10-K 1 czwi-20180930x10k.htm 10-K Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
 
 
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended September 30, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from             to            
Commission file number 001-33003
 
 
CITIZENS COMMUNITY BANCORP, INC.
(Exact name of registrant as specified in its charter)
 
Maryland
 
20-5120010
(State or other jurisdiction of
incorporation or organization)
 
(IRS Employer
Identification Number)
2174 EastRidge Center, Eau Claire, WI 54701
(Address of principal executive offices)
715-836-9994
(Registrant’s telephone number, including area code)


Securities registered pursuant to Section 12(b) of the Act:
 
 
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $.01 par value per share
 
NASDAQ Global MarketSM

Securities registered pursuant to Section 12(g) of the Act: None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  ý
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  ý    No  ¨




Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.   ¨ 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer", "accelerated filer", "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
 
Accelerated filer
 
x
Non-accelerated filer
 
¨
 
Smaller reporting company  
 
x
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 Act). Yes  ¨ No  x

The aggregate market value of common stock held by non-affiliates of the registrant, computed by reference to the closing price as of the last business day of the registrant's most recently completed second fiscal quarter, March 29, 2018, was approximately $78.1 million.


APPLICABLE ONLY TO CORPORATE REGISTRANTS
Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:
At December 10, 2018 there were 10,953,512 shares of the registrant’s common stock, par value $0.01 per share, outstanding.
 
DOCUMENTS INCORPORATED BY REFERENCE
None
 





CITIZENS COMMUNITY BANCORP, INC.
FORM 10-K
September 30, 2018
TABLE OF CONTENTS
 
 
 
Page Number
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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As used in this report, the terms “we,” “us,” “our,” “Citizens Community Bancorp” and the “Company” mean Citizens Community Bancorp, Inc. and its wholly owned subsidiary, Citizens Community Federal N.A., unless the context indicates another meaning. As used in this report, the term “Bank” means our wholly owned subsidiary, Citizens Community Federal N.A.
Forward-Looking Statements
Certain matters discussed in this Form 10-K contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and the Company intends that these forward-looking statements be covered by the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. These statements may be identified by the use of forward-looking words or phrases such as “anticipate,” “believe,” “could,” “expect,” “intend,” “may,” “planned,” “potential,” “should,” “will,” “would,” or the negative of those terms or other words of similar meaning.  Similarly, statements that describe the Company’s future plans, objectives or goals are also forward-looking statements. Such forward-looking statements are inherently subject to many uncertainties in the Company’s operations and business environment.
Factors that could affect actual results or outcomes include the matters described under the caption “Risk Factors” in Item 1A of this report and the following:

conditions in the financial markets and economic conditions generally;
the possibility of a deterioration in the residential real estate markets;
interest rate risk;
lending risk;
the sufficiency of loan allowances;
changes in the fair value or ratings downgrades of our securities;
competitive pressures among depository and other financial institutions;
our ability to realize the benefits of net deferred tax assets;
our ability to maintain or increase our market share;
acts of terrorism and political or military actions by the United States or other governments;
legislative or regulatory changes or actions, or significant litigation, adversely affecting the Company or Bank;
increases in FDIC insurance premiums or special assessments by the FDIC;
disintermediation risk;
our inability to obtain needed liquidity;
our ability to raise capital needed to fund growth or meet regulatory requirements;
the possibility that our internal controls and procedures could fail or be circumvented;
our ability to attract and retain key personnel;
our ability to keep pace with technological change;
cybersecurity risks;
risks posed by acquisitions and other expansion opportunities;
difficulties and delays in integrating the acquired business operations or fully realizing the cost savings and other benefits;
changes in federal or state tax laws;
changes in accounting principles, policies or guidelines and their impact on financial performance;
restrictions on our ability to pay dividends; and
the potential volatility of our stock price.

Stockholders, potential investors and other readers are urged to consider these factors carefully in evaluating the forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements. The forward-looking statements made herein are only made as of the date of this filing and the Company undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances occurring after the date of this report.


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PART 1
ITEM 1. BUSINESS
General
Citizens Community Bancorp, Inc. (the "Company") is a Maryland corporation organized in 2004. The Company is a bank holding company and is subject to regulation by the Office of the Comptroller of the Currency (“OCC”) and by the Federal Reserve Bank. Our primary activities consist of holding the stock of our wholly-owned subsidiary bank, Citizens Community Federal N.A. (the "Bank"), and providing commercial, agricultural and consumer banking activities through the Bank. At September 30, 2018, we had approximately $975 million in total assets, $747 million in deposits, and $136 million in equity. Unless otherwise noted herein, all monetary amounts in this report, other than share, per share and capital ratio amounts, are stated in thousands.
Citizens Community Federal N.A.
The Bank is a federally chartered National Bank serving customers in Wisconsin, Minnesota and Michigan through 21 full-service branch locations as of September 30, 2018. Its primary markets include the Chippewa Valley Region in Wisconsin, the Twin Cities and Mankato Minnesota, and various rural communities around these areas. The Bank offers traditional community banking services to businesses, agricultural operators and consumers, including one-to-four family residential mortgages.
Wells Insurance Agency, a Minnesota corporation formed in 1976 and wholly owned subsidiary of the Bank (“WIA”), provides financial and insurance products to customers of the Bank and members of the general public in the Bank's market area. Intercompany interest income and interest expenses are eliminated in the preparation of the consolidated financial statements. WIA maintains adequate cash at the Bank to fund operations.
Acquisitions
On June 20, 2018, the Company entered into a Stock Purchase Agreement (the “Stock Purchase Agreement”) with United Bancorporation and its wholly-owned subsidiary, United Bank, a Wisconsin chartered bank (“United Bank”) to acquire 100% of the common stock of United Bank . On October 19, 2018, the Company completed the acquisition of United Bank. In connection with the acquisition, the Company merged United Bank with and into the Bank, with the Bank surviving the merger. Our financial statements for the fiscal year ended September 30, 2018 do not include the impact of the October 19, 2018 closing of the United Bank acquisition. The Company plans to file separate financial statements and pro forma financial information, as required by SEC rules, in a Current Report on Form 8-K within the prescribed 75-day period following consummation of the acquisition of United Bank. See Note 19, “Subsequent Events” for additional information.
On August 18, 2017, the Company completed its merger with Wells Financial Corporation (“WFC”), pursuant to the merger agreement, dated March 17, 2017. At that time, the separate corporate existence of WFC ceased, and the Company survived the merger. In connection with the merger, the Company caused Wells Federal Bank to merge with and into the Bank, with the Bank surviving the merger. The merger expanded the Bank's market share in Mankato and southern Minnesota, and added seven branch locations along with expanded services through Wells Insurance Agency, Inc.. For further disclosure and discussion, see Note 2, “Acquisitions”.
Capital Raising Transactions
On June 20, 2018, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with each of a limited number of institutional and other accredited investors, including certain officers and directors of the Company (collectively the “Purchasers”), pursuant to which the Company sold an aggregate of 500,000 shares of the Company’s 8.00% Series A Mandatorily Convertible Non-Cumulative Non-Voting Perpetual Preferred Stock, par value $0.01 per share, (the “Series A Preferred Stock”), in a private placement (the “Private Placement”) at $130.00 per share, for aggregate gross proceeds of $65 million.
On September 28, 2018, each share of Series A Preferred Stock was mandatorily converted into 10 shares of common stock following receipt of stockholder approval of the issuance of the 5,000,000 shares of common stock.
Internet Website
We maintain a website at www.ccf.us. We make available through that website, free of charge, copies of our Annual report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements for our annual stockholders’ meetings and amendments to those reports or documents, as soon as reasonably practicable after we electronically file those materials with, or furnish them to, the Securities and Exchange Commission (“SEC”). We are not including the information contained on or available through our website as a part of, or incorporating such information by reference into, this Annual Report on Form 10-K. The SEC also maintains a website at www.sec.gov that contains reports, proxy statements and other information regarding SEC registrants.

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Selected Consolidated Financial Information
This information is included in Item 6; “Selected Financial Data” herein.

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Yields Earned and Rates Paid
This information is included in Item 7; “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Statement of Operations Analysis” herein.
Rate/Volume Analysis
This information is included in Item 7; “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Statement of Operations Analysis” herein.
Average Balance, Interest and Average Yields and Rates
This information is included in Item 7; “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Statement of Operations Analysis” herein.
Lending Activities
We offer a variety of loan products including commercial real estate loans, commercial and industrial (C&I) loans, agricultural real estate loans, agricultural non-real estate loans, residential mortgages, home equity lines-of-credit and consumer loans. We make real estate, consumer, commercial and agricultural loans in accordance with the basic lending policies established by Bank management and approved by our Board of Directors. We focus our lending activities on individual consumers and small commercial borrowers within our market areas. Our lending has been historically concentrated primarily within Wisconsin, Minnesota and Michigan. Competitive and economic pressures exist in our lending markets, and recent and any future developments in (a) the general economy, (b) real estate lending markets, and (c) the banking regulatory environment could have a material adverse effect on our business and operations. These factors may impact the credit quality of our existing loan portfolio, or adversely impact our ability to originate sufficient high quality loans in the future.
Our total gross outstanding loans, before net deferred loan costs and unamortized discounts on acquired loans, as of September 30, 2018, were $762,693, consisting of $353,020 in commercial agricultural real estate loans, $102,843 in commercial/agricultural non-real estate loans, $209,781 in residential real estate loans and $97,089 in consumer non-real estate loans. See Item 7; “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Balance Sheet Analysis” for further analysis of our loan portfolio.
Investment Activities
We maintain a portfolio of investments, consisting primarily of mortgage-backed securities, U.S. Government sponsored agency securities, bonds and other obligations issued by states and their political subdivisions, corporate debt securities and corporate asset based securities. We attempt to balance our portfolio to manage interest rate risk, regulatory requirements, and liquidity needs while providing an appropriate rate of return commensurate with the risk of the investment. See Item 7; “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Balance Sheet Analysis Investment Securities” for further analysis of our investment portfolio.
Deposits and Other Sources of Funds
General. The Company's primary sources of funds are deposits; amortization, prepayments and maturities of outstanding loans; other short- term investments; and funds provided from operations.
Deposits. We offer a broad range of deposit products through our branches, including demand deposits, various savings and money-market accounts and certificates of deposit. Deposits are insured by the Deposit Insurance Fund of the Federal Deposit Insurance Corporation (“FDIC”) up to statutory limits. At September 30, 2018, our total deposits were $746,529 including interest bearing deposits of $659,034 and non-interest bearing deposits of $87,495.
Borrowings. In addition to our primary sources of funds, we maintain access to additional sources of funds through borrowing, including FHLB borrowings, lines of credit with the Federal Reserve Bank, our Revolving Loan and our Note. See Item 7; “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Balance Sheet Analysis Federal Home Loan Bank (FHLB) advances and other borrowings” for further analysis of our borrowings.
Competition
We compete with other financial institutions and businesses both in attracting and retaining deposits and making loans in all of our principal markets. We believe the primary factors in competing for deposits are interest rates, personalized services, the quality and range of financial services, technology, convenient locations and office hours, and alternative delivery systems. One such delivery system is remote deposit capture for those commercial customers that are not conveniently located near one of our branches or mobile banking for retail customers. Competition for deposit products comes primarily from other banks, credit unions and non-bank competitors, including insurance companies, money market and mutual funds, and other investment

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alternatives. We believe the primary factors in competing for loans are interest rates, loan origination fees, and the quality and the range of lending services. Successful loan originations tend to depend not only on interest rate and terms of the loan but also on being responsive and flexible to the customer's needs. Competition for loans comes primarily from other banks, mortgage banking firms, credit unions, finance companies, leasing companies and other financial intermediaries. Some of our competitors are not subject to the same degree of regulation as that imposed on national banks or federally insured institutions, and these other institutions may be able to price loans and deposits more aggressively. We also face direct competition from other banks and their holding companies that have greater assets and resources than ours. However, we have been able to compete effectively with other financial institutions by building customer relationships with a focus on small-business solutions, including internet and mobile banking, electronic bill pay and remote deposit capture.
 
Regulation and Supervision
The banking industry is highly regulated, and the Company and the Bank are subject to numerous laws and regulations. As a bank holding company, the Company is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve System (the “FRB”). The Bank is also subject to regulation, supervision and examination by the OCC. The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System. In addition, the Bank’s deposit accounts are insured by the FDIC to the maximum extent permitted by law, and the FDIC has certain enforcement powers over the Bank.
The following is a brief summary of material statutes and regulations that affect the Company and the Bank. The following summary is not a complete discussion or analysis and is qualified in its entirety by reference to the statutes and regulations summarized below. Changes in statutes, regulations and policies applicable to the Company or the Bank cannot be predicted with certainty, but they may have a material effect on the business and earnings of the Company.
Securities Regulation and Listing
Our common stock is registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) and is listed on the NASDAQ Global Market under the symbol “CZWI.” We are subject to the information, proxy solicitation, insider trading, corporate governance, and other disclosure requirements and restrictions of the Exchange Act, as well as the Securities Act of 1933 (the “Securities Act”), both administered by the SEC. As a company listed on the NASDAQ Global Market, we are subject to NASDAQ standards for listed companies.
The Company is currently a “smaller reporting company” which allows us to provide certain simplified and scaled disclosures in our filings with the SEC. In June 2018, the SEC adopted amendments that raised the thresholds for a company to be eligible to provide scaled disclosures as a smaller reporting company to $250 million of public float. As such, we will remain a smaller reporting company for so long as the market value of the Company’s common stock held by non-affiliates as of the end of its most recently completed second fiscal quarter is less than $250 million. Although we remain a smaller reporting company, we have become an “accelerated filer” because our public float exceeds $75 million.
Sarbanes-Oxley Act.
The Sarbanes-Oxley Act of 2002 (SOX) was enacted to increase corporate responsibility, to provide for enhanced penalties for accounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosures pursuant to the securities laws. SOX and the SEC’s implementing regulations include provisions addressing, among other matters, the duties, functions and qualifications of audit committees for all public companies; certification of financial statements by the chief executive officer and the chief financial officer; the forfeiture of bonuses or other incentive-based compensation and profits from the sale of an issuer’s securities by directors and senior officers in the twelve month period following initial publication of any financial statements that later require restatement; disclosure of off-balance sheet transactions; a prohibition on personal loans to directors and officers, except (in the case of banking companies) loans in the normal course of business; expedited filing requirements for reports of beneficial ownership of company stock by insiders; disclosure of a code of ethics for senior officers, and of any change or waiver of such code; the formation of a public accounting oversight board; auditor independence; disclosure of fees paid to the company's auditors for non-audit services and limitations on the provision of such services; attestation requirements for company management and external auditors, relating to internal controls and procedures; and various increased criminal penalties for violations of federal securities laws.
Section 404 of SOX requires management of the Company to undertake a periodic assessment of the adequacy and effectiveness of the Company’s internal control over financial reporting. Since the Company has become an “accelerated filer, “ we have become subject to the provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that an independent registered public accounting firm provide an attestation report on the Company’s internal control over financial reporting and the operating effectiveness of these controls, making the public reporting process more costly. The Company has incurred, and expects to continue to incur, costs in connection with its on-going compliance with Section 404.


