Waterstone Financial, Inc
Annual Report 2016

Plain-text annual report

Dear Fellow Shareholder: Waterstone Financial celebrated its 95th anniversary in 2016, posting record pre-tax earnings and improved asset quality. The Community Banking and Mortgage Banking segments both contributed to the 66% increase in per share earnings. The strong performance enabled Waterstone Financial to increase its quarterly dividend by 140% during the year. Financial highlights from 2016 include: Consolidated net income totaled $25.5 million for the year ended December 31, 2016 (2016), an increase of 54% compared to $16.6 million for the year ended December 31, 201 5 (201 5); Consolidated return on average assets totaled 1.45% for 2016 compared to 0.94% in 20 15; Community Banking contributed a record pre-tax incom e of $2 1.0 million, which represents an 80.0% increase compared t o $11 .7 million in 201 5; Loan growth of 5.6% was the highest year over-year-growth in eight years; Transaction deposits increased $39.5 million, or 16.2%; Total non-performing assets decreased $10.8 million, or40.4%, to $16.0 million at December 31, 201 6. Non-performing assets tota I 0.89% of tot a I assets as of December 31, 201 6; Total past due loans decreased by 29.3%, to $8.2 million at December 31, 2016. Past due loans represent 0.7% of total loans as of December 31, 2016; Mortgage Banking earned a record pre-tax income of $20.9 million in 2016, which represents a 49.1 % increase compared to $14.0 million earned in 201 5; Mortgage Banking originated a record $2.5 billion of loans du ring 2016, compared to $2.0 bill ion in 2015. Loans made for the pu rpose of purchasing a residence accounted for 82.9% and 83.7% of t ot al originations for the years ended 2016 and 2015, respectively. In addition, we continue to give back to the communities we serve, as the WaterStone Bank Fund, part of t he Waukesha County Community Foundation, donated over $875,000 in 2016 to approximately 250 different local, non-profit organizations. One of our more significant donations was made in the interest of bringing back a beloved local institution: The Milwaukee Air & Water Show. Our employees continue to provide exceptional service to our customers which directly contributes to the strong financial returns provided to shareholders. Through their efforts, WaterStone Bank was recognized in 2016, for the seventh consecutive year, as one of the Milwaukee Journal Sentinel's Top 100 Workplaces. On behalf of the Board of Directors, and all the dedicated employees at Waterstone, we thank our customers and shareholders fo r their continued loyalty and trust. ~ Gordon April 6, 2017 Dear Fellow Shareholder, We invite you to attend the Waterstone Financial, Inc. Annual Meeting of Shareholders, which will be held at WaterStone Bank SSB, 11200 W. Plank Ct., Wauwatosa, Wisconsin at 9:00 a.m., Central Time, on Tuesday, May 16, 2017. We are once again furnishing proxy materials to our shareholders over the internet, as permitted by rules adopted by the Securities and Exchange Commission. You may read, print and download our 2016 Annual Report to Shareholders on Form 10-K and our Proxy Statement at www.proxyvote.com. On April 6, 2017, we mailed our shareholders a notice containing instructions on how to access these materials and how to vote their shares online. The notice provides instructions on how you can request a paper copy of these materials by mail, by telephone or by e-mail. If you requested your materials via e-mail, the e-mail contains voting instructions and links to the materials on the internet. You may vote your shares by internet, by telephone, by regular mail or in person at the Annual Meeting. Instructions regarding the various methods of voting are contained on the notice and on the Proxy Card. The proxy materials describe the formal business to be transacted at the Annual Meeting. Included in the materials is our Annual Report on Form 10-K, which contains detailed information concerning our activities and operating performance. On behalf of the board, we request that you vote your shares now, even if you currently plan to attend the Annual Meeting. This will not prevent you from voting in person, but will assure that your vote is counted. Sincerely, DOUGLAS S. GORDON Chief Executive Officer WATERSTONE FINANCIAL, INC. 11200 W. Plank Ct. Wauwatosa, Wisconsin 53226 (414) 761-1000 ______________________________ NOTICE OF ANNUAL MEETING OF SHAREHOLDERS TO BE HELD ON MAY 16, 2017 _____________________________ To the Shareholders of Waterstone Financial, Inc.: The 2017 annual meeting of shareholders of Waterstone Financial, Inc. will be held on Tuesday, May 16, 2017, at 9:00 a.m., Central Time, at WaterStone Bank SSB, 11200 W. Plank Ct., Wauwatosa, Wisconsin for the following purposes: (1) Electing two directors to serve for a term expiring in 2020; (2) Approving an advisory, non-binding resolution to approve the executive compensation described in the Proxy Statement; (3) Ratifying the selection of RSM US LLP as Waterstone Financial, Inc.’s independent registered public accounting firm; and Transacting such other business as may properly come before the Annual Meeting or any adjournment or postponement thereof. The board of directors has fixed March 22, 2017 as the record date for the determination of shareholders entitled to notice of and to vote at the annual meeting and any adjournment thereof. Only shareholders of record at the close of business on that date will be entitled to vote at the annual meeting and any adjournments thereof. We call your attention to the Proxy Statement accompanying this notice for a more complete statement regarding the matters to be acted upon at the annual meeting. Please read it carefully. By Order of the Board of Directors Wauwatosa, Wisconsin April 6, 2017 William F. Bruss Executive Vice President and Secretary PROXY STATEMENT WATERSTONE FINANCIAL, INC. 11200 W. Plank Ct. Wauwatosa, Wisconsin 53226 (414) 761-1000 ______________________ SOLICITATION AND VOTING This Proxy Statement and accompanying Proxy Card are furnished to the shareholders of Waterstone Financial, Inc. (“Waterstone Financial” or the “Company”) in connection with the solicitation of proxies by the Waterstone Financial board of directors for use at the annual meeting of shareholders on Tuesday, May 16, 2017, and at any adjournment of the meeting. The 2016 Annual Report on Form 10-K is enclosed with the Proxy Statement and contains business and financial information concerning us. Our proxy materials are being made available to shareholders on or about April 6, 2017. Record Date and Meeting Information. The board of directors has fixed March 22, 2017 as the record date for the determination of shareholders entitled to notice of and to vote at the annual meeting and any adjournment thereof. Only holders of record of our common stock, the only class of voting stock of Waterstone Financial outstanding, as of the close of business on the record date are entitled to notice of and to vote at the annual meeting. Each share of common stock is entitled to one vote. At the record date, there were 29,432,773 shares of common stock issued and outstanding. The board of directors of Waterstone Financial knows of no matters to be acted upon at the annual meeting other than as set forth in the notice attached to this Proxy Statement. If any other matters properly come before the annual meeting, or any adjournment thereof, it is the intention of the persons named in the proxy to vote such proxies in accordance with their best judgment on such matters. Voting Your Shares. Any shareholder entitled to vote at the annual meeting may vote either in person, by a properly executed proxy or online as described in the notice to shareholders and the proxy card. Shares represented by properly executed proxies received by Waterstone Financial will be voted at the annual meeting, or any adjournment thereof, in accordance with the terms of such proxies, unless revoked. Where no instructions are indicated, validly executed proxies will be voted “FOR” the proposals set forth in this Proxy Statement for consideration at the Annual Meeting. A shareholder may revoke a proxy at any time prior to the time when it is voted by filing a written notice of revocation with our corporate secretary at the address set forth above, by delivering a properly executed proxy bearing a later date, using the internet or telephone voting options explained on the Proxy Card, or by voting in person at the annual meeting. Attendance at the annual meeting will not in itself constitute revocation of a proxy. If you are a shareholder whose shares are not registered in your name, you will need appropriate documentation from your record holder in order to vote in person at the annual meeting. Shares in Employee Plans. Any shareholder who owns shares through an allocation to that person’s account under the WaterStone Bank SSB Employee Stock Ownership Plan (the “ESOP”) or who has purchased shares in the Employer Stock Fund in the Waterstone Bank SSB 401(k) Plan (the “401(k) Plan”) will receive separate Vote Authorization Forms to instruct the ESOP Trustee and 401(k) Plan Trustee how to vote those shares. The deadline for returning instructions is May 9, 2017. The Trustee of both the ESOP and 401(k) Plan, Principal Trust Company, will vote shares allocated to a plan participant’s account in accordance with the participant’s instructions. Upon the direction of the plan administrator, the Trustee will vote the unallocated ESOP shares and any allocated ESOP shares for which no voting instructions are received in the same proportion as allocated shares for which it has received voting instructions. In addition, the Trustee will vote unvoted shares allocated to participants’ accounts in the 401(k) Plan in accordance with directions received from the plan administrator. Quorum and Required Vote. A majority of the votes entitled to be cast by the shares entitled to vote, represented in person or by proxy, will constitute a quorum of shareholders at the annual meeting. Shares for which 1 authority is withheld to vote for director nominees and broker non-votes (i.e., proxies from brokers or nominees indicating that such persons have not received instructions from the beneficial owners or other persons entitled to vote shares as to a matter with respect to which the brokers or nominees do not have discretionary power to vote) will be considered present for purposes of establishing a quorum. The inspector of election appointed by the board of directors will count the votes and ballots at the annual meeting. As to the election of directors, shareholders may vote “FOR” or “WITHHELD” as to each or all of the nominees. A plurality of the votes cast at the annual meeting by the holders of shares of common stock entitled to vote is required for the election of directors. In other words, the individuals who receive the largest number of votes are elected as directors up to the maximum number of directors in a class to be chosen at the annual meeting. With respect to the election of directors, any shares not voted, whether by withheld authority, broker non-vote or otherwise, will have no effect on the election of directors except to the extent that the failure to vote for an individual results in another individual receiving a comparatively larger number of votes. As to the advisory, non-binding resolution to approve our executive compensation as described in this Proxy Statement, a shareholder may: (i) vote “FOR” the resolution; (ii) vote “AGAINST” the resolution; or (iii) “ABSTAIN” from voting on the resolution. The affirmative vote of a majority of the votes cast at the Annual Meeting, without regard to either broker non-votes, or shares as to which the “ABSTAIN” box has been selected on the proxy card, is required for the approval of this non-binding resolution. While this vote is required by law, it will neither be binding on Waterstone Financial, Inc. or the board of directors, nor will it create or imply any change in the fiduciary duties of, or impose any additional fiduciary duty on Waterstone Financial, Inc. or the board of directors. As to the ratification of the independent registered public accounting firm, shareholders may vote “FOR” or “AGAINST,” or may “ABSTAIN” from voting on the matter. The affirmative vote of a majority of the votes cast at the Annual Meeting, without regard to either broker non-votes, or shares as to which the “ABSTAIN” box has been selected on the proxy card, is required to ratify RSM US LLP as our independent registered public accounting firm for the year ending December 31, 2017. Expenses and Solicitation. We will pay expenses in connection with the solicitation of proxies. Proxies will be solicited principally by mail, but may also be solicited by our directors, officers and other employees in person or by telephone, facsimile or other means of communication. Those directors, officers and employees will receive no compensation therefor in addition to their regular compensation, but may be reimbursed for their related out-of-pocket expenses. Brokers, dealers, banks, or their nominees, who hold common stock on behalf of another will be asked to send proxy materials and related documents to the beneficial owners of such stock, and we will reimburse those persons for their reasonable expenses. Limitations on Voting. The Company’s Articles of Incorporation provide that, subject to certain exceptions, record owners of the Company’s common stock that is beneficially owned by a person who beneficially owns in excess of 10% of the Company’s outstanding shares are not entitled to any vote any of the shares held in excess of the 10% limit. BENEFICIAL OWNERSHIP OF COMMON STOCK Persons and groups who beneficially own in excess of 5% of our shares of common stock are required to file certain reports with the Securities and Exchange Commission regarding such ownership pursuant to the Securities Exchange Act of 1934. The following table sets forth, as of March 22, 2017, the shares of our common stock beneficially owned by each person known to us who was the beneficial owner of more than 5% of the outstanding shares of our common stock, as well as by our directors, executive officers and directors and executive officers as a group. 2 Name of Beneficial Owner Total Shares Beneficially Owned (1)(2) Percent of All Common Stock Outstanding 5% or Greater Shareholders Homestead Partners LP Homestead Odyssey Partners LP Arles Partners LP Arles Advisors Inc Warren A. Mackey 40 Worth Street 10th Floor New York, New York 10013 Renaissance Technologies LLC Renaissance Technologies Holdings Corporation 800 Third Avenue New York, New York 10022 BlackRock, Inc. BlackRock Inc. 55 East 52nd Street New York, NY 10055 Dimensional Fund Advisors LP Building One 6300 Bee Cave Road Austin, Texas 78746 Delaware Charter Guarantee & Trust Company dba Principal Trust Company as Trustee for the 2010 Amended and Restated Waterstone Bank SSB Employee Stock Ownership Plan and the Waterstone Bank 401(K) Plan 1013 Centre Road Suite 300 Wilmington Delaware 19805-1265 Directors and Executive Officers Rebecca M. Arndt ......................................... Ellen S. Bartel ............................................... William F. Bruss ........................................... Thomas E. Dalum ......................................... Eric J. Egenhoefer ......................................... Mark R. Gerke .............................................. Kevin P. Gillespie ......................................... Douglas S. Gordon ........................................ Michael L. Hansen ........................................ Patrick S. Lawton.......................................... Kristine A. Rappé ......................................... Stephen J. Schmidt ........................................ 1,674,764 (3) 5.7% 2,363,274 (4) 8.0% 1,467,103 (6) 5.0% 1,474,812 (5) 5.0% 2,661,033 (7) 9.0% 88,334 60,734 125,665 150,127 104,136 60,691 12,000 528,283 291,413 255,990 66,318 95,078 * * * * * * * 1.8% * * * * All directors and executive officers as a group (12 persons) (8) ............................................... 3,630,466 12.3% Less than 1%. ______________________ * (1) Unless otherwise noted, the specified persons have sole voting and dispositive power as to the shares. Number of shares identified as indirect beneficial ownership with shared voting and dispositive power: Ms. Arndt – 41,845; Ms. Bartel – 7,734, Mr. Bruss – 47,250; Mr. Dalum – 61,596; Mr. Gerke – 17,610; Mr. Gordon – 52,826; Mr. Hansen – 186,541; Mr. Lawton – 10,532; group – 2,217,361. Includes the following shares underlying options which are exercisable within 60 days of March 22, 2017: Ms. Arndt – 10,390; Messrs. Bartel, Dalum, Hansen, Lawton, Rappe and Schmidt – 25,000 shares each; Mr. Bruss – 50,405; Mr. Egenhoefer – 58,865; Mr. Gerke – 7,292; Mr. Gillespie – 12,000; Mr. Gordon – 60,000; all directors and executive officers as a group – 348,651. 3 (3) Based on a Schedule 13D filed with the Securities and Exchange Commission on May 18, 2015. (4) Based on a Schedule 13G/A filed with the Securities and Exchange Commission on February 14, 2017. (5) Based on a Schedule 13G filed with the Securities and Exchange Commission on February 9, 2017. (6) Based on a Schedule 13G filed with the Securities and Exchange Commission on March 9, 2017. (7) Based on a Schedule 13G/A filed with the Securities and Exchange Commission on April 14, 2016. Such total includes shares purchased by plan participants in the Employer Stock Fund within the Waterstone Bank SSB 401(k) Plan, as well as allocated and unallocated shares held in trust within the WaterStone Bank SSB Employee Stock Ownership Plan. (8) The total for the group (but not any individual) includes 1,791,427 unallocated shares held in the employee stock ownership plan, as to which voting and dispositive power is shared. As administrator, WaterStone Bank SSB (“WaterStone Bank” or the “Bank”) (through its ESOP Committee) may direct the ESOP Trustee to vote shares which have not yet been allocated to participants, provided that such vote is required to be made in the same proportion as allocated voted shares unless it is determined that to do so would not be in the best interest of participants and beneficiaries of the ESOP. Employees may vote the shares allocated to their accounts; the administrator will vote unvoted shares in its discretion. Allocated shares are included only if allocated to listed executive officers, in which case they are included in those individuals’ (and the group’s) beneficial ownership. PROPOSAL 1 – THE ELECTION OF DIRECTORS Waterstone Financial’s Board of Directors consists of seven members. Our bylaws provide that approximately one-third of the directors are to be elected annually. Directors of Waterstone Financial are generally elected to serve for a three-year period and until their respective successors have been elected. Directors Michael L. Hansen and Stephen J. Schmidt, whose terms expire at the annual meeting, are being nominated for re-election as directors, each for a term expiring at the 2020 annual meeting of shareholders. Shares represented by proxies will be voted FOR the election of the nominees unless otherwise specified by the executing shareholder. If a nominee declines or is unable to act as a director, proxies may be voted with discretionary authority for a substitute nominee designated by the board. Except as indicated herein, there are no arrangements or understandings between any nominee and any other person pursuant to which such nominee was selected. The following details include for each of our nominees and directors: their age as of December 31, 2016; the year in which they first became a director of WaterStone Bank; the year that their term expires; and their business experience for at least the past five years. None of the directors listed below currently serves as a director, or served as a director during the past five years, of a publicly-held entity (other than Waterstone Financial). The following also includes the particular experience, qualifications, attributes, or skills considered by the Nominating and Corporate Governance Committee that led the board of directors to conclude that such person should serve as a director of Waterstone Financial. The mailing address for each person listed is 11200 West Plank Ct., Wauwatosa, Wisconsin 53226. The board of directors unanimously recommends that shareholders vote FOR the election of the director nominees listed below. Principal Occupation and Business Experience Director Since (1) Name and Age Michael L. Hansen, 65 (4)(5)(6) Nominees for Terms expiring in 2020 Business investor; current significant ownership interest in Jacsten Holdings LLC and Mid-States Contracting, Inc. In addition to extensive entrepreneurial experience, Mr. Hansen is a C.P.A. with 13 years of audit and tax experience at an international public accounting firm. Mr. Hansen brings this experience to the board of directors and to the audit committee in particular. Mr. Hansen has a B.B.A. from the University of Notre Dame. Stephen J. Schmidt, 55 (3)(4)(6) President of Schmidt and Bartelt Funeral and Cremation Services. Mr. Schmidt has entrepreneurial experience and extensive community contact throughout the communities served by WaterStone Bank. Mr. Schmidt has an Associate’s Degree from the New England Institute and a B.A. from the University of Wisconsin – Stevens Point. Continuing Directors - Term expiring in 2018 4 2003 2002 Douglas S. Gordon, 59 Chief Executive Officer and President of Waterstone Financial and WaterStone Bank since January 2007; President and Chief Operating Officer of WaterStone Bank from 2005 to 2007; real estate investor. Mr. Gordon brings extensive prior banking experience as an executive officer at M&I Bank and at Security Savings Bank. He has extensive firsthand knowledge and experience with our lending markets and our customers. Mr. Gordon has a B.A. from the University of Wisconsin – Parkside and an M.B.A. from Marquette University. Patrick S. Lawton, 60 (2)(3)(6) Managing Director of Fixed Income Capital Markets for Robert W. Baird & Co., Incorporated. As an R.W. Baird Managing Director, Mr. Lawton brings his investment portfolio expertise to the board of directors. Mr. Lawton has a B.S.B.A. and an M.B.A. from Marquette University. Ellen S. Bartel, 62 (3)(4)(5) Thomas E. Dalum, 76 (3)(5) Kristine A. Rappé, 60 (5)(6) Continuing Directors - Terms expiring in 2019 President of Divine Savior Holy Angels (DSHA) High School (Milwaukee, Wisconsin) since 1998 where she has achieved significant improvements in DSHA’s curriculum, facilities, financial infrastructure, image, and reputation. Ms. Bartel has balanced DSHA’s budget for 18 consecutive years, overseen endowment growth from under $1 million to over $14 million, and has developed recruitment strategies resulting in an incoming class wait list for 19 consecutive years. Prior to her employment at DSHA, Ms. Bartel held several positions at Alverno College (Milwaukee, Wisconsin) (1986 to 1997), with the most recent being Vice President of Institutional Advancement from 1994 to 1997. Ms. Bartel’s experience overseeing a large educational institution provides the board of directors with significant perspective on financial management and human resources matters. Ms. Bartel has a B.A. and an M.S.A. from the University of Notre Dame. Former chairman and CEO of UELC, an equipment leasing company and of DUECO, an equipment manufacturer and distributor. Mr. Dalum brings an entrepreneurial background, a long-standing record of community involvement and public service plus more than 30 years of experience as a member of the WaterStone Bank board of directors. Mr. Dalum has a B.A. from the University of Notre Dame and an M.B.A. from Northwestern University. Special advisor to the Wisconsin Energy Foundation (Milwaukee, Wisconsin) following a 30-year career with Wisconsin Energy Corporation. In her roles at Wisconsin Energy Corporation as Vice President of Customer Services (1994 to 2001), Vice President and Corporate Secretary (2001 to 2004) and Senior Vice President and Chief Administrative Officer (2004 to 2012), Ms. Rappé had responsibility for shared services including information technology, human resources, supply chain management, business continuity/corporate security, and the WEC Foundation. Ms. Rappé’s experience overseeing a large corporate entity provides the board of directors with significant perspective on financial management and human resources matters, and she has a long- standing history of community involvement and public service. Ms. Rappé has a B.A. from the University of Wisconsin – Oshkosh. 2005 2000 2013 1979 2013 _________________ (1) Indicates the date when director was first elected to the board of WaterStone Bank. Messrs. Lawton, Hansen, Dalum, Schmidt and Gordon became directors of Waterstone Financial’s predecessor federal corporation in 2005. Ms. Bartel and Ms. Rappé became directors of Waterstone Financial in 2014. (2) Chairman of the Board and of WaterStone Bank, effective January 1, 2007. (3) Member of the compensation committee, of which Mr. Dalum is Chairman. (4) Member of the nominating committee, of which Mr. Schmidt and Ms. Bartel are Co-chairmen. (5) Member of the audit committee, of which Mr. Hansen is Chairman. (6) Member of the executive committee, of which Ms. Rappé is Chairman. 5 Information regarding named executive officers who are not directors of Waterstone Financial is set forth in the following table. Except as noted below, each of these individuals has held that position for at least the past five years. Name and Age William F. Bruss, 47 Mark R. Gerke, 42 Rebecca M. Arndt, 49 Eric J. Egenhoefer, 41 Kevin P. Gillespie, 59 Offices and Positions with Waterstone Financial and WaterStone Bank Executive Vice President since January 2015, Chief Operating Officer (appointed June 2013), General Counsel and Secretary, Waterstone Financial and WaterStone Bank Chief Financial Officer since February 2016, Chief Accounting Officer (appointed 2014), Senior Vice President, Waterstone Financial and WaterStone Bank since 2014, Controller 2005 to February 2016 Senior Vice President – Retail Operations of WaterStone Bank President of Waterstone Mortgage Corporation Chief Operating Officer of Waterstone Mortgage Corporation since May 2014, Regional Vice President of Envoy Mortgage 2013 to April 2014, Manager BBVA Compass 2012, Executive Vice President of Nationstar Mortgage Corporation from 2010 to 2011 Board Meetings and Committees Executive Officer Since 2005 2016 2006 2008 2016 The board of directors of Waterstone Financial met 12 times during the year ended December 31, 2016 on behalf of Waterstone Financial and an additional 12 times in their capacity as directors of WaterStone Bank. The board of directors consists of a majority of “independent directors” within the meaning of the NASDAQ corporate governance listing standards. The board of directors determines the independence of each director in accordance with NASDAQ Stock Market rules, which include all elements of independence as set forth in the listing requirements for NASDAQ securities. The board of directors has determined that Directors Bartel, Dalum, Hansen, Lawton, Rappé and Schmidt are “independent” directors within the meaning of such standards. In evaluating the independence of our independent directors, we found no transactions between us and our independent directors that are not required to be reported in this proxy statement and that had an impact on our determination as to the independence of our directors. Therefore, all members of the audit, compensation and nominating committees are “independent.” As part of their meetings, independent directors regularly met without management or non- independent directors present. No member of the board of directors or any committee thereof attended fewer than 75% of the aggregate of: (i) the total number of meetings of the Board of Directors (held during the period for which he has been a director); and (ii) the total number of meetings held by all committees of the board of directors on which he or she served (during the periods that he or she served). The audit committee of Waterstone Financial met 11 times during the year ended December 31, 2016. The board of directors has determined that each member of the audit committee meets not only the independence requirements applicable to the committee as prescribed by the NASDAQ corporate governance listing standards, but also by the Securities and Exchange Commission. On behalf of the audit committee, Mr. Hansen, its chair, also regularly consults with Waterstone Financial’s independent registered public accounting firm about Waterstone Financial’s periodic public financial disclosures. The board believes that all of the members of the audit committee have sufficient experience, knowledge and other personal qualifications to be “financially literate” and to be active, effective and contributing members of the audit committee. Mr. Hansen has been designated an “audit committee financial expert” pursuant to the Sarbanes-Oxley Act of 2002 and the Securities and Exchange Commission regulations. See also “Report of the Audit Committee” for other information pertaining to the audit committee. The compensation committee of Waterstone Financial held five meetings during the year ended December 31, 2016. Each member of the compensation committee is considered independent as defined in the NASDAQ corporate governance listing standards. The compensation committee has the responsibility for and authority to either establish or recommend to the board: compensation policies and plans; salaries, bonuses and benefits for all officers; salary and benefit levels for employees; determinations with respect to stock options and restricted stock awards; and other personnel policies and procedures. The compensation committee has the authority to delegate the 6 development, implementation and execution of benefit plans to management. See also “Compensation Discussion and Analysis” and “Compensation Committee Interlocks and Insider Participation” for other information pertaining to the compensation committee. The nominating and corporate governance committee (“nominating committee”) of Waterstone Financial held one meeting during the year ended December 31, 2016. Each member of the nominating committee is considered “independent” as defined in the NASDAQ corporate governance listing standards. The functions of the nominating committee include the following:     to lead the search for individuals qualified to become members of the board of directors and to select director nominees to be presented for shareholder approval; to review and monitor compliance with the requirements for board independence; to review the committee structure and make recommendations to the board of directors regarding committee membership; and to develop and recommend to the board of directors for its approval a set of corporate governance guidelines. The nominating committee identifies nominees by first evaluating the current members of the board of directors willing to continue in service. Current members of the board of directors with skills and experience that are relevant to our business and who are willing to continue in service are first considered for re-nomination, balancing the value of continuity of service by existing members of the board of directors with that of obtaining a new perspective. If any member of the board of directors does not wish to continue in service, or if the committee or the board decides not to re-nominate a member for re-election, or if the size of the board of directors is increased, the nominating committee would solicit suggestions for director candidates from all board members. Qualifications of director candidates are described in the Appendix to the Nominating and Corporate Governance Committee Charter. Factors considered include strength of character, honesty and integrity, an inquiring and independent mind, judgment, skill, diversity, education, experience with businesses and other organizations, the interplay of the candidates’ experience with the experience of other board members and the extent to which the candidate would be a desirable addition to the board and its committees. Nominees must have a background which demonstrates an understanding of business and financial affairs and the complexities of a business organization. Although a career in business is not essential, the nominee should have a proven record of competence and accomplishments through leadership in industry, education, the professions or government. Areas of core competency that should be represented on the board as a whole include accounting and finance, business judgment, management, crisis response, industry knowledge, leadership and strategic vision. The nominating committee will also take into account whether a candidate satisfies the criteria for “independence” under the NASDAQ corporate governance listing standards and, if a nominee is sought for service on the audit committee, the financial and accounting expertise of a candidate, including whether an individual qualifies as an “audit committee financial expert.” The nominating committee will consider proposed nominees whose names are submitted to it by shareholders, and it does not intend to evaluate proposed nominees differently depending upon who has made the proposal. Shareholders can submit the names of qualified candidates for director by writing to our Corporate Secretary at 11200 W. Plank Ct., Wauwatosa, WI 53226. The Corporate Secretary must receive a submission not more than 110 days and not less than 80 days prior to the date of our next annual meeting. The submission must include the following information:   a statement that the writer is a shareholder and is proposing a candidate for consideration by the nominating committee; the name and address of the shareholder as they appear on our books and number of shares of our common stock that are owned beneficially by such shareholder (if the shareholder is not a holder of record, appropriate evidence of the shareholder’s ownership will be required); 7        the name, address and contact information for the candidate, and the number of shares of common stock that are owned by the candidate (if the candidate is not a holder of record, appropriate evidence of the shareholder’s ownership should be provided); a statement of the candidate’s business and educational experience; such other information regarding the candidate as would be required to be included in the Proxy Statement pursuant to Securities and Exchange Commission Regulation 14A; a statement detailing any relationship between us and the candidate; a statement detailing any relationship between the candidate and any of our customers, suppliers or competitors; detailed information about any relationship or understanding between the proposing shareholder and the candidate; and a statement that the candidate is willing to be considered and willing to serve as a director if nominated and elected. A nomination submitted by a shareholder for presentation at an annual meeting of shareholders will also need to comply with any additional procedural and informational requirements we may adopt in the future, including those set forth in “Shareholder Proposals and Notices.” Waterstone Financial has adopted charters for the audit, compensation and nominating committees. We will continue to respond to and comply with Securities and Exchange Commission and NASDAQ Stock Market requirements relating to board committees. Copies of the charters for our audit, compensation and nominating committees (including director selection criteria) and other corporate governance documents can be found on our website, at www.wsbonline.com, on the “Corporate Overview” tab under the link “Investors.” If any of those documents are changed, or related documents adopted, those changes and new documents will be posted on our corporate website at that address. Other Board and Corporate Governance Matters Board Leadership Structure and Risk Oversight Role. The role of chairman of the board of directors and chief executive officer of the Company are not currently held by the same person. The chairman of the board has never been an officer or employee of the Company or WaterStone Bank. The foregoing structure is not mandated by any provision of law or our articles of incorporation or bylaws, but the board of directors currently believes that this structure provides for an appropriate balance of authority between management and the board. The board of directors reserves the right to establish a different structure in the future. The board of directors of the Company, all of the members of which are also members of the board of directors of WaterStone Bank, is actively involved in the Company’s and Bank’s risk oversight activities, through the work of numerous committees of the Company and Bank, and the policy approval function of the board of directors of WaterStone Bank. Communications between Shareholders and the Board. A shareholder who wants to communicate with the board of directors or with any individual director can write to our Corporate Secretary at 11200 W. Plank Ct., Wauwatosa, WI 53226, Attention: Board Administration. The letter should indicate that the author is a shareholder and if shares are not held of record, should include appropriate evidence of stock ownership. Depending on the subject matter, management will:    forward the communication to the director or directors to whom it is addressed; attempt to handle the inquiry directly, i.e. where it is a request for information about us or it is a stock- related matter; or not forward the communication if it is primarily commercial in nature, relates to an improper or irrelevant topic, or is unduly hostile, threatening, illegal or otherwise inappropriate. At each board meeting, management shall present a summary of all communications received since the last meeting that were not forwarded and make those communications available to the directors. 8 Director Attendance at Annual Shareholders’ Meeting. Waterstone Financial expects all of its directors to attend the annual meeting of shareholders. All directors attended our 2016 annual meeting of shareholders. Code of Business Conduct and Ethics. Waterstone Financial has adopted a code of business conduct and ethics that reflects current circumstances and Securities and Exchange Commission and NASDAQ definitions for such codes. The code of business conduct and ethics covers us, WaterStone Bank and other subsidiaries. Among other things, the code of business conduct and ethics includes provisions regarding honest and ethical conduct, conflicts of interest, full and fair disclosure, compliance with law, and reporting of and sanctions for violations. The code applies to all directors, officers and employees of Waterstone Financial and subsidiaries. We have posted a copy of the code of business conduct and ethics on our corporate website, at www.wsbonline.com, on the “Corporate Overview” tab under the link “Investors” and then “Governance Documents.” As further matters are documented, or if those documents (including the code of business conduct and ethics) are changed, waivers from the code of business conduct and ethics are granted, or new procedures are adopted, those new documents, changes and/or waivers will be posted on the corporate website at that address. COMPENSATION DISCUSSION AND ANALYSIS Executive Summary. It is the intent of the Compensation Committee to provide our Named Executive Officers with a total compensation package that is market competitive, promotes the achievement of our strategic objectives and is aligned with operating and other performance metrics to support long-term shareholder value. In addition, we have structured our executive compensation program to include elements that are intended to create appropriate balance between risk and reward. Compensation Philosophy. The primary objectives of our executive compensation programs are to attract and retain highly-qualified executives and to encourage extraordinary management efforts through well-designed incentive opportunities, with the goal of improving the performance of Waterstone Financial, Inc. and its subsidiaries consistent with the interests of our shareholders. We base our compensation decisions on three basic principles:    Meeting the Demands of the Market – Our goal is to compensate our employees at competitive levels that position us as the employer of choice among our peers who provide similar financial services in the markets we serve. Aligning with Shareholders – We intend to use equity compensation as a key component of our compensation mix to develop a culture of ownership among our key personnel and to align their individual financial interests with the interests of our shareholders. Driving Performance – We base compensation in part on the attainment of company-wide, business unit and individual targets that return positive results to our bottom line. Executive compensation includes base salary, discretionary bonus and equity incentive awards. The programs are intended to reward the accomplishment of strategic plan goals and objectives as evaluated by members of the compensation committee. They are further intended to reward enhanced shareholder value as measured by the trading price of our common stock. Effect of 2016 Advisory Vote on Named Executive Officer Compensation. At our 2016 Annual Meeting, we provided our shareholders with the opportunity to cast an advisory vote on executive compensation (a “say-on- pay proposal”). At our 2016 annual meeting of shareholders, 83.7% of the votes cast on the say-on-pay proposal at that meeting were voted in favor of the proposal. The Compensation Committee believes this affirms shareholders’ support of our approach to executive compensation, and therefore the Compensation Committee did not significantly change its approach in 2016. We will hold annual say-on-pay votes until the next shareholders vote regarding the frequency of say-on-pay votes, which we expect to occur at the 2020 annual meeting of shareholders. The Compensation Committee will continue to consider the outcome of our say-on-pay vote, regulatory changes and emerging best practices when making future compensation decisions for the Named Executive Officers. 9 Role of the Compensation Committee. The Compensation Committee is responsible for reviewing all compensation components for the Named Executive Officers annually, including base salary, annual incentive, long- term incentives/equity, benefits and other perquisites. The committee examines the total compensation mix, pay- for-performance relationship, and how all these elements in the aggregate comprise each executive’s total compensation package to ensure that our compensation is competitive in the market place and that the mix of benefits accurately reflects our compensation philosophy. The Compensation Committee operates under a written charter that establishes its responsibilities. The Compensation Committee and the Board of Directors review the charter annually to ensure that the scope of the charter is consistent with the role of the committee. A copy of the charter can be found on our website under the Investor Relations tab. Use of Consultants. The Compensation Committee has the authority to engage compensation consultants from time to time to assist it in the compensation governance process for determining the compensation of our Named Executive Officers. The consultants provide expertise about competitive trends in the marketplace, including established and emerging compensation practices at other similarly situated companies. The Compensation Committee did not use the services of a compensation consultant to assist in determining compensation of our Named Executive Officers or other officers during 2016. Role of Management. The executive officers who serve as a resource to the Compensation Committee are the President and Chief Executive Officer, with respect to compensation for the other Named Executive Officers, and the Chief Operating Officer and General Counsel and the Assistant Vice President and Director of Human Resources, with respect to compensation of other officers and employees of WaterStone Bank. The executives provide the Compensation Committee with data, analyses, input and recommendation. The Compensation Committee considers our Chief Executive Officer’s evaluation of each Named Executive Officer’s performance and recommendation of appropriate compensation. However, our Chief Executive Officer does not participate in any decisions relating to his own compensation. Components of Executive Compensation and 2016 Decisions. Our compensation program consists of four main components: base salary, annual incentives, long-term incentive/equity, and benefits and perquisites. The following section summarizes the role of each component, how decisions are made and the resulting 2016 decision process as it relates to the named executive officers. Base Salary. In determining the base salary of executive officers, the committee reviewed, among other things, third party surveys of peer institutions, the historical compensation of those officers under review and performance measures of Waterstone Financial, Inc. and its subsidiaries. The Compensation Committee’s executive base salary review and analyses for calendar year 2016 resulted in a $25,000 increase to $825,000 in base salary from 2015 to 2016 for the Chief Executive Officer. The calendar 2016 average increase for our Named Executive Officers, excluding the Chief Financial Officer, was 3.1%. The Compensation Committee concluded that the level of base salary did not need to be further raised in order to accomplish the objectives noted above. Base salary for the president of the mortgage banking subsidiary, Waterstone Mortgage Corporation, resulted in a $9,000 increase to $309,000 in base salary from 2015 to 2016. Bonus – WaterStone Bank. Following shareholder approval of the Waterstone Financial, Inc. 2015 Equity Incentive Plan on March 3, 2015, the Compensation Committee of WaterStone Bank decided not to pay a cash bonus in 2016 to Named Executive Officers who are also officers of WaterStone Bank, but instead awarded equity incentives, which have been deemed to better align the long-term interests of Named Executive Officers with those of shareholders. Additional details regarding equity incentives are provided below. Bonus – Waterstone Mortgage Corporation. The President and Chief Operating Officer of Waterstone Mortgage Corporation are entitled to a bonus of 5.00% and 2.75%, respectively, of subsidiary pre-tax income in excess of 20% of Waterstone Mortgage Corporation’s average equity during the year in which the bonus is earned, before bonus expense, as adjusted for (i) the difference between the cost of the intracompany line of credit provided by WaterStone Bank and third-party pricing, and (ii) $100,000, as the estimated value of support services provided by WaterStone Bank. No bonus is payable if Waterstone Mortgage Corporation or WaterStone Bank becomes subject to a regulatory order caused or contributed to by the operations of Waterstone Mortgage Corporation. 10 Equity Incentives. The Compensation Committee believes that equity-based compensation can provide an important incentive to executive officers while also aligning their interests with those of shareholders, since the value of the compensation will depend upon stock price performance. The equity incentive elements of total compensation are intended to further the Compensation Committee’s objectives of executive retention through longer vesting schedules and enhanced shareholder value due to the value of grants being tied to the trading price of our common stock. All equity awards given to the Named Executive Officers of WaterStone Bank are at the discretion of the Committee and are generally subjective in nature. The Committee considers the position of the Named Executive Officer, the officer’s level of influence and the corresponding ability to contribute toward the success of Waterstone Financial, Inc., and individual and corporate performance as well as the level of equity awards granted to individuals with similar positions at similar companies. In March 2015, both restricted stock awards and option awards were granted to directors and WaterStone Bank executive officers, except for the Chief Financial Officer, under our 2015 Equity Incentive Plan. In June 2016, both restricted stock awards and option awards were granted to the Chief Financial Officer. See “Executive Compensation-Plan-Based Awards” for additional information about grants made to WaterStone Bank executive officers. The restricted stock awards granted to employees under this plan vest in five installments over four years with one installment vesting immediately upon grant. The stock awards granted to directors under this plan vest in eight installments over seven years with one installment vesting immediately upon grant. In March 2015, 50,000 and 30,000 stock option awards were granted to Mr. Egenhoefer and Mr. Gillespie, respectively. The grant price and the exercise price of the option awards granted were equal to the closing market price for our shares of common stock on the grant date. These option awards vest in equal installments over a five years. In the event of an involuntary termination of employment following a change in control, the unvested equity incentive awards held by each recipient will vest automatically. The mutual-to-stock conversion of Lamplighter Financial, MHC was not considered a change in control. The Employee Stock Ownership Plan is a tax-qualified retirement plan that benefits all eligible WaterStone Bank employees proportionately. The Employee Stock Ownership Plan replaced WaterStone Bank’s defined benefit pension plan and is not separately considered in the review and evaluation of annual executive compensation. Employee Stock Ownership Plan allocations are made annually as of December 31 to all eligible WaterStone Bank employees. An employee must complete a full year of service and be employed by us on December 31 in order to receive an annual allocation each year. In the event of plan termination, all allocated benefits become fully vested immediately, any outstanding loan will be repaid from shares in the unallocated suspense account and the amounts remaining in the suspense account will be allocated to participant accounts proportionally. Dividends paid with respect to shares of Waterstone Financial, Inc. stock in the unallocated suspense account may be used to repay any Employee Stock Ownership Plan loan. To the extent the dividends exceeded the annual loan payment, the remaining dividend amount would cause additional shares to be allocated to participants or may be credited proportionately to participant accounts. Compensation Committee Report The Compensation Committee has reviewed and discussed the section of this proxy statement entitled “Compensation Discussion and Analysis” with management. Based on this review and discussion, the Compensation Committee recommended to the board of directors that the “Compensation Discussion and Analysis” be included in this proxy statement. This report has been provided by the Compensation Committee: Thomas E. Dalum, Chairman Ellen S. Bartel Patrick S. Lawton Stephen J. Schmidt 11 PROPOSAL 2 – ADVISORY VOTE ON EXECUTIVE COMPENSATION The compensation of our Principal Executive Officer, Principal Financial Officer and the four other most highly compensated executive officers of the Company (“Named Executive Officers”) is described above in general and is shown in detail in the Executive Compensation and Compensation Discussion and Analysis sections. Shareholders are urged to read the Executive Compensation and Compensation Discussion and Analysis sections of this Proxy Statement, which discusses our compensation policies and procedures with respect to our Named Executive Officers. In accordance with Section 14A of the Exchange Act, shareholders will be asked at the Annual Meeting to provide their support with respect to the compensation of our Named Executive Officers by voting on the following advisory, non-binding resolution: RESOLVED, that the compensation paid to the “named executive officers,” as disclosed in the Company’s Proxy Statement for the 2017 Annual Meeting of Shareholders pursuant to Item 402 Securities and Exchange Commission Regulation S-K, including the Compensation Discussion and Analysis, the 2016 compensation tables and narrative discussion is hereby approved. We will hold annual say-on-pay votes until the next shareholders vote regarding the frequency of say-on- pay votes, which we expect to occur at the 2020 annual meeting of shareholders. This advisory vote, commonly referred to as a “say-on-pay” advisory vote, is non-binding on the board of directors. Although non-binding, the board of directors and the compensation committee value constructive dialogue on executive compensation and other important governance topics with our shareholders and encourage all shareholders to vote their shares on this matter. The board of directors and the compensation committee will review the voting results and take them into consideration when making future decisions regarding our executive compensation. Unless otherwise instructed, validly executed proxies will be voted “FOR” this resolution. The board of directors unanimously recommends that you vote “FOR” the resolution set forth in Proposal 2. 12 EXECUTIVE COMPENSATION Summary Compensation Table. The following table shows the compensation of our Named Executive Officers, including, Douglas S. Gordon, our principal executive officer and five other executive officers who received total compensation of more than $100,000 during the year ended December 31, 2016 (collectively, the “Named Executive Officers”). The “Change in Pension Value and Nonqualified Deferred Compensation Earnings” column has been omitted because no listed individual earned any compensation during the listed years of a type required to be disclosed in this column. SUMMARY COMPENSATION TABLE Name and Principal Position Douglas S. Gordon Chief Executive Officer of Waterstone Financial and WaterStone Bank Eric J. Egenhoefer President of Waterstone Mortgage Corporation Year 2016 2015 2014 2016 2015 2014 Salary ($)(1) 825,000 800,000 780,000 309,000 300,000 250,000 Bonus ($) — — 700,000 — — — Stock Awards ($)(2) — 3,187,500 — — — — Option Awards ($)(2) — 486,000 — — 162,000 — Non-Equity Incentive Plan Compensation ($) All Other Compensation ($)(3) — — — 853,963 507,250 50,000 67,320 56,031 46,930 6,000 9,213 6,600 78,169 64,664 53,757 — — 2016 31,900 165,000 299,600 — — — 2016 2015 2014 — 97,200 — — — 81,890 291,500 283,000 275,000 — 382,500 — William F. Bruss Chief Operating Officer and General Counsel of Waterstone Financial and WaterStone Bank Mark R. Gerke Chief Financial Officer of Waterstone Financial and WaterStone Bank Rebecca M. Arndt Vice President, Retail Operations of WaterStone Bank Kevin Gillespie Chief Operating Officer of Waterstone Mortgage Corporation Allan R. Hosack (4) Former Chief Financial Officer of Waterstone Financial and WaterStone Bank ________________________________ (1) Salary includes amounts contributed by participants in the WaterStone Bank 401(k) Plan. Mr. Gordon’s salary includes 401(k) — 223,125 — 171,500 166,500 161,500 — 318,750 — — 129,600 — 71,985 237,000 190,246 — — 48,225 — — 68,425 — 48,600 — 426,981 278,988 206,000 200,000 2016 2015 2014 2016 2015 2014 — 97,200 2016 2015 — — — — — — — — — — 47,492 41,547 37,168 999 24,087 10,993 6,000 6,000 48,589 Total ($) 892,320 4,529,531 1,526,930 1,168,963 978,463 306,600 369,669 827,364 410,647 545,089 218,992 479,772 246,893 638,981 574,069 72,894 709,437 269,664 contributions of $24,000 in 2016 and 2015 and $23,000 in 2014. Mr. Bruss’ salary includes 401(k) contributions of $16,466 in 2016, $13,478 in 2015, and $8,250 in 2014. Mr. Gerke’s salary includes a 401(k) contribution of $15,961 in 2016. Ms. Arndt’s salary includes 401(k) contributions of $17,133 in 2016, $17,256 in 2015, and $16,117 in 2014. Mr. Hosack’s salary includes a 401(k) contribution of $999 in 2016, $18,000 in 2015, and $16,189 in 2014. In 2016, a 401(k) matching contribution was made by WaterStone Bank in the amount of $626 for Mr. Gordon, $1,047 for Mr. Bruss, $1,533 for Mr. Gerke, and $1,647 for Ms. Arndt. In 2015, a 401(k) matching contribution was made by WaterStone Bank in the amount of $602 for Mr. Gordon, $755 for Mr. Bruss, $1,818 for Mr. Hosack, and $1,645 for Ms. Arndt. In 2014, a 401(k) matching contribution was made by WaterStone Bank in the amount of $900 for Mr. Gordon, $1,235 for Mr. Bruss, $1,645 for Mr. Hosack, and $1,612 for Ms. Arndt. Mr. Gillespie’s salary includes a 401(k) contribution of $1,712 in 2016. In 2016, a 401(k) matching contribution was made by Waterstone Mortgage Corporation in the amount of $734 for Mr. Gillespie. (2) Reflects the aggregate grant-date fair value of the stock and option awards granted during the years shown as calculated in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718. The assumptions used in the valuation of these awards are included in the “Stock Based Compensation” footnote to Waterstone Financial’s audited financial statements for the years ended December 31, 2016, 2015 and 2014 included in our Annual Report on Form 10-K for the year ended December 31, 2016, as filed with the Securities and Exchange Commission. (3) For 2016, “All Other Compensation” includes Employee Stock Ownership Plan shares valued at $18.40 per share allocated on December 31, 2016 and totaling $61,842 for Mr. Gordon, $61,842 for Mr. Bruss, $35,770 for Mr. Gerke, and $39,983 for Ms. Arndt; club membership dues of $1,573 for Mr. Gordon, $7,199 for Mr. Bruss, $2,741 for Mr. Gerke, and $876 for Ms. Arndt; and personal use of company-owned vehicles equal to $3,904 for Mr. Gordon, $9,127 for Mr. Bruss, $3,885 for Mr. Gerke, $6,633 for Ms. Arndt, and $999 for Mr. Hosack. Mr. Gerke received $6,193 for a discounted employee special terms program for home mortgage loans on principal residences. Mr. Egenhoefer and Mr. Gillespie were each paid a car allowance of $6,000 in 2016. (4) Mr. Hosack resigned from the Company, effective February 29, 2016. 13 Employment Agreements Employment Agreement with Douglas S. Gordon. Effective as of October 21, 2014, WaterStone Bank entered into an employment agreement with Douglas S. Gordon, President and Chief Executive Officer of WaterStone Bank, for a term continuing through December 31, 2018. Commencing on January 1, 2016, and continuing on each January 1st anniversary date thereafter, the term of the agreement will renew for an additional year, such that the remaining term will always be three years, unless written notice of non-renewal is provided to Mr. Gordon at least 30 days prior to the anniversary date. Under the agreement, Mr. Gordon’s annual base salary for 2017 is $850,000. In addition, Mr. Gordon is entitled to participate in the employee benefit plans, arrangements and perquisites offered by WaterStone Bank and is entitled to participate in any incentive compensation or bonus plan or arrangement of WaterStone Bank or Waterstone Financial in which he is eligible to participate. The Bank will also pay or reimburse him for business expenses incurred, pay or reimburse him for annual country club dues and furnish him an automobile or reimburse him for the expense of leasing an automobile and for reasonable expenses associated with the use of such automobile. In the event of Mr. Gordon’s involuntary termination of employment for reasons other than cause, disability, death or retirement, or in the event Mr. Gordon resigns during the term of the agreement for “good reason” (as defined in the agreement), Mr. Gordon will receive a lump-sum severance payment equal to the sum of (i) his earned but unpaid salary as of the date of his termination of employment, (ii) the benefits he is entitled to as a former employee under the employee benefit plans maintained by WaterStone Bank or Waterstone Financial, (iii) the remaining base salary and bonuses Mr. Gordon would have earned if he had continued his employment for the remaining term of the Agreement and had earned a bonus and/or incentive award in each year in an amount equal to the average bonus and/or incentive award earned by him over the three calendar years preceding the year in which the termination occurs, (iv) the annual contributions or payments that would have been made on Mr. Gordon’s behalf to any employee benefit plans of WaterStone Bank or Waterstone Financial as if Mr. Gordon had continued his employment with WaterStone Bank for the remaining term of the Agreement, and (v) the annual payments that would have been made related to membership in a country club and the use of an automobile for the remaining term of the Agreement. In addition, all awards under the Wauwatosa Holdings 2006 Equity Incentive Plan and the Waterstone Financial, Inc. 2015 Equity Incentive Plan that would have vested had Mr. Gordon continued his employment with WaterStone Bank for the remaining term of the Agreement will vest as of the date of termination, provided that if the terms of the Incentive Plan do not allow for such vesting, WaterStone Bank will make a lump sum payment to Mr. Gordon in an amount equal to the value to Mr. Gordon if such awards had become vested and, with respect to stock options, been exercised. Upon the occurrence of an event of termination described above, Mr. Gordon will be entitled to continued life insurance coverage and non-taxable medical and dental insurance coverage for the remaining term of the agreement. Upon termination of Mr. Gordon’s employment by Waterstone Financial or WaterStone Bank following a change in control of Waterstone Financial or WaterStone Bank, or Mr. Gordon’s resignation due to good reason following a change in control, Mr. Gordon will receive a lump sum payment within 30 days after the date of termination substantially similar to the payment that he would receive on such a termination without regard to a change in control, except that such payments will be calculated based on a remaining term of the agreement of 36 months. In addition, all awards under the Wauwatosa Holdings 2006 Equity Incentive Plan and the Waterstone Financial, Inc. 2015 Equity Incentive Plan will vest as of the date of termination. Upon the occurrence of an event of termination described above, Mr. Gordon will be entitled to continued life insurance coverage and non-taxable medical and dental insurance coverage for a period of 36 months from the date of termination. In the event of Mr. Gordon’s disability and subsequent termination of employment, Mr. Gordon will receive the benefits provided under any disability program sponsored by Waterstone Financial or WaterStone Bank. To the extent such benefits are less than Mr. Gordon’s base salary at the date of termination, and less than 66 2/3% of Mr. Gordon’s base salary after the first year following termination, Mr. Gordon will be entitled to the difference between the disability benefits provided under any disability program sponsored by Waterstone Financial or WaterStone Bank and his base salary for a period of one year. After the first year following termination, Mr. Gordon will be entitled to the difference between the disability benefits provided under any disability program sponsored by Waterstone Financial or WaterStone Bank and 66 2/3% of Mr. Gordon’s base salary, through the earliest to occur of the date of Mr. Gordon’s death, recovery from disability or the date Mr. Gordon attains age 65. 