2018 ANNUAL REPORT
TABLE OF CONTENTS
Financial Highlights ............................................................................................................................................................... 1
Letter to Shareholders and Clients ......................................................................................................................................... 2
Board of Directors .................................................................................................................................................................. 4
Five-year Consolidated Financial Highlights ......................................................................................................................... 5
Management Discussion and Analysis ................................................................................................................................... 6
Consolidated Financial Statements ........................................................................................................................................ 25
Notes to Consolidated Financial Statements .......................................................................................................................... 29
Report of Independent Registered Public Accounting Firm .................................................................................................. 60
Other Financial Data .............................................................................................................................................................. 61
Selected Quarterly Financial Data ......................................................................................................................................... 62
Common Stock Information ................................................................................................................................................... 64
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 thirteen full service offices in Minnesota located in Albert Lea, Austin, Eagan, Kasson (2),
La Crescent, Owatonna, Rochester (4), Spring Valley and Winona and one full service office in Marshalltown, Iowa. The
Bank also operates two loan origination offices located in Sartell, Minnesota and Delafield, Wisconsin.
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 ..................................................................................... $
Per Common Share Information:
Earnings per common share and common share equivalents:
Basic .............................................................................................. $
Diluted ...........................................................................................
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 .............................................................................................
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 ..................................................................
At or For the Year Ended
December 31,
Percentage
2018
2017
Change
30,381
2,233
28,148
(649)
28,797
3,330
1,255
2,095
1,034
7,714
25,387
11,124
2,888
8,236
1.89
1.71
21.90
18.05
19.62
17.19
114.14%
1.14%
9.88
4.03
3.51
11.52
11.67
0.43
70.79
27,680
1,797
25,883
(523 )
26,406
3,354
1,202
2,138
960
7,654
25,254
8,806
4,402
4,404
1.04
0.90
19.45
16.60
19.10
17.97
106.29 %
0.63 %
5.52
3.86
3.62
11.43
11.18
0.52
75.30
9.8%
24.3
8.8
(24.1)
9.1
(0.7)
4.4
(2.0)
7.7
0.8
0.5
26.3
(34.4)
87.0
81.0%
79.0
4.4
(3.0)
0.8
4.4
(17.3)
(6.0)
December 31,
Percentage
2018
2017
Change
712,315
79,980
3,444
586,688
623,352
83,147
13.26%
11.00
13.26
14.52
722,685
77,472
1,837
585,931
635,601
80,818
12.45%
10.68
12.45
13.71
(1.4)%
3.2
87.5
0.1
(1.9)
2.9
6.5%
3.0
6.5
5.9
1
LETTER TO SHAREHOLDERS AND CLIENTS
I am pleased to present you with our 2018 Annual Report. As I reflect on the past year, a
number of events, milestones and outcomes stand out above others for me.
Like most for-profit businesses, our company benefited from the Tax Cuts and Jobs Act that
was signed into law in December 2017. The lower federal tax rate substantially reduced our
federal income tax expense for 2018. The long term impact of the tax bill remains to be seen
since some provisions it contains are not permanent. Furthermore, residents of states like
Minnesota that have comparatively high state and local taxes rates might find themselves
paying more in taxes than in previous years since the tax bill includes a cap on state and local
taxes which can be claimed as an itemized deduction. These changes could have an impact on
future consumer spending and borrowing.
During 2018, the Open Market Committee of the Federal Reserve raised its benchmark interest
rate four times. This action resulted in a 100 basis point increase in the Prime Rate to 5.50% -
its highest level since March 2008. Since our bank is asset sensitive, we were positioned to
benefit from the increase in interest rates and our net interest income for the year increased $2.2 million to $28.1 million. The
rising short term rates resulted in many commercial borrowers requesting long term fixed rates on their loans. Fortunately,
our lenders were able to retain our best clients while limiting the interest rate risk associated with increasing the loan portfolio
duration.
Asset quality continued to improve during the year with non-performing assets declining by over 18%. Competition for loan
growth remained fierce in a number of our markets both in terms of loan pricing and structure. In response, management
elected to use these market conditions to identify and move over $16 million in higher risk loans out of the bank. While this
action adversely impacted outstanding loan balances at year end, it was a significant factor in the reverse provision for loan
losses of $0.6 million that was experienced during the year. I am very proud of the job that our lenders and credit
administration staff did to accomplish the above results.
Our tier I leverage ratio at year end was a strong 11.0%. When combined with our previously mentioned strong asset quality,
we are in an excellent position to weather potential economic downturns or capitalize on acquisition opportunities.
Our efficiency ratio, a measure of how many cents in noninterest expense it costs to generate one dollar of income, improved
to 70.79% from 75.30% the previous year. This ratio continues to be a focus of management who looks to increase non-
interest income and reduce non-interest expense wherever possible.
We believe that quality organic growth should always be a top priority for management. We also believe that organic growth
derived by expanding existing relationships can be the most cost effective growth. Therefore we worked diligently this past
year to improve communication across product lines, and our employees have been encouraged and rewarded to identify and
satisfy client needs.
We recognize that organic growth will not, in itself, be sufficient to achieve our growth goals and that a proactive acquisition
strategy is needed. During 2018 we identified a number of opportunities to grow the bank through branch and whole bank
acquisitions. We performed an initial analysis of each opportunity and prepared bids for several banks and/or branch
purchases during the year. Unfortunately, we were not successful in our bidding on any of these opportunities because we
were unable to meet the sellers’ pricing expectations. We continue to search for new opportunities to grow the bank through
acquisitions and will remain disciplined in our approach to determining the purchase price of the acquisition and the potential
impact it would have on HMN shareholders.
2
While bank delivery channels continue to move toward more mobile and online transactions, we understand that we must
continue to provide traditional facilities to serve our clients as well. In April 2018, we opened our new full service branch in
Owatonna, Minnesota, which replaced the loan production office we had been operating in that market since 2015. The design
of this branch utilizes the latest technology and floor plan which enabled us to reduce staff count by approximately 25%
compared to older branches. During the year we also announced plans to remodel and expand our existing drive up facility
and consolidate our two offices in Kasson, Minnesota into that facility. The goal of this project is to reduce overhead expense
while improving convenience for our clients. In the fourth quarter of 2018, we purchased an existing branch facility in the
greater Milwaukee, Wisconsin area to support our growing loan portfolio in that market. We plan to move our existing
Delafield, Wisconsin loan production office into the new facility and open a full service branch later in 2019.
We also recognize the importance of dedicating sufficient resources to support online and mobile banking platforms. In 2018,
we rolled out our new online mortgage loan application for new and existing clients. The response was very positive as it
allows our busy clients access to a convenient channel to provide us with the information we need to underwrite and approve
their loan request. We are continuing to develop additional online channels for new and existing clients to apply for the many
other products we offer.
Finally, during this past year all of the outstanding HMN common stock warrants issued in 2008 in connection with the U.S.
Treasury Capital Purchase Program were either exercised by the warrant holder or purchased by the Company. I am proud to
say that HMN Financial repaid 100% of the funds invested in us by the U.S. Treasury.
I want to take this opportunity to thank our investors, employees and our Board of Directors for their help and support in
making 2018 a successful year for HMN Financial.
Best Regards,
Bradley 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
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 ..............................................
Net income .........................................................
Preferred stock dividends and discount ..............
Net income available to common shareholders .. $
2018
30,381
2,233
28,148
(649)
28,797
3,330
1,255
2,095
1,034
7,714
25,387
11,124
2,888
8,236
0
8,236
Year Ended December 31,
2016
2015
2017
27,680
1,797
25,883
(523)
26,406
3,354
1,202
2,138
960
7,654
25,254
8,806
4,402(1)
4,404
0
4,404
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
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
2014
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)
5,669
Basic earnings per common share ...................... $
Diluted earnings per common share ...................
1.89
1.71
1.04
0.90
1.52
1.34
0.69
0.61
1.40
1.23
(1) Relates to the decrease in the Company’s net deferred tax asset as a result of the reduction in the corporate federal tax rate from 34% to 21% in the fourth
quarter of 2017.
2018
Selected Financial Condition Data:
(Dollars in thousands, except per share data)
Total assets .......................................................... $ 712,315 722,685 682,023 643,161 577,426
78,477 111,974 137,834
Securities available for sale ..................................
79,980
2,076
2,009
3,444
Loans held for sale ...............................................
Loans receivable, net ............................................ 586,688 585,931 551,171 463,185 365,113
Deposits ................................................................ 623,352 635,601 592,811 559,387 496,750
Federal Home Loan Bank advances and other
borrowings ..........................................................
Stockholders’ equity .............................................
Book value per common share .............................
0
83,147
17.19
9,000
69,645
15.54
0
80,818
17.97
7,000
75,919
16.91
December 31,
2016
0
76,013
14.77
77,472
1,837
3,779
2017
2015
2014
Number of full service offices ..............................
Number of loan origination offices ......................
14
2
13
3
13
3
13
3
11
2
Key Ratios: (2)
Stockholders’ equity to total assets at year end ....
Average stockholders’ equity to average assets ...
Return on stockholders’ equity (ratio of net
income to average equity) ...................................
Return on assets (ratio of net income to average
assets) .................................................................
11.67%
11.52
11.18%
11.43
11.13%
11.07
10.83%
11.70
13.16%
13.25
9.88
5.52
8.71
4.27
9.12
1.14
0.63
0.96
0.50
1.21
(2) 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
This Annual Report, other reports filed by the Company
with the Securities and Exchange Commission (SEC), and
the HMN Financial, Inc.’s (HMN or the Company) 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 the
financial performance of our core banking operations,
maintaining credit quality, reducing non-performing assets,
and generating improved financial results (including
profitability); the adequacy and amount of liquidity and
capital resources available to the Home Federal Savings
Bank (the Bank); the Company’s liquidity and capital
requirements; our expectations for core capital and our
strategies and potential strategies for maintenance thereof;
changes in loan production; changes in the size of the
Bank’s loan portfolio; the amount of the Bank’s non-
performing assets and the appropriateness of the allowance
therefor; anticipated future levels of the provision for loan
losses; future losses on non-performing assets; the amount
and composition of interest-earning assets; the amount of
yield enhancements relating to non-accruing and purchased
loans; the amount and composition of non-interest and
interest-bearing liabilities; the availability of alternate
funding sources; the payment of dividends by HMN; the
future outlook for the Company; the amount of deposits that
will be withdrawn from checking and money market
accounts and how any withdrawn deposits will be replaced
and priced; the projected changes in net interest income
based on rate shocks; the range that interest rates may
fluctuate over the next twelve months; the net market risk of
interest rate shocks; the future outlook for the issuer of the
trust preferred securities held by the Bank; the ability of the
Bank to pay dividends to HMN; the ability to remain well
capitalized; the impact of new accounting pronouncements;
and compliance by the Bank with regulatory standards
the Bank’s status as “well-
generally
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
standard, directive or
requirement.
regulatory
(including
such
A number of factors could cause actual results to differ
the Company’s assumptions and
materially
expectations. These include but are not limited to the
adequacy and marketability of real estate and other
from
collateral securing loans to borrowers; federal and state
regulation and enforcement; possible legislative and
regulatory changes, including changes to regulatory capital
rules; the ability of the Bank to comply with other applicable
regulatory capital requirements; enforcement activity of the
OCC and FRB in the event of our non-compliance with any
applicable regulatory standard or requirement; adverse
economic, business and competitive developments such as
shrinking interest margins, reduced collateral values,
deposit outflows, changes in credit or other risks posed by
the Company’s loan and investment portfolios; changes in
costs associated with traditional and alternate funding
sources, including changes in collateral advance rates and
policies of the Federal Home Loan Bank (FHLB);
technological, computer-related or operational difficulties,
including those from any third party cyberattack; results of
litigation; reduced demand for financial services and loan
products; changes in accounting policies and guidelines, or
monetary and fiscal policies of the federal government or
tax
the
Company’s access to and adverse changes in securities
markets; the market for credit related assets; the future
flow
financial
operating
requirements and capital spending priorities of
the
Company and the Bank; the availability of internal and, as
required, external sources of funding; our ability to attract
and retain employees; or other significant uncertainties.
Additional factors that may cause actual results to differ
from the 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 SEC. 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, 2018.
international economic developments;
condition,
results,
laws;
cash
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
6
MANAGEMENT DISCUSSION AND ANALYSIS
spread. Net interest income and net interest rate spread are
affected by changes in interest rates, the volume and
composition of interest-earning assets and interest-bearing
liabilities, and the level of non-performing assets. The
Company's net earnings are also affected by the generation
of non-interest income, which consists primarily of gains
from the sale of loans 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 compensation and benefits,
occupancy and equipment expenses, provisions for loan
losses,
insurance,
services,
amortization expense on mortgage servicing assets, data
processing costs and income taxes. The earnings of financial
institutions, such as the Bank, are also significantly affected
by prevailing economic and competitive conditions,
particularly changes in interest rates, government monetary
and fiscal policies, and regulations of various regulatory
authorities. Lending activities are influenced by the demand
for and supply of business credit, single family and
commercial properties, competition among lenders, the
level of interest rates and the availability of funds. Deposit
flows and costs of deposits are influenced by prevailing
market rates of interest on competing investments, account
maturities and the levels of personal income and savings.
professional
deposit
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, historical loss experience and
observations made by the Company's ongoing internal audit
and regulatory exam processes. Loans are charged off to the
7
for
the
the non-homogeneous
to determine
loss allowance for
extent they are deemed to be uncollectible. The Company
the
has established separate processes
appropriateness of
its
loan
homogeneous and non-homogeneous loan portfolios. The
determination of the allowance on the homogeneous single
family and consumer loan portfolios is calculated on a
pooled basis with individual determination of the allowance
for all non-performing loans. The determination of the
allowance
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
identified credit
are assigned
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.
reviewed periodically and any
The estimates are
adjustments are recorded in the provision for loan losses in
the periods in which the adjustments become known.
Because of the size of some loans, changes in estimates can
have a significant impact on the loan loss provision. The
allowance is allocated to individual loan categories based
upon the relative risk characteristics of the loan portfolios
and the actual loss experience. The Company increases its
allowance for loan losses by charging the provision for loan
losses against income and by receiving recoveries of
previously charged off loans. The Company decreases its
allowance by crediting the provision for loan losses and
recording loan charge offs. The current year activity 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.
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
relates to the allowance for loan and real estate losses. For
tax purposes only the net charge-offs are deductible while
the entire provision for loan losses is used to determine book
income. A deferred tax asset is created because of the timing
difference of when the expense is recognized for book and
tax purposes. Under 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
and dependent upon management’s
judgment and
evaluation of both positive and negative evidence, including
the forecasts of future income, tax planning strategies, and
assessments of the current and future economic and
business conditions. The positive evidence considered
includes the Company’s cumulative net income in the prior
three year period, the ability to implement tax planning
strategies to accelerate taxable income recognition, and the
probability that taxable income will be generated in future
periods. The Company could not currently identify any
negative evidence. It is possible that future conditions may
differ substantially from those anticipated in determining
that no valuation allowance was required on deferred tax
assets and adjustments may be required in the future.
Determining the ultimate settlement of any tax position
requires significant estimates and judgments in arriving at
the amount of tax benefits to be recognized in the financial
statements. It is possible that the tax benefits realized upon
the ultimate resolution of a tax position may result in tax
benefits
those
estimated.
that are significantly different from
8
Results of Operations
Comparison of 2018 with 2017
Net income was $8.2 million for 2018, an increase of $3.8
million, or 87.0%, compared to net income of $4.4 million
for 2017. Diluted earnings per share for the year ended
December 31, 2018 was $1.71, an increase of $0.81 per
share compared to diluted earnings per share of $0.90 for
the year ended December 31, 2017. The increase in net
income for 2018 is due primarily to a $2.2 million increase
in net interest income and a $1.5 million decrease in income
tax expense between the periods. Net interest income
increased primarily because of the higher interest income
earned on loans and cash balances as a result of the 100 basis
point increase in the federal funds rate between the periods.
The decrease in income tax expense is primarily because of
the enactment of the Tax Cuts and Jobs Act on December
22, 2017 which required the Company to record $1.1
million in additional income tax expense in the fourth
quarter of 2017 and reduced the Company’s federal income
tax rate in 2018.