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The Dodd-Frank Act
The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (Dodd-Frank Act) significantly changed the regulatory structure for financial institutions and their holding companies, including with respect to lending, deposit, investment, trading and operating activities. Among other provisions, the Dodd-Frank Act:
permanently increased the FDIC’s standard maximum deposit insurance amount to $250,000, changed the FDIC insurance assessment base to assets rather than deposits and increased the reserve ratio for the deposit insurance fund to ensure the future strength of the fund;
repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts;
created and centralized significant aspects of consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (the “CFPB”). Smaller institutions are subject to rules promulgated by the CFPB and are also examined and supervised by their federal banking regulators for consumer compliance purposes;
imposed limits for debit card interchange fees for issuers that have assets greater than $10 billion, which also could affect the amount of interchange fees collected by financial institutions with less than $10 billion in assets;
restricted the preemption of state law by federal law and disallowed subsidiaries and affiliates of national banks from availing themselves of such preemption;
imposed comprehensive regulation of the over-the-counter derivatives market subject to significant rulemaking processes, to include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself;
established new requirements related to mortgage lending, including prohibitions against payment of steering incentives and provisions relating to underwriting standards, disclosures, appraisals and escrows;
prohibited banks and their affiliates from engaging in proprietary trading and investing in and sponsoring certain unregistered investment companies (the Volcker Rule); and
implemented corporate governance revisions that apply to all public companies, not just financial institutions.
Federal banking regulators and other agencies including, among others, the FRB, the OCC and the CFPB, have been engaged in extensive rule-making efforts under the Dodd-Frank Act.  Some of the rules that have been adopted or proposed to comply with Dodd-Frank Act mandates are discussed in more detail below.
2018 Regulatory Reform
In May 2018, the Economic Growth, Regulatory Relief and Consumer Protection Act (the “EGRRCPA”), was enacted to modify or remove certain financial reform rules and regulations, including some of those implemented under the Dodd-Frank Act. While the EGRRCPA maintains most of the regulatory structure established by the Dodd-Frank Act, it amends certain aspects of the regulatory framework for small depository institutions with assets of less than $10 billion and for large banks with assets of more than $50 billion. Many of these changes could result in meaningful regulatory relief for community banks such as the Bank.
The EGRRCPA, among other matters, expands the definition of qualified mortgages which may be held by a financial institution and simplifies the regulatory capital rules for financial institutions and their holding companies with total consolidated assets of less than $10 billion by instructing the federal banking regulators to establish a single “Community Bank Leverage Ratio” of between 8 and 10 percent. Any qualifying depository institution or its holding company that exceeds the “community bank leverage ratio” will be considered to have met generally applicable leverage and risk-based regulatory capital requirements and any qualifying depository institution that exceeds the new ratio will be considered to be “well capitalized” under the prompt corrective action rules. The EGRRCPA also expands the category of holding companies that may rely on the “Small Bank Holding Company and Savings and Loan Holding Company Policy Statement” (the “HC Policy Statement”) by raising the maximum amount of assets a qualifying holding company may have from $1 billion to $3 billion. This expansion also excludes such holding companies from the minimum capital requirements of the Dodd-Frank Act. In addition, the EGRRCPA includes regulatory relief for community banks regarding regulatory examination cycles, call reports, the Volcker Rule (proprietary trading prohibitions), mortgage disclosures and risk weights for certain high-risk commercial real estate loans.
Section 201 requires the Federal banking agencies to promulgate a rule establishing a new “Community Bank Leverage Ratio” of 8%-10% for depository institutions and depository institution holding companies, including banks and bank holding companies, with less than $10 billion in total consolidated assets. If such a depository institution or holding company maintains tangible equity in excess of this leverage ratio, it would be deemed to be in compliance with (1) the leverage and risk-based capital requirements promulgated by the Federal banking agencies; (2) in the case of a depository institution, the capital ratio

9



requirements to be considered “well capitalized” under the Federal banking agencies’ “prompt corrective action” regime; and (3) “any other capital or leverage requirements” to which the depository institution or holding company is subject, in each case unless the appropriate Federal banking agency determines otherwise based on the particular institution’s risk profile. In carrying out these requirements, the Federal banking agencies are required to consult with State banking regulators and notify the applicable State banking regulator of any qualifying community bank that exceeds or no longer exceeds the Community Bank Leverage Ratio.
It is difficult at this time to predict when or how any new standards under the EGRRCPA will ultimately be applied to us or what specific impact the EGRRCPA and the yet-to-be-written implementing rules and regulations will have on community banks.
Capital Adequacy
Banks and bank holding companies, as regulated institutions, are required to maintain minimum levels of capital. The FRB and the OCC have adopted minimum risk-based capital requirements (Tier 1 capital, common equity Tier 1 capital (“CET1”) and total capital) and leverage capital requirements, as well as guidelines that define components of the calculation of capital and the level of risk associated with various types of assets. Financial institutions are expected
to maintain a level of capital commensurate with the risk profile assigned to their assets in accordance with the guidelines.
In addition to the minimum risk-based capital and leverage ratios, banking organizations must maintain a “capital conservation buffer” consisting of CET1 in an amount equal to 2.5% of risk-weighted assets in order to avoid restrictions on their ability to make capital distributions and to pay certain discretionary bonus payments to executive officers. In order to avoid those restrictions, the capital conservation buffer effectively increases the minimum CET1 capital, Tier 1 capital, and
total capital ratios for U.S. banking organizations to 7.0%, 8.5%, and 10.5%, respectively. Banking organizations with capital levels that fall within the buffer will be required to limit dividends, share repurchases or redemptions (unless replaced within the same calendar quarter by capital instruments of equal or higher quality), and discretionary bonus payments. The capital conservation buffer will be fully phased in on January 1, 2019.
The Bank’s capital categories are determined solely for the purpose of applying the “prompt corrective action” rules described below and they are not necessarily an accurate representation of its overall financial condition or prospects for other purposes. Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting
brokered deposits, and certain other restrictions on its business. See “Bank Regulation - Prompt Corrective Action” below.
Bank Holding Company Regulation
As a bank holding company, the Company is subject to the Bank Holding Company Act of 1956 (the “BHCA”) and regulation and supervision by the FRB. A bank holding company is required to obtain the approval of the FRB before making certain acquisitions or engaging in certain activities. Bank holding companies and their subsidiaries are also subject to restrictions on transactions with insiders and affiliates.
A bank holding company is required to obtain the approval of the FRB before it may acquire all or substantially all of the assets of any bank, and before it may acquire ownership or control of the voting shares of any bank if, after giving effect to the acquisition, the bank holding company would own or control more than five percent of the voting shares of such bank. The approval of the FRB is also required for the merger or consolidation of bank holding companies.
Pursuant to the BHCA, the FRB has the power to order any bank holding company or its subsidiaries to terminate any activity or to terminate its ownership or control of any subsidiary when the FRB has reasonable grounds to believe that continuation of such activity or ownership constitutes a serious risk to the financial soundness, safety or stability of any bank subsidiary of the bank holding company.
The Company is required to file periodic reports with the FRB and provide any additional information the FRB may require. The FRB also has the authority to examine the Company and its subsidiaries, as well as any arrangements between the Company and its subsidiaries, with the cost of any such examinations to be borne by the Company.  Banking subsidiaries of bank holding companies are also subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates.
Bank Regulation
Anti-Money Laundering and OFAC Regulation. The Bank is subject to a number of anti-money laundering laws (“AML”) and regulations. The Bank Secrecy Act of 1970 (“BSA”) and subsequent laws and regulations require the Bank to take steps to prevent the use of the Bank or its systems from facilitating the flow of illegal or illicit money or terrorist funds. Those requirements include ensuring effective board and management oversight, establishing policies and procedures, performing comprehensive risk assessments, developing effective monitoring and reporting capabilities, ensuring adequate training and establishing a comprehensive independent audit of BSA compliance activities.

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The Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“Patriot Act”) significantly expanded the AML and financial transparency laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. Regulations promulgated under the Patriot Act impose various requirements on financial institutions, such as standards for verifying client identification at account opening and maintaining expanded records (including “Know Your Customer” and “Enhanced Due Diligence” practices) and other obligations to maintain appropriate policies, procedures and controls to aid the process of preventing, detecting, and reporting money laundering and terrorist financing. An institution subject to the Patriot Act must provide AML training to employees, designate an AML compliance officer and annually audit the AML program to assess its effectiveness. The FDIC continues to issue regulations and additional guidance with respect to the application and requirements of BSA and AML.
The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. Based on their administration by the United States Department of the Treasury's Office of Foreign Assets Control (“OFAC”), these are typically known as the “OFAC” rules. The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “United States persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to United States jurisdiction (including property in the possession or control of United States persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC.
Failure of a financial institution to maintain and implement adequate BSA, AML and OFAC programs, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution and result in material fines and sanctions. The Bank has implemented policies and procedures to comply with the foregoing requirements.
Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) establishes a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, in which all institutions are placed. The federal banking agencies have also specified by regulation the relevant capital levels for each category.
A “well-capitalized” bank is one that is not required to meet and maintain a specific capital level for any capital measure pursuant to any written agreement, order, capital directive, or prompt corrective action directive, and has a total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8%, a CET1 capital ratio of at least 6.5%, and a Tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for
purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices, which requires certain remedial action.
The FRB may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. At this time, the bank regulatory agencies are more inclined to impose higher capital requirements to meet well-capitalized standards and future regulatory change could impose higher capital standards as a routine matter. The Bank, as a matter of prudent management, targets as its goal the maintenance of capital ratios which exceed these minimum requirements and that are consistent with the Bank’s risk profile.
Deposit Insurance. The deposits of the Bank are insured by the Deposit Insurance Fund (DIF) of the FDIC up to the limits set forth under applicable law and are subject to the deposit insurance premium assessments of the DIF. Under the Dodd-Frank Act, the maximum per depositor FDIC insurance amount increased from $100,000 to $250,000. The FDIC applies a risk-based system for setting deposit insurance assessments, which was amended by the Dodd-Frank Act. Under this system, the assessment rates for an insured depository institution vary according to the level of risk incurred in its activities. To arrive at an assessment rate for a banking institution, the FDIC places it in one of four risk categories determined by reference to its capital levels and supervisory ratings. In addition, in the case of those institutions in the lowest risk category, the FDIC further determines its assessment rate based on certain specified financial ratios or, if applicable, its long-term debt ratings. The assessment rate schedule can change from time to time, at the discretion of the FDIC, subject to certain limits. In addition to deposit insurance assessments, the FDIC is authorized to collect assessments from FDIC insured depository institutions to service the outstanding obligations of Financing Corporation (FICO).

