1016 Civic Center Drive NW
Rochester, Minnesota 55901
507.535.1200 • www.hmnf.com
2016
Annual Report
2016_AnnualReport_full.indd 1
2/15/2017 1:19:39 PM
1
Financial Highlights ............................................................................................................................................................
2
Letter to Shareholders and Clients ......................................................................................................................................
4
Board of Directors ...............................................................................................................................................................
5
Five-year Consolidated Financial Highlights ......................................................................................................................
Management Discussion and Analysis ................................................................................................................................
6
Consolidated Financial Statements ..................................................................................................................................... 27
Notes to Consolidated Financial Statements ....................................................................................................................... 31
Report of Independent Registered Public Accounting Firm ................................................................................................ 64
Other Financial Data ........................................................................................................................................................... 65
Selected Quarterly Financial Data ....................................................................................................................................... 66
Common Stock Information ................................................................................................................................................ 68
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 (2), La Crescent,
Rochester (4), Spring Valley and Winona; one full service office in Marshalltown, Iowa; and three loan origination offices
in Minnesota located in Sartell, Owatonna, and Mankato and one loan origination office in Delafield, Wisconsin.
Per Common Share Information:
Earnings per common share and common share equivalents
Basic ................................................................................................ $
Diluted .............................................................................................
1.52
1.34
FINANCIAL HIGHLIGHTS
Operating Results:
(Dollars in thousands, except per share data)
Total interest income ............................................................................... $
Total interest expense ..............................................................................
Net interest income ..........................................................................
Provision for loan losses .........................................................................
Net interest income after provision for loan losses ..........................
Fees and service charges .........................................................................
Loan servicing fees .................................................................................
Gain on sales of loans .............................................................................
Other non-interest income .......................................................................
Total non-interest income ................................................................
Total non-interest expense ...............................................................
Income before income tax expense .........................................................
Income tax expense .................................................................................
Net income .......................................................................................
Preferred stock dividends ................................................................
Net income available to common shareholders ............................... $
Stock price (for the year)
High ................................................................................................. $
Low ..................................................................................................
Close ................................................................................................
Book value per common share ................................................................
Closing price to book value .....................................................................
Financial Ratios:
Return on average assets .........................................................................
Return on average stockholders’ equity ..................................................
Net interest margin ..................................................................................
Operating expenses to average assets ......................................................
Average stockholders’ equity to average assets ......................................
Stockholders’ equity to total assets at year end .......................................
Non-performing assets to total assets ......................................................
Efficiency ratio ........................................................................................
Balance Sheet Data:
(Dollars in thousands)
Total assets .............................................................................................. $
Securities available for sale .....................................................................
Loans held for sale ..................................................................................
Loans receivable, net ...............................................................................
Deposits ...................................................................................................
Federal Home Loan Bank advances and other borrowings .....................
Stockholders’ equity ................................................................................
Home Federal Savings Bank regulatory capital ratios:
Common equity tier 1 capital ..........................................................
Tier 1 leverage .................................................................................
Tier 1 risk-based capital...................................................................
Total risk-based capital ....................................................................
1
At or For the Year Ended
December 31,
Percentage
2016
2015
Change
27,349
1,593
25,756
(645)
26,401
3,427
1,108
2,618
1,048
8,201
24,130
10,472
4,122
6,350
0
6,350
18.55
10.81
17.50
16.91
103.49%
0.96%
8.71
4.11
3.66
11.07
11.13
0.57
71.06
21,453
1,507
19,946
(164)
20,110
3,316
1,046
1,964
1,327
7,653
23,196
4,567
1,611
2,956
(108)
2,848
0.69
0.61
12.92
10.18
11.55
15.54
74.32%
0.50%
4.27
3.56
3.92
11.70
10.83
0.97
84.05
27.5%
5.7
29.1
(293.3)
31.3
3.3
5.9
33.3
(21.0)
7.2
4.0
129.3
155.9
114.8
100.0
123.0
92.0%
104.0
15.4
(6.6)
(5.4)
2.8
(41.2)
(15.5)
December 31,
Percentage
2016
2015
Change
682,023
78,477
2,009
551,171
592,811
7,000
75,919
13.42%
11.55
13.42
14.68
643,161
111,974
3,779
463,185
559,387
9,000
69,645
14.08%
11.46
14.08
15.35
6.0%
(29.9)
(46.8)
19.0
6.0
(22.2)
9.0
(4.7)%
0.8
(4.7)
(4.4)
LETTER TO SHAREHOLDERS AND CLIENTS
I am very proud to present you with our 2016 Annual Report. It reflects the hard work of a
very dedicated group of employees and the patronage shown by our many loyal clients.
Net income for the year was $6.4 million and the return on average stockholders’ equity
was 8.71%. While I am pleased with these bottom line results, I am especially pleased with
the significant changes our balance sheet has undergone throughout the year, which I
believe has positioned us to become a more profitable bank in the years to come.
While our total assets grew $39 million, or 6.1% during the year, our gross loan portfolio
grew over $87 million, or 18.5%, during the same period. Most importantly, we grew in all
four of the major loan categories – single family residential, commercial real estate,
commercial business, and consumer, for the first time in over eight years. This growth was
funded in part by a corresponding reduction in our lower-yielding investment portfolio. The
asset growth and composition changes resulted in a $5.8 million increase in net interest
income from the prior year.
Growth in deposits was another bright spot as the overall average deposits grew over $62 million in 2016 with all deposit
account types showing growth during the year. Almost $43 million of the average deposit growth was related to the
acquisitions we made during the past eighteen months, with the remaining growth related to organic deposit growth at our
existing branches.
In April of 2016, we acquired certain assets and liabilities of the Albert Lea branch of Deerwood Bank. We were fortunate
to find a branch in one of our existing markets that we could purchase without incurring significant increases in our overhead
expense. The integration of client portfolios went very smoothly and the transition to servicing these deposits out of our
existing branch facility helped make this office one of the largest community banks in that market.
2016 also marked the first full year of operation of the branches we acquired in Kasson, Minnesota in August of the prior
year. This purchase has proven to be well timed and a very good fit for our Bank. Our new Kasson employees have done a
remarkable job of transitioning their client base to Home Federal.
Other divisions of our Bank reported strong operating results as well. Our residential mortgage lending operation generated
sales into the secondary market of $89.1 million in 2016 and recognized $2.1 million in gains on the sale of these loans. Our
Small Business Administration (SBA) and United States Department of Agriculture (USDA) lenders also sold over $7.5
million in loans during the year recognizing a gain on sale of $0.5 million. Finally, Home Federal Investments Services, our
wholly owned Bank subsidiary that offers our clients investment products and advice, reported record revenues and income
for the year as well.
These results are due in large part to a major staffing upgrade we embarked on over the past three years. Our surveys of
businesses and individuals in the markets we serve found that a growing number of prospective clients are disappointed with
what they view as a general decline in the experience and authority levels of management at their local bank. For them, access
to an experienced local manager, who has been given the authority to make a decision, is an important factor in determining
where they choose to bank. We responded by training our local managers to offer all types and categories of Bank products
while recruiting and retaining new talent where needed. While this staffing structure might be more expensive than the more
common centralized approach, we are confident that it is an important point of differentiation in today’s competitive
marketplace.
Our focus on credit quality continued during the year. Non-performing assets declined nearly $2.3 million, or 37%, to $3.9
million at year-end. Our past due ratio as of year-end was less than 1%, while our reserve for problem loans was 1.80% of
net total loans. Our improved asset quality positioned us to record a credit provision for loan loss during the year of $0.6
million.
2
At HMN, we believe our Company and our employees have a responsibility to give back to the local communities we serve.
To that end, our employees collectively donated over 5,000 hours to local community service projects and nonprofits in 2016.
Furthermore, Home Federal Savings Bank contributed almost $200,000 to various community projects, non-profits, and
charities during the year.
I believe that our work in 2016 has positioned HMN to continue to grow and prosper in the coming years. Thank you for
your support in making that happen.
Best Regards,
Brad Krehbiel
President/CEO
3
BOARD OF DIRECTORS
Dr. Hugh Smith
Chairman of the Board
Bradley Krehbiel
President and CEO
Allen Berning
Michael Bue
Bernard Nigon
Dr. Wendy Shannon
Dr. Patricia Simmons
Mark Utz
Hans Zietlow
4
FIVE-YEAR CONSOLIDATED FINANCIAL HIGHLIGHTS
Selected Operations Data:
(Dollars in thousands, except per share data)
Total interest income ............................................ $
Total interest expense ...........................................
Net interest income .......................................
Provision for loan losses ......................................
Net interest income after provision for loan
losses ...........................................................
Fees and service charges ......................................
Loan servicing fees ..............................................
Gain on sales of loans ..........................................
Other non-interest income ....................................
Total non-interest income .............................
Total non-interest expense ............................
Income before income tax expense ......................
Income tax expense (benefit) ...............................
Net income ....................................................
Preferred stock dividends and discount .........
Net income available to common
2016
27,349
1,593
25,756
(645)
26,401
3,427
1,108
2,618
1,048
8,201
24,130
10,472
4,122
6,350
0
Year Ended December 31,
2014
2013
2015
21,453
1,507
19,946
(164)
20,110
3,316
1,046
1,964
1,327
7,653
23,196
4,567
1,611
2,956
(108)
20,613
1,211
19,402
(6,998)
26,400
3,458
1,058
1,828
940
7,284
21,403
12,281
4,902
7,379
(1,710)
22,983
3,289
19,694
(7,881)
27,575
3,513
1,029
2,102
668
7,312
22,623
12,264
(14,406) (1)
26,670
(2,068)
2012
30,816
7,139
23,677
2,544
21,133
3,325
964
3,574
1,127
8,990
24,670
5,453
132
5,321
(1,861)
shareholders ................................................ $
6,350
2,848
5,669
24,602
3,460
Basic earnings per common share ................. $
Diluted earnings per common share ..............
1.52
1.34
0.69
0.61
1.40
1.23
6.15
5.71
0.88
0.86
(1) Relates to the elimination of the deferred tax asset valuation reserve at December 31, 2013.
2016
Selected Financial Condition Data:
(Dollars in thousands, except per share data)
Total assets .......................................................... $ 682,023 643,161 577,426 648,622 653,327
85,891
78,477 111,974 137,834 107,956
Securities available for sale ..................................
Loans held for sale ...............................................
2,584
1,502
2,009
Loans receivable, net ............................................ 551,171 463,185 365,113 384,615 454,045
Deposits ................................................................ 592,811 559,387 496,750 553,930 514,951
70,000
7,000
FHLB advances and other borrowings .................
60,834
75,919
Stockholders’ equity .............................................
8.02
16.91
Book value per common share .............................
0
85,675
13.49
0
76,013
14.77
9,000
69,645
15.54
December 31,
2014
2,076
3,779
2013
2015
2012
Number of full service offices ..............................
Number of loan origination offices(2) ...................
13
3
13
3
11
2
11
1
12
1
Key Ratios: (3)
Stockholders’ equity to total assets at year end ....
Average stockholders’ equity to average assets ...
Return on stockholders’ equity
11.13%
11.07
10.83%
11.70
13.16%
13.25
13.21%
10.77
9.31%
8.81
(ratio of net income to average equity) .........
8.71
4.27
9.12
42.22
8.94
Return on assets
(ratio of net income to average assets) ..........
0.96
0.50
1.21
4.55
0.79
(2) The Company opened a 4th loan origination office in Mankato, Minnesota on January 1, 2017.
(3) Average balances were calculated based upon amortized cost without the market value impact of ASC 320.
See accompanying notes to consolidated financial statements.
5
MANAGEMENT DISCUSSION AND ANALYSIS
the
results
financial
improved
This Annual Report, other reports filed by the Company
with the Securities and Exchange Commission, and the
Company’s 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,” “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
financial performance and
profitability of our core banking operations, improving
credit quality, reducing non-performing assets, and
generating
(including
profitability); 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
the
the Bank’s non-performing assets and
of
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 and composition of
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 trust preferred
securities held by the Bank; the ability of the Bank to pay
dividends to HMN; the ability of HMN to pay the principal
and interest payments on its third party note payable; the
ability to remain well capitalized; 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.
from
A number of factors could cause actual results to differ
materially
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
6
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
interest
competitive developments such as shrinking
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; acquisition integration costs; our
ability to attract and retain employees; or other significant
uncertainties. Additional factors that may cause actual
results to differ from the Company’s assumptions and
expectations include those set forth in the Company’s most
recent filing on Forms 10-K and 10-Q with the Securities
and Exchange Commission. All forward-looking statements
are qualified by, and should be considered in conjunction
with, such cautionary statements. For additional discussion
of the risks and uncertainties applicable to the Company,
see the “Risk Factors” sections of the Company’s Annual
Report on Form 10-K for the year ended December 31,
2016.
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 Financial, Inc. (HMN or the Company) is the stock
savings bank holding company for Home Federal Savings
Bank (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
MANAGEMENT DISCUSSION AND ANALYSIS
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 and real estate owned, 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 salaries and benefits, occupancy
expenses, provisions for loan losses, deposit insurance,
amortization expense on mortgage servicing assets, data
processing costs and income taxes. The earnings of
financial
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.
institutions, such as
Critical Accounting Estimates
Critical accounting policies are those policies that the
Company's management believes are the most important to
understanding the Company’s financial condition and
operating results. These critical accounting policies often
involve estimates and assumptions that could have a
material impact on the Company’s financial statements. The
Company has identified the following critical accounting
policies 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 and regional economic conditions
such as unemployment data, loan delinquencies, local
economic conditions, demand for single-family homes,
demand for commercial real estate and building lots, loan
portfolio composition and 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
7
for
consumer
the non-homogeneous
loan
the
single-family
loss allowance for
and
its
appropriateness of
homogeneous
loan
portfolios and its 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
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
are assigned
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.
loans without
to all
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 are typically based on the
appraised value of the property less estimated selling costs.
The estimates are reviewed periodically and adjustments, if
any, 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 and the
actual
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. The
current year activity in the allowance resulted in 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.
loss experience. The Company
increases
MANAGEMENT DISCUSSION AND ANALYSIS
to
tax consequences attributable
Income Taxes
Deferred tax assets and liabilities are recognized for the
future
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
relate to the allowance for loan and real estate losses and
state net operating loss carryforwards. For income tax
purposes, only net charge-offs are deductible, not the entire
provision for loan losses. Under generally accepted
accounting principles, 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
judgment and
and dependent upon management’s
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 Company considers both positive
and negative evidence regarding the ultimate realizability of
deferred
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.
tax assets. Positive evidence
includes
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
those
estimated.
that are significantly different from
8
Accounting for Loans Acquired in a Business Combination
Loans acquired in a business combination are initially
recorded at their acquisition date fair values. The fair values
of the purchased loans are based on the present value of the
expected cash flows, including principal, interest and
prepayments. Periodic principal and interest cash flows are
adjusted for expected losses and prepayments, then
discounted to determine the present value and summed to
arrive at the estimated fair value. Fair value estimates
involve assumptions and judgments as to credit risk, interest
rate risk, prepayment risk, liquidity risk, default rates, loss
severity, payment speeds, collateral values and discount
rate. Purchased loans are divided into loans with evidence
of credit quality deterioration, which are accounted for
under Accounting Standards Codification (ASC) topic 310-
30 (purchased credit impaired (PCI)) and loans that do not
meet this criteria, which are accounted for under ASC topic
310-20 (performing). PCI loans have experienced a
to
deterioration of credit quality
acquisition for which it is probable that the Bank will not be
able to collect all principal and interest payments on the
loan. In the assessment of credit quality, numerous
assumptions, interpretations and judgments must be made,
based on internal and third-party credit quality information
and ultimately the determination as to the probability that
all contractual cash flows will not be able to be collected.
This is a point in time assessment and inherently subjective
due to the nature of the available information and judgment
involved.
from origination
Subsequent to the acquisition date, the Bank continues to
estimate the amount and timing of cash flows expected to
be collected on PCI loans. The present value of any
decreases in expected cash flows after the acquisition date
will generally result in an impairment charge recorded as a
provision for loan losses, resulting in an increase to the
allowance for loan losses. Increases in expected cash flows
will generally result in a recovery of any previously
recorded allowance for loan losses, to the extent applicable,
and/or a reclassification from the nonaccretable difference
to accretable yield, which will be recognized prospectively.
For acquired performing loans, the difference between the
acquisition date fair value and the contractual amounts due
at the acquisition date represents the fair value adjustment.
Fair value adjustments may be discounts or premiums to a
loan's cost basis and are accreted or amortized into interest
income over the loan's remaining life using the level yield
method.
is similar
Subsequent to the acquisition date, the methods utilized to
estimate the required allowance for loan losses for these
loans
loans. See “Note 2
Acquisitions” and “Note 6 Allowance for Loan Losses and
Credit Quality Information” in the Notes to Consolidated
Financial Statements for more information regarding
acquired loans.
to originated
MANAGEMENT DISCUSSION AND ANALYSIS
Results of Operations
Comparison of 2016 with 2015
Net income was $6.4 million for 2016, an increase of $3.4
million compared to net income of $3.0 million for 2015.
Net income available to common shareholders was $6.4
million for 2016, an increase of $3.6 million compared to
net income available to common shareholders of $2.8
million for 2015. Diluted earnings per share for the year
ended December 31, 2016 was $1.34, an increase of $0.73
per share compared to diluted earnings per share of $0.61
for the year ended December 31, 2015. The increase in net
income for 2016 is due primarily to a $5.9 million increase
in interest income as a result of an increase in the average
interest-earning assets and a change in the composition of
the average interest-earning assets held between the
periods. Gain on sales of loans increased $0.7 million due
to an increase in single family mortgage loan production
and sales between the periods. The provision for loan losses
decreased $0.5 million between the periods due to
improvements in the credit quality of the commercial loan
portfolio. These increases in income were partially offset by
a $1.0 million increase in compensation expense due to
annual increases in compensation and an increase in the
number of employees related to the increased loan
production. Income tax expense increased $2.5 million
because of the increase in pre-tax income between the
periods.
Net Interest Income
Net interest income was $25.8 million for 2016, an increase
of $5.9 million, or 29.1%, from $19.9 million for 2015.
Interest income was $27.3 million for 2016, an increase of
$5.8 million, or 27.5%, from $21.5 million for 2015.
Interest income increased between the periods because of
an increase in the average interest-earning assets and a
change in the composition of the average interest-earning
assets held, which resulted in an increase in the average
yields earned between the periods. While the average
interest-earning assets increased $67.3 million between the
periods, the average interest-earning assets held in higher
yielding loans increased $120.4 million and the amount of
average interest-earning assets held in lower yielding cash
and investments decreased $53.1 million between the
periods. The yield on average interest-earning assets was
also enhanced by $2.2 million, or 30 basis points, due to
loan prepayment penalties, yield adjustments recognized on
purchased loans, and interest payments received on non-
accruing and previously charged off loans during 2016. Due
to the decreasing amounts of interest payments receive on
previously charged off loans that are available for recapture,
the yield adjustments to interest income are anticipated to
decrease significantly in 2017 from those experienced in
2016. The increase in the average outstanding loans
between the periods was primarily the result of an increase
in the commercial loan portfolio, which occurred because
of an increase in loan originations and a reduction in loan
payoffs between the periods. Average outstanding loans
also increased $18.6 million between the periods as a result
of the acquisitions that occurred in the third quarter of 2015
and the second quarter of 2016. The average yield earned
on interest-earning assets was 4.36% for 2016, an increase
of 53 basis points from 3.83% for 2015.
Interest expense was $1.6 million for 2016, an increase of
$0.1 million, or 5.7%, compared to $1.5 million for 2015.
Interest expense increased because of an increase in the
average outstanding interest-bearing liabilities. The average
rate paid on interest-bearing liabilities decreased 1 basis
point between the periods because of the change in the
composition of the average interest-bearing liabilities.
While the average interest-bearing liabilities increased
$62.9 million between the periods, the average amount held
in lower rate checking and money market accounts
increased $58.0 million and the average amount held in
higher rate certificates of deposits and other borrowings
increased $4.9 million between the periods. The increase in
the average outstanding deposits between the periods was
primarily due to the $42.9 million increase that occurred as
a result of the acquisitions that occurred in the third quarter
of 2015 and the second quarter of 2016. The average interest
rate paid on interest-bearing liabilities was 0.28% for 2016
compared to 0.29% for 2015. Net interest margin (net
interest income divided by average interest-earning assets)
for 2016 was 4.11%, an increase of 55 basis points
compared to 3.56% for 2015.
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.
9
MANAGEMENT DISCUSSION AND ANALYSIS
Average
Outstanding
Balance
2016
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Outstanding
Balance
2015
Interest
Earned/
Paid
Average
Yield/
Rate
Average
Outstanding
Balance
2014
Interest
Earned/
Paid
Average
Yield/
Rate
Year Ended December 31,
(Dollars in thousands)
Interest-earning assets:
Securities available for sale:
Mortgage-backed and
related securities .......................... $
Other marketable securities ............
Loans held for sale ..........................
Loans receivable, net(1) (2) ...............
FHLB stock .....................................
Other, including cash equivalents ..
Total interest-earning assets ........... $
1,631
84,528
3,046
58
1,289
126
513,974 25,774
6
770
23,337
96
627,286 27,349
Interest-bearing liabilities:
NOW accounts ................................ $
Passbooks ........................................
Money market accounts ..................
Certificate accounts ........................
Brokered deposits ...........................
FHLB advances and other
borrowings ...................................
Total interest-bearing liabilities ...... $
Noninterest checking ......................
Other noninterest-bearing
liabilities ......................................
Total interest-bearing liabilities and
noninterest-bearing deposits ........ $
Net interest income .........................
Net interest rate spread ...................
Net earning assets ........................... $
Net interest margin .........................
Average interest-earning assets to
average interest-bearing
liabilities and noninterest-bearing
deposits ........................................
50
62
366
524
0
591
85,440
71,728
164,522
100,942
0
9,374
432,006
145,450
1,434
578,890
1,593
25,756
48,396
3.56 % $
1.52
4.14
5.01
0.78
0.41
4.36
$
0.06 % $
0.09
0.22
0.52
0.00
6.30
$
0.28% $
4.08%
$
4.11%
3,274
130,806
2,507
116
1,881
87
394,086 19,302
4
734
28,544
63
559,951 21,453
17
42
347
528
0
573
76,136
55,273
153,441
96,600
0
9,225
390,675
124,342
985
516,002
1,507
19,946
43,949
3.54% $
1.44
3.47
4.90
0.54
0.22
3.83 $
0.02% $
0.08
0.23
0.55
0.00
6.21
$
0.29% $
3.54%
$
3.56%
4.40 %
1.06
3.73
5.12
0.51
0.24
3.59
0.02 %
0.07
0.26
0.67
1.45
0
0.00
3,726
119,484
1,557
164
1,269
58
369,571 18,929
4
778
79,373
189
574,489 20,613
14
32
414
739
12
71,666
47,200
162,207
110,256
830
0
392,159
125,767
924
518,850
1,211
19,402
55,639
0.23%
3.35 %
3.38 %
108.36%
108.52%
110.72%
(1) Tax exempt income was not significant; therefore, the yield was not presented on a tax equivalent basis for any of the years presented.
(2) Calculated net of deferred loan fees, loan discounts, loans in process and loss reserves.
10
MANAGEMENT DISCUSSION AND ANALYSIS
Net interest margin increased to 4.11% in 2016 from 3.56%
in 2015 primarily because of a change in the composition of
average interest-earning assets held, which resulted in an
increase in the average yields earned between the periods.
The increases in the average yields earned was due to
having larger average balances of higher earning loans and
smaller average balances of lower earning cash and
investments during 2016 when compared to 2015. The yield
on average interest-earning assets was also enhanced $2.2
million, or 30 basis points, in 2016 due to loan prepayment
penalties, yield adjustments recognized on purchased loans,
and interest payments received on non-accruing and
previously charged off loans. Average net earning assets
increased from $43.9 million in 2015 to $48.4 million in
2016. The $4.5 million increase in net earning assets is due
primarily to the net income earned in 2016.
interest
income and
The following table presents the dollar amount of changes
in
interest expense for major
components of interest-earning assets and interest-bearing
liabilities. It quantifies the changes in interest income and
interest expense related
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).
to changes
in
Year Ended December 31,
2016 vs. 2015
Increase
(Decrease)
Due to
2015 vs. 2014
Increase
(Decrease)
Due to
Volume (1)
Rate(1)
Total
Increase
(Decrease) Volume (1)
Total
Increase
(Decrease)
Rate(1)
(Dollars in thousands)
Interest-earning assets:
Securities available for sale:
Mortgage-backed and related securities ........... $
Other marketable securities ..............................
