INFORMATION

Item 1. Legal Proceedings	67
Item 1A. Risk Factors Item 2. Unregistered Sales of Equity Securities and Use of Proceeds Item 3. Defaults Upon Senior Securities Item 4. Mine Safety Disclosures Item 5. Other Information	67 67 67 67 67
Item 6. Exhibits	68
Signatures	68

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

	(Unaudited)
	September 30, 2020			December 31, 2019
Assets	(Dollars In Thousands, except share and per share data)
Cash	$	54,681		$	52,814
Federal funds sold		21,151			12,704
Interest-earning deposits in other financial institutions and other short term investments		10,730			8,782
Cash and cash equivalents		86,562			74,300
Securities available for sale (at fair value)		153,201			178,476
Loans held for sale (at fair value)		385,803			220,123
Loans receivable		1,434,132			1,388,031
Less: Allowance for loan losses		18,844			12,387
Loans receivable, net		1,415,288			1,375,644

Office properties and equipment, net		23,961			25,028
Federal Home Loan Bank stock (at cost)		26,720			21,150
Cash surrender value of life insurance		63,255			69,665
Real estate owned, net		772			748
Prepaid expenses and other assets		65,260			31,213
Total assets	$	2,220,822		$	1,996,347

Liabilities and Shareholders’ Equity
Liabilities:
Demand deposits	$	169,218		$	130,063
Money market and savings deposits		271,283			197,942
Time deposits		744,150			739,771
Total deposits		1,184,651			1,067,776

Borrowings		552,126			483,562
Advance payments by borrowers for taxes		25,987			4,212
Other liabilities		58,629			47,111
Total liabilities		1,821,393			1,602,661

Shareholders’ equity:
Preferred stock (par value $0.01 per share)
Authorized - 50,000,000 shares at September 30, 2020 and at December 31, 2019, no shares issued		-			-
Common stock (par value $0.01 per share)
Authorized - 100,000,000 shares at September 30, 2020 and at December 31, 2019
Issued - 25,220,036 at September 30, 2020 and 27,148,411 at December 31, 2019
Outstanding - 25,220,036 at September 30, 2020 and 27,148,411 at December 31, 2019		252			271
Additional paid-in capital		182,960			211,997
Retained earnings		229,289			197,393
Unearned ESOP shares		(15,727	)		(16,617	)
Accumulated other comprehensive income, net of taxes		2,655			642
Total shareholders’ equity		399,429			393,686
Total liabilities and shareholders’ equity	$	2,220,822		$	1,996,347

See accompanying notes to unaudited consolidated financial statements.

WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three months ended September 30,					Nine months ended September 30,
	2020		2019			2020		2019
	(In Thousands, except per share amounts)

Interest income:
Loans	$	18,224	$	18,558		$	54,404	$	53,688
Mortgage-related securities		588		737			1,960		2,260
Debt securities, federal funds sold and short-term investments		732		1,083			2,493		3,515
Total interest income		19,544		20,378			58,857		59,463
Interest expense:
Deposits		3,495		4,479			11,760		12,813
Borrowings		2,640		2,745			7,913		7,579
Total interest expense		6,135		7,224			19,673		20,392
Net interest income		13,409		13,154			39,184		39,071
Provision (credit) for loan losses		1,025		(80	)		6,310		(730	)
Net interest income after provision for loan losses		12,384		13,234			32,874		39,801
Noninterest income:
Service charges on loans and deposits		672		503			3,384		1,272
Increase in cash surrender value of life insurance		714		728			1,587		1,579
Mortgage banking income		72,112		36,062			166,292		93,526
Other		2,265		201			2,868		564
Total noninterest income		75,763		37,494			174,131		96,941
Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		39,405		27,514			100,695		75,227
Occupancy, office furniture, and equipment		2,469		2,629			7,744		8,085
Advertising		861		913			2,625		2,834
Data processing		922		1,003			3,023		2,641
Communications		339		358			994		1,039
Professional fees		4,738		954			7,647		2,438
Real estate owned		11		24			55		75
Loan processing expense		1,336		858			3,620		2,542
Other		2,920		1,979			9,495		6,055
Total noninterest expenses		53,001		36,232			135,898		100,936
Income before income taxes		35,146		14,496			71,107		35,806
Income tax expense		8,853		3,572			17,797		8,697
Net income	$	26,293	$	10,924		$	53,310	$	27,109
Income per share:
Basic	$	1.08	$	0.42		$	2.16	$	1.04
Diluted	$	1.08	$	0.42		$	2.15	$	1.03
Weighted average shares outstanding:
Basic		24,297		25,772			24,720		26,168
Diluted		24,380		25,962			24,842		26,372

See accompanying notes to unaudited consolidated financial statements.

WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)

	Three months ended September 30,						Nine months ended September 30,
	2020			2019			2020		2019
	(In Thousands)
Net income	$	26,293		$	10,924		$	53,310	$	27,109

Other comprehensive (loss) income, net of tax:
Net unrealized holding (loss) gain on available for sale securities:
Net unrealized holding (loss) gain arising during the period, net of tax benefit (expense) of $41, $2, $(754), $(1,125), respectively		(104	)		(6	)		2,013		3,010
Total other comprehensive (loss) income		(104	)		(6	)		2,013		3,010
Comprehensive income	$	26,189		$	10,918		$	55,323	$	30,119

See accompanying notes to unaudited consolidated financial statements.

WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

(Unaudited)

	Common Stock						Additional Paid-In Capital			Retained Earnings			Unearned ESOP Shares			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
	Shares			Amount
For the nine months ended Septeber 30, 2020	(In Thousands, except per share amounts)
Balances at January 1, 2020		27,148		$	271		$	211,997		$	197,393		$	(16,617	)	$	642		$	393,686

Comprehensive income:
Net income		-			-			-			53,310			-			-			53,310
Other comprehensive income		-			-			-			-			-			2,013			2,013
Total comprehensive income																				55,323

ESOP shares committed to be released to Plan participants		-			-			327			-			890			-			1,217
Cash dividend declared, $0.86 per share		-			-			-			(21,414	)		-			-			(21,414	)
Stock compensation activity, net of tax		222			3			2,783			-			-			-			2,786
Stock compensation expense		-			-			553			-			-			-			553
Purchase of common stock returned to authorized but unissued		(2,150	)		(22	)		(32,700	)		-			-			-			(32,722	)
Balances at September 30, 2020		25,220		$	252		$	182,960		$	229,289		$	(15,727	)	$	2,655		$	399,429

For the nine months ended September 30, 2019	(In Thousands, except per share amounts)
Balances at January 1, 2019		28,463		$	285		$	232,406		$	187,153		$	(17,804	)	$	(2,361	)	$	399,679

Comprehensive income:
Net income		-			-			-			27,109			-			-			27,109
Other comprehensive income		-			-			-			-			-			3,010			3,010
Total comprehensive income																				30,119

ESOP shares committed to be released to Plan participants		-			-			429			-			890			-			1,319
Cash dividend declared, $0.86 per share		-			-			-			(22,582	)		-			-			(22,582	)
Stock based compensation activity		47			-			603			-			-			-			603
Stock compensation expense		-			-			832			-			-			-			832
Purchase of common stock returned to authorized but unissued		(1,363	)		(14	)		(22,713	)		-			-			-			(22,727	)
Balances at September 30, 2019		27,147		$	271		$	211,557		$	191,680		$	(16,914	)	$	649		$	387,243

	Common Stock						Additional Paid-In Capital			Retained Earnings			Unearned ESOP Shares			Accumulated Other Comprehensive Income (Loss)			Total Shareholders' Equity
	Shares			Amount
For the three months ended Septeber 30, 2020	(In Thousands, except per share amounts)
Balances at July 1, 2020		25,843		$	258		$	192,762		$	205,863		$	(16,023	)	$	2,759		$	385,619

Comprehensive income:
Net income		-			-			-			26,293			-			-			26,293
Other comprehensive loss		-			-			-			-			-			(104	)		(104	)
Total comprehensive income																				26,189

ESOP shares committed to be released to Plan participants		-			-			99			-			296			-			395
Cash dividend declared, $0.12 per share		-			-			-			(2,867	)		-			-			(2,867	)
Stock compensation activity, net of tax		177			2			2,253			-			-			-			2,255
Stock compensation expense		-			-			164			-			-			-			164
Purchase of common stock returned to authorized but unissued		(800	)		(8	)		(12,318	)		-			-			-			(12,326	)
Balances at September 30, 2020		25,220		$	252		$	182,960		$	229,289		$	(15,727	)	$	2,655		$	399,429

For the three months ended September 30, 2019	(In Thousands, except per share amounts)
Balances at July 1, 2019		27,626		$	276		$	219,262		$	183,820		$	(17,210	)	$	655		$	386,803

Comprehensive income:
Net income		-			-			-			10,924			-			-			10,924
Other comprehensive loss		-			-			-			-			-			(6	)		(6	)
Total comprehensive income																				10,918

ESOP shares committed to be released to Plan participants		-			-			148			-			296			-			444
Cash dividend declared, $0.12 per share		-			-			-			(3,064	)		-			-			(3,064	)
Stock based compensation activity		16			-			209			-			-			-			209
Stock compensation expense		-			-			234			-			-			-			234
Purchase of common stock returned to authorized but unissued		(495	)		(5	)		(8,296	)		-			-			-			(8,301	)
Balances at September 30, 2019		27,147		$	271		$	211,557		$	191,680		$	(16,914	)	$	649		$	387,243

See accompanying notes to unaudited consolidated financial statements.

WATERSTONE FINANCIAL, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Nine months ended September 30,
	2020			2019
	(In Thousands)

Operating activities:
Net income	$	53,310		$	27,109
Adjustments to reconcile net income to used in operating activities:
Provision (credit) for loan losses		6,310			(730	)
Provision for depreciation		1,901			1,829
Deferred taxes		(2,445	)		1,303
Stock based compensation		553			832
Net amortization of premium/discount on debt and mortgage related securities		102			164
Amortization of unearned ESOP shares		1,217			1,319
Amortization and impairment of mortgage servicing rights		774			167
Gain on sale of loans held for sale		(171,374	)		(96,024	)
Loans originated for sale		(3,063,835	)		(2,092,948	)
Proceeds on sales of loans originated for sale		3,069,529			2,092,816
Gain on death benefit on bank owned life insurance		(1,456	)		-
Decrease (increase) in accrued interest receivable		181			(248	)
Increase in cash surrender value of life insurance		(1,587	)		(1,579	)
(Decrease) increase in accrued interest on deposits and borrowings		(245	)		92
Decrease in prepaid tax expense		2,794			1,812
Net gain related to real estate owned		(5	)		(20	)
Change in other assets and other liabilities		(12,074	)		(4,185	)
Net cash used in operating activities		(116,350	)		(68,291	)

Investing activities:
Net increase in loans receivable		(46,322	)		(7,102	)
Purchases of:
FHLB stock		(5,570	)		(2,700	)
Mortgage related securities		(4,455	)		(12,121	)
Debt securities		(5,000	)		-
Bank owned life insurance		(180	)		(180	)
Premises and equipment, net		(917	)		(2,247	)
Proceeds from:
Principal repayments on mortgage-related securities		33,635			21,920
Maturities of debt securities		3,760			1,835
Sales of real estate owned		353			1,204
Proceeds from death benefit on bank owned life insurance		9,633			-
Net cash (used in) provided by investing activities		(15,063	)		609

Financing activities:
Net increase in deposits		116,875			1,074
Net change in short term borrowings		68,564			40,749
Repayment of long term debt		-			(125,000	)
Proceeds from long term debt		-			165,000
Cash paid for advance payments by borrowers for taxes		9,870			10,961
Cash dividends on common stock		(21,698	)		(22,889	)
Purchase of common stock returned to authorized but unissued		(32,722	)		(22,727	)
Proceeds from stock option exercises		2,786			603
Net cash provided by financing activities		143,675			47,771
Increase (decrease) in cash and cash equivalents		12,262			(19,911	)
Cash and cash equivalents at beginning of period		74,300			86,101
Cash and cash equivalents at end of period	$	86,562		$	66,190

Supplemental information:
Cash paid or credited during the period for:
Income tax payments	$	17,448		$	6,709
Interest payments		19,918			20,300
Noncash activities:
Loans receivable transferred to real estate owned		369			946
Dividends declared but not paid in other liabilities		3,217			3,492

See accompanying notes to unaudited consolidated financial statements.

Note 1 — Basis of Presentation

The unaudited interim consolidated financial statements include the accounts of Waterstone Financial, Inc. (the “Company”) and the Company’s subsidiaries.

WaterStone Bank SSB (the "Bank") is a community bank that has served the banking needs of its customers since 1921. WaterStone Bank also has an active mortgage banking subsidiary, Waterstone Mortgage Corporation.

WaterStone Bank conducts its community banking business from 13 banking offices located in Milwaukee, Washington and Waukesha Counties, Wisconsin, as well as a loan production office in Minneapolis, Minnesota. WaterStone Bank's principal lending activity is originating one- to four-family, multi-family residential real estate, and commercial real estate loans for retention in its portfolio. WaterStone Bank also offers home equity loans and lines of credit, construction and land loans, commercial business loans, and consumer loans. WaterStone Bank funds its loan production primarily with retail deposits and Federal Home Loan Bank advances. Our deposit offerings include: certificates of deposit, money market savings accounts, transaction deposit accounts, non-interest bearing demand accounts and individual retirement accounts. Our investment securities portfolio is comprised principally of mortgage-backed securities, government-sponsored enterprise bonds and municipal obligations.

WaterStone Bank's mortgage banking operations are conducted through its wholly-owned subsidiary, Waterstone Mortgage Corporation. Waterstone Mortgage Corporation originates single-family residential real estate loans for sale into the secondary market. Waterstone Mortgage Corporation utilizes lines of credit provided by WaterStone Bank as a primary source of funds, and also utilizes a line of credit with another financial institution as needed.

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles (“GAAP”) for interim financial information, Rule 10-01 of Regulation S-X and the instructions to Form 10-Q. The financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) necessary to present fairly the financial position, results of operations, changes in shareholders’ equity, and cash flows of the Company for the periods presented.

The accompanying unaudited consolidated financial statements and related notes should be read in conjunction with the Company’s December 31, 2019 Annual Report on Form 10-K. Operating results for the nine months ended September 30, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020 or for any other period.

The preparation of the unaudited consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating to the reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include the allowance for loan losses, income taxes, and fair value measurements. Actual results could differ from those estimates.

Impacts of COVID-19

In March, 2020, the World Health Organization declared the outbreak of COVID-19 as a global pandemic, which continues to spread throughout the United States and around the world. The declaration of a global pandemic indicates that almost all public commerce and related business activities must be, to varying degrees, curtailed with the goal of decreasing the rate of new infections. The outbreak and continuing spread of COVID-19 could adversely impact a broad range of industries in which the Company’s customers operate and impair their ability to fulfill their financial obligations to the Company. On March 3, 2020, the Federal Open Market Committee reduced the target federal funds rate by 50 basis points to 1.00% to 1.25%. This rate was further reduced to a target range of 0% to 0.25% on March 16, 2020. These reductions in interest rates and other effects of the COVID-19 outbreak may adversely affect the Company’s financial condition and results of operations. As a result of the spread of the COVID-19 coronavirus, economic uncertainties have arisen which may negatively impact net interest income and noninterest income. Other financial impacts could occur though such potential impacts are unknown at this time.

Subsequent Events

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. There were no significant subsequent events for the quarter ended September 30, 2020 through the issuance date of these unaudited consolidated financial statements that warranted adjustment to or disclosure in the unaudited consolidated financial statements.

Reclassifications

Certain prior period amounts have been reclassified to conform to current period presentation. These reclassifications did not result in any changes to previously reported net income. The Company reclassified the Cost of Shares Repurchased line item presented in prior periods to the Additional Paid in Capital line item in the Consolidated Statements of Financial Condition. The Cost of Shares Repurchased column was reclassified to the Additional Paid in Capital line in the Consolidated Statements of Changes in Shareholders’ Equity.

Impact of Recent Accounting Pronouncements

ASC Topic 326 "Financial Instruments - Credit Losses." Authoritative accounting guidance under ASC Topic 326, "Financial Instruments - Credit Losses" amended the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information for credit loss estimates. The measurement of expected credit losses is based on relevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. The authoritative guidance also requires a financial asset (or a group of financial assets) measured at amortized cost basis to be presented at the net amount expected to be collected (net of the allowance for credit losses). In addition, the credit losses relating to available-for-sale debt securities should be recorded through an allowance for credit losses rather than a write-down.

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. It included an option for entities to delay the adoption of ASC Topic 326 until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. Due to the uncertainty on the economy and unemployment from COVID-19, the Company has determined to delay its adoption of ASC Topic 326 and has calculated and recorded its provision for loan losses under the incurred loss model that existed prior to ASC Topic 326.

The Company has input the available historical Company data to build an internal model and is reviewing the assumptions to support the calculation under ASC Topic 326. Management’s methodology for estimating the allowance for credit losses under the current expected credit losses (CECL) model includes the use of relevant available information, from internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts. Historical credit loss experience by vintage classified by loans with similar risk profiles provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are considered for differences in current loan-specific risk characteristics such as changes in underwriting standards, portfolio mix, portfolio volume, delinquency rates, interest rates, or other relevant factors. Management will continue to review and adjust these and other factors. Ongoing evaluations have been performed by vintage adjusted for prepayments. For two portfolio segments, management expects to use a weighted average remaining maturity methodology, which contemplates loss expectations on a pool basis, relying on historic loss rates.

Management is validating the CECL model and methodologies; however we expect an initial increase to the allowance for credit loss, including reserves for unfunded commitments, not to exceed 130% of the December 31, 2019 allowance. When finalized, this one-time increase as a result of the adoption of CECL will be recorded, net of tax, as an adjustment to retained earnings effective on the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. This estimate is subject to change based on continuing refinement and validation of the model and methodologies.

Financial statement users should be aware that the allowance for credit loss is, by design, inherently sensitive to changes in economic outlook, loan and lease portfolio composition, portfolio duration, and other factors.

As we continue to evaluate the provisions of ASC Topic 326 as of and for the nine months ended September 30, 2020, we are considering the following in developing our forecast and its effect on our CECL calculations:

•	Duration, extent and severity of COVID-19;

•	Effect of government assistance; and

•	Unemployment and effect on economies and markets.

Note 2— Securities Available for Sale

The amortized cost and fair values of the Company’s investment in securities available for sale follow:

	September 30, 2020
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
	(In Thousands)
Mortgage-backed securities	$	24,872	$	1,228	$	-		$	26,100
Collateralized mortgage obligations:
Government sponsored enterprise issued		57,424		2,095		-			59,519
Private-label issued		3,595		55		-			3,650
Mortgage-related securities		85,891		3,378		-			89,269

Government sponsered enterprise bonds		2,500		-		(1	)		2,499
Municipal securities		47,970		2,192		-			50,162
Other debt securities		12,500		-		(1,229	)		11,271
Debt securities		62,970		2,192		(1,230	)		63,932
	$	148,861	$	5,570	$	(1,230	)	$	153,201

	December 31, 2019
	Amortized cost		Gross unrealized gains		Gross unrealized losses			Fair value
	(In Thousands)
Mortgage-backed securities	$	33,773	$	422	$	(45	)	$	34,150
Collateralized mortgage obligations:
Government sponsored enterprise issued		81,232		776		(254	)		81,754
Mortgage-related securities		115,005		1,198		(299	)		115,904

Municipal securities		51,898		1,795		(1	)		53,692
Other debt securities		10,000		-		(1,120	)		8,880
Debt securities		61,898		1,795		(1,121	)		62,572
	$	176,903	$	2,993	$	(1,420	)	$	178,476

The Company’s mortgage-backed securities and collateralized mortgage obligations issued by government sponsored enterprises are guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. At September 30, 2020, $897,000 of the Company’s mortgage related securities were pledged as collateral to secure mortgage banking related activities and $7.8 million were pledged as collateral to secure back-to-back swaps. At December 31, 2019, $1.2 million of the Company's mortgage related securities were pledged as collateral to secure mortgage banking related activities.