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     The Dodd-Frank Act changed the assessment formula for determining deposit insurance premiums and modified certain insurance coverage provisions of the FDIA. The FDIC’s implementing rules redefined the base for FDIC insurance assessments from the amount of insured deposits to average consolidated total assets less average tangible equity.
     Federal Home Loan Bank (“FHLB”) System. The Bank is a member of the FHLB of Chicago, which is one of the 11 regional Federal Home Loan Banks. The primary purpose of the FHLBs is to provide funding to their saving association members in support of the home financing credit function of the members. Each FHLB serves as a reserve or central bank for its members within its assigned region. FHLBs are funded primarily from proceeds derived from the sale of consolidated obligations of the FHLB System. FHLBs make loans or advances to members in accordance with policies and procedures established by the board of directors of the FHLB. These policies and procedures are subject to the regulation and oversight of the Federal Housing Financing Board. All advances from a FHLB are required to be fully secured by sufficient collateral as determined by the FHLB. Long-term advances are required to be used for residential home financing and small business and agricultural loans.
As a member, the Bank is required to purchase and maintain stock in the FHLB of Chicago. As of September 30, 2018, the Bank had $3,015 million in FHLB stock, which was in compliance with this requirement. The Bank receives dividends on its FHLB stock.
Community Reinvestment Act. The Community Reinvestment Act (“CRA”) is intended to encourage insured depository institutions, while operating safely and soundly, to help meet the credit needs of their communities. CRA specifically directs the federal bank regulatory agencies, in examining insured depository institutions, to assess their record of helping to meet the credit needs of their entire community, including low- and moderate-income neighborhoods, consistent with safe and sound banking practices. CRA further requires the agencies to take a financial institution's record of meeting its community credit needs into account when evaluating applications for, among other things, domestic branches, consummating mergers or acquisitions or holding company formations.
The federal banking agencies have adopted regulations which measure a bank’s compliance with its CRA obligations on a performance-based evaluation system. This system bases CRA ratings on an institution’s actual lending service and investment performance rather than the extent to which the institution conducts needs assessments, documents community outreach or complies with other procedural requirements. The ratings range from “outstanding” to a low of “substantial noncompliance.”
The Bank had a CRA rating of “Satisfactory” as of its most recent regulatory examination.
Consumer Compliance and Fair Lending Laws. The Bank is subject to a number of federal and state laws designed to protect borrowers and promote lending to various sectors of the economy and population. These laws include the Patriot Act, BSA, the Foreign Account Tax Compliance Act, CRA, the Fair Credit Reporting Act, as amended by the Fair and Accurate Credit Transactions Act, the Equal Credit Opportunity Act, the Truth in Lending Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the National Flood Insurance Act, various state law counterparts, and the Consumer Financial Protection Act of 2010, which constitutes part of the Dodd-Frank Act. The enforcement of fair lending laws has been an increasing area of focus for regulators, including the OCC and CFPB.
Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act of 2017 (“Tax Act”), enacted on December 22, 2017, reduces corporate Federal income tax rates for the Company from 34% to 24.5% for 2018, and 21% for 2019. The Company anticipates that this tax rate change should reduce its federal income tax liability in future years, but the Company did recognize certain effects of the tax law changes related to the revaluation of the deferred tax assets to both the revaluation of timing differences and the unrealized loss on securities. See Item 7; “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, under the heading “Critical Accounting Estimates Income Taxes.”
Effects of Government Monetary Policy
 The earnings of the Company are affected by general and local economic conditions and by the policies of various governmental regulatory authorities. In particular, the FRB regulates money supply, credit conditions and interest rates in order to influence general economic conditions, primarily through open market operations in United States Government Securities, varying the discount rate on member bank borrowings, setting reserve requirements against member and nonmember bank deposits, regulating interest rates payable by member banks on time and savings deposits and expanding or contracting the money supply. FRB monetary policies have had a significant effect on the operating results of commercial banks and their holding companies, including the Bank and the Company, in the past and are expected to continue to do so in the future.
Employees
At December 10, 2018, we had 254 full-time employees and 282 total employees, company-wide. We have no unionized employees, and we are not subject to any collective bargaining agreements.

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ITEM 1A. RISK FACTORS
The risks described below are not the only risks we face. Additional risks that we do not yet know of or that we currently believe are immaterial may also impair our future business operations. If any of the events or circumstances described in the following risks actually occurs, our business, financial condition or results of operations could be materially adversely affected. In such cases, the trading price of our common stock could decline.
Our business may be adversely affected by conditions in the financial markets and economic conditions generally. We operate primarily in the Wisconsin, Minnesota and Michigan markets. As a result, our financial condition, results of operations and cash flows are significantly impacted by changes in the economic conditions in those areas. In addition, our business is susceptible to broader economic trends within the United States economy. Economic conditions have a significant impact on the demand for our products and services, as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. A significant decline in general economic conditions caused by inflation, recession, tariffs, unemployment, changes in securities markets, changes in housing market prices or other factors could impact economic conditions and, in turn, could have a material adverse effect on our financial condition and results of operations.
Deterioration in the markets for residential real estate, including secondary residential mortgage loan markets, could reduce our net income and profitability. During the severe recession that lasted from 2007 to 2009, softened residential housing markets, increased delinquency and default rates, and volatile and constrained secondary credit markets negatively impacted the mortgage industry. Our financial results were adversely affected by these effects including changes in real estate values, primarily in Wisconsin, Minnesota and Michigan, and our net income declined as a result. Decreases in real estate values adversely affected the value of property used as collateral for loans as well as investments in our portfolio. Continued slow growth in the economy since 2009 resulted in increased competition and lower rates, which has negatively impacted our net income and profits.
The foregoing changes could affect our ability to originate loans and deposits, the fair value of our financial assets and liabilities and the average maturity of our securities portfolio. An increase in the level of interest rates may also adversely affect the ability of certain of our borrowers to repay their obligations. If interest rates paid on deposits or other borrowings were to increase at a faster rate than the interest rates earned on loans and investments, our net income would be adversely affected.
We are subject to interest rate risk. Through our banking subsidiary, the Bank, our profitability depends in large part on our net interest income, which is the difference between interest earned from interest-earning assets, such as loans and mortgage-backed securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings. Our net interest income will be adversely affected if market interest rates change such that the interest we pay on deposits and borrowings increase faster than the interest earned on loans and investments. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. Market interest rates change over time due to many factors that are beyond our control, including but not limited to: general economic conditions and government policy decisions, especially policies of the Federal Reserve Bank. Accordingly, our results of operations, like those of other financial institutions, are impacted by changes in interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in interest rates and our ability to adapt to these changes is known as interest rate risk.
We are subject to lending risk. There are inherent risks associated with our lending activities. These risks include the impact of changes in interest rates and changes in the economic conditions in the markets we serve, as well as those across the United States. An increase in interest rates or weakening economic conditions (such as high levels of unemployment) could adversely impact the ability of borrowers to repay outstanding loans, or could substantially weaken the value of collateral securing those loans. Downward pressure on real estate values could increase the potential for problem loans and thus have a direct impact on our consolidated results of operations.
We are subject to higher lending risks with respect to our commercial and agricultural banking activities which could adversely affect our financial condition and results of operations. Our loans include commercial and agricultural loans, which include loans secured by real estate as well as loans secured by personal property. Commercial real estate lending, including agricultural loans, typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Agricultural non-real estate loans carry significant risks as they may involve larger balances concentrated with a single borrower or group of related borrowers. In addition, repayment of such loans depends on the successful operation or management of the farm property securing the loan for which an operating loan is utilized. Farming operations may be affected by factors outside of the borrower's control, including adverse weather conditions, such as drought, hail or floods that can severely limit crop yields and declines in market prices for agricultural products. Although the Bank manages lending risks through its underwriting and credit administration policies, no assurance can be given that such risks will not materialize, in which event, our financial condition, results of operations, cash flows and business prospects could be materially adversely affected.

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Our allowance for loan losses may be insufficient. To address risks inherent in our loan portfolio, we maintain an allowance for loan losses that represents management’s best estimate of probable losses that exist within our loan portfolio. The level of the allowance reflects management’s continuing evaluation of various factors, including specific credit risks, historical loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions, and unidentified losses inherent in the current loan portfolio. Determining the appropriate level of the allowance for loan losses involves a high degree of subjectivity and requires us to make estimates of significant credit risks, which may undergo material changes. In evaluating our impaired loans, we assess repayment expectations and determine collateral values based on all information that is available to us. However, we must often make subjective decisions based on our assumption about the creditworthiness of the borrowers and the values of collateral securing these loans.
Deterioration in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans, and other factors, both within and outside of our control, may require an increase in our allowance for loan losses. In addition, bank regulatory agencies periodically examine our allowance for loan losses and may require an increase in the allowance or the recognition of further loan charge-offs, based on judgments different from those of our management.
If charge-offs in future periods exceed our allowance for loan losses, we will need to take additional loan loss provisions to increase our allowance for loan losses. Any additional loan loss provision will reduce our net income or increase our net loss, which could have a direct material adverse effect on our financial condition and results of operations.
A new accounting standard may require us to increase our allowance for loan losses and may have a material adverse effect on our financial condition and results of operations.
The Financial Accounting Standards Board (“FASB”) has adopted a new accounting standard that will be effective for the Company for our first fiscal year after December 15, 2019. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected credit losses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan losses that are probable, which may require us to increase our allowance for loan losses, and to greatly increase the types of data we will need to collect and review to determine the appropriate level of the allowance for loan losses Banking regulators expect the new accounting standard will increase the allowance for loan losses. Any change in the allowance for loan losses at the time of adoption will be an adjustment to retained earnings and would change the Bank’s capital levels. Any increase in our allowance for loan losses or expenses incurred to determine the appropriate level of the allowance for loan losses may have a material adverse effect on our financial condition and results of operations.
Changes in the fair value or ratings downgrades of our securities may reduce our stockholders’ equity, net earnings, or regulatory capital ratios. At September 30, 2018, $118,482 of our securities, were classified as available for sale and $4,619 were classified as held to maturity. The estimated fair value of our available for sale securities portfolio may increase or decrease depending on market conditions. Our available for sale securities portfolio is comprised of fixed-rate, and to a lessor extent, floating rate securities. We increase or decrease stockholders’ equity by the amount of the change in unrealized gain or loss (the difference between the estimated fair value and amortized cost) of our available for sale securities portfolio, net of the related tax benefit or provision, under the category of accumulated other comprehensive income/loss. Therefore, a decline in the estimated fair value of this portfolio will result in a decline in our reported stockholders’ equity, as well as our book value per common share and tangible book value per common share. This decrease will occur even though the securities are not sold. In the case of debt securities, if these securities are never sold, the decrease may be recovered over the life of the securities.
We conduct a periodic review and evaluation of our securities portfolio to determine if the decline in the fair value of any security below its cost basis is other-than-temporary. Factors which we consider in our analysis include, but are not limited to, the severity and duration of the decline in fair value of the security, the financial condition and near-term prospects of the issuer, whether the decline appears to be related to issuer conditions or general market or industry conditions, our intent and ability to retain the security for a period of time sufficient to allow for any anticipated recovery in fair value and the likelihood of any near-term fair value recovery. We generally view changes in fair value caused by changes in interest rates as temporary, which is consistent with our experience. If we deem such decline to be other-than-temporary related to credit losses, the security is written down to a new cost basis and the resulting loss is charged to earnings as a component of non-interest income in the period in which the decline in value occurs.
We have, in the past, recorded other than temporary impairment (“OTTI”) charges, principally arising from investments in non-agency mortgage-backed securities. We continue to monitor our securities portfolio as part of our ongoing OTTI evaluation process. No assurance can be given that we will not need to recognize OTTI charges related to securities in the future. Future OTTI charges would cause decreases to both Tier 1 and Risk-based capital levels which may expose the Company and/or the Bank to additional regulatory restrictions.

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The capital that we are required to maintain for regulatory purposes is impacted by, among other factors, the securities ratings on our portfolio. Therefore, ratings downgrades on our securities may also have a material adverse effect on our risk-based regulatory capital levels.
Competition may affect our results. We face strong competition in originating loans, in seeking deposits and in offering other banking services. We compete with commercial banks, trust companies, mortgage banking firms, credit unions, finance companies, mutual funds, insurance companies and brokerage and investment banking firms. Our market area is also served by commercial banks and savings associations that are substantially larger than us in terms of deposits and loans and have greater human and financial resources. This competitive climate can make it difficult to establish, maintain and retain relationships with new and existing customers and can lower the rate we are able to charge on loans, increase the rates we must offer on deposits, and affect our charges for other services. Those factors can, in turn, adversely affect our results of operations and profitability.
We are a community bank and our ability to maintain our reputation is critical to the success of our business and the failure to do so may materially adversely affect our performance.
We are a community bank, and our reputation is one of the most valuable components of our business. A key component of our business strategy is to rely on our reputation for customer service and knowledge of local markets to expand our presence by capturing new business opportunities from existing and prospective customers in our market area and contiguous areas. As such, we strive to conduct our business in a manner that enhances our reputation. This is done, in part, by recruiting, hiring and retaining employees who share our core values of being an integral part of the communities we serve, delivering superior service to our customers and caring about our customers and associates. If our reputation is negatively affected by the actions of our employees, by our inability to conduct our operations in a manner that is appealing to current or prospective customers, or otherwise, our business and, therefore, our operating results may be materially adversely affected.
We may not have sufficient pre-tax net income in future periods to fully realize the benefits of our net deferred tax assets. Assessing the need for, or the sufficiency of, a valuation allowance requires management to evaluate all available evidence. Based on future pre-tax net income projections and the planned execution of existing tax planning strategies, we believe that it is more likely than not that we will fully realize the benefits of our net deferred tax assets. However, our current assessment is based on assumptions and judgments that may or may not reflect actual future results. If a valuation allowance becomes necessary, it could have a material adverse effect on our consolidated results of operations and financial condition.
Maintaining or increasing our market share may depend on lowering prices and market acceptance of new products and services. Our success depends, in part, on our ability to adapt our products and services to evolving industry standards and customer demands. We face increasing pressure to provide products and services at lower prices, which can reduce our net interest margin and revenues from our fee-based products and services. In addition, the widespread adoption of new technologies, including internet and mobile banking services, could require us to make substantial expenditures to modify or adapt our existing products and services. Also, these and other capital investments in our business may not produce expected growth in earnings anticipated at the time of the expenditure. We may not be successful in introducing new products and services, achieving market acceptance of our products and services, or developing and maintaining loyal customers, which in turn, could adversely affect our results of operations and profitability.
Acts or threats of terrorism and political or military actions by the United States or other governments could adversely affect general economic industry conditions. Geopolitical conditions may affect our earnings. Acts or threats of terrorism and political actions taken by the United States or other governments in response to terrorism, or similar activity, could adversely affect general or industry conditions and, as a result, our consolidated financial condition and results of operations.
We operate in a highly regulated environment, and are subject to changes, which could increase our cost structure or have other negative impacts on our operations. The banking industry is extensively regulated at the federal and state levels. Insured depository institutions and their holding companies are subject to comprehensive regulation and supervision by financial regulatory authorities covering all aspects of their organization, management and operations. We are also subject to regulation by the SEC. Our compliance with these regulations, including compliance with regulatory commitments, is costly. Regulation includes, among other things, capital and reserve requirements, permissible investments and lines of business, mergers and acquisitions, restrictions on transactions with insiders and affiliates, anti-money laundering regulations, dividend limitations, community reinvestment requirements, limitations on products and services offered, loan limits, geographical limits, and consumer credit regulations. The system of supervision and regulation applicable to us establishes a comprehensive framework for our operations and is intended primarily for the protection of the Deposit Insurance Fund, our depositors and the public, rather than our stockholders. Failure to comply with applicable laws, regulations or policies could result in sanction by regulatory agencies, civil monetary penalties, and/or damage to our reputation, which could have a material adverse effect on our business, consolidated financial condition and results of operations. In addition, any change in government regulation could have a material adverse effect on our business.

