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Exhibit 13.

 

Table of Contents

 

 

Financial Highlights

1

Letter to Shareholders and Clients

2

Board of Directors

3

Five-year Consolidated Financial Highlights

4

Management Discussion and Analysis

5

Consolidated Financial Statements

20

Notes to Consolidated Financial Statements

24

Report of Independent Registered Public Accounting Firm

51

Other Financial Data

54

Selected Quarterly Financial Data

55

Common Stock Information

57

Corporate and Shareholder Information

Inside Back Cover

Directors and Officers

Inside Back Cover

 

HMN Financial, Inc. and Home Federal Savings Bank are headquartered in Rochester, Minnesota. Home Federal Savings Bank operates twelve full service offices in Minnesota located in Albert Lea, Austin, Eagan, Kasson, La Crescent, Owatonna, Rochester (4), Spring Valley and Winona, one full service office in Marshalltown, Iowa, and one full service office in Pewaukee, Wisconsin. The Bank also operates two loan origination offices in Sartell, Minnesota and La Crosse, Wisconsin.

 

 

 

 

Financial Highlights

 

   

At or For the Year Ended

         

Operating Results:

 

December 31,

   

Percentage

 

(Dollars in thousands, except per share data)

 

2021

   

2020

   

Change

 

Total interest income

  $ 31,761       31,959       (0.6

)%

Total interest expense

    1,553       2,851       (45.5 )

Net interest income

    30,208       29,108       3.8  

Provision for loan losses

    (2,119 )     2,699       (178.5 )

Net interest income after provision for loan losses

    32,327       26,409       22.4  

Fees and service charges

    3,125       2,877       8.6  

Loan servicing fees

    1,555       1,356       14.7  

Gain on sales of loans

    6,566       9,531       (31.1 )

Other non-interest income

    3,017       1,319       128.7  

Total non-interest income

    14,263       15,083       (5.4 )

Total non-interest expense

    27,661       27,122       2.0  

Income before income tax expense

    18,929       14,370       31.7  

Income tax expense

    5,365       4,068       31.9  

Net income

  $ 13,564       10,302       31.7  
                         

Per Common Share Information:

                       

Earnings per common share and common share equivalents:

                       

Basic

  $ 3.03       2.23          

Diluted

    3.01       2.22          

Stock price (for the year):

                       

High

    25.61       21.76          

Low

    17.20       13.06          

Close

    24.67       17.20          

Book value per common share

    24.11       21.65          

Closing price to book value

    102.32

%

    79.45

%

       
                         

Financial Ratios:

                       

Return on average assets

    1.38

%

    1.21

%

    14.0

%

Return on average stockholders’ equity

    12.62       10.56       19.5  

Net interest margin

    3.18       3.55       (10.4 )

Operating expenses to average assets

    2.81       3.16       (11.1 )

Average stockholders’ equity to average assets

    10.92       11.43       (4.5 )

Stockholders’ equity to total assets at year end

    10.29       11.35       (9.3 )

Non-performing assets to total assets

    0.46       0.37       24.3  

Efficiency ratio

    62.20       61.26       1.5  

 

Balance Sheet Data:

 

December 31,

   

Percentage

 

(Dollars in thousands)

 

2021

   

2020

   

Change

 

Total assets

  $ 1,069,538       909,580       17.6

%

Securities available for sale

    285,765       148,090       93.0  

Loans held for sale

    5,575       6,186       (9.9 )

Loans receivable, net

    652,502       642,630       1.5  

Deposits

    950,666       795,204       19.5  

Stockholders’ equity

    110,031       103,252       6.6  

Home Federal Savings Bank regulatory capital ratios:

                       

Common equity Tier 1 capital

    13.18

%

    13.62

%

    (3.2

)%

Tier 1 leverage

    9.47       9.85       (3.9 )

Tier 1 risk-based capital

    13.18       13.62       (3.2 )

Total risk-based capital

    14.43       14.87       (3.0 )
                         

 

1

 

I am proud to present you with our 2021 Annual Report.

 

The year represented our second fiscal year of operation under the COVID-19 Pandemic and we were able to bring forward much of what we learned in dealing with the Pandemic from the previous year. This experience enabled us to reopen our branches to foot traffic and to call many of our employees back to work in their offices, albeit in most cases on a hybrid work from home, work from office basis. Our primary goal was to deliver our products and services in an effective manner that would also protect the health of both our clients and employees. I am proud of how flexible our employees have been over the past two years and pleased to report that we experienced no major workplace-based outbreaks of the virus.

 

Bolstered by strong mortgage lending revenue, income earned from the Paycheck Protection Program and a continuing improvement in asset quality, the Company posted its highest net income since 2013.

 

Our mortgage lending area originated over $247 million of loans during the year. While most of these loans were sold into the secondary market, we retained over $90 million for our mortgage loan portfolio, providing valuable earning assets for future years.

 

Our Business Banking department faced significant interest rate competition across all of our markets as market loan rates declined during the year. Our strategy to compete for the best clients on price, but not compromising on credit quality, has made it challenging to grow our commercial loan portfolio as some competition has eased underwriting standards to attract new business. The $2.1 million credit provision for loan losses we recorded during the year reflects the continued performance of our loan portfolios during the year despite the headwinds many businesses encountered because of the Pandemic.

 

Our Business Banking and Small Business Administration (SBA) departments worked very diligently during the year to administer the Paycheck Protection Program for the SBA. This included working with clients to process the forgiveness of loans originated in 2020 under the first round of the program and to originate and process loan forgiveness for loans originated in 2021 under the second round of the program. I am proud to report that as of year-end, close to 100% of loans originated under both funding rounds have been forgiven as agreed. We estimate that our clients were able to protect the jobs of approximately 5,000 individuals in the markets that we serve.

bkrehbiel.jpg

 

During the year, we focused an increased amount of resources to expand our agricultural loan portfolio. Several of our branches are in cities surrounded by prime agricultural land. Our strategy is to grow this portfolio in a sustainable manner by identifying and attracting the strongest producer in each market with the best production staff and state of the art digital banking products and services. By year-end, our agricultural loan portfolio had grown to over $22 million in outstanding balances.

 

Our balance sheet experienced strong asset growth during the year, driven primarily by a substantial growth in deposits. While admittedly some of these deposits represent the proceeds of government support payments designed to stimulate the economy, consumer spending habits have also changed, resulting in a higher savings rate. I am proud to point out that, as of year-end, our deposit base did not include non-core sources of funds such as brokered deposits or Federal Home Loan Bank advances.

 

Our capital ratios continued to be strong throughout the year, with the Bank reporting a Tier I leverage ratio of 9.5% at the year-end, which was $10 million over our 8.5% internal benchmark for core capital.

 

Dividends from the Bank to HMN during the year totaled $6 million, raising our holding company capital ratio to 10.3%. Most importantly, by year-end, HMN held $12.5 million in cash and had no debt, making the Company a significant source of strength for the Bank.

 

I am pleased that our strong trends in earnings and capital accretion placed us in a position to commence quarterly dividends with the declaration of a dividend to our common shareholders that was paid in the first quarter of 2022. This dividend was our first common shareholder dividend paid since 2008.

 

Finally, I would be remiss if I didn’t mention that in January of 2022 we suffered the sudden and unexpected loss of our valued friend, colleague, and fellow member of our Board of Directors, Mike Bue. Mike had served on our board since 2016. He was a member of several committees but mentioned to a number of us that his favorite was that of the Executive Loan Committee, for which he served as Chairman. Mike was a consummate career banker who earned the respect of everyone he interacted with. He will be greatly missed by everyone who had the good fortune to know and work with him.

 

I want to thank you for your continued support of HMN Financial, Inc. and Home Federal Savings Bank. Together with our talented staff, I look forward to continuing to work diligently to grow our organization one relationship at time.