The amortized cost and fair values of investment securities by contractual maturity at September 30, 2020 are shown below. Actual maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

	Amortized Cost		Fair Value
	(In Thousands)
Debt and other securities
Due within one year	$	5,512	$	5,556
Due after one year through five years		36,877		37,925
Due after five years through ten years		20,581		20,451
Due after ten years		-		-
Mortgage-related securities		85,891		89,269
	$	148,861	$	153,201

Gross unrealized losses on securities available for sale and the fair value of the related securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position were as follows:

	September 30, 2020
	Less than 12 months					12 months or longer					Total
	Fair value		Unrealized loss			Fair value		Unrealized loss			Fair value		Unrealized loss
	(In Thousands)
Mortgage-backed securities	$	-	$	-		$	-	$	-		$	-	$	-
Collateralized mortgage obligations:
Government sponsored enterprise issued		-		-			-		-			-		-
Private label issued		-		-			-		-			-		-
Government sponsored enterprise bonds		2,499		(1	)		-		-			2,499		(1	)
Municipal securities		-		-			-		-			-		-
Other debt securities		2,476		(24	)		8,795		(1,205	)		11,271		(1,229	)
	$	4,975	$	(25	)	$	8,795	$	(1,205	)	$	13,770	$	(1,230	)

	December 31, 2019
	Less than 12 months					12 months or longer					Total
	Fair value		Unrealized loss			Fair value		Unrealized loss			Fair value		Unrealized loss
	(In Thousands)
Mortgage-backed securities	$	2,929	$	(20	)	$	2,849	$	(25	)	$	5,778	$	(45	)
Collateralized mortgage obligations:
Government sponsored enterprise issued		21,723		(136	)		7,180		(118	)		28,903		(254	)
Municipal securities		100		(1	)		-		-			100		(1	)
Other debt securities		-		-			8,880		(1,120	)		8,880		(1,120	)
	$	24,752	$	(157	)	$	18,909	$	(1,263	)	$	43,661	$	(1,420	)

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. In evaluating whether a security’s decline in market value is other-than-temporary, management considers the length of time and extent to which the fair value has been less than cost, the financial condition of the issuer and the underlying obligors, quality of credit enhancements, volatility of the fair value of the security, the expected recovery period of the security and ratings agency evaluations. In addition, the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds and the value of any underlying collateral.

As of September 30, 2020, the Company held one municipal security that had previously been deemed to be other-than-temporarily impaired. The security was issued by a tax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company received audited financial statements with respect to the municipal issuer that called into question the ability of the underlying taxing district that issued the security to operate as a going concern. During the year ended December 31, 2012, the Company's analysis of this security resulted in $77,000 in credit losses charged to earnings with respect to this municipal security. An additional $17,000 credit loss was charged to earnings during the year ended December 31, 2014 with respect to this security as a sale occurred at a discounted price. There have been no additional credit losses related to the security. As of September 30, 2020, this security had an amortized cost of $116,000 and total life-to-date impairment of $94,000.

As of September 30, 2020, the Company had one corporate debt security which had been in an unrealized loss position for twelve months or longer and this security represents a loss of 12.1% of its aggregate amortized cost. The security was determined not to be other-than-temporarily impaired as of September 30, 2020. The Company has determined that the decline in fair value of the security is primarily attributable to an increase in market interest rates compared to the stated rates on this security and is not attributable to credit deterioration. As the Company does not intend to sell nor is it more likely than not that it will be required to sell the security before recovery of the amortized cost basis, it is not considered other-than-temporarily impaired. The unrealized losses for the corporate debt security with an unrealized loss greater than 12 months is due to the current slope of the yield curve. The security currently earns a floating rate that is indexed to the 10 year Treasury interest rate that is reset on a quarterly basis.

Deterioration of general economic market conditions could result in the recognition of future other than temporary impairment losses within the investment portfolio and such amounts could be material to our consolidated financial statements.

During the nine months ended September 30, 2020 and September 30, 2019, there were no sales of securities.

Note 3 - Loans Receivable

Loans receivable at September 30, 2020 and December 31, 2019 are summarized as follows:

	September 30, 2020		December 31, 2019
	(In Thousands)
Mortgage loans:
Residential real estate:
One- to four-family	$	452,491	$	480,280
Multi-family		599,637		584,859
Home equity		15,410		18,071
Construction and land		66,726		37,033
Commercial real estate		241,248		236,703
Consumer		783		832
Commercial loans		57,837		30,253
	$	1,434,132	$	1,388,031

The Company provides several types of loans to its customers, including residential, construction, commercial and consumer loans. Significant loan concentrations are considered to exist for a financial institution when there are amounts loaned to one borrower or to multiple borrowers engaged in similar activities that would cause them to be similarly impacted by economic or other conditions. While the Company's credit risks are geographically concentrated in the Milwaukee metropolitan area, there are no concentrations with individual or groups of related borrowers. While the real estate collateralizing these loans is primarily residential in nature, it ranges from owner-occupied single family homes to large apartment complexes.

Qualifying loans receivable totaling $1.32 billion and $1.07 billion at September 30, 2020 and December 31, 2019, respectively, were pledged as collateral against $504.0 million and $470.0 million in outstanding Federal Home Loan Bank of Chicago ("FHLB") advances under a blanket security agreement at September 30, 2020 and December 31, 2019.

Certain of the Company's executive officers, directors, employees, and their related interests have loans with the Bank. Loans outstanding to such parties were approximately $6.5 million as of September 30, 2020 and $6.3 million as of December 31, 2019. None of these loans were past due or considered impaired as of September 30, 2020 or December 31, 2019.

As of September 30, 2020 and December 31, 2019, there were no loans 90 or more days past due and still accruing interest.

An analysis of past due loans receivable as of September 30, 2020 and December 31, 2019 follows:

	As of September 30, 2020
	1-59 Days Past Due⁽¹⁾			60-89 Days Past Due⁽²⁾		90 Days or Greater		Total Past Due		Current⁽³⁾		Total Loans
	(In Thousands)
Mortgage loans:
Residential real estate:
One- to four-family		$	1,608	$	-	$	2,647	$	4,255	$	448,236	$	452,491
Multi-family			-		-		314		314		599,323		599,637
Home equity			50		-		40		90		15,320		15,410
Construction and land			-		51		-		51		66,675		66,726
Commercial real estate			699		-		51		750		240,498		241,248
Consumer			-		-		-		-		783		783
Commercial loans			95		-		-		95		57,742		57,837
Total		$	2,452	$	51	$	3,052	$	5,555	$	1,428,577	$	1,434,132

	As of December 31, 2019
	1-59 Days Past Due⁽¹⁾			60-89 Days Past Due⁽²⁾		90 Days or Greater		Total Past Due		Current⁽³⁾		Total Loans
	(In Thousands)
Mortgage loans:
Residential real estate:
One- to four-family		$	1,179	$	638	$	3,969	$	5,786	$	474,494	$	480,280
Multi-family			-		-		360		360		584,499		584,859
Home equity			-		10		-		10		18,061		18,071
Construction and land			-		-		-		-		37,033		37,033
Commercial real estate			-		-		303		303		236,400		236,703
Consumer			-		-		-		-		832		832
Commercial loans			6		-		-		6		30,247		30,253
Total		$	1,185	$	648	$	4,632	$	6,465	$	1,381,566	$	1,388,031

⁽¹⁾Includes $407,000 and $53,000 at September 30, 2020 and December 31, 2019, respectively, which are on non-accrual status.

⁽²⁾Includes $- and $291,000 at September 30, 2020 and December 31, 2019, respectively, which are on non-accrual status.

⁽³⁾Includes $2.6 million and $2.0 million at September 30, 2020 and December 31, 2019, respectively, which are on non-accrual status.

A summary of the activity for the nine months ended September 30, 2020 and 2019 in the allowance for loan losses follows:

	One- to Four- Family			Multi-Family			Home Equity			Construction and Land		Commercial Real Estate		Consumer			Commercial		Total
	(In Thousands)
Nine months ended September 30, 2020
Balance at beginning of period	$	4,907		$	4,138		$	201		$	610	$	2,145	$	14		$	372	$	12,387
Provision (credit) for loan losses		854			1,703			(6	)		1,004		2,300		33			422		6,310
Charge-offs		(9	)		(5	)		(13	)		-		-		(10	)		-		(37	)
Recoveries		132			17			22			2		11		-			-		184
Balance at end of period	$	5,884		$	5,853		$	204		$	1,616	$	4,456	$	37		$	794	$	18,844

Nine months ended September 30, 2019
Balance at beginning of period	$	5,742		$	4,153		$	325		$	400	$	2,126		$	20		$	483		$	13,249
Provision (credit) for loan losses		(488	)		(19	)		(89	)		157		(200	)		(1	)		(90	)		(730	)
Charge-offs		(69	)		(2	)		(44	)		-		(2	)		(5	)		-			(122	)
Recoveries		116			13			19			-		2			-			-			150
Balance at end of period	$	5,301		$	4,145		$	211		$	557	$	1,926		$	14		$	393		$	12,547

A summary of the activity for the three months ended September 30, 2020 and 2019 in the allowance for loan losses follows:

	One- to Four- Family			Multi-Family			Home Equity			Construction and Land		Commercial Real Estate		Consumer			Commercial		Total
	(In Thousands)
Three months ended September 30, 2020
Balance at beginning of period	$	5,715		$	5,870		$	218		$	1,153	$	4,124	$	38		$	616	$	17,734
Provision (credit) for loan losses		100			(25	)		(18	)		462		328		-			178		1,025
Charge-offs		(2	)		-			-			-		-		(1	)		-		(3	)
Recoveries		71			8			4			1		4		-			-		88
Balance at end of period	$	5,884		$	5,853		$	204		$	1,616	$	4,456	$	37		$	794	$	18,844

Three months ended September 30, 2019
Balance at beginning of period	$	5,303		$	4,315		$	275		$	412	$	1,913		$	12	$	387	$	12,617
Provision (credit) for loan losses		(39	)		(173	)		(35	)		145		14			2		6		(80	)
Charge-offs		(44	)		(1	)		(36	)		-		(2	)		-		-		(83	)
Recoveries		81			4			7			-		1			-		-		93
Balance at end of period	$	5,301		$	4,145		$	211		$	557	$	1,926		$	14	$	393	$	12,547

A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of September 30, 2020 follows:

	One- to Four- Family		Multi- Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
Allowance related to loans individually evaluated for impairment	$	24	$	-	$	-	$	-	$	-	$	-	$	-	$	24
Allowance related to loans collectively evaluated for impairment		5,860		5,853		204		1,616		4,456		37		794		18,820
Balance at end of period	$	5,884	$	5,853	$	204	$	1,616	$	4,456	$	37	$	794	$	18,844

Loans individually evaluated for impairment	$	8,035	$	616	$	75	$	-	$	6,037	$	-	$	-	$	14,763
Loans collectively evaluated for impairment		444,456		599,021		15,335		66,726		235,211		783		57,837		1,419,369
Total gross loans	$	452,491	$	599,637	$	15,410	$	66,726	$	241,248	$	783	$	57,837	$	1,434,132

A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of December 31, 2019 follows:

	One- to Four-Family		Multi- Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
Allowance related to loans individually evaluated for impairment	$	32	$	-	$	-	$	-	$	7	$	-	$	-	$	39
Allowance related to loans collectively evaluated for impairment		4,875		4,138		201		610		2,138		14		372		12,348
Balance at end of period	$	4,907	$	4,138	$	201	$	610	$	2,145	$	14	$	372	$	12,387

Loans individually evaluated for impairment	$	8,725	$	667	$	84	$	-	$	581	$	-	$	-	$	10,057
Loans collectively evaluated for impairment		471,555		584,192		17,987		37,033		236,122		832		30,253		1,377,974
Total gross loans	$	480,280	$	584,859	$	18,071	$	37,033	$	236,703	$	832	$	30,253	$	1,388,031

The following table presents information relating to the Company’s internal risk ratings of its loans receivable as of September 30, 2020 and December 31, 2019:

	One to Four- Family		Multi-Family		Home Equity		Construction and Land		Commercial Real Estate		Consumer		Commercial		Total
	(In Thousands)
At September 30, 2020
Substandard	$	8,035	$	616	$	261	$	-	$	325	$	-	$	721	$	9,958
Watch		6,983		-		6		4,330		12,193		-		4,242		27,754
Pass		437,473		599,021		15,143		62,396		228,730		783		52,874		1,396,420
	$	452,491	$	599,637	$	15,410	$	66,726	$	241,248	$	783	$	57,837	$	1,434,132

At December 31, 2019
Substandard	$	8,725	$	668	$	285	$	-	$	581	$	-	$	754	$	11,013
Watch		5,975		-		3		-		1,412		-		847		8,237
Pass		465,580		584,191		17,783		37,033		234,710		832		28,652		1,368,781
	$	480,280	$	584,859	$	18,071	$	37,033	$	236,703	$	832	$	30,253	$	1,388,031

Factors that are important to managing overall credit quality include sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, early identification of potential problems, an allowance for loan losses, and sound non-accrual and charge-off policies. Our underwriting policies require an officers' loan committee review and approval of all loans in excess of $500,000. A member of the credit department, independent of the loan originator, performs a loan review for all loans. Our ability to manage credit risk depends in large part on our ability to properly identify and manage problem loans. To do so, we maintain a loan review system under which our credit management personnel review non-owner occupied one- to four-family, multi-family, construction and land, and commercial real estate loans that individually, or as part of an overall borrower relationship exceed $1.0 million in potential exposure and review commercial loans that individually, or as part of an overall borrower relationship exceed $200,000 in potential exposure. Loans meeting these criteria are reviewed on an annual basis, or more frequently, if the loan renewal is less than one year. With respect to this review process, management has determined that pass loans include loans that exhibit acceptable financial statements, cash flow and leverage. Watch loans have potential weaknesses that deserve management's attention, and if left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the credit. Substandard loans are considered inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged. These loans generally have a well-defined weakness that may jeopardize liquidation of the debt and are characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Finally, a loan is considered to be impaired when it is probable that the Company will not be able to collect all amounts due according to the contractual terms of the loan agreement. Management has determined that all non-accrual loans and loans modified under troubled debt restructurings meet the definition of an impaired loan.

The Company's procedures dictate that an updated valuation must be obtained with respect to underlying collateral at the time a loan is deemed impaired. Updated valuations may also be obtained upon transfer from loans receivable to real estate owned based upon the age of the prior appraisal, changes in market conditions or known changes to the physical condition of the property.

Estimated fair values are reduced to account for sales commissions, broker fees, unpaid property taxes and additional selling expenses to arrive at an estimated net realizable value. The adjustment factor is based upon the Company's actual experience with respect to sales of real estate owned over the prior two years. In situations in which we are placing reliance on an appraisal that is more than one year old, an additional adjustment factor is applied to account for downward market pressure since the date of appraisal. The additional adjustment factor is based upon relevant sales data available for our general operating market as well as company-specific historical net realizable values as compared to the most recent appraisal prior to disposition.

With respect to multi-family income-producing real estate, appraisals are reviewed and estimated collateral values are adjusted by updating significant appraisal assumptions to reflect current real estate market conditions. Significant assumptions reviewed and updated include the capitalization rate, rental income and operating expenses. These adjusted assumptions are based upon recent appraisals received on similar properties as well as on actual experience related to real estate owned and currently under Company management.

The following tables present data on impaired loans at September 30, 2020 and December 31, 2019.

	As of September 30, 2020
	Recorded Investment		Unpaid Principal		Reserve		Cumulative Charge-Offs
	(In Thousands)
Total Impaired with Reserve
One- to four-family	$	210	$	210	$	24	$	-
Multi-family		-		-		-		-
Home equity		-		-		-		-
Construction and land		-		-		-		-
Commercial real estate		-		-		-		-
Consumer		-		-		-		-
Commercial		-		-		-		-
		210		210		24		-
Total Impaired with no Reserve
One- to four-family		7,825		8,820		-		995
Multi-family		616		1,427		-		811
Home equity		75		75		-		-
Construction and land		-		-		-		-
Commercial real estate		6,037		6,037		-		-
Consumer		-		-		-		-
Commercial		-		-		-		-
		14,553		16,359		-		1,806
Total Impaired
One- to four-family		8,035		9,030		24		995
Multi-family		616		1,427		-		811
Home equity		75		75		-		-
Construction and land		-		-		-		-
Commercial real estate		6,037		6,037		-		-
Consumer		-		-		-		-
Commercial		-		-		-		-
	$	14,763	$	16,569	$	24	$	1,806

	As of December 31, 2019
	Recorded Investment		Unpaid Principal		Reserve		Cumulative Charge-Offs
	(In Thousands)
Total Impaired with Reserve
One- to four-family	$	217	$	217	$	32	$	-
Multi-family		-		-		-		-
Home equity		-		-		-		-
Construction and land		-		-		-		-
Commercial real estate		7		416		7		409
Consumer		-		-		-		-
Commercial		-		-		-		-
		224		633		39		409
Total Impaired with no Reserve
One- to four-family		8,508		9,531		-		1,023
Multi-family		667		1,491		-		824
Home equity		84		84		-		-
Construction and land		-		-		-		-
Commercial real estate		574		574		-		-
Consumer		-		-		-		-
Commercial		-		-		-		-
		9,833		11,680		-		1,847
Total Impaired
One- to four-family		8,725		9,748		32		1,023
Multi-family		667		1,491		-		824
Home equity		84		84		-		-
Construction and land		-		-		-		-
Commercial real estate		581		990		7		409
Consumer		-		-		-		-
Commercial		-		-		-		-
	$	10,057	$	12,313	$	39	$	2,256

The difference between a loan’s recorded investment and the unpaid principal balance represents a partial charge-off resulting from a confirmed loss when the value of the collateral securing the loan is below the loan balance and management’s assessment that the full collection of the loan balance is not likely.

The following tables present data on impaired loans for the nine months ended September 30, 2020 and 2019.

	Nine months ended September 30,
	2020				2019
	Average Recorded Investment		Interest Paid		Average Recorded Investment		Interest Paid
	(In Thousands)
Total Impaired with Reserve
One- to four-family	$	214	$	12	$	265	$	11
Multi-family		-		-		-		-
Home equity		-		-		-		-
Construction and land		-		-		-		-
Commercial real estate		-		-		11		-
Consumer		-		-		-		-
Commercial		-		-		-		-
		214		12		276		11
Total Impaired with no Reserve
One- to four-family		7,986		353		7,779		358
Multi-family		643		61		715		60
Home equity		78		3		129		6
Construction and land		-		-		-		-
Commercial real estate		6,059		208		660		19
Consumer		-		-		-		-
Commercial		-		-		-		-
		14,766		625		9,283		443
Total Impaired
One- to four-family		8,200		365		8,044		369
Multi-family		643		61		715		60
Home equity		78		3		129		6
Construction and land		-		-		-		-
Commercial real estate		6,059		208		671		19
Consumer		-		-		-		-
Commercial		-		-		-		-
	$	14,980	$	637	$	9,559	$	454

When a loan is considered impaired, interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower’s financial condition and prospects for repayment, including consideration of the borrower’s sustained historical repayment performance and other relevant factors.

The determination as to whether an allowance is required with respect to impaired loans is based upon an analysis of the value of the underlying collateral and/or the borrower’s intent and ability to make all principal and interest payments in accordance with contractual terms. The evaluation process is subject to the use of significant estimates and actual results could differ from estimates. This analysis is primarily based upon third party appraisals and/or a discounted cash flow analysis. In those cases in which no allowance has been provided for an impaired loan, the Company has determined that the estimated value of the underlying collateral exceeds the remaining outstanding balance of the loan. Of the total $14.6 million of impaired loans as of September 30, 2020 for which no allowance has been provided, $1.8 million in net charge-offs have been recorded to reduce the unpaid principal balance to an amount that is commensurate with the loans’ net realizable value, using the estimated fair value of the underlying collateral. To the extent that further deterioration in property values continues, the Company may have to reevaluate the sufficiency of the collateral servicing these impaired loans which may result in additional provisions to the allowance for loans losses or charge-offs.

At September 30, 2020, total impaired loans included $9.6 million of troubled debt restructurings. Troubled debt restructurings involve granting concessions to a borrower experiencing financial difficulty by modifying the terms of the loan in an effort to avoid foreclosure. The vast majority of debt restructurings include a modification of terms to allow for an interest only payment and/or reduction in interest rate. The restructured terms are typically in place for six to twelve months. At December 31, 2019, total impaired loans included $4.0 million of troubled debt restructurings.