Loans held for sale ................................................
Loans receivable, net ............................................
Cash equivalents ...................................................
FHLB stock ...........................................................
Total interest-earning assets ............................. $
Interest-bearing liabilities:
NOW accounts ...................................................... $
Passbooks ..............................................................
Money market accounts ........................................
Certificates of deposit ...........................................
Brokered deposits .................................................
FHLB advances and other borrowings .................
Total interest-bearing liabilities .......................
Increase (decrease) in net interest income ................ $
(58)
(665)
19
5,824
(12)
0
5,108
1
12
18
26
0
16
73
5,035
0
73
20
648
45
2
788
32
8
1
(30)
0
2
13
775
(58)
(592)
39
6,472
33
2
5,896
33
20
19
(4)
0
18
86
5,810
(20)
120
36
1,175
(121)
0
1,190
1
5
20
(104)
(12)
0
(90)
1,280
(28)
492
(7)
(802)
(5)
0
(350)
1
5
(86)
(107)
0
573
386
(736)
(48)
612
29
373
(126)
0
840
2
10
(66)
(211)
(12)
573
296
544
(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.
11
MANAGEMENT DISCUSSION AND ANALYSIS
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.
Weighted average yield on:
Securities available for sale:
At December 31, 2016
Weighted average rate on:
Mortgage-backed and related securities ...................... 3.51% NOW accounts ............................................................... 0.07%
Other marketable securities ......................................... 1.34
Passbooks ...................................................................... 0.08
Loans held for sale .......................................................... 4.65 Money market accounts ................................................. 0.24
ICS/CDARS................................................................... 0.28
Loans receivable, net ....................................................... 4.69
Certificates of deposit .................................................... 0.61
Federal Home Loan Bank stock ...................................... 0.50
Other interest-earnings assets .......................................... 0.75
Federal Home Loan Bank advances and other
Combined weighted average yield on interest-
borrowings ................................................................. 6.50
earning assets .............................................................. 4.14
Combined weighted average rate on interest-
bearing liabilities........................................................
Interest rate spread .........................................................
0.27
3.87
Provision for Loan Losses
The provision for loan losses was ($0.6) million for the year
ended December 31, 2016, a decrease of $0.4 million, from
($0.2) million for the year ended December 31, 2015. The
provision for loan losses decreased between the periods
primarily because of the decrease in the reserve percentages
applied to certain risk rated loan categories as a result of an
internal analysis performed. Total non-performing assets
were $3.9 million at December 31, 2016, a decrease of $2.3
million, or 37.4%, from $6.2 million at December 31, 2015.
Non-performing
loans decreased $0.9 million and
foreclosed and repossessed assets decreased $1.4 million
during 2016.
A reconciliation of the allowance for loan losses for 2016 and 2015 is summarized as follows:
(Dollars in thousands)
Balance at January 1 ................................................................................................................................. $
Provision ...................................................................................................................................................
Charge offs:
Commercial ...........................................................................................................................................
Commercial real estate ..........................................................................................................................
Consumer ..............................................................................................................................................
Single-family .......................................................................................................................................
Recoveries .................................................................................................................................................
Balance at December 31 ........................................................................................................................... $
Specific allowance .................................................................................................................................... $
General allowance .....................................................................................................................................
$
2016
2015
9,709
(645)
(180)
(67)
(108)
(66)
1,260
9,903
988
8,915
9,903
8,332
(164 )
(69 )
0
(105 )
(19 )
1,734
9,709
1,009
8,700
9,709
12
MANAGEMENT DISCUSSION AND ANALYSIS
The allowance for loan losses increased in 2016 when
compared to 2015 primarily because of the increase in the
loan portfolio between the periods.
Non-Interest Income
Non-interest income was $8.2 million for the year ended
December 31, 2016, an increase of $0.5 million from $7.7
million for the year ended December 31, 2015.
The following table presents the components of non-interest income:
(Dollars in thousands)
Fees and service charges ............................................... $
Loan servicing fees .......................................................
Gain on sales of loans ...................................................
Other non-interest income .............................................
Total non-interest income ......................................... $
Year ended December 31,
2015
2014
2016
Percentage
Increase (Decrease)
2016/2015
2015/2014
3,427
1,108
2,618
1,048
8,201
3,316
1,046
1,964
1,327
7,653
3,458
1,058
1,828
940
7,284
3.3%
5.9
33.3
(21.0)
7.2
(4.1)%
(1.1)
7.4
41.2
5.1
The increase in non-interest income is primarily related to
the $0.7 million increase in the gain on sales of loans due to
an increase in single family loan originations and sales
between the periods. Fees and service charges increased
$0.1 million between the periods due primarily to an
increase in debit card income. Loan servicing fees increased
$0.1 million due to an increase in the loans serviced for
others between the periods. These increases were partially
offset by a $0.3 million decrease in other non-interest
income because of a decrease in the gains realized on
acquisitions between the periods.
Non-Interest Expense
Non-interest expense was $24.1 million for the year ended
December 31, 2016, an increase of $0.9 million from $23.2
million for the year ended December 31, 2015. The
following table presents the components of non-interest
expense:
(Dollars in thousands)
Compensation and benefits ........................................... $
(Gains) losses on real estate owned ...............................
Occupancy and equipment ............................................
Data processing .............................................................
Professional services .....................................................
Other .............................................................................
Total non-interest expense ........................................ $
Year ended December 31,
2015
2014
2016
Percentage
Increase (Decrease)
2016/2015
2015/2014
14,764
(596)
4,041
1,161
1,257
3,503
24,130
13,733
218
3,722
1,020
1,108
3,395
23,196
13,332
(1,194)
3,691
1,011
1,216
3,347
21,403
7.5 %
3.0%
(373.4 )
8.6
13.8
13.4
3.2
4.0
118.3
0.8
0.9
(8.9)
1.4
8.4
Compensation expense increased $1.0 million between the
periods due to annual increases in compensation and an
increase in the number of employees between the periods
because of the increased loan production. Occupancy and
equipment expense increased $0.3 million because of
increased software and equipment expenses. Other non-
interest expense increased $0.1 million due primarily to an
increase in loan related expenses as a result of the increase
in loans originated between the periods. Data processing
expense increased $0.1 million between the periods due to
increased mobile and on-line banking costs. Other
professional expenses increased $0.1 million primarily due
to expenses related to the acquisition that occurred in the
second quarter of 2016. These increases in non-interest
expenses were partially offset by a $0.8 million increase in
the gains on real estate owned between the periods primarily
because of the gains that were recognized on the sale of two
commercial properties during 2016.
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, as previously discussed.
Income tax expense was $4.1 million for the year ended
December 31, 2016, an increase of $2.5 million, from $1.6
million for the year ended December 31, 2015. The increase
in income tax expense between the periods is primarily
related to the increase in pre-tax income in 2016 when
compared to 2015.
Net Income Available to Common Shareholders
Net income available to common shareholders was $6.4
million for 2016, an increase of $3.6 million from the $2.8
million net income available to common shareholders for
2015. Basic earnings per common share for the year ended
December 31, 2016 was $1.52, an increase of $0.83 from
the basic earnings per common share of $0.69 for the year
13
MANAGEMENT DISCUSSION AND ANALYSIS
ended December 31, 2015. Diluted earnings per common
share for the year ended December 31, 2016 was $1.34, an
increase of $0.73 from diluted earnings per common share
of $0.61 for the year ended December 31, 2015. Net income
available to common shareholders and the basic and diluted
earnings per common share increased primarily because of
the increase in net income and a reduction in the dividends
required to be paid on the outstanding Fixed Rate
Cumulative Perpetual Preferred Stock Series A (the
“Preferred Stock”) between the periods. On February 17,
2015 the Company redeemed the final 10,000 shares of its
outstanding Preferred Stock and, as a result, no dividends
were required to be paid on the Preferred Stock after that
date.
Comparison of 2015 with 2014
Net income was $3.0 million for 2015, a decrease of $4.4
million, from $7.4 million for 2014. Net income available
to common shareholders was $2.8 million for the year
ended December 31, 2015, a decrease of $2.9 million, from
net income available to common shareholders of $5.7
million for 2014. Diluted earnings per common share for the
year ended December 31, 2015 was $0.61, a decrease of
$0.62 compared to the diluted earnings per common share
of $1.23 for the year ended December 31, 2014. The
decrease in net income in 2015 is due primarily to a $6.8
million decrease in the credit provision for loan losses
between the periods. The decrease in the credit provision
was primarily because there was more commercial loan
growth and fewer recoveries of previously charged off loans
in 2015 when compared to 2014. Net income also decreased
$1.4 million due to the change in the losses recognized on
real estate owned between the periods. The increased losses
in 2015 as compared to 2014 were primarily due to a large
gain realized on the sale of a commercial property in 2014.
These decreases in net income were partially offset by a
$0.5 million increase in net interest income due to increases
in outstanding loan balances and a $3.3 million decrease in
income tax expense as a result of the decreased pre-tax
income between the periods.
Net interest income was $19.9 million for 2015, an increase
of $0.5 million, or 2.8%, from $19.4 million for 2014.
Interest income was $21.5 million for 2015, an increase of
$0.9 million, or 4.1%, from $20.6 million for 2014. Interest
income increased between the periods primarily because of
a change in the composition of average interest-earning
assets held, which resulted in an increase in the average
yields earned between the periods. While the average
interest-earning assets decreased $14.5 million between the
periods, the average interest-earning assets held in higher
yielding loans increased $25.5 million and the amount held
in lower yielding cash and investments decreased $40.0
million between the periods. The increase in the average
outstanding loans between the periods was primarily the
result of an increase in the commercial loan portfolio, which
14
in
increase
loan
occurred primarily because of an
originations and a reduction in loan payoffs between the
periods. The Company also acquired $24.1 million of loans
through an acquisition that occurred in the third quarter of
2015. The average yield earned on interest-earning assets
was 3.83% for 2015, an increase of 24 basis points from
3.59% for 2014.
Interest expense was $1.5 million for the year ended
December 31, 2015, an increase of $0.3 million, or 24.4%,
from $1.2 million for 2014. Interest expense increased
primarily because of the change in the composition of the
average interest-bearing liabilities held, which resulted in
an increase in the average rate paid between the periods.
While the average interest-bearing liabilities decreased $2.8
million between the periods, the average amount held in
higher rate advances and other borrowings increased $9.3
million, the average amount held in higher rate certificates
of deposit decreased $14.5 million, and the average amount
held in other lower rate checking and money market
deposits increased $2.4 million between the periods. The
increase in the average rates paid was primarily due to the
$10.0 million holding company note payable that was
funded in the first quarter of 2015 in connection with the
redemption of all of the remaining Preferred Stock. Interest
expense increases related to borrowing costs were partially
offset by the lower interest rates paid on deposit accounts
between the periods as a result of the low interest rate
environment that continued to exist in 2015. The average
interest rate paid on interest-bearing liabilities was 0.29%
for 2015, an increase of 6 basis points from the 0.23%
average interest rate paid in 2014. Net interest margin (net
interest income divided by average interest-earning assets)
for 2015 was 3.56%, an increase of 18 basis points,
compared to 3.38% for 2014.
Net interest margin increased to 3.56% in 2015 from 3.38%
in 2014 primarily because of a change in the composition of
the average interest-earning assets held, which resulted in
an increase in the average yields earned between the
periods. The increases in the average yields earned due to
having larger average balances of higher earning loans and
smaller average balances of lower earning cash and
investments was partially offset by an increase in the
average rates paid on the average interest-bearing liabilities
held between the periods. The increase in the average rates
paid was primarily due to the $10.0 million holding
company note payable that was funded in the first quarter
of 2015 in connection with the redemption of all of the
remaining Preferred Stock. Average net earning assets
decreased $11.7 million to $43.9 million in 2015 compared
to $55.6 million for 2014 primarily because the proceeds of
the $10.0 million note payable that was funded in the first
quarter of 2015 were used to redeem outstanding Preferred
Stock.
MANAGEMENT DISCUSSION AND ANALYSIS
The provision for loan losses was ($0.2 million) for the year
ended December 31, 2015, an increase of $6.8 million, from
($7.0 million) for the year ended December 31, 2014. The
credit provision for loan losses decreased primarily because
there was more commercial loan growth, fewer credit rating
upgrades, and fewer recoveries of previously charged off
loans in 2015 when compared to 2014. The decrease in non-
performing loans relates primarily to a commercial real
estate development relationship that was upgraded to
performing status during 2015 due to the improved financial
performance of the project as a result of increased lot sales.
The allowance for loan losses increased in 2015 when
compared to 2014 primarily because of the $99.3 million
increase in the loan portfolio between the periods.
Non-interest income was $7.7 million for the year ended
December 31, 2015, an increase of $0.4 million, compared
to $7.3 million for the year ended December 31, 2014. The
increase is primarily related to a gain of $0.3 million that
was recognized on an acquisition that occurred in the third
quarter of 2015. Gain on sales of loans increased $0.1
million, or 7.4%, between the periods primarily because of
an increase in single-family loan originations and sales.
Other non-interest income increased $0.1 million primarily
due to an increase in income related to the sale of non-
insured investment products. These increases in non-
interest income were partially offset by a $0.1 million
decrease in fees and service charges primarily because of a
decrease in retail and commercial overdraft fees between
the periods.
Non-interest expense was $23.2 million for the year ended
December 31, 2015, an increase of $1.8 million, or 8.4%,
from $21.4 million for the same period in 2014. Losses on
real estate owned increased $1.4 million between the
periods primarily because of a $1.0 million gain that was
recognized on the sale of a single commercial property in
increased $0.4 million
2014. Compensation expense
between the periods primarily because of an increase in the
expenses related to restricted stock awards and increased
incentive accruals due to increased loan production. These
increases in non-interest expense were partially offset by a
decrease of $0.1 million in deposit insurance costs due
primarily to a decrease in insurance rates between the
periods.
The Company considers the calculation of current and
deferred income taxes to be a critical accounting policy that
is subject to significant estimates. Actual results could differ
significantly from the estimates and interpretations used in
determining the current and deferred income tax assets and
liabilities. Income tax expense was $1.6 million for the year
ended December 31, 2015, a decrease of $3.3 million from
$4.9 million for the same period in 2014. The decrease in
income tax expense between the periods is primarily related
to the decrease in pre-tax income in 2015 when compared
to 2014.
Net income available to common shareholders was $2.8
million for 2015, a decrease of $2.9 million from the $5.7
million net income available to common shareholders in
2014. Basic earnings per common share for the year ended
December 31, 2015 was $0.69, a decrease of $0.71 from the
basic earnings per common share of $1.40 for the year
ended December 31, 2014. Diluted earnings per common
share for the year ended December 31, 2015 was $0.61, a
decrease of $0.62 from diluted earnings per common share
of $1.23 for the year ended December 31, 2014. The net
income available to common shareholders and the basic and
diluted earnings per common share decreased primarily
because of the decrease in net income between the periods
that was partially offset by a reduction in the dividends paid
on the outstanding Preferred Stock. On February 17, 2015
the Company redeemed the final 10,000 shares of its
outstanding Preferred Stock and, as a result, no dividends
were required to be paid on the Preferred Stock after that
date.
15
MANAGEMENT DISCUSSION AND ANALYSIS
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 fees and discounts and allowances for losses as of the dates indicated:
(Dollars in thousands)
Real Estate Loans:
2016
Amount Percent
2015
December 31,
2014
2013
2012
Amount Percent Amount Percent Amount Percent Amount Percent
One-to-four family ..................... $ 103,255 18.41% $ 90,945 19.24% $ 69,841 18.70% $ 76,467 19.31% $ 97,037 20.40%
Multi-family ............................... 36,777
6.56
Commercial ................................ 230,955 41.18
Construction or development ..... 31,348
5.59
Total real estate loans ....... 402,335 71.74
2.47
12,324
196,926 41.65 163,365 43.73 178,486 45.06 220,721 46.39
38,103
2.61
338,298 71.55 261,509 70.00 270,917 68.40 341,944 71.87
2.61 15,700
8.05 12,603
2.05 11,756
1.98 12,430
3.37
4.20
8,113
7,851
Other Loans:
Consumer Loans:
Automobile ............................
3,036
Home equity line ................... 40,476
Home equity .......................... 16,302
Recreational vehicles.............
7,553
Other ......................................
5,916
0.54
7.22
2.91
1.35
1.05
Total consumer loans ........ 73,283 13.07
Commercial business loans........ 85,176 15.19
Total other loans ............... 158,459 28.26
Total loans ......................... 560,794 100.00% 472,819 100.00% 373,556 100.00% 396,049 100.00% 475,773 100.00%
0.13
7.68
2.39
0.00
1.15
64,415 13.62 54,925 14.71 53,423 13.49 53,975 11.35
70,106 14.83 57,122 15.29 71,709 18.11 79,854 16.78
134,521 28.45 112,047 30.00 125,132 31.60 133,829 28.13
0.61
1,124
8.24 36,832
3.13 12,420
0.56
0
4,549
1.08
0.30
971
9.86 36,178
3.33 11,629
0
0.00
4,645
1.22
0.25
623
9.13 36,521
2.94 11,390
0.00
0
5,441
1.17
2,885
38,980
14,782
2,650
5,118
Less:
Unamortized discounts ..............
Net deferred loan (costs) fees ....
Allowance for losses ..................
20
(300)
9,903
Total loans receivable, net $ 551,171
16
(91)
9,709
$ 463,185
14
97
8,332
$ 365,113
33
0
11,401
$ 384,615
33
87
21,608
$ 454,045
In 2016, the Company’s loan portfolio increased because of
an increase in the loan originations as a result of an
improving economy and an increase in lending staff. The
loan portfolio also increased $6.0 million as a result of the
acquisition that occurred in the second quarter of 2016.
Because of the enhanced lending staff and the improving
economic conditions projected, it is anticipated that the size
of our overall loan portfolio will continue to increase in
2017.
Single family real estate loans were $103.3 million at
December 31, 2016, an increase of $12.4 million, compared
to $90.9 million at December 31, 2015. Mortgage loan
originations increased in 2016 as a result of additional
mortgage lending staff and an increased emphasis on
originating shorter term and adjustable rate mortgage loans
that were placed into the portfolio. The majority of the
longer term mortgage loans that were originated during the
year continued to be sold into the secondary market and
were not placed in the loan portfolio in order to manage the
Company’s interest rate risk position. The increased
origination of loans placed into the loan portfolio was the
primary reason for the increase in the single family loan
portfolio during 2016.
Multi-family real estate loans were $36.8 million at
December 31, 2016, an increase of $24.5 million, compared
to $12.3 million at December 31, 2015. The increase in
multi-family real estate loans in 2016 is primarily the result
of the $16.6 million in multi-family construction loans
where the construction phase was completed and the loan
was reclassified as a multi-family real estate loan. The
origination of multi-family loans also increased between the
periods.
Commercial real estate loans were $231.0 million at
December 31, 2016, an increase of $34.1 million, compared
to $196.9 million at December 31, 2015. Commercial
business loans were $85.2 million at December 31, 2016, an
increase of $15.1 million, compared to $70.1 million at
December 31, 2015. Increased commercial loan production
as a result of increased demand for commercial loans
resulted in an increase in the commercial business and
commercial real estate loan portfolios in 2016.
Construction or development loans were $31.3 million at
December 31, 2016, a decrease of $6.8 million, compared
to $38.1 million at December 31, 2015. The decrease was
the net result of the following activity during 2016: $26.0
million in new construction loans originated, $2.7 million
in advances on existing loans, $5.8 million in loans paid-
off, and $29.7 million in loans moved to a permanent loan
classification because
the construction phase was
completed.
Home equity lines of credit were $40.5 million at December
31, 2016, an increase of $1.5 million, compared to $39.0
million at December 31, 2015. The open-end home equity
16
MANAGEMENT DISCUSSION AND ANALYSIS
lines are generally written with an adjustable rate and a 10
year draw period which requires interest only payments
followed by a 10 year repayment period which fully
amortizes the outstanding balance. Closed-end home equity
loans are written with fixed or adjustable rates with terms
up to 15 years. Home equity loans were $16.3 million at
December 31, 2016, an increase of $1.5 million, compared
to $14.8 million at December 31, 2015. The increase in the
open-end equity lines and closed-end equity loans is related
primarily to an increase in originations between the
periods.
Recreational vehicle loans were $7.6 million at December
31, 2016, an increase of $4.9 million, compared to $2.7
million at December 31, 2015. These loans have been made
primarily to finance the recreational vehicle sales of a single
dealer within the Bank’s market area and the increase in
balances between the periods is due to an increase in
originations.
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, as
previously discussed. 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-homogenous 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 $9.9 million, or 1.77% of
gross loans at December 31, 2016, compared to $9.7
million, or 2.05% of gross loans at December 31, 2015. The
allowance for loan losses increased primarily due to an
$88.0 million increase in the loan portfolio between the
periods. The increase in the allowance due to loan growth
was partially offset by a decrease in the allowance due to
lower reserve percentages being used for certain risk rated
commercial loans between the periods as a result of an
internal analysis of the most recent charge-off history that
was performed during the year. The decrease in the
allowance as a percentage of outstanding loans, from 2.05%
of gross loans at December 31, 2015 to 1.77% of gross loans
at December 31, 2016, reflects the improved credit quality
of the loan portfolio between the periods.
The following table reflects the activity in the allowance for loan losses and selected statistics:
(Dollars in thousands)
Balance at beginning of year ................................................................. $
Provision for losses ...........................................................................
Charge-offs:
Single family ................................................................................
Consumer ......................................................................................
Commercial business....................................................................
Commercial real estate .................................................................
Recoveries .........................................................................................
Net recoveries (charge-offs) .........................................................
Balance at end of year ........................................................................... $
Year-end allowance for loan losses as a percent of year end gross
2016
2015
December 31,
2014
2013
2012
9,709
(645)
(66)
(108)
(180)
(67)
1,260
839
9,903
8,332
(164)
11,401
(6,998)
21,608
(7,881)
23,888
2,544
(19)
(105)
(69)
0
1,734
1,541
9,709
(92)
(131)
(55)
(936)
5,143
3,929
8,332
(200)
(484)
(651)
(3,711)
2,720
(2,326)
11,401
(63)
(1,071)
(2,464)
(5,719)
4,493
(4,824)
21,608
loan balance ........................................................................................
1.77%
2.05 %
2.23 %
2.88 %
4.54%
Ratio of net loan (recoveries) charge-offs to average loans
outstanding .........................................................................................
(0.16)
(0.36)
(1.02)
0.53
0.91
17
MANAGEMENT DISCUSSION AND ANALYSIS
The following table reflects the allocation of the allowance for loan losses:
2016
2015
December 31,
2014
2013
2012
Allocated
Allowance
as a % of
Loan
Category
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Percent of
Loans in
Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Percent of
Loans in
Each
Category
to Total
Loans
Category
1.09%
2.46
1.86
2.05
2.05
19.24%
52.31
13.62
14.83
100.00%
Category
1.57%
2.62
1.84
2.11
2.23
18.70%
51.30
14.71
15.29
100.00%
Category
2.13%
3.32
2.07
3.08
2.88
19.31%
49.09
13.49
18.11
100.00%
Category
2.91%
5.55
2.12
5.08
4.54
20.40%
51.47
11.35
16.78
100.00%
Single family ..................
Commercial real estate ...
Consumer .......................
Commercial business .....
Total .....................
1.15%
1.66
2.20
2.53
1.77
18.41 %
53.33
13.07
15.19
100.00 %
The allocated reserve percentages for commercial real
estate decreased in 2016 due to the general improvement in
the credit quality of the commercial real estate portfolio.
The allocation of the allowance for loan losses for single
family, commercial, and consumer loans increased due to
an increase in the outstanding balances and changes in the
types of loans held in these categories between the
periods.
