10-K 1 hmnf20171231_10k.htm FORM 10-K hmnf20171231_10k.htm

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-K

 

[x]

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

For the fiscal year ended December 31, 2017

OR

[  ]

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

For the transition period from _____ to ______.

 

Commission file number: 0-24100.

HMN FINANCIAL, INC.

(Exact name of registrant as specified in its charter)

Delaware

41-1777397

(State or other jurisdiction of incorporation or organization)

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

   

1016 Civic Center Drive Northwest

55901

Rochester, Minnesota

(Zip Code)

(Address of principal executive offices)

 
   

(507) 535-1200

 

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, par value $.01 per share

 

Nasdaq Global Market

 

 

Securities registered pursuant to section 12(g) of the Act:

 

None
(Title of class)

 

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

YES [ ] NO [ X ]

 

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

YES [ ] NO [ X ]

 

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 requirements for the past 90 days.

YES [ X ] NO [   ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES [ X ] NO [    ]

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 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. [ X ]

 

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

Large accelerated filer [     ]    Accelerated filer                     [      ]  
Non-accelerated filer   [     ] Smaller reporting company   [ X ]
(Do not check if a smaller reporting company) Emerging growth company   [     ]

   

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

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES [   ] NO [ X ]

 

As of June 30, 2017, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was $61.9 million based on the closing stock price of $17.55 on such date as reported on the Nasdaq Global Market.

 

As of February 19, 2018, the number of outstanding shares of common stock of the registrant was 4,504,234.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s annual report to stockholders for the year ended December 31, 2017 (Annual Report), are incorporated by reference in Parts I and II of this Form 10-K. Portions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A not later than 120 days after the close of the registrant’s fiscal year ended December 31, 2017 are incorporated by reference in Part III of this Form 10-K.

 

 

TABLE OF CONTENTS

 

    Page
PART I  
     

Item 1.

Business

5

Item 1A.

Risk Factors

30

Item 1B.

Unresolved Staff Comments

39

Item 2.

Properties

40

Item 3.

Legal Proceedings

40

Item 4.

Mine Safety Disclosures

40

 

 

 

PART II

 

 

 

 

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

40

Item 6.

Selected Financial Data

40

Item 7.

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

40

Item 7A.  

Quantitative and Qualitative Disclosures About Market Risk

40

Item 8.

Financial Statements and Supplementary Data

41

Item 9.

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

41

Item 9A.

Controls and Procedures

41

Item 9B.

Other Information

42

 

 

 

PART III

 

 

 

 

Item 10.

Directors, Executive Officers and Corporate Governance

42

Item 11.

Executive Compensation

42

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

43

Item 13.

Certain Relationships and Related Transactions, and Director Independence

42

Item 14.

Principal Accounting Fees and Services

42

 

 

 

PART IV

 

 

 

 

Item 15.

Exhibits, Financial Statement Schedules

43

Item 16.  

Form 10-K Summary

43

Index to Exhibits

44

Signatures

47

 

 

Forward-Looking Statements

 

The information presented or incorporated by reference in this Form 10-K contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the Exchange Act). These statements are often identified by such forward-looking terminology as “expect,” “intend,” “look,” “believe,” “anticipate,” “estimate,” “project,” “seek,” “may,” “will,” “would,” “could,” “should,” “trend,” “target,” and “goal” or similar statements or variations of such terms and include, but are not limited to, those relating to growing our core deposit relationships and loan balances, enhancing the financial performance of our core banking operations, maintaining credit quality, reducing non-performing assets, and generating improved financial results (including profitability); the extent of the positive impact of the lower federal tax rate on future earnings; the adequacy and amount of available liquidity and capital resources to the Bank; the Company’s liquidity and capital requirements; our expectations for core capital and our strategies and potential strategies for maintenance thereof; improvements in loan production; changes in the size of the Bank’s loan portfolio; the amount of the Bank’s non-performing assets and the appropriateness of the allowance therefor; anticipated future levels of the provision for loan losses; future losses on non-performing assets; the amount and composition of interest-earning assets; the amount of yield enhancements relating to non-accruing and purchased loans; the amount and composition of non-interest and interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends by HMN; the future outlook for the Company; the amount of deposits that will be withdrawn from checking and money market accounts and how the withdrawn deposits will be replaced; the projected changes in net interest income based on rate shocks; the range that interest rates may fluctuate over the next twelve months; the net market risk of interest rate shocks; the future outlook for the issuer of the trust preferred securities held by the Bank; the ability of the Bank to pay dividends to HMN; the ability to remain well capitalized; the impact of new accounting pronouncements, and compliance by the Bank with regulatory standards generally (including the Bank’s status as “well-capitalized”) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject, specifically, and possible responses of the Office of the Comptroller of the Currency (OCC), Board of Governors of the Federal Reserve System (FRB), the Bank, and the Company to any failure to comply with any such regulatory standard, directive or requirement.

 

A number of factors could cause actual results to differ materially from the Company’s assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including additional changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the OCC and FRB in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Company’s loan and investment portfolios; changes in costs associated with alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank (FHLB); technological, computer-related or operational difficulties; results of litigation; reduced demand for financial services and loan products; changes in accounting policies and guidelines, or monetary and fiscal policies of the federal government or tax laws; international economic developments; the Company’s access to and adverse changes in securities markets; the market for credit related assets; the future operating results, financial condition, cash flow requirements and capital spending priorities of the Company and the Bank; the availability of internal and, as required, external sources of funding; our ability to attract and retain employees; or other significant uncertainties. For additional discussion of the risks and uncertainties applicable to the Company, see the “Risk Factors” section of this Form 10-K. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements.

 

All statements in this Form 10-K, including forward-looking statements, speak only as of the date they are made, and we undertake no duty to update any of the forward-looking statements after the date of this Form 10-K.

 

 

PART I

ITEM 1. BUSINESS

 

General

 

HMN Financial, Inc. (HMN and, together with its subsidiaries, the Company) is a stock savings bank holding company that owns 100 percent of Home Federal Savings Bank (the Bank). The Bank has a community banking philosophy and operates retail banking and loan production facilities in Minnesota, Iowa and Wisconsin. The Bank has two wholly owned subsidiaries, Osterud Insurance Agency, Inc. (OIA), which does business as Home Federal Investment Services and offers financial planning products and services, and HFSB Property Holdings, LLC (HPH), which is currently inactive, but has acted in the past as an intermediary for the Bank in holding and operating certain foreclosed properties. HMN was incorporated in Delaware in 1994.

 

As a community-oriented financial institution, the Company seeks to serve the financial needs of communities in its market area. The Company’s business involves attracting deposits from the general public and businesses and using such deposits to originate or purchase single family residential, commercial real estate and multi-family mortgage loans as well as consumer, construction and commercial business loans. The Company also invests in mortgage-backed and related securities, U.S. government agency obligations and other permissible investments. The executive offices of the Company are located at 1016 Civic Center Drive Northwest, Rochester, Minnesota 55901. Its telephone number at that address is (507) 535-1200. The Company’s website is www.hmnf.com. Information contained on the Company’s website is expressly not incorporated by reference into this Form 10-K.