The following presents data on troubled debt restructurings:

		As of September 30, 2020
		Accruing				Non-accruing					Total
		Amount		Number		Amount			Number		Amount			Number
	(Dollars in Thousands)

One- to four-family		$	2,736		2		$	564		4		$	3,300		6
Multi-family			-		-			272		2			272		2
Commercial real estate			5,986		2			-		-			5,986		2
		$	8,722		4		$	836		6		$	9,558		10

		As of December 31, 2019
		Accruing				Non-accruing					Total
		Amount		Number		Amount			Number		Amount			Number
	(Dollars in Thousands)

One- to four-family		$	2,740		2		$	685		5		$	3,425		7
Multi-family			-		-			308		2			308		2
Commercial real estate			278		1			7		1			285		2
		$	3,018		3		$	1,000		8		$	4,018		11

At September 30, 2020, $9.6 million in loans had been modified in troubled debt restructurings and $836,000 of these loans were included in the non-accrual loan total. The remaining $8.7 million, while meeting the internal requirements for modification in a troubled debt restructuring, were current with respect to payments under their original loan terms at the time of the restructuring and, therefore, continued to be included with accruing loans. Provided these loans perform in accordance with the modified terms, they will continue to be accounted for on an accrual basis.

All loans that have been modified in a troubled debt restructuring are considered to be impaired. As such, an analysis has been performed with respect to all of these loans to determine the need for a valuation reserve. When a loan is expected to perform in accordance with the restructured terms and ultimately return to and perform under contract terms, a valuation allowance is established for an amount equal to the excess of the present value of the expected future cash flows under the original contract terms as compared with the modified terms, including an estimated default rate. When there is doubt as to the borrower’s ability to perform under the restructured terms or ultimately return to and perform under market terms, a valuation allowance is established equal to the impairment when the carrying amount exceeds fair value of the underlying collateral. As a result of the impairment analysis, no valuation allowance was recorded as of September 30, 2020 with respect to the $9.6 million in troubled debt restructurings. As of December 31, 2019, a $7,000 valuation allowance had been established with respect to the $4.0 million in troubled debt restructurings.

After a troubled debt restructuring reverts to market terms, a minimum of six consecutive contractual payments must be received prior to consideration for a return to accrual status. If an updated credit department review indicates no other evidence of elevated credit risk, the loan is returned to accrual status at that time.

The following presents troubled debt restructurings by concession type:

		As of September 30, 2020
	Performing in accordance with modified terms					In Default				Total
	Amount			Number		Amount		Number		Amount		Number
	(Dollars in Thousands)
Interest reduction and principal forbearance		$	3,535		6	$	-		-	$	3,535		6
Interest reduction			311		3		-		-		311		3
Principal forbearance			5,712		1		-		-		5,712		1
		$	9,558		10	$	-		-	$	9,558		10

		As of December 31, 2019
	Performing in accordance with modified terms					In Default				Total
	Amount			Number		Amount		Number		Amount		Number
	(Dollars in Thousands)
Interest reduction and principal forbearance		$	3,246		6	$	448		2	$	3,694		8
Interest reduction			324		3		-		-		324		3
		$	3,570		9	$	448		2	$	4,018		11

There was one commercial real estate loan modified as troubled debt restructurings with a balance of $5.7 million during the three and nine months ended September 30, 2020. There were no loans modified as troubled debt restructurings during the three and nine months ended September 30, 2019.

There were no troubled debt restructurings within the past twelve months for which there was a default during the three or nine months ended September 30, 2020 or September 30, 2019.

The provisions of the CARES Act included an election to not apply the guidance on accounting for troubled debt restructurings to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) December 31, 2020 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Company elected to adopt these provisions of the CARES Act. At September 30, 2020, the Company had approximately $3.2 million in outstanding loans subject to interest and principal and principal deferral agreements.

The following table presents data on non-accrual loans as of September 30, 2020 and December 31, 2019:

	September 30, 2020			December 31, 2019
	(Dollars in Thousands)
Non-accrual loans:
Residential real estate:
One- to four-family	$	5,299		$	5,985
Multi-family		616			667
Home equity		75			70
Construction and land		-			-
Commercial real estate		51			303
Commercial		-			-
Consumer		-			-
Total non-accrual loans	$	6,041		$	7,025
Total non-accrual loans to total loans receivable		0.42	%		0.51	%
Total non-accrual loans to total assets		0.27	%		0.35	%

Note 4— Real Estate Owned

Real estate owned is summarized as follows:

	September 30, 2020			December 31, 2019
	(In Thousands)

One- to four-family	$	70		$	46
Multi-family		-			-
Construction and land		1,256			1,256
Commercial real estate		-			-
Total real estate owned		1,326			1,302
Valuation allowance at end of period		(554	)		(554	)
Total real estate owned, net	$	772		$	748

The following table presents the activity in the Company’s real estate owned:

	Nine months ended September 30,
	2020			2019
	(In Thousands)
Real estate owned at beginning of the period	$	748		$	2,152
Transferred from loans receivable		369			946
Sales (net of gains / losses)		(345	)		(1,201	)
Write downs		-			-
Other		-			(10	)
Real estate owned at the end of the period	$	772		$	1,887

Residential one- to four-family mortgage loans that were in the process of foreclosure were $2.7 million at September 30, 2020 and $2.3 million at December 31, 2019.

Note 5— Mortgage Servicing Rights

The following table presents the activity in the Company’s mortgage servicing rights:

	Nine months ended September 30,
	2020			2019
	(In Thousands)
Mortgage servicing rights at beginning of the period	$	282		$	109
Additions		8,936			225
Amortization		(754	)		(68	)
Sales		-			-
Mortgage servicing rights at end of the period		8,464			266
Valuation allowance during the period		(42	)		(99	)
Mortgage servicing rights at end of the period, net	$	8,422		$	167

During the nine months ended September 30, 2020, $3.06 billion in residential loans were originated for sale on a consolidated basis. During the same period, sales of loans held for sale totaled $3.07 billion, generating mortgage banking income of $166.3 million. The unpaid principal balance of loans serviced for others was $1.24 billion and $64.9 million at September 30, 2020 and December 31, 2019, respectively. These loans are not reflected in the consolidated statements of financial condition.

The fair value of mortgage servicing rights were $9.9 million at September 30, 2020 and $180,000 at September 30, 2019. During the nine months ended September 30, 2020 and September 30, 2019, the Company did not sell any mortgage servicing rights.

The following table shows the estimated future amortization expense for mortgage servicing rights for the periods indicated:

Estimate for the period ending December 31:	(In Thousands)
2020	$	596
2021		2,609
2022		1,550
2023		1,374
2024		940
Thereafter		1,353
Total	$	8,422

Note 6— Deposits

At September 30, 2020 and December 31, 2019, time deposits with balances greater than $250,000 amounted to $77.3 million and $70.6 million, respectively.

A summary of the contractual maturities of time deposits at September 30, 2020 is as follows:

	(In Thousands)

Within one year	$	701,230
More than one to two years		38,658
More than two to three years		2,430
More than three to four years		686
More than four through five years		1,146
	$	744,150

Note 7— Borrowings

Borrowings consist of the following:

	September 30, 2020					December 31, 2019
	Balance		Weighted Average Rate			Balance		Weighted Average Rate
	(Dollars in Thousands)
Short term:
Repurchase agreement	$	48,126		3.25	%	$	13,562		4.66	%
Federal Home Loan Bank, Chicago		34,000		0.13	%		-		-

Long term:
Federal Home Loan Bank, Chicago advances maturing:
2027		50,000		1.73	%		50,000		1.73	%
2028		255,000		2.37	%		255,000		2.37	%
2029		165,000		1.61	%		165,000		1.61	%
	$	552,126		2.02	%	$	483,562		2.11	%

The short-term repurchase agreement represents the outstanding portion of a total $55.0 million commitment with one unrelated bank. The short-term repurchase agreement is utilized by Waterstone Mortgage Corporation to finance loans originated for sale. This agreement is secured by the underlying loans being financed. Related interest rates are based upon the note rate associated with the loans being financed. The short-term repurchase agreement had a $48.1 million balance at September 30, 2020 and a $13.6 million balance at December 31, 2019.

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. In addition, the Company enters into agreements under which it sells loans held for sale subject to an obligation to repurchase the same loans. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and not as a sale and subsequent repurchase of assets. The obligation to repurchase the assets is reflected as a liability in the Company's consolidated statements of financial condition, while the securities and loans held for sale underlying the repurchase agreements remain in the respective investment securities and loans held for sale asset accounts. In other words, there is no offsetting or netting of the investment securities or loans held for sale assets with the repurchase agreement liabilities. The Company's repurchase agreement is subject to master netting agreements, which sets forth the rights and obligations for repurchase and offset. Under the master netting agreement, the Company is entitled to set off the collateral placed with a single counterparty against obligations owed to that counterparty.

The $34.0 million short-term advances consists of one $30.0 million advance with a fixed rate of 0.15% and a maturity date of October 22, 2020 and one $4.0 million advance with a fixed rate of 0.00% and a maturity date of May 1, 2021.

The $50.0 million advance due in 2027 has a fixed rate of 1.73% and has a contractual maturity date in December 2027.

The $255.0 million in advances due in 2028 consists of one $25.0 million advance with a fixed rate of 2.16%, two advances totaling $55.0 million with a fixed rate of 2.27% and with a FHLB single call option in March 2021, one advance of $25.0 million with a fixed rate of 2.40%, two advances totaling $50.0 million with fixed rates of 2.34% and 2.48% and with a FHLB single call option in May 2021, one advance of $50.0 million with a fixed rate of 2.34% and with a FHLB quarterly call option currently available, and one advance of $50.0 million with a fixed rate of 2.57% and with a FHLB quarterly call option that currently available.

The $165.0 million in advances due in 2029 consists of one $50.0 million advance with a fixed rate of 1.98% with a FHLB quarterly call option in May 2022, one $50.0 million advance with a fixed rate of 1.75% with a FHLB quarterly call option beginning in August 2021, one $25.0 million advance with a fixed rate of 1.52% with a FHLB quarterly call option beginning in November 2020, and one advance of $40.0 million with a fixed rate of 1.02% and with a FHLB quarterly call option currently available.

The Company selects loans that meet underwriting criteria established by the FHLB as collateral for outstanding advances. The Company’s borrowings from the FHLB are limited to 80% of the carrying value of unencumbered one- to four-family mortgage loans, 75% of the carrying value of multi-family loans and 64% of the carrying value of home equity loans. In addition, these advances were collateralized by FHLB stock of $26.7 million at September 30, 2020 and $21.2 million at December 31, 2019. In the event of prepayment, the Company is obligated to pay all remaining contractual interest on the advance.

Note 8 – Regulatory Capital

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements, or overall financial performance deemed by the regulators to be inadequate, 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 the Company's and Bank’s assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. The Company's and Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

As required by applicable legislation, the federal banking agencies were required to develop a “Community Bank Leverage Ratio” (the ratio of a bank’s tangible equity capital to average total consolidated assets) for financial institutions with assets of less than $10 billion. A “qualifying community bank” that exceeds this ratio will be deemed to be in compliance with all other capital and leverage requirements, including the capital requirements to be considered “well capitalized” under Prompt Corrective Action statutes. The federal banking agencies may consider a financial institution’s risk profile when evaluating whether it qualifies as a community bank for purposes of the capital ratio requirement.

The federal banking agencies must set the minimum capital for the new Community Bank Leverage Ratio at not less than 8% and not more than 10%. Beginning in the second quarter 2020 and until the end of the year, a banking organization that has a leverage ratio of 8% or greater and meets certain other criteria may elect to use the Community Bank Leverage Ratio framework; and qualified community banks will have until January 1, 2022, before the Community Bank Leverage Ratio requirement is re-established at greater than 9%. Pursuant to Section 4012 of the CARES Act and related interim final rules, the Community Bank Leverage Ratio will be 8% beginning in the second quarter and for the remainder of calendar year 2020, 8.5% for calendar year 2021, and 9% thereafter. A financial institution can elect to be subject to this new definition, and opt-out of this new definition, at any time. As a qualified community bank, we elected to opt-out of this definition during the second quarter of 2020.

Prompt corrective action regulations provide five classifications: well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If only adequately capitalized, regulatory approval is required to accept brokered deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required.

The minimum capital ratios set forth in the Regulatory Capital Plans will be increased and other minimum capital requirements will be established if and as necessary. In accordance with the Regulatory Capital Plans, the Bank will not pursue any acquisition or growth opportunity, declare any dividend or conduct any stock repurchase that would cause the Bank's total risk-based capital ratio and/or its Tier 1 leverage ratio to fall below the established minimum capital levels or the capital levels required for capital adequacy plus the captial conservation buffer. The minimum captial conservation buffer is 2.5%.

As of September 30, 2020, the Bank was well-capitalized, with all capital ratios exceeding the well-capitalized requirement. There are no conditions or events that management believes have changed the Bank’s prompt corrective action capitalization category.

The Bank is subject to regulatory restrictions on the amount of dividends it may declare and pay to the Company without prior regulatory approval, and to regulatory notification requirements for dividends that do not require prior regulatory approval.

The actual and required capital amounts and ratios for the Bank as of September 30, 2020 and December 31, 2019 are presented in the table below:

	September 30, 2020
	Actual					For Capital Adequacy Purposes					Minimum Capital Adequacy with Capital Buffer					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars In Thousands)
Total Capital (to risk-weighted assets)
Consolidated Waterstone Financial, Inc.	$	414,966		23.82	%	$	139,342		8.00	%	$	182,886		10.50	%	$	N/A		N/A
WaterStone Bank		388,156		22.29	%		139,342		8.00	%		182,886		10.50	%		174,177		10.00	%
Tier 1 Capital (to risk-weighted assets)
Consolidated Waterstone Financial, Inc.		396,122		22.74	%		104,506		6.00	%		148,051		8.50	%		N/A		N/A
WaterStone Bank		369,312		21.20	%		104,506		6.00	%		148,051		8.50	%		139,342		8.00	%
Common Equity Tier 1 Capital (to risk-weighted assets)
Consolidated Waterstone Financial, Inc.		396,122		22.74	%		78,380		4.50	%		121,924		7.00	%		N/A		N/A
WaterStone Bank		369,312		21.20	%		78,380		4.50	%		121,924		7.00	%		113,215		6.50	%
Tier 1 Capital (to average assets)
Consolidated Waterstone Financial, Inc.		396,122		18.09	%		87,571		4.00	%		N/A		N/A			N/A		N/A
WaterStone Bank		369,312		16.87	%		87,571		4.00	%		N/A		N/A			109,464		5.00	%
State of Wisconsin (to total assets)
WaterStone Bank		369,312		16.64	%		133,135		6.00	%		N/A		N/A			N/A		N/A

	December 31, 2019
	Actual					For Capital Adequacy Purposes					Minimum Capital Adequacy with Capital Buffer					To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio			Amount		Ratio			Amount		Ratio			Amount		Ratio
	(Dollars In Thousands)
Total Capital (to risk-weighted assets)
Consolidated Waterstone Financial, Inc.	$	404,748		26.17	%	$	123,731		8.00	%	$	162,398		10.50	%	$	N/A		N/A
WaterStone Bank		353,357		22.85	%		123,716		8.00	%		162,378		10.50	%		154,646		10.00	%
Tier 1 Capital (to risk-weighted assets)
Consolidated Waterstone Financial, Inc.		392,361		25.37	%		92,799		6.00	%		131,465		8.50	%		N/A		N/A
WaterStone Bank		340,970		22.05	%		92,787		6.00	%		131,449		8.50	%		123,716		8.00	%
Common Equity Tier 1 Capital (to risk-weighted assets)
Consolidated Waterstone Financial, Inc.		392,361		25.37	%		69,599		4.50	%		108,265		7.00	%		N/A		N/A
WaterStone Bank		340,970		22.05	%		69,590		4.50	%		108,252		7.00	%		100,520		6.50	%
Tier 1 Capital (to average assets)
Consolidated Waterstone Financial, Inc.		392,361		19.69	%		79,691		4.00	%		N/A		N/A			N/A		N/A
WaterStone Bank		340,970		17.11	%		79,691		4.00	%		N/A		N/A			99,614		5.00	%
State of Wisconsin (to total assets)
WaterStone Bank		340,970		17.11	%		119,590		6.00	%		N/A		N/A			N/A		N/A

Note 9 – Income Taxes

Income tax expense totaled $17.8 million for the nine months ended September 30, 2020 compared to $8.7 million during the nine months ended September 30, 2019. Income tax expense was recognized on the statement of income during the nine months ended September 30, 2020 at an effective rate of 25.0% of pretax income compared to 24.3% during the nine months ended September 30, 2019. During the nine months ended September 30, 2020, the Company recognized a benefit of approximately $82,000 related to stock awards exercised compared to a benefit of $113,000 recognized during the nine months ended September 30, 2019. The Company recognized a benefit of $354,000 related to the proceeds received on the bank owned life insurance death benefit during the nine months ended September 30, 2020.

Note 10– Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities

The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the consolidated statements of financial condition. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

	September 30, 2020		December 31, 2019
	(In Thousands)
Financial instruments whose contract amounts represent potential credit risk:
Commitments to extend credit under amortizing loans (1)	$	18,290	$	13,389
Commitments to extend credit under home equity lines of credit (2)		13,742		13,776
Unused portion of construction loans (3)		77,017		90,439
Unused portion of business lines of credit		19,558		14,623
Standby letters of credit		1,296		885

⁽¹⁾ Commitments for loans are extended to customers for up to 90 days after which they expire. Excludes commitments to originate loans held for sale, which are discussed in the following footnote.

⁽²⁾ Unused portions of home equity loans are available to the borrower for up to 10 years.

⁽³⁾ Unused portions of construction loans are available to the borrower for up to one year.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the counter-party. Collateral obtained generally consists of mortgages on the underlying real estate.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds mortgages on the underlying real estate as collateral supporting those commitments for which collateral is deemed necessary.

The Company has determined that there are no probable losses related to commitments to extend credit or the standby letters of credit as of September 30, 2020 and December 31, 2019.

Residential mortgage loans sold to others are predominantly conventional residential first lien mortgages. The Company’s agreements to sell residential mortgage loans in the normal course of business usually require certain representations and warranties on the underlying loans sold related to credit information, loan documentation and collateral, which if subsequently are untrue or breached, could require the Company to repurchase certain loans affected. The Company has only been required to make insignificant repurchases as a result of breaches of these representations and warranties. The Company’s agreements to sell residential mortgage loans also contain limited recourse provisions. The recourse provisions are limited in that the recourse provision ends after certain payment criteria have been met. With respect to these loans, repurchase could be required if defined delinquency issues arose during the limited recourse period. Given that the underlying loans delivered to buyers are predominantly conventional first lien mortgages, historical experience has resulted in insignificant losses and repurchase activity. The Company's reserve for losses related to these recourse provisions totaled $3.2 million and $921,000 as of September 30, 2020 and December 31, 2019, respectively.

In the normal course of business, the Company, or its subsidiaries, are involved in various legal proceedings. In the opinion of management, any liability resulting from pending proceedings would not be expected to have a material adverse effect on the Company's consolidated financial statements.

Herrington et al. v. Waterstone Mortgage Corporation

Waterstone Mortgage Corporation was a defendant in a class action lawsuit that was filed in the United States District Court for the Western District of Wisconsin and subsequently compelled to arbitration before the American Arbitration Association. The plaintiff class alleged that Waterstone Mortgage Corporation violated certain provisions of the Fair Labor Standards Act (FLSA) and failed to pay loan officers consistent with their employment agreements. On July 5, 2017, the arbitrator issued a Final Award finding Waterstone Mortgage Corporation liable for unpaid minimum wages, overtime, unreimbursed business expenses, and liquidated damages under the FLSA. On December 8, 2017, the District Court confirmed the award in large part, and entered a judgment against Waterstone in the amount of $7.3 milllion in damages to Claimants, $3.3 million in attorney fees and costs, and a $20,000 incentive fee to Plaintiff Herrington.

Subsequently, the Seventh Circuit Court of Appeals issued a ruling in October 2018 vacating the District Court’s order enforcing the arbitration award, and remanded the case to the District Court. On April 25, 2019, the District Court held that Plaintiff’s claims must be resolved through single-plaintiff arbitration. As a result, it vacated the July 5, 2017 arbitration award in its entirety, and issued a revised judgement in Waterstone’s favor.