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. The balance in the
allowance for real estate losses was $0.7 million at
December 31, 2016 and $0.8 million at December 31, 2015.
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 at a rate materially less than the market rate
to borrowers whose financial condition has deteriorated.
Foreclosed and repossessed assets include assets acquired
in settlement of loans. Total non-performing assets were
$3.9 million at December 31, 2016, a decrease of $2.3
million, or 37.4%, from $6.2 million at December 31, 2015.
Non-performing
loans decreased $0.9 million and
foreclosed and repossessed assets decreased $1.4 million
during 2016. The following table sets forth the amounts and
categories of non-performing assets (non-accrual loans and
foreclosed and repossessed assets) in the Company’s
portfolio:
18
MANAGEMENT DISCUSSION AND ANALYSIS
(Dollars in thousands)
Non-performing loans:
2016
2015
December 31,
2014
2013
2012
Single family ............................................................ $
Commercial real estate .............................................
Consumer .................................................................
Commercial business ...............................................
Total .....................................................................
Foreclosed and repossessed assets:
Single family ............................................................
Commercial real estate .............................................
Consumer .................................................................
Total .....................................................................
Total non-performing assets ......................................... $
Total as a percentage of total assets .............................
Total non-performing loans.......................................... $
Total as a percentage of total loans receivable, net ......
Allowance for loan losses to non-performing loans .....
916
1,384
630
343
3,273
0
611
16
627
$
3,900
0.57 %
$
3,273
0.59 %
302.56 %
1,655
1,694
786
46
4,181
48
1,997
0
2,045
6,226 $
0.97 %
4,181 $
0.90 %
232.22 %
1,564
8,750
486
120
10,920
50
3,053
0
3,103
14,023 $
2.43%
10,920 $
2.99%
76.30%
1,602
14,549
737
608
17,496
0
6,898
0
6,898
24,394 $
3.76 %
17,496 $
4.55 %
65.17 %
2,492
25,543
300
1,640
29,975
1,595
9,000
0
10,595
40,570
6.21%
29,975
6.60%
72.09%
Gross interest income which would have been recorded had
the non-accruing loans been current in accordance with
their original terms amounted to $0.6 million for 2016, $0.4
million for 2015, and $0.9 million for 2014. The amounts
that were included in interest income on a cash basis for
these loans were $0.4 million, $0.2 million, and $0.2
million, respectively.
At December 31, 2016, 2015 and 2014, there were loans
included in loans receivable, net, with terms that had been
modified in a TDR totaling $3.3 million, $2.5 million, and
$9.4 million, respectively. Had the loans performed in
accordance with their original terms throughout 2016, 2015,
and 2014, the Company would have recorded gross interest
income of $0.6 million, $0.4 million, and $0.9 million,
respectively. During 2016, 2015 and 2014 the Company
recorded gross interest income of $0.4 million, $0.2 million,
and $0.3 million, respectively.
For the loans that were modified in 2016, $0.2 million were
unclassified and performing, and $1.7 million were non-
performing at December 31, 2016. The increase in TDRs in
2016 relates primarily to one commercial relationship
totaling $1.3 million that was downgraded from performing
to non-performing status and was restructured during the
year. Of the loans that were modified in 2016 and
outstanding at December 31, 2016, $1.3 million related to
loans secured by commercial real estate and $0.4 million
related to first or second mortgages on single family
property, and the remaining modifications related to other
consumer or commercial business loans.
For the loans that were modified in 2015, $0.5 million were
unclassified and performing, and $0.7 million were non-
performing at December 31, 2015. The decrease in TDRs in
2015 relates primarily
to a group of commercial
development loans totaling $6.0 million that were upgraded
to performing status and met the criteria to be removed from
TDR classification during the year. Of the loans that were
modified in 2015 and outstanding at December 31, 2015,
$0.8 million related to loans secured by first or second
mortgages on single family properties, and the remaining
modifications related to other consumer or commercial
business loans.
For the loans that had been modified in 2014, $0.1 million
were unclassified and performing and $0.1 million were
non-performing at December 31, 2014. The decrease in
TDRs in 2014 relates primarily to two related commercial
development loans totaling $3.5 million that were charged
down to $2.5 million and paid off during the year. TDRs
also decreased during the year by $1.4 million due to the
paydown of six
in an unrelated commercial
development, as well as $1.0 million due to the payoff of a
loan for another unrelated commercial development. Of the
loans that were modified in 2014 and outstanding at
December 31, 2014, $0.2 million related to loans secured
by first or second mortgages on single family properties,
and the remaining modifications related to other consumer
loans.
loans
19
MANAGEMENT DISCUSSION AND ANALYSIS
The following table sets forth the amount of TDRs in the Company’s portfolio:
(Dollars in thousands)
2016
2015
December 31,
2014
2013
2012
Single family ............................................................. $
Commercial real estate ..............................................
Consumer ..................................................................
Commercial business ................................................
Total TDRs ...........................................................
TDRs on accrual status .............................................
TDRs on non-accrual status ......................................
Total ...................................................................... $
448
1,774
709
369
3,300
1,297
2,003
3,300
647
725
732
415
2,519
1,618
901
2,519
368
7,956
571
555
9,450
7,414
2,036
9,450
840
14,781
697
1,074
17,392
3,780
13,612
17,392
3,540
24,702
1,814
1,614
31,670
7,125
24,545
31,670
In addition to the TDRs and the non-performing loans set
forth in the table above of all non-performing assets, the
Company may identify other potential problem loans.
Potential problem loans are loans that are not in non-
performing status, however, there are circumstances present
to create doubt as to the ability of the borrower to comply
with present repayment terms. The decision of management
to include performing loans in potential problem loans does
not necessarily mean that the Company expects losses to
occur but that management recognized a higher degree of
risk associated with these loans. The level of potential
problem loans is another predominant factor in determining
the relative level of the allowance for loan losses. There
were no potential problem loans identified by the Company
as of December 31, 2016. The four loan relationships that
are reported as potential problem loans at December 31,
2015 were $6.0 million in loans to two unrelated trucking
companies and $0.5 million in loans secured by agricultural
assets to two unrelated individuals. The three loan
relationships reported as potential problem loans at
December 31, 2014 were a $3.8 million loan to an
educational institution, a $0.6 million loan to a small
manufacturing business, and three loans totaling $0.3
million to a golf course.
Liquidity and Capital Resources
The Company attempts to manage its liquidity position so
that the funding needs of borrowers and depositors are met
timely and in a 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. Unpledged
securities could also be pledged and used as collateral for
20
additional borrowings with the FHLB or Federal Reserve
Bank of Minneapolis to generate additional cash.
The primary financing activity is the attraction of retail and
internet deposits. The Bank has the ability to borrow
additional funds from the FHLB or Federal Reserve Bank
of Minneapolis by pledging additional securities or loans,
to applicable borrowing base and collateral
subject
requirements. See “Note 12 Federal Home Loan Bank
(FHLB) Advances and Other Borrowings” in the Notes to
Consolidated Financial Statements for more information on
additional advances that could be drawn based upon
existing collateral levels with the FHLB and the 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.
the
following major
Cash and cash equivalents at December 31, 2016 were
$27.6 million, a decrease of $12.2 million, compared to
$39.8 million at December 31, 2015. Net cash provided by
operating activities during 2016 was $25.5 million. The
Company conducted
investing
activities during 2016: principal payments and maturity
proceeds received on securities available for sale and FHLB
stock were $139.2 million, purchases of securities available
for sale and FHLB stock were $106.8 million, and the
proceeds from the sale of premises and other real estate
were $2.4 million. The Company also purchased premises
and equipment of $1.6 million. Net loans receivable
increased $89.6 million due primarily to increased loan
originations. The Company completed a branch acquisition
and received $6.1 million in net cash in connection with the
transaction. Net cash used by investing activities during
2016 was $50.4 million. The Company conducted the
following major financing activities during 2016: deposits
increased $14.5 million,
from
borrowings of $45.0 million and repaid borrowings of $47.0
received proceeds
MANAGEMENT DISCUSSION AND ANALYSIS
million. Net cash provided by financing activities was $12.6
million for 2016.
Company had $3.3 million in cash and other assets that
could readily be turned into cash.
The Bank has certificates of deposits from customers with
outstanding balances of $57.8 million that mature during
2017. 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 $61.9 million in checking and
money market accounts of four 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 or 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.
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 2016, the Bank paid dividends to the
Company of $3.0 million and at December 31, 2016, the
On February 17, 2015, the Company redeemed the final
10,000 shares of outstanding Preferred Stock. The Preferred
Stock redemption was funded through a $10.0 million term
loan to HMN from an unrelated third party that was
evidenced by a promissory note. The interest payments on
the note are due quarterly. The principal balance of the note
bears interest at a rate of 6.50% and is payable in
consecutive annual installments of $1.0 million on each
December 15, beginning December 15, 2015, with the
balance due on December 15, 2021.
The Company’s primary use of cash is the payment of
principal and interest on the third party note payable and
holding company level expenses, including the payment of
director and management fees, legal expenses, and other
regulatory costs. The Company does not anticipate that it
will have on a stand-alone basis adequate liquid resources
to make future interest and principal payments on its third
party note payable and fund the Company-level expenses.
The Company plans to continue to fund its liquidity needs
through dividends from the Bank or by obtaining external
capital. Provided that no default or event of default has
occurred and is continuing, the Company may also, at its
option, elect to defer payment of one installment of
principal on the third party note payable otherwise due prior
to the maturity date, in which event such installment will
become due and payable on the maturity date.
Contractual Obligations and Commercial Commitments
The Company has certain obligations and commitments to make future payments under existing contracts. At December 31,
2016, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:
(Dollars in thousands)
Contractual Obligations:
Total borrowings ....................................................... $
Annual rental commitments under non-cancellable
Payments Due by Period
Total
Less than
1 Year
1-3 Years
4-5 Years
More than
5 Years
7,000
1,000
2,000
4,000
0
operating leases ......................................................
Total contractual obligations ................................. $
5,856
12,856
843
1,843
1,452
3,452
1,380
5,380
2,181
2,181
Other Commercial Commitments:
Commercial lines of credit ........................................ $
Commitments to lend ................................................
Standby letters of credit ............................................
Total other commercial commitments ................... $
50,229
31,831
1,902
83,962
26,523
9,797
1,575
37,895
9,282
4,736
327
14,345
9,414
7,220
0
16,634
5,010
10,078
0
15,088
Amount of Commitments Expiring by Period
21
MANAGEMENT DISCUSSION AND ANALYSIS
Regulatory Capital Requirements
Effective January 1, 2015 the capital requirements of the
Company and the Bank were changed to implement the
regulatory requirements of the Basel III capital reforms. The
Basel III requirements, among other things, (i) apply a
strengthened set of capital requirements to the Bank (the
Company is exempt, pursuant to the Small Bank Holding
Company Policy Statement (Policy Statement) described
below), including requirements relating to common equity
as a component of core capital, (ii) implement a “capital
conservation buffer” against risk and a higher minimum tier
1 capital requirement, and (iii) revise the rules for
calculating risk-weighted assets for purposes of such
requirements. The rules made corresponding revisions to
the prompt corrective action framework and include the
capital ratios and buffer requirements which will be phased
in incrementally, with full implementation scheduled for
January 1, 2019. Failure by the Bank 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, both the Company and the Bank must
meet specific capital guidelines that involve quantitative
measures of their 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,
factors.
Management believes that, as of December 31, 2016, the
Bank’s capital ratios were in excess of those quantitative
capital ratio standards set forth under the prompt corrective
action regulations. 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
the
requirement to be “well-capitalized” in the future. See
“Note 17 Regulatory Capital” of the Notes to Consolidated
Financial Statements for a table which reflects the Bank’s
capital compared to these capital requirements.
risk weightings
further adjust
other
and
In the second quarter of 2015, the FRB amended its Policy
Statement, which exempted small bank holding companies
from the above capital requirements, by raising the asset
size threshold for determining applicability from $500
million to $1 billion. The Policy Statement was also
expanded to include savings and loan holding companies
that meet the Policy Statement’s qualitative requirements
for exemption. The Company met the qualitative exemption
requirements, and therefore, is exempt from the above
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, including potential
Company-level expenses and the payment of principal and
interest payments on the third party note payable, 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, if issued at less than the Company’s book
value would dilute the per share book value of the
Company’s common stock, dilute the Company’s earnings
per share, and could result in a change of 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 its control, and on the Company’s financial
performance and plans. Accordingly, the Company may not
be able to raise additional capital, if deemed prudent, on
favorable economic terms, or other terms acceptable to it. If
the Bank cannot satisfactorily address its capital needs as
they arise, the Bank’s ability to maintain or expand its
operations, maintain compliance with the regulatory capital
requirements, to operate without additional regulatory or
other restrictions, and its operating results, could be
materially adversely affected.
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
tax
considerations, industry standards, economic conditions,
general business practices and other factors. The Company
to common
has not made any dividend payments
stockholders during the three year period ending December
31, 2016.
restrictions,
regulatory
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
22
MANAGEMENT DISCUSSION AND ANALYSIS
stockholders. Further, any determination as to whether,
when and in what amount to declare and pay any such
dividends would be subject to the discretion of the boards
of directors of the Bank and the Company and would
depend on numerous factors including the results of
operations, financial conditions, growth plans, and cash
flow requirements of the Company and the Bank.
Impact of Inflation and Changing Prices
The impact of inflation is reflected in the increased cost of
operations. Unlike most industrial companies, nearly all of
the assets and liabilities of the Company are monetary in
nature. As a result, interest rates have a greater impact on
the Company's performance than do the effects of general
levels of inflation. Interest rates do not necessarily move in
the same direction or to the same extent as the prices of
goods and services.
New Accounting Pronouncements
In January 2016, the FASB issued ASU 2016-01, Financial
Instruments – Overall (Subtopic 825-10) Recognition and
Measurement of Financial Assets and Financial Liabilities.
The amendments in this ASU require, among other things,
equity investments to be measured at fair value with
changes in fair value recognized in net income and that
public business entities use the exit price notion when
measuring the fair value of financial instruments for
disclosure purposes. The amendments also require an entity
to present separately in other comprehensive income the
portion of the total change in the fair value of a liability
resulting from a change in the instrument-specific credit
risk when the entity has elected to measure the liability at
fair value in accordance with the fair value option for
financial instruments. In addition, the amendments also
eliminate the requirement for public business entities to
disclose the method(s) and significant assumptions used to
estimate the fair value that is required to be disclosed for
financial instruments measured at amortized cost on the
balance sheet. The ASU is intended to reduce diversity in
practice and is effective for public business entities for
fiscal years beginning after December 15, 2017, including
interim periods within those fiscal years. The amendments
should be applied by means of a cumulative-effect
adjustment to the balance sheet as of the beginning of the
fiscal year of adoption. The adoption of this ASU in the first
quarter of 2018 is not anticipated to have a material impact
on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases
(Topic 842). The amendments in the ASU create Topic 842,
Leases, and supersede the lease requirements in Topic 840,
Leases. The objective of this ASU is to establish the
principles that lessees and lessors shall apply to report
useful information to users of financial statements about the
amount, timing, and uncertainty of cash flows arising from
a lease. The main difference between previous GAAP and
this ASU is the recognition of lease assets and lease
liabilities by lessees for those leases classified as operating
leases under previous GAAP. The amendment requires a
lessee to recognize in the statement of financial position a
liability to make lease payments (the lease liability) and the
right-of-use asset representing its right to use the underlying
asset for the lease term. The accounting applied by a lessor
is largely unchanged from that applied under previous
GAAP. In transition, lessees and lessors are required to
recognize and measure leases at the beginning of the earliest
period presented using a modified retrospective approach.
The modified retrospective approach includes a number of
optional practical expedients that entities may elect to apply
that will, in effect, continue to account for leases that
commence before the effective date in accordance with
previous GAAP unless
is modified. The
the
amendments in the ASU, for public business entities that are
U. S. Securities and Exchange Commission (SEC) filers, are
effective for fiscal years beginning after December 15,
2018, including interim periods within those fiscal years.
The adoption of this ASU in the first quarter of 2019 is not
anticipated to have a material impact on the Company’s
consolidated financial statements.
lease
the
income
including
the FASB
transactions
In March 2016,
issued ASU 2016-09,
Compensation – Stock Compensation (Topic 718). The
amendments in this ASU affect all entities that issue share-
based payment awards to their employees. The amendments
are intended to simplify the accounting for share-based
payment
tax
consequences, classification of awards as either equity or
liabilities, and classification on the statement of cash flows.
The amendments in this ASU, for public business entities,
are effective for fiscal years beginning after December 15,
2016, including interim periods within those annual periods.
Amendments should be applied using a modified
retrospective transition method by means of a cumulative-
effect adjustment to equity as of the beginning of the period
in which the guidance is adopted. The adoption of this ASU
in the first quarter of 2017 is not anticipated to have a
material impact on the Company’s consolidated financial
statements.
In June 2016, the FASB issued ASU 2016-13, Financial
Instruments-Credit Losses (Topic 326): Measurement of
Credit Losses on Financial Instruments. The amendments
in this ASU affect all entities that measure credit losses on
financial instruments including loans, debt securities, trade
receivables, net investments in leases, off-balance sheet
credit exposures, reinsurance receivables, and any other
financial asset that has a contractual right to receive cash
that is not specifically excluded. The main objective of this
ASU is to provide financial statement users with more
decision-useful information about the expected credit losses
on financial instruments and other commitments to extend
credit held by a reporting entity at each reporting date. To
achieve this objective, the amendments in this ASU replace
the incurred loss impairment methodology required in
23
MANAGEMENT DISCUSSION AND ANALYSIS
current GAAP with a methodology that reflects expected
credit losses that requires consideration of a broader range
of reasonable and supportable information to estimate credit
losses. The amendments in this ASU will affect entities to
varying degrees depending on the credit quality of the assets
held by the entity, the duration of the assets held, and how
the entity applies the current incurred loss methodology.
The amendments in this ASU, for public business entities
that are U. S. Securities and Exchange Commission (SEC)
filers, are effective for fiscal years beginning after
December 15, 2019, including interim periods within those
annual periods. All entities may adopt the amendments in
the ASU early as of the fiscal years beginning after
December 15, 2018, including interim periods within those
fiscal years. Amendments should be applied using a
modified retrospective transition method by means of a
cumulative-effect adjustment to equity as of the beginning
of the period in which the guidance is adopted. Management
is in the process of evaluating the impact that the adoption
of this ASU in the first quarter of 2020 will have on the
Company’s consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement
of Cash Flows (Topic 230): Classification of Certain Cash
Receipts and Cash Payments. The amendments in this ASU
affect all entities that are required to present a statement of
cash flows under Topic 230 and address the following eight
specific cash flow issues: debt prepayment or debt
extinguishment costs; settlement of zero-coupon debt
instruments or other debt instruments with coupon interest
rates that are insignificant in relation to the effective interest
rate of the borrowing; contingent consideration payments
made after a business combination; proceeds from the
settlement of
the
settlement of corporate-owned life insurance policies;
distributions received from equity method investees;
beneficial
transactions; and
in securitization
separately identifiable cash flows and application of the
predominance principle. This ASU is intended to reduce
for public
diversity
business entities that are U. S. Securities and Exchange
insurance claims; proceeds from
in practice and
is effective
interest
Commission (SEC) filers for fiscal years beginning after
December 15, 2017, and interim periods within those fiscal
years with early adoption permitted. Upon adoption, the
amendments should be applied using a retrospective
transition method to each period presented. The adoption of
this ASU in the first quarter of 2018 is not anticipated to
have a material impact 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, 2016.
Market Value
(Dollars in thousands)
Basis point change in interest rates
Total market-risk sensitive assets ............................................................ $
Total market-risk sensitive liabilities ......................................................
Off-balance sheet financial instruments ..................................................
Net market risk ........................................................................................ $
Percentage change from current market value ........................................
-100
686,536
582,820
(256)
103,972
(21.13)%
0
673,175
541,354
0
131,821
0.00%
+100
660,259
503,943
(16 )
156,332
18.59 %
+200
647,134
471,842
15
175,277
32.97%
24
MANAGEMENT DISCUSSION AND ANALYSIS
(the Model Assumptions)
The preceding table was prepared utilizing the following
assumptions
regarding
prepayment and decay ratios that were determined by
management based upon
their review of historical
prepayment speeds and decay rates. Fixed rate loans were
assumed to prepay at annual rates of between 2% and 40%,
depending on the note rate and the period to maturity.
Adjustable rate mortgages (ARMs) were assumed to prepay
at annual rates of between 7% and 53%, 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. Passbook and
money market accounts were assumed to decay at annual
rates of 19% and 7%, respectively. Non-interest checking
and NOW accounts were assumed to decay at annual rates
of 4% and 14%, respectively. Commercial non-interest
checking and NOW accounts were assumed to decay at
annual rates of 17% and 9%, respectively. Commercial
MMDA accounts were assumed to decay at annual rates of
23%.
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
liabilities, such as
table. Certain
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
sustained increase in interest rates.
the
in
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,
2016 to determine if its current level of interest rate risk is
25
acceptable. The following table projects the estimated
impact on net interest income during the 12 month period
ending December 31, 2017 of immediate interest rate
changes called rate shocks:
(Dollars in thousands)
Rate Shock
in Basis Points
+200
+100
0
-100
$
Net Interest
Change
Percent
Change
2,859
1,408
0
(1,441)
11.15%
5.49
0.00
(5.62)
The preceding table was prepared utilizing the Model
Assumptions. Certain shortcomings are inherent in the
method of analysis presented in the foregoing 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 foregoing 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
adjustable rate loans that would re-price to higher interest
rates in the next twelve months than there are deposits that
would re-price.
In an attempt to manage its 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
timing and
implementation of transactions as intended to assure
attainment of the Bank's objectives in an effective manner.
In addition, the Board reviews, on a quarterly basis, the
Bank's asset/liability position, including simulations of the
effect on the Bank's capital of various interest rate
scenarios.
the
In managing its asset/liability mix, the Bank may, at times,
depending on the relationship between long 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.
Off-Balance Sheet Arrangements
The Company has no off-balance sheet arrangements other
than commitments to originate and sell loans in the ordinary
course of business. See “Note 18 Financial Instruments
with Off-Balance Sheet Risk” in the Notes to Consolidated
information.
for
Financial
Management believes that the Company has sufficient
liquidity to satisfy its off-balance sheet obligations.
Statements
additional
MANAGEMENT DISCUSSION AND ANALYSIS
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 restructure its balance
sheet in order to better match the maturities of its assets and
liabilities. In the past, more long term fixed rate loans were
placed into the single family loan portfolio. In recent years,
the Bank has focused its 30 year fixed rate single family
residential lending program on 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
loan
production continues to be in adjustable rate loans that re-
price every one, two, or three years.
the Bank’s commercial
26
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31, December 31,
2016
2015
ASSETS
Cash and cash equivalents ................................................................................................ $
Securities available for sale:
Mortgage-backed and related securities
27,561
39,782
(amortized cost $993 and $2,237) .............................................................................
1,005
2,283
Other marketable securities
(amortized cost $78,846 and $110,092) ...................................................................
Loans held for sale ...........................................................................................................
Loans receivable, net ........................................................................................................
Accrued interest receivable ..............................................................................................
Real estate, net .................................................................................................................
Federal Home Loan Bank stock, at cost ...........................................................................
Mortgage servicing rights, net ..........................................................................................
Premises and equipment, net ...........................................................................................
Goodwill ...........................................................................................................................
Core deposit intangible, net ..............................................................................................
Prepaid expenses and other assets ....................................................................................
Deferred tax asset, net ......................................................................................................
Total assets ................................................................................................................ $
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits ............................................................................................................................ $
Other borrowings .............................................................................................................
Accrued interest payable ..................................................................................................
Customer escrows ............................................................................................................
Accrued expenses and other liabilities .............................................................................
Total liabilities ..........................................................................................................
77,472
78,477
2,009
551,171
2,626
611
770
1,604
8,223
802
454
1,768
5,947
682,023
592,811
7,000
236
1,011
5,046
606,104
109,691
111,974
3,779
463,185
2,254
2,045
691
1,499
7,469
0
393
1,417
8,673
643,161
559,387
9,000
242
830
4,057
573,516
Commitments and contingencies
Stockholders’ equity:
Serial-preferred stock: ($.01 par value)
authorized 500,000 shares; issued shares 0 ...............................................................