 

Best Regards,

 

bk01.jpg

Bradley Krehbiel

 

President and Chief Executive Officer

 

2

 

Board of Directors

 

wshannon.jpg
bkrehbiel.jpg

Dr. Wendy Shannon

Board Chair

Bradley Krehbiel

President and CEO

         

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sborgman.jpg
bnigon.jpg

Allen Berning

Sequoya Borgman

Bernard Nigon

                           

bbwilliams.jpg
mutz.jpg
hzietlow.jpg

Dr. Barbara Butts Williams

Mark Utz

Hans Zietlow

 

3

 

Five-Year Consolidated Financial Highlights

 

Selected Operations Data:

 

Year Ended December 31,

 

(Dollars in thousands, except per share data)

 

2021

   

2020

   

2019

   

2018

   

2017

 

Total interest income

  $ 31,761       31,959       31,890       30,381       27,680  

Total interest expense

    1,553       2,851       3,339       2,233       1,797  

Net interest income

    30,208       29,108       28,551       28,148       25,883  

Provision for loan losses

    (2,119 )     2,699       (1,216 )     (649 )     (523 )

Net interest income after provision for loan losses

    32,327       26,409       29,767       28,797       26,406  

Fees and service charges

    3,125       2,877       3,100       3,330       3,354  

Loan servicing fees

    1,555       1,356       1,278       1,255       1,202  

Gain on sales of loans

    6,566       9,531       2,941       2,095       2,138  

Other non-interest income

    3,017       1,319       1,136       1,114       1,032  

Total non-interest income

    14,263       15,083       8,455       7,794       7,726  

Total non-interest expense

    27,661       27,122       27,105       25,467       25,326  

Income before income tax expense

    18,929       14,370       11,117       11,124       8,806  

Income tax expense

    5,365       4,068       3,324       2,888       4,402 (1) 

Net income

  $ 13,564       10,302       7,793       8,236       4,404  
                                         

Basic earnings per common share

  $ 3.03       2.23       1.69       1.89       1.04  

Diluted earnings per common share

    3.01       2.22       1.68       1.71       0.90  

 

(1) Relates to the decrease in the Company’s net deferred tax asset as a result of the reduction in the corporate federal tax rate from 34% to 21% in the fourth quarter of 2017.

 

Selected Financial Condition Data:

 

At December 31,

 

(Dollars in thousands, except per share data)

 

2021

   

2020

   

2019

   

2018

   

2017

 

Total assets

  $ 1,069,538       909,580       777,639       712,315       722,685  

Securities available for sale

    285,765       148,090       107,592       79,859       77,472  

Loans held for sale

    5,575       6,186       3,606       3,444       1,837  

Loans receivable, net

    652,502       642,630       596,392       586,688       585,931  

Deposits

    950,666       795,204       673,870       623,352       635,601  

Stockholders’ equity

    110,031       103,252       92,648       83,147       80,818  

Book value per common share

    24.11       21.65       19.13       17.19       17.97  
                                         

Number of full service offices

    14       14       14       14       13  

Number of loan origination offices

    2       1       1       2       3  
                                         

Key Ratios: (2)

                                       

Stockholders’ equity to total assets at year end

    10.29

%

    11.35

%

    11.91

%

    11.67

%

    11.18

%

Average stockholders’ equity to average assets

    10.92       11.43       12.06       11.52       11.43  

Return on stockholders’ equity (ratio of net income to average equity)

    12.62       10.56       8.74       9.88       5.52  

Return on assets (ratio of net income to average assets)

    1.38       1.21       1.05       1.14       0.63  

 

(2) Average balances were calculated based upon amortized cost without the market value impact of ASC 320.

 

4

 

Management Discussion and Analysis

 

This Annual Report, other reports filed by HMN Financial, Inc. (HMN or the Company) with the Securities and Exchange Commission (SEC), and the Companys proxy statement may contain forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are often identified by such forward-looking terminology as expect, estimate, intend, look, believe, anticipate, project, continue, may, will, would, could, target, goal, should, and trend, or similar statements or variations of such terms and include, but are not limited to, those relating to maintaining credit quality; maintaining net interest margins; the adequacy and amount of available liquidity and capital resources to Home Federal Savings Bank (the Bank); the Companys liquidity and capital requirements; the anticipated impacts of the COVID-19 Pandemic and efforts to mitigate the same on the general economy, our clients, and the allowance for loan losses; the amount of the Banks non-performing assets in future periods and the appropriateness of the allowances 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 and compositions of non-interest and interest-bearing liabilities; the availability of alternate funding sources; the payment of dividends or repurchases of stock by HMN; 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 anticipated results of litigation and our assessment of the impact on our financial statements; 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 Banks status as well-capitalized) and other supervisory directives or requirements to which the Company or the Bank are or may become expressly subject.

 

A number of factors, many of which may be amplified by the COVID-19 pandemic and efforts to mitigate the same, could cause actual results to differ materially from the Companys assumptions and expectations. These include but are not limited to the adequacy and marketability of real estate and other collateral securing loans to borrowers; federal and state regulation and enforcement; possible legislative and regulatory changes, including changes to regulatory capital rules; the ability of the Bank to comply with other applicable regulatory capital requirements; enforcement activity of the Office of the Comptroller of the Currency (OCC) and the Federal Reserve Bank of Minneapolis in the event of our non-compliance with any applicable regulatory standard or requirement; adverse economic, business and competitive developments such as continued shrinking interest margins, reduced collateral values, deposit outflows, changes in credit or other risks posed by the Companys loan and investment portfolios; changes in costs associated with traditional and alternate funding sources, including changes in collateral advance rates and policies of the Federal Home Loan Bank (FHLB) and the Federal Reserve Bank; technological, computer-related or operational difficulties including those from any third party cyberattack; 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; domestic and international economic developments; the Companys 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. Additional factors that may cause actual results to differ from the Companys assumptions and expectations include those set forth in the Risk Factors section of the Companys Annual Report on Form 10-K for the year ended December 31, 2021. All forward-looking statements are qualified by, and should be considered in conjunction with, such cautionary statements.

 

All statements in this Annual Report, including forward-looking statements, speak only as of the date hereof, and we undertake no duty to update any of the forward-looking statements after the date of this Annual Report.

 

Overview

HMN is the stock savings bank holding company for the Bank, which operates community banking and loan production offices in Minnesota, Iowa and Wisconsin. The earnings of the Company are primarily dependent on the Bank's net interest income, which is the difference between interest earned on loans and investments, and the interest paid on interest-bearing liabilities such as deposits and other borrowings. The difference between the average rate of interest earned on assets and the average rate paid on liabilities is the interest rate spread. Net interest income is produced when interest-earning assets equal or exceed interest-bearing liabilities and there is a positive interest rate spread. Net interest income and net interest rate spread are affected by changes in interest rates, the volume and composition of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company's net earnings are also affected by the generation of non-interest income, which consists primarily of gains from the sale of loans, fees for servicing loans, commissions on the sale of uninsured investment products, and service charges on deposit accounts. The Bank incurs expenses in addition to interest expense in the form of compensation and benefits, occupancy and equipment expenses, provisions for loan losses, data processing costs, professional services, deposit insurance, amortization expense on mortgage servicing assets, advertising expenses, and income taxes. The earnings of financial institutions, such as the Bank, are also significantly affected by prevailing economic and competitive conditions, particularly changes in interest rates, government monetary and fiscal policies, and regulations of various regulatory authorities. Lending activities are influenced by the demand for and supply of business credit, single family and commercial properties, competition among lenders, the level of interest rates and the availability of funds. Deposit flows and costs of deposits are influenced by prevailing market rates of interest on competing investments, account maturities and the levels of personal income and savings.

 

5

 

Critical Accounting Estimates

While our significant accounting policies are described in the notes to our consolidated financial statements, we believe the following discussion addresses our most critical accounting estimates, which are those estimates made in accordance with U.S. generally accepted accounting principles (GAAP) that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. The Company has identified the following critical accounting estimates that management believes involve the most difficult, subjective, and/or complex judgments that are inherently uncertain. Therefore, actual financial results could differ significantly depending upon the estimates, assumptions and other factors used.