In May 2019, Herrington re-initiated her individual arbitration. The arbitrator issued a written award on February 18, 2020 in which he found Waterstone liable for damages, based on an assumed workweek of 50 hours and $100 in unreimbursed expenses per workweek, awarding Herrington $14,952 in damages on her claims. Herrington has since sought $4.9 million in fees and costs on her award, which includes fees dating back to 2011 and the vacated proceeding. On May 6, 2020, the arbitrator issued an award that would allow Herrington to recover $1.1 million in attorney fees and costs.

Herrington has moved to confirm the award and Waterstone has subsequently moved to vacate the award in court. If the award is confirmed, Waterstone retains its appellate rights to challenge the award before the Seventh Circuit. Waterstone believes that it has meaningful avenues to vacate the award. However, given the details of these recent developments, Waterstone does believe that it has met the criteria with respect to recognizing a loss contingency under GAAP. As such, the Company recorded a loss reserve with respect to this matter for approximately $1.1 million during the three months ended March 31, 2020.

Various Claimants v. Waterstone Mortgage Corporation

Subsequent to the aforementioned decision by the United States District Court for the Western District of Wisconsin, which ruled that claims brought forth under the Herrington class action lawsuit must be resolved through single-plaintiff arbitration, in May 2019, approximately 89 of the prior claimants in the aforementioned class action lawsuit filed new demands in arbitration asserting similar claims (“the Arbitrations”). Currently, the total amount of arbitrations is approximately 100, as some other individuals who filed in court have been compelled to arbitration. Waterstone has answered the arbitration demands and denies the allegations, and Waterstone will continue to vigorously defend its interests in these matters. The first hearings are scheduled for the latter half of 2020. Waterstone does not believe a loss is probable at this time, as that term is used in assessing loss contingencies. Accordingly, in accordance with the authoritative guidance in the evaluation of contingencies, the Company has not recorded an accrual related to these matters. However, an unfavorable outcome is reasonably possible with respect to these individual matters and Waterstone would not characterize the chance of any loss as “remote.” Given the early stage of the individual proceedings, Waterstone cannot yet offer an opinion on the estimated range of any possible loss, in the event of an unfavorable opinion in any of the proceedings.

Raleen Johnson v. Watestone

Subsequent to the aforementioned decision by the United States District Court for the Western District of Wisconsin vacating the prior collective award, on May 3, 2019, Raeleen Johnson and approximately 35 other Loan Originators who were prior Claimants in the Herrington Arbitration also filed a claim in the Eastern District of Wisconsin, in the United States District Court for the Eastern District of Wisconsin, Johnson et al. v. Waterstone Mortgage Corporation. The Johnson action claims that Waterstone Mortgage Corporation violated the FLSA by failing to pay loan officers minimum and overtime wages. They also allege Waterstone breached its contractual agreement regarding their compensation.

The Johnson action was plead as a class and collective action, brought on behalf of Johnson and other Waterstone loan originators. The Court issued a scheduling order in March 2020, setting a discovery cutoff in December 2020 and deadline to file dispositive motions in January 2021. However, Johnson did not move for certification of her claims, and in August 2020, the Court issued an order finding that since no motion for certification had been filed, the case would not proceed as a class action.

Tentative Resolution of Claims

In September 2020, the parties reached a tentative agreement to resolve all of the above claims, including the Herrington individual arbitration and resulting $1.1 million award, the Arbitrations, and the Raeleen Johnson action. The proposed settlement payment is $4.25 million in total, which would fully resolve all of the alleged claims and all attorney fees and costs. The proposed settlement is contingent on it being approved by the individual claimants in the above actions. If the claimants do not approve the terms of the settlement, Waterstone may void the agreement.

As a result of the tentative agreement, the parties have agreed to stay all activity in the pending actions pending completion of the settlement, including the arbitrations set in 2020. The Johnson court issued an order vacating all pretrial dates, and the Herrington court issued an order postponing entry of judgment given the tentative agreement. Given the tentative proposed agreement, Waterstone does believe that it has met the criteria with respect to recognizing a loss contingency under GAAP. As such, the Company recorded a loss reserve with respect to this matter for approximately $4.25 million as of September 30, 2020. As the $1.1 million award related to Herrington was previously recognized during the three months ended March 31, 2020, the impact on the statement of operations during the three months ended September 30, 2020 amounted to charge to earnings of approximately $3.2 million.

Note 11 – Derivative Financial Instruments

Mortgage Banking Derviatives

In connection with its mortgage banking activities, the Company enters into derivative financial instruments as part of its strategy to manage its exposure to changes in interest rates. Mortgage banking derivatives include interest rate lock commitments provided to customers to fund mortgage loans to be sold in the secondary market and forward commitments for the future delivery of such loans to third party investors. It is the Company’s practice to enter into forward commitments for the future delivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes in interest rates on its commitments to fund the loans as well as on its portfolio of mortgage loans held for sale. The Company’s mortgage banking derivatives have not been designated as hedge relationships. These instruments are used to manage the Company’s exposure to interest rate movements and other identified risks but do not meet the strict hedge accounting requirements of ASC 815. Changes in the fair value of derivatives not designated in hedging relationships are recorded as a component of mortgage banking income in the Company’s consolidated statements of operations. The Company does not use derivatives for speculative purposes.

Forward commitments to sell mortgage loans represent commitments obtained by the Company from a secondary market agency to purchase mortgages from the Company at specified interest rates and within specified periods of time. Commitments to sell loans are made to mitigate interest rate risk on interest rate lock commitments to originate loans and loans held for sale. At September 30, 2020, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of approximately $896.8 million and interest rate lock commitments with an aggregate notional amount of approximately $636.6 million. The fair value of the forward commitments to sell mortgage loans at September 30, 2020 included a loss of $445,000 that is reported as a component of other liabilities on the Company's consolidated statement of financial condition. The fair value of the interest rate locks at September 30, 2020 included a gain of $12.6 million that is reported as a component of other assets on the Company's consolidated statements of financial condition. At December 31, 2019, the Company had forward commitments to sell mortgage loans with an aggregate notional amount of $345.0 million and interest rate lock commitments with an aggregate notional amount of approximately $174.3 million. The fair value of the forward commitments to sell mortgage loans at December 31, 2019 included a gain of $3,000 that is reported as a component of other assets on the Company's consolidated statement of financial condition. The fair value of the interest rate locks at December 31, 2019 included a gain of $1.8 million that is reported as a component of other assets on the Company's consolidated statements of financial condition.

In determining the fair value of its derivative loan commitments, the Company considers the value that would be generated by the loan arising from exercise of the loan commitment when sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondary mortgage market. The fair value of these commitments is recorded on the consolidated statements of financial condition with the changes in fair value recorded as a component of mortgage banking income.

The significant unobservable input used in the fair value measurement of the Company's mortgage banking derivatives, including interest rate lock commitments, is the loan pull through rate. This represents the percentage of loans currently in a lock position which the Company estimates will ultimately close. Generally, the fair value of an interest rate lock commitment will be positively (negatively) impacted when the prevailing interest rate is lower (higher) than the interest rate lock commitment. Generally, an increase in the pull through rate will result in the fair value of the interest rate lock increasing when in a gain position, or decreasing when in a loss position. The pull through rate is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. The pull through rate is computed using historical data and the ratio is periodically reviewed by the Company.

Interest Rate Swaps

The Company may offer derivative contracts to its customers in connection with their risk management needs. The Company manages the risk associated with these contracts by entering into an equal and offsetting derivative with a third-party dealer through back-to-back swaps. These derivatives generally work together as an economic interest rate hedge, but the Company does not designate them for hedge accounting treatment. Consequently, changes in fair value of the corresponding derivative financial asset or liability are recorded as either a charge or credit to current earnings during the period in which the changes occurred. The fair value of the swaps is recorded as both an asset and a liability, in other assets and other liabilities on the Company's consolidated statement of financial condition, respectively, in equal amounts for these transactions.

The aggregate amortizing notional value of back-to-back swaps with various commercial borrowers was $108.0 million at September 30, 2020 and $30.9 million at December 31, 2019. The Company receives fixed rates and pays floating rates based upon LIBOR on the swaps with commercial borrowers. These swaps mature in December 2029 to June 2037. Commercial borrower swaps are completed independently with each borrower and are not subject to master netting arrangements. These commercial borrower swaps were reported as a component of other assets on the Company's consolidated statement of financial condition of $5.8 million as of September 30, 2020 and $680,000 as of December 31, 2019. As of September 30, 2020 and December 31, 2019, no back-to-back swaps were in default.

The aggregate amortizing notional value of back-to-back swaps with dealer counterparties was $108.0 million as of September 30, 2020 and $30.9 million as of December 31, 2019. The Company pays fixed rates and receives floating rates based upon LIBOR on the swaps with dealer counterparties. These swaps maturity dates range from December 2029 to June 2037. Dealer counterparty swaps are subject to master netting agreements among the contracts within our Bank and are reported as a component of other liabilities on the Company's consolidated statement of financial condition of $5.8 million as of September 30, 2020 and $680,000 as of December 31, 2019. No right of offset existed with dealer counterparty swaps as of September 30, 2020 and December 31, 2019.

All changes in the fair value of these instruments are recorded in other non-interest income. The Company pledged $7.8 million in mortgage backed securities to secure its obligation under these contracts at September 30, 2020 and $710,000 in cash at December 31, 2019.

Note 12 – Earnings Per Share

Earnings per share are computed using the two-class method. Basic earnings per share is computed by dividing net income allocated to common shares by the weighted average number of common shares outstanding during the applicable period. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares.

There were 124,000 and 110,000 antidilutive shares of common stock for the three months ended September 30, 2020 and 2019, respectively. There were 123,000 and 110,000 antidilutive shares of common stock for the nine months ended September 30, 2020 and 2019, respectively.

Presented below are the calculations for basic and diluted earnings per share:

	Three months ended September 30,				Nine months ended September 30,
	2020		2019		2020		2019
	(In Thousands, except per share amounts)

Net income	$	26,293	$	10,924	$	53,310	$	27,109

Weighted average shares outstanding		24,297		25,772		24,720		26,168
Effect of dilutive potential common shares		83		190		122		204
Diluted weighted average shares outstanding		24,380		25,962		24,842		26,372

Basic earnings per share	$	1.08	$	0.42	$	2.16	$	1.04
Diluted earnings per share	$	1.08	$	0.42	$	2.15	$	1.03

Note 13 – Fair Value Measurements

ASC Topic 820, "Fair Value Measurements and Disclosures" defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements. The standard also emphasizes that fair value (i.e., the price that would be received in an orderly transaction that is not a forced liquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risk such as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. When considering the assumptions that market participants would use in pricing the asset or liability, this accounting standard establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.

Level 1 inputs - In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that we have the ability to access.

Level 2 inputs - Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 inputs that are observable for the asset or liability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets where there are few transactions and inputs other than quoted prices that are observable for the asset or liability, such as interest rates and yield curves that are observable at commonly quoted intervals.

Level 3 inputs - Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset or liability.

In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

The following table presents information about our assets recorded in our consolidated statements of financial condition at their fair value on a recurring basis as of September 30, 2020 and December 31, 2019, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value.

			Fair Value Measurements Using
	September 30, 2020		Level 1		Level 2		Level 3
	(In Thousands)

Assets
Available-for-sale securities
Mortgage-backed securities	$	26,100	$	-	$	26,100	$	-
Collateralized mortgage obligations
Government sponsored enterprise issued		59,519		-		59,519		-
Private-label issued		3,650		-		3,650		-
Government sponsored enterprise bonds		2,499		-		2,499		-
Municipal securities		50,162		-		50,162		-
Other debt securities		11,271		-		11,271		-
Loans held for sale		385,803		-		385,803		-
Mortgage banking derivative assets		12,600		-		-		12,600
Interest rate swap assets		5,794		-		5,794		-
Liabilities
Mortgage banking derivative liabilities		445		-		-		445
Interest rate swap liabilities		5,794		-		5,794		-

			Fair Value Measurements Using
	December 31, 2019		Level 1		Level 2		Level 3
	(In Thousands)

Assets
Available-for-sale securities
Mortgage-backed securities	$	34,150	$	-	$	34,150	$	-
Collateralized mortgage obligations
Government sponsored enterprise issued		81,754		-		81,754		-
Municipal securities		53,692		-		53,692		-
Other debt securities		8,880		-		8,880		-
Loans held for sale		220,123		-		220,123		-
Mortgage banking derivative assets		1,835		-		-		1,835
Interest rate swap assets		680		-		680		-
Liabilities
Mortgage banking derivative liabilities		-		-		-		-
Interest rate swap liabilities		680		-		680		-

The following summarizes the valuation techniques for assets recorded in our consolidated statements of financial condition at their fair value on a recurring basis:

Available-for-sale securities – The Company’s investment securities classified as available for sale include: mortgage-backed securities, collateralized mortgage obligations, government sponsored enterprise bonds, municipal securities and other debt securities. The fair value of mortgage-backed securities, collateralized mortgage obligations and government sponsored enterprise bonds are determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities, prepayment models and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. These model and matrix measurements are classified as Level 2 in the fair value hierarchy. The fair value of municipal and other debt securities is determined by a third party valuation source using observable market data utilizing a multi-dimensional relational pricing model. Standard inputs to this model include observable market data such as benchmark yields, reported trades, broker quotes, rating updates and issuer spreads. These model measurements are classified as Level 2 in the fair value hierarchy. The change in fair value is recorded through an adjustment to the statement of comprehensive income.

Loans held for sale – The Company carries loans held for sale at fair value under the fair value option model. Fair value is generally determined by estimating a gross premium or discount, which is derived from pricing currently observable in the secondary market, principally from observable prices for forward sale commitments. Loans held-for-sale are considered to be Level 2 in the fair value hierarchy of valuation techniques. The change in fair value is recorded through an adjustment to the statement of income.

Mortgage banking derivatives - Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company utilizes a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment and then multiplying by quoted investor prices. The Company also utilizes a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. While there are Level 2 and 3 inputs used in the valuation models, the Company has determined that one or more of the inputs significant in the valuation of both of the mortgage banking derivatives fall within Level 3 of the fair value hierarchy. The change in fair value is recorded through an adjustment to the statement of income.

Interest rate swap assets/liabilities - The Company offers loan level swaps to its customers and offsets its exposure from such contracts by entering into mirror image swaps with a financial institution / swap counterparty. The fair values of derivatives are based on valuation models using observable market data as of the measurement date. Our derivatives are traded in an over-the-counter market where quoted market prices are not always available. Therefore, the fair values of derivatives are determined using quantitative models that utilize multiple market inputs. The inputs will vary based on the type of derivative, but could include interest rates, prices and indices to generate continuous yield or pricing curves, prepayment rates, and volatility factors to value the position. The majority of market inputs are actively quoted and can be validated through external sources, including brokers, market transactions and third-party pricing services. Interest rate swap assets and liabilities are considered to be Level 2 in the fair value hierarchy of valuation techniques. The change in fair value is recorded through an adjustment to the statement of operations, within other income and other expense.

The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2020 and 2019.

	Nine months ended September 30,
	2020		2019
	(In Thousands)

Mortgage derivative, net balance at the beginning of the period	$	1,835	$	898
Mortgage derivative gain, net		10,320		2,345
Mortgage derivative, net balance at the end of the period	$	12,155	$	3,243

There were no transfers in or out of Level 1, 2 or 3 measurements during the periods.

Assets Recorded at Fair Value on a Non-recurring Basis

The following tables present information about our assets recorded in our consolidated statements of financial condition at their fair value on a non-recurring basis as of September 30, 2020 and December 31, 2019, and indicate the fair value hierarchy of the valuation techniques utilized to determine such fair value.

			Fair Value Measurements Using
	September 30, 2020		Level 1		Level 2		Level 3
	(In Thousands)
Impaired loans, net (1)	$	186	$	-	$	-	$	186
Real estate owned		772		-		-		772
Impaired mortgage servicing rights		235		-		-		235

			Fair Value Measurements Using
	December 31, 2019		Level 1		Level 2		Level 3
	(In Thousands)
Impaired loans, net (1)	$	185	$	-	$	-	$	185
Real estate owned		748		-		-		748
Impaired mortgage servicing rights		206		-		-		206

(1) Represents collateral-dependent impaired loans, net, which are included in loans.

Loans – We do not record loans at fair value on a recurring basis. On a non-recurring basis, loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at net realizable value of the underlying collateral. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of impaired loans, loans that have been deemed to be impaired are considered to be Level 3 in the fair value hierarchy of valuation techniques. At September 30, 2020, loans determined to be impaired with an outstanding balance of $210,000 were carried net of specific reserves of $24,000 for a fair value of $186,000. At December 31, 2019, loans determined to be impaired with an outstanding balance of $224,000 were carried net of specific reserves of $39,000 for a fair value of $185,000. Impaired loans collateralized by assets which are valued in excess of the net investment in the loan do not require any specific reserves.

Real estate owned – On a non-recurring basis, real estate owned is recorded in our consolidated statements of financial condition at the lower of cost or fair value. Fair value is determined based on third party appraisals and, if less than the carrying value of the foreclosed loan, the carrying value of the real estate owned is adjusted to the fair value. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of the properties, real estate owned is considered to be Level 3 in the fair value hierarchy of valuation techniques. There were no writedowns during the nine months ended September 30, 2020 and 2019, respectively. At September 30, 2020 and December 31, 2019, real estate owned totaled $772,000 and $748,000, respectively.

Mortgage servicing rights – The Company utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fair value of mortgage servicing rights. The model utilizes prepayment assumptions to project cash flows related to the mortgage servicing rights based upon the current interest rate environment, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The model considers characteristics specific to the underlying mortgage portfolio, such as: contractually specified servicing fees, prepayment assumptions, delinquency rates, late charges and costs to service. Given the significance of the unobservable inputs utilized in the estimation process, mortgage servicing rights are classified as Level 3 within the fair value hierarchy. The Company records the mortgage servicing rights at the lower of amortized cost or fair value. At September 30, 2020 and December 31, 2019, there were $98,000 and $77,000, respectively, of impairment on mortgage servicing rights.

For Level 3 assets and liabilities measured at fair value on a non-recurring basis as of September 30, 2020, the significant unobservable inputs used in the fair value measurements were as follows:

					Significant Unobservable Input Value
	Fair Value at September 30, 2020		Valuation Technique	Significant Unobservable Inputs	Minimum Value			Maximum Value			Weighted Average

Mortgage banking derivatives, net	$	12,155	Pricing models	Pull through rate		12.0	%		95.0	%		86.0	%
Impaired loans		186	Market approach	Discount rates applied to appraisals		15.0	%		15.0	%		15.0	%
Real estate owned		772	Market approach	Discount rates applied to appraisals		13.0	%		59.0	%		48.0	%
Mortgage servicing rights		235	Pricing models	Prepayment rate		7.9	%		36.4	%		15.2	%
				Discount rate		9.5	%		14.3	%		10.0	%
				Cost to service	$	76.46		$	164.13		$	83.17

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Fair value information about financial instruments follows, whether or not recognized in the consolidated statements of financial condition, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company.

The carrying amounts and fair values of the Company’s financial instruments consist of the following:

	September 30, 2020										December 31, 2019
	Carrying amount		Fair Value								Carrying amount		Fair Value
	Carrying amount		Total		Level 1		Level 2		Level 3		Carrying amount		Total		Level 1		Level 2		Level 3
	(In Thousands)
Financial Assets
Cash and cash equivalents	$	86,562	$	86,562	$	86,562	$	-	$	-	$	74,300	$	74,300	$	65,800	$	8,500	$	-
Securities available-for-sale		153,201		153,201		-		153,201		-		178,476		178,476		-		178,476		-
Loans held for sale		385,803		385,803		-		385,803		-		220,123		220,123		-		220,123		-
Loans receivable		1,434,132		1,448,660		-		-		1,448,660		1,388,031		1,426,224		-		-		1,426,224
FHLB stock		26,720		26,720		-		26,720		-		21,150		21,150		-		21,150		-
Accrued interest receivable		5,163		5,163		5,163		-		-		5,344		5,344		5,344		-		-
Mortgage servicing rights		8,422		9,926		-		-		9,926		282		282		-		-		282
Mortgage banking derivative assets		12,600		12,600		-		-		12,600		1,835		1,835		-		-		1,835
Interest rate swap asset		5,794		5,794		-		5,794		-		680		680		-		680		-

Financial Liabilities
Deposits		1,184,651		1,185,424		440,501		744,923		-		1,067,776		1,070,083		328,005		742,078		-
Advance payments by borrowers for taxes		25,987		25,987		25,987		-		-		4,212		4,212		4,212		-		-
Borrowings		552,126		572,521		-		572,521		-		483,562		483,846		-		483,846		-
Accrued interest payable		1,314		1,314		1,314		-		-		1,559		1,559		1,559		-		-
Mortgage banking derivative liabilities		445		445		-		-		445		-		-		-		-		-
Interest rate swap liability		5,794		5,794		-		5,794		-		680		680		-		680		-

The following methods and assumptions were used by the Company in determining its fair value disclosures for financial instruments.