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We have become subject to more stringent capital requirements, which may adversely impact our return on equity, require us to raise additional capital, or limit our ability to pay dividends or repurchase shares.
The Basel III Rules, which became effective for us on January 1, 2015, included new minimum risk-based capital and leverage ratios and refines the definition of what constitutes “capital” for calculating these ratios. The new minimum capital requirements are: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 to risk-based assets capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from prior rules); and (iv) a Tier 1 leverage ratio of 4%. The Basel III Rules also establish a “capital conservation buffer” of 2.5%, and, when fully phased in, will result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%; (ii) a Tier 1 to risk-based assets capital ratio of 8.5%; and (iii) a total capital ratio of 10.5%. The capital conservation buffer will be fully phased in on January 1, 2019. An institution will be subject to limitations on paying dividends, engaging in share repurchases and paying discretionary bonuses if its capital level falls below the buffer amount. The application of more stringent capital requirements could, among other things, result in lower returns on equity, and result in regulatory actions if we are unable to comply with such requirements. Furthermore, the imposition of liquidity requirements in connection with the implementation of the Basel III Rules could result in our having to lengthen the term of our funding sources, change our business models or increase our holdings of liquid assets. Specifically, the Bank’s ability to pay dividends will be limited if it does not have the capital conservation buffer required by the new capital rules, which may further limit the Company’s ability to pay dividends to stockholders.
We are subject to increases in FDIC insurance premiums and special assessments by the FDIC, which will adversely affect our earnings. We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. For example, during 2008 and 2009, higher levels of bank failures dramatically increased resolution costs of the FDIC and depleted the Deposit Insurance Fund. On July 21, 2010, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act, which, in part, permanently raised the current standard maximum deposit insurance amount to $250,000 per customer (up from $100,000). These programs placed additional stress on the Deposit Insurance Fund. In order to maintain a strong funding position and restore reserve ratios of the Deposit Insurance Fund, the FDIC increased assessment rates of the insured institutions. If additional bank or financial institution failures increase, or if the cost of resolving prior failures exceeds expectations, we may be required to pay even higher FDIC premiums than the current levels. Any future increases or required prepayments of FDIC insurance premiums may adversely impact our earnings and financial condition.
Customers may decide not to use banks to complete their financial transactions, which could result in a loss of income to us. Technology and other changes are allowing customers to complete financial transactions that historically have involved banks at one or both ends of the transaction. For example, customers can now pay bills and transfer funds directly without going through a bank. The process of eliminating banks as intermediaries, known as disintermediation, could result in the loss of fee income, as well as the loss of customer deposits.
We could experience an unexpected inability to obtain needed liquidity. Liquidity measures the ability to meet current and future cash flow needs as they become due. The liquidity of a financial institution reflects its ability to meet loan requests, to accommodate possible outflows in deposits, and to take advantage of interest rate market opportunities. The ability of a financial institution to meet its current financial obligations is a function of its balance sheet structure, its ability to liquidate assets and its access to alternative sources of funds. We seek to ensure our funding needs are met by maintaining an appropriate level of liquidity through asset/liability management. If we become unable to obtain funds when needed, it could have a material adverse effect on our business and, in turn, our consolidated financial condition and results of operations. Moreover, it could limit our ability to take advantage of what we believe to be good market opportunities for expanding our loan portfolio.
Future growth, operating results or regulatory requirements may require us to raise additional capital but that capital may not be available. We are required by federal and state regulatory authorities to maintain adequate levels of capital to support our operations. To the extent our future operating results erode capital or we elect to expand through loan growth or acquisition, we may be required to raise additional capital.
Our ability to raise capital will depend on conditions in the capital markets, which are outside of our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital when needed or on favorable terms. If we cannot raise additional capital when needed or if we are subject to material unfavorable terms for such capital, we may be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These actions could negatively impact our ability to operate or further expand our operations and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our consolidated financial condition and results of operations.
Our internal controls and procedures may fail or be circumvented. Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well-designed and operated, is based in part on certain assumptions and can provide only reasonable assurances that the objectives of the system are met. Any (a) failure or circumvention of our controls and procedures, (b) failure to adequately address any internal control deficiencies, or (c) failure to comply with regulations related to controls and

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procedures could have a material effect on our business, consolidated financial condition and results of operations. See Item 9A “Controls and Procedures” for further discussion of our internal controls.
Our Reporting Obligations As A Public Company Are Costly. Reporting requirements of a public company change depending on the reporting classification in which the Company falls as of the end of its second quarter of each fiscal year. The Company is currently a “smaller reporting company” which allows us to provide certain simplified and scaled disclosures in our filings. We will remain a smaller reporting company for so long as the market value of the Company’s common stock held by non-affiliates as of the end of its most recently completed second fiscal quarter is less than $250 million. Although we remain a smaller reporting company, we have become an “accelerated filer” because our public float exceeds $75 million. As such we have become subject to the provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that an independent registered public accounting firm provide an attestation report on the effectiveness of internal control over financial reporting, making the public reporting process more costly.
We may not be able to attract or retain key people. Our success depends, in part, on our ability to attract and retain key people. We depend on the talents and leadership of our executive team, including Stephen M. Bianchi, our Chief Executive Officer, and James S. Broucek, our Chief Financial Officer. Competition for the best people in most activities engaged in by us can be intense, and we may not be able to hire people or retain them. Although Mr. Bianchi and Mr. Broucek are under employment agreements expiring in 2019 and 2020, respectively, unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our local markets, years of industry experience and the difficulty of promptly finding qualified replacement personnel.
We continually encounter technological change. The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology driven by new or modified products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.
We rely on network and information systems and other technologies, and, as a result, we are subject to various Cybersecurity risks. Cybersecurity refers to the combination of technologies, processes and procedures established to protect information technology systems and data from unauthorized access, attack, or damage. Our business involves the storage and transmission of customers’ personal information. While we have internal policies and procedures designed to prevent or limit the effect of a failure, interruption or security breach of our information systems, as well as contracts and service agreements with applicable outside vendors, we cannot be assured that any such failures, interruptions or security breaches will not occur or, if they do, that they will be addressed adequately. Unauthorized disclosure of sensitive or confidential client or customer information, whether through a breach of our computer systems or otherwise, could severely harm our business. Although we have implemented measures to prevent security breaches, cyber incidents and other security threats, our facilities and systems, and those of third party service providers, may be vulnerable to security breaches, acts of vandalism, computer viruses, misplaced or lost data, programming and/or human error, or other similar events that could have a material adverse effect on our business. Furthermore, the storage and transmission of such data is regulated at the federal and state level. Privacy information security laws and regulation changes, and compliance therewith, may result in cost increases due to system changes and the development of new administrative processes. If we fail to comply with applicable laws and regulations or experience a data security breach involving the misappropriation, loss or other unauthorized disclosure of confidential information, whether by us or our vendors, our reputation could be damaged, possibly resulting in lost future business, and we could be subject to fines, penalties, administrative orders and other legal risks as a result of a breach or non-compliance.
Acquisition and expansion activities may disrupt our business, dilute existing stockholders and adversely affect our operating results. We recently acquired through merger, CBN and WFC. On June 20, 2018, the Company entered into a Stock Purchase Agreement with United Bancorporation and its wholly-owned subsidiary, United Bank, a Wisconsin chartered bank. On October 19, 2018, the Company completed its previously announced acquisition of United Bank. We intend to continue to evaluate potential acquisitions and expansion opportunities in the normal course of our business. Although the integration of CBN and WFC into our operations is successfully proceeding, we cannot assure you that we will be able to adequately or profitably manage the Acquisition of United Bank or any such future acquisitions. Acquiring other banks or financial service companies, such as United Bank, as well as other geographic and product expansion activities, involve various risks including:
risks of unknown or contingent liabilities;
unanticipated costs and delays;
risks that acquired new businesses do not perform consistent with our growth and profitability
expectations;

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risks of entering new markets or product areas where we have limited experience;
risks that growth will strain our infrastructure, staff, internal controls and management, which may
require additional personnel, time and expenditures;
exposure to potential asset quality issues with acquired institutions;
difficulties, expenses and delays of integrating the operations and personnel of acquired institutions, and
start-up delays and costs of other expansion activities;
potential disruptions to our business;
possible loss of key employees and customers of acquired institutions;
potential short-term decreases in profitability; and
diversion of our management’s time and attention from our existing operations and business.
Our failure to execute our acquisition strategy could adversely affect our business, results of operations, financial condition and future prospects.
We may fail to realize the anticipated cost savings and other financial benefits of the United Bank acquisition on the anticipated schedule, if at all. Our ability to realize success following consummation of the acquisition of United Bank will depend, in part, on our ability to successfully combine and integrate the businesses of the Company and United Bank. We may face significant challenges in integrating United Bank’s operations into our operations in a timely and efficient manner and in retaining personnel from United Bank that we anticipate needing. Achieving the anticipated cost savings and financial benefits of the acquisition will depend, in part, on whether we can successfully integrate these businesses. It is possible that the integration process could result in the loss of key employees, the disruption of each company’s ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with clients, customers, depositors and employees or to achieve the anticipated benefits of the acquisition. In addition, the integration of certain operations will require the dedication of significant management resources, which may temporarily distract management’s attention from the day-to-day business of the combined company. Any inability to realize the full extent of, or any of, the anticipated cost savings and financial benefits of the acquisition, as well as any delays encountered in the integration process, could have an adverse effect on the business and results of operations of the combined company, which may affect the market price of our common stock.
Changes in federal or state tax laws could adversely affect our business, financial condition and results of operations. Our business, financial condition and results of operations are impacted by tax policy implemented at the federal and state level. The Tax Act was enacted in December 2017. Among other things, the Tax Act reduces the corporate federal income tax rate for the Company from 34 percent to 24.5 percent for 2018, and 21 percent for 2019, which would result in changes in the valuation of deferred tax asset and liabilities, and includes a number of provisions that will have an impact on the banking industry, borrowers and the market for single-family residential real estate. We revalued our net deferred tax assets to account for the future impact of the lower corporate tax rates. The recent changes in the tax laws may have an adverse effect on the market for, and valuation of, residential properties, and on the demand for such loans in the future, and could make it harder for borrowers to make their loan payments. In addition, these recent changes may also have a disproportionate effect on taxpayers in states with high residential home prices and high state and local taxes. If home ownership becomes less attractive, demand for mortgage loans could decrease. The value of the properties securing loans in our loan portfolio may be adversely impacted as a result of the changing economics of home ownership, which could reduce our profitability and  materially adversely affect our business, financial condition and results of operations.
We cannot predict whether any other tax legislation will be enacted in the future or whether any such changes to existing federal or state tax law would have a material adverse effect on our business, financial condition and results of operations. We continue to evaluate the impact the Tax Act and other enacted tax reform may have on our business, financial conduction and results of operations.
We are subject to changes in accounting principles, policies or guidelines. Our financial performance is impacted by accounting principles, policies and guidelines. Some of these policies require the use of estimates and assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they require management to make subjective and complex judgments about matters that are inherently uncertain and because it is likely that materially different amounts would be reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are incorrect, we may experience material losses.
From time to time, the FASB and the SEC change the financial accounting and reporting standards or the interpretation of those standards that govern the preparation of our financial statements. These changes are beyond our control, can be difficult to predict and could materially impact how we report our financial condition and results of operations. Changes in these standards are continuously occurring, and given recent economic conditions, more drastic changes may occur. The implementation of such changes could have a material adverse effect on our financial condition and results of operations.
Our ability to pay dividends depends primarily on dividends from our banking subsidiary, the Bank, which is subject to regulatory and other limitations. We are a bank holding company and our operations are conducted primarily by our banking

18



subsidiary, the Bank. Since we receive substantially all of our revenue from dividends from the Bank, our ability to pay dividends on our common stock depends on our receipt of dividends from the Bank.
The Company is a legal entity separate and distinct from its banking subsidiary. As a bank holding company, the Company is subject to certain restrictions on its ability to pay dividends under applicable banking laws and regulations. Federal bank regulators are authorized to determine under certain circumstances relating to the financial condition of a bank holding company or a bank that the payment of dividends would be an unsafe or unsound practice and to prohibit payment thereof. In particular, federal bank regulators have stated that paying dividends that deplete a banking organization’s capital base to an inadequate level would be an unsafe and unsound banking practice and that banking organizations should generally pay dividends only out of current operating earnings. In addition, in the current financial and economic environment, the Federal Reserve has indicated that bank holding companies should carefully review their dividend policy and has discouraged payment ratios that are at maximum allowable levels unless both asset quality and capital are very strong.
The ability of the Bank to pay dividends to us is also subject to its profitability, financial condition, capital expenditures and other cash flow requirements. The Bank may not be able to generate adequate cash flow to pay us dividends in the future. The Company's ability to pay dividends is also subject to the terms of its Business Note Agreement dated August 1, 2018, which prohibits the Company from making dividend payments while an event of default has occurred and is continuing under the loan agreement or from allowing payment of a dividend which would create an event of default. The Company has pledged 100% of Bank stock as collateral for the loan and credit facilities. The inability to receive dividends from the Bank could have an adverse effect on our business and financial condition.
Furthermore, holders of our common stock are only entitled to receive the dividends as our Board of Directors may declare out of funds legally available for such payments. Although we have historically paid cash dividends on our common stock, we are not required to do so and our Board of Directors could reduce or eliminate our common stock dividend in the future. This could adversely affect the market price of our common stock.
Our shares of common stock are thinly traded and our stock price may be more volatile. Because our common stock is thinly traded, its market price may fluctuate significantly more than the stock market in general or the stock prices of similar companies, which are exchanged, listed or quoted on the NASDAQ Stock Market. We believe there are 10,516,359 shares of our common stock held by nonaffiliates as of December 10, 2018. Thus, our common stock will be less liquid than the stock of companies with broader public ownership, and as a result, the trading prices for our shares of common stock may be more volatile. Among other things, trading of a relatively small volume of our common stock may have a greater impact on the trading price of our stock than would be the case if our public float were larger.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.