 

Market Area

 

The Company serves the southern Minnesota counties of Dodge, Fillmore, Freeborn, Houston, Mower, Olmsted and Winona and portions of Goodhue, Steele and Wabasha through its corporate office located in Rochester, Minnesota and its eleven branch offices located in Albert Lea, Austin, Kasson (2), La Crescent, Rochester (4), Spring Valley and Winona, Minnesota. The portion of the Company’s southern Minnesota market area consisting of Rochester and the contiguous communities is composed of primarily urban and suburban communities, while the balance of the Company's southern Minnesota market area consists primarily of rural areas and small towns. Primary industries in the Company's southern Minnesota market area include manufacturing, agriculture, health care, wholesale and retail trade, service industries and education. Major employers include the Mayo Clinic, Hormel Foods (a food processing company) and IBM. The Company's market area is also the home of Winona State University, Rochester Community and Technical College, University of Minnesota - Rochester, Winona State University - Rochester Center and Austin’s Riverland Community College.

 

The Company serves Dakota County, in the southern portion of the Minneapolis and St. Paul metropolitan area, from its office located in Eagan, Minnesota. Major employers in this market area include Delta Airlines, Patterson Companies (dental and animal health), UTC (aerospace systems), CHS Cooperative, Flint Hills Resources LP (oil refinery), Unisys Corp (computer software), Blue Cross Blue Shield of Minnesota and West Group, a Thomson Reuters business (legal research).

 

The Company serves the Iowa county of Marshall through its branch office located in Marshalltown, Iowa. Major employers in the area include Swift & Company (pork processors), Emerson (automation solutions, and commercial and residential solutions), Lennox Industries (furnace and air conditioner manufacturing), Iowa Veterans Home (hospital care), Marshall Community School District (education) and UnityPoint Health (hospital care).

 

 

Based upon information obtained from the U.S. Census Bureau for 2016 (the last year for which information is available), the population of the seven primary counties in the Company’s southern Minnesota market area was estimated as follows: Dodge – 20,506; Fillmore – 21,003; Freeborn – 30,446; Houston – 18,814; Mower – 39,163; Olmsted – 153,102; and Winona – 50,948. For these same seven counties, the median household income from the U.S. Census Bureau for 2012-2016 ranged from $48,827 to $69,308. The population of Dakota County was 417,486 and the median household income was $77,321. With respect to Iowa, the population of Marshall County was 40,312 and the median household income was $54,193.

 

 

Lending Activities

 

General. Historically, the Company has originated 15 and 30 year fixed rate mortgage loans secured by single family residences for its loan portfolio. Over the past 20 years, the Company has focused on managing interest rate risk and improving interest margins by increasing its investment in shorter term and generally higher yielding commercial real estate, commercial business and construction loans, while reducing its investment in longer term single family real estate loans. The Company continues to originate 15 and 30 year fixed rate mortgage loans and some shorter term fixed rate loans. The shorter term fixed rate loans and adjustable rate loans are generally placed into portfolio, while the majority of the 15 and 30 year fixed rate mortgage loans are sold in the secondary mortgage market. Mortgage interest rates continued to be at relatively low levels in 2017 and very few 15 and 30 year loans were placed into portfolio, as most were sold into the secondary market in order to manage the Company’s interest rate risk position. The Company also offers an array of consumer loan products that include both open and closed end home equity loans. Home equity lines of credit have adjustable interest rates based upon the prime rate, as published in the Wall Street Journal, plus a margin. Refer to “Note 5 Loans Receivable, Net and “Note 6 Allowance for Loan Losses and Credit Quality Information in the Notes to Consolidated Financial Statements in the Annual Report for more information on the loan portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).

 

The following table shows the composition of the Company's loan portfolio by fixed and adjustable rate loans as of December 31:

 

   

2017

   

2016

   

2015

   

2014

   

2013

 
                                                                                 

(Dollars in thousands)

 

Amount

   

Percent

   

Amount

   

Percent

   

Amount

   

Percent

   

Amount

   

Percent

   

Amount

   

Percent

 

Fixed rate Loans

                                                                               

Real estate:

                                                                               

Single family

  $ 53,869       9.06

%

  $ 55,143       9.83

%

  $ 55,226       11.68

%

  $ 46,288       12.39

%

  $ 47,377       11.96

%

Multi-family

    20,254       3.40       29,171       5.20       8,045       1.70       10,919       2.92       7,687       1.94  

Commercial

    179,755       30.22       159,195       28.38       117,790       24.91       104,178       27.89       109,387       27.62  

Construction

    26,715       4.49       13,438       2.40       27,381       5.79       7,361       1.97       2,645       0.67  

Total real estate loans

    280,593       47.17       256,947       45.81       208,442       44.08       168,746       45.17       167,096       42.19  

Consumer loans:

                                                                               

Automobile

    2,894       0.49       3,036       0.54       2,885       0.61       1,124       0.30       971       0.25  

Home equity

    8,315       1.40       9,744       1.74       10,231       2.16       10,711       2.87       11,629       2.94  

Recreational vehicle

    13,181       2.21       7,553       1.35       2,650       0.56       0       0.00       0       0.00  

Other

    4,270       0.72       5,447       0.97       4,635       0.99       4,091       1.09       4,174       1.05  

Total consumer loans

    28,660       4.82       25,780       4.60       20,401       4.32       15,926       4.26       16,774       4.24  

Commercial business loans

    55,642       9.36       53,019       9.46       39,197       8.29       32,147       8.61       40,122       10.13  

Total non-real estate loans

    84,302       14.18       78,799       14.06       59,598       12.61       48,073       12.87       56,896       14.37  

Total fixed rate loans

    364,895       61.35       335,746       59.87       268,040       56.69       216,819       58.04       223,992       56.56  
                                                                                 

 

Adjustable rate Loans

                                                                               

Real estate:

                                                                               

Single family

    53,136       8.93       48,112       8.58       35,719       7.55       23,553       6.31       29,090       7.34  

Multi-family

    8,395       1.41       7,606       1.36       4,279       0.90       4,781       1.28       426       0.11  

Commercial

    79,269       13.33       71,760       12.80       79,136       16.74       59,187       15.84       69,099       17.45  

Construction

    19,729       3.32       17,910       3.19       10,722       2.27       5,242       1.40       5,206       1.31  

Total real estate loans

    160,529       26.99       145,388       25.93       129,856       27.46       92,763       24.83       103,821       26.21  

Consumer:

                                                                               

Home equity line

    36,869       6.20       40,476       7.22       38,561       8.16       36,832       9.86       36,178       9.13  

Home equity

    7,508       1.26       6,558       1.17       4,970       1.05       1,709       0.46       0       0.00  

Other

    730       0.12       469       0.08       483       0.10       458       0.12       471       0.12  

Total consumer loans

    45,107       7.58       47,503       8.47       44,014       9.31       38,999       10.44       36,649       9.25  

Commercial business loans

    24,267       4.08       32,157       5.73       30,909       6.54       24,975       6.69       31,587       7.98  

Total non-real estate loans

    69,374       11.66       79,660       14.20       74,923       15.85       63,974       17.13       68,236       17.23  

Total adjustable rate loans

    229,903       38.65       225,048       40.13       204,779       43.31       156,737       41.96       172,057       43.44  

Total loans

    594,798       100.00

%

    560,794       100.00

%

    472,819       100.00

%

    373,556       100.00

%

    396,049       100.00

%

Less

                                                                               

Unamortized discounts

    19               20               16               14               33          

Net deferred loan (costs) fees

    (463 )             (300 )             (91 )             97               0          

Allowance for losses on loans

    9,311               9,903               9,709               8,332               11,401          

Total loans receivable, net

  $ 585,931             $ 551,171             $ 463,185             $ 365,113             $ 384,615          

 

 

The following table illustrates the interest rate maturities of the Company's loan portfolio at December 31, 2017. Loans which have adjustable or renegotiable interest rates are shown as maturing in the period during which the contract is due. Scheduled repayments of principal are reflected in the year in which they are scheduled to be paid. The schedule does not reflect the effects of possible prepayments or enforcement of due-on-sale clauses.