Net Interest Income
Net interest income was $28.1 million for 2018, an increase
of $2.2 million, or 8.8%, from $25.9 million for the same
period of 2017. Interest income was $30.4 million for 2018,
an increase of $2.7 million, or 9.8%, from $27.7 million for
the same period of 2017. Interest income increased
primarily because of the higher interest amounts earned on
loans and cash balances as a result of the 100 basis point
increase in the federal funds rate between the periods and a
$27.9 million increase in the average interest-earning assets
held between the periods. Interest income also increased
$0.5 million because of a change in the amount of yield
enhancements recognized on purchased and non-accruing
loans between the periods. The average yield earned on
interest-earning assets was 4.35% for 2018, an increase of
22 basis points from 4.13% for 2017. The average yield
earned on interest-earning assets increased 8 basis points as
a result of the change in yield enhancements recognized
between the periods.
Interest expense was $2.2 million for 2018, an increase of
$0.4 million, or 24.3%, from $1.8 million for 2017. The
average interest rate paid on non-interest and interest-
bearing liabilities was 0.35% for 2018, an increase of 6 basis
points from 0.29% paid in 2017. The increase in the interest
paid on non-interest and interest-bearing liabilities was
primarily because of the 100 basis point increase in the
federal funds rate which increased the cost of deposits
between the periods and a $22.5 million increase in the
average non-interest and interest-bearing liabilities held
between the periods.
MANAGEMENT DISCUSSION AND ANALYSIS
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.
Average
Outstanding
Balance
2018
Interest
Earned/
Paid
Average
Yield/
Rate
(Dollars in thousands)
Interest-earning assets:
Securities available for sale:
Year Ended December 31,
2017
Interest
Earned/
Paid
Average
Outstanding
Balance
Average
Yield/
Rate
Average
Outstanding
Balance
2016
Interest
Earned/
Paid
Average
Yield/
Rate
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 .................. $
Interest-bearing liabilities:
Checking accounts ................................. $
Passbooks ...............................................
Money market accounts .........................
Certificate accounts ...............................
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 ......
8,550
70,827
1,765
586,664
861
29,706
698,373
197
1,138
89
28,446
27
484
30,381
62
61
865
1,243
2
2,233
28,148
86,750
77,630
199,202
114,243
140
477,965
156,482
1,534
635,981
62,392
% $
2.30
1.61
5.04
4.85
3.14
1.63
4.35
2,524
74,035
1,905
573,894
874
17,214
$ 670,446
0.07% $
0.08
0.43
1.09
1.71
87,416
76,592
179,675
106,006
6,335
$ 456,024
156,149
1,279
0.35
% $ 613,452
4.00%
$
4.03%
56,994
57
1,103
94
26,274
12
140
27,680
77
63
560
770
327
1,797
25,883
1,631
2.26
% $
84,528
1.49
3,046
4.93
513,974
4.58
770
1.37
23,337
0.81
4.13 $ 627,286
58
1,289
126
25,774
6
96
27,349
50
62
366
524
591
1,593
25,756
0.09% $
0.08
0.31
0.73
5.16
85,440
71,728
164,522
100,942
9,374
$ 432,006
145,450
1,434
0.29
% $ 578,890
3.84%
$
3.86%
48,396
3.56%
1.52
4.14
5.01
0.78
0.41
4.36
0.06%
0.09
0.22
0.52
6.30
0.28
%
4.08%
4.11%
109.81 %
109.29%
108.36%
(1) Tax exempt income was not material; therefore, the yield was not presented on a tax equivalent basis for any of the years presented.
(2) Calculated net of deferred loan costs, loan discounts, loans in process and loss reserves.
Net interest margin for 2018 was 4.03%, an increase of 17
basis points, compared to 3.86% for 2017. The increase in
the net interest margin is primarily related to the increase in
interest income which is primarily due to the increase in the
average yields earned on the average interest-earning assets
held between the periods. Average net earning assets
increased from $57.0 million in 2017 to $62.4 million in
2018. The $5.4 million increase in the net earning assets in
2018 is due primarily to the net income earned in 2018 that
was partially offset by the purchase of fixed assets and
warrants.
9
MANAGEMENT DISCUSSION AND ANALYSIS
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
to changes
in
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).
2018 vs. 2017
Increase
(Decrease)
Due to
Year Ended December 31,
2017 vs. 2016
Increase
(Decrease)
Due to
Volume (1)
Rate(1)
Total
Increase
(Decrease)
Volume (1)
Rate(1)
Total
Increase
(Decrease)
136
(48)
(7)
806
102
0
989
6
0
37
79
(325)
(203)
1,192
4
83
2
1,366
242
15
1,712
(21)
(2)
268
394
0
639
1,073
140
35
(5 )
2,172
344
15
2,701
(15 )
(2 )
305
473
(325 )
436
2,265
32
(160)
(47)
3,091
(25)
1
2,892
3
4
39
77
(275)
(152)
3,044
(33)
(26)
15
(2,591)
69
5
(2,561)
24
(3)
155
169
11
356
(2,917)
(1)
(186)
(32)
500
44
6
331
27
1
194
246
(264)
204
127
(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:
Checking accounts ................................ $
Passbooks ..............................................
Money market accounts ........................
Certificates of deposit ...........................
FHLB advances and other borrowings .
Total interest-bearing liabilities ....... $
Increase (decrease) in net interest income $
(1) For purposes of this table, changes attributable to both rate and volume which cannot be segregated have been allocated proportionately to the change
due to volume and the change due to rate.
The following table sets forth the weighted average yields
on the Company's interest-earning assets, the weighted
average interest rates on interest-bearing liabilities and the
interest rate spread between the weighted average yields and
rates as of the date indicated. Non-accruing loans have been
included in the average outstanding loan balances in the
table as loans carrying a zero yield.
Weighted average yield on:
Securities available for sale:
At December 31, 2018
Weighted average rate on:
Mortgage-backed and related securities ............................... 2.27% Checking accounts ......................................................................... 0.10%
Other marketable securities .................................................. 1.63
Loans held for sale .................................................................... 5.12
Loans receivable, net ................................................................ 4.90
FHLB stock ............................................................................... 3.25
Other interest-earnings assets ................................................... 1.88
Combined weighted average yield on interest-earning assets .. 4.45
Passbooks ....................................................................................... 0.08
Money market accounts ................................................................. 0.56
Certificates of deposit .................................................................... 1.32
Combined weighted average rate on interest-bearing liabilities ... 0.43
Interest rate spread ......................................................................... 4.02
Provision for Loan Losses
The provision for loan losses was ($0.6) million for the year
ended December 31, 2018, a decrease of $0.1 million, from
($0.5) million for the year ended December 31, 2017. The
provision for loan losses decreased between the periods
primarily because of the improved credit quality of the loan
portfolio and
the payoff of certain non-performing
commercial loans which resulted in a decrease in the
reserves required between the periods.
10
MANAGEMENT DISCUSSION AND ANALYSIS
A reconciliation of the allowance for loan losses for 2018 and 2017 is summarized as follows:
(Dollars in thousands)
Balance beginning of period .......................................................................................................................................... $
Provision ........................................................................................................................................................................
Charge offs:
Commercial business ................................................................................................................................................
Commercial real estate ..............................................................................................................................................
Consumer ..................................................................................................................................................................
Single family .............................................................................................................................................................
Recoveries .....................................................................................................................................................................
Balance at December 31, ............................................................................................................................................... $
Allocated to:
General allowance ......................................................................................................................................................... $
Specific allowance .........................................................................................................................................................
$
2018
2017
9,311 $
(649)
(270)
0
(226)
(24)
544
8,686 $
7,892
794
8,686
9,903
(523)
(311)
(50)
(288)
(6)
586
9,311
8,238
1,073
9,311
Non-Interest Income
Non-interest income was $7.7 million for the year ended December 31, 2018, the same as for the year ended December 31,
2017. 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,
2017
2018
3,330
1,255
2,095
1,034
7,714
3,354
1,202
2,138
960
7,654
Percentage
Increase (Decrease)
2016
2018/2017
2017/2016
3,427
1,108
2,618
1,048
8,201
(0.7 )%
4.4
(2.0 )
7.7
0.8
(2.1)%
8.5
(18.3)
(8.4)
(6.7)
Other non-interest income increased $0.1 million primarily
because of an increase in the revenue earned on the sale of
uninsured investment products between the periods. Loan
servicing fees increased $0.1 million between the periods
due to an increase in the single family loans being serviced.
These increases in non-interest income were offset by a
decrease in the gain on sales of loans due to a decrease in
single family loan originations and sales between the
periods. Fees and service charges decreased slightly
between the periods primarily because of a decrease in
overdraft fees.
Non-Interest Expense
Non-interest expense was $25.4 million for the year ended December 31, 2018, an increase of $0.1 million, or 0.5%, from
$25.3 million for the year ended December 31, 2017. The following table presents the components of non-interest expense:
(Dollars in thousands)
Compensation and benefits .......................................... $
Occupancy and equipment ...........................................
Data processing.............................................................
Professional services ....................................................
Other .............................................................................
Total non-interest expense ............................................ $
Year ended December 31,
2017
2018
14,728
4,304
1,270
1,137
3,948
25,387
15,007
4,068
1,106
1,285
3,788
25,254
Percentage
Increase (Decrease)
2016
2018/2017
2017/2016
14,764
4,041
1,161
1,257
2,907
24,130
(1.9)%
5.8
14.8
(11.5)
4.2
0.5
1.6 %
0.7
(4.7 )
2.2
30.3
4.7
11
MANAGEMENT DISCUSSION AND ANALYSIS
Occupancy and equipment expense increased $0.2 million
because of increases in depreciation and real estate tax
expenses. Data processing costs increased $0.2 million
primarily because of an increase in mobile and on-line
banking costs between the periods. Other non-interest
expense increased $0.2 million between the periods due to
an increase in the fraud losses incurred on deposit accounts
and an increase in deposit insurance rates. These increases
in non-interest expense were partially offset by a $0.3
million decrease in compensation and benefits expense
primarily because of a decrease in employees between the
periods. Professional services expense decreased $0.2
million between the periods primarily because of a decrease
in legal expenses.
Income Taxes
The Company considers the calculation of current and
deferred income taxes to be a critical accounting policy that
is subject to significant estimates. Income tax expense was
$2.9 million for the year ended December 31, 2018, a
decrease of $1.5 million, from $4.4 million for the year
ended December 31, 2017. The decrease in income tax
expense is due primarily to the enactment of the Tax Cuts
and Jobs Act on December 22, 2017 which required the
Company to record $1.1 million in additional income tax
expense in the fourth quarter of 2017 and reduced the
Company’s federal income tax rate in 2018.
Comparison of 2017 with 2016
Net income was $4.4 million for 2017, a decrease of $2.0
million compared to net income of $6.4 million for 2016.
Diluted earnings per share for the year ended December 31,
2017 was $0.90, a decrease of $0.44 per share compared to
diluted earnings per share of $1.34 for the year ended
December 31, 2016. The decrease in net income for 2017 is
due primarily to a $0.5 million decrease in the gain on sales
of loans because of a decrease in commercial government
guaranteed loan sales and a $0.5 million decrease in the
gains on real estate owned because of fewer sales between
the periods. Net income also decreased $0.4 million due to
an increase in other non-interest expenses primarily related
to advertising expenses, $0.3 million due to an increase in
income tax expense, $0.2 million because of an increase in
compensation and benefits and $0.1 million due to an
increase in the loan loss provision between the periods. The
increase in income tax expense is due primarily to the $1.1
million decrease in the Company’s net deferred tax asset as
a result of the reduction in the corporate federal tax rate in
connection with the enactment of the Tax Cuts and Jobs Act
in the fourth quarter of 2017. These decreases in net income
were partially offset by an increase in net interest income of
$0.1 million 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.
Net interest income was $25.9 million for 2017, an increase
of $0.1 million, or 0.5%, from $25.8 million for the same
period of 2016. Interest income was $27.7 million for 2017,
an increase of $0.4 million, or 1.2%, from $27.3 million for
the same period of 2016. Interest income increased $2.4
million 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 a 6
basis point increase in the average yields earned between
the periods. While the average interest-earning assets
increased $43.2 million between the periods, the average
interest-earning assets held in higher yielding loans
increased $58.8 million and the amount of average interest-
earning assets held in lower yielding cash and investments
decreased $15.6 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 occurred because of an increase in loan
originations and a reduction in loan payoffs between the
periods. The increase in interest income as a result of these
items was partially offset by a decrease in interest income
as a result of recognizing a lower amount of yield
income
enhancements between
decreased $2.1 million due to a decrease in the amount of
yield enhancements recognized from loan prepayment
penalties, yield adjustments on purchased loans, and the
interest payments received on non-accruing and previously
charged off commercial real estate loans. This resulted in a
29 basis point decrease in the average yield between the
periods. The average yield earned on interest-earning assets
was 4.13% for 2017, a decrease of 23 basis points from
4.36% for 2016. The decrease in the average yield earned
on interest-earning assets is primarily related to the decrease
in yield enhancements recognized between the periods.
the periods. Interest
Interest expense was $1.8 million for 2017, an increase of
$0.2 million, or 12.8%, compared to $1.6 million for 2016.
The average interest rate paid on non-interest and interest-
bearing liabilities was 0.29% for 2017, an increase of 1 basis
point from 0.28% for 2016. The average rate paid increased
between the periods due to an increase in the rates paid on
certain money market and certificate of deposit accounts.
This increase was partially offset by a decrease in the
interest paid on other borrowings due to a decrease in the
average borrowings outstanding between the periods. While
the average non-interest and interest-bearing liabilities
increased $34.6 million between the periods, the average
amount held in lower rate checking, savings, and money
market accounts increased $10.4 million, the average
amount held in higher rate premium money market accounts
increased $22.5 million, and the average amount held in
higher rate borrowings and certificates of deposit increased
$1.7 million between the periods.
12
MANAGEMENT DISCUSSION AND ANALYSIS
Net interest margin decreased 25 basis points to 3.86% in
2017 from 4.11% in 2016 primarily because of a $2.1
million, or 29 basis point decrease
the yield
enhancements recognized between the periods. Average net
earning assets increased from $48.4 million in 2016 to $57.0
million in 2017. The $8.6 million increase in net earning
assets is due to the net income earned in 2017 adjusted for
non-cash items including the expenses incurred related to
deferred tax asset changes and depreciation.
in
The provision for loan losses was ($0.5) million for the year
ended December 31, 2017, an increase of $0.1 million, from
($0.6) million for the year ended December 31, 2016. The
provision for loan losses increased between the periods
primarily because of the increase in the reserves required on
certain commercial loans due to a deterioration of their
credit quality.
Non-interest income was $7.7 million for the year ended
December 31, 2017, a decrease of $0.5 million, from $8.2
million for the year ended December 31, 2016. The decrease
in non-interest income is primarily related to the $0.5
million decrease in the gain on sales of loans due to a
decrease in commercial government guaranteed loan sales
between the periods. Fees and service charges decreased
$0.1 million between the periods due primarily to a decrease
in overdraft fees. Other non-interest income decreased $0.1
million because of a decrease in the revenue earned on the
sale of uninsured investment products between the periods.
These decreases in non-interest income were partially offset
by a $0.1 million increase in loan servicing fees earned due
to an increase in the loans being serviced for others between
the periods.
Non-interest expense was $25.3 million for the year ended
December 31, 2017, an increase of $1.2 million, from $24.1
million for the year ended December 31, 2016. Gains on real
estate owned decreased $0.5 million between the periods
due to the gains that were recognized on the sale of two
commercial properties in 2016. Other non-interest expense
increased $0.4 million primarily due to an increase in
advertising expense between the periods. Compensation
expense increased $0.2 million between the periods due to
normal annual salary increases. Occupancy and equipment
expense increased slightly because of increased software
and equipment expenses. Professional services expense
increased slightly due to an increase in legal expenses
between the periods. These increases in non-interest
expense were partially offset by a $0.1 million decrease in
data processing expense due to a decrease in debit card costs
between the periods.