0
0
Common stock ($.01 par value):
authorized 16,000,000; issued shares 9,128,662 .......................................................
Additional paid-in capital .................................................................................................
Retained earnings, subject to certain restrictions .............................................................
Accumulated other comprehensive loss ...........................................................................
Unearned employee stock ownership plan shares ............................................................
Treasury stock, at cost 4,639,739 and 4,645,769 shares ..................................................
Total stockholders’ equity .........................................................................................
Total liabilities and stockholders’ equity ......................................................................... $
91
50,566
86,886
(820)
(2,223)
(58,581)
75,919
682,023
91
50,388
80,536
(214 )
(2,417 )
(58,739 )
69,645
643,161
See accompanying notes to consolidated financial statements.
27
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
Years ended December 31
(Dollars in thousands, except per share amounts)
Interest income:
Loans receivable ............................................................................. $
Securities available for sale:
Mortgage-backed and related ......................................................
Other marketable .........................................................................
Cash equivalents .............................................................................
Other ...............................................................................................
Total interest income ...................................................................
Interest expense:
Deposits ..........................................................................................
Federal Home Loan Bank advances and other borrowings ............
Total interest expense ..................................................................
Net interest income ..................................................................
Provision for loan losses ....................................................................
Net interest income after provision for loan losses ..................
Non-interest income:
Fees and service charges .................................................................
Loan servicing fees .........................................................................
Gain on sales of loans .....................................................................
Other ...............................................................................................
Total non-interest income ...........................................................
Non-interest expense:
Compensation and benefits ............................................................
(Gains) losses on real estate owned ................................................
Occupancy and equipment ..............................................................
Data processing...............................................................................
Professional services .......................................................................
Other ...............................................................................................
Total non-interest expense ..........................................................
Income before income tax expense .........................................
Income tax expense ............................................................................
Net income ..................................................................................
Preferred stock dividends ...................................................................
Net income available to common shareholders ........................... $
Other comprehensive (loss) income, net of tax ..................................
Comprehensive income available to common shareholders ............... $
Basic earnings per common share ...................................................... $
Diluted earnings per common share ................................................... $
See accompanying notes to consolidated financial statements.
2016
2015
2014
25,900
19,389
18,987
58
1,289
96
6
27,349
1,002
591
1,593
25,756
(645)
26,401
3,427
1,108
2,618
1,048
8,201
14,764
(596)
4,041
1,161
1,257
3,503
24,130
10,472
4,122
6,350
0
6,350
(606)
5,744
1.52
1.34
116
1,881
63
4
21,453
934
573
1,507
19,946
(164 )
20,110
3,316
1,046
1,964
1,327
7,653
13,733
218
3,722
1,020
1,108
3,395
23,196
4,567
1,611
2,956
(108 )
2,848
204
3,052
0.69
0.61
164
1,269
189
4
20,613
1,211
0
1,211
19,402
(6,998 )
26,400
3,458
1,058
1,828
940
7,284
13,332
(1,194 )
3,691
1,011
1,216
3,347
21,403
12,281
4,902
7,379
(1,710 )
5,669
256
5,925
1.40
1.23
28
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Additional
Preferred Common Paid-in
Capital
Stock
Stock
91
51,175
Retained
Earnings
72,211
7,379
Accumulated
Other
Comprehensive
Income
(Loss)
(674)
Unearned
Employee
Stock
Total
Stock-
Ownership Treasury holders’
Plan
Stock
Equity
(Dollars in thousands)
Balance, December 31, 2013...................... $ 26,000
Net income .............................................
Other comprehensive income ................
Redemption of preferred stock ..............
Stock compensation tax benefits ...........
Restricted stock awards .........................
Amortization of restricted stock
awards .................................................
Preferred stock dividends ......................
Earned employee stock ownership
plan shares ...........................................
(16,000)
Balance, December 31, 2014...................... $ 10,000
91
Net income .............................................
Other comprehensive income ................
Redemption of preferred stock ..............
Restricted stock awards .........................
Restricted stock awards forfeiture .........
Amortization of restricted stock
awards .................................................
Preferred stock dividends ......................
Earned employee stock ownership
plan shares ...........................................
Balance, December 31, 2015 .................... $
Net income ............................................
Other comprehensive loss ...................
Stock compensation expense ...............
Restricted stock awards ......................
Amortization of restricted stock
awards ................................................
Earned employee stock ownership
plan shares .........................................
Balance, December 31, 2016 .................... $
(10,000)
0
91
0
91
1
(1,262)
240
53
50,207
(332)
9
447
57
50,388
79
(158)
177
80
50,566
256
(418)
204
(214)
(606)
(1,785)
77,805
2,956
(225)
80,536
6,350
(2,804)
(60,324)
1,262
194
(2,610)
(59,062)
332
(9)
193
(2,417)
(58,739)
158
85,675
7,379
256
(16,000)
1
0
240
(1,785)
247
76,013
2,956
204
(10,000)
0
0
447
(225)
250
69,645
6,350
(606)
79
0
177
274
75,919
86,886
(820)
194
(2,223)
(58,581)
See accompanying notes to consolidated financial statements.
29
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31 (Dollars in thousands)
Cash flows from operating activities:
2016
2015
2014
Net income .................................................................................................................. $
Adjustments to reconcile net income to cash provided by operating activities:
6,350
2,956
7,379
Provision for loan losses ........................................................................................
Depreciation ...........................................................................................................
Amortization of premiums (discounts), net ...........................................................
Amortization of deferred loan fees ........................................................................
Amortization of core deposit intangible ................................................................
Amortization of purchased loan fair value adjustments ........................................
Amortization of mortgage servicing rights ............................................................
Capitalized mortgage servicing rights ...................................................................
Deferred income tax expense .................................................................................
Securities losses (gains), net ..................................................................................
(Gains) losses on sales of real estate and premises ................................................
Gain on sales of loans ............................................................................................
Proceeds from sales of loans held for sale .............................................................
Disbursements on loans held for sale .....................................................................
Amortization of restricted stock awards ................................................................
Amortization of unearned ESOP shares ................................................................
Earned ESOP shares priced above original cost ....................................................
Stock option compensation expense ......................................................................
(Increase) decrease in accrued interest receivable .................................................
(Decrease) increase in accrued interest payable ....................................................
Increase in other assets ...........................................................................................
Increase (decrease) in other liabilities ....................................................................
Other, net ................................................................................................................
Net cash provided by operating activities .........................................................
Cash flows from investing activities:
Proceeds from sales of securities available for sale ...................................................
Principal collected on securities available for sale .....................................................
Proceeds collected on maturity of securities available for sale ..................................
Purchases of securities available for sale ...................................................................
Purchase of Federal Home Loan Bank stock .............................................................
Redemption of Federal Home Loan Bank stock ........................................................
Proceeds from sales of real estate and premises .........................................................
Net (increase) decrease in loans receivable ...............................................................
Gain on acquisition .....................................................................................................
Acquisition payment (net of cash acquired) ..............................................................
Purchases of premises and equipment ........................................................................
Net cash used by investing activities .................................................................
Cash flows from financing activities:
Increase (decrease) in deposits ...................................................................................
Redemption of preferred stock ...................................................................................
Dividends paid to preferred stockholders ...................................................................
Proceeds from borrowings ..........................................................................................
Repayment of borrowings ...........................................................................................
Increase in customer escrows .....................................................................................
Net cash provided (used) by financing activities ..............................................
Decrease in cash and cash equivalents ..............................................................
Cash and cash equivalents, beginning of year ................................................................
Cash and cash equivalents, end of year ........................................................................... $
Supplemental cash flow disclosures:
Cash paid for interest .................................................................................................. $
Cash paid for income taxes .........................................................................................
Supplemental noncash flow disclosures:
Loans transferred to loans held for sale ......................................................................
Transfer of loans to real estate ....................................................................................
See accompanying notes to consolidated financial statements.
(645)
850
47
(1,011)
92
(529)
601
(706)
3,128
10
(596)
(2,618)
99,121
(79,783)
177
194
80
79
(265)
(9)
(323)
999
270
25,513
20
1,245
136,145
(104,968)
(1,879)
1,800
2,369
(89,570)
0
6,080
(1,607)
(50,365)
14,468
0
0
45,000
(47,000)
163
12,631
(12,221)
39,782
27,561
1,599
436
15,002
591
(164 )
706
(3 )
(964 )
28
(657 )
555
(547 )
1,722
(6 )
218
(1,964 )
78,278
(69,941 )
447
193
57
0
(346 )
137
(239 )
302
52
10,820
10,951
1,694
175,070
(144,069 )
(2,152 )
2,238
1,127
(80,447 )
(289 )
4,816
(803 )
(31,864 )
15,375
(10,000 )
(225 )
65,000
(56,000 )
42
14,192
(6,852 )
46,634
39,782
1,358
191
8,125
110
(6,998 )
576
18
(340 )
0
0
517
(316 )
4,566
0
(1,194 )
(1,828 )
56,040
(41,557 )
240
194
53
1
240
(53 )
(444 )
(265 )
515
17,344
0
2,148
125,000
(157,004 )
0
7
4,816
13,455
0
0
(847 )
(12,425 )
(57,182 )
(16,000 )
(5,964 )
0
0
175
(78,971 )
(74,052 )
120,686
46,634
1,264
0
13,243
142
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2016, 2015 and 2014
NOTE 1 Description of the Business and Summary of
Significant Accounting Policies
HMN Financial, Inc. (HMN or 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.
The consolidated financial statements included herein are
for HMN, the Bank, OIA, and HPH. All significant
intercompany accounts and
transactions have been
eliminated in consolidation.
The Company evaluated subsequent events through the
filing date of our annual 10-K with the Securities and
Exchange Commission on March 10, 2017.
the consolidated
Use of Estimates
In preparing
financial statements,
management is required to make estimates and assumptions
that affect the reported amounts of assets and liabilities as
of the date of the balance sheet and revenues and expenses
for the period. Actual results could differ from those
estimates.
the date of
An estimate that is particularly susceptible to change relates
to the determination of the allowance for loan losses.
Management believes that the allowance for loan losses is
appropriate to cover probable losses inherent in the
portfolio at
the balance sheet. While
management uses available information to recognize losses
on loans, future additions to the allowance may be
necessary based on changes in economic conditions and
other factors. In addition, various regulatory agencies, as an
integral part of their examination process, periodically
review the allowance for loan losses. Such agencies may
require changes to the allowance based on their judgment
about information available to them at the time of their
examination.
Cash and Cash Equivalents
The Company considers highly liquid investments with
original maturities of three months or less to be cash
equivalents.
Securities
Securities are accounted for according to their purpose and
holding period. The Company classifies its debt and equity
securities in one of three categories:
Trading Securities
Securities held principally for resale in the near term
are classified as trading securities and are recorded at
their fair values. Unrealized gains and losses on trading
securities are included in other income.
Securities Held to Maturity
Securities that the Company has the positive intent and
ability to hold to maturity are reported at cost and
adjusted for premiums and discounts
that are
recognized in interest income using the interest method
over the period to maturity. Unrealized losses on
securities held to maturity reflecting a decline in value
judged to be other than temporary are charged to
income and a new cost basis is established.
Securities Available for Sale
Securities available for sale consist of securities not
classified as trading securities or as securities held to
maturity. They include securities that management
intends to use as part of its asset/liability strategy or that
may be sold in response to changes in interest rates,
changes
in prepayment risk, or similar factors.
Unrealized gains and losses, net of income taxes, are
reported as a separate component of stockholders’
equity until realized. Gains and losses on the sale of
securities available for sale are determined using the
specific identification method and recognized on the
trade date. Premiums and discounts are recognized in
interest income using the interest method over the
period to maturity. Unrealized losses on securities
available for sale reflecting a decline in value judged to
be other than temporary are charged to income and a
new cost basis is established.
Management monitors the investment security portfolio for
impairment on an individual security basis and has a process
in place to identify securities that could potentially have a
credit impairment that is other than temporary. This process
involves analyzing the length of time and extent to which
the fair value has been less than the amortized cost basis,
the market liquidity for the security, the financial condition
and near-term prospects of the issuer, expected cash flows,
and the Company's intent and ability to hold the investment
for a period of time sufficient to recover the temporary loss,
including determining whether it is more-likely-than-not
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
that the Company will be required to sell the security prior
to recovery. To the extent it is determined that a security is
deemed
impaired, an
impairment loss is recognized.
to be other-than-temporarily
Loans Held for Sale
Mortgage loans originated or purchased which are intended
for sale in the secondary market are carried at the lower of
cost or estimated market value in the aggregate. Net fees
and costs associated with acquiring or originating loans held
for sale are deferred and included in the basis of the loan in
determining the gain or loss on the sale of the loans. Gains
on the sale of loans are recognized on the settlement date.
Net unrealized losses are recognized through a valuation
allowance by charges to income.
Loans Receivable, net
Loans receivable, net, are carried at amortized cost. Loan
origination fees received, net of certain loan origination
costs, are deferred as an adjustment to the carrying value of
the related loans, and are amortized into income using the
interest method over the estimated life of the loans.
Premiums and discounts on purchased participation loans
are amortized into interest income using the interest method
over the period to contractual maturity, adjusted for
estimated prepayments.
The allowance for loan losses is based on a 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 and regional economic conditions
(such as unemployment data, loan delinquencies, local
economic conditions, 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. In connection with the
determination of the allowance for loan losses, management
obtains independent appraisals for significant properties or
other collateral securing classified loans. Appraisals on
collateral dependent commercial real estate and commercial
business loans are obtained when it is determined that the
borrower’s risk profile has deteriorated and the loan is
third party
impaired. Subsequent new
classified as
appraisals of properties securing impaired commercial real
estate and commercial business loans are prepared at least
every two years. For all land development loan types, a new
third party appraisal is prepared on an annual basis where
current activity is not consistent with the assumptions made
in the most recent third party appraisal. Non-performing
residential and consumer home equity loans and home
equity lines may have a third party appraisal or an internal
the
impairment
evaluation completed depending on the size of the loan and
location of the property. These appraisals, or internal
valuations, are generally completed when a residential or
consumer home equity loan or home equity line of credit
becomes 120 days past due and are typically updated after
possession of the property is obtained. Valuations are
reviewed on a quarterly basis and adjustments are made to
the allowance for loan losses for temporary impairments
and charge-offs are
is
taken when
determined to be permanent. The fair market value of the
properties for all loan types are adjusted for estimated
selling costs in order to determine the net realizable value
of the properties. The allowance for loan losses is
established for known problem loans, as well as for loans
which are not currently known to require an allowance.
Loans are charged off to the extent they are deemed to be
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 are typically
based on the appraised value of the property less estimated
selling costs. The estimates are reviewed periodically and
adjustments, if any, are recorded in the provision for loan
losses in the periods in which the adjustments become
known. The allowance is allocated to individual loan
categories based upon the relative risk characteristics of the
loan portfolios and the actual loss experience. The
Company increases its allowance for loan losses by
charging the provision for loan losses against income and
decreases its allowance by crediting the provision for loan
losses. 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.
Interest income is recognized on an accrual basis except
when collectability is in doubt. When loans are placed on a
non-accrual basis, generally when the loan is 90 days past
due, previously accrued but unpaid interest is reversed from
income. If the ultimate collectability of a loan is in doubt
and the loan is placed in nonaccrual status, the cost recovery
method is used and cash collected is applied to first reduce
the principal outstanding. Generally, the Company returns
a loan to accrual status when all delinquent interest and
principal becomes current under the terms of the loan
agreement and collectability of remaining principal and
interest is no longer doubtful. Previously collected interest
payments that were applied to principal when the loan was
classified as non-accrual are recorded as interest income
using the effective yield method over the estimated life of
the loan, including expected renewal terms.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
All impaired loans are valued at the present value of
expected future cash flows discounted at the loan's initial
effective interest rate. The fair value of the collateral of an
impaired collateral-dependent loan or an observable market
price, if one exists, may be used as an alternative to
discounting. If the value of the impaired loan is less than the
recorded investment in the loan, the impaired amount is
charged off. A loan is considered impaired when, based on
current information and events, it is probable that the
Company will be unable to collect all amounts due
according to the contractual terms of the loan agreement.
Impaired loans include all loans which are on non-accrual,
delinquent as to principal and interest for 90 days or greater,
or restructured in a troubled debt restructuring (TDR)
involving a modification of terms. All non-accruing loans
are reviewed for impairment on an individual basis.
Included in loans receivable, net, are certain loans that have
been modified in order to maximize collection of the loan
balances. The Company evaluates all loan modifications
and if the Company, for legal or economic reasons related
to the borrower's financial difficulties, grants a concession
compared to the original terms and conditions of the loan
that the Company would not otherwise consider, the
modified loan is considered a TDR and is classified as an
impaired loan. If the TDR loan was performing (accruing)
prior to the modification, it typically will remain accruing
after the modification as long as it continues to perform
according to the modified terms. If the TDR loan was non-
performing (non-accruing) prior to the modification, it will
remain non-accruing after the modification for a minimum
of six months. If the loan performs according to the
modified terms for a minimum of six months, it typically
will be returned to accruing status. In general, there are two
conditions in which a TDR loan is no longer considered to
be a TDR and potentially not classified as impaired. The
first condition is whether the loan is refinanced with terms
that reflect normal market terms for the type of credit
involved. The second condition is whether the loan is repaid
or charged off.
Purchased Loans Acquired Through Business
Combinations
Purchased loans acquired in a business combination,
including loans that have evidence of deterioration of credit
quality since origination and for which it is probable, at
acquisition, that the Company will be unable to collect all
contractually required payments, are initially recorded at
fair value as determined by the present value of expected
future cash flows with no valuation allowance. The
difference between the undiscounted cash flows expected at
acquisition and the investment in the loan is an accretable
yield adjustment and is recognized as interest income using
the effective yield method over the life of the loan.
Contractually required payments for principal and interest
that exceed the undiscounted cash flows expected at
acquisition is a nonaccretable difference and is not
recognized as a yield adjustment, loss accrual, or a valuation
allowance. Increases in expected cash flows subsequent to
the initial investment are recognized prospectively through
an adjustment of the yield on the loan over its remaining
life. Decreases in expected cash flows after the loan is
acquired are recognized as an impairment and charged to
the provision for loan losses.
Transfers of Financial Assets and Participating Interests
Transfers of an entire financial asset or a participating
interest in an entire financial asset are accounted for as sales
when control over the assets has been surrendered. Control
over transferred assets is deemed to be surrendered when
(1) the assets have been isolated from the Company, (2) the
transferee obtains the right (free of conditions that constrain
it from taking advantage of that right) to pledge or exchange
the transferred assets, and (3) the Company does not
maintain effective control over the transferred assets
through an agreement to repurchase them before their
maturity.
The transfer of a participating interest in an entire financial
asset must also meet the definition of a participating
interest. A participating interest in a financial asset has all
of the following characteristics: (1) from the date of
transfer, it must represent a proportionate (pro rata)
ownership interest in the financial asset, (2) from the date
of transfer, all cash flows received, except any cash flows
allocated as any compensation for servicing or other
services performed, must be divided proportionately among
participating interest holders in the amount equal to their
share ownership, (3) the rights of each participating interest
holder must have the same priority, and (4) no party has the
right to pledge or exchange the entire financial asset unless
all participating interest holders agree to do so.
Real Estate, net
Real estate acquired through loan foreclosure or deed in lieu
of foreclosure, is initially recorded at its fair value less
estimated selling costs. Third party appraisals are obtained
as soon as practical after obtaining possession of the
property. Valuations are reviewed quarterly by management
and an allowance for losses is established if the carrying
value of a property exceeds its fair value less estimated
selling costs.
income. The Company evaluates
Mortgage Servicing Rights, net
Mortgage servicing rights are capitalized at fair value and
amortized in proportion to, and over the period of, estimated
net servicing
its
capitalized mortgage servicing rights for impairment each
quarter. Loan type and note rate are the predominant risk
characteristics of the underlying loans used to stratify
capitalized mortgage servicing rights for purposes of
measuring impairment. Any impairment is recognized
through a valuation allowance.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Premises and Equipment, net
Land is carried at cost. Office buildings, improvements,
furniture and equipment are carried at cost less accumulated
depreciation. Depreciation is computed on a straight-line
basis over estimated useful lives of 5 to 40 years for office
buildings and improvements and 3 to 10 years for furniture
and equipment.
Goodwill
The Company records goodwill for acquisition amounts
paid in excess of the net assets purchased. Goodwill is not
amortized, but is tested for impairment at least annually or
more frequently if there are indications of impairment.
Core Deposit Intangible, net
The Company records the estimated fair value of the
deposit base acquired in an acquisition as a core deposit
intangible asset. The recorded amount is amortized on a
straight line basis over the estimated life of the deposits
acquired.
Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of
The Company reviews long-lived assets and certain
identifiable intangibles for impairment whenever events or
changes in circumstances indicate that the carrying amount
of an asset may not be recoverable.
Stock Based Compensation
The Company recognizes the grant-date fair value of stock
option and restricted stock awards issued as compensation
expense, amortized over the vesting period.
Employee Stock Ownership Plan (ESOP)
The Company has an ESOP that borrowed funds from the
Company and purchased shares of HMN common stock.
The Company makes quarterly principal and interest
payments on the ESOP loan. As the debt is repaid, ESOP
shares that were pledged as collateral for the debt are
released from collateral based on the proportion of debt
service paid in the year and then allocated to eligible
employees. The Company accounts for its ESOP in
accordance with ASC 718, Employers' Accounting for
Employee Stock Ownership Plans. Accordingly, the shares
pledged as collateral are reported as unearned ESOP shares
in stockholders' equity. As shares are determined to be
ratably released from collateral, the Company reports
compensation expense equal to the current market price of
the shares, and the shares become outstanding for earnings
per share computations.
Income Taxes
Deferred tax assets and liabilities are recognized for 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 of a change in tax rates
on deferred tax assets and liabilities is recognized in income
in the period that includes the enactment date. 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 asset is
subjective and dependent upon judgment concerning
management’s evaluation of both positive and negative
evidence regarding the ultimate realizability of deferred tax
assets.
Earnings per Common Share
Basic earnings per common share excludes dilution and is
computed by dividing the income available to common
stockholders by the weighted-average number of common
shares outstanding for the period. Diluted earnings per
common share reflects the potential dilution that could
occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted
in the issuance of common stock that shared in the earnings
of the entity.
Comprehensive Income
Comprehensive income is defined as the change in equity
during a period from transactions and other events from
non-owner sources. Comprehensive income is the total of
net income and other comprehensive income (loss), which
for the Company is comprised of unrealized gains and
losses on securities available for sale.
Segment Information
The amount of each segment item reported is the measure
reported to the chief operating decision maker for purposes
of making decisions about allocating resources to the
segment and assessing its performance. Adjustments and
eliminations made in preparing an enterprise’s general-
purpose financial statements and allocations of revenues,
expenses and gains or losses are included in determining
reported segment profit or loss if they are included in the
measure of the segment’s profit or loss that is used by the
chief operating decision maker. Similarly, only those assets
that are included in the measure of the segment’s assets that
are used by the chief operating decision maker are reported
for that segment.
New Accounting Pronouncements
In January 2016, the FASB issued ASU 2016-01, Financial
Instruments – Overall (Subtopic 825-10) Recognition and
Measurement of Financial Assets and Financial Liabilities.