19



ITEM 2. PROPERTIES
The Company leases its main administrative offices located at 2174 EastRidge Center, Eau Claire, WI 54701. At September 30, 2018, the Bank had a total of 21 full-service branch offices located in the Wisconsin cities of Altoona, Barron, Chippewa Falls, Eau Claire, Ellsworth, Ladysmith, Rice Lake (2) and Spooner, the Minnesota cities of Albert Lea, Blue Earth, Fairmont, Faribault, Mankato, Minnesota Lake, Oakdale, Red Wing, St. James, St. Peter and Wells, and Rochester Hills, Michigan. Of these, the Bank owns 11 and leases the remaining 10 branch offices. On October 19, 2018, the Bank merged with United Bank, adding 6 branch offices located in central Wisconsin for a total of 27 full-service branch offices. Of these additional branch offices, the Bank owns all six branch offices. Management believes that our current facilities are adequate to meet our present and immediately foreseeable needs. For more information on our properties and equipment, see Note 6, Office Properties and Equipment of Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K. For more information on our leases, see Note 11, Commitments and Contingencies of Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.

ITEM 3. LEGAL PROCEEDINGS
In the normal course of business, the Company and/or the Bank occasionally become involved in various legal proceedings. While the outcome of any such proceeding cannot be predicted with certainty, in our opinion, any liability from such proceedings would not have a material adverse effect on the business or financial condition of the Company.
ITEM 4. MINE SAFETY DISCLOSURES
None
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Historically, trading in shares of our common stock has been limited. Citizens Community Bancorp, Inc. common stock is traded on the NASDAQ Global Market under the symbol “CZWI”.
We had approximately 521 stockholders of record at December 10, 2018. The number of stockholders does not separately reflect persons or entities that hold their stock in nominee or “street” name through various brokerage firms. We believe that the number of beneficial owners of our common stock on that date was substantially greater.
The holders of our common stock are entitled to receive such dividends when and as declared by our Board of Directors and approved by our regulators. In determining the payment of cash dividends, our Board of Directors considers our earnings, capital and debt servicing requirements, the financial ratio guidelines of our regulators, our financial condition and other relevant factors.
The Company's ability to pay dividends on its common stock is dependent on the dividend payments it receives from the Bank, since the Company receives substantially all of its revenue in the form of dividends from the Bank. Future dividends are not guaranteed and will depend on the Company's ability to pay them. For more information on dividends, see Note 10, Capital Matters of Notes to Consolidated Financial Statements contained in Item 8 of this Form 10-K.
The table below shows the shares withheld from employees to satisfy tax withholding obligations during the three months ended September 30, 2018.
Period
 
Total Number of Shares Purchased (1)
 
Average Price Paid per Share
 
Total Number of Shares purchased as Part of Publicly Announced Plans or Programs
 
Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
August 1, 2018 - August 31, 2018
 
202
 
$
14.00

 
 
September 1, 2018 - September 30, 2018
 
324
 
$
14.14

 
 
Total
 
526
 
$
14.08

 
 
(1) Represents shares of common stock withheld from employees to satisfy tax withholding obligations associated with the vesting of restricted stock awards.


20






ITEM 6. SELECTED FINANCIAL DATA
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Year ended September 30,
(dollars in thousands, except per share data)
 
 
 
 
 
 
 
 
 
 
 
 
 
2018
 
2017
 
2016
 
2015
 
2014
Selected Results of Operations Data:
 
 
 
 
 
 
 
 
 
 
Interest income
 
38,896

 
27,878

 
$
25,084

 
$
23,004

 
$
24,033

Interest expense
 
8,593

 
5,610

 
5,007

 
4,438

 
4,275

Net interest income
 
30,303

 
22,268

 
20,077

 
18,566

 
19,758

Provision for loan losses
 
1,300

 
319

 
75

 
656

 
1,910

Net interest income after provision for loan losses
 
29,003

 
21,949

 
20,002

 
17,910

 
17,848

Fees and service charges
 
4,635

 
2,937

 
2,923

 
3,006

 
2,868

Net impairment losses recognized in earnings
 

 

 

 

 
(78
)
Net gain (loss) on sale of available for sale securities
 
(17
)
 
111

 
63

 
60

 
(168
)
Other non-interest income
 
2,752

 
1,703

 
929

 
847

 
794

Non-interest income
 
7,370

 
4,751

 
3,915

 
3,913

 
3,416

Non-interest expense
 
29,764

 
22,878

 
20,058

 
17,403

 
17,224

Income before provision for income taxes
 
6,609

 
3,822

 
3,859

 
4,420

 
4,040

Income tax provision
 
2,326

 
1,323

 
1,286

 
1,614

 
1,530

Net income
 
$
4,283

 
$
2,499

 
$
2,573

 
$
2,806

 
$
2,510

Per Share Data: (1)
 
 
 
 
 
 
 
 
 
 
Net income per share (basic) (1)
 
$
0.72

 
$
0.47

 
$
0.49

 
$
0.54

 
$
0.49

Net income per share (diluted) (1)
 
$
0.58

 
$
0.46

 
$
0.49

 
$
0.54

 
$
0.48

Cash dividends per common share
 
$
0.20

 
$
0.16

 
$
0.12

 
$
0.08

 
$
0.04

Book value per share at end of period
 
$
12.45

 
$
12.48

 
$
12.27

 
$
11.74

 
$
11.23

Tangible book value per share at end of period
 
$
11.05

 
$
9.78

 
$
11.22

 
$
11.72

 
$
11.20



21




CITIZENS COMMUNITY BANCORP, INC.
 
 
 
 
 
 
 
 
 
 
FIVE YEAR SELECTED CONSOLIDATED FINANCIAL DATA (CONTINUED)
 
 
Year ended September 30,
(dollars in thousands, except per share data)
 
 
 
 
 
 
 
 
 
 
 
 
 
2018
 
2017
 
2016
 
2015
 
2014
Selected Financial Condition Data:
 
 
 
 
 
 
 
 
 
 
Total assets
 
975,409

 
940,664

 
695,865

 
580,148

 
569,815

Investment securities
 
123,101

 
101,336

 
86,792

 
87,933

 
70,974

Total loans, net of deferred costs (fees)
 
759,247

 
732,995

 
574,439

 
450,510

 
470,366

Total deposits
 
746,529

 
742,504

 
557,677

 
456,298

 
449,767

Short-term FHLB borrowings
 
63,000

 
90,000

 
45,461

 
33,600

 
20,000

Other FHLB borrowings
 

 

 
13,830

 
25,291

 
38,891

Other borrowings
 
24,619

 
30,319

 
11,000

 

 

Total shareholders’ equity
 
135,847

 
73,483

 
64,544

 
61,454

 
58,019

Weighted average basic common shares outstanding
 
5,943,891

 
5,361,843

 
5,241,458

 
5,208,708

 
5,163,373

Weighted average diluted common shares outstanding
 
7,335,247

 
5,378,360

 
5,257,304

 
5,239,942

 
5,196,706

Performance Ratios:
 
 
 
 
 
 
 
 
 
 
Return on average assets
 
0.45
%
 
0.34
%
 
0.40
%
 
0.49
%
 
0.45
%
Return on average total shareholders’ equity
 
4.35
%
 
3.76
%
 
4.08
%
 
4.70
%
 
4.47
%
Net interest margin (2)
 
3.42
%
 
3.31
%
 
3.27
%
 
3.36
%
 
3.61
%
Net interest spread (2)
 

 
 
 
 
 
 
 
 
Average during period
 
3.27
%
 
3.19
%
 
3.15
%
 
3.24
%
 
3.54
%
End of period
 
3.37
%
 
3.47
%
 
3.31
%
 
3.15
%
 
3.58
%
Net overhead ratio (3)
 
2.35
%
 
2.48
%
 
2.39
%
 
2.35
%
 
2.46
%
Average loan-to-average deposit ratio
 
99.52
%
 
100.87
%
 
101.08
%
 
101.63
%
 
101.57
%
Average interest bearing assets to average interest bearing liabilities
 
114.92
%
 
114.96
%
 
114.38
%
 
114.15
%
 
109.35
%
Efficiency ratio (4)
 
79.01
%
 
84.67
%
 
83.60
%
 
77.42
%
 
74.08
%
Asset Quality Ratios:
 
 
 
 
 
 
 
 
 
 
Non-performing loans to total loans (5)
 
1.10
%
 
1.10
%
 
0.62
%
 
0.27
%
 
0.34
%
Allowance for loan losses to:
 

 
 
 
 
 
 
 
 
Total loans (net of unearned income)
 
0.89
%
 
0.81
%
 
1.06
%
 
1.44
%
 
1.38
%
Non-performing loans
 
81.04
%
 
73.90
%
 
169.92
%
 
532.02
%
 
410.47
%
Net charge-offs to average loans
 
0.07
%
 
0.07
%
 
0.10
%
 
0.14
%
 
0.35
%
Non-performing assets to total assets
 
1.14
%
 
1.49
%
 
0.62
%
 
0.37
%
 
0.46
%
Capital Ratios:
 
 
 
 
 
 
 
 
 
 
Shareholders’ equity to assets (6)
 
13.93
%
 
7.81
%
 
9.28
%
 
10.59
%
 
10.18
%
Average equity to average assets (6)
 
10.32
%
 
9.09
%
 
9.87
%
 
10.39
%
 
9.98
%
Tier 1 capital (leverage ratio) (7)
 
9.2
%
 
9.2
%
 
9.3
%
 
10.6
%
 
10.1
%
Total risk-based capital (7)
 
13.1
%
 
13.2
%
 
14.1
%
 
16.8
%
 
16.3
%

(1)
Earnings per share are based on the weighted average number of shares outstanding for the period.
(2)
Net interest margin represents net interest income as a percentage of average interest earning assets, and net interest rate spread represents the difference between the weighted average yield on interest earning assets and the weighted average cost of interest bearing liabilities.
(3)
Net overhead ratio represents the difference between non-interest expense and non-interest income, divided by average assets.
(4)
Efficiency ratio represents non-interest expense, divided by the sum of net interest income and non-interest income, excluding impairment losses from OTTI.

22




(5)
Non-performing loans are either 90+ days past due or nonaccrual. Non-performing assets consist of non-performing loans plus other real estate owned plus other collateral owned.
(6)
Company ratios
(7)
Bank regulatory ratios


23




ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The following discussion sets forth management’s discussion and analysis of our consolidated financial condition and results of operations that should be read in conjunction with our consolidated financial statements, related notes, the selected financial data and the statistical information presented elsewhere in this report for a more complete understanding of the following discussion and analysis. Unless otherwise noted, years refer to the Company’s fiscal years ended September 30, 2018 and 2017.
PERFORMANCE SUMMARY
The following is a brief summary of some of the significant factors that affected our operating results in 2018. See the remainder of this section for a more thorough discussion. Unless otherwise stated, all monetary amounts in this Management's Discussion and Analysis of Financial Condition and Results of Operations, other than share, per share and capital ratio amounts, are stated in thousands.
As management continues to execute its strategy to grow certain loan portfolio segments, and reduce concentrations in certain other loan portfolio segments, we view our loan portfolio as follows. The Community Banking loan portfolios reflect management’s strategy to grow its commercial banking business and consumer lending. The Legacy loan portfolios reflect management’s strategy to sell substantially all newly originated fixed rate one to four family residential real estate loans in the secondary market and the discontinuation of originated and purchased indirect paper loans.
We reported net income of $4,283 for the year ended September 30, 2018, compared to net income of $2,499 for the year ended September 30, 2017. Diluted earnings per share were $0.58 for 2018 compared to $0.46 for the year ended September 30, 2017. Return on average assets for the year ended September 30, 2018 was 0.45%, compared to 0.34% for the year ended September 30, 2017. The return on average equity was 4.35% for 2018 and 3.76% for 2017. An annual cash dividend in the amount of $0.20 per share and $0.16 per share was paid in the fiscal year ended September 30, 2018 and 2017, respectively.
On August 18, 2017, the Company completed its merger with WFC, pursuant to the merger agreement, dated March 17, 2017. At that time, the separate corporate existence of WFC ceased, and the Company survived the merger. In connection with the merger, the Company caused Wells Federal Bank to merge with and into the Bank, with the Bank surviving the merger.
On June 20, 2018, the Company entered into the Stock Purchase Agreement with United Bancorporation and its wholly-owned subsidiary, United Bank. On October 19, 2018, the Company completed the acquisition of United Bank. The Company acquired 100% of the common stock of United Bank for a purchase price of approximately $50.7 million, plus approximately $0.4 million in closing date purchase price, for a total cash consideration of approximately $51.1 million. The acquisition resulted in increases of approximately $268 million in total assets, $240 million in loans and $214 million in deposits, respectively. In connection with the acquisition, the Company merged United Bank with and into the Bank, with the Bank surviving the merger.
We closed the United Bank acquisition on October 19, 2018, which will enhance the composition of core community banking loans and increase our market presence in Eau Claire and the Chippewa Valley markets. We expect to report assets in excess of $1.2 billion next quarter and rank second in market presence in Eau Claire County as measured by deposits. The combination of two independent financial institutions will be better positioned to provide enhanced product lines and services along with knowledge and resources to or customers, which we expect to be beneficial to our shareholders over time.
On June 20, 2018, the Company entered into a Securities Purchase Agreement with the Purchasers, pursuant to which the Company sold an aggregate of 500,000 shares of the Company’s Series A Preferred Stock, in the Private Placement at $130.00 per share, for aggregate gross proceeds of $65 million.
Each share of Series A Preferred Stock was mandatorily converted into ten shares of common stock following receipt of stockholder approval of the issuance of the 5,000,000 shares of common stock on September 28, 2018.