Cash and Cash Equivalents

The carrying amount reported in the consolidated statements of financial condition for cash and cash equivalents is a reasonable estimate of fair value.

Securities

The fair value of securities is generally determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmark securities and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuer spread. Prepayment models are used for mortgage related securities with prepayment features.

Loans Held for Sale

Fair value is estimated using the prices of the Company’s existing commitments to sell such loans and/or the quoted market price for commitments to sell similar loans.

Loans Receivable

The fair value estimation process for the loan portfolio uses an exit price concept and reflects discounts the Company believes are consistent with discounts in the market place. Fair values are estimated for portfolios of loans with similar characteristics. Loans are segregated by type such as one- to four-family, multi-family, home equity, construction and land, commercial real estate, commercial, and other consumer. The fair value of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for similar maturities. The fair value analysis also includes other assumptions to estimate fair value, intended to approximate those a market participant would use in an orderly transaction, with adjustments for discount rates, interest rates, liquidity, and credit spreads, as appropriate.

FHLB Stock

For FHLB stock, the carrying amount is the amount at which shares can be redeemed with the FHLB and is a reasonable estimate of fair value.

Deposits and Advance Payments by Borrowers for Taxes

The fair values for interest-bearing and noninterest-bearing negotiable order of withdrawal accounts, savings accounts, and money market accounts are, by definition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturities to a schedule of aggregated expected monthly maturities of the outstanding certificates of deposit. The advance payments by borrowers for taxes are equal to their carrying amounts at the reporting date.

Borrowings

Fair values for borrowings are estimated using a discounted cash flow calculation that applies current interest rates to estimated future cash flows of the borrowings.

Accrued Interest Payable and Accrued Interest Receivable

For accrued interest payable and accrued interest receivable, the carrying amount is a reasonable estimate of fair value.

Commitments to Extend Credit and Standby Letters of Credit

Commitments to extend credit and standby letters of credit are generally not marketable. Furthermore, interest rates on any amounts drawn under such commitments would be generally established at market rates at the time of the draw. Fair values for the Company’s commitments to extend credit and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements, the counterparty’s credit standing, and discounted cash flow analyses. The fair value of the Company’s commitments to extend credit was not material at September 30, 2020 and December 31, 2019.

Mortgage Banking Derivative Assets and Liabilities

Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forward commitments to sell residential mortgage loans to various investors. The Company relies on a valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the current interest rate environment, and then multiplying by quoted investor prices. The Company also relies on a valuation model to estimate the fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricing available. On the Company’s consolidated statements of financial condition, instruments that have a positive fair value are included in prepaid expenses and other assets, and those instruments that have a negative fair value are included in other liabilities.

Interest Rate Swap Assets and Liabilities

The carrying value and fair value of existing derivative financial instruments are based upon independent valuation models, which use widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative contract. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.

Note 14 – Segment Reporting

Selected financial and descriptive information is required to be provided about reportable operating segments, considering a "management approach" concept as the basis for identifying reportable segments. The management approach is based on the way that management organizes the segments within the enterprise for making operating decisions, allocating resources, and assessing performance. Consequently, the segments are evident from the structure of the enterprise's internal organization, focusing on financial information that an enterprise's chief operating decision-makers use to make decisions about the enterprise's operating matters.

The Company has determined that it has two reportable segments: community banking and mortgage banking. The Company's operating segments are presented based on its management structure and management accounting practices. The structure and practices are specific to the Company and therefore, the financial results of the Company's business segments are not necessarily comparable with similar information for other financial institutions.

Community Banking

The community banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin along with a loan office in Minneapolis, Minnesota. Within this segment, the following products and services are provided: (1) lending solutions such as residential mortgages, home equity loans and lines of credit, personal and installment loans, real estate financing, business loans, and business lines of credit; (2) deposit and transactional solutions such as checking, credit, debit and pre-paid cards, online banking and bill pay, and money transfer services; (3) investable funds solutions such as savings, money market deposit accounts, IRA accounts, certificates of deposit, and (4) fixed and variable annuities, insurance as well as trust and investment management accounts.

Consumer products include loan and deposit products: mortgage, home equity loans and lines, personal term loans, demand deposit accounts, interest bearing transaction accounts and time deposits. Consumer products also include personal investment services. Business banking products include secured and unsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, demand deposit accounts, interest bearing transaction accounts and time deposits.

Mortgage Banking

The mortgage banking segment provides residential mortgage loans for the primary purpose of sale on the secondary market. Mortgage banking products and services are provided by offices in 48 states with the ability to lend in 48 states.

Presented below is the segment information:

	As of or for the three months ended September 30, 2020
	Community Banking		Mortgage Banking			Holding Company and Other			Consolidated
	(In Thousands)

Net interest income (expense)	$	13,461	$	(58	)	$	6		$	13,409
Provision for loan losses		1,000		25			-			1,025
Net interest income (expense) after provision for loan losses		12,461		(83	)		6			12,384

Noninterest income		3,104		73,143			(484	)		75,763

Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		5,000		34,559			(154	)		39,405
Occupancy, office furniture and equipment		874		1,595			-			2,469
Advertising		252		609			-			861
Data processing		490		426			6			922
Communications		113		226			-			339
Professional fees		266		4,465			7			4,738
Real estate owned		11		-			-			11
Loan processing expense		-		1,336			-			1,336
Other		818		2,444			(342	)		2,920
Total noninterest expenses		7,824		45,660			(483	)		53,001
Income before income taxes		7,741		27,400			5			35,146
Income tax expense		1,565		7,284			4			8,853
Net income	$	6,176	$	20,116		$	1		$	26,293

Total assets	$	2,118,968	$	458,526		$	(356,672	)	$	2,220,822

	As of or for the three months ended September 30, 2019
	Community Banking			Mortgage Banking			Holding Company and Other			Consolidated
	(In Thousands)

Net interest income (expense)	$	13,885		$	(774	)	$	43		$	13,154
Provision for loan losses		(150	)		70			-			(80	)
Net interest income (expense) after provision for loan losses		14,035			(844	)		43			13,234

Noninterest income		1,415			36,535			(456	)		37,494

Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		4,075			23,616			(177	)		27,514
Occupancy, office furniture and equipment		942			1,687			-			2,629
Advertising		202			711			-			913
Data processing		588			411			4			1,003
Communications		90			268			-			358
Professional fees		223			688			43			954
Real estate owned		24			-			-			24
Loan processing expense		-			858			-			858
Other		583			1,725			(329	)		1,979
Total noninterest expenses		6,727			29,964			(459	)		36,232
Income before income taxes		8,723			5,727			46			14,496
Income tax expense		1,982			1,584			6			3,572
Net income	$	6,741		$	4,143		$	40		$	10,924

Total assets	$	1,969,835		$	301,565		$	(265,971	)	$	2,005,429

	As of or for the nine months ended September 30, 2020
	Community Banking		Mortgage Banking			Holding Company and Other			Consolidated
	(In Thousands)

Net interest income (expense)	$	40,070	$	(948	)	$	62		$	39,184
Provision for loan losses		6,075		235			-			6,310
Net interest income (expense) after provision for loan losses		33,995		(1,183	)		62			32,874

Noninterest income		7,068		168,159			(1,096	)		174,131

Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		15,074		86,085			(464	)		100,695
Occupancy, office furniture and equipment		2,754		4,990			-			7,744
Advertising		797		1,828			-			2,625
Data processing		1,773		1,234			16			3,023
Communications		301		693			-			994
Professional fees		690		6,935			22			7,647
Real estate owned		55		-			-			55
Loan processing expense		-		3,620			-			3,620
Other		1,930		8,235			(670	)		9,495
Total noninterest expenses		23,374		113,620			(1,096	)		135,898
Income before income taxes		17,689		53,356			62			71,107
Income tax expense		3,293		14,492			12			17,797
Net income	$	14,396	$	38,864		$	50		$	53,310

	As of or for the nine months ended September 30, 2019
	Community Banking			Mortgage Banking			Holding Company and Other			Consolidated
	(In Thousands)

Net interest income (expense)	$	40,547		$	(1,511	)	$	35		$	39,071
Provision (credit) for loan losses		(850	)		120			-			(730	)
Net interest income (expense) after provision for loan losses		41,397			(1,631	)		35			39,801

Noninterest income		3,375			94,470			(904	)		96,941

Noninterest expenses:
Compensation, payroll taxes, and other employee benefits		13,502			62,255			(530	)		75,227
Occupancy, office furniture and equipment		2,858			5,227			-			8,085
Advertising		603			2,231			-			2,834
Data processing		1,538			1,091			12			2,641
Communications		265			774			-			1,039
Professional fees		651			1,734			53			2,438
Real estate owned		75			-			-			75
Loan processing expense		-			2,542			-			2,542
Other		1,707			4,823			(475	)		6,055
Total noninterest expenses		21,199			80,677			(940	)		100,936
Income before income taxes		23,573			12,162			71			35,806
Income tax expense		5,263			3,415			19			8,697
Net income	$	18,310		$	8,747		$	52		$	27,109

Note 15 – Leases

The Company has entered into operating lease agreements for two of its community banking branch locations, all of its mortgage banking office locations, and some of its office equipment. The leases have fixed terms defined regarding the payments and length. The Company elected not to include short-term leases (i.e., leases with initial terms of twelve months or less), or equipment leases (deemed immaterial) on the consolidated statements of financial condition. Some of the leases included options to extend the leases. These options are reviewed and factored into the length of the lease if the option is expected to be extended. Leases did not contain an implicit rate; therefore, the Company used the incremental borrowing rates for the discount rate. There were no sale and leaseback transactions, leveraged leases, or lease transactions with related parties during the three or nine months ended September 30, 2020 and December 31, 2020.

At September 30, 2020, the Company had lease liabilities totaling $7.0 million and right-of-use assets totaling $6.5 million related to these leases. Lease liabilities and right-of-use assets are reflected in other liabilities and other assets, respectively, on the consolidated statements of financial condition.

The cost components of our operating leases were as follows for the three and nine months ended September 30, 2020 and September 30, 2019:

	Three months ended September 30, 2020		Three months ended September 30, 2019		Nine months ended September 30, 2020		Nine months ended September 30, 2019
	(In Thousands)
Operating lease cost	$	786	$	809	$	2,380	$	2,371
Variable cost		134		111		374		527
Short-term lease cost		184		230		563		757
Total	$	1,104	$	1,150	$	3,317	$	3,655

At September 30, 2020, the Company had leases that had not yet commenced, but will create approximately $578,000 of additional lease liabilities and right-of-use assets for the Company in the fourth quarter of 2020.

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

	Nine months ended September 30, 2020
	(Dollars in Thousands)
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	2,689
Initial recognition of right of use asset		474
Initial recognition of lease liabilities		474
Weighted average remaining lease term - operating leases, in years		2.7
Weighted average discount rate - operating leases		5.3	%

As of September 30, 2020, lease liability information for the Company is summarized in the following table.

Maturity analysis	Operating leases
	(In Thousands)
One year or less	$	2,930
More than one year through two years		1,988
More than two years through three years		1,511
More than three years through four years		715
More than four years through five years		92
More than five years		918
Total lease payments		8,154
Present value discount		(1,182	)
Lease liability	$	6,972

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Information

This Quarterly Report on Form 10-Q may contain various forward-looking statements, which can be identified by the use of words such as “estimate,” “project,” “believe,” “intend,” “anticipate,” “plan,” “seek,” “expect” and similar expressions and verbs in the future tense. These forward-looking statements include, but are not limited to:

●		Statements of our goals, intentions and expectations;
●		Statements regarding our business plans, prospects, growth and operating strategies;
●		Statements regarding the quality of our loan and investment portfolio; and
●		Estimates of our risks and future costs and benefits.

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.

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:

●		general economic conditions, either nationally or in our market area, including employment prospects, that are different than expected;
●		the effect of any pandemic; including COVID-19;
●		competition among depository and other financial institutions;
●		inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues, the fair value of financial instruments or the origination levels in our lending business, or increase the level of defaults, losses or prepayments on loans we have made and make whether held in portfolio or sold in the secondary markets;
●		adverse changes in the securities or secondary mortgage markets;
●		changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;
●		changes in monetary or fiscal policies of the U.S. Government, including policies of the U.S. Treasury and the Federal Reserve Board;
●		our ability to manage market risk, credit risk and operational risk in the current economic conditions;
●		our ability to enter new markets successfully and capitalize on growth opportunities;
●		our ability to successfully integrate acquired entities;
●		decreased demand for our products and services;
●		changes in tax policies or assessment policies;
●		the inability of third-party providers to perform their obligations to us;
●		changes in consumer demand, spending, borrowing and savings habits;
●		changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the Securities and Exchange Commission or the Public Company Accounting Oversight Board;
●		our ability to retain key employees;
●		cyber attacks, computer viruses and other technological risks that may breach the security of our websites or other systems to obtain unauthorized access to confidential information and destroy data or disable our systems;
●		technological changes that may be more difficult or expensive than expected;
●		the ability of third-party providers to perform their obligations to us;
●		the effects of any federal government shutdown;
●		the ability of the U.S. Government to manage federal debt limits;
●		significant increases in our loan losses; and
●		changes in the financial condition, results of operations or future prospects of issuers of securities that we own.

See also the factors referred to in reports filed by the Company with the Securities and Exchange Commission (particularly those under the caption “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and Quarterly Report on Form 10-Q for the quarter ended March 31, 2020).

The risks included here are not exhaustive. Other sections of this report may include additional factors which could adversely affect our business and financial performance. New risks emerge from time to time and it is not possible for management to predict all such risks, nor can it assess the impact of all such risks on our business or the extent to which any risk, or combination of risks, may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Overview

The following discussion and analysis is presented to assist the reader in understanding and evaluating the Company’s financial condition and results of operations. It is intended to complement the unaudited consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Quarterly Report on Form 10-Q and should be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the three and nine months ended September 30, 2020 and 2019 and the financial condition as of September 30, 2020 compared to the financial condition as of December 31, 2019.

As described in the notes to the unaudited consolidated financial statements, we have two reportable segments: community banking and mortgage banking. The community banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin along with a loan production office in Minneapolis, Minnesota. Consumer products include loan products, deposit products, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estate construction loans, and deposit accounts. The mortgage banking segment, which is conducted by offices in 21 states through Waterstone Mortgage Corporation, consists of originating residential mortgage loans primarily for sale in the secondary market.

Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of our provision for loan losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. We have provided below a discussion of the material results of operations for each segment on a separate basis for the three and nine months ended September 30, 2020 and 2019, which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of the Company, which includes the consolidated operations of the Bank and Waterstone Mortgage Corporation, for the same periods.

Significant Items

Earnings comparisons for the three and nine months ended September 30, 2020 and 2019 were impacted by the Significant Items summarized below.

COVID-19 and the CARES Act

The COVID-19 pandemic has caused economic and social disruption on an unprecedented scale. While some industries have been impacted more severely than others, all businesses have been impacted to some degree. This disruption has resulted in the shuttering of businesses across the country, significant job loss, and aggressive measures by the federal government.

Congress, the President, and the Federal Reserve have taken several actions designed to cushion the economic fallout. Most notably, the Coronavirus Aid, Relief and Economic Security (“CARES”) Act was signed into law at the end of March 2020 as a $2 trillion legislative package. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors. The package also includes extensive emergency funding for hospitals and providers. In addition to the general impact of COVID-19, certain provisions of the CARES Act as well as other recent legislative and regulatory relief efforts are expected to have a material impact on our operations. While it is not possible to know the full universe or extent of these impacts as of the date this filing, we are disclosing potentially material items of which we are aware.

•

The CARES Act allows for a temporary delay in the adoption of accounting guidance under Accounting Standards Codification Topic 326, “Financial Instruments – Credit Losses (“CECL”) until the earlier of December 31, 2020 or after the end of the COVID-19 national emergency. During the quarter ended March 31, 2020, pursuant to the recently-enacted CARES Act and guidance from the Securities and Exchange Commission (“SEC”) and Financial Accounting Standards Board (“FASB”), we elected to delay adoption of CECL. Our September 30, 2020 financial statements include an allowance for loan losses that was prepared under the existing incurred loss methodology.

•

Under the CARES Act, loans less than 30 days past due as of December 31, 2019 and COVID-19 modifications are considered current. A financial institution suspended the requirements under accounting principles generally accepted in the United States (US GAAP) for loan modifications related to COVID-19 that would otherwise be categorized as a troubled debt restructuring (“TDR”). This includes a suspension of the requirement to determine impairment of these modifications for accounting purposes. In keeping with regulatory guidance to work with borrowers during this unprecedented situation, the Company has executed a payment deferral program for our lending clients that are adversely affected by the pandemic. As of September 30, 2020, the Company had modified eight loans totaling $3.2 million consisting of principal or principal and interest. In accordance with the CARES Act issued in April 2020, these short-term deferrals are not considered troubled debt restructurings.

•

The CARES Act authorized the Small Business Administration (“SBA”) to temporarily guarantee loans under a new loan program call the Paycheck Protection Program (“PPP”). As a qualified SBA lender, we were automatically authorized to originate PPP loans. The Company is actively participating in assisting our customers with applications for resources through the program. PPP loans will have: (a) an interest rate of 1.0%, (b) a five-year loan term to maturity for loans made on or after June 5, 2020 (loans made prior to June 5, 2020 have a two-year term, however borrowers and lenders may mutually agree to extend the maturity for such loans to five years); and (c) principal and interest payments deferred for six months from the date of disbursement. The SBA will guarantee 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP. As of September 30, 2020, we have funded 279 loans totaling $30.1 million. The $30.1 million is outstanding as of September 30, 2020.

Our fee income could be reduced due to COVID-19. In keeping with guidance from regulators, we are working with COVID-19 affected customers to waive fees from a variety of sources, such as, but not limited to, insufficient funds and overdraft fees, ATM fees, account maintenance fees, etc. These reductions in fees are thought, at this time, to be temporary in conjunction with the length of the expected COVID-19 related economic crisis. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact is likely to impact our fee income in future periods.

Our interest income could be reduced due to COVID-19. In keeping with guidance from regulators, we are actively working with COVID-19 affected borrowers to defer their payments, interest, and fees. While interest and fees will still accrue to income, through normal GAAP accounting, should eventual credit losses on these deferred payments emerge, interest income and fees accrued would need to be reversed. In such a scenario, interest income in future periods could be negatively impacted. At this time, we are unable to project the materiality of such an impact, but recognize the breadth of the economic impact may affect our borrowers’ ability to repay in future periods.

Capital and liquidity

As of September 30, 2020, all of our capital ratios, and our subsidiary bank’s capital ratios, were in excess of all regulatory requirements. While we believe that we have sufficient capital to withstand an extended economic recession brought about by COVID-19, our reported and regulatory capital ratios could be adversely impacted by further credit losses.

We maintain access to multiple sources of liquidity. Wholesale funding markets have remained open to us, but rates for short term funding have recently been volatile. If funding costs are elevated for an extended period of time, it could have an adverse effect on our net interest margin. If an extended recession caused large numbers of our deposit customers to withdraw their funds, we might become more reliant on volatile or more expensive sources of funding.

There were no Significant Items during the three and nine months ended September 30, 2019.

Comparison of Community Banking Segment Results of Operations for the Three Months Ended September 30, 2020 and 2019

Net income totaled $6.2 million for the three months ended September 30, 2020 compared to $6.7 million for the three months ended September 30, 2019. Net interest income decreased $424,000 to $13.5 million for the three months ended September 30, 2020 compared to $13.9 million for the three months ended September 30, 2019. Interest income on loans increased on volume offset by a decrease in interest earned in the other interest-earning asset categories. Interest expense decreased as funding rates decreased.