 

   

Real Estate

                                                 

(Dollars in thousands)

 

Single family

   

Multi-family and

Commercial

   

Construction

   

Consumer

   

Commercial Business

   

Total

 
                                                                                                 

Due During Years Ending

December 31,

 

Amount

   

Weighted

Average

Rate

   

Amount

   

Weighted

Average

Rate

   

Amount

   

Weighted

Average

Rate

   

Amount

   

Weighted

Average

Rate

   

Amount

   

Weighted

Average

Rate

   

Amount

   

Weighted

Average

Rate

 
                                                                                                 

2018 ​​​​​​(1)

  $ 8,806       4.26

%

  $ 48,712       4.56

%

  $ 24,686       3.91

%

  $ 7,395       5.74

%

  $ 43,473       4.88

%

  $ 133,072       4.59

%

2019

    9,239       4.09       39,359       4.55       1,684       4.78       5,302       5.67       10,656       4.68       66,240       4.60  

2020

    9,358       4.05       48,517       4.43       3,254       4.26       4,183       5.48       10,309       4.58       75,621       4.45  

2021 through 2022

    16,321       4.11       78,765       4.50       6,040       4.12       6,795       5.34       14,358       4.42       122,279       4.47  

2023 through 2027

    24,528       3.96       63,051       4.48       8,526       4.51       11,865       5.41       1,033       5.04       109,003       4.47  

2028 through 2042

    33,329       3.99       9,050       5.07       2,254       4.67       37,904       4.83       22       5.26       82,559       4.51  

2043 and thereafter

    5,424       3.67       219       5.69       0       0.00       323       0.00       58       0.00       6,024       3.51  
    $ 107,005             $ 287,673             $ 46,444             $ 73,767             $ 79,909             $ 594,798          

 

 

(1)

Includes demand loans, loans having no stated maturity, and overdraft loans.

 

The total amount of loans due after December 31, 2018 which have predetermined interest rates is $283.1 million, while the total amount of loans due after such date which have floating or adjustable interest rates is $178.6 million. Construction or development loans at December 31, 2017 were $23.1 million for single family dwellings, $11.6 million for multi-family and $11.7 million for nonresidential.

 

 

The aggregate amount of loans and extensions of credit that the Bank is permitted to make to any one borrower is generally limited to 15% of unimpaired capital and surplus. In addition to the 15% limit, the Bank is permitted to lend an additional amount equal to 10% of unimpaired capital and surplus if the additional amount is fully secured by “readily marketable collateral” having a current market value of at least 100% of the loan or extension of credit. Similarly, the Bank is permitted to lend additional amounts equal to the lesser of 30% of unimpaired capital and surplus, or $30 million, for certain residential development loans. Applicable law establishes a number of rules for combining loans to separate borrowers. Loans or extensions of credit to one person may be attributed to other persons if: (i) the proceeds of a loan or extension of credit are used for the direct benefit of the other person; or (ii) a common enterprise is deemed to exist between persons. At December 31, 2017, based upon the 15% limitation, the Bank's regulatory limit for loans to one borrower was approximately $12.8 million and no loans to any one borrower exceeded this amount. At December 31, 2017, the Bank’s largest aggregate amount of loans to one borrower totaled $11.6 million. All of the loans for the largest borrower were performing in accordance with their terms as of December 31, 2017 and the borrower had no affiliation with the Bank other than its relationship as a borrower.

 

All of the Bank's lending is subject to its written underwriting standards and to loan origination procedures. Decisions on loan requests are made on the basis of detailed applications and property valuations determined by an independent appraiser. The loan applications are designed primarily to determine the borrower's ability to repay. The more significant items on the application are verified through the use of credit reports, financial statements, tax returns or confirmations.

 

Single family loans are originated either for inclusion in the loan portfolio under the Bank’s Portfolio First loan program or for sale in the secondary market to the Federal National Mortgage Association (FNMA) on a servicing retained basis or to other third party investors on a servicing released basis. The limit for retail mortgages originated for sale on the secondary market was $424,100 and $417,000 for 2017 and 2016, respectively, and these loans require the approval of a designated secondary market underwriter.

 

Three levels of approval authority have been established for loans originated under the Portfolio First loan program. The three levels of authority include Approved Portfolio First Lenders, Market Presidents and Credit Administration positions with Portfolio First approval authority. Approved Portfolio First Lenders are select mortgage loan officers recommended for the Portfolio First program approval authority by their Market President and are approved by the Chief Operating Officer. The Credit Administration positions with Portfolio First approval authority include the Rochester Market President, Director of Retail Lending and Loan Servicing, Vice President of Credit Administration, Chief Credit Officer and the Chief Operating Officer.

 

Loans less than $350,000 require the approval of the Portfolio First Lender, the Market President and one Credit Administration individual with Portfolio First approval authority. Loans over $350,000 require the approval of the Portfolio First Lender, the Market President and two Credit Administration individuals with Portfolio First approval authority. Loans where the total aggregate amount of all loan obligations owed or guaranteed to the Bank plus the new obligation is greater than $2.0 million require the approval of a majority of the Senior Loan Committee, which is comprised of the Bank’s most experienced lending staff.

 

Loans that meet the underwriting guidelines of secondary market investors are approved by designated Credit Administration positions. The Credit Administration positions with secondary market approval authority include Retail Loan Underwriters, Director of Retail Lending and Servicing, Vice President of Credit Administration, Chief Credit officer and the Chief Operating Officer. Approval level authorities are granted by the Chief Credit Officer or Chief Operating Officer and confirmed by the Executive Loan Committee on an annual basis. Loans are originated based on the specific guidelines established by the secondary market investor.

 

The Bank generally requires title insurance on its mortgage loans, as well as fire and extended coverage casualty insurance in amounts at least equal to the principal amount of the loan or the value of improvements on the property. The Bank also requires flood insurance to protect the property securing its interest when the property is located in a flood plain.

 

 

Single Family Residential Real Estate Lending. At December 31, 2017, the Company's single family real estate loans, consisting of both fixed rate and adjustable rate loans, totaled $107.0 million, an increase of $3.7 million from $103.3 million at December 31, 2016. The increase in the single family loans in 2017 is the result of an increased emphasis on originating shorter term fixed rate and adjustable rate mortgage loans that were placed into the portfolio during 2017. The majority of the longer term loans that were originated during the year continued to be sold into the secondary market in order to manage the Company’s interest rate risk position.