24




Key factors behind the earnings results were:
For the fiscal year ended September 30, 2018, pre-tax income, as adjusted for merger related costs and branch closure costs, would have increased $489. The aforementioned costs, along with $338 of additional income tax provision, primarily due to the Tax Cuts and Jobs Act of 2017, resulted in a net increase of $0.10 per diluted share after-tax.
Net interest income for the year ended September 30, 2018, grew 32% to $29,003 from $21,949 in fiscal 2017, largely due to the full-year impact of the WFC acquisition, and to a lesser extent, organic growth.
For the year ended September 30, 2018, the net interest margin increased 11 bps to 3.42% from 3.31% for the comparable 2017 period. The full-year impact of the WFC acquisition helped the Company minimize the impact of short-term interest rate increases by the Federal Reserve.
Loan loss provision increased to $1,300 for the year ended September 30, 2018, compared to $319 for the comparable 2017 period. Provision increased due to organic growth of portfolio loans and the impact of the remix of the loan portfolio to commercial lending, which has a higher required loan loss provision than provision levels associated with one to four residential and indirect loan portfolios.
For the year ended September 30, 2018, total non-interest income grew 55% to $7,370 from $4,751 for the comparable 2017 period. Growth in non-interest income is due largely to business lines enhanced or acquired as a result of the WFC acquisition. In addition, mortgage gain on sale increased due to the Company's increased volume of saleable residential loans.
Non-interest expense increased 30% to $29,764 for the year ended September 30, 2018, from $22,878 for the comparable prior 2017 period, primarily due to (1) the full-year impact of the WFC acquisition, (2) the impact of losses on OREO valuation reductions, primarily due to the sales of the Company's two closed branches, and largest OREO parcel totaling $504, (3) a branch closing and (4) increased professional service costs associated with the United Bank acquisition, legal costs of $198 for litigation settled in June 2018, and Sarbanes-Oxley 404 compliance costs.
Fiscal 2018 operations reflect a remix of loan composition. At September 30, 2017, commercial, multi-family, construction and agricultural loans for both operating purposes and secured by real estate totaled 60.0% of the total loan portfolio versus 48.2% one year earlier.
Net loans were $752,499 at September 30, 2018, compared to $727,053 at September 30, 2017. The increase in loans is due to growth in the Company’s commercial lending portfolios, which more than offset the planned reductions in the Company’s residential and indirect loan portfolios.
The allowance for loan and lease losses was 0.89% of total loans at September 30, 2018, compared to 0.81% one year earlier. The modest increase is due to overall loan growth and loan volume changes between our Legacy to Community Banking loan portfolios.
Nonperforming assets ("NPA") decreased to $11,095, or 1.14% of total assets at September 30, 2018, compared to $14,058, or 1.49% of total assets at September 30, 2017. The reduction in NPA is largely due to reductions in OREO due to sales. In fiscal 2018, the Bank sold one closed branch and the largest other real estate owned ("OREO") property balance, which were carried at $1,501 at September 30, 2017. In addition, during fiscal 2018, the Bank sold one other closed branch that was added to OREO during fiscal 2018. The Bank recorded writedowns on these two closed branch properties of $449 during fiscal 2018. Additionally, the Bank reduced the contract for deed portfolio by $1,635 to $1,811 at September 30, 2018, due to loan repayments and refinancings, including balances of $1,038 which the Bank refinanced and moved to the loan portfolio, due to meeting the criteria for sale accounting.
Total deposits were $746,529 at September 30, 2018, compared to $742,504 at September 30, 2017.
FHLB advances decreased from $90,000 at September 30, 2017 to $63,000 at September 30, 2018, as certain funding needs were met by proceeds from the June 2018 preferred stock offering. Other borrowings decreased by $5,700 during the year ended September 30, 2018, due to reductions in the Company's senior debt.
CRITICAL ACCOUNTING ESTIMATES
Our consolidated financial statements are prepared in accordance with Accounting Standards Generally Accepted in the United States of America ("GAAP") as applied in the United States. In connection with the preparation of our financial statements, we are required to make assumptions and estimates about future events, and apply judgments that affect the reported amount of assets, liabilities, revenue, expenses and the related disclosures. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. Some of these estimates are more critical than others. Below is a discussion of our critical accounting estimates
Allowance for Loan Losses.
We maintain an allowance for loan losses to absorb probable and inherent losses in our loan portfolio. The allowance is based on ongoing, quarterly assessments of the estimated probable incurred losses in our loan portfolio. In evaluating the level of the allowance for loan loss, we consider the types of loans and the amount of loans in our loan portfolio, historical loss

25




experience, adverse situations that may affect the borrower’s ability to repay, the estimated value of any underlying collateral, prevailing economic conditions and other relevant factors determined by management. We follow all applicable regulatory guidance, including the “Interagency Policy Statement on the Allowance for Loan and Lease Losses,” issued by the Federal Financial Institutions Examination Council (FFIEC). We believe that the Bank’s Allowance for Loan Losses Policy conforms to all applicable regulatory requirements. However, based on periodic examinations by regulators, the amount of the allowance for loan losses recorded during a particular period may be adjusted.
Our determination of the allowance for loan losses is based on (1) specific allowances for specifically identified and evaluated impaired loans and their corresponding estimated loss based on likelihood of default, payment history, and net realizable value of underlying collateral. Specific allocations for collateral dependent loans are based on fair value of the underlying collateral relative to the unpaid principal balance of individually impaired loans. For loans that are not collateral dependent, the specific allocation is based on the present value of expected future cash flows discounted at the loan’s original effective interest rate through the repayment period; and (2) a general allowance on loans not specifically identified in (1) above, based on historical loss ratios, which are adjusted for qualitative and general economic factors. We continue to refine our allowance for loan losses methodology, with an increased emphasis on historical performance adjusted for applicable economic and qualitative factors.
Assessing the allowance for loan losses is inherently subjective as it requires making material estimates, including the amount and timing of future cash flows expected to be received on impaired loans, any of which estimates may be susceptible to significant change. In our opinion, the allowance, when taken as a whole, reflects estimated probable loan losses in our loan portfolio.

Goodwill.
We account for goodwill and other intangible assets in accordance with ASC Topic 350, “Intangibles - Goodwill and Other.” The Company records the excess of the cost of acquired entities over the fair value of identifiable tangible and intangible assets acquired, less liabilities assumed, as goodwill. The Company amortizes acquired intangible assets with definite useful economic lives over their useful economic lives utilizing the straight-line method. On a periodic basis, management assesses whether events or changes in circumstances indicate that the carrying amounts of the intangible assets may be impaired. The Company does not amortize goodwill and any acquired intangible asset with an indefinite useful economic life, but reviews them for impairment at a reporting unit level on an annual basis, or when events or changes in circumstances indicate that the carrying amounts may be impaired. A reporting unit is defined as any distinct, separately identifiable component of the Company’s one operating segment for which complete, discrete financial information is available and reviewed regularly by the segment’s management. The Company has one reporting unit as of September 30, 2018 which is related to its banking activities. The Company has performed the required goodwill impairment test and has determined that goodwill was not impaired as of September 30, 2018.    
Fair Value Measurements and Valuation Methodologies.
We apply various valuation methodologies to assets and liabilities which often involve a significant degree of judgment, particularly when liquid markets do not exist for the particular items being valued. Quoted market prices are referred to when estimating fair values for certain assets, such as most investment securities. However, for those items for which an observable liquid market does not exist, management utilizes significant estimates and assumptions to value such items. Examples of these items include loans, deposits, borrowings, goodwill, core deposit intangible assets, other assets and liabilities obtained or assumed in business combinations, and certain other financial instruments. These valuations require the use of various assumptions, including, among others, discount rates, rates of return on assets, repayment rates, cash flows, default rates, and liquidation values. The use of different assumptions could produce significantly different results, which could have material positive or negative effects on the Company’s results of operations, financial condition or disclosures of fair value information.
In addition to valuation, the Company must assess whether there are any declines in value below the carrying value of assets that should be considered other than temporary or otherwise require an adjustment in carrying value and recognition of a loss in the consolidated statement of income. Examples include but are not limited to; loans, investment securities, goodwill, core deposit intangible assets and deferred tax assets, among others. Specific assumptions, estimates and judgments utilized by management are discussed in detail herein in management’s discussion and analysis of financial condition and results of operations and in notes 1, 2, 3, 4, 5, 6, 7, 13 and 14 of Condensed Notes to Consolidated Financial Statements.
Income Taxes.
Amounts provided for income tax expenses are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable under tax laws. Deferred income tax assets and liabilities, which arise principally from temporary differences between the amounts reported in the financial statements and the tax basis of certain assets and liabilities, are included in the amounts provided for income taxes. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized.

26




The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income and tax planning strategies which will create taxable income during the periods in which those temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income, and if necessary, tax planning strategies in making this assessment.
The assessment of tax assets and liabilities involves the use of estimates, assumptions, interpretations, and judgments concerning certain accounting pronouncements and application of specific provisions of federal and state tax codes. There can be no assurance that future events, such as court decisions or positions of federal and state taxing authorities, will not differ from management’s current assessment, the impact of which could be material to our consolidated results of our operations and reported earnings. We believe that the deferred tax assets and liabilities are adequate and properly recorded in the accompanying consolidated financial statements. As of September 30, 2018, management does not believe a valuation allowance related to the realizability of its deferred tax assets is necessary.
The Tax Cuts and Jobs Act of 2017 ("Tax Act"), enacted on December 22, 2017, reduces corporate Federal income tax rates for the Company from 34% to 24.5% for 2018, and 21% for 2019. GAAP requires the impact of the provisions of the Tax Act be accounted for in the period of enactment. At December 31, 2017, we had not completed our accounting for the tax effects of enactment of the Tax Act; however, in certain cases, as described below, we made a reasonable estimate and continue to account for those items based on our existing accounting under ASC 740, Income Taxes, and the provisions of the tax laws that were in effect immediately prior to enactment. The Company revalued its net deferred tax assets to account for the future impact of lower corporate taxes. For the items for which we were able to determine a reasonable estimate, we recorded an increased provisional amount of income tax expense of $275 in December 2017, related to the revaluation of the deferred tax assets to both the revaluation of timing differences and the unrealized loss on securities. In the fourth quarter of fiscal 2018, based on updated information obtained in connection with the filing of our tax return and analysis of our net deferred tax asset both from the return and 2018 tax provisions, we finalized the tax analysis and recorded an additional $63 of expense, or a net increase in our tax provision for the year of $338 related to the Tax Act.
STATEMENT OF OPERATIONS ANALYSIS
2018 compared to 2017
Net Interest Income. Net interest income represents the difference between the dollar amount of interest earned on interest bearing assets and the dollar amount of interest paid on interest bearing liabilities. The interest income and expense of financial institutions are significantly affected by general economic conditions, competition, policies of regulatory authorities and other factors.
Interest rate spread and net interest margin are used to measure and explain changes in net interest income. Interest rate spread is the difference between the yield on interest earning assets and the rate paid for interest bearing liabilities that fund those assets. Net interest margin is expressed as the percentage of net interest income to average interest earning assets. Net interest margin exceeds interest rate spread because non-interest bearing sources of funds (“net free funds”), principally demand deposits and stockholders’ equity, also support interest earning assets. The narrative below discusses net interest income, interest rate spread, and net interest margin.
Net interest income on a tax-equivalent basis was $30,514 for 2018, compared to $22,563 for 2017. Interest income on tax exempt securities is computed on a tax equivalent basis. The net interest margin for 2018 was 3.42% compared to 3.31% for 2017. The 11 basis point increase in net interest margin was mainly attributable to a 29 basis point increase in loan yields with only a 1 basis point decrease in deposits costs. Loan yields increased primarily due to lending portfolio shifts from our legacy to community banking portfolios. The slight change in deposit costs is due to customers shifting from money market and other interest-bearing deposit accounts to certificate accounts in the current rising interest rate environment offset by increases resulting from the full-year impact of the acquired, lower rate, WFC deposit portfolio.
Also contributing to the net interest margin increase is a 7 basis point increase on investment securities yields, primarily due to purchases at yields above average portfolio rates, offset by a 117 basis point increase in borrowing costs, largely due to higher short-term interest rates. Borrowing costs increased due to higher average outstanding borrowings balances during fiscal 2018, despite lower borrowings balances at September 30, 2018. Borrowings balances were lower at September 30, 2018 due to reduced reliance on FHLB borrowings for loan funding needs, and payoff of over $5 million of corporate borrowings in the fourth quarter of fiscal 2018.
As shown in the rate/volume analysis table below, positive volume changes resulted in a $7,556 increase in net interest income in 2018. Average loan volume increases were due to commercial real estate and non-real estate loan growth in the current fiscal year over the prior fiscal year, arising from the full-year impact of the WFC acquisition and management's strategy to continue to grow its Community Banking portfolio and allow runoff of its Legacy loan portfolio. The increase and changes in the composition of interest earning assets resulted in a $11,018 increase in interest income for 2018, and a $2,983