Income tax expense was $4.4 million for the year ended
December 31, 2017, an increase of $0.3 million, from $4.1
million for the year ended December 31, 2016. The increase
in income tax expense is due primarily to the $1.1 million
decrease in the Company’s net deferred tax asset as result
of the reduction in the corporate federal tax rate in
connection with the enactment of the Tax Cuts and Jobs Act
in the fourth quarter of 2017. The increase in income tax
expense as a result of the tax law change was partially offset
by a decrease in income tax expense due to a decrease in
pre-tax income between the periods.
13
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 costs/fees and discounts and the allowance for losses as of the dates indicated:
(Dollars in thousands)
Real Estate Loans:
2018
Amount Percent
2017
December 31,
2016
2015
2014
Amount Percent Amount Percent Amount Percent Amount Percent
Single family ................................................ $ 110,698
Multi-family ................................................. 50,150
Commercial .................................................. 257,036
Construction or development ....................... 28,944
Total real estate loans .............................. 446,828
Other Loans:
Consumer Loans:
18.61% $107,005 17.99% $103,255 18.41% $ 90,945 19.24% $ 69,841 18.70%
4.20
28,649 4.81 36,777
8.43
259,024 43.55 230,955 41.18 196,926 41.65 163,365 43.73
43.21
46,444 7.81 31,348
4.87
3.37
441,122 74.16 402,335 71.74 338,298 71.55 261,509 70.00
75.12
6.56 12,324
5.59 38,103
2.61 15,700
8.05 12,603
0.30
Automobile ..............................................
2,483
9.86
Home equity line ..................................... 32,273
3.33
Home equity ............................................ 16,733
0.00
Recreational vehicles ............................... 16,226
1.22
4,817
Other ........................................................
73,767 12.40 73,283 13.07 64,415 13.62 54,925 14.71
Total consumer loans .......................... 72,532
79,909 13.44 85,176 15.19 70,106 14.83 57,122 15.29
Commercial business loans .......................... 75,496
Total other loans ................................. 148,028
153,676 25.84 158,459 28.26 134,521 28.45 112,047 30.00
Total loans ........................................... $ 594,856 100.00% $594,798 100.00% $560,794 100.00% $472,819 100.00% $373,556 100.00%
3,036
36,869 6.20 40,476
15,823 2.66 16,302
7,553
13,181 2.21
5,916
5,000 0.84
0.54
2,885
7.22 38,980
2.91 14,782
2,650
1.35
5,118
1.05
0.61
1,124
8.24 36,832
3.13 12,420
0
0.56
4,549
1.08
0.42
5.42
2.81
2.73
0.81
12.19
12.69
24.88
2,894 0.49
Less:
Unamortized discounts.................................
Net deferred loan (costs) fees ......................
Allowance for losses ....................................
17
(535)
8,686
Total loans receivable, net ....................... $ 586,688
19
(463)
9,311
$585,931
20
(300)
9,903
$551,171
16
(91)
9,709
$463,185
14
97
8,332
$365,113
The limited growth in the loan portfolio in 2018 was
primarily because the loan originations during the year were
almost entirely offset by loan prepayments. Based on
current economic conditions and the projected loan
origination and prepayment amounts, it is anticipated that
our overall loan portfolio growth will be limited in 2019.
Single family real estate loans were $110.7 million at
December 31, 2018, an increase of $3.7 million, compared
to $107.0 million at December 31, 2017. The single family
loan portfolio increased in 2018 due to 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 were sold into the secondary
market and were not placed in the loan portfolio in order to
manage the Company’s interest rate risk position.
Multi-family real estate loans were $50.2 million at
December 31, 2018, an increase of $21.6 million, compared
to $28.6 million at December 31, 2017. The increase in
multi-family real estate loans in 2018 is primarily due to
loans
the
construction loan category due to the completion of
construction phase of the project.
loan category from
transferred
into
this
Commercial real estate loans were $257.0 million at
December 31, 2018, a decrease of $2.0 million, compared
14
to $259.0 million at December 31, 2017. Commercial
business loans were $75.5 million at December 31, 2018, a
decrease of $4.4 million, compared to $79.9 million at
December 31, 2017. The decrease in commercial real estate
and commercial business loans in 2018 is because loan
payoffs exceeded loan originations during the year with
some of the payoffs related to the Bank’s initiative to
improve the credit quality of the loan portfolio.
Construction or development loans were $28.9 million at
December 31, 2018, a decrease of $17.5 million, compared
to $46.4 million at December 31, 2017. The decrease in
construction loans is primarily related to the $29.7 million
of construction loans on projects that were completed
during the year that were moved to a permanent loan
classification. An additional $14.0 million in construction
loans were paid off during the year. These decreases in
construction loans were partially offset by $20.7 million in
newly originated construction loans and $5.5 million in
advances on previously originated construction loans.
Home equity lines of credit were $32.3 million at December
31, 2018, a decrease of $4.6 million, compared to $36.9
million at December 31, 2017. The open-end home equity
lines are generally written with an adjustable rate and a ten
year draw period which requires interest only payments
followed by a ten year repayment period which fully
amortizes the outstanding balance. Home equity loans were
MANAGEMENT DISCUSSION AND ANALYSIS
$16.7 million at December 31, 2018, an increase of $0.9
million, compared to $15.8 million at December 31, 2017.
Closed-end home equity loans are written with fixed or
adjustable rates with terms up to fifteen years. The change
in the open-end equity lines and closed-end equity loans is
primarily the result of an increase in the payoffs of open-
ended home equity lines of credit. The increased payoffs are
the result of borrowers continued preference to obtain a
fixed rate closed-equity loan or to refinance their first
mortgage and roll their outstanding open-end equity loan
balances into their new home loan.
Recreational vehicle loans were $16.2 million at December
31, 2018, an increase of $3.0 million, compared to $13.2
million at December 31, 2017. 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 the
balance between the periods is due to loan originations
exceeded principal repayments during 2018.
Allowance for Loan Losses
The determination of the allowance for loan losses and the
related provision is a critical accounting policy of the
Company that is subject to significant estimates. The current
level of the allowance for loan losses is a result of
management’s assessment of the risks within the portfolio
based on the information obtained through the credit
evaluation process. The Company utilizes a risk-rating
system on non-homogeneous commercial real estate and
commercial business loans that includes regular credit
reviews to identify and quantify the risk in the commercial
portfolio. Management conducts quarterly reviews of the
entire loan portfolio and evaluates the need to adjust the
allowance balance on the basis of these reviews.
Management actively monitors asset quality and, when
appropriate, charges off loans against the allowance for loan
losses. Although management believes it uses the best
information available to make determinations with respect
to the allowance for loan losses, future adjustments may be
necessary if economic conditions differ substantially from
the economic conditions in the assumptions used to
determine the size of the allowance for loan losses.
The allowance for loan losses was $8.7 million, or 1.46% of
gross loans at December 31, 2018, compared to $9.3
million, or 1.57% of gross loans at December 31, 2017. The
allowance for loan losses decreased primarily because of the
improved credit quality of the loan portfolio and the payoff
of certain non-performing commercial loans which resulted
in a decrease in the reserves required 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 .................................................................................................
Commercial real estate ..................................................................................
Consumer .......................................................................................................
Commercial business .....................................................................................
Recoveries ..........................................................................................................
Net recoveries (charge-offs) ..........................................................................
Balance at end of year ............................................................................................ $
Year end allowance for loan losses as a percent of year end gross loan balance ..
Ratio of net loan recoveries (charge-offs) to average loans outstanding ...............
Allowance as a percent of total assets at year end .................................................
2018
2017
December 31,
2016
2015
2014
9,311
(649)
9,903
(523)
9,709
(645)
8,332
(164 )
11,401
(6,998)
(24)
0
(226)
(270)
544
24
8,686
1.46%
0.00
1.22
(6)
(50)
(288)
(311)
586
(69)
9,311
1.57%
(0.01)
1.29
(66)
(67)
(108)
(180)
1,260
839
9,903
1.77%
0.16
1.45
(19 )
0
(105 )
(69 )
1,734
1,541
9,709
2.05 %
0.36
1.51
(92)
(936)
(131)
(55)
5,143
3,929
8,332
2.23%
1.02
1.44
15
MANAGEMENT DISCUSSION AND ANALYSIS
The following table reflects the allocation of the allowance for loan losses:
2018
2017
December 31,
2016
2015
2014
Allocated
Allowance
as a % of
Loan
Category
Percent
of Loans
in Each
Category
to Total
Loans
Allocated
Allowance
as a % of
Loan
Category
Percent
of Loans
in Each
Category
to Total
Loans
0.84% 17.99%
1.52 56.17
2.21 12.40
2.14 13.44
1.57 100.00%
Allocated
Allowance
as a % of
Loan
Category
Percent
of Loans
in Each
Category
to Total
Loans
1.15% 18.41%
1.66 53.33
2.20 13.07
2.53 15.19
1.77 100.00%
Allocated
Allowance
as a % of
Loan
Category
Percent
of Loans
in Each
Category
to Total
Loans
1.09% 19.24%
2.46 52.31
1.86 13.62
2.05 14.83
2.05 100.00%
Allocated
Allowance
as a % of
Loan
Category
Percent
of Loans
in Each
Category
to Total
Loans
1.57 % 18.70%
2.62 51.30
1.84 14.71
2.11 15.29
2.23 100.00%
Single family ..................
Commercial real estate ..
Consumer .......................
Commercial business .....
Total ..........................
0.75%
1.45
2.24
1.80
1.46
18.61%
56.51
12.19
12.69
100.00%
The allocated allowance percentages for single family,
commercial business and commercial real estate loans
decreased in 2018 primarily because of an improvement in
the credit quality of the loans held in these portfolios. The
allocation of the allowance for loan losses for consumer
loans increased due to changes in the types of loans held
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. There was no
allowance for real estate losses at December 31, 2018 or
December 31, 2017.
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 $3.1
million at December 31, 2018, a decrease of $0.7 million,
or 18.0%, from $3.8 million at December 31, 2017. Non-
performing loans decreased $0.5 million and foreclosed and
repossessed assets decreased $0.2 million between the
periods. 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:
16
MANAGEMENT DISCUSSION AND ANALYSIS
(Dollars in thousands)
Non-performing loans:
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 ....
2018
2017
December 31,
2016
2015
2014
730
1,311
489
148
2,678
0
414
0
414
3,092
0.43%
2,678
$
0.46%
324.27%
949
1,364
553
278
3,144
0
627
0
627
3,771
916
1,384
630
343
3,273
0
611
16
627
3,900
1,655
1,694
786
46
4,181
48
1,997
0
2,045
6,226
3,144
0.52 %
$
0.54 %
296.11 %
3,273
0.57 %
$
0.59 %
302.56 %
4,181
0.97 %
$
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 %
Gross interest income which would have been recorded had
the non-accruing loans been current in accordance with their
original terms amounted to $0.3 million for the years ended
December 31, 2018 and 2017, and $0.6 million for the year
ended December 31, 2016. The amounts that were included
in interest income on a cash basis for these loans were $0.1
million, $0.1 million and $0.4 million, respectively.
At December 31, 2018, 2017 and 2016, there were loans
included in loans receivable, net, with terms that had been
modified in a TDR totaling $2.5 million, $3.0 million and
$3.3 million, respectively. Had the loans performed in
accordance with their original terms throughout 2018, 2017
and 2016, the Company would have recorded gross interest
income of $0.3 million, $0.4 million and $0.6 million,
respectively. During 2018, 2017 and 2016 the Company
recorded gross interest income of $0.2 million, $0.2 million
and $0.4 million, respectively.
For the loans that were modified in 2018, $0.4 million were
classified and performing and $1.2 million were non-
performing at December 31, 2018. The decrease in TDRs in
2018 relates primarily to several retail consumer TDRs that
were paid or charged off during the year, as well as one
commercial business loan that was charged off. Of the loans
that were modified in 2018 and outstanding at December 31,
2018, $1.1 million related to loans secured by commercial
real estate, $0.4 million related to first or second mortgages
on single family properties and the remaining modifications
related to other consumer or commercial business loans.
For the loans that were modified in 2017, $0.6 million were
classified and performing and $0.4 million were non-
performing at December 31, 2017. The decrease in TDRs in
2017 related primarily to one commercial relationship
totaling $0.5 million that had performed according to the
restructured terms and met the criteria to be upgraded to
non-TDR status during the year. Of the loans that were
modified in 2017 and outstanding at December 31, 2017,
$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 were modified in 2016, $0.2 million were
classified and performing and $1.7 million were non-
performing at December 31, 2016. The increase in TDRs in
2016 related 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, $0.4 million
related to first or second mortgages on single family
properties and the remaining modifications related to other
consumer or commercial business loans.
17
MANAGEMENT DISCUSSION AND ANALYSIS
The following table sets forth the amount of TDRs in the Company’s portfolio:
(Dollars in thousands)
2018
2017
December 31,
2016
2015
2014
Single family ............................................................ $
Commercial real estate .............................................
Consumer .................................................................
Commercial business ...............................................
Total TDRs .......................................................... $
TDRs on accrual status ............................................ $
TDRs on non-accrual status .....................................
Total ..................................................................... $
636
1,110
522
208
2,476
1,018
1,458
2,476
685
1,210
758
391
3,044
1,129
1,915
3,044
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
In addition to the TDRs and the non-performing loans set
forth in the previous table 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, 2018 or December 31, 2016. There was
one potential problem loan relationship totaling $7.5 million
identified by the Company as of December 31, 2017. These
loans are secured primarily by multi-family properties and
other business assets.
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
additional borrowings with the FHLB or Federal Reserve
Bank of Minneapolis.
18
The primary financing activity is the attraction of retail,
commercial, and internet deposits. The Bank also has the
ability to borrow additional funds from the FHLB or Federal
Reserve Bank of Minneapolis by pledging additional
securities or loans, subject to applicable borrowing base and
collateral requirements. See “Note 12 Federal Home Loan
Bank (FHLB) Advances and Other Borrowings” in the
Notes to Consolidated Financial Statements for more
information on 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, 2018 were $20.7
million, a decrease of $16.9 million, compared to $37.6
million at December 31, 2017. Net cash provided by
operating activities during 2018 was $17.8 million. The
Company conducted
investing
activities during 2018: purchases of securities available for
sale and FHLB stock were $5.2 million; principal payments
and maturity proceeds received on securities available for
sale and FHLB stock were $2.5 million; and the proceeds
from the sale of premises and other real estate were $0.4
million. Net loans receivable increased $11.5 million and
the Company also purchased premises and equipment of
$2.5 million. Net cash used by investing activities during
2018 was $16.3 million. The Company conducted the
following major financing activities during 2018: deposits
decreased $12.2 million, repaid borrowings of $6.8 million,
received proceeds from borrowings of $6.8 million,
repurchased outstanding warrants of $6.5 million, customer
escrows increased $0.3 million, and recognized excess tax
benefits from options exercised of $0.1 million. Net cash
used by financing activities was $18.3 million for 2018.
MANAGEMENT DISCUSSION AND ANALYSIS
The Bank has certificates of deposits from customers with
outstanding balances of $75.7 million that mature during
2019. 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 $46.8 million in checking and
money market accounts of three 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 2018, the Bank paid dividends to the
Company of $6.0 million and at December 31, 2018, the
Company had $1.5 million in cash and other assets that
could readily be turned into cash.
The Company’s primary use of cash is the payment of
holding company level expenses including the payment of
director and management fees, legal expenses and other
regulatory costs. The Company plans to continue to fund its
liquidity needs through dividends from the Bank, or if
deemed prudent, by obtaining external capital.
Contractual Obligations and Commercial Commitments
The Company has certain obligations and commitments to make future payments under existing contracts. At December 31,
2018, the aggregate contractual obligations (excluding bank deposits) and commercial commitments were as follows:
(Dollars in thousands)
Contractual Obligations:
Annual rental commitments under non-cancellable
Total
Less than
1 Year
1-3 Years
4-5 Years
More than
5 Years
Payments Due by Period
operating leases ................................................................ $
Total contractual obligations ............................................ $
4,937
4,937
888
888
1,711
1,711
1,653
1,653
685
685
Other Commercial Commitments:
Commercial lines of credit .................................................... $
Commitments to lend ............................................................
Standby letters of credit ........................................................