The amendments in this ASU require, among other things,
equity investments to be measured at fair value with
changes in fair value recognized in net income and that
public business entities use the exit price notion when
measuring the fair value of financial instruments for
disclosure purposes. The amendments also require an entity
34
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
to present separately in other comprehensive income the
portion of the total change in the fair value of a liability
resulting from a change in the instrument-specific credit
risk when the entity has elected to measure the liability at
fair value in accordance with the fair value option for
financial instruments. In addition, the amendments also
eliminate the requirement for public business entities to
disclose the method(s) and significant assumptions used to
estimate the fair value that is required to be disclosed for
financial instruments measured at amortized cost on the
balance sheet. The ASU is intended to reduce diversity in
practice and is effective for public business entities for
fiscal years beginning after December 15, 2017, including
interim periods within those fiscal years. The amendments
should be applied by means of a cumulative-effect
adjustment to the balance sheet as of the beginning of the
fiscal year of adoption. The adoption of this ASU in the first
quarter of 2018 is not anticipated to have a material impact
on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases
(Topic 842). The amendments in the ASU create Topic 842,
Leases, and supersede the lease requirements in Topic 840,
Leases. The objective of this ASU is to establish the
principles that lessees and lessors shall apply to report
useful information to users of financial statements about the
amount, timing, and uncertainty of cash flows arising from
a lease. The main difference between previous GAAP and
this ASU is the recognition of lease assets and lease
liabilities by lessees for those leases classified as operating
leases under previous GAAP. The amendment requires a
lessee to recognize in the statement of financial position a
liability to make lease payments (the lease liability) and the
right-of-use asset representing its right to use the underlying
asset for the lease term. The accounting applied by a lessor
is largely unchanged from that applied under previous
GAAP. In transition, lessees and lessors are required to
recognize and measure leases at the beginning of the earliest
period presented using a modified retrospective approach.
The modified retrospective approach includes a number of
optional practical expedients that entities may elect to apply
that will, in effect, continue to account for leases that
commence before the effective date in accordance with
previous GAAP unless
is modified. The
the
amendments in the ASU, for public business entities that are
U. S. Securities and Exchange Commission (SEC) filers, are
effective for fiscal years beginning after December 15,
2018, including interim periods within those fiscal years.
The adoption of this ASU in the first quarter of 2019 is not
anticipated to have a material impact on the Company’s
consolidated financial statements.
lease
the FASB
issued ASU 2016-09,
In March 2016,
Compensation – Stock Compensation (Topic 718). The
amendments in this ASU affect all entities that issue share-
based payment awards to their employees. The amendments
are intended to simplify the accounting for share-based
the
income
including
transactions
tax
payment
consequences, classification of awards as either equity or
liabilities, and classification on the statement of cash flows.
The amendments in this ASU, for public business entities,
are effective for fiscal years beginning after December 15,
2016, including interim periods within those annual periods.
Amendments should be applied using a modified
retrospective transition method by means of a cumulative-
effect adjustment to equity as of the beginning of the period
in which the guidance is adopted. The adoption of this ASU
in the first quarter of 2017 is not anticipated to have a
material impact on the Company’s consolidated financial
statements.
In June 2016, the FASB issued ASU 2016-13, Financial
Instruments-Credit Losses (Topic 326): Measurement of
Credit Losses on Financial Instruments. The amendments
in this ASU affect all entities that measure credit losses on
financial instruments including loans, debt securities, trade
receivables, net investments in leases, off-balance sheet
credit exposures, reinsurance receivables, and any other
financial asset that has a contractual right to receive cash
that is not specifically excluded. The main objective of this
ASU is to provide financial statement users with more
decision-useful information about the expected credit losses
on financial instruments and other commitments to extend
credit held by a reporting entity at each reporting date. To
achieve this objective, the amendments in this ASU replace
the incurred loss impairment methodology required in
current GAAP with a methodology that reflects expected
credit losses that requires consideration of a broader range
of reasonable and supportable information to estimate credit
losses. The amendments in this ASU will affect entities to
varying degrees depending on the credit quality of the assets
held by the entity, the duration of the assets held, and how
the entity applies the current incurred loss methodology.
The amendments in this ASU, for public business entities
that are U. S. Securities and Exchange Commission (SEC)
filers, are effective for fiscal years beginning after
December 15, 2019, including interim periods within those
annual periods. All entities may adopt the amendments in
the ASU early as of the fiscal years beginning after
December 15, 2018, including interim periods within those
fiscal years. Amendments should be applied using a
modified retrospective transition method by means of a
cumulative-effect adjustment to equity as of the beginning
of the period in which the guidance is adopted. Management
is in the process of evaluating the impact that the adoption
of this ASU in the first quarter of 2020 will have on the
Company’s consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement
of Cash Flows (Topic 230): Classification of Certain Cash
Receipts and Cash Payments. The amendments in this ASU
affect all entities that are required to present a statement of
cash flows under Topic 230 and address the following eight
specific cash flow issues: debt prepayment or debt
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
interest
insurance claims; proceeds from
extinguishment costs; settlement of zero-coupon debt
instruments or other debt instruments with coupon interest
rates that are insignificant in relation to the effective interest
rate of the borrowing; contingent consideration payments
made after a business combination; proceeds from the
the
settlement of
settlement of corporate-owned life insurance policies;
distributions received from equity method investees;
beneficial
transactions; and
in securitization
separately identifiable cash flows and application of the
predominance principle. This ASU is intended to reduce
diversity in practice and is effective for public business
entities that are U. S. Securities and Exchange Commission
(SEC) filers for fiscal years beginning after December 15,
2017, and interim periods within those fiscal years with
early adoption permitted. Upon adoption, the amendments
should be applied using a retrospective transition method to
each period presented. The adoption of this ASU in the first
quarter of 2018 is not anticipated to have a material impact
on the Company’s consolidated financial statements.
Derivative Financial Instruments
The Company uses derivative financial instruments in order
to manage the interest rate risk on residential loans held for
sale and its commitments to extend credit for residential
loans. The Company may also from time to time use interest
rate swaps to manage interest rate risk. Derivative financial
instruments include commitments to extend credit and
forward mortgage loan sales commitments.
Reclassifications
Certain amounts in the consolidated financial statements for
the prior years have been reclassified to conform to the
current year presentation.
the
NOTE 2 Acquisitions
The Company records purchased assets and liabilities at
their fair market value at the time of purchase in accordance
with
- Business
requirements of ASU 805
Combinations. On April 8, 2016, the Bank completed the
acquisition of loans and assumption of liabilities of the
Deerwood Bank branch in Albert Lea, Minnesota. The
transaction increased the Bank’s assets by $19.0 million,
including increases in loans, cash, goodwill, and core
deposit intangible of $11.9 million, $6.1 million, $0.8
million, and $0.2 million, respectively. The Bank also
assumed deposit liabilities of $19.0 million. The acquired
loans and deposits are being serviced from Home Federal’s
existing branch location at 143 West Clark Street, Albert
Lea, Minnesota.
On August 14, 2015, the Bank completed the acquisition of
certain assets and assumption of certain liabilities of Kasson
36
State Bank. The transaction increased the Bank’s total
assets by $52.8 million including increases in loans of $24.1
million, investments of $17.5 million, cash of $10.0 million,
core deposit intangible of $0.4 million and other assets of
$0.8 million. The Bank also assumed liabilities of $49.3
million, including $47.3 million of deposits and $2.0
million in other liabilities. Consideration paid was $3.2
million and a gain on the transaction of $0.3 million was
recorded. The Bank continues to operate both of the former
Kasson State Bank locations in Kasson, Minnesota acquired
in the transaction as branches of Home Federal Savings
Bank.
Determining the estimated fair value of the acquired assets
and assumed liabilities required the Bank to estimate cash
flows expected to result from those assets and liabilities and
to discount those cash flows at appropriate rates of interest.
The most significant of those determinations related to the
fair valuation of the loans acquired, which management
considers to be a critical accounting estimate that involves
significant estimates and assumptions. The fair value of the
loans purchased was based on the present value of the
expected cash flows. Periodic principal and interest cash
flows were adjusted for expected losses and prepayments,
then discounted to determine the present value and summed
to arrive at the estimated fair value. For such loans, the
excess of cash flows expected at acquisition over the
estimated fair value is recognized as interest income over
the remaining lives of the loans. The difference between
contractually required payments at acquisition and the cash
flows expected to be collected at acquisition reflects the
impact of estimated credit losses and other factors, such as
prepayments. In accordance with GAAP, there was no
carry-over of previously established allowances for loan
losses established on the seller’s records. As a result,
standard industry coverage ratios with regard to the
allowance for credit losses are less meaningful after the
acquisitions. The purchased loans were divided into loans
with evidence of credit quality deterioration, which are
accounted for under ASC topic 310-30 (purchased credit
impaired (PCI)) and loans that do not meet this criteria,
which are accounted for under ASC
topic 310-20
(performing). PCI loans have experienced a deterioration of
credit quality from origination to acquisition for which it is
probable that the Bank will not be able to collect all
contractually required principal and interest payments on
the loan. Subsequent decreases in the expected cash flows
require the Bank to evaluate the need for additions to the
allowance for credit losses. Subsequent improvements in
expected cash flows generally result in a reduction of
previously established allowance for credit losses or the
recognition of additional interest income over the remaining
lives of the loans.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 Other Comprehensive (Loss) Income
The components of other comprehensive (loss) income and the related tax effects were as follows:
(Dollars in thousands)
Securities available for sale:
Gross unrealized (losses) gains arising
Before
Tax
2016
Tax
Effect
For the years ended December 31,
2015
Tax
Effect
Before
Tax
of Tax
Net
Net
of Tax
Before
Tax
2014
Tax
Effect
Net
of Tax
during the period .............................. $ (1,016)
(404)
(612)
344
137
207
38
(218)
256
Less reclassification of net (losses)
gains included in net income ...........
(10)
(4)
(6)
6
3
3
0
0
0
Net unrealized (losses) gains arising
during the period .............................. (1,006)
Other comprehensive (loss) income .... $ (1,006)
(400)
(400)
(606)
(606)
338
338
134
134
204
204
38
38
(218)
(218)
256
256
The tax effect in 2014 includes the impact of the reversal of certain deferred tax asset valuation reserve components that
reversed in 2014 as a result of the changes that occurred in the investment portfolio during the year.
NOTE 4 Securities Available for Sale
A summary of securities available for sale at December 31, 2016 and 2015 is as follows:
(Dollars in thousands)
December 31, 2016
Mortgage-backed securities:
Amortized
cost
Gross
unrealized
gains
Gross
unrealized
losses
Fair value
Federal Home Loan Mortgage Corporation (FHLMC) ................. $
Federal National Mortgage Association (FNMA) ...........................
Collateralized mortgage obligations:
FHLMC .............................................................................................
Other marketable securities:
U.S. Government agency obligations ...............................................
Municipal obligations .......................................................................
Corporate obligations .......................................................................
Corporate preferred stock ................................................................
Corporate equity ...............................................................................
$
December 31, 2015
Mortgage-backed securities:
FHLMC ............................................................................................... $
FNMA .................................................................................................
Collateralized mortgage obligations:
FHLMC ...............................................................................................
Other ...................................................................................................
Other marketable securities:
U.S. Government agency obligations ..................................................
Municipal obligations .........................................................................
Corporate obligations ..........................................................................
Corporate preferred stock ....................................................................
Corporate equity ..................................................................................
$
37
327
295
371
993
74,979
2,819
290
700
58
78,846
79,839
728
725
742
42
2,237
105,003
3,991
340
700
58
110,092
112,329
10
7
0
17
16
0
2
0
57
75
92
31
22
2
0
55
68
18
0
0
5
91
146
0
0
(5)
(5)
(1,079)
(20)
0
(350)
0
(1,449)
(1,454)
0
0
(1)
(8)
(9)
(129)
(7)
(6)
(350)
0
(492)
(501)
337
302
366
1,005
73,916
2,799
292
350
115
77,472
78,477
759
747
743
34
2,283
104,942
4,002
334
350
63
109,691
111,974
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In 2016, the Company sold $20,000 of available for sale
securities and recognized a loss of $10,000 on the sales.
because obligors may have the right to call or prepay
obligations with or without call or prepayment penalties:
In 2015, the Company sold $11.0 million of available for
sale securities and recognized a gain of $6,000 on the sales.
The Company did not sell any available for sale securities
and did not recognize any gains or losses on investments in
2014.
The following table presents the amortized cost and
estimated fair value of securities available for sale at
December 31, 2016, based upon contractual maturity
adjusted for scheduled repayments of principal and
projected prepayments of principal based upon current
economic conditions and interest rates. Actual maturities
may differ from the maturities in the following table
(Dollars in thousands)
Due one year or less ........................................... $
Due after one year through five years ................
Due after five years through ten years ...............
Due after ten years ..............................................
No stated maturity ..............................................
Total ........................................................... $
Amortized
Cost
15,561
63,144
263
813
58
79,839
Fair
Value
15,358
62,282
261
461
115
78,477
The allocation of mortgage-backed securities in the table
above is based upon the anticipated future cash flow of the
securities using estimated mortgage prepayment speeds.
The following table shows the gross unrealized losses and fair values for the securities available for sale portfolio aggregated
by investment category and length of time that individual securities have been in a continuous unrealized loss position at
December 31, 2016 and 2015:
Less Than Twelve Months
Fair
Value
# of
Investments
Unrealized
Losses
(Dollars in thousands)
December 31, 2016
Collateralized mortgage
Twelve Months or More
Fair
Value
# of
Investments
Unrealized
Losses
Total
Fair
Value
Unrealized
Losses
obligations:
FNMA ................................
Other marketable
securities:
U.S. Government agency
obligations .......................
Municipal obligations .......
Corporate preferred
stock .................................
Total temporarily impaired
securities ............................
December 31, 2015
Collateralized mortgage
obligations:
FNMA ................................
Other ..................................
Other marketable securities:
U.S. Government agency
obligations ........................
Municipal obligations .........
Corporate obligations .........
Corporate preferred stock ...
Total temporarily impaired
1 $
262
(3 )
1 $
104
(2) $
366
(5)
13 63,896
2,327
14
(1,079 )
(19 )
0
2
0
214
0 63,896
2,541
(1)
(1,079)
(20)
0
0
0
1
350
(350)
350
(350)
28 $ 66,485
(1,101 )
4 $
668
(353) $ 67,153
(1,454)
1 $
2
346
34
(1 )
(8 )
9 44,878
2,010
334
0
12
1
0
(129 )
(7 )
(6 )
0
0 $
0
0
0
0
1
0
0
0 $
0
346
34
(1)
(8)
0
0
0
350
0 44,878
2,010
0
334
0
350
(350)
(129)
(7)
(6)
(350)
securities .............................
25 $ 47,602
(151 )
1 $
350
(350) $ 47,952
(501)
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
We review our investment portfolio on a quarterly basis for
indications of impairment. This review includes analyzing
the length of time and the extent to which the fair value has
been lower than the cost, the market liquidity for the
investment, the financial condition and near-term prospects
of the issuer, including any specific events which may
influence the operations of the issuer, and our intent and
ability to hold the investment for a period of time sufficient
to recover the temporary loss. The unrealized losses on U.S.
Government agency obligations are the result of changes in
interest rates. The unrealized losses reported for the
corporate preferred stock at December 31, 2016 relates to a
single trust preferred security that was issued by the holding
company of a small community bank. Typical of most trust
preferred issuances, the issuer has the ability to defer
interest payments for up to five years with interest payable
on the deferred balance. In September 2014, the issuer paid
all deferred interest that was due and all payments were
current as of September 30, 2014. Since January 2015, the
issuer has deferred its scheduled interest payments as
allowed by the terms of the security agreement. The issuer’s
subsidiary bank has generated modest net income amounts
over the past several years and met the regulatory
requirements to be considered “well capitalized” based on
its most recent regulatory filing. Based on a review of the
issuer, it was determined that the trust preferred security
was not other-than-temporarily impaired at December 31,
2016. The Company does not intend to sell the preferred
stock and has the intent and ability to hold it for a period of
time sufficient to recover the temporary loss. Management
believes that the Company will receive all principal and
interest payments contractually due on the security and that
the decrease in the market value is primarily due to a lack
of liquidity in the market for trust preferred securities.
Management will continue to monitor the credit risk of the
issuer and may be required to recognize other-than-
temporary impairment charges on this security in future
periods.
NOTE 5 Loans Receivable, Net
A summary of loans receivable at December 31, 2016 and
2015, is as follows:
(Dollars in thousands)
Residential real estate loans:
2016
2015
Single family conventional .......................... $ 103,125
Single family FHA .......................................
92
Single family VA .........................................
38
103,255
90,587
206
152
90,945
Commercial real estate:
Lodging ........................................................
Retail/office ..................................................
Nursing home/health care ............................
Land developments ......................................
Golf courses .................................................
Restaurant/bar/café ......................................
Alternative fuel plants ..................................
Warehouse ....................................................
Construction:
43,285
53,935
8,185
24,240
1,560
5,851
0
26,630
27,428
45,097
9,183
21,272
4,163
5,854
2,205
18,337
Single family builder ...............................
Multi-family ............................................
Commercial real estate ............................
Manufacturing ..............................................
Churches/community service .......................
Multi-family .................................................
Other .............................................................
21,944
2,610
6,794
15,743
10,199
36,777
41,327
299,080
15,152
18,865
4,086
11,585
8,195
12,324
43,607
247,353
Consumer:
Autos ............................................................
Home equity line ..........................................
Home equity .................................................
Other – secured ............................................
Recreational vehicles ...................................
Land/lots ......................................................
Other – unsecured ........................................
3,036
40,476
16,302
2,048
7,553
2,362
1,506
73,283
2,885
38,980
14,782
2,031
2,650
1,144
1,943
64,415
Commercial business
85,176
Total loans ............................................... 560,794
70,106
472,819
Less:
Unamortized discounts ................................
Net deferred loan costs ................................
Allowance for loan losses ............................
20
(300 )
9,903
Total loans receivable, net ....................... $ 551,171
Commitments to originate or purchase loans ... $ 47,220
Commitments to deliver loans to secondary
16
(91)
9,709
463,185
27,184
market ............................................................ $
9,595
8,071
Weighted average contractual rate of loans in
portfolio .........................................................
4.45 %
4.54%
39
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Included in total commitments to originate or purchase
loans are fixed rate loans aggregating $29.6 million and
$22.3 million as of December 31, 2016 and 2015,
respectively. The interest rates on these loan commitments
ranged from 2.75% to 5.125% at December 31, 2016 and
from 3.00% to 5.49% at December 31, 2015.
The aggregate amount of loans to executive officers and
directors of the Company was $0.2 million, $2.7 million and
$2.8 million at December 31, 2016, 2015 and 2014,
respectively. During 2016, there was no activity on loans to
executive officers and directors other than the $2.5 million
in loans that were reclassified during the period due to a
change in borrower classification. During 2015, repayments
on loans to executive officers and directors were $0.1
million, new loans to executive officers and directors
totaled $0.2 million, and loans closed or paid off were $0.2
million. During 2014, repayments on loans to executive
officers and directors were $0.1 million, new loans to
executive officers and directors totaled $0.2 million, sales
of executive officer and director loans were $0.2 million,
and loans reclassified were $0.2 million. All loans were
made in the ordinary course of business on normal credit
terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with
unrelated parties.
At December 31, 2016, 2015 and 2014, the Company was
servicing loans for others with aggregate unpaid principal
balances of approximately $425.5 million, $391.9 million
and $379.7 million, respectively.
The Company originates residential, commercial real estate
and other loans primarily in Minnesota, Wisconsin, and
Iowa. At December 31, 2016 and 2015, the Company had
in its portfolio single-family residential loans located in the
following states:
2016
2015
(Dollars in thousands)
Iowa ................................ $
Minnesota .......................
Missouri ..........................
Wisconsin .......................
Other states .....................
Amount
4,470
87,135
1,206
8,779
1,665
Total ...................... $ 103,255
Percent
of Total
Amount
5,387
75,417
918
7,956
1,267
4.3 % $
84.4
1.2
8.5
1.6
Percent
of Total
5.9 %
82.9
1.0
8.8
1.4
100.0% $ 90,945 100.0 %
Amounts under one million dollars in both years are included in “Other
states”.
At December 31, 2016 and 2015, the Company had in its portfolio commercial real estate loans located in the following
states:
2016
2015
(Dollars in thousands)
Alabama ............................................................................................... $
Florida ..................................................................................................
Idaho ....................................................................................................
Indiana .................................................................................................
Iowa .....................................................................................................
Minnesota ............................................................................................
North Carolina .....................................................................................
North Dakota........................................................................................
Tennessee .............................................................................................
Wisconsin ............................................................................................
Other states ..........................................................................................
Total ............................................................................................. $
Amount
Percent
of Total
Amount
Percent
of Total
1,902
3,781
3,529
2,189
1,973
213,983
2,926
8,447
1,036
57,512
1,802
299,080
0.7 % $
1.3
1.2
0.7
0.7
71.5
1.0
2.8
0.3
19.2
0.6
100.0 % $
2,056
3,738
3,678
4,608
1,106
184,670
4,203
7,979
260
31,918
3,137
247,353
0.8 %
1.5
1.5
1.9
0.4
74.7
1.7
3.2
0.1
12.9
1.3
100.0 %
Amounts under one million dollars in both years are included in “Other states”.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 Allowance for Loan Losses and Credit Quality Information
The allowance for loan losses is summarized as follows:
(Dollars in thousands)
Balance, December 31, 2013 ........................................ $
Single Family
1,628
Commercial
Real Estate Consumer
Commercial
Business
Total
6,458
1,106
2,209
11,401
Provision for losses ................................................... $
Charge-offs ...............................................................
Recoveries .................................................................
Balance, December 31, 2014 ........................................ $
Provision for losses ................................................... $
Charge-offs ...............................................................
Recoveries .................................................................
Balance, December 31, 2015 ........................................ $
Provision for losses .................................................. $
Charge-offs ..............................................................
Recoveries ................................................................
Balance, December 31, 2016 ....................................... $
Allocated to:
Specific reserves ....................................................... $
General reserves ........................................................
Balance, December 31, 2015 ........................................ $
Allocated to:
Specific reserves ...................................................... $
General reserves ......................................................
Balance, December 31, 2016 ....................................... $
Loans receivable at December 31, 2015:
(440)
(92)
0
1,096
(105)
(19)
18
990
262
(66)
0
1,186
(3,518)
(936)
3,020
5,024
(427)
0
1,481
6,078
(1,788)
(67)
730
4,953
(4)
(131)
38
1,009
254
(105)
42
1,200
481
(108)
40
1,613
(3,036)
(55)
2,085
1,203
114
(69)
193
1,441
400
(180)
490
2,151
223
767
990
296
5,782
6,078
370
830
1,200
120
1,321
1,441
235
951
1,186
248
4,705
4,953
434
1,179
1,613
71
2,080
2,151
(6,998)
(1,214)
5,143
8,332
(164)
(193)
1,734
9,709
(645)
(421)
1,260
9,903
1,009
8,700
9,709
988
8,915
9,903
Individually reviewed for impairment ....................... $
Collectively reviewed for impairment .......................
Ending balance .......................................................... $
2,203
88,742
90,945
2,204
245,149
247,353
977
63,438
64,415
415
69,691
70,106
5,799
467,020
472,819
Loans receivable at December 31, 2016:
Individually reviewed for impairment .................. $
Collectively reviewed for impairment ...................
Ending balance ........................................................ $
1,107
102,148
103,255
1,880
297,200
299,080
940
72,343
73,283
643
84,533
85,176
4,570
556,224
560,794
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the amount of classified and unclassified loans at December 31, 2016 and 2015:
December 31, 2016
Classified
Unclassified
(Dollars in thousands)
Single family .......................................... $
Commercial real estate:
Special
Mention Substandard Doubtful Loss
2,130
457
74
Total
Total
Total
Loans
0
2,661
100,594 103,255
Real estate rental and leasing ...........
Other ..................................................
Consumer ...............................................
Commercial business:
1,577
1,702
0
Transportation industry ...................
Other ..................................................
$
0
3,973
7,709
3,156
7,187
531
4,065
2,916
19,985
0
0
110
0
0
184
0
0
299
4,733
8,889
940
148,610 153,343
136,848 145,737
72,343 73,283
0
0
4,065
6,889
299 28,177
6,444 10,509
67,778 74,667
532,617 560,794
December 31, 2015
Classified
Unclassified
(Dollars in thousands)
Single family ........................................... $
Commercial real estate:
Special
Mention Substandard Doubtful Loss
2,889
189
55
Total
Total
Total
Loans
0
3,133
87,812
90,945
Real estate rental and leasing ..............
Other ...................................................
Consumer ................................................
Commercial business:
1,910
917
0
4,827
9,473
639
Transportation industry .......................
Other ...................................................