 

Allowance for Loan Losses and Related Provision

The allowance for loan losses is based on periodic analysis of the loan portfolio and is maintained at an amount considered to be appropriate by management to provide for probable losses inherent in the loan portfolio as of the balance sheet dates. In this analysis, management considers factors including, but not limited to, specific occurrences of loan impairment, actual and anticipated changes in the size of the portfolios, national, regional and local economic conditions such as unemployment data, loan delinquencies, demand for single family homes, demand for commercial real estate and building lots, loan portfolio composition, historical loss experience and observations made by the Company's ongoing internal audit and regulatory exam processes. Loans are charged off to the extent they are deemed to be uncollectible. The Company has established separate processes to determine the appropriateness of the loan loss allowance for its homogeneous and non-homogeneous loan portfolios. The determination of the allowance on the homogeneous single family and consumer loan portfolios is calculated on a pooled basis with individual determination of the allowance for all non-performing loans. The determination of the allowance for the non-homogeneous commercial, commercial real estate and multi-family loan portfolios involves assigning standardized risk ratings and loss factors that are periodically reviewed. The loss factors are estimated based on the Company's own loss experience and other qualitative factors and are assigned to all loans without identified credit weaknesses. For each non-performing loan, the Company also performs an individual analysis of impairment that is based on the expected cash flows or the value of the assets collateralizing the loans and establishes any necessary reserves or charges off all loans, or portions thereof, that are deemed uncollectible.

 

The appropriateness of the allowance for loan losses is dependent upon management’s estimates of variables affecting valuation, appraisals of collateral, evaluations of performance and status and the amounts and timing of future cash flows expected to be received on impaired loans. Such estimates, appraisals, evaluations and cash flows may be subject to adjustments due to changing economic prospects of borrowers or properties. The fair market value of collateral dependent loans is typically based on the appraised value of the property less estimated selling costs. The estimates are reviewed periodically and any adjustments are recorded in the provision for loan losses in the periods in which the adjustments become known. Because of the size of some loans, changes in estimates can have a significant impact on the loan loss provision. The allowance is allocated to individual loan categories based upon the relative risk characteristics of the loan portfolios, the actual loss experience and other qualitative factors. The Company increases its allowance for loan losses by charging the provision for loan losses against income and by receiving recoveries of previously charged off loans. The Company decreases its allowance by crediting the provision for loan losses and recording loan charge-offs. The current year activity resulted in a decrease in the allowance and a credit to the loan loss provision. The methodology for establishing the allowance for loan losses takes into consideration probable losses that have been identified in connection with specific loans as well as losses in the loan portfolio that have not been specifically identified. Although management believes that based on current conditions the allowance for loan losses is maintained at an appropriate amount to provide for probable loan losses inherent in the portfolio as of the balance sheet dates, future conditions may differ substantially from those anticipated in determining the allowance for loan losses and adjustments may be required in the future. In addition, the Company will be required to adopt Accounting Standards Update (ASU) 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments in the first quarter of 2023. See “Note 1 - New Accounting Pronouncements in the Notes to Consolidated Financial Statements for further information on the potential impact of adopting ASU 2016-13.

 

6

 

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. These calculations are based on many complex factors including estimates of the timing of reversals of temporary differences, the interpretation of federal and state income tax laws, and a determination of the differences between the tax and the financial reporting basis of assets and liabilities. Actual results could differ significantly from the estimates and interpretations used in determining the current and deferred income tax assets and liabilities.

 

The Company maintains significant net deferred tax assets for deductible temporary differences, the largest of which relates to the allowance for loan losses. For tax purposes only the net charge-offs are deductible while the entire provision for loan losses is used to determine book income. A deferred tax asset is created because of the timing difference of when the expense is recognized for book and tax purposes. Under GAAP, a valuation allowance is required to be recognized if it is “more likely than not” that the deferred tax asset will not be realized. The determination of the realizability of the deferred tax assets is highly subjective and dependent upon management’s judgment and evaluation of both positive and negative evidence, including the forecasts of future income, tax planning strategies, and assessments of the current and future economic and business conditions. The positive evidence considered includes the Company’s cumulative net income in the prior three-year period, the ability to implement tax planning strategies to accelerate taxable income recognition, and the probability that taxable income will be generated in future periods. The Company could not currently identify any negative evidence. It is possible that future conditions may differ substantially from those anticipated in determining that no valuation allowance was required on deferred tax assets and adjustments may be required in the future.

 

Determining the ultimate settlement of any tax position requires significant estimates and judgments in arriving at the amount of tax benefits to be recognized in the financial statements. It is possible that the tax benefits realized upon the ultimate resolution of a tax position may result in tax benefits that are significantly different from those estimated.

 

Litigation
Estimates related to litigation are inherently subjective and the ultimate resolution of any litigation may be different than current management estimates. See “Note 18 Commitments and Contingencies” in the Notes to Consolidated Financial Statements for further information on outstanding litigation matters.

 

COVID-19 Pandemic

In 2020, the spread of COVID-19 slowed economic activity in many countries, including the United States. Millions of Americans were at some point ordered to stay home, including those residing in the states of Minnesota and Wisconsin, and many businesses were ordered to be closed for a period of time or to operate at reduced capacities in order to reduce the spread of COVID-19. These orders severely reduced the flow of commerce which reduced, or entirely eliminated, the revenue streams for many small businesses. This reduction in income forced many small businesses to close temporarily, furlough employees, or terminate operations entirely.

 

In 2021 several COVID-19 vaccines were approved for distribution and became available to the general public.  Since that time, the majority of the population in the United States received an initial vaccination, with some also obtaining a recommended booster vaccination when it became available in the fall of 2021.  Despite these vaccinations, the original virus has mutated multiple times and continues to infect both vaccinated and unvaccinated individuals.  Due to the variations in both the seriousness of symptoms and degree of transmissibility with these variants, surges of positive cases began to occur in the fourth quarter of 2021 and continue as we begin 2022. Because of the increase in COVID-19 infections, some mask mandate orders were put back in place in certain areas of the country and some schools implemented distance learning for short periods of time in order to reduce the spread of COVID-19. The impact of these measures on the economy, however, has been much less than previously experienced due to having fewer government mitigation measures requiring people to stay at home or to close down certain businesses than when the pandemic first began.

 

The Bank has, and continues to be, impacted by the disruption in economic activity due to the pandemic. During 2020, it temporarily closed the lobbies in all of its locations and for a period of time conducted business entirely through the drive-ups at the branches that have that capability. Branches without drive-up facilities were closed for a period of time in order to meet the social distancing guidelines recommended by health officials. Beginning in January 2021, the Bank re-opened all of its lobbies to walk-in services during limited hours while continuing to offer drive-up service during normal business hours. The Bank continues to encourage its customers to conduct business through its on-line loan and deposit account services, as well as through ATM and night drop facilities available at its branches.

 

7

 

The Coronavirus Aid, Relief, and Economic Security (CARES) Act was signed into law on March 27, 2020 and the Bank’s regulators issued the Interagency Statement on Loan Modification and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus on April 7, 2020. In accordance with regulatory guidance, the Bank offered loan payment accommodations to certain customers by deferring the loan payments on their outstanding loans with the Bank for up to six months. After the initial deferral period was over, the Bank granted additional accommodations on certain loans to borrowers in accordance with Section 4013 of the CARES Act on a case-by-case basis. See “Note 6 Allowance for Loan Losses and Credit Quality Information in the Notes to Consolidated Financial Statements for further information.

 

The extent of any future impact on the Company related to the pandemic is difficult to determine as it is not clear how many times the virus will mutate, how effective the vaccines will be on future mutations of the virus, the impact that any future mutations will have on economic activity, or what the long-term implications will be on customer behavior as a result of the pandemic, among other factors. The impact on the Bank’s loan portfolio is also unclear for many of the same reasons. At this time, the Company has not seen a negative impact on its deposit relationships as many of its clients have been able to conduct their business with the Bank through the drive-ups, ATMs, night drop, on-line banking website, or by using its mobile banking application.

 

Paycheck Protection Program (PPP)

The Bank actively participated in helping businesses that applied for forgivable loans under the PPP as part of the CARES Act. The Bank had the following activity related to the first round of the PPP through December 31, 2021:

 

(Dollars in thousands)

 

Number of

Loans

   

Amount

   

Net

Deferred

Fees

 

Originated

    413     $ 53,153       1,837  

Repaid

    (130 )     (19,484 )     0  

Net deferred fees recognized

    0       0       (1,097 )

Balance, December 31, 2020

    283     $ 33,669       740  

Repaid

    (283 )     (33,669 )     0  

Net deferred fees recognized

    0       0       (740 )

Balance, December 31, 2021

    0     $ 0       0  
                         

 

The Consolidated Appropriations Act of 2021 was signed into law on December 27, 2020 and allocated $284 billion to the Small Business Administration (SBA) to fund a second round of the PPP. The Bank actively participated in the second round of the PPP and had the following activity through December 31, 2021:

 

(Dollars in thousands)

 

Number of

Loans

   

Amount

   

Net

Deferred

Fees

 

Originated

    466     $ 28,965       1,625  

Repaid

    (459 )     (26,306 )     0  

Net deferred fees recognized

    0       0       (1,551 )

Balance, December 31, 2021

    7     $ 2,659       74  
                         

 

It is anticipated that the outstanding loans at December 31, 2021 will be forgiven by the SBA and the remaining net deferred fees will be recognized into income when the loans are repaid.