The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current quarter allowance using the incurred loss model. There was a provision for loan losses of $1.0 million for the three months ended September 30, 2020 compared to a negative provision of $150,000 for the three months ended September 30, 2019. During the three months ended September 30, 2020, we made adjustments to our qualitative factors, primarily to account for the significant increase in loans downgraded to our Watch caterogy.

Total noninterest income increased $1.7 million due primarily to gains as a result of two death benefits received on bank-owned life insurance policies in the current quarter. The loan fees increased primarily due to loan prepayment fees and fees earned on loan swaps. Cash surrender value of life insurance decreased as the balance decreased year over year as a result of the death benefits. Other income slightly increased primarily due to wealth management and rental income.

Compensation, payroll taxes, and other employee benefits expense increased $925,000 to $5.0 million due primarily to an increase in salaries expense, health insurance expense, and variable compensation. Occupancy, office furniture and equipment decreased due primarily to decreased computer and furniture and equipment expense. Advertising expense increased primarily due to deposit promotions during the three months ended September 30, 2020. Data processing fees decreased due to the digital conversion fees that began in 2019. Professional fees increased for the three months ended September 30, 2020 due to additional audit and legal fees in 2020. Other noninterest expense increased as a result of a credit for FDIC insurance received during the three months ended September 30, 2019 but not during the three months ended September 30, 2020.

Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30, 2020 and 2019

Net income totaled $20.1 million for the three months ended September 30, 2020 compared to $4.1 million for the three months ended September 30, 2019. We originated $1.30 billion in mortgage loans held for sale (including sales to the community banking segment) during the three months ended September 30, 2020, which represents an increase of $445.4 million, or 52.3%, from the $851.3 million originated during the three months ended September 30, 2019. The increase in loan production volume was driven by a $286.8 million, or 160.4%, increase in refinance products as mortgage rates decreased. Mortgage purchase products increased $158.7 million, or 23.6% due to the high demand of single family homes. Total mortgage banking noninterest income increased $36.6 million, or 100.2%, to $73.1 million during the three months ended September 30, 2020 compared to $36.5 million during the three months ended September 30, 2019. The increase in mortgage banking noninterest income was related to a 52.3% increase in volume and a 26.5% increase in gross margin on loans originated and sold for the three months ended September 30, 2020 compared to September 30, 2019. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The gross margin on loans originated and sold expansion reflects increased industry demand due to the current low rate environment. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.

Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Loans originated for the purchase of a residential property, which generally yield a higher margin than loans originated for refinancing existing loans, comprised 64.1% of total originations during the three months ended September 30, 2020, compared to 79.0% of total originations during the three months ended September 30, 2019, respectively, as refinance demand accelerated from the low rate environment. The mix of loan type trended towards more conventional loans and less governmental loans; with conventional loans and governmental loans comprising 75.6% and 24.4% of all loan originations, respectively, during the three months ended September 30, 2020, compared to 70.1% and 29.9% of all loan originations, respectively, during the three months ended September 30, 2019.

Total compensation, payroll taxes and other employee benefits increased $10.9 million, or 46.3%, to $34.6 million for the three months ended September 30, 2020 compared to $23.6 million for the three months ended September 30, 2019. The increase in compensation expense was primarily a result of the increase in commission expense as fundings increased, bonus and incentives due to record originations. In addition, branch manager pay increased as branches were more profitable. Professional fees increased due to a tentative settlement agreement related to the Herrington litigation (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information). Occupancy, office furniture, and equipment decreased due to lower rent driven by a reduction in branches as underperforming branches closed over the past year. Advertising expense decreased as the low rate environment attracted customers. Loan processing expenses increased due primarily to increased application and funding volumes as interest rates remain low in 2020. Other noninterest expense increased primarily due to amortization of mortgage servicing rights as the value of the servicing portfolio has increased in 2020 compared to 2019.

Consolidated Waterstone Financial, Inc. Results of Operations

	Three months ended September 30,
	2020			2019
	(Dollars in Thousands, except per share amounts)

Net income	$	26,293			10,924
Earnings per share - basic		1.08			0.42
Earnings per share - diluted		1.08			0.42
Annualized return on average assets		4.78	%		2.17	%
Annualized return on average equity		26.30	%		11.15	%

Net Interest Income

Average Balance Sheets, Interest and Yields/Costs

The following tables set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans are included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferred fees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalent yield, where applicable.

	Three months ended September 30,
	2020							2019
	Average Balance		Interest		Yield/Cost			Average Balance		Interest		Yield/Cost
	(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable and held for sale (1)	$	$1,766,715	$	$18,224		4.10	%	$	$1,579,575	$	$18,558		4.66	%
Mortgage related securities (2)		96,529		588		2.42	%		114,051		737		2.56	%
Debt securities, federal funds sold and short-term investments (2)(3)		166,160		801		1.92	%		169,621		1,157		2.71	%
Total interest-earning assets		2,029,404		19,613		3.84	%		1,863,247		20,452		4.35	%

Noninterest-earning assets		160,526							137,723
Total assets	$	$2,189,930						$	$2,000,970

Liabilities and equity
Interest-bearing liabilities:
Demand accounts	$	$50,590		11		0.09	%	$	$37,015		8		0.09	%
Money market, savings, and escrow accounts		282,349		473		0.67	%		206,474		298		0.57	%
Time deposits		741,265		3,011		1.62	%		739,544		4,173		2.24	%
Total interest-bearing deposits		1,074,204		3,495		1.29	%		983,033		4,479		1.81	%
Borrowings		531,588		2,640		1.98	%		509,099		2,745		2.14	%
Total interest-bearing liabilities		1,605,792		6,135		1.52	%		1,492,132		7,224		1.92	%

Noninterest-bearing liabilities
Noninterest-bearing deposits		129,911							86,849
Other noninterest-bearing liabilities		56,451							33,130
Total noninterest-bearing liabilities		186,362							119,979
Total liabilities		1,792,154							1,612,111
Equity		397,776							388,859
Total liabilities and equity	$	$2,189,930						$	$2,000,970

Net interest income / Net interest rate spread (4)				13,478		2.32	%				13,228		2.43	%
Less: taxable equivalent adjustment				69		0.01	%				74		0.01	%
Net interest income / Net interest rate spread, as reported			$	$13,409		2.31	%			$	$13,154		2.42	%
Net interest-earning assets (5)	$	$423,612						$	$371,115
Net interest margin(6)						2.63	%						2.80	%
Tax equivalent effect						0.01	%						0.02	%
Net interest margin on a fully tax equivalent basis (6)						2.64	%						2.82	%
Average interest-earning assets to average interest-bearing liabilities						126.38	%						124.87	%

__________

(1) Interest income includes net deferred loan fee amortization income of $349,000 and $136,000 for the three months ended September 30, 2020 and 2019, respectively.

(2) Average balance of mortgage related and debt securities are based on amortized historical cost.

(3) Interest income from tax-exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2020 and 2019. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.75% and 2.53% for the three months ended September 30, 2020 and 2019, respectively.

(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis.

(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(6) Net interest margin represents net interest income divided by average total interest-earning assets.

Rate/Volume Analysis

The following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows the effects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changes in volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rate and volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

	Three months ended September 30,
	2020 versus 2019
	Increase (Decrease) due to
	Volume			Rate			Net
	(In Thousands)
Interest income:
Loans receivable and held for sale (1)(2)	$	2,030		$	(2,364	)	$	(334	)
Mortgage related securities (3)		(107	)		(42	)		(149	)
Debt securities, federal funds sold and short-term investments (3)(4)		(23	)		(333	)		(356	)
Total interest-earning assets		1,900			(2,739	)		(839	)

Interest expense:
Demand accounts		3			-			3
Money market, savings, and escrow accounts		118			57			175
Time deposits		10			(1,172	)		(1,162	)
Total interest-earning deposits		131			(1,115	)		(984	)
Borrowings		150			(255	)		(105	)
Total interest-bearing liabilities		281			(1,370	)		(1,089	)
Net change in net interest income	$	1,619		$	(1,369	)	$	250

______________

(1) Interest income includes net deferred loan fee amortization income of $349,000 and $136,000 for the three months ended September 30, 2020 and 2019, respectively.

(2) Non-accrual loans have been included in average loans receivable balance.

(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the three months ended September 30, 2020 and September 30, 2019.

Net interest income increased $255,000, or 1.9%, to $13.4 million during the three months ended September 30, 2020 compared to $13.2 million during the three months ended September 30, 2019.

●		Interest income on loans decreased $334,000 due primarily to a 56 basis point decrease in average yield on loans as London Interbank Offered Rate (LIBOR) and U.S. Treasury rates continued to decrease offset by an increase of $187.1 million, or 11.8%, in average loans. The increase in average loan balance was driven by a $49.7 million, or 3.6%, increase in the average balance of loans held in portfolio and by an increase of $137.5 million, or 68.8%, in the average balance of loans held for sale.
●		Interest income from mortgage-related securities decreased $149,000 as the yield decreased 14 basis points and the average balance decreased $17.5 million.
●		Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) decreased $351,000 due to a 78 basis point decrease in the average yield. The decrease in average yield was primarily driven by the decrease in federal funds rate over the past year and as higher yielding securities have matured. The average balance decreased $3.5 million to $166.2 million due to a lower municipal securities balances as maturities that occurred throughout the past 12 months were not replaced due to market conditions. Offsetting those decreases, the balance of FHLB stock increased with additional FHLB borrowings.
●		Interest expense on time deposits decreased $1.2 million, or 27.8%, primarily due to a 62 basis point decrease in average cost of time deposits. Offset the decrease in average cost of time deposits, the average balance of time deposits increased $1.7 million compared to the prior year period.
●		Interest expense on money market, savings, and escrow accounts increased $175,000, or 58.7%, due primarily to a 10 basis point increase in average cost of money market, savings, and escrow accounts along with an increase in average balance of $75.9 million. Money market accounts have been a focus over the year and the Company has aggressively marketed new customers through various new offerings and new branches that opened within the past 12 months.
●		Interest expense on borrowings decreased $105,000, or 3.8%, due to a decrease in the average cost of borrowings of 16 basis points to 1.98% during the three months ended September 30, 2020 compared to 2.14% during the three months ended September 30, 2019. The decrease in the cost of borrowings resulted from the new short-term fundings borrowed at a lower rate. Offsetting the decrease in rate, the average borrowing volume increased $22.5 million to $531.6 million during the three months ended September 30, 2020, compared to $509.1 million during the three months ended September 30, 2019. The increase was primarily due to the funding of the loans held for sale.

Provision for Loan Losses

The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current quarter allowance using the incurred loss model. The provision for loan losses was $1.0 million for the three months ended September 30, 2020 compared to $80,000 of negative provision for loan losses for the three months ended September 30, 2019 as there was an increase in loans downgraded to our Watch category. Additional qualitative risk factors were applied to each of the loan categories primarily to account for the downgrades. We had a provision for loan losses of $1.0 million at the community banking segment and $25,000 for the mortgage banking segment. Net recoveries were $85,000 for the three months ended September 30, 2020.

The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are used to determine an appropriate allowance for loan losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section for an analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Losses" section.

Noninterest Income

	Three months ended September 30,
	2020		2019		$ Change			% Change
	(Dollars in Thousands)

Service charges on loans and deposits	$	672	$	503	$	169			33.6	%
Increase in cash surrender value of life insurance		714		728		(14	)		(1.9	)%
Mortgage banking income		72,112		36,062		36,050			100.0	%
Other		2,265		201		2,064			1,026.9	%
Total noninterest income	$	75,763	$	37,494	$	38,269			102.1	%

Total noninterest income increased $38.3 million, or 102.1%, to $75.8 million during the three months ended September 30, 2020 compared to $37.5 million during the three months ended September 30, 2019. The increase resulted primarily from an increase in mortgage banking income and other noninterest income.

●		The increase in mortgage banking income was primarily the result of an increase in loan origination volume and gross margin on loans originated and sold. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. Total loan origination volume on a consolidated basis increased $445.8 million, or 54.2%, to $1.27 billion during the three months ended September 30, 2020 compared to $822.8 million during the three months ended September 30, 2019. Gross margin on loans originated and sold increased 26.5% at the mortgage banking segment. See "Comparison of Mortgage Banking Segment Results of Operations for the Three Months Ended September 30, 2020 and 2019" above for additional discussion of the increase in mortgage banking income.
●		Service charges on loans and deposits increased primarily due to loan prepayment fees and fees earned on loan swaps.
●		The decrease in cash surrender value of life insurance was due primarily to an decrease in balance as death benefit proceeds were received on two policies.
●		The increase in other noninterest income was due primarily to increases in gain from death benefit on bank owned life insurance, mortgage servicing fee income, wealth management revenue, and rental income. Mortgage servicing fee income increased as loans sold with servicing rights retained increased due to market conditions.

Noninterest Expenses

	Three months ended September 30,
	2020		2019		$ Change			% Change
	(Dollars in Thousands)

Compensation, payroll taxes, and other employee benefits	$	39,405	$	27,514	$	11,891			43.2	%
Occupancy, office furniture and equipment		2,469		2,629		(160	)		(6.1	)%
Advertising		861		913		(52	)		(5.7	)%
Data processing		922		1,003		(81	)		(8.1	)%
Communications		339		358		(19	)		(5.3	)%
Professional fees		4,738		954		3,784			396.6	%
Real estate owned		11		24		(13	)		(54.2	)%
Loan processing expense		1,336		858		478			55.7	%
Other		2,920		1,979		941			47.5	%
Total noninterest expenses	$	53,001	$	36,232	$	16,769			46.3	%

Total noninterest expenses increased $16.8 million, or 46.3%, to $53.0 million during the three months ended September 30, 2020 compared to $36.2 million during the three months ended September 30, 2019.

●		Compensation, payroll taxes and other employee benefits expense at our mortgage banking segment increased $10.9 million, or 46.3%, to $34.6 million during the three months ended September 30, 2020. The increase in compensation expense was primarily a result of an increase in commission expense as fundings increased and branch manager pay increased as branches were more profitable.
●		Compensation, payroll taxes and other employee benefits expense at the community banking segment increased $925,000, or 22.7%, to $5.0 million during the three months ended September 30, 2020. The increase was due primarily to an increase in salaries expense due to annual raises and additional branches, health insurance expense as claims increased, and variable compensation as executives are eligible for an increased bonus.
●		Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $92,000 to $1.6 million during the three months ended September 30, 2020, primarily resulting from lower rent expense offset by an increase in computer equipment expense to accomodate remote working.
●		Occupancy, office furniture and equipment expense at the community banking segment decreased $68,000 to $874,000 during the three months ended September 30, 2020. The decrease was due primarily to decreased computer and furniture and equipment expenses.
●		Advertising expense decreased $52,000, or 5.7%, to $861,000 during the three months ended September 30, 2020. This was primarily due to marketing decreases at the mortgage banking segment as volumes were largely driven by lower rates. Advertising at the community banking segment increased due to promotions for deposit customers.
●		Data processing expense decreased $81,000, or 8.1%, to $922,000 during the three months ended September 30, 2020. This was primarily due to conversion expenses for the new ditigal banking platform rollout at the community banking segment during the three months ended September 30, 2019.
●		Professional fees increased $3.8 million to $4.7 million during the three months ended September 30, 2020. This was primarily due to a $4.25 million tentative legal settlement (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information).
●		Loan processing expense increased $478,000, or 55.7%, to $1.3 million during the three months ended September 30, 2020. This was primarily due to an increase in loan costs associated with the increased application volumes as mortgage rates declined.
●		Other noninterest expense increased $941,000, or 47.5%, to $2.9 million during the three months ended September 30, 2020. The increase at the mortgage banking segment was primarily due to amortization of mortgage servicing rights as the value of the servicing portfolio has increased in 2020 compared to 2019. Additionally, other noninterest expenses increased at the community banking segment as the FDIC issued a credit for the three months ended September 30, 2019 but not for the three months ended September 30, 2020.

Income Taxes

Income tax expense totaled $8.9 million for the three months ended September 30, 2020 compared to $3.6 million during the three months ended September 30, 2019. Income tax expense was recognized on the statement of income during the three months ended September 30, 2020 at an effective rate of 25.2% of pretax income compared to 24.6% during the three months ended September 30, 2019. The increase in rate is primarily due to higher pretax income. The Company recognized a benefit of $354,000 related to the proceeds received on the bank owned life insurance death benefit during the three months ended September 30, 2020.

Comparison of Community Banking Segment for the Nine Months Ended September 30, 2020 and 2019

Net income decreased $3.9 million for the nine months ended September 30, 2020 to $14.4 million compared to net income of $18.3 million for the nine months ended September 30, 2019. Net interest income decreased $477,000 to $40.1 million for the nine months ended September 30, 2020 compared to $40.5 million for the nine months ended September 30, 2019. Net interest income decreased primarily due to a decrease from mortgage-related securities and other interest-earning assets interest. Offsetting the decreases on net interest income, interest income on loans increased due to an increase in volume and interest expense on time deposits decreased as replacement rates were lower.

The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current quarter allowance using the incurred loss model. Provision for loan losses was $6.1 million for the nine months ended September 30, 2020 compared to a negative provision of $850,000 for the nine months ended September 30, 2019 as economic conditions significantly worsened during the nine months ended September 30, 2020.

Total noninterest income increased $3.7 million due primarily to increases in loan fees and a gain from death benefits on bank owned life insurance. The loan fees increased primarily due to loan prepayment fees and fees earned on loan swaps. Cash surrender value of life insurance decreased as the balance decreased due to death benefit proceeds received on two bank owned life insurance policies. Other income increased primarily due to gain on death benefits, wealth management fees, and rental income.

Compensation, payroll taxes, and other employee benefits expense increased $1.6 million to $15.1 million due primarily to an increase in salaries expense, health insurance expense, and variable compensation. Occupancy, office furniture and equipment decreased due primarily to computer and snow plowing expense. Data processing and advertising expense increased primarily due to the rollout of a new ditigal banking platform and promotions for deposit customers during the nine months ended September 30, 2020. Communications expenese, professional fees, and other expenses, increased while real estate owned expenses decreased.

Comparison of Mortgage Banking Segment Operations for the Nine Months Ended September 30, 2020 and 2019

Net income totaled $38.9 million for the nine months ended September 30, 2020 compared to $8.7 million for the nine months ended September 30, 2019. We originated $3.15 billion in mortgage loans held for sale (including sales to the community banking segment) during the nine months ended September 30, 2020, which represents an increase of $1.00 billion, or 46.7%, from the $2.15 billion originated during the nine months ended September 30, 2019. The increase in loan production volume was driven by a $870.9 million, or 265.7%, increase in refinance products as mortgage rates decreased. Mortgage purchase products increased $131.3 million, or 7.2% due to an increased housing demand. Total mortgage banking noninterest income increased $73.7 million, or 78.0%, to $168.2 million during the nine months ended September 30, 2020 compared to $94.5 million during the nine months ended September 30, 2019. The increase in mortgage banking noninterest income was related to a 46.7% increase in volume and an 17.8% increase in gross margin on loans originated and sold for the nine months ended September 30, 2020 compared to September 30, 2019. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. The increase in gross margin on loans originated and sold reflects industry demand due to the low rate environment resulting in higher volume. We sell loans on both a servicing-released and a servicing-retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.

Additionally, our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Our origination efforts continue to be focused on loans made for the purpose of residential purchases, as opposed to mortgage refinance. The percentage of origination volume related to purchase activity decreased to 61.9% from 84.7% of total originations for the nine months ended September 30, 2020 and 2019, respectively, as refinance demand accelerated from the low rate environment. The mix of loan type trended towards more conventional loans and less governmental loans; with conventional loans and governmental loans comprising 74.7% and 25.3% of all loan originations, respectively, during the nine months ended September 30, 2020, compared to 69.7% and 30.3% of all originations, respectively, during the nine months ended September 30, 2019.

Total compensation, payroll taxes and other employee benefits increased $23.8, or 38.3%, to $86.1 million for the nine months ended September 30, 2020 compared to $62.3 million for the nine months ended September 30, 2019. The increase in compensation expense was primarily a result of the increase in commission expense as fundings increased, bonus and incentives due to record originations. In addition, branch manager pay increased as branches were more profitable. Occupancy, office furniture, and equipment expense decreased due to lower rent expense as underperforming branches closed offset by an increase in computer expenses to accommodate remote work. Advertising expense decreased as the low rate environment attracted customers. Loan processing expenses increased for the nine months ended September 30, 2020 as loan costs increased due to loan application volume. Professional fees increased primarily due to a $4.25 million legal settlement (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information) along with ongoing litigation costs. Other noninterest expense increased primarily due to increased provision for loan sale losses as there was additional uncertainity regarding selling loans to third party investors from COVID-19 pandemic challenges and the amortization of mortgage servicing rights as the value of the servicing portfolio has increased in 2020 compared to 2019.