$
4,082
841
7,939
18
1,515
19,361
0
0
52
0
0
107
0
0
286
6,737
10,390
977
118,639 125,376
111,587 121,977
64,415
63,438
0
0
286
4,100
2,356
27,693
9,349
5,249
58,401
60,757
445,126 472,819
Classified loans represent special mention, performing
substandard, and non-performing loans categorized as
substandard, doubtful and loss. Loans classified as special
mention are loans that have potential weaknesses that, if left
uncorrected, may result in deterioration of the repayment
prospects for the asset or in the Bank’s credit position at
some future date. Loans classified as substandard are loans
that are generally inadequately protected by the current net
worth and paying capacity of the obligor, or by the collateral
pledged, if any. Loans classified as substandard have a well-
defined weakness or weaknesses that jeopardize the
liquidation of the debt. Substandard loans are characterized
by the distinct possibility that the Bank will sustain some
loss if the deficiencies are not corrected. Loans 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. A loan classified as loss is considered
uncollectible and of such little value that continuance as an
asset on the balance sheet is not warranted. Loans classified
as substandard or doubtful require the Bank to perform an
analysis of the individual loan and charge off any loans, or
portion thereof, that are deemed uncollectible.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The aging of past due loans at December 31, 2016 and 2015 is summarized as follows:
(Dollars in thousands)
2016
30-59
Days Past
Due
60-89
Days Past
Due
90 Days
or More
Past Due
Total
Past Due
Current
Loans
Total
Loans
Loans 90
Days or
More Past
Due and
Still
Accruing
Single family ...................................... $
Commercial real estate:
Real estate rental and leasing ...
Other ..........................................
Consumer ...........................................
Commercial business:
Transportation industry ...........
Other ..........................................
$
2015
Single family ....................................... $
Commercial real estate:
Real estate rental and leasing ......
Other ...........................................
Consumer ............................................
Commercial business:
Transportation industry ...............
Other ...........................................
$
0
0
0
0
0
0
0
0
0
0
0
0
0
0
342
158
179
679 102,576 103,255
0
0
412
0
85
839
0
0
117
0
0
275
0
0
140
0
274
593
0 153,343 153,343
0 145,737 145,737
73,283
72,614
669
0
359
10,509
10,509
74,667
74,308
1,707 559,087 560,794
490
130
799
1,419
89,526
90,945
0
0
330
0
45
865
0
289
262
0
0
681
0
0
119
0
0
918
0 125,376 125,376
289 121,688 121,977
64,415
711
63,704
0
45
9,349
9,349
60,757
60,712
2,464 470,355 472,819
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Impaired loans include loans that are non-performing (non-
accruing) and loans that have been modified in a TDR. The
following table summarizes impaired loans and related
allowances for the years ended December 31, 2016 and
2015:
(Dollars in thousands)
Loans with no related allowance recorded:
December 31, 2016
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
Single family ............................................................ $
Commercial real estate:
Real estate rental and leasing .............................
Other ....................................................................
Consumer .................................................................
Commercial business:
217
217
40
26
312
122
1,771
312
Other ....................................................................
274
356
0
0
0
0
0
567
40
29
449
81
Loans with an allowance recorded:
Single family ............................................................
Commercial real estate:
Real estate rental and leasing .............................
Other ....................................................................
Consumer .................................................................
Commercial business:
890
890
235
1,022
0
1,814
628
0
1,814
644
0
248
434
389
1,856
553
Other ....................................................................
369
921
71
423
Total:
Single family ............................................................
Commercial real estate:
Real estate rental and leasing .............................
Other ....................................................................
Consumer .................................................................
Commercial business:
Other ....................................................................
$
1,107
1,107
235
1,589
40
1,840
940
643
4,570
122
3,585
956
1,277
7,047
0
248
434
71
988
429
1,885
1,002
504
5,409
15
0
97
13
18
17
0
229
13
57
32
0
326
26
75
459
44
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)
Loans with no related allowance recorded:
December 31, 2015
Recorded
Investment
Unpaid
Principal
Balance
Related
Allowance
Average
Recorded
Investment
Interest
Income
Recognized
Single family ............................................................. $
Commercial real estate:
Real estate rental and leasing ................................
Other .....................................................................
Consumer ..................................................................
Commercial business:
Other .....................................................................
1,251
1,251
44
25
475
184
1,706
476
0
79
0
0
0
0
0
943
46
5,462
387
36
Loans with an allowance recorded:
Single family .............................................................
Commercial real estate:
Real estate rental and leasing ................................
Other .....................................................................
Consumer ..................................................................
Commercial business:
952
952
223
1,045
0
2,135
502
0
2,135
519
0
296
370
3
1,920
448
Other .....................................................................
415
967
120
429
Total:
Single family .............................................................
Commercial real estate:
Real estate rental and leasing ................................
Other .....................................................................
Consumer ..................................................................
Commercial business:
Other .....................................................................
$
2,203
2,203
223
1,988
44
2,160
977
415
5,799
184
3,841
995
1,046
8,269
0
296
370
49
7,382
835
120
1,009
465
10,719
60
7
96
10
0
14
0
32
20
20
74
7
128
30
20
259
At December 31, 2016, 2015 and 2014, non-accruing loans
totaled $3.3 million, $4.2 million and $10.9 million,
respectively, for which the related allowance for loan losses
was $0.8 million, $0.7 million and $0.8 million,
respectively. Non-accruing loans for which no specific
allowance has been
recorded because management
determined that the value of the collateral was sufficient to
repay the loan totaled $0.7 million, $1.4 million and $8.0
million at December 31, 2016, 2015, and 2014,
respectively. Had the loans performed in accordance with
their original terms, the Company would have recorded
gross interest income on the loans of $0.6 million, $0.5
million and $0.9 million in 2016, 2015 and 2014,
respectively. For the years ended December 31, 2016, 2015,
and 2014, the Company recognized interest income on these
loans of $0.4 million, $0.3 million and $0.2 million,
respectively. All of the interest income that was recognized
for non-accruing loans was recognized using the cash basis
method of income recognition. Non-accrual loans also
include some of the loans that have had terms modified in a
TDR.
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes non-accrual loans at
December 31, 2016 and 2015:
The following table summarizes TDRs at December 31,
2016 and 2015:
(Dollars in thousands)
Single family ............................................................. $
Commercial real estate:
Real estate rental and leasing ................................
Other......................................................................
Consumer ...................................................................
Commercial business:
2016
2015
916
1,655
(Dollars in thousands)
Single family ............................................................ $
Commercial real estate:
41
1,343
630
44
1,650
786
Other .....................................................................
Consumer ..................................................................
Commercial business:
2016
2015
448
647
1,774
709
725
732
Other......................................................................
$
343
3,273
46
4,181
Included in loans receivable, net, are certain loans that have
been modified in order to maximize collection of loan
balances. If the Company, for legal or economic reasons
related to the borrower’s financial difficulties, grants a
concession compared to the original terms and conditions
of the loan, the modified loan is considered a troubled debt
restructuring (TDR).
At December 31, 2016, 2015 and 2014, there were loans
included in loans receivable, net, with terms that had been
modified in a TDR totaling $3.3 million, $2.5 million and
$9.4 million, respectively. Had these loans been performing
in accordance with their original terms throughout 2016,
2015, and 2014, the Company would have recorded gross
interest income of $0.6 million, $0.4 million and $0.9
million, respectively. During 2016, 2015 and 2014, the
Company recognized interest income of $0.4 million, $0.2
million and $0.3 million, respectively, on these loans. For
the loans that were modified in 2016, $0.2 million were
classified and performing, and $1.7 million were non-
performing at December 31, 2016.
Other .....................................................................
$
369
415
3,300 2,519
As of December 31, 2016, the Bank had commitments to
lend an additional $0.4 million to a borrower who has TDR
and non-accrual loans. These additional funds are for the
construction of single family homes with a maximum loan-
to-value ratio of 75%. These loans are secured by the home
under construction. There were commitments to lend
additional funds of $1.5 million to this same borrower at
December 31, 2015.
TDR concessions can include reduction of interest rates,
extension of maturity dates, forgiveness of principal and/or
interest due, or acceptance of real estate or other assets in
full or partial satisfaction of the debt. Loan modifications
are not reported as TDRs after 12 months if the loan was
modified at a market rate of interest for comparable risk
loans, and the loan is performing in accordance with the
terms of the restructured agreement. All loans classified as
TDRs are considered to be impaired.
When a loan is modified as a TDR, there may be a direct,
material impact on the loans within the Consolidated
Balance Sheets, as principal balances may be partially
forgiven. The financial effects of TDRs are presented in the
following table and represent the difference between the
outstanding recorded balance pre-modification and post-
modification, for the periods ending December 31, 2016
and 2015:
Year ended December 31, 2016
Pre-
modification
Outstanding
Recorded
Investment
Post-
modification
Outstanding
Recorded
Investment
Year ended December 31, 2015
Pre-
modification
Outstanding
Recorded
Investment
Post-
modification
Outstanding
Recorded
Investment
Number of
Contracts
Number of
Contracts
4 $
251
263
4 $
476
(Dollars in thousands)
Troubled debt restructurings:
Single family .......................................
Commercial real estate:
Other ...............................................
Consumer ............................................
Commercial business:
Other ...............................................
Total ....................................................
1
18
2
25 $
1,274
382
257
2,164
1,274
384
201
2,122
1
21
1
27 $
209
527
44
1,256
46
478
209
530
44
1,261
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Loans that were restructured within the 12 months preceding December 31, 2016 and 2015 and defaulted during the year
are presented in the table below:
(Dollars in thousands)
Troubled debt restructurings that subsequently
defaulted:
Commercial real estate:
Year ended December 31, 2016
Outstanding
Number of
Contracts
Recorded
Investment
Year ended December 31, 2015
Outstanding
Number of
Contracts
Recorded
Investment
Other .............................................................
Consumer ........................................................
Total ................................................................
1
1
2
$
$
183
4
187
0
0
0
$
$
0
0
0
The Company considers a loan to have defaulted when it
becomes 90 or more days past due under the modified
terms, when it is placed in non-accrual status, when it
becomes other real estate owned, or when it becomes non-
compliant with some other material requirement of the
modification agreement.
Loans that were non-accrual prior to modification remain
non-accrual for at least six months following modification.
Non-accrual TDR loans that have performed according to
the modified terms for six months may be returned to
accruing status. Loans
to
modification remain on accrual status after the modification
as long as the loan continues to perform under the new
terms.
that were accruing prior
TDRs are reviewed for impairment following the same
methodology as other impaired loans. For loans that are
collateral dependent, the value of the collateral is reviewed
and additional reserves may be added as needed. Loans that
are not collateral dependent may have additional reserves
established if deemed necessary. The allocated allowance
for TDRs was $0.6 million, or 6.2%, of the total $9.9 million
in allowance for loan losses at December 31, 2016, and $0.5
million, or 5.2%, of the total $9.7 million in allowance for
loan losses at December 31, 2015.
Loans acquired in a business combination are segregated
into two types: purchased performing loans with a discount
attributable at least in part to credit quality and PCI loans
with evidence of significant credit deterioration. Purchased
performing loans are accounted for in accordance with ASC
310-20 “Nonrefundable Fees and Other Costs” as these
loans do not have evidence of credit deterioration since
origination. PCI loans are accounted for in accordance with
ASC 310-30 “Receivables – Loans and Debt Securities
Acquired with Deteriorated Credit Quality” as they display
significant credit deterioration since origination. In
accordance with ASC 310-30, for PCI loans, the difference
between contractually required payments at acquisition and
the cash flows expected to be collected is referred to as the
non-accretable difference. This amount is not recognized as
a yield adjustment or as a loss accrual or a valuation
allowance. Furthermore, any excess of cash flows expected
at acquisition over the estimated fair value is referred to as
the accretable yield and is recognized into interest income
over the remaining life of the loans when there is a
reasonable expectation about the amount and timing of such
cash flows. Increases in expected cash flows subsequent to
the initial investment are recognized prospectively through
an adjustment of the yield on the loan over its remaining
estimated life. Decreases in expected cash flows are
recognized immediately as an impairment through the
provision for loan losses.
The following is additional information with respect to
loans acquired through acquistions:
(Dollars in thousands)
Purchased Performing Loans:
Balance at December 31, 2015 ........... $
Contractual
Principal
Receivable
Accretable
Difference
Carrying
Amount
18,539
(459) 18,080
Loans acquired during the
period ..........................................
11,772
(211) 11,561
Change due to
payments/refinances .................
Change due to loan charge-off ....
Balance at December 31, 2016 ......... $
(13,413 )
(156 )
16,742
340 (13,073)
(158)
(332) 16,410
(2)
(Dollars in thousands)
Purchased Credit Impaired Loans:
Balance at December 31, 2015 ........... $
Contractual
Principal
Receivable
Non-
Accretable
Difference
Carrying
Amount
555
(162)
393
Loans acquired during the
period ..........................................
329
(37)
292
Change due to
payments/refinances .................
Balance at December 31, 2016 ......... $
(449 )
435
147
(52)
(302)
383
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
As a result of acquisitions, the Company has PCI loans for
which there was, at acquisition, evidence of deterioration of
credit quality since origination and for which it was
probable at acquisition that all contractually required
payments would not be collected. The carrying amount of
those loans as of December 31, 2016 was $0.4 million.
The gross carrying amount of intangible assets and the
associated accumulated amortization at December 31, 2016
and 2015 are presented in the following table. Amortization
expense for intangible assets was $0.7 million, $0.6 million,
and $0.5 million for the years ended December 31, 2016,
2015, and 2014, respectively.
(Dollars in thousands)
December 31, 2016
Gross
Unamortized
Carrying Accumulated Intangible
Amount Amortization Assets
Mortgage servicing rights . $
Core deposit intangible ......
Goodwill ..............................
Total ..................................... $
3,954
574
802
5,330
(2,350)
(120)
0
(2,470)
December 31, 2015
Mortgage servicing rights .... $
Core deposit intangible ........
Total ..................................... $
3,739
421
4,160
(2,240)
(28)
(2,268)
1,604
454
802
2,860
1,499
393
1,892
The following
amortization expense for amortizing intangible assets:
the estimated future
indicates
table
(Dollars in thousands)
Year ended December 31,
2017 ......................................... $
2018 .........................................
2019 .........................................
2020 .........................................
2021 .........................................
Thereafter .................................
$
Mortgage
Servicing
Rights
Core
Deposit
Intangible
Total
Amortizing
Intangible
Assets
440
350
297
215
162
140
1,604
99
99
99
99
47
11
454
539
449
396
314
209
151
2,058
No amortization expense relating to goodwill is recorded as
generally accepted accounting principles do not allow
goodwill to be amortized, but require that it be tested for
impairment at least annually, or sooner, if there are
indications that impairment may exist.
Projections of amortization are based on asset balances and
the interest rate environment that existed at December 31,
2016. The Company’s actual experience may be
significantly different depending upon changes in mortgage
interest rates and other market conditions.
No material provision for loan losses was recognized during
the period ended December 31, 2016 related to acquired
loans as there was no significant change to the credit quality
of the loans.
NOTE 7 Accrued Interest Receivable
Accrued interest receivable at December 31 is summarized
as follows:
(Dollars in thousands)
Securities available for sale ....................................... $
Loans receivable ........................................................
$
2016
2015
400
2,226
2,626
422
1,832
2,254
NOTE 8 Intangible Assets
The Company’s intangible assets consist of core deposit
intangibles, goodwill, and mortgage servicing rights. A
summary of mortgage servicing rights activity for 2016 and
2015 is as follows:
(Dollars in thousands)
Mortgage servicing rights:
Balance, beginning of year ........................................ $
Originations ...............................................................
Amortization ..............................................................
Balance, end of year ..................................................
Valuation reserve .......................................................
Mortgage servicing rights, net ................................... $
Fair value of mortgage servicing rights .................... $
2016
2015
1,499
706
(601)
1,604
0
1,604
2,952
1,507
547
(555)
1,499
0
1,499
2,590
All of the single family loans sold where the Company
continues to service the loans are serviced for Federal
National Mortgage Association
the
individual loan sale program. The following is a summary
of the risk characteristics of the loans being serviced for
FNMA at December 31, 2016:
(FNMA) under
Loan
Principal
Balance
Weighted
Average
Interest
Rate
Weighted
Average
Remaining
Term
(months)
Number
of Loans
(Dollars in thousands)
Original term:
30 year fixed rate ................. $235,933
15 year fixed rate ................. 110,377
57
Adjustable rate .....................
4.07%
3.12
2.75
305 1,953
140 1,163
2
293
48
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 Real Estate
A summary of real estate at December 31, 2016 and 2015 is as follows:
(Dollars in thousands)
Real estate in judgment subject to
Residential
2016
Commercial
& Other
Total
Residential
2015
Commercial
& Other
Total
redemption........................................ $
Real estate acquired through
foreclosure ........................................
Real estate acquired through deed in
lieu of foreclosure .............................
Allowance for losses ...........................
$
0
0
0
0
0
0
0
0
110
0
110
1,245
1,245
0
2,269
2,269
28
1,273
(662)
611
28
1,273
(662)
611
0
110
(62)
48
465
2,734
(737)
1,997
465
2,844
(799)
2,045
NOTE 10 Premises and Equipment
A summary of premises and equipment at December 31,
2016 and 2015 is as follows:
2016
(Dollars in thousands)
2,021
Land ......................................................................... $
8,930
Office buildings and improvements ........................
Furniture and equipment ......................................... 12,478 12,714
24,165 23,665
Accumulated depreciation ....................................... (15,942) (16,196)
7,469
2,021
9,666
2015
8,223
$
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 Deposits
Deposits and their weighted average interest rates at December 31, 2016 and 2015 are summarized as follows:
2016
2015
Weighted
Average
Rate
Percent
of Total
Weighted
Average
Rate
Percent of
Total
(Dollars in thousands)
Noninterest checking .....................................................
NOW accounts ...............................................................
Savings accounts ............................................................
Money market accounts .................................................
Amount
0.00% $ 158,024
92,670
0.07
74,238
0.08
165,179
0.25
490,111
Certificates by rate:
0-0.99% ..........................................................................
1-1.99% ..........................................................................
2-2.99% ..........................................................................
3-3.99% ..........................................................................
Total certificates ............................................................
Total deposits .................................................................
79,628
22,958
0
114
102,700
$ 592,811
0.61
0.20
26.7%
15.6
12.5
27.9
82.7
13.4
3.9
0.0
0.0
17.3
100.0%
Amount
0.00% $ 151,737
0.04 82,425
0.09 66,421
0.22 159,959
460,542
85,391
12,611
733
110
0.53 98,845
0.17 $ 559,387
27.1%
14.7
11.9
28.6
82.3
15.3
2.3
0.1
0.0
17.7
100.0%
At December 31, 2016 and 2015, the Company had $172.6
million and $183.0 million, respectively, of deposit
accounts with balances of $250,000 or more. At December
31, 2016 and 2015, the Company had no certificate accounts
that had been acquired through a broker.
Certificates had the following maturities at December 31, 2016 and 2015:
(Dollars in thousands)
Remaining term to maturity
1-6 months .............................................................................................. $
7-12 months ............................................................................................
13-36 months ..........................................................................................
Over 36 months .......................................................................................
$
2016
2015
Weighted
Average
Rate
Amount
Weighted
Average
Rate
Amount
32,418
25,424
36,111
8,747
102,700
0.36% $
0.45
0.81
1.18
0.61
$
36,040
26,019
28,706
8,080
98,845
0.44%
0.37
0.65
1.05
0.53
At December 31, 2016 and 2015, the Company had pledged
mortgage loans and mortgage-backed and related securities
with an amortized cost of approximately $17.4 million and
$28.0 million, respectively, as collateral for certain
deposits. An additional $1.0 million of letters of credit from
the Federal Home Loan Bank (FHLB) were pledged at
December 31, 2016 and 2015 as collateral on certain Bank
deposits.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest expense on deposits is summarized as follows for the years ended December 31, 2016, 2015 and 2014:
(Dollars in thousands)
NOW accounts ............................................................................................... $
Savings accounts ............................................................................................
Money market accounts .................................................................................
Certificates .....................................................................................................
$
2016
2015
2014
50
62
366
524
1,002
17
42
347
528
934
14
32
414
751
1,211
NOTE 12 FHLB Advances and Other Borrowings
The Bank had no outstanding advances from the FHLB or
borrowings from the Federal Reserve Bank of Minneapolis
as of December 31, 2016 or December 31, 2015. At
December 31, 2016 it had collateral pledged to the FHLB
consisting of FHLB stock, mortgage loans, and investments
with a borrowing capacity of approximately $105.7 million.
The Bank had the ability to draw additional borrowings of
$104.7 million from the FHLB, based upon the mortgage
loans and securities that were pledged at December 31,
2016, subject to a requirement to purchase FHLB stock. The
Bank also had the ability to draw additional borrowings of
the Federal Reserve Bank of
$85.8 million from
Minneapolis, based upon the loans that were pledged to
them as of December 31, 2016, subject to approval from the
Board of Governors of the Federal Reserve System (FRB).
At December 31, 2015 the Bank had collateral pledged to
the FHLB consisting of FHLB stock, mortgage loans, and
investments with a borrowing capacity of approximately
$96.3 million. The Bank had the ability to draw additional
borrowings of $95.3 million from the FHLB, based upon
the mortgage loans and securities that were pledged as of
December 31, 2015, subject to a requirement to purchase
FHLB stock. The Bank also had the ability to draw
additional borrowings of $73.5 million from the Federal
Reserve Bank of Minneapolis, based upon the loans that
were pledged to them as of December 31, 2015, subject to
approval from the FRB.
On December 15, 2014, the Company entered into a Loan
Agreement with an unrelated third party, providing for a
term loan of up to $10.0 million that was evidenced by a
promissory note (the Note) with an interest rate of 6.50%
per annum. The principal balance of the Note is payable in
consecutive equal annual installments of $1.0 million on
each anniversary of the date of the Loan Agreement,
commencing on December 15, 2015, with the balance due
on December 15, 2021. Provided that no default or event of
default has occurred and is continuing, the Company may,
at its option, elect to defer the payment of one installment
of principal on the Note otherwise due prior to the maturity
date, in which event such installment will become due and
payable on the maturity date. The Company may voluntarily
prepay the Note in whole or in part without penalty and the
Company has prepaid $1.0 million of principal on the Note
the required annual payments. The
in addition
outstanding loan balance was $7.0 million at December 31,
2016 and $9.0 million at December 31, 2015.
to
NOTE 13 Income Taxes
Income tax expense for the years ended December 31, 2016,
2015 and 2014 is as follows:
(Dollars in thousands)
Current:
2016
2015
2014
Federal ................................................. $
State .....................................................
Total current ...................................
939
55
994
(87)
(24)
(111)
262
74
336
Deferred:
Federal .................................................
State .....................................................
Total deferred .................................
Income tax expense ................................ $
2,322
806
3,128
4,122
1,393
329
1,722
1,611
3,753
813
4,566
4,902
The reasons for the difference between the expected income
tax expense utilizing the federal corporate tax rate of 34%
and the actual income tax expense are as follows:
(Dollars in thousands)
Expected federal income tax expense ..... $
Items affecting federal income tax:
State income taxes, net of federal
2016
2015
2014
3,560
1,553
4,176
income tax deduction .......................
Tax exempt interest .............................
Other, net .............................................
Income tax expense ................................ $
622
(16)
(44)
4,122
259
(44)
(157)
1,611
698
(45)
73
4,902
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The tax effects of temporary differences that give rise to the
deferred tax assets and deferred tax liabilities are as follows
at December 31:
(Dollars in thousands)
Deferred tax assets:
2016
2015
Allowances for loan and real estate losses ........... $
Deferred compensation costs ................................
Deferred ESOP loan asset .....................................
Nonaccruing loan interest .....................................
Federal net operating loss carryforward ...............
State net operating loss carryforward ...................
Alternative minimum tax credit carryforward ......
Capitalized other real estate owned expenses ......
Net unrealized loss on securities available for
sale .....................................................................
Other......................................................................
Total gross deferred tax assets .........................
4,186
262
704
313
0
1,366
118
56
4,169
235
710
361
1,805
2,255
500
530
542
91
142
155
7,638 10,862
Deferred tax liabilities:
Deferred loan fees ................................................
Premises and equipment basis difference .............