14 In the event of Mr. Gordon’s death during the term of the agreement, Mr. Gordon’s beneficiary, legal representatives or estate will be paid Mr. Gordon’s base salary for one year and WaterStone Bank will continue to provide Mr. Gordon’s family the same medical, dental, and other health benefits that were provided by WaterStone Bank to Mr. Gordon’s family immediately prior the Mr. Gordon’s death, on the same terms, including cost. In the event of termination due to Mr. Gordon’s retirement, no amount or benefit will be due Mr. Gordon under the Agreement. The employment agreement restricts Mr. Gordon from revealing confidential information of Waterstone Financial and WaterStone Bank. In addition, for one year following termination of employment (other than upon termination following a change in control), Mr. Gordon may not compete with Waterstone Financial and WaterStone Bank or solicit or hire WaterStone Bank’s employees. Employment Agreement with Eric J. Egenhoefer. Waterstone Mortgage Corporation is a party to an employment agreement with its President, Eric J. Egenhoefer. The agreement has a term continuing through December 31, 2018, and will be extended at the end of each year for a period of one year unless terminated as provided in the agreement. Under the agreement, Mr. Egenhoefer is entitled to a base salary in 2017 of $318,270 and participation in company-wide employee benefits, including Waterstone Mortgage Corporation’s 401(k) Plan and other qualified and non-qualified plans that may be maintained by the company. Mr. Egenhoefer is also entitled to annual bonus compensation pursuant to the bonus formula set forth in the agreement. Mr. Egenhoefer may terminate his employment for “good reason,” which includes any material breach of the agreement by Waterstone Mortgage Corporation, including the failure, without “good cause” (as defined in the agreement), to pay the amounts due under the agreement on a timely basis. In the event the agreement is terminated for good reason or in the event Waterstone Mortgage Corporation terminates Mr. Egenhoefer’s employment for any reason other than “good cause,” Mr. Egenhoefer will be entitled to receive his base salary through the remaining term of the agreement. In the event of termination due to disability, Mr. Egenhoefer will receive any unpaid base salary earned prior to the effective date of termination and reimbursement of expenses to which Mr. Egenhoefer is entitled. In the event of Mr. Egenhoefer’s death during the term of the agreement, the agreement will terminate with no payment of severance compensation to Mr. Egenhoefer’s estate. Similarly, in the event of his termination for good cause, Mr. Egenhoefer will not be entitled to any severance compensation. In the event of Mr. Egenhoefer’s termination of employment, the agreement contains provisions which prevent him from soliciting business from customers of Waterstone Mortgage Corporation, withdrawing any customers’ business, hiring any employees, consultants or personnel of Waterstone Mortgage Corporation, disclosing confidential information or competing with Waterstone Mortgage Corporation for one year following termination of employment. 15 Plan-Based Awards The following table sets forth for the year ended December 31, 2016 certain information as to grants of plan-based awards. The stock awards vest ratably in five installments, commencing with the first installment vesting on March 6, 2015, and each vesting installment on each subsequent anniversary of the date of grant. The stock options vest ratably over a five-year period commencing one year from the date of date and expire if not exercised prior to the end of the tenth year following the date of grant. The non-equity award granted to Mr. Egenhoefer is described above in “—Compensation Discussion and Analysis—Bonus-Waterstone Mortgage Corporation.” For further discussion and details regarding the accounting treatment and underlying assumptions relative to stock-based compensation, see Note 10, “Stock-Based Compensation,” of the Notes to Consolidated Financial Statements included in Part II, Item 8, “Financial Statements and Supplementary Data” of Waterstone Financial, Inc.’s 2016 Form 10-K. GRANTS OF PLAN-BASED AWARDS FOR THE YEAR ENDED DECEMBER 31, 2016 Estimated Future Payouts Under Non-Equity Incentive Plan Awards (1) Name Mark R. Gerke Eric J. Egenhoefer Kevin P. Gillespie Grant Date 6/21/2016 6/21/2016 Threshold ($) — — — — Target ($) — — 507,250 278,988 Maximum ($) — — — — All Other Stock Awards: Number of Shares of Stock (#) 20,000 — — — All Other Option Awards: Number of Securities Underlying Options (#) — 10,000 — — Grant Date Fair Value of Stock and Option Awards ($) 299,600 31,900 — — Exercise or Base Price of Option Awards ($) — 14.98 — — _______________________ (1) On an annual basis, Mr. Egenhoefer and Mr. Gillespie are entitled to earn a bonus under the criteria described under “— Compensation Discussion and Analysis—Bonus.” There is no minimum, target or maximum amount. Therefore, pursuant to Securities and Exchange Commission regulations, the target amount listed is based upon operating results for the year ended December 31, 2016 and equals the actual 2016 award. Outstanding Equity Awards at Year End. The following table sets forth information with respect to outstanding equity awards as of December 31, 2016. Grants were made under our 2006 and 2015 Equity Incentive Plans. OUTSTANDING EQUITY AWARDS AT DECEMBER 31, 2016 Option Awards Stock Awards Number of Securities Underlying Unexercised Options (#) Exercisable 30,000 38,865 10,000 30,724 6,000 — 2,000 — — 3,000 6,000 Number of Securities Underlying Unexercised Options (#) Unexercisable 120,000 (5) — 40,000 (5) 7,681 (5) 24,000 (5) 3,292 (5) 8,000 (5) 10,000 (5) 4,390 (5) 12,000 (5) 24,000 (5) Option Exercise Price ($) 12.75 3.47 12.75 1.73 12.75 1.73 12.75 14.98 1.73 12.75 12.75 Number of Shares or Units of Stock That Have Not Vested (#) 150,000 (2) — — 5,487 (1) 18,000 (2) — — 16,000 (3) 3,292 (1) 10,500 (2) — Market Value of Shares or Units of Stock That Have Not Vested ($)(4) 2,760,000 — — 100,961 331,200 — — 294,400 60,573 193,200 — Option Expiration Date 3/4/2025 10/20/2020 3/4/2025 1/4/2022 3/4/2025 1/4/2022 3/4/2025 6/21/2026 1/4/2022 3/4/2025 3/4/2025 Name Douglas S. Gordon Eric J. Egenhoefer William F. Bruss Mark R. Gerke Rebecca M. Arndt Kevin P. Gillespie ______________________ (1) Consists of restricted shares awarded on January 4, 2012 under the 2006 Equity Incentive Plan. The restricted shares vest in five annual increments of 20% each beginning on the first anniversary of the initial award. 16 (2) Consists of restricted shares awarded on March 4, 2015 under the 2015 Equity Incentive Plan. The restricted shares vest in five increments of 20% each beginning on the March 6, 2015 and subsequently on each anniversary of the initial award. (3) Consists of restricted shares awarded on June 21, 2016 under the 2015 Equity Incentive Plan. The restricted shares vest in five increments of 20% each beginning on the June 22, 2016 and subsequently on each anniversary of the initial award. (4) Based on the $18.40 per share closing price of our common stock on December 31, 2016. (5) Options vest in five annual increments of 20% each beginning on the first anniversary of the grant date. Option Exercises and Stock Vested. The following table sets forth information with respect to option exercises and stock that vested during the year ended December 31, 2016. OPTION EXERCISES AND STOCK VESTED DURING THE YEAR ENDED DECEMBER 31, 2016 Option Awards Stock Awards Name Number of Shares Acquired on Exercise (#) 274,325 16,000 54,865 11,521 36,210 Value Realized on Exercise ($) 240,258 246,080 40,600 46,877 128,181 Douglas S. Gordon Eric J. Egenhoefer William F. Bruss Mark R. Gerke Rebecca M. Arndt ________________________________ (1) Based on the $14.02 per share closing price of our common stock on March 7, 2016. (2) Of the total $160,266, $76,146 was based on 5,486 shares at the $13.88 closing price of our common stock on January 4, 2016 and Number of Shares Acquired on Vesting(#) 50,000 — 11,486 4,000 6,792 Value Realized on Vesting ($) 701,000 (1) — 160,266 (2) 60,520 (3) 94,763 (4) $84,120 was based on 6,000 shares at the $14.02 closing price of our common stock on March 7, 2016. (3) Based on the $15.13 per share closing price of our common stock on June 22, 2016. (4) Of the total $94,763, $45,693 was based on 3,292 shares at the $13.88 closing price of our common stock on January 4, 2016 and $49,070 was based on 3,500 shares at the $14.02 closing price of our common stock on March 7, 2016. Potential Payments Upon Termination or Change in Control The following table sets forth estimates of the amounts that would become payable to our Named Executive Officers, under employment agreements and/or equity award agreements in the event of their termination of employment on December 31, 2016, under designated circumstances. The table does not include vested or accrued benefits under any tax-qualified benefit plans that do not discriminate in scope, terms or operation in favor of Executive Officers or equity awards or other benefits in which the executive is vested without regard to the change in control. The estimates shown are highly dependent on a variety of factors, including but not limited to the date of termination, interest rates, federal, state, and local tax rates, and compensation history. Actual payments due could vary substantially from the estimates shown. We consider each termination scenario listed below to be exclusive of all other scenarios and do not expect that any of our Executive Officers would be eligible to collect the benefits shown under more than one termination scenario. If a Named Executive Officer is terminated for “cause” as defined in the applicable agreement or award, we have no contractual payment or other obligations under the agreement. 17 Mr. Gordon Mr. Egenhoefer Mr. Bruss Mr. Gerke Ms. Arndt Mr. Gillespie Discharge Without Cause or Resignation With Good Reason — no Change in Control Severance payment Medical, dental and life insurance benefits Acceleration of vesting of stock options Acceleration of vesting of $ 3,045,607 (1) 46,771 (2) $ 309,000 (1) — $ 678,000 (4) — restricted stock Total 2,760,000 (5) $ 6,530,378 $ — 618,000 $ 4,710,610 (3) 70,157 (2) $ 309,000 (3) — — — — — — — — $ $ $ — — — — — — — $ $ $ — — — — — — — $ $ $ — — — — — — — $ $ Discharge Without Cause or Resignation With Good Reason — Change in Control Related Severance payment (lump sum) Medical, dental and life insurance benefits Acceleration of vesting of stock options Acceleration of vesting of Disability Severance/disability payment Acceleration of vesting of stock option Acceleration of vesting of restricted stock Total Death Salary continuation payment Medical, dental and life insurance benefits Acceleration of vesting of stock options Acceleration of vesting of 678,000 (4) 226,000 (4) 263,642 (4) 134,278 (4) 140,981 (4) 135,600 (4) restricted stock Total 2,760,000 (5) $ 8,218,767 $ — 844,000 432,161 (5) 294,400 (5) $ 695,803 $ 428,678 $ 3,575,000 (6) $ — $ — $ — 678,000 (4) 226,000 (4) 263,642 (4) 134,278 (4) 2,760,000 (5) $ 7,013,000 $ 825,000 23,386 $ $ — 226,000 432,161 (5) 294,400 (5) $ 695,803 $ 428,678 — — $ — — $ — — $ $ $ $ 253,773 (5) 394,754 — — 135,600 — $ $ 140,981 (4) 135,600 (4) 253,773 (5) 394,754 — — $ $ — 135,600 — — 678,000 (4) 226,000 (4) 263,642 (4) 134,278 (4) 140,981 (4) 135,600 (4) restricted stock Total 2,760,000 (5) $ 4,286,386 $ — 226,000 432,161 (5) 294,400 (5) $ 695,803 $ 428,678 $ 253,773 (5) 394,754 $ — 135,600 _____________________________ (1) The cash severance payment under Mr. Gordon’s employment agreement equals (i) the remaining base salary and employee benefits to which he is entitled under his employment agreement over the remaining term of the agreement, assuming he had earned a bonus equal to the average bonus or incentive award earned over the three calendar years preceding the year of termination, as determined under the agreement; (ii) the annual contributions that would have been made on Mr. Gordon’s behalf under any employee benefit plans in which he participated; and (iii) the annual payments towards country club dues and automobile lease and expenses that he would be entitled to for the remaining term of the agreement. The severance payment is paid under Mr. Egenhoefer’s employment agreement in the event of his termination for good reason. The payment is equal to the remaining base salary to which he is entitled under his employment agreement over the remaining term of the agreement. (2) Mr. Gordon will be entitled to non-taxable medical and dental coverage and life insurance coverage for the remaining term of the agreement, in the event of a termination without cause or for good reason not related to a change in control. In the event of an involuntary termination without cause or for good reason following a change in control, Mr. Gordon will be entitled to the continuation of the same benefits for a period of 36 months from the date of termination. (3) For Mr. Gordon, the cash severance benefit payable on an involuntary termination of employment or termination for good reason in connection with a change in control is the same as the payment in such a termination that occurs without regard to a change in control, except that such payments would be calculated utilizing the highest bonus or incentive award earned over the three calendar years preceding the year of termination and would be based on a 36-month term. For Mr. Egenhoefer, the severance payment is paid under his employment agreement in the event of his termination for good reason. The payment is equal to the remaining base salary to which he is entitled under his employment agreement over the remaining term of the agreement (4) For Mr. Gordon, based on the cash difference between the exercise price of the option, which was $12.75, and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 120,000 unvested stock options. For Mr. Egenhoefer, based on the cash difference between the exercise price of the option, which was $12.75, and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 40,000 unvested stock options. For Mr. Bruss, based on the cash difference between the exercise price of the option ($1.73, on a split adjusted basis) and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 18 7,681 unvested stock options, as well as the cash difference between the exercise price of the option, which was $12.75, and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 24,000 unvested stock options. For Mr. Gerke, based on the cash difference between the exercise price of the option ($1.73, on a split adjusted basis) and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 3,292 unvested stock options, the cash difference between the exercise price of the option, which was $12.75, and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 8,000 unvested stock options, as well as, the cash difference between the exercise price of the option, which was $14.98, and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 10,000 unvested stock options. For Ms. Arndt, based on the cash difference between the exercise price of the option ($1.73, on a split adjusted basis) and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 4,390 unvested stock options, as well as the cash difference between the exercise price of the option, which was $12.75, and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 12,000 unvested stock options. For Mr. Gillespie, based on the cash difference between the exercise price of the option, which was $12.75, and the fair market value of our stock on December 31, 2016, which was $18.40, multiplied by 24,000 unvested stock options. (5) For Mr. Gordon, represents the fair market value on December 31, 2016 of 150,000 shares of restricted stock that would vest on the (6) occurrence of the specified event. For Mr. Bruss, represents the fair market value on December 31, 2016 of 23,487 shares of restricted stock that would vest on the occurrence of the specified event. For Mr. Gerke, represents the fair market value on December 31, 2016 of 16,000 shares of restricted stock that would vest on the occurrence of the specified event. For Ms. Arndt, represents the fair market value on December 31, 2016 of 13,792 shares of restricted stock that would vest on the occurrence of the specified event. In the event of Mr. Gordon’s disability, to the extent that any disability benefits payable under a disability program sponsored by the Bank is less than his base salary during the first year after termination or less than 66-2/3% of his base salary after the first year of his termination, Mr. Gordon will receive a supplement to such disability benefit under the employment agreement to ensure that his aggregate disability benefit is equal to his base salary during the first year and equal to 66-2/3% of his base salary after the first year of his disability. (This benefit can be provided under a supplemental disability policy providing such benefit, in lieu of providing it under the employment agreement.) 19 Director Compensation Set forth below is summary compensation for each of our non-employee directors for the year ended December 31, 2016. DIRECTOR COMPENSATION TABLE FOR THE YEAR ENDED DECEMBER 31, 2016 Name Ellen S. Bartel Nominating Committee Co-chairman Thomas E. Dalum Compensation Committee Chairman Michael L. Hansen Audit Committee Chairman Patrick S. Lawton Chairman of the Board Kristine A. Rappé Executive Committee Chairman Stephen J. Schmidt Nominating Committee Co-chairman Fees earned or paid in cash ($)(1) 18,000 Total ($) 18,000 18,000 18,000 24,000 24,000 30,000 30,000 18,000 18,000 18,000 18,000 _____________________ (1) Includes annual retainer, committee and chairmanship fees. As of December 31, 2016, Mr. Lawton had 30,000 unvested shares of restricted stock, Mr. Hansen had 24,000 unvested shares of restricted stock, and Messrs. Bartel, Dalum, Rappe, and Schmidt had 21,000 unvested shares of restricted stock, respectively. Messrs. Bartel, Dalum, Hansen, Lawton, Rappe, and Schmidt had 12,500 vested but unexercised stock options and 87,500 unvested stock options, respectively. In 2016, we paid each non-officer director annual meeting fees of $18,000. Additional annual fees paid to the Chairman of the Board totaled $12,000 and additional annual fees paid to the Chairman of the Audit Committee totaled $6,000. SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE Under the federal securities laws, Waterstone Financial directors, its executive officers and any person holding more than 10% of the common stock are required to report their initial ownership of the common stock and any change in that ownership to the SEC. Specific due dates for these reports have been established and we are required to disclose in this Proxy Statement any failure to file such reports by these dates during the last year. Based soley on our review of Forms 3, 4, and 5 during or for the year ended December 31, 2016, we believe that all of our filing requirements were satisfied on a timely basis for the year ended December 31, 2016. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION None of the members of the compensation committee was an officer or employee of Waterstone Financial, WaterStone Bank or any subsidiary, nor did any of them have any other reportable interlock. TRANSACTIONS WITH CERTAIN RELEATED PERSONS WaterStone Bank has had, and expects to continue to have, regular business dealings with its officers and directors, as well as their associates and the firms which they serve. Our historical policy has been that transactions with our directors and executive officers be on terms that are no more beneficial to the director or executive officer than we would provide to unaffiliated third parties. Under our policies and procedures, all of our transactions with officers and directors require review, approval or ratification by the board of directors. Directors and executive officers, and their associates, regularly deposit funds with WaterStone Bank. The deposits are made on the same terms and conditions which are offered to other depositors. 20 In the ordinary course of business, WaterStone Bank makes loans available to its directors, officers and employees. After six months of continuous employment, full-time employees of WaterStone Bank were entitled to receive a mortgage loan at a reduced interest rate, consistent with applicable laws and regulations. In December 2005, the board discontinued the employee loan program for employee loans originated after March 31, 2006. Employee loans at reduced interest rates originated on or before March 31, 2006 continue on their same terms. The chart below lists the executive officers who participated in the employee mortgage loan program during the year ended December 31, 2016 and certain information with respect to their loans. No directors or other executive officers of Waterstone Financial participated in the employee mortgage loan program during the year ended December 31, 2016. Name Largest Aggregate Balance 01/01/16 to 12/31/16 Interest Rate Non- employee Interest Rate Principal Balance 12/31/16 Principal Paid 01/01/16 to 12/31/16 Interest Paid 01/01/16 to 12/31/16 Mark R. Gerke $ 210,967 1.72% 5.50% $ 198,901 $ 11,883 $ 3,533 Name Largest Aggregate Balance 01/01/15 to 12/31/15 Interest Rate Non- employee Interest Rate Principal Balance 12/31/15 Principal Paid 01/01/15 to 12/31/15 Interest Paid 01/01/15 to 12/31/15 William F. Bruss Mark R. Gerke $ 251,088 $ 222,850 1.73% 1.73% 5.50% 5.50% $ — $ 210,967 $ 251,088 $ 11,883 $ 2,103 $ 3,727 Name Largest Aggregate Balance 01/01/14 to 12/31/14 Interest Rate Non- employee Interest Rate Principal Balance 12/31/14 Principal Paid 01/01/14 to 12/31/14 Interest Paid 01/01/14 to 12/31/14 William F. Bruss $ 261,631 1.65% 5.50% $ 251,088 $ 10,543 $ 4,250 At the time of termination of employment with WaterStone Bank, the interest rate will be adjusted to the non-employee interest rate as set forth in the mortgage note. These loans neither involve more than the normal risk of collection nor present other unfavorable features. Federal regulations permit executive officers and directors to participate in loan programs that are available to other employees, as long as the director or executive officer is not given preferential treatment compared to other participating employees. Loans made to directors or executive officers, including any modification of such loans, must be approved by a majority of disinterested members of the board of directors. The interest rate on loans to directors and officers is the same as that offered to other employees. Other than described above, and except for loans to directors made in the ordinary course of business that were made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable loans with persons not related to WaterStone Bank and for which management believes neither involve more than the normal risk of collection nor present other unfavorable features, since January 1, 2016, the beginning of our last fiscal year, we and our subsidiaries have not had any transaction or series of transactions, or business relationships, nor are any such transactions or relationships proposed, in which the amount involved exceeds $120,000 and in which our directors, executive officers or 5% or more shareholders have a direct or indirect material interest. REPORT OF THE AUDIT COMMITTEE The audit committee of the Waterstone Financial board of directors was created in accordance with Section 3(a)(58)(a) of the Exchange Act. The audit committee’s functions include meeting with our independent registered public accounting firm and making recommendations to the board regarding the independent registered public accounting firm; assessing the adequacy of internal controls, accounting methods and procedures; review of public disclosures required for compliance with securities laws; and consideration and review of various other matters relating to the our financial accounting and reporting. No member of the audit committee is employed by or has any other material relationship with us other than as a customer or shareholder. The members are “independent” as 21 defined in Rule 5605(a)(2) of the NASDAQ listing standards. The board of directors has adopted a written charter for the audit committee which can be found on our website. In connection with its function to oversee and monitor our financial reporting process, the audit committee has done the following:    reviewed and discussed the audited financial statements for the year ended December 31, 2016 with management; discussed with RSM US LLP, our independent registered public accounting firm, those matters which are required to be discussed under Public Company Accounting Oversight Board (United States) (“PCAOB”) Auditing Standard No. 1301; and received the written disclosures and the letter from RSM US LLP required by PCAOB and has discussed with RSM US LLP its independence. This report has been provided by the audit committee: Michael L. Hansen, Chairman Ellen S. Bartel Thomas E. Dalum Kristine A. Rappé Based on the foregoing, the audit committee recommended to the board that those audited financial statements be included in our Annual Report on Form 10-K for the year ended December 31, 2016. In addition, the audit committee also considered the fees paid to RSM US LLP for services provided by RSM US LLP during the year ended December 31, 2016. PROPOSAL 3 – RATIFICATION OF THE APPOINTMENT OF OUR INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM The firm of RSM US LLP has audited the books and records of Waterstone Financial as of and for the year ended December 31, 2016 and has served as Waterstone Financial’s principal independent accountant since June 3, 2014. Representatives of RSM US LLP are expected to be present at the annual meeting to respond to appropriate questions and to make a statement if they so desire. The Audit Committee of the Board of Directors has selected RSM US LLP as our independent registered public accountants for the fiscal year ended December 31, 2016. We are submitting the selection of independent registered public accountants for shareholder ratification at the annual meeting. If our shareholders do not ratify the selection, the Audit Committee will reconsider whether to retain RSM US LLP, but may still retain them. As reflected in the tables below, Waterstone Financial incurred fees in fiscal years 2016 and 2015 for professional services provided by RSM US LLP related to those periods. Year Ended December 31, 2016 December 31, 2015 Audit Fees ……………… Total $ 241,800 $ 241,800 $ 226,400 $ 226,400 Audit fees consist of professional services rendered for the audit of our financial statements and review of our Forms 10-Q. 22 Policy on Audit Committee Pre-Approval of Audit and Non-Audit Services of the Independent Registered Public Accounting Firm The audit committee’s policy is to pre-approve all audit and non-audit services provided by the independent registered public accounting firm. These services may include audit services, audit-related services, tax services and other services. Pre-approval is generally provided for up to one year and any pre-approval is detailed as to particular service or category of services and is generally subject to a specific budget. The audit committee has delegated pre-approval authority to its Chairman when expedition of services is necessary. The independent registered public accounting firm and management are required to periodically report to the full audit committee regarding the extent of services provided by the independent registered public accounting firm in accordance with this pre-approval, and the fees for the services performed to date. All audit services for the past two fiscal years were pre-approved by the audit committee. SHAREHOLDER PROPOSALS AND NOTICES Shareholder proposals must be received by the Secretary of Waterstone Financial, William F. Bruss, no later than December 7, 2017 in order to be considered for inclusion in next year’s annual meeting proxy materials pursuant to Securities and Exchange Commission Rule 14a-8. Under Securities and Exchange Commission rules relating to the discretionary voting of proxies at shareholder meetings, if a proponent of a matter for shareholder consideration (other than a shareholder proposal) fails to notify Waterstone Financial at least 45 days prior to the month and day of mailing the prior year’s Proxy Statement, then management proxies are allowed to use their discretionary voting authority if a proposal is raised at the annual meeting, without any discussion of the matter in the Proxy Statement. Therefore, any such matters must be received by February 21, 2017 in the case of the 2017 annual meeting of shareholders. Waterstone Financial is not aware of any such proposals for the 2016 annual meeting. Our Bylaws provide an advance notice procedure for certain business, or nominations to the board of directors, to be brought before an annual meeting of shareholders. In order for a stockholder to properly bring business before an annual meeting, or to propose a nominee to the board of directors, our Secretary must receive written notice not earlier than the 90th day nor later than the 80th day prior to date of the annual meeting; provided, however, that in the event that less than 90 days’ notice or prior public disclosure of the date of the annual meeting is provided to shareholders, then, to be timely, notice by the stockholder must be so received not later than the tenth day following the day on which public announcement of the date of such meeting is first made. The notice with respect to stockholder proposals that are not nominations for director must set forth as to each matter such stockholder proposes to bring before the annual meeting: (i) a brief description of the business desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting; (ii) the name and address of such stockholder as they appear on our books and of the beneficial owner, if any, on whose behalf the proposal is made; (iii) the class or series and number of shares of our capital stock which are owned beneficially or of record by such stockholder and such beneficial owner; (iv) a description of all arrangements or understandings between such stockholder and any other person or persons (including their names) in connection with the proposal of such business by such stockholder and any material interest of such stockholder in such business; and (v) a representation that such stockholder intends to appear in person or by proxy at the annual meeting to bring such business before the meeting. The notice with respect to director nominations must include (i) as to each individual whom the stockholder proposes to nominate for election as a director, (A) all information relating to such person that would indicate such person’s qualification under Article 2, Section 12 of our Bylaws, including an affidavit that such person would not be disqualified under the provisions of Article 2, Section 12 of the Bylaws and (B) all other information relating to such individual that is required to be disclosed in connection with solicitations of proxies for election of directors, or is otherwise required, in each case pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended, or any successor rule or regulation; and (ii) as to the stockholder giving the notice, (A) the name and address of such stockholder as they appear on our books and of the beneficial owner, if any, on whose behalf the nomination is made; (B) the class or series and number of shares of our capital stock which are owned beneficially or of record by such stockholder and such beneficial owner; (C) a description of all arrangements or understandings 23 between such stockholder and each proposed nominee and any other person or persons (including their names) pursuant to which the nomination(s) are to be made by such stockholder; (D) a representation that such stockholder intends to appear in person or by proxy at the meeting to nominate the persons named in its notice; and (E) any other information relating to such stockholder that would be required to be disclosed in a proxy statement or other filings required to be made in connection with solicitations of proxies for election of directors pursuant to Regulation 14A under the Securities Exchange Act of 1934 or any successor rule or regulation. Such notice must be accompanied by a written consent of each proposed nominee to be named as a nominee and to serve as a director if elected. The date on which the next Annual Meeting of Shareholders is expected to be held is May 16, 2017. Advance written notice for certain business, or nominations to the Board of Directors, to be brought before the next annual meeting must be given to us no earlier than February 15, 2018 and no later than February 25, 2018. If notice is received before February 15, 2018 or after February 25, 2018, it will be considered untimely, and we will not be required to present the matter at the shareholders meeting. By Order of the Board of Directors William F. Bruss Executive Vice President and Secretary Wauwatosa, Wisconsin April 6, 2017 We will provide a copy of the Waterstone Financial Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2016 (without exhibits) without charge to any record or beneficial owner of our common stock on the written request of that person directed to: Mark R. Gerke, Chief Financial Officer, Waterstone Financial, Inc., 11200 W. Plank Ct., Wauwatosa, WI 53226. The 10-K provides a list of exhibits, which will be provided for a reasonable fee to reflect duplication and mailing costs; exhibits are also available through the Securities and Exchange Commission’s website at www.sec.gov. 24 SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549F O R M 1 0 - K[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2016Commission file number: 001-36271WATERSTONE FINANCIAL, INC.(Exact name of registrant as specified in its charter)Maryland 90-1026709(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 11200 W Plank Ct, Wauwatosa, Wisconsin 53226(Address of principal executive offices) (Zip Code)(414) 761-1000Registrant's telephone number, including area code:Securities registered pursuant to Section 12(b) of the Act:Common Stock, $0.01 Par Value The NASDAQ Stock Market, LLC(Title of class) (Name of each exchange on which registered)Securities registered pursuant to Section 12(g) of the Act:NONEIndicate by check mark whether the registrant is a well-known seasoned issuer (as defined in Rule 405 of the 1933 Act).Yes ☐ No TIndicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the 1934 Act.Yes ☐ No T Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past90 days.Yes T No ☐Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submitand post such files)Yes T No ☐Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best ofregistrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of"large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange ActLarge accelerated filero Accelerated filerþ Non-accelerated filer(Do not check if a smaller reporting company)o Smaller Reporting CompanyoIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 under the Exchange Act).Yes ☐ No TThe aggregate market value of the voting and non-voting common equity held by non-affiliates of the Registrant, computed by reference to the price at which thecommon equity was last sold on June 30, 2016 as reported by the NASDAQ Global Select Market® was approximately $447.1 million.As of February 28, 2017, 29,446,462 shares of the Registrant's Common Stock were issued and outstanding.DOCUMENTS INCORPORATED BY REFERENCE Part of Form 10-K Into WhichDocument Portions of Document are IncorporatedProxy Statement for Annual Meeting of Part IIIShareholders on May 16, 2017 WATERSTONE FINANCIAL, INC.FORM 10-K ANNUAL REPORT TO THE SECURITIES AND EXCHANGE COMMISSIONFOR THE YEAR ENDED DECEMBER 31, 2016 TABLE OF CONTENTS ITEM PAGE PART I 3 1.Business 3 - 281A.Risk Factors 28 - 331B.Unresolved Staff Comments 332.Properties 343.Legal Proceedings 344.Mine Safety Disclosures 34 PART II 35 5.Market for Registrant's Common Equity, Related Stockholders Matters and Issuer Purchases of Equity Securities 35 - 366.Selected Financial Data 37 - 387.Management's Discussion and Analysis of Financial Condition and Results of Operations 39 - 517A.Quantitative and Qualitative Disclosures About Market Risk 528.Financial Statements and Supplementary Data 53 - 949.Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 959A.Controls and Procedures 95 - 969B.Other Information 97 PART III 97 10.Directors, Executive Officers and Corporate Governance 9711.Executive Compensation 9712.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 9713.Certain Relationships and Related Transactions, and Director Independence 9814.Principal Accountant Fees and Services 98 PART IV 98 15.Exhibits and Financial Statement Schedules 98 Signatures 9916.Form 10-K Summary 99 - 2 -PART 1Item 1. BusinessForward-Looking StatementsThis Form 10-K may contain or incorporate by reference various forward-looking statements, which can be identified by the use of words such as "estimate,""project," "believe," "intend," "anticipate," "plan," "seek," "expect" and similar expressions and verbs in the future tense. These forward-looking statements include,but are not limited to:• Statements of our goals, intentions and expectations;• Statements regarding our business plans, prospects, growth and operating strategies;• Statements regarding the quality of our loan and investment portfolio;• Estimates of our risks and future costs and benefits.These forward-looking statements are based on current beliefs and expectations of our management and are inherently subject to significant business,economic and competitive uncertainties and contingencies, many of which are beyond our control. In addition, these forward-looking statements are subject toassumptions with respect to future business strategies and decisions that are subject to change.The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements.● general economic conditions, either nationally or in our market area, that are different than expected;● competition among depository and other financial institutions;● inflation and changes in the interest rate environment that reduce our margins and yields, our mortgage banking revenues or reduce the fair value offinancial instruments or reduce the origination levels in our lending business, or increase the level of defaults, losses or prepayments on loans wehave made and make whether held in portfolio or sold in the secondary markets;●adverse changes in the securities or secondary mortgage markets;● changes in laws or government regulations or policies affecting financial institutions, including changes in regulatory fees and capital requirements;● our ability to manage market risk, credit risk and operational risk in the current economic conditions;● our ability to enter new markets successfully and capitalize on growth opportunities;● our ability to successfully integrate acquired entities;●decreased demand for our products and services;● changes in tax policies or assessment policies;● the inability of third-party provider to perform their obligations to us;● changes in consumer spending, borrowing and savings habits;● changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, theSecurities and Exchange Commission or the Public Company Accounting Oversight Board;● our ability to retain key employees;● significant increases in our loan losses; and● changes in the financial condition, results of operations or future prospects of issuers of securities that we own.See also the factors regarding future operations discussed in "Management's Discussion and Analysis of Financial Condition and Results of Operations"and "Risk Factors" below.Waterstone Financial, Inc.Waterstone Financial, Inc., a Maryland corporation ("New Waterstone"), was organized in June 2013. Upon completion of the mutual-to-stock conversion ofLamplighter Financial, MHC in January 2014, New Waterstone became the holding company of WaterStone Bank SSB and succeeded to all of the business andoperations of Waterstone Financial, Inc., a Federal corporation ("Waterstone-Federal") and each of Waterstone-Federal and Lamplighter Financial, MHC ceased toexist. In this report, we refer to WaterStone Bank, our wholly owned subsidiary, both before and after the reorganization, as "WaterStone Bank" or the "Bank."New Waterstone did not engage in any business prior to the completion of the mutual-to-stock conversion of Lamplighter Financial, MHC on January 22,2014. Consequently, this Annual Report on Form 10-K reflects the financial condition and operating results of Waterstone-Federal and its subsidiaries, including theBank, until January 22, 2014, and of New Waterstone, and its subsidiaries, including the Bank, thereafter. The words "Waterstone Financial," "we" and "our" thus areintended to refer to Waterstone-Federal and its subsidiaries with respect to matters and time periods occurring on or before January 22, 2014, and to New Waterstoneand its subsidiaries with respect to matters and time periods occurring thereafter. Waterstone Financial, Inc. and its subsidiaries, including WaterStone Bank, are referred to herein as the "Company," "Waterstone Financial," or "we."The Company maintains a website at www.wsbonline.com. We make available through that website, free of charge, copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports and proxy materials as soon as is reasonably practical after theCompany electronically files those materials with, or furnishes them to, the Securities and Exchange Commission. You may access those reports by following the linksunder "Investor Relations" at the Company's website. Information on this website is not and should not be considered a part of this document.Waterstone Financial's executive offices are located at 11200 West Plank Court, Wauwatosa, Wisconsin 53226, and its telephone number at this address is(414) 761-1000.- 3 -BUSINESS OF WATERSTONE BANKGeneralWaterStone Bank is a community bank that has served the banking needs of its customers since 1921. WaterStone Bank also has an active mortgage bankingsubsidiary, Waterstone Mortgage Corporation, which had 77 offices in 22 states as of December 31, 2016.WaterStone Bank conducts its community banking business from 11 banking offices located in Milwaukee, Washington and Waukesha Counties, Wisconsin,as well as a loan production office in Minneapolis, Minnesota. WaterStone Bank's principal lending activity is originating one- to four-family and multi-familyresidential real estate loans for retention in its portfolio. At December 31, 2016, such loans comprised 33.4% and 47.4%, respectively, of WaterStone Bank's loanportfolio. WaterStone Bank also offers home equity loans and lines of credit, construction and land loans, commercial real estate and commercial business loans, andconsumer loans. WaterStone Bank funds its loan production primarily with retail deposits and Federal Home Loan Bank advances. Our deposit offerings includecertificates of deposit, money market savings accounts, transaction deposit accounts, non-interest bearing demand accounts and individual retirement accounts. Ourinvestment securities portfolio is comprised principally of mortgage-backed securities, government-sponsored enterprise bonds, municipal obligations, and other debtsecurities.WaterStone Bank is subject to comprehensive regulation and examination by the Wisconsin Department of Financial Institutions (the "WDFI") and theFederal Deposit Insurance Corporation.WaterStone Bank's executive offices are located at 11200 West Plank Court, Wauwatosa, Wisconsin 53226, and its telephone number is (414) 761-1000. Itswebsite address is www.wsbonline.com.WaterStone Bank's mortgage banking operations are conducted through its wholly-owned subsidiary, Waterstone Mortgage Corporation. WaterstoneMortgage Corporation originates single-family residential real estate loans for sale into the secondary market. Waterstone Mortgage Corporation utilizes lines ofcredit provided by WaterStone Bank as a primary source of funds, and also utilizes a line of credit with another financial institution as needed. On a consolidatedbasis, Waterstone Mortgage Corporation originated approximately $2.38 billion, which excludes the loans originated from Waterstone Mortgage Corporation andpurchased by WaterStone Bank, in mortgage loans held for sale during the year ended December 31, 2016.Market AreaWaterStone Bank. WaterStone Bank's market area is broadly defined as the Milwaukee, Wisconsin metropolitan market, which is geographically located inthe southeast corner of the state. WaterStone Bank's primary market area is Milwaukee and Waukesha counties and the five surrounding counties of Ozaukee,Washington, Jefferson, Walworth and Racine. We have six branch offices in Milwaukee County, four branch offices in Waukesha County and one branch office inWashington County. At June 30, 2016 (the latest date for which information was publicly available), 49.2% of deposits in the State of Wisconsin were located in theseven-county metropolitan Milwaukee market and 43.3% of deposits in the State of Wisconsin were located in the three counties in which the Bank has a branchoffice.WaterStone Bank's primary market area for deposits includes the communities in which we maintain our banking office locations. Our primary lending marketarea is broader than our primary deposit market area and includes all of the primary market area noted above but extends further west to the Madison, Wisconsinmarket and further north to the Appleton and Green Bay, Wisconsin markets. In addition, in October 2013 we opened a loan production office in Minneapolis,Minnesota, which has a primary lending market area of the Minneapolis-St. Paul, Minnesota metropolitan market.Waterstone Mortgage Corporation. As of December 31, 2016, Waterstone Mortgage Corporation had 15 offices in Wisconsin, 13 offices in Florida, nineoffices in Pennsylvania, six offices in Minnesota, five offices in Indiana, Ohio, and Texas, two offices in each of Arizona, California, Maryland, and Virginia, and oneoffice in each of Colorado, Georgia, Idaho, Illinois, Iowa, Maine, Massachusetts, New Hampshire, Oregon, Tennessee, and Washington. CompetitionWaterStone Bank. WaterStone Bank faces competition within our market area both in making real estate loans and attracting deposits. The Milwaukee-Waukesha-West Allis metropolitan statistical area has a high concentration of financial institutions, including large commercial banks, community banks and creditunions. The Federal Deposit Insurance Corporation has determined that our market area is a "high-rate" area with regard to deposit pricing as compared to the rest ofthe United States. As of June 30, 2016, based on the Federal Deposit Insurance Corporation's annual Summary of Deposits Report, we had the eighth largest marketshare in our metropolitan statistical area out of 51 financial institutions in our metropolitan statistical area, representing 1.5% of all deposits. Our competition for loans and deposits comes principally from commercial banks, savings institutions, mortgage banking firms and credit unions. We faceadditional competition for deposits from money market funds, brokerage firms, and mutual funds. Some of our competitors offer products and services that we do notoffer, such as trust services and private banking.Our primary focus is to build and develop profitable consumer and commercial customer relationships while maintaining our role as a community bank.Waterstone Mortgage Corporation. Waterstone Mortgage Corporation faces competition for originating loans both directly within the markets in which itoperates and from entities that provide services throughout the United States through internet services. Waterstone Mortgage Corporation's competition comesprincipally from other mortgage banking firms, as well as from commercial banks, savings institutions and credit unions.Lending Activities The scope of the discussion included under "Lending Activities" is limited to lending operations related to loans originated for investment. A discussion ofthe lending activities related to loans originated for sale is included under "Mortgage Banking Activities."- 4 - Historically, our principal lending activity has been originating mortgage loans for the purchase or refinancing of residential real estate. Generally, we retainthe loans that we originate, which we refer to as loans originated for investment. One- to four-family residential mortgage loans represented $392.8 million, or 33.4%, ofour total loan portfolio at December 31, 2016. Multi-family residential mortgage loans represented $558.6 million, or 47.4%, of our total loan portfolio at December 31,2016. We also offer construction and land loans, commercial real estate loans, home equity lines of credit and commercial loans. At December 31, 2016, commercialreal estate loans, commercial business loans, home equity loans, and land and construction loans totaled $159.4 million, $26.8 million, $21.8 million and $18.2 million,respectively.Loan Portfolio Composition. The following table sets forth the composition of our loan portfolio in dollar amounts and as a percentage of the total portfolioat the dates indicated. At December 31, 2016 2015 2014 2013 2012 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent (Dollars in Thousands) Mortgage loans: Residential real estate: One- to four-family $392,817 33.35% $381,992 34.26% $411,979 37.62% $413,614 37.85% $460,821 40.65%Multi-family 558,592 47.42% 547,250 49.08% 522,281 47.70% 521,597 47.75% 514,363 45.37%Home equity 21,778 1.85% 24,326 2.18% 29,207 2.67% 35,432 3.24% 36,494 3.22%Construction and land 18,179 1.54% 19,148 1.72% 17,081 1.56% 31,905 2.92% 33,818 2.98%Commercial real estate 159,401 13.53% 118,820 10.66% 94,771 8.65% 71,698 6.56% 65,495 5.78%Commercial loans 26,798 2.28% 23,037 2.07% 19,471 1.78% 18,296 1.67% 22,549 1.99%Consumer 319 0.03% 361 0.03% 200 0.02% 134 0.01% 132 0.01% Total loans 1,177,884 100.00% 1,114,934 100.00% 1,094,990 100.00% 1,092,676 100.00% 1,133,672 100.00% Allowance for loanlosses (16,029) (16,185) (18,706) (24,264) (31,043) Loans, net $1,161,855 $1,098,749 $1,076,284 $1,068,412 $1,102,629 Loan Portfolio Maturities and Yields. The following table summarizes the final maturities of our loan portfolio at December 31, 2016. Maturities are basedupon the final contractual payment dates and do not reflect the impact of prepayments and scheduled monthly payments that will occur. One- to four-family Multi-family Home Equity Construction and Land Due during the year ended Weighted Weighted Weighted Weighted December 31, Amount AverageRate Amount AverageRate Amount AverageRate Amount AverageRate (Dollars in Thousands) 2017 $17,193 4.77% $28,856 3.98% $2,722 4.83% $1,600 3.57%2018 6,611 4.48% 37,410 4.25% 2,509 5.30% 909 4.48%2019 5,545 4.90% 46,663 4.36% 1,826 4.59% 1,002 4.46%2020 2,731 4.71% 64,352 4.29% 3,547 4.78% 6,504 3.26%2021 8,477 4.96% 88,961 4.20% 3,233 4.88% 2,612 3.88%2022 and thereafter 352,260 4.50% 292,350 4.18% 7,941 4.54% 5,552 4.34%Total $392,817 4.53% $558,592 4.20% $21,778 4.76% $18,179 3.83% Commercial Real Estate Commercial Consumer Total Due during the year ended Weighted Weighted Weighted Weighted December 31, Amount AverageRate Amount AverageRate Amount AverageRate Amount AverageRate (Dollars in Thousands) 2017 $7,363 4.90% $13,593 4.02% $154 6.71% $71,481 4.30%2018 12,361 4.16% 5,261 3.87% 20 3.97% 65,081 4.27%2019 23,763 4.49% 1,708 4.24% 14 5.00% 80,521 4.44%2020 17,046 4.23% 3,539 4.48% - 0.00% 97,719 4.25%2021 21,725 4.21% 2,171 4.42% 131 4.54% 127,310 4.26%2022 and thereafter 77,143 4.17% 526 4.74% - 0.00% 735,772 4.33%Total $159,401 4.26% $26,798 4.11% $319 5.57% $1,177,884 4.32% - 5 -The following table sets forth the scheduled repayments of fixed and adjustable rate loans at December 31, 2016 that are contractually due after December31, 2017. Due After December 31, 2017 Fixed Adjustable Total (In Thousands) Mortgage loans Real estate loans: One- to four-family $16,434 $359,190 $375,624 Multi-family 181,725 348,011 529,736 Home equity 4,888 14,168 19,056 Construction and land 12,857 3,722 16,579 Commercial 77,973 74,065 152,038 Commercial 9,084 4,121 13,205 Consumer 165 - 165 Total loans $303,126 $803,277 $1,106,403 One- to Four-Family Residential Mortgage Loans. One- to four-family residential mortgage loans totaled $392.8 million, or 33.4% of total loans atDecember 31, 2016. One- to four-family residential mortgage loans originated for investment during the year ended December 31, 2016 totaled $78.0 million, or 30.7% ofall loans originated for investment. Our one- to four-family residential mortgage loans have fixed or adjustable rates. Our adjustable-rate mortgage loans generallyprovide for maximum annual rate adjustments of 200 basis points, with a lifetime maximum adjustment of 600 basis points. Our adjustable-rate mortgage loans typicallyamortize over terms of up to 30 years, and are indexed to the 12-month LIBOR rate. Single family adjustable rate mortgages are originated at both our communitybanking segment and our mortgage banking segment. We do not and have never offered residential mortgage loans specifically designed for borrowers with sub-prime credit scores, including Alt-A and negative amortization loans. Further, prior to 2007, we did not offer indexed, adjustable-rate loans other than home equitylines of credit, and we have never offered "teaser rate" first mortgage products.Adjustable rate mortgage loans can decrease the interest rate risk associated with changes in market interest rates by periodically repricing, but involveother risks because, as interest rates increase, the loan payments by the borrower increase, thus increasing the potential for default by the borrower. At the same time,the marketability of the underlying collateral may be adversely affected by higher interest rates. Upward adjustment of the contractual interest rate is also limited bythe maximum periodic and lifetime interest rate adjustments permitted by our loan documents and, therefore, the effectiveness of adjustable rate mortgage loans indecreasing the risk associated with changes in interest rates may be limited during periods of rapidly rising interest rates. Moreover, during periods of rapidlydeclining interest rates the interest income received from the adjustable rate loans can be significantly reduced, thereby adversely affecting interest income.All residential mortgage loans that we originate include "due-on-sale" clauses, which give us the right to declare a loan immediately due and payable in theevent that, among other things, the borrower sells or otherwise transfers the real property subject to the mortgage and the loan is not repaid. We also requirehomeowner's insurance and where circumstances warrant, flood insurance, on properties securing real estate loans. The average one- to four-family first mortgageloan balance was $178,000 on December 31, 2016, and the largest outstanding balance on that date was $4.6 million, which is a consolidation loan that is collateralizedby 29 properties. A total of 80.4% of our one- to four-family loans are collateralized by properties in the state of Wisconsin.Multi-family Real Estate Loans. Multi-family loans totaled $558.6 million, or 47.4% of total loans at December 31, 2016. Multi-family loans originated forinvestment during the year ended December 31, 2016 totaled $118.1 million, or 46.5% of all loans originated for investment. These loans are generally secured byproperties located in our primary market area. Our multi-family real estate underwriting policies generally provide that such real estate loans may be made in amountsof up to 80% of the appraised value of the property provided the loan complies with our current loans-to-one borrower limit. Multi-family real estate loans are offeredwith interest rates that are fixed for periods of up to five years or are variable and either adjust based on a market index or at our discretion. Contractual maturities donot exceed 10 years while principal and interest payments are typically based on a 30-year amortization period. In reaching a decision whether to make a multi-familyreal estate loan, we consider gross revenues and the net operating income of the property, the borrower's expertise and credit history, business cash flow, and theappraised value of the underlying property. In addition, we will also consider the terms and conditions of the leases and the credit quality of the tenants. We generallyrequire that the properties securing these real estate loans have debt service coverage ratios (the ratio of earnings before interest, income taxes, depreciation andamortization divided by interest expense and current maturities of long term debt) of at least 1.15 times. Generally, multi-family loans made to corporations,partnerships and other business entities require personal guarantees by the principals and by the owners of 20% or more of the borrower.A multi-family borrower's financial information is monitored on an ongoing basis by requiring periodic financial statement updates, payment history reviewsand periodic face-to-face meetings with the borrower. We generally require borrowers with aggregate outstanding balances exceeding $1.0 million to provide updatedfinancial statements and federal tax returns annually. These requirements also apply to all guarantors on these loans. We also require borrowers with rentalinvestment property to provide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable. The averageoutstanding multi-family mortgage loan balance was $869,000 on December 31, 2016, with the largest outstanding balance at $13.9 million. At December 31, 2016, ourlargest exposure to one multi-family borrower or to a related group of borrowers was $36.2 million.Loans secured by multi-family real estate generally involve larger principal amounts than owner-occupied, one- to four-family residential mortgage loans.Because payments on loans secured by multi-family properties often depend on the successful operation or management of the properties, repayment of such loansmay be affected by adverse conditions in the real estate market or the economy.- 6 -Home Equity Loans and Lines of Credit. We also offer home equity loans and home equity lines of credit, both of which are secured by owner-occupiedand non-owner occupied one- to four-family residences. At December 31, 2016, outstanding home equity loans and equity lines of credit totaled $21.8 million, or 1.9%of total loans outstanding. At December 31, 2016, the unadvanced portion of home equity lines of credit totaled $14.4 million. Home equity loans and lines originatedfor investment during the year ended December 31, 2016 totaled $5.0 million, or 2.0% of all loans originated for investment. The underwriting standards utilized forhome equity loans and home equity lines of credit include a determination of the applicant's credit history, an assessment of the applicant's ability to meet existingobligations and payments on the proposed loan, and the value of the collateral securing the loan. Home equity loans are offered with adjustable rates of interest andwith terms up to 10 years. The loan-to-value ratio for our home equity loans and our lines of credit is generally limited to 90% when combined with the first securitylien, if applicable. Our home equity lines of credit have ten-year terms and adjustable rates of interest, subject to a contractual floor, which are indexed to the primerate, as reported in The Wall Street Journal. Interest rates on home equity lines of credit are generally limited to a maximum rate of 18%. The average outstandinghome equity loan balance was $41,000 at December 31, 2016, with the largest outstanding balance at that date of $573,000. Construction and Land Loans. We originate construction loans for the acquisition of land and the construction of single-family residences, multi-familyresidences, and commercial real estate buildings. At December 31, 2016, construction and land loans totaled $18.2 million, or 1.5% of total loans. Construction andland loans originated for investment during the year ended December 31, 2016 totaled $5.9 million, or 2.3% of all loans originated for investment. At December 31,2016, the unadvanced portion of these construction loans totaled $21.1 million.Our construction mortgage loans generally provide for the payment of interest only during the construction phase, which is typically up to nine monthsalthough our policy is to consider construction periods as long as 12 months or more. At the end of the construction phase, the construction loan converts to alonger-term mortgage loan. Construction loans can be made with a maximum loan-to-value ratio of 90%, provided that the borrower obtains private mortgage insuranceif the loan balance exceeds 80% of the lesser of the appraised value or acquisition cost of the secured property. The average outstanding construction loan balancetotaled $1.6 million on December 31, 2016, with the largest outstanding balance at $5.2 million. The average outstanding land loan balance was $170,000 on December31, 2016, and the largest outstanding balance on that date was $942,000.Before making a commitment to fund a construction loan, we require an appraisal of the property by an independent licensed appraiser. We also review andinspect each property before disbursement of funds during the term of the construction loan. Loan proceeds are disbursed after inspection based on either thepercentage of completion method or the actual cost of the completed work.Construction financing is generally considered to involve a higher degree of credit risk than longer-term financing on improved, owner-occupied real estate.Risk of loss on a construction loan depends largely upon the accuracy of the initial estimate of the value of the property at completion of construction compared tothe estimated cost (including interest) of construction and other assumptions. If the estimate of construction cost is inaccurate, we may be required to advance fundsbeyond the amount originally committed in order to protect the value of the property. Additionally, if the estimate of value is inaccurate, we may be confronted with aproject, when completed, with a value that is insufficient to ensure full repayment of the loan.Commercial Real Estate Loans. Commercial real estate loans totaled $159.4 million at December 31, 2016, or 13.5% of total loans, and are made up of loanssecured by office and retail buildings, industrial buildings, churches, restaurants, other retail properties and mixed use properties. Commercial real estate loansoriginated for investment during the year ended December 31, 2016 totaled $35.4 million, or 13.9% of all loans originated for investment. These loans are generallysecured by property located in our primary market area. Our commercial real estate underwriting policies provide that such real estate loans may be made in amounts ofup to 80% of the appraised value of the property. Commercial real estate loans are offered with interest rates that are fixed up to five years or are variable and eitheradjust based on a market index or at our discretion. Contractual maturities do not exceed 10 years while principal and interest payments are typically based on a 30-year amortization period. In reaching a decision whether to make a commercial real estate loan, we consider gross revenues and the net operating income of theproperty, the borrower's expertise and credit history, business cash flow, and the appraised value of the underlying property. In addition, we will also consider theterms and conditions of the leases and the credit quality of the tenants. We generally require that the properties securing these real estate loans have debt servicecoverage ratios (the ratio of earnings before interest, income taxes, depreciation and amortization divided by interest expense and current maturities of long term debt)of at least 1.15 times. Environmental surveys are required for commercial real estate loans when environmental risks are identified. Generally, commercial real estateloans made to corporations, partnerships and other business entities require personal guarantees by the principals and by the owners of 20% or more of the borrower.A commercial real estate borrower's financial information is monitored on an ongoing basis by requiring periodic financial statement updates, paymenthistory reviews and periodic face-to-face meetings with the borrower. We generally require borrowers with aggregate outstanding balances exceeding $1.0 million toprovide annual updated financial statements and federal tax returns. These requirements also apply to all guarantors on these loans. We also require borrowers toprovide an annual report of income and expenses for the property, including a tenant list and copies of leases, as applicable. The average commercial real estate loanin our portfolio at December 31, 2016 was $766,000, and the largest outstanding balance at that date was $8.6 million.Commercial Loans. Commercial loans totaled $26.8 million at December 31, 2016, or 2.3% of total loans, and are made up of loans secured by accountsreceivable, inventory, equipment and real estate. Commercial loans originated for investment during the year ended December 31, 2016 totaled $11.7 million, or 4.6% ofall loans originated.Our commercial loans are generally made to borrowers that are located in our primary market area. Working capital lines of credit are granted for the purposeof carrying inventory and accounts receivable or purchasing equipment. These lines require that certain working capital ratios must be maintained and are monitoredon a monthly or quarterly basis. Working capital lines of credit are short-term loans of 12 months or less with variable interest rates. At December 31, 2016, theunadvanced portion of working capital lines of credit totaled $15.1 million. Outstanding balances fluctuate up to the maximum commitment amount based onfluctuations in the balance of the underlying collateral. Personal property loans secured by equipment are considered commercial business loans and are generallymade for terms of up to 84 months and for up to 80% of the value of the underlying collateral. Interest rates on equipment loans may be either fixed or variable. Commercial business loans are generally variable rate loans with initial fixed rate periods of up to five years.A commercial business borrower's financial information is monitored on an ongoing basis by requiring periodic financial statement updates, usuallyquarterly, payment history reviews and periodic face-to-face meetings with the borrower. The average outstanding commercial loan at December 31, 2016 was $209,000and the largest outstanding balance on that date was $5.0 million.