Total other commercial commitments ............................. $
58,222
18,877
2,608
79,707
30,163
9,181
1,819
41,163
16,832
183
225
17,240
11,227
7,538
564
19,329
0
1,975
0
1,975
Amount of Commitments Expiring by Period
Regulatory Capital Requirements
The Company and the Bank are subject to the Basel III
regulatory capital requirements. The Basel III requirements,
among other things, (i) apply a set of capital requirements
to the Bank (the Company is exempt, pursuant to the Small
Bank Holding Company Policy Statement
(Policy
including requirements
Statement) described below),
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)
set forth rules for calculating risk-weighted assets for
purposes of
rules made
corresponding revisions to the prompt corrective action
ratios and buffer
framework and
requirements. The
include capital
such
requirements which are fully phased in as of 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 its assets, liabilities and certain off-
items as calculated under regulatory
balance sheet
accounting practices. The capital amounts and classification
are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
19
MANAGEMENT DISCUSSION AND ANALYSIS
The Board of Governors of the Federal Reserve System
(FRB) amended its Policy Statement, to exempt small bank
holding companies with assets less than $3 billion from the
above capital requirements. 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 currently meets
the
qualitative exemption requirements, and therefore, is
exempt from the above capital requirements.
Quantitative measures established by regulations to ensure
capital adequacy require the Bank to maintain minimum
amounts and ratios of common equity Tier 1 capital to risk
weighted assets, Tier 1 capital to adjusted total assets, Tier
1 capital to risk weighted assets and total capital to risk
weighted assets. The Bank must also 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 2018, the capital
conservation buffer was 1.875%, and in 2019, and for all
periods thereafter, the buffer amount increases to 2.50%.
Management believes that, as of December 31, 2018, the
Bank’s capital ratios were in excess of those quantitative
capital ratio standards set forth under the current prompt
the capital
corrective action
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 adjust 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.
regulations,
including
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 the Company’s 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,
anticipated asset growth, general business practices and
other factors. The Company has not made any dividend
payments to common stockholders during the three year
period ending December 31, 2018 but will continue to
evaluate the best use of the Company’s capital based on the
factors identified above.
restrictions,
regulatory
The Company also serves as a source of capital, liquidity
and financial support to the Bank. Depending upon the
operating performance of the Bank and the Company’s
other liquidity and capital needs, the Company may find it
prudent, subject to prevailing capital market conditions and
other factors, to raise additional capital through issuance of
its common stock or other equity securities. Additional
capital would potentially permit the Company to implement
a strategy of growing Bank assets. Depending on the
circumstances, if it were to raise capital, the Company may
deploy it to the Bank for general banking purposes, or may
retain some or all of it for use by the Company.
If the Company raises capital through the issuance of
additional shares of common stock or other equity
Under applicable federal banking laws and regulations, no
dividends can be declared or paid by the Bank to the
Company without notice to and non-objection from the
applicable banking regulator. There is no assurance that the
Bank and the Company would satisfy the applicable
regulatory requirements necessary to effect any such
dividends. The payment of dividends by the Company is
dependent upon the Company having adequate cash or other
assets that can be converted to cash to pay dividends to its
stockholders. 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 board of
directors of both the Bank and the Company and would
depend on numerous factors including the results of
operations, financial conditions, asset growth plans and cash
flow requirements of the Company and the Bank.
20
MANAGEMENT DISCUSSION AND ANALYSIS
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.
the
New Accounting Pronouncements
In February 2016, the Financial Accounting Standards
Board (FASB) issued Accounting Standards Update (ASU)
2016-02, Leases (Topic 842). The amendments in the ASU
create Topic 842, Leases, and supersede
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
retrospective approach. The modified
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 the lease is
modified. As entities started to implement the new leases
standard, many preparers were encountering some
unanticipated costs and complexities associated with the
modified retrospective transition method, particularly the
comparative period reporting requirements. In response to
these issues, the FASB in July 2018 issued ASU 2018-11.
The amendments in this ASU provide lessors with an
additional (and optional) transition method to adopt the new
leases standard. Under this new transition method, an entity
initially applies the new leases standard at the adoption date
and recognizes a cumulative-effect adjustment to the
opening balance of retained earnings in the period of
adoption. The amendments in these ASU’s, for public
business entities, are effective for fiscal years beginning
after December 15, 2018, including interim periods within
those fiscal years. The adoption of these ASU’s in the first
quarter of 2019 resulted in a $4.5 million right-of-use asset
and an offsetting lease payment obligation liability being
recorded on January 1, 2019.
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 filers with the SEC, 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 has accumulated the charge off information
necessary to calculate the appropriate life of loan loss
percentages for the various loan categories, has identified
several key metrics to help identify and project anticipated
changes in the credit quality of our loan portfolio upon
enactment, and is in the process of evaluating the
determination of potential qualitative reserve amounts and
the impact that the adoption of this ASU in the first quarter
of 2020 will have on the Company’s consolidated financial
statements.
21
MANAGEMENT DISCUSSION AND ANALYSIS
the FASB
incorporated
in market pricing on
issued ASU 2017-08,
In March 2017,
Receivables – Nonrefundable Fees and Other Costs
(Subtopic 310-20): Premium Amortization on Purchased
Callable Debt Securities. The amendments in this ASU
shorten the amortization period for certain callable debt
securities held at a premium. Specifically, the amendments
require the premium to be amortized to the earliest call date.
The amendments do not require an accounting change for
securities held at a discount, as discounts continue to be
amortized to maturity. This ASU is intended to more closely
align the amortization period of premiums and discounts to
expectations
the
underlying securities. In most cases, market participants
price securities to the call date that produces the worst yield
when the coupon is above current market rates and price
securities to maturity when the coupon is below market
rates. As a result, the amendments more closely align
interest income recorded on bonds held at a premium or a
discount with the economics of the underlying instrument.
This ASU is intended to reduce diversity in practice and is
effective for public business entities for fiscal years, and
interim periods within those fiscal years, beginning after
December 15, 2018 with early adoption permitted. Upon
adoption, the amendments should be applied using a
modified retrospective basis through a cumulative-effect
adjustment directly to retained earnings as of the beginning
of the period of adoption. Additionally, in the period of
adoption, an entity should provide disclosures about a
change in accounting principles. The adoption of this ASU
in the first quarter of 2019 had no impact on the Company’s
consolidated financial statements as the Company was
already accounting for the premiums and discounts on debt
securities in accordance with the requirements of the ASU.
In August 2018, the FASB issued ASU 2018-13, Fair Value
Measurement (Topic 820), Disclosure Framework –
Changes to the Disclosure Requirements for Fair Value
Measurement. The Amendments in this ASU apply to all
entities that are required, under existing GAAP, to make
disclosures about recurring or nonrecurring fair value
measurements and modify the disclosure requirements on
fair value measurements in Topic 820, Fair Value
Measurement, including the consideration of costs and
benefits. The ASU removed, modified, and added various
disclosure requirements in Topic 820. The amendments also
eliminate at a minimum from the phrase an entity shall
disclose at a minimum to promote the appropriate exercise
of discretion by entities when considering fair value
measurement disclosures and to clarify that materiality is an
appropriate consideration of entities and their auditor when
evaluating disclosure requirements. The amendments in the
ASU are effective for all entities for fiscal years, and interim
periods within those fiscal years, beginning after December
15, 2019. An entity is permitted to early adopt the
implementation of any removed or modified disclosures
upon issuance of the ASU and delay adoption of the
additional disclosures until their effective date. The
Company has not opted to early adopt any portion of this
ASU and the adoption in the first quarter of 2020 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, 2018.
(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 .........................
-200
718,657
636,787
(342)
82,212
(38.37)%
Market Value
-100
706,293
596,613
(177)
109,857
0
693,894
560,502
0
133,392
+100
+200
680,891
528,934
9
151,948
667,940
501,772
27
166,141
(17.64)%
0.00%
13.91%
24.55%
22
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 its review of historical prepayment
speeds and decay rates. Fixed rate loans were assumed to
prepay at annual rates of between 3% and 39%, depending
on the note rate and the period to maturity. Adjustable rate
mortgages (ARMs) were assumed to prepay at annual rates
of between 5% and 54%, depending on the note rate and the
period to maturity. Mortgage-backed securities were
projected to have prepayments based upon the underlying
collateral securing the instrument. All loan prepayments
vary based on the note rate and period to maturity of the
individual loans. Certificate accounts were assumed not to
be withdrawn until maturity. Retail money market demand
accounts (MMDAs) and passbook accounts were assumed
to decay at annual rates of 1% and 3%, respectively. Retail
non-interest checking and negotiable order of withdrawal
(NOW) accounts were assumed to decay at annual rates of
9% and 0%,
respectively. Commercial non-interest
checking and NOW accounts were assumed to decay at
annual rates of 27% and 28%, respectively. Commercial
MMDAs were assumed to decay at annual rates of between
12% and 32%.
Certain shortcomings are inherent in the method of analysis
presented in the foregoing table. The interest rates on certain
types of assets and liabilities may fluctuate in advance of
changes in market interest rates, while interest rates on other
types of assets and liabilities may lag behind changes in
market interest rates. The model assumes that the difference
between the current interest rate being earned or paid
compared to a treasury instrument or other interest index
with a similar term to maturity (the interest spread) will
remain constant over the interest changes disclosed in the
table. Changes in interest spread could impact projected
market value changes. Certain assets, such as ARMs, have
features that restrict changes in interest rates on a short-term
basis and over the life of the assets. The market value of the
interest-bearing assets that are approaching their lifetime
interest rate caps or floors could be different from the values
calculated in the table. Certain liabilities, such as certificates
of deposit, have fixed rates that restrict interest rate changes
until maturity. In the event of a change in interest rates,
prepayment and early withdrawal levels may deviate
significantly from
the
those assumed
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.
in calculating
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,
2018 to determine if its current level of interest rate risk is
23
acceptable. The following table projects the estimated
impact on net interest income during the twelve month
period ending December 31, 2019 of immediate interest rate
changes called rate shocks:
(Dollars in thousands)
Rate Shock
in Basis Points
+200
+100
0
-100
-200
$
Net Interest
Change
Percent
Change
2,238
1,121
0
(1,275)
(2,851)
7.72%
3.87
0.00
(4.40)
(9.83)
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 loans
that are anticipated to 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
timing and
investment strategies and oversees
implementation of transactions as intended to assure
attainment of the Bank's objectives in an effective manner.
In addition, each quarter the Board reviews the Bank's
asset/liability position, including simulations of the effect
on the Bank's capital of various interest rate scenarios.
the
In managing its asset/liability composition, the Bank may,
at times, depending on the relationship between long-term
and short-term interest rates, market conditions and
consumer preference, place more emphasis on managing net
interest margin than on better matching the interest rate
sensitivity of its assets and liabilities in an effort to enhance
net interest income. Management believes that the increased
net interest income resulting from a mismatch in the
maturity of its asset and liability portfolios can, in certain
situations, provide high enough returns to justify the
increased exposure to sudden and unexpected changes in
interest rates.
in adjustable rate loans that reprice every one, two, or three
years.
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
Financial
information.
for
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 continued to focus 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. A significant portion
of the Bank’s commercial loan production continues to be
24
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
December 31, December 31,
2018
2017
ASSETS
Cash and cash equivalents ............................................................................................... $
Securities available for sale:
Mortgage-backed and related securities (amortized cost $8,159 and $5,148) .............
Other marketable securities (amortized cost $73,343 and $73,653) ............................
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 ........................................................................................................................... $
Accrued interest payable .................................................................................................
Customer escrows ...........................................................................................................
Accrued expenses and other liabilities ............................................................................
Total liabilities .............................................................................................................
Commitments and contingencies
Stockholders’ equity:
Serial-preferred stock ($.01 par value): authorized 500,000 shares; issued 0 ..............
Common stock ($.01 par value): authorized 16,000,000 shares; issued 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 4,292,838 and 4,631,124 shares ..................................................
Total stockholders’ equity ...........................................................................................
Total liabilities and stockholders’ equity......................................................................... $
See accompanying notes to consolidated financial statements.
20,709
37,564
8,023
71,957
79,980
3,444
586,688
2,356
414
867
1,855
9,635
802
255
2,668
2,642
712,315
623,352
346
1,448
4,022
629,168
0
91
40,090
99,754
(1,096)
(1,836)
(53,856)
83,147
712,315
5,068
72,404
77,472
1,837
585,931
2,344
627
817
1,724
8,226
802
355
1,314
3,672
722,685
635,601
146
1,147
4,973
641,867
0
91
50,623
91,448
(957)
(2,030)
(58,357)
80,818
722,685
25
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 .........................................................................
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 .............................................................
Occupancy and equipment ..............................................................
Data processing ...............................................................................
Professional services .......................................................................
Other ...............................................................................................
Total non-interest expense ..........................................................
Income before income tax expense ..........................................
Income tax expense ............................................................................
Net income ..................................................................................
Other comprehensive loss, 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.
2018
2017
2016
28,535
26,368
25,900
197
1,138
511
30,381
2,231
2
2,233
28,148
(649)
28,797
3,330
1,255
2,095
1,034
7,714
14,728
4,304
1,270
1,137
3,948
25,387
11,124
2,888
8,236
(69)
8,167
1.89
1.71
57
1,103
152
27,680
1,470
327
1,797
25,883
(523 )
26,406
3,354
1,202
2,138
960
7,654
15,007
4,068
1,106
1,285
3,788
25,254
8,806
4,402
4,404
(137 )
4,267
1.04
0.90
58
1,289
102
27,349
1,002
591
1,593
25,756
(645 )
26,401
3,427
1,108
2,618
1,048
8,201
14,764
4,041
1,161
1,257
2,907
24,130
10,472
4,122
6,350
(606 )
5,744
1.52
1.34
26
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
Additional
Other
Stock
Unearned
Accumulated Employee
Total
Stock-
Preferred Common Paid-in
Stock
Capital
Stock
0
91
Retained Comprehensive Ownership Treasury holders’
Earnings
50,388 80,536
6,350
Equity
Stock
(214)
(Loss)
Plan
(Dollars in thousands)
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 ......................... $
Net income ...............................................
Other comprehensive income ...................
Reclassification of certain income tax
effects from accumulated other
comprehensive income .........................
Stock compensation expense ....................
Restricted stock awards.............................
Stock awards withheld for tax
withholding ...........................................
Amortization of restricted stock awards ...
Earned employee stock ownership plan
shares ....................................................
Balance, December 31, 2017 ......................... $
Net income ...............................................
Other comprehensive loss ......................
Reclassification due to adjustments for
equity securities as required by ASU
2016-01 .................................................
Stock warrants purchased......................
Exercise of stock warrants .....................
Exercise of stock options ........................
Tax benefits of exercised stock options .
Stock compensation expense ..................
Restricted stock awards ..........................
Amortization of restricted stock
awards ..................................................
Earned employee stock ownership plan
shares ...................................................
Balance, December 31, 2018 ....................... $
79
(158)
177
80
0
91
50,566 86,886
4,404
(606)
(2,417 ) (58,739 ) 69,645
6,350
(606)
79
0
177
158
(820)
21
194
274
(2,223 ) (58,581 ) 75,919
4,404
21
158
(158)
278
(54 )
0
41
0
(54)
147
41
(278)
147
147
0
91
50,623 91,448
8,236
(957)
(69)
193
340
(2,030 ) (58,357 ) 80,818
8,236
(69)
70
(70)
(6,453)
(4,168)
(145)
64
17
(188)
134
206
0
91
40,090 99,754
(1,096)
4,168
145
188
0
(6,453)
0
0
64
17
0
134
194
400
(1,836 ) (53,856 ) 83,147
See accompanying notes to consolidated financial statements.
27
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years ended December 31 (Dollars in thousands)
Cash flows from operating activities:
2018
2017
2016
Net income ........................................................................................................................... $
Adjustments to reconcile net income to cash provided by operating activities:
8,236
4,404
Provision for loan losses .................................................................................................
Depreciation ....................................................................................................................
Amortization of premiums (discounts), net ....................................................................
Amortization of deferred loan fees .................................................................................
Amortization of core deposit intangible ..........................................................................
Amortization of purchased asset fair value adjustments ................................................
Amortization of mortgage servicing rights .....................................................................
Capitalized mortgage servicing rights .............................................................................
Deferred income tax expense ..........................................................................................
Reclassification of certain income tax effects from accumulated other
comprehensive loss .....................................................................................................
Securities losses, net ........................................................................................................
Loss (gain) on sale of premises .......................................................................................