 

 

Results of Operations

 

Comparison of 2021 with 2020

Net income was $13.6 million for 2021, an increase of $3.3 million, or 31.7%, compared to net income of $10.3 million for 2020. Diluted earnings per share for the year ended December 31, 2021 was $3.01, an increase of $0.79 per share, compared to diluted earnings per share of $2.22 for the year ended December 31, 2020. The increase in net income between the periods was primarily because of a $4.8 million decrease in the provision for loan losses. The provision for loan losses decreased primarily because of the reduction in the required reserves due to the reduced economic impact of the COVID-19 pandemic and the results of an internal analysis of the loan portfolio. Other non-interest income increased $1.7 million due primarily to an increase in the gains that were realized on the sale of real estate owned. Net interest income increased $1.1 million primarily due to an increase in the yield enhancements that were realized on PPP loans that were repaid during the period and also because of a decrease in the interest rates paid on deposits. These increases in net income were partially offset by a $3.0 million decrease in the gain on sales of mortgage loans due to a decrease in mortgage loan activity between the periods. Compensation expense increased $0.5 million due primarily to an increase in incentives earned between the periods. Income tax expense also increased $1.3 million as a result of the increased pre-tax income between the periods.

 

8

 

Net Interest Income

Net interest income was $30.2 million for 2021, an increase of $1.1 million, or 3.8%, from $29.1 million for 2020. Interest income was $31.8 million for 2021, a decrease of $0.2 million, or 0.6%, from $32.0 million for 2020. Interest income decreased despite the $2.3 million in yield enhancements that were recognized on PPP loans during the period and the $130.8 million increase in the average interest-earning assets between the periods. These increases in interest income were entirely offset by a decrease in the average yield earned on interest-earning assets which was 3.34% for 2021, a decrease of 56 basis points from 3.90% for 2020. The decrease in the average yield is primarily related to the decrease in the prime rate that occurred in the first quarter of 2020, which lowered the rate on adjustable rate loans in the portfolio as well as any new or renewing fixed rate loans that were originated since that time.

 

Interest expense was $1.6 million for 2021, a decrease of $1.3 million, or 45.5%, from $2.9 million for 2020. Interest expense decreased despite the $123.1 million increase in the average interest-bearing liabilities and non-interest bearing deposits between the periods primarily because of the decrease in the average interest rate paid on deposits. The average interest rate paid on interest-bearing liabilities and non-interest bearing deposits was 0.18% for 2021, a decrease of 20 basis points from 0.38% for 2020. The decrease in the interest paid on interest-bearing liabilities was primarily because of the decrease in deposit rates as a result of the decrease in the federal funds rate in the first quarter of 2020.

 

The following table presents the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Non-accruing loans have been included in the average outstanding loan balance in the table as loans carrying a zero yield.

 

   

Year Ended December 31,

 
   

2021

   

2020

 

(Dollars in thousands)

 

Average

Outstanding

Balance

   

Interest

Earned/

Paid

   

Average

Yield/

Rate

   

Average

Outstanding

Balance

   

Interest

Earned/

Paid

   

Average

Yield/

Rate

 

Interest-earning assets:

                                               

Securities available for sale(1):

                                               

Mortgage-backed and related securities

  $ 167,759       1,864       1.11

%

  $ 61,364       1,155       1.88

%

Other marketable securities

    42,878       282       0.66       46,407       702       1.51  

Loans held for sale

    5,335       159       2.98       7,292       215       2.95  

Loans receivable, net(1) (2)

    631,969       29,290       4.63       644,912       29,709       4.61  

FHLB stock and other earning assets including cash equivalents

    102,146       166       0.16       59,321       178       0.30  

Total interest-earning assets

  $ 950,087       31,761       3.34     $ 819,296       31,959       3.90  
                                                 

Interest-bearing liabilities:

                                               

Checking accounts

  $ 157,857       182       0.12

%

  $ 122,781       151       0.12

%

Savings accounts

    113,314       69       0.06       90,064       65       0.07  

Money market accounts

    245,409       557       0.23       209,522       840       0.40  

Certificate accounts

    93,650       745       0.80       115,079       1,795       1.56  

FHLB advances and other borrowings

    0       0       0.00       0       0       0.00  

Total interest-bearing liabilities

  $ 610,230                     $ 537,446                  

Noninterest checking

    257,549                       207,456                  

Other noninterest-bearing liabilities

    2,490                       2,251                  

Total interest-bearing liabilities and noninterest-bearing deposits

  $ 870,269       1,553       0.18

%

  $ 747,153       2,851       0.38

%

Net interest income

            30,208                     $ 29,108          

Net interest rate spread

                    3.16

%

                    3.52

%

Net earning assets

  $ 79,818                     $ 72,143                  

Net interest margin

                    3.18

%

                    3.55

%

Average interest-earning assets to average interest-bearing liabilities

            109.17

%

                    109.66

%

       
                                                 

(1) Tax exempt income was not material; therefore, the yield was not presented on a tax equivalent basis for any of the years presented.
(2) Calculated net of deferred loan costs, loan discounts, loans in process and loss reserves.
 

Net interest margin (net interest income divided by average interest-earning assets) for 2021 was 3.18%, a decrease of 37 basis points, compared to 3.55% for 2020. The decrease in the net interest margin is primarily related to the decrease in the average yield earned on interest-earning assets as a result of the decrease in the prime rate that occurred in the first quarter of 2020.

 

9

 

Average net earning assets increased to $79.8 million in 2021 compared to $72.1 million in 2020. The $7.7 million increase in the average net earning assets in 2021 is due primarily to the net income earned in 2021 that was partially offset by the purchase of premises and equipment and treasury stock.

 

The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It quantifies the changes in interest income and interest expense related to changes in the average outstanding balances (volume) and those changes caused by fluctuating interest rates. For each category of interest-earning assets and interest-bearing liabilities, information is provided on changes attributable to (i) changes in volume (i.e. changes in volume multiplied by old rate) and (ii) changes in rate (i.e. changes in rate multiplied by current volume).

 

    Year Ended December 31,  
   

2021 vs. 2020

         
   

Increase (Decrease)

Due to

         

(Dollars in thousands)

 

Volume (1)

   

Rate(1)

   

Total

Increase

(Decrease)

 

Interest-earning assets:

                       

Securities available for sale:

                       

Mortgage-backed and related securities

  $ 2,003       (1,294 )     709  

Other marketable securities

    (53 )     (367 )     (420 )

Loans held for sale

    (58 )     2       (56 )

Loans receivable, net

    (711 )     292       (419 )

Other

    114       (126 )     (12 )

Total interest-earning assets

  $ 1,295       (1,493 )     (198 )

Interest-bearing liabilities:

                       

Checking accounts

  $ 57       (26 )     31  

Savings accounts

    17       (13 )     4  

Money market accounts

    166       (449 )     (283 )

Certificate accounts

    (335 )     (715 )     (1,050 )

Total interest-bearing liabilities

  $ (95 )     (1,203 )     (1,298 )

Increase (decrease) in net interest income

  $ 1,390       (290 )     1,100  

 

(1) For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change due to volume and the change due to rate.

 

The following table sets forth the weighted average yields on the Company's interest-earning assets, the weighted average interest rates on interest-bearing liabilities and the interest rate spread between the weighted average yields and rates as of the date indicated. Non-accruing loans have been included in the average outstanding loan balances in the table as loans carrying a zero yield.