- 7 -The following table shows loan origination, principal repayment activity, transfers to real estate owned, charge-offs and sales during the years indicated. As of or for the Year Ended December 31, 2016 2015 2014 (In Thousands) Total gross loans receivable and held for sale at beginning of year $1,281,450 $1,220,063 $1,189,697 Real estate loans originated for investment: Residential One- to four-family 78,045 41,835 48,325 Multi-family 118,072 117,657 88,958 Home equity 5,037 7,265 4,177 Construction and land 5,878 11,085 8,806 Commercial real estate 35,443 43,138 29,294 Total real estate loans originated for investment 242,475 220,980 179,560 Consumer loans originated for investment - 688 10 Commercial loans originated for investment 11,692 23,467 7,863 Total loans originated for investment 254,167 245,135 187,433 Principal repayments (185,020) (203,271) (159,619)Transfers to real estate owned (4,590) (15,580) (16,645)Loan principal charged-off (1,607) (6,340) (8,855)Net activity in loans held for investment 62,950 19,944 2,314 Loans originated for sale 2,378,926 1,986,147 1,661,376 Loans sold (2,320,194) (1,944,704) (1,633,324)Net activity in loans held for sale 58,732 41,443 28,052 Total gross loans receivable and held for sale at end of year $1,403,132 $1,281,450 $1,220,063 Origination and Servicing of Loans. All loans originated for investment are underwritten pursuant to internally developed policies and procedures. Whilewe generally underwrite owner-occupied residential mortgage loans to Freddie Mac and Fannie Mae standards, due to several unique characteristics, our loansoriginated prior to 2008 do not conform to the secondary market standards. The unique features of these loans include interest payments in advance of the month inwhich they are earned and discretionary rate adjustments that are not tied to an independent index.Exclusive of our mortgage banking operations, we retain in our portfolio all of the loans that we originate. At December 31, 2016, WaterStone Bank was notservicing any loan it originated and subsequently sold to unrelated third parties. Loan servicing includes collecting and remitting loan payments, accounting forprincipal and interest, contacting delinquent mortgagors, supervising foreclosures and property dispositions in the event of unremedied defaults, making certaininsurance and tax payments on behalf of the borrowers and generally administering the loans.Loan Approval Procedures and Authority. WaterStone Bank's lending activities follow written, non-discriminatory, underwriting standards and loanorigination procedures established by WaterStone Bank's board of directors. The loan approval process is intended to assess the borrower's ability to repay the loan,the viability of the loan and the adequacy of the value of the property that will secure the loan, if applicable. To assess the borrower's ability to repay, we review theemployment and credit history and information on the historical and projected income and expenses of borrowers. Loan officers, with concurrence from independent credit officers and underwriters, are authorized to approve and close any loan that qualifies underWaterStone Bank underwriting guidelines within the following lending limits: ●A secured one- to four-family mortgage loan up to $500,000 for a borrower with total outstanding loans from us of less than $1,000,000 that isindependently underwritten can be approved by select loan officers. ●A loan up to $500,000 for a borrower with total outstanding loans from us of less than $500,000 can be approved by select commercial loan officers. ●Any secured mortgage loan ranging from $500,001 to $2,999,999 or any new loan to a borrower with outstanding loans from us exceeding $1,000,000 mustbe approved by the Officer Loan Committee. ●Any loan for $3,000,000 or more must be approved by the Officer Loan Committee and the board of directors prior to closing. Any new loan to a borrowerwith outstanding loans from us exceeding $10,000,000 must be reviewed by the board of directors. - 8 -Asset QualityWhen a loan becomes more than 30 days delinquent, WaterStone Bank sends a letter advising the borrower of the delinquency. The borrower is given aspecific date by which delinquent payments must be made or by which they must contact WaterStone Bank to make arrangements to bring the loan current over alonger period of time. If the borrower fails to bring the loan current within the specified time period or to make arrangements to cure the delinquency over a longerperiod of time, the matter is referred to legal counsel and foreclosure or other collection proceedings are considered.All loans are reviewed on a regular basis, and loans are placed on non-accrual status when they become 90 or more days delinquent. When loans are placedon non-accrual status, unpaid accrued interest is reversed, and further income is recognized only to the extent received when collection of the remaining principalbalance is reasonably assured.Non-Performing Assets. Non-performing assets consist of non-accrual loans and other real estate owned. Loans are generally placed on non-accrual statuswhen contractually past due 90 days or more as to interest or principal payments. Additionally, whenever management becomes aware of facts or circumstances thatmay adversely impact the collectability of principal or interest on loans, management may place such loans on non-accrual status immediately, rather than waiting untilthe loan becomes 90 days past due. At the time a loan is placed on non-accrual status, previously accrued and uncollected interest on such loans is reversed andadditional income is recorded only to the extent that payments are received and the collection of principal is reasonably assured. Generally, loans are restored toaccrual status when the obligation is brought current, has performed in accordance with the contractual terms for a reasonable period of time, and the ultimatecollectability of the total contractual principal and interest is no longer in doubt. The table below sets forth the amounts and categories of our non-accrual loans and real estate owned at the dates indicated. At December 31, 2016 2015 2014 2013 2012 (Dollars in Thousands) Non-accrual loans: Residential One- to four-family $7,623 $13,888 $23,918 $30,207 $46,467 Multi-family 1,427 2,553 12,001 13,498 23,205 Home equity 344 437 445 1,585 1,578 Construction and land - 239 401 4,195 2,215 Commercial real estate 422 460 947 938 668 Commercial 41 27 299 521 511 Consumer - - - 17 24 Total non-accrual loans 9,857 17,604 38,011 50,961 74,668 Real estate owned One- to four-family 2,141 4,610 10,896 12,980 17,353 Multi-family - 209 2,210 3,040 9,890 Construction and land 5,082 5,262 5,400 6,258 7,029 Commercial real estate 300 300 300 385 1,702 Total real estate owned 7,523 10,381 18,806 22,663 35,974 Valuation allowance at end of period (1,405) (1,191) (100) - - Total real estate owned, net 6,118 9,190 18,706 22,663 35,974 Total non-performing assets $15,975 $26,794 $56,817 $73,624 $110,642 Total non-accrual loans to total loans, net 0.84% 1.58% 3.47% 4.66% 6.59%Total non-accrual loans to total assets 0.55% 1.00% 2.13% 2.62% 4.50%Total non-performing assets to total assets 0.89% 1.52% 3.18% 3.78% 6.66%All loans that meet or exceed 90 days with respect to past due principal and interest are recognized as non-accrual. Troubled debt restructurings which arestill on non-accrual either due to being past due 90 days or greater, or which have not yet performed under the modified terms for a reasonable period of time, areincluded in the table above. In addition, loans which are past due less than 90 days are evaluated to determine the likelihood of collectability given other credit riskfactors such as early stage delinquency, the nature of the collateral or the results of a borrower fiscal review. When the collection of all contractual principal andinterest is determined to be unlikely, the loan is moved to non-accrual status and an updated appraisal of the underlying collateral is ordered. This process generallytakes place between contractual past due dates 60 and 90 days. Upon determining the updated estimated value of the collateral, a loan loss provision is recorded toestablish a specific reserve to the extent that the outstanding principal balance exceeds the updated estimated net realizable value of the collateral. When a loan isdetermined to be uncollectible, generally coinciding with the initiation of foreclosure action, the specific reserve is reviewed for adequacy, adjusted if necessary, andcharged-off.- 9 -The following table sets forth activity in our non-accrual loans for the years indicated. At and for the Year Ended December 31, 2016 2015 2014 2013 2012 (Dollars in Thousands) Balance at beginning of year $17,604 $38,011 $50,961 $74,668 $78,218 Additions 3,114 10,165 21,585 33,488 44,617 Transfers to real estate owned (4,590) (15,580) (16,645) (13,552) (22,282)Charge-offs (667) (3,809) (7,099) (11,792) (8,379)Returned to accrual status (4,183) (5,824) (4,470) (26,005) (8,194)Principal paydowns and other (1,421) (5,359) (6,321) (5,846) (9,312)Balance at end of year $9,857 $17,604 $38,011 $50,961 $74,668 Total non-accrual loans decreased by $7.7 million, or 44.0%, to $9.9 million as of December 31, 2016 compared to $17.6 million as of December 31, 2015. Theratio of non-accrual loans to total loans receivable was 0.84% at December 31, 2016 compared to 1.58% at December 31, 2015. During the year ended December 31,2016, $4.6 million were transferred to real estate owned, $667,000 in loan principal was charged off, $1.4 million in principal payments were received and $4.2 million inloans were returned to accrual status. Offsetting this activity, $3.1 million in loans were placed on non-accrual status during the year ended December 31, 2016.Of the $9.9 million in total non-accrual loans as of December 31, 2016, $9.4 million in loans have been specifically reviewed to assess whether a specificvaluation allowance is necessary. A specific valuation allowance is established for an amount equal to the impairment when the carrying value of the loan exceeds thepresent value of expected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral with an adjustmentmade for costs to dispose of the asset. Based upon these specific reviews, a total of $2.1 million in partial charge-offs have been recorded with respect to these loansas of December 31, 2016. Partially charged-off loans measured for impairment based upon net realizable collateral value are maintained in a "non-performing" statusand are disclosed as impaired loans. In addition, specific reserves totaling $510,000 have been recorded as of December 31, 2016. The remaining $498,000 of non-accrual loans were reviewed on an aggregate basis and $100,000 in general valuation allowance was deemed necessary related to those loans as of December 31, 2016. The $100,000 in general valuation allowance is based upon a migration analysis performed with respect to similar non-accrual loans in prior periods.The outstanding principal balance of our five largest non-accrual loans as of December 31, 2016 totaled $2.1 million, which represents 21.1% of total non-accrual loans as of that date. These five loans are carried net of cumulative life-to-date charge-offs of $15,000. Aggregate specific valuation allowances with respectto these five loans total $106,000 as of December 31, 2016.For the year ended December 31, 2016, gross interest income that would have been recorded had our non-accruing loans been current in accordance withtheir original terms was $701,000. We received $531,000 of interest payments on such loans during the year ended December 31, 2016. Interest payments received aretreated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible.If the remaining book value is not deemed to be fully collectible, all payments received are applied to unpaid principal. Determination as to the ultimate collectability ofthe remaining book value is supported by an updated credit department evaluation of the borrower's financial condition and prospects for repayment, includingconsideration of the borrower's sustained historical repayment performance and other relevant factors.There were no accruing loans past due 90 days or more during the years ended December 31, 2016, 2015 or 2014.Troubled Debt Restructurings. The following table summarizes troubled debt restructurings by the Company's internal risk rating. At December 31, 2016 2015 2014 2013 2012 (Dollars in Thousands) Troubled debt restructurings Substandard $7,025 $14,436 $22,629 $25,258 $48,449 Watch 3,112 3,103 3,488 4,329 11,172 Total troubled debt restructurings $10,137 $17,539 $26,117 $29,587 $59,621 Troubled debt restructurings totaled $10.1 million at December 31, 2016, compared to $17.5 million at December 31, 2015. At December 31, 2016, $9.4 million oftroubled debt restructurings, or 92.5%, were performing in accordance with their restructured terms. All troubled debt restructurings are considered to be impaired andare risk rated as either substandard or watch and are included in the internal risk rating tables disclosed in the notes to the consolidated financial statements. Specificreserves have been established to the extent that the collateral-based impairment analyses indicate that a collateral shortfall exists or to the extent that a discountedcash flow analysis results in an impairment.We do not participate in government-sponsored troubled debt restructuring programs. Our troubled debt restructurings are short-term modifications. Typical initial restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. Restructured terms do not include areduction of the outstanding principal balance unless mandated by a bankruptcy court. Troubled debt restructuring terms may be renewed or further modified at theend of the initial term for an additional period if performance has been acceptable and the short-term borrower difficulty persists.- 10 -Information with respect to the accrual status of our troubled debt restructurings is provided in the following table. At December 31, 2016 2015 Accruing Non-accruing Accruing Non-accruing (In Thousands) One- to four-family $3,296 $2,399 $3,900 $5,739 Multi-family 2,514 1,427 2,546 2,317 Home equity 49 97 - 98 Construction and land - - 1,556 - Commercial real estate 295 60 1,306 77 $6,154 $3,983 $9,308 $8,231 The following table sets forth activity in our troubled debt restructurings for the years indicated. At or for the Year Ended December 31, 2016 2015 Accruing Non-accruing Accruing Non-accruing (In Thousands) Balance at beginning of year $9,308 $8,231 $10,819 $15,298 Additions 49 - - 1,005 Change in accrual status - - - - Charge-offs - (207) - (358)Returned to contractual/market terms (2,567) (2,780) (1,044) (3,965)Transferred to real estate owned - (839) - (3,039)Principal paydowns and other (636) (422) (467) (710)Balance at end of period $6,154 $3,983 $9,308 $8,231 For the year ended December 31, 2016, gross interest income that would have been recorded had our troubled debt restructurings been current in accordancewith their contractual terms was $592,000. We received $513,000 of interest payments on such loans during the year ended December 31, 2016. Interest paymentsreceived on non-accrual troubled debt restructurings are treated as interest income on a cash basis as long as the remaining book value of the loan (i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all payments received are applied tounpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated credit department evaluation of the borrower'sfinancial condition and prospects for repayment, including consideration of the borrower's sustained historical repayment performance and other relevant factors.If a restructured loan is current in all respects and a minimum of six consecutive restructured payments have been received, it can be considered for return toaccrual status. After a restructured loan that is current in all respects reverts to contractual/market terms, if a credit department review indicates no evidence ofelevated market risk, the loan is removed from the troubled debt restructuring classification.Loan Delinquency. The following table summarizes loan delinquency in total dollars and as a percentage of the total loan portfolio: At December 31, 2016 2015 (Dollars in Thousands) Loans past due less than 90 days $2,910 $2,599 Loans past due 90 days or more 5,289 8,932 Total loans past due $8,199 $11,531 Total loans past due to total loans receivable 0.70% 1.03%Past due loans decreased by $3.3 million, or 28.9%, to $8.2 million at December 31, 2016 from $11.5 million at December 31, 2015. Loans past due 90 days ormore decreased by $3.6 million, or 40.8%, during the year ended December 31, 2016 while loans past due less than 90 days increased by $311,000, or 12.0%. The $3.6million decrease in loans past due 90 days or more was primarily due to a decrease in the one- to four-family real estate loans of $1.9 million and multi-family real estateloans of $1.5 million during the year ended December 31, 2016.- 11 -Potential Problem Loans. We define potential problem loans as substandard loans which are still accruing interest. We do not necessarily expect to realizelosses on all potential problem loans, but we recognize potential problem loans carry a higher probability of default and require additional attention by management. The aggregate principal amounts of potential problem loans as of December 31, 2016 and 2015 were approximately $5.6 million and $8.4 million, respectively. Management believes it has established an adequate allowance for probable loan losses as appropriate under generally accepted accounting principles.Real Estate Owned.Total real estate owned decreased by $3.1 million, or 33.4%, to $6.1 million at December 31, 2016, compared to $9.2 million at December 31, 2015. During theyear ended December 31, 2016, $4.6 million was transferred from loans to real estate owned upon completion of foreclosure. During the same period, sales of real estateowned totaled $7.0 million. Write-downs totaled $656,000 during the year ended December 31, 2016. New appraisals received on real estate owned and collateral dependent impaired loans are based upon an "as is value" assumption. During the period oftime in which we are awaiting receipt of an updated appraisal, loans evaluated for impairment based upon collateral value are measured by the following:● Applying an updated adjustment factor to an existing appraisal;● Confirming that the physical condition of the real estate has not significantly changed since the last valuation date;● Comparing the estimated current value of the collateral to that of updated sales values experienced on similar collateral;● Comparing the estimated current value of the collateral to that of updated values seen on current appraisals of similar collateral; and● Comparing the estimated current value to that of updated listed sales prices on our real estate owned and that of similar properties (notowned by the Company).We owned 30 properties at December 31, 2016, compared to 69 properties as of December 31, 2015 and 142 properties at December 31, 2014. Habitable realestate owned is managed with the intent of attracting a lessee to generate revenue. Foreclosed properties are transferred to real estate owned at estimated netrealizable value, with charge-offs, if any, charged to the allowance for loan losses upon transfer to real estate owned. The fair value is primarily based upon updatedappraisals in addition to an analysis of current real estate market conditions.Allowance for Loan LossesWe establish valuation allowances on loans that are deemed to be impaired. A loan is considered impaired when, based on current information and events, itis probable that we will not be able to collect all amounts due according to the contractual terms of the loan agreement. A valuation allowance is established for anamount equal to the impairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan's originaleffective interest rate or the fair value of the underlying collateral.We also establish valuation allowances based on an evaluation of the various risk components that are inherent in the loan portfolio. The risk componentsthat are evaluated include past loan loss experience; the level of non-performing and classified assets; current economic conditions; volume, growth, and compositionof the loan portfolio; adverse situations that may affect the borrower's ability to repay; the estimated value of any underlying collateral; regulatory guidance; andother relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previously charged-off loans and reduced by charge-offs. Theappropriateness of the allowance for loan losses is reviewed and approved quarterly by the WaterStone Bank board of directors. The allowance reflects management'sbest estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in the loan portfolio, and is based on a risk modeldeveloped and implemented by management and approved by the WaterStone Bank board of directors.Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality andeconomic conditions. In addition, the Federal Deposit Insurance Corporation and the WDFI, as an integral part of their examination process, periodically reviewWaterStone Bank's allowance for loan losses. Such regulators have the authority to require WaterStone Bank to recognize additions to the allowance based on theirjudgments of information available to them at the time of their review or examination.Any loan that is 90 or more days past due is placed on non-accrual and classified as a non-performing loan. A loan is classified as impaired when it isprobable that we will be unable to collect all amounts due in accordance with the terms of the loan agreement. Non-performing loans are then evaluated and accountedfor in accordance with generally accepted accounting principles. - 12 -The following table sets forth activity in our allowance for loan losses for the years indicated. At or for the Year Ended December 31, 2016 2015 2014 2013 2012 (Dollars in Thousands) Balance at beginning of year $16,185 $18,706 $24,264 $31,043 $32,430 Provision for loan losses 380 1,965 1,150 4,532 8,300 Charge-offs: Mortgage loans One- to four-family 1,003 3,855 2,424 8,706 6,472 Multi-family 489 2,281 5,247 1,640 1,108 Home equity 112 72 191 630 485 Construction and land 3 84 496 1,480 1,668 Commercial real estate - 45 199 160 1,182 Consumer - 3 5 - 4 Commercial - - 293 8 59 Total charge-offs 1,607 6,340 8,855 12,624 10,978 Recoveries: Mortgage loans One- to four-family 811 649 1,833 957 667 Multi-family 152 992 189 258 56 Home equity 36 110 14 35 25 Construction and land 72 58 75 51 250 Commercial real estate - 40 27 - - Consumer - 5 6 6 - Commercial - - 3 6 293 Total recoveries 1,071 1,854 2,147 1,313 1,291 Net charge-offs 536 4,486 6,708 11,311 9,687 Allowance at end of year $16,029 $16,185 $18,706 $24,264 $31,043 Ratios: Allowance for loan losses to non-performing loans at end of year 162.62% 91.94% 49.21% 47.61% 41.58%Allowance for loan losses to loans outstanding at end of year 1.36% 1.45% 1.71% 2.22% 2.74%Net charge-offs to average loans outstanding 0.05% 0.37% 0.55% 0.94% 0.76%Current year provision for loan losses to net charge-offs 70.90% 43.80% 17.14% 40.07% 85.68%Net charge-offs to beginning of the year allowance 3.31% 23.98% 27.65% 36.44% 29.87% - 13 - Allocation of Allowance for Loan Losses. The following table sets forth the allowance for loan losses allocated by loan category, the total loan balances bycategory, and the percent of loans in each category to total loans at the dates indicated. The allowance for loan losses allocated to each category is not necessarilyindicative of future losses in any particular category and does not restrict the use of the allowance to absorb losses in other categories. At December 31, 2016 2015 2014 Allowancefor LoanLosses % ofLoans inCategoryto TotalLoans % ofAllowanceinCategory toTotalAllowance Allowancefor LoanLosses % ofLoans inCategoryto TotalLoans % ofAllowancein Categoryto TotalAllowance Allowancefor LoanLosses % ofLoans inCategoryto TotalLoans % ofAllowanceinCategoryto TotalAllowance (Dollars in Thousands) Real Estate: Residential One- to four-family $7,164 33.35% 44.69% $7,763 34.26% 47.96% $9,877 37.62% 52.80%Multi-family 4,809 47.42% 30.00% 5,000 49.08% 30.89% 5,358 47.70% 28.64%Home equity 364 1.85% 2.27% 433 2.18% 2.68% 422 2.67% 2.26%Construction and land 1,016 1.54% 6.34% 904 1.72% 5.59% 687 1.56% 3.67%Commercial real estate 1,951 13.53% 12.17% 1,680 10.66% 10.38% 1,951 8.65% 10.43%Commercial 713 2.28% 4.45% 396 2.07% 2.45% 403 1.78% 2.15%Consumer 12 0.03% 0.07% 9 0.03% 0.06% 8 0.02% 0.04%Total allowance for loan losses $16,029 100.00% 100.00% $16,185 100.00% 100.00% $18,706 100.00% 100.00% At December 31, 2013 2012 Allowance forLoan Losses % of Loans inCategory toTotal Loans % of Allowancein Category toTotal Allowance Allowance forLoan Losses % of Loans inCategory toTotal Loans % of Allowancein Category toTotal Allowance (Dollars In Thousands) Real Estate: Residential One- to four-family $11,549 37.85% 47.59% $17,819 40.65% 57.40%Multi-family 7,211 47.75% 29.72% 7,734 45.37% 24.90%Home equity 1,807 3.24% 7.45% 2,097 3.22% 6.76%Construction and land 1,613 2.92% 6.65% 1,323 2.98% 4.26%Commercial real estate 1,402 6.56% 5.78% 1,259 5.78% 4.06%Commercial 648 1.67% 2.67% 781 1.99% 2.52%Consumer 34 0.01% 0.14% 30 0.01% 0.10%Total allowance for loan losses $24,264 100.00% 100.00% $31,043 100.00% 100.00%All impaired loans meeting the criteria established by management are evaluated individually, based primarily on the value of the collateral securing each loanand the ability of the borrowers to repay according to the terms of the loans, or based upon an analysis of the present value of the expected future cash flows underthe original contract terms as compared to the modified terms in the case of certain troubled debt restructurings. Specific loss allowances are established as requiredby this analysis. At least once each quarter, management evaluates the appropriateness of the balance of the allowance for loan losses based on several factors someof which are not loan specific, but are reflective of the inherent losses in the loan portfolio. This process includes, but is not limited to, a periodic review of loancollectability in light of historical experience, the nature and volume of loan activity, conditions that may affect the ability of the borrower to repay, underlying value ofcollateral and economic conditions in our immediate market area. All loans for which a specific loss review is not required are segregated by loan type and a lossallowance is established by using loss experience data and management's judgment concerning other matters it considers significant including trends in non-performing loan balances, impaired loan balances, classified asset balances and the current economic environment. The allowance is allocated to each category ofloans based on the results of the above analysis.- 14 -The above analysis is both quantitative and subjective, as it requires us to make estimates that are susceptible to revisions as more information becomesavailable. Although we believe that we have established the allowance at levels appropriate to absorb probable and estimable losses, additions may be necessary iffuture economic conditions differ substantially from the current environment.At December 31, 2016, the allowance for loan losses was $16.0 million, compared to $16.2 million at December 31, 2015. As of December 31, 2016, theallowance for loan losses to total loans receivable was 1.36% and 162.62% of non-performing loans, compared to 1.45%, and 91.94%, respectively at December 31,2015. The decrease in the allowance for loan losses during the year ended December 31, 2016 reflects a continued stabilization in both the quality of the loan portfolioas well as the overall local real estate market. During each period we experienced a stabilization or improvement in a number of key loan-related loan quality metrics,including impaired loans, substandard loans, charge-offs, loans contractually past due and non-accrual loans.Net charge-offs totaled $536,000, or 0.05% of average loans for the year ended December 31, 2016, compared to $4.5 million, or a 0.37% of average loans forthe year ended December 31, 2015. The $4.0 million decrease in net charge-offs was primarily the result of a decrease in charge-offs in all categories except a slightincrease in home equity and consumer loans. Net charge-offs related to loans secured by one- to four-family residential loans decreased $3.0 million, or 94.0%, to$192,000 for year ended December 31, 2016, as compared to $3.2 million for the year ended December 31, 2015. Net charge-offs related to loans secured by multi-familyresidential loans decreased $952,000, or 73.9%, to $337,000 for year ended December 31, 2016, as compared to $1.3 million for the year ended December 31, 2015.Partially offsetting the decreases, net charge-offs related to loans secured by home equity loans increased $114,000, or 300.0%, to $76,000 for year ended December 31,2016, as compared to a recovery of $38,000 for the year ended December 31, 2015.Mortgage Banking ActivityIn addition to the lending activities previously discussed, we also originate single-family residential mortgage loans for sale in the secondary market throughWaterstone Mortgage Corporation. We originated $2.38 billion in mortgage loans held for sale during the year ended December 31, 2016, which was an increase of$392.8 million, or 19.8%, from the $1.99 billion originated during the year ended December 31, 2015. The loans sold volume increased during the year ended December31, 2016 such that total mortgage banking income increased $21.8 million, or 21.9%, to $121.1 million during the year ended December 31, 2016 compared to $99.3million during the year ended December 31, 2015. The increase in loan production volume was driven by a 20.1% increase in mortgage purchase products and a 27.4%increase in refinance products. In addition, margins increased for the year ended December 31, 2016 compared to December 31, 2015. We sell loans on both aservicing-released and a servicing retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retainservicing.Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federalgovernment, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Loans originated for the purchase of a residential property, which generallyyield a higher margin than loans originated for refinancing existing loans, comprised 82.9% of total originations during the year ended December 31, 2016, compared to83.7% of total originations during the year ended December 31, 2015. The mix of loan type trended slightly towards more conventional loans and less governmentalloans comprising 65.1% and 34.9% of all loan originations, respectively, during the year ended December 31, 2016, compared 66.4% and 33.6% of all loan originations,respectively, during the year ended December 31, 2015. Investment ActivitiesWauwatosa Investments, Inc. is WaterStone Bank's investment subsidiary headquartered in the State of Nevada. Wauwatosa Investments, Inc. manages theback office function for WaterStone Bank's investment portfolio. Our Chief Financial Officer and Treasury Officer are responsible for executing purchases and sales inaccordance with our investment policy and monitoring the investment activities of Wauwatosa Investments, Inc. The investment policy is reviewed annually bymanagement and changes to the policy are recommended to and subject to the approval of our board of directors. Authority to make investments under the approvedinvestment policy guidelines is delegated by the board to designated employees. While general investment strategies are developed and authorized by management,the execution of specific actions rests with the Chief Financial Officer and Treasury Officer who may act jointly in performing security trades. The Chief FinancialOfficer and Treasury Officer are responsible for ensuring that the guidelines and requirements included in the investment policy are followed and that all securities areconsidered prudent for investment. The Chief Financial Officer and the Treasury Officer are authorized to execute investment transactions (purchases and sales)without the prior approval of the board provided they are within the scope of the established investment policy.Our investment policy requires that all securities transactions be conducted in a safe and sound manner. Investment decisions are based upon a thoroughanalysis of each security instrument to determine its quality, inherent risks, fit within our overall asset/liability management objectives, effect on our risk-based capitalmeasurement and prospects for yield and/or appreciation. Consistent with our overall business and asset/liability management strategy, which focuses on sustaining adequate levels of core earnings, our investmentportfolio is comprised primarily of securities that are classified as available for sale. During the year ended December 31, 2016, no investment securities were sold. During the year ended December 31, 2015, one municipal security was sold with a total book value of $991,000 was sold at a gain of $44,000. During the year endedDecember 31, 2014, no investment securities were sold.Available for Sale PortfolioGovernment Sponsored Enterprise Bonds. At December 31, 2016, our Government sponsored enterprise bond portfolio totaled $2.5 million, all of which wereissued by Federal National Mortgage Association ("Fannie Mae") and were classified as available for sale. The weighted average yield on these securities was 1.18%and the weighted average remaining average life was 1.3 years at December 31, 2016. While these securities generally provide lower yields than other investments inour securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes and prepayment protection. The estimated fairvalue of our government sponsored enterprise bond portfolio at December 31, 2016 was $3,000 more than the amortized cost of $2.5 million.- 15 -Mortgage-backed Securities and Collateralized Mortgage Obligations. We purchase mortgage-backed securities and collateralized mortgage obligationsguaranteed by Fannie Mae, Freddie Mac and Ginnie Mae. We invest in mortgage-backed securities and collateralized mortgage obligations to achieve positiveinterest rate spreads with minimal administrative expense, and to lower our credit risk. We regularly monitor the credit quality of this portfolio.Mortgage-backed securities and collateralized mortgage obligations are created by the pooling of mortgages and the issuance of a security. These securitiestypically represent a participation interest in a pool of single-family or multi-family mortgages, although we focus our investments on mortgage related securitiesbacked by one- to four-family mortgages. The issuers of such securities pool and resell the participation interests in the form of securities to investors such asWaterStone Bank, and in the case of government agency sponsored issues, guarantee the payment of principal and interest to investors. Mortgage-backed securitiesand collateralized mortgage obligations generally yield less than the loans that underlie such securities because of the cost of payment guarantees, if any, and creditenhancements. These fixed-rate securities are usually more liquid than individual mortgage loans.At December 31, 2016, mortgage-backed securities totaled $73.4 million. The mortgage-backed securities portfolio had a weighted average yield of 2.39% anda weighted average remaining life of 3.6 years at December 31, 2016. The estimated fair value of our mortgage-backed securities portfolio at December 31, 2016 was$555,000 more than the amortized cost of $72.9 million. Mortgage-backed securities valued at $67.8 million are pledged as collateral for borrowings at December 31,2016. A $1.7 million mortgage-backed security is pledged as collateral for mortgage banking activity at December 31, 2016. Investments in mortgage-backed securitiesinvolve a risk that actual prepayments may differ from estimated prepayments over the life of the security, which may require adjustments to the amortization of anypremium or accretion of any discount relating to such instruments, thereby changing the net yield on such securities. There is also reinvestment risk associated withthe cash flows from such securities or if such securities are redeemed by the issuer. In addition, the market value of such securities may be adversely affected in arising interest rate environment, particularly since all of our mortgage-backed securities have a fixed rate of interest. The relatively short weighted average remaininglife of our mortgage-backed security portfolio mitigates our potential risk of loss in a rising interest rate environment.At December 31, 2016, collateralized mortgage obligations totaled $62.0 million. At December 31, 2016, the collateralized mortgage obligations portfolioconsisted entirely of securities backed by government sponsored enterprises or U.S. Government agencies. The collateralized mortgage obligations portfolio had aweighted average yield of 2.11% and a weighted average remaining life of 3.5 years at December 31, 2016. The estimated fair value of our collateralized mortgageobligations portfolio at December 31, 2016 was $295,000 less than the amortized cost of $62.3 million. Collateralized mortgage obligations valued at $16.6 million arepledged as collateral for borrowings at December 31, 2016. A $646,000 collateralized mortgage obligation security is pledged as collateral for mortgage banking activityat December 31, 2016. Investments in collateralized mortgage obligations involve a risk that actual prepayments may differ from estimated prepayments over the life ofthe security, which may require adjustments to the amortization of any premium or accretion of any discount relating to such instruments, thereby changing the netyield on such securities. There is also reinvestment risk associated with the cash flows from such securities or if such securities are redeemed by the issuer. Inaddition, the market value of such securities may be adversely affected in a rising interest rate environment, particularly since all of our collateralized mortgageobligations have a fixed rate of interest. The relatively short weighted average remaining life of our collateralized mortgage obligation portfolio mitigates our potentialrisk of loss in a rising interest rate environment.Municipal Obligations. These securities consist of obligations issued by school districts, counties and municipalities or their agencies and include generalobligation bonds, industrial development revenue bonds and other revenue bonds. Our investment policy requires that such municipal obligations be rated A+ orbetter by a nationally recognized rating agency at the date of purchase. A security that is downgraded below investment grade will require additional analysis ofcreditworthiness and a determination will be made to hold or dispose of the investment. At December 31, 2016, our municipal obligations portfolio totaled $70.7million, all of which was classified as available for sale. The weighted average yield on this portfolio was 3.55% at December 31, 2016, with a weighted averageremaining life of 6.6 years. The estimated market value of our municipal obligations bond portfolio at December 31, 2016 was $385,000 more than the amortized cost of$70.3 million. During the year ended December 31, 2012, the Company identified two municipal securities that were deemed to be other-than-temporarily impaired. Both securities were issued by a tax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company's analysis oftwo securities in this municipality resulted in $100,000 in credit losses that were charged to earnings with respect to these two municipal securities. An additional$17,000 credit loss was charged to earnings during the year ended December 31, 2014 with respect to these two securities as a sale occurred at a discountedprice. During the year ended December 31, 2016, one of these municipal issuer bonds matured. The Company received the full principal and interest on the bond andrecovered $23,000 of previously recorded other-than-temporary impairment. As of December 31, 2016, the remaining impaired bond had an amortized cost of $116,000and a total life-to-date impairment of $94,000. Other Debt Securities. As of December 31, 2016, we held other debt securities with a fair value of $17.0 million and amortized cost of $17.4 million. Other debtsecurities include a trust preferred security issued by a financial institution and corporate bonds. The weighted average yield on this portfolio is 4.45% at December31, 2016, with a weighted average remaining life of 15.6 years.Certificates of Deposit. At December 31, 2016, we held certificates of deposit with a fair value and amortized cost of $1.2 million. The weighted average yieldon these securities was 1.47% and the weighted average remaining average life was 1.4 years at December 31, 2016. While these certificates generally provide loweryields than other investments in our securities investment portfolio, we maintain these investments, to the extent appropriate, for liquidity purposes and prepaymentprotection. - 16 -Investment Securities Portfolio.The following table sets forth the carrying values of our available for sale securities portfolio at the dates indicated. At December 31, 2016 2015 2014 Amortized Amortized Amortized Cost Fair Value Cost Fair Value Cost Fair Value (In Thousands) Securities available for sale: Mortgage-backed securities $72,858 $73,413 $95,911 $96,667 $115,670 $117,128 Collateralized mortgage obligations Government sponsored enterprise issued 62,297 62,002 70,605 70,428 58,821 59,071 Government sponsored enterprise bonds 2,500 2,503 3,750 3,746 6,750 6,711 Municipal obligations 70,311 70,696 77,509 79,159 76,037 77,108 Other debt securities 17,399 16,950 17,401 16,963 7,404 7,528 Certificates of deposit 1,225 1,231 2,695 2,695 5,880 5,897 Total securities available for sale $226,590 $226,795 $267,871 $269,658 $270,562 $273,443 The following table sets forth the amortized cost and estimated fair value of securities, by issuer, as of December 31, 2016, that exceeded 10% of ourstockholders' equity as of that date. At December 31, 2016 Amortized Cost Fair Value (In Thousands) Fannie Mae $89,866 $90,010 Freddie Mac $43,041 $43,143 Portfolio Maturities and Yields. The composition and maturities of the securities portfolio at December 31, 2016 are summarized in the following table. Maturities are based on the final contractual payment dates and do not reflect the impact of prepayments or early redemptions that may occur. Municipal obligationyields have not been adjusted to a tax-equivalent basis. Certain mortgage related securities have interest rates that are adjustable and will reprice annually within thevarious maturity ranges. These repricing schedules are not reflected in the table below. One Year or Less More than One Yearthrough Five Years More than Five Yearsthrough Ten Years More than Ten Years Total Securities Weighted Weighted Weighted Weighted Weighted Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield (Dollars in Thousands) Securities available for sale: Mortgage-backedsecurities $370 4.91% $65,925 2.32% $2,330 2.72% $4,233 3.16% $72,858 2.39%Collateralized mortgageobligations Governmentsponsored enterpriseissued 299 3.26% 59,462 2.12% 2,536 1.76% - - 62,297 2.11%Government sponsoredenterprise bonds - - 2,500 1.18% - - - - 2,500 1.18%Municipal obligations 8,492 2.22% 12,457 2.79% 41,332 3.80% 8,030 4.84% 70,311 3.55%Other debt securities - - 5,007 2.70% - - 12,392 5.16% 17,399 4.45%Certificates of deposit 245 1.45% 980 1.84% - - - - 1,225 1.47%Total securitiesavailable for sale $9,406 2.34% $146,331 2.27% $46,198 3.64% $24,655 4.71% $226,590 2.81%- 17 -Sources of FundsGeneral. Deposits have traditionally been our primary source of funds for use in lending and investment activities. We also rely on advances from theFederal Home Loan Bank of Chicago and borrowings from other commercial banks in the form of repurchase agreements collateralized by investment securities. Inaddition to deposits and borrowings, we derive funds from scheduled loan payments, investment maturities, loan prepayments, retained earnings and income onearning assets. While scheduled loan payments and income on earning assets are relatively stable sources of funds, deposit inflows and outflows can vary widelyand are influenced by prevailing market interest rates, economic conditions and competition from other financial institutions.Deposits. A majority of our depositors are persons who work or reside in Milwaukee and Waukesha Counties and, to a lesser extent, other southeasternWisconsin communities. We offer a selection of deposit instruments, including checking, savings, money market deposit accounts, and fixed-term certificates ofdeposit. Deposit account terms vary, with the principal differences being the minimum balance required, the amount of time the funds must remain on deposit and theinterest rate. As of December 31, 2016, certificates of deposit comprised 70.2% of total customer deposits, and had a weighted average cost of 1.03% on that date. Ourreliance on certificates of deposit has resulted in a higher cost of funds than would otherwise be the case if demand deposits, savings and money market accountsmade up a larger part of our deposit base. Development of our branch network and expansion of our commercial products and services and aggressively seeking lowercost savings, checking and money market accounts are expected to result in decreased reliance on higher-cost certificates of deposit.Interest rates paid, maturity terms, service fees and withdrawal penalties are established on a periodic basis. Deposit rates and terms are based primarily oncurrent operating strategies and market rates, liquidity requirements, rates paid by competitors and growth goals. To attract and retain deposits, we rely uponpersonalized customer service, long-standing relationships and competitive interest rates. We also provide remote deposit capture, internet banking and mobilebanking.The flow of deposits is influenced significantly by general economic conditions, changes in money market and other prevailing interest rates andcompetition. The variety of deposit accounts that we offer allows us to be competitive in obtaining funds and responding to changes in consumer demand. Based onhistorical experience, management believes our deposits are relatively stable. The ability to attract and maintain money market accounts and certificates of deposit,and the rates paid on these deposits, has been and will continue to be significantly affected by market conditions. At December 31, 2016 and December 31, 2015,$666.6 million and $650.1 million of our deposit accounts were certificates of deposit, of which $469.3 million and $508.4 million, respectively, had maturities of one yearor less.Deposits increased by $56.1 million, or 6.3%, from December 31, 2015 to December 31, 2016. The increase in deposits was the result of a $39.5 million, or16.2%, increase in total transaction accounts and a $16.5 million, or 2.5%, increase in time deposits. The Company had no deposits obtained from brokers as ofDecember 31, 2016 and December 31, 2015.The following table sets forth the distribution of total deposit accounts, by account type, at the dates indicated. At December 31, 2016 2015 2014 Weighted Weighted Weighted Average Average Average Balance Percent Rate Balance Percent Rate Balance Percent Rate (Dollars in Thousands) Deposit type: Demanddeposits $78,393 8.26% 0.00% $69,170 7.74% 0.00% $63,885 7.39% 0.00%NOWaccounts 41,978 4.42% 0.05% 33,503 3.75% 0.06% 28,277 3.27% 0.06%Savings 62,514 6.58% 0.04% 59,256 6.63% 0.04% 58,783 6.80% 0.04%Money market 99,942 10.53% 0.41% 81,375 9.11% 0.41% 60,380 6.99% 0.14%Totaltransactionaccounts 282,827 29.79% 0.16% 243,304 27.23% 0.15% 211,325 24.45% 0.06% Certificates ofdeposit 666,584 70.21% 1.03% 650,057 72.77% 0.97% 652,635 75.55% 0.83%Totaldeposits $949,411 100.00% 0.77% $893,361 100.00% 0.75% $863,960 100.00% 0.64% - 18 - At December 31, 2013 2012 Weighted Weighted Average Average Balance Percent Rate Balance Percent Rate (Dollars in Thousands) Deposit type: Demand deposits $45,850 3.68% 0.00% $39,767 4.23% 0.00%NOW accounts 47,425 3.81% 0.03% 44,373 4.72% 0.03%Savings 451,476 36.27% (1) 0.01% 54,837 5.84% 0.10%Money market 62,240 5.00% 0.11% 63,616 6.77% 0.15%Total transaction accounts 606,991 48.76% (1) 0.02% 202,593 21.56% 0.08% Certificates of deposit 637,750 51.24% 0.69% 736,920 78.44% 0.83%Total deposits $1,244,741 100.00% (1) 0.36% $939,513 100.00% 0.67%(1) As of December 31, 2013, savings accounts included $388.7 million in deposits from our second-step offering. These deposits had a stated rate of 0.01%. Exclusive of these deposits the weighted average rate of the remaining savings accounts, total transaction accounts and total deposits was 0.04%, 0.05% and 0.53%,respectively. At December 31, 2016, the aggregate balance of certificates of deposit of $100,000 or more was approximately $237.2 million. The following table sets forth thematurity of those certificates at December 31, 2016. (In Thousands) Due in: Three months or less $34,173 Over three months through six months 37,188 Over six months through 12 months 97,862 Over 12 months 67,990 Total 237,213 Borrowings. Our borrowings at December 31, 2016 consist of $295.0 million in advances from the Federal Home Loan Bank of Chicago, $84.0 million inrepurchase agreements collateralized by investment securities and $8.2 million outstanding balance in short-term repurchase agreements used to finance loans held forsale. The following table sets forth information concerning balances and interest rates on borrowings at the dates and for the periods indicated. At or For the Year Ended December 31, 2016 2015 2014 Borrowings: (Dollars in Thousands) Balance outstanding at end of year $387,155 $441,203 $434,000 Weighted average interest rate at the end of year 2.27% 3.88% 3.89%Maximum amount of borrowings outstanding at any month end during the year $414,745 $474,000 $454,686 Average balance outstanding during the year $381,803 $437,964 $442,731 Weighted average interest rate during the year 3.39% 3.94% 3.93% Subsidiary ActivitiesWaterstone Financial currently has one wholly-owned subsidiary, WaterStone Bank, which in turn has three wholly-owned subsidiaries. WauwatosaInvestments, Inc., which holds and manages our investment portfolio, is located and incorporated in Nevada. Waterstone Mortgage Corporation is a mortgagebanking business incorporated in Wisconsin. Main Street Real Estate Holdings, LLC is an inactive Wisconsin limited liability corporation and previously ownedWaterStone Bank office facilities and held WaterStone Bank office facility leases.Wauwatosa Investments, Inc. Established in 1998, Wauwatosa Investments, Inc. operates in Nevada as WaterStone Bank's investment subsidiary. Thiswholly-owned subsidiary owns and manages the majority of the consolidated investment portfolio. It has its own board of directors currently comprised of itsPresident, the WaterStone Bank Chief Financial Officer, Treasury Officer and the Chairman of Waterstone Financial's board of directors.- 19 -Waterstone Mortgage Corporation. Acquired in February 2006, Waterstone Mortgage Corporation is a mortgage banking business with offices in 22states. It has its own board of directors currently comprised of its President, its Chief Operating Officer, its Chief Financial Officer, the WaterStone Bank ChiefExecutive Officer, Chief Financial Officer and Executive Vice President and General Counsel.Main Street Real Estate Holdings, LLC. Established in 2002, Main Street Real Estate Holdings, LLC was established to acquire and hold WaterStone Bankoffice and retail facilities, both owned and leased. Main Street Real Estate Holdings, LLC currently conducts real estate broker activities limited to real estate owned.PersonnelAs of December 31, 2016, we had 895 full-time equivalent employees. A total of 178 are WaterStone Bank employees and 717 are employees of WaterstoneMortgage Corporation. Our employees are not represented by any collective bargaining group. Management believes that we have good working relations with ouremployees.Supervision and RegulationGeneralWaterStone Bank is a stock savings bank organized under the laws of the State of Wisconsin. The lending, investment, and other business operations ofWaterStone Bank are governed by Wisconsin law and regulations, as well as applicable federal law and regulations, and WaterStone Bank is prohibited from engagingin any operations not authorized by such laws and regulations. WaterStone Bank is subject to extensive regulation, supervision and examination by the WDFI and bythe Federal Deposit Insurance Corporation. This regulation and supervision establishes a comprehensive framework of activities in which an institution may engageand is intended primarily for the protection of the Federal Deposit Insurance Corporation's deposit insurance fund and depositors, and not for the protection ofsecurity holders. WaterStone Bank also is regulated to a lesser extent by the Federal Reserve Board, governing reserves to be maintained against deposits and othermatters. WaterStone Bank also is a member of and owns stock in the Federal Home Loan Bank of Chicago, which is one of the 11 regional banks in the Federal HomeLoan Bank System. Under this system of regulation, the regulatory authorities have extensive discretion in connection with their supervisory, enforcement, rulemaking andexamination activities and policies, including rules or policies that: establish minimum capital levels; restrict the timing and amount of dividend payments; govern theclassification of assets; determine the adequacy of loan loss reserves for regulatory purposes; and establish the timing and amounts of assessments and fees.Moreover, as part of their examination authority, the banking regulators assign numerical ratings to banks and savings institutions relating to capital, asset quality,management, liquidity, earnings and other factors. These ratings are inherently subjective and the receipt of a less than satisfactory rating in one or more categoriesmay result in enforcement action by the banking regulators against a financial institution. A less than satisfactory rating may also prevent a financial institution, suchas WaterStone Bank or its holding company, from obtaining necessary regulatory approvals to access the capital markets, pay dividends, acquire other financialinstitutions or establish new branches.In addition, we must comply with significant anti-money laundering and anti-terrorism laws and regulations, Community Reinvestment Act laws andregulations, and fair lending laws and regulations. Government agencies have the authority to impose monetary penalties and other sanctions on institutions that failto comply with these laws and regulations, which could significantly affect our business activities, including our ability to acquire other financial institutions orexpand our branch network.As a savings and loan holding company, Waterstone Financial is required to comply with the rules and regulations of the Federal Reserve Board. It isrequired to file certain reports with the Federal Reserve Board and is subject to examination by and the enforcement authority of the Federal Reserve Board. Waterstone Financial is also subject to the rules and regulations of the Securities and Exchange Commission under the federal securities laws.Any change in applicable laws or regulations, whether by the WDFI, the Federal Deposit Insurance Corporation, the Federal Reserve Board or Congress,could have a material adverse impact on the operations and financial performance of Waterstone Financial, WaterStone Bank and Waterstone Mortgage Corporation.Set forth below is a brief description of material regulatory requirements that are or will be applicable to WaterStone Bank, Waterstone Mortgage Corporationand Waterstone Financial. The description is limited to certain material aspects of the statutes and regulations addressed, and is not intended to be a completedescription of such statutes and regulations and their effects on WaterStone Bank, Waterstone Mortgage Corporation and Waterstone Financial. Intrastate and Interstate Merger and Branching ActivitiesWisconsin Law and Regulation. Any Wisconsin savings bank meeting certain requirements may, upon approval of the WDFI, establish one or more branchoffices in the state of Wisconsin or the states of Illinois, Indiana, Iowa, Kentucky, Michigan, Minnesota, Missouri, and Ohio. In addition, upon WDFI approval, aWisconsin savings bank may establish a branch office in any other state as the result of a merger or consolidation.Federal Law and Regulation. The Interstate Banking Act permits the federal banking agencies to, under certain circumstances, approve acquisitiontransactions between banks located in different states, regardless of whether an acquisition would be prohibited under state law. The Interstate Banking Act, asamended, authorizes de novo branching into another state at locations at which banks chartered by the host state could establish a branch. Additionally, the IBAauthorizes branching by merger, subject to certain state law limitations.