Gains on real estate owned, net .......................................................................................
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 ..........................................................
Increase (decrease) in accrued interest payable ..............................................................
(Increase) decrease in other assets ..................................................................................
(Decrease) increase 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 owned ............................................................................
Net increase in loans receivable ..........................................................................................
Acquisition payment (net of cash acquired) ........................................................................
Proceeds from sale of premises ...........................................................................................
Purchases of premises and equipment .................................................................................
Net cash used by investing activities ..............................................................................
Cash flows from financing activities:
(Decrease) increase in deposits ............................................................................................
Warrants purchased ..............................................................................................................
Stock awards withheld for tax withholding .........................................................................
Excess tax benefit from options exercised ..........................................................................
Proceeds from borrowings ...................................................................................................
Repayment of borrowings ....................................................................................................
Increase in customer escrows ..............................................................................................
Net cash (used) provided by financing activities ............................................................
(Decrease) increase 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 ...............................................................................
Loans held for sale transferred to loans ...............................................................................
Transfer of loans to real estate owned, net ..........................................................................
See accompanying notes to consolidated financial statements.
28
(649)
1,078
16
(260)
99
(70)
551
(682)
1,084
0
36
11
(80)
(2,095)
88,649
(76,489)
134
194
206
17
(12)
200
(1,343)
(1,024)
2
17,809
0
1,914
310
(4,888)
(322)
272
367
(11,483)
0
0
(2,497)
(16,327)
(12,249)
(6,453)
0
64
6,801
(6,801)
301
(18,337)
(16,855)
37,564
20,709
2,034
4,264
11,642
0
74
(523)
949
(3)
(240)
99
(85)
555
(675)
2,105
158
0
(8)
(72)
(2,138)
90,127
(78,751)
147
193
147
41
282
(91)
417
(62)
67
17,043
0
953
20,100
(20,035)
(3,999)
3,952
309
(43,194)
0
8
(1,011)
(42,917)
42,794
0
(54)
0
99,200
(106,200)
137
35,877
10,003
27,561
37,564
1,887
1,879
9,211
164
253
6,350
(645)
850
47
(1,011)
92
(529)
601
(706)
3,128
0
10
0
(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)
6,080
0
(1,607)
(50,365)
14,468
0
0
0
45,000
(47,000)
163
12,631
(12,221)
39,782
27,561
1,599
436
15,002
0
591
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2018, 2017 and 2016
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 (SEC) on March 8, 2019.
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.
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 date of 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
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.
review
tax consequences attributable
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. These calculations are based on many complex
factors including estimates of the timing of reversals of
temporary differences, the interpretation of federal and state
to
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.
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
that are
for premiums and discounts
recognized in interest income using the interest method
with discounts amortized over the period to maturity
and premiums amortized to the earliest call date.
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 method with
the
interest
discounts amortized over the period to maturity and
premiums amortized to the earliest call date. 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.
income using
29
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
that the Company will be required to sell the security prior
to recovery. To the extent it is determined that a security is
impaired, an
deemed
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
classified as
third party
impaired. Subsequent new
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 materially 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 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 taken when the
impairment is 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. 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.
30
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, the borrower has consistently made the required
payments for a period of six months, and the 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.
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 more,
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 and performs according to the modified terms for
a period of at least one year. 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.
31
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
its
net servicing
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.
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. The Company is no longer subject to federal or state
income tax examinations by tax authorities for years before
2014.
Earnings per Common Share
Basic earnings per common share excludes dilution and is
computed by dividing the income available to common
shareholders 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.
32
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
the
New Accounting Pronouncements
In February 2016, the Financial Accounting Standards
Board (FASB) issued Accounting Standards Update (ASU)
2016-02, Leases (Topic 842). The amendments in the ASU
create Topic 842, Leases, and supersede
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
retrospective approach. The modified
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 the lease is
modified. As entities started to implement the new leases
standard, many preparers were encountering some
unanticipated costs and complexities associated with the
modified retrospective transition method, particularly the
comparative period reporting requirements. In response to
these issues, the FASB in July 2018 issued ASU 2018-11.
The amendments in this ASU provide lessors with an
additional (and optional) transition method to adopt the new
leases standard. Under this new transition method, an entity
initially applies the new leases standard at the adoption date
and recognizes a cumulative-effect adjustment to the
opening balance of retained earnings in the period of
adoption. The amendments in these ASU’s, for public
business entities, are effective for fiscal years beginning
after December 15, 2018, including interim periods within
those fiscal years. The adoption of these ASU’s in the first
quarter of 2019 resulted in the Company recording a $4.5
million right-of-use asset and an offsetting lease payment
obligation liability on January 1, 2019.
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 filers with the SEC, 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 has accumulated the charge off information
necessary to calculate the appropriate life of loan loss
percentages for the various loan categories, has identified
several key metrics to help identify and project anticipated
changes in the credit quality of our loan portfolio upon
enactment, and is in the process of evaluating the
determination of potential qualitative reserve amounts and
the impact that the adoption of this ASU in the first quarter
of 2020 will have on the Company’s consolidated financial
statements.
33
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
the FASB
incorporated
in market pricing on
issued ASU 2017-08,
In March 2017,
Receivables – Nonrefundable Fees and Other Costs
(Subtopic 310-20): Premium Amortization on Purchased
Callable Debt Securities. The amendments in this ASU
shorten the amortization period for certain callable debt
securities held at a premium. Specifically, the amendments
require the premium to be amortized to the earliest call date.
The amendments do not require an accounting change for
securities held at a discount, as discounts continue to be
amortized to maturity. This ASU is intended to more closely
align the amortization period of premiums and discounts to
expectations
the
underlying securities. In most cases, market participants
price securities to the call date that produces the worst yield
when the coupon is above current market rates and price
securities to maturity when the coupon is below market
rates. As a result, the amendments more closely align
interest income recorded on bonds held at a premium or a
discount with the economics of the underlying instrument.
This ASU is intended to reduce diversity in practice and is
effective for public business entities for fiscal years, and
interim periods within those fiscal years, beginning after
December 15, 2018 with early adoption permitted. Upon
adoption, the amendments should be applied using a
modified retrospective basis through a cumulative-effect
adjustment directly to retained earnings as of the beginning
of the period of adoption. Additionally, in the period of
adoption, an entity should provide disclosures about a
change in accounting principles. The adoption of this ASU
in the first quarter of 2019 had no impact on the Company’s
consolidated financial statements as the Company was
already accounting for the premiums and discounts on debt
securities in accordance with the requirements of the ASU.
In August 2018, the FASB issued ASU 2018-13, Fair Value
Measurement (Topic 820), Disclosure Framework –
Changes to the Disclosure Requirements for Fair Value
Measurement. The Amendments in this ASU apply to all
entities that are required, under existing GAAP, to make
disclosures about recurring or nonrecurring fair value
measurements and modify the disclosure requirements on
fair value measurements in Topic 820, Fair Value
Measurement, including the consideration of costs and
benefits. The ASU removed, modified, and added various
disclosure requirements in Topic 820. The amendments also
eliminate at a minimum from the phrase an entity shall
disclose at a minimum to promote the appropriate exercise
of discretion by entities when considering fair value
measurement disclosures and to clarify that materiality is an
appropriate consideration of entities and their auditor when
evaluating disclosure requirements. The amendments in the
ASU are effective for all entities for fiscal years, and interim
periods within those fiscal years, beginning after December
15, 2019. An entity is permitted to early adopt the
implementation of any removed or modified disclosures
upon issuance of the ASU and delay adoption of the
34
additional disclosures until their effective date. The
Company has not opted to early adopt any portion of this
ASU and the adoption in the first quarter of 2020 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 year have been reclassified to conform to the
current year presentation.
NOTE 2 Acquisitions
The Company records purchased assets and liabilities at
their fair market value at the time of purchase in accordance
with the requirements of ASU 805 - Business 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 previously existing branch
location in Albert Lea.
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. 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
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
allowance for credit losses are less meaningful after the
acquisition. The purchased loans were divided into loans
with evidence of credit quality deterioration, which are
accounted for under ASC topic 310-30 “Receivables –
Loans and Debt Securities Acquired with Deteriorated
Credit Quality” (purchased credit impaired (PCI)) and loans
that do not meet this criteria, which are accounted for under
ASC topic 310-20 “Nonrefundable Fees and Other Costs”
(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.
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
2018
Tax
Effect
For the years ended December 31,
2017
Tax
Effect
Before
Tax
Net
of Tax
Net
of Tax
Before
Tax
2016
Tax
Effect
Net
of Tax
during the period ..................................... $
(94)
(25)
(69)
33
12
21
(1,016)
(404)
(612)
Less reclassification of net losses included
in net income ...........................................
0
0
0
0
0
0
(10)
(4)
(6)
Net unrealized (losses) gains arising during
the period .................................................
(94)
(25)
(69)
33
12
21
(1,006)
(400)
(606)
Reclassification of certain income tax
effects from accumulated other
comprehensive income............................
Other comprehensive (loss) income ............ $
0
(94)
0
(25)
0
(69)
0
33
(158)
170
158
(137)
0
(1,006)
0
(400)
0
(606)
The reclassification in 2017 relates to the change in the tax rate that occurred because of the enactment of the Tax Cuts and
Jobs Act in the fourth quarter of 2017.
35
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 Securities Available for Sale
A summary of securities available for sale at December 31, 2018 and 2017 is as follows:
(Dollars in thousands)
December 31, 2018
Mortgage-backed securities:
Federal National Mortgage Association (FNMA) ............................... $
Federal Home Loan Mortgage Corporation (FHLMC) .....................
Collateralized mortgage obligations:
FNMA .......................................................................................................
Other marketable securities:
U.S. Government agency obligations ....................................................
Municipal obligations .............................................................................
Corporate obligations .............................................................................
Corporate preferred stock .....................................................................
Corporate equity .....................................................................................
December 31, 2017
Mortgage-backed securities:
FNMA ....................................................................................................... $
FHLMC .....................................................................................................
Collateralized mortgage obligations:
FNMA .......................................................................................................
$
Other marketable securities:
U.S. Government agency obligations .......................................................
Municipal obligations ...............................................................................
Corporate obligations ................................................................................
Corporate preferred stock .........................................................................
Corporate equity ........................................................................................
$
The Company did not sell any available for sale securities
in 2018, but did recognize some losses on equity securities
that were not considered material due to the adoption of
ASU 2016-01, Financial Instruments – Overall (Subtopic
825-10) Recognition and Measurement of Financial Assets
and Financial Liabilities in the first quarter of 2018. The
Company did not sell any available for sale securities and
did not recognize any gains or losses on investments in
2017. In 2016, there were no material gains or losses
recognized.
The following table presents the amortized cost and
estimated fair value of securities available for sale at
December 31, 2018, 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
Amortized
Cost
Gross
Unrealized
Gains
Gross
Unrealized
Losses
Fair Value
3,886
4,074
199
8,159
69,971
2,378
173
700
121
73,343
81,502
4,834
91
223
5,148
69,962
2,699
234
700
58
73,653
78,801
0
0
0
0
0
1
0
0
0
1
1
1
2
0
3
0
2
0
0
99
101
104
(117)
(10)
(9)
(136)
(1,236)
(10)
(1)
(140)
0
(1,387)
(1,523)
(78)
0
(5)
(83)
(1,201)
(8)
(1)
(140)
0
(1,350)
(1,433)
3,769
4,064
190
8,023
68,735
2,369
172
560
121
71,957
79,980
4,757
93
218
5,068
68,761
2,693
233
560
157
72,404
77,472
may differ from the maturities in the following table
because obligors may have the right to call or prepay
obligations with or without call or prepayment penalties:
(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
Fair
Value
1,781
74,973
2,472
633
121
79,980
1,805
76,286
2,514
776
121
81,502
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.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2018 and 2017:
(Dollars in thousands)
December 31, 2018
Mortgage backed securities:
Less Than Twelve Months
Fair
Value
# of
Investments
Unrealized
Losses
Twelve Months or More
Fair
Value
# of
Investments
Unrealized
Losses
Total
Fair
Value
Unrealized
Losses
FNMA ..........................................................
FHLMC .......................................................
Collateralized mortgage obligations:
FNMA ..........................................................
Other marketable securities:
U.S. Government agency obligations .......
Municipal obligations ................................
Corporate obligations ................................
Corporate preferred stock ........................
Total temporarily impaired securities .....
0 $
1
0
0
3
0
0
4 $
0
4,060
0
(10 )
2 $
0
3,769
0
(117) $
0
3,769
4,060
(117)
(10)
0
0
1
190
(9)
190
(9)
0
498
0
0
4,558
0
(2 )
0
0
(12 )
14 68,735
1,467
8
172
1
1
560
27 $ 74,893
(1,236) 68,735
1,965
172
560
(1,511) $ 79,451
(8)
(1)
(140)
(1,236)
(10)
(1)
(140)
(1,523)
December 31, 2017
Mortgage backed securities:
FNMA ..........................................................
2 $
4,703
(78 )
Collateralized mortgage obligations:
FNMA ..........................................................
1
218
(5 )
0 $
0
0
0
0 $
4,703
(78)
0
218
(5)
Other marketable securities:
U.S. Government agency obligations ..........
Municipal obligations ..................................
Corporate obligations ...................................
Corporate preferred stock ............................
Total temporarily impaired securities ..........
9,819
2
2,268
14
233
1
0
0
20 $ 17,241
(163 )
(8 )
(1 )
0
(255 )
12 58,942
0
0
0
0
1
560
13 $ 59,502
(1,038) 68,761
2,268
233
560
(1,178) $ 76,743
0
0
(140)
(1,201)
(8)
(1)
(140)
(1,433)
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
impaired securities other than the corporate preferred stock
are the result of changes in interest rates. The unrealized
losses reported for the corporate preferred stock at
December 31, 2018 relates to a single trust preferred
security that was issued by the holding company of a small
community bank. As of December 31, 2018 all payments
were current on the trust preferred security and the issuer’s
subsidiary bank was considered to be “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, 2018. 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.
37
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 Loans Receivable, Net
A summary of loans receivable at December 31, 2018 and
2017, is as follows:
(Dollars in thousands)
Residential real estate loans:
2018
2017
Single family conventional ....................... $
Single family Federal Housing
110,580
106,881
Administration (FHA) ..........................
84
88
Single family Veterans
Administration (VA) ............................
Commercial real estate:
Lodging .....................................................
Retail/office ...............................................
Nursing home/health care .........................
Land developments ...................................
Golf courses ..............................................
Restaurant/bar/café ...................................
Warehouse .................................................
Construction:
Single family ........................................
Multi-family .........................................
Commercial real estate .........................
Manufacturing ...........................................
Churches/community service ....................
Multi-family ..............................................
Other ..........................................................
Consumer:
Autos .........................................................
Home equity line .......................................
Home equity ..............................................
Recreational vehicles ................................
Land/lots ....................................................
Other – secured .........................................
Other – unsecured .....................................
Commercial business .....................................
Total loans ............................................
Less:
34
110,698
36
107,005
45,259
69,539
3,712
18,865
397
8,196
34,634
20,442
4,931
3,571
22,029
11,103
50,150
43,302
336,130
2,483
32,273
16,733
16,226
2,145
1,423
1,249
72,532
75,496
594,856
55,675
64,780
7,352
21,058
1,112
5,929
25,891
23,090
11,649
11,705
22,136
12,734
28,649
42,357
334,117
2,894
36,869
15,823
13,181
1,587
1,911
1,502
73,767
79,909
594,798
Unamortized discounts..............................
Net deferred loan costs..............................
Allowance for loan losses .........................
Total loans receivable, net .................... $
17
(535)
8,686
586,688
19
(463)
9,311
585,931
Commitments to originate or purchase
loans .......................................................... $
13,183
24,692
Commitments to deliver loans to secondary
market ........................................................ $
7,289
5,629
Weighted average contractual rate of loans
in portfolio .................................................
4.83%
4.56%
Included in total commitments to originate or purchase
loans are fixed rate loans aggregating $11.0 million and
$18.1 million as of December 31, 2018 and 2017,
respectively. The interest rates on these loan commitments
ranged from 4.125% to 6.375% at December 31, 2018 and
from 3.375% to 5.210% at December 31, 2017.