 

The Company offers conventional fixed rate single family loans that have maximum terms of 30 years. In order to manage interest rate risk, the Company typically sells the majority of fixed rate loan originations with terms to maturity of 15 years or greater that are eligible for sale in the secondary market. The interest rates charged on the fixed rate loan products are based on the secondary market delivery rates, as well as other competitive factors. The Company also originates fixed rate loans with terms up to 30 years that are insured by the Federal Housing Administration (FHA), Veteran’s Administration (VA), Minnesota Housing Finance Agency, Iowa Finance Authority or United States Department of Agriculture-Guaranteed Housing (RD).

 

The Company also offers one year adjustable rate mortgages (ARMs) at a margin (generally 400 to 600 basis points) over the yield on the Average Weekly One Year U.S. Treasury Constant Maturity Index for terms of up to 30 years. The ARMs offered by the Company allow the borrower to select (subject to pricing) an initial period of one to seven years between the loan origination and the date the first interest rate change occurs. The ARMs generally have a 200 basis point annual interest rate change cap and a lifetime cap of 600 basis points over or under the initial rate. The Company’s originated ARMs do not permit negative amortization of principal, generally do not contain prepayment penalties and are not convertible into fixed rate loans. Because of the low interest rate environment that has existed over the last few years, a limited number of ARM loans have been originated as consumers have generally opted for longer term fixed rate loans.

 

In underwriting single family residential real estate loans, the Company evaluates the borrower's credit history, ability to make principal, interest and escrow payments, the value of the property that will secure the loan and debt-to-income ratios. Properties securing single family residential real estate loans made by the Company are appraised by independent appraisers. The Company originates residential mortgage loans with loan-to-value ratios up to 100% for owner-occupied homes and up to 85% for non-owner-occupied homes; however, private mortgage insurance is generally required to reduce the Company's exposure to 80% or less of the value on most loans. The Company generally seeks to underwrite its loans in accordance with secondary market, FHA, VA or RD standards. However, the Company does originate shorter term fixed rate and adjustable rate single family loans for its portfolio that do not meet certain secondary market guidelines.

 

The Company's residential mortgage loans customarily include due-on-sale clauses giving it the right to declare the loan immediately due and payable in the event that, among other things, the borrower sells or otherwise disposes of the property subject to the mortgage.

 

At both December 31, 2017 and December 31, 2016, $0.9 million of the single family residential loan portfolio were non-performing.

 

Commercial Real Estate and Multi-Family Lending. The Company originates permanent commercial real estate and multi-family loans secured by properties located primarily in its market area. It also purchases a limited amount of participations in commercial real estate and multi-family loans originated by third parties. The commercial real estate and multi-family loan portfolio includes loans secured by motels, hotels, apartment buildings, churches, manufacturing plants, land developments, office buildings, business facilities, shopping malls, nursing homes, golf courses, restaurants, warehouses, convenience stores and other non-residential building properties primarily located in the upper Midwestern portion of the United States. At December 31, 2017, the Company’s commercial and multi-family real estate loans totaled $287.7 million, an increase of $20.0 million from $267.7 million at December 31, 2016.

 

 

Permanent commercial real estate and multi-family loans are generally originated for a maximum term of 10 years and may have longer amortization periods with balloon maturity features. The interest rates may be fixed for the term of the loan or have adjustable features that are tied to the prime rate or another published index. Commercial real estate and multi-family loans are generally written in amounts up to 80% of the lesser of the appraised value of the property or the purchase price and generally have a debt service coverage ratio of at least 120%. The debt service coverage ratio is the ratio of net cash from operations to debt service payments. The Company may originate construction loans secured by commercial or multi-family real estate, or may purchase participation interests in third party originated construction loans secured by commercial or multi-family real estate.

 

Appraisals on commercial real estate and multi-family real estate properties are performed by independent appraisers prior to the time the loan is made. For transactions less than $250,000, the Company may use an internal valuation. All appraisals on commercial and multi-family real estate are reviewed and approved by a qualified Bank employee or independent third party. The Bank's underwriting procedures require verification of the borrower's credit history, income and financial statements, banking relationships and income projections for the property. The commercial loan policy generally requires personal guarantees from the proposed borrowers. An initial on-site inspection is generally required for all collateral properties for loans with balances in excess of $250,000. Independent annual reviews are performed for aggregate commercial lending relationships that exceed $500,000. The reviews cover financial performance, documentation completeness and accuracy of loan risk ratings.

 

Multi-family and commercial real estate loans generally present a higher level of risk than loans secured by single family residences. This greater risk is due to several factors, including the concentration of principal in a limited number of loans and borrowers, the effects of general economic conditions on income producing properties and the increased difficulty of evaluating and monitoring these types of loans. Furthermore, the repayment of loans secured by multi-family and commercial real estate is typically dependent upon the successful operation of the related real estate project. If the cash flow from the project is reduced (for example, if leases are not obtained or renewed), the borrower's ability to repay the loan may be impaired. At December 31, 2017 and 2016, $1.4 million of loans in the commercial real estate portfolio were non-performing. The largest non-performing lending relationship in this category as of December 31, 2017 was a $1.2 million loan secured by a manufacturing facility located in the Bank’s primary market area.

 

Construction Lending. The Company makes construction loans to individuals for the construction of their residences and to builders for the construction of single family residences. It also makes a limited number of loans to builders for houses built on speculation. Construction loans also include commercial real estate loans.

 

Almost all loans to individuals for the construction of their residences are structured as permanent loans. These loans are made on the same terms as residential loans, except that during the construction phase, which typically lasts up to twelve months, the borrower pays interest only. Generally, the borrower also pays a construction fee at the time of origination plus other costs associated with processing the loan. Residential construction loans are underwritten pursuant to the same guidelines used for originating residential loans on existing properties.

 

Construction loans to builders or developers of single family residences generally carry terms of one year or less.

 

Construction loans to owner occupants are generally made in amounts up to 95% of the lesser of cost or appraised value, but no more than 90% of the loan proceeds can be disbursed until the building is completed. The Company generally limits the loan-to-value ratios on loans to builders to 80%. Prior to making a commitment to fund a construction loan, the Company requires a valuation of the property, financial data and verification of the borrower's income. The Company obtains personal guarantees for substantially all of its construction loans to builders. Personal financial statements of guarantors are also obtained as part of the loan underwriting process. Construction loans are generally located in the Company's market area.

 

Construction loans are obtained principally through continued business from builders and developers who have previously borrowed from the Bank, as well as referrals from existing clients and walk-in clients. The application process includes a submission to the Bank of accurate plans, specifications and costs of the project to be constructed. These items are one factor utilized in the determination of the appraised value of the subject property to be built.