- 20 -Loans and InvestmentsWisconsin Law and Regulations. Under Wisconsin law and regulation, WaterStone Bank is authorized to make, invest in, sell, purchase, participate orotherwise deal in mortgage loans or interests in mortgage loans without geographic restriction, including loans made on the security of residential and commercialproperty. Wisconsin savings banks also may lend funds on a secured or unsecured basis for business, commercial or agricultural purposes, provided the total of allsuch loans does not exceed 20% of the savings bank's total assets, unless the WDFI authorizes a greater amount. Loans are subject to certain other limitations,including percentage restrictions based on total assets.Wisconsin savings banks may invest funds in certain types of debt and equity securities, including obligations of federal, state and local governments andagencies. Subject to prior approval of the WDFI, compliance with capital requirements and certain other restrictions, Wisconsin savings banks may invest inresidential housing development projects. Wisconsin savings banks may also invest in service corporations or subsidiaries with the prior approval of the WDFI,subject to certain restrictions. Similarly, the line of credit that WaterStone Bank provides to Waterstone Mortgage Corporation is subject to the approval of the WDFI.Wisconsin savings banks may make loans and extensions of credit, both direct and indirect, to one borrower in amounts up to 15% of the savings bank'scapital plus an additional 10% for loans fully secured by readily marketable collateral. In addition, and notwithstanding the 15% of capital and additional 10% of capitallimitations set forth above, Wisconsin savings banks may make loans to one borrower, or a related group of borrowers, for any purpose in an amount not to exceed$500,000, or to develop domestic residential housing units in an amount not to exceed the lesser of $30 million or 30% of the savings bank's capital, subject to certainconditions. At December 31, 2016, WaterStone Bank did not have any loans which exceeded the "loans-to-one borrower" limitations.In addition, under Wisconsin law, WaterStone Bank must qualify for and maintain a level of qualified thrift investments equal to 60% of its assets asprescribed in Section 7701(a)(19) of the Internal Revenue Code of 1986, as amended. A Wisconsin savings bank that fails to meet this qualified thrift lender testbecomes subject to certain operating restrictions otherwise applicable only to commercial banks. At December 31, 2016, WaterStone Bank maintained 91.1% of itsassets in qualified thrift investments and therefore met the qualified thrift lender requirement.Federal Law and Regulation. Federal Deposit Insurance Corporation regulations also govern the equity investments of WaterStone Bank and,notwithstanding Wisconsin law and regulations, Federal Deposit Insurance Corporation regulations prohibit WaterStone Bank from making certain equity investmentsand generally limit WaterStone Bank's equity investments to those that are permissible for national banks and their subsidiaries. Under Federal Deposit InsuranceCorporation regulations, WaterStone Bank must obtain prior Federal Deposit Insurance Corporation approval before directly, or indirectly through a majority-ownedsubsidiary, engaging "as principal" in any activity that is not permissible for a national bank unless certain exceptions apply. The activity regulations provide thatstate banks that meet applicable minimum capital requirements would be permitted to engage in certain activities that are not permissible for national banks, includingcertain real estate and securities activities conducted through subsidiaries. The Federal Deposit Insurance Corporation will not approve an activity that it determinespresents a significant risk to the Federal Deposit Insurance Corporation insurance fund. The current activities of WaterStone Bank and its subsidiaries are permissibleunder applicable federal regulations.Loans to, and other transactions with, affiliates of WaterStone Bank, such as Waterstone Financial, are restricted by the Federal Reserve Act and regulationsissued by the Federal Reserve Board thereunder. See "—Transactions with Affiliates and Insiders" below.Lending StandardsWisconsin Law and Regulation. Wisconsin law and regulations issued by the WDFI impose on Wisconsin savings banks certain fairness in lendingrequirements and prohibit savings banks from discriminating against a loan applicant based upon the applicant's physical condition, developmental disability, sex,marital status, race, color, creed, national origin, religion or ancestry.Federal Law and Regulation. The federal banking agencies have adopted uniform regulations prescribing standards for extensions of credit that are securedby liens on interests in real estate or made for the purpose of financing the construction of a building or other improvements to real estate. Under the joint regulationsadopted by the federal banking agencies, all insured depository institutions, such as WaterStone Bank, must adopt and maintain written policies that establishappropriate limits and standards for extensions of credit that are secured by liens or interests in real estate or are made for the purpose of financing permanentimprovements to real estate. These policies must establish loan portfolio diversification standards, prudent underwriting standards (including loan-to-value limits) thatare clear and measurable, loan administration procedures, and loan documentation, approval and reporting requirements. The real estate lending policies must reflectconsideration of the Interagency Guidelines for Real Estate Lending Policies that have been adopted by the federal bank regulators. The Interagency Guidelines, among other things, require a depository institution to establish internal loan-to-value limits for real estate loans that are not inexcess of the following supervisory limits: ●for loans secured by raw land, the supervisory loan-to-value limit is 65% of the value of the collateral; ●for land development loans (i.e., loans for the purpose of improving unimproved property prior to the erection of structures), the supervisory limit is75%; ●for loans for the construction of commercial, over four-family or other non-residential property, the supervisory limit is 80%; ●for loans for the construction of one- to four-family properties, the supervisory limit is 85%; and ●for loans secured by other improved property (e.g., farmland, completed commercial property and other income-producing property, including non-owner occupied, one- to four-family property), the limit is 85%.Although no supervisory loan-to-value limit has been established for owner-occupied, one- to four-family and home equity loans, the Interagency Guidelinesstate that for any such loan with a loan-to-value ratio that equals or exceeds 90% at origination, an institution should require appropriate credit enhancement in theform of either mortgage insurance or readily marketable collateral.- 21 -DepositsWisconsin Law and Regulation. Under Wisconsin law, WaterStone Bank is permitted to establish deposit accounts and accept deposits. WaterStone Bank'sboard of directors, or its designee, determines the rate and amount of interest to be paid on or credited to deposit accounts subject to Federal Deposit InsuranceCorporation limitations.Deposit InsuranceWisconsin Law and Regulation. Under Wisconsin law, WaterStone Bank is required to obtain and maintain insurance on its deposits from a depositinsurance corporation. The deposits of WaterStone Bank are insured up to the applicable limits by the Federal Deposit Insurance Corporation.Federal Law and Regulation. WaterStone Bank is a member of the Deposit Insurance Fund, which is administered by the Federal Deposit InsuranceCorporation. The Bank's deposit accounts are insured by the Federal Deposit Insurance Corporation, generally up to a maximum of $250,000.The Federal Deposit Insurance Corporation imposes an assessment against all depository institutions. An institution's assessment rate depends upon theperceived risk of the institution to the Deposit Insurance Fund, with less risky institutions paying lower rates. Currently, assessments for institutions of less than $10billion of total assets are based on financial measures and supervisory ratings derived from statistical models estimating the probability of failure within three years. That system was effective July 1, 2016 and replaces a system under which each institution was assigned to a risk category. Assessment rates (inclusive of possibleadjustments) currently range from 1.5 to 30 basis points of each institution's total assets less tangible capital. The current scale, also effective July 1, 2016, is areduction from the previous range of 2.5 to 45 basis points. The Federal Deposit Insurance Corporation may increase or decrease the range of assessments uniformly,except that no adjustment can deviate more than two basis points from the base assessment rate without notice and comment rulemaking. The existing systemrepresents a change, required by the Dodd-Frank Act, from the Federal Deposit Insurance Corporation's prior practice of basing the assessment on an institution'saggregate deposits.The Federal Deposit Insurance Corporation has the authority to increase insurance assessments. A significant increase in insurance premiums would have anadverse effect on the operating expenses and results of operations of WaterStone Bank. We cannot predict what deposit insurance assessment rates will be in thefuture.Insurance of deposits may be terminated by the Federal Deposit Insurance Corporation upon a finding that an institution has engaged in unsafe or unsoundpractices, is in an unsafe or unsound condition to continue operations or has violated any applicable law, regulation, rule, order or condition imposed by the FederalDeposit Insurance Corporation. We do not know of any practice, condition or violation that might lead to termination of deposit insurance.In addition to the Federal Deposit Insurance Corporation assessments, the Financing Corporation (FICO) is authorized to impose and collect, with theapproval of the Federal Deposit Insurance Corporation, assessments for anticipated payments, issuance costs and custodial fees on bonds issued by the FICO in the1980s to recapitalize the former Federal Savings and Loan Insurance Corporation. The bonds issued by the FICO are due to mature in 2017 through 2019. For thequarter ended December 31, 2016, the annualized FICO assessment was equal to 0.60 basis points of total assets less tangible capital.CapitalizationWisconsin Law and Regulation. Wisconsin savings banks are required to maintain a minimum capital to assets ratio of 6% and must maintain total capitalnecessary to ensure the continuation of insurance of deposit accounts by the Federal Deposit Insurance Corporation. If the WDFI determines that the financialcondition, history, management or earning prospects of a savings bank are not adequate, the WDFI may require a higher minimum capital level for the savings bank. Ifa Wisconsin savings bank's capital ratio falls below the required level, the WDFI may direct the savings bank to adhere to a specific written plan established by theWDFI to correct the savings bank's capital deficiency, as well as a number of other restrictions on the savings bank's operations, including a prohibition on thedeclaration of dividends. At December 31, 2016 and 2015, WaterStone Bank's capital to assets ratio, as calculated under Wisconsin law, was 20.90% and 20.43%,respectively.Federal Law and Regulation. Federal regulations require Federal Deposit Insurance Corporation insured depository institutions to meet several minimumcapital standards: a common equity Tier 1 capital to risk-based assets ratio of 4.5%, a Tier 1 capital to risk-based assets ratio of 6.0%, a total capital to risk-basedassets of 8.0%, and a 4.0% Tier 1 capital to total assets leverage ratio. The existing capital requirements were effective January 1, 2015 and are the result of a final ruleimplementing regulatory amendments based on recommendations of the Basel Committee on Banking Supervision and certain requirements of the Dodd-Frank Act.Common equity Tier 1 capital is generally defined as common stockholders' equity and retained earnings. Tier 1 capital is generally defined as common equityTier 1 and additional Tier 1 capital. Additional Tier 1 capital includes certain noncumulative perpetual preferred stock and related surplus and minority interests inequity accounts of consolidated subsidiaries. Total capital includes Tier 1 capital (common equity Tier 1 capital plus additional Tier 1 capital) and Tier 2 capital. Tier 2capital is comprised of capital instruments and related surplus, meeting specified requirements, and may include cumulative preferred stock and long-term perpetualpreferred stock, mandatory convertible securities, intermediate preferred stock and subordinated debt. Also included in Tier 2 capital is the allowance for loan andlease losses limited to a maximum of 1.25% of risk-weighted assets and, for institutions that have exercised an opt-out election regarding the treatment of AccumulatedOther Comprehensive Income ("AOCI"), up to 45% of net unrealized gains on available-for-sale equity securities with readily determinable fair market values. Institutions that have not exercised the AOCI opt-out have AOCI incorporated into common equity Tier 1 capital (including unrealized gains and losses on available-for-sale-securities). Calculation of all types of regulatory capital is subject to deductions and adjustments specified in the regulations.In determining the amount of risk-weighted assets for purposes of calculating risk-based capital ratios, all assets, including certain off-balance sheet assets(e.g., recourse obligations, direct credit substitutes, residual interests) are multiplied by a risk weight factor assigned by the regulations based on the risks believedinherent in the type of asset. Higher levels of capital are required for asset categories believed to present greater risk. For example, a risk weight of 0% is assigned tocash and U.S. government securities, a risk weight of 50% is generally assigned to prudently underwritten first lien one to four- family residential mortgages, a riskweight of 100% is assigned to commercial and consumer loans, a risk weight of 150% is assigned to certain past due loans and a risk weight of between 0% to 600% isassigned to permissible equity interests, depending on certain specified factors.- 22 -In addition to establishing the minimum regulatory capital requirements, the regulations limit capital distributions and certain discretionary bonus paymentsto management if the institution does not hold a "capital conservation buffer" consisting of 2.5% of common equity Tier 1 capital to risk-weighted asset above theamount necessary to meet its minimum risk-based capital requirements. The capital conservation buffer requirement is being phased in beginning January 1, 2016 at0.625% of risk-weighted assets and increasing each year until fully implemented at 2.5% on January 1, 2019.In assessing an institution's capital adequacy, the Federal Deposit Insurance Corporation takes into consideration, not only these numeric factors, butqualitative factors as well, including the bank's exposure to interest rate risk. The Federal Deposit Insurance Corporation has the authority to establish higher capitalrequirements for individual institutions where deemed necessary due to a determination that an institution's capital level is, or is likely to become, inadequate in lightof particular circumstances.Safety and Soundness StandardsEach federal banking agency, including the Federal Deposit Insurance Corporation, has adopted guidelines establishing general standards relating to internalcontrols, information and internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth, asset quality, earnings andcompensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risks andexposures specified in the guidelines. The guidelines prohibit excessive compensation as an unsafe and unsound practice and describe compensation as excessivewhen the amounts paid are unreasonable or disproportionate to the services performed by an executive officer, employee, director, or principal shareholder.Prompt Corrective Regulatory ActionFederal bank regulatory authorities are required to take "prompt corrective action" with respect to institutions that do not meet minimum capital requirements.For these purposes, the statute establishes five capital categories: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, andcritically undercapitalized. Under the regulations, as amended effective January 1, 2015 to incorporate the previously mentioned amendments to the regulatory capitalrequirements, a bank is deemed to be (i) "well capitalized" if it has total risk-based capital of 10.0% or more, has a Tier 1 risk-based capital ratio of 8.0% or more, has aTier 1 leverage capital ratio of 5.0% or more and a common equity Tier 1 ratio of 6.5% or more, and is not subject to any written capital order or directive; (ii)"adequately capitalized" if it has a total risk-based capital ratio of 8.0% or more, a Tier 1 risk-based capital ratio of 6.0% or more, a Tier 1 leveraged capital ratio of 4.0%or more and a common equity Tier 1 ratio of 4.5% or more, and does not meet the definition of "well capitalized"; (iii) "undercapitalized" if it has a total risk-basedcapital ratio that is less than 8.0%, a Tier 1 risk-based capital ratio that is less than 6.0%, a Tier 1 leverage capital ratio that is less than 4.0% or a common equity Tier 1ratio of less than 4.5%; (iv) "significantly undercapitalized" if it has a total risk-based capital ratio that is less than 6.0% and a Tier 1 risk-based capital ratio that is lessthan 4.0% or a common equity Tier 1 ratio of less than 3.0%; and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or lessthan 2.0%.Federal law and regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequatelycapitalized and may require an institution classified as less than well capitalized to comply with supervisory actions as if it were in the next lower category (except thatthe Federal Deposit Insurance Corporation may not reclassify a significantly undercapitalized institution as critically undercapitalized).The Federal Deposit Insurance Corporation may order savings banks that have insufficient capital to take corrective actions. For example, a savings bankthat is categorized as "undercapitalized" is subject to growth limitations and is required to submit a capital restoration plan, and a holding company that controls sucha savings bank is required to guarantee that the savings bank complies with the restoration plan. A "significantly undercapitalized" savings bank may be subject toadditional restrictions. Savings banks deemed by the Federal Deposit Insurance Corporation to be "critically undercapitalized" would be subject to the appointment ofa receiver or conservator.At December 31, 2016, WaterStone Bank was considered well-capitalized with a common equity Tier 1 ratio of 28.29%, Tier 1 leverage ratio of 21.17%, a Tier 1risk-based ratio of 28.29% and a total risk based capital ratio of 29.50%.DividendsUnder Wisconsin law and applicable regulations, a Wisconsin savings bank that meets its regulatory capital requirements may declare dividends on capitalstock based upon net profits to the Parent company, provided that its paid-in surplus equals its capital stock. If the paid-in surplus of the savings bank does not equalits capital stock, the board of directors may not declare a dividend unless at least 10% of the net profits of the preceding half year, in the case of quarterly or semi-annual dividends, or 10% of the net profits of the preceding year, in the case of annual dividends, has been transferred to paid-in surplus. In addition, prior WDFIapproval is required before dividends exceeding 50% of net profits for any calendar year may be declared and before a stock dividend may be declared out of retainedearnings. Under WDFI regulations, a Wisconsin savings bank which has converted from mutual to stock form also is prohibited from paying a dividend on its capitalstock if the payment causes the regulatory capital of the savings bank to fall below the amount required for its liquidation account.The Federal Deposit Insurance Corporation has the authority to prohibit WaterStone Bank from paying dividends if, in its opinion, the payment of dividendswould constitute an unsafe or unsound practice in light of the financial condition of WaterStone Bank. Institutions may not pay dividends if they would be"undercapitalized" following payment of the dividend within the meaning of the prompt corrective action regulations.Information with respect to dividends declared and paid by Waterstone Financial is disclosed under Holding Company Dividends.- 23 -Liquidity and ReservesWisconsin Law and Regulation. Under WDFI regulations, all Wisconsin savings banks are required to maintain a certain amount of their assets as liquidassets, consisting of cash and certain types of investments. The exact amount of assets a savings bank is required to maintain as liquid assets is set by the WDFI, butgenerally ranges from 4% to 15% of the savings bank's average daily balance of net withdrawable accounts plus short-term borrowings (the "Required LiquidityRatio"). At December 31, 2016, WaterStone Bank's Required Liquidity Ratio was 8.0%, and WaterStone Bank was in compliance with this requirement. In addition, 50%of the liquid assets maintained by a Wisconsin savings bank must consist of "primary liquid assets," which are defined to include securities issued by the UnitedStates Government and United States Government agencies. At December 31, 2016, WaterStone Bank was in compliance with this requirement.Federal Law and Regulation. Under federal law and regulations, WaterStone Bank is required to maintain sufficient liquidity to ensure safe and soundbanking practices. Regulation D, promulgated by the Federal Reserve Board, imposes reserve requirements on all depository institutions, including WaterStone Bank,which maintain transaction accounts or non-personal time deposits. Checking accounts, NOW accounts, Super NOW checking accounts, and certain other types ofaccounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to Regulation D reserve requirements, asare any non-personal time deposits (including certain money market deposit accounts) at a savings institution. For 2016, a depository institution is required tomaintain average daily reserves equal to 3% on the first $110.2 million of transaction accounts, plus 10% of that portion of total transaction accounts in excess of$110.2 million. The first $15.2 million of otherwise reservable balances (subject to adjustment by the Federal Reserve Board) are exempt from the reserve requirements.These percentages and threshold limits are subject to adjustment by the Federal Reserve Board. Savings institutions have authority to borrow from the FederalReserve's "discount window," but Federal Reserve policy generally requires savings institutions to exhaust all other sources before borrowing from the FederalReserve. As of December 31, 2016, WaterStone Bank met its Regulation D reserve requirements.Transactions with Affiliates and InsidersWisconsin Law and Regulation. Under Wisconsin law, a savings bank may not make a loan to a person owning 10% or more of its stock, an affiliated person,agent, or attorney of the savings bank, either individually or as an agent or partner of another, except as under the rules of the WDFI and regulations of the FederalDeposit Insurance Corporation. In addition, unless the prior approval of the WDFI is obtained, a savings bank may not purchase, lease or acquire a site for an officebuilding or an interest in real estate from an affiliated person, including a shareholder owning more than 10% of its capital stock, or from any firm, corporation, entity orfamily in which an affiliated person or 10% shareholder has a direct or indirect interest.Federal Law and Regulation. Sections 23A and 23B of the Federal Reserve Act govern transactions between an insured savings bank, such as WaterStoneBank, and any of its affiliates, including Waterstone Financial. The Federal Reserve Board has adopted Regulation W, which comprehensively implements andinterprets Sections 23A and 23B, in part by codifying prior Federal Reserve Board interpretations under Sections 23A and 23B.An affiliate of a savings bank is any company or entity that controls, is controlled by or is under common control with the savings bank. A subsidiary of asavings bank that is not also a depository institution or a "financial subsidiary" under federal law is not treated as an affiliate of the savings bank for the purposes ofSections 23A and 23B; however, the Federal Deposit Insurance Corporation has the discretion to treat subsidiaries of a savings bank as affiliates on a case-by-casebasis. Sections 23A and 23B limit the extent to which a savings bank or its subsidiaries may engage in "covered transactions" with any one affiliate to an amountequal to 10% of such savings bank's capital stock and surplus, and limit all such transactions with all affiliates to an amount equal to 20% of such capital stock andsurplus. The statutory sections also require that all such transactions be on terms that are consistent with safe and sound banking practices. The term "coveredtransaction" includes the making of loans, purchase of assets, issuance of guarantees and other similar types of transactions. Further, most loans and otherextensions of credit by a savings bank to any of its affiliates must be secured by collateral in amounts ranging from 100% to 130% of the loan amounts, depending onthe type of collateral. In addition, any covered transaction by a savings bank with an affiliate and any purchase of assets or services by a savings bank from anaffiliate must be on terms that are substantially the same, or at least as favorable, to the savings bank as those that would be provided to a non-affiliate.A savings bank's loans to its executive officers, directors, any owner of more than 10% of its stock (each, an insider) and any of certain entities affiliated withany such person (an insider's related interest) are subject to the conditions and limitations imposed by Section 22(h) of the Federal Reserve Act and the FederalReserve Board's Regulation O thereunder. Under these restrictions, the aggregate amount of the loans to any insider and the insider's related interests may not exceedthe loans-to-one-borrower limit applicable to national banks, which is comparable to the loans-to-one-borrower limit applicable to WaterStone Bank's loans. All loansby a savings bank to its insiders and insiders' related interests in the aggregate may not exceed the savings bank's unimpaired capital and unimpaired surplus. Withcertain exceptions, loans to an executive officer, other than loans for the education of the officer's children and certain loans secured by the officer's residence, maynot exceed the greater of $25,000 or 2.5% of the savings bank's unimpaired capital and unimpaired surplus, but in no event more than $100,000. Regulation O alsorequires that any proposed loan to an insider or a related interest of that insider be approved in advance by a majority of the board of directors of the savings bank,with any interested director not participating in the voting, if such loan, when aggregated with any existing loans to that insider and the insider's related interests,would exceed either $500,000 or the greater of $25,000 or 5% of the savings bank's unimpaired capital and surplus. Generally, such loans must be made on substantiallythe same terms as, and follow credit underwriting procedures that are no less stringent than, those that are prevailing at the time for comparable transactions withother persons and must not present more than a normal risk of collectability.An exception to this requirement is made for extensions of credit made pursuant to a benefit or compensation plan of a bank that is widely available toemployees of the savings bank and that does not give any preference to insiders of the bank over other employees of the bank. Consistent with these requirements,the Bank offered employees special terms for home mortgage loans on their principal residences. Effective April 1, 2006, this program was discontinued for new loanoriginations. Under the terms of the discontinued program, the employee interest rate is based on the Bank's cost of funds on December 31st of the immediatelypreceding year and is adjusted annually. At December 31, 2016, the rate of interest on an employee rate mortgage loan was 1.72%, compared to the weighted averagerate of 4.25% on all single family mortgage loans. This rate decreased to 1.19% effective March 1, 2017. Employee rate mortgage loans totaled $1.5 million, or 0.4%, ofour residential mortgage loan portfolio on December 31, 2016.- 24 -Transactions between Bank Customers and AffiliatesUnder Wisconsin and federal laws and regulations, Wisconsin savings banks, such as WaterStone Bank, are subject to the prohibitions on certain tyingarrangements. A savings bank is prohibited, subject to certain exceptions, from extending credit to or offering any other service to a customer, or fixing or varying theconsideration for such extension of credit or service, on the condition that such customer obtain some additional service from the institution or certain of its affiliatesor not obtain services of a competitor of the institution.Examinations and AssessmentsWaterStone Bank is required to file periodic reports with and is subject to periodic examinations by the WDFI and FDIC. Federal regulations require annualon-site examinations for all depository institutions except certain well-capitalized and highly rated institutions with assets of less than $500 million which are examinedevery 18 months. Recent legislation extended the 18 month examination cycle to qualifying institutions of less than $1 billion in assets, subject to agencyimplementing regulations. WaterStone Bank is required to pay examination fees and annual assessments to fund its supervision.Customer PrivacyUnder Wisconsin and federal law and regulations, savings banks, such as WaterStone Bank, are required to develop and maintain privacy policies relating toinformation on its customers, restrict access to and establish procedures to protect customer data. Applicable privacy regulations further restrict the sharing of non-public customer data with non-affiliated parties if the customer requests.Community Reinvestment ActUnder the Community Reinvestment Act, WaterStone Bank has a continuing and affirmative obligation consistent with its safe and sound operation to helpmeet the credit needs of its entire community, including low and moderate income neighborhoods. The Community Reinvestment Act does not establish specificlending requirements or programs for financial institutions nor does it limit an institution's discretion to develop the types of products and services that it believes arebest suited to its particular community, consistent with the Community Reinvestment Act. The Community Reinvestment Act requires the Federal Deposit InsuranceCorporation, in connection with its examination of WaterStone Bank, to assess WaterStone Bank's record of meeting the credit needs of its community and to take thatrecord into account in the Federal Deposit Insurance Corporation's evaluation of certain applications by WaterStone Bank. For example, the regulations specify that abank's Community Reinvestment Act performance will be considered in its expansion (e.g., branching) proposals and may be the basis for approving, denying orconditioning the approval of an application. As of the date of its most recent regulatory examination, WaterStone Bank was rated "satisfactory" with respect to itsCommunity Reinvestment Act compliance.Federal Home Loan Bank SystemThe Federal Home Loan Bank System, consisting of 11 Federal Home Loan Banks, is under the jurisdiction of the Federal Housing Finance Board. Thedesignated duties of the Federal Housing Finance Board are to supervise the Federal Home Loan Banks; ensure that the Federal Home Loan Banks carry out theirhousing finance mission; ensure that the Federal Home Loan Banks remain adequately capitalized and able to raise funds in the capital markets; and ensure that theFederal Home Loan Banks operate in a safe and sound manner.WaterStone Bank, as a member of the Federal Home Loan Bank of Chicago, is required to acquire and hold shares of capital stock in the Federal Home LoanBank of Chicago in specified amounts. WaterStone Bank is in compliance with this requirement with an investment in Federal Home Loan Bank of Chicago stock of$13.3 million at December 31, 2016.Among other benefits, the Federal Home Loan Banks provide a central credit facility primarily for member institutions. It is funded primarily from proceedsderived from the sale of consolidated obligations of the Federal Home Loan Bank System. It makes advances to members in accordance with policies and proceduresestablished by the Federal Housing Finance Board and the board of directors of the Federal Home Loan Bank of Chicago. At December 31, 2016, WaterStone Bank had$295.0 million in advances from the Federal Home Loan Bank of Chicago.USA PATRIOT ActThe USA PATRIOT Act gives the federal government powers to address terrorist threats through enhanced domestic security measures, expandedsurveillance powers, increased information sharing and broadened anti-money laundering requirements. The USA PATRIOT Act also required the federal bankingagencies to take into consideration the effectiveness of controls designed to combat money laundering activities in determining whether to approve a merger or otheracquisition application of a member institution. Accordingly, if we engage in a merger or other acquisition, our controls designed to combat money laundering wouldbe considered as part of the application process. We have established policies, procedures and systems designed to comply with these regulations. Regulation of Waterstone Mortgage CorporationWaterstone Mortgage Corporation is subject to numerous federal, state and local laws and regulations and may be subject to various judicial andadministrative decisions imposing various requirements and restrictions on its business. These laws, regulations and judicial and administrative decisions to whichWaterstone Mortgage Corporation is subject include those pertaining to: real estate settlement procedures; fair lending; fair credit reporting; truth in lending;compliance with net worth and financial statement delivery requirements; compliance with federal and state disclosure and licensing requirements; the establishmentof maximum interest rates, finance charges and other charges; secured transactions; collection, foreclosure, repossession and claims-handling procedures; other tradepractices and privacy regulations providing for the use and safeguarding of non-public personal financial information of borrowers; and guidance on non-traditionalmortgage loans issued by the federal financial regulatory agencies. Waterstone Mortgage Corporation may also be required to comply with any additionalrequirements that its customers may be subject to by their regulatory authorities. - 25 -Holding Company RegulationWaterstone Financial is a unitary savings and loan holding company subject to regulation and supervision by the Federal Reserve Board. The FederalReserve Board has enforcement authority over Waterstone Financial and its non-savings institution subsidiaries. Among other things, this authority permits theFederal Reserve Board to restrict or prohibit activities that are determined to be a risk to WaterStone Bank. In addition, any company that owns or controls, directly orindirectly, more than 25% of the voting securities of a state savings bank is subject to regulation as a savings bank holding company by the WDFI. WaterstoneFinancial is subject to regulation as a savings bank holding company under Wisconsin law. However, the WDFI has not issued specific regulations governing savingsbank holding companies. As a savings and loan holding company, Waterstone Financial's activities are limited to those activities permissible by law for financial holding companies (ifWaterstone Financial makes an election to be treated as a financial holding company and meets the other requirements to be a financial holding company) or multiplesavings and loan holding companies. A financial holding company may engage in activities that are financial in nature, incidental to financial activities orcomplementary to a financial activity. Such activities include lending and other activities permitted for bank holding companies, insurance and underwriting equitysecurities. Multiple savings and loan holding companies are authorized to engage in activities specified by federal regulation.Federal law prohibits a savings and loan holding company, directly or indirectly, or through one or more subsidiaries, from acquiring more than 5% of anothersavings institution or savings and loan holding company without prior written approval of the Federal Reserve Board, and from acquiring or retaining control of anydepository institution not insured by the Federal Deposit Insurance Corporation. In evaluating applications by holding companies to acquire savings institutions, theFederal Reserve Board must consider such things as the financial and managerial resources and future prospects of the company and institution involved, the effectof the acquisition on and the risk to the federal deposit insurance fund, the convenience and needs of the community and competitive factors. A savings and loanholding company may not acquire a savings institution in another state and hold the target institution as a separate subsidiary unless it is a supervisory acquisitionunder Section 13(k) of the Federal Deposit Insurance Act or the law of the state in which the target is located authorizes such acquisitions by out-of-state companies. Savings and loan holding companies historically have not been subject to consolidated regulatory capital requirements, although bank holding companieshave been. The Dodd-Frank Act requires the Federal Reserve Board to establish minimum consolidated capital requirements for depository institution holdingcompanies that are as stringent as those required for the insured depository subsidiaries. The final capital rule discussed above implemented the consolidated capitalrequirements for bank and savings and loan holding companies (of greater than $1 billion in consolidated assets), effective January 1, 2015. Waterstone Financial'sconsolidated capital exceeded the minimum requirements as of December 31, 2016. The Dodd-Frank Act extended the "source of strength" doctrine to savings and loan holding companies. The Federal Reserve Board promulgatedregulations implementing the "source of strength" policy, which requires holding companies to act as a source of strength to their subsidiary depository institutionsby providing capital, liquidity and other support in times of financial stress.The Federal Reserve Board has issued a policy statement regarding the payment of dividends and the repurchase of shares of common stock by bankholding companies and savings and loan holding companies. In general, the policy provides that dividends should be paid only out of current earnings and only if theprospective rate of earnings retention by the holding company appears consistent with the organization's capital needs, asset quality and overall financial condition.Regulatory guidance provides for prior regulatory consultation with respect to capital distributions in certain circumstances such as where the company's net incomefor the past four quarters, net of dividends previously paid over that period, is insufficient to fully fund the dividend or the company's overall rate of earningsretention is inconsistent with the company's capital needs and overall financial condition. The ability of a holding company to pay dividends may be restricted if asubsidiary bank becomes undercapitalized. The policy statement also states that a holding company should inform the Federal Reserve Board supervisory staff priorto redeeming or repurchasing common stock or perpetual preferred stock if the holding company is experiencing financial weaknesses or if the repurchase orredemption would result in a net reduction, as of the end of a quarter, in the amount of such equity instruments outstanding compared with the beginning of thequarter in which the redemption or repurchase occurred. These regulatory policies may affect the ability of Waterstone Financial to pay dividends, repurchase sharesof common stock or otherwise engage in capital distributions. Holding Company DividendsWaterstone Financial will not be permitted to pay dividends on its common stock if its stockholders' equity would be reduced below the amount of theliquidation account established by Waterstone Financial in connection with the conversion. The source of dividends will depend on the net proceeds retained byWaterstone Financial and earnings thereon, and dividends from WaterStone Bank. In addition, Waterstone Financial will be subject to state law limitations and federalbank regulatory policy on the payment of dividends. Maryland law generally limits dividends if the corporation would not be able to pay its debts in the usual courseof business after giving effect to the dividend or if the corporation's total assets would be less than the corporation's total liabilities plus the amount needed to satisfythe preferential rights upon dissolution of stockholders whose preferential rights on dissolution are superior to those receiving the distribution.The dividend rate and continued payment of dividends will depend on a number of factors, including our capital requirements, our financial condition andresults of operations, tax considerations, statutory and regulatory limitations, and general economic conditions.Federal Securities Laws RegulationSecurities Exchange Act. Waterstone Financial common stock is registered with the Securities and Exchange Commission. Waterstone Financial is subjectto the information, proxy solicitation, insider trading restrictions and other requirements under the Securities Exchange Act of 1934.Shares of common stock purchased by persons who are not affiliates of Waterstone Financial may be resold without registration. Shares purchased by anaffiliate of Waterstone Financial are subject to the resale restrictions of Rule 144 under the Securities Act of 1933. If Waterstone Financial meets the current publicinformation requirements of Rule 144 under the Securities Act of 1933, each affiliate of Waterstone Financial that complies with the other conditions of Rule 144,including those that require the affiliate's sale to be aggregated with those of other persons, would be able to sell in the public market, without registration, a numberof shares not to exceed, in any three-month period, the greater of 1% of the outstanding shares of Waterstone Financial, or the average weekly volume of trading inthe shares during the preceding four calendar weeks. In the future, Waterstone Financial may permit affiliates to have their shares registered for sale under theSecurities Act of 1933.- 26 -Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 is intended to improve corporate responsibility, to provide for enhanced penalties foraccounting and auditing improprieties at publicly traded companies and to protect investors by improving the accuracy and reliability of corporate disclosurespursuant to the securities laws. We have policies, procedures and systems designed to comply with these regulations, and we review and document such policies,procedures and systems to ensure continued compliance with these regulations. Change in Control RegulationsUnder the Change in Bank Control Act, no person may acquire control of a savings and loan holding company such as Waterstone Financial unless theFederal Reserve Board has been given 60 days' prior written notice and has not issued a notice disapproving the proposed acquisition, taking into considerationcertain factors, including the financial and managerial resources of the acquirer and the competitive effects of the acquisition. Control, as defined under federal law,means ownership, control of or holding irrevocable proxies representing more than 25% of any class of voting stock, control in any manner of the election of amajority of the institution's directors, or a determination by the regulator that the acquiror has the power, directly or indirectly, to exercise a controlling influence overthe management or policies of the institution. Acquisition of more than 10% of any class of a savings and loan holding company's voting stock constitutes arebuttable determination of control under the regulations under certain circumstances including where, as is the case with Waterstone Financial, the issuer hasregistered securities under Section 12 of the Securities Exchange Act of 1934.In addition, federal regulations provide that no company may acquire control of a savings and loan holding company without the prior approval of theFederal Reserve Board. Any company that acquires such control becomes a "savings and loan holding company" subject to registration, examination and regulationby the Federal Reserve Board.Further, without the prior written approval of the Federal Reserve Board, no person may make an offer or announcement of an offer to purchase shares oractually acquire shares of a converted institution or its holding company for a period of three years from the date of the completion of the conversion if, upon thecompletion of such offer, announcement or acquisition, the person would become the beneficial owner of more than 10% of the outstanding stock of the institution orits holding company. The Federal Reserve Board has defined "person" to include any individual, group acting in concert, corporation, partnership, association, jointstock company, trust, unincorporated organization or similar company, a syndicate or any other group formed for the purpose of acquiring, holding or disposing ofsecurities of an insured institution. However, offers made exclusively to a bank or its holding company, or to an underwriter or member of a selling group acting on theconverting institution's or its holding company's behalf for resale to the general public, are excepted. The regulation also provides civil penalties for willful violationor assistance in any such violation of the regulation by any person connected with the management of the converting institution or its holding company or whocontrols more than 10% of the outstanding shares or voting rights of a converted institution or its holding company.Federal and State TaxationFederal TaxationGeneral. Waterstone Financial and subsidiaries are subject to federal income taxation in the same general manner as other corporations, with someexceptions discussed below. Waterstone Financial and subsidiaries constitute an affiliated group of corporations and, therefore, are eligible to report their income ona consolidated basis. The following discussion of federal taxation is intended only to summarize certain pertinent federal income tax matters and is not acomprehensive description of the tax rules applicable to Waterstone Financial or WaterStone Bank. The company is no longer subject to federal tax examinations foryears before 2014.Method of Accounting. For federal income tax purposes, Waterstone Financial currently reports its income and expenses on the accrual method ofaccounting and uses a tax year ending December 31 for filing its federal income tax returns.Bad Debt Reserves. Prior to the Small Business Protection Act of 1996 (the "1996 Act"), WaterStone Bank was permitted to establish a reserve for bad debtsand to make annual additions to the reserve. These additions could, within specified formula limits, be deducted in arriving at our taxable income. As a result of the1996 Act, WaterStone Bank was required to use the specific charge-off method in computing its bad debt deduction beginning with its 1996 federal tax return. Savingsinstitutions were required to recapture any excess reserves over those established as of December 31, 1987 (base year reserve). At December 31, 2016, WaterStoneBank had no reserves subject to recapture in excess of its base year.Waterstone Financial is required to use the specific charge-off method to account for tax bad debt deductions.Taxable Distributions and Recapture. Prior to 1996, bad debt reserves created prior to 1988 were subject to recapture into taxable income if WaterStone Bankfailed to meet certain thrift asset and definitional tests or made certain distributions. Tax law changes in 1996 eliminated thrift-related recapture rules. However, undercurrent law, pre-1988 tax bad debt reserves remain subject to recapture if WaterStone Bank makes certain non-dividend distributions, repurchases any of its commonstock, pays dividends in excess of earnings and profits, or fails to qualify as a "bank" for tax purposes. At December 31, 2016, our total federal pre-base year bad debtreserve was approximately $16.7 million.Alternative Minimum Tax. The Internal Revenue Code imposes an alternative minimum tax at a rate of 20% on a base of regular taxable income plus certaintax preferences, less any available exemption. The alternative minimum tax is imposed to the extent it exceeds the regular income tax. Net operating losses can offset nomore than 90% of alternative taxable income. Certain payments of alternative minimum tax may be used as credits against regular tax liabilities in future years. Due to afederal net operating loss carry back generated in 2008, Waterstone Financial became subject to alternative minimum tax for 2006 and 2007. At December 31, 2016, theCompany had no such amounts available as credits for carryover.- 27 -Net Operating Loss Carryovers. A financial institution may carry back net operating losses to the preceding two taxable years and forward to thesucceeding 20 taxable years. A 2009 federal tax law change allows for a one-time carry back of either 2008 or 2009 taxable losses for up to five years. WaterstoneFinancial had a federal net operating loss carryforward of $3.0 million at December 31, 2011, which was fully utilized during the year ended December 31, 2012. AtDecember 31, 2016, the Company had no federal net operating loss carryovers.Corporate Dividends-Received Deduction. Waterstone Financial may exclude from its federal taxable income 100% of dividends received from WaterStoneBank as a wholly-owned subsidiary by filing consolidated tax returns. The corporate dividends-received deduction is 80% when the corporation receiving thedividend owns at least 20% of the stock of the distributing corporation. The dividends-received deduction is 70% when the corporation receiving the dividend ownsless than 20% of the distributing corporation. State TaxationThe Company is subject to primarily the Wisconsin corporate franchise (income) tax and taxation in a number of states due primarily to the operations of themortgage banking segment. Under current law, the state of Wisconsin imposes a corporate franchise tax of 7.9% on the combined taxable incomes of the members ofour consolidated income tax group. The Company is no longer subject to state income tax examinations by certain state tax authorities for years before 2012.As a Maryland business corporation, Waterstone Financial is required to file an annual report and pay franchise taxes to the state of Maryland.Item 1A. Risk Factors An investment in our securities is subject to risks inherent in our business and the industry in which we operate. Before making an investment decision, youshould carefully consider the risks and uncertainties described below and all other information included in this report. The risks described below may adversely affectour business, financial condition and operating results. In addition to these risks and the other risks and uncertainties described in Item 1, "Business-Forward LookingStatements" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," there may be additional risks and uncertaintiesthat are not currently known to us or that we currently deem to be immaterial that could materially and adversely affect our business, financial condition or operatingresults. The value or market price of our securities could decline due to any of these identified or other risks. Past financial performance may not be a reliable indicatorof future performance, and historical trends should not be used to anticipate results or trends in future periods.We operate in a highly regulated environment and we are subject to supervision, examination and enforcement action by various bank regulatory agencies.We are subject to extensive supervision, regulation, and examination by the WDFI, the Federal Deposit Insurance Corporation and the Federal ReserveBoard. As a result, we are limited in the manner in which we conduct our business, undertake new investments and activities, and obtain financing. This system ofregulation is designed primarily for the protection of the Deposit Insurance Fund and our depositors, and not for the benefit of our stockholders. Under this systemof regulation, the regulatory authorities have extensive discretion in connection with their supervisory, enforcement, rulemaking and examination activities andpolicies, including rules or policies that: establish minimum capital levels; restrict the timing and amount of dividend payments; govern the classification of assets;determine the adequacy of loan loss reserves for regulatory purposes; and establish the timing and amounts of assessments and fees.Moreover, as part of their examination authority, the banking regulators assign numerical ratings to banks and savings institutions relating to capital, assetquality, management, liquidity, earnings and other factors. These ratings are inherently subjective and the receipt of a less than satisfactory rating in one or morecategories may result in enforcement action by the banking regulators against a financial institution. A less than satisfactory rating may also prevent a financialinstitution, such as WaterStone Bank or its holding company, from obtaining necessary regulatory approvals to access the capital markets, pay dividends, acquireother financial institutions or establish new branches.Federal regulations governing the mutual-to-stock conversion required that we prepare a business plan that addresses, among other items, our projectedoperations and activities for three years following the conversion. The business plan is a confidential document that was submitted to the banking regulatoryagencies and may not reflect currently unanticipated potential business opportunities or activities, such as increased dividends or acquisitions of other financialinstitutions. Federal regulations require that we operate within the parameters of the business plan, and that the Federal Reserve Board approve any materialdeviation from the business plan. This could affect our ability to conduct activities that deviate from the regulatory business plan that would otherwise benefit ourstockholders.In addition, we must comply with significant anti-money laundering and anti-terrorism laws and regulations, Community Reinvestment Act laws andregulations, and fair lending laws and regulations. Government agencies have the authority to impose monetary penalties and other sanctions on institutions that failto comply with these laws and regulations, which could significantly affect our business activities, including our ability to acquire other financial institutions orexpand our branch network.Changing interest rates may have a negative effect on our results of operations.Our earnings and cash flows are dependent on our net interest income and income from our mortgage banking operations. Interest rates are highly sensitiveto many factors that are beyond our control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular,the Federal Reserve Board. Changes in market interest rates could have an adverse effect on our financial condition and results of operations. If rates further declineor continue to stay in a low rate environment, it could have a negative effect on net interest margin, reduced net interest income, and devaluation of our deposit base.- 28 -Decreases in interest rates often result in increased prepayments of loans and mortgage-related securities, as borrowers refinance their loans to reduceborrowings costs. Under these circumstances, we are subject to reinvestment risk to the extent we are unable to reinvest the cash received from such prepayments inloans or other investments that have interest rates that are comparable to the interest rates on existing loans and securities.Increases in interest rates can also have an adverse impact on our results of operations. A portion of our loans have adjustable interest rates. While thehigher payment amounts we would receive on these loans in a rising interest rate environment may increase our interest income, some borrowers may be unable toafford the higher payment amounts, which may result in a higher rate of loan delinquencies and defaults, as well as lower loan originations, as borrowers who mayqualify for a loan based on certain mortgage repayments, may not be able to afford repayments based on higher interest rates for the same loan amounts. Themarketability of the underlying collateral also may be adversely affected in a high interest rate environment. Although we have implemented asset and liability management strategies designed to reduce the effects of changes in interest rates on our results ofoperations, any substantial, unexpected, prolonged change in market interest rate could have a material adverse effect on our financial condition and results ofoperations. Also, our interest rate models and assumptions likely may not fully predict or capture the impact of actual interest rate changes on our balance sheet. See "Management's Discussion and Analysis of Financial Condition and Results of Operations—Management of Market Risk."We rely heavily on certificates of deposit, which has increased our cost of funds and could continue to do so in the future.Our reliance on certificates of deposit to fund our operations has resulted in a higher cost of funds than would otherwise be the case if we had a higherpercentage of demand deposits, savings deposits and money market accounts. In addition, if our certificates of deposit do not remain with us, we may be required toaccess other sources of funds, including loan sales, other types of deposits, including replacement certificates of deposit, securities sold under agreements torepurchase, advances from the Federal Home Loan Bank of Chicago and other borrowings. Depending on market conditions, we may be required to pay higher rateson such deposits or other borrowings than we currently pay on our certificates of deposit.We intend to increase our commercial business lending, and we intend to continue our commercial real estate and multi-family residential real estate lending,which may expose us to increased lending risks and have a negative effect on our results of operations.We continue to focus on originating commercial business, commercial real estate and multi-family residential real estate loans. These types of loans generallyhave a higher risk of loss compared to our one- to four-family residential real estate loans. Commercial business loans may expose us to greater credit risk than loanssecured by residential real estate because the collateral securing these loans may not be sold as easily as residential real estate. In addition, commercial business andcommercial real estate loans may also involve relatively large loan balances to individual borrowers or groups of borrowers. These loans also have greater credit riskthan residential real estate loans as repayment is generally dependent upon the successful operation of the borrower's business. Also, the collateral underlyingcommercial business loans may fluctuate in value. Some of our commercial business loans are collateralized by equipment, inventory, accounts receivable or otherbusiness assets, and the liquidation of collateral in the event of default is often an insufficient source of repayment because accounts receivable may be uncollectibleand inventories may be obsolete or of limited use. Multi-family residential real estate and commercial real estate loans involve increased risk because repayment isdependent on income being generated in amounts sufficient to cover property maintenance and debt service. In addition, if loans that are collateralized by real estatebecome troubled and the value of the real estate has been significantly impaired, then we may not be able to recover the full contractual amount of principal andinterest that we anticipated at the time we originated the loan, which could cause us to increase our provision for loan losses and adversely affect our financialcondition and results of operations.Secondary mortgage market conditions could have a material impact on our financial condition and results of operations.Our mortgage banking operations provide a significant portion of our non-interest income. In addition to being affected by interest rates, the secondarymortgage markets are also subject to investor demand for residential mortgage loans and increased investor yield requirements for these loans. These conditions mayfluctuate or worsen in the future. In light of current conditions, there is greater risk in retaining mortgage loans pending their sale to investors. We believe our abilityto retain fixed-rate residential mortgage loans is limited. As a result, a prolonged period of secondary market illiquidity may reduce our loan production volumes andcould have a material adverse effect on our financial condition and results of operations.Changes in the programs offered by secondary market purchasers or our ability to qualify for their programs may reduce our mortgage banking revenues, whichwould negatively impact our non-interest income.We generate mortgage revenues primarily from gains on the sale of single-family mortgage loans pursuant to programs currently offered by Fannie Mae,Freddie Mac, Ginnie Mae and non-GSE investors. These entities account for a substantial portion of the secondary market in residential mortgage loans. Any futurechanges in these programs, our eligibility to participate in such programs, the criteria for loans to be accepted or laws that significantly affect the activity of suchentities could, in turn, materially adversely affect our results of operations. If we are required to repurchase mortgage loans that we have previously sold, it would negatively affect our earningsOne of our primary business operations is our mortgage banking, which involves originating residential mortgage loans for sale in the secondary marketunder agreements that contain representations and warranties related to, among other things, the origination and characteristics of the mortgage loans. We may berequired to repurchase mortgage loans that we have sold in cases of borrower default or breaches of these representations and warranties. If we are required torepurchase mortgage loans or provide indemnification or other recourse, this could increase our costs and thereby affect our future earnings.