 

At December 31, 2021

 

Weighted average yield on:

       

Weighted average rate on:

       

Securities available for sale:

                 

Mortgage-backed and related securities

    1.06

%

Checking accounts

    0.12

%

Other marketable securities

    0.54  

Savings accounts

    0.06  

Loans held for sale

    3.42  

Money market accounts

    0.21  

Loans receivable, net

    4.14  

Certificate accounts

    0.53  

FHLB stock and other interest-earning assets

    0.19  

Combined weighted average rate on interest-bearing liabilities

    0.13  

Combined weighted average yield on interest-earning assets

    2.93  

Interest rate spread

    2.80  
                   

 

Provision for Loan Losses

The provision for loan losses was ($2.1) million for 2021, a decrease of $4.8 million from the $2.7 million provision for loan losses for 2020. The provision for loan losses decreased primarily because of the reduction in the required reserves due to the reduced economic impact of the COVID-19 pandemic and the results of an internal analysis of the loan portfolio. The provision also decreased between the periods due to an increase in the current year in the recoveries received on previously charged off loans. During 2020, the Company increased its allowance for loan losses due to the changes in the economic environment related to the disruption in business activity as a result of the COVID-19 pandemic. The amount of the increase in the allowance for loan losses related to the economic environment was based, in part, on the amount of loans to borrowers in the hospitality, restaurant and entertainment industries that were negatively impacted by the COVID-19 pandemic. The underlying operations supporting many of the loans that were initially negatively impacted by the pandemic have improved and the amount of loans requiring accommodations decreased in 2021. At December 31, 2021, the Company had no loans with outstanding loan accommodations in accordance with Section 4013 of the CARES Act, compared to $34.6 million of outstanding loans that had been granted accommodations at December 31, 2020. See “Note 6 Allowance for Loan Losses and Credit Quality Information” in the Notes to Consolidated Financial Statements for additional information related to deferrals and loan modifications to borrowers impacted by the COVID-19 pandemic.

 

10

 

Non-Interest Income

Non-interest income was $14.3 million for 2021, a decrease of $0.8 million, or 5.4%, from $15.1 million for 2020. The following table presents the components of non-interest income:

 

   

Year Ended December 31,

   


Percentage

 

(Dollars in thousands)

 

2021

   

2020

   

Change

 

Fees and service charges

  $ 3,125       2,877       8.6

%

Loan servicing fees

    1,555       1,356       14.7  

Gain on sales of loans

    6,566       9,531       (31.1 )

Other non-interest income

    3,017       1,319       128.7  

Total non-interest income

  $ 14,263       15,083       (5.4 )
                         

 

Gain on sales of loans decreased $3.0 million between the periods primarily because of a decrease in single family loan originations and sales. This decrease in non-interest income was partially offset by an increase in other non-interest income of $1.7 million due primarily to a $1.4 million increase in the gain realized on the sale of commercial real estate owned and an increase in the income earned on the sale of uninsured investment products between the periods. Fees and service charges increased $0.2 million between the periods because of an increase in debit card income due to an increase in the volume of transactions. Loan servicing fees increased $0.2 million between the periods due to an increase in the aggregate balances of single family mortgage loans that were being serviced for others.

 

Non-Interest Expense

Non-interest expense was $27.7 million for 2021, an increase of $0.6 million, or 2.0%, from $27.1 million for 2020. The following table presents the components of non-interest expense:

 

   

Year Ended December 31,

   

Percentage

 

(Dollars in thousands)

 

2021

   

2020

   

Change

 

Compensation and benefits

  $ 16,114       15,646       3.0

%

Occupancy and equipment

    4,372       4,429       (1.3 )

Data processing

    1,445       1,314       10.0  

Professional services

    1,438       1,405       2.3  

Other

    4,292       4,328       (0.8 )

Total non-interest expense

  $ 27,661       27,122       2.0  
                         

 

Compensation and benefits expense increased $0.5 million because of an increase in the incentives earned between the periods. Data processing expense increased $0.1 million due primarily to increased debit card processing costs. Professional services expense increased slightly between the periods primarily because of an increase in employee recruitment fees. These increases in non-interest expense were partially offset by a $0.1 million decrease in occupancy and equipment expense due primarily to a decrease in building rent expense between the periods. Other non-interest expense decreased slightly between the periods due primarily to a decrease in mortgage servicing expense due to a decrease in prepayments on loans being serviced for third parties.

 

Income Taxes

The Company considers the calculation of current and deferred income taxes to be a critical accounting policy that is subject to significant estimates. Income tax expense was $5.4 million for 2021, an increase of $1.3 million from $4.1 million for 2020. The increase in income tax expense between the periods is primarily the result of an increase in pre-tax income.

 

11

 

Financial Condition

Loans Receivable, Net

The following table sets forth the information on the Company's loan portfolio in dollar amounts and percentages before deductions for deferred costs/fees and discounts and the allowance for losses as of the dates indicated:

 

   

December 31,

 
   

2021

   

2020

 

(Dollars in thousands)

 

Amount

   

Percent

   

Amount

   

Percent

 

Real Estate Loans:

                               

Single family

  $ 163,322       24.67

%

  $ 135,023       20.65

%

Multi-family

    43,140       6.51       41,456       6.34  

Commercial

    306,490       46.30       307,755       47.07  

Construction and development

    47,238       7.14       31,493       4.82  

Total real estate loans

    560,190       84.62       515,727       78.88  

Other Loans:

                               

Consumer Loans:

                               

  Home equity line

    17,467       2.64       21,308       3.26  

  Home equity

    7,557       1.14       11,549       1.76  

  Recreational vehicles

    10,985       1.66       15,645       2.39  

  Other

    5,636       0.85       6,889       1.06  

Total consumer loans

    41,645       6.29       55,391       8.47  

Commercial business loans

    60,165       9.09       82,673       12.65  

Total other loans

    101,810       15.38       138,064       21.12  

Total loans

  $ 662,000       100.00

%

  $ 653,791       100.00

%

Less:

                               

Unamortized discounts

    10               12          

Net deferred loan fees

    209               450          

Allowance for losses

    9,279               10,699          

Total loans receivable, net

  $ 652,502             $ 642,630          
                                 

 

The growth in the loan portfolio in 2021 was primarily because of the growth experienced in single family real estate, construction and development loans, and multi-family loans that was partially offset by a decrease in commercial business and consumer loans. Based on current economic conditions and the projected loan origination and prepayment amounts, it is anticipated that the overall growth in the loan portfolio will be limited in 2022.

 

Single family real estate loans were $163.3 million at December 31, 2021, an increase of $28.3 million, compared to $135.0 million at December 31, 2020. The single family loan portfolio increased in 2021 primarily because of an increase in the amount of originated loans that were placed in the portfolio during 2021 compared to 2020. The single family loan portfolio increased due to a $20.5 million increase in the amount of saleable 10 and 15 year single family loans that were placed into the loan portfolio rather than being sold in the secondary market. These loans were placed into the portfolio in order to increase the overall loan portfolio balance and improve the overall yield earned on interest earning assets during 2021.

 

Multi-family real estate loans were $43.1 million at December 31, 2021, an increase of $1.6 million, compared to $41.5 million at December 31, 2020. The increase in multi-family real estate loans in 2021 is primarily the result of new loan originations and transfers in of completed multi-family construction loans exceeding the loans that were repaid during the year.

 

Commercial real estate loans were $306.5 million at December 31, 2021, a decrease of $1.3 million, compared to $307.8 million at December 31, 2020. The outstanding commercial real estate loans decreased despite the $41.1 million increase in originations between the periods as there were also more loans that were paid off during 2021 compared to 2020.

 

Construction and development loans were $47.2 million at December 31, 2021, an increase of $15.7 million, compared to $31.5 million at December 31, 2020. The increase in construction loans is primarily related to the $21.5 million increase in the amount of originations and advances on existing loans between the periods. This increase in outstanding construction and development loans was partially offset by an increase in the amount of loans that were either paid off or moved to another loan category after the construction projects were completed.

 

12

 

Home equity lines of credit were $17.5 million at December 31, 2021, a decrease of $3.8 million, compared to $21.3 million at December 31, 2020. The open-end home equity lines are generally written with an adjustable rate and a two to ten year draw period which requires interest only payments followed by a ten year repayment period which fully amortizes the outstanding balance. Home equity loans were $7.5 million at December 31, 2021, a decrease of $4.0 million, compared to $11.5 million at December 31, 2020. Closed-end home equity loans are written with fixed or adjustable rates with terms up to fifteen years. The overall decrease in the open-end equity lines and closed-end equity loans is related primarily to an increase in loan payoffs and other principal reductions as borrowers refinanced their homes and rolled outstanding equity loan balances into their first mortgage.