Originated mortgage servicing rights ...................
Federal tax liability on state net operating loss
carryforwards .....................................................
Core deposit intangible .........................................
Other......................................................................
Total gross deferred tax liabilities ....................
Net deferred tax assets ..................................... $
100
126
636
676
74
79
1,691
5,947
247
139
594
779
105
325
2,189
8,673
The Company has no
loss
carryforwards and $14.3 million of state net operating loss
carryforwards at December 31, 2016 that expire beginning
in 2023.
federal net operating
included
Retained earnings at December 31, 2016
approximately $8.8 million for which no provision for
income taxes was made. This amount represents allocations
of income to bad debt deductions for tax purposes.
Reduction of amounts so allocated for purposes other than
absorbing losses will create income for tax purposes, which
will be subject to the then-current corporate income tax rate.
The Company considers the determination of the deferred
tax asset amount and the need for any valuation reserve to
be a critical accounting policy that requires significant
judgment. The Company has, in its judgment, made
reasonable assumptions and considered both positive and
negative evidence relating to the ultimate realization of
deferred
the
cumulative net income generated over the prior three year
period and the probability that taxable income will be
generated in future periods. Negative evidence includes the
current general business and economic environments.
Based upon this evaluation, the Company determined that
no valuation allowance was required with respect to the net
deferred tax assets at December 31, 2016 and 2015.
tax assets. Positive evidence
includes
NOTE 14 Employee Benefits
All eligible full-time employees of the Bank that were hired
prior to 2002 were included in a noncontributory retirement
plan sponsored by the Financial Institutions Retirement
Fund (FIRF). The Home Federal Savings Bank (Employer
#8006) plan participates in the Pentegra Defined Benefit
Plan for Financial Institutions (the Pentegra DB Plan). The
Pentegra DB Plan’s Employer Identification Number is 13-
5645888 and the Plan number is 333. The Pentegra DB Plan
operates as a multi-employer plan for accounting purposes
under the Employee Retirement Income Security Act of
1974, as amended (ERISA), and the Internal Revenue Code.
There are no collective bargaining agreements in place that
require contributions to the Pentegra DB Plan.
The Pentegra DB Plan is a single plan under Internal
Revenue Code Section 413(c) and, as a result, all of the
assets stand behind all of the liabilities. Accordingly, under
the Pentegra DB Plan, contributions made by a participating
employer may be used to provide benefits to participants of
other participating employers.
Effective September 1, 2002, the accrual of benefits for
existing participants was frozen and no new enrollments
were permitted into the plan. The actuarial present value of
accumulated plan benefits and net assets available for
benefits relating to the Bank's employees was not available
at December 31, 2016 because such information is not
accumulated for each participating institution. As of June
30, 2016, the Pentegra DB Plan valuation report reflected
that the Bank was obligated to make a contribution totaling
$0.2 million which was expensed in 2016 and paid in the
first quarter of 2017.
Funded status (market value of plan assets divided by
funding target) as of July 1 for the 2016, 2015, and 2014
plan years were 97.09%, 96.01%, and 97.98%, respectively.
Market value of plan assets reflects contributions received
through June 30, 2016.
Total employer contributions made to the Pentegra DB
Plan, as reported on Form 5500, equal $163.1 million,
$190.8 million, and $136.5 million for the plan years ended
June 30, 2015, 2014 and 2013, respectively. The Bank’s
contributions to the Pentegra DB Plan are not more than 5%
of the total contributions to the Pentegra DB Plan. There is
no funding improvement plan or rehabilitation plan as part
of this multi-employer plan.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following contributions were paid by the Bank during the fiscal years ending December 31:
(Dollars in thousands)
2016
Date Paid
10/15/16 .................. $
Total ....................... $
Amount
Date Paid
Amount
Date Paid
Amount
2015
2014
33* 10/15/2015
12/30/2015
33
$
$
42 10/15/2014
151 12/30/2014
193
$
$
46
164
210
* An additional contribution of $119,000 was accrued at December 31, 2016 and paid in the first quarter of 2017.
The Company has a qualified, tax-exempt savings plan with
a deferred feature qualifying under Section 401(k) of the
Internal Revenue Code (the 401(k) Plan). All employees
who have attained 18 years of age are eligible to participate
in the 401(k) Plan. Participants are permitted to make
contributions to the 401(k) Plan equal to the lesser of 50%
of their annual salary or the maximum allowed by law,
which was $18,000 for 2016 and 2015 and $17,500 for
2014. The Company matches 25% of each participant’s
contributions up to a maximum of 8% of their annual salary.
Participant contributions and earnings are fully and
immediately vested. The Company’s contributions are
vested on a three year cliff basis, are expensed annually, and
were $0.2 million in 2016 and 2015 and $0.1 million in
2014.
The Company has adopted an Employee Stock Ownership
Plan (the ESOP) that meets the requirements of Section
4975(e)(7) of the Internal Revenue Code and Section
407(d)(6) of ERISA and, as such, the ESOP is empowered
to borrow in order to finance purchases of the common
stock of HMN. The ESOP borrowed $6.1 million from the
Company to purchase 912,866 shares of common stock in
the initial public offering of HMN in 1994. As a result of a
merger with Marshalltown Financial Corporation (MFC),
the ESOP borrowed $1.5 million in 1998 to purchase an
additional 76,933 shares of HMN common stock to account
for the additional employees and avoid dilution of the
benefit provided by the ESOP. The ESOP debt requires
quarterly payments of principal plus interest at 7.52%. The
Company has committed to make quarterly contributions to
the ESOP necessary to repay the loans including interest.
The Company contributed $0.5 million in 2016, 2015, and
2014.
As the debt is repaid, ESOP shares that were pledged as
collateral for the debt are released from collateral based on
the proportion of debt service paid in the year and then
allocated to eligible employees. The Company accounts for
its ESOP in accordance with ASU 718, Employers'
Accounting
for Employee Stock Ownership Plans.
Accordingly, the shares pledged as collateral are reported as
unearned ESOP shares in stockholders' equity. As shares
are determined to be ratably released from collateral, the
Company reports compensation expense equal to the
current market price of the shares, and the shares become
outstanding for earnings per common share computations.
ESOP compensation expense was $0.3 million for each of
the years ending December 31, 2016, 2015 and 2014.
All employees of the Bank are eligible to participate in the
ESOP after they attain age 18 and complete one year of
service during which they worked at least 1,000 hours. A
summary of the ESOP share allocation is as follows for the
years ended December 31:
Shares held by participants
2016
2015
2014
beginning of the year ...................... 334,277 336,024 347,887
24,317
(36,180)
Shares allocated to participants .........
Shares distributed to participants ......
Shares held by participants end of
24,377
(18,784)
24,317
(26,064)
year ................................................. 339,870 334,277 336,024
Unreleased shares beginning of the
year ................................................. 304,123 328,440 352,757
Shares released during year ...............
(24,317)
Unreleased shares end of year ........... 279,746 304,123 328,440
Total ESOP shares end of year .......... 619,616 638,400 664,464
Fair value of unreleased shares at
(24,377)
(24,317)
December 31 ................................... $4,895,555 3,512,621 4,072,656
In March 2001, the HMN Financial, Inc. 2001 Omnibus
Stock Plan (2001 Plan) was adopted by the Company. In
April 2009, this plan was superseded by the HMN
Financial, Inc. 2009 Equity and Incentive Plan (2009 Plan)
and options or restricted shares were no longer awarded
from the 2001 Plan. As of December 31, 2016, all
outstanding options issued under the 2001 Plan have
expired.
The purpose of the 2009 Plan is to provide key personnel
and advisors with an opportunity to acquire a proprietary
interest in the Company. The opportunity to acquire a
proprietary interest in the Company is intended to aid in
attracting, motivating and retaining key personnel and
advisors, including non-employee directors, and to align
their interests with those of the Company’s stockholders.
350,000 shares of HMN common stock were initially
available for distribution under the 2009 Plan in either
restricted stock or stock options, subject to adjustment for
future stock splits, stock dividends and similar changes to
the capitalization of the Company. Additionally, shares of
restricted stock that are awarded are counted as 1.2 shares
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
for purposes of determining the total shares available for
issuance under the 2009 Plan. As of December 31, 2016,
there were 15,000 vested and 34,229 unvested options
under the 2009 Plan that remain unexercised. These options
expire 10 years from the date of grant and have a weighted
average exercise price of $9.25.
A summary of activities under all plans for the past three years is as follows:
Shares
Available
For Grant
Unvested
Restricted
Shares
Options
Outstanding
Outstanding
Unvested options
Award
Value/
Weighted
Average
Exercise
Price
Weighted
Average
Grant Date
Fair Value
Vesting
Period
Number
2001 Plan
December 31, 2013 ......................
Forfeited/expired ......................
December 31, 2014 ......................
Forfeited/expired ......................
December 31, 2015 ......................
December 31, 2016 .....................
2009 Plan
December 31, 2013 ......................
Granted January 7, 2014 ..........
Granted May 27, 2014 .............
Forfeited/expired ......................
Vested ......................................
December 31, 2014 ......................
Granted January 27, 2015 ........
Granted April 28, 2015 ............
Granted June 8, 2015 ...............
Forfeited/expired ......................
Forfeited/expired ......................
Vested ......................................
December 31, 2015 ......................
Granted January 26, 2016 .....
Granted January 26, 2016 .....
Granted April 26, 2016 ..........
Vested ......................................
December 31, 2016 .....................
Total all plans .............................
0
0
0
0
0
0
121,053
(28,627)
(26,561)
30,540
0
96,405
(11,903)
(3,158)
(398)
395
15,000
0
96,341
(4,087)
(34,229)
(3,149)
0
54,876
54,876
0
0
0
0
0
0
45,540 $
(30,540)
15,000
(15,000)
0
0
28.21
27.33
30.00
30.00
0.00
0.00
0
0
0
0
0
0
101,806
23,856
22,134
0
(62,938)
84,858
9,919
2,632
332
(329)
0
(58,526)
38,886
3,406
0
2,624
(24,320)
20,596
20,596
15,000 $
0
0
0
0
15,000
0
0
0
0
0
0
15,000
0
34,229
0
0
49,229
49,229 $
4.77
N/A
N/A
4.77
N/A
N/A
N/A
4.77
N/A
11.21
N/A
9.25
9.25
3,000 $
0
0
0
(3,000 )
0
0
0
0
0
0
0
0
0
34,229
0
0
34,229
34,229 $
3 years
3 years
3 years
1 year
1 year
3 years
3 years
1 year
4.41
4.41
4.04
4.04
4.04
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes information about stock options outstanding at December 31, 2016:
Date of Grant
May 6, 2009 ............................ $
4.77
January 26, 2016 ..................... $ 11.21
Exercise
Price
Number
Outstanding
15,000
34,229
49,229
Weighted
Average
Remaining
Contractual
Life in
Years
2.4
9.1
Number
Exercisable
15,000
0
15,000
Number
Unexercisable
Unrecognized
Compensation
Expense
0 $
34,229
34,229 $
0
59,528
59,528
Weighted
Average Years
Over Which
Unrecognized
Compensation
will be
Recognized
N/A
2.1
The Company will issue shares from treasury stock upon
the exercise of outstanding options.
In accordance with ASC 718, the Company recognized
compensation expense relating to the stock options granted
in 2016 over the vesting period. The amount of the expense
was determined under the fair value method. There were no
options granted in 2015 or 2014.
The fair value for each option grant is estimated on the date
of the grant using a Black Scholes option valuation model.
The assumptions used in determining the fair value of the
options granted during 2016 are as follows:
Risk-free interest rate ............................................................
Expected life ..........................................................................
Expected volatility .................................................................
Expected dividends ................................................................
2016
2.10%
10 years
22.83%
0.00%
NOTE 15 Earnings per Common Share
The following table reconciles the weighted average shares outstanding and net income for basic and diluted earnings per
common share:
(Dollars in thousands, except per share data)
Weighted average number of common shares outstanding used in basic
2016
Year ended December 31,
2015
2014
earnings per common share calculation .......................................................
4,180,994
4,127,453
4,060,404
Net dilutive effect of :
Options and warrants .................................................................................
Restricted stock awards ..............................................................................
553,386
13,367
513,505
34,959
507,856
55,783
Weighted average number of common shares outstanding adjusted for
effect of dilutive securities ..........................................................................
4,747,747
4,675,917
4,624,043
Net income ..................................................................................................... $
Dividends on preferred stock .........................................................................
Net income available to common shareholders .............................................. $
Basic earnings per common share .................................................................. $
Diluted earnings per common share ............................................................... $
6,350
0
6,350
1.52
1.34
2,956
(108)
2,848
0.69
0.61
7,379
(1,710 )
5,669
1.40
1.23
55
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 16 Stockholders' Equity
The Company did not repurchase any shares of its common
stock or pay any dividends on its common stock during
2016, 2015 or 2014.
The Company's certificate of incorporation authorizes the
issuance of up to 500,000 shares of preferred stock, and on
December 23, 2008, the Company completed the sale of
26,000 shares of Fixed Rate Cumulative Perpetual Preferred
Stock, Series A (Preferred Stock) to the United Stated
Department of Treasury (Treasury). The Preferred Stock
had a liquidation value of $1,000 per share and a related
warrant was also issued to purchase 833,333 shares of HMN
common stock at an exercise price of $4.68 per share (the
Warrant). The transaction was part of the Treasury’s Capital
Purchase Program under
the Emergency Economic
Stabilization Act of 2008.
On February 17, 2015, the Company redeemed the final
10,000 shares of the outstanding Preferred Stock. On May
21, 2015, the Treasury sold the Warrant at an exercise price
of $4.68 to three unaffiliated third party investors for an
aggregate purchase price of $5.7 million. Two of the
investors received a warrant to purchase 277,777.67 shares
and one investor received a warrant to purchase 277,777.66
shares. All of the warrants were still outstanding as of
December 31, 2016 and may be exercised at any time prior
to their expiration date of December 23, 2018. The
Company received no proceeds from this transaction and it
had no effect on the Company’s capital, financial condition
or results of operations.
In order to grant a priority to eligible accountholders in the
event of future liquidation, the Bank, at the time of
conversion to a stock savings bank, established a liquidation
account equal to its regulatory capital as of September 30,
1993. In the event of future liquidation of the Bank, an
eligible accountholder who continues to maintain their
deposit account shall be entitled to receive a distribution
from the liquidation account. The total amount of the
liquidation account will decrease as the balance of eligible
accountholders is reduced subsequent to the conversion,
based on an annual determination of such balance.
NOTE 17 Regulatory Capital
Effective January 1, 2015 the capital requirements of the
Company and the Bank were changed to implement the
regulatory requirements of the Basel III capital reforms. The
Basel III requirements, among other things, (i) apply a
strengthened set of capital requirements to the Bank (the
Company is exempt, pursuant to the Small Bank Holding
Company Policy Statement (Policy Statement) described
below), including requirements relating to common equity
as a component of core capital, (ii) implement a “capital
conservation buffer” against risk and a higher minimum tier
1 capital requirement, and (iii) revise the rules for
calculating risk-weighted assets for purposes of such
requirements. The rules made corresponding revisions to
the prompt corrective action framework and include the
new capital ratios and buffer requirements which will be
phased
implementation
scheduled for January 1, 2019. 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 their 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.
incrementally, with
full
in
from
The FRB amended its Policy Statement, to exempt small
bank holding companies
the above capital
requirements, by raising the asset size threshold for
determining applicability from $500 million to $1 billion.
The Policy Statement was also expanded to include savings
and
the Policy
Statement’s qualitative requirements for exemption. The
Company met the qualitative exemption requirements, and
therefore, is exempt from the above capital requirements.
loan holding companies
that meet
Quantitative measures established by regulations to ensure
capital adequacy require the Bank to maintain minimum
amounts and ratios (set forth in the following table and
defined in the regulation) 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.
56
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2016 and 2015, the Bank's capital amounts and ratios are presented for actual capital, required capital and
excess capital including amounts and ratios in order to qualify as being well capitalized under the prompt corrective action
regulations:
Actual
Amount
Percent of
Assets(1)
Required to be
Adequately Capitalized
Percent of
Assets(1)
Amount
Excess Capital
Amount
Percent of
Assets(1)
To Be Well Capitalized
Under Prompt
Corrective Action
Provisions
Amount
Percent of
Assets(1)
(Dollars in thousands)
December 31, 2016
Common equity tier 1
capital ........................... $ 77,634
77,634
77,634
84,900
Tier 1 leverage ................
Tier 1 risk-based capital .
Total risk-based capital ..
13.42 % $ 26,032
26,876
11.55
34,709
13.42
46,278
14.68
4.50% $ 51,602
50,758
4.00
42,925
6.00
38,622
8.00
8.92% $ 37,601
33,595
7.55
46,278
7.42
57,848
6.68
6.50%
5.00
8.00
10.00
December 31, 2015
Common equity tier 1
capital ............................ $ 71,520
71,520
71,520
77,934
Tier 1 leverage .................
Tier 1 risk-based capital ...
Total risk-based capital ....
14.08 % $ 22,854
24,971
11.46
30,473
14.08
40,630
15.35
4.50% $ 48,666
46,549
4.00
41,047
6.00
37,304
8.00
9.58% $ 33,012
31,213
7.46
40,630
8.08
50,788
7.35
6.50%
5.00
8.00
10.00
(1) Based upon the Bank’s adjusted total assets for the purpose of the Tier 1 leverage capital ratio and risk-weighted assets for the purpose of the risk-
based capital ratios.
Beginning in 2016, the Bank must maintain a capital
conservation buffer 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. For 2016, the capital
conservation buffer is 0.625%. The buffer amount will
increase incrementally each year until 2019 when the entire
2.50% capital conservation buffer will be fully phased in.
Management believes that, as of December 31, 2016, the
Bank’s capital ratios were in excess of those quantitative
capital ratio standards applicable on that date, set forth
under the 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 Office of the
Comptroller of the Currency has extensive discretion in its
supervisory and enforcement activities, and can further
adjust the requirement to be well-capitalized in the future.
57
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 18 Financial Instruments with Off-Balance Sheet
Risk
The Company is a party to financial instruments with off-
balance sheet risk in the normal course of business to meet
the financing needs of its customers. These financial
instruments include commitments to extend credit. These
commitments involve, to varying degrees, elements of
credit and interest rate risk in excess of the amounts
recognized in the balance sheet. The contract amounts of
these instruments reflect the extent of involvement by the
Company.
The Company's exposure to credit loss in the event of
nonperformance by the other party to the financial
instrument for commitments to extend credit is represented
by the contract amount of these commitments. The
Company uses
in making
commitments as it does for on-balance sheet instruments.
the same credit policies
collateralized primarily with commercial real estate
mortgages. Draws on standby letters of credit would be
initiated by the secured party under the terms of the
underlying obligation. Since the conditions under which the
Bank is required to fund the standby letters of credit may
not materialize, the cash requirements are expected to be
less than the total outstanding commitments.
The Company has certain obligations and commitments to
make future payments under existing contracts. At
December 31, 2016, the aggregate contractual obligations
(excluding bank deposits) and commercial commitments
were as follows:
Payments Due by Period
(Dollars in thousands)
Contractual Obligations:
Total
Less
than 1
Year
1-3
Years
4-5
Years
After 5
Years
December 31,
Contract Amount
2016
2015
Total borrowings ............... $ 7,000 1,000 2,000 4,000
Annual rental commitments
0
under non-cancellable
operating leases ................ 5,856
843 1,452 1,380 2,181
$12,856 1,843 3,452 5,380 2,181
(Dollars in thousands)
Financial instruments whose contract amount
represents credit risk:
Commitments to originate, fund or purchase
7,587
loans:
Single family mortgages .................................. $
4,292
Commercial real estate mortgages ................... 33,953 18,834
1,310
Non-real estate commercial loans ....................
Undisbursed balance of loans closed ............... 39,841 44,082
Unused lines of credit ....................................... 100,893 96,354
1,077
Letters of credit ................................................
Total commitments to extend credit ..................... $ 184,596 165,949
8,071
Forward commitments .......................................... $
9,595
1,902
420
Commitments to extend credit are agreements to lend to a
customer, at the customer’s request, as long as there is no
violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since
a portion of the commitments are expected to expire without
being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Bank
evaluates each customer's creditworthiness on a case-by-
case basis. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on
the loan type and on management's credit evaluation of the
borrower. Collateral consists primarily of residential and
commercial real estate and personal property.
Forward commitments represent commitments to sell loans
to a third party following the closing of the loan and are
entered into in the normal course of business by the Bank.
The Bank issued standby letters of credit which guarantee
the performance of customers to third parties. The standby
letters of credit outstanding expire over the next 26 months
and totaled $1.9 million at December 31, 2016 and $1.0
million at December 31, 2015. The letters of credit are
58
Amount of Commitments
Expiring by Period
Other Commercial
Commitments:
Commercial lines of
credit ................................. $50,229 26,523 9,282 9,414 5,010
Commitments to lend ........ 31,831 9,797 4,736 7,220 10,078
0
Standby letters of credit ..... 1,902 1,575
$83,962 37,895 14,345 16,634 15,088
327
0
NOTE 19 Derivative Instruments and Hedging
Activities
The Company originates single-family residential loans for
sale into the secondary market and enters into commitments
to sell those loans in order to mitigate the interest rate risk
associated with holding the loans until they are sold. The
Company accounts for its commitments in accordance with
ASC 815, Accounting for Derivative Instruments and
Hedging Activities.
the
into
loans
The Company had commitments outstanding to extend
credit to future borrowers that had not closed prior to the
end of the year, which is referred to as its mortgage pipeline.
As commitments to originate loans enter the mortgage
pipeline, the Company generally enters into commitments
the secondary market. The
to sell
commitments to originate and sell loans are derivatives that
are recorded at fair value. As a result of marking these
derivatives to fair value for the period ended December 31,
2016, the Company recorded an increase in other liabilities
of $11,000, an increase in other assets of $30,000 and a net
gain on the sale of loans of $19,000. As a result of marking
these derivatives to fair value for the period ended
December 31, 2015, the Company recorded a decrease in
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
other liabilities of $7,000, an increase in other assets of
$20,000 and a net gain on the sale of loans of $27,000.
liabilities are traded and the reliability of the assumptions
used to determine fair value. These levels are:
As of December 31, 2016 and 2015,
the current
commitments to sell loans held for sale are derivatives that
do not qualify for hedge accounting. The loans held for sale
that are not hedged are recorded at the lower of cost or
market. As a result of marking these loans for the period
ended December 31, 2016, the Company recorded a
decrease in other liabilities of $14,000 and a net gain on the
sale of loans of $14,000. As a result of marking these loans
for the period ended December 31, 2015, the Company
recorded an increase in other liabilities of $3,000, and a net
loss on the sales of loans of $3,000.
NOTE 20 Fair Value Measurement
ASC 820, Fair Value Measurements, establishes a
framework for measuring the fair value of assets and
liabilities using a hierarchy system consisting of three
levels, based on the markets in which the assets and
Level 1 - Valuation is based upon quoted prices for
identical instruments traded in active markets that the
Company has the ability to access.
Level 2 - Valuation is based upon quoted prices for
similar instruments in active markets, quoted prices for
identical or similar instruments in markets that are not
active, and model-based valuation techniques for which
significant assumptions are observable in the market.
Level 3 – Valuation is generated from model-based
techniques
that use significant assumptions not
observable in the market and are used only to the extent
that observable
inputs are not available. These
unobservable assumptions reflect our own estimates of
assumptions that market participants would use in
pricing the asset or liability. Valuation techniques
include use of option pricing models, discounted cash
flow models and similar techniques.
The following table summarizes the assets of the Company for which fair values are determined on a recurring basis as of
December 31, 2016 and 2015.
Carrying Value at December 31, 2016
(Dollars in thousands)
Securities available for sale ....................................................... $
Mortgage loan commitments .....................................................
Total ............................................................................................ $
Total
Level 1
78,477
66
78,543
Level 3
Level 2
0
0
0
78,477
66
78,543
Carrying Value at December 31, 2015
(Dollars in thousands)
Securities available for sale .......................................................... $ 111,974
Mortgage loan commitments ........................................................