- 29 -Recent regulations could restrict our ability to originate and sell loans.The Consumer Financial Protection Bureau has issued a rule designed to clarify for lenders how they can avoid legal liability under the Dodd-Frank Act,which would hold lenders accountable for ensuring a borrower's ability to repay a mortgage. Loans that meet this "qualified mortgage" definition will be presumed tohave complied with the new ability-to-repay standard. Under the Consumer Financial Protection Bureau's rule, a "qualified mortgage" loan must not contain certainspecified features, including: ●excessive upfront points and fees (those exceeding 3% of the total loan amount, less "bona fide discount points" for prime loans); ●interest-only payments; ●negative-amortization; and ●terms longer than 30 years Also, to qualify as a "qualified mortgage," a borrower's total monthly debt-to-income ratio may not exceed 43%. Lenders must also verify and document theincome and financial resources relied upon to qualify the borrower for the loan and underwrite the loan based on a fully amortizing payment schedule and maximuminterest rate during the first five years, taking into account all applicable taxes, insurance and assessments.In addition, the Dodd-Frank Act requires the regulatory agencies to issue regulations that require securitizers of loans to retain not less than 5% of the creditrisk for any asset that is not a "qualified residential mortgage."Furthermore, the Dodd-Frank Act requires the Consumer Finance Protection Bureau to adopt rules and publish forms that combine certain disclosures thatconsumers receive in connection with applying for and closing on certain mortgage loans under the Truth in Lending Act and the Real Estate Settlement ProceduresAct. The Consumer Financial Protection Bureau has implemented a final rule to implement this requirement, and the final rule was effective in October 2015.We currently sell in the secondary market the significant majority of the one- to four-family residential real estate loans that we originate. These finalrules could have a significant effect on the secondary market for loans and the types of loans we originate, and restrict our ability to make loans, any of which couldlimit our growth or profitability.Changes in economic conditions could adversely affect our earnings, as our borrowers' ability to repay loans and the value of the collateral securing our loansdecline. Economic conditions have an impact, to some extent, on our overall performance. Conditions such as an economic recession, rising unemployment,changes in interest rates, money supply and other factors beyond our control may adversely affect our asset quality, deposit levels and loan demand and, therefore,our earnings. Because a majority of our loans are secured by real estate, decreases in real estate values could adversely affect the value of property used as collateral.Adverse changes in the economy may also have a negative effect on the ability of our borrowers to make timely repayments of their loans, which could have anadverse impact on our earnings. Consequently, declines in the economy in our market area could have a material adverse effect on our financial condition and resultsof operations.If our allowance for loan losses is not sufficient to cover actual loan losses, our results of operations would be negatively affected.In determining the amount of the allowance for loan losses, we analyze our loss and delinquency experience by loan categories and we consider the effect ofexisting economic conditions. In addition, we make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthinessof our borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. If the results of our analyses areincorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our loan portfolio, which would require additions to our allowance and woulddecrease our net income. Our emphasis on loan growth and on increasing our portfolio of commercial real estate loans, as well as any future credit deterioration, couldrequire us to increase our allowance further in the future.The Financial Accounting Standards Board has adopted a new accounting standard that will be effective for us for our first fiscal year after December 15,2019. This standard, referred to as Current Expected Credit Loss, or CECL, will require financial institutions to determine periodic estimates of lifetime expected creditlosses on loans, and recognize the expected credit losses as allowances for loan losses. This will change the current method of providing allowances for loan lossesthat are probable, which may require us to increase our allowance for loan losses, and to greatly increase the types of data we would need to collect and review todetermine the appropriate level of the allowance for loan losses. Any resulting increase in our allowance for loan losses or expenses incurred to determine theappropriate level of the allowance for loan losses may have a material adverse effect on our results of operations and financial condition.In addition, bank regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize furtherloan charge-offs. Any increase in our allowance for loan losses or loan charge-offs as required by these regulatory authorities may have a material adverse effect onour results of operations and financial condition.Because most of our borrowers are located in the Milwaukee, Wisconsin metropolitan area, a prolonged downturn in the local economy, or a decline in local realestate values, could cause an increase in nonperforming loans or a decrease in loan demand, which would reduce our profits.Substantially all of our loans are secured by real estate located in our primary market area. Weakness in our local economy and our local real estate marketscould adversely affect the ability of our borrowers to repay their loans and the value of the collateral securing our loans, which could adversely affect our results ofoperations. Real estate values are affected by various factors, including supply and demand, changes in general or regional economic conditions, interest rates,governmental rules or policies and natural disasters. Weakness in economic conditions also could result in reduced loan demand and a decline in loan originations. Inparticular, a significant decline in real estate values would likely lead to a decrease in new loan originations and increased delinquencies and defaults by ourborrowers.- 30 -Strong competition within our market areas may limit our growth and profitability.Competition in the banking and financial services industry is intense. In our market areas, we compete with commercial banks, savings institutions, mortgagebrokerage firms, credit unions, finance companies, mutual funds, money market funds, insurance companies, and brokerage firms operating locally and elsewhere. Some of our competitors have greater name recognition and market presence and offer certain services that we do not or cannot provide, all of which benefit them inattracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we do.Financial reform legislation is expected to increase our costs of operations.The Dodd-Frank Act has significantly changed the regulation of banks and savings institutions and affects the lending, deposit, investment, trading andoperating activities of financial institutions and their holding companies. The Dodd-Frank Act requires various federal agencies to adopt a broad range of newimplementing rules and regulations, and to prepare numerous studies and reports for Congress. The federal agencies have been given significant discretion indrafting the implementing rules and regulations, many of which are not in final form. As a result, we cannot at this time predict the extent to which the Dodd-Frank Actwill impact our business, operations or financial condition. However, compliance with the Dodd-Frank Act and its implementing regulations and policies has alreadyresulted in changes to our business and operations, as well as additional costs, and diverted management's time from other business activities, which adverselyaffects our financial condition and results of operations. Non-compliance with the USA PATRIOT Act, Bank Secrecy Act, or other laws and regulations could result in fines or sanctions.The USA PATRIOT and Bank Secrecy Acts require financial institutions to develop programs to prevent financial institutions from being used for moneylaundering and terrorist activities. If such activities are detected, financial institutions are obligated to file suspicious activity reports with the U.S. Treasury's Office ofFinancial Crimes Enforcement Network. These rules require financial institutions to establish procedures for identifying and verifying the identity of customersseeking to open new financial accounts. Failure to comply with these regulations could result in fines or sanctions. During the last year, several banking institutionshave received large fines for non-compliance with these laws and regulations. While we have developed policies and procedures designed to assist in compliancewith these laws and regulations, these policies and procedures may not be effective in preventing violations of these laws and regulations.Changes in our accounting policies or in accounting standards could materially affect how we report our financial condition and results of operations.Our accounting policies are essential to understanding our financial condition and results of operations. Some of these policies require the use of estimatesand assumptions that may affect the value of our assets or liabilities and financial results. Some of our accounting policies are critical because they requiremanagement to make difficult, subjective, and complex judgments about matters that are inherently uncertain, and because it is likely that materially different amountswould be reported under different conditions or using different assumptions. If such estimates or assumptions underlying our financial statements are incorrect, wemay experience material losses.From time to time, the Financial Accounting Standards Board and the Securities and Exchange Commission change the financial accounting and reportingstandards or the interpretation of those standards that govern the preparation of our financial statements. These changes are beyond our control, can be hard topredict and could materially affect how we report our financial condition and results of operations. We could also be required to apply a new or revised standardretroactively, which may result in our restating our prior period financial statements.The need to account for certain assets at estimated fair value may adversely affect our results of operations.We report certain assets, such as loans held for sale, at estimated fair value. Generally, for assets that are reported at fair value, we use quoted market pricesor valuation models that utilize observable market inputs to estimate fair value. Because we carry these assets on our books at their estimated fair value, we may incurlosses even if the asset in question presents minimal credit risk.Changes in the valuation of our securities portfolio could adversely affect our profits.Our securities portfolio may be impacted by fluctuations in market value, potentially reducing accumulated other comprehensive income and/or earnings. Fluctuations in market value may be caused by changes in market interest rates, lower market prices for securities and limited investor demand. Managementevaluates securities for other-than-temporary impairment on a monthly basis, with more frequent evaluation for selected issues. In analyzing a debt issuer's financialcondition, management considers whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies haveoccurred, industry analysts' reports and, to a lesser extent given the relatively insignificant levels of depreciation in our debt portfolio, spread differentials between theeffective rates on instruments in the portfolio compared to risk-free rates. In analyzing an equity issuer's financial condition, management considers industry analysts'reports, financial performance and projected target prices of investment analysts within a one-year time frame. If this evaluation shows impairment to the actual orprojected cash flows associated with one or more securities, a potential loss to earnings may occur. Changes in interest rates can also have an adverse effect on ourfinancial condition, as our available-for-sale securities are reported at their estimated fair value, and therefore are impacted by fluctuations in interest rates. Weincrease or decrease our stockholders' equity by the amount of change in the estimated fair value of the available-for-sale securities, net of taxes. The declines inmarket value could result in other-than-temporary impairments of these assets, which would lead to accounting charges that could have a material adverse effect onour net income and capital levels. Because the nature of the financial services business involves a high volume of transactions, we face significant operational risks.We operate in diverse markets and rely on the ability of our employees and systems to process a high number of transactions. Operational risk is the risk ofloss resulting from our operations, including but not limited to, the risk of fraud by employees or persons outside our company, the execution of unauthorizedtransactions by employees, errors relating to transaction processing and technology, breaches of the internal control system and compliance requirements, andbusiness continuation and disaster recovery. Insurance coverage may not be available for such losses, or where available, such losses may exceed insurance limits.This risk of loss also includes the potential legal actions that could arise as a result of an operational deficiency or as a result of noncompliance with applicableregulatory standards, adverse business decisions or their implementation, and customer attrition due to potential negative publicity. In the event of a breakdown inthe internal control system, improper operation of systems or improper employee actions, we could suffer financial loss, face regulatory action, and suffer damage toour reputation.- 31 -Risks associated with system failures, interruptions, or breaches of security could negatively affect our earnings.Information technology systems are critical to our business. We use various technology systems to manage our customer relationships, general ledger,securities investments, deposits and loans. We have established policies and procedures to prevent or limit the effect of system failures, interruptions, and securitybreaches, but such events may still occur or may not be adequately addressed if they do occur. In addition, any compromise of our systems could deter customersfrom using our products and services. Although we rely on security systems to provide security and authentication necessary to effect the secure transmission ofdata, these precautions may not protect our systems from security breaches.In addition, we outsource a majority of our data processing to certain third-party providers. If these third-party providers encounter difficulties, or if we havedifficulty communicating with them, our ability to adequately process and account for transactions could be affected, and our business operations could be adverselyaffected. Threats to information security also exist in the processing of customer information through various other vendors and their personnel.The occurrence of any system failures, interruption, or breach of security could damage our reputation and result in a loss of customers and businessthereby subjecting us to additional regulatory scrutiny, or could expose us to litigation and possible financial liability. Any of these events could have a materialadverse effect on our financial condition and results of operations.Our risk management framework may not be effective in mitigating risk and reducing the potential for significant losses.Our risk management framework is designed to minimize risk and loss to us. We seek to identify, measure, monitor, report and control our exposure to risk,including strategic, market, liquidity, compliance and operational risks. While we use a broad and diversified set of risk monitoring and mitigation techniques, thesetechniques are inherently limited because they cannot anticipate the existence or future development of currently unanticipated or unknown risks. Recent economicconditions and heightened legislative and regulatory scrutiny of the financial services industry, among other developments, have increased our level of risk.Accordingly, we could suffer losses as a result of our failure to properly anticipate and manage these risks.Our business may be adversely affected by an increasing prevalence of fraud and other financial crimes.Our loans to businesses and individuals and our deposit relationships and related transactions are subject to exposure to the risk of loss due to fraud andother financial crimes. We have experienced losses due to apparent fraud and other financial crimes. While we have policies and procedures designed to preventsuch losses, losses may still occur.Acquisitions may disrupt our business and dilute stockholder value.We regularly evaluate merger and acquisition opportunities with other financial institutions and financial services companies. As a result, negotiations maytake place and future mergers or acquisitions involving cash, debt, or equity securities may occur at any time. We would seek acquisition partners that offer us eithersignificant market presence or the potential to expand our market footprint and improve profitability through economies of scale or expanded services. Acquiring other banks, businesses, or branches may have an adverse effect on our financial results and may involve various other risks commonlyassociated with acquisitions, including, among other things: ●difficulty in estimating the value of the target company; ●payment of a premium over book and market values that may dilute our tangible book value and earnings per share in the short and long term; ●potential exposure to unknown or contingent tax or other liabilities of the target company; ●exposure to potential asset quality problems of the target company; ●potential volatility in reported income associated with goodwill impairment losses; ●difficulty and expense of integrating the operations and personnel of the target company; ●inability to realize the expected revenue increases, cost savings, increases in geographic or product presence, and/or other projected benefits; ●potential disruption to our business; ●potential diversion of our management's time and attention; ●the possible loss of key employees and customers of the target company; and ●potential changes in banking or tax laws or regulations that may affect the target company. - 32 -Various factors may make takeover attempts more difficult to achieve.Our articles of incorporation and bylaws, federal regulations, Maryland law, shares of restricted stock and stock options that we have granted or may grantto employees and directors and stock ownership by our management and directors, and various other factors may make it more difficult for companies or persons toacquire control of Waterstone Financial without the consent of our board of directors. A shareholder may want a takeover attempt to succeed because, for example, apotential acquiror could offer a premium over the then prevailing price of our common stock. Legal and regulatory proceedings and related matters could adversely affect us or the financial services industry in general.We, and other participants in the financial services industry upon whom we rely to operate, have been and may in the future become involved in legal andregulatory proceedings. Most of the proceedings we consider to be in the normal course of our business or typical for the industry; however, it is inherently difficultto assess the outcome of these matters, and other participants in the financial services industry or we may not prevail in any proceeding or litigation. There could besubstantial cost and management diversion in such litigation and proceedings, and any adverse determination could have a materially adverse effect on our business,brand or image, or our financial condition and results of our operations.Our funding sources may prove insufficient to replace deposits at maturity and support our future growth.We must maintain sufficient funds to respond to the needs of depositors and borrowers. As a part of our liquidity management, we use a number of fundingsources in addition to core deposit growth and repayments and maturities of loans and investments. As we continue to grow, we are likely to become more dependenton these sources, which may include Federal Home Loan Bank advances, proceeds from the sale of loans, federal funds purchased and brokered certificates ofdeposit. Adverse operating results or changes in industry conditions could lead to difficulty or an inability to access these additional funding sources. Our financialflexibility will be severely constrained if we are unable to maintain our access to funding or if adequate financing is not available to accommodate future growth atacceptable interest rates. If we are required to rely more heavily on more expensive funding sources to support future growth, our revenues may not increaseproportionately to cover our costs. In this case, our operating margins and profitability would be adversely affected.We are subject to environmental liability risk associated with lending activitiesA significant portion of our loan portfolio is secured by real estate, and we could become subject to environmental liabilities with respect to one or more ofthese properties. During the ordinary course of business, we may foreclose on and take title to properties securing defaulted loans. In doing so, there is a risk thathazardous or toxic substances could be found on these properties. If hazardous conditions or toxic substances are found on these properties, we may be liable forremediation costs, as well as for personal injury and property damage, civil fines and criminal penalties regardless of when the hazardous conditions or toxicsubstances first affected any particular property. Environmental laws may require us to incur substantial expenses to address unknown liabilities and may materiallyreduce the affected property's value or limit our ability to use or sell the affected property. In addition, future laws or more stringent interpretations or enforcementpolicies with respect to existing laws may increase our exposure to environmental liability. Although we have policies and procedures to perform an environmentalreview before initiating any foreclosure action on nonresidential real property, these reviews may not be sufficient to detect all potential environmental hazards. Theremediation costs and any other financial liabilities associated with an environmental hazard could have a material adverse effect on us.Item 1B. Unresolved Staff CommentsNone - 33 -Item 2. PropertiesWe operate from our corporate center, our 11 full-service banking offices, our drive-through office and 11 automated teller machines, located in Milwaukee,Washington and Waukesha Counties, Wisconsin. In addition, we operate a loan production office in Minneapolis, Minnesota. The net book value of our premises,land, equipment and leasehold improvements was $23.7 million at December 31, 2016. The following table sets forth information with respect to our corporate centerand our full-service banking offices as of February 28, 2017.Corporate Center11200 West Plank CourtWauwatosa, Wisconsin 53226Wauwatosa7500 West State StreetWauwatosa, Wisconsin 53213Brookfield (1)17495 W Capitol Dr.Brookfield, WI 53045 Franklin/Hales Corners6555 South 108th StreetFranklin, Wisconsin 53132Germantown/Menomonee FallsW188N9820 Appleton AvenueGermantown, Wisconsin 53022Oak Creek6560 South 27th StreetOak Creek, Wisconsin 53154 Oconomowoc/Lake Country (1)1233 Corporate Center DriveOconomowoc, Wisconsin 53066Pewaukee1230 George Towne DrivePewaukee, Wisconsin 53072Waukesha/Brookfield21505 East Moreland Blvd.Waukesha, Wisconsin 53186 West Allis10101 West Greenfield AvenueWest Allis, Wisconsin 53214Fox Point8607 North Port Washington RoadFox Point, WI 53217Greenfield5000 West Loomis RoadGreenfield, WI 53220 Commercial Real Estate Loan Production Office (1)701 Washington Avenue NSuite 525Minneapolis, MN 55401 (1)Leased propertyIn addition to our banking offices, as of December 31, 2016, our mortgage banking operation had 15 offices in Wisconsin, 13 offices in Florida, nine offices inPennsylvania, six offices in Minnesota, five offices in Indiana, Ohio, and Texas, two offices in each of Arizona, California, Maryland, and Virginia, and one office ineach of Colorado, Georgia, Idaho, Illinois, Iowa, Maine, Massachusetts, New Hampshire, Oregon, Tennessee, and Washington. Item 3. Legal ProceedingsWaterStone Bank and its wholly owned subsidiary, Waterstone Mortgage Corporation are involved in various legal actions arising in the normal course ofbusiness, including the proceeding specifically discussed below. While the ultimate outcome of pending proceedings cannot be predicted with certainty, it is theopinion of management, after consultation with counsel representing us in such proceedings, that the resolution of these proceedings will not have a material adverseeffect on our consolidated financial position or results of operation.Herrington, et al. v. Waterstone Mortgage CorporationWaterstone Mortgage Corporation is a defendant in a lawsuit that was filed in the Federal District Court for the Western District of Wisconsin and has beentransferred to arbitration alleging that Waterstone Mortgage Corporation violated the Fair Labor Standards Act and failed to pay loan officers consistent with theirvarious contracts. Waterstone Mortgage Corporation is and will continue to vigorously defend its interests in this matter..Item 4. Mine Safety DisclosuresNot applicable- 34 -Part IIItem 5. Market for Registrant's Common Equity and Related Stockholder Matters and Issuer Purchase of Equity SecuritiesOur shares of common stock are traded on the NASDAQ Global Select Market® under the symbol WSBF. The approximate number of shareholders of recordof Waterstone common stock as of February 28, 2017 was 1,691. On that same date there were 29,446,462 shares of common stock issued and outstanding.The Company did not make any monthly common stock purchases during the fourth quarter of 2016. Period TotalNumber ofSharesPurchased AveragePrice Paidper Share Total Number ofSharesPurchasedas Part ofPubliclyAnnouncedPlans MaximumNumber ofShares thatMayYet BePurchasedUnderthe Plan(a) October 1, 2016 - October 31, 2016 - $- - 989,500 November 1, 2016 - November 30, 2016 - - - 989,500 December 1, 2016 - December 31, 2016 - - - 989,500 Total - $- - 989,500 (a) On September 4, 2015, the Board of Directors terminated the existing plan and authorized the repurchase of 1,500,000 shares of common stock. The following table presents the high and low quarterly trading prices and dividends declared for Waterstone Financial's common stock for the years endedDecember 31, 2016 and 2015. 2016 High Low DividendsDeclared 1st Quarter $14.12 $13.42 $0.05 2nd Quarter 15.33 13.69 0.08 3rd Quarter 17.08 15.15 0.08 4th Quarter 19.20 16.50 0.12 2015 High Low DividendsDeclared 1st Quarter $13.24 $12.67 $0.05 2nd Quarter 13.28 12.70 0.05 3rd Quarter 13.60 12.43 0.05 4th Quarter 14.44 13.14 0.05 The plan governing the conversion of Lamplighter Financial, MHC (the "MHC") to stock form provided for the establishment of special "liquidationaccounts" for the benefit of certain depositors of WaterStone Bank in an amount equal to the greater of the MHC's ownership interest in the retained earnings of theCompany as of the date of the latest balance sheet contained in the prospectus utilized in the 2014 stock offering or the retained earnings of Waterstone Bank at thetime it reorganized into the MHC. Following the completion of the conversion, under the rules of the Board of Governors of the Federal Reserve System, WaterStoneBank is not permitted to pay dividends on its capital stock to Waterstone Financial, its sole shareholder, if WaterStone Bank's shareholder's equity would be reducedbelow the amount of the liquidation accounts. The liquidation accounts will be reduced annually to the extent that eligible account holders have reduced theirqualifying deposits. Subsequent increases will not restore an eligible account holder's interest in the liquidation accounts.The future payment of dividends will depend upon a number of factors, including capital requirements, our financial condition and results of operations, taxconsiderations, statutory and regulatory limitations and general economic conditions and regulatory restrictions that affect our ability to pay dividends. We cannotassure you that any dividends will not be reduced or eliminated in the future. Special cash or stock dividends, to the extent permitted by applicable policy andregulation, may be paid in addition to, or in lieu of, regular cash dividends. - 35 -PERFORMANCE GRAPHSet forth below is a line graph comparing the cumulative total shareholder return on Waterstone Financial common stock, based on the market price of thecommon stock and assuming reinvestment of cash dividends, with the cumulative total return of companies on the SNL Thrift NASDAQ Index and the Russell 2000.The graph assumes $100 was invested on December 31, 2011, in Waterstone Financial, Inc. common stock and each of those indices.Waterstone Financial, Inc.Index12/31/1112/31/1212/31/1312/31/1412/31/1512/31/16Waterstone Financial, Inc.100.00412.70587.30773.86842.481,118.36SNL Thrift NASDAQ index100.00119.34151.33167.60191.52243.50Russell 2000100.00116.35161.52169.43161.95196.45 - 36 -Item 6. Selected Financial DataSELECTED CONSOLIDATED FINANCIAL AND OTHER DATAThe summary financial information presented below is derived in part from the Company's audited financial statements, although the table itself is not audited. Thefollowing data should be read together with the Company's consolidated financial statements and related notes and "Management's Discussion and Analysis ofFinancial Condition and Results of Operations" later in this report. The Company's subscription offering related to its second-step conversion closed on December 17,2013. As a result, cash and cash equivalents and deposits at December 31, 2013 include $388.7 million in proceeds from the offering. Upon completion of the offeringon January 22, 2014, $253.0 million of the proceeds were used to purchase shares by shareholders and the remaining oversubscribed funds were returned tosubscribers. The result has a significant impact on certain comparative balance sheet totals and on ratios that are based on those numbers. At or for the Year Ended December 31, 2016 2015 2014 2013 2012 (In Thousands, except per share amounts) Selected Financial Condition Data: Total assets $1,790,619 $1,762,729 $1,783,380 $1,947,039 $1,661,076 Cash and cash equivalents 47,217 100,471 172,820 429,169 71,469 Securities available for sale 226,795 269,658 273,443 213,418 205,017 Loans held for sale 225,248 166,516 125,073 97,021 133,613 Loans receivable 1,177,884 1,114,934 1,094,990 1,092,676 1,133,672 Allowance for loan losses 16,029 16,185 18,706 24,264 31,043 Loans receivable, net 1,161,855 1,098,749 1,076,284 1,068,412 1,102,629 Real estate owned, net 6,118 9,190 18,706 22,663 35,974 Deposits 949,411 893,361 863,960 1,244,741 939,513 Borrowings 387,155 441,203 434,000 455,197 479,888 Total shareholders' equity 410,690 391,930 450,237 214,472 202,634 Selected Operating Data: Interest income $63,736 $61,963 $63,634 $62,864 $69,846 Interest expense 20,292 23,119 22,327 23,658 27,901 Net interest income 43,444 38,844 41,307 39,206 41,945 Provision for loan losses 380 1,965 1,150 4,532 8,300 Net interest income after provision for loan losses 43,064 36,879 40,157 34,674 33,645 Noninterest income 126,365 104,474 84,568 87,799 91,203 Noninterest expense 127,435 115,534 104,818 99,144 102,138 Income before income taxes 41,994 25,819 19,907 23,329 22,710 Provision for income taxes (benefit) 16,462 9,249 7,175 8,621 (12,204) Net income $25,532 $16,570 $12,732 $14,708 $34,914 Per common share: Income per share - basic $0.94 $0.57 $0.38 $0.43 $1.02 Income per share - diluted $0.93 $0.56 $0.38 $0.43 $1.02 Book value $13.95 $13.33 $13.08 $6.84 $6.52 Dividends declared $0.33 $0.20 $0.20 N/A N/A - 37 - At or for the Year Ended December 31, 20162015201420132012Selected Financial Ratios and Other Data: Performance Ratios: Return on average assets1.45 %0.94 %0.71 %0.90%2.07%Return on average equity6.333.992.897.0118.89Interest rate spread (1)2.261.912.032.362.45Net interest margin (2)2.642.362.442.562.62Noninterest expense to average assets7.246.585.826.056.04Efficiency ratio (3)75.0580.6183.2778.3176.71Average interest-earning assets to average interest-bearingliabilities130.56131.54139.98113.96109.84Dividend payout ratio (4)27.6635.2052.48N/AN/A Capital Ratios: Waterstone Financial, Inc.: Equity to total assets at end of period22.94 %22.23 %25.25 %11.02 %12.20 %Average equity to average assets22.9023.6224.5112.8210.94Total capital to risk-weighted assets32.2333.4141.25N/AN/ATier 1 capital to risk-weighted assets31.0232.1639.99N/AN/ACommon equity tier 1 capital to risk-weighted assets31.0232.16N/AN/AN/ATier 1 capital to average assets23.2022.2024.80N/AN/AWaterStone Bank: Total capital to risk-weighted assets29.5030.9231.9821.6717.34Tier I capital to risk-weighted assets28.2929.6730.7320.4116.07Common equity tier 1 capital to risk-weighted assets28.2929.67N/AN/AN/ATier I capital to average assets21.1720.4519.0412.4811.13 Asset Quality Ratios: Allowance for loan losses as a percent of total loans1.36 %1.45 %1.71 %2.22 %2.74 %Allowance for loan losses as a percent of non-performing loans162.6291.9449.2147.6141.58Net charge-offs to average outstanding loans during the period0.050.370.550.940.76Non-performing loans as a percent of total loans0.841.583.474.666.59Non-performing assets as a percent of total assets0.891.523.183.786.66 Other Data: Number of full-service banking offices1111988Number of full-time equivalent employees895770731849726(1) Represents the difference between the weighted average yield on average interest-earning assets and the weighted average cost of interest-bearing liabilities.(2) Represents net interest income as a percent of average interest-earning assets.(3) Represents non-interest expense divided by the sum of net interest income and noninterest income.(4) Represents dividends paid per share divided by basic earnings per share.N/A - Not applicable - 38 -Item 7. Management's Discussion and Analysis of Financial Condition and Results of OperationsOverviewThe following discussion and analysis is presented to assist the reader in understanding and evaluating of the Company's financial condition and results ofoperations. It is intended to complement the consolidated financial statements, footnotes, and supplemental financial data appearing elsewhere in this Form 10-K andshould be read in conjunction therewith. The detailed discussion in the sections below focuses on the results of operations for the years ended December 31, 2016,2015, and 2014 and the financial condition as of December 31, 2016 compared to the financial condition as of December 31, 2015.As described in the notes to consolidated financial statements, we have two reportable segments: community banking and mortgage banking. Thecommunity banking segment provides consumer and business banking products and services to customers. Consumer products include loan products, depositproducts, and personal investment services. Business banking products include loans for working capital, inventory and general corporate use, commercial real estateconstruction loans, and deposit accounts. The mortgage banking segment, which is conducted through Waterstone Mortgage Corporation, consists of originatingresidential mortgage loans primarily for sale in the secondary market.Our community banking segment generates the significant majority of our consolidated net interest income and requires the significant majority of ourprovision for loan losses. Our mortgage banking segment generates the significant majority of our noninterest income and a majority of our noninterest expenses. Wehave provided below a discussion of the material results of operations for each segment on a separate basis for the years ended December 31, 2016, 2015, and 2014,which focuses on noninterest income and noninterest expenses. We have also provided a discussion of the consolidated operations of Waterstone Financial, whichincludes the consolidated operations of WaterStone Bank and Waterstone Mortgage Corporation, for the same periods.Critical Accounting PoliciesCritical accounting policies are those that involve significant judgments and assumptions by management and that have, or could have, a material impact onour income or the carrying value of our assets.Allowance for Loan Losses. WaterStone Bank establishes valuation allowances on loans deemed to be impaired. A loan is considered impaired when, basedon current information and events, it is probable that WaterStone Bank will not be able to collect all amounts due according to the contractual terms of the loanagreement. A valuation allowance is established for an amount equal to the impairment when the carrying amount of the loan exceeds the present value of theexpected future cash flows, discounted at the loan's original effective interest rate or the fair value of the underlying collateral (specific component). The Companyrecognizes the change in present value of expected future cash flows on impaired loans attributable to the passage of time as bad debt expense. On an ongoing basis,at least quarterly for financial reporting purposes, the fair value of collateral dependent impaired loans and real estate owned is determined or reaffirmed by thefollowing procedures: ●Obtaining updated real estate appraisals or performing updated discounted cash flow analysis; ●Confirming that the physical condition of the real estate has not significantly changed since the last valuation date; ●Comparing the estimated current book value to that of updated sales values experienced on similar real estate owned; ●Comparing the estimated current book value to that of updated values seen on more current appraisals of similar properties; and ●Comparing the estimated current book value to that of updated listed sales prices on our real estate owned and that of similar properties (not ownedby the Company).WaterStone Bank also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the credit portfolio(general component). The risk components that are evaluated include past loan loss experience; the level of non-performing and classified assets; current economicconditions; volume, growth, and composition of the loan portfolio; adverse situations that may affect the borrower's ability to repay; the estimated value of anyunderlying collateral; regulatory guidance; and other relevant factors. The allowance is increased by provisions charged to earnings and recoveries of previouslycharged-off loans and reduced by charge-offs. Charge-offs approximate the amount by which the outstanding principal balance exceeds the estimated net realizablevalue of the underlying collateral. The appropriateness of the allowance for loan losses is reviewed and approved quarterly by the WaterStone Bank Board ofDirectors. The allowance reflects management's best estimate of the amount needed to provide for the probable loss on impaired loans and other inherent losses in theloan portfolio, and is based on a risk model developed and implemented by management and approved by the WaterStone Bank Board of Directors.Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in loan quality andeconomic conditions. More specifically, if our future charge-off experience increases substantially from our past experience, or if the value of underlying loancollateral, in our case mostly real estate, declines in value by a substantial amount, or if unemployment in our primary market area increases significantly, our allowancefor loan losses may be inadequate and we will incur higher provisions for loan losses and lower net income in the future.In addition, state and federal regulators periodically review the WaterStone Bank allowance for loan losses. Such regulators have the authority to requireWaterStone Bank to recognize additions to the allowance at the time of their examination. Income Taxes. The Company and its subsidiaries file consolidated federal, combined state income tax, and separate state income tax returns. The provisionfor income taxes is based upon income in the consolidated financial statements, rather than amounts reported on the income tax return. Deferred tax assets andliabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilitiesand their respective tax bases as well as for net operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected toapply 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 achange in tax rates is recognized as income or expense in the period that includes the enactment date. Under generally accepted accounting principles, a valuation allowance is required to be recognized if it is "more likely than not" that a deferred tax asset willnot be realized. The determination of the realizability of deferred tax assets is highly subjective and dependent upon judgment concerning management's evaluation ofboth positive and negative evidence, the forecasts of future income, applicable tax planning strategies, and assessments of current and future economic and businessconditions. Examples of positive evidence may include the existence of taxes paid in available carry-back years as well as the probability that taxable income will begenerated in future periods. Examples of negative evidence may include cumulative losses in a current year and prior two years and general business and economictrends.- 39 -Positions taken in the Company's tax returns are subject to challenge by the taxing authorities upon examination. The benefit of uncertain tax positions areinitially recognized in the financial statements only when it is more likely than not that the position will be sustained upon examination by the tax authorities. Such taxpositions are both initially and subsequently measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon settlementwith the tax authority, assuming full knowledge of the position and all relevant facts. Interest and penalties on income tax uncertainties are classified within income taxexpense in the income statement.Fair Value Measurements. The Company determines the fair value of its assets and liabilities in accordance with ASC 820. ASC 820 establishes a standardframework for measuring and disclosing fair value under generally accepted accounting principles. A number of valuation techniques are used to determine the fairvalue of assets and liabilities in the Company's financial statements. The valuation techniques include quoted market prices for investment securities, appraisals ofreal estate from independent licensed appraisers and other valuation techniques. Fair value measurements for assets and liabilities where limited or no observablemarket data exists are based primarily upon estimates, and are often calculated based on the economic and competitive environment, the characteristics of the asset orliability and other factors. Therefore, the valuation results cannot be determined with precision and may not be realized in an actual sale or immediate settlement of theasset or liability. Additionally, there are inherent weaknesses in any calculation technique, and changes in the underlying assumptions used, including discount ratesand estimates of future cash flows, could significantly affect the results of current or future values. Significant changes in the aggregate fair value of assets andliabilities required to be measured at fair value or for impairment are recognized in the income statement under the framework established by generally acceptedaccounting principles.Recent Accounting Pronouncements. Refer to Note 1 of our consolidated financial statements for a description of recent accounting pronouncementsincluding the respective dates of adoption and effects on results of operations and financial condition.Comparison of Consolidated Waterstone Financial, Inc. Financial Condition at December 31, 2016 and at December 31, 2015Total Assets. Total assets increased by $27.9 million, or 1.6%, to $1.79 billion at December 31, 2016 from $1.76 billion at December 31, 2015. The increase intotal assets primarily reflects an increase in loans and loans held for sale offset by a reduction in cash and cash equivalents and securities available for sale. Fundingneeded for the loans receivable and loans held for sale was provided by a reduction of cash and cash equivalents and paydowns in securities available for sale.Cash and Cash Equivalents. Cash and cash equivalents decreased $53.3 million to $47.2 million at December 31, 2016 from $100.5 million at December 31,2015. The decrease in cash and cash equivalents primarily reflects the increase in loans receivable and loans held for sale. In addition, cash was used to pay downborrowings, purchase bank owned life insurance, and repurchase shares since December 31, 2015.Securities Available for Sale. Securities available for sale decreased by $42.9 million to $226.8 million at December 31, 2016 from $269.7 million at December31, 2015. The decrease was due to paydowns in mortgage related securities and maturities of debt securities exceeding security purchases for the year.Loans Held for Sale. Loans held for sale increased $58.7 million, or 35.3%, to $225.2 million at December 31, 2016 from $166.5 million at December 31, 2015. The increase related to increased fourth quarter funding volumes at our mortgage subsidiary compared to the fourth quarter of 2015. During the quarter endedDecember 31, 2016, $622.5 million in residential loans were funded compared to $441.0 million the fourth quarter of 2015.Loans Receivable. Loans receivable held for investment increased $63.0 million to $1.18 billion at December 31, 2016. The increase in total loans receivablewas primarily attributable to increases in the one- to four-family, multi-family, commercial real estate, and commercial loan categories. Offsetting those increases, thehome equity, construction and land, and consumer categories decreased slightly.Allowance for Loan Losses. The allowance for loan losses decreased $156,000 to $16.0 million at December 31, 2016 from $16.2 million at December 31, 2015. The decrease resulted from the charge-off of specific reserves and improvement of key loan quality metrics decreasing the allowance related to the loans collectivelyreviewed. The overall decrease was primarily related to the one- to four-family, multi-family, and home equity categories. Offsetting those decreases, the allowance forloan losses increased for the commercial loan category along with the commercial real estate and construction and land categories. Federal Home Loan Bank stock. Total Federal Home Loan Bank stock decreased $6.2 million from December 31, 2015. During the year ended December 31,2016, $12.5 million of stock was sold as $220.0 million Federal Home Loan Bank borrowings matured. A total of $6.3 million of stock was purchased when $100.0 millionof new long-term borrowings along with new short term borrowings were entered into with the Federal Home Loan Bank.Cash Surrender Value of Life Insurance. Total cash surrender value of life insurance increased $11.9 million, or 24.1%, from December 31, 2015. During theyear ended December 31, 2016, the Company purchased a $10.0 million bank owned life insurance policy, along with continued earnings aiding in increasing the policyvalues.Real Estate Owned. Total real estate owned decreased by $3.1 million, or 33.4%, to $6.1 million at December 31, 2016, compared to $9.2 million at December31, 2015. During the year ended December 31, 2016, $4.6 million was transferred from loans to real estate owned upon completion of foreclosure. During the sameperiod, sales of real estate owned totaled $7.0 million. Write-downs totaled $656,000 during the year ended December 31, 2016.Deposits. Deposits increased by $56.1 million to $949.4 million at December 31, 2016, from $893.4 million at December 31, 2015. The increase was driven by anincrease in more cost effective transaction accounts along with an increase in time deposits to help fund loan and loans held for sale growth and reduce our relianceon wholesale funding.Borrowings. Total borrowings decreased $54.0 million to $387.2 million at December 31, 2016, from $441.2 million at December 31, 2015. A total of $220.0million of fixed rate borrowings matured and were paid off during the current year. These were replaced with $100.0 million of new fixed rate long-term borrowings withthe Federal Home Loan Bank and with funds raised through our retail delivery channels. Short term borrowings increased $66.0 million at December 31, 2016 fromDecember 31, 2015 for both the community banking and mortgage banking segment to fund loans held for sale.Other Liabilities. Other liabilities increased $6.0 million at December 31, 2016 compared to December 31, 2015. The increase related to an increased dividendpayable from a dividend rate increase and increased accrued salaries at the mortgage banking segment with more fundings.- 40 -Shareholders' Equity. Shareholders' equity increased by $18.8 million, or 4.8%, to $410.7 million at December 31, 2016 from $391.9 million at December 31,2015. The increase in shareholders' equity was primarily due to net income, additional paid in capital as stock options were exercised, and the vesting of ESOP shares.These increases were offset by the repurchase of stock, dividends declared, along with accumulated other comprehensive income decreasing as the fair value of thesecurity portfolio decreased. Comparison of Community Banking Segment Operations for the Years Ended December 31, 2016 and 2015Net income from our community banking segment for the year ended December 31, 2016 totaled $14.0 million compared to net income of $8.3 million for theyear ended December 31, 2015. Net interest income increased $5.2 million to $42.9 million for the year ended December 31, 2016 compared to $37.7 million for the yearended December 31, 2015 due to an increase in average loan balances and a reduction in our overall cost of fundings. The long-term borrowings that matured werereplaced with a lower cost mix of funding, including long and short-term borrowings and deposits raised through our retail network. The provision for loan lossesdecreased $1.4 million compared to the prior year. Noninterest income increased $1.1 million to $4.6 million for the year ended December 31, 2016. The increase was mostly due to an increase in fees earned onloans, driven primarily by pre-payment activity.Compensation, payroll taxes, and other employee benefits expense increased $730,000 to $17.2 million due to increases in health insurance costs and ESOPexpense offset from the immediate vesting of 94,100 restricted share awards that amounted to $1.2 million in additional compensation expense in the prior year. Othernon-interest expenses increased from the prior year. Occupancy, office furniture, and equipment remained consistent to the prior year. FDIC insurance premiums andreal estate owned expenses decreased from the prior year as a direct result of improved asset quality metrics.Comparison of Mortgage Banking Segment Operations for the Years Ended December 31, 2016 and 2015Net income from our mortgage banking segment for the year ended December 31, 2016 totaled $12.3 million compared to net income of $8.3 million for the yearended December 31, 2015. We originated $2.38 billion in mortgage loans held for sale during the year ended December 31, 2016, which was an increase of $392.8million, or 19.8%, from the $1.99 billion originated during the year ended December 31, 2015, which was primarily responsible for an increase in total mortgage bankingincome of $21.8 million, or 21.9%, to $121.1 million during the year ended December 31, 2016 compared to $99.3 million during the year ended December 31, 2015. Theincrease in loan production volume was driven by a 20.1% increase in mortgage purchase products and a 27.4% increase in refinance products. In addition, marginsincreased for the year ended December 31, 2016 compared to December 31, 2015. We sell loans on both a servicing-released and a servicing retained basis. Waterstone Mortgage Corporation has contracted with a third party to service the loans for which we retain servicing.Our overall margin can be affected by the mix of both loan type (conventional loans versus governmental) and loan purpose (purchase versus refinance). Conventional loans include loans that conform to Fannie Mae and Freddie Mac standards, whereas governmental loans are those loans guaranteed by the federalgovernment, such as a Federal Housing Authority or U.S. Department of Agriculture loan. Loans originated for the purchase of a residential property, which generallyyield a higher margin than loans originated for refinancing existing loans, comprised 82.9% of total originations during the year ended December 31, 2016, compared to83.7% of total originations during the year ended December 31, 2015. The mix of loan type trended slightly towards more conventional loans and less governmentalloans comprising 65.1% and 34.9% of all loan originations, respectively, during the year ended December 31, 2016, compared 66.4% and 33.6% of all loan originations,respectively, during the year ended December 31, 2015.During the year ended December 31, 2016, no mortgage servicing rights were sold. During the year ended December 31, 2015, mortgage servicing rightsrelated to $580.2 million in loans receivable with a book value of $4.4 million were sold at a gain of $901,000. Total compensation, payroll taxes and other employee benefits increased $12.6 million, or 19.1%, to $78.3 million for the year ended December 31, 2016compared to $65.7 million for the year ended December 31, 2015. The increase in compensation expense was primarily a result of the increase in mortgage bankingincome, given our commission-based loan officer compensation model. Other noninterest expense increased $1.4 million to $17.5 million as fundings increased drivingmore volume-based expenses.Comparison of Consolidated Waterstone Financial, Inc. Results of Operations for the Years Ended December 31, 2016 and 2015 Years Ended December 31, 2016 2015 (Dollars in Thousands, except pershare amounts) Net income $25,532 16,570 Earnings per share - basic 0.94 0.57 Earnings per share - diluted 0.93 0.56 Return on assets 1.45% 0.94%Return on equity 6.33% 3.99% - 41 -Average Balance Sheets, Interest and Yields/Costs The following table set forth average balance sheets, annualized average yields and costs, and certain other information for the periods indicated. Non-accrual loans were included in the computation of the average balances of loans receivable and held for sale. The yields set forth below include the effect of deferredfees, discounts and premiums that are amortized or accreted to interest income or expense. Yields on interest-earning assets are computed on a fully tax-equivalentyield, where applicable. Years Ended December 31, 2016 2015 2014 Average Average Average Average Average Average Balance Interest Rate Balance Interest Rate Balance Interest Rate (Dollars in Thousands) Interest-earning assets: Loans receivable and held for sale(1) $1,291,955 57,185 4.43% $1,214,691 55,175 4.54% $1,215,051 57,316 4.72%Mortgage related securities (2) 153,980 3,048 1.98% 169,182 3,229 1.91% 164,468 2,996 1.82%Debt securities, federal funds soldandshort-term investments (2)(3) 198,475 4,317 2.18% 264,398 4,489 1.70% 311,548 4,192 1.35%Total interest-earningassets 1,644,410 64,550 3.93% 1,648,271 62,893 3.82% 1,691,067 64,504 3.81%Noninterest-earning assets 116,826 107,954 108,621 Total assets $1,761,236 $1,756,225 $1,799,688 Interest-bearing liabilities: Demand accounts $34,659 19 0.05% $31,295 20 0.06% $41,544 16 0.04%Money market and savingsaccounts 168,775 392 0.23% 143,174 197 0.14% 160,575 113 0.07%Certificates of deposit 674,310 6,953 1.03% 640,640 5,662 0.88% 640,858 4,797 0.75%Total interest-bearingdeposits 877,744 7,364 0.84% 815,109 5,879 0.72% 842,977 4,926 0.58%Borrowings 381,803 12,928 3.39% 437,964 17,240 3.94% 442,731 17,401 3.93%Total interest-bearingliabilities 1,259,547 20,292 1.61% 1,253,073 23,119 1.84% 1,285,708 22,327 1.74% Noninterest-bearing liabilities Non-interest bearingdeposits 76,016 65,965 50,212 Other non-interest bearingliabilities 22,426 22,282 22,739 Total non-interest bearingliabilities 98,442 88,247 72,951 Total liabilities 1,357,989 1,341,320 1,358,659 Equity 403,247 414,905 441,029 Total liabilities and equity $1,761,236 $1,756,225 $1,799,688 Net interest income / Net interestrate spread (4) 44,258 2.32% 39,774 1.98% 42,177 2.08%Less: taxable equivalentadjustment 814 0.05% 930 0.07% 870 0.05%Net interest income / Net interestrate spread, as reported 43,444 2.37% 38,844 1.91% 41,307 2.03%Net interest-earning assets (5) $384,863 $395,198 $405,359 Net interest margin (6) 2.64% 2.36% 2.44%Tax equivalent effect 0.05% 0.05% 0.05%Net interest margin on a fully taxequivalent basis 2.69% 2.41% 2.49%Average interest-earning assets toaverage interest-bearing liabilities 130.56% 131.54% 139.98% (1) Includes net deferred loan fee amortization income of $720,000, $573,000 and $627,000 for the years ended December 31, 2016, 2015 and 2014, respectively.(2) Average balance of available for sale securities is based on amortized historical cost.(3)Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 35% for all periods presented. The yields on debtsecurities, federal funds sold and short-term investments before tax-equivalent adjustments were 1.76%, 1.35%, and 1.07% for the years ended December 31, 2016,2015, and 2014, respectively.(4) Net interest rate spread represents the difference between the yield on average interest-earning assets and the cost of average interest-bearing liabilities and is presented on a fully tax equivalent basis..(5) Net interest-earning assets represent total interest-earning assets less total interest-bearing liabilities.(6) Net interest margin represents net interest income divided by average total interest-earning assets.- 42 -Rate/Volume AnalysisThe following table sets forth the effects of changing rates and volumes on our net interest income for the periods indicated. The rate column shows theeffects attributable to changes in rate (changes in rate multiplied by prior volume). The volume column shows the effects attributable to changes in volume (changesin volume multiplied by prior rate). The net column represents the sum of the prior columns. For purposes of this table, changes attributable to changes in both rateand volume that cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume. Years Ended December 31, Years Ended December 31, 2016 versus 2015 2015 versus 2014 Increase (Decrease) due to Increase (Decrease) due to Volume Rate Net Volume Rate Net (In Thousands) Interest and dividend income: Loans receivable and held for sale(1) (2) $3,446 $ (1,436) $2,010 $ (17) $ (2,124) $ (2,141)Mortgage related securities(3) (298) 117 (181) 87 146 233 Other interest-earning assets(3) (4) (1,267) 1,095 (172) (695) 992 297 Total interest-earning assets 1,881 (224) 1,657 (625) (986) (1,611) Interest expense: Demand accounts 2 (3) (1) (5) 9 4 Money market and savings accounts 27 168 195 (13) 97 84 Certificates of deposit 275 1,016 1,291 (2) 867 865 Total interest-bearing deposits 304 1,181 1,485 (20) 973 953 Borrowings (2,063) (2,249) (4,312) (188) 27 (161) Total interest-bearing liabilities (1,759) (1,068) (2,827) (208) 1,000 792 Net change in net interest income $3,640 $844 $4,484 $ (417) $ (1,986) $ (2,403)(1)Includes net deferred loan fee amortization income of $720,000, $573,000 and $627,000 for the years ended December 31, 2016, 2015 and 2014, respectively.(2)Non-accrual loans have been included in average loans receivable balance.(3)Includes available for sale securities. Average balance of available for sale securities is based on amortized historical cost.(4)Interest income from tax exempt securities is computed on a taxable equivalent basis using a tax rate of 35% for all periods presented.Net Interest IncomeNet interest income increased $4.6 million, or 11.8%, to $43.4 million during the year ended December 31, 2016 compared to $38.8 million during the year endedDecember 31, 2015.●Interest income on loans increased due to an increase in average balance of $77.3 million offset by a 11 basis point decrease in average yield on loans. Theincrease in average loan balance was driven by a $46.0 million increase in the average balance of loans held in portfolio and a $31.3 million increase in theaverage balance of loans held for sale.●Interest income from mortgage related securities decreased due to a $15.2 million decrease in average balance. As securities have paid down in 2015 and 2016,fewer securities were purchased to replace those securities due to unfavorable market yields.●Interest income from other interest earning assets (comprised of debt securities, federal funds sold and short-term investments) increased due to a 41 basispoint increase in the average yield due to an increase in higher yielding corporate securities balance, an increase in the federal funds rate and an increase inFHLB stock dividend rate, offset by a $65.9 million decrease in the total other earning assets average balance.●Interest expense on deposits increased primarily due to an increase in the average cost of time deposits of 15 basis points along with a $33.6 million increasein average balance of time deposits for the year ended December 31, 2016 compared to the year ended December 31, 2015.●Interest expense on money market and savings accounts increased $195,000 due to an increase in both rate and average balance. Increases in both rate andvolume reflect the Company's strategy to aggressively grow this segment of retail funds.●Interest expense on borrowings decreased $4.3 million due to the maturity of $220.0 million of fixed rate borrowings that were paid off during the current yearwith lower rate long term fixed borrowings and funds raised through our retail delivery channels. A total of $220.0 million FHLB borrowings at a weightedaverage rate of 4.34% matured during 2016. The Company borrowed $100.0 million of long-term FHLB borrowings during 2016 at a weighted average rate of0.78%. In addition to the long-term borrowings, short-term FHLB advances were utilized to help with the fundings at the mortgage banking segmentthroughout 2016. - 43 -Provision for Loan Losses Our provision for loan losses decreased $1.6 million, or 80.7%, to $380,000 during the year ended December 31, 2016, from $2.0 million during the year endedDecember 31, 2015 as asset quality metrics continued to improve. The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are usedto determine an appropriate allowance for loan losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section foran analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Loss" section. Noninterest Income Years Ended December 31, 2016 2015 $ Change % Change (Dollars in Thousands) Service charges on loans and deposits $2,232 1,648 584 35.4%Increase in cash surrender value of life insurance 1,767 1,417 350 24.7%Mortgage banking income 121,069 99,318 21,751 21.9%Gain on sale of available for sale securities - 44 (44) N/MOther 1,297 2,047 (750) (36.6%) Total noninterest income $126,365 104,474 21,891 21.0%N/M - Not meaningful Total noninterest income increased $21.9 million, or 21.0%, to $126.4 million during the year ended December 31, 2016 compared to $104.5 million during theyear ended December 31, 2015. The increase resulted primarily from an increase in mortgage banking income offset by a decrease in other noninterest income.●The increase in mortgage banking income was the result of an increase in origination volumes and margins. The volume increased $392.8 million, or 19.8%, to$2.38 billion during the year ended December 31, 2016 compared to a $1.99 billion during the year ended December 31, 2015. See "Comparison of MortgageBanking Segment Operations for the Years Ended December 31, 2016 and 2015" above, for additional discussion of the increase in mortgage banking income.●The increase in service charges on loans and deposits was related to an increase in loan prepayment penalties in 2016.●The increase in cash surrender value of life insurance was related to the additional earnings on the $10.0 million policy purchased in March 2016.●The Company sold one municipal security at a gain in the prior year compared to none in the current year period.