 

 

At December 31, 2017, construction loans totaled $46.4 million, an increase of $15.1 million from $31.3 million at December 31, 2016. Total construction loans included $23.1 million and $21.9 million of single family residential, $11.6 million and $2.6 million of multi-family residential and $11.7 million and $6.8 million of commercial real estate loans at December 31, 2017 and 2016, respectively. The nature of construction loans makes them more difficult to evaluate and monitor than loans on existing buildings. The risk of loss on a construction loan is dependent largely upon the accuracy of the initial estimate of the property's value upon completion of the project, experience of the builder and the estimated cost (including interest) of the project. If the estimate of value proves to be inaccurate, the Company may be confronted, at or prior to the maturity of the loan, with a project having a value that is insufficient to assure full repayment or the possibility of having to make substantial investments to complete and sell the project. Because defaults in repayment may not occur during the construction period, it may be difficult to identify problem loans at an early stage. In these cases, the Company may be required to modify the terms of the loan. At both December 31, 2017 and December 31, 2016, $0.1 million of construction loans in the commercial real estate portfolio were non-performing. The non-performing construction loans are loans to parties related through common ownership to construct model homes that when sold, or subject to a purchase agreement, are converted to performing loans and the interest is recognized.

 

Consumer Lending. The Company originates a variety of consumer loans, including home equity loans (open-end and closed-end), automobile, recreational vehicles, mobile home, lot loans, loans secured by deposit accounts and other loans for household and personal purposes. At December 31, 2017, the Company’s consumer loans totaled $73.8 million, an increase of $0.5 million from $73.3 million at December 31, 2016.

 

Consumer loan terms vary according to the type and value of collateral, length of contract and creditworthiness of the borrower. The Company's consumer loans are made at fixed or adjustable interest rates, with terms up to 20 years for secured loans and up to five years for unsecured loans.

 

The Company's home equity loans are written so that the total commitment amount, when combined with the balance of any other outstanding mortgage liens, generally does not exceed 90% of the appraised value of the property or an internally established market value. Internal market values are established using current market data, including recent sales data, and are typically lower than third party appraised values. The closed-end home equity loans are written with fixed or adjustable rates with terms up to 15 years. The open-end home equity lines are written with an adjustable rate and a 2 to 10 year draw period that requires interest only payments followed by a 10 year repayment period that fully amortizes the outstanding balance. The consumer may access the open-end home equity line by making a withdrawal at the Bank, transferring funds through our online or mobile banking products or writing a check on the home equity line of credit account. Open and closed-end equity loans, which are generally secured by second mortgages on the borrower’s principal residence, represented 71.4% of the Company’s consumer loan portfolio at December 31, 2017.

 

The underwriting standards employed by the Company for consumer loans include a determination of the applicant's payment history on other debts and their ability to meet existing obligations and payments on the proposed loan. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes a comparison of the value of the security, if any, in relation to the proposed loan amount. Consumer loans may entail greater credit risk than do residential mortgage loans, particularly in the case of consumer loans that are unsecured or are secured by rapidly depreciable assets, such as automobiles, recreational vehicles or mobile homes. In these cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. In addition, consumer loan collections are dependent on the borrower's continuing financial stability, and thus are more likely to be affected by adverse personal circumstances. Furthermore, the application of various federal and state laws, including bankruptcy and insolvency laws, may limit the amount that can be recovered on such loans. At both December 31, 2017 and December 31, 2016 the consumer loan portfolio had $0.6 million of non-performing loans.

 

 

Commercial Business Lending. The Company maintains a portfolio of commercial business loans to borrowers associated with the real estate industry as well as to retail, manufacturing operations and professional firms. The Company's commercial business loans generally have terms ranging from six months to five years and may have either fixed or variable interest rates. The Company's commercial business loans generally include personal guarantees and are usually, but not always, secured by business assets such as inventory, equipment, leasehold interests in equipment, fixtures, real estate and accounts receivable. The underwriting process for commercial business loans includes consideration of the borrower's financial statements, tax returns, projections of future business operations and inspection of the subject collateral, if any. The Company may also purchase a limited amount of participation interests in commercial business loans originated outside of the Company’s market area from third party originators. These loans generally have underlying collateral of inventory or equipment and repayment periods of less than ten years. At December 31, 2017, the Company’s commercial business loans totaled $79.9 million, a decrease of $5.3 million from $85.2 million at December 31, 2016.

 

Unlike residential mortgage loans, which generally are made on the basis of the borrower's ability to make repayment from his or her income, and which are secured by real property with more easily ascertainable value, commercial business loans are of higher risk and typically are made on the basis of the borrower's ability to make repayment from the cash flow of the borrower's business. As a result, the availability of funds for the repayment of commercial business loans may be substantially dependent on the success of the business itself. Furthermore, the collateral securing the loans may depreciate over time, may be difficult to appraise and may fluctuate in value based on the success of the business. At December 31, 2017 and 2016, $0.3 million of loans in the commercial business loan portfolio were non-performing.

 

 

Originations, Purchases and Sales of Loans and Mortgage-Backed and Related Securities

 

Real estate loans are generally originated by the Company's salaried loan officers. Mortgage and consumer loan officers may also receive a commission in addition to their base salary for meeting production and other branch goals. Loan applications are taken in all branch and loan production offices.

 

The Company originates both fixed and adjustable rate loans, however, its ability to originate loans is dependent upon the relative client demand for loans in its markets. Demand for adjustable rate loans is affected by the interest rate environment. The number of adjustable rate loans remained low in 2017 due to the low long term fixed mortgage rates that existed during the year. The Company originated for its portfolio $7.8 million of single family adjustable rate loans during 2017, a decrease of $10.6 million from $18.4 million in 2016. The Company also originated for its portfolio $25.0 million of fixed rate single family loans during 2017, a decrease of $1.9 million from $26.9 million for 2016. The changes in the adjustable rate single family loans that were placed into the loan portfolio in 2017 are the result of customer’s preference to lock in fixed rate loans due to the low interest rate environment and the increased expectation of increased mortgage rates in the future. The slight decrease in fixed rate loans originated in 2017 compared to 2016 is the result of lower originations of fixed rate loans that did not meet secondary market criteria between the periods.      

 

During the past several years, the Company has focused its portfolio loan origination efforts on commercial real estate, commercial business and consumer loans because these loans have terms to maturity and adjustable interest rate characteristics that are generally more beneficial to the Company in managing interest rate risk than traditional single family fixed rate conventional loans. The Company originated $148.3 million of multi-family and commercial real estate, commercial business and consumer loans (which excludes commercial real estate loans for construction or development) during 2017, an increase of $7.8 million from originations of $140.5 million for 2016. The increase in originations primarily reflects the $18.6 million and $9.3 million increase in commercial business and commercial real estate loans, respectively, in 2017 compared to 2016. Multi-family loan originations decreased $16.5 million and consumer loan originations decreased $3.6 million between the periods.

 

 

In order to supplement loan demand in the Company's market area and geographically diversify its loan portfolio, the Company, from time to time, purchases participations in real estate loans from selected sellers, with yields based upon then-current market rates. The Company reviews and underwrites all loans purchased to ensure that they meet the Company's underwriting standards, and the seller generally continues to service the loans. The Company has generally not experienced higher losses or credit quality issues with purchased participations than other loans originated by the Company. The Company purchased $7.2 million of loans during 2017, a decrease of $9.1 million from $16.3 million purchased during 2016. All of the loans purchased have terms and interest rates that are similar in nature to the Company's originated single family, commercial real estate, construction and development and commercial business portfolios. See Note 5 Loans Receivable, Net and “Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements in the Annual Report for more information on purchased loans (incorporated by reference in Item 8 of Part II of this Form 10-K).