The aggregate amount of loans to executive officers and
directors of the Company was $0.1 million, $0.1 million and
$0.2 million at December 31, 2018, 2017 and 2016,
respectively. There was no activity during 2018 on loans to
executive officers and directors. There was no activity
during 2017 and 2016 other than the $0.1 million and $2.5
million in loans reclassified during the respective periods
due to a change in borrower classification. 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, 2018, 2017 and 2016, the Company was
servicing loans for others with aggregate unpaid principal
balances of $480.6 million, $471.4 million and $425.5
million, respectively.
The Company originates residential, commercial real estate
and other loans primarily in Minnesota, Wisconsin and
Iowa. At December 31, 2018 and 2017, the Company had
in its portfolio single family residential loans located in the
following states:
2018
2017
Percent
of Total
Amount
(Dollars in thousands)
Iowa ................................. $
2,778
Minnesota ........................ 98,505
0
Missouri ...........................
8,105
Wisconsin ........................
Other states (1) ..................
1,310
Total ............................ $ 110,698
Amount
3,605
90,345
1,841
9,894
1,320
100.0% $ 107,005
2.5% $
89.0
0.0
7.3
1.2
Percent
of Total
3.4%
84.4
1.7
9.3
1.2
100.0%
(1) Amounts under one million dollars in both years are included in “Other
states”.
38
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2018 and 2017, the Company had in its portfolio commercial real estate loans located in the following
states:
(Dollars in thousands)
Alabama .................................................................................................... $
Florida .......................................................................................................
Idaho .........................................................................................................
Indiana ......................................................................................................
Iowa ..........................................................................................................
Minnesota .................................................................................................
North Carolina ..........................................................................................
North Dakota ............................................................................................
Ohio ..........................................................................................................
Pennsylvania .............................................................................................
Wisconsin .................................................................................................
Other states(1) ............................................................................................
Total ..................................................................................................... $
2018
Amount
Percent
of Total
2017
Amount
Percent
of Total
0
4,795
3,171
3,031
7,563
238,397
5,442
1,043
1,566
1,914
67,196
2,012
336,130
0.0% $
1.4
0.9
0.9
2.3
70.9
1.6
0.3
0.5
0.6
20.0
0.6
100.0% $
1,742
2,790
3,371
3,374
4,755
232,991
5,996
1,093
1,680
2,056
72,510
1,759
334,117
0.5%
0.9
1.0
1.0
1.4
69.8
1.8
0.3
0.5
0.6
21.7
0.5
100.0%
(1)Amounts under one million dollars in both years are included in “Other states”.
NOTE 6 Allowance for Loan Losses and Credit Quality Information
The allowance for loan losses is summarized as follows:
Single
Family
Commercial
Real Estate
Consumer
Commercial
Business
Total
(Dollars in thousands)
Balance, December 31, 2015 ........................................ $
Provision for losses .................................................. $
Charge-offs ...............................................................
Recoveries ................................................................
Balance, December 31, 2016 ........................................ $
Provision for losses .................................................. $
Charge-offs ...............................................................
Recoveries ................................................................
Balance, December 31, 2017 ........................................ $
Provision for losses ................................................. $
Charge-offs .............................................................
Recoveries ...............................................................
Balance, December 31, 2018 ...................................... $
Allocated to:
Specific reserves ...................................................... $
General reserves .......................................................
Balance, December 31, 2017 ........................................ $
Allocated to:
Specific reserves ..................................................... $
General reserves .....................................................
Balance, December 31, 2018 ...................................... $
Loans receivable at December 31, 2017:
990
6,078
1,200
1,441
262
(66)
0
1,186
(280)
(6)
0
900
(44)
(24)
1
833
192
708
900
98
735
833
(1,788 )
(67 )
730
4,953
(75 )
(50 )
245
5,073
(421 )
0
217
4,869
441
4,632
5,073
451
4,418
4,869
481
(108)
40
1,613
263
(288)
42
1,630
202
(226)
16
1,622
263
1,367
1,630
172
1,450
1,622
400
(180)
490
2,151
(431)
(311)
299
1,708
(386)
(270)
310
1,362
177
1,531
1,708
73
1,289
1,362
Individually reviewed for impairment ..................... $
Collectively reviewed for impairment .....................
Ending balance ......................................................... $
1,523
105,482
107,005
1,364
332,753
334,117
880
72,887
73,767
507
79,402
79,909
Loans receivable at December 31, 2018:
Individually reviewed for impairment ................. $
Collectively reviewed for impairment ..................
Ending balance ....................................................... $
1,226
109,472
110,698
1,311
334,819
336,130
856
71,676
72,532
303
75,193
75,496
39
9,709
(645)
(421)
1,260
9,903
(523)
(655)
586
9,311
(649)
(520)
544
8,686
1,073
8,238
9,311
794
7,892
8,686
4,274
590,524
594,798
3,696
591,160
594,856
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following table summarizes the amount of classified and unclassified loans at December 31, 2018 and 2017:
December 31, 2018
Classified
Unclassified
(Dollars in thousands)
Single family .............................................. $
Commercial real estate:
Special
Mention Substandard Doubtful
40
1,771
150
Loss
Total
0
1,961
Total
Total
Loans
108,737 110,698
Real estate rental and leasing ..............
Other ......................................................
Consumer ...................................................
Commercial business ................................
$
5,564
4,879
0
6,647
17,240
4,805
5,118
709
2,761
15,164
0
0
41
0
81
0
0
106
0
106
10,369
9,997
856
9,408
32,591
185,195 195,564
130,569 140,566
71,676
72,532
75,496
66,088
562,265 594,856
(Dollars in thousands)
Special
Mention Substandard Doubtful
Loss
Total
Total
December 31, 2017
Classified
Unclassified
77
2,154
44
0
2,275
104,730
Total
Loans
107,005
Single family ................................................ $
Commercial real estate:
Real estate rental and leasing ..................
Other ........................................................
Consumer .....................................................
Commercial business ...................................
$
5,022
9,135
0
5,781
20,015
3,813
4,257
631
5,506
16,361
0
0
119
0
163
0
0
130
0
130
8,835
13,392
880
11,287
36,669
166,342
145,548
72,887
68,622
558,129
175,177
158,940
73,767
79,909
594,798
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.
40
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The aging of past due loans at December 31, 2018 and 2017 is summarized as follows:
(Dollars in thousands)
2018
30-59 Days
60-89 Days
Past Due
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 .................................
$
2017
Single family ................................................ $
Commercial real estate:
Real estate rental and leasing ..................
Other ........................................................
Consumer .....................................................
Commercial business ...................................
$
680
325
77
1,082
109,616
110,698
0
0
391
21
1,092
0
0
100
0
425
0
0
279
0
356
0
0
770
21
1,873
195,564
140,566
71,762
75,475
592,983
195,564
140,566
72,532
75,496
594,856
727
294
669
1,690
105,315
107,005
0
0
734
34
1,495
0
0
117
0
411
0
0
235
180
1,084
0
0
1,086
214
2,990
175,177
158,940
72,681
79,695
591,808
175,177
158,940
73,767
79,909
594,798
0
0
0
0
0
0
0
0
0
0
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, 2018 and 2017:
(Dollars in thousands)
Loans with no related allowance recorded:
December 31, 2018
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 .............................................................................
458
0
25
515
477
0
1,682
515
0
0
0
0
465
27
81
510
Loans with an allowance recorded:
Single family ........................................................................
Commercial real estate:
Real estate rental and leasing ........................................
Other ................................................................................
Consumer .............................................................................
Commercial business ..........................................................
Total:
768
768
98
859
201
1,085
341
303
201
1,085
341
854
21
430
172
73
82
1,673
395
385
Single family ........................................................................
Commercial real estate:
Real estate rental and leasing ........................................
Other ................................................................................
Consumer .............................................................................
Commercial business ..........................................................
$
1,226
1,245
98
1,324
201
1,110
856
303
3,696
201
2,767
856
854
5,923
21
430
172
73
794
109
1,754
905
385
4,477
21
0
106
14
5
7
0
9
13
26
7
106
23
13
175
41
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands)
Loans with no related allowance recorded:
December 31, 2017
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 ............................................................
415
415
35
25
414
0
51
1,682
414
0
0
0
0
0
0
414
38
26
406
100
Loans with an allowance recorded:
Single family .........................................................................
Commercial real estate:
Real estate rental and leasing ...........................................
Other .................................................................................
Consumer ..............................................................................
Commercial business ............................................................
Total:
1,108
1,108
192
878
0
1,304
466
507
0
1,304
483
1,358
0
441
263
177
155
1,715
457
443
Single family .........................................................................
Commercial real estate:
Real estate rental and leasing ...........................................
Other .................................................................................
Consumer ..............................................................................
Commercial business ............................................................
$
1,523
1,523
192
1,292
35
1,329
880
507
4,274
51
2,986
897
1,358
6,815
0
441
263
177
1,073
193
1,741
863
543
4,632
24
0
96
7
0
31
0
0
14
22
55
0
96
21
22
194
At December 31, 2018, 2017 and 2016, non-accruing loans
totaled $2.7 million, $3.2 million and $3.3 million,
respectively, for which the related allowance for loan losses
was $0.7 million, $0.9 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 $0.4 million, $0.4 million and $0.7
million at December 31, 2018, 2017 and 2016, respectively.
Had the non-accruing loans performed in accordance with
their original terms, the Company would have recorded
gross interest income on the loans of $0.3 million, $0.3
million and $0.6 million in 2018, 2017 and 2016,
respectively. For the years ended December 31, 2018, 2017
and 2016, the Company recognized interest income on these
loans of $0.1 million, $0.1 million and $0.4 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.
The following table summarizes non-accrual loans at
December 31, 2018 and 2017:
(Dollars in thousands)
Single family ................................................... $
Commercial real estate:
Real estate rental and leasing ......................
Other............................................................
Consumer .........................................................
Commercial business .......................................
$
2018
2017
730
949
201
1,110
489
148
2,678
35
1,329
553
278
3,144
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 TDR.
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
At December 31, 2018, 2017 and 2016, there were loans
included in loans receivable, net, with terms that had been
modified in a TDR totaling $2.5 million, $3.0 million and
$3.3 million, respectively. Had these loans been performing
in accordance with their original terms throughout 2018,
2017 and 2016, the Company would have recorded gross
interest income of $0.3 million, $0.4 million and $0.6
million, respectively. During 2018, 2017 and 2016, the
Company recognized interest income of $0.2 million, $0.2
million and $0.4 million, respectively, on these loans. For
the loans that were modified in 2018, $0.4 million were
classified and performing and $1.2 million were non-
performing at December 31, 2018.
The following table summarizes TDRs at December 31,
2018 and 2017:
(Dollars in thousands)
Single family ................................................... $
Commercial real estate:
Other ...........................................................
Consumer .........................................................
Commercial business.......................................
$
2018
2017
636
685
1,110
522
208
2,476
1,210
758
391
3,044
As of December 31, 2018, the Bank had commitments to
lend an additional $0.9 million to a borrower who has a 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 $0.8 million to this same borrower at
December 31, 2017.
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, 2018 and
2017:
(Dollars in thousands)
Troubled debt restructurings:
Single family ................................................
Commercial real estate:
Real estate rental and leasing ..................
Other ........................................................
Consumer .....................................................
Commercial business ...................................
Total .............................................................
Year ended December 31, 2018
Pre-
modification
Outstanding
Recorded
Investment
Post-
modification
Outstanding
Recorded
Investment
Number of
Contracts
Year ended December 31, 2017
Pre-
modification
Outstanding
Recorded
Investment
Post
-modification
Outstanding
Recorded
Investment
Number of
Contracts
2 $
1
2
10
1
16 $
217
220
3 $
282
54
1,518
373
70
2,232
54
1,518
373
70
2,235
0
0
15
1
19 $
0
0
588
416
1,286
514
0
0
591
116
1,221
Loans that were restructured within the 12 months preceding December 31, 2018 and 2017 and defaulted during the year are
presented in the table below:
(Dollars in thousands)
TDRs that subsequently defaulted:
Year ended December 31, 2018
Year ended December 31, 2017
Number of
Contracts
Outstanding
Recorded
Investment
Number of
Contracts
Outstanding
Recorded
Investment
Consumer ....................................................................
Total ............................................................................
1 $
1 $
17
17
1 $
1 $
65
65
43
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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 reserves for
TDRs was $0.6 million, or 7.2%, of the total $8.7 million in
allowance for loan losses at December 31, 2018, and $0.9
million, or 9.8%, of the total $9.3 million in allowance for
loan losses at December 31, 2017.
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.
44
The following is additional information with respect to
loans acquired through acquisitions:
(Dollars in thousands)
Purchased Performing Loans:
Balance at December 31, 2015 ........... $
Loans acquired during the period .. $
Change due to
Contractual
Principal
Receivable
Accretable
Difference
Net
Carrying
Amount
18,539
(459) 18,080
11,772
(211) 11,561
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)
Change due to
payments/refinances .................... $
Transferred to foreclosed assets .....
Change due to loan charge-off .......
Balance at December 31, 2017 ........... $
(6,594)
(2)
(18)
10,128
101
0
0
(231)
(6,493)
(2)
(18)
9,897
Change due to
payments/refinances .................. $
Balance at December 31, 2018 ......... $
(2,815)
7,313
49
(182)
(2,766)
7,131
Contractual
Principal
Receivable
Non-
Accretable
Difference
Accretable
Difference
Net
Carrying
Amount
(Dollars in thousands)
Purchased Credit Impaired
Loans:
Balance at December 31,
2015 ....................................... $
555
(162)
0
393
Loans acquired during the
period ................................ $
329
(37)
0
292
Transfer to accretable
difference ..........................
0
199
(199)
0
Change due to
payments/refinances .........
(449)
0
147
(302)
Balance at December 31,
2016 ....................................... $
435
0
(52)
383
Change due to
payments/refinances ......... $
(33)
0
13
(20)
Balance at December 31,
2017 ....................................... $
402
0
(39)
363
Change due to
payments/refinances ....... $
(214)
Balance at December 31,
2018 ....................................... $
188
0
0
33
(181)
(6)
182
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, 2018 was $0.2 million.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The gross carrying amount of intangible assets and the
associated accumulated amortization at December 31, 2018
and 2017 are presented in the following table. Amortization
expense for intangible assets was $0.7 million for each of
the years ended December 31, 2018, 2017 and 2016.
(Dollars in thousands)
December 31, 2018
Gross
Carrying
Amount
Unamortized
Accumulated Intangible
Amortization Assets
Mortgage servicing rights .. $
Core deposit intangibles ....
Goodwill...............................
Total ..................................... $
December 31, 2017
Mortgage servicing rights .... $
Core deposit intangibles .......
Goodwill ...............................
Total ...................................... $
4,526
574
802
5,902
4,244
574
802
5,620
(2,671)
(319)
0
(2,990)
(2,520)
(219)
0
(2,739)
1,855
255
802
2,912
1,724
355
802
2,881
The following
amortization expense for amortizing intangible assets:
the estimated future
indicates
table
(Dollars in thousands)
Year ended December 31,
2019 .......................................... $
2020 ..........................................
2021 ..........................................
2022 ..........................................
2023 ..........................................
Thereafter .................................
$
Mortgage
Servicing
Rights
Core
Deposit
Intangible
Total
Amortizing
Intangible
Assets
467
389
344
284
206
165
1,855
99
99
47
10
0
0
255
566
488
391
294
206
165
2,110
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,
2018. 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, 2018 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 ..............................................
$
2018
2017
381
1,975
2,356
352
1,992
2,344
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 2018 and
2017 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 .......... $
2018
2017
1,724
682
(551)
1,855
0
1,855
3,901
1,604
675
(555)
1,724
0
1,724
3,196
All of the single family loans sold where the Company
continues to service the loans are serviced for FNMA under
the individual loan sale program. The following is a
summary of the risk characteristics of the loans being
serviced for FNMA at December 31, 2018:
Loan
Principal
Balance
Weighted
Average
Interest
Rate
Weighted
Average
Remaining
Term
(months)
Number
of
Loans
(Dollars in thousands)
Original term:
30 year fixed rate .............. $ 301,378
15 year fixed rate .............. 93,698
53
Adjustable rate ..................