●The $750,000 decrease in other noninterest income was primarily due to a decrease in gain on mortgage servicing rights as there were no sales of mortgageservicing rights during the year ended December 31, 2016 compared to a $901,000 gain on sales of mortgage servicing rights during the year ended December31, 2015. The year ended December 31, 2015 included gain on a bulk sale of mortgage servicing rights as well as gains on certain loan-level sales ofservicing. During the year ended December 31, 2016, there were no bulk sales of mortgage servicing rights and loan-level sales of servicing were classified asmortgage banking income.Noninterest Expenses Years Ended December 31, 2016 2015 $ Change % Change (Dollars in Thousands) Compensation, payroll taxes, and other employee benefits $95,056 81,753 13,303 16.3%Occupancy, office furniture and equipment 9,347 9,287 60 0.6%Advertising 2,743 2,947 (204) (6.9%)Data processing 2,520 2,354 166 7.1%Communications 1,462 1,416 46 3.2%Professional fees 2,135 2,354 (219) (9.3%)Real estate owned 399 2,664 (2,265) (85.0%)FDIC insurance premiums 615 1,058 (443) (41.9%)Other 13,158 11,701 1,457 12.5% Total noninterest expenses $127,435 115,534 11,901 10.3% - 44 - Total noninterest expenses increased $11.9 million, or 10.3%, to $127.4 million during the year ended December 31, 2016 compared to $115.5 million during theyear ended December 31, 2015.●Compensation, payroll taxes and other employee benefit expense increased $13.3 million primarily due to an $12.6 million increase in compensation, payrolltaxes and other benefits within our mortgage banking segment. The increase in compensation within our mortgage banking segment correlates to theincrease in mortgage banking income due to the commission-based compensation structure in place for our mortgage banking loan officers.●Compensation, payroll taxes and other employee benefits expense increased $730,000 within the community banking segment primarily due to salaryincreases due to adding two branches in the second half of 2015 along with annual raises, health insurance costs, and ESOP expense offset by a reduction instock compensation expense related to the grant of stock awards during 2015 that contained an immediate vesting provision.●Occupancy, office furniture and equipment expense increased resulting from additional rent expense in the current year compared to prior year due to theaddition of mortgage banking segment branches during 2016. Offsetting the rent increase, there was less depreciation expense at the mortgage bankingsegment in the year ended December 31, 2016 compared to the prior year. Additionally, the community banking segment had lower expense year over year.●Advertising expense decreased as a result of mortgage banking segment branches advertising less with mortgage demand remaining high.●Data processing increased as the mortgage banking segment brought its hedging operations in-house.●Professional fees expense decreased as a result of a decrease in legal fees at the mortgage banking segment.●Net real estate owned expense decreased $2.3 million, to $399,000 of expense, during 2016 compared to 2015. Property management expense, aside fromgains/losses on sales of real estate owned decreased $1.1 million to $596,000 during 2016 compared to 2015 due to a reduction in the number of propertiesunder management during 2016. Net gains on sales of real estate owned decreased $382,000 to $853,000 during 2016 compared to $1.2 million during 2015. Real estate owned writedowns decreased $1.5 million to $656,000 for 2016 compared to $2.2 million for 2015.●FDIC insurance premiums decreased in 2016 compared to 2015 due to improved asset quality metrics.●Other noninterest expense increased primarily due to increased expense at the mortgage banking segment which correlated with the increased origination andfunding volumes. Income Taxes Income tax expense increased $7.2 million to $16.5 million during the year ended December 31, 2016, compared to $9.2 million during the year ended December31, 2015. Income tax expense was recognized during the year ended December 31, 2016 at an effective rate of 39.2% compared to an effective rate of 35.8% during theyear ended December 31, 2015. The increase in the effective rate was due to the write off of a deferred tax asset and an increase in pretax income, which minimizes theimpact of tax deductions and tax-exempt income. At the beginning of the year, the Company had a deferred tax asset of $857,000 related to stock options awarded in 2007. During the year ended December 31,2016, all of the options that gave rise to the deferred tax asset were exercised and a tax deduction was realized to the extent that the exercise price exceeded the optionstrike price. The amount of the deduction realized by the Company was significantly less than the deferred tax asset. As a result, the remaining deferred tax asset waswritten off and the Company recognized $658,000 in additional income tax expense.Comparison of Community Banking Segment Operations for the Years Ended December 31, 2015 and 2014Net income from our community banking segment for the year ended December 31, 2015 totaled $8.3 million compared to net income of $10.0 million for theyear ended December 31, 2014. Net interest income decreased $1.9 million to $37.7 million for the year ended December 31, 2015 compared to $39.6 million the yearended December 31, 2014 due to a decrease in average rate driven by turnover of the loan portfolio. The provision for loan losses increased $850,000 compared to theprior year. Compensation, payroll taxes, and other employee benefits expense increased $1.5 million to $16.5 million due to the distribution of additional equity awards in2015. The immediate vesting of 94,100 restricted share awards amounted to $1.2 million in additional compensation expense. Occupancy, office furniture, andequipment expense decreased slightly from the prior year. FDIC insurance premium expense decreased $337,000 due to a decrease in the FDIC assessment as a resultof the Bank's improved CAMELS ratings and continued improvement in asset quality ratios. Real estate owned expense increased for the year ended December 31,2015 compared to prior year due to a larger amount of writedowns which reflects management's plan to expedite the sale of older properties. Other non-interestexpenses decreased from the prior year. Comparison of Mortgage Banking Segment Operations for the Years Ended December 31, 2015 and 2014Net income from our mortgage banking segment for the year ended December 31, 2015 totaled $8.3 million compared to net income of $2.4 million for the yearended December 31, 2014. Mortgage banking segment revenues increased $19.8 million, or 24.2%, to $101.5 million for the year ended December 31, 2015 compared tothe year ended December 31, 2014. The increase in mortgage banking revenues was attributable to an increase in sales volume along with an increase in margin. Loans originated for sale in the secondary market totaled $2.0 billion during the year ended December 31, 2015, representing a $324.8 million, or 19.6%, increase inoriginations from the year ended December 31, 2014 which totaled $1.7 billion. In addition to the increases in revenue resulting from an increase in origination volume,mortgage banking revenues increased due to an increase in average sales margin across all product types and geographic markets.- 45 -Loans originated for the purpose of a residential property purchase increased 14.1% and comprised 83.7% of production during the year ended December 31,2015. The mix of loan type changed slightly with the purpose of a residential property purchase and the purpose of refinance loans comprising 83.7% and 16.3% of allloan originations, respectively, during the year ended December 31, 2015 compared to 87.0% and 13.0% in the prior year. Origination volumes of conventional loansincreased 25.8% and governmental loans increased 6.6%. The mix of loan type changed slightly with conventional loans and governmental loans comprising 66.4%and 33.6% of all loan originations, respectively, during the year ended December 31, 2015. During the year ended December 31, 2014 conventional loans andgovernmental loans comprised 62.6% and 37.4% of all loan originations, respectively. Conventional loans include loans that conform to Fannie Mae and Freddie Macstandards, whereas governmental loans are those loans guaranteed by the federal government, such as a Federal Housing Authority or U.S. Department ofAgriculture loan.During the year ended December 31, 2015, mortgage servicing rights related to $580.2 million in loans receivable with a book value of $4.4 million were sold ata gain of $901,000. During the year ended December 31, 2014, mortgage servicing rights related to $713.0 million in loans receivable with a book value of $4.6 millionwere sold at a gain of $2.5 million. Total compensation, payroll taxes and other employee benefits increased $11.1 million, or 20.3%, to $65.7 million for the year ended December 31, 2015compared to the year ended December 31, 2014. The increase in compensation expense was primarily a result of the increase in mortgage banking income, given ourcommission-based loan officer compensation model.Occupancy expense decreased $1.0 million to $6.0 million during the year ended December 31, 2015 compared to the year ended December 31, 2014. Thedecrease resulted from less rent expense in the current year compared to prior year due to closing underperforming mortgage banking branches during the first half of2014, as well as finding more favorable leases for a number of branches. Comparison of Consolidated Waterstone Financial, Inc. Results of Operations for the Years Ended December 31, 2015 and 2014 Years Ended December 31, 2015 2014 (Dollars in Thousands, except pershare amounts) Net income $16,570 12,732 Earnings per share - basic 0.57 0.38 Earnings per share - diluted 0.56 0.38 Return on assets 0.94% 0.71%Return on equity 3.99% 2.89% Net Interest Income Net interest income decreased $2.5 million, or 6.0%, to $38.8 million during the year ended December 31, 2015 compared to $41.3 million during the year endedDecember 31, 2014.●Interest income on loans decreased due to an 18 basis point decrease in average yield on loans. The average balance of loans receivable stayed consistentcompared to the prior year.●Interest income from mortgage related securities increased due to an increase in the average balance of mortgage related securities. Funds received from thesecond step offering completed in January 2014 were used, in part, to purchase additional securities throughout 2014. Also, the yield increased nine basispoint to 1.91% for the year ended December 31, 2015.●Interest income from other interest earning assets (comprised of debt securities, federal funds sold and short-term investments) increased due to an increase inhigher yielding municipal securities and corporate bond securities balances in 2015 compared to cash being held in 2014. The yield increased 28 basis pointsyear-over-year (35 basis points on a fully tax-equivalent basis). The decrease in average balance reflects utilization of the $248.3 million in net proceeds thatwere received from our stock offering during January 2014 to purchase securities, fund loans held for sale, and repurchase shares.●Interest expense on deposits increased primarily due to an increase in the average cost of time deposits of 13 basis points as average balance of time depositsstayed consistent for the years ended December 31, 2015 and December 31, 2014.●Interest expense on borrowings decreased slightly due to the decreased use of short-term repurchase agreements within our mortgage banking segment to fundloan originations to be sold in the secondary market during the year ended December 31, 2015.- 46 -Provision for Loan Losses Our provision for loan losses increased $815,000, or 70.9%, to $2.0 million during the year ended December 31, 2015, from $1.2 million during the year endedDecember 31, 2014. The increase was largely related to two loans collateralized by out-of-state single-family properties and one loan collateralized by a multi-familyproperty. The provision is primarily a function of the Company's reserving methodology and assessments of certain quantitative and qualitative factors which are usedto determine an appropriate allowance for loan losses for the period. See further discussion regarding the allowance for loan losses in the "Asset Quality" section foran analysis of charge-offs, nonperforming assets, specific reserves and additional provisions and the "Allowance for Loan Loss" section.Noninterest Income Years Ended December 31, 2015 2014 $ Change % Change (Dollars in Thousands) Service charges on loans and deposits $1,648 1,486 162 10.9% Increase in cash surrender value of life insurance 1,417 1,290 127 9.8% Gain on other-than-temporary investments - 44 (44) (100.0% )Portion of gain recognized in other comprehensive income (beforetax) - (61) 61 (100.0% )Net impairment losses recognized in earnings - (17) 17 (100.0% )Mortgage banking income 99,318 77,982 21,336 27.4% Gain on sale of available for sale securities 44 - 44 N/M Other 2,047 3,827 (1,780) (46.5% ) Total noninterest income $104,474 84,568 19,906 23.5% N/M - Not meaningful Total noninterest income increased $19.9 million, or 23.5%, to $104.5 million during the year ended December 31, 2015 compared to $84.6 million during the yearended December 31, 2014. The increase resulted primarily from an increase in mortgage banking income offset by a decrease in other noninterest income.●The increase in mortgage banking income was the result of an increase in origination volumes and margins. The volume increased $324.8 million, or 19.5%, to$2.0 billion during the year ended December 31, 2015 compared to a $1.7 billion during the year ended December 31, 2014. See "Comparison of MortgageBanking Segment Operations for the Years Ended December 31, 2015 and 2014" above, for additional discussion of the increase in mortgage banking income.●The increase in service charges on loans and deposits was related to an increase in loan prepayment penalties in 2015.●The increase in cash surrender value of life insurance was related to the additional earnings on the $10.0 million policy purchased in May 2014.●The Company recorded impairment on one municipal security in the prior year compared to none in the current year period.●The Company sold one municipal security at a gain in the current year compared to none in the prior year period.●The decrease in other noninterest income was primarily due to a decrease in the sale of mortgage servicing rights which resulted in a $901,000 gain during theyear ended December 31, 2015 compared to a $2.5 million gain on sales of mortgage servicing rights during the year ended December 31, 2014. - 47 -Noninterest Expenses Years Ended December 31, 2015 2014 $ Change % Change (Dollars in Thousands) Compensation, payroll taxes, and other employee benefits $81,753 69,172 12,581 18.2%Occupancy, office furniture and equipment 9,287 10,369 (1,082) (10.4%)Advertising 2,947 2,949 (2) (0.1%)Data processing 2,354 2,245 109 4.9%Communications 1,416 1,690 (274) (16.2%)Professional fees 2,354 2,393 (39) (1.6%)Real estate owned 2,664 2,482 182 7.3%FDIC insurance premiums 1,058 1,395 (337) (24.2%)Other 11,701 12,123 (422) (3.5%) Total noninterest expenses $115,534 104,818 10,716 10.2% Total noninterest expenses increased $10.7 million, or 10.2%, to $115.5 million during the year ended December 31, 2015 compared to $104.8 million during theyear ended December 31, 2014.●Compensation, payroll taxes and other employee benefit expense increased $12.6 million primarily due to an $11.1 million increase in compensation, payroll taxesand other benefits within our mortgage banking segment. The increase in compensation within our mortgage banking segment correlates to the increase inmortgage banking income due to the commission-based compensation structure in place for our mortgage banking loan officers.●Compensation, payroll taxes and other employee benefits expense increased $1.5 million within the community banking segment primarily due to stock awardsgranted in 2015. Of the $1.5 million increase, $1.2 million is related to the immediate vesting of the stock compensation awarded. Additional increases were dueto community branch additions and annual compensation increases.●Occupancy, office furniture and equipment expense decreased resulting from less rent expense at the mortgage banking segment in the current year comparedto prior year due to closing underperforming mortgage banking branches during the first half of 2014 along with branch efficiencies. Additionally, there was lesssnow removal expense for the year ended December 31, 2015 compared to the prior year. Offsetting those decreases, additional expense was incurred due to theaddition of two bank branches towards the end of 2015.●Advertising expense stayed consistent in the current year to the prior year. Increases at the community banking segment were due to the promotions foropening new branches which were offset by improved expense management at our mortgage banking segment.●Data processing expense increased $109,000 to $2.4 million for the year ended December 31, 2015. This was due to a one-time expense for an upgrade of systemsoftware.●Communication expense decreased $274,000 to $1.4 million for the year ended December 31, 2015. This was due to decreases in postage and telephone charges.●Professional fees expense decreased as a result of a decrease in audit and tax expenses offset by an increase in legal fees.●Real estate owned expense increased $182,000, or 7.3%, to $2.7 million for the year ended December 31, 2015. Real estate owned writedowns increased $678,000to $2.2 million facilitating a plan to liquidate certain aged properties. Partially offsetting the increased expense related to writedown activity, propertymanagement expense decreased by $127,000 and net gains realized on sales increased $370,000 as certain property values have improved.●FDIC insurance premiums decreased due to a decrease in our assessment rate in 2015 compared to 2014 due to improved asset quality and as capital increased.●Other noninterest expense decreased primarily due to a continued focus on controlling expenses within the mortgage banking segment. Income Taxes Driven by an increase in pre-tax income, income tax expense increased $2.1 million to $9.2 million during the year ended December 31, 2015, compared to $7.2million during the year ended December 31, 2014. Income tax expense was recognized during the year ended December 31, 2015 at an effective rate of 35.8% comparedto an effective rate of 36.0% during the year ended December 31, 2014. The Company has a deferred tax asset of $857,000 related to stock options awarded in 2007. The stock options awarded in 2007 are set to expire in January2017. If these awards are not exercised, the Company will have to recognize additional tax expense equal to the amount of the deferred tax asset upon expiration. PerASC 718, the determination of a need for a valuation allowance against stock-based compensation awards by a company should not consider the current fair marketvalue of its stock. Therefore, no valuation allowance has been recorded against these awards, even though these awards are currently out-of-the-money and unlikelyto be exercised.- 48 -Liquidity and Capital ResourcesWe maintain liquid assets at levels we consider adequate to meet our liquidity needs. The liquidity ratio is equal to average daily cash and cash equivalentsfor the period divided by average total assets. We adjust our liquidity levels to fund loan commitments, repay our borrowings, fund deposit outflows and pay realestate taxes on mortgage loans. We also adjust liquidity as appropriate to meet asset and liability management objectives. The operational adequacy of our liquidityposition at any point in time is dependent upon the judgment of the Chief Financial Officer as supported by the Asset/Liability Committee. Liquidity is monitored on adaily, weekly and monthly basis using a variety of measurement tools and indicators. Regulatory liquidity, as required by the WDFI, is based on current liquid assetsas a percentage of the prior month's average deposits and short-term borrowings. Minimum primary liquidity is equal to 4.0% of deposits and short-term borrowingsand minimum total regulatory liquidity is equal to 8.0% of deposits and short-term borrowings. The Bank's primary and total regulatory liquidity at December 31, 2016were 7.29% and 18.28%, respectively.Our primary sources of liquidity are deposits, amortization and repayment of loans, sales of loans held for sale, maturities of investment securities and othershort-term investments, and earnings and funds provided from operations. While scheduled principal repayments on loans are a relatively predictable source offunds, deposit flows and loan repayments are greatly influenced by market interest rates, economic conditions, and rates offered by our competitors. We set theinterest rates on our deposits to maintain a desired level of total deposits. In addition, we invest excess funds in short-term, interest-earning assets, which provideliquidity to meet lending requirements. Additional sources of liquidity used to manage long- and short-term cash flows include advances from the FHLB.A portion of our liquidity consists of cash and cash equivalents, which are a product of our operating, investing and financing activities. At December 31,2016 and 2015, $47.2 million and $100.5 million, respectively, of our assets were invested in cash and cash equivalents. Our primary sources of cash are principalrepayments on loans, proceeds from the calls and maturities of debt and mortgage related securities, increases in deposit accounts, Federal funds purchased andadvances from the Federal Home Loan Bank of Chicago. The significant decrease in cash and cash equivalents as of December 31, 2016 resulted from $58.7 millionused to fund loans held for sale and $68.1 million to fund loans held for investment.Our cash flows are derived from operating activities, investing activities and financing activities as reported in our Consolidated Statements of Cash Flowsincluded in our Consolidated Financial Statements.During the years ended December 31, 2016, 2015, and 2014 loan repayments net of loan originations resulted in a negative cash flows of $68.1 million, $40.0million and $25.7 million. The growth in loans receivable is reflective of the Bank's focus in growing multi-family residential property and commercial real estate loans.Cash received from the calls, maturities and principal repayments of debt and mortgage related securities and structured notes totaled $54.8 million, $50.3 million and$46.4 million for the years ended December 31, 2016, 2015 and 2014, respectively. We purchased $14.5 million, $49.9 million and $103.6 million in debt securities,mortgage related securities and certificates of deposits classified as available for sale during the years ended December 31, 2016, 2015 and 2014, respectively. Therewere no securities sold during the years ended December 31, 2016 and 2014, respectively. We sold a $1.0 million available for sale debt security during the year endedDecember 31, 2015. During the year ended December 31, 2016, $3.9 million of common stock was repurchased compared to $72.7 million for the year ended December31, 2015. There were no repurchases of common stock in 2014.Deposits increased by $56.1 million to December 31, 2016 from December 31, 2015. The increase in deposits was the result of a $17.7 million increase indemand deposits, $21.8 million in money market and savings accounts, and $16.5 million increase in certificates of deposits. Deposit flows are generally affected bythe level of interest rates, market conditions and products offered by local competitors and other factors.Liquidity management is both a daily and longer-term function of business management. If we require funds beyond our ability to generate them internally,borrowing agreements exist with the Federal Home Loan Bank of Chicago, which provide an additional source of funds. At December 31, 2016, we had $295.0 million infixed-rate advances from the Federal Home Loan Bank of Chicago, of which $130.0 million are due within 12 months, and all of which are putable at the option of theFederal Home Loan Bank of Chicago. The weighted average rate on these advances was 1.75% as of December 31, 2016.At December 31, 2016, we had outstanding commitments to originate loans of $30.9 million and unfunded commitments under construction loans, lines ofcredit and standby letters of credit of $50.9 million. At December 31, 2016, certificates of deposit scheduled to mature in less than one year totaled $469.3 million. Basedon prior experience, management believes that a significant portion of such deposits will remain with us, although there can be no assurance that this will be the case.In the event a significant portion of our deposits are not retained by us, we will have to utilize other funding sources, such as Federal Home Loan Bank of Chicagoadvances, Federal Reserve Discount Window or brokered deposits to maintain our level of assets. However, such borrowings may not be available on attractive terms,or at all, if and when needed. Alternatively, we would reduce our level of liquid assets, such as our cash and cash equivalents and securities available for sale in orderto meet funding needs. In addition, the cost of such deposits may be significantly higher if market interest rates are higher or there is an increased amount ofcompetition for deposits in our market area at the time of renewal.Waterstone Financial, Inc. and WaterStone Bank are subject to various regulatory capital requirements, including a risk-based capital measure. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off-balance sheet items tobroad risk categories. At December 31, 2016, Waterstone Financial, Inc. and WaterStone Bank exceeded all regulatory capital requirements and is considered "wellcapitalized" under regulatory guidelines. See "Supervision and Regulation—Capital Requirements" and note 9 of the notes to the consolidated financial statements. Shareholders' equity increased by $18.8 million, or 4.8%, to $410.7 million at December 31, 2016 from $391.9 million at December 31, 2015. The increase inshareholders' equity was primarily due to net income, additional paid in capital as stock options were exercised, and the vesting of ESOP shares. These increases wereoffset by the repurchase of stock, dividends declared, along with accumulated other comprehensive income decreasing as the fair value of the security portfoliodecreased.The Company's Board of Directors authorized a stock repurchase program in the first quarter of 2015. The Company authorized two stock repurchaseprograms in the second quarter of 2015. The Company's Board of Directors authorized a fourth stock repurchase program in the third quarter of 2015. The timing of thepurchases will depend on certain factors, including but not limited to, market conditions and prices, available funds and alternative uses of capital. The stockrepurchase program may be carried out through open-market purchases, block trades, negotiated private transactions and pursuant to a trading plan that will beadopted in accordance with Rule 10b5-1 under the Securities Exchange Act of 1934. Repurchased shares are held by the Company as authorized but unissued shares.- 49 -The Company repurchased 5,847,153 shares at an average price of $12.96 under previously approved stock repurchase plans. The Company is authorized topurchase up to 989,500 additional shares under the current approved stock repurchase program as of December 31, 2016. The Company repurchased shares forminimum tax withholding settlements on equity compensation. These purchases are not included in the 5,847,153 total above and do not count against the maximumnumber of shares that may yet be purchased under the Board of Directors' authorization.Contractual Obligations, Commitments, Contingent Liabilities, and Off-balance Sheet Arrangements WaterStone Bank has various financial obligations, including contractual obligations and commitments that may require future cash payments. The followingtables present information indicating various non-deposit contractual obligations and commitments of WaterStone Bank as of December 31, 2016 and the respectivematurity dates.Contractual Obligations More Than More Than One Year Three Years One Year or Through Through Five Over Five Total Less Three Years Years Years (In Thousands) Deposits without a stated maturity (4) $282,827 $282,827 $- $- $- Certificates of deposit (4) 666,584 469,269 192,075 5,240 - Bank lines of credit (4) 8,155 8,155 - - - Federal Home Loan Bank advances (1) 295,000 130,000 65,000 100,000 - Repurchase agreements (2) (4) 84,000 84,000 - - - Operating leases (3) 9,840 2,926 3,676 1,593 1,645 Salary continuation agreements 85 85 - - - Total Contractual Obligations $1,346,491 $977,262 $260,751 $106,833 $1,645 _______________(1) Secured under a blanket security agreement on qualifying assets, principally, mortgage loans. Excludes interest that will accrue on the advances.(2) The repurchase agreements are callable on a quarterly basis.(3) Represents non-cancellable operating leases for offices and equipment.(4) Excludes interest. The following table details the amounts and expected maturities of significant off-balance sheet commitments as of December 31, 2016. Commitments toextend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract and generally have fixed expirationdates or other termination clauses.Other Commitments More than More than One Year Three through Years One Year Three Through Over Five Total or Less Years Five Years Years (In Thousands) Real estate loan commitments(1) $30,903 $30,903 $- $- $- Unused portion of home equity lines of credit(2) 14,367 14,367 - - - Unused portion of construction loans(3) 21,137 21,137 - - - Unused portion of business lines of credit 15,095 15,095 - - - Standby letters of credit 333 333 - - - (1) Commitments for loans are extended to customers for up to 180 days after which they expire.(2) Unused portions of home equity loans are available to the borrower for up to 10 years.(3) Unused portions of construction loans are available to the borrower for up to one year.Impact of Inflation and Changing PricesThe financial statements and accompanying notes have been prepared in accordance with accounting principles generally accepted in the United States("GAAP"). GAAP generally requires the measurement of financial position and operating results in terms of historical dollars without consideration for changes in therelative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of our operations. Unlike industrial companies,our assets and liabilities are primarily monetary in nature. As a result, changes in market interest rates have a greater impact on performance than do the effects ofinflation.- 50 -Quarterly Financial InformationThe following table sets forth certain unaudited quarterly data for the periods indicated: Quarter Ended March 31 June 30 September 30 December 31 (In thousands, except per share data) 2016 (unaudited) Interest income $15,596 $15,748 $16,330 $16,062 Interest expense 5,613 5,583 5,005 4,091 Net interest income 9,983 10,165 11,325 11,971 Provision for loan losses 205 - 135 40 Net interest income after provision for loan losses 9,778 10,165 11,190 11,931 Total noninterest income 21,445 36,351 37,412 31,157 Total noninterest expense 25,222 34,231 35,541 32,441 Income before income taxes 6,001 12,285 13,061 10,647 Income taxes 2,140 4,518 5,556 4,248 Net income $3,861 $7,767 $7,505 $6,399 Income per share – basic $0.14 $0.29 $0.28 $0.23 Income per share - diluted $0.14 $0.29 $0.27 $0.23 2015 (unaudited) Interest income $15,018 $15,742 $15,795 $15,408 Interest expense 5,582 5,682 5,885 5,970 Net interest income 9,436 10,060 9,910 9,438 Provision for loan losses 335 805 580 245 Net interest income after provision for loan losses 9,101 9,255 9,330 9,193 Total noninterest income 22,033 31,040 28,551 22,850 Total noninterest expense 26,428 31,947 29,786 27,373 Income before income taxes 4,706 8,348 8,095 4,670 Income taxes 1,690 3,064 2,896 1,599 Net income $3,016 $5,284 $5,199 $3,071 Income per share – basic $0.09 $0.17 $0.19 $0.11 Income per share - diluted $0.09 $0.17 $0.19 $0.11 - 51 -Item 7A. Quantitative and Qualitative Disclosures About Market RiskManagement of Market RiskGeneral. The majority of our assets and liabilities are monetary in nature. Consequently, our most significant form of market risk is interest rate risk. Ourassets, consisting primarily of mortgage loans, have longer maturities than our liabilities, consisting primarily of deposits. As a result, a principal part of our businessstrategy is to manage interest rate risk and reduce the exposure of our net interest income to changes in market interest rates. Accordingly, WaterStone Bank's boardof directors has established an Asset/Liability Committee which is responsible for evaluating the interest rate risk inherent in our assets and liabilities, for determiningthe level of risk that is appropriate given our business strategy, operating environment, capital, liquidity and performance objectives, and for managing this riskconsistent with the guidelines approved by the board of directors. Management monitors the level of interest rate risk on a regular basis and the Asset/LiabilityCommittee meets at least weekly to review our asset/liability policies and interest rate risk position, which are evaluated quarterly.We have sought to manage our interest rate risk in order to minimize the exposure of our earnings and capital to changes in interest rates. We haveimplemented the following strategies to manage our interest rate risk: (i) emphasizing variable rate loans including variable rate one- to four-family, and commercial realestate loans as well as three to five year commercial real estate balloon loans; (ii) reducing and shortening the expected average life of the investment portfolio; and(iii) whenever possible, lengthening the term structure of our deposit base and our borrowings from the FHLBC. These measures should reduce the volatility of ournet interest income in different interest rate environments.Income Simulation. Simulation analysis is an estimate of our interest rate risk exposure at a particular point in time. At least quarterly we review thepotential effect changes in interest rates may have on the repayment or repricing of rate sensitive assets and funding requirements of rate sensitive liabilities. Ourmost recent simulation uses projected repricing of assets and liabilities at December 31, 2016 on the basis of contractual maturities, anticipated repayments andscheduled rate adjustments. Prepayment rate assumptions may have a significant impact on interest income simulation results. Because of the large percentage ofloans and mortgage-backed securities we hold, rising or falling interest rates may have a significant impact on the actual prepayment speeds of our mortgage relatedassets that may in turn affect our interest rate sensitivity position. When interest rates rise, prepayment speeds slow and the average expected lives of our assetswould tend to lengthen more than the expected average lives of our liabilities and therefore would most likely have a positive impact on net interest income andearnings.The following interest rate scenario displays the percentage change in net interest income over a one-year time horizon assuming increases of 100, 200 and300 basis points and a decreases of 100 basis points. The results incorporate actual cash flows and repricing characteristics for balance sheet accounts following aninstantaneous parallel change in market rates based upon a static (no growth balance sheet).Analysis of Net Interest Income Sensitivity Immediate Change in Rates +300 +200 +100 -100 (Dollar Amounts in Thousands) As of December 31, 2016 Dollar Change $5,214 3,428 1,690 (2,002) Percentage Change 10.51% 6.91 3.41 (4.04)At December 31, 2016, a 100 basis point instantaneous increase in interest rates had the effect of increasing forecast net interest income over the next 12months by 3.41% while a 100 basis point decrease in rates had the effect of decreasing net interest income by 4.04%. - 52 -Item 8. Financial Statements and Supplementary Data Report of Independent Registered Public Accounting Firm To the Board of Directors and ShareholdersWaterstone Financial, Inc. We have audited the accompanying consolidated statements of financial condition of Waterstone Financial, Inc. and Subsidiaries (the Company) as of December 31,2016 and 2015, and the related consolidated statements of operations, comprehensive income, shareholders' equity and cash flows for each of the three years in theperiod ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on thesefinancial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we planand perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a testbasis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significantestimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for ouropinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Waterstone Financial, Inc. andSubsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31,2016, in conformity with U.S. generally accepted accounting principles. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Waterstone Financial, Inc. andSubsidiaries' internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control — Integrated Framework issued bythe Committee of Sponsoring Organizations of the Treadway Commission in 2013, and our report dated March 3, 2017 expressed an unqualified opinion on theeffectiveness of Waterstone Financial, Inc. and Subsidiaries' internal control over financial reporting. /s/ RSM US LLP Milwaukee, Wisconsin March 3, 2017 - 53 -Waterstone Financial, Inc. and SubsidiariesConsolidated Statements of Financial ConditionDecember 31, 2016 and 2015 December 31, 2016 2015 Assets (In Thousands, except share data) Cash $7,878 57,419 Federal funds sold 26,828 20,297 Interest-earning deposits in other financial institutions and other short term investments 12,511 22,755 Cash and cash equivalents 47,217 100,471 Securities available for sale (at fair value) 226,795 269,658 Loans held for sale (at fair value) 225,248 166,516 Loans receivable 1,177,884 1,114,934 Less: Allowance for loan losses 16,029 16,185 Loans receivable, net 1,161,855 1,098,749 Office properties and equipment, net 23,655 25,328 Federal Home Loan Bank stock (at cost) 13,275 19,500 Cash surrender value of life insurance 61,509 49,562 Real estate owned, net 6,118 9,190 Prepaid expenses and other assets 24,947 23,755 Total assets $1,790,619 1,762,729 Liabilities and Shareholders' Equity Liabilities: Demand deposits $120,371 102,673 Money market and savings deposits 162,456 140,631 Time deposits 666,584 650,057 Total deposits 949,411 893,361 Borrowings 387,155 441,203 Advance payments by borrowers for taxes 4,716 3,661 Other liabilities 38,647 32,574 Total liabilities 1,379,929 1,370,799 Shareholders' equity: Preferred stock (par value $.01 per share) Authorized - 50,000,000 shares in 2016 and 2015, no shares issued - - Common stock (par value $.01 per share) Authorized - 100,000,000 shares in 2016 and 2015 Issued - 29,430,123 in 2016 and29,407,455 in 2015 Outstanding - 29,430,123 in 2016 and 29,407,455 in 2015 294 294 Additional paid-in capital 322,934 317,022 Retained earnings 184,565 168,089 Unearned ESOP shares (20,178) (21,365)Accumulated other comprehensive (loss) income, net of taxes (378) 582 Cost of shares repurchased (5,908,150 in 2016 and 5,624,415 in 2015), at cost (76,547) (72,692)Total shareholders' equity 410,690 391,930 Total liabilities and shareholders' equity $1,790,619 1,762,729 See accompanying notes to consolidated financial statements- 54 -Waterstone Financial, Inc. and SubsidiariesConsolidated Statements of OperationsYears ended December 31, 2016, 2015 and 2014 Years ended December 31, 2016 2015 2014 (In Thousands, except per share amounts) Interest income: Loans $57,185 55,175 57,316 Mortgage-related securities 3,048 3,229 2,996 Debt securities, federal funds sold and short-term investments 3,503 3,559 3,322 Total interest income 63,736 61,963 63,634 Interest expense: Deposits 7,364 5,879 4,926 Borrowings 12,928 17,240 17,401 Total interest expense 20,292 23,119 22,327 Net interest income 43,444 38,844 41,307 Provision for loan losses 380 1,965 1,150 Net interest income after provision for loan losses 43,064 36,879 40,157 Noninterest income: Service charges on loans and deposits 2,232 1,648 1,486 Increase in cash surrender value of life insurance 1,767 1,417 1,290 Total gain on other-than-temporary impaired investment - - 44 Portion of gain recognized in other comprehensive income (before tax) - - (61)Net impairment losses recognized in earnings - - (17)Mortgage banking income 121,069 99,318 77,982 Gain on sale of available for sale securities - 44 - Other 1,297 2,047 3,827 Total noninterest income 126,365 104,474 84,568 Noninterest expenses: Compensation, payroll taxes, and other employee benefits 95,056 81,753 69,172 Occupancy, office furniture, and equipment 9,347 9,287 10,369 Advertising 2,743 2,947 2,949 Data processing 2,520 2,354 2,245 Communications 1,462 1,416 1,690 Professional fees 2,135 2,354 2,393 Real estate owned 399 2,664 2,482 FDIC insurance premiums 615 1,058 1,395 Other 13,158 11,701 12,123 Total noninterest expenses 127,435 115,534 104,818 Income before income taxes 41,994 25,819 19,907 Income tax expense 16,462 9,249 7,175 Net income $25,532 16,570 12,732 Income per share: Basic $0.94 0.57 0.38 Diluted $0.93 0.56 0.38 Weighted average shares outstanding: Basic 27,037 29,161 33,406 Diluted 27,374 29,431 33,643 See accompanying notes to consolidated financial statements- 55 -Waterstone Financial, Inc. and SubsidiariesConsolidated Statements of Comprehensive IncomeYears ended December 31, 2016, 2015 and 2014 Years ended December 31, 2016 2015 2014 (In Thousands) Net income $25,532 16,570 12,732 Other comprehensive (loss) income, net of tax: Net unrealized holding gain (loss) on available for sale securities arising during the period, net of tax(expense) benefit of $622, $412 and ($1,722) respectively (960) (638) 2,666 Reclassification adjustment for net (gain) loss on available for sale securities realized during the period,net of tax expense (benefit) of $0, $17 and ($7), respectively - (27) 10 Total other comprehensive (loss) income (960) (665) 2,676 Comprehensive income $24,572 15,905 15,408 See accompanying notes to consolidated financial statements - 56 -Waterstone Financial, Inc. and SubsidiariesConsolidated Statements of Changes in Shareholders' EquityYears Ended December 31, 2016, 2015 and 2014 Common Stock Shares Amount AdditionalPaid-InCapital RetainedEarnings UnearnedESOPShares AccumulatedOtherComprehensiveIncome (Loss) TreasuryShares TotalShareholders'Equity (In Thousands) Balances at December 31, 2013 31,349 $341 110,480 151,195 (854) (1,429) (45,261) 214,472 Comprehensive income: Net income - - - 12,732 - - - 12,732 Other comprehensive income: - - - - 2,676 - 2,676 Total comprehensive income 15,408 Purchase of ESOP Shares - - - - (22,884) - - (22,884)ESOP shares committed to bereleased to Plan participants - - 31 - 1,186 - - 1,217 Cash dividend, $0.20 per share - - - (6,623) - - - (6,623)Stock compensation activity,net of tax - - 116 - - - - 116 Stock based compensationexpense - - 109 - - - - 109 Merger of LamplighterFinancial, MHC (23) (231) 305 - - - - 74 Exchange of common stock (8) (83) 83 - - - - - Treasury stock retired - (27) (45,234) - - - 45,261 - Proceeds of stock offering, netof costs 34 344 248,004 - - - - 248,348 Balances at December 31, 2014 34,420 $344 313,894 157,304 (22,552) 1,247 - 450,237 Comprehensive income: Net income - - - 16,570 - - - 16,570 Other comprehensive loss: - - - - - (665) - (665)Total comprehensive income 15,905 ESOP shares committed to bereleased to Plan participants - - 198 - 1,187 - - 1,385 Cash dividend, $0.20 per share - - - (5,785) - - - (5,785)Stock compensation activity 611 6 113 - - - - 119 Stock based compensationexpense - - 2,817 - - - - 2,817 Purchase of common stockreturned to authorized butunissued (5,624) (56) - - - - (72,692) (72,748) Balances at December 31, 2015 29,407 $ 294 317,022 168,089 (21,365) 582 (72,692) 391,930 Comprehensive income: Net income - - - 25,532 - - - 25,532 Other comprehensive loss: - - - - - (960) - (960)Total comprehensive income 24,572 ESOP shares committed to bereleased to Plan participants - - 446 - 1,187 - - 1,633 Cash dividend, $0.33 per share - - - (9,056) - - - (9,056)Stock compensation activity 307 3 3,553 - - - - 3,556 Stock based compensationexpense - - 1,913 - - - - 1,913 Purchase of common stockreturned to authorized butunissued (284) (3) - - - - (3,855) (3,858) Balances at December 31, 2016 29,430 $294 322,934 184,565 (20,178) (378) (76,547) 410,690 See accompanying notes to consolidated financial statements- 57 -Waterstone Financial, Inc. and SubsidiariesConsolidated Statements of Cash FlowsYears ended December 31, 2016, 2015 and 2014 Years ended December 31, 2016 2015 2014 Operating activities: (In Thousands) Net income $25,532 16,570 12,732 Adjustments to reconcile net income to net cash used in operating activities: Provision for loan losses 380 1,965 1,150 Provision for depreciation 2,615 3,106 3,283 Deferred income taxes 1,564 (154) 3,716 Stock based compensation 1,913 2,817 109 Net amortization of premium/discount on debt and mortgage related securities 991 1,305 1,583 Amortization of unearned ESOP shares 1,633 1,385 1,217 Amortization and valuation allowance on mortgage servicing rights 598 491 445 Gain on sale of loans held for sale (123,154) (98,382) (82,146)Loans originated for sale (2,378,926) (1,986,147) (1,661,376)Proceeds on sales of loans originated for sale 2,443,347 2,043,086 1,715,470 Increase in accrued interest receivable (173) (79) (225)Increase in cash surrender value of life insurance (1,767) (1,417) (1,290)(Decrease) increase in accrued interest on deposits and borrowings (726) 42 5 Increase (decrease) in other liabilities 4,659 2,425 (1,581)Increase (decrease) in accrued tax payable 557 1,467 (453)Gain on sale of available for sale securities - (44) – Impairment of securities - - 17 Net (gain) loss on real estate owned (197) 968 659 Gain on sale of mortgage servicing rights - (901) (2,456)Other (2,908) (1,494) 6,925 Net cash used in operating activities (24,062) (12,991) (2,216)Investing activities: Net increase in loans receivable (68,076) (40,011) (25,668)Purchases of and proceeds from: Debt securities (5,285) (16,119) (22,009)Mortgage related securities (9,215) (33,750) (80,837)Certificates of deposits - - (735)Premises and equipment, net (1,085) (2,966) (1,949)Bank owned life insurance (10,180) (180) (10,180)Purchase of FHLB Stock (6,300) (2,000) - Principal repayments on mortgage-related securities 39,935 40,755 28,515 Maturities of debt securities 14,855 9,510 17,864 Sales of debt securities - 1,034 – Death benefit from bank owned life insurance - 2,883 – Sales of foreclosed properties and other assets 7,796 24,716 19,751 Redemption of FHLB stock 12,525 – – Net cash used in investing activities (25,030) (16,128) (75,248)Financing activities: Net increase in deposits 56,050 29,401 9,523 Net change in short term borrowings 65,952 7,203 (21,197)Repayment of long term debt (220,000) - - Proceeds from long term debt 100,000 - - Net (decrease) increase in advance payments by borrowers for taxes 1,055 (1,330) 2,509 Cash dividends in common stock (6,917) (5,869) (5,003)Financing for purchase of ESOP shares - - (22,884)Proceeds from stock option exercises 3,556 113 49 Oversubscribed stock proceeds returned to subscribers - - (141,882)Purchase of common stock returned to authorized but unissued (3,858) (72,748) - Net cash used in financing activities (4,162) (43,230) (178,885)Decrease in cash and cash equivalents (53,254) (72,349) (256,349)Cash and cash equivalents at beginning of year 100,471 172,820 429,169 Cash and cash equivalents at end of year $47,217 100,471 172,820 Supplemental information: Cash paid or credited during the period for: Income tax payments 14,352 7,933 3,847 Interest payments 21,018 23,077 22,322 Noncash investing activities: Loans receivable transferred to other real estate 4,590 15,580 16,645 Deposits utilized to purchase common stock - - 248,422 Dividends declared but not paid in other liabilities 3,677 1,537 1,620 - 58 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 20141)Summary of Significant Accounting PoliciesThe following significant accounting and reporting policies of Waterstone Financial, Inc. and subsidiaries (collectively, the "Company"), conform to U.S.generally accepted accounting principles, or ("GAAP"), and are used in preparing and presenting these consolidated financial statements.a)Plan of Conversion and ReorganizationOn June 6, 2013, the Board of Directors of Lamplighter Financial, MHC ("MHC") and the Board of Directors of Waterstone Financial, Inc., a federalcorporation, ("Waterstone-Federal") adopted a Plan of Conversion and Reorganization (the "Plan"). Pursuant to the Plan, Waterstone Financial, Inc., aMaryland corporation, ("New Waterstone") was organized and the MHC converted from the mutual holding company form of organization to the fully publicform on January 22, 2014. As part of the conversion, the MHC's ownership interest of Waterstone-Federal was offered for sale in a public offering. A total of25,300,000 shares were sold in the offering at a price $10.00 per share, resulting in gross proceeds of $253.0 million. Expenses related to the offering totaledapproximately $4.7 million. The existing publicly held shares of Waterstone-Federal were exchanged for new shares of common stock of New Waterstone at aconversion ratio of 1.0973-to-one. The exchange ratio ensured that immediately after the conversion and public offering, the public shareholders ofWaterstone-Federal owned the same aggregate percentage of New Waterstone common stock that they owned immediately prior to that time (excludingshares purchased in the stock offering and cash received in lieu of fractional shares). When the conversion and public offering was completed, NewWaterstone became the holding company of WaterStone Bank SSB and succeeded to all of the business and operations of Waterstone-Federal and each ofWaterstone-Federal and Lamplighter Financial, MHC ceased to exist. A total of 34,405,458 shares of New Waterstone common stock were outstanding afterthe completion of the offering and exchange.The Plan provided for the establishment of special "liquidation accounts" for the benefit of certain depositors of WaterStone Bank in an amount equal to thegreater of the MHC's ownership interest in the retained earnings of the Company as of the date of the latest balance sheet contained in the prospectus or theretained earnings of WaterStone Bank at the time it reorganized into the MHC. Following the completion of the conversion, under the rules of the Board ofGovernors of the Federal Reserve System, WaterStone Bank is not permitted to pay dividends on its capital stock to Waterstone Financial, Inc., its soleshareholder, if WaterStone Bank's shareholder's equity would be reduced below the amount of the liquidation accounts. The liquidation accounts will bereduced annually to the extent that eligible account holders have reduced their qualifying deposits. Subsequent increases will not restore an eligible accountholder's interest in the liquidation accounts.Share and per share amounts have been restated to reflect the completion of our second-step conversion on January 22, 2014 at a conversion ratio of 1.0973unless noted otherwise.New Waterstone did not engage in any business prior to the completion of the mutual-to-stock conversion of Lamplighter Financial, MHC on January 22,2014. Consequently, these financial statements and footnotes reflect the financial condition and operating results of Waterstone-Federal and its subsidiaries,including the Bank, until January 22, 2014, and of New Waterstone, and its subsidiaries, including the Bank, thereafter. The words "Waterstone Financial,""we" and "our" thus are intended to refer to Waterstone-Federal and its subsidiaries with respect to matters and time periods occurring on or before January22, 2014, and to New Waterstone and its subsidiaries with respect to matters and time periods occurring thereafter.b)Nature of Operations The Company is a one-bank holding company with two operating segments – community banking and mortgage banking. The Bank is principally engaged inthe business of attracting deposits from the general public and using such deposits to originate real estate, business and consumer loans. The Bank provides a full range of financial services to customers through branch locations in southeastern Wisconsin. In addition, the Bank has a loanproduction office in Minneapolis, Minnesota. The Bank is subject to the regulations of certain federal and state agencies and undergoes periodicexaminations by those regulatory authorities. The Bank owns a mortgage banking subsidiary that originates residential real estate loans held for sale at various branch offices across thecountry. Mortgage banking volume fluctuates widely given movements in interest rates. Mortgage banking income is reported as a single line item in thestatements of operations while mortgage banking expense is distributed among the various noninterest expense lines. Compensation, payroll taxes and otheremployee benefits expense varies directly with mortgage banking income. c)Principles of Consolidation The consolidated financial statements include the accounts and operations of Waterstone Financial, Inc. and its wholly owned subsidiary, WaterStoneBank. The Bank has the following wholly owned subsidiaries: Wauwatosa Investments, Inc., Waterstone Mortgage Corporation, and Main Street Real EstateHoldings, LLC. All significant intercompany accounts and transactions have been eliminated in consolidation. d)Use of Estimates The preparation of the consolidated financial statements requires management of the Company to make a number of estimates and assumptions relating tothe reported amount of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and thereported amounts of revenues and expenses during the period. Significant items subject to such estimates and assumptions include: the allowance for loanlosses, income taxes, and fair value measurements. Actual results could differ from those estimates and the current economic environment has increased thedegree of uncertainty inherent in those estimates and assumptions. - 59 - Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 e)Cash and Cash Equivalents The Company considers federal funds sold and highly liquid debt instruments with a maturity of three months or less when purchased to be cashequivalents.f)Securities Available for Sale Securities At the time of purchase, investment securities are classified as available for sale, as management has the intent and ability to hold such securities for anindefinite period of time, but not necessarily to maturity. Any decision to sell investment securities available for sale would be based on various factors,including, but not limited to asset/liability management strategies, changes in interest rates or prepayment risks, liquidity needs, or regulatory capitalconsiderations. Available for sale securities are carried at fair value, with the unrealized gains and losses, net of deferred tax, reported as a separatecomponent of equity in accumulated other comprehensive income. The cost of debt securities is adjusted for amortization of premiums and accretion ofdiscounts to maturity or, in the case of mortgage-backed securities and collateralized mortgage obligations, over the estimated life of the security. Suchamortization is included in interest income from securities. Realized gains or losses on securities sales (using specific identification method) are included inother income. Declines in value judged to be other than temporary are included in net impairment losses recognized in earnings in the consolidatedstatements of operations.Other Than Temporary ImpairmentOne of the significant estimates related to securities is the evaluation of investments for other than temporary impairment. The Companyassesses investment securities with unrealized loss positions for other than temporary impairment on at least a quarterly basis. When the fair value of aninvestment is less than its amortized cost at the balance sheet date of the reporting period for which impairment is assessed, the impairment is designated aseither temporary or other than temporary. In evaluating other than temporary impairment, management considers the length of time and extent to which thefair value has been less than cost and the expected recovery period of the security, the financial condition and near-term prospects of the issuer, and theintent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value in thenear term. Declines in the fair value of investment securities below amortized cost are deemed to be other than temporary when the Company cannot assertthat it will recover its amortized cost basis, including whether the present value of cash flows expected to be collected is less than the amortized cost basis ofthe security. If it is more likely than not that the Company will be required to sell the security before recovery or if the Company has the intent to sell, an otherthan temporary impairment write down is recognized in earnings equal to the difference between the security's amortized cost and its fair value. If it is notmore likely than not that the Company will be required to sell the security before recovery and if the Company does not intend to sell, the other thantemporary impairment write down is separated into an amount representing credit loss, which is recognized in earnings, and an amount related to otherfactors, which is recognized as a separate component of equity. Following the recognition of an other than temporary impairment representing credit loss, thebook value of an investment less the impairment loss realized becomes the new cost basis. The determination as to whether an other than temporaryimpairment exists and, if so, the amount considered other than temporarily impaired, or not impaired, is subjective and, therefore, the timing and amount ofother than temporary impairments constitute material estimates that are subject to significant change.Federal Home Loan Bank StockFederal Home Loan Bank stock is carried at cost, which is the amount that the stock is redeemable by tendering to the FHLBC or the amount at which sharescan be sold to other FHLBC members. g)Loans Held for Sale The origination of residential real estate loans is an integral component of the business of the Company. The Company generally sells its originations oflong-term fixed interest rate mortgage loans in the secondary market, and on a selective basis, retains the rights to service the loans sold. Gains and losses onthe sales of these loans are determined using the specific identification method. Mortgage loans originated for sale are generally sold within 45 days afterclosing. The Company has elected to carry loans held for sale at fair value. Fair value is generally determined by estimating a gross premium or discount, which isderived from pricing currently observable in the market. The amount by which cost differs from market value is accounted for as a valuation adjustment tothe carrying value of the loans. Changes in value are included in mortgage banking income in the consolidated statements of operations. Costs to originate loans held for sale are expensed as incurred and are included on the appropriate noninterest expense lines of the statements ofoperations. Salaries, commissions and related payroll taxes are the primary costs to originate and comprised approximately 76.7% of total mortgage bankingnoninterest expense for 2016. The value of mortgage loans held for sale and other residential mortgage loan commitments to customers are hedged by utilizing both best efforts andmandatory forward commitments to sell loans to investors in the secondary market. Such forward commitments are generally entered into at the time whenapplications are taken to protect the value of the mortgage loans from increases in market interest rates during the period held. The Company recognizesrevenue associated with the expected future cash flows of servicing loans at the time a forward loan commitment is made, as required under Securities andExchange Commission Staff Accounting Bulletin No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings. - 60 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 h)Loans Receivable and Related Interest Income Loans are classified as held for investment when management has both the intent and ability to hold the loan for the foreseeable future, or until maturity orpayoff. Loans are carried at the principal amount outstanding, net of any unearned income, charge-offs and unamortized deferred fees and costs. Loanorigination and commitment fees and certain direct loan origination costs are deferred and the net amount amortized as an adjustment of the related loanyield. Amortization is based on a level-yield method over the contractual life of the related loans or until the loan is paid in full. Loan interest income is recognized on the accrual basis. Accrual of interest is generally discontinued either when reasonable doubt exists as to the full,timely collection of interest or principal, or when a loan becomes contractually past due more than 90 days with respect to interest or principal. At that time,previously accrued and uncollected interest on such loans is reversed and additional income is recorded only to the extent that payments are received andthe collection of principal is reasonably assured. Generally, loans are restored to accrual status when the obligation is brought current, has performed inaccordance with the contractual terms for a reasonable period of time, and the ultimate collectability of the total contractual principal and interest is no longerin doubt.A loan is accounted for as a troubled debt restructuring if the Company, for economic reasons related to the borrower's financial condition, grants aconcession to the borrower that it would not otherwise consider. A troubled debt restructuring typically involves a modification of terms such as a reductionof the stated interest rate, a deferral of principal payments or a combination of both for a temporary period of time. If the borrower was performing inaccordance with the original contractual terms at the time of the restructuring, the restructured loan is accounted for on an accruing basis as long as theborrower continues to comply with the modified terms. If the loan was not accounted for on an accrual basis at the time of restructuring, the restructuredloan remains in non-accrual status until the loan completes a minimum of six consecutive contractual payments.i)Allowance for Loan Losses The allowance for loan losses is presented as a reserve against loans and represents the Bank's assessment of probable loan losses inherent in the loanportfolio. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged toincome. Estimated loan losses are charged against the allowance when the loan balance is confirmed to be uncollectible directly or indirectly by the borroweror upon initiation of a foreclosure action by the Bank. Subsequent recoveries, if any, are credited to the allowance as long as it is within 90 days of beingtransferred to real estate owned. The allowance provides for probable losses that have been identified with specific customer relationships and for probable losses believed to be inherent inthe loan portfolio, but have not been specifically identified. The Bank utilizes its own loss history to estimate inherent losses on loans. Although the Bankallocates portions of the allowance to specific loans and loan types, the entire allowance is available for any loan losses that occur. The Bank evaluates the need for specific valuation allowances on loans that are considered impaired. A loan is considered impaired when, based on currentinformation and events, it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement.Within the loan portfolio, all non-accrual loans and loans modified under troubled debt restructurings have been determined by the Bank to meet thedefinition of an impaired loan. In addition, other loans may be considered impaired loans. A valuation allowance is established for an amount equal to theimpairment when the carrying amount of the loan exceeds the present value of the expected future cash flows, discounted at the loan's original effectiveinterest rate or the fair value of the underlying collateral. The Bank also establishes valuation allowances based on an evaluation of the various risk components that are inherent in the loan portfolio. The riskcomponents that are evaluated include past loan loss experience; the level of non-performing and classified assets; current economic conditions; volume,growth, and composition of the loan portfolio; adverse situations that may affect the borrower's ability to repay; the estimated value of any underlyingcollateral; regulatory guidance; and other relevant factors. The appropriateness of the allowance for loan losses is approved quarterly by the Bank's board of directors. The allowance reflects management's bestestimate of the amount needed to provide for the probable loss on impaired loans, as well as other credit risks of the Bank, and is based on a risk modeldeveloped and implemented by management and approved by the Bank's board of directors. Actual results could differ from this estimate, and future additions to the allowance may be necessary based on unforeseen changes in economic conditions.In addition, federal regulators periodically review the Bank's allowance for loan losses. Such regulators have the authority to require the Bank to recognizeadditions to the allowance at the time of their examination. j)Real Estate Owned Real estate owned consists of properties acquired through, or in lieu of, loan foreclosure. Real estate owned is transferred into the portfolio at estimated netrealizable value. To the extent that the net carrying value of the loan exceeds the estimated fair value of the property at the date of transfer, the excess ischarged to the allowance for loan losses within 90 days of being transferred. Subsequent write-downs to reflect current fair market value, as well as gainsand losses upon disposition and revenue and expenses incurred in maintaining such properties, are treated as period costs and included in real estate ownedin the consolidated statements of operations. - 61 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014k)Mortgage Servicing Rights The Company sells residential mortgage loans in the secondary market and, on a selective basis, retains the right to service the loans sold. Upon sale, amortgage servicing rights asset is capitalized, which represents the then current fair value of future net cash flows expected to be realized for performingservicing activities. Mortgage servicing rights, when purchased, are initially recorded at fair value. Mortgage servicing rights are amortized over the periodof estimated net servicing income, and assessed for impairment at each reporting date. Mortgage servicing rights are carried at the lower of the initialcapitalized amount, net of accumulated amortization, or estimated fair value, and are included in other assets, net in the consolidated balance sheets. To theextent that the Company sells mortgage servicing rights, a gain is recognized for the amount of which sale proceeds exceed the remaining unamortized cost ofthe servicing rights that were sold. Gains on sale of mortgage serving rights are included in other noninterest income in the consolidated statements ofoperations.l)Cash Surrender Value of Life Insurance The Company purchased bank owned life insurance on the lives of certain employees. The Company is the beneficiary of the life insurance policies. Thecash surrender value of life insurance is reported at the amount that would be received in cash if the polices were surrendered. Increases in the cash value ofthe policies and proceeds of death benefits received are recorded in noninterest income. The increase in cash surrender value of life insurance is not subjectto income taxes, as long as the Company has the intent and ability to hold the policies until the death benefits are received. m)Office Properties and Equipment Office properties and equipment, including leasehold improvements and software, are stated at cost, net of depreciation and amortization. Depreciation andamortization are computed on the straight-line method over the estimated useful lives of the related assets. Leasehold improvements are amortized over thelease term, if shorter than the estimated useful life. Maintenance and repairs are charged to expense as incurred, while additions or major improvements arecapitalized and depreciated over their estimated useful lives. Estimated useful lives of the assets are 10 to 30 years for office properties, 3 to 10 years forequipment, and 3 years for software. Rent expense related to long-term operating leases is recorded on the accrual basis. n)Income Taxes The Company and its subsidiaries file consolidated federal and combined state income tax returns. The provision for income taxes is based upon income inthe consolidated financial statements, rather than amounts reported on the income tax returns. Deferred tax assets and liabilities are recognized for the futuretax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases,as well as net operating loss carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in theyears 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 isrecognized as income or expense in the period that includes the enactment date. The Company evaluates the realizability of its deferred tax assets on a quarterly basis. Under generally accepted accounting principles, a valuation allowanceis required to be recognized if it is "more likely than not" that a deferred tax asset will not be realized. The determination of the realizability of the deferred taxassets is highly subjective and dependent upon judgment concerning management's evaluation of both positive and negative evidence, the forecasts offuture income, applicable tax planning strategies, and assessments of current and future economic and business conditions.Positions taken in the Company's tax returns may be subject to challenge by the taxing authorities upon examination. The benefit of uncertain tax positionsare initially recognized in the financial statements only when it is more likely than not the position will be sustained upon examination by the taxauthorities. Such tax positions are both initially and subsequently measured as the largest amount of tax benefit that is greater than 50% likely of beingrealized upon settlement with the tax authority, assuming full knowledge of the position and all relevant facts. Interest and penalties on income taxuncertainties are classified within income tax expense in the income statement.o)Earnings Per Share Earnings per share are computed using the two-class method. Basic earnings per share is computed by dividing net income allocated to commonshareholders by the weighted average number of common shares outstanding during the applicable period, excluding outstanding participatingsecurities. Diluted earnings per share is computed by dividing net income by the weighted average number of common shares outstanding adjusted for thedilutive effect of all potential common shares. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue commonstock were exercised. Shares of the Employee Stock Ownership Plan committed to be released are considered outstanding for both common and dilutedEPS. Incentive stock compensation awards granted can result in dilution. p)Comprehensive Income Comprehensive income is the total of reported net income and changes in unrealized gains or losses, net of tax, on securities available for sale. q)Employee Stock Ownership Plan (ESOP) Compensation expense under the ESOP is equal to the fair value of common shares released or committed to be released to participants in the ESOP in eachrespective period. Common stock purchased by the ESOP and not committed to be released to participants is included in the consolidated statements offinancial condition at cost as a reduction of shareholders' equity. - 62 - Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 r)Impact of Recent Accounting Pronouncements ASC Topic 606 "Revenue from Contracts with Customers." New authoritative accounting guidance under ASC Topic 606, "Revenue from Contracts withCustomers" amended prior guidance to require an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amountthat reflects the consideration to which the entity expects to be entitled in exchange for those goods or services and to provide clarification on identifyingperformance obligations and licensing implementation guidance. The new authoritative guidance was initially effective for reporting periods after January 1,2017 but was deferred to January 1, 2018. The Company is evaluating the new guidance but does not expect it to have a significant impact on the Company'sstatements of operations or financial condition.ASC Topic 825 "Financial Instruments." New authoritative accounting guidance under ASC Topic 825 "Financial Instruments" amended prior guidance torequire equity investments (except those accounted for under the equity method of accounting) to be measured at fair value with changes in fair valuerecognized in net income. An entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, ifany, plus or minus changes resulting from observable price changes in orderly transactions for the identical or similar investment of the same issuer. The newguidance simplifies the impairment assessment of equity investments without readily determinable fair values, requires public entities to use the exit pricenotion when measuring the fair value of financial instruments for disclosure purposes, requires an entity to present separately in other comprehensiveincome the portion of the total change in the fair value of a liability resulting from changes in the instrument-specific credit risk when the entity has selectedthe fair value option for financial instruments and requires separate presentation of financial assets and liabilities by measurement category and form offinancial asset. The new authoritative guidance will be effective for reporting periods after January 1, 2018 and is not expected to have a significant impact onthe Company's statements of operations or financial condition.ASC Topic 842 "Leases." New authoritative accounting guidance under ASC Topic 842 "Leases" amended prior guidance to require lessees to recognize theassets and liabilities arising from all leases on the balance sheet. The new authoritative guidance defines a lease as a contract, or part of a contract, thatconveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. Inaddition, the qualifications for a sale and leaseback transaction have been amended. The new authoritative guidance also requires qualitative andquantitative disclosures by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertaintyof cash flows arising from leases. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest periodpresented using a modified retrospective approach. The new authoritative guidance will be effective for reporting periods after January 1, 2019. The Companyis evaluating the new guidance and its impact on the Company's statements of operations and financial condition.ASC Topic 718 "Compensation - Stock Compensation." New authoritative accounting guidance under ASC Topic 718 "Compensation - StockCompensation" amended prior guidance on several aspects, including the income tax consequences, classification of awards as either equity or liability, andclassification on the statement of cash flows. The new authoritative guidance allows for all excess tax benefits and tax deficiencies to be recognized asincome tax benefit or expense in the income statement. The tax effects of exercised or vested awards should be treated as discrete items in the reportingperiod in which they occur. An entity also should recognize excess tax benefits regardless of whether the benefit reduces taxes payable in the current period.For earnings per share, anticipated excess tax benefits will not be included in assumed proceeds when applying the treasury method for computing dilutiveshares. For the statement of cash flows, excess tax benefits should be classified along with other income tax cash flows as an operating activity, and cashpaid by an employer when directly withholding shares for tax withholding purposes should be classified as a financing activity. The new authoritativeguidance also allows an entity to make an entity-wide accounting policy election to either estimate the number of awards that are expected to vest or accountfor forfeitures when they occur. In addition, the threshold to qualify for equity classification permits withholding up to the maximum statutory tax rates in theapplicable jurisdictions. The new authoritative guidance will be effective for reporting periods after January 1, 2017 and is not expected to have a significantimpact on the Company's statements of operations or financial condition.ASC Topic 326 "Financial Instruments - Credit Losses." New authoritative accounting guidance under ASC Topic 326 "Financial Instruments - CreditLosses" amended the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses and requiresconsideration of a broader range of reasonable and supportable information for credit loss estimates. The measurement of expected credit losses is based onrelevant information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect thecollectability of the reported amount. The new authoritative guidance also requires a financial asset (or a group of financial assets) measured at amortizedcost basis to be presented at the net amount expected to be collected (net of the allowance for credit losses). In addition, the credit losses relating toavailable-for-sale debt securities should be recorded through an allowance for credit losses rather than a write-down. The new authoritative guidance will beeffective for reporting periods after January 1, 2020. The Company is evaluating the new guidance and its impact on the Company's statements of operationsor financial condition. - 63 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 2)Securities Securities Available for Sale The amortized cost and fair value of the Company's investment in securities follow: December 31, 2016 Amortized cost Grossunrealizedgains Grossunrealizedlosses Fair value (In Thousands) Mortgage-backed securities $72,858 798 (243) 73,413 Collateralized mortgage obligations Government sponsored enterprise issued 62,297 70 (365) 62,002 Mortgage related securities 135,155 868 (608) 135,415 Government sponsored enterprise bonds 2,500 4 (1) 2,503 Municipal securities 70,311 685 (300) 70,696 Other debt securities 17,399 154 (603) 16,950 Debt securities 90,210 843 (904) 90,149 Certificates of deposit 1,225 7 (1) 1,231 $226,590 1,718 (1,513) 226,795 December 31, 2015 Amortized cost Grossunrealizedgains Grossunrealizedlosses Fair value (In Thousands) Mortgage-backed securities $95,911 1,004 (248) 96,667 Collateralized mortgage obligations Government sponsored enterprise issued 70,605 123 (300) 70,428 Mortgage related securities 166,516 1,127 (548) 167,095 Government sponsored enterprise bonds 3,750 – (4) 3,746 Municipal securities 77,509 1,730 (80) 79,159 Other debt securities 17,401 209 (647) 16,963 Debt securities 98,660 1,939 (731) 99,868 Certificates of deposit 2,695 4 (4) 2,695 $267,871 3,070 (1,283) 269,658 The Company's mortgage-backed securities and collateralized mortgage obligations issued by government sponsored enterprises are guaranteed by one of thefollowing government sponsored enterprises: Fannie Mae, Freddie Mac or Ginnie Mae. At December 31, 2016, $93.2 million of the Company's mortgage relatedsecurities were pledged as collateral to secure repurchase agreement obligations of the Company. As of December 31, 2016, $2.4 million of the Company'smortgage related securities were pledged as collateral to secure mortgage banking related activities. The amortized cost and fair value of securities at December 31, 2016, by contractual maturity, are shown below. Expected maturities may differ from contractualmaturities because issuers or borrowers may have the right to prepay obligations with or without prepayment penalties. December 31, 2016 Amortized cost Fair value (In Thousands) Debt securities: Due within one year $8,737 8,751 Due after one year through five years 20,944 20,891 Due after five years through ten years 41,332 41,684 Due after ten years 20,422 20,054 Mortgage-related securities 135,155 135,415 $226,590 226,795 - 64 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 Total proceeds and gross gains and losses from sales of investment securities available for sale for each of periods listed below. December 31, 2016 2015 2014 (In Thousands) Gross gains $- 44 - Gross losses - - - Gains on sale of investment securities, net $- 44 - Proceeds from sales of investment securities $- 1,034 - Gross unrealized losses on securities available for sale and the fair value of the related securities, aggregated by investment category and length of time thatindividual securities have been in a continuous unrealized loss position, were as follows: December 31, 2016 Less than 12 months 12 months or longer Total Fairvalue Unrealizedloss Fairvalue Unrealizedloss Fairvalue Unrealizedloss (In Thousands) Mortgage-backed securities $23,433 (222) 1,068 (21) 24,501 (243)Collateralized mortgage obligations Government sponsored enterprise issued 39,395 (365) - - 39,395 (365)Government sponsored enterprise bonds 2,000 (1) - - 2,000 (1)Municipal securities 32,141 (300) – – 32,141 (300)Other debt securities - - 9,397 (603) 9,397 (603)Certificates of deposit 489 (1) - - 489 (1) $97,458 (889) 10,465 (624) 107,923 (1,513) December 31, 2015 Less than 12 months 12 months or longer Total Fairvalue Unrealizedloss Fairvalue Unrealizedloss Fairvalue Unrealizedloss (In Thousands) (In Thousands) Mortgage-backed securities $18,488 (163) 5,577 (85) 24,065 (248)Collateralized mortgage obligations Government sponsored enterprise issued 48,281 (300) - - 48,281 (300)Government sponsored enterprise bonds 3,246 (4) - - 3,246 (4)Municipal securities 9,409 (18) 5,555 (62) 14,964 (80)Other debt securities 14,363 (647) - - 14,363 (647)Certificates of deposit 976 (4) - - 976 (4) $94,763 (1,136) 11,132 (147) 105,895 (1,283) The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment. In evaluatingwhether a security's decline in market value is other-than-temporary, management considers the length of time and extent to which the fair value has been lessthan cost, financial condition of the issuer and the underlying obligors, quality of credit enhancements, volatility of the fair value of the security, the expectedrecovery period of the security and ratings agency evaluations. In addition, the Company may also evaluate payment structure, whether there are defaultedpayments or expected defaults, prepayment speeds and the value of any underlying collateral. As of December 31, 2016, the Company identified one municipal security that was deemed to be other-than-temporarily impaired. The security was issued by atax incremental district in a municipality located in Wisconsin. During the year ended December 31, 2012, the Company received audited financial statementswith respect to the municipal issuer that called into question the ability of the underlying taxing district that issued the securities to operate as a goingconcern. During the year ended December 31, 2012, the Company's analysis of two securities in this municipality resulted in $100,000 in credit losses that werecharged to earnings with respect to these two municipal securities. An additional $17,000 credit loss was charged to earnings during the year ended December31, 2014 with respect to these two securities as a sale occurred at a discounted price. During the year ended December 31, 2016, one of these municipal issuerbonds matured. The Company received the full principal and interest on the bond and recovered $23,000 of previously recorded other-than-temporaryimpairment. As of December 31, 2016, the remaining impaired bond had an amortized cost of $116,000 and a total life-to-date impairment of $94,000. - 65 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014As of December 31, 2016, the Company had one corporate debt security and one mortgage-backed security which had been in an unrealized loss position fortwelve months or longer. These securities were determined not to be other-than-temporarily impaired as of December 31, 2016. The Company has determinedthat the decline in fair value of these securities is not attributable to credit deterioration, and as the Company does not intend to sell nor is it more likely thannot that it will be required to sell these securities before recovery of the amortized cost basis, these securities are not considered other-than-temporarilyimpaired.Continued deterioration of general economic market conditions could result in the recognition of future other-than-temporary impairment losses within theinvestment portfolio and such amounts could be material to our consolidated financial statements.The following table presents the change in other-than-temporary credit related impairment charges on municipal securities for which a portion of the other-than-temporary impairments related to other factors was recognized in other comprehensive loss. (in thousands) Credit-related impairments on securities as of December 31, 2014 $117 Credit related impairments related to a security for which other-than-temporary impairment was not previously recognized - Increase in credit related impairments related to securities for which an other-than-temporary impairment was previously recognized - Credit-related impairments on securities as of December 31, 2015 117 Credit related impairments related to a security for which other-than-temporary impairment was not previously recognized - Decrease in credit related impairments related to securities for which an other-than-temporary impairment was previously recognized (23)Credit-related impairments on securities as of December 31, 2016 $94 3)Loans Receivable Loans receivable at December 31, 2016 and 2015 are summarized as follows: December 31, 2016 2015 Mortgage loans: (In Thousands) Residential real estate: One- to four-family $392,817 381,992 Multi family 558,592 547,250 Home equity 21,778 24,326 Construction and land 18,179 19,148 Commercial real estate 159,401 118,820 Consumer 319 361 Commercial loans 26,798 23,037 Total loans receivable $1,177,884 1,114,934 The Company provides several types of loans to its customers, including residential, construction, commercial and consumer loans. Significant loanconcentrations are considered to exist for a financial institution when there are amounts loaned to one borrower or to multiple borrowers engaged in similaractivities that would cause them to be similarly impacted by economic or other conditions. While credit risks tend to be geographically concentrated in theCompany's Milwaukee metropolitan area and while 82.6% of the Company's loan portfolio involves loans that are secured by residential real estate, there are noconcentrations with individual or groups of related borrowers. While the real estate collateralizing these loans is primarily residential in nature, it ranges fromowner-occupied single family homes to large apartment complexes. Qualifying loans receivable totaling $911.9 million and $872.8 million are pledged as collateral against $295.0 million in outstanding Federal Home Loan Bank ofChicago advances under a blanket security agreement at both December 31, 2016 and December 31, 2015. - 66 - Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 An analysis of past due loans receivable as of December 31, 2016 and 2015 follows: As of December 31, 2016 1-59 Days PastDue (1) 60-89 Days PastDue (2) Greater Than90Days Total Past Due Current (3) Total Loans Mortgage loans: (In Thousands) Residential real estate: One- to four-family $2,403 7 4,623 7,033 385,784 392,817 Multi family 376 - 401 777 557,815 558,592 Home equity 82 - 35 117 21,661 21,778 Construction and land - - - - 18,179 18,179 Commercial real estate - - 203 203 159,198 159,401 Consumer - - - - 319 319 Commercial loans 42 - 27 69 26,729 26,798 Total $2,903 7 5,289 8,199 1,169,685 1,177,884 As of December 31, 2015 1-59 Days PastDue (1) 60-89 Days PastDue (2) Greater Than90Days Total Past Due Current (3) Total Loans Mortgage loans: (In Thousands) Residential real estate: One- to four-family $851 1,133 6,503 8,487 373,505 381,992 Multi family - 207 1,858 2,065 545,185 547,250 Home equity 255 96 110 461 23,865 24,326 Construction and land - - 238 238 18,910 19,148 Commercial real estate 57 - 223 280 118,540 118,820 Consumer - - - - 361 361 Commercial loans - - - - 23,037 23,037 Total $1,163 1,436 8,932 11,531 1,103,403 1,114,934 (1)Includes $148,000 and $315,000 for December 31, 2016 and 2015, respectively, which are on non-accrual status.(2)Includes $- and $467,000 for December 31, 2016 and 2015, respectively, which are on non-accrual status.(3)Includes $4.4 million and $7.9 million for December 31, 2016 and 2015, respectively, which are on non-accrual status.As of December 31, 2016 and 2015, there are no loans that are 90 or more days past due and still accruing interest. - 67 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 A summary of the activity for the years ended 2016, 2015 and 2014 in the allowance for loan losses follows: One- toFour-Family MultiFamily Home Equity Constructionand Land CommercialReal Estate Consumer Commercial Total (In Thousands) Year ended December 31, 2016 Balance at beginning of period $7,763 5,000 433 904 1,680 9 396 16,185 Provision for loan losses (407) 146 7 43 271 3 317 380 Charge-offs (1,003) (489) (112) (3) - - - (1,607)Recoveries 811 152 36 72 - - - 1,071 Balance at end of period $7,164 4,809 364 1,016 1,951 12 713 16,029 Year ended December 31, 2015 Balance at beginning of period $9,877 5,358 422 687 1,951 8 403 18,706 Provision for loan losses 1,092 931 (27) 243 (266) (1) (7) 1,965 Charge-offs (3,855) (2,281) (72) (84) (45) (3) - (6,340)Recoveries 649 992 110 58 40 5 - 1,854 Balance at end of period $7,763 5,000 433 904 1,680 9 396 16,185 Year ended December 31, 2014 Balance at beginning of period $11,549 7,211 1,807 1,613 1,402 34 648 24,264 Provision for loan losses (1,081) 3,205 (1,208) (505) 721 (27) 45 1,150 Charge-offs (2,424) (5,247) (191) (496) (199) (5) (293) (8,855)Recoveries 1,833 189 14 75 27 6 3 2,147 Balance at end of period $9,877 5,358 422 687 1,951 8 403 18,706 A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of the year ended December 31,2016 follows: One- toFour-Family MultiFamily Home Equity Constructionand Land CommercialReal Estate Consumer Commercial Total (In Thousands) Allowance related to loansindividually evaluated forimpairment $499 - 79 - 83 - 1 662 Allowance related to loanscollectively evaluated forimpairment 6,665 4,809 285 1,016 1,868 12 712 15,367 Balance at end of period $7,164 4,809 364 1,016 1,951 12 713 16,029 Loans individually evaluated forimpairment $10,920 3,941 442 - 718 - 41 16,062 Loans collectively evaluated forimpairment 381,897 554,651 21,336 18,179 158,683 319 26,757 1,161,822 Total gross loans $392,817 558,592 21,778 18,179 159,401 319 26,798 1,177,884 - 68 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 A summary of the allowance for loan loss for loans evaluated individually and collectively for impairment by collateral class as of the year ended December 31,2015 follows: One- toFour-Family MultiFamily Home Equity Constructionand Land CommercialReal Estate Consumer Commercial Total (In Thousands) Allowance related to loansindividually evaluated forimpairment $1,114 242 108 3 106 - 3 1,576 Allowance related to loanscollectively evaluated forimpairment 6,649 4,758 325 901 1,574 9 393 14,609 Balance at end of period $7,763 5,000 433 904 1,680 9 396 16,185 Loans individually evaluated forimpairment $18,385 5,100 472 1,795 1,766 - 27 27,545 Loans collectively evaluated forimpairment 363,607 542,150 23,854 17,353 117,054 361 23,010 1,087,389 Total gross loans $381,992 547,250 24,326 19,148 118,820 361 23,037 1,114,934 The following table presents information relating to the Company's internal risk ratings of its loans receivable as of December 31, 2016 and 2015: One- to Four-Family MultiFamily Home Equity Constructionand Land CommercialReal Estate Consumer Commercial Total At December 31, 2016(In Thousands) Substandard $12,845 1,427 428 - 717 - 41 15,458 Watch 10,509 3,975 149 436 1,389 - 3,671 20,129 Pass 369,463 553,190 21,201 17,743 157,295 319 23,086 1,142,297 $392,817 558,592 21,778 18,179 159,401 319 26,798 1,177,884 At December 31, 2015(In Thousands) Substandard $19,148 2,553 684 1,794 1,766 - 55 26,000 Watch 11,352 3,634 128 - 1,161 - 402 16,677 Pass 351,492 541,063 23,514 17,354 115,893 361 22,580 1,072,257 $381,992 547,250 24,326 19,148 118,820 361 23,037 1,114,934 Factors that are important to managing overall credit quality include sound loan underwriting and administration, systematic monitoring of existing loans andcommitments, effective loan review on an ongoing basis, early identification of potential problems, an appropriate allowance for loan losses, and sound non-accrual and charge-off policies. Our underwriting policies require an officers' loan committee review and approval of all loans in excess of $500,000. Inaddition, an independent loan review function exists for all loans. Our ability to manage credit risk depends in large part on our ability to properly identifyand manage problem loans. To do so, we maintain a loan review system under which our credit management personnel review non-owner occupied one- tofour-family, over four-family, construction and land, commercial real estate and commercial loans that individually, or as part of an overall borrowerrelationship exceed $10.0 million in potential exposure. Loans meeting these criteria are reviewed on an annual basis, or more frequently, if the loan renewal isless than one year. With respect to this review process, management has determined that pass loans include loans that exhibit acceptable financialstatements, cash flow and leverage. Watch loans have potential weaknesses that deserve management's attention, and if left uncorrected, these potentialweaknesses may result in deterioration of the repayment prospects for the credit. Substandard loans are considered inadequately protected by the currentnet worth and paying capacity of the obligor or the collateral pledged. These loans generally have a well-defined weakness that may jeopardize liquidation ofthe debt and are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Finally, a loan is consideredto be impaired when it is probable that the Bank will not be able to collect all amounts due according to the contractual terms of the loan agreement.Management has determined that all non-accrual loans and loans modified under troubled debt restructurings meet the definition of an impaired loan.The Company's procedures dictate that an updated valuation must be obtained with respect to underlying collateral at the time a loan is deemedimpaired. Updated valuations may also be obtained upon transfer from loans receivable to real estate owned based upon the age of the prior appraisal,changes in market conditions or known changes to the physical condition of the property.Estimated fair values are reduced to account for sales commissions, broker fees, unpaid property taxes and additional selling expenses to arrive at anestimated net realizable value. The adjustment factor is based upon the Company's actual experience with respect to sales of real estate owned over the priortwo years. In situations in which we are placing reliance on an appraisal that is more than one year old, an additional adjustment factor is applied to accountfor downward market pressure since the date of appraisal. The additional adjustment factor is based upon relevant sales data available for our generaloperating market as well as company-specific historical net realizable values as compared to the most recent appraisal prior to disposition. - 69 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014With respect to over-four family income producing real estate, appraisals are reviewed and estimated collateral values are adjusted by updating significantappraisal assumptions to reflect current real estate market conditions. Significant assumptions reviewed and updated include the capitalization rate, rentalincome and operating expenses. These adjusted assumptions are based upon recent appraisals received on similar properties as well as on actual experiencerelated to real estate owned and currently under Company management.The following tables present data on impaired loans at December 31, 2016 and 2015. As of or for the Year Ended December 31, 2016 RecordedInvestment UnpaidPrincipal Reserve CumulativeCharge-Offs AverageRecordedInvestment Interest PaidYTD Total Impaired with Reserve One- to four-family $3,007 3,007 499 - 3,063 88 Multi family - - - - - - Home equity 188 188 79 - 198 15 Construction and land - - - - - - Commercial real estate 280 689 83 409 295 15 Consumer - - - - - - Commercial 1 1 1 - 2 - $3,476 3,885 662 409 3,558 118 Total Impaired with no Reserve One- to four-family $7,913 9,245 - 1,332 8,150 401 Multi family 3,941 4,952 - 1,011 4,005 230 Home equity 254 254 - - 258 9 Construction and land - - - - - - Commercial real estate 438 438 - - 442 13 Consumer - - - - - - Commercial 40 40 - - 46 2 $12,586 14,929 - 2,343 12,901 655 Total Impaired One- to four-family $10,920 12,252 499 1,332 11,213 489 Multi family 3,941 4,952 - 1,011 4,005 230 Home equity 442 442 79 - 456 24 Construction and land - - - - - - Commercial real estate 718 1,127 83 409 737 28 Consumer - - - - - - Commercial 41 41 1 - 48 2 $16,062 18,814 662 2,752 16,459 773 The difference between a loan's recorded investment and the unpaid principal balance represents a partial charge-off resulting from a confirmed loss due to thevalue of the collateral securing the loan being below the loan balance and management's assessment that the full collection of the loan balance is not likely.When a loan is considered impaired, interest payments received are treated as interest income on a cash basis as long as the remaining book value of the loan(i.e., after charge-off of all identified losses) is deemed to be fully collectible. If the remaining book value is not deemed to be fully collectible, all paymentsreceived are applied to unpaid principal. Determination as to the ultimate collectability of the remaining book value is supported by an updated creditdepartment evaluation of the borrower's financial condition and prospects for repayment, including consideration of the borrower's sustained historicalrepayment performance and other relevant factors. - 70 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 As of or for the Year Ended December 31, 2015 RecordedInvestment UnpaidPrincipal Reserve CumulativeCharge-Offs AverageRecordedInvestment Interest PaidYTD Total Impaired with Reserve One- to four-family $7,903 8,923 1,114 1,020 8,113 393 Multi family 1,055 1,055 242 - 1,044 42 Home equity 169 169 108 - 174 10 Construction and land 156 269 3 113 155 - Commercial real estate 314 723 106 409 367 23 Consumer - - - - - - Commercial 3 3 3 - 5 1 $9,600 11,142 1,576 1,542 9,858 469 Total Impaired with no Reserve One- to four-family $10,482 11,991 - 1,509 10,676 500 Multi family 4,045 5,090 - 1,045 4,106 245 Home equity 303 303 - - 307 13 Construction and land 1,639 1,639 - - 1,827 62 Commercial real estate 1,452 1,452 - - 1,458 72 Consumer - - - - - - Commercial 24 24 - - 29 2 $17,945 20,499 - 2,554 18,403 894 Total Impaired One- to four-family $18,385 20,914 1,114 2,529 18,789 893 Multi family 5,100 6,145 242 1,045 5,150 287 Home equity 472 472 108 - 481 23 Construction and land 1,795 1,908 3 113 1,982 62 Commercial real estate 1,766 2,175 106 409 1,825 95 Consumer - - - - - - Commercial 27 27 3 - 34 3 $27,545 31,641 1,576 4,096 28,261 1,363 The determination as to whether an allowance is required with respect to impaired loans is based upon an analysis of the value of the underlying collateraland/or the borrower's intent and ability to make all principal and interest payments in accordance with contractual terms. The evaluation process is subject tothe use of significant estimates and actual results could differ from estimates. This analysis is primarily based upon third party appraisals and/or a discountedcash flow analysis. In those cases in which no allowance has been provided for an impaired loan, the Company has determined that the estimated value of theunderlying collateral exceeds the remaining outstanding balance of the loan. Of the total $12.6 million of impaired loans as of December 31, 2016 for which noallowance has been provided, $2.3 million in charge-offs have been recorded to reduce the unpaid principal balance to an amount that is commensurate with theloan's net realizable value, using the estimated fair value of the underlying collateral. To the extent that further deterioration in property values continues, theCompany may have to reevaluate the sufficiency of the collateral servicing these impaired loans resulting in additional provisions to the allowance for loanslosses or charge-offs. - 71 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 The following presents data on troubled debt restructurings: As of December 31, 2016 Accruing Non-accruing Total Amount Number Amount Number Amount Number (Dollars in Thousands) One- to four-family $3,296 3 $2,399 34 $5,695 37 Multi family 2,514 1 1,427 5 3,941 6 Home equity 49 1 97 1 146 2 Commercial real estate 295 1 60 1 355 2 $6,154 6 $3,983 41 $10,137 47 As of December 31, 2015 Accruing Non-accruing Total Amount Number Amount Number Amount Number (Dollars in Thousands) One- to four-family $3,900 4 $5,739 45 $9,639 49 Multi family 2,546 1 2,317 7 4,863 8 Home equity - - 98 1 98 1 Construction and land 1,556 2 - - 1,556 2 Commercial real estate 1,306 1 77 1 1,383 2 $9,308 8 $8,231 54 $17,539 62 Troubled debt restructurings involve granting concessions to a borrower experiencing financial difficulty by modifying the terms of the loan in an effort toavoid foreclosure. Typical restructured terms include six to twelve months of principal forbearance, a reduction in interest rate or both. In no instances havethe restructured terms included a reduction of outstanding principal balance. At December 31, 2016, $10.1 million in loans had been modified in troubled debtrestructurings and $4.0 million of these loans were included in the non-accrual loan total. The remaining $6.2 million, while meeting the internal requirements formodification in a troubled debt restructuring, were current with respect to payments under their original loan terms at the time of the restructuring and thus,continued to be included with accruing loans. Provided these loans perform in accordance with the modified terms, they will continue to be accounted for onan accrual basis.All loans that have been modified in a troubled debt restructuring are considered to be impaired. As such, an analysis has been performed with respect to all ofthese loans to determine the need for a valuation reserve. When a loan is expected to perform in accordance with the restructured terms and ultimately return toand perform under contract terms, a valuation allowance is established equal to the excess of the present value of the expected future cash flows under theoriginal contract terms as compared with the modified terms, including an estimated default rate. When there is doubt as to the borrower's ability to performunder the restructured terms or ultimately return to and perform under market terms, a valuation allowance is established equal to the impairment when thecarrying amount exceeds fair value of the underlying collateral. As a result of the impairment analysis, a $293,000 valuation allowance has been established asof December 31, 2016 with respect to the $10.1 million in troubled debt restructurings. As of December 31, 2015, $996,000 in valuation allowance had beenestablished with respect to the $17.5 million in troubled debt restructurings.If an updated credit department review indicates no other evidence of elevated credit risk and the borrower completes a minimum of six consecutive contractualpayments, the loan is returned to accrual status at that time. - 72 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 The following presents troubled debt restructurings by concession type at December 31, 2016 and 2015: As of December 31, 2016 Performing inaccordance withmodified terms In Default Total Amount Number Amount Number Amount Number (Dollars in Thousands) Interest reduction and principal forbearance $8,221 22 761 2 8,982 24 Principal forbearance 49 1 - - 49 1 Interest reduction 1,106 22 - - 1,106 22 $9,376 45 761 2 10,137 47 As of December 31, 2015 Performing inaccordance withmodified terms In Default Total Amount Number Amount Number Amount Number (Dollars in Thousands) Interest reduction and principal forbearance $13,971 30 1,012 5 14,983 35 Principal forbearance 97 1 - - 97 1 Interest reduction 2,459 26 - - 2,459 26 $16,527 57 1,012 5 17,539 62 The following presents data on troubled debt restructurings: For the Year Ended December 31, 2016 December 31, 2015 Amount Number Amount Number (Dollars in Thousands) Loans modified as a troubled debt restructure One- to four-family $- - 186 3 Multi family - - 819 2 Home equity 49 1 - - $49 1 1,005 5 There were no troubled debt restructurings for which there was a default during the year ended December 31, 2016. There were four troubled debt restructurings forwhich there was a default during the year ended December 31, 2015, which totaled $935,000 and were primarily made up of multi family loans.The following table presents data on non-accrual loans: As of December 31, 2016 2015 (Dollars in Thousands) Residential One- to four-family $7,623 13,888 Multi family 1,427 2,553 Home equity 344 437 Construction and land - 239 Commercial real estate 422 460 Commercial 41 27 Consumer - - Total non-accrual loans $9,857 17,604 Total non-accrual loans to total loans 0.84% 1.58%Total non-accrual loans to total assets 0.55% 1.00% - 73 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 4)Office Properties and Equipment Office properties and equipment are summarized as follows: December 31, 2016 2015 (In Thousands) Land $6,668 6,668 Office buildings and improvements 30,319 29,990 Furniture and equipment 12,868 12,655 49,855 49,313 Less accumulated depreciation (26,200) (23,985) $23,655 25,328 Depreciation of premises and equipment totaled $2.6 million, $3.1 million and $3.3 million for the years ended December 31, 2016, 2015 and 2014, respectively. The Company and certain subsidiaries are obligated under non-cancelable operating leases for other facilities and equipment. Rent and equipment leaseexpense totaled $4.4 million, $3.8 million and $4.5 million for the years ended December 31, 2016, 2015 and 2014, respectively. The appropriate minimum annualcommitments under all non-cancelable lease agreements as of December 31, 2016 are as follows: Operatingleases (In Thousands) Within one year $2,926 One to two years 2,254 Two to three years 1,422 Three to four years 968 Four through five years 625 After five years 1,645 Total $9,840 5)Real Estate Owned Real estate owned is summarized as follows: December 31, 2016 2015 (In Thousands) One- to four-family $2,141 4,610 Multi-family - 209 Construction and land 5,082 5,262 Commercial real estate 300 300 Total 7,523 10,381 Valuation allowance at end of period (1,405) (1,191)Total real estate owned, net $6,118 9,190 The following table presents the activity in real estate owned: Year Ended December 31, 2016 2015 (In Thousands) Real estate owned at beginning of period $9,190 18,706 Transferred in from loans receivable 4,590 15,580 Sales (7,006) (23,413)Write downs (656) (2,202)Other activity - 519 Real estate owned at end of period $6,118 9,190 - 74 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 6)Mortgage Servicing Rights The following table presents the activity related to the Company's mortgage servicing rights: Year ended December 31, 2016 2015 (In Thousands) Mortgage servicing rights at beginning of the period $1,422 $2,511 Additions 1,436 3,838 Amortization (598) (481)Sales - (4,446)Mortgage servicing rights at end of the period 2,260 1,422 Valuation allowance at end of period - - Mortgage servicing rights at the end of the period, net $2,260 $1,422 During the twelve months ended December 31, 2016, on a consolidated basis, $2.38 billion, which excludes the loans originated from Waterstone MortgageCorporation and purchased by WaterStone Bank, in residential loans were originated for sale. During the same period, sales of loans held for sale totaled $2.32 billion,generating mortgage banking income of $121.1 million. The unpaid principal balance of loans serviced for others was $318.6 million and $176.4 million at December 31,2016 and December 31, 2015 respectively. These loans are not reflected in the consolidated statements of financial condition.During the twelve months ended December 31, 2016, the Company did not sell any mortgage servicing rights. During the twelve months ended December 31, 2015, theCompany sold mortgage servicing rights related to $580.2 million in loans receivable and with a book value of $4.4 million for $5.3 million resulting in a gain on sale of$901,000.The following table shows the estimated future amortization expense for mortgage servicing rights at December 31, 2016 for the periods indicated: (In Thousands) Estimate for the years ended December 31:2017 $418 2018 374 2019 330 2020 285 2021 242 Thereafter 611 Total $2,260 - 75 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 7)Deposits The aggregate amount of time deposit accounts with balances greater than $250,000 at December 31, 2016 and 2015 amounted to $44.5 million and $37.7 million,respectively. A summary of interest expense on deposits is as follows: Years ended December 31, 2016 2015 2014 (In Thousands) Interest-bearing demand deposits $19 20 16 Money market and savings deposits 392 197 113 Time deposits 6,953 5,662 4,797 $7,364 5,879 4,926 A summary of the contractual maturities of time deposits at December 31, 2016 is as follows: (In Thousands) Within one year $469,269 One to two years 183,330 Two to three years 8,745 Three to four years 3,297 Four through five years 1,943 $666,584 - 76 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 8)Borrowings Borrowings consist of the following: December 31, 2016 December 31, 2015 Balance WeightedAverageRate Balance WeightedAverageRate (Dollars in Thousands) Short term: Repurchase agreements $8,155 3.52% 7,203 3.19% Federal Home Loan Bank, Chicago advances 65,000 0.61% - - Long term: Federal Home Loan Bank advances maturing: 2016 - - 220,000 4.34%2017 65,000 3.19% 65,000 3.19%2018 65,000 2.97% 65,000 2.97%2021 100,000 0.78% - - Repurchase agreements maturing: 2017 84,000 3.96% 84,000 3.96% $387,155 2.27% 441,203 3.88%The short-term repurchase agreements represents the outstanding portion of a total $35.0 million commitment with one unrelated bank. The short-termrepurchase agreement is utilized by Waterstone Mortgage Corporation to finance loans originated for sale. This agreement is secured by the underlying loansbeing financed. Related interest rates are based upon the note rate associated with the loans being financed. The short-term repurchase agreement had a $8.2million balance on a total commitment of $35.0 million at December 31, 2016. The $65.0 million in short-term consist of two advances totaling $25.0 million with a fixed rate of 0.70% and a maturity date of January 3, 2017 and one advancefor $40.0 million with a fixed rate of 0.55% and a maturity date of January 23, 2017.The $65.0 million in advances due in 2017 consist of three advances with fixed rates ranging from 3.09% to 3.46% callable quarterly until maturity. The $65.0 million in advances due in 2018 consist of three advances with fixed rates ranging from 2.73% to 3.11% callable quarterly until maturity.The $100.0 million in advances due in 2021 consist of two advances totaling $50.0 million with fixed rates ranging from 0.67% to 0.73% with a FHLB quarterlycall option beginning in June 2018 and one advance for $50.0 million with a fixed rate of 0.85% with a FHLB quarterly call option beginning in September 2018. The $84.0 million in repurchase agreements have fixed rates ranging from 2.89% to 4.31% callable quarterly until their maturity in 2017. The repurchaseagreements are collateralized by securities available for sale with an estimated fair value of $93.2 million at December 31, 2016. The Company selects loans that meet underwriting criteria established by the Federal Home Loan Bank Chicago (FHLBC) as collateral for outstandingadvances. The Company's borrowings at the FHLBC are limited to 79% of the carrying value of unencumbered one- to four-family mortgage loans, 51% of thecarrying value of home equity loans and 75% of the carrying value of over four-family loans. In addition, these advances are collateralized by FHLBC stock of$13.3 million at December 31, 2016 and $19.5 million at December 31, 2015. In the event of prepayment, the Company is obligated to pay all remaining contractualinterest on the advance. 9)Regulatory Capital The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capitalrequirements, or overall financial performance deemed by the regulators to be inadequate, can initiate certain mandatory and possibly additional discretionary actionsby regulators that, if undertaken, could have a direct material effect on the Company's financial condition and results of operations. Under capital adequacy guidelinesand the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Company's andBank's assets, liabilities, and certain off-balance-sheet items, as calculated under regulatory accounting practices. The Company's and Bank's capital amounts andclassification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. The Federal Reserve Board and the FDIC issued final rules implementing the Basel III regulatory capital framework and related Dodd-Frank Wall Street Reform andConsumer Protection Act changes. The rules revise minimum capital requirements and adjust prompt corrective action thresholds. The final rules revised theregulatory capital elements, added a new common equity Tier I capital ratio, increased the minimum Tier 1 capital ratio requirements and implemented a new capitalconservation buffer. The rules also permitted certain banking organizations to retain, through a one-time election, the existing treatment for accumulated othercomprehensive income. The Company and the Bank have made the election to retain the existing treatment for accumulated other comprehensive income. The finalrules took effect for the Company and the Bank on January 1, 2015, subject to a transition period for certain parts of the rules.- 77 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 The table below includes the new regulatory capital ratio requirements that became effective on January 1, 2015. Beginning in 2016, an additional capital conservationbuffer was added to the minimum requirements for capital adequacy purposes, subject to a three year phase-in period. The capital conservation buffer will be fullyphased-in on January 1, 2019 at 2.5 percent. A banking organization with a conservation buffer of less than 2.5 percent (or the required phase-in amount in years priorto 2019) will be subject to limitations on capital distributions, including dividend payments and certain discretionary bonus payments to executive officers. At thepresent time, the ratios for the Company and the Bank are sufficient to meet the fully phased-in conservation buffer. The actual and required capital amounts and ratios as of December 31, 2016 and 2015 are presented in the table below: December 31, 2016 Actual For CapitalAdequacy Purposes Minimum Capital Adequacywith Capital Buffer To Be Well-CapitalizedUnder Prompt CorrectiveAction Provisions Amount Ratio Amount Ratio Amount Ratio Amount Ratio (Dollars In Thousands) Total capital (to risk-weightedassets) Consolidated WaterstoneFinancial , Inc. $426,496 32.23% 105,870 8.00% 114,141 8.625% N/A N/A WaterStone Bank 389,602 29.50% 105,641 8.00% 113,895 8.625% 132,052 10.00%Tier I capital (to risk-weightedassets) Consolidated WaterstoneFinancial , Inc. 410,467 31.02% 79,402 6.00% 87,673 6.625% N/A N/A WaterStone Bank 373,573 28.29% 79,231 6.00% 87,484 6.625% 105,641 8.00%Common Equity Tier 1 Capital (torisk-weighted assets) Consolidated WaterstoneFinancial , Inc. 410,467 31.02% 59,552 4.50% 67,823 5.125% N/A N/A WaterStone Bank 373,573 28.29% 59,423 4.50% 67,676 5.125% 85,834 6.50%Tier I capital (to average assets) Consolidated WaterstoneFinancial , Inc. 410,467 23.20% 70,760 4.00% N/A N/A N/A N/A WaterStone Bank 373,573 21.17% 70,573 4.00% N/A N/A 88,216 5.00%State of Wisconsin (to totalassets) WaterStone Bank 373,573 20.90% 107,247 6.00% N/A N/A N/A N/A December 31, 2015 (Dollars In Thousands) Total capital (to risk-weightedassets) Consolidated WaterstoneFinancial , Inc. $405,947 33.41% 97,207 8.00% N/A N/A N/A N/A WaterStone Bank 374,435 30.92% 96,885 8.00% N/A N/A 121,106 10.00%Tier I capital (to risk-weightedassets) Consolidated WaterstoneFinancial , Inc. 390,747 32.16% 72,905 6.00% N/A N/A N/A N/A WaterStone Bank 359,284 29.67% 72,664 6.00% N/A N/A 96,885 8.00%Common Equity Tier 1 Capital (torisk-weighted assets) Consolidated WaterstoneFinancial , Inc. 390,747 32.16% 54,679 4.50% N/A N/A N/A N/A WaterStone Bank 359,284 29.67% 54,498 4.50% N/A N/A 78,719 6.50%Tier I capital (to average assets) Consolidated WaterstoneFinancial , Inc. 390,747 22.20% 70,417 4.00% N/A N/A N/A N/A WaterStone Bank 359,284 20.45% 70,286 4.00% N/A N/A 87,857 5.00%State of Wisconsin (to totalassets) WaterStone Bank 359,284 20.43% 105,493 6.00% N/A N/A N/A N/A - 78 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 10)Stock Based Compensation Stock-Based Compensation Plan In 2006, the Company's shareholders approved the 2006 Equity Incentive Plan. All stock awards granted under this plan vest over a period of five years and arerequired to be settled in shares of the Company's common stock. The exercise price for all stock options granted is equal to the quoted NASDAQ marketclosing price on the date that the awards were granted and expire ten years after the grant date, if not exercised. All restricted stock grants are issued frompreviously unissued shares.In 2015, the Company's shareholders approved the 2015 Equity Incentive Plan. A total of 2,530,000 stock options and 1,012,000 restricted shares were approvedfor award. The 665,000 stock options granted to employees under this plan vest over a period of five years. The 600,000 stock option awards granted todirectors under this plan vest over a period of eight years. The exercise price for all stock options granted is equal to the quoted NASDAQ market close priceon the date that the awards were granted and expire ten years after the grant date, if not exercised. The 385,500 restricted stock awards granted to employeesunder this plan vest in five installments over four years with one installment vesting immediately. The 184,000 stock awards granted to directors under this planvest in eight installments over seven years with one installment vesting immediately. The fair value of the awards were equal to the quoted NASDAQ marketclosing price on the vest date. Accounting for Stock-Based Compensation Plan The fair value of stock options granted is estimated on the grant date using a Black-Scholes pricing model. The fair value of restricted shares is equal to thequoted NASDAQ market closing price on the date of grant. The fair value of stock grants is recognized as compensation expense on a straight-line basis overthe vesting period of the grants. Compensation expense is included in compensation, payroll taxes and other employee benefits in the consolidated statementsof income.Assumptions are used in estimating the fair value of stock options granted. The weighted average expected life of the stock options represent the period oftime that the options are expected to be outstanding and is based on the historical results from the previous awards. The risk-free interest rate is based on theU.S. Treasury yield curve in effect at the time of grant. The expected volatility is based on the actual volatility of a peer group including Waterstone Financial,Inc. stock from approximately five years prior to issuance date. The following assumptions were used in estimating the fair value of options granted in the yearsended December 31, 2016 and 2015. 