 

The Company did not acquire any loans through an acquisition in 2017 but acquired loans totaling $12.0 million in an acquisition that occurred in the second quarter of 2016.

 

The Company has mortgage-backed and related securities that are held, based on investment intent, in the "available for sale" portfolio. The Company did not acquire any mortgage-backed securities in 2017 or 2016 through an acquisition. The Company purchased $5.1 million of mortgage-backed securities in 2017 and none were purchased in 2016. The limited amount of mortgage-backed securities purchased is because debt instruments issued by federal agencies, such as FNMA and the Federal Home Loan Mortgage Corporation (FHLMC), continued to be more appealing to purchase due to their shorter duration given the low interest rate environment that continued to exist in 2017. In 2017, the Company did not sell any mortgage backed securities and in 2016 it sold $30,000 of mortgage-backed securities that were previously acquired in an acquisition. The securities were sold due primarily to the small lot size of the individual securities. See “Investment Activities” below.

 

 

The following table shows the loan and mortgage-backed and related securities origination, purchase, acquisition, sale and repayment activities of the Company for the periods indicated.

 

LOANS HELD FOR INVESTMENT

                       
   

Year Ended December 31,

 

(Dollars in thousands)

 

2017

   

2016

   

2015

 

Originations by type:

                       

Adjustable rate:

                       

Real estate -

                       

- single family

  $ 7,833       18,442       12,111  

- multi-family

    1,167       9,246       0  

- commercial

    23,818       14,591       21,489  

- construction or development

    30,799       40,132       19,920  

Non-real estate -

                       

- consumer

    11,585       15,481       18,852  

- commercial business

    3,428       10,353       19,538  

Total adjustable rate

    78,630       108,245       91,910  
                         

Fixed rate:

                       

Real estate -

                       

- single family

    25,016       26,948       27,612  

- multi-family

    3,718       12,107       4,042  

- commercial

    42,203       42,176       47,306  

- construction or development

    16,559       19,181       38,299  

Non-real estate -

                       

- consumer

    16,639       16,335       11,610  

- commercial business

    45,767       20,196       18,281  

Total fixed rate

    149,902       136,943       147,150  

Total loans originated

    228,532       245,188       239,060  
                         

Purchases:

                       

Real estate -

                       

- single family

    203       0       2,800  

- multi-family

    0       750       0  

- commercial

    500       1,130       7,501  

- construction or development

    4,740       2,500       5,500  

Non-real estate -

                       

- commercial business

    1,756       11,949       2,600  

Total loans purchased

    7,199       16,329       18,401  
                         

Acquisition:

                       

Real estate -

                       

- single family

    0       146       4,985  

- multi-family

    0       0       100  

- commercial

    0       5,808       7,712  

Non-real estate -

                       

- consumer

    0       3,536       5,226  

- commercial business

    0       2,546       6,037  

Total loans acquired

    0       12,036       24,060  
                         

Sales, participations and repayments:

                       

Real estate -

                       

- multi-family

    0       4,500       0  

- commercial

    10,565       9,002       4,504  

- construction or development

    3,221       13,765       14,602  

Non-real estate -

                       

- consumer

    834       719       516  

- commercial business

    53,240       634       154  

Total sales

    67,860       28,620       19,776  

Transfers to loans held for sale

    9,047       15,002       8,125  

Principal repayments

    123,912       140,944       154,054  

Total reductions

    200,819       184,566       181,955  

Decrease in other items, net

    (908 )     (1,012 )     (303 )

Net increase

  $ 34,004       87,975       99,263  

 

 

LOANS HELD FOR SALE

 
   

Year Ended December 31,

 

(Dollars in thousands)

 

2017

   

2016

   

2015

 

Originations by type:

                       

Fixed rate:

 

Real estate -

 

- single family

    78,751       79,783       69,941  

Total fixed rate

    78,751       79,783       69,941  

Total loans originated

    78,751       79,783       69,941  
   

Sales and repayments:

 

Real estate -

 

- single family

    83,475       88,355       71,992  

Total sales

    83,475       88,355       71,992  

Transfers from loans held for investment

    (4,558 )     (6,822 )     (3,778 )

Principal repayments

    6       20       24  

Total reductions

    78,923       81,553       68,238  

Net (decrease) increase

  $ (172 )     (1,770 )     1,703  

 

 

MORTGAGE-BACKED AND RELATED SECURITIES

 

   

Year Ended December 31,

 

(Dollars in thousands)

 

2017

   

2016

   

2015

 
                         

Purchases:

                       

Fixed rate mortgage-backed securities

  $ 5,055       0       2,343  

CMOs and REMICs (1)

    0       0       3,116  

Total purchases

    5,055       0       5,459  
                         

Sales:

                       

Fixed rate mortgage-backed securities

    0       0       2,174  

CMOs and REMICs

    0       30       2,021  

Total sales

    0       30       4,195  
                         

Principal repayments

    (993 )     (1,247 )     (1,890 )

Net increase (decrease)

  $ 4,062       (1,277 )     (626 )

 

(1) Collateralized mortgage obligations and real estate mortgage investment conduits

 

Classified Assets and Delinquencies

 

Classification of Assets. Federal regulations require that each savings institution evaluate and classify its assets on a regular basis. In addition, in connection with examinations of savings institutions, the OCC and the Federal Deposit Insurance Corporation (FDIC) examiners may identify problem assets and, if appropriate, require them to be classified with an adverse rating. There are three adverse classifications: substandard, doubtful, and loss. Assets classified as substandard have one or more defined weaknesses and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Assets classified as doubtful have the weaknesses of those classified as substandard, with additional characteristics that make collection in full on the basis of currently existing facts, conditions and values questionable, and there is a high possibility of loss. An asset classified as loss is considered uncollectible and of such little value that continuance as an asset on the balance sheet of the institution is not warranted. Assets classified as substandard or doubtful require the institution to establish prudent specific allowances for loan losses. If an asset, or portion thereof, is classified as a loss, the institution charges off such amount. If an institution does not agree with an OCC or FDIC examiner's classification of an asset, it may appeal the determination to the OCC District Director or the appropriate FDIC personnel. On the basis of management's review of its assets, at December 31, 2017, the Bank classified a total of $17.3 million of its loans and real estate as follows:

 

(Dollars in thousands)

 

Single

Family

   

Real Estate

Construction or Development

   

Commercial and

Multi-family

    Consumer    

Commercial

Business

    Real Estate     Total  

Substandard

  $ 2,154       120       7,950       631       5,506       627       16,988  

Doubtful

    44       0       0       119       0       0       163  

Loss

    0       0       0       130       0       0       130  

Total

  $ 2,198       120       7,950       880       5,506       627       17,281  

 

 

The Bank's classified assets consist of non-performing loans and loans and other assets of concern discussed in Management’s Discussion and Analysis of Financial Condition and Results of Operations (incorporated by reference in Item 7 of Part II of this Form 10-K). See Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements in the Annual Report (incorporated by reference in Item 8 of Part II of this Form 10-K) for more information on classified assets. At December 31, 2017, these asset classifications were materially consistent with those of the OCC and FDIC.