Consolidated Waterstone Financial, Inc. Results of Operations

	Nine months ended September 30,
	2020			2019
	(Dollars in Thousands, except per share amounts)

Net income	$	53,310		$	$27,109
Earnings per share - basic		2.16			1.04
Earnings per share - diluted		2.15			1.03
Annualized return on average assets		3.35	%		1.84	%
Annualized return on average equity		18.02	%		9.21	%

Net Interest Income

Average Balance Sheets, Interest and Yields/Costs

	Nine months ended September 30,
	2020							2019
	Average Balance		Interest		Yield/Cost			Average Balance		Interest		Yield/Cost
	(Dollars in Thousands)
Assets
Interest-earning assets:
Loans receivable and held for sale (1)	$	$1,696,493	$	$54,404		4.28	%	$	$1,536,532	$	$53,688		4.67	%
Mortgage related securities (2)		104,752		1,960		2.50	%		114,748		2,260		2.63	%
Debt securities, federal funds sold and short-term investments (2)(3)		178,775		2,703		2.02	%		181,375		3,741		2.76	%
Total interest-earning assets		1,980,020		59,067		3.98	%		1,832,655		59,689		4.35	%

Noninterest-earning assets		146,959							133,530
Total assets	$	$2,126,979						$	$1,966,185

Liabilities and equity
Interest-bearing liabilities:
Demand accounts	$	$45,275		27		0.08	%	$	$36,345		23		0.08	%
Money market, savings, and escrow accounts		251,377		1,364		0.72	%		192,195		891		0.62	%
Time deposits		735,350		10,369		1.88	%		737,286		11,899		2.16	%
Total interest-bearing deposits		1,032,002		11,760		1.52	%		965,826		12,813		1.77	%
Borrowings		545,631		7,913		1.94	%		484,572		7,579		2.09	%
Total interest-bearing liabilities		1,577,633		19,673		1.67	%		1,450,398		20,392		1.88	%

Noninterest-bearing liabilities
Noninterest-bearing deposits		112,777							92,075
Other noninterest-bearing liabilities		41,502							30,345
Total noninterest-bearing liabilities		154,279							122,420
Total liabilities		1,731,912							1,572,818
Equity		395,067							393,367
Total liabilities and equity	$	$2,126,979						$	$1,966,185

Net interest income / Net interest rate spread (4)				39,394		2.31	%				39,297		2.47	%
Less: taxable equivalent adjustment				210		0.01	%				226		0.01	%
Net interest income / Net interest rate spread, as reported			$	$39,184		2.30	%			$	$39,071		2.46	%
Net interest-earning assets (5)	$	$402,387						$	$382,257
Net interest margin(6)						2.64	%						2.85	%
Tax equivalent effect						0.02	%						0.02	%
Net interest margin on a fully tax equivalent basis (6)						2.66	%						2.87	%
Average interest-earning assets to average interest-bearing liabilities						125.51	%						126.36	%

__________

(1) Interest income includes net deferred loan fee amortization income of $948,000 and 458,000 for the nine months ended September 30, 2020 and 2019, respectively.

(2) Average balance of mortgage related and debt securities are based on amortized historical cost.

(3) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2020 and 2019. The yields on debt securities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.86% and 2.59% for the nine months ended September 30, 2020 and 2019, respectively.

(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.

(6) Net interest margin represents net interest income divided by average total interest-earning assets.

Rate/Volume Analysis

	Nine months ended September 30,
	2020 versus 2019
	Increase (Decrease) due to
	Volume			Rate			Net
	(In Thousands)
Interest income:
Loans receivable and held for sale (1)(2)	$	5,385		$	(4,669	)	$	716
Mortgage related securities (3)		(176	)		(124	)		(300	)
Debt securities, federal funds sold and short-term investments (3) (4)		(55	)		(983	)		(1,038	)
Total interest-earning assets		5,154			(5,776	)		(622	)

Interest expense:
Demand accounts		4			-			4
Money market, savings, and escrow accounts		310			163			473
Time deposits		(30	)		(1,500	)		(1,530	)
Total interest-earning deposits		284			(1,337	)		(1,053	)
Borrowings		776			(442	)		334
Total interest-bearing liabilities		1,060			(1,779	)		(719	)
Net change in net interest income	$	4,094		$	(3,997	)	$	97

______________

(1)	Interest income includes net deferred loan fee amortization income of $948,000 and $458,000 for the nine months ended September 30, 2020 and 2019, respectively.

(2) Non-accrual loans have been included in average loans receivable balance.

(3) Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.

(4) Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 21% for the nine months ended September 30, 2020 and 2019.

Net interest income increased $113,000, or 0.3%, to $39.2 million during the nine months ended September 30, 2020 compared to $39.1 million during the nine months ended September 30, 2019.

●		Interest income on loans increased $716,000 due primarily to an increase of $160.0 million, or 10.4%, in average loans offset by a 39 basis point decrease in average yield on loans as LIBOR and U.S. Treasury rates continue to decrease. The increase in average loan balance was driven by a $37.4 million, or 2.7%, increase in the average balance of loans held in portfolio and by an increase of $122.5 million, or 76.9%, in the average balance of loans held for sale.
●		Interest income from mortgage related securities decreased $300,000 primarily as the yield decreased 13 basis points. Additionally, the average balance decreased $10.0 million.
●		Interest income from other interest-earning assets (comprised of debt securities, federal funds sold and short-term investments) decreased $1.0 million due to a 73 basis point decrease in the average yield. The decrease in average yield was primarily driven by the decrease in federal funds rate over the past year and as higher yielding securities have matured. The average balance decreased $2.6 million to $178.8 million due to lower municipal securities balances as maturities occurred throughout the past 12 months and were not replaced due to market conditions. Offsetting those decreases, the balance of FHLB stock increased with additional FHLB borrowings.
●		Interest expense on time deposits decreased $1.5 million, or 12.9%, primarily due to a 28 basis point decrease in average cost of time deposits. Additionally, the average balance of time deposits decreased $1.9 million compared to the prior year period.
●		Interest expense on money market, savings, and escrow accounts increased $473,000, or 53.1%, due primarily to a 10 basis point increase in average cost of money market, savings, and escrow accounts along with an increase in average balance of $59.2 million. Money market accounts have been a focus over the year and the Company has aggressively marketed new customers through various new offerings and new branches that opened within the past 12 months.
●		Interest expense on borrowings increased $334,000, or 4.4%, due to an increase of $61.1 million to $545.6 million in average borrowing volume during the nine months ended September 30, 2020. The increase was primarily due to the funding of the loans held for sale. Offsetting the increase in volume, the average cost of borrowings decreased 15 basis points to 1.94% during the nine months ended September 30, 2020, compared to 2.09% during the nine months ended September 30, 2019. The decrease in the cost of borrowings resulted from the new short-term fundings borrowed at a lower rate.

Provision for Loan Losses

The Company delayed adoption of ASC Topic 326 as permited under the CARES Act. The Company calculated the current year allowance using the incurred loss model. The provision for loan losses was $6.3 million for the nine months ended September 30, 2020 compared to a negative provision for loan losses of $730,000 for the nine months ended September 30, 2019 as economic conditions worsened due to the COVID-19 pandemic along with an increase of loan downgrades to our Watch category. Additional qualitative risk factors were applied to each of the loan categories primarily to account for the significant increase in the unemployment rate and those downgrades. We had a provision for loan losses of $6.1 million at the community banking segment and $235,000 for the mortgage banking segment. Net recoveries were $147,000 for the nine months ended September 30, 2020.

Noninterest Income

			Nine months ended September 30,
	2020		2019		$ Change		% Change
			(Dollars in Thousands)

Service charges on loans and deposits	$	3,384	$	1,272	$	2,112		166.0	%
Increase in cash surrender value of life insurance		1,587		1,579		8		0.5	%
Mortgage banking income		166,292		93,526		72,766		77.8	%
Other		2,868		564		2,304		408.5	%
Total noninterest income	$	174,131	$	96,941	$	77,190		79.6	%

Total noninterest income increased $77.2 million, or 79.6%, to $174.1 million during the nine months ended September 30, 2020 compared to $96.9 million during the nine months ended September 30, 2019. The increase resulted primarily from an increase in mortgage banking income along with increases in all noninterest income categories.

●		The increase in mortgage banking income was primarily the result of an increase in loan origination volume and gross margin on loans originated and sold. Gross margin on loans originated and sold is the ratio of mortgage banking income (excluding the change in interest rate lock fair value) divided by total loan originations. Total loan origination volume on a consolidated basis increased $970.9 million, or 46.4%, to $3.06 billion during the nine months ended September 30, 2020 compared to $2.09 billion during the nine months ended September 30, 2019. Gross margin on loans originated and sold increased 17.8% at the mortgage banking segment. See "Comparison of Mortgage Banking Segment Results of Operations for the Nine Months Ended September 30, 2020 and 2019" above for additional discussion of the increase in mortgage banking income.
●		Service charges on loans and deposits increased primarily due to loan prepayment fees and fees earned on loan swaps.
●		The increase in cash surrender value of life insurance was due primarily to an increase in average balance.
●		The increase in other noninterest income was due primarily to increases in gain from death benefit on bank owned life insurance, mortgage servicing fee income, wealth management revenue, and rental income. Mortgage servicing fee income increased as loans sold with servicing rights retained increased due to market conditions.

Noninterest Expenses

	Nine months ended September 30,
	2020		2019		$ Change			% Change
	(Dollars in Thousands)

Compensation, payroll taxes, and other employee benefits	$	$100,695	$	75,227	$	25,468			33.9	%
Occupancy, office furniture and equipment		7,744		8,085		(341	)		(4.2	)%
Advertising		2,625		2,834		(209	)		(7.4	)%
Data processing		3,023		2,641		382			14.5	%
Communications		994		1,039		(45	)		(4.3	)%
Professional fees		7,647		2,438		5,209			213.7	%
Real estate owned		55		75		(20	)		(26.7	)%
Loan processing expense		3,620		2,542		1,078			42.4	%
Other		9,495		6,055		3,440			56.8	%
Total noninterest expenses	$	$135,898	$	100,936	$	34,962			34.6	%

Total noninterest expenses increased $35.0 million, or 34.6%, to $135.9 million during the nine months ended September 30, 2020 compared to $100.9 million during the nine months ended September 30, 2019.

●		Compensation, payroll taxes and other employee benefit expense at our mortgage banking segment increased $23.8 million, or 38.3%, to $86.1 million for the nine months ended September 30, 2020. The increase in compensation expense was primarily a result of an increase in commission expense as fundings increased and branch manager pay increased as branches were more profitable.
●		Compensation, payroll taxes and other employee benefits expense at the community banking segment increased $1.6 million, or 11.6%, to $15.1 million during the nine months ended September 30, 2020. The increase was due primarily to an increase in salaries expense due to annual raises, health insurance expense as claims increased, and variable compensation as executives are eligible for an increased bonus. Offsetting the increases, equity award expense decreased as a majority of awards granted in 2015 had a final vesting in 2019.
●		Occupancy, office furniture and equipment expense at the mortgage banking segment decreased $237,000 to $5.0 million during the nine months ended September 30, 2020, resulting from lower rent expense as a result of underperforming branches closing. Offsetting the decreases, computer expenses increased to accomodate remote working.
●		Occupancy, office furniture and equipment expense at the community banking segment decreased $104,000 to $2.8 million during the nine months ended September 30, 2020. The decrease was due primarily to lower computer, furniture and equipment, and snow plowing expense.
●		Advertising expense decreased $403,000 at the mortgage banking segment as lower rates generated customer activity. Offsetting the decrease at the mortgage banking segment, advertising increased $194,000 at the community banking segment to promote the opening of a new branch, the new digital banking platform, and promotions for deposit customers.
●		Data processing expense increased $382,000, or 14.5%, to $3.0 million during the nine months ended September 30, 2020. This was primarily due to the new ditigal banking platform rollout at the community banking segment and new contracts at the mortgage banking segment as technology investments continue to increase.
●		Professional fees expense increased $5.2 million, or 213.7%, to $7.6 million primarily as a result of an increase in legal fees at the mortgage banking segment for a $4.25 million tentative legal settlement (see further discussion in Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information) and ongoing litigation costs along with an increase in audit expense at the community banking segment.
●		Loan processing expense increased $1.1 million, or 42.4%, to $3.6 million during the nine months ended September 30, 2020. This was primarily due to an increase in loan costs associated with the application volumes as mortgage rates declined.
●		Other noninterest expense increased $3.4 million for the nine months ended September 30, 2020 due to an increase at the mortgage banking segment. The increase at the mortgage banking segment was primarily due to an increased provision for loan sale losses as there was additional uncertainity regarding selling loans to third party investors from COVID-19 pandemic challenges. Additionally, amortization of mortgage servicing rights increased as the value of the servicing portfolio has increased in 2020 compared to 2019. Other noninterest expenses increased at the community banking segment due primarily to loan related costs for the nine months ended September 30, 2020 along with a decrease in other regulator fees.

Income Taxes

Comparison of Financial Condition at September 30, 2020 and December 31, 2019

Total Assets – Total assets increased by $224.5 million, or 11.2%, to $2.22 billion at September 30, 2020 from $2.00 billion at December 31, 2019. The increase in total assets primarily reflects an increase in loans held for sale, loans receivable and prepaid expenses and other assets due to an increase in the fair market value of the loan rate lock commitments partially offset by a decrease in securities available for sale. The total assets increase reflects liability increases in deposits, additional short-term debt, advance payments by borrowers for taxes, and other liabilities due to hedging liabilities.

Cash and Cash Equivalents – Cash and cash equivalents increased $12.3 million, or 16.5%, to $86.6 million at September 30, 2020, compared to $74.3 million at December 31, 2019. The increase in cash and cash equivalents primarily reflects the additional source of funds through an increase in deposits, short-term borrowings, and advance payments by borrowers for taxes.

Securities Available for Sale – Securities available for sale decreased $25.3 million to $153.2 million at September 30, 2020. The decrease was primarily due to paydowns in mortgage-related securities and maturities of debt securities exceeding security purchases for the year.

Loans Held for Sale - Loans held for sale increased $165.7 million to $385.8 million at September 30, 2020 due to the increase of refinancing activity resulting from the reduction in mortgage rates.

Loans Receivable - Loans receivable held for investment increased $46.1 million to $1.43 billion at September 30, 2020. The increase in total loans receivable was attributable to increases in commercial real estate, construction and land, multi-family, and commercial loan categories. The growth in the commercial loan category was driven by $30.1 million of PPP loans originated during the nine months ended September 30, 2020. Partially offsetting those increases, one- to four-family, home equity, and consumer loan categories decreased.

The following table shows loan originations during the periods indicated.

	For the				For the
	Nine months ended September 30,				Year Ended
	2020		2019		December 31, 2019
			(In Thousands)
Real estate loans originated for investment:
Residential
One- to four-family	$	90,290	$	66,113	$	95,461
Multi-family		133,027		64,301		110,136
Home equity		4,914		3,756		5,804
Construction and land		41,418		48,567		59,814
Commercial real estate		26,637		24,645		49,710
Total real estate loans originated for investment		296,286		207,382		320,925
Consumer loans originated for investment		275		55		55
Commercial business loans originated for investment		41,944		5,426		7,517
Total loans originated for investment	$	338,505	$	212,863	$	328,497

Allowance for Loan Losses - The allowance for loan losses increased $6.5 million to $18.8 million at September 30, 2020. The increase resulted from a provision due to increased economic uncertainity increasing the required allowance related to the loans collectively reviewed. The overall increase was primarily related to each of the one- to four-family, multi-family, home equity, construction and land, commercial real estate, consumer, and commercial categories. See Note 3 for further discussion on the allowance for loan losses.

Real Estate Owned – Total real estate owned increased $24,000 to $772,000 at September 30, 2020. During the nine months ended September 30, 2020, $369,000 of loans were transferred from loans receivable to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $345,000. There were no writedowns during the nine months ended September 30, 2020.

Prepaid expenses and other assets – Total prepaid expenses and other assets increased $34.0 million to $54.8 million at September 30, 2020. The increase was primarily due to increases in loan rate lock commitments, funding receivables from investors, and receivables from back-to-back interest rate swaps.

Deposits – Total deposits increased $116.9 million to $1.18 billion at September 30, 2020. The increase was driven by an increase of $73.3 million in money market and savings deposits, $39.2 million in demand deposits, and $4.4 million in time deposits.

Borrowings – Total borrowings increased $68.6 million, or 14.2%, to $552.1 million at September 30, 2020. The community banking segment added $34.0 million in short-term FHLB borrowings. External short-term borrowings at the mortgage banking segment increased a total of $34.6 million at September 30, 2020 from December 31, 2019.

Advance Payments by Borrowers for Taxes - Advance payments by borrowers for taxes increased $21.8 million to $26.0 million at September 30, 2020. The increase was the result of payments received from borrowers for their real estate taxes and is seasonally normal, as balances increase during the course of the calendar year until real estate tax obligations are paid in the fourth quarter.

Other Liabilities - Other liabilities increased $11.5 million to $58.6 million at September 30, 2020 compared to December 31, 2019. Other liabilities increased primarily due to liabilies resulting from payables due on back-to-back swaps, accrued compensation, and forward commitments to sell loans at the mortgage banking segment. Offsetting the increase, other liabilities decreased related to a seasonal decrease in outstanding checks related to advance payments by borrowers for taxes. The Company receives payments from borrowers for their real estate taxes during the course of the calendar year until real estate tax obligations are paid in the fourth quarter. At the time at which the disbursements are made, the outstanding checks are classified as other liabilities in the statements of financial condition. These amounts remain classified as other liabilities until settled.

Shareholders’ Equity – Shareholders' equity increased $5.7 million to $399.4 million at September 30, 2020 from December 31, 2019. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised and equity awards vested, an increase in fair value of the security portfolio, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends and the repurchase of stock.

ASSET QUALITY

NONPERFORMING ASSETS

	At September 30,			At December 31,
	2020			2019
	(Dollars in Thousands)
Non-accrual loans:
Residential
One- to four-family	$	5,299		$	5,985
Multi-family		616			667
Home equity		75			70
Construction and land		-			-
Commercial real estate		51			303
Commercial		-			-
Consumer		-			-
Total non-accrual loans		6,041			7,025

Real estate owned
One- to four-family		70			46
Multi-family		-			-
Construction and land		1,256			1,256
Commercial real estate		-			-
Total real estate owned		1,326			1,302
Valuation allowance at end of period		(554	)		(554	)
Total real estate owned, net		772			748
Total nonperforming assets	$	6,813		$	7,773

Total non-accrual loans to total loans		0.42	%		0.51	%
Total non-accrual loans to total assets		0.27	%		0.35	%
Total nonperforming assets to total assets		0.31	%		0.39	%

All loans that are 90 days or more past due with respect to principal and interest are recognized as non-accrual. Troubled debt restructurings that are non-accrual either due to being past due greater than 90 days or which have not yet performed under the modified terms for a reasonable period of time, are included in the table above. In addition, loans that are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit risk factors such as early stage delinquency, the nature of the collateral or the results of a borrower review. When the collection of all contractual principal and interest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered. This process generally takes place when a loan is contractually past due between 60 and 89 days. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded to establish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan is determined to be uncollectible, typically coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, and charged-off.

The following table sets forth activity in our non-accrual loans for the periods indicated.

	At or for the Nine Months
	Ended September 30,
	2020			2019
	(In Thousands)

Balance at beginning of period	$	7,025		$	6,555
Additions		2,327			2,241
Transfers to real estate owned		(369	)		(946	)
Charge-offs		(3	)		(8	)
Returned to accrual status		(1,563	)		(237	)
Principal paydowns and other		(1,376	)		(1,292	)
Balance at end of period	$	6,041		$	6,313

Total non-accrual loans decreased by $984,000, or 14.0%, to $6.0 million as of September 30, 2020 compared to $7.0 million as of December 31, 2019. The ratio of non-accrual loans to total loans receivable was 0.42% at September 30, 2020 compared to 0.51% at December 31, 2019. During the nine months ended September 30, 2020, $2.3 million in loans were placed on non-accrual status. Offsetting this activity, $1.6 million returned to accrual status, $1.4 million in principal payments were received, and $369,000 transferred to real estate owned during the nine months ended September 30, 2020.