 

Recreational vehicle loans were $11.0 million at December 31, 2021, a decrease of $4.6 million, compared to $15.6 million at December 31, 2020. These loans have been made primarily to finance the recreational vehicle sales of a single dealer within the Bank’s market area and the decrease in the balance between the periods is primarily due to a decrease in originations as a result of discontinuing the recreational vehicle loan program in 2021.

 

Commercial business loans were $60.2 million at December 31, 2021, a decrease of $22.5 million, compared to $82.7 million at December 31, 2020. The decrease in commercial business loans in 2021 is primarily because of the $31.0 million decrease in outstanding PPP loans between the periods due to the repayments that occurred during the year. The $8.5 million increase in non-PPP commercial business loans is because of an increase in originations between the periods.

 

Allowance for Loan Losses

The determination of the allowance for loan losses and the related provision is a critical accounting policy of the Company that is subject to significant estimates. The allowance for loan losses is made up of general reserves on the entire loan portfolio and specific reserves on impaired loans. The general reserve amount includes quantitative reserves based on our past loan loss history and qualitative reserves for other items determined to have a potential impact on future loan losses. The current level of the allowance for loan losses is a result of management’s assessment of the risks within the portfolio based on the information obtained through the credit evaluation process. The Company utilizes a risk-rating system on non-homogeneous commercial real estate and commercial business loans that includes regular credit reviews to identify and quantify the risk in the commercial portfolio. Management conducts quarterly reviews of the entire loan portfolio and evaluates the need to adjust the allowance balance on the basis of these reviews.

 

Management actively monitors asset quality and, when appropriate, charges off loans against the allowance for loan losses. Although management believes it uses the best information available to make determinations with respect to the allowance for loan losses, future adjustments may be necessary if economic conditions differ substantially from the economic conditions in the assumptions used to determine the size of the allowance for loan losses.

 

The allowance for loan losses was $9.3 million, or 1.40% of gross loans at December 31, 2021, compared to $10.7 million, or 1.64% of gross loans at December 31, 2020. The allowance for loan losses decreased in 2021 primarily because of a decrease in qualitative reserves related to the COVID-19 pandemic. The decrease in qualitative reserves for COVID-19 was due to an improvement in the underlying operations supporting many of the loans that were initially negatively impacted by the COVID-19 pandemic.

 

The following table reflects the activity in the allowance for loan losses and selected statistics:

 

   

December 31,

 

(Dollars in thousands)

 

2021

   

2020

 

Balance at beginning of year

  $ 10,699       8,564  

Provision for losses

    (2,119 )     2,699  

Charge-offs:

               

Commercial real estate

    (36 )     (730 )

Consumer

    (42 )     (84 )

Commercial business

    0       (8 )

Recoveries

    777       258  

Net recoveries (charge-offs)

    699       (564 )

Balance at end of year

  $ 9,279       10,699  

Year end allowance for loan losses as a percent of year end gross loan balance

    1.40

%

    1.64

%

Ratio of net loan recoveries (charge-offs) to average loans outstanding

    0.11       (0.09 )

Allowance as a percent of total assets at year end

    0.87       1.18  
                 

 

13

 

The following table presents information related to net recoveries (charge-offs) by loan category:

 

   

2021

   

2020

 
(Dollars in thousands)  

Net
Recoveries

   

Ratio of Net
Recoveries to

Average Loans

Outstanding

   

Net
(Charge-offs)

Recoveries

   

Ratio of Net
(Charge-offs)

Recoveries to

Average Loans

Outstanding

 

Commercial real estate

  $ 617       0.16 %   $ (703 )     (0.19

)%

Consumer

    16       0.30       (55 )     (0.09

)

Commercial business

    66       0.09       194       0.26

 

    $ 699       0.11     $ (564 )     (0.09

)

                                 

 

The following table reflects the allocation of the allowance for loan losses by loan category:

 

   

December 31,

 
   

2021

   

2020

 
(Dollars in thousands)  

Allocated

Allowance

as a % of

Loan

Category

   

Percent

of Loans

in Each

Category

to Total

Loans

   

Allocated Allowance

as a % of

Loan

Category

   

Percent

of Loans

in Each

Category

to Total

Loans

 

Single family

    0.60

%

    24.67

%

    0.76

%

    20.65

%

Commercial real estate

    1.61       59.95       1.92       58.23  

Consumer

    2.35       6.29       2.51       8.47  

Commercial business

    1.56       9.09       1.19       12.65  

Total

    1.40       100.00

%

    1.64       100.00

%

                                 

 

The allocated allowance percentages for all loan categories, except commercial business loans, decreased in 2021 primarily because of the reduction in the required reserves due to the reduced economic impact of the COVID-19 pandemic. The increase in the allowance percentage for commercial business loans between the periods is due to the $31.0 million decrease in PPP loans that are included in this category that are guaranteed by the SBA and have no allocated allowance amount.

 

Allowance for Real Estate Losses

Real estate properties acquired or expected to be acquired through loan foreclosures are initially recorded at fair value less estimated selling costs. Management periodically performs valuations and an allowance for losses is established if the carrying value of a property exceeds its fair value less estimated selling costs. There was no allowance for real estate losses at December 31, 2021 or 2020.

 

Non-performing Assets

Loans are reviewed at least quarterly and if the collectability of any loan is doubtful, it is placed on non-accrual status. Loans are placed on non-accrual status when either principal or interest is 90 days or more past due, unless, in the judgment of management, the loan is well collateralized and in the process of collection. Interest accrued and unpaid at the time a loan is placed on non-accrual status is charged against interest income. Subsequent payments are either applied to the outstanding principal balance or recorded as interest income, depending on the assessment of the ultimate collectability of the loan. Restructured loans include the Bank's troubled debt restructurings (TDRs) that involved forgiving a portion of interest or principal or making a loan with terms that the Bank would not normally grant to borrowers whose financial condition had deteriorated. Foreclosed and repossessed assets include assets acquired in settlement of loans. Total non-performing assets were $4.9 million at December 31, 2021, an increase of $1.6 million, or 47.9%, from $3.3 million at December 31, 2020. Non-performing loans increased $1.9 million and foreclosed and repossessed assets decreased $0.3 million during 2021. The increase in non-performing loans is primarily related to a $3.4 million hotel loan that was classified as non-performing during the year that was partially offset by a $1.0 million commercial real estate loan that was classified as non-performing at December 31, 2020 that became performing during 2021. The decrease in the foreclosed and repossessed assets is related to changes in foreclosed commercial properties between the periods.

 

14

 

The following table sets forth the amounts and categories of non-performing assets in the Company’s portfolio:

 

   

December 31,

 

(Dollars in thousands)

 

2021

   

2020

 

Non-performing loans:

               

Single family

  $ 340       502  

Commercial real estate

    3,757       1,484  

Consumer

    517       689  

Commercial business

    7       9  

Total

    4,621       2,684  

Foreclosed and repossessed assets:

               

Commercial real estate

    290       636  

Total

    290       636  

Total non-performing assets

  $ 4,911       3,320  

Total as a percentage of total assets

    0.46

%

    0.37

%

Total non-performing loans

  $ 4,621     $ 2,684  

Total as a percentage of total loans receivable

    0.70

%

    0.41

%

Allowance for loan losses to non-performing loans

    200.81

%

    398.72

%

                 

 

Gross interest income which would have been recorded had the non-accruing loans been current in accordance with their original terms amounted to $0.3 million for the year ended December 31, 2021 and $0.2 million for the year ended December 31, 2020. The amounts that were included in interest income on a cash basis for these loans were $0.2 million for the year ended December 31, 2021 and $0.1 million for the year ended December 31, 2020.

 

At December 31, 2021 and 2020, there were loans included in loans receivable, net, with terms that had been modified in a TDR totaling $1.1 million and $1.5 million, respectively. Had these loans been performing in accordance with their original terms throughout 2021 and 2020, the Company would have recorded gross interest income of $0.1 million in both years. During 2021 and 2020, the amount of interest income received on these loans was not material.