 

Delinquency Procedures. Generally, the following procedures apply to delinquent single family real estate loans. When a borrower fails to make a required payment on a loan, the Company attempts to cure the delinquency by contacting the borrower. A late notice is sent on all loans over 16 days delinquent. Additional written and verbal contacts are made with the borrower between 30 and 60 days after the due date. If the loan is contractually delinquent 90 days, the Company sends a 30-day demand letter to the borrower and after the loan is contractually delinquent 120 days, institutes appropriate action to foreclose on the property. If foreclosed, the property is sold at a sheriff’s sale and may be purchased by the Company. Delinquent commercial real estate and commercial business loans are generally handled in a similar manner. The Company's procedures for repossession and sale of consumer collateral are subject to various requirements under state consumer protection laws.

 

Real estate acquired by the Company as a result of foreclosure is typically classified as real estate in judgment for six to twelve months and thereafter as real estate owned until it is sold. When property is acquired by foreclosure or deed in lieu of foreclosure, it is recorded as real estate owned at the estimated fair value less the estimated cost of disposition. After acquisition, all costs incurred in maintaining the property are expensed. Costs relating to the development and improvement of the property, however, are capitalized to the extent of fair value less disposition cost.

 

The following table sets forth the Company's loan delinquencies by loan type, amount and percentage of type at December 31, 2017 for loans past due 60 days or more.

 

   

Loans Delinquent For:

   

Total Delinquent

 
   

60-89 Days

   

90 Days and Over

   

Loans

 
(Dollars in thousands)   Number     Amount    

Percent

of Loan

Category

    Number     Amount    

Percent

of Loan

Category

    Number     Amount     Percent of Loan Category  
                                                                         

Single family real estate

    6     $ 294       0.27

%

    8     $ 669       0.63

%

    14     $ 963       0.89

%

Consumer

    7       117       0.16       7       235       0.32       14       352       0.48  

Commercial business

    0       0       0.00       2       180       0.23       2       180       0.23  

Total

    13     $ 411       0.07

%

    17     $ 1,084       0.18

%

    30     $ 1,495       0.25

%

 

Loans delinquent for 90 days and over are generally non-accruing and are included in the Company’s non-performing asset total at December 31, 2017.

 

Investment Activities 

 

The Company utilizes the available for sale securities portfolio in virtually all aspects of asset/liability management. In making investment decisions, the Investment-Asset/Liability Committee considers, among other things, the yield and interest rate objectives, the credit risk position and the Bank's liquidity and projected cash flow requirements.

 

 

Securities. Federally chartered savings institutions have the authority to invest in various types of liquid assets, including United States Treasury obligations, securities of various federal agencies, certain certificates of deposit of insured banks and savings institutions, certain bankers' acceptances, repurchase agreements and federal funds. Subject to various restrictions, the holding company of a federally chartered savings institution may also invest its assets in commercial paper, investment grade corporate debt securities and mutual funds whose assets conform to the investments that a federally chartered savings institution is otherwise authorized to make directly.

 

The investment strategy of the Company has been directed toward a mix of high-quality assets (primarily government callable agency obligations) with steps and short and intermediate terms to maturity. At December 31, 2017, the Company did not own any investment securities of a single issuer that exceeded 10% of the Company's stockholders’ equity other than U.S. government agency obligations.

 

The Bank invests a portion of its liquid assets in interest-earning overnight deposits of the FHLB of Des Moines and the Federal Reserve Bank of Minneapolis. Other investments include high grade municipal bonds, corporate preferred stock, corporate equity securities and medium-term (up to five years) federal agency notes. HMN invests in the same type of investment securities as the Bank. See Note 4 Securities Available For Sale” in the Notes to Consolidated Financial Statements in the Annual Report for additional information regarding the Company's securities portfolio (incorporated by reference in Item 8 of Part II of this Form 10-K).

 

 

The following table sets forth the composition of the Company's securities portfolio, excluding mortgage-backed and related securities, at the dates indicated.

 

   

December 31, 2017

   

December 31, 2016

   

December 31, 2015

 

(Dollars in thousands)

 

Amortized

   

Adjusted

   

Fair

   

% of

   

Amortized

   

Adjusted

   

Fair

   

% of

   

Amortized

   

Adjusted

   

Fair

   

% of

 
   

Cost

     To    

Value

   

Total

   

Cost

     To    

Value

   

Total

   

Cost

     To    

Value

   

Total

 

Securities available for sale:

                                                                                               

U.S. Government agency obligations

  $ 69,962       (1,201 )     68,761       64.0

%

  $ 74,979       (1,063 )     73,916       72.2

%

  $ 105,003       (61 )     104,942       71.4

%

Municipal obligations

    2,699       (6 )     2,693       2.5       2,819       (20 )     2,799       2.7       3,991       11       4,002       2.8  

Corporate obligations

    234       (1 )     233       0.2       290       2       292       0.3       340       (6 )     334       0.2  

Corporate preferred stock

    700       (140 )     560       0.5       700       (350 )     350       0.3       700       (350 )     350       0.2  

Corporate equity (1)

    58       99       157       0.1       58       57       115       0.1       58       5       63       0.0  

Subtotal

    73,653               72,404       67.3       78,846               77,472       75.6       110,092               109,691       74.6  

Federal Home Loan Bank stock (1)

    817               817       0.8       770               770       0.8       691               691       0.5  

Total investment securities and Federal Home Loan Bank stock

    74,470               73,221       68.1       79,616               78,242       76.4       110,783               110,382       75.1  
                                                                                                 

Average remaining life of investment securities excluding Federal Home Loan Bank stock (years)

 

2.61

                           

2.52

                           

1.48

                         
                                                                                                 

Other interest earning assets:

                                                                                               

Cash equivalents

  $ 34,265               34,265       31.9     $ 24,140               24,140       23.6     $ 36,570               36,570       24.9  

Total

  $ 108,735               107,486       100.0

%

  $ 103,756               102,382       100.0

%

  $ 147,353               146,952       100.0

%

Average remaining life or term to repricing of investment securities and other interest earning assets, excluding Federal Home Loan Bank stock (years)

 

1.78

                           

1.72

                           

1.11

                         

 

(1)Average life assigned to holdings is five years.

 

 

The composition and maturities of the investment securities portfolio, excluding FHLB stock, mortgage-backed and related securities, are indicated in the following table.

 

 

   

December 31, 2017

 
   

 

1 Year

or Less

   

After 1

through 5

Years

   

After 5

through 10

Years

   

Over 10 Years

   

No stated

maturity

   

Total Securities

 

 

(Dollars in thousands)

 

Amortized

Cost

   

Amortized

Cost

   

Amortized

Cost

   

Amortized

Cost

   

Amortized

Cost

   

Amortized

Cost

   

Adjusted

To

   

Fair

Value

 
Securities available for sale:                                                                

U.S. government agency securities(1)

  $ 55,000       14,962       0       0       0       69,962       (1,201 )     68,761  

Municipal obligations

    311       2,388       0       0       0       2,699       (6 )     2,693  

Corporate obligations

    0       234       0       0       0       234       (1 )     233  

Corporate preferred stock

    0       0       0       700       0       700       (140 )     560  

Corporate equity

    0       0       0       0       58       58       99       157  

Total

  $ 55,311       17,584       0       700       58       73,653       (1,249 )     72,404  
                                                                 

Weighted average yield

    1.35 %     1.74 %     0.00 %     5.52 %     1.80

%

    1.48

%

               

 

(1) Callable U.S. government agency securities maturity date based on first available call date that the security is anticipated to be called.