4.17%
3.17
4.38
307
130
269
2,314
964
2
45
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 9 Real Estate, Net
A summary of real estate at December 31, 2018 and 2017 is as follows:
2018
2017
(Dollars in thousands)
Real estate in judgment subject to redemption ......... $
Real estate acquired through foreclosure ..................
Allowance for losses .................................................
Real estate, net .......................................................... $
Residential Commercial
0
0
0
0
0
0
414
414
0
414
Total
Residential Commercial
40
0
0
414
40
414
0
0
40
414
173
414
587
0
587
Total
213
414
627
0
627
NOTE 10 Premises and Equipment
A summary of premises and equipment at December 31,
2018 and 2017 is as follows:
(Dollars in thousands)
Land ................................................................. $
Office buildings and improvements ................
Furniture and equipment .................................
Accumulated depreciation ...............................
$
2018
2017
2,621
10,878
12,935
26,434
(16,799)
9,635
2,021
9,844
12,507
24,372
(16,146)
8,226
The increase in premises and equipment related primarily to
the purchase of a building in the Milwaukee area that will
be used as a new location for our existing loan production
office in that market.
46
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 11 Deposits
Deposits and their weighted average interest rates at December 31, 2018 and 2017 are summarized as follows:
(Dollars in thousands)
Noninterest checking ...................
NOW accounts .............................
Savings accounts .........................
Money market accounts ...............
Certificates by rate:
0-0.99% .......................................
1-1.99% .......................................
2-2.99% .......................................
3-3.99% .......................................
Total certificates ..........................
Total deposits ...............................
Weighted
Average
Rate
2018
Amount
Percent
of Total
Weighted
Average
Rate
2017
Amount
Percent
of Total
0.00% $
0.10
0.08
0.56
1.32
0.43
$
163,500
88,715
76,839
181,374
510,428
32,904
47,627
31,680
713
112,924
623,352
26.2 %
14.3
12.3
29.1
81.9
5.3
7.6
5.1
0.1
18.1
100.0 %
0.00% $
0.05
0.08
0.40
0.94
0.30
$
172,007
90,599
75,255
186,937
524,798
58,444
43,691
8,550
118
110,803
635,601
27.1%
14.3
11.8
29.4
82.6
9.2
6.9
1.3
0.0
17.4
100.0%
At December 31, 2018 and 2017, the Company had $182.0
million and $204.2 million, respectively, of deposit
accounts with balances of $250,000 or more. At December
31, 2018 and 2017, the Company had no certificate accounts
that had been acquired through a broker.
Certificates had the following maturities at December 31, 2018 and 2017:
(Dollars in thousands)
Remaining term to maturity
1-6 months ................................................................................. $
7-12 months ...............................................................................
13-36 months .............................................................................
Over 36 months .........................................................................
$
2018
2017
Amount
Weighted
Average
Rate
Amount
Weighted
Average
Rate
39,004
36,711
33,941
3,268
112,924
1.23% $
1.29
1.46
1.44
1.32
$
28,133
37,439
39,382
5,849
110,803
0.54%
0.95
1.14
1.28
0.94
At December 31, 2018 and 2017, the Company had pledged
mortgage loans and mortgage-backed and related securities
with an amortized cost of approximately $17.9 million and
$18.9 million, respectively, as collateral for certain deposits.
47
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Interest expense on deposits is summarized as follows for the years ended December 31, 2018, 2017 and 2016:
(Dollars in thousands)
NOW accounts .................................................................................. $
Savings accounts ..............................................................................
Money market accounts ....................................................................
Certificates ........................................................................................
$
2018
2017
2016
62
61
865
1,243
2,231
77
63
560
770
1,470
50
62
366
524
1,002
NOTE 12 Federal Home Loan Bank (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, 2018 or December 31, 2017. At
December 31, 2018 the Bank had collateral pledged to the
FHLB consisting of FHLB stock, mortgage loans, and
investments with a borrowing capacity of approximately
$167.6 million, based upon the mortgage loans and
securities that were pledged at December 31, 2018, subject
to a requirement to purchase FHLB stock. The Bank also
had the ability to draw additional borrowings of $73.0
million from the Federal Reserve Bank of Minneapolis,
based upon the loans that were pledged to them as of
December 31, 2018, subject to approval from the Board of
Governors of the Federal Reserve System (FRB).
At December 31, 2017 the Bank had collateral pledged to
the FHLB consisting of FHLB stock, mortgage loans, and
investments with a borrowing capacity of approximately
$106.3 million, subject to a requirement to purchase FHLB
stock. The Bank also had the ability to draw additional
borrowings of $77.9 million from the Federal Reserve Bank
of Minneapolis, based upon the loans that were pledged to
them as of December 31, 2017, subject to approval from the
FRB.
NOTE 13 Income Taxes
Income tax expense for the years ended December 31, 2018,
2017 and 2016 is as follows:
(Dollars in thousands)
Current:
Federal ...................................... $
State ..........................................
Total current ........................
Deferred:
Federal ......................................
State ..........................................
Total deferred ......................
Income tax expense ...................... $
2018
2017
2016
1,690
115
1,805
234
849
1,083
2,888
2,287
10
2,297
1,412
693
2,105
4,402
939
55
994
2,322
806
3,128
4,122
The reasons for the difference between the expected income
tax expense utilizing the federal corporate tax rate of 21%
in 2018, and 34% in 2017 and 2016 and the actual income
tax expense are as follows:
(Dollars in thousands)
Expected federal income tax
2018
2017
2016
expense ..................................... $
2,336
2,994
3,560
Items affecting federal income
tax:
State income taxes, net of
federal income tax
deduction .............................
Tax exempt interest ..................
Change in federal tax rate ........
Other, net ..................................
Income tax expense ...................... $
559
(11)
0
4
2,888
529
(16)
1,062
(167)
4,402
622
(16)
0
(44)
4,122
48
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:
Allowances for loan and real estate losses ... $
Deferred compensation costs ........................
Deferred ESOP loan asset .............................
Nonaccruing loan interest .............................
State net operating loss carryforward ...........
Alternative minimum tax credit
2018
2017
2,428
154
473
185
160
2,602
166
487
221
824
carryforward .............................................
208
175
Net unrealized loss on securities available
for sale ......................................................
Other ..............................................................
Total gross deferred tax assets .................
Deferred tax liabilities:
Deferred loan costs .......................................
Premises and equipment basis difference .....
Originated mortgage servicing rights ...........
Federal tax liability on state net operating
loss carryforwards ....................................
Other ..............................................................
Total gross deferred tax liabilities ............
Net deferred tax assets .............................. $
426
91
4,125
367
509
519
34
54
1,483
2,642
372
92
4,939
37
380
482
280
88
1,267
3,672
The Company has no
loss
carryforwards and $1.8 million of state net operating loss
carryforwards at December 31, 2018 that expire beginning
in 2023.
federal net operating
On December 22, 2017 the Tax Cuts and Jobs Act became
law. Among other things, this law reduced the corporate tax
rate for the Company from 34% to 21% effective January 1,
2018. In accordance with current accounting guidelines, this
change in the tax rate was reflected as an adjustment to the
Company’s deferred tax items at December 31, 2017. The
net result of this adjustment was to reduce the Company’s
net deferred tax asset by $1.1 million with a corresponding
increase to income tax expense in the fourth quarter of 2017.
Retained earnings at December 31, 2018
included
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
the
deferred
tax assets. Positive evidence
includes
cumulative net income generated over the prior three year
period and the probability that taxable income will be
generated in future periods. The Company could not
currently identify any negative evidence. Based upon this
evaluation, the Company determined that no valuation
allowance was required with respect to the net deferred tax
assets at December 31, 2018 and 2017.
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
have been 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, 2018 because such information is
not accumulated for each participating institution. As of
June 30, 2018, the Pentegra DB Plan valuation report
reflected that the Bank was obligated to make a contribution
totaling $0.1 million which was paid and expensed in 2018.
Funded status (market value of plan assets divided by
funding target) as of July 1 for the 2018, 2017, and 2016
plan years were 89.86%, 95.45%, and 97.09%, respectively.
Market value of plan assets reflects contributions received
through June 30, 2018.
Total employer contributions made to the Pentegra DB Plan,
as reported on Form 5500, equal $367.1 million, $153.2
million, and $163.1 for the plan years ended June 30, 2017,
2016 and 2015, 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.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The following contributions were paid by the Bank during the fiscal years ending December 31:
(Dollars in thousands)
2018
Date Paid
Amount
$
10/11/2018 ............
12/27/2018 ............
Total ..................... $
2017
2016
Date Paid
0 01/06/2017 ............... (1) $
26 10/15/2017 ...............
92 12/27/2017 ...............
118
$
Amount
Date Paid
Amount
119
$
27 10/15/2016 ...............
99
245
$
0
33
0
33
(1) The contribution relates to the 2016 plan year and was accrued at December 31, 2016.
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 $18,500 for 2018 and $18,000 for 2017 and
2016. 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 2018, 2017 and 2016.
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 to 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 2018, 2017 and
2016.
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 $0.5 million for 2018,
$0.4 million for 2017 and $0.3 million for 2016.
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
beginning of the year................
Shares allocated to participants ....
Shares distributed to participants .
Shares held by participants end
2018
2017
2016
357,135 339,870 334,277
24,377
24,317
(18,784)
(41,215)
24,317
(7,052)
of year .......................................
340,237 357,135 339,870
Unreleased shares beginning of
the year .....................................
Shares released during year ..........
Unreleased shares end of year ......
Total ESOP shares end of year .....
Fair value of unreleased shares
255,429 279,746 304,123
(24,317)
(24,377)
(24,317)
231,112 255,429 279,746
571,349 612,564 619,616
at December 31 ........................ $ 4,534,417 4,878,694 4,895,555
In April 2009 the HMN Financial, Inc. 2009 Equity and
Incentive Plan (2009 Plan) was adopted by the Company. In
April 2017, the 2009 Plan was superseded by the HMN
Financial, Inc. 2017 Equity Incentive Plan (2017 Plan) and
options or restricted shares were no longer awarded from
the 2009 Plan. As of December 31, 2018 there were 22,819
vested and 11,410 unvested options outstanding under the
2009 Plan. These options expire 10 years from the date of
grant and have an average exercise price of $11.21. There
were also 7,340 shares of restricted stock previously granted
to current employees under the 2009 Plan that as of
December 31, 2018 remained unvested.
50
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The purpose of the 2017 Plan is to attract and retain the best
available personnel for positions of responsibility with the
Company, to provide additional incentives to them and align
their interests with those of the Company’s stockholders,
and to thereby promote the Company’s long-term business
success. 375,000 shares of HMN common stock were
initially available for distribution under the 2017 Plan in
either restricted stock or options, subject to adjustment for
future stock splits, stock dividends and similar changes to
capitalization of the Company. Additionally, shares of
restricted stock that are awarded are counted as 1.5 shares
for purposes of determining the total shares available for
issuance under the 2017 Plan. As of December 31, 2018,
there were no options outstanding under the 2017 Plan.
There were 7,224 shares of restricted stock previously
granted to current employees under the 2017 Plan that
remained unvested at December 31, 2018.
A summary of activities under all plans for the past three years is as follows:
Shares
Available
For Grant
Unvested
Restricted
Shares
Award Value/
Weighted
Average
Options
Outstanding
Outstanding
Exercise Price
Number
Weighted
Average
Grant Date
Fair Value
Vesting
Period
(in years)
Unvested options
2009 Plan
December 31, 2015 ......................
Granted January 26, 2016 .......
Granted January 26, 2016 .......
Granted April 26, 2016 ...........
Vested ......................................
December 31, 2016 ......................
Granted January 31, 2017 .......
Transferred to 2017 Plan .........
Vested ......................................
December 31, 2017 ......................
Options Exercised .................
Vested .....................................
December 31, 2018 .....................
2017 Plan
April 25, 2017 ..............................
Granted May 5, 2017 ..............
Transferred from 2009 Plan ........
December 31, 2017 ......................
Granted January 23, 2018 ....
Granted April 24, 2018 .........
Vested .....................................
December 31, 2018 .....................
96,341
(4,087)
(34,229)
(3,149)
0
54,876
(11,164)
(43,712)
0
0
0
0
0
375,000
(3,420)
43,712
415,292
(10,044)
(792)
0
404,456
38,886
3,406
0
2,624
(24,320)
20,596
9,303
0
(15,018)
14,881
0
(7,541)
7,340
0
2,280
0
2,280
6,696
528
(2,280)
7,224
15,000 $
0
34,229
0
0
49,229 $
0
0
0
49,229 $
(15,000)
0
34,229 $
0
0
0
0
0
0
0
0
4.77
N/A
11.21
N/A
N/A
9.25
N/A
N/A
N/A
9.25
N/A
11.21
N/A
N/A
N/A
N/A
N/A
N/A
N/A
0
0
34,229 $
0
0
34,229 $
(11,409)
22,820 $
(11,410)
11,410 $
0
0
0
0
4.04
4.04
4.04
4.04
4.04
4.04
3
3
1
3
1
3
1
Total all plans .............................
404,456
14,564
34,229 $
11.21
11,410 $
4.04
The following table summarizes information about stock options outstanding at December 31, 2018:
(Dollars in thousands)
Date of Grant
Exercise
Price
January 26, 2016 ............... $
11.21
Weighted
Average
Remaining
Contractual
Life in Years
7.1
Number
Outstanding
34,229
34,229
Weighted
Average
Years Over
Which
Unrecognized
Compensation
will be
Recognized
Number
Unexercisable
Unrecognized
Compensation
Expense
11,410 $
11,410 $
1,165
1,165
0.1
Number
Exercisable
22,819
22,819
51
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The Company will issue shares from treasury stock upon the
exercise of outstanding options.
The assumptions used in determining the fair value of the
options granted during 2016 are as follows:
In accordance with ASC 718, the Company recognizes
compensation expense relating to stock options over the
vesting period. The amount of the expense was determined
under the fair value method. The fair value for each option
grant is estimated on the date of the grant using the Black
Scholes option valuation method. There were no options
granted in 2018 or 2017.
Risk-free interest rate ...............................................
Expected life (in years) .............................................
Expected volatility ....................................................
Expected dividends ...................................................
2016
2.10%
10
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 earnings per common
Year ended December 31,
2017
2016
2018
share calculation ................................................................................................................................
4,368,289
4,215,899
4,180,994
Net dilutive effect of :
Options and warrants ........................................................................................................................
Restricted stock awards.....................................................................................................................
Weighted average number of common shares outstanding adjusted for effect of dilutive securities ..
423,818
10,868
4,802,975
640,410
11,662
4,867,971
553,386
13,367
4,747,747
Net income available to common shareholders .................................................................................... $
Basic earnings per common share ......................................................................................................... $
Diluted earnings per common share ...................................................................................................... $
8,236
1.89
1.71
4,404
1.04
0.90
6,350
1.52
1.34
NOTE 16 Stockholders' Equity
The Company did not repurchase any shares of its common
stock in the open market or pay any dividends on its
common stock during 2018, 2017 or 2016. The Company
did purchase 3,589 shares of common stock, at a value of
$19.94 per share, from a director in a cashless exchange of
options exercised in 2018.
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 States
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 outstanding Preferred Stock. On May 21,
2015, the Treasury sold the Warrant at an exercise price of
$4.68 per share to three unaffiliated third party investors for
an aggregate purchase price of $5.7 million. In 2018, all of
the outstanding Warrants were either exercised by the
Warrant holder or repurchased by the Company. These
Warrant transactions resulted in the Company issuing an
additional 319,651 shares of common stock from treasury
shares for Warrants that were exercised and paying $6.5
million in cash to repurchase the remaining Warrants. As a
result of these transactions, the Company no longer has any
obligations under the Warrant.
On November 28, 2018, the Board of Directors announced
a new share repurchase program, pursuant to which the
Company may purchase shares of its common stock for an
aggregate purchase price not to exceed $6 million. The
share repurchase program does not obligate the Company to
purchase any shares and has no set expiration date. No
shares were repurchased by the Company in 2018 under the
share repurchase program.
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.