2016 2015 Minimum Maximum Minimum Maximum Dividend Yield 1.46% 2.56% 1.45% 1.57%Risk-free interest rate 1.22% 2.04% 1.60% 1.72%Expected volatility 27.17% 31.47% 28.24% 31.88%Weighted average expected life 4.5 5.5 4.5 5.0 Weighted average per share value of options $2.84 4.52 3.08 3.24 The Company estimates potential forfeitures of stock grants and adjusts compensation expense recorded accordingly. The estimate of forfeitures will beadjusted over the requisite service period to the extent that actual forfeitures differ, or are expected to differ, from such estimates. Changes in estimatedforfeitures will be recognized in the period of change and will also impact the amount of stock compensation expense to be recognized in future periods. - 79 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 A summary of the Company's stock option activity for the years ended December 31, 2016, 2015 and 2014 is presented below.Stock Options Shares WeightedAverageExercise Price WeightedAverageYearsRemaining inContractualTerm AggregateIntrinsic Value(000's) Outstanding December 31, 2013 1,098,947 $12.11 4.18 2,744 Options exercisable at December 31, 2013 870,707 14.23 3.28 636 Granted - - - Exercised (31,624) 1.73 361 Forfeited (96,576) 13.33 (18)Outstanding December 31, 2014 970,747 12.33 3.32 797 Options exercisable at December 31, 2014 824,803 14.16 2.67 (829) Granted 1,210,000 12.79 1,584 Exercised (62,276) 1.90 760 Forfeited (15,424) 13.42 10 Outstanding December 31, 2015 2,103,047 12.90 6.15 2,533 Options exercisable at December 31, 2015 810,255 14.25 1.63 (123) Granted 55,000 15.54 151 Exercised (736,548) 15.04 2,388 Forfeited (59,000) 13.15 303 Outstanding December 31, 2016 1,362,499 11.83 7.74 8,785 Options exercisable at December 31, 2016 304,595 9.66 6.44 2,625 The following table summarizes information about the Company's stock options outstanding at December 31, 2016. OptionsOutstanding WeightedAverageExercise Price RemainingLife(Years) OptionsExercisable WeightedAverageExercise Price RemainingLife(Years) Range of ExercisePrices $0.01 - $5.00 138,811 $2.24 4.68 94,909 $2.45 4.52 $5.01 - $10.00 - - - - - - $10.01 - $15.00 1,194,973 12.82 8.16 195,971 12.73 7.80 Over $15.01 28,715 17.31 5.37 13,715 15.74 0.33 1,362,499 $11.83 7.74 304,595 $9.66 6.44 - 80 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 The following table summarizes information about the Company's nonvested stock option activity for the years ended December 31, 2016 and 2015: Stock Options Shares WeightedAverageGrant Date FairValue Nonvested at December 31, 2014 145,944 $1.32 Granted 1,210,000 3.23 Vested (55,957) 2.20 Forfeited (7,195) 3.19 Nonvested at December 31, 2015 1,292,792 3.09 Nonvested at December 31, 2015 1,292,792 $3.09 Granted 55,000 3.46 Vested (230,888) 2.86 Forfeited (59,000) 3.19 Nonvested at December 31, 2016 1,057,904 3.16 The Company amortizes the expense related to stock options as compensation expense over the vesting period. During the year ended December 31, 2016,55,000 options were granted, 59,000 were forfeited, of which none were vested. During the year ended December 31, 2015, 1,210,000 options were granted,15,424 were forfeited, of which 8,229 were vested. During the year ended December 31, 2014, no options were granted and 96,576 were forfeited, of which 82,297were vested. Expense for the stock options granted of $641,000, $580,000 and $80,000 was recognized during the years ended December 31, 2016, 2015 and 2014,respectively. At December 31, 2016, the Company had $2.8 million in estimated unrecognized compensation costs related to outstanding stock options that isexpected to be recognized over a weighted average period of 59 months.The following table summarizes information about the Company's restricted stock shares activity for the years ended December 31, 2016 and 2015: Restricted Stock Shares WeightedAverageGrant Date FairValue Nonvested at December 31, 2014 49,380 $1.73 Granted 549,500 12.77 Vested (110,559) 11.11 Forfeited - - Nonvested at December 31, 2015 488,321 12.03 Nonvested at December 31, 2015 488,321 12.03 Granted 20,000 14.84 Vested (109,559) 11.17 Forfeited (20,000) 12.75 Nonvested at December 31, 2016 378,762 12.39 The Company amortizes the expense related to restricted stock awards as compensation expense over the vesting period. During the year ended December 31,2016, 20,000 shares of restricted stock were granted and 20,000 shares were forfeited. During the year ended December 31, 2015, 549,500 shares of restrictedstock were granted and no shares were forfeited. Expense for the restricted stock awards of $1.3 million, $2.2 million and $28,000 was recorded for the yearsended December 31, 2016, 2015 and 2014, respectively. At December 31, 2016, the Company had $3.6 million of unrecognized compensation expense related torestricted stock shares that is expected to be recognized over a weighted average period of 42 months.11)Employee Benefit Plans The Company has two 401(k) profit sharing plans and trusts covering substantially all employees. WaterStone Bank employees over 18 years of age areimmediately eligible to participate in the Bank's plan. Waterstone Mortgage employees over 18 years of age are eligible to participate in its plan as of the first ofthe month following their date of employment. Participating employees may annually contribute pretax compensation in accordance with IRS limits. TheCompany made matching contributions of $759,000, $595,000 and $488,000 to the plans during the years ended December 31, 2016, 2015 and 2014 respectively. - 81 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 12)Employee Stock Ownership Plan All employees are eligible to participate in the WaterStone Bank Employee Stock Ownership Plan (the "Plan") after they attain twenty one years of age andcomplete twelve consecutive months of service in which they work at least 1,000 hours of service. The Plan debt is secured by shares of the Company. TheCompany has committed to make annual contributions to the Plan necessary to repay the loan, including interest. During the year ended December 31, 2014, the Plan borrowed an additional $23.8 million from the Company, refinanced the remaining 83,561 shares (related tothe 2005 Plan purchase), and purchased an additional 2,024,000 shares of common stock of the Company in the open market. While the shares are not releasedand allocated to Plan participants until the loan payment is made, the shares are deemed to be earned and are therefore, committed to be released throughoutthe service period. As such, one-twentieth of the total 2,107,561 shares are scheduled to be released annually as shares are earned over a period of twentyyears, beginning with the period ended December 31, 2014. As the debt is repaid, shares are released from collateral and allocated to active participantaccounts. The shares pledged as collateral are reported as "Unearned ESOP shares" in the consolidated statement of financial condition. As shares arecommitted to be released from collateral, the Company reports compensation expense equal to the average fair market price of the shares, and the sharesbecome outstanding for earnings per share computations. Compensation expense attributed to the ESOP was $1.6 million, $1.4 million and $1.2 million,respectively for the years ended December 31, 2016, 2015 and 2014. The aggregate activity in the number of unearned ESOP shares, considering the allocation of those shares committed to be released as of December 31, 2016and 2015 is as follows: 2016 2015 Beginning ESOP shares 1,896,805 2,002,183 Shares committed to be released (105,378) (105,378)Unreleased shares 1,791,427 1,896,805 Fair value of unreleased shares (in millions) $33.0 26.7 13)Income TaxesThe provision for income taxes for the year ended December 31, 2016, 2015 and 2014 consists of the following: Years ended December 31, 2016 2015 2014 (In Thousands) Current: Federal $12,255 8,061 3,158 State 2,643 1,342 301 14,898 9,403 3,459 Deferred: Federal 1,084 (447) 2,578 State 480 293 1,138 1,564 (154) 3,716 Total $16,462 9,249 7,175 - 82 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 The income tax provisions differ from that computed at the Federal statutory corporate tax rate for the years ended December 31, 2016, 2015 and 2014 as follows: Years ended December 31, 2016 2015 2014 (Dollars In Thousands) Income before income taxes $41,994 25,819 19,907 Tax at Federal statutory rate (35%) 14,698 9,037 6,967 Add (deduct) effect of: State income taxes net of Federal income tax benefit 2,030 1,063 936 Cash surrender value of life insurance (619) (496) (451)Non-deductible ESOP and stock option expense 268 181 39 Tax-exempt interest income (529) (552) (514)Non-deductible compensation 254 154 170 Stock option write off 773 - - Stock compensation (517) - - Other 104 (138) 28 Income tax provision 16,462 9,249 7,175 Effective tax rate 39.2% 35.8% 36.0% The significant components of the Company's net deferred tax assets (liabilities) included in prepaid expenses and other assets are as follows at December 31,2016 and 2015: December 31, 2016 2015 Gross deferred tax assets: (In Thousands) Fixed assets $729 765 Compensation agreements 27 96 Restricted stock and stock options 638 1,363 Allowance for loan losses 6,109 6,285 Repurchase reserve for loans sold 183 192 Real estate owned 1,529 1,643 Nonaccrual interest 531 709 Capital loss carryforward 21 441 Unrealized loss on impaired securities 36 45 Other 313 165 Total gross deferred tax assets 10,116 11,704 Gross deferred tax liabilities: Unrealized gain on securities available for sale, net (81) (701)Mortgage servicing rights (894) (575)FHLB stock (303) (728)Deferred loan fees (820) (738)Deferred liabilities (2,098) (2,742)Net deferred tax assets $8,018 8,962 The Company had a Wisconsin net operating loss carry forward of $28,000 at December 31, 2016 which will begin to expire in 2028. The Company has a capitalloss carry forward of $56,000 which will expire if unused as of December 31, 2017. Under the Internal Revenue Code and Wisconsin Statutes, the Company was permitted to deduct, for tax years beginning before 1988, an annual addition to areserve for bad debts. This amount differs from the provision for loan losses recorded for financial accounting purposes. Under prior law, bad debt deductionsfor income tax purposes were included in taxable income of later years only if the bad debt reserves were used for purposes other than to absorb bad debtlosses. Because the Company did not intend to use the reserve for purposes other than to absorb losses, no deferred income taxes were provided. Retainedearnings at December 31, 2016 include approximately $16.7 million for which no deferred Federal or state income taxes were provided. Deferred income taxeshave been provided on certain additions to the tax reserve for bad debts. The Company and its subsidiaries file consolidated federal and combined state tax returns. One subsidiary also files separate state income tax returns in certainstates. The Company is no longer subject to state income tax examinations by certain state tax authorities for years before 2012 or subject to federal taxexaminations for the years before 2014.In the fourth quarter of 2014, the Internal Revenue Service commenced an examination of the Company's federal income tax returns for 2012 through 2013. Theexamination concluded in the fourth quarter 2015 with no findings or adjustments proposed. - 83 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 201414) Offsetting of Assets and LiabilitiesThe Company enters into agreements under which it sells securities subject to an obligation to repurchase the same or similar securities. In addition, theCompany enters into agreements under which it sells loans held for sale subject to an obligation to repurchase the same loans. Under these arrangements,the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company torepurchase the assets. As a result, these repurchase agreements are accounted for as collateralized financing arrangements (i.e., secured borrowings) and notas a sale and subsequent repurchase of assets. The obligation to repurchase the assets is reflected as a liability in the Company's consolidated statements ofcondition, while the securities and loans held for sale underlying the repurchase agreements remain in the respective investment securities and loans held forsale asset accounts. In other words, there is no offsetting or netting of the investment securities or loans held for sale assets with the repurchase agreementliabilities. The Company's repurchase agreements are subject to master netting agreements, which sets forth the rights and obligations for repurchase andoffset. Under the master netting agreement, the Company is entitled to set off the collateral placed with a single counterparty against obligations owed to thatcounterparty.The following table presents the liabilities subject to an enforceable master netting agreement as of December 31, 2016 and December 31, 2015. GrossRecognizedLiabilities Gross AmountsOffset Net AmountsPresented Gross AmountsNot Offset Net Amount (In thousands) December 31, 2016 Repurchase Agreements Short-term $8,155 - 8,155 8,155 - Long-term 84,000 - 84,000 84,000 - $92,155 - 92,155 92,155 - December 31, 2015 Repurchase Agreements Short-term $7,203 - 7,203 7,203 - Long-term 84,000 - 84,000 84,000 - $91,203 - 91,203 91,203 - 15)Commitments, Off-Balance Sheet Arrangements, and Contingent Liabilities 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 and standby letters of credit. Those instruments involve, to varying degrees, elements ofcredit and interest rate risk in excess of the amounts recognized in the consolidated balance sheets. The contract or notional amounts of those instrumentsreflect the extent of involvement the Company has in particular classes of financial instruments. December 31, 2016 2015 (In Thousands) Financial instruments whose contract amounts represent potential credit risk: Commitments to extend credit under first mortgage loans(1) $30,903 10,307 Commitments to extend credit under home equity lines of credit 14,367 14,173 Unused portion of construction loans 21,137 25,545 Unused portion of business lines of credit 15,095 16,392 Standby letters of credit 333 566 (1) Excludes commitments to originate loans held for sale, which are discussed in the following footnoteCommitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitmentsgenerally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expirewithout being drawn upon, the total commitment amounts do not necessarily represent future cash requirements of the Company. The Company evaluates eachcustomer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, isbased on management's credit evaluation of the counter-party. Collateral obtained generally consists of mortgages on the underlying real estate. Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit riskinvolved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company holds mortgages on theunderlying real estate as collateral supporting those commitments for which collateral is deemed necessary. - 84 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 The Company has determined that there are no probable losses related to commitments to extend credit or the standby letters of credit as of December 31, 2016and 2015.In the normal course of business, the Company, or it's subsidiaries are involved in various legal proceedings. In the opinion of management, any liabilityresulting from pending proceedings would not be expected to have a material adverse effect on the Company's consolidated financial statements.Herrington, et al. v. Waterstone Mortgage CorporationWaterstone Mortgage Corporation is a defendant in a lawsuit that was filed in the Federal District Court for the Western District of Wisconsin and has beentransferred to arbitration alleging that Waterstone Mortgage Corporation violated the Fair Labor Standards Act and failed to pay loan officers consistent withtheir various contracts. Waterstone Mortgage Corporation is and will continue to vigorously defend its interests in this matter. 16)Derivative Financial Instruments In connection with its mortgage banking activities, the Company enters into derivative financial instruments as part of its strategy to manage its exposure tochanges in interest rates. Mortgage banking derivatives include interest rate lock commitments provided to customers to fund mortgage loans to be sold in thesecondary market and forward commitments for the future delivery of such loans. It is the Company's practice to enter into forward commitments for the futuredelivery of residential mortgage loans when interest rate lock commitments are entered into in order to economically hedge the effect of future changes ininterest rates on its commitments to fund the loans as well as on its portfolio of mortgage loans held-for-sale. The Company's mortgage banking derivativeshave not been designated as being a hedge relationship. These instruments are used to manage the Company's exposure to interest rate movements and otheridentified risks but do not meet the strict hedge accounting requirements of ASC 815. Changes in the fair value of derivatives not designated in hedgingrelationships are recorded directly in earnings. The Company does not use derivatives for speculative purposes.Forward commitments to sell mortgage loans represent commitments obtained by the Company from a secondary market agency to purchase mortgages fromthe Company at specified interest rates and within specified periods of time. Commitments to sell loans are made to mitigate interest rate risk on interest ratelock commitments to originate loans and loans held for sale. At December 31, 2016, the Company had forward commitments to sell mortgage loans with anaggregate notional amount of $253.1 million and interest rate lock commitments with an aggregate notional amount of approximately $178.0 million. The fairvalue of the forward commitments to sell mortgage loans at December 31, 2016 included a loss of $69,000 that is reported as a component of other liabilities onthe Company's consolidated statement of financial condition. The fair value of the interest rate locks at December 31, 2016 included a gain of $3.4 million that isreported as a component of other assets on the Company's consolidated statements of financial condition.In determining the fair value of its derivative loan commitments, the Company considers the value that would be generated when the loan arising from exerciseof the loan commitment is sold in the secondary mortgage market. That value includes the price that the loan is expected to be sold for in the secondarymortgage market. The fair value of these commitments is recorded on the consolidated statements of financial condition with the changes in fair value recordedas a component of mortgage banking income.Residential mortgage loans sold to others are predominantly conventional residential first lien mortgages. The Company's agreements to sell residentialmortgage loans in the normal course of business usually require certain representations and warranties on the underlying loans sold related to creditinformation, loan documentation and collateral, which if subsequently are untrue or breached, could require the Company to repurchase certain loans affected.The Company has only been required to make insignificant repurchases as a result of breaches of representations and warranties. The Company's agreementsto sell residential mortgage loans also contain limited recourse provisions. The recourse provisions are limited in that the recourse provision ends after certainpayment criteria have been met. With respect to these loans, repurchase could be required if defined delinquency issues arose during the limited recourseperiod. Given that the underlying loans delivered to buyers are predominantly conventional first lien mortgages and that historical experience shows negligiblelosses and insignificant repurchase activity, management believes that losses and repurchases under the limited recourse provisions will continue to beinsignificant. 17)Fair Values Measurements ASC Topic 820, "Fair Value Measurements and Disclosures" defines fair value, establishes a framework for measuring fair value, and expands disclosures aboutfair value measurements. This accounting standard applies to reported balances that are required or permitted to be measured at fair value under existingaccounting pronouncements. The standard also emphasizes that fair value (i.e., the price that would be received in an orderly transaction that is not a forcedliquidation or distressed sale at the measurement date), among other things, is based on exit price versus entry price, should include assumptions about risksuch as nonperformance risk in liability fair values, and is a market-based measurement, not an entity-specific measurement. When considering the assumptionsthat market participants would use in pricing the asset or liability, this accounting standard establishes a fair value hierarchy that distinguishes between marketparticipant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1and 2 of the hierarchy) and the reporting entity's own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of thehierarchy).The fair value hierarchy prioritizes inputs used to measure fair value into three broad levels.Level 1 inputs - In general, fair values determined by Level 1 inputs use quoted prices in active markets for identical assets or liabilities that we have the abilityto access. - 85 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014Level 2 inputs - Fair values determined by Level 2 inputs use inputs other than quoted prices included in Level 1 inputs that are observable for the asset orliability, either directly or indirectly. Level 2 inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similarassets or liabilities in markets where there are few transactions and inputs other than quoted prices that are observable for the asset or liability, such as interestrates and yield curves that are observable at commonly quoted intervals.Level 3 inputs - Level 3 inputs are unobservable inputs for the asset or liability and include situations where there is little, if any, market activity for the asset orliability.In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair valuehierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in itsentirety. The Company's assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considersfactors specific to the asset or liability.The following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a recurring basis asof December 31, 2016 and December 31, 2015, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. Fair Value Measurements Using December 31,2016 Level 1 Level 2 Level 3 (In Thousands) Available for sale securities Mortgage-backed securities $73,413 - 73,413 - Collateralized mortgage obligations Government sponsored enterprise issued 62,002 - 62,002 - Government sponsored enterprise bonds 2,503 - 2,503 - Municipal securities 70,696 - 70,696 - Other debt securities 16,950 2,541 14,409 - Certificates of deposit 1,231 - 1,231 - Loans held for sale 225,248 - 225,248 - Mortgage banking derivative assets 3,403 - - 3,403 Mortgage banking derivative liabilities 69 - - 69 Fair Value Measurements Using December 31,2015 Level 1 Level 2 Level 3 (In Thousands) Available for sale securities Mortgage-backed securities $96,667 - 96,667 - Collateralized mortgage obligations Government sponsored enterprise issued 70,428 - 70,428 - Government sponsored enterprise bonds 3,746 - 3,746 - Municipal securities 79,159 - 79,159 - Other debt securities 16,963 2,600 14,363 - Certificates of deposit 2,695 - 2,695 - Loans held for sale 166,516 - 166,516 - Mortgage banking derivative assets 2,313 - - 2,313 Mortgage banking derivative liabilities 125 - - 125 The following summarizes the valuation techniques for assets recorded in our consolidated statements of financial condition at their fair value on a recurringbasis:Available for sale securities – The Company's investment securities classified as available for sale include: mortgage-backed securities, collateralized mortgageobligations, government sponsored enterprise bonds, municipal securities and other debt securities. The fair value of mortgage-backed securities, collateralizedmortgage obligations and government sponsored enterprise bonds are determined by a third party valuation source using observable market data utilizing amatrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields, reported trades,broker quotes, issuer spreads, benchmark securities, prepayment models and bid/offer market data. For securities with an early redemption feature, an optionadjusted spread model is utilized to adjust the issuer spread. These model and matrix measurements are classified as Level 2 and Level 3 in the fair valuehierarchy. The fair value of municipal securities is determined by a third party valuation source using observable market data utilizing a multi-dimensionalrelational pricing model. Standard inputs to this model include observable market data such as benchmark yields, reported trades, broker quotes, rating updatesand issuer spreads. These model measurements are classified as Level 2 in the fair value hierarchy. The fair value of other debt securities, which includes atrust preferred security issued by a financial institution and corporate bonds. The fair value of the trust preferred security is determined through quoted pricesin active markets and is classified as Level 1 in the fair value hierarchy. The corporate bond is valued by a third party valuation source using observable marketdata utilizing a matrix or multi-dimensional relational pricing model. Standard inputs to these models include observable market data such as benchmark yields,reported trades, broker quotes, issuer spreads, benchmark securities, prepayment models and bid/offer market data. - 86 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014Loans held for sale – The Company carries loans held for sale at fair value under the fair value option model. Fair value is generally determined by estimating agross premium or discount, which is derived from pricing currently observable in the secondary market, principally from observable prices for forward salecommitments. Loans held-for-sale are considered to be Level 2 in the fair value hierarchy of valuation techniques.Mortgage banking derivatives - Mortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individualcustomers and forward commitments to sell residential mortgage loans to various investors. The Company utilizes a valuation model to estimate the fair valueof its interest rate lock commitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historicalexperience and the current interest rate environment and then multiplying by quoted investor prices. The Company also utilizes a valuation model to estimatethe fair value of its forward commitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments againstapplicable investor pricing available. While there are Level 2 and 3 inputs used in the valuation models, the Company has determined that one or more of theinputs significant in the valuation of both of the mortgage banking derivatives fall within Level 3 of the fair value hierarchy.The table below presents reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during 2016 and2015. Mortgagebankingderivatives, net Balance at December 31, 2014 $999 Transfer into level 3 - Mortgage derivative gain, net 1,189 Balance at December 31, 2015 2,188 Transfer into level 3 - Mortgage derivative gain, net 1,146 Balance at December 31, 2016 $3,334 Assets Recorded at Fair Value on a Non-recurring BasisThe following table presents information about our assets recorded in our consolidated statement of financial position at their fair value on a non-recurringbasis as of December 31, 2016 and December 31, 2015, and indicates the fair value hierarchy of the valuation techniques utilized to determine such fair value. Fair Value Measurements Using December 31,2016 Level 1 Level 2 Level 3 (In Thousands) Impaired loans, net (1) $2,814 - - 2,814 Real estate owned 6,118 - - 6,118 Fair Value Measurements Using December 31,2015 Level 1 Level 2 Level 3 (In Thousands) Impaired loans, net (1) $8,024 - - 8,024 Real estate owned 9,190 - - 9,190 _________(1) Represents collateral-dependent impaired loans, net, which are included in loans.Loans – We do not record loans at fair value on a recurring basis. On a non-recurring basis, loans determined to be impaired are analyzed to determinewhether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidated statements of financial condition at net realizable value ofthe underlying collateral. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider disposition costs and also totake into consideration the age of the most recent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate thefair value of impaired loans, loans that have been deemed to be impaired are considered to be Level 3 in the fair value hierarchy of valuation techniques. AtDecember 31, 2016, loans determined to be impaired with an outstanding balance of $3.5 million were carried net of specific reserves of $662,000 for a fairvalue of $2.8 million. At December 31, 2015, loans determined to be impaired with an outstanding balance of $9.6 million were carried net of specific reservesof $1.6 million for a fair value of $8.0 million. Impaired loans collateralized by assets which are valued in excess of the net investment in the loan do notrequire any specific reserves. - 87 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014Real estate owned – On a non-recurring basis, real estate owned, is recorded in our consolidated statements of financial condition at the lower of cost or fairvalue. Fair value is determined based on third party appraisals and, if less than the carrying value of the foreclosed loan, the carrying value of the real estateowned is adjusted to the fair value. Appraised values are adjusted to consider disposition costs and also to take into consideration the age of the mostrecent appraisal. Given the significance of the adjustments made to appraised values necessary to estimate the fair value of the properties, real estate ownedis considered to be Level 3 in the fair value hierarchy of valuation techniques. Changes in the fair value of real estate owned totaled $656,000 and $2.2 millionduring the year ended December 31, 2016 and 2015, respectively and are recorded in real estate owned expense. At December 31, 2016 and December 31, 2015,real estate owned totaled $6.1 million and $9.2 million, respectively. Mortgage servicing rights - The Company utilizes an independent valuation from a third party which uses a discounted cash flow model to estimate the fairvalue of mortgage servicing rights. The model utilizes prepayment assumptions to project cash flows related to the mortgage servicing rights based upon thecurrent interest rate environment, which is then discounted to estimate an expected fair value of the mortgage servicing rights. The model considerscharacteristics specific to the underlying mortgage portfolio, such as: contractually specified servicing fees, prepayment assumptions, delinquency rates, latecharges and costs to service. Given the significance of the unobservable inputs utilized in the estimation process, mortgage servicing rights are classified asLevel 3 within the fair value hierarchy. The Company records the mortgage servicing rights at the lower of amortized cost or fair value. For the purpose ofmeasuring impairment, mortgage servicing rights are stratified based upon predominant risk characteristics of the underlying loans. At December 31, 2016and December 31, 2015, there was no impairment identified for mortgage servicing rights.For Level 3 assets and liabilities measured at fair value on a recurring or non-recurring basis as of December 31, 2016, the significant unobservable inputs usedin the fair value measurements were as follows: Fair Value at Significant Significant Unobservable InputValue December 31,2016 ValuationTechniqueUnobservableInputs MinimumValue MaximumValue Mortgage banking derivatives $3,334 Pricing modelsPull through rate 52.4% 99.9%Impaired loans 2,814 Market approachDiscount rates applied toappraisals 15.0% 35.0%Real estate owned 6,118 Market approachDiscount rates applied toappraisals 9.5% 85.7%Mortgage servicing rights 3,232 Pricing modelsPrepayment rate 6.7% 29.4% Discount rate 10.0% 12.0% Cost to service $76.00 $713.00 ___________ The significant unobservable input used in the fair value measurement of the Company's mortgage banking derivatives, including interest rate lockcommitments, is the loan pull through rate. This represents the percentage of loans currently in a lock position which the Company estimates will ultimatelyclose. Generally, the fair value of an interest rate lock commitment will be positively (negatively) impacted when the prevailing interest rate is lower (higher)than the interest rate lock commitment. Generally, an increase in the pull through rate will result in the fair value of the interest rate lock increasing when in again position, or decreasing when in a loss position. The pull through rate is largely dependent on the loan processing stage that a loan is currently in and thechange in prevailing interest rates from the time of the rate lock. The pull through rate is computed using historical data and the ratio is periodically reviewedby the Company. The significant unobservable inputs used in the fair value measurement of collateral for collateral-dependent impaired loans and real estate owned included inthe above table primarily relate to discounting criteria applied to independent appraisals received with respect to the collateral. Discounts applied to theappraisals are dependent on the vintage of the appraisal as well as the marketability of the property. The discount factor is computed using actual realizationrates on properties that have been foreclosed upon and liquidated in the open market.The significant unobservable inputs used in the fair value measurement or mortgage servicing rights include the prepayment rate, discount rate and cost toservice. The prepayment rate represents the assumed rate of prepayment of the outstanding principal balance of the underlying mortgage notes. Significantincreases (decreases) in any of those inputs in isolation could result in a significantly lower (higher) fair value measurement. Although the prepayment rate anddiscount rate are not directly interrelated, they will generally move in opposite directions. Fair value information about financial instruments follows, whether or not recognized in the consolidated statements of financial condition, for which it ispracticable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or othervaluation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Inthat regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized inimmediate settlement of the instrument. Certain financial instruments and all nonfinancial instruments are excluded from its disclosure requirements.Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. - 88 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 The carrying amounts and fair values of the Company's financial instruments consist of the following at December 31, 2016 and December 31, 2015: December 31, 2016 December 31, 2015 Carryingamount Fair Value Carryingamount Fair Value Total Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 (In Thousands) Financial Assets Cash and cash equivalents $47,217 47,217 34,967 12,250 - 100,471 100,471 100,471 - - Securities available-for-sale 226,795 226,795 2,541 224,254 - 269,658 269,658 2,600 267,058 - Loans held for sale 225,248 225,248 - 225,248 - 166,516 166,516 - 166,516 - Loans receivable 1,177,884 1,212,967 - - 1,212,967 1,114,934 1,165,370 - - 1,165,370 FHLB stock 13,275 13,275 - 13,275 - 19,500 19,500 - 19,500 - Accrued interest receivable 4,281 4,281 4,281 - - 4,108 4,108 4,108 - - Mortgage servicing rights 2,260 3,232 - - 3,232 1,422 1,658 - - 1,658 Mortgage banking derivativeassets 3,403 3,403 - - 3,403 2,313 2,313 - - 2,313 Financial Liabilities Deposits 949,411 949,825 282,827 666,998 - 893,361 894,015 243,304 650,711 - Advance payments byborrowers for taxes 4,716 4,716 4,716 - - 3,661 3,661 3,661 - - Borrowings 387,155 390,932 - 390,932 - 441,203 463,238 - 463,238 - Accrued interest payable 916 916 916 - - 1,642 1,642 1,642 - - Mortgage banking derivativeliabilities 69 69 - - 69 125 125 - - 125 The following methods and assumptions were used by the Company in determining its fair value disclosures for financial instruments.Cash and Cash Equivalents The carrying amount reported in the consolidated statements of financial condition for cash and cash equivalents is a reasonable estimate of fair value for theseshort-term instruments.Securities The fair value of securities is determined by a third party valuation source using observable market data utilizing a matrix or multi-dimensional relational pricingmodel. Standard inputs to these models include observable market data such as benchmark yields, reported trades, broker quotes, issuer spreads, benchmarksecurities and bid/offer market data. For securities with an early redemption feature, an option adjusted spread model is utilized to adjust the issuerspread. Prepayment models are used for mortgage related securities with prepayment features.Loans Held for Sale Fair value is estimated using the prices of the Company's existing commitments to sell such loans and/or the quoted market price for commitments to sell similarloans. Loans Receivable Loans determined to be impaired are analyzed to determine whether a collateral shortfall exists, and if such a shortfall exists, are recorded on our consolidatedstatements of financial condition at fair value. Fair value is determined based on third party appraisals. Appraised values are adjusted to consider dispositioncosts and also to take into consideration the age of the most recent appraisal. With respect to loans that are not considered to be impaired, fair value isestimated by discounting the future contractual cash flows using discount rates that that reflect a current rate offered to borrowers of similar credit standing forthe remaining term to maturity. This method of estimating fair value does not incorporate the exit-price concept of fair value prescribed by ASC 820-10 andgenerally produces a higher fair value. - 89 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014FHLB Stock For FHLB stock, the carrying amount is the amount at which shares can be redeemed with the FHLB and is a reasonable estimate of fair value. Deposits and Advance Payments by Borrowers for Taxes The fair values for interest-bearing and noninterest-bearing negotiable order of withdrawal accounts, savings accounts, and money market accounts are, bydefinition, equal to the amount payable on demand at the reporting date (i.e., their carrying amounts). The fair values for fixed-rate certificates of deposit areestimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates of similar remaining maturities to a scheduleof aggregated expected monthly maturities of the outstanding certificates of deposit. The advance payments by borrowers for taxes are equal to their carryingamounts at the reporting date. Borrowings Fair values for borrowings are estimated using a discounted cash flow calculation that applies current interest rates to estimated future cash flows of theborrowings.Accrued Interest Payable and Accrued Interest Receivable For accrued interest payable and accrued interest receivable, the carrying amount is a reasonable estimate of fair value. Mortgage Banking Derivative Assets and LiabilitiesMortgage banking derivatives include interest rate lock commitments to originate residential loans held for sale to individual customers and forwardcommitments to sell residential mortgage loans to various investors. The Company relies on a valuation model to estimate the fair value of its interest rate lockcommitments to originate residential mortgage loans held for sale, which includes applying a pull through rate based upon historical experience and the currentinterest rate environment, and then multiplying by quoted investor prices. The Company also relies on a valuation model to estimate the fair value of its forwardcommitments to sell residential loans, which includes matching specific terms and maturities of the forward commitments against applicable investor pricingavailable. On the Company's Consolidated Statements of Condition, instruments that have a positive fair value are included in prepaid expenses and otherassets, and those instruments that have a negative fair value are included in other liabilities. 18)Earnings Per Share Earnings per share are computed using the two-class method. Basic earnings per share is computed by dividing net income allocated to common shares by theweighted average number of common shares outstanding during the applicable period, excluding outstanding participating securities. Participating securitiesinclude unvested restricted stock awards. Unvested restricted stock awards issued in 2012 are considered participating securities because holders of thesesecurities have the right to receive dividends at the same rate as holders of the Company's common stock. Diluted earnings per share is computed by dividingnet income by the weighted average number of common shares outstanding adjusted for the dilutive effect of all potential common shares. For the year ended December 31, 2016 2015 2014 (In Thousands, except per share amounts) Net income 25,532 16,570 12,732 Net income available to unvested restricted stockholders 15 19 19 Net income available to common stockholders $25,517 16,551 12,713 Weighted average shares outstanding 27,037 29,161 33,406 Effect of dilutive potential common shares 337 270 237 Diluted weighted average shares outstanding 27,374 29,431 33,643 Basic income per share $0.94 0.57 0.38 Diluted income per share $0.93 0.56 0.38 - 90 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 19)Condensed Parent Company Only Statements Statements of Financial Condition December 31, 2016 2015 (In Thousands) Assets Cash and cash equivalents $37,989 30,833 Securities available for sale (at fair value) 2,541 2,600 Investment in subsidiaries 373,705 359,191 Other assets 170 904 Total Assets $414,405 393,528 Liabilities and shareholders' equity Liabilities: Other liabilities 3,715 1,598 Shareholders' equity Preferred Stock (par value $.01 per share), Authorized - 50,000,000 shares in 2016 and 2015, no shares issued - - Common stock (par value $.01 per share), Authorized - 100,000,000 shares in 2016 and in 2015, Issued - 29,430,123 in 2016and 29,407,455 in 2015, Outstanding - 29,430,123 in 2016 and 29,407,455 in 2015 294 294 Additional paid-in-capital 322,934 317,022 Retained earnings 184,565 168,089 Unearned ESOP shares (20,178) (21,365)Cost of shares repurchased (5,908,150 in 2016 and 5,624,415 in 2015), at cost (76,547) (72,692)Accumulated other comprehensive (loss) income (net of taxes) (378) 582 Total shareholders' equity 410,690 391,930 Total liabilities and shareholders' equity $414,405 393,528 Statements of Operations For the year ended December 31, 2016 2015 2014 (In Thousands) Interest income $716 770 1,078 Equity in income of subsidiaries 26,309 16,513 12,431 Total income 27,025 17,283 13,509 Compensation - - 52 Professional fees 34 24 2 Other expense 553 586 370 Total expense 587 610 424 Income before income tax expense 26,438 16,673 13,085 Income tax expense 906 103 353 Net income $25,532 16,570 12,732 - 91 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 Statements of Cash Flows For the year ended December 31, 2016 2015 2014 (In Thousands) Cash flows from operating activities Net income $25,532 16,570 12,732 Adjustments to reconcile net income to net cash provided by operating activities: Amortization of unearned ESOP 1,633 1,385 1,217 Stock based compensation 1,913 2,817 109 Deferred income taxes 854 49 80 Equity in earnings of subsidiaries (26,309) (16,513) (12,431)Change in other assets and liabilities (2,031) (1,286) 599 Net cash provided by operating activities 1,592 3,022 2,306 Cash flows used in investing activities: Capital contributions to subsidiary - - (124,211)Call of debt securities - - 2,609 Net cash used in investing activities - - (121,602) Dividends received from subsidiary 12,783 4,678 - Cash dividends on common stock (6,917) (5,869) (5,003)Financing for purchase of ESOP shares - - (22,884)Proceeds from stock option exercises 3,556 113 49 Proceeds/refunds from stock offering - - 248,422 Purchase of common stock returned to authorized but unissued (3,858) (72,748) - Net cash provided by (used in) financing activities 5,564 (73,826) 220,584 Net increase (decrease) in cash 7,156 (70,804) 101,288 Cash and cash equivalents at beginning of year 30,833 101,637 349 Cash and cash equivalents at end of year $37,989 30,833 101,637 - 92 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 20)Segment Reporting Selected financial and descriptive information is required to be provided about reportable operating segments, considering a "management approach" concept asthe basis for identifying reportable segments. The management approach is based on the way that management organizes the segments within the enterprise formaking operating decisions, allocating resources, and assessing performance. Consequently, the segments are evident from the structure of the enterprise'sinternal organization, focusing on financial information that an enterprise's chief operating decision-makers use to make decisions about the enterprise's operatingmatters.The Company has determined that it has two reportable segments: community banking and mortgage banking. The Company's operating segments are presentedbased on its management structure and management accounting practices. The structure and practices are specific to the Company and therefore, the financialresults of the Company's business segments are not necessarily comparable with similar information for other financial institutions.Community BankingThe Community Banking segment provides consumer and business banking products and services to customers primarily within Southeastern Wisconsin alongwith a loan production office in Minneapolis, Minnesota. Within this segment, the following products and services are provided: (1) lending solutions such asresidential mortgages, home equity loans and lines of credit, personal and installment loans, real estate financing, business loans, and business lines of credit; (2)deposit and transactional solutions such as checking, credit, debit and pre-paid cards, online banking and bill pay, and money transfer services; (3) investablefunds solutions such as savings, money market deposit accounts, IRA accounts, certificates of deposit, and (4) fixed and variable annuities, insurance as well astrust and investment management accounts.Consumer products include loan and deposit products: mortgage, home equity loans and lines, personal term loans, demand deposit accounts, interest bearingtransaction accounts and time deposits. Consumer products also include personal investment services. Business banking products include secured andunsecured lines and term loans for working capital, inventory and general corporate use, commercial real estate construction loans, demand deposit accounts,interest bearing transaction accounts and time deposits.Mortgage BankingThe Mortgage Banking segment provides residential mortgage loans for the primary purpose of sale in the secondary market. Mortgage banking products andservices are provided by offices in 22 states. As of or for the Year ended December 31, 2016 CommunityBanking MortgageBanking HoldingCompany andOther Consolidated (in thousands) Net interest income $42,940 216 288 43,444 Provision for loan losses 200 180 - 380 Net interest income after provision for loan losses 42,740 36 288 43,064 Noninterest income 4,619 122,842 (1,096) 126,365 Noninterest expenses: Compensation, payroll taxes, and other employee benefits 17,192 78,288 (424) 95,056 Occupancy, office furniture, and equipment 3,165 6,182 - 9,347 FDIC insurance premiums 615 - - 615 Real estate owned 399 - - 399 Other 4,979 17,549 (510) 22,018 Total noninterest expenses 26,350 102,019 (934) 127,435 Income before income taxes 21,009 20,859 126 41,994 Income taxes 7,006 8,550 906 16,462 Net income $14,003 12,309 (780) 25,532 Total Assets $1,794,697 252,864 (256,942) 1,790,619 - 93 -Waterstone Financial, Inc. and SubsidiariesNotes to Consolidated Financial StatementsYears ended December 31, 2016, 2015 and 2014 As of or for the Year ended December 31, 2015 CommunityBanking MortgageBanking HoldingCompany andOther Consolidated (in thousands) Net interest income $37,735 759 350 38,844 Provision for loan losses 1,600 365 - 1,965 Net interest income after provision for loan losses 36,135 394 350 36,879 Noninterest income 3,493 101,499 (518) 104,474 Noninterest expenses: Compensation, payroll taxes, and other employee benefits 16,462 65,712 (421) 81,753 Occupancy, office furniture and equipment 3,278 6,009 - 9,287 FDIC insurance premiums 1,058 - - 1,058 Real estate owned 2,649 15 - 2,664 Other 4,512 16,169 91 20,772 Total noninterest expenses 27,959 87,905 (330) 115,534 Income before income taxes 11,669 13,988 162 25,819 Income taxes 3,419 5,727 103 9,249 Net income $8,250 8,261 59 16,570 Total Assets $1,729,582 188,324 (155,177) 1,762,729 As of or for the Year ended December 31, 2014 CommunityBanking MortgageBanking HoldingCompany andOther Consolidated (in thousands) Net interest income $39,591 1,051 665 41,307 Provision for loan losses 750 400 - 1,150 Net interest income after provision for loan losses 38,841 651 665 40,157 Noninterest income 3,264 81,710 (406) 84,568 Noninterest expenses: Compensation, payroll taxes, and other employee benefits 14,915 54,626 (369) 69,172 Occupancy, office furniture and equipment 3,350 7,019 - 10,369 FDIC insurance premiums 1,395 - - 1,395 Real estate owned 2,473 9 - 2,482 Other 4,819 16,616 (35) 21,400 Total noninterest expenses 26,952 78,270 (404) 104,818 Income before income taxes 15,153 4,091 663 19,907 Income taxes 5,173 1,649 353 7,175 Net income $9,980 2,442 310 12,732 Total Assets $1,758,707 145,980 (121,307) 1,783,380 - 94 - Item 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNoneItem 9A. Controls and ProceduresDisclosure Controls and Procedures: Waterstone Financial, Inc. management, with the participation of Waterstone Financial, Inc.'s Chief Executive Officer and ChiefFinancial Officer, has evaluated the effectiveness of Waterstone Financial, Inc.'s disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the end of the period covered by this report. Based on such evaluation,Waterstone Financial, Inc.'s Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of such period, Waterstone Financial, Inc.'sdisclosure controls and procedures are effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed byWaterstone Financial, Inc. in the reports that it files or submits under the Exchange Act.Change in Internal Control Over Financial Reporting: There have not been any changes in Waterstone Financial, Inc.'s internal control over financial reporting (assuch term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the final fiscal quarter of the period to which this report relates that havematerially affected, or are reasonably likely to materially affect, Waterstone Financial, Inc.'s internal control over financial reporting.Management's Annual Report on Internal Control Over Financial ReportingManagement of Waterstone Financial Inc. (the "Company") is responsible for establishing and maintaining adequate internal control over financial reporting. TheCompany's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of the Company's financial statements for external purposes in accordance with generally accepted accounting principles. Internal control over financialreporting is defined in Rules 13a-15(f) and 15d-15(f) promulgated under the Securities Exchange Act of 1934, as amended (the "Exchange Act").As of December 31, 2016, management assessed the effectiveness of the Company's internal control over financial reporting based on criteria for effective internalcontrol over financial reporting established in "Internal Control—Integrated Framework," issued by the Committee of Sponsoring Organization of the TreadwayCommission (COSO) in 2013. Based on this assessment, management has determined that the Company's internal control over financial reporting as of December 31,2016 is effective.RSM US LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report onForm 10-K, has issued a report on the effectiveness of the Company's internal control over financial reporting as of December 31, 2016. The report, which expresses anunqualified opinion on the effectiveness of the Company's internal control over financial reporting as of December 31, 2016, is included below under the heading"Report of Independent Registered Public Accounting Firm." - 95 - REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMTo the Board of Directors and ShareholdersWaterstone Financial, Inc. We have audited Waterstone Financial, Inc. and Subsidiaries' internal control over financial reporting as of December 31, 2016, based on criteria established in InternalControl — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 2013. Waterstone Financial, Inc. andSubsidiaries' management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting included in the accompanying Management's Annual Report on Internal Control over Financial Reporting. Our responsibility is toexpress an opinion on the Company's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we planand perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our auditincluded obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating thedesign and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considerednecessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and thepreparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financialreporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactionsand dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financialstatements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance withauthorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorizedacquisition, use or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance withthe policies or procedures may deteriorate. In our opinion, Waterstone Financial, Inc. and Subsidiaries' maintained, in all material respects, effective internal control over financial reporting as of December 31,2016, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commissionin 2013. We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements ofWaterstone Financial, Inc. and Subsidiaries and our report dated March 3, 2017 expressed an unqualified opinion. /s/ RSM US LLP Milwaukee, Wisconsin March 3, 2017 - 96 -Item 9B. Other Information.NonePart IIIItem 10. Directors, Executive Officers and Corporate GovernanceThe information in the Company's definitive Proxy Statement, prepared for the 2017 Annual Meeting of Shareholders, which contains information concerningdirectors of the Company under the caption "Proposal 1 - Election of Directors" and compliance with Section 16 reporting requirements under the caption "Section16(a) Beneficial Ownership Reporting Compliance" continued below and information concerning corporate governance under the caption "Other Board and CorporateGovernance Matters" and "Board Meetings and Committees" in Part I hereof is incorporated herein by reference.Executive Officers of the RegistrantThe table below sets forth certain information regarding the persons who have been determined, by our board of directors, to be executive officers of theCompany. The executive officers of the Company are elected annually and hold office until their respective successors have been elected or until death, resignation,retirement or removal by the Board of directors. Name and Age Offices and Positions with Waterstone Financial and Subsidiaries* ExecutiveOfficerSinceDouglas S. Gordon, 59 Chief Executive Officer and President of Waterstone Financial and of WaterStone Bank 2005William F. Bruss, 47 General Counsel, Executive Vice President and Secretary of Waterstone Financial and of WaterStone Bank 2005Mark R. Gerke, 42 Chief Financial Officer and Vice President of Waterstone Financial and of WaterStone Bank 2016Rebecca M. Arndt, 49 Senior Vice President – Retail Operations of WaterStone Bank 2006Eric J. Egenhoefer, 41 President of Waterstone Mortgage Corporation 2008Kevin P. Gillespie, 59 Chief Operating Officer of Waterstone Mortgage Corporation 2014*Excluding directorships and excluding positions with Bank subsidiary that do not constitute a substantial part of the officers' duties.Item 11. Executive CompensationThe information in the Company's definitive Proxy Statement, prepared for the 2017 Annual Meeting of Shareholders, which contains information concerningthis item under the captions "Executive Compensation," "Director Compensation," "Compensation Committee Interlocks and Insider Participation," "CompensationDiscussion and Analysis," and "Compensation Committee Report" is incorporated herein by reference. Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersThe information in the Company's definitive Proxy Statement, prepared for the 2017 Annual Meeting of Shareholders, which contains information concerningthis item under the caption "Beneficial Ownership of Common Stock" is incorporated herein by reference.Compensation PlansSet forth below is information as of December 31, 2016 regarding equity compensation plans that have been approved by shareholders. The Company has noequity based benefit plans, other than its employee stock ownership plan, that were not approved by shareholders.Plan Number ofshares to beissued uponexercise ofoutstandingoptions andrights Weightedaverage optionexercise price Number ofsecuritiesremainingavailable forissuance underplan 2006 Equity Incentive Plan 1,362,496(1) $4.01 277,197 2015 Equity Incentive Plan 1,750,500(2) $12.90 1,791,500 __________(1)Consists of 996,335 shares reserved for grants of stock options and 366,161 shares reserved for grants of restricted stock. On December 31, 2016, 163,499 optionswere outstanding with a weighted average exercise price of $4.01 of which 119,597 were exercisable as of that date.(2)Consists of 1,201,000 shares reserved for grants of stock options and 549,500 shares reserved for grants of restricted stock. On December 31, 2016, 1,199,000options were outstanding with a weighted average exercise price of $12.90 of which 184,998 were exercisable as of that date.- 97 -Item 13. Certain Relationships and Related Transactions and Director IndependenceThe information in the Company's definitive Proxy Statement, prepared for the 2017 Annual Meeting of Shareholders, which contains information concerningthis item under the captions "Transactions with Certain Related Parties" and "Board Meetings and Committees" is incorporated herein by reference.Item 14. Principal Accountant Fees and ServicesThe information in the Company's definitive Proxy Statement, prepared for the 2017 Annual Meeting of Shareholders, which contains information concerningthis item under the caption "Proposal 3 - Ratification of the Appointment of Our Independent Registered Public Accounting Firm," is incorporated herein by reference. Part IVPart IVItem 15. Exhibits and Financial Statement Schedules(a)Documents filed as part of the Report:1. and 2. Financial Statements and Financial Statement Schedules.The following consolidated financial statements of Waterstone Financial, Inc. and subsidiaries are filed as part of this report under Item 8, "Financial Statements andSupplementary Data":Report of RSM US LLP, Independent Registered Public Accounting Firm, on consolidated financial statements.Consolidated Statements of Financial Condition – December 31, 2016 and 2015.Consolidated Statements of Operations – Years ended December 31, 2016, 2015 and 2014.Consolidated Statements of Comprehensive Income – Years ended December 31, 2016, 2015 and 2014.Consolidated Statements of Changes in Shareholders' Equity – Years ended December 31, 2016, 2015 and 2014.Consolidated Statements of Cash Flows – Years ended December 31, 2016, 2015 and 2014.Notes to Consolidated Financial Statements. All schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the relatedinstructions or are inapplicable, and therefore have been omitted.(b). Exhibits. See Exhibit Index following the signature page of this report, which is incorporated herein by reference. Each management contract orcompensatory plan or arrangement required to be filed as an exhibit to this report is identified in the Exhibit Index by an asterisk following its exhibit number. - 98 - Item 16. Form 10-K SummaryNot applicable.SIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized. WATERSTONE FINANCIAL, INC.March 3, 2017 By:/s/Douglas S. Gordon Douglas S. Gordon Chief Executive OfficerPOWER OF ATTORNEYEach person whose signature appears below hereby authorizes Douglas S. Gordon, Mark R. Gerke, and William F. Bruss, or any of them, as attorneys-in-fact withfull power of substitution, to execute in the name and on behalf of such person, individually, and in each capacity stated below or otherwise, and to file, any and allamendments to this report.Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and inthe capacities indicated.*Signature and Title/s/Douglas S. Gordon /s/Patrick S. LawtonDouglas S. Gordon, Patrick S. Lawton, Chairman and DirectorChief Executive Officer and Director (Principal Executive Officer) /s/Mark R. Gerke /s/Ellen S. BartelMark R. Gerke Ellen S. Bartel, DirectorChief Financial Officer /s/William F. Bruss /s/Thomas E. DalumWilliam F. Bruss Thomas E Dalum, DirectorChief Operating Officer /s/Michael L. Hansen Michael L. Hansen, Director /s/Kristine A. Rappé Kristine A. Rappé, Director /s/Stephen J. Schmidt Stephen J. Schmidt, Director*Each of the above signatures is affixed as of March 3, 2017. - 99 -WATERSTONE FINANCIAL, INC("Waterstone Financial" or the "Company")Commission File No. 000-51507EXHIBIT INDEXTO2016 REPORT ON FORM 10-KThe following exhibits are filed with, or incorporated by reference in, this Annual Report on Form 10-K for the year ended December 31, 2016: ExhibitDescriptionIncorporated HereinBy Reference ToFiledHerewith 3.1Articles of Incorporation of the Company (2) 3.2Bylaws of the Company (2) 10.1Wauwatosa Holdings, Inc 2006 Equity Incentive Plan †(1) 10.2Employment Agreement By and Between Waterstone Mortgage Corporation and EricJ. Egenhoefer †(2) 10.3Bonus Description for President of Waterstone Mortgage Corporation †(2) 10.4Waterstone Financial, Inc. 2015 Equity Incentive Plan †(3) 10.5Employment Agreement By and Between WaterStone Bank SSB and Douglas S.Gordon †(4) 11.1Statement re: Computation of Per Share EarningsSee Note 18 in Part II Item 8 21.1List of Subsidiaries X 23.1Consent of Independent Registered Public Accounting Firm X 24.1Powers of AttorneySignature Page 31.1Sarbanes-Oxley Act Section 302 Certification signed by the Chief Executive Officer ofWaterstone Financial X 31.2Sarbanes-Oxley Act Section 302 Certification signed by the Chief Financial Officer ofWaterstone Financial X 32.1Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002 signed by the Chief Executive Officer of WaterstoneFinancial X 32.2Certification pursuant to 18 U.S. C. Section 1350, as adopted pursuant to Section 906of the Sarbanes-Oxley Act of 2002 signed by the Chief Financial Officer of WaterstoneFinancial X† Management compensation contract or agreement(1) Incorporated by reference to Appendix A to the Definitive Proxy Statement for the 2006 Annual Meeting of Shareholders filed by Wauwatosa Holdings, Inc (thepredecessor corporation to Waterstone Financial, Inc., a federal corporation) (Commission file no. 000-51507), filed with the U.S. Securities and Exchange Commissionon March 27, 2006.(2) Incorporated by reference to the registration Statement on Form S-1 (Registration No. 333-189160), initially filed with the U.S. Securities and Exchange Commissionon June 7, 2013.(3) Incorporated by reference to Appendix A to the proxy statement for the Special Meeting of Shareholders filed with the Securities and Exchange Commission onJanuary 23, 2015 (File No. 001-36271).(4) Incorporated by reference to Exhibit 10.1 to Report on Form 8-K filed with the U.S. Securities and Exchange Commission on October 24, 2014 (File No. 001-36271). - 100 -Exhibit 21.1The following table sets forth the name and jurisdiction of incorporation/charter of the Company's subsidiaries as of December 31, 2016. Inactive subsidiariesare not listed. All of the subsidiaries are 100% owned.Name of SubsidiaryJurisdiction of Incorporation/Charter WaterStone Bank, SSB (1)WisconsinWauwatosa Investments, Inc. (2)NevadaWaterstone Mortgage Corporation (2)WisconsinMain Street Real Estate Holdings, LLC (2)Wisconsin____________(1) Direct subsidiary of Waterstone Financial, Inc.(2) Direct subsidiary of WaterStone Bank Exhibit 23.1Consent of Independent Registered Public Accounting Firm To the Board of DirectorsWaterstone Financial, Inc. We consent to the incorporation by reference in the registration statements on Form S-8 (nos. 333-202566 and 333-194502) of Waterstone Financial, Inc. of our reportsdated March 3, 2017, relating to our audits of the consolidated financial statements and internal control over financial reporting, which appear in this Annual Reporton Form 10-K of Waterstone Financial, Inc. for the year ended December 31, 2016. /s/ RSM US LLP Milwaukee, Wisconsin March 3, 2017 Exhibit 31.1CERTIFICATIONI, Douglas S. Gordon, certify that:1. I have reviewed this annual report on Form 10-K for the year ended December 31, 2016 of Waterstone Financial, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made,in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, toprovide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes inaccordance with generally accepted accounting principles;c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness ofthe disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscalquarter (the registrant's fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant's internal control over financial reporting; and5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant'sauditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the registrant's ability to record, process, summarize and report financial information; andb) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control overfinancial reporting.Date: March 3, 2017/s/ Douglas S. GordonDouglas S. GordonChief Executive OfficerExhibit 31.2CERTIFICATIONI, Mark R. Gerke, certify that:1. I have reviewed this annual report on Form 10-K for the year ended December 31, 2016 of Waterstone Financial, Inc.;2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made,in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition,results of operations and cash flows of the registrant as of, and for, the periods presented in this report;4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) for the registrant and have:a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensurethat material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this report is being prepared;b)Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, toprovide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles;c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness ofthe disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscalquarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, theregistrant's internal control over financial reporting; and5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant'sauditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely toadversely affect the registrant's ability to record, process, summarize and report financial information; andb) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control overfinancial reporting.Date: March 3, 2017/s/ Mark R. GerkeMark R. GerkeChief Financial OfficerExhibit 32.1CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Waterstone Financial, Inc. (the "Company") on Form 10-K for the year ended December 31, 2016, as filed with theSecurities and Exchange Commission on the date hereof (the "Report"), I, Douglas S. Gordon, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C.§1350, as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company./s/ Douglas S. Gordon Douglas S. GordonChief Executive OfficerMarch 3, 2017Exhibit 32.2CERTIFICATION PURSUANT TO18 U.S.C. SECTION 1350,AS ADOPTED PURSUANT TOSECTION 906 OF THE SARBANES-OXLEY ACT OF 2002In connection with the Annual Report of Waterstone Financial, Inc. (the "Company") on Form 10-K for the year ended December 31, 2016 as filed with theSecurities and Exchange Commission on the date hereof (the "Report"), I, Mark R. Gerke, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. §1350,as adopted pursuant to §906 of the Sarbanes-Oxley Act of 2002, that to the best of my knowledge:(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company./s/ Mark R. GerkeMark R. GerkeChief Financial OfficerMarch 3, 2017

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