27




increase in interest expense due partially to acquisition of WFC assets and liabilities and the increase in borrowings to facilitate the acquisition. Rate changes on interest earning assets caused an increase in interest income by $2,113 and increased interest expense by $1,634, for a net impact of a $479 increase in net interest income between 2018 and 2017.
Average Balances, Net Interest Income, Yields Earned and Rates Paid. The following table shows interest income from average interest earning assets, expressed in dollars and yields, and interest expense on average interest bearing liabilities, expressed in dollars and rates. Also presented is the weighted average yield on interest earning assets on a tax-equivalent basis, rates paid on interest bearing liabilities and the resultant spread at September 30 for each of the last two fiscal years. Non-accruing loans have been included in the table as loans carrying a zero yield.
Average interest earning assets were $892,472 in 2018 compared to $682,545 in 2017. Average loans outstanding increased to $735,602 in 2018 from $568,670 in 2017. Interest income on loans increased $9,713, of which $7,958 related to the increase in average outstanding balances, offset by an increase in interest income due to higher yields on such loans in the amount of $1,755.
Average interest bearing liabilities increased $182,859 in 2018 from their 2017 levels. The increase in average interest-bearing liabilities was primarily due to the full-year effect of both the deposits acquired in the WFC acquisition and, to a lesser extent, holding company borrowings used to facilitate the purchase. Average interest bearing deposits increased $154,850, or 30.3% to $665,782 in 2018. Interest expense on interest bearing deposits increased $822 during 2018 from the volume and mix changes and increased $422 from the impact of the rate environment, resulting in an aggregate increase of $1,244 in interest expense on interest bearing deposits.
 
 
 
Year ended September 30, 2018
 
Year ended September 30, 2017
 
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
 
Average
Balance
 
Interest
Income/
Expense
 
Average
Yield/
Rate
Average interest earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
24,747

 
$
308

 
1.24
%
 
$
19,368

 
$
139

 
0.72
%
Loans
 
735,602

 
35,539

 
4.83
%
 
568,670

 
25,826

 
4.54
%
Interest-bearing deposits
 
7,871

 
149

 
1.89
%
 
1,922

 
29

 
1.51
%
Investment securities (1)
 
116,517

 
2,508

 
2.33
%
 
87,449

 
1,679

 
2.26
%
Non-marketable equity securities, at cost
 
7,735

 
392

 
5.07
%
 
5,136

 
205

 
3.99
%
Total interest earning assets (1)
 
$
892,472

 
$
38,896

 
4.38
%
 
$
682,545

 
$
27,878

 
4.13
%
Average interest-bearing liabilities:
 
 
 


 

 


 


 

Savings accounts
 
$
94,854

 
$
162

 
0.17
%
 
$
53,530

 
$
67

 
0.13
%
Demand deposits
 
149,282

 
475

 
0.32
%
 
65,283

 
273

 
0.42
%
Money market
 
118,229

 
738

 
0.62
%
 
126,487

 
555

 
0.44
%
CD’s
 
269,749

 
3,807

 
1.41
%
 
236,590

 
3,104

 
1.31
%
IRA’s
 
33,668

 
361

 
1.07
%
 
29,042

 
300

 
1.03
%
Total deposits
 
$
665,782

 
$
5,543

 
0.83
%
 
$
510,932

 
$
4,299

 
0.84
%
FHLB Advances and other borrowings
 
110,790

 
3,050

 
2.75
%
 
82,781

 
1,311

 
1.58
%
Total interest-bearing liabilities
 
$
776,572

 
$
8,593

 
1.11
%
 
$
593,713

 
$
5,610

 
0.94
%
Net interest income
 


 
$
30,303

 

 


 
$
22,268

 

Interest rate spread
 

 

 
3.27
%
 

 

 
3.19
%
Net interest margin (1)
 

 

 
3.42
%
 

 

 
3.31
%
Average interest earning assets to average interest-bearing liabilities
 

 

 
1.15
%
 

 

 
1.15
%
 
(1) Fully taxable equivalent (FTE). The average yield on tax exempt securities is computed on a tax equivalent basis using a tax rate of 24.5% and 34% for the twelve months ended September 30, 2018 and September 30, 2017, respectively. The FTE adjustment to net interest income included in the rate calculations totaled $211 and $295 for the years ended September 30, 2018 and 2017, respectively.


28




Rate/Volume Analysis. The following table presents the dollar amount of changes in interest income and interest expense for the components of interest earning assets and interest bearing liabilities that are presented in the preceding table. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to: (1) changes in volume, which are changes in the average outstanding balances multiplied by the prior period rate (i.e. holding the initial rate constant); and (2) changes in rate, which are changes in average interest rates multiplied by the prior period volume (i.e. holding the initial balance constant).
 
 
 
Year ended September 30,
2018 v. 2017
Increase (decrease) due to
 
 
Volume (1)
 
Rate (1)
 
Total
Increase /
(Decrease)
Interest income:
 
 
 
 
 
 
Cash and cash equivalents
 
$
45

 
$
124

 
$
169

Loans
 
7,958

 
1,755

 
9,713

Interest-bearing deposits
 
107

 
13

 
120

Investment securities
 
676

 
153

 
829

Non-marketable equity securities, at cost
 
119

 
68

 
187

Total interest earning assets
 
$
8,905

 
$
2,113

 
$
11,018

Interest expense:
 

 

 

Savings accounts
 
$
64

 
$
31

 
$
95

Demand deposits
 
293

 
(91
)
 
202

Money market accounts
 
(39
)
 
222

 
183

CD’s
 
455

 
248

 
703

IRA’s
 
49

 
12

 
61

Total deposits
 
822

 
422

 
1,244

FHLB Advances and other borrowings
 
527

 
1,212

 
1,739

Total interest bearing liabilities
 
1,349

 
1,634

 
2,983

Net interest income
 
$
7,556

 
$
479

 
$
8,035

 
(1)
the change in interest due to both rate and volume has been allocated in proportion to the relationship to the dollar amounts of the change in each.
Provision for Loan Losses. We determine our provision for loan losses (“provision”, or “PLL”) based on our desire to provide an adequate allowance for loan losses (“ALL”) to reflect probable and inherent credit losses in our loan portfolio.
Net loan charge-offs for the years ended September 30, 2018 and 2017 were $494 and $445, respectively. Net charge-offs to average loans were 0.07% for both of the periods ended September 30, 2018 and September 30, 2017, respectively.
We recorded provisions for loan losses of $1,300 and $319 for the years ended September 30, 2018 and 2017, respectively, reflecting organic loan growth and the impact of slightly higher charge-offs. Also contributing to higher provision for loan losses was the impact of the remix of the loan portfolio to commercial lending and runoff of one to four residential and indirect loans, which will increase the allowance due to higher provision levels on commercial lending utilized by the Bank. Management believes that the provision taken for the year ended September 30, 2018 is adequate in view of the present condition of the Bank's loan portfolio and the sufficiency of collateral supporting non-performing loans. We are continually monitoring non-performing loan relationships and will make provisions, as necessary, if the facts and circumstances change. In addition, a decline in the quality of our loan portfolio as a result of general economic conditions, factors affecting particular borrowers or our market areas, or other factors could all affect the adequacy of our ALL. If there are significant charge-offs against the ALL, or we otherwise determine that the ALL is inadequate, we will need to record an additional PLL in the future. See Note 1, “Nature of Business and Summary of Significant Accounting Policies - Allowance for Loan Losses” of "Notes to Consolidated Financial Statements and Supplementary Data" to this Form 10-K, for further analysis of the provision for loan losses.

29




Non-Interest Income. The following table reflects the various components of non-interest income for the years ended September 30, 2018 and 2017, respectively.
 
 
 
Years Ended September 30,
 
Change from Prior Year
 
 
2018
 
2017
 
2018 over 2017
Noninterest Income:
 
 
 
 
 
 
Service charges on deposit accounts
 
$
1,792

 
$
1,433

 
25.05%
Interchange income
 
1,284

 
789

 
62.74%
Loan servicing income
 
1,379

 
380

 
262.89%
Gain on sale of mortgage loans
 
943

 
686

 
37.46%
Loan fees and service charges
 
521

 
438

 
18.95%
Insurance commission income
 
720

 
122

 
490.16%
Settlement proceeds
 

 
283

 
N/M
Gains (losses) on available for sale securities
 
(17
)
 
111

 
(115.32)%
Other
 
748

 
509

 
46.95%
Total non-interest income
 
$
7,370

 
$
4,751

 
55.13%
N/M means not meaningful
Increases in service charges on deposit accounts, interchange income, loan fees and service charges and insurance commission income are all primarily attributable to the full-year impact of business lines enhanced or acquired as a result of the WFC acquisition. The increases in loan servicing income and gain on sale of mortgage loans are due to the Company’s growth in mortgage banking activities, including the sale and servicing of residential mortgage loans.
Non-Interest Expense. The following table reflects the various components of non-interest expense for the years ended September 30, 2018 and 2017, respectively.
 
 
 
Years ended September 30,
 
% Change From Prior Year
 
 
2018
 
2017
 
2018 over 2017
Noninterest Expense:
 
 
 
 
 
 
Compensation and related benefits
 
$
14,979

 
$
10,862

 
37.90%
Occupancy
 
2,975

 
2,780

 
7.01%
Office
 
1,715

 
1,204

 
42.44%
Data processing
 
2,928

 
2,052

 
42.69%
Amortization of intangible assets
 
644

 
219

 
194.06%
Amortization of mortgage servicing rights
 
335

 
39

 
N/M
Advertising, marketing and public relations
 
745

 
545

 
36.70%
FDIC premium assessment
 
472

 
300

 
57.33%
Professional services
 
2,323

 
2,078

 
11.79%
Losses on repossessed assets, net
 
535

 
32

 
N/M
Other
 
2,113

 
2,767

 
(23.64)%
Total noninterest expense
 
$
29,764

 
$
22,878

 
30.10%
Noninterest expense (annualized) / Average assets
 
3.12
%
 
3.13
%
 
 
N/M means not meaningful
Compensation and benefits increased due to the full year impact of staffing increases associated with the WFC acquisition and other staffing increases to support business growth, including the hiring of four new commercial lenders in the second quarter of fiscal 2018.
Occupancy costs, consisting primarily of office rental and depreciation expenses, increased largely due to the full-year impact of the WFC branches, partially offset by lower lease costs of $431.
Data processing expenses increased in 2018 due to increased costs associated with a larger customer base.

30




The amortization of core deposit expenses increased in 2018 due to the full year impact of the core deposit intangible and customer acquisition cost related to the WFC acquisition.
Advertising, marketing and public relations expenses increased $200 during the twelve months ended September 30, 2018, primarily due to rebranding efforts of the Bank, and increased advertising of the Bank’s deposit products.
Professional services expense increased in the current year, primarily due to increased use of outside professionals in connection with acquisition related activities. Also included in 2018 professional services expense are; legal costs of $198 resulting from resolved litigation, approximately $121 on Sarbanes-Oxley 404 compliance and $55 from engaging a compensation consultant to assist with executive and director compensation programs.
The increase in losses on repossessed assets is primarily due to write downs on two closed branch offices in the third quarter of fiscal 2018 totaling $449. At September 30, 2018, there are no properties in foreclosed and repossessed assets in excess of $500.
Other expenses decreased $519 in the current twelve-month period. In fiscal 2017, other expenses included approximately $1,060 more in merger, contract termination, and branch closure costs than in 2018. Increases in fiscal 2018 are due, primarily to (1) loan collection and processing expenses of approximately $340, (2) employee recruitment costs of approximately $130 and (2) insurance costs of approximately $90.
Income Taxes. Income tax provision was $2,326 for the year ended September 30, 2018, compared to $1,323 for the year ended September 30, 2017. Our effective tax rate increased from 34.6% at September 30, 2017 to 35.2% at September 30, 2018. The higher effective tax rate for the year ended September 30, 2018 was the result of revaluation of net deferred tax assets in the first and fourth quarters of fiscal 2018, and the tax impact of non-deductible acquisition costs. The Tax Cuts and Jobs Act of 2017, enacted on December 22, 2017, reduces the corporate Federal income tax rate for the Company from 34% to 24.5% in the current year, and to 21% thereafter. Applying the new accounting guidance for the Tax Act, resulted in additional income tax provision of $338 for the year ended September 30, 2018.
See Note 1, “Nature of Business and Summary of Significant Accounting Policies” and Note 14, “Income Taxes” in the accompanying Notes to Consolidated Financial Statements for a further discussion of income tax accounting, and the impact of the Tax Cuts and Jobs Act of 2017. Income tax expense recorded in the accompanying Consolidated Statements of Operations involves interpretation and application of certain accounting pronouncements and federal and state tax codes and is, therefore, considered a critical accounting policy. We undergo examination by various taxing authorities. Such taxing authorities may require that changes in the amount of tax expense or the amount of the valuation allowance be recognized when their interpretations differ from those of management, based on their judgments about information available to them at the time of their examinations.
BALANCE SHEET ANALYSIS
Total assets were $975,409 at September 30, 2018, compared to $940,664 at September 30, 2017. The increase is attributable primarily to organic loan growth, and an increase in investment securities purchases, funded by operations. Cash and cash equivalents decreased from $41,677 to $34,494, due to management increasing the yield on the Company's liquidity portfolio by moving to higher yielding investments.
Gross loans increased $26,080, or 3.5%, from $736,613 at September 30, 2017 to $762,693 at September 30, 2018. At September 30, 2018, total gross Community Banking portfolio loans, consisting of commercial, agricultural and consumer loans was $488,396 or 64.3% of total gross loans, compared to $391,763 or 53.5% of total gross loans at September 30, 2017. Legacy portfolio loans, consisting of indirect paper and one-to-four family loans totaled $274,297 or 36.1% of total gross loans at September 30, 2018, compared to $344,850 or 47.0% at September 30, 2017. Gross commercial and agricultural real estate secured loans totaled $353,020, or 46.5% of total gross loans at September 30, 2018, compared to $273,900, or 37.4%, respectively at September 30, 2017, representing a 28.9% increase over the prior year’s balance. The Community Banking portfolio increased $96,633, or 24.7% while the Legacy loan portfolio planned runoff was $70,553, or a 20.5% reduction in Legacy portfolio loan balances during the current year.
Loans. Total loans outstanding, net of deferred loan fees and costs, increased to $759,247 at September 30, 2018, a 3.6% increase from their balance of $732,995 at September 30, 2017.