36
Total ............................................................................................. $ 112,010
Total
Level 1
Level 2
Level 3
0
0
0
111,974
36
112,010
0
0
0
0
0
0
59
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company may also be required, from time to time, to
measure certain other financial assets at fair value on a
nonrecurring basis in accordance with generally accepted
accounting principles. These adjustments to fair value
usually result from the application of the lower-of-cost-or-
market accounting or write downs of individual assets. For
assets measured at fair value on a nonrecurring basis in
2016 and 2015 that were still held at December 31, the
following table provides the level of valuation assumptions
used to determine each adjustment and the carrying value of
the related individual assets or portfolios at December 31,
2016 and 2015.
Carrying Value at December 31, 2016
(Dollars in thousands)
Loans held for sale ...................................................... $
Mortgage servicing rights, net ...................................
Loans (1) ........................................................................
Real estate, net (2) .........................................................
Total ............................................................................. $
Total
Level 1
2,009
1,604
3,582
611
7,806
Level 3
Level 2
0
0
0
0
0
2,009
1,604
3,582
611
7,806
Carrying Value at December 31, 2015
(Dollars in thousands)
Loans held for sale ........................................................ $
Mortgage servicing rights, net .......................................
Loans (1) ........................................................................
Real estate, net (2) ..........................................................
Total .............................................................................. $
Total
Level 1
Level 2
Level 3
3,779
1,499
4,790
2,045
12,113
0
0
0
0
0
3,779
1,499
4,790
2,045
12,113
Year Ended
December
31, 2016
Total gains
(losses)
0
0
0
0
0
14
0
(380)
(197)
(563)
Year Ended
December
31, 2015
Total gains
(losses)
0
0
0
0
0
(3)
0
(373)
(262)
(638)
(1) Represents carrying value and related specific reserves on loans for which adjustments are based on the appraised value of the collateral.
The carrying value of loans fully charged-off is zero.
(2) Represents the fair value and related losses on foreclosed real estate and other collateral owned that were measured at fair
value subsequent to their initial classification as foreclosed assets.
NOTE 21 Fair Value of Financial Instruments
ASC 825, Disclosures about Fair Values of Financial
Instruments, requires disclosure of the estimated fair values
of the Company's financial instruments, including assets,
liabilities and off-balance sheet items for which it is
practicable to estimate fair value. The fair value estimates
are made as of December 31, 2016 and 2015 based upon
relevant market information, if available, and upon the
characteristics of the financial instruments themselves.
Because no market exists for a significant portion of the
Company's financial instruments, fair value estimates are
based upon judgments regarding future expected loss
experience,
risk
characteristics of various financial instruments, and other
conditions,
economic
current
factors. The estimates are subjective in nature and involve
uncertainties and matters of significant judgment and
therefore cannot be determined with precision. Changes in
assumptions could significantly affect the estimates.
Fair value estimates are based only on existing financial
instruments without attempting to estimate the value of
anticipated future business or the value of assets and
liabilities that are not considered financial instruments. In
addition, the tax ramifications related to the realization of
the unrealized gains and losses can have a significant effect
on the fair value estimates and have not been considered in
any of the estimates.
60
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The estimated fair value of the Company's financial instruments are shown below. Following the table, there is an explanation
of the methods and assumptions used to estimate the fair value of each class of financial instruments.
December 31, 2016
Fair value hierarchy
December 31, 2015
Carrying
amount
Estimated
fair value Level 1 Level 2 Level 3
Contract
amount
Carrying
amount
Estimated
fair value
Contract
amount
(Dollars in thousands)
Financial assets:
Cash and cash equivalents .......... $ 27,561
Securities available for sale ........
78,477
Loans held for sale ......................
2,009
Loans receivable, net .................. 551,171
FHLB stock .................................
770
Accrued interest receivable .........
2,626
27,561 27,561
78,477
2,009
552,395
770
2,626
78,477
2,009
552,395
770
2,626
3,779
39,782
39,782
111,974 111,974
3,779
463,185 458,539
691
2,254
691
2,254
Financial liabilities:
Deposits ....................................... 592,811
FHLB advances and other
borrowings ...............................
Accrued interest payable .............
7,000
236
593,297
593,297
559,387 558,731
7,018
236
7,018
236
9,000
242
9,000
242
Off-balance sheet financial
instruments:
Commitments to extend credit ....
Commitments to sell loans..........
66
(22 )
66
(22)
184,596
9,595
36
(26)
36 165,949
8,071
(26)
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents
approximates their fair value.
Securities Available for Sale
The fair values of securities were based upon quoted market
prices.
Loans Held for Sale
The fair values of loans held for sale were based upon
quoted market prices for loans with similar interest rates and
terms to maturity.
Loans Receivable
The fair values of loans receivable were estimated for
groups of loans with similar characteristics. The fair value
of the loan portfolio, with the exception of the adjustable
rate portfolio, was calculated by discounting the scheduled
cash flows through the estimated maturity using anticipated
prepayment speeds and using discount rates that reflect the
credit and interest rate risk inherent in each loan portfolio.
The fair value of the adjustable loan portfolio was estimated
by grouping the loans with similar characteristics and
comparing the characteristics of each group to the prices
quoted for similar types of loans in the secondary market.
FHLB Stock
The carrying amount of FHLB stock approximates its fair
value.
Accrued Interest Receivable
The carrying amount of accrued interest receivable
approximates its fair value since it is short-term in nature
and does not present unanticipated credit concerns.
Deposits
The fair value of demand deposits, savings accounts and
certain money market account deposits is the amount
payable on demand at the reporting date. The fair value of
fixed maturity certificates of deposit is estimated using the
rates currently offered for deposits of similar remaining
maturities.
The fair value estimate for deposits does not include the
benefit that results from the low cost funding provided by
the Company's existing deposits and long-term customer
relationships compared to the cost of obtaining different
sources of funding. This benefit is commonly referred to as
the core deposit intangible.
FHLB Advances and Other Borrowings
The fair values of advances and borrowings with fixed
maturities are estimated based on discounted cash flow
analysis using as discount rates the interest rates charged by
the FHLB for borrowings of similar remaining maturities.
Accrued Interest Payable
The carrying amount of accrued
approximates its fair value since it is short-term in nature.
interest payable
Commitments to Extend Credit
The fair values of commitments to extend credit are
estimated using the fees normally charged to enter into
similar agreements, taking into account the remaining terms
of the agreements and the present creditworthiness of the
counter parties.
Commitments to Sell Loans
The fair values of commitments to sell loans are estimated
using the quoted market prices for loans with similar
interest rates and terms to maturity.
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 22 HMN Financial, Inc. Financial Information (Parent Company Only)
The following are the condensed financial statements for the parent company only as of December 31, 2016 and 2015 and
for the years ended December 31, 2016, 2015 and 2014.
(Dollars in thousands)
Condensed Balance Sheets
Assets:
Cash and cash equivalents .......................................................................................... $
Investment in subsidiaries ...........................................................................................
Prepaid expenses and other assets ..............................................................................
Deferred tax asset, net .................................................................................................
Total assets ......................................................................................................... $
Liabilities and Stockholders' Equity:
Other borrowed money ............................................................................................... $
Accrued expenses and other liabilities .......................................................................
Total liabilities ...................................................................................................
Common stock ............................................................................................................
Additional paid-in capital ...........................................................................................
Retained earnings ........................................................................................................
Net unrealized losses on securities available for sale ................................................
Unearned employee stock ownership plan shares ......................................................
Treasury stock, at cost, 4,639,739 and 4,645,769 shares ...........................................
Total stockholders' equity ..................................................................................
Total liabilities and stockholders' equity ........................................................... $
Condensed Statements of Income
Interest income ............................................................................................................ $
Interest expense ...........................................................................................................
Equity income of subsidiaries .....................................................................................
Compensation and benefits .........................................................................................
Occupancy ...................................................................................................................
Data processing ...........................................................................................................
Professional services ...................................................................................................
Other............................................................................................................................
Income before income tax benefit .....................................................................
Income tax benefit ......................................................................................................
Net income ......................................................................................................... $
Condensed Statements of Cash Flows
Cash flows from operating activities:
Net income ................................................................................................................. $
Adjustments to reconcile net income to cash used by operating activities:
Equity income of subsidiaries ................................................................................
Deferred income tax benefit (expense) ..................................................................
Earned employee stock ownership shares priced above original cost ...................
Stock option compensation ....................................................................................
Amortization of restricted stock awards ................................................................
Decrease in unearned ESOP shares .......................................................................
Decrease (increase) in other assets .........................................................................
Decrease in other liabilities ....................................................................................
Other, net ................................................................................................................
Net cash used by operating activities ................................................................
Cash flows from investing activities:
Decrease in loans receivable, net ...........................................................................
Net cash provided by investing activities ..........................................................
Cash flows from financing activities:
Redemption of preferred stock ...............................................................................
Dividends to preferred stockholders ......................................................................
Proceeds from borrowings .....................................................................................
Repayments of borrowings ....................................................................................
Dividends received from Bank ..............................................................................
Net cash provided by financing activities ..............................................................
Increase in cash and cash equivalents ....................................................................
Cash and cash equivalents, beginning of year ................................................................
Cash and cash equivalents, end of year ........................................................................... $
62
2016
2015
2014
3,314
78,108
44
756
82,222
7,000
(697)
6,303
91
50,566
86,886
(820)
(2,223)
(58,581)
75,919
82,222
0
(589)
7,148
(264)
(30)
(6)
(138)
(329)
5,792
(558)
6,350
2,564
74,565
33
1,000
78,162
9,000
(483)
8,517
91
50,388
80,536
(214)
(2,417)
(58,739)
69,645
78,162
1
(571)
3,629
(269)
(30)
(6)
(119)
(216)
2,419
(537)
2,956
6,350
2,956
(7,148)
244
80
79
177
194
(11)
(214)
(1)
(250)
0
0
0
0
0
(2,000)
3,000
1,000
750
2,564
3,314
(3,629)
22
57
0
447
193
(23)
(692)
1
(668)
900
900
(10,000)
(225)
10,000
(1,000)
3,000
1,775
2,007
557
2,564
1
0
7,644
(233 )
(24 )
(6 )
(165 )
(374 )
6,843
(536 )
7,379
7,379
(7,644 )
(92 )
53
1
240
194
69
(420 )
0
(220 )
100
100
(16,000 )
(5,964 )
0
0
22,500
536
416
141
557
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 23 Business Segments
The Bank has been identified as a reportable operating
segment in accordance with the provisions of ASC 280.
HMN, the holding company, did not meet the quantitative
thresholds for a reportable segment and therefore is
included in the “Other” category. The Company evaluates
performance and allocates resources based on the segment’s
net income, return on average assets, and return on average
equity. Each corporation is managed separately with its own
officers and board of directors.
The following table sets forth certain information about the reconciliations of reported net income and assets for each of the
Company’s reportable segments.
(Dollars in thousands)
Home
Federal
Savings
Bank
Other
Eliminations
Consolidated
Total
At or for the year ended December 31, 2016:
Interest income – external customers .............................................. $
Non-interest income – external customers ......................................
Intersegment interest income ...........................................................
Intersegment non-interest income ...................................................
Interest expense .................................................................................
Non-interest expense .........................................................................
Income tax expense (benefit) ............................................................
Net income .........................................................................................
Total assets .........................................................................................
At or for the year ended December 31, 2015:
Interest income – external customers .................................................. $
Non-interest income – external customers ..........................................
Intersegment interest income ..............................................................
Intersegment non-interest income .......................................................
Interest expense ...................................................................................
Non-interest expense ...........................................................................
Income tax expense (benefit) ..............................................................
Net income ..........................................................................................
Total assets ..........................................................................................
At or for the year ended December 31, 2014:
Interest income – external customers .................................................. $
Non-interest income – external customers ..........................................
Intersegment interest income ..............................................................
Intersegment non-interest income .......................................................
Interest expense ...................................................................................
Non-interest expense ...........................................................................
Income tax expense (benefit) ..............................................................
Net income ..........................................................................................
Total assets ..........................................................................................
27,349
8,201
0
210
1,004
23,572
4,680
7,148
681,257
21,453
7,653
0
204
937
22,760
2,148
3,629
642,151
20,613
7,284
0
180
1,213
20,781
5,438
7,644
576,397
0
0
1
7,148
589
768
(558)
6,350
82,222
0
0
1
3,629
571
640
(537)
2,956
78,162
0
0
2
7,644
0
802
(536)
7,379
76,221
0
0
(1)
(7,358)
0
(210)
0
(7,148)
(81,456)
0
0
(1)
(3,833)
(1)
(204)
0
(3,629)
(77,152)
0
0
(2)
(7,824)
(2)
(180)
0
(7,644)
(75,192)
27,349
8,201
0
0
1,593
24,130
4,122
6,350
682,023
21,453
7,653
0
0
1,507
23,196
1,611
2,956
643,161
20,613
7,284
0
0
1,211
21,403
4,902
7,379
577,426
63
64
OTHER FINANCIAL DATA
The following tables set forth certain information as to the Bank’s Federal Home Loan Bank (FHLB) advances.
(Dollars in thousands)
Maximum Balance:
Year Ended December 31,
2016
2015
2014
FHLB advances ........................................................................................ $
FHLB short-term advances ......................................................................
15,500
15,500
Average Balance:
FHLB advances ........................................................................................
FHLB short-term advances ......................................................................
468
468
16,000
16,000
551
551
0
0
0
0
See “Note 12 Federal Home Loan Bank (FHLB) Advances and Other Borrowings” in the Notes to Consolidated Financial
Statements for more information on the Bank’s FHLB advances and other borrowings.
65
December 31, 2016
September 30, 2016
June 30, 2016
6,711
420
6,291
(374)
6,665
874
296
770
257
2,197
3,748
(161)
1,047
308
386
877
6,205
2,657
973
1,684
0
1,684
0.40
0.35
6,954
404
6,550
80
6,470
901
280
656
310
2,147
3,723
(11)
998
299
252
940
6,201
2,416
1,002
1,414
0
1,414
0.34
0.30
0.99%
8.93
11.07
3.89
0.84%
7.55
11.10
4.10
682,023
1,005
77,472
2,009
551,171
592,811
7,000
75,919
685,667
1,306
78,810
5,879
540,583
592,243
9,000
74,834
7,159
395
6,764
381
6,383
873
271
705
253
2,102
3,598
(75 )
1,006
281
368
855
6,033
2,452
974
1,478
0
1,478
0.35
0.31
0.91 %
8.23
11.07
4.36
653,385
1,641
73,924
3,159
530,425
563,060
9,000
73,337
SELECTED QUARTERLY FINANCIAL DATA
(Dollars in thousands, except per share data)
Selected Operations Data (3 months ended):
Interest income ...................................................................... $
Interest expense .....................................................................
Net interest income ...........................................................
Provision for loan losses .......................................................
Net interest income after provision for loan losses ...........
Non-interest income:
Fees and service charges ...................................................
Loan servicing fees ...........................................................
Gain on sales of loans .......................................................
Other .................................................................................
Total non-interest income .............................................
Non-interest expense:
Compensation and benefits ...............................................
(Gains) losses on real estate owned ...................................
Occupancy and equipment ................................................
Data processing .................................................................
Professional services .........................................................
Other .................................................................................
Total non-interest expense ............................................
Income before income tax expense ...................................
Income tax expense ...............................................................
Net income ........................................................................
Preferred stock dividends ..................................................
Net income available to common stockholders ................. $
Basic earnings per common share ......................................... $
Diluted earnings per common share ...................................... $
Financial Ratios:
Return on average assets(1) ....................................................
Return on average common equity(1) ....................................
Average equity to average assets ..........................................
Net interest margin(1)(2)..........................................................
(Dollars in thousands)
Selected Financial Condition Data:
Total assets ............................................................................ $
Securities available for sale:
Mortgage-backed and related securities ............................
Other marketable securities ...............................................
Loans held for sale ................................................................
Loans receivable, net ............................................................
Deposits ................................................................................
FHLB advances and other borrowings ..................................
Stockholders’ equity .............................................................
(1) Annualized
(2) Net interest income divided by average interest-earning assets
66
March 31, 2016
December 31, 2015
September 30, 2015
June 30, 2015
March 31, 2015
6,525
374
6,151
(732)
6,883
779
261
487
228
1,755
3,695
(349)
990
273
251
831
5,691
2,947
1,173
1,774
0
1,774
0.43
0.38
1.12%
10.12
11.11
4.09
638,156
1,984
103,844
4,467
490,260
551,506
9,000
71,687
6,109
393
5,716
75
5,641
827
268
536
330
1,961
3,448
97
981
267
325
878
5,996
1,606
516
1,090
0
1,090
0.26
0.23
0.69%
6.19
11.70
3.80
5,390
397
4,993
(56)
5,049
863
262
613
493
2,231
3,299
168
936
254
273
1,039
5,969
1,311
491
820
0
820
0.20
0.18
0.53%
4.77
11.91
3.44
5,070
391
4,679
(183)
4,862
844
257
530
236
1,867
3,540
65
926
268
293
708
5,800
929
344
585
0
585
0.14
0.13
0.42%
3.50
12.30
3.56
643,161
618,917
564,001
2,283
109,691
3,779
463,185
559,387
9,000
69,645
7,080
138,258
5,153
432,174
531,586
10,000
68,710
2,115
123,326
5,968
368,110
481,476
10,000
67,494
4,884
326
4,558
0
4,558
782
261
285
268
1,596
3,448
(112)
879
231
217
770
5,433
721
260
461
(108)
353
0.09
0.08
0.33%
2.60
12.62
3.42
565,487
2,471
151,674
2,663
360,370
483,323
10,000
66,775
67
COMMON STOCK INFORMATION
The common stock of the Company is listed on the Nasdaq Stock Market (Nasdaq) under the symbol HMNF. As of December
31, 2016, the Company had 9,128,662 shares of common stock issued and 4,639,739 shares in treasury stock. As of December
31, 2016, there were 572 stockholders of record and 1,036 estimated beneficial stockholders. The following table presents
the stock price information for the Company as furnished by Nasdaq for each quarter for the last two fiscal years. On February
13, 2017, the last reported sale price of shares of our common stock on the Nasdaq was $18.50 per share. The Company has
not paid a dividend on its common stock during the two year period ending December 31, 2016 and no common stock
dividends are anticipated to be paid in 2017. See “Liquidity and Capital Resources – Dividends” in the “Management
Discussion and Analysis” section of this annual report for a description of restrictions on the ability of the Company and the
Bank to pay dividends.
December 31,
2016
September 30,
2016
For the Quarter Ended
March 31,
2016
December 31,
2015
June 30,
2016
September 30,
2015
June 30,
2015
March 31,
2015
HIGH ........... $
LOW ............
CLOSE ........
18.55
13.58
17.50
15.00
13.25
14.16
14.44
11.25
13.58
11.80
10.81
11.26
12.06
11.06
11.55
12.06
10.88
11.51
12.61
10.18
11.79
12.92
11.46
12.10
The following graph and table compares the total cumulative stockholders’ return on the Company’s common stock to the
NASDAQ U.S. Stock Index (“NASDAQ Composite”), which includes all NASDAQ traded stocks of U.S. companies, and
the SNL Bank NASDAQ Index. The graph and table assume that $100 was invested on December 31, 2011 and that all
dividends were reinvested.
Index
HMN Financial, Inc. ...........................
NASDAQ Composite ..........................
SNL Bank NASDAQ Index ................
12/31/11
12/31/12
12/31/13
12/31/14
12/31/15
100.00
100.00
100.00
179.30
117.45
119.19
545.97
164.57
171.31
640.50
188.84
177.42
596.59
201.98
191.53
12/31/16
903.93
219.89
265.56
68
HMN FINANCIAL, INC.
1016 Civic Center Drive NW
Rochester, MN 55901
(507) 535-1200
ANNUAL MEETING
The annual meeting of shareholders will
be held on Tuesday, April 25, 2017 at
10:00 a.m. (Central Time) at the
Rochester Golf and Country Club, 3100
West Country Club Road, Rochester,
Minnesota.
LEGAL COUNSEL
Faegre Baker Daniels LLP
2200 Wells Fargo Center
90 South Seventh Street
Minneapolis, MN 55402-3901
INDEPENDENT REGISTERED PUBLIC
ACCOUNTING FIRM
CliftonLarsonAllen LLP
220 South Sixth Street, Suite 300
Minneapolis, MN 55402-1436
INVESTOR INFORMATION AND FORM 10-K
HMN’s Form 10-K, filed with the
Securities and Exchange Commission,
is available without charge upon
written request from:
HMN Financial, Inc.
Attn: Cindy Hamlin, Investor Relations
1016 Civic Center Drive NW
Rochester, MN 55901
or at www.hmnf.com
TRANSFER AGENT AND REGISTRAR
Inquiries regarding change of address,
transfer requirements, and lost
certificates should be directed to HMN’s
transfer agent:
Wells Fargo Bank, N.A.
Shareowner Services
1110 Centre Pointe Curve, Suite 101
MAC N9173-010
Mendota Heights, MN 55120
www.wellsfargo.com/shareownerservices
(800) 468-9716
DIRECTORS
DR. HUGH C. SMITH
Chairman of the Board
HMN and Home Federal Savings Bank
Retired Professor of Medicine, Mayo
Clinic College of Medicine and
Consultant in Cardiovascular Division,
Mayo Clinic
ALLEN J. BERNING
Chief Executive Officer
Ambient Clinical Analytics
MICHAEL A. BUE
Retired President and
Chief Executive Officer
Security State Bank of Lewiston
BRADLEY C. KREHBIEL
President and Chief Executive Officer
HMN and Home Federal Savings Bank
BERNARD R. NIGON
Retired Audit Partner with RSM US LLP
(formerly McGladrey & Pullen, LLP)
DR. WENDY S. SHANNON
Assistant Professor, Winona State
University
DR. PATRICIA S. SIMMONS
Retired Professor of Pediatric and
Adolescent Medicine, Mayo Clinic
College of Medicine
MARK E. UTZ
Attorney at law, Wendland Utz, Ltd.
HANS K. ZIETLOW
Director of Real Estate for Kwik Trip,
Inc.
EXECUTIVE OFFICERS WHO ARE NOT
DIRECTORS
JON J. EBERLE
Senior Vice President, Chief Financial
Officer and Treasurer of HMN and
Executive Vice President, Chief
Financial Officer and Treasurer of Home
Federal Savings Bank
SUSAN K. KOLLING
Senior Vice President
HMN and Home Federal Savings Bank
LAWRENCE D. MCGRAW
Executive Vice President and
Chief Operating Officer
Home Federal Savings Bank
BRANCH OFFICES OF BANK
Albert Lea
143 West Clark Street
Albert Lea, MN 56007
(507) 379-2551
Austin
201 Oakland Avenue West
Austin, MN 55912
(507) 434-2500
Eagan
2805 Dodd Road, Suite 160
Eagan, MN 55121
(651) 405-2000
Kasson
203 West Main
Kasson, MN 55944
(507) 634-7022
502 South Mantorville Avenue
Kasson, MN 55944
(507) 634-4141
La Crescent
208 South Walnut
La Crescent, MN 55947
(507) 895-9200
Marshalltown
303 West Main Street
Marshalltown, IA 50158
(641) 754-6198
Rochester
1201 South Broadway
Rochester, MN 55901
(507) 536-2416
1016 Civic Center Drive NW
Rochester, MN 55901
(507) 535-1309
100 1st Avenue Bldg., Suite 200
Rochester, MN 55902
(507) 280-7256
2048 Superior Drive NW, Suite 400
Rochester, MN 55901
(507) 226-0800
Spring Valley
715 North Broadway
Spring Valley, MN 55975
(507) 346-9709
Winona
175 Center Street
Winona, MN 55987
(507) 453-6460
LOAN PRODUCTION OFFICES
Sartell
50 14th Ave E, Suite 100
Sartell, MN 56377
(320) 654-4020
Owatonna
1850 Austin Road, Suite 103
Owatonna, MN 55060
(507) 413-6420
Mankato
100 Warren Street, Suite 300
Mankato, MN 56001
(507) 455-0174
Delafield
3960 Hillside Drive, Suite 206
Delafield, WI 53018
(262) 337-9511
1016 Civic Center Drive NW
Rochester, Minnesota 55901
507.535.1200 • www.hmnf.com
2016
Annual Report
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