 

For the loans that were modified in 2021, none were classified and performing, and $0.3 million were non-performing at December 31, 2021. The decrease in TDRs in 2021 related primarily to a single family first mortgage loan that paid off during the year. Of the loans that were modified in 2021 and outstanding at December 31, 2021, $0.2 million related to a loan secured by commercial real estate and $0.1 million consisted of two unrelated loans secured by first mortgages on single family properties.

 

For the loans that were modified in a TDR in 2020, none were classified and performing and $0.3 million were non-performing at December 31, 2020. The decrease in TDRs in 2020 was primarily due to two related commercial loans that had performed according to their restructured terms and met the criteria to be upgraded to non-TDR status during the year. Of the loans that were modified in 2020 and outstanding at December 31, 2020, $0.2 million related to a loan secured by commercial real estate and $0.1 million related to a loan secured by a first mortgage on a single family property.

 

The following table sets forth the amount of TDRs in the Company’s portfolio:

 

   

December 31,

 

(Dollars in thousands)

 

2021

   

2020

 

Single family

  $ 254       612  

Commercial real estate

    355       211  

Consumer

    442       630  

Commercial business

    0       25  

Total TDRs

  $ 1,051       1,478  
                 

TDRs on accrual status

  $ 29       442  

TDRs on non-accrual status

    1,022       1,036  

Total

  $ 1,051       1,478  
                 

 

This TDR table does not include loan accommodations that were granted during 2021 and 2020 to borrowers in accordance with the Interagency Statement on Loan Modification and Reporting for Financial Institutions Working with Customers Affected by the Coronavirus or Section 4013 of the CARES Act. See “Note 6 Allowance for Loan Losses and Credit Quality Information in the Notes to Consolidated Financial Statements for further information on accommodations that were granted to borrowers in 2021 and 2020.

 

15

 

Liquidity and Capital Resources

The Company manages its liquidity position so that the funding needs of borrowers and depositors are met in a timely and cost-effective manner. Asset liquidity is the ability to convert assets to cash through the maturity or sale of the asset. Liability liquidity is the ability of the Bank to obtain retail, internet, or brokered deposits or to borrow funds from third parties such as the FHLB or the Federal Reserve Bank of Minneapolis.

 

The primary investing activities are the origination of loans and the purchase of securities. Principal and interest payments on loans and securities, along with the proceeds from the sale of loans held for sale, are the primary sources of cash for the Bank. Additional cash can be obtained by selling securities from the available for sale portfolio or by selling loans or mortgage servicing rights.

 

The primary financing activity is the attraction of retail, commercial and internet deposits. The Bank also has the ability to borrow funds from the FHLB or Federal Reserve Bank of Minneapolis based on the collateral value of the loans pledged, subject to applicable borrowing base and collateral requirements. See “Note 12 Federal Home Loan Bank (FHLB) Advances and Other Borrowings” in the Notes to Consolidated Financial Statements for more information on the advances that could be drawn based upon existing collateral levels with the FHLB and the Federal Reserve Bank of Minneapolis. Unpledged securities could also be pledged and used as collateral for additional borrowings with the FHLB or Federal Reserve Bank of Minneapolis.

 

The Bank's most liquid assets are cash and cash equivalents, which consist of short-term highly liquid investments with original maturities of less than three months that are readily convertible to known amounts of cash, and interest-bearing deposits. The level of these assets is dependent on the operating, financing and investing activities during any given period.

 

Cash and cash equivalents for the Company at December 31, 2021 were $94.1 million, an increase of $7.8 million, compared to $86.3 million at December 31, 2020. Net cash provided by operating activities during 2021 was $24.3 million. The Company conducted the following major investing activities during 2021: purchases of securities available for sale and FHLB stock were $214.0 million; principal payments and maturity proceeds received on securities available for sale were $71.1 million; and the proceeds from the sale of premises and other real estate were $2.1 million. Net loans receivable increased $18.4 million and the Company purchased premises and equipment of $8.3 million. Net cash used by investing activities during 2021 was $167.4 million. The Company conducted the following major financing activities during 2021: deposits increased $155.5 million; purchased treasury stock of $4.6 million; and customer escrows increased $0.1 million. Net cash provided by financing activities was $151.0 million for 2021.

 

The Bank has certificates of deposits from customers with outstanding balances of $62.3 million that mature during 2022. Based upon past experience, management anticipates that the majority of the deposits will renew for another term. The Company believes that deposits that do not renew will be replaced with deposits from other customers or FHLB advances. Proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.

 

The Bank has deposits of $161.5 million in checking and money market accounts of eleven customers that have individual relationship balances greater than $5.0 million. These funds may be withdrawn at any time, however, management anticipates that the majority of these deposits will remain on deposit with the Bank over the next twelve months. If these deposits are withdrawn, it is anticipated that they would be funded with available cash, replaced with deposits from other customers or with advances from the FHLB. Proceeds from the sale of securities could also be used to fund unanticipated outflows of deposits.

 

Dividends from the Bank have been the Company’s primary source of cash. The Bank is restricted under applicable federal banking law from paying dividends to the Company without prior notice to and non-objection of the applicable regulator. During 2021, the Bank paid dividends to the Company of $6.0 million and at December 31, 2021, the Company had an available cash balance of $12.5 million.

 

The Company’s primary use of cash is the payment of holding company level expenses including the payment of director and management fees, legal expenses and regulatory costs. The Company may also use cash to repurchase stock or pay any declared dividends. The Company plans to continue to fund its liquidity needs through dividends from the Bank, or if deemed prudent, by obtaining external capital.

 

16

 

Contractual Obligations and Commercial Commitments

The Company has no off-balance sheet arrangements other than commitments to originate and sell loans in the ordinary course of business. The Company does have certain obligations and commitments to make future payments under existing contracts. See “Note 18 Commitments and Contingencies” in the Notes to Consolidated Financial Statements for further information on the outstanding contractual obligations and commercial commitments at December 31, 2021.

 

Regulatory Capital Requirements

The Bank is subject to the Basel III regulatory capital requirements. The Basel III requirements, among other things, (i) apply a set of capital requirements to the Bank, including requirements relating to common equity as a component of core capital, (ii) implement a “capital conservation buffer” against risk and a minimum Tier 1 capital requirement, and (iii) set forth rules for calculating risk-weighted assets for purposes of such requirements. The rules made corresponding revisions to the prompt corrective action framework and include capital ratios and buffer requirements. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

The Board of Governors of the Federal Reserve Bank (FRB) amended its Policy Statement, to exempt small bank and savings and loan holding companies with assets less than $3 billion from the above capital requirements. The Company currently meets the qualitative exemption requirements, and therefore, is exempt from the above capital requirements.

 

Quantitative measures established by regulations to ensure capital adequacy require the Bank to maintain minimum amounts and ratios of common equity Tier 1 capital to risk-weighted assets, Tier 1 capital to adjusted total assets, Tier 1 capital to risk-weighted assets and total capital to risk-weighted assets.

 

The Bank must maintain a capital conservation buffer of at least 2.50% composed of common equity Tier 1 capital above its minimum risk-based capital requirements in order to avoid limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. Management believes that, as of December 31, 2021, the Bank’s capital ratios were in excess of those quantitative capital ratio standards set forth under the current prompt corrective action regulations, including the capital conservation buffer described above. However, there can be no assurance that the Bank will continue to maintain such status in the future. The OCC has extensive discretion in its supervisory and enforcement activities, and can adjust the requirement to be well-capitalized in the future. See “Note 17 Regulatory Capital” in the Notes to Consolidated Financial Statements for a table that reflects the Bank’s capital compared to these capital requirements.

 

The Company also serves as a source of capital, liquidity and financial support to the Bank. Depending upon the operating performance of the Bank and the Company’s other liquidity and capital needs, the Company may find it prudent, subject to prevailing capital market conditions and other factors, to raise additional capital through issuance of its common stock or other equity securities. Additional capital would potentially permit the Company to implement a strategy of growing Bank assets. Depending on the circumstances, if it were to raise capital, the Company may deploy it to the Bank for general banking purposes, or may retain some or all of it for use by the Company.