31




The following table reflects the composition, or mix, of our loan portfolio at September 30, for the last three completed fiscal years:
 
 
2018
 
2017
 
2016
 
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
Community Banking Loan Portfolios:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial/Agricultural real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
$
216,703

 
28.6
 %
 
$
159,962

 
21.8
 %
 
$
88,940

 
15.5
 %
Agricultural real estate
 
70,517

 
9.3
 %
 
68,002

 
9.3
 %
 
28,198

 
4.9
 %
Multi-family real estate
 
48,061

 
6.3
 %
 
26,228

 
3.6
 %
 
19,135

 
3.3
 %
Construction and land development
 
17,739

 
2.3
 %
 
19,708

 
2.7
 %
 
16,580

 
2.9
 %
Commercial/Agricultural non-real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial non-real estate
 
76,254

 
10.0
 %
 
55,251

 
7.5
 %
 
31,001

 
5.4
 %
Agricultural non-real estate
 
26,549

 
3.5
 %
 
23,873

 
3.3
 %
 
14,647

 
2.6
 %
Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Purchased HELOC loans
 
13,729

 
1.8
 %
 
18,071

 
2.5
 %
 

 
 %
Consumer non-real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Other consumer
 
18,844

 
2.5
 %
 
20,668

 
2.8
 %
 
19,715

 
3.4
 %
Total Community Banking Loan Portfolios
 
488,396

 
64.3
 %
 
391,763

 
53.5
 %
 
218,216

 
38.0
 %
 
 
 
 
 
 
 
 
 
 
 
 
 
Legacy Loan Portfolios:
 
 
 
 
 
 
 
 
 
 
 
 
Residential real estate:
 
 
 
 
 
 
 
 
 
 
 
 
One to four family
 
196,052

 
25.8
 %
 
229,563

 
31.3
 %
 
187,738

 
32.7
 %
Consumer non-real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Originated indirect paper
 
60,991

 
8.0
 %
 
85,732

 
11.7
 %
 
119,073

 
20.7
 %
Purchased indirect paper
 
17,254

 
2.3
 %
 
29,555

 
4.0
 %
 
49,221

 
8.6
 %
Total Legacy Loan Portfolios
 
274,297

 
36.1
 %
 
344,850

 
47.0
 %
 
356,032

 
62.0
 %
Gross loans
 
762,693

 
 
 
736,613

 
 
 
574,248

 
 
Unearned net deferred fees and costs and loans in process
 
557

 
0.1
 %
 
1,471

 
0.2
 %
 
1,915

 
0.3
 %
Unamortized discount on acquired loans
 
(4,003
)
 
(0.5
)%
 
(5,089
)
 
(0.7
)%
 
(1,724
)
 
(0.3
)%
Total loans (net of unearned income and deferred expense)
 
759,247

 
100.0
 %
 
732,995

 
100.0
 %
 
574,439

 
100.0
 %
Allowance for loan losses
 
(6,748
)
 
 
 
(5,942
)
 
 
 
(6,068
)
 
 
Total loans receivable, net
 
$
752,499

 
 
 
$
727,053

 
 
 
$
568,371

 
 
In September 2017, the Bank purchased, on a non-recourse basis, a 90% participation in $23,977 of loans secured by second liens on certain residential real estate properties. The seller retained servicing of the purchased loans, and is paid a 40bp servicing fee, based on the outstanding balance of the purchased loans. The balance of the Bank's share of the purchased loans decreased to $13,729 at September 30, 2018.

32




The following table sets forth, for our last three fiscal years, fixed and adjustable rate loans in our loan portfolio:
 
 
 
2018
 
2017
 
2016
 
 
Amount
 
Percent
 
Amount
 
Percent
 
Amount
 
Percent
Fixed rate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Residential real estate
 
$
165,328

 
21.8
 %
 
$
208,949

 
28.5
 %
 
$
173,051

 
30.2
 %
Commercial/Agricultural real estate
 
169,692

 
22.4
 %
 
160,249

 
21.9
 %
 
92,030

 
16.0
 %
Total fixed rate real estate loans
 
335,020

 
44.2
 %
 
369,198

 
50.4
 %
 
265,081

 
46.2
 %
Non-real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer non-real estate
 
96,843

 
12.8
 %
 
135,955

 
18.5
 %
 
188,009

 
32.7
 %
Commercial/Agricultural non-real estate
 
73,406

 
9.7
 %
 
53,165

 
7.3
 %
 
25,839

 
4.5
 %
Total fixed rate non-real estate loans
 
170,249

 
22.4
 %
 
189,120

 
25.8
 %
 
213,848

 
37.2
 %
Total fixed rate loans
 
505,269

 
66.5
 %
 
558,318

 
76.2
 %
 
478,929

 
83.4
 %
Adjustable rate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Residential real estate
 
44,453

 
5.9
 %
 
38,685

 
5.3
 %
 
14,687

 
2.6
 %
Commercial/Agricultural real estate
 
183,328

 
24.1
 %
 
113,651

 
15.5
 %
 
60,823

 
10.6
 %
Total adjustable rate real estate loans
 
227,781

 
30.0
 %
 
152,336

 
20.8
 %
 
75,510

 
13.2
 %
Non-real estate loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer non-real estate
 
246

 
0.0
 %
 

 
0.0
 %
 

 
0.0
 %
Commercial/Agricultural non-real estate
 
29,397

 
3.9
 %
 
25,959

 
3.5
 %
 
19,809

 
3.4
 %
Total adjustable rate non-real estate loans
 
29,643

 
3.9
 %
 
25,959

 
3.5
 %
 
19,809

 
3.4
 %
Total adjustable rate loans
 
257,424

 
33.9
 %
 
178,295

 
24.3
 %
 
95,319

 
16.6
 %
Gross loans
 
762,693

 

 
736,613

 

 
574,248

 

Unearned net deferred fees and costs and loans in process
 
557

 
0.1
 %
 
1,471

 
0.2
 %
 
1,915

 
0.3
 %
Unamortized discount on acquired loans
 
(4,003
)
 
(0.5
)%
 
(5,089
)
 
(0.7
)%
 
(1,724
)
 
(0.3
)%
Total loans (net of unearned income)
 
759,247

 
100.0
 %
 
732,995

 
100.0
 %
 
574,439

 
100.0
 %
Allowance for loan losses
 
(6,748
)
 

 
(5,942
)
 

 
(6,068
)
 

Total loans receivable, net
 
$
752,499

 

 
$
727,053

 

 
$
568,371

 

The Bank offers loans with fixed and adjustable interest rates. The Bank's Legacy portfolio consists largely of fixed-rate loans, and this portfolio is being runoff. In addition, the Company has continued to grow the adjustable rate loan portfolio. As such, Fixed rate loans declined to 66.5% of gross loans in 2018, compared to 76.2% at September 30, 2018.
Our loan portfolio is diversified by types of borrowers and industry groups within the market areas that we serve. Significant loan concentrations are considered to exist for a financial entity when the amounts of loans to multiple borrowers engaged in similar activities cause them to be similarly impacted by economic or other conditions. At September 30, 2018, we identified two concentrations of loans; commercial real estate loans comprise 28.6% of our total loan portfolio, and one to four family residential real estate loans comprise 25.8% of our total loan portfolio.
In order to limit exposure to interest rate risk, we have developed strategies to shorten the average maturity of our fixed rate loan portfolio by originating shorter term loans, offering new adjustable rate loan products and selling the vast majority of the Bank's longer term fixed rate loans.

33




Loan amounts and their contractual maturities for the years presented are as follows:
 
 
 
Real estate
Non-real estate
 
 
 
 
 
Residential real estate
 
Commercial/Agricultural real estate
 
Consumer non-real estate
 
Commercial/Agricultural non-real estate
 
Total
 
 
Amount
 
Weighted
Average
Rate
 
Amount
 
Weighted
Average
Rate
 
Amount
 
Weighted
Average
Rate
 
Amount
 
Weighted
Average
Rate
 
Amount
 
Weighted
Average
Rate
Due in one year or less
 
$
14,520

 
5.19
%
 
$
35,777

 
4.64
%
 
$
2,525

 
7.84
%
 
$
50,237

 
5.33
%
 
$
103,059

 
5.13
%
Due after one year through five years
 
67,806

 
5.10
%
 
105,814

 
4.56
%
 
39,644

 
5.15
%
 
35,848

 
5.07
%
 
249,112

 
4.87
%
Due after five years
 
127,455

 
4.86
%
 
211,429

 
4.68
%
 
54,920

 
5.35
%
 
16,718

 
4.64
%
 
410,522

 
4.82
%
 
 
$
209,781

 
4.96
%
 
$
353,020

 
4.64
%
 
$
97,089

 
5.33
%
 
$
102,803

 
5.13
%
 
$
762,693

 
4.88
%
(1)
Includes loans having no stated maturity and overdraft loans.
We believe that the critical factors in the overall management of credit or loan quality are sound loan underwriting and administration, systematic monitoring of existing loans and commitments, effective loan review on an ongoing basis, recording an adequate allowance to provide for incurred loan losses, and reasonable non-accrual and charge-off policies.
Risk Management and the Allowance for Loan Losses. The loan portfolio is our primary asset subject to credit risk. To address this credit risk, we maintain an ALL for probable and inherent credit losses through periodic charges to our earnings. These charges are shown in our accompanying Consolidated Statements of Operations as Provision for Loan Losses. See “Statement of Operations Analysis - Provision for Loan Losses” above. We attempt to control, monitor and minimize credit risk through the use of prudent lending standards, a thorough review of potential borrowers prior to lending and ongoing and timely review of payment performance. Asset quality administration, including early identification of loans performing in a substandard manner, as well as timely and active resolution of problems, further enhances management of credit risk and minimization of loan losses. Any losses that occur and that are charged off against the ALL are periodically reviewed with specific efforts focused on achieving maximum recovery of both principal and interest on the affected loan.
At least quarterly, we review the adequacy of the ALL. Based on an estimate computed pursuant to the requirements of ASC 450-10, “Accounting for Contingencies” and ASC 310-10, “Accounting by Creditors for Impairment of a Loan”, the analysis of the ALL consists of three components: (i) specific credit allocation established for expected losses relating to specific impaired loans for which the recorded investment in the loan exceeds its fair value; (ii) general portfolio allocation based on historical loan loss experience for significant loan categories; and (iii) general portfolio allocation based on qualitative factors such as economic conditions and other relevant factors specific to the markets in which we operate. We continue to refine our ALL methodology by introducing a greater level of granularity to our loan portfolio. We currently segregate loans into pools based on common risk characteristics for purposes of determining the ALL. The additional segmentation of the portfolio is intended to provide a more effective basis for the determination of qualitative factors affecting our ALL. In addition, management continually evaluates our ALL methodology to assess whether modifications in our methodology are appropriate in light of underwriting practices, market conditions, identifiable trends, regulatory pronouncements or other factors. We believe that any modifications or changes to the ALL methodology would be to enhance the accuracy of the ALL. However, any such modifications could result in materially different ALL levels in future periods.

34




Changes in the ALL by loan portfolio segment for the years presented were as follows:
 
 
Residential Real Estate
 
Commercial/Agriculture Real Estate
 
Consumer Non-real Estate
 
Commercial/Agricultural Non-real Estate
 
Unallocated
 
Total
Year Ended September 30, 2018:
 
 
 
 
 
 
 
 
 
 
 
 
Allowance for Loan Losses:
 
 
 
 
 
 
 
 
 
 
 
 
Beginning balance, October 1, 2017
 
$
1,458

 
$
2,523

 
$
936

 
$
897

 
$
128

 
$
5,942

Charge-offs
 
(96
)
 
(1
)
 
(309
)
 
(52
)
 

 
(458
)
Recoveries
 
45

 

 
117

 
12

 

 
174

Provision
 

 
755

 
85

 
230

 

 
1,070

Allowance allocation adjustment
 
(372
)
 
(1
)
 
(165
)
 
(47
)
 
154

 
(431
)
Total Allowance on originated loans
 
$
1,035

 
$
3,276

 
$
664

 
$
1,040

 
$
282

 
$
6,297

Purchased credit impaired loans
 

 

 

 

 

 

Other acquired loans
 

 

 

 

 

 

Beginning balance, October 1, 2017
 
$

 
$

 
$

 
$

 
$

 
$

Charge-offs
 
(106
)
 
(73
)
 
(70
)
 

 

 
(249
)
Recoveries
 
34

 

 
5