Of the $6.0 million in total non-accrual loans as of September 30, 2020, $4.9 million in loans have been specifically reviewed to assess whether a specific valuation allowance is necessary. A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds the present value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustment made for costs to dispose of the asset. Based upon these specific reviews, a total of $1.2 million in cumulative partial net charge-offs have been recorded over the life of these loans as of September 30, 2020. Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a "non-performing" status and are disclosed as impaired loans. In addition, specific reserves totaling $24,000 have been recorded as of September 30, 2020. The remaining $1.2 million of non-accrual loans were reviewed on an aggregate basis and $237,000 in general valuation allowance was deemed appropriate related to those loans as of September 30, 2020. The $237,000 in valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.

The outstanding principal balance of our five largest non-accrual loans as of September 30, 2020 totaled $2.1 million, which represents 34.5% of total non-accrual loans as of that date. These five loans have not had any cumulative life-to-date net charge-offs and $24,000 in specific valuation allowance was deemed necessary based on net realizable collateral value with respect to these five loans as of September 30, 2020.

For the nine months ended September 30, 2020, gross interest income that would have been recorded had our non-accruing loans been current in accordance with their original terms was $311,000. We received $320,000 of interest payments on such loans during the nine months ended September 30, 2020. Interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.

There were no accruing loans past due 90 days or more at September 30, 2020 or December 31, 2019.

TROUBLED DEBT RESTRUCTURINGS

The following table summarizes information with respect to the accrual status of our troubled debt restructurings:

	As of September 30, 2020
	Accruing		Non-accruing		Total
	(In Thousands)

One- to four-family	$	2,736	$	564	$	3,300
Multi-family		-		272		272
Commercial real estate		5,986		-		5,986
	$	8,722	$	836	$	9,558

	As of December 31, 2019
	Accruing		Non-accruing		Total
	(In Thousands)

One- to four-family	$	2,740	$	685	$	3,425
Multi-family		-		308		308
Commercial real estate		278		7		285
	$	3,018	$	1,000	$	4,018

All troubled debt restructurings are considered to be impaired, are risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the unaudited consolidated financial statements. Specific reserves have been established to the extent that collateral-based impairment analyses indicate that a collateral shortfall exists.

We do not participate in government-sponsored troubled debt restructuring programs. Our troubled debt restructurings are short-term modifications. Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. Restructured terms do not include a reduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at the end of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists.

If a restructured loan is current in all respects and a minimum of six consecutive restructured payments have been received, it can be considered for return to accrual status. After a restructured loan that is current in all respects reverts to contractual/market terms, if a credit department review indicates no evidence of elevated market risk, the loan is removed from the troubled debt restructuring classification.

We modified loans for borrowers that were not considered troubled debt under the CARES Act. Loans less than 30 days past due as of December 31, 2019 were allowed for modifications if the borrower experienced a COVID-19 hardship. As of September 30, 2020, the Company has modified $3.2 million of loans consisting of the deferral of principal and interest or deferral of interest. In accordance with the CARES Act, these short term deferrals are not considered troubled debt restructurings.

The following table summarizes information with respect to the loans modified under the CARES Act as of September 30, 2020.

	September 30, 2020

Loan modifications:
Residential real estate:
One- to four-family	$	2,915
Commercial real estate		225
Commercial		32
Total loan modifications	$	3,172
Total loan modifications to total loans receivable		0.22	%

LOAN DELINQUENCY

The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio:

	At September 30,			At December 31,
	2020			2019
	(Dollars in Thousands)

Loans past due less than 90 days	$	2,503		$	1,833
Loans past due 90 days or more		3,052			4,632
Total loans past due	$	5,555		$	6,465

Total loans past due to total loans receivable		0.39	%		0.47	%

Past due loans decreased by $910,000, or 14.1%, to $5.6 million at September 30, 2020 from $6.5 million at December 31, 2019. Loans past due less than 90 days increased by $670,000, or 36.6%, primarily in the one- to four-family loan category. Loans past due 90 days or more decreased by $1.6 million, or 34.1%, primarily in the one- to four-family during the nine months ended September 30, 2020.

REAL ESTATE OWNED

Total real estate owned increased by $24,000, or 3.2%, to $772,000 at September 30, 2020, compared to $748,000 at December 31, 2019. During the nine months ended September 30, 2020, $369,000 of loans were transferred to real estate owned upon completion of foreclosure. During the same period, sales of real estate owned totaled $345,000. There were no write downs during the nine months ended September 30, 2020. New appraisals received on real estate owned and collateral dependent impaired loans are based upon an “as is value” assumption. During the period of time in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:

●		Applying an updated adjustment factor (as described previously) to an existing appraisal;
●		Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;
●		Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral;
●		Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and
●		Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (not owned by the Company).

Virtually all habitable real estate owned (both residential and commercial properties) is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are recorded at the lower of carrying value or fair value, less costs to sell, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned within 90 days of being transferred. Subsequent write-downs to reflect current fair market value, as well as gains and losses upon disposition and revenue and expenses incurred in maintaining such properties, are treated as period costs and included in real estate owned in the consolidated statements of income. The fair value is primarily based upon updated appraisals in addition to an analysis of current real estate market conditions.

ALLOWANCE FOR LOAN LOSSES

	At or for the Nine Months
	Ended September 30,
	2020			2019
	(Dollars in Thousands)

Balance at beginning of period	$	12,387		$	13,249
Provision (credit) for loan losses		6,310			(730	)
Charge-offs:
Mortgage
One- to four-family		9			69
Multi-family		5			2
Home equity		13			44
Commercial real estate		-			2
Construction and land		-			-
Consumer		10			5
Commercial		-			-
Total charge-offs		37			122
Recoveries:
Mortgage
One- to four-family		132			116
Multi-family		17			13
Home equity		22			19
Commercial real estate		11			2
Construction and land		2			-
Consumer		-			-
Commercial		-			-
Total recoveries		184			150
Net recoveries		(147	)		(28	)
Allowance at end of period	$	18,844		$	12,547

Ratios:
Allowance for loan losses to non-accrual loans at end of period		311.94	%		198.75	%
Allowance for loan losses to loans receivable at end of period		1.31	%		0.91	%
Net recoveries to average loans outstanding (annualized)		(0.01	)%		0.00	%
(Provision) credit for loan losses to net recoveries		(4,292.52	)%		2,607.14	%
Net recoveries to beginning of the period allowance (annualized)		(1.59	)%		(0.28	)%

The allowance for loan losses increased $6.5 million to $18.8 million at September 30, 2020, compared to $12.4 million at December 31, 2019. The increase in allowance for loan losses reflects the $6.3 million provision. The provision recorded during the current year reflects an increased allocation related to the economic condition qualatitive factor as a result of the COVID-19 pandemic in each of the loan categories. Additionally, there were increased qualatitive factors to account for an increase of loan downgrades to our Watch category.

We had net recoveries of $147,000, or 0.01% of average loans annualized, for the nine months ended September 30, 2020, compared to net recoveries of $28,000, or less than 0.01% of average loans annualized, for the nine months ended September 30, 2019. Of the $147,000 in recoveries during the nine months ended September 30, 2020, the majority of the activity related to loans secured by one- to four-family residential loans.

Our underwriting policies and procedures emphasize that credit decisions must rely on both the credit quality of the borrower and the estimated value of the underlying collateral. Credit quality is assured only when the estimated value of the collateral is objectively determined and is not subject to significant fluctuation.

The allowance for loan losses has been determined in accordance with GAAP. We are responsible for the timely and periodic determination of the amount of the allowance required. Any future provisions for loan losses will continue to be based upon our assessment of the overall loan portfolio and the underlying collateral, trends in non-performing loans, current economic conditions and other relevant factors. To the best of management’s knowledge, all probable losses have been provided for in the allowance for loan losses.

The establishment of the amount of the loan loss allowance inherently involves judgments by management as to the appropriateness of the allowance, which ultimately may or may not be correct. Higher than anticipated rates of loan default would likely result in a need to increase provisions in future years.

Liquidity and Capital Resources

We maintain liquid assets at levels we consider adequate to meet our liquidity needs. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay real estate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The level of our liquidity position at any point in time is dependent upon the judgment of the senior management as supported by the Asset/Liability Committee. Liquidity is monitored on a daily, weekly and monthly basis using a variety of measurement tools and indicators.

Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and other short-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source of funds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set the interest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provide liquidity to meet lending requirements. Additional sources of liquidity used for the purpose of managing long- and short-term cash flows include advances from the FHLB.

During the nine months ended September 30, 2020, primary uses of cash and cash equivalents included: $3.06 billion in funding loans held for sale, $46.3 million for funding of loans receivable, $32.7 million in purchases of our common stock, $21.7 million for cash dividends paid, $5.6 million for purchases of FHLB stock, $4.5 million for purchases of mortgage related securities, and $5.0 million for purchases of debt securities.

During the nine months ended September 30, 2020, primary sources of cash and cash equivalents included: $3.07 billion in proceeds from the sale of loans held for sale, $34.0 million in proceeds from short-term FHLB borrowings, $34.6 million in proceeds from additional short-term borrowings, $116.9 million from an increase in deposits, $33.6 million in principal repayments on mortgage related securities, $3.8 million in maturities of debt securities, $53.3 million in net income, $9.6 million in proceeds from death benefits on bank owned life insurance, and a $9.9 million increase in advance payments by borrowers for taxes.

During the nine months ended September 30, 2019, primary uses of cash and cash equivalents included: $2.09 billion in funding loans held for sale, $22.9 million for cash dividends paid, $12.1 million for purchases of mortgage related securities, and $22.7 million in purchases of our common stock.

During the nine months ended September 30, 2019, primary sources of cash and cash equivalents included: $2.09 billion in proceeds from the sale of loans held for sale, $40.0 million in additional proceeds from long-term borrowings, $1.1 million from an increase in deposits, $40.7 million in additional proceeds from short-term borrowings, $21.9 million in principal repayments on mortgage related securities, $7.7 million from a decrease in loans receivable, and $27.1 million in net income.

A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At September 30, 2020 and 2019, respectively, $86.6 million and $66.2 million of our assets were invested in cash and cash equivalents. At September 30, 2020, cash and cash equivalents were comprised of the following: $54.7 million in cash held at the Federal Reserve Bank and other depository institutions and $31.9 million in federal funds sold and short-term investments. Our primary sources of cash are principal repayments on loans, proceeds from the calls and maturities of debt and mortgage-related securities, increases in deposit accounts, advances from the FHLB, and repurchase agreements from other institutions.

Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally, borrowing agreements exist with the FHLB which provide an additional source of funds. At September 30, 2020, we had $470.0 million in long-term advances from the FHLB with contractual maturity dates in 2027, 2028, and 2029. The 2028 advance maturities have single call options in March 2021 and May 2021, along with two advances that have quarterly call options. Two advances are currently callable quarterly. The 2029 advance maturities have quarterly call option currently available and the other options beginning November 2020, August 2021, and May 2022. We had $34.0 million in short-term advances with the FHLB and contractual maturities in October 2020 and May 2021. As an additional source of funds, the mortgage banking segment has a repurchase agreement. At September 30, 2020, we had $48.1 million outstanding under the repurchase agreement with a total outstanding commitment of $55.0 million.

At September 30, 2020, we had outstanding commitments to originate loans receivable of $16.8 million. In addition, at September 30, 2020, we had unfunded commitments under construction loans of $76.2 million, unfunded commitments under business lines of credit of $22.8 million and unfunded commitments under home equity lines of credit and standby letters of credit of $14.4 million. At September 30, 2020, certificates of deposit scheduled to mature in one year or less totaled $701.2 million. Based on prior experience, management believes that, subject to the Bank’s funding needs, a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case. In the event a significant portion of our deposits is not retained by us, we will have to utilize other funding sources, such as FHLB advances, in order to maintain our level of assets. However, we cannot assure that such borrowings would be available on attractive terms, or at all, if and when needed. Alternatively, we could reduce our level of liquid assets, such as our cash and cash equivalents and securities available-for-sale in order to meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount of competition for deposits in our market area at the time of renewal.

Waterstone Financial, Inc. is a separate legal entity from WaterStone Bank and must provide for its own liquidity to pay dividends to its shareholders, repurchase shares of its common stock, and for other corporate purposes. The primary source of liquidity for Waterstone Financial, Inc. is dividend payments from WaterStone Bank. The ability of WaterStone Bank to pay dividends is subject to regulatory restrictions. At September 30, 2020, Waterstone Financial, Inc. (on an unconsolidated basis) had liquid assets totaling $26.9 million.

Capital

Shareholders' equity increased $5.7 million to $399.4 million at September 30, 2020 from December 31, 2019. Shareholders' equity increased primarily due to net income, additional paid-in capital as stock options were exercised, equity awards vesting, the fair value of the security portfolio, and unearned ESOP shares vesting. Partially offsetting the increases, there were decreases due to the declaration of regular and special dividends and the repurchase of stock.

The Company's Board of Directors authorized a stock repurchase program in the third quarter of 2020. As of September 30, 2020, the Company had repurchased 10.5 million shares at an average price of $14.34 under previously approved stock repurchase plans.

WaterStone Bank is subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items to broad risk categories. At September 30, 2020, WaterStone Bank exceeded all regulatory capital requirements and is considered “well capitalized” under regulatory guidelines. See “Notes to Unaudited Consolidated Financial Statements - Note 8 - Regulatory Capital.”

Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements

The following tables present information indicating various contractual obligations and commitments of the Company as of September 30, 2020 and the respective maturity dates.

					More than		More than
					One Year		Three Years		Over
			One Year		Through		Through		Five
	Total		or Less		Three Years		Five Years		Years
	(In Thousands)
Demand deposits (3)	$	169,218	$	$169,218	$	-	$	-	$	-
Money market and savings deposits (3)		271,283		271,283		-		-		-
Time deposit (3)		744,150		701,230		41,088		1,832		-
Repurchase agreements (3)		48,126		48,126		-		-		-
Federal Home Loan Bank advances (1)		504,000		34,000		-		-		470,000
Operating leases (2)		8,925		2,958		3,500		1,549		918
	$	1,745,702	$	$1,226,815	$	$44,588	$	$3,381	$	$470,918

⁽¹⁾ Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest which will accrue on the advances. See call provisions in Note 7 - Borrowings.

⁽²⁾ Represents non-cancelable operating leases for offices and equipment.

⁽³⁾ Excludes interest.

See Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities of the notes to unaudited consolidated financial statements for additional information.

Off-Balance Sheet Commitments

The following table details the amounts and expected maturities of significant off-balance sheet commitments as of September 30, 2020.

					More than		More than
					One Year		Three Years		Over
			One Year		Through		Through		Five
	Total		or Less		Three Years		Five Years		Years
	(In Thousands)
Real estate loan commitments (1)	$	18,290	$	18,290	$	-	$	-	$	-
Unused portion of home equity lines of credit (2)		13,742		13,742		-		-		-
Unused portion of construction loans (3)		77,017		77,017		-		-		-
Unused portion of business lines of credit		19,558		19,558		-		-		-
Standby letters of credit		1,296		1,296		-		-		-
Total Other Commitments	$	129,903	$	129,903	$	-	$	-	$	-

General: Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and generally have fixed expiration dates or other termination clauses.

⁽¹⁾ Commitments for loans are extended to customers for up to 90 days after which they expire.

⁽²⁾ Unused portions of home equity loans are available to the borrower for up to 10 years.

⁽³⁾ Unused portions of construction loans are available to the borrower for up to one year.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Management of Market Risk

General. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Our assets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our business strategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, WaterStone Bank’s board of directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determining the level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this risk consistent with the guidelines approved by the board of directors. Management monitors the level of interest rate risk on a regular basis and the Asset/Liability Committee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.

We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We have implemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial real estate loans as well as three to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and (iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLB. These measures should reduce the volatility of our net interest income in different interest rate environments.

Income Simulation. Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time. At least quarterly we review the potential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities. Our most recent simulation uses projected repricing of assets and liabilities at September 30, 2020 on the basis of contractual maturities, anticipated repayments and scheduled rate adjustments. Prepayment rate assumptions may have a significant impact on interest income simulation results. Because of the large percentage of loans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our mortgage related assets that may in turn affect our interest rate sensitivity position. When interest rates rise, prepayment speeds slow and the average expected lives of our assets would tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a positive impact on net interest income and earnings.

The following interest rate scenario displays the percentage change in net interest income over a one-year time horizon assuming increases of 100, 200 and 300 basis points and a decreases of 100 basis points. The results incorporate actual cash flows and repricing characteristics for balance sheet accounts following an instantaneous parallel change in market rates based upon a static no growth, balance sheet.

Analysis of Net Interest Income Sensitivity

	Immediate Change in Rates
		+300		+200	+100	-100
	(Dollar Amounts in Thousands)
As of September 30, 2020
Dollar Change	$	$1,115		1,519	982	(1,993	)
Percentage Change		1.95	%	2.65	1.71	(3.48	)

At September 30, 2020, a 100 basis point instantaneous increase in interest rates had the effect of increasing forecast net interest income over the next 12 months by 1.71% while a 100 basis point decrease in rates had the effect of decreasing net interest income by 3.48%.

Item 4. Controls and Procedures

Disclosure Controls and Procedures: Company management, with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, the Company’s disclosure controls and procedures are effective.

Internal Control Over Financial Reporting: There have been no material changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter to which this report relates that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The information required by this item is set forth in Part I, Item 1, Note 10 - Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities.

Item 1A. Risk Factors

Except as previously disclosed, there have been no material changes in risk factors applicable to the Company from those disclosed in “Risk Factors” in Item 1A of the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 and Quarterly report on Form 10-Q for the quarter ended March 31, 2020.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Following are the Company’s monthly common stock repurchases during the third quarter of 2020:

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans		Maximum Number of Shares that May Yet Be Purchased Under the Plan^(a)
July 1, 2020 - July 31, 2020		52,650	$	$15.31		52,650		1,947,350
August 1, 2020 - August 31, 2020		299,990		15.57		299,990		1,647,360
September 1, 2020 - Setember 30, 2020		447,322		15.31		447,322		1,200,038
Total		799,962	$	$15.41		799,962		1,200,038

(a)	On July 21, 2020, the Board of Directors announced the completion of the then-existing stock repurchase plan and authorized the repurchase of 2,000,000 shares of common stock pursuant to a new share repurchase plan. The maximum amount of shares were purchased under this plan.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

Exhibit No.		Description	Filed Herewith
	10.2	Form of Incentive Stock Option Agreement (1)
	10.3	Form of Non-Qualified Stock Option Agreement (1)
	10.4	Form of Restricted Stock Award Agreement (1)
	10.5	Form of Performance Based Restricted Stock Unit Agreement (1)
	10.6	Form of Performance Based Restricted Stock Award Agreement (1)
	31.1	Sarbanes-Oxley Act Section 302 Certification signed by the Chief Executive Officer of Waterstone Financial, Inc.		X
	31.2	Sarbanes-Oxley Act Section 302 Certification signed by the Chief Financial Officer of Waterstone Financial, Inc.		X
	32.1	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Executive Officer of Waterstone Financial, Inc.		X
	32.2	Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of Waterstone Financial, Inc.		X
	101	The following financial statements from Waterstone Financial, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline Extensive Business Reporting Language (XBRL): (i) consolidated statements of financial condition, (ii) consolidated statements of income, (iii) consolidated statements of comprehensive income, (iv) consolidated statements of changes in shareholders' equity, (v) consolidated statements of cash flows and (vi) the notes to consolidated financial statements.		X
	104	Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)		X

(1) Incorporated by reference to the registration Statement on Form S-1 (Registration No. 333-249232), initially filed with the U.S. Securities and Exchange Commission on October 1, 2020.

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.

	WATERSTONE FINANCIAL, INC. (Registrant)
Date: November 4, 2020
	/s/ Douglas S. Gordon
	Douglas S. Gordon
	Chief Executive Officer Principal Executive Officer
Date: November 4, 2020
	/s/ Mark R. Gerke
	Mark R. Gerke
	Chief Financial Officer Principal Financial Officer