 

If the Company raises capital through the issuance of additional shares of common stock or other equity securities, it would dilute the ownership interests of existing stockholders and could result in a change in control of the Company and the Bank. New investors may also have rights, preferences and privileges senior to the Company’s current stockholders which may adversely impact the Company’s current stockholders. The Company’s ability to raise additional capital through the issuance of equity securities, if deemed prudent, will depend on, among other factors, conditions in the capital markets at that time, which are outside of the Company’s control. Accordingly, the Company may not be able to raise additional capital, if deemed prudent, on favorable economic terms, or other terms acceptable to it.

 

Dividends

The declaration of dividends is subject to, among other things, the Company's financial condition and results of operations, the Bank's compliance with regulatory capital requirements and other regulatory restrictions, tax considerations, industry standards, economic conditions, anticipated asset growth, general business practices and other factors. The Company did not make any dividend payments to common stockholders during the two-year period ending December 31, 2021 but will continue to evaluate the best use of the Company’s capital based on the factors identified above.

 

17

 

Under applicable federal banking laws and regulations, no dividends can be declared or paid by the Bank to the Company without notice to and non-objection from the applicable banking regulator. There is no assurance that the Bank and the Company would satisfy the applicable regulatory requirements necessary to effect any such dividends. The payment of dividends by the Company is dependent upon the Company having adequate cash or other assets that can be converted to cash to pay dividends to its stockholders and is subject to the discretion of the Board of Directors of both the Bank and the Company and would depend on numerous factors including the results of operations, financial conditions, asset growth plans, planned stock repurchases, and the cash flow requirements of the Company and the Bank.

 

In January 2022, the Company’s Board of Directors declared a quarterly dividend of 6 cents per share of common stock payable on March 9, 2022 to stockholders of record at the close of business on February 16, 2022. The declaration and amount of any future cash dividends remains subject to the sole discretion of the Board of Directors and will depend upon many factors, including the Company’s results of operations, financial condition, capital requirements, regulatory and contractual restrictions, business strategy and other factors deemed relevant by the Board of Directors.

 

New Accounting Pronouncements

“Note 1 Description of the Business and Summary of Significant Accounting Policies in the Notes to Consolidated Financial Statements discusses recently issued accounting pronouncements that the Company will be required to adopt. Also discussed is management’s expectation of the impact these new accounting pronouncements will have on the Company’s consolidated financial statements.

 

Market Risk

Market risk is the risk of loss from adverse changes in market prices and rates. The Company's market risk arises primarily from interest rate risk inherent in its investing, lending and deposit taking activities. Management actively monitors and manages its interest rate risk exposure.

 

The Company's profitability is affected by fluctuations in interest rates. A sudden and substantial change in interest rates may adversely impact the Company's earnings to the extent that the interest rates borne by assets and liabilities do not change at the same speed, to the same extent, or on the same basis. The Company monitors the projected changes in net interest income that occur if interest rates were to suddenly change up or down. The Rate Shock Table located in the following Asset/Liability Management section of this Management’s Discussion and Analysis discloses the Company's projected changes in net interest income based upon immediate interest rate changes called rate shocks.
 

The Company utilizes a model that uses the discounted cash flows from its interest-earning assets and its interest-bearing liabilities to calculate the current market value of those assets and liabilities. The model also calculates the changes in market value of the interest-earning assets and interest-bearing liabilities under different interest rate changes.

 

The following table discloses the projected changes in market value to the Company’s interest-earning assets and interest-bearing liabilities based upon incremental 100 basis point changes in interest rates from interest rates in effect on December 31, 2021.

 

(Dollars in thousands)

 

Market Value

 

Basis point change in interest rates

 

-100

   

0

   

+100

   

+200

 

Total market-risk sensitive assets

  $ 1,075,897       1,059,780       1,037,029       1,013,668  

Total market-risk sensitive liabilities

    980,648       920,067       870,045       826,865  

Off-balance sheet financial instruments

    (66 )     0       409       780  

Net market risk

  $ 95,315       139,713       166,575       186,023  

Percentage change from current market value

    (31.78

)%

    0.00

%

    19.23

%

    33.15

%

                                 

 

The preceding table was prepared utilizing the following assumptions (the Model Assumptions) regarding prepayment and decay ratios that were determined by management based upon its review of historical prepayment speeds and decay rates. Fixed rate loans were assumed to prepay at annual rates of between 4% and 59%, depending on the note rate and the period to maturity. Adjustable rate mortgages (ARMs) were assumed to prepay at annual rates of between 6% and 49%, depending on the note rate and the period to maturity. Mortgage-backed securities were projected to have prepayments based upon the underlying collateral securing the instrument. All loan prepayments vary based on the note rate and period to maturity of the individual loans. Certificate accounts were assumed not to be withdrawn until maturity. Retail money market demand accounts (MMDAs) and passbook accounts were assumed to decay at an annual rate of 17%. Retail non-interest and interest-bearing checking accounts were assumed to decay at annual rates of 19% and 24%, respectively. Commercial non-interest and interest-bearing checking accounts were assumed to decay at annual rates of 16% and 23%, respectively. Commercial MMDAs were assumed to decay at annual rates of between 13% and 26%.

 

18

 

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. The interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types of assets and liabilities may lag behind changes in market interest rates. The model assumes that the difference between the current interest rate being earned or paid compared to a treasury instrument or other interest index with a similar term to maturity (the interest spread) will remain constant over the interest changes disclosed in the table. Changes in interest spread could impact projected market value changes. Certain assets, such as ARMs, have features that restrict changes in interest rates on a short-term basis and over the life of the assets. The market value of the interest-bearing assets that are approaching their lifetime interest rate caps or floors could be different from the values calculated in the table. Certain liabilities, such as certificates of deposit, have fixed rates that restrict interest rate changes until maturity. In the event of a change in interest rates, prepayment and early withdrawal levels may deviate significantly from those assumed in calculating the foregoing table. The ability of many borrowers to service their debt may also decrease in the event of a substantial increase in interest rates.

 

Asset/Liability Management

The Company's management reviews the impact that changing interest rates will have on the net interest income projected for the twelve months following December 31, 2021 to determine if its current level of interest rate risk is acceptable. The following table projects the estimated impact on net interest income during the twelve month period ending December 31, 2022 of immediate interest rate changes called rate shocks:

 

(Dollars in thousands)

 

Rate Shock

in Basis Points

   

Net Interest

Change

   

Percent

Change

 

+200

    $ 1,474       5.48

%

+100

      725       2.70  
      0       0       0.00  
-100       (1,436 )     (5.34 )

 

The preceding table was prepared utilizing the Model Assumptions. Certain shortcomings are inherent in the method of analysis presented in the preceding table. In the event of a change in interest rates, prepayment and early withdrawal levels would likely deviate significantly from those assumed in calculating the preceding table. The ability of many borrowers to service their debt may decrease in the event of a substantial increase in interest rates and could impact net interest income. The increase in interest income in a rising rate environment is because there are more loans that are anticipated to reprice to higher interest rates in that environment in the next twelve months than there are deposits that would reprice.

 

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

 

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

 

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

 

19

 

 

Consolidated Balance Sheets

 
         
  

December 31,

  

December 31,

 

(Dollars in thousands, except par value)

 

2021

  

2020

 
         

ASSETS

        

Cash and cash equivalents

 $94,143   86,269 

Securities available for sale:

        

Mortgage-backed and related securities (amortized cost $247,275 and $99,821)

  245,397   101,464 

Other marketable securities (amortized cost $40,691 and $46,491)

  40,368   46,626 

Total securities available for sale

  285,765   148,090 
         

Loans held for sale

  5,575   6,186 

Loans receivable, net

  652,502   642,630 

Accrued interest receivable

  2,132   3,102 

Mortgage servicing rights, net

  3,280   3,043 

Premises and equipment, net

  17,373   10,133 

Goodwill

  802   802 

Core deposit intangible

  10   57 

Prepaid expenses and other assets

  5,427   7,241 

Deferred tax asset, net

  2,529   2,027 

Total assets

 $1,069,538   909,580 
         
         

LIABILITIES AND STOCKHOLDERS EQUITY

        

Deposits

 $950,666   795,204 

Accrued interest payable

  63   140 

Customer escrows

  2,143