 

 

Mortgage-Backed and Related Securities. In order to supplement loan production and achieve its asset/liability management goals, the Company invests in mortgage-backed and related securities. All of the mortgage-backed and related securities owned by the Company are issued, insured or guaranteed either directly or indirectly by a U.S. Government Agency and are considered to be investment grade securities. The Company had $5.1 million of mortgage-backed and related securities all classified as “available for sale” at December 31, 2017, compared to $1.0 million of mortgage-backed and related securities classified as available for sale at December 31, 2016. The Company purchased $5.1 million in mortgage-backed securities in 2017 and did not purchase any in 2016.

 

The contractual maturities of the mortgage-backed and related securities portfolio without any prepayment assumptions at December 31, 2017 are as follows:

 

 

 

(Dollars in thousands)

 

5 Years

or Less

   

5 to 10

Years

   

10 to 20

Years

   

Over 20

Years

   

Dec. 31,

2017

Balance Outstanding

 

Securities available for sale:

                                       

Federal Home Loan Mortgage Corporation

  $ 93       0       0       0       93  

Federal National Mortgage Association

    54       0       4,703       0       4,757  

Collateralized Mortgage Obligations

    0       0       0       218       218  

Total

  $ 147       0       4,703       218       5,068  
                                         

Weighted average yield

    4.41

%

    0.00

%

    2.02

%

    3.03

%

    2.13

%

 

At December 31, 2017, the Company did not have any non-agency mortgage-backed or related securities in excess of 10% of its stockholders' equity.

 

Mortgage-backed and related securities can serve as collateral for borrowings and, through sales and repayments, as a source of liquidity. In addition, mortgage-backed and related securities available for sale can be sold to respond to changes in economic conditions.

 

Sources of Funds

 

General. The Bank's primary sources of funds are retail, commercial, internet and brokered deposits, payments of loan principal, interest earned on loans and securities, repayments and maturities of securities, borrowings and other funds provided from operations.

 

 

Deposits. The Bank offers a variety of deposit accounts to retail and commercial clients having a wide range of interest rates and terms. The Bank's deposits consist of savings, negotiable order of withdrawal (NOW), non-interest bearing checking, money market and certificate accounts (including individual retirement accounts). The Bank relies primarily on competitive pricing policies and client service to attract and retain these deposits.

 

The variety of deposit accounts offered by the Bank has allowed it to be competitive in obtaining funds and to respond with flexibility to changes in consumer demand. As clients have become more interest rate conscious, the Bank has become more susceptible to short-term fluctuations in deposit flows. The Bank manages the pricing of its deposits in keeping with its asset/liability management, profitability and growth objectives. Based on its experience, the Bank believes that its savings and NOW accounts are relatively stable sources of deposits. However, the ability of the Bank to attract and maintain certificates of deposit and money market accounts, and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. The increase in deposits in 2017 relates primarily to the $35.9 million in commercial deposit growth and the $6.9 million in retail deposit growth that was experienced. The increase in commercial deposits in 2017 includes $9.0 million in wholesale commercial deposits acquired through an internet bulletin board service and $3.6 million in growth from clients in the alternative energy industry. The increase in deposits in 2016 related to commercial deposits from clients in the alternative energy industry. The deposits in 2016 also increased $19.0 million as a result of a branch acquisition that occurred in the second quarter of 2016. The increase in deposits in 2015 related primarily to the $47.3 million in deposits that were acquired in an acquisition in the third quarter of 2015.

 

The following table sets forth the savings flows at the Bank during the periods indicated.

 

   

Year Ended December 31,

 

(Dollars in thousands)

 

2017

   

2016

   

2015

 

Opening balance

  592,811       559,387       496,750  

Deposits

    4,500,620       4,323,445       4,084,845  

Deposits acquired in acquisitions

    0       18,977       47,280  

Withdrawals

    (4,458,537 )     (4,309,719 )     (4,070,087 )

Interest credited

    707       721       599  

Ending balance

    635,601       592,811       559,387  

Net increase

  42,790       33,424       62,637  

Percent increase

    7.22

%

    5.98

%

    12.61

%

 

The following table sets forth the dollar amount of deposits in the various types of deposit products offered by the Bank as of December 31:

 

(Dollars in thousands)

 

2017

   

2016

   

2015

 

Transaction and Savings Deposits(1):

 

 

Amount

   

Percent

of Total

   

 

Amount

   

Percent

of Total

   

 

Amount

   

Percent

of Total

 

Noninterest checking

  $ 172,007       27.1

%

  $ 158,024       26.7

%

  $ 151,737       27.1

%

NOW – 0.05%(2)

    90,599       14.3       92,670       15.6       82,425       14.7  

Savings– 0.08%(3)

    75,255       11.8       74,238       12.5       66,421       11.9  

Money market – 0.40%(4)

    186,937       29.4       165,179       27.9       159,959       28.6  

Total non-certificates

  $ 524,798       82.6

%

  $ 490,111       82.7

%

  $ 460,542       82.3

%

                                                     

Certificates:

                                               
0.00

-

0.99%   $ 58,444       9.2

%

  $ 79,628       13.4

%

  $ 85,391       15.3

%

1.00

-

1.99%     43,691       6.9       22,958       3.9       12,611       2.3  
2.00

-

2.99%     8,550       1.3       0       0.0       733       0.1  
3.00

-

3.99%     118       0.0       114       0.0       110       0.0  

Total Certificates

    110,803       17.4

%

    102,700       17.3

%

    98,845       17.7

%

Total Deposits

  $ 635,601       100.0

%

  $ 592,811       100.0

%

  $ 559,387       100.0

%

 

 

(1)

Reflects weighted average rates paid on transaction and savings deposits at December 31, 2017.

 

(2)

The weighted average rate on NOW Accounts for 2016 was 0.07% and for 2015 was 0.04%.

 

 

 

(3)

The weighted average rate on Savings Accounts for 2016 was 0.08% and for 2015 was 0.09%.

 

(4)

The weighted average rate on Money Market Accounts for 2016 was 0.25% and for 2015 was 0.22%.

 

The following table shows rate and maturity information for the Bank’s certificates of deposit as of December 31, 2017.

 

 

(Dollars in thousands)

   

0.00-

0.99%

     

1.00-

1.99%

     

2.00-

2.99%

     

3.00-

3.99%

   

 

Total

   

Percent

of Total

 
Certificate accounts maturing in quarter ending:                                                

March 31, 2018

  $ 9,406       1,276       0       0       10,682       9.64

%

June 30, 2018

    13,876       2,786       789       0       17,451       15.75  

September 30, 2018

    14,673       2,931       4,613       0       22,217       20.05  

December 31, 2018

    7,291       5,427       2,386       118       15,222       13.74  

March 31, 2019

    3,289       2,177       0       0       5,466       4.93  

June 30, 2019

    2,894       3,083       0       0       5,977       5.39  

September 30, 2019

    1,900       4,749       0       0       6,649       6.00  

December 31, 2019

    1,588       2,832       0       0       4,420       3.99  

March 31, 2020

    833