52
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 17 Regulatory Capital
The Company and the Bank are subject to the Basel III
regulatory capital requirements. The Basel III requirements,
among other things, (i) apply a set of capital requirements
to the Bank (the Company is exempt, pursuant to the Small
(Policy
Bank Holding Company Policy Statement
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)
set forth rules for calculating risk-weighted assets for
purposes of
rules made
corresponding revisions to the prompt corrective action
ratios and buffer
framework and
requirements which are fully phased in as of 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 its assets, liabilities and certain off-
requirements. The
include capital
such
balance sheet
items as calculated under regulatory
accounting practices. The capital amounts and classification
are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
The FRB amended its Policy Statement, to exempt small
bank holding companies with assets less than $3 billion
from the above capital requirements. 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 currently meets
the qualitative exemption requirements, and therefore, is
exempt from the above capital requirements.
Quantitative measures established by regulations to ensure
capital adequacy require the Bank to maintain minimum
amounts and ratios (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.
At December 31, 2018 and 2017, 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
To Be Well Capitalized
Under Prompt
Corrective Action
Provisions
Excess Capital
Amount
Percent of
Assets(1)
Amount
Percent of
Assets(1)
79,552
79,552
79,552
87,063
13.26% $
11.00
13.26
14.52
26,988
28,923
35,983
47,978
4.50 % $
4.00
6.00
8.00
52,564
50,629
43,569
39,085
8.76% $
7.00
7.26
6.52
38,982
36,154
47,978
59,972
6.50%
5.00
8.00
10.00
(Dollars in thousands)
December 31, 2018
Common equity Tier 1 capital ............ $
Tier 1 leverage ......................................
Tier 1 risk-based capital .....................
Total risk-based capital .......................
December 31, 2017
Common equity Tier 1 capital ............... $
Tier 1 leverage .......................................
Tier 1 risk-based capital ........................
Total risk-based capital..........................
76,279
76,279
76,279
83,957
12.45% $
10.68
12.45
13.71
27,561
28,569
36,748
48,997
4.50 % $
4.00
6.00
8.00
48,718
47,710
39,531
34,960
7.95% $
6.68
6.45
5.71
39,810
35,711
48,997
61,246
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.
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 2018, the capital conservation buffer
was 1.875% and in 2019, and for all periods thereafter, the
buffer amount increases to 2.50%. Management believes
that, as of December 31, 2018, the Bank’s capital ratios
were in excess of those quantitative capital ratio standards
set forth under the current prompt corrective action
regulations, including the capital conservation buffer
described above. However, there can be no assurance that
the Bank will continue to maintain such status in the future.
The Office of the Comptroller of the Currency has extensive
discretion in its supervisory and enforcement activities, and
can adjust the requirement to be well-capitalized in the
future. In addition, the Company must adhere to various
U.S. Department of Housing and Urban Development
(HUD) regulatory guidelines including required minimum
53
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
capital and liquidity amounts to maintain their Federal
Housing Administration approved status. Failure to comply
with the HUD guidelines could result in withdrawal of this
certification. As of December 31, 2018, the Company was
in compliance with HUD guidelines.
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
in making
Company uses
commitments as it does for on-balance sheet instruments.
the same credit policies
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 44 months
and totaled $2.6 million at December 31, 2018 and $1.9
million at December 31, 2017. The letters of credit are
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, 2018, the aggregate contractual obligations
(excluding bank deposits) and commercial commitments
were as follows:
(Dollars in thousands)
Financial instruments whose contract amount
represents credit risk:
Commitments to originate, fund or
purchase loans:
Single family .......................................... $
Commercial real estate ...........................
Commercial business ..............................
Undisbursed balance of loans closed .....
Unused lines of credit .............................
Letters of credit .......................................
Total commitments to extend credit ................ $
Forward commitments ..................................... $
December 31,
Contract Amount
2017
2018
(Dollars in thousands)
Contractual Obligations:
Annual rental
Payments Due by Period
Less
than 1
Year
1-3
Years
4-5
Years
More
than 5
Years
Total
6,081
6,320
782
23,749
107,438
2,608
146,978
7,289
3,792
12,968
6,495
44,712
103,811
1,867
173,645
5,629
commitments under
non-cancellable
operating leases............ $ 4,937 888 1,711 1,653 685
Total contractual
obligations ............... $ 4,937 888 1,711 1,653 685
Amount of Commitments
Expiring by Period
Other Commercial
Commitments:
Commercial lines of
credit ............................ $58,222 30,163 16,832 11,227
Commitments to lend ....... 18,877 9,181
Standby letters of credit ... 2,608 1,819
Total other
0
183 7,538 1,975
0
564
225
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.
commercial
commitments ...... $79,707 41,163 17,240 19,329 1,975
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.
54
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. The marking of these derivatives
to fair value for the periods ended December 31, 2018 and
December 31, 2017 did not have a material impact on the
Company’s consolidated financial statements.
loans
into
the
As of December 31, 2018 and 2017,
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. The marking of these loans for the periods ended
December 31, 2018 and December 31, 2017 did not have a
material impact on the Company’s consolidated financial
statements.
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
liabilities are traded and the reliability of the assumptions
used to determine fair value. These levels are:
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, 2018 and 2017.
(Dollars in thousands)
Securities available for sale .............................................................. $
Mortgage loan commitments ............................................................
Total .................................................................................................... $
Total
Level 1
Level 2
Level 3
79,980
40
80,020
0
0
0
79,980
40
80,020
Carrying Value at December 31, 2018
(Dollars in thousands)
Securities available for sale ................................................................. $
Mortgage loan commitments ...............................................................
Total ..................................................................................................... $
Total
Level 1
Level 2
Level 3
77,472
28
77,500
0
0
0
77,472
28
77,500
Carrying Value at December 31, 2017
0
0
0
0
0
0
55
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 2018
and 2017 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, 2018
and 2017.
Carrying Value at December 31, 2018
(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
3,444
1,855
2,902
414
8,615
0
0
0
0
0
3,444
1,855
2,902
414
8,615
Carrying Value at December 31, 2017
(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
1,837
1,724
3,201
627
7,389
0
0
0
0
0
1,837
1,724
3,201
627
7,389
Year Ended
December 31,
2018
Total gains
(losses)
0
0
0
0
0
0
0
0
0
0
45
0
(97 )
0
(52 )
Year Ended
December 31,
2017
Total gains
(losses)
1
0
(413)
0
(412)
(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, 2018 and 2017 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.
56
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.
(Dollars in thousands)
Financial assets:
December 31, 2018
Fair value hierarchy
December 31, 2017
Carrying
amount
Estimated
fair value
Level 1 Level 2
Level 3
Contract
amount
Carrying
amount
Estimated
fair value
Contract
amount
Cash and cash equivalents ......... $
Securities available for sale .......
Loans held for sale .....................
Loans receivable, net .................
FHLB stock ................................
Accrued interest receivable ........
20,709
79,980
3,444
586,688
867
2,356
20,709 20,709
79,980
3,444
578,978
867
2,356
79,980
3,444
578,978
867
2,356
Financial liabilities:
Deposits ......................................
Accrued interest payable ............
623,352
346
617,722
346
617,722
346
37,564
77,472
1,837
585,931
817
2,344
37,564
77,472
1,837
585,494
817
2,344
635,601
146
635,905
146
Off-balance sheet financial
instruments:
Commitments to extend credit ...
Commitments to sell loans .........
40
(56)
40
(56)
146,978
7,289
28
(11)
28 173,645
5,629
(11)
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 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. The fair value disclosures for both the
fixed and adjustable rate portfolios were adjusted to reflect
the exit price amount anticipated to be received from the
sale of the portfolio in an open market transaction as
required upon adoption of ASU 2016-01, Financial
Instruments – Overall (Subtopic 825-10) Recognition and
Measurement of Financial Assets and Financial Liabilities
beginning in the first quarter of 2018.
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 disclosures for all of the deposits
were adjusted to reflect the exit price amount anticipated to
be received from the sale of the deposits in an open market
transaction as required upon adoption of ASU 2016-01,
Financial
(Subtopic 825-10)
Recognition and Measurement of Financial Assets and
Financial Liabilities beginning in the first quarter of 2018.
Instruments – Overall
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.
57
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, 2018 and 2017 and
for the years ended December 31, 2018, 2017 and 2016.
(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:
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, 4,292,838 and 4,631,124 shares ...........................................
Total stockholders' equity.......................................................................................
Total liabilities and stockholders' equity ................................................................ $
Condensed Statements of 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 ...................................................................................
Earned employee stock ownership shares priced above original cost ...................
Stock option compensation ....................................................................................
Amortization of restricted stock awards ................................................................
Decrease in unearned ESOP shares ........................................................................
Increase in other assets ...........................................................................................
Decrease in other liabilities ....................................................................................
Other, net ................................................................................................................
Net cash used by operating activities ................................................................
Cash flows from financing activities:
Warrants purchased ................................................................................................
Excess tax benefit from options exercised .............................................................
Stock awards withheld for tax withholding ...........................................................
Repayments of borrowings .....................................................................................
Dividends received from Bank ...............................................................................
Net cash (used) provided by financing activities ...................................................
(Decrease) increase in cash and cash equivalents ..................................................
Cash and cash equivalents, beginning of year ................................................................
Cash and cash equivalents, end of year ........................................................................... $
2018
2017
2016
1,534
79,737
2,014
95
83,380
233
233
91
40,090
99,754
(1,096)
(1,836)
(53,856)
83,147
83,380
0
8,800
(221)
(30)
(6)
(124)
(331)
8,088
(148)
8,236
2,057
77,006
1,867
141
81,071
253
253
91
50,623
91,448
(957 )
(2,030 )
(58,357 )
80,818
81,071
(306 )
4,878
(257 )
(30 )
(6 )
(130 )
(319 )
3,830
(574 )
4,404
8,236
4,404
(8,800)
46
206
17
134
194
(146)
(20)
(1)
(134)
(6,453)
64
0
0
6,000
(389)
(523)
2,057
1,534
(4,878 )
615
147
41
147
193
(6 )
(866 )
0
(203 )
0
0
(54 )
(7,000 )
6,000
(1,054 )
(1,257 )
3,314
2,057
(589 )
7,148
(264 )
(30 )
(6 )
(138 )
(329 )
5,792
(558 )
6,350
6,350
(7,148 )
244
80
79
177
194
(11 )
(214 )
(1 )
(250 )
0
0
0
(2,000 )
3,000
1,000
750
2,564
3,314
58
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, 2018:
Interest income – external customers ............................................................. $
Non-interest income – external customers .....................................................
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, 2017:
Interest income – external customers ...................................................................... $
Non-interest income – external customers .........................................................
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, 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 ..........................................................................................................
30,381
7,714
222
2,233
24,897
3,036
8,800
710,281
27,680
7,654
210
1,491
24,722
4,976
4,879
722,532
27,349
8,201
0
210
1,004
23,572
4,680
7,148
681,257
0
0
8,800
0
712
(148 )
8,236
83,380
0
0
4,879
306
742
(574 )
4,404
79,254
0
0
1
7,148
589
768
(558 )
6,350
82,222
0
0
(9,022)
0
(222)
0
(8,800)
(81,346)
0
0
(5,089)
0
(210)
0
(4,879)
(79,101)
0
0
(1)
(7,358)
0
(210)
0
(7,148)
(81,456)
30,381
7,714
0
2,233
25,387
2,888
8,236
712,315
27,680
7,654
0
1,797
25,254
4,402
4,404
722,685
27,349
8,201
0
0
1,593
24,130
4,122
6,350
682,023
59
60
OTHER FINANCIAL DATA
The following tables set forth certain information as to the Bank’s FHLB advances.
(Dollars in thousands)
Maximum Balance:
2018
Year Ended December 31,
2017
2016
FHLB advances ........................................................................................................... $
FHLB short-term advances .........................................................................................
Average Balance:
FHLB advances ...........................................................................................................
FHLB short-term advances .........................................................................................
6,800
6,800
140
140
18,800
18,800
1,693
1,693
15,500
15,500
468
468
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.
61
December 31, 2018
September 30, 2018
June 30, 2018
7,797
650
7,147
(167)
7,314
909
314
483
242
1,948
3,652
1,062
331
264
997
6,306
2,956
604
2,352
0.51
0.51
7,970
587
7,383
(652)
8,035
870
343
489
234
1,936
3,574
1,073
310
326
931
6,214
3,757
1,045
2,712
0.62
0.56
7,456
526
6,930
295
6,635
785
297
679
293
2,054
3,678
1,072
334
298
931
6,313
2,376
649
1,727
0.40
0.35
1.29%
11.24
11.52
4.06
1.47%
12.90
11.54
4.14
0.95%
8.25
11.61
3.97
712,315
8,023
71,957
3,444
586,688
623,352
0
83,147
737,445
8,207
71,397
2,109
586,092
651,429
0
79,994
726,285
8,895
71,630
3,624
589,855
639,535
0
81,825
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 ...............................................
Occupancy and equipment ................................................
Data processing .................................................................
Professional services .........................................................
Other .................................................................................
Total non-interest expense ............................................
Income before income tax expense ...................................
Income tax expense ...............................................................
Net income ........................................................................ $
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 (end of period):
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
62
March 31, 2018
December 31, 2017
September 30, 2017
June 30, 2017
March 31, 2017
7,158
470
6,688
(125)
6,813
766
301
444
265
1,776
3,824
1,097
295
249
1,089
6,554
2,035
590
1,445
0.34
0.29
0.82%
7.07
11.65
3.95
722,339
9,455
71,719
2,234
591,840
633,805
0
82,056
6,767
435
6,332
59
6,273
837
296
610
216
1,959
3,641
953
311
302
1,002
6,209
2,023
1,636
387
0.09
0.08
0.21 %
1.88
11.43
3.64
7,255
493
6,762
(581)
7,343
848
299
521
241
1,909
3,642
1,050
243
307
1,017
6,259
2,993
1,213
1,780
0.42
0.37
0.99%
8.78
11.43
3.92
6,999
461
6,538
269
6,269
845
306
488
267
1,906
3,780
1,026
260
417
956
6,439
1,736
712
1,024
0.24
0.21
0.60%
5.19
11.51
3.98
722,685
716,610
725,183
5,068
72,404
1,837
585,931
635,601
0
80,818
5,450
72,901
2,594
583,057
628,971
0
80,632
613
78,034
2,061
590,259
634,101
7,000
78,723
6,659
408
6,251
(270)
6,521
824
301
519
236
1,880
3,944
1,039
292
259
813
6,347
2,054
841
1,213
0.29
0.25
0.73%
6.35
11.49
3.91
680,981
797
77,751
2,430
565,040
591,376
7,000
77,400
63
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, 2018, the Company had 9,128,662 shares of common stock issued and 4,292,838 shares in treasury stock. As of December
31, 2018, there were 479 stockholders of record and 1,033 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
11, 2019, the last reported sale price of shares of our common stock on the Nasdaq was $20.02 per share. The Company has
not paid a dividend on its common stock during the two year period ending December 31, 2018. 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.
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 Nasdaq
Bank Index. The graph and table assume that $100 was invested on December 31, 2013 and that all dividends were reinvested.
Index
HMN Financial, Inc. ..................... $
Nasdaq Composite ........................ $
NASDAQ Bank ............................ $
12/31/13
12/31/14
12/31/15
12/31/16
12/31/17
12/31/18
100.00 $
100.00 $
100.00 $
117.31 $
114.62 $
104.89 $
109.27 $
122.81 $
113.29 $
165.56 $
133.19 $
155.71 $
180.70 $
172.11 $
164.24 $
185.62
165.84
136.99
64
HMN FINANCIAL, INC.
1016 Civic Center Drive NW
Rochester, MN 55901
(507) 535-1200
MICHAEL A. BUE
Retired President and
Chief Executive Officer
Security State Bank of Lewiston
ANNUAL MEETING
The annual meeting of shareholders
will be held on Tuesday, April 23, 2019
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:
Equiniti Trust Company
EQ Shareowner Services
1110 Centre Pointe Curve, Suite 101
Mendota Heights, MN 55120
www.shareowneronline.com
(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, a provider
of clinical decision support products
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
Former Assistant Professor,
Winona State University
Mark E. Utz
Attorney at law, Wendland Utz, Ltd.
HANS K. ZIETLOW
Former 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
LAWRENCE D. MCGRAW
Executive Vice President and
Chief Operating Officer
Home Federal Savings Bank
BRANCH OFFICES OF THE 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
Owatonna
1015 West Frontage Road, Suite 100
Owatonna, MN 55060
(